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State Farm Mutual Automobile Insurance Co. v. State

Decided: May 16, 1991.


On certification to the Superior Court, Chancery Division.

Handler, J. Chief Justice Wilentz and Justices Clifford, Pollock, O'Hern, and Stein join in this opinion. Justice Garibaldi has filed a separate concurring opinion.


This appeal arises from three actions filed by automobile insurance companies in the Superior Court, Chancery Division, all challenging the facial constitutionality of the Fair Automobile Insurance Reform Act of 1990, L. 1990, c. 8 (the Reform Act or the Act). State Farm Mutual Automobile Insurance Company (State Farm) and Liberty Mutual Insurance Company (Liberty Mutual) contend that certain surtaxes and assessments imposed by the Reform Act deny insurers any possibility of a reasonable rate of return and are a taking without just compensation and a violation of due process. Allstate Insurance Company (Allstate), as well as State Farm and Liberty Mutual, claims that the Act is an impairment of contracts because it compels insurers to pay the accumulated debt attributable to the State's prior system for insuring high-risk drivers. Other constitutional claims are that the Act is intentional punitive legislation against insurance companies; that the surtaxes and assessments exact an extraterritorial tax because a mutual insurer's New Jersey business will operate at a loss and revenues from operations in other states will subsidize New Jersey rates; that the Act's "producer assignment program" violates

due process because it compels insurers either to accept liabilities they did not incur, or to forfeit their right to do business in New Jersey; and that the Act's requirements that rates in New Jersey be based on an insurer's nationwide profitability violate the Commerce Clause of the United States Constitution.

On May 8, 1990, State Farm filed its complaint in the Chancery Division, Mercer County. Allstate and Liberty Mutual began their challenges in federal rather than state court; however, both federal actions were dismissed on jurisdictional grounds. Allstate and Liberty Mutual then filed actions in the Chancery Division in July and November 1990, respectively.

In what has become the main action on appeal, State Farm Mutual Automobile Insurance Company v. State, State Farm moved for a preliminary injunction, requesting relief from payments to be made to the State under the Act. In deciding that motion, the court focused on the issues of impairment of contracts and taking without just compensation. The court determined that the two questions were interrelated, in that State Farm would have to prove it was precluded from earning a fair rate of return to show that its contractual expectations had been substantially impaired. The court concluded that the Act's provisions for collecting payments from insurers to cover obligations arising under the prior system of automobile insurance regulation is a valid regulatory scheme, as long as it does not result in losses that would be an unconstitutional taking or a violation of due process. Examining in detail the Reform Act's provisions for additional surtaxes and assessments on insurers, the court also determined that while the Act, on its face, prohibited any form of offsetting rate relief for the surtaxes, it did not necessarily prohibit rate relief for the assessments. The court ruled that State Farm was entitled to a hearing to determine whether it could obtain a fair rate of return through rate-increase applications notwithstanding the exclusion of the surtax from the expense base in a rate filing. The court also granted a preliminary injunction, authorizing

State Farm to make its statutory payments into court rather than to the State.

The State immediately moved before the Appellate Division for leave to appeal and for a stay of the Chancery Division's preliminary injunction. The stay was granted and on the following day State Farm applied to this Court to vacate the Appellate Division's stay. That application was denied, leaving the stay in effect. In July, the Appellate Division granted the State's motion for leave to appeal. Thereafter Allstate, then proceeding in the Chancery Division after its federal court action had been dismissed, successfully moved before the Appellate Division to intervene in the State Farm appeal.

State Farm then filed a motion for direct certification, which this Court granted in November 1990. While that motion was pending, Liberty Mutual, which, like Allstate, had had its federal court complaint dismissed without prejudice, simultaneously filed a complaint in the Chancery Division and successfully moved before this Court to intervene in the State Farm appeal. Thus, the claims of the insurers are pursued here by plaintiff State Farm and intervenors Allstate and Liberty Mutual; in addition, the American Insurance Association has participated as an amicus throughout the State Farm litigation.


For years, New Jersey's system of automobile insurance regulation, like those of many other states, has faced an intractable problem of providing coverage for high-risk drivers. Prior to 1983, drivers who could not obtain coverage directly from insurers in the voluntary market were insured through an Assigned Risk Plan (N.J.S.A. 17:29D-1), under which the Commissioner of Insurance apportioned high-risk drivers among all auto insurers doing business in New Jersey. In 1983, the Automobile Full Insurance Availability Act, N.J.S.A. 17:30E-1 through -24, replaced the assigned-risk system with the New Jersey Automobile Full Insurance Underwriting Association,

commonly known as the Joint Underwriting Association or JUA.

All insurers licensed to write automobile insurance in New Jersey were required to be members of the JUA. The objective of the new scheme was to create a more extensive system of allocating high-risk drivers to carriers, and through the JUA, to provide such drivers with coverage at rates equivalent to those charged in the voluntary market. Originally, the JUA was governed by a board of directors, a majority of whom were representatives of insurers and insurance producers (i.e., agents and brokers). The board was to adopt a Plan of Operation to carry out the JUA's objectives. Even though the board had primary responsibility for management of the JUA, the Commissioner retained plenary powers to veto actions of the board or to countermand board decisions that might not be consonant with the State's regulatory scheme.

The JUA, a good deal more complex than the prior Assigned Risk Plan, worked as follows. Insurers (and subsequently certain qualified non-insurer entities) could apply to become "servicing carriers," which would bear administrative responsibility for collecting premiums, arranging coverage, and the like, and which would receive fees for such services from the JUA. However, the statute, the Plan of Operation, and the agreements between the JUA and servicing carriers all provided that claims and liabilities of the JUA would be borne by it independently; servicing carriers were to be insulated from such claims and liabilities. See, e.g., N.J.S.A. 17:30E-7(e); JUA Plan of Operation, dated January 23, 1989, Article V, Paragraph 3; Servicing Carrier Contract between JUA and State Farm, dated October 27, 1983, Article V, Section 5.2.

Because the JUA insured high-risk drivers but also required that their rates be the same as voluntary-market rates (see N.J.S.A. 17:30E-13), it was anticipated that premium revenues would not cover costs of claims against JUA policies. Therefore, in addition to normal premium income, the JUA was also

given income from Department of Motor Vehicle surcharges for moving violations and drunken driving convictions, policy "flat charges," and "residual market equalization charges," or RMECs, to be added to policy rates for voluntary-market insureds. N.J.S.A. 17:30E-8. Thus, the JUA was a system in which the insurance costs of high-risk drivers were subsidized by the imposition of fees on segments of the general population of motorists. The JUA was supposed to be operated on a no-profit, no-loss basis, with RMECs increased or decreased as needed to accomplish that result.

However one may view the objectives of the JUA, the system did not achieve its goals. More and more drivers became unable to procure voluntary-market coverage, until by 1988 over 50% of New Jersey drivers had to be insured through the JUA. Claims against JUA insureds were sizeable and greatly exceeded the JUA's available income. Despite the imposition of substantial RMECs from 1988 through 1990, the JUA nonetheless accumulated a deficit of over $3.3 billion in unpaid claims and other losses.

Automobile insurance reform, including the reduction of the cost of insurance, and particularly some plan for eliminating the unwieldy JUA, repaying its debt, and replacing it with a more workable distribution of the automobile insurance market, became a priority for the Legislature and the executive branch in 1990. By March of that year the Reform Act had been adopted.

The principal goals of the Act were to reduce insurance costs for most New Jersey drivers, to depopulate the JUA by switching insureds to the voluntary market, and to create a funding mechanism to pay off the JUA debt. To these ends, the Act provided that the JUA would cease writing or renewing policies as of October 1, 1990. The "depopulation" of the JUA would be accomplished by classifying insured drivers into three categories: (1) high-risk drivers in the (revived) Assigned Risk Plan (10% of the market); (2) "non-standard" risk drivers, who would

be insured by private insurers directly, but who could be charged rates up to 135% of those of standard risks (15% of the market); and (3) standard-risk, voluntary-market insureds covered at prevailing rates (the remaining 75% of the market). Presumably, the higher rates now to be charged high-risk and "non-standard" risk drivers should bring the premium income on such coverage in line with actual costs, and this coverage would no longer be subsidized.

There remains, however, the problem of how to pay off the JUA's prior accumulated debt of over $3.3 billion; this, too, is addressed by the Reform Act. The Act creates the New Jersey Automobile Insurance Guaranty Fund (Auto Fund), a separate fund within the State Treasury, to collect and disburse the various payments designed to pay off the JUA debt. Reform Act, Section 23; N.J.S.A. 17:33B-5. The Act assigns to the Auto Fund certain sources of income that under the prior scheme went to the JUA, e.g., surcharges for driving violations and drunken driving convictions. It also creates new sources of revenue for the Auto Fund, e.g., fees on lawyers, doctors, and auto body repair businesses, higher automobile registration fees, and, most significant in the context of this litigation, the imposition of additional assessments and surtaxes on insurers. See Reform Act, Sections 63 through 68, N.J.S.A. 17:33B-58 through -63 (additional fees); Section 74, N.J.S.A. 17:30A-8a(9) and -8a(10) (assessments); Section 76, N.J.S.A. 17:33B-49 (surtaxes).

The assessments imposed on insurance carriers are collected through the Property Liability Insurance Guaranty Association (PLIGA). Reform Act, Section 74, N.J.S.A. 17:30A-8a(9). PLIGA was created in 1974 to impose assessments on New Jersey property-casualty insurers to pay claims against carriers that had become insolvent. (L. 1974, c. 17; N.J.S.A. 17:30A-1 through 17:30A-20). See Railroad Roofing & Bldg. Supply Co. v. Financial Fire & Casualty Co., 85 N.J. 384, 389-90 (1981). The Reform Act requires PLIGA to make additional assessments to be applied exclusively to the JUA

debt. These assessments, denominated by the Act as "loans," are paid into the Auto Fund. N.J.S.A. 17:30A-8a(10). They are to be set at rates designed to net $160 million per year for eight years (1990 through 1997); for 1990, the assessments represented 2.7% of net premiums of the property-casualty insurers.

Section 75 of the Reform Act, N.J.S.A. 17:30A-16, addresses recoupment from policyholders of PLIGA assessments both for insolvencies and for the JUA bailout. Insurers have always been permitted to pass through the insolvency assessments to policyholders. The insolvency passthrough originally was accomplished by rate increases, but in 1979 the method was changed to direct surcharges on policy premiums. The surcharges for insolvency assessments continue to be authorized under the Reform Act. N.J.S.A. 17:30A-16a. However, the Act expressly prohibits such surcharges to recover the new assessments for the JUA bailout. Section 75b states:

No member insurer shall impose a surcharge on the premiums of any policy to recoup assessments paid pursuant to [the provision requiring assessments to be loaned to the Auto Fund].

[N.J.S.A. 17:30A-16b.]

In addition to the new assessments, the Reform Act, Section 76, imposes a special surtax on insurers to go toward the JUA bailout. N.J.S.A. 17:33B-49. This surtax is a greater amount, 5% of net premiums, but is imposed for a shorter period (only three years, 1990, 1991 and 1992), than the assessments. The additional surtax is designed to net a total of $300,000,000 over the three-year period into the Auto Fund. Reform Act, Section 77, N.J.S.A. 17:33B-50. Because the objective is to secure $300 million in net proceeds, the 5% surtax rate can be adjusted, depending upon the amount of insurers' net premiums. The 5% rate cannot be exceeded, and it is theoretically possible that the Director of Taxation could lower the rate; but such a lowering could occur only if automobile insurance net premiums increased significantly, a highly unlikely event given both the supposed premium-reducing effects of the Act and current market conditions. The Reform Act, Section 78, addresses the

question of whether the additional surtaxes can be charged to consumers:

The Commissioner of Insurance shall take such action as is necessary to ensure that private passenger automobile insurance policyholders shall not pay for the surtax imposed pursuant to section 76.

[N.J.S.A. 17:33B-51.]

The insurers argue that because of the passthrough prohibitions of Sections 75 and 78, it is impossible for the Commissioner of Insurance to grant any rate relief to counteract the substantial loss of net income that will result from the new assessments and surtaxes. The insurers further claim that the assessments and surtaxes will necessarily cause them to operate at a loss, and they will thus be deprived of a constitutionally adequate rate of return.

The insurers point to their 1990 experience as an example of the impossibility of achieving a fair rate of return under the Act. They claim that the maximum profit they would be permitted under current ratemaking procedures would be 3.5% of premiums, and that a surtax of 5% and an assessment of 2.7% would necessarily more than offset the permitted return, and mandate an operating loss for 1990.

The State, to the contrary, argues (1) that Sections 75 and 78 do not absolutely prohibit rate relief; (2) that the insurers have failed to account for certain positive effects on their profitability that may result from the Act's so-called "cost-saving" provisions and from other statutory and regulatory means available for increasing rates; and (3) that Section 2g of the Act, N.J.S.A. 17:33B-2g, clarifies the Commissioner's authority to allow an adequate rate of return for all insurers.


The scrutiny of the Reform Act that the Court is here called on to perform is of limited scope. In considering the constitutionality of legislation, courts do not weigh its efficacy or wisdom. Moreover, legislative enactments "are presumed to be valid and the burden on the proponent of invalidity is a

heavy one." Hutton Park Gardens v. Town Council, 68 N.J. 543, 564-65 (1975). In challenges limited to the facial constitutionality of legislation, the effects on particular participants in an industry are not dispositive; rather, the question is whether the "mere enactment" of a statute offends constitutional rights. Hodel v. Virginia Surface Mining and Reclamation Ass'n, Inc., 452 U.S. 264, 295, 69 L. Ed. 2d 1, 28 (1981) (citing Agins v. City of Tiburon, 447 U.S. 255, 260, 65 L. Ed. 2d 106, 112 (1980)). In cases dealing with the validity of price-control statutes, such as the Reform Act, holdings of facial unconstitutionality are exceedingly rare. See, e.g., Guaranty Nat'l Ins. Co. v. Gates, 916 F.2d 508 (9th Cir. 1990) (Nevada statute freezing insurance rates held unconstitutional; provisions allowing rate relief only for insurers in danger of insolvency were not sufficient to assure a constitutionally adequate rate of return); see also Birkenfeld v. City of Berkeley, 17 Cal. 3d 129, 550 P.2d 1001, 130 Cal. Rptr. 465 (1976) (rent-control ordinance did not meet even minimal due-process standard, because ordinance's procedures for reviewing landlords' rent-increase applications entailed such long delays that landlords would be forced to operate at an inadequate rate of return for indefinite periods).

The primary bases of the insurers' challenges to the Reform Act are the takings clause of the fifth amendment to the United States Constitution (as applicable to state action through the fourteenth amendment), the due process clause of the fourteenth amendment, and analogous provisions of the New Jersey Constitution. Although the takings and due process claims are factually interrelated and are ordinarily brought in tandem in challenges to governmental rate or price-control regulations, each is actually a distinct basis for challenge.

Of the two pertinent constitutional issues, the courts have developed more definite and clearer standards for substantive due process claims than for takings claims. This Court has chosen to apply the same standards developed by the United

States Supreme Court under the federal Constitution for resolving due process claims under the New Jersey Constitution. Hutton Park Gardens, supra, 68 N.J. 543. Courts have, of course, long been reluctant to interfere with the states' regulation of their internal economic affairs. Thus, the United States Supreme Court's 1934 decision of Nebbia v. New York, 291 U.S. 502, 525, 78 L. Ed. 940, 950, upholding the constitutionality of a state system of price supports for milk, set the basic standard for validity under the due process clause: "the guaranty of due process . . . demands only that the law shall not be unreasonable, arbitrary or capricious, and that the means selected shall have a real and substantial relation to the object sought to be attained."

The standards governing takings claims originally developed in cases examining the constitutionality of the physical occupation of real property. Such standards became more fully and subtly developed in a number of United States Supreme Court cases dealing with government price regulation of utilities and the natural gas industry. See, e.g., Duquesne Light Co. v. Barasch, 488 U.S. 299, 102 L. Ed. 2d 646 (1989); Permian Basin Area Rate Cases, 390 U.S. 747, 20 L. Ed. 2d 312 (1968); FPC v. Hope Natural Gas Co., 320 U.S. 591, 88 L. Ed. 333 (1944). Further, many decisions involving rent-control ordinances have adopted and modified the law of takings and due process claims. See, e.g., Pennell v. City of San Jose, 485 U.S. 1, 99 L. Ed. 2d 1 (1988); Helmsley v. Borough of Fort Lee, 78 N.J. 200 (1978), appeal dismissed, 440 U.S. 978, 60 L. Ed. 2d 237 (1979); Hutton Park Gardens, supra, 68 N.J. 543. To some extent, ...

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