On appeal from the Commissioner of Insurance.
Before Judges King, Brody and Thomas.
The opinion of the court was delivered by KING, P.J.A.D.
This appeal concerns whether the Commissioner of Insurance exceeded his authority in promulgating a regulation, N.J.A.C. 11:3-20.5(e), under the Excess Profits Law, N.J.S.A. 17:29A-5.6 to - 5.16, intended to implement the mandate of the Fair Automobile Insurance Reform Act of 1990, N.J.S.A. 17:33B-1 to -62; L. 1990, c. 8, (the FAIR Act) requiring that automobile insurers not pass through to insureds the cost imposed on insurers of erasing about one-half of the $3.3 billion deficit accumulated by the New Jersey Automobile Full Insurance Underwriting Association (JUA). The FAIR Act imposes a 5% surtax on automobile insurers for the years 1990-1992 and a 2.7% assessment (adjustable annually) on all property and casualty insurers for the years 1990-1997. The FAIR Act has "anti-pass-through" provisions which are designed to prevent insureds from paying for the JUA bailout. Our Supreme Court upheld the facial constitutionality of the FAIR Act against the challenge that it was confiscatory but only by construing the FAIR Act to require the Commissioner to set rates high enough to insure a "constitutionally adequate" rate of return. State Farm Mut. Auto. Ins. Co. v. State, 124 N.J. 32, 590 A.2d 191 (1991). The effect of the Court's decision was to preclude insurers from including the surtax and assessment in the rate base unless absolutely necessary to achieve a fair and reasonable rate of return.
The question before us is whether the Commissioner exceeded his authority in prohibiting automobile insurers from deducting the surtax and assessment as an expense in their excess profit report unless the Commissioner permitted the insurer to include the surtax and assessment in its rate filing. The Commissioner justifies his regulatory action as necessary to implement the intent of the Legislature in adopting the FAIR Act prohibition against "pass-throughs." Appellants, three automobile insurance companies, claim that this action violates both the express language of, and the intent of, the Excess Profits Law which attempts to measure accurately an automobile insurer's actual profits. Appellants also contend that the regulation is unconstitutional as confiscatory on its face. The Commissioner contends that the appeal is nonjusticiable and should be dismissed because none of the appellants have ever showed excess profits and have not been harmed by the new regulation.
We find that the insurers have a right to challenge the regulation on its face, even though they have not realized any "excess profit." We uphold the validity of the regulation which denies the insurers the right to include and "pass through" the surtaxes and assessments as expenses for purposes of calculating excess profits. We also conclude that the regulation is not facially confiscatory.
On June 19, 1991 the Commissioner issued Bulletin No. 91-8, which informed all automobile insurers that neither the 5% surtax nor the 2.7% assessment should be included as an expense in calculating the Excess Profits Report due July 1, 1991 (for calendar year 1990). Two of the appellants here, Selective Insurance Company of America (Selective) and Hanover Insurance Company (Hanover) appealed. On July 2, 1992, in an unpublished opinion, we invalidated Bulletin No. 91-8 on the ground that the declared policy should have been promulgated pursuant to the rulemaking process. We did not reach the merits. See In re Comm'r of Ins.'s
Issuance of Bulletin No. 91-8, No. A-6099-90 (App. Div. July 2, 1992).
In fact, the Commissioner had proposed and actually adopted the new rule several weeks before we decided the above case. On February 18, 1992 the Commissioner proposed to amend N.J.A.C. 11:3-20.5 to codify Bulletin No. 91-8's policy of prohibiting insurers from treating assessments and surtaxes as expenses for purposes of calculating excess profits. 24 N.J.R. 529 (Feb. 18, 1992). On May 28 and June 11, 1992, respectively, the Commissioner issued orders No. A92-189 and No. A92-212, which implemented the change. The regulation, now codified at N.J.A.C. 11:3-20.5(e), as well as technical revisions to the excess profit report form, were adopted on June 15, 1992. 24 N.J.R. 2264 (June 15, 1992). Selective and Hanover, this time joined by State Farm Mutual Automobile Insurance Company (State Farm), filed this notice of appeal on July 30, 1992.
A brief review of the relevant regulatory insurance statutes and the Commissioner's interpretation of them is helpful.
A. New Jersey Automobile Insurance Rate Regulation
Since 1944 automobile insurance companies doing business in New Jersey have been subject to prior approval of their rates. N.J.S.A. 17:29A-1. Rates must be high enough to ensure the safety and soundness of the insurance company, but not unreasonably high. N.J.S.A. 17:29A-4. The Commissioner must approve rates that are "reasonable and adequate, and not unfairly discriminatory," taking into account a "reasonable profit for the insurer." N.J.S.A. 17:29A-11.
Since 1973 "reasonable and adequate" rates have been fixed with reference to the Clifford Formula, developed by Justice Clifford when he was the Commissioner of Insurance. Under the Clifford Formula, rates are fixed so that an insurance company can earn a post-tax profit of 3.5% of its premiums. In re
Application of Ins. Rating Bd., 63 N.J. 413, 417, 307 A.2d 604 (1973) (upholding the Clifford Formula). Appellants and the Commissioner agree that this equals a pre-tax return of 5.3%. See 22 N.J.R. 2082, 2083 (July 16, 1990). The Clifford Formula, now set forth in administrative regulation N.J.A.C. 11:3-16.10, does not allow insurers to include all expenses in the rate base. Even before adoption of the FAIR Act, the regulation excluded fines, lobbying expenses, charitable and political contributions, punitive damage awards, and advertising and other expenses incurred in connection with proposed changes to insurance regulations from the rate base. N.J.A.C. 11:3-16.10(b)(8).
B. The Excess Profits Law
An insurer must predict future performance in order to establish a premium that will generate the appropriate rate of return. Frequently, actual performance differs from the prediction, and an insurer may enjoy more or less profit than anticipated. The Excess Profits Law reflects the Legislature's determination that excess profits be returned to policyholders.
The Legislature enacted the first Excess Profits Law in 1983. L. 1983, c. 357 (codified at N.J.S.A. 17:29A-5.2 to -5.5 and repealed by L. 1988, c. 118, § 12). See American Employers' Ins. Co. v. Commissioner of Ins., 236 N.J. Super. 428, 430-31, 566 A.2d 202 (App. Div. 1989). The major relevant difference between the original law and the Excess Profits Law enacted in 1988, L. 1988, c. 118 (codified at N.J.S.A. 17:29A-5.6 to -5.16), is a reduction in the permitted excess profit from 5% to 2.5% of earned premiums. N.J.S.A. 17:29A-5.8. The 1988 Excess Profits Law was enacted at the same time as the comprehensive reforms included in the Automobile Insurance Reform Act of 1988, L. 1988, c. 119. See In re Dep't of Ins.'s Order Nos. A89-119 and A90-125, 129 N.J. 365, 373 (1992). One major change of the Reform Act was the creation of "flex rating," which allows an insurance company to increase premiums by the annual increase in the Consumer Price Index plus 3% without the Commissioner's prior approval. Id. at 373-74. However, this greater
potential for profit was tempered by the stricter excess profits limitation of 2.5%, thereby insuring "that the industry does not abuse this rate-making flexibility and that any rate increase is justified." Id. at 373, quoting Governor's Reconsideration and Recommendation Statement, Senate No. 2637, L. 1988, c. 119.
According to Governor Kean, the 1988 Excess Profits Law was designed to "assure that a complete and accurate assessment of profits and losses is presented by insurers." Governor's Conditional Veto Message, Senate No. 3090 (Nov. 9, 1987). As explained by the New Jersey Department of Insurance's 1989 Annual Report, the purpose is to insure that an insurance company that makes an unusually large profit returns the excess to its policyholders. The parties here agree that a profit is excess if it exceeds 7.8% of premiums -- the 5.3% pre-tax return allowed by the Clifford Formula plus the 2.5% above that permitted by the Excess Profits Law.
With limited exceptions, automobile insurers must file a report with the Commissioner on or before July 1 of each year, reflecting profits and losses for the several preceding years. N.J.S.A. 17:29A-5.7. Excess profits are deemed to exist when, for the three calendar years immediately preceding the date of the profits report, the sum of an insurer's "total actuarial gain" and "excess investment income" for all private passenger automobile coverages combined exceeds 2.5% of earned premiums. N.J.S.A. 17:29A-5.8; N.J.A.C. 11:3-20.7(a).*fn1 "Actuarial gain" means underwriting income less the allowance for profit and contingencies, which amount may be positive or negative. N.J.S.A. 17:29A-5.6(b). "Total actuarial gain" is the sum of the actuarial gains for the
three calendar-accident years immediately preceding the due date of the profits report required by statute, less certain ...