New York Codes, Rules and Regulations
Title 11 - INSURANCE
Chapter V - Rates And Rating Organizations
Subchapter F - Treatment Of Excess Profits In Motor Vehicle Insurance
Part 166 - Treatment Of Excess Profits In Motor Vehicle Insurance
Subpart 166-2 - Discussion Of General Rules
Section 166-2.0 - Discussion of introduction

(a) The determination of "excess profits" is an undertaking of considerable technical difficulty. For more than 60 years, regulators and others have attempted to measure the profitability of insurance operations and to compare insurer results to those of other industries. This department is aware of the peculiarities of insurance accounting and of the nature of the business itself which makes completely precise measurement and comparison impossible.[FN1] From time to time, however, events inside and outside the insurance industry have influenced profits and have spurred renewed inquiries into the question of profitability. These events include the introduction and subsequent reform of No-Fault insurance, the recurring energy crises of the 1970's (and a resulting sharp drop in driving), the introduction of more fuel-efficient and more difficult-to- repair automobiles, the rise and fall of auto theft rings, and unprecedented rates of inflation coupled with historically high interest rates.

(b) No responsible regulator can ignore these events. The insurance business is affected with the public interest and must inform the public of what is happening to its funds. The department does not expect that implementation of section 677(5) (now section 2329) of the Insurance Law will end debate on the subject. This regulation presents a reasonably simple, practical, and conceptually defensible approach to the determination of excess profits which takes into account the interests of all concerned--consumers, insurers, regulators and investors.

(c) If insurer profitability were relatively stable over time, the task of selecting an excess profit level would be simplified. However, insurer results have historically followed a cyclical pattern. To comply with the statute, the excess point must be set at a level which permits an economically acceptable return over many years, since no retrospective recovery is possible following years of poor results.

(d) Some witnesses who testified at the department's public hearings on the regulation favored a threshold so high as to virtually eliminate the possibility of excess profits, while others would have chosen a level low enough that excess profits would be earned quite often. The statute, however, is more moderate than either of these approaches. Unlike those who argue that all profits are ultimately reasonable, the premise of the statute is that excess profits may indeed occur from time to time. In order to serve the public properly, therefore, there should be a method to measure insurer profitability and to credit policyholders with dividends should such excess profits occur. Those who urge a more aggressive approach to profitability have also misread our mandate. Auto insurance, for the most part, is not priced like participating life insurance, where an allowance for future dividends is included in the initial premium. Rates, which must be approved by this department, are set at a reasonably low level of profitability. Thus, a methodology which allows insurers to retain their profits in most instances is consistent with the statute, and with a properly operating system.

(e) Regulators know that consumers are adversely affected at both extremes of the underwriting cycle. When loss experience is poor, insurers can justify requests for substantial and frequent rate increases. In good times, however, when underwriting profits exceed the target level, consumers tend to overpay for a period of time until rates are lowered or loss costs increase. It is unrealistic to expect insurers to share their good fortune with their policyholders on a purely voluntary basis. Therefore, this regulation is intended to provide a mechanism for restoring balance to the system in the event that overall rates of return exceed expectations.

(f) The department recognizes that carrying out the mandate of section 677(5) (now section 2329) is a unique and difficult task. The department's consultant, Professor C. Arthur Williams, who is also editor of the Journal of Risk and Insurance, prepared a report[FN2] entitled "Determining Excess Profit Refunds on New York State Automobile Insurance 1974-1982" (hereinafter cited as Williams). His final report reflects consideration of the comments and suggestions of consumers, specialists in insurance accounting, and others who presented their views at these hearings. Professor Williams' report represents a major advance in the measurement of insurer profitability. His approach, which uses all-industry data averaged over time, produces results which have few of the distortions present in earlier measures.

(g) Several witnesses at the department's public hearings argued that competition is the best arbiter of price and the best regulator of profit. The auto insurance market in New York is competitive. Hundreds of companies offer coverage at a wide range of prices; consumers are urged to shop for coverage; the great majority of insureds obtain their automobile coverage in the voluntary market. Therefore, the department recognizes that some competitive profit control already exists. Thus, an excess profit formula must have adequate justification in order not to disrupt the natural forces of the marketplace.

(h) A review of New York's historically volatile results indicates that it is indeed possible to have unusually good results in a single year, and that it is necessary to establish a formula for dealing with such results if they occur with consistency.

[FN1] Insurers' annual statements, which are required to be filed with each state's insurance department, follow statutory accounting methods, which tend to value assets and liabilities on a liquidation basis. This method is more conservative than "GAAP" methods used in other industries, which typically evaluate assets and liabilities on a going-concern basis. Statutory accounting is somewhat better suited to measuring an insurer's solvency.

The insurance business itself is unlike other industries. Liabilities are uncertain until payment (sometimes years after they are incurred), although revenue is certain at a much earlier point. Funds on which investment income is earned are derived from several sources, including stockholders (if any), current policyholders and past policyholders. Even measurement of the inherent riskiness of the insurance business (and of the financial return required to take such risk) has produced wide differences of opinnion.

[FN2] Earlier drafts of the report were the subject of public hearings in July 1979 and again in April 1981. The department held a further hearing on this proposed regulation on October 5, 1982.