ascertains that they are neither excessive, nor inadequate, nor unfairly discriminatory. In support of its rate increase, NBCU offered the following proposed percentage breakdown of the premium dollar:

NBCU's presentation was based on the premiums-earned/losses-incurred criteria as distinguished from the premiums-written/losses-paid criteria. Substantial differences in anderwriting results are obtained under the two criteria. (Generally, all other factors being equal, the loss ratio of earned premiums and incurred losses will be substantially higher and, obviously, could well make the difference between underwriting profit or loss.) The Commissioner felt that earned premiums to losses paid was a sounder, more logical relationship, which offered more precise data to permit a comparison of "apples to apples."

The Commissioner noted the importance of accounting principles in two specific areas solvency and ratemaking. It seemed quite clear to him that the test for solvency and the criteria for ratemaking should be quite different. When dealing with solvency, the test should simply be whether a company has assets “at least equal to all liabilities and required reserves together with its total issued and outstanding capital stock and minimum surplus." To determine whether a company has met the test for solvency, the earnedpremium/incurred-loss criterion is both necessary and proper. In determining whether the rates proposed by a company or a rating bureau meet the various standards, it would seem that the more accurate and precise test from an underwriting point of view (and one that would reflect most clearly the company's true profit and loss picture) would be to compare earned premiums against losses paid. This the Commissioner held was to be the accounting principle applied in Maryland.

He further held that investment income on unearned premium reserves was to be considered as a component part of underwriting income. However, he did not believe that investment income from loss reserves should be considered in ratemaking because loss reserves are funded out of a company's capital and accumulated surplus. The policyholder,

in his opinion, should not be entitled to share in any income realized from this source. In other words, since the loss reserves are in effect backed up by the capital and surplus of the company, the stockholder whose funds are at risk should be entitled to the fruits thereof.

(The Maryland positon, as expressed in this brief, has been partially reversed by the published statement, dated January 19, 1968, of the Maryland Insurance Commissioner. Newton I. Steers, Jr.)

Wisconsin: Preliminary Memo to the Wisconsin Insurance Laws Revision Committee (March 1966)

In March 1966, Spencer L. Kimball and Herbert S. Denenberg submitted their thoughts on several questions raised with the Wisconsin Insurance Laws Revision Committee. Their thinking was tentative. The following were the main questions they addressed.

(a) Should the statutes provide for public hearings before the Commissioner of Insurance grants rate increases? Are the powers of the Commissioner adequate under present statutes, or should his power be expanded in this respect? In general, they tended to conclude that the Commissioner had the power to call for any hearings he desired and that if there were any question about this power an amendment to the statutes should be made to ensure that he had the power. No other actions should be taken to change other aspects of the law respecting hearings without full examination of the entire area.

(b) Should automobile insurance companies be required to include investment income as part of their total income in establishing rates on their policies?4 Basically, they recommended this question be put off for full consideration in connection with other aspects of rate regulation. They mentioned that in progress at the University of Wisconsin School of Commerce was a relevant study which should be watched with great interest. They noted that the attention of rate regulatory bodies everywhere seems to have been directed toward the production of an underwriting profit rather than an overall profit since the McCarran-Ferguson Act was passed (1945). Soon after, the New York Insurance Department produced the McCullough Report urging that cognizance be taken of investment income in rate regulation. There was no satisfactory solution to the problem except acquiescence to the status quo. The matter is intimately related to other aspects of rate regulation and cannot adequately be discussed outside the context of a complete reexamination of rate regulatory problems.

A related question would have to be asked: whether appreciation of assets should also be brought into the formula; and, if so, how valuation of these assets should be made. They felt that the differences in rates due to this income would be small. They raised the question of what an appropriate profit level for an insurance company should be. They felt that insurance company spokesmen have in general been of little help in these matters, since they have tended to engage in such extravagant special pleading as to prejudice their case.

4They referenced Kimball's article, "The Goals of Insurance Law: Means vs. Ends," Journal of Insurance (1962), pp. 19-29, for hints on the basic question.

:

They asked a series of 12 questions which would have to be answered in order to answer the main question. The following are the more important of these questions.

(1) What is a fair rate of return on investment in the insurance
business?

(2) On what asset base should that return be computed?

(3) Should asset appreciation also be considered? If so, how should
valuation be performed?

(4) Should rates reflect stock market fluctuations and other
investment yield changes? Would the change make rates too
unstable?

(5) Is it equitable for the policyholders to take the benefit of
investment gains but not shoulder the burden of investment losses?
Asset depreciation losses?

(6) What are the policyholders' and stockholders' relative equities in

the investment earnings of companies?

(c) What should be done to extend and expand the uninsured motorist coverage now available to automobile owners in Wisconsin? They concluded that not much should be done.

(d) What is the present policy of insurance companies in (1) cancelling the policy of an insured motorist, and (2) refusing to renew a motorist's policy at the expiration date? Are all insured motorists treated equitably in this respect? They noted that more study was needed in this area and that some mild ameliorative measure might be needed.

(e) If automobile insurance rates continue to go up, should the state consider going into the automobile insurance business in order to make policies available to any motorist who desires insurance? They concluded that no further consideration should be given at this time to the possibility of a state insurance fund for any portion of the automobile insurance market.

SUMMARY STATEMENT OF PROBLEM

The sum and substance of the preceding two sections is a general argument about prices and profits in the property and liability insurance industry. On the one side there are urgings for price relief in this insurance; on the other, there are counter-urgings that the reduction of price and the consequent reduction of profit will offset the very things our society desires of our insurance system: its availability in the form and quantity needed to encourage economic growth (capacity) and its solvency-the assurance that it will be able to withstand the statistical shocks of insured losses and honor its future obligations when they arise.

39-280 O 71 pt. 17A 16

This report presents the results of an examination of prices and profits in the property and liability insurance industry over the 11-year period 1955-1966. This examination attempts to establish to what extent there is justification for a reduction in prices or profits through a redistribution of investment income, a change in treatment of prepaid expenses, or any other alteration producing equivalent effects on prices and profits.

The criteria governing the ratemaking procedures are the objectives of adequacy and non-excessiveness of price universally subscribed to by regulatory agencies. It will not serve to resolve the several issues on insurance pricing to argue the question of investment income on the grounds of ownership of investment earnings. Citing analogies with banking will only be met with counter-analogies and counter-assertions and will leave the matter of ownership to be settled finally by legal dictum. Similarly, the question of accounting practices can be argued by invoking analogies with other situations, but not with any hope of convincing those genuinely interested in the provision of efficient and effective insurance. Because these approaches to the question of price are so obviously futile and because they would merely extend and not settle the central issue of proper price in property and liability insurance, we have sought other means by which to test price and have concentra ted attention on tests of adequacy and non-excessiveness.

Unfortunately, the terms adequacy and non-excessiveness as applied to insurance prices are not defined. The laws of some states do go as far as establishing “broad zones of reasonableness,"5 but no quantitative measures by which these attributes can be gauged have been agreed upon. The complications of price in property and liability insurance are enormous and arise out of the fact that insurance is priced by a ratemaking formula which targets an underwriting profit allowance. This profit allowance varies not only among the regulatory jurisdictions, but also by line of insurance. A price is thus set for a product whose cost will not be known until some time in the future. The insurance regulator, in attempting to keep prices at levels that are neither too high nor too low, invokes his own judgments about the meanings of adequacy and excessiveness. It is well known that, although there is no complete agreement on the proper measure of true profits of the industry, it is difficult to make rates in a way that produces a targeted level of underwriting profit. The laws of chance, at least in the short term, operate to produce profits significantly different from the targeted levels.

In the investment end of the insurance business, assets are risked in a somewhat different environment. Regulation here is of a different form and character, and it is intended to safeguard assets held by the companies against future claims. The profits earned on investments are the result of the play of the marketplace in which the insurance companies are permitted to operate.

The total profits of the property liability firm are the combination of earnings in operations in two separate risk environments: underwriting and investment. Any analysis of prices and profits in the industry must necessarily examine both areas of activity. Although the property and liability firm risks its assets in two separate environments, it must be appreciated that the underwriting and investment activities are interdependent. The firm's 5Frederick G. Crane, "Automobile Insurance Rate Regulation," Ohio State University, Business Research Monograph No. 105 (Columbus, Ohio, 1962), p. 70.

policies with regard to both underwriting and investment are made in recognition of the results jointly achieved in underwriting and investment. That is, policies and actions in investments will in some sense depend on underwriting performance, and vice versa. It is, therefore, not possible to speak with any assurance on what total profits would have been if the loss ratio had been a few percentage points higher or lower than actual, or if investment income had been some amount larger or smaller than actual. Total profit is not the simple linear combination of two independent quantities, but rather the combined result of the interdependent investment and underwriting policies of the firm.

Consequently, in analyzing the prices and profits of the insurance industry, we have examined total profits over a long enough period of time to provide representative results for the industry. We have examined industry structure and organization to determine whether or not there is effective competition in insurance, on the presumption that this competition would provide the discipline in the market for the benefit and protection of consumers. We have examined industry profits for evidences of monopoly profits by comparing its profits with those of other sectors of the American economy, in particular with those of comparable risk. With the available facts on the industry's form and performance and with the results of a proper measure of its profit results, we believe it is possible to provide a better answer to the question of whether or not any profit-reducing change in the rate making formula of property and liability insurance is now justified.

Specifically, this investigation has been addressed to the following tasks:
(a) Industry profits: This question was explored (using industry data
sheets as described in Appendix C and modified as explained in
Section III) to develop a complete picture of company returns
between 1955 and 1965 and the invested assets of the firm in the
corresponding periods.

(b) Industiral organization: The form and performance of the
industry, its progressiveness, efficiency, asset and sales
concentrations and other features which, taken together, serve as
indicators of competitiveness or monopolistic behavior. Absence
of excessive profits (in the task described above) is a necessary but
not sufficient condition for competitiveness; a monopolist can
choose to be lazy rather than rich. This second task is a search for
evidence of either kind of behavior.

(c) Solvency: Many of the features of the industry are affected by
price. A feature of principal concern is that of solvency. The
relationship of solvency to price was explored with the aid of a
theoretical model which provides a means of testing the sensitivity
of probability of insolvency to price for the insurance firm.

Within these tasks we believe we have developed quantitative measures and tests or adequacy and non-excessiveness of overall industry profits, on the basis of which it can e better determined whether the price of insurance is proper or not.

Sources of data employed in this analysis are described in Appendix C.