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 166-2.1 - Discussion of reasonable rate of return

Current through Register Vol. 46, No. 28, July 10, 2024
(a) A reasonable rate of return has been
					 established by utilizing the average annual aftertax rate of return earned by
					 other industries experiencing substantially the same variation in their rates
					 of return. Professor Williams offers two choices for the reasonable rate of
					 return, both based on standard statistical techniques. One measures risk using
					 the variance in insurers' annual rates of return in New York; the other
					 approach uses the standard deviation in these annual rates of return. Using
					 data from 1962 through 1978, the department's consultant calculates a
					 reasonable return of 21.6 percent (using variance) and 17.9 percent (using
					 standard deviation).[FN3] The department has recalculated these figures using
					 data through 1980 and has obtained returns of 22.7 percent (variance) and 18.3
					 percent (standard deviation).
(b)
					 The consultant states that both the variance measure and the standard deviation
					 measure can be statistically and logically justified. He chooses the standard
					 deviation measure (rounded to 18 percent), in part because "the indicated
					 reasonable rate of return is closer to what most of the other methods
					 [discussed in the report] appear to suggest."[FN4] Although the 18- percent
					 reasonable profit point exceeds the return actually earned by the industry,
					 historical results reflect two factors: interest rates far lower than current
					 levels, and the disastrous underwriting losses of the mid-1970's. Although
					 lower investment yields affected countrywide results as well, less severe
					 underwriting results have produced national rates of return considerably closer
					 to the 18-percent level. As insurers' long-term portfolios (containing
					 investments at extremely low yields) are gradually reinvested in higher
					 yielding securities, it is expected that the return actually earned by the
					 industry should more closely approximate 18 percent. The department therefore
					 concurs with Professor Williams' choice of 18 percent.
(c) Several speakers at the October 5, 1982
					 public hearing contended that the choice of 18 percent was too high, in view of
					 the falling interest rates of the last few months, and the historical failure
					 of the industry to earn such a return over an extended period. The department
					 has rejected the suggestion to reduce the "reasonable" point at this time,
					 however, because it is undesirable to modify the results of a long-term
					 analysis as a result of recent events which may not persist.
(d) Before selecting the Williams approach
					 for estimating the reasonable rate of return, the department had reviewed other
					 methods of measuring profitability. Two of these deserve particular mention.
					 The Capital Asset Pricing Model (CAP-M) has been used in other states, and is
					 often employed in financial analysis. Professor Williams expresses several
					 reservations about CAP-M, including the fact that there are serious technical
					 difficulties involved in estimating the parameters of the model which would be
					 needed to apply CAP-M retrospectively to one line of business in one state.
					 Additionally, this department observed that CAP-M is highly sensitive to
					 volatile interest rates (since one of its parameters is the currently avaiable
					 risk-free rate of return), even though these rates often do not reflect what
					 insurers actually earn. While this method may prove useful at some future date
					 in a more stable financial market, it would be an unwise selection at this
					 time.
(e) Use of the discounted
					 cash flow method has also been suggested to estimate a reasonable rate of
					 return. It is extremely difficult to obtain representative data for this
					 analysis; data submitted by the Consumer Protection Board in support of this
					 approach (which has been used in public utility regulation) were based on nine
					 stock insurers, two of which do not write automobile business in New York. The
					 method analyzes insurers' dividend patterns and retained earnings countrywide
					 for all lines in order to estimate a reasonable rate of return. No reflection
					 of the underwriting results of New York's automobile business is included. This
					 deficiency appears to invalidate the approach, since one intent of the statute
					 is to provide a safeguard in the event that unusual occurrences, such as a
					 no-fault law or other legislative enactment, would produce windfall profits in
					 New York. The department notes that much of the difficulty of implementing
					 section 677(5) (now section 2329) arises from the requirement that a "by line,
					 by state" analysis be made, although many of the components are, by their
					 nature, companywide quantities. Additionally, there is no methodology for
					 selecting an excess profit above the reasonable point, as the law requires.
					 While there is much to admire in the work of public utility regulators, their
					 approach is not generally applicable to the task before the department, largely
					 because of the differing competitive nature of the industries.
(f) An additional consideration in the
					 department's choice of its consultant's approach, and of the 18-percent
					 reasonable rate of return, is the department's own survey of money managers and
					 investment advisers. The survey, mentioned in Williams (at page 17), asked the
					 respondents to indicate what rate of return insurers specializing in automobile
					 insurance should realize. The median rate of return specified by these managers
					 and advisers was 18 percent.
(g)
					 The department recognizes that the 18-percent figure may be inappropriate for
					 future years, as economic conditions and actual insurer results may change. An
					 important part of the department's ongoing monitoring of profitability will be
					 periodic reevaluation of this figure.
[FN3] Williams, pp. 46-47.
[FN4] Williams, p. 48.