Opinion ID: 2073828
Heading Depth: 1
Heading Rank: 2

Heading: allowance for expenses

Text: A. The Method of Determining the Allowance for Expenses. Before the decision on 1975 rates by the Commissioner's predecessor, it had been customary to calculate the expense allowance by multiplying the Rate Level Pure Premium by an expense multiplier. This multiplier was defined as the ration of the expenses attributed to the insurance line in the basis year (1974 in the instant hearings) to the developed losses for that line for the year. The defect of the method is that, as anticipated losses increase, the dollar amount allocated to expenses grows proportionately even in the absence of evidence that any such increase in expenses is expected. Although the Bureau advocated a return to the multiplier method in this year's hearing, the Bureau's actuary acknowledged that it could result in extra money for the insurers. [17] A new approach was introduced for 1975 and in the decision under review the Commissioner continued and sought to refine his predecessor's work. The portion of company expense attributed to claims adjustment was considered to follow losses closely so that the multiplier method could continue to be used for those expenses. [18] However, the manner of determining the expense allowance for acquisition (agent's and brokers' commissions), filed administration, and general administration costs was to be similar to that for establishing the 1976 Rate Level Pure Premium: the total of these expenses for the 1974 policy year would be divided by the 1974 exposure (yielding the average expense per insured vehicle) and adjusted to the 1976 policy year by the application of an appropriate trend and projection factor. The component of the total premium thus calculated may be termed the Expense Pure Premium. Finally, the allowance for incidental taxes, licenses, and fees, which traditionally had been part of the multiplicative expense factor, was considered to be related to the total premium, rather than the 1976 Rate Level Pure Premium or Expense Pure Premium, and so was to be separately calculated. [19] B. Alleged Errors in Application of the Method. The Bureau states in its brief that the method used by the Commissioner in determining the expense allowance may in the abstract be preferable to the older multiplier method. It argues, however, that the trend and projection factor (to adjust certain of the 1974 expenses to 1976 cost levels) was too low, and also that including the acquisition expenses in the Expense Pure Premium, rather than compensating for them by the multiplier method, was error. (1) Trend and projection factor. The factor as approved by the Commissioner was admittedly a compromise. The Division developed an internal estimate of the factor based on the change in insurance company expenses from 1973 to 1974 (as revealed by statistics maintained by the Bureau), and recommended a factor of 1.0929. The Bureau  assuming the multiplier procedure was to be discarded  proposed an external measure of the factor, derived from statistics maintained by the United States Department of Labor concerning wages for fire, marine, and casualty insurance carriers. It recommended a projection factor of 1.198. The best choice view of the Commissioner has been described above. It would apply here, but the Commissioner found that neither party had prepared a fully convincing analysis. The Division's estimate did not deal with the probability that the rate of growth of inflation had increased since 1974. The Bureau's factor disregarded the apparently contradictory actual experience of the insurers [20] and was also out of line with the over-all trend of wages in apparently industry. [21] As a best choice rule could not be safely applied, the prudent alternative, according to the Commissioner, was to average the probably understated factor of the Division and the probably overstated factor of the Bureau. He adopted a trend and projection factor of 1.145. We cannot say he was wrong. Cf. Boston Gas Co. v. Department of Pub. Util., 368 Mass. 780, 804 (1975). It should be noted for future reference that the Bureau attacked the Division's estimate, founded on internal data, as unreliable because the insurers estimate some expenses by setting them equal to a fraction of premium volume and therefore the expenses reported do not coincide with actual expenses, but are more directly affected by the rates set for the year. This is a curious commentary on the manner of reporting expense information to the Division: if reported expenses are inaccurate for projection, the question is raised whether they may not be inaccurate in absolute amount. [22] (2) Acquisition expenses. The commissions to agents and brokers for selling policies have been traditionally determined as percentages of the premiums on the policies. In the past this practice has conformed to the ratemaking process in which the expenses have been determined by the multiplier method. [23] The Conclusion that acquisition expenses should not be so treated in ratemaking is hardly startling: if costs of medical care were expected to sky-rocket in a given year, thereby affecting the projected losses, but salaries were not expected to rise at all, the old method would nonetheless raise the allowance for acquisition expenses in proportion to the expected losses, despite the close connection of commissions to wages. In the end the Bureau did not really attack the Commissioner's fundamental approach to acquisition expenses, but argued instead that the companies had not had a chance to adjust their contractual commitments to it because by statute (G.L.c. 175, § 163) insurers must given agents and brokers ninety days' notice of changes in their contracts and the Commissioner's decisions was not issued until mid-November. [24] The answer is that the predecessor Commissioner treated acquisition expenses in the same fashion as the current Commissioner who indicated his intentions early in the hearings. [25]