Opinion ID: 1189013
Heading Depth: 3
Heading Rank: 4

Heading: The Validity of the Rate Regulations as to Rollbacks With Respect to the Ratemaking Formula

Text: The superior court determined that the rate regulations as to rollbacks are invalid on their face with respect to the ratemaking formula. Before we proceed further, we would do well to make two observations. One is relatively narrow, and concerns matters of accounting. In his separate opinion in the landmark decision of Power Comm'n v. Hope Gas Co. (1944) 320 U.S. 591 [88 L.Ed. 333, 64 S.Ct. 281] (hereafter sometimes Hope ), Justice Jackson commented: To make a fetish of mere accounting is to shield from examination the deeper causes, forces, movements, and conditions which should govern rates.... [B]ookkeeping is hardly an exact science. As a representation of the condition and trend of a business, it uses symbols of certainty to express values that actually are in constant flux. It may be said that in commercial or investment banking or any business extending credit success depends on knowing what not to believe in accounting. Few concerns go into bankruptcy or reorganization whose books do not show them solvent and often even profitable.... However, our quest for certitude is so ardent that we pay an irrational reverence to a technique that uses symbols of certainty, even though experience again and again warns us that they are delusive. ( Id. at pp. 643-644, fn. 40 [88 L.Ed. at p. 367] (opn. of Jackson, J.).) We shall pay no such reverence. The other observation is relatively broad, and concerns matters of policy. Under Proposition 103 as construed in Calfarm, insurers were allowed to file rollback-exemption applications. An insurer that filed such an application should not be penalized for having charged, pending approval and subject to refund, a rate for the rollback year higher than the maximum rate of 80 percent of the 1987 rate. That appears obvious. But neither should it be rewarded for having done so. That seems less obvious. It is nonetheless true. As stated, the ratemaking formula is designed to yield a premium that the insurer should receive from its insureds in order to earn a sum amounting to (1) the reasonable cost of providing insurance and (2) the capital used and useful for providing insurance multiplied by a fair rate of return. By charging a higher rate for the rollback year, the insurer increased its cost of providing insurance, for example, by incurring liability for added commissions, state premium tax, and federal income tax on the added premiums. It also increased its capital multiplied by a rate of return, specifically by increasing its capital base, for example, by triggering added surplus to back up the added premiums. Such increases would inflate the premium yielded by the ratemaking formula. They cannot be recognized. If they were, a higher rate would be self-justifying: the fact that the insurer charged such a rate would grant it a right to have done so. That cannot be. There is surely no unfairness in nonrecognition. Insurers were on notice that, in charging a higher rate, they were proceeding at their own risk: they had to establish their entitlement to that rate; it did not carry its entitlement within itself. For illustration, let us consider the following example. Insurer A and Insurer B are similarly situated. The 1987 rate for each was $1,000. A maximum rate for the rollback year of 80 percent of the 1987 rate, viz., $800, is nonconfiscatory and otherwise lawful for each under the rate rollback requirement provision of Proposition 103. Not disputing the matter, Insurer A reduces its rate to $800. Filing a rollback-exemption application, Insurer B takes the opposite path and increases its rate to $1,200. In so doing, Insurer B increases its cost of providing insurance by incurring liability for: (1) added commissions at, say, the customary rate of 20 percent on the added premium of $400, equaling $80; (2) added state premium tax at, say, the established rate of 2.37 percent on the added premium of $400, equaling $9.48; and (3) added federal income tax at, say, the marginal rate of 34 percent on the added premium of $400, equaling $136  to the total of $225.48. Insurer B also increases its capital multiplied by a rate of return. It does so, specifically, by increasing its capital base, by triggering added surplus at, say, the simplest leverage ratio of 1:1, to back up the added premium of $400, in the amount of $400. Let us assume a rate of return of 10 percent. Insurer B thereby increases its capital multiplied by a rate of return to the total of $40. Insurer B 's increases, if they were recognized, would inflate the premium yielded by the ratemaking formula by $265.48  $225.48 for the cost component plus $40 for the capital component. In other words, Insurer B 's increases, if they were recognized, would increase its maximum rate for the rollback year from $800 to $1,065.48. They cannot be recognized. Insurer B has charged $400 too much: it must refund that amount. It should suffer no penalty for its overcharge. That means that it must refund only $400 (exclusive of interest). But neither should it be given a reward for its overcharge. That means that it must indeed refund $400 (exclusive of interest). Otherwise, inequity would result. There would be unfairness between Insurer A and Insurer B , which would be treated dissimilarly as subjects of the rate rollback requirement provision, Insurer A with a maximum rate of $800 and Insurer B with a maximum rate of $1,065.48. There would also be unfairness between Insurer B and its insureds; the former overcharging the latter and the latter overpaying the former in the amount of $265.48. Lastly, there would be unfairness between the insureds of Insurer A and the insureds of Insurer B , who would be treated dissimilarly as beneficiaries of the rate rollback requirement provision, the former receiving the mandated decrease in rates equaling $200 and the latter receiving a prohibited increase in rates equaling $265.48. (16) The first of two major bases on which the superior court rested its determination that the rate regulations as to rollbacks are invalid with respect to the ratemaking formula was its conclusion to the following effect: Proposition 103 does not authorize the Insurance Commissioner to adopt any ratemaking formula whatsoever to implement the rate rollback requirement provision; it does not permit him to set rates himself; as a general matter, it allows him merely to approve or disapprove rates proposed by individual insurers, applying (as relevant here) the excessive/inadequate standard; as to rollbacks specifically, it requires him to approve any proposed rate that is minimally above the inadequate and to disapprove any other, even if such other rate falls at some other point below the excessive. The superior court's conclusion in this regard is substantially erroneous. At the outset, we must make the following observation. Through the ratemaking formula, the Insurance Commissioner does not himself set rates for insurers. Rather, he simply determines the rate or rates that the individual insurer may itself set within the constraints of Proposition 103 as construed in Calfarm. For the prior approval system, the ratemaking formula is used to fix for the individual insurer the range of rates within the bounds of the excessive and the inadequate. For the rate rollback, with which we are here concerned, it is used to fix for the individual insurer its maximum rate under Proposition 103 as construed in Calfarm  i.e., the rate that is 80 percent of the 1987 rate or such rate greater than 80 percent of the 1987 rate as is minimally nonconfiscatory. In Calfarm, we stated that under Proposition 103 any insurer who believes the rates set by [Insurance Code] section 1861.01, subdivision (a), are confiscatory may file an application with the Insurance Commissioner for approval of a higher rate. If that application is filed before November 8, 1989, the insurer may immediately begin charging that higher rate pending approval from the commissioner. After that date insurance rates subject to Proposition 103 must be approved by the commissioner prior to their use, but ... the commissioner can approve an interim rate pending [his or] her final decision. If the commissioner finds the initiative's rate, or some other rate less than the insurer charged, is fair and reasonable, the insurer must refund excess premiums collected with interest. No insurer, however, will be compelled to charge the rates set by the initiative unless it either acquiesces in that rate or is unable to prove that a higher rate is constitutionally required.  ( Calfarm Ins. Co. v. Deukmejian, supra, 48 Cal.3d at p. 825, italics added and fn. omitted.) As construed in Calfarm, Proposition 103 does in fact authorize the Insurance Commissioner to adopt a ratemaking formula to implement the rate rollback requirement provision  specifically, to determine whether, for an individual insurer, a maximum rate for the rollback year higher than 80 percent of the 1987 rate is required to avoid confiscation and, if so, what such higher maximum rate is. By its very terms, Proposition 103 sets a maximum rate for the rollback year. As construed in Calfarm, Proposition 103 requires the Insurance Commissioner, if he finds the initiative's maximum rate confiscatory for an individual insurer, to determine a higher maximum rate that is minimally nonconfiscatory. To do so, he must, as it were, make a rate. And to do that, we believe, he may proceed by formula rather than case by case. Indeed, it is arguable that he should proceed in that fashion. One of the purposes of Proposition 103 is to protect consumers from arbitrary insurance rates.... (Prop. 103, Gen. Elec. (Nov. 8, 1988) § 2, reprinted in Ballot Pamp., Proposed Stats. and Amends. to Cal. Const. with arguments to voters, Gen. Elec. (Nov. 8, 1988) p. 99.) Formulaic ratemaking furthers that goal. Case-by-case ratemaking does the opposite. (Cf. 1 Davis & Pierce, Administrative Law Treatise (3d ed. 1994) § 6.7, p. 261 [Over the years, commentators, judges, and Justices have shown near unanimity in extolling the virtues of the rulemaking process over the process of making `rules' through case-by-case adjudication.].) There is, without doubt, nothing novel in the use of formulas of all sorts. (Cf., e.g., Cal. Code Regs., tit. 22, § 51536 et seq. [setting rates for reimbursement for hospital inpatient services provided to Medi-Cal program beneficiaries]; see especially id., § 51549 [establishing a reimbursement formula].) It goes without saying that when the Insurance Commissioner determines that a maximum rate higher than Proposition 103's is minimally nonconfiscatory for an individual insurer, he does not set a rate. This point bears emphasis because it was inexplicably ignored by the superior court: For the rollback year, strictly speaking, each and every insurer set its own rates; the Insurance Commissioner set not a one. In concluding to the contrary, the superior court read Proposition 103 as construed in Calfarm to preclude the Insurance Commissioner from setting rates himself and to allow him merely to approve or disapprove rates proposed by individual insurers, applying (as relevant here) the excessive/inadequate standard. This was a misreading. Proposition 103 as construed in Calfarm requires the Insurance Commissioner, if he finds the initiative's maximum rate confiscatory for an individual insurer, to determine a higher maximum rate that is minimally nonconfiscatory. He does not set a rate in so doing. Further, it is not the case that Proposition 103 as construed in Calfarm allows the Insurance Commissioner merely to approve or disapprove insurer-proposed rates under the excessive/inadequate standard. That standard belongs to the prior approval system, which governs rates from November 8, 1989, into the future. It does not extend to the rate rollback, which obtained for rates from November 8, 1988, through November 7, 1989. Even if it did, it would matter not. The superior court effectively recognized that an individual insurer's maximum rate for the rollback year, if above 80 percent of the 1987 rate, must be that which is minimally nonconfiscatory: Under the rate rollback requirement provision  to use the terms appearing in Insurance Code section 1861.05, subdivision (a)  a rate is inadequate if confiscatory and excessive if more than minimally nonconfiscatory and above 80 percent of the 1987 rate. It would exalt form over substance, and entail the needless expense of time and money, to hold that the commissioner could only disapprove a perhaps numberless succession of insurer-proposed rates fixed above the minimally nonconfiscatory until finally he was required to approve such a rate that happened to hit the proper level  instead of simply determining the minimally nonconfiscatory rate at the outset. Proposition 103 as construed in Calfarm does not require the commissioner to take a passive role when an active one is not barred. [15] (17) In supporting the superior court's conclusion to the effect that Proposition 103 does not authorize the Insurance Commissioner to adopt any ratemaking formula whatsoever to implement the rate rollback requirement provision, the insurers take the same fatal misstep. That is to say, they misread Proposition 103 as construed in Calfarm. Their misreading, however, appears even more profound. They would apparently abrogate the rate rollback requirement provision in its entirety by requiring the commissioner to proceed as under the prior approval system, i.e., to approve any proposed rate that is below the excessive and above the inadequate. The commissioner may not do so. As stated, under the rate rollback requirement provision  to use the terms appearing in Insurance Code section 1861.05, subdivision (a)  a rate is inadequate if confiscatory and excessive if more than minimally nonconfiscatory and above 80 percent of the 1987 rate. At the heart of the insurers' argument is an assertion to the effect that Calfarm invalidated the rate rollback requirement provision and substituted in its place the substantive standard of the prior approval system. The assertion is unsupported. Calfarm invalidated the procedural mechanism for relief from the rate rollback requirement provision and not the rate rollback requirement provision itself. It substituted the procedural mechanism for the prior approval system and not the substantive standard of the prior approval system. (18a), (19a) The second of the two major bases on which the superior court rested its determination that the rate regulations as to rollbacks are invalid with respect to the ratemaking formula was its conclusion to the following effect: Proposition 103 does not authorize the Insurance Commissioner to adopt the ratemaking formula in question to implement the rate rollback requirement provision; that formula is recursive; unique and without precedent among similar statutes containing the widely used excessive/inadequate standard; and internally inconsistent: through operation of the efficiency standards, the variable expense factor, and the leverage factor, it precludes a return covering the insurer's cost of service plus 10 percent of its capital base  a 10 percent rate of return on the capital base being defined as the lower boundary of the range of reasonable rates of return; through such preclusion, the formula is also confiscatory; confiscation does not require deep financial hardship within the meaning of Jersey Central. In this regard too, the superior court's conclusion is substantially erroneous. (18b) To be sure, the ratemaking formula is indeed recursive. But contrary to the superior court's evident belief and the insurers' vigorously urged position, that is no vice. The adjective is not pejorative. It is merely descriptive. Simply put, it means in this context that the value solved for figures in the solution itself. For example, an insurer desires to determine the rate it must charge its insureds to net $100 after paying a 20 percent commission to its agents. It uses the following recursive formula, in which r refers to the rate to be charged: r = $100 + 0.2 r ; r - 0.2 r = $100; 0.8 r = $100; r = $125. In and of itself, recursiveness is not objectionable. To the extent that the complaint goes beyond recursiveness to mere complexity, it fails. Although complicated, the ratemaking formula is not unduly so. (Cf., e.g., Cal. Code Regs., tit. 22, § 51536 et seq. [setting rates for reimbursement for hospital inpatient services provided to Medi-Cal program beneficiaries]; see especially id., § 51549 [establishing a reimbursement formula].) Similarly, the ratemaking formula is apparently unique and without precedent among similar statutes containing the widely used excessive/inadequate standard. But again contrary to the superior court's evident belief and the insurers' vigorously urged position, that is no vice. The reason is short and simple: So far as the ratemaking formula functions in the rate rollback, the temporary regulatory regime that operated from November 8, 1988, through November 7, 1989, it has nothing to do with the prior approval system, the permanent regulatory regime that obtains from November 8, 1989, into the future. That the two regimes are distinct is apparent in Proposition 103. It remains such in our construction of the initiative in Calfarm. In any event, we must observe that the excessive/inadequate standard as defined in Proposition 103 is itself apparently unique and without precedent among similar statutes.... In subdivision (a) of Insurance Code section 1861.05, it shows itself to be distinguishable from the others: In considering whether a rate is excessive, inadequate or unfairly discriminatory, no consideration shall be given to the degree of competition and the commissioner shall consider whether the rate mathematically reflects the insurance company's investment income. The insurers direct our attention to what purports to be a campaign statement made prior to the November 8, 1988, General Election by Voter Revolt, the proponent of Proposition 103, to the effect that the prior approval system in the initiative is [b]ased on [a] tested system in effect in 19 states. The statement says only that the initiative's prior approval system is based on similar systems. It does not say that it is identical to any one. The insurers argue in substance that the excessive/inadequate standard as defined in the initiative should be interpreted in accordance with the insurance industry's or the actuarial profession's understanding of its operative terms. We believe that subdivision (a) of Insurance Code section 1861.05, as quoted above, stands in the way. (19b) Further, the ratemaking formula is not internally inconsistent. Contrary to the superior court's evident assumption, the ratemaking formula does not purport to guarantee the individual insurer a rate covering its cost of service plus 10 percent of its capital base independent of the various adjustments, exclusions, etc., incorporated therein. (20) We do not think it improper  constitutionally or otherwise  for the rate regulations as to rollbacks to recognize as the insurer's cost of service only the reasonable cost of providing insurance. It is not objectionable that the ratemaking formula's efficiency standards operate to define the reasonable cost of providing insurance after subjecting the insurer's expenses ... to downward normative pressure. ( Massachusetts Auto. Rating & Accident Prevention Bureau v. Commissioner of Ins. (1980) 381 Mass. 592, 602 [411 N.Ed.2d 762, 768].) The insurers charge that such devices are unprecedented outside the monopoly or public utility setting. That does not appear to be the case. (See 411 N.Ed.2d at pp. 768-769.) It is also not objectionable that the ratemaking formula's variable expense factor excludes from the reasonable cost of providing insurance such commissions and state premium taxes as would have been avoided had the insurer charged a rate for the rollback year no higher than the maximum rate set by Proposition 103 as construed in Calfarm  i.e., the rate that is 80 percent of the 1987 rate or such rate greater than 80 percent of the 1987 rate as is minimally nonconfiscatory. [I]t surely cannot be reasonable for an investor to assume that each and every expenditure ... will be allowed by regulatory authorities. ( Jersey Cent. Power & Light Co. v. F.E.R.C., supra, 810 F.2d at p. 1193 (conc. opn. of Starr, J.).) (21) Neither do we think it improper for the rate regulations as to rollbacks to recognize as the insurer's capital base only the capital used and useful for providing insurance. (See Jersey Cent. Power & Light Co. v. F.E.R.C., supra, 810 F.2d at p. 1175 [holding that the used and useful rule is a permissible tool[] of ratemaking under the takings clause].) On this point, the superior court is in accord, expressly acknowledging that insureds need not provide a return on capital which is not required for insurance business and impliedly acknowledging that insureds need not provide a return on capital that is not actually employed for that purpose. As stated above, it appears that the insurance industry's surplus (i.e., its available capital backing up premiums) is greatly represented by appreciating assets, as opposed to depreciating assets. At one and the same time, surplus surplus  that is, surplus beyond what is useful to back up premiums  inflates the insurer's capital base and any rate set thereon to the disadvantage of its insureds and also produces investment income from appreciating assets. [I]t surely cannot be reasonable for an investor to assume that each and every [investment] ... will be [recognized] by regulatory authorities. ( Jersey Cent. Power & Light Co. v. F.E.R.C., supra, 810 F.2d at p. 1193 (conc. opn. of Starr, J.).) (22) In addition, we do not think it improper for the rate regulations as to rollbacks to take account of investment income on capital used and useful for providing insurance. The observation by the administrative law judge is sound. [U]nlike other businesses such as public utilities, insurers need not transform their capital into physical assets like a power plant, but may keep them instead in liquid assets like stocks and bonds. Surplus may simultaneously support the insurance business and earn investment income. Certainly, under the prior approval system, in the words of Insurance Code section 1861.05, subdivision (a), Proposition 103 expressly requires that the Insurance Commissioner shall consider whether the rate mathematically reflects the insurance company's investment income. The initiative thereby impliedly requires that the commissioner shall offset the latter against the former. We note that, to the benefit of insurers, the regulations in question take no account of investment income on capital not used and useful for providing insurance. They thereby effectively prohibit the commissioner from considering any of such investment income in carrying out the mandate of Calfarm, i.e., in determining whether, for the individual insurer, a maximum rate for the rollback year higher than 80 percent of the 1987 rate is required to avoid confiscation and, if so, what such higher maximum rate is. In other words, they prevent a portion of investment income that would otherwise reduce an insurer's maximum rate for the rollback year from doing so. (19c) It bears emphasis that the 10 percent rate of return on the individual insurer's capital base, which is defined as the lower boundary of the range of reasonable rates of return, is not an entitlement conferred by the rate regulations as to rollbacks. It is simply a component of the ratemaking formula. ( Fireman's Fund Ins. Co. v. Garamendi, supra, 790 F. Supp. at p. 948.) Of course, any given rate of return can operate to generate a rate that is much too high or much too low. The result depends directly on how the insurer's capital base is determined and indirectly on how its cost of service is specified. If the capital base is overstated, the defined rate of return will produce a return that is unduly high; if the opposite, the same rate of return will produce a return that is unduly low. Similarly, if the cost of service is inflated, the covering of expenses will itself generate a profit without regard to the defined rate of return; if the opposite, the covering of expenses will not avoid a loss unless the same rate of return generates an offsetting profit. [16] Not only is the ratemaking formula not internally inconsistent, it is also not confiscatory or arbitrary, discriminatory, or demonstrably irrelevant to legitimate policy. At this point, we would do well to rehearse, and elaborate on, the principles set out in Calfarm. The Fourteenth Amendment to the United States Constitution provides in relevant part that [no] state [shall] deprive any person of ... property, without due process of law.... (23a) The standard for determining whether a state price-control regulation is constitutional under the Due Process Clause is well established: `Price control is unconstitutional ... if arbitrary, discriminatory, or demonstrably irrelevant to the policy the legislature is free to adopt....' ( Pennell v. San Jose (1988) 485 U.S. 1, 11 [99 L.Ed.2d 1, 14, 108 S.Ct. 849].) A legitimate and rational goal of price or rate regulation is the protection of consumer welfare. ( Id. at p. 13 [99 L.Ed.2d at p. 15].) Such regulation is presumptively constitutional under the due process clause. (See, e.g., Tenoco Oil Co. v. Dept. of Consumer Affairs (1st Cir.1989) 876 F.2d 1013, 1022, fn. 15.) The burden of proving otherwise rests on the party asserting the violation.... ( Ibid. ) It is not easily met. For the last half-century, courts have upheld challenged governmental acts unless no reasonably conceivable set of facts could establish a rational relationship between the regulation and the government's legitimate ends. ( Ibid., italics in original.) It is enough that there is an evil at hand for correction, and that it might be thought that the particular ... measure was a rational way to correct it. ( Williamson v. Lee Optical Co., supra, 348 U.S. at p. 488 [99 L.Ed. at p. 572] [speaking generally of state regulation of business and industrial conditions].) The Fifth Amendment to the United States Constitution declares as pertinent here that private property [shall not] be taken for public use without just compensation. (24) This prohibition binds the states through the mandate of the Fourteenth Amendment, quoted above, that [no] state [shall] deprive any person of ... property, without due process of law.... ( Chicago, Burlington &c. R'D v. Chicago (1897) 166 U.S. 226, 235-241 [41 L.Ed. 979, 984-986, 17 S.Ct. 581].) In other words, the Fifth Amendment's takings clause is enforceable against the states through the Fourteenth Amendment's due process clause. (25a) The takings clause limits the power of the states to regulate, control, or fix prices that producers charge consumers for goods or services. (See, e.g., Duquesne Light Co. v. Barasch (1989) 488 U.S. 299, 307-308 [102 L.Ed.2d 646, 656-657, 109 S.Ct. 609].) Rate-making is indeed but one species of price-fixing. [Citation.] The fixing of prices, like other applications of the police power, may reduce the value of the property which is being regulated. But the fact that the value is reduced does not mean that the regulation is invalid. ( Power Comm'n v. Hope Gas Co., supra, 320 U.S. at p. 601 [88 L.Ed. at p. 344].) [17] The crucial question under the takings clause is whether the rate set is just and reasonable. (See, e.g., Duquesne Light Co. v. Barasch, supra, 488 U.S. at pp. 307-308 [102 L.Ed.2d at pp. 656-657].) If it is not just and reasonable, it is confiscatory. ( Ibid. ) If it is confiscatory, it is invalid. ( Ibid. ) [I]t is the result reached not the method employed which is controlling. ( Power Comm'n v. Hope Gas Co., supra, 320 U.S. at p. 602 [88 L.Ed. at p. 345]; see Duquesne Light Co. v. Barasch, supra, 488 U.S. at p. 310 [102 L.Ed.2d at pp. 658-659].) The method may of course be traditional, and may involve case-by-case ratemaking using data reflecting the condition and performance of the regulated firm as an individual entity. But it may also be novel (see Duquesne Light Co. v. Barasch, supra, 488 U.S. at p. 316 [102 L.Ed.2d at p. 662] [stating that the designation of a single theory of ratemaking as a constitutional requirement would unnecessarily foreclose alternatives which could benefit both consumers and investors]), and may implicate formulaic ratemaking (see Permian Basin Area Rate Cases (1968) 390 U.S. 747, 768-770 [20 L.Ed.2d 312, 336-338, 88 S.Ct. 1344]) using data reflecting the condition and performance of a group of regulated firms (see id. at pp. 766-790 [20 L.Ed.2d at pp. 335-349]; Giles Lowery Stockyards v. Dept. of Agriculture (5th Cir.1977) 565 F.2d 321, 327 [The `just and reasonable' principle does not require `that the cost of each company be ascertained and its rates fixed with respect to its own costs.' [Citation.] It is permissible for an agency to use average costs rather than the costs of individual regulated firms.]). It is not subject to piecemeal examination: The economic judgments required in rate proceedings are often hopelessly complex and do not admit of a single correct result. The Constitution is not designed to arbitrate these economic niceties. ( Duquesne Light Co. v. Barasch, supra, 488 U.S. at p. 314 [102 L.Ed.2d at p. 661].) And, of course, courts are not equipped to carry out such a task. (See, e.g., Harris v. Capital Growth Investors XIV (1991) 52 Cal.3d 1142, 1166 [278 Cal. Rptr. 614, 805 P.2d 873] [stating that we are ill equipped to make microeconomic decisions].) [S]o long as rates as a whole afford [the regulated firm] just compensation for [its] over-all services to the public, they are not confiscatory. ( B. & O.R. Co. v. United States (1953) 345 U.S. 146, 150 [97 L.Ed. 912, 916, 73 S.Ct. 592].) That a particular rate may not cover the cost of a particular good or service does not work confiscation in and of itself. (See id. at pp. 147-150 [97 L.Ed. at pp. 914-916].) In other words, confiscation is judged with an eye toward the regulated firm as an enterprise. (26a) The answer to the question whether the rate set is just and reasonable depends on a balancing of the interests of the producers of the goods or services under regulation and the interests of the consumers of such goods or services. In Power Comm'n v. Hope Gas Co., supra, 320 U.S. 591, the court spoke through Justice Douglas. The Hope court made plain that the consumer has a legitimate interest in freedom from exploitation. (See Power Comm'n v. Hope Gas Co., supra, 320 U.S. at p. 610 [88 L.Ed. at p. 349] [recognizing that exploitation of consumers at the hands of natural gas companies was an evil[]]; see generally, Power Comm'n v. Pipeline Co. (1942) 315 U.S. 575, 606-608 [86 L.Ed. 1037, 1060-1061, 62 S.Ct. 736] (conc. opn. of Black, Douglas, and Murphy, JJ.).) The Hope court also made plain that, for its part, the producer has a legitimate concern with [its own] financial integrity.... From the investor or company point of view it is important that there be enough revenue not only for operating expenses but also for the capital costs of the business. These include service on the debt and dividends on the stock. [Citation.] By that standard the return to the equity owner should be commensurate with returns on investments in other enterprises having corresponding risks. That return, moreover, should be sufficient to assure confidence in the financial integrity of the enterprise, so as to maintain its credit and to attract capital. ( Power Comm'n v. Hope Gas Co., supra, 320 U.S. at p. 603 [88 L.Ed. at p. 345].) It must be emphasized that the foregoing describes an interest that the producer may pursue and not a right that it can demand. That interest is only one of the variables in the constitutional calculus of reasonableness. ( Permian Basin Area Rate Cases, supra, 390 U.S. at p. 769 [20 L.Ed.2d at p. 337].) A regulated [firm] has no constitutional right to a profit.... ( Jersey Cent. Power & Light Co. v. F.E.R.C., supra, 810 F.2d at pp. 1180-1181; accord, Power Comm'n v. Pipeline Co., supra, 315 U.S. at p. 590 [86 L.Ed.2d at p. 1052] [regulation does not insure that the business shall produce net revenues]; Power Comm'n v. Hope Gas Co., supra, 320 U.S. at p. 603 [86 L.Ed. at p. 345], quoting Power Comm'n v. Pipeline Co., supra, 315 U.S. at p. 590 [86 L.Ed.2d at p. 1051].) Indeed, such a firm has no constitutional right even against a loss. (See Market Street R. Co. v. Comm'n (1945) 324 U.S. 548, 564 [89 L.Ed. 1171, 1183, 65 S.Ct. 770] [holding that a rate is not necessarily confiscatory even if it compel[s] a regulated firm to operate at a loss].) [18] In balancing the relevant producer and consumer interests for a just and reasonable rate, one is concerned with a broad zone of reasonableness and not with any particular point therein. ( Permian Basin Area Rate Cases, supra, 390 U.S. at p. 770 [20 L.Ed.2d at p. 338].) So long as the rate set is within that zone, there can be no constitutional objection.... ( Ibid. ) (27a) In attempting to balance producer and consumer interests, one may of course arrive at a rate that disappoints one or even both parties. But a striking of the balance to the producer's detriment does not necessarily work confiscation. Indeed, it can threaten confiscation only when it prevents the producer from operating successfully  as that phrase is impliedly defined in prior opinions and is expressly used in this, viz., operating successfully during the period of the rate and subject to then-existing market conditions. [19] The Hope court itself expressly held that [r]ates which enable the company to operate successfully, to maintain its financial integrity, to attract capital, and to compensate its investors for the risks assumed certainly cannot be condemned as invalid, even though they might produce only a meager return.... ( Power Comm'n v. Hope Gas Co., supra, 320 U.S. at p. 605 [88 L.Ed. at p. 346].) A year later, the court restated this holding in even simpler terms in a unanimous opinion by Justice Jackson: a company [cannot] complain if the return which was allowed made it possible for the company to operate successfully. ( Market Street R. Co. v. Comm'n, supra, 324 U.S. at p. 566 [89 L.Ed. at p. 1184].) The Hope court's holding is indisputably vital. Just five years ago, in Duquesne Light Co. v. Barasch, supra, 488 U.S. 299, the court, in an opinion by Chief Justice Rehnquist, undertook to review[] 90 years of its own cases concerning ... rate regulation (2 Rotunda & Nowak, Treatise on Constitutional Law (2d ed. 1992) § 15.12, p. 504), and then went on to reaffirm the[] teachings of Hope, quoting in the process the holding set out above ( Duquesne Light Co. v. Barasch, supra, 488 U.S. at p. 310 [102 L.Ed.2d at pp. 658-659]). Consistently with Hope, it effectively defined a confiscatory rate thus: A rate is too low if it is `so unjust as to destroy the value of [the] property for all the purposes for which it was acquired,' and in so doing `practically deprive[s] the owner of property without due process of law[.]' ( Id. at pp. 307-308 [102 L.Ed.2d at p. 657], quoting Covington &c. Turnpike Co. v. Sandford (1896) 164 U.S. 578, 597 [41 L.Ed. 560, 567, 17 S.Ct. 198].) Thus, a producer may complain of confiscation only if the rate in question does not allow it to operate successfully. This conclusion follows from the Hope court's holding that it cannot complain if it enables it to operate successfully. (See Tribe, American Constitutional Law (2d ed. 1988) p. 593, fn. 3 [characterizing Hope as a standard that only the most egregiously confiscatory rate structure would have difficulty meeting].) In a word, the inability to operate successfully is a necessary  but not a sufficient  condition of confiscation. In Jersey Central, the United States Court of Appeals for the District of Columbia Circuit, sitting in bank, and speaking through Judge Bork, explained: Under Hope, ... the only circumstances under which there is a possibility of a taking of investors' property by virtue of rate regulation is when a [regulated firm] is in the sort of financial difficulty described in Justice Douglas' opinion, viz., deep financial hardship. ( Jersey Cent. Power & Light Co. v. F.E.R.C., supra, 810 F.2d at p. 1181, fn. 3.) The firm may experience such hardship when it does not earn enough revenue for both operating expenses and the capital costs of the business, including service on the debt and dividends on the stock, of a magnitude that would allow a return to the equity owner that is commensurate with returns on investments in other enterprises having corresponding risks and sufficient to assure confidence in the financial integrity of the enterprise, so as to maintain its credit and to attract capital. ( Power Comm'n v. Hope Gas Co., supra, 320 U.S. at p. 603 [88 L.Ed. at p. 345].) But absent the sort of deep financial hardship described in Hope, concluded the Jersey Central court, there is no taking.... ( Jersey Cent. Power & Light Co. v. F.E.R.C., supra, 810 F.2d at p. 1181, fn. 3.) This follows from the fact that, under Hope, a regulated firm may claim that a rate is confiscatory only if the rate does not allow it to operate successfully. In such circumstances, the firm is not inaptly characterized as experiencing deep financial hardship as a result of the rate. Although Jersey Central was not unanimous, on this point at least the dissenters were in accord with the majority. In Hope,  stated Judge Mikva, the Court faced an assertion by the [regulated firm] that the rates fixed by the [regulator] were so low as to be unjust and unreasonable. In testing this challenge, the Court essentially questioned whether the [regulated firm's] shareholders had anything to complain about. The Court examined what was `important' `from the investor or company point of view' and found that the rate at issue fully satisfied any legitimate investor interest. [Citation.] Accordingly, the Court held that the rate could not be condemned from the investor viewpoint. [Citation.] One year later, Justice Jackson, speaking for a unanimous court [in Market Street R. Co. v. Comm'n, supra, 324 U.S. at page 566 [89 L.Ed. at p. 1184], restated] ... the Court's holding in Hope : `All that was held was that a company could not complain if the return which was allowed made it possible for the company to operate successfully.' ( Jersey Cent. Power & Light Co. v. F.E.R.C., supra, 810 F.2d at p. 1211 (dis. opn. of Mikva, J.).) (25b) When, as here, the question arises whether a regulation is violative of the takings clause on its face, the question is whether its terms preclude the setting of a rate that is just and reasonable as to the regulated firm, and hence nonconfiscatory. (Cf. Calfarm Ins. Co. v. Deukmejian, supra, 48 Cal.3d at p. 816 [speaking of a statute]; but see Fireman's Fund Ins. Co. v. Garamendi, supra, 790 F. Supp. at p. 948 [implying that a regulation is not properly subject to a facial takings challenge either in whole or in part].) (23b), (25c), (26b), (27b) Finally, the law under the due process clause of article I, sections 7 and 15 of the California Constitution and the takings clause of article I, section 19 of that same instrument is in accord with the foregoing principles. (28) Against this background, the ratemaking formula cannot be deemed arbitrary, discriminatory, or demonstrably irrelevant to legitimate policy. It is demonstrably relevant to the policy of protection of consumer welfare  a policy that the voters were free to adopt, and did in fact adopt, in approving Proposition 103. Further, it is not arbitrary, taking an approach to rates that is a reasonable one, although not the only such approach. Lastly, it is not discriminatory. To the extent that it may be said to disfavor insurers and favor their insureds, it does so well within the limits marked out by due process jurisprudence since at least the late 1930's. (29) Neither can the ratemaking formula be deemed confiscatory. Its terms do not themselves preclude the setting of a rate that is just and reasonable. Put differently, they do not themselves impose a rate, to quote Jersey Central, that inflicts on insurers the sort of deep financial hardship described in Hope. ... ( Jersey Cent. Power & Light Co. v. F.E.R.C., supra, 810 F.2d at p. 1181, fn. 3.) This point is crucial. It deserves special emphasis. The superior court committed fundamental error. At least in the general case, such as this, confiscation does indeed require deep financial hardship within the meaning of Jersey Central, i.e., the inability of the regulated firm to operate successfully  meaning, again, the inability of the regulated firm to operate successfully during the period of the rate and subject to then-existing market conditions. (Accord, Rural Telephone Coalition v. F.C.C. (D.C. Cir.1988) 838 F.2d 1307, 1313 [267 App.D.C. 357] [following Jersey Central to hold that absent `deep financial hardship ... there is no taking'].) Hence, it does not arise, as the superior court erroneously believed, whenever a rate simply does not produce[] a profit which an investor could reasonably expect to earn in other businesses with comparable investment risks and which is sufficient to attract capital. Profit of that magnitude is, of course, an interest that the producer may pursue. But it is not a right that it can demand. It is only one of the variables in the constitutional calculus of reasonableness. ( Permian Basin Area Rate Cases, supra, 390 U.S. at p. 769 [20 L.Ed.2d at p. 337].) In FERC v. Pennzoil Producing Co. (1979) 439 U.S. 508, 518 [58 L.Ed.2d 773, 782-783, 99 S.Ct. 765], the court declared, with a quotation from Hope, that the notion that [a regulator] is required to maintain, or even allowed to maintain to the exclusion of other considerations, the profit margin of any particular [regulated firm] is incompatible ... with a basic precept of rate regulation. `The fixing of prices, like other applications of the police power, may reduce the value of the property which is being regulated. But the fact that the value is reduced does not mean that the regulation is invalid.' In concluding that the ratemaking formula cannot be deemed confiscatory on the ground that its terms themselves preclude the setting of a rate that is just and reasonable, we have given special attention to the definition of 10 percent as the lower boundary of the range of reasonable rates of return. The Fireman's Fund court considered an argument by insurers, including those here, that the 10% rate of return set by the Commissioner is the constitutional minimum, and that any improperly disallowed expenses, or improper decreases in the capital base to which the rate of return is applied, have the effect of lowering the rate below the constitutional minimum. ( Fireman's Fund Ins. Co. v. Garamendi, supra, 790 F. Supp. at p. 948.) The court rejected the point. [The insurers] assume that the Commissioner selected the 10% figure in a vacuum. By itself, the figure has no constitutional dimension. And it is not res judicata on the issue of what constitutes the minimum nonconfiscatory rate. As the Commissioner points out, `[t]he 10 percent is not the end result of the regulations but merely a component.' It is the end result that counts. ( Ibid. ) We are in accord. It must be remembered that the rate regulations as to rollbacks expressly provide for variances as the final mechanism for rate adjustments necessary to avoid confiscation. We believe that if confiscation nonetheless results, it is properly charged against the variances. We shall turn to that question below. (See pt. III.I., post. ) [20] In supporting the superior court's conclusion that Proposition 103 does not authorize the Insurance Commissioner to adopt the ratemaking formula in question to implement the rate rollback requirement provision, the insurers make a number of arguments. Most have been anticipated and answered in the preceding discussion. Their ultimate constitutional premise is unsound. To repeat: At least in the general case, such as this, confiscation does indeed require deep financial hardship within the meaning of Jersey Central. Hence, it does not arise, as the superior court erroneously believed, whenever a rate does not produce[] a profit which an investor could reasonably expect to earn in other businesses with comparable investment risks and which is sufficient to attract capital. Profit of that magnitude is, of course, an interest that the producer may pursue. But it is not a right that it can demand. It is only one of the variables in the constitutional calculus of reasonableness. ( Permian Basin Area Rate Cases, supra, 390 U.S. at p. 769 [20 L.Ed.2d at p. 337].) The insurers also argue against the ratemaking formula on what appears to be the ground that the United States and/or California Constitutions prohibit the use of such a formula, at least when constitutional rights are implicated. More than 50 years of regulatory jurisprudence in this court and the United States Supreme Court refute the assertion. The insurers further argue against the ratemaking formula with what appears to be an assertion that the formula may prove to be even more confiscatory than the rate rollback requirement provision of Proposition 103 itself. The former offers a possibility of relief from the latter's maximum rate. It simply cannot reduce that rate further. (30a) In addition, the insurers argue against the ratemaking formula thus: the formula improperly looks toward factors including the individual insurer's profits; a proper formula  at least according to 20th Century  would impose general price caps on the rates of insurers generally. [21] We do not think the ratemaking formula improper for looking toward factors including the individual insurer's profits. The insurers say that such an orientation would be proper only in the monopoly or public utility setting, which assertedly does not include the insurance industry. They do not persuade. The insurers press their position. The gist of their argument is that the voters' approval of Proposition 103 and their disapproval of other insurance-related measures on the same ballot, especially Proposition 100, reveals an intent to establish a system of regulation that turns out to be remarkably similar to that of open competition. The point is urged strongly. But it falls of its own weight. (31) If nothing else is clear, this is: Proposition 103 was intended to do away with the open competition system. The initiative provides for control of rates by means of regulation  initially through the rate rollback, the temporary regulatory regime that operated from November 8, 1988, through November 7, 1989, and then through the prior approval system, the permanent regulatory regime that obtains from November 8, 1989, into the future. Such control of rates as may be said to have existed under the open competition system was essentially through market forces alone. That the initiative seeks, as it were, to open competition by repeal[ing] laws that ... bar banks from selling insurance ( Calfarm Ins. Co. v. Deukmejian, supra, 48 Cal.3d at p. 841 [referring to Prop. 103, Gen. Elec. (Nov. 8, 1988), § 7, reprinted in Ballot Pamp., Proposed Stats. and Amends. to Cal. Const. with arguments to voters, Gen. Elec. (Nov. 8, 1988) p. 141]) does not preserve the open competition system. That one of the initiative's purposes is to encourage a competitive insurance marketplace (Prop. 103, Gen. Elec. (Nov. 8, 1988), § 2, reprinted in Ballot Pamp., Proposed Stats. and Amends. to Cal. Const. with arguments to voters, Gen. Elec. (Nov. 8, 1988) p. 99) does not deny that another of its purposes is to subject that marketplace to rate regulation. Similarly, that one of the initiative's intermediate goals is the encouragement of a competitive insurance marketplace does not deny that its ultimate goal is the guaranty that insurance is fair, available, and affordable for all Californians. ( Ibid. ) (30b) We agree with the insurers that a ratemaking formula that looks toward factors including the individual insurer's profits would have fit quite easily within the context of Proposition 100. (See Prop. 100, Gen. Elec. (Nov. 8, 1988) § 8, reprinted in Ballot Pamp., Proposed Stats. and Amends. to Cal. Const. with arguments to voters, Gen. Elec. (Nov. 8, 1988) pp. 131-132.) But we disagree that a ratemaking formula of this sort is out of place in the setting of Proposition 103. Most broadly stated, the insurers' argument seems to be that under the rate rollback, Proposition 103 requires that rates must be determined, as it were, in the abstract, without consideration in a ratemaking formula or elsewhere of the individual insurer's performance and condition, as revealed in cost of service, capital base, rate of return, etc. That cannot be. As approved by the voters, the initiative in subdivision (b) of Insurance Code section 1861.01 made relief from the rate rollback requirement provision dependent on a substantial threat of insolvency. Insolvency implicates the individual insurer's performance and condition. As construed in Calfarm, the initiative makes relief dependent on confiscation. ( Calfarm Ins. Co. v. Deukmejian, supra, 48 Cal.3d at pp. 816-826.) Confiscation also implicates the individual insurer's performance and condition. As to 20th Century's argument for regulation by price caps rather than factors including profits, we find persuasive the administrative law judge's response. An argument of this sort is bottomed on policy rather than law  specifically, a policy that would have us ignore Calfarm 's emphasis on such factors as profits and Proposition 103's call for reduction of rates industry-wide, regardless of whether the rates were low or high by industry standards.... (Italics added in place of underscoring in original.) Under the rate rollback requirement provision  to use the terms appearing in Insurance Code section 1861.05, subdivision (a)  a rate is inadequate if confiscatory and excessive if more than minimally nonconfiscatory and above 80 percent of the 1987 rate.