Opinion ID: 1293583
Heading Depth: 1
Heading Rank: 16

Heading: underwriting profit

Text: The next question presented is one argued by the Commissioner in his brief. Unfortunately he failed to give any notice of appeal from the Court of Appeals' determination adverse to his position, and appellants have consequently filed a motion to this Court to strike that portion of the Commissioner's brief. In view of the importance of the question presented for future ratemaking hearings, however, we elect to address the question on its merits, despite the procedural irregularity. Among the factors to which due consideration is to be given in determining a proper insurance rate is a reasonable margin for underwriting profit and . . . contingencies. G.S. 58-124.19(2). In his order, the Commissioner in essence rejected the traditional five percent of gross premium allowed for underwriting profit and contingencies. In lieu thereof, the Commissioner adopted a complicated, lengthy and novel formula for determining underwriting profit allowance. Among his conclusions were the following: 18. That the determination of underwriting profit margins should be calculated in accord with contemporary concepts of risk and return as understood in financial theory, specifically the capital asset pricing model as testified to by expert witness Dr. William Bishop Fairley and detailed in the attached appendix[,] the use of which theory and methodology in automobile insurance ratemaking has been upheld by the Supreme Judicial Court of Massachusetts. 19. That, to determine the level of underwriting profit allowance which, if earned along with minimum reasonable investment results, would produce for the average carrier a rate of return on capital expressed, as a percentage of premium volume, equal to that achieved by a typical business of similar risk characteristics[.] [F]ive sequential steps are involved:. . . . Following the above, the Commissioner's order sets out the detailed five sequential steps, comprising three pages of the record. We think the Court of Appeals correctly and succinctly presented the issue. Judge Arnold wrote: William Fairley qualified as an expert in economics and statistics, and testified as to the proper method of calculating appropriate rates of return in the insurance industry. His theory, in essence, requires that a target rate of return to the insurance companies be established. This is done by considering the systematic risk in the industry, that is, the degree to which the variability in return on an investment in that industry moves with the stock market, and adding the necessary reward to encourage investors to hold those securities. (For example, a stock that went down twenty percent when the market went down ten would have a high systematic risk and would require a higher reward.) This target rate of return is then used to calculate the appropriate underwriting profit as follows: Target Return = Underwriting + Investment + Investment Profit Return on Return on Cash Flow Capital or Underwriting = Target - Investment - Investment Return Return on Return on Cash Flow Capital The Commissioner ordered that this capital asset pricing model be used to calculate underwriting profit margins. 41 N.C.App. at 318, 255 S.E.2d at 562. We first observe that we do not reject the Commissioner's formula because it is either complicated, lengthy, or novel. As explained fully in Section II. of this opinion, we do not interpret prevailing law to require that administrative agencies be unimaginative in the discharge of their duties. Indeed, within the general guidelines of the statutes, administrative agencies are to work out the details in order to effectuate the general policy set forth by the applicable statutes. The expertise of the administrative agency is absolutely essential in dealing with technical and complicated matters such as that presented by this issue. However, for the reasons stated below, we agree with the Court of Appeals' conclusion that this portion of the Commissioner's order must be reversed.