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

Heading: allowance for losses

Text: A. The Formation of the Rate Level Pure Premium. Whereas the Commissioner innovated in his methods for establishing the allowances for expenses and profits, he used the conventional method for determining the loss allowance. The rate setter uses as his basis for prediction the most recent year for which reasonably complete claims data are available; in setting the 1976 rates, he used the claims experience for the 1974 policy year. The rate setter takes the total claims arising from 1974 policies plus certain expenses allocated to those claims (1974 losses in insurance terminology) and divides by the total insurance exposure, i.e., the number of car years for which policies were written. Thereby he derives the 1974 Raw Pure Premium. This figure is the observed 1974 loss cost per vehicle. From it, the rate setter builds a parallel predicted figure for 1976 just adequate to cover the expected 1976 loss  the 1976 Rate Level Pure Premium. He does this by making several adjustments in the 1974 Raw Pure Premium to take account of the fact that the data arising out of 1974 policies are not final, and the further fact that the 1976 experience will differ in predictable ways from that observed for the 1974 policy year. Each of the adjustments is expressed as a multiplicative factor. (1) The development factor. The 1974 data are not final at the time of the rate setting process. Some claims have not yet been filed, and the loss adjuster's estimate of the size of claims filed but not paid may prove to be erroneous. The adjustment of the 1974 Raw Pure Premium to reflect expected final loss experience is made by means of a development factor which is estimated from the observed change during the course of a year of the losses attributed to other policy years. See Massachusetts Bonding & Ins. Co. v. Commissioner of Ins., 329 Mass. 265, 274 (1952). (2) Trend and projection factors. The losses on the 1976 policies will be paid, on average, later than those on the 1974 policies, and it can be expected that cost levels for the losses in the two years will differ, necessitating an adjustment for the change in those levels. The 1974 losses reflect experience for policies centered on July 1, 1974, and the period for which rates are set centers on July 1, 1976. The trend factor adjusts for observed changes in price levels from July, 1974, to a later point for which data are available, and the projection factor adjusts for any expected continued change in prices to July, 1976. [5] (3) Frequency adjustment. If the probability that an insured vehicle will be involved in a claim is expected to be different in 1976 than in 1974, a further adjustment is needed to reflect the difference. Before getting into our analysis of the factors just mentioned, we note that the data for 1974 which form the basis for the estimation of the 1976 Rate Level Pure Premium were collected and summarized by the Bureau, and are not directly challenged here. The Bureau's contention is that the Commissioner committed certain errors in fixing the adjustment factors in the light of these data and others. As the type of insurance coverage has a bearing on the estimation of the adjustment factors, we have to consider separately the bodily-injury and property-damage coverages. B. The Bodily-Injury Coverages. (1) The development factor. The Bureau recommended a development factor of 1.085, based on an examination of the change in the course of one year (1974) of the losses attributed to a series of recent policy years. However, the actuary for the Division of Insurance (Division) observed that the development factor for changes in the losses in the previous year (1973) was much less. He considered the factor to be a predictor which should not vary radically from one rate revision to the next; and he attributed the difference in the factors for the two years to some form of variation in the data rather than to [the] intrinsic property of the losses themselves. Accordingly, he recommended, as the factor for 1976, a more stable predictor, the average for the two years, 1.038. This recommendation the Commissioner adopted. The Bureau argues, first, that the industry is entitled to consistency of approach, and hence the traditional procedure, using a factor derived from a single year's observations, must be followed. See Boston Gas Co. v. Department of Pub. Util., 367 Mass. 92, 104 (1975) (condemning decision according to the whim or caprice of the Department). But the Commissioner gave a convincing reason for his departure from the tradition in citing the need for a less volatile predictor. Cf. id. at 104. Indeed the Bureau's own actuary testified to the desirability of averaging in order to make the development factor more stable and accurate. [6] Second, the Bureau argues that if an averaging technique is to be used, the average should be extended over a longer period, and the development factor observed for 1973 should be rejected as aberrant. A longer-term average, dropping the low year 1973, would produce a larger factor. [7] But the Bureau presents no reasoned argument demonstrating error on the Commissioner's part. The 1973 data, which yield a development factor of 0.990, are viewed as aberrant merely because the figure is lower than the other numbers of the series. There is no suggestion that the 1973 data are unreliable, and it would seem odd to reject the data from the one year in which the insurers' estimates of their losses at the beginning of the year were nearly exactly correct as measured by the changes at the end of the year. As to the desirability of a longer-term average, the Bureau points to testimony of the Division's actuary suggesting a five-year period. But the suggestion was quite tentative and was accompanied by the thought that the problem should be studied more fully before the next rate revision with an attempt to reach agreement on a stable development factor. We may note that if an average over a longer period would produce a result less subject to fluctuation, it might do so at the expense of using data that could be regarded as obsolescent or stale. On the whole we cannot conclude that the choice of a two-year average was wrong. Our view is fortified somewhat by the fact that, in portions of the hearing dealing with other coverages, the Bureau itself proposed development factors based on two-year averages. See note 6 supra. Compare Massachusetts Bonding & Ins. Co. v. Commissioner of Ins., 329 Mass. 265, 274-277 (1952) (upholding Commissioner's determination of development factor despite impressive evidence in support of alternative procedure). (2) Frequency adjustment. In its original presentation the Bureau argued that 1974, the basis year, was aberrant in respect to frequency because of the effects of the fuel shortage in reducing the use of cars and so the number of claims. Therefore the Bureau recommended a frequency adjustment of 1.05. It refused to acknowledge, at least initially, that there were any long-term trends in the accident-frequency data. The Division's actuary, on the other hand, presented a study, using Registry of Motor Vehicles accident information from 1971 to 1975, which revealed a long-term downward trend in accident frequency after an adjustment for the effects of the energy shortage. His conclusion from the composite study was that the required upward adjustment of the 1974 data for the energy shortage was more than offset by the downward trend, and he therefore recommended a frequency factor of 0.950. Thereupon the Bureau, adopting the Division's approach, attempted to deal with trend, but it used somewhat different data taken from the registry: it calculated the trend and the fuel-shortage adjustment from a set of registry subcategories of data [8] supposed to parallel the insurance claims. Weighing each category by a factor which it considered appropriate, the Bureau derived an overall frequently factor of 1.100. The Commissioner concluded that no frequency adjustment could be justified. He thought the two competing presentations have merit on the assumption that a trending method is to be used at all. At this point, I am not convinced that any adjustment or trend is called for. He found there was no compelling evidence that 1976 frequency rates will either be higher or lower than 1974 rates. The Commissioner's conclusion was consistent with the approach taken in previous rate decisions, in which no frequency adjustment was made. In criticism of the Commissioner's decision, the Bureau says that while trending might be unjustified (the position first taken by the Bureau), the Commissioner erred in seemingly disregarding the need for an adjustment of the 1974 data to correct for the energy shortage. Here, we think, the Bureau reads the Commissioner's opinion too finely. The Division and Bureau studies were both composites embracing not only a search for trends in accident frequencies, but adjustment for the gasoline shortage; the Commissioner's opinion does not ignore the latter consideration (it refers to the effects on the accident rate of the increased prices of fuel, the energy crises, and external, changing forces, ... with relatively short life spans); the opinion simply reflects the Commissioner's judgment that neither study was strong enough to warrant a departure from the 1974 data. As to the Bureau's argument that its study must be given credence, it may be observed that the Bureau acknowledged the poor correlation between the registry's statistics and the claims against insurers [9] and that the Division was concerned that additional random variation was introduced in the Bureau's study by using registry data on the number of persons injured, rather than on the number of accidents, in calculating frequency; and there was further concern by the Division that the Bureau might be giving undue weight to certain subcategories of the registry data. See note 8 supra. The Commissioner could likewise find the Division's presentation, finding a downward trend, less than persuasive. It seems to us significant that the Commissioner did not merely attempt to project the data, as did the parties; rather he reached for the underlying casual phenomena and considered what their continuing influence would be. He ended by finding that there were a host of ... influencing variables, and that [w]hether their impacts will diminish or rise next year is an extraordinarily tough question. His conclusion that [n]one of the data exist in stable, easily trended series, and hence that a frequency adjustment was inappropriate, is not shown to be erroneous. C. The Property-Damage Coverages. (1) Development factor for property-damage liability losses. As in the bodily-injury portion of the hearing, the Bureau advocated here the use of a development factor derived from the observation of a single year (1974). Its recommended factor to be applied in calculating the 1976 Rate Level Pure Premium was 1.157%. To prevent undue fluctuation from year to year, the Commissioner, following the Division's recommendation, adopted a two-year average  a development factor of 1.1155. To the general criticism already noted, the Bureau adds the point that there was no evidence in the record of the development factors for prior years. The arguments then follow that the decision was based on material outside the record, requiring reversal (see American Employers' Ins. Co. v. Commissioner of Ins., 298 Mass. 161, 166-167 [1937]), or is equally vulnerable because of the absence of a showing that the development factor was unstable in fact from year to year. As to the first contention, we need only note that the two-year average was admitted in evidence and the Bureau has not claimed that it is inaccurate. And, since the development factor for 1974 is in the record, the factor for 1973 may be derived from the average by a trivial calculation. As to the second argument, since the average is different from the development factor for 1973 there must be some instability in the factor. And if the factor was not unstable, no prejudice could be shown from the use of an average instead of a single-year result. (2) Trend and projection factor for comprehensive coverages. It was only with respect to the comprehensive coverages that any significant question arose in finding a trend and projection factor appropriate to the losses. Comprehensive coverage provides insurance against damage of the insured's own vehicle due to theft, vandalism, fire, or other hazards. The Division recommended that the trend and projection factor be drawn from the Consumer Price Index (CPI) for Automobile Repairs and Maintenance, and suggested a combined factor of 1.248. The Bureau was content to use the CPI for the projection factor, but recommended that the trend factor be drawn from internal data: it would calculate the trend from the change observed in the cost of the average comprehensive claim in Massachusetts from a certain period in 1974 to an identical period in 1975. This comparison suggested that the cost of a comprehensive claim had increased by 31.9% and the Bureau requested recognition of a 25% change in the trend factor; its recommended combined trend and projection factor would then be 1.405. [10] There was testimony that the theft frequency had increased disproportionately to other covered losses [11] and that a theft claim was considerably more expensive on average than claims for the other losses. As the CPI cannot reveal the increased cost of an average comprehensive claim arising from the change in the mix of covered losses, the Commissioner properly rejected the Divisions' suggestion that the CPI be used to derive a trend factor. But the Commissioner also found it not obvious that the Bureau's figures were cogent. He noted a claim by the Division's actuary that two Bureau exhibits were mutually inconsistent and both conflicted with certain industry fast-track data for Massachusetts. (He also acknowledged that there was no conclusive proof of inconsistency.) He remarked that [i]nternal data is flawed to the extent that it allows for [ sic: reflects] overpayment of losses through poor carrier policing of damage appraisers (many of whom have business relationships with the body shops at which the work is done). The internal data also appeared to depend heavily on the sample data base and time period chosen for comparison. Nevertheless, the Commissioner thought the best answer lay closer to the Bureau's figure than the Division's. Yet he felt he could not accept the precise Bureau figure because of the questions raised and because the Bureau had failed to prepare an external index (based on data other than claim experience) justifying the increase. Mediating between the Bureau and Division figures (1.40 and 1.25) on the basis of their relative persuasiveness, he selected and combined trend and projection factor of 1.35, thus giving greater weight to the Bureau figure. The Bureau argues that the Commissioner's judgment is itself flawed, and in substantial part we agree. Any apparent discrepancy between the Bureau's exhibits and between those exhibits and the fast-track data is readily explained. [12] The Commissioner's references to the body-shop overpayment problem and to the failure of the Bureau to prepare an external index also suffer on analysis. Both subjects are related to the Commissioner's effort to introduce normative considerations into ratemaking: his view (with which we agree in principle) is that regulation should provide cost control as well as cost observation. To introduce such control, the Commissioner would prepare an index based on data external to the insurance industry and his best choice between the index and one based on internal data would be the lower of the two: if the external indicator is lower, it should be chosen so that the regulated industry is made subject to the same discipline as the outside world; if the internal indicator is lower, then it should be chosen because there is no excuse for the regulator to pass out free money. [13] An external index may be useful in helping to assess the credence to be given internal data, but we doubt that the Commissioner's rule of preference would always be appropriate. For if the cost changes reflected in the internal data are not subject to control by the insurer, then recognizing only the lower costs shown in an external index would go beyond subjecting a regulated industry to the rigors of simulated competition; it would prevent legitimate price changes based on real and uncontrollable changes in costs. As the body-shop overpayment problem presumably is subject to control by the insurers, there may be justification for turning here to an external index. But it seems the problem was first raised in the decision itself; no party points to any evidence concerning body-shop practices. And even if such a problem were shown to exist, overpayments must be proved to have become more prevalent in 1975 than in 1974 in order to justify a change in the trend factor rather than a change of the underlying loss base. In the absence of evidence on the record, the Commissioner's comment becomes speculation concerning a matter of fact and it cannot form an adequate foundation for decision. See American Employers' Ins. Co. v. Commissioner of Ins., 335 Mass. 748, 756 (1957); American Employers' Ins. Co. v. Commissioner of Ins., 298 Mass. 161, 167-168. (1937). As to the failure of the Bureau to prepare an index based on external data, we need only say that it was somewhat unclear to the parties how to create such an index and that the Bureau was not aware of the consequences of the failure to prepare such a display. The rationale for decision which we find to have merit is the Commissioner's observation that the trend factor drawn from internal data was suspect because it seemed to depend heavily on the data base and time periods chosen for comparison. (The Bureau compared both the first six months and the first eight months of 1975 with like periods in 1974.) Although the Division's actuary felt that a trend shown from less than full-year data would be comparatively close to the full-year experience, the Bureau's exhibits put this in doubt. The eight-month data, on which the Bureau relied, would show a cost increase of 31.9% whereas a similar calculation with the six-month data would show a cost increase of approximately 36.2%. The sensitivity of the trend factor to the data base is not directly revealed but is suggested by the different percentage increase in claims (from 1974 to 1975) derived in calculations founded on different bases. [14] Indeed, the Bureau's request for a trend factor of 1.25, rather than the factor of 1.319 derived from the eight-month data, indicates a certain skepticism about its own evidence. In view of the softness of the Bureau's requested figure, we cannot find that it was error for the Commissioner to discount the historical display on which the figure was based slightly more than did the Bureau. [15] (3) Special discount for anti-theft devices. Statute 1975, c. 707, § 2, amending G.L.c. 175, § 113B, provides: In fixing and establishing classifications of risks for comprehensive fire and theft coverage so-called to motor vehicles, the commissioner shall provide for appropriate reductions in the premium charges covering such vehicles if such vehicle is equipped with an anti-theft mechanism or device approved by the Commissioner. [16] During the course of the hearing the Bureau filed an exhibit suggesting a 10% discount on comprehensive coverages for vehicles having an alarm that could be heard at a distance of 300 feet and that was set off by entry through any door or opening of the hood. In response, the Commissioner ruled: Rather than accepting the Bureau's arbitrary standard, I will leave the definition of an effective anti-theft device to the individual companies for 1976, ordering only that a 10% discount be offered for devices the insurer determines to be effective. Further, the Commissioner directed the Bureau to prepare for the next year's hearing a definition of suitable devices and documentation for setting the discount. In challenging this disposition the Attorney General does not claim that 10% was inadequate as a discount; he argues that the Commissioner was unfaithful to the statute in allowing each company to determine what constitutes a suitable device. The Bureau, however, was not aware of experience anywhere in the country concerning such devices; and, in the absence of pertinent data, the Commissioner asserts that his action was a pragmatic and sensible solution to the problem for 1976. The better course might well have been for the Commissioner to attempt to define and approve suitable devices and set a discount. These would have been somewhat arbitrary, but industry-wide experience on the loss rates of equipped cars could then have been analyzed systematically for use in future years. Under the Commissioner's ruling the data for 1976 may prove less valuable. Our review of the Commissioner's decision is perforce undertaken late in the policy year and there would be little benefit in inviting the Commissioner to run a different course for 1976. We acknowledge, too, that had the Commissioner adopted a tentative definition, consumers who purchase devices in reliance on it might have found that these did not meet the standard finally adopted. It was indicated that a definition would be forthcoming that might apply to the next year's rates.