State Farm Lloyds v. Rathgeber

• Citation: 453 S.W.3d 87
• Decision Date: 26 November 2014
• Docket Number: NO. 03–11–00322–CV,03–11–00322–CV
• Parties: State Farm Lloyds, Appellant v. Julia Rathgeber, in her official capacity as Commissioner of Insurance;Texas Department of Insurance; and Office of Public Insurance Counsel, Appellees
• Court: Texas Court of Appeals

453 S.W.3d 87

State Farm Lloyds, Appellant

v.Julia Rathgeber, in her official capacity as Commissioner of Insurance;¹ Texas Department of Insurance; and Office of Public Insurance Counsel, Appellees

NO. 03–11–00322–CV

Court of Appeals of Texas, Austin.

Filed: November 26, 2014

Deeia D. Beck, Office of Public Insurance Counsel, Jack Hohengarten, Assistant Attorney General, Austin, TX, for appellee.

Douglas W. Alexander, Susan S. Vance, Alexander Dubose Jefferson & Townsend, L.L.P., Susan G. Conway, P. M. Schenkkan, Graves, Dougherty, Hearon & Moody, P.C., Austin, TX, for appellant.

Before Chief Justice Jones, Justices Pemberton and Henson

OPINION

Bob Pemberton, Justice

State Farm Lloyds appeals a district court judgment affirming a final order of the Commissioner of Insurance determining that it had charged consumers homeowners insurance premiums that were excessive for several years during the 2000s and ordering refunds with interest. We will affirm the Commissioner's order with respect to the first year at issue, but must reverse as to the remaining years and remand for further proceedings. We also hold that there was reversible error in the Commissioner's award of interest on refunds he determined to be due.

BACKGROUND

This appeal arises from the proceedings on remand this Court required in Geeslin v. State Farm Lloyds (State Farm Lloyds I ),² and we will refer the reader to that opinion for a comprehensive explanation of statutory context and procedural prologue. On remand, the Texas Department of Insurance (TDI) noticed a “re-hearing” to determine whether the Commissioner should affirm the reduction TDI had ordered in the “initial rate” State Farm Lloyds had filed under former art. 5.26–1 of the Insurance Code,³ or require a greater or lesser reduction instead.⁴ The Office of Public Insurance Counsel (OPIC) intervened. The hearing was ultimately conducted over several days in 2009, and the record was closed in November of that year.

The State Farm Lloyds “rate” in dispute at the hearing referred to “the cost of insurance per exposure unit ... with an adjustment to account for the treatment of expenses, profit, and individual insurer variation in loss experience, and before any application of individual risk variations.”⁵ Former art. 5.26–1 required that the “initial rate” filed by State Farm Lloyds and ultimately approved by TDI be “just, reasonable, adequate, not excessive, and not unfairly discriminatory for the risks to which it applies.”⁶ These requirements, simply put, mean that an insurer charges consumers a price sufficient to recover both its projected expenses of assuming risks under its policy and a profit yielding a “reasonable” rate of return on its capital, but not a profit “unreasonably” higher than this.⁷ The requirements also operate against a constitutional backdrop. This Court has held—most recently in State Farm Lloyds I —that government-set rates are deemed to effect an unconstitutional taking of an insurer's property if the insurer cannot recover both its projected “operating expenses” and a “reasonable rate of return” on its capital.⁸

In advocating their views of a reasonable rate that would comply with these statutory and constitutional requirements, the parties, generally speaking, followed a common methodology in which they calculated an “indicated” rate comprised of the sum of several specified categories of projected expenses per exposure unit (e.g., estimated payments or losses related to hurricanes), plus an additional “underwriting profit” provision calculated so as to ensure that State Farm Lloyds obtained an overall profit (including net income from both premiums and investments) sufficient to provide a rate of return on its capital equivalent to that which it could obtain in alternative investments of equivalent risk (i.e., a return compensating it for the “opportunity cost” of its capital).⁹ The indicated rate would then be compared to the premium State Farm Lloyds was projected to earn per exposure unit under the filed initial rate it had charged its customers. If the indicated rate was less than State Farm Lloyds's projected premiums, its initial rate would be deemed excessive. Conversely, if the indicated rate equaled or exceeded the projected premiums, a rate reduction would be considered confiscatory. Although generally following the same method for calculating the indicated rate and any required reduction, the parties differed with respect to the cost or expense elements that should be included in the indicated rate and their amount.

The issues were further framed by an unusual procedural posture on remand. As explained in State Farm Lloyds I, former art. 5.26–1 (a component of the 78th Legislature's watershed S.B. 14) had governed the first of three phases through which the Legislature imposed rate regulation on what had become a largely unregulated Texas homeowners insurance market.¹⁰ Under former art. 5.26–1, effective June 11, 2003 through August 31, 2004, insurers were required to file their initial regulated rates within 20 days of the statute's effective date and implement them.¹¹ After this initial filing, former art. 5.142, effective June 11, 2003, through November 30, 2004, provided temporary rate-regulation procedures.¹² Under former art. 5.142, insurers were required to file their rates with TDI and await the Commissioner's approval before implementing them.¹³ Then, beginning on December 1, 2004, a permanent file-and-use regime, governed by former art. 5.13–2 of the Insurance Code (now codified as chapter 2251 of that code)¹⁴ took effect whereby insurers file their rates with TDI and implement them, subject to the Commissioner's power to disapprove the rates before they go into effect or disapprove further use of the rates after they go into effect.¹⁵ In State Farm Lloyds's case, TDI had ordered, and the Commissioner had affirmed, a 12% reduction in the insurer's initial filed rate. This reduction, all other things being equal, would have taken effect on September 7, 2003. However, in former art. 5.26–1, the Legislature had allowed an insurer who sought judicial review of a rate-reduction order, as State Farm Lloyds had, the option of charging its filed rate while litigation was pending,¹⁶ subject to mandatory refunds of “the difference in overcharged premium to each policyholder, plus interest,” if “on final appeal the court upholds the commissioner's determination that the insurer's rates are excessive.”¹⁷ State Farm had availed itself of this option and continued charging its initial filed rate (which we will term its “implemented rate”), notwithstanding the Commissioner's opposition to it, pending litigation over its validity.

As events turned out, the first round of litigation over State Farm Lloyds's implemented rate had not concluded until 2008, when this Court issued its State Farm Lloyds I decision. In remanding the case to the Commissioner for further proceedings despite former art. 5.26–1's expiration on September 1, 2004, this Court observed that the Legislature had provided that the expiration “ ‘does not affect an action or proceeding against an insurer subject to that law for failure to comply with that law before its expiration, regardless of when the action or proceeding was commenced, and that law is continued in effect for that purpose.’ ”¹⁸ In the meantime, however, State Farm Lloyds's implemented rate has remained in effect not only as its operative initial rate under former art. 5.26–1, but also as the insurer's operative rate under former art. 5.142, which had contained parallel provisions authorizing the insurer to charge its desired rate pending appeal, subject to refunds with interest if the rate was later found excessive.¹⁹ State Farm Lloyds had similarly continued charging the implemented rate as the file-and-use regime began on December 1, 2004, and would ultimately do so, despite TDI's attempts to restrict the insurer from continuing to charge the rate and the insurer's efforts to obtain rate increases,²⁰ until mid–2008, when the Commissioner finally approved increased rates effective on June 1 for new business and August 1 for renewal business. Consequently, the dispute on remand concerned whether State Farm Lloyds, through its implemented rate, had overcharged its policyholders not only between September 7, 2003, and August 31, 2004, the period in which former art. 5.26–1 had been in effect, but whether it had continued to do so for several years thereafter. The statutory standards governing the “excessiveness” of State Farm's “rate” after September 1, 2004, were essentially identical to those applicable under former art. 5.26–1.²¹

But while the hearing on remand thus concerned whether State Farm Lloyds had overcharged its customers in the past, the Commissioner emphasized that “ratemaking is a prospective endeavor,” alluding to the longstanding principles barring retroactive ratemaking, the making of “a retrospective inquiry to determine whether a prior rate was reasonable and imposing a surcharge when rates were too low or a refund when rates are too high.”²² He likewise observed that both the relevant Insurance Code provisions²³ and actuarial principles²⁴ contemplated prospective ratemaking based on estimates of future costs, and he additionally deemed it “unfair to judge the reasonableness of any of the parties' estimates of future costs based on information that was unknowable” at the time the estimates were made.” (Emphases in original.) Thus, the proper ratemaking inquiry on remand, as the Commissioner reasoned, centered not on real-life events that had occurred while the implemented rate was in effect, viewed in hindsight—as he put it, “retrospective evidence ... has no business in a rate hearing”—but on the rate or rates the Commissioner should have set prospectively from the perspective of a time preceding the period or periods in which the rate was used. To that end, the Commissioner focused the inquiry on information...