DEPARTMENT OF BANKING AND INSURANCEIN THE MATTER OF THE APPLICATION )
During the past few years State Farm Indemnity Company (SF Indemnity) has experienced an excessive growth in private passenger auto insurance policyholders due to business practices that increased its share of that market. Its financial statements indicate, however, that its recent growth has been accompanied by declining financial results. If this unprofitable growth continues unabated, it will further threaten the financial health of the company and its important role as a provider of coverage to New Jersey auto insurance policyholders. Therefore, in accordance with applicable statutes, I am granting SF Indemnity’s request for a temporary suspension of some of its obligations under New Jersey statutes in light of the significant growth it has experienced, which will provide it an opportunity to review its structure and business practices so as to promote its future provision of services. I am also directing SF Indemnity to provide the Department with information necessary to continue to closely monitor its operations so as to assure that the suspension continues to be warranted. This temporary suspension in SF Indemnity’s full participation in the market will not affect its existing policyholders, who will continue to be able to renew their present policies and add new cars and drivers.
This Decision and Order does not provide any increase in rates. Rather the effect of this Decision and Order is limited to temporarily relieving SF Indemnity from accepting new business from new applicants. As set forth below, this relief is an appropriate measure to be taken at this time.
SF Indemnity is an Illinois-domiciled property casualty insurer and a wholly-owned subsidiary of State Farm Mutual Automobile Insurance Company (SF Mutual). In 1992, the Department’s then Commissioner issued an Order approving the Plan of Orderly Withdrawal of SF Mutual from the automobile insurance business in New Jersey, and, as a result, that company withdrew from writing auto insurance policies in New Jersey. However, the Plan for Orderly Withdrawal provided that another company, SF Indemnity, would serve as the replacement carrier for SF Mutual and assume all of its automobile insurance business beginning April 1, 1993. SF Indemnity was provided a fixed amount of capital by its parent SF Mutual to support its automobile insurance business in New Jersey; the terms of the 1992 Order did not require SF Mutual to infuse additional capital or provide a parental guarantee. SF Indemnity has no other insurance business in any other state, and in New Jersey it only writes automobile insurance. The parent company, SF Mutual, provides homeowners’ and other property insurance in New Jersey and this Order does not affect SF Mutual or any of its policies. Since 1993, SF Indemnity has grown substantially from the approximately 550,000 automobiles insured then to 811,670 automobiles insured as of year end 2000.
For the first several years, SF Indemnity appeared to prosper. Its capital and surplus, which represents the difference between its total assets and its liabilities and reserves established to pay claims, grew to $445 million as of 1998. Capital and surplus is necessary under our laws to assure that there is sufficient money available for an insurer to pay its future claims and liabilities, and is a measure of the insurer’s financial health. SF Indemnity’s operating results were so strong that, in 1997, it returned a dividend of $41 million to its New Jersey policyholders, representing a refund of excess profits computed pursuant to the New Jersey excess profit statute. Again in 1998, SF Indemnity’s Excess Profit Report, which reflected its operating results for 1995, 1996 and 1997, revealed an excess profit in the amount of about $38 million, which was also returned to policyholders later that year.
Beginning in 1999, however, its condition reflected in financial statements appeared to show a dramatic reversal. In 1999, SF Indemnity determined that its reserves for losses and loss expenses, that is, the money set aside to pay future claims and related expenses, should be increased $146 million based upon insufficient reserves set aside in prior years. As a result of this accounting change, its Annual Statement as of December 31, 1999 reported an underwriting loss for the year (calculated without recognition of investment income) of $147 million. After investment income was added in, its 1999 loss on paper was $ 30 million.
This reversal continued to be shown on financial statements for the year 2000. In the second quarter of 2000, SF Indemnity again increased its reserves for losses and loss expenses by $111 million, making a total increase in reserves on paper of $257 million in less than one year. Its year end 2000 Annual Statement reported another total loss for the year of $128 million, which reduced its reported capital and surplus from $445 million as of December 31, 1998 to $283 million as of December 31, 2000.
In September 2000, after discussion with company officials about its reported financial results, I called an examination of SF Indemnity in order to obtain an independent evaluation of its loss and loss expense reserves and to verify the information set forth on its financial statements. As noted below in the Analysis section, the information provided by this examination, completed in February of this year, was critical in arriving at the appropriate course of action in this matter.
SF Indemnity’s financial results in New Jersey parallel, to some degree, the results of its parent company. According to a published report, during the year 2000, SF Mutual cut its automobile insurance rates in some jurisdictions in order to gain market share and better compete with other national insurers. State Farm Group’s year end 2000 results, however, reported a decline in net income of 60%, due to a combination of increased claims and reduced rates.
SF Indemnity also made business decisions that, in retrospect, directly contributed to its rapid growth in market share, but at a cost. In 1998, SF Indemnity filed amendments to its rating plan in accordance with N.J.S.A. 17:29A-46.1, the tier rating plan statute enacted in 1997. By 2000, the tier rating plan filed by SF Indemnity resulted in approximately 88% of its total insured automobiles being insured at preferred rates, that is, rates below its standard rate level. Even for higher risk new business, SF issued these policies at preferred rates – which amounted to discounts of 20-35% off its standard rates. As New Jersey consumers began to "shop around" for more competitive prices on automobile insurance (as the tier rating statute was intended to encourage), SF Indemnity’s rate of growth accelerated. Its tier rating system apparently had the effect of attracting more "higher risk" drivers and discouraging some "lower risk" drivers from keeping or purchasing its coverage. As a result, its loss ratio, that is, the percentage of the premiums paid that goes to pay claims and claim expenses, grew from 78.4% (as reported on its 1998 Annual Statement) to 114.0% (as reported on its 2000 Annual Statement).
At the Department’s suggestion, SF Indemnity has since filed, and we approved effective January 8, 2001, amendments to its tier rating plan that rate all new insureds at the standard rate level. The filing had demonstrated that these new insureds had a substantially higher loss ratio and were contributing to the increase in the company’s overall loss ratio reflected in its financial statements. SF Indemnity has recently filed for approval for additional changes to its tier rating system. This filing was just received on March 23, 2001 and is currently under review by the Department.
In October 2000, SF Indemnity filed a request for a rate increase that would increase its overall premium income level by 16.8%. This rate increase request has been referred by the Department for a hearing at the Office of Administrative Law, where the need for this will be fully explored in a public forum.
Finally, in December 2000, State Farm Indemnity filed a request for immediate relief from N.J.S.A. 17:33B-15, which requires that automobile insurers provide automobile insurance coverage to all "eligible person" applicants. "Eligible persons" are defined by statute and regulation based primarily on driving record - - less than nine eligibility points from motor vehicle violations and at-fault accidents - - but also reflect other risk factors and the membership requirements of some insurers. SF Indemnity’s application also requested relief from certain other related insurer obligations. In December 2000, the request for immediate relief from insuring all eligible persons was denied, because SF Indemnity’s financial condition did not meet the criteria established under our statutes for immediate relief. Nevertheless, we reserved decision on whether future relief should be granted based on the results of the then in-progress review of SF Indemnity’s reserves and a verification that the numbers reported in their financial statements were accurate. The decision to deny immediate relief was reconfirmed upon a request by SF Indemnity for reconsideration; since then, SF Indemnity has appealed the denial of immediate relief to the Superior Court of New Jersey, Appellate Division, which is pending.
As set forth below, the relief being granted herein is an appropriate incremental step toward addressing the company’s financial problems in a way that minimizes disruption to the New Jersey personal auto insurance market.
Initially, it is appropriate to note that over the past decade, several changes in New Jersey law have contributed to a more competitive market among personal automobile insurers. As the result of statutes enacted in 1988 and 1990, auto insurers are required to develop and utilize rates based primarily on their own experience, rather than upon rating organizations that had previously established rates on behalf of several insurers together. In 1997, the Legislature authorized the introduction of tier rating systems, which have promoted even greater differentiation among auto insurers’ rates, based upon each insurer’s own experience and marketing strategies. The result has been positive for consumers who shop around - - they are often able to obtain comparable coverage at better rates - - but has resulted in winners and losers among the companies that provide the coverage. While SF Indemnity’s tier rating strategy may have worked in other jurisdictions, it did not work here. Rather, it resulted in unprofitable growth that now requires the regulatory actions set forth in this Decision and Order.
New Jersey statutes at N.J.S.A. 17:33B-15 require all personal lines automobile insurers to provide automobile insurance coverage for all applicants who are "eligible persons" as defined in the statutes and administrative rules. This obligation was enacted in 1990, and took effect in 1992, in order to provide better access for all New Jersey citizens to the private automobile insurance market and to remedy the problems experienced in the 1980s with the JUA. Additionally, N.J.S.A. 17:29D-1 requires automobile insurers to provide coverage to their share of drivers in the New Jersey assigned risk plan, the Personal Automobile Insurance Plan (PAIP). Finally, N.J.S.A. 17:33C-1 and implementing regulations generally require automobile insurers to maintain a share of insured automobiles in designated "automobile insurance urban enterprise zones" proportionate to its Statewide market share.
Our statutes provide the Commissioner with authority to immediately suspend an insurer’s obligations to issue policies in compliance with these statutes if the insurer is found to be in an "unsafe or unsound financial condition," which is defined in terms of having sufficient capital and surplus to support the total amount of premium received, based on nationally recognized standards. As noted above, in December 2000, SF Indemnity’s application for immediate relief was denied because it did not meet the premium to surplus ratio that would support a finding that it was in an unsafe or unsound financial condition.
Another statute (N.J.S.A. 17:33B-20) however, provides the Commissioner with additional authority to suspend these automobile insurer obligations if the Commissioner finds, in her discretion, that continued compliance threatens an insurer’s financial health looking forward into the future. That statute provides a broader set of criteria to be used in making such a determination. Not only should the Commissioner consider the insurer’s ratio of premiums to surplus, but also should consider whether continuing to issue policies to all eligible persons may result in an adverse change in ratings by national insurance financial rating services; whether the insurer has other financial ratios that are outside generally acceptable ranges as established by the National Association of Insurance Commissioners; and whether the insurer has a net reduction of capital/surplus greater than 25% during a period of two years or less. In other words, relief under this second statutory provision provides the authority to address financial problems upon a determination that current trends threaten an insurer’s financial condition in the future.
Similar authority and criteria are established in other statutes for relief from the obligation to accept assigned risks through the PAIP (N.J.S.A. 17:33B-24). Additionally, in accordance with the Department’s regulation establishing the urban enterprise zone program, an insurer that is entitled to relief from insuring PAIP assigned risks is also relieved of the obligation to maintain its proportionate share of risks in the urban enterprise zones.
As set forth in the financial findings below, continued compliance with the obligations to insure all eligible persons and provide coverage to assigned risks threatens SF Indemnity’s future financial health, applying the various criteria set forth in the statutes. First, according to its Annual Statement for the calendar year ending December 31, 2000 (2000 Annual Statement), SF Indemnity experienced a loss from operations of $128 million, resulting in a decrease of unassigned funds in the amount of $131 million since year end 1999. Together with the loss experienced in 1999, this change resulted in a $161 million decrease in SF Indemnity’s capitalization in the two year period since year end 1998. Second, SF Indemnity’s 2000 Annual Statement showed a premium to surplus ratio of 2.92 to 1, deteriorating from 2.04 shown on its 1999 Annual Statement, and approaching the level of 3.0 to 1 generally considered to indicate that a company’s financial health is threatened. Third, SF Indemnity’s 2000 Annual Statement indicated a two year overall operating loss ratio of 114.0%, which means that for every dollar of premium collected it incurs $ 1.14 in claims and claim expenses (not including its other costs of doing business). This is a financial ratio that reflects continuing operating losses and if continued would threaten the insurer’s financial health. Fourth, SF Indemnity has reported that its communications with national insurance rating agencies indicate that its ratings may be downgraded. Finally, SF Indemnity’s premium to surplus ratio, as computed based on its own reserving methodology, continues to deteriorate.
As noted above, the Department conducted an examination which included an independent review of SF Indemnity’s loss and loss expense reserves and verification of the data used to develop its financial statements. The Department’s independent consulting actuary concluded that while SF Indemnity has excess reserves, they were nevertheless in the range of reasonableness, and its findings support the determination to grant the relief set forth in this Decision and Order.
Considering all of this information, it is clear that continued compliance with the obligations to insure all new applicant eligible persons and to provide coverage to new assigned risk exposures would further strain SF Indemnity’s capital and threaten its financial health. If these trends were to continue, SF Indemnity would continue to experience operating losses and lose capital, and its financial condition would continue to deteriorate. Therefore, granting SF’s request for the temporary suspension of compliance with the auto insurer obligations set forth above is plainly warranted based upon the criteria set forth in applicable statutes and regulations and is the best method to slow growth while at the same time not harming existing policyholders. SF Indemnity currently has sufficient capital and surplus to support its business.
However, in order to determine the effect of this suspension of obligations, continued close monitoring of the company’s financial picture is warranted. Therefore, I am ordering that SF Indemnity provide the Department with additional periodic financial statements on a monthly basis in order that we may continue to closely monitor its financial condition and determine whether this temporary suspension should be continued.
NOW, THEREFORE, IT IS on this ___6th___ day of April, 2001 ORDERED that:
I further direct that a copy of the Order be transmitted to the Director of the Illinois Department of Insurance, SF Indemnity’s domestic regulator.
Karen L. Suter