08-004916 State Farm Florida Insurance Company vs. Office Of Insurance Regulation Status: Closed Recommended Order on Friday, December 12, 2008.

Summary: Fact-finder is unable to determine from a preponderance of the evidence whether either the indicated or requested rates in the rate filing are not excessive, inadequate, or unfairly discriminatory.

STATE OF FLORIDA

DIVISION OF ADMINISTRATIVE HEARINGS

STATE FARM FLORIDA INSURANCE )

COMPANY, )

)

Petitioner, )

)

vs. ) Case No. 08-4916

)

OFFICE OF INSURANCE REGULATION, )

)

Respondent. )

)

RECOMMENDED ORDER

Administrative Law Judge (ALJ) Daniel Manry conducted the

final hearing of this case for the Division of Administrative

Hearings (DOAH) on October 27 through 30, 2008, in Tallahassee,

Florida.

APPEARANCES

For Petitioner: Cynthia S. Tunnicliff, Esquire

Brian A. Newman, Esquire

Pennington, Moore, Wilkinson,

Bell & Dunbar, P.A.

215 South Monroe Street, Second Floor

Post Office Box 10095

Tallahassee, Florida 32302-2095

C. Ryan Reetz, Esquire

Mia B. Fraser, Esquire

Squire, Sanders & Dempsey, LLP

200 South Biscayne Boulevard, Suite 4000

Miami, Florida 33131

Vincent J. Rio, Esquire

State Farm Insurance Companies

One State Farm Plaza, A-3

Bloomington, Illinois 61701-4300

For Respondent: S. Marc Herskovitz, Esquire

Elenita Gomez, Esquire

Office of Insurance Regulation

Legal Services Office

200 East Gaines Street

Tallahassee, Florida 32399-0333

STATEMENT OF THE ISSUE

The issue is whether Petitioner has shown by a

preponderance of the evidence that an indicated rate increase of

67.0 percent, or, in the alternative, a requested rate increase

of 47.1 percent, is not excessive, inadequate, or unfairly

discriminatory within the meaning of Subsections 627.062(2)(b),

paragraphs 1, 2, 5, 8, 10 through 12, and 14; 627.062(2)(e),

paragraphs 1, 3, 6, and 10; 627.062(2)(j); 627.0628; 627.0629;

and 627.06291, Florida Statutes (2008). 1

PRELIMINARY STATEMENT

On July 16, 2008, Petitioner filed a request for rate

increase with Respondent. By letter dated August 25, 2008,

Respondent issued a Notice of Intent to Disapprove the rate

request (the Notice of Intent). Petitioner timely requested an

administrative hearing, and, on October 2, 2008, Respondent

referred the dispute to DOAH to conduct the hearing.

At the hearing, Petitioner presented the testimony of seven

witnesses, submitted 34 exhibits for admission into evidence,

and re-called one witness in rebuttal. Respondent called one

witness and submitted 32 exhibits.

The identity of the witnesses and exhibits and the rulings

regarding each are reported in the seven-volume Transcript filed

with DOAH on November 12, 2008. The ALJ gave the parties eight

days after the date the Transcript was filed with DOAH to file

their respective proposed recommended orders (PROs). The

parties agreed to add the eight days they needed for preparation

of their PROs to the statutory requirement for a recommended

order no later than 30 days after the filing of the Transcript.

The parties timely filed their respective PROs on November 20,

2008, and this Recommended Order must be issued no later than

December 20, 2008.

FINDINGS OF FACT

1. The petitioner is State Farm Florida Insurance Company

(State Farm Florida). Respondent is the state agency

responsible for regulating insurance rates in the state.

2. State Farm Florida is a wholly-owned subsidiary of

State Farm Mutual Automobile Company (State Farm Mutual). State

Farm Mutual is the parent company of four wholly-owned

subsidiaries. The four siblings are State Farm Florida; State

Farm Fire and Casualty (Fire & Casualty); State Farm Lloyds,

Inc. (Lloyds); and State Farm General Insurance Company

(General). The parent and siblings are an affiliated group, for

purposes of federal and state income taxes, and file a

consolidated tax return.

3. State Farm Mutual writes property and casualty

insurance, including homeowners insurance, through Fire &

Casualty in 47 states. In Florida, Texas, and California, State

Farm Mutual conducts the business of insurance through State

Farm Florida, Lloyds, and General, respectively.

4. State Farm Florida filed a request for a rate increase

of 47.1 percent (the requested rate). The request is a “rate

filing” defined in Subsection 627.0621(1)(a). The rate filing

is intended to be effective for new business on December 1,

2008, and for renewals on March 1, 2009.

5. The rate filing indicates that a rate increase of

67.6 percent is the actual rate indicated by the documentation

in the rate filing (the indicated rate). However, State Farm

Florida reduced the indicated rate during the administrative

hearing to 67.0 percent to reflect approximately 7,000 policies

that State Farm Florida renewed without wind coverage, so-called

“ex-winded” policies. State Farm Florida reduced the indicated

rate from 67.0 percent to the requested rate of 47.1 percent in

an effort to obtain quick approval of the rate filing because

State Farm Florida is allegedly, “Losing money every day.”

6. The Notice of Intent states the grounds for denying the

rate filing in 23 numbered paragraphs. Respondent dismissed the

grounds stated in paragraph number 14. The Findings of Fact

refer to the original numbers in the Notice of Intent but

address only paragraphs numbered 1 through 13 and 15 through 23.

This Recommended Order makes no further reference to the grounds

stated in paragraph number 14 of the Notice of Intent.

7. The Notice of Intent and the grounds stated therein

constitute proposed agency action. This Recommended Order

constitutes recommended agency action. Neither form of agency

action may go beyond the powers, functions, and duties delegated

by the Legislature in Chapter 627 without constituting an

invalid exercise of delegated legislative authority defined in

Subsection 120.52(8). 2 To that end, the ALJ required the witness

for Respondent to identify the statutory authority that

Respondent relies on for each numbered ground in the Notice of

Intent. The ALJ also required each witness for Petitioner to

specify the paragraph number of the ground in the Notice of

Intent which his or her testimony addressed.

8. The Notice of Intent relies on Sections 627.062,

627.0628, 627.0629, and 627.06291 as statutory authority for the

numbered grounds in the Notice of Intent. Each ground and the

corresponding statutory authority is listed as follows:

Ground Statutory Authority

1 §§ 627.062(2)(b)8., 627.0628,

627.0629, and 627.06291;

2 § 627.062(2)(b)8.;

3 § 627.062(2)(b)11. and 12.;

4-5 § 627.062(2)(b)11.;

6-8 § 627.062(2)(b)12.;

9-11 § 627.062(2)(b)2.;

12 § 627.062(2)(b)11.;

13 § 627.062(2)(b)2.;

15-16 § 627.062(2)(b)2.;

17 § 627.062(2)(b)10. and 11.;

18 § 627.062(2)(e)1.-3. and 10.;

19 § 627.062(2)(b)8.;

20 § 627.062(2)(b)5.;

21 § 627.062(2)(b)8. and 11.;

22 § 627.062(2)(b) and (2)(e)6.; and

23 § 627.062(2)(j).

9. Respondent has not determined that the rate filing is

excessive, inadequate, or unfairly discriminatory within the

meaning of Subsection 627.062(1). Rather, Respondent proposes

final agency action determining that the information provided by

State Farm Florida is insufficient for Respondent to

independently determine whether either the indicated or

requested rate in the rate filing is excessive, inadequate, or

unfairly discriminatory.

10. Respondent asserts that the fact-finder’s

determination of the sufficiency of the evidence submitted by

State Farm Florida is limited to the information that State Farm

Florida submitted with the initial filing. Respondent claims

that the fact-finder may not rely on any information submitted

by State Farm Florida during the final hearing if that

information was not submitted with the initial filing.

Respondent relies on the statutory requirement in Subsection

627.062(9)(a) for an insurer to certify, in relevant part, that

the initial rate filing does not omit any material fact and

fairly presents in all material respects the basis for the rate

filing.

11. The ALJ rejects the agency’s conclusion that the

certification requirement in Subsection 627.062(9)(a) limits the

evidence in the final hearing to the information that State Farm

Florida submitted with the initial rate filing. Neither the

Legislature nor Respondent has promulgated any explicit

standards that prescribe the information that must be included

in a rate filing. Other reasons for rejecting the agency’s

proposed interpretation of Subsection 627.062(9)(a) are

discussed in the Conclusions of Law.

12. The fact-finder has weighed all of the evidence

admitted during the final hearing, including information

submitted after the initial filing (post-filing evidence). The

Findings of Fact are based on evidence of circumstances as they

existed through the conclusion of the final hearing.

13. A brief discussion of the history preceding the

current rate filing provides context for this proceeding. State

Farm Mutual incorporated State Farm Florida in 1998 with an

initial capitalization of $607,500,000.00. The hurricanes of

2004 wiped out the surplus of State Farm Florida. In 2004,

State Farm Mutual recapitalized State Farm Florida with a loan

of $750,000,000.00 so that State Farm Florida could continue

doing business in Florida.

14. State Farm Florida obtained an approval from

Respondent for a prior rate filing of 52.7 percent. The rate

increase became effective November 1, 2006.

15. In November and December 2006, premiums on renewals

increased significantly. Beginning sometime in the middle of

2007, average premium began to decline.

16. The direct written premium for State Farm Florida that

had been $1,889.00 in November and December 2006 declined to

$1,350.00. In the first quarter of 2008 and the third quarter

of 2008, direct written premium rose slightly to $1,399.00.

17. The decline in premium revenues is the moving force

behind the current rate filing. The Legislature has found in

Subsection 627.062(2)(e)3. that rates are inadequate if they are

insufficient, together with investment income attributable to

them, to sustain projected losses and expenses in the class of

business to which the rates apply.

18. The reasons for the reduction in premium revenue are

undisputed. State Farm Florida has non-renewed some policies;

excluded wind from the covered risk of other policies, a process

described by the parties as ex-winding; provided discounts to

policyholders who improved covered property with wind-mitigation

features identified in Subsection 627.0629(1), identified by the

parties as wind-mitigation discounts; and allegedly incurred an

increase in costs, not the least of which is the cost of

reinsurance for excess losses.

19. State Farm Florida asserts that the decline in premium

revenue caused by non-renewals, ex-winding, wind-mitigation

discounts, and increased costs such as the cost of reinsurance

justifies a rate increase equal to the indicated rate of

67.0 percent or the requested rate of 47.1 percent. The

Legislature requires, in Subsection 627.062(2)(g), Petitioner to

show by a preponderance of the evidence that either the

indicated or requested rate is not excessive, inadequate, or

unfairly discriminatory.

20. The fact-finder is unable to determine from a

preponderance of the evidence that the indicated and requested

rates are not excessive, inadequate, or unfairly discriminatory.

This is not a finding that the indicated and requested rates are

excessive, inadequate, or unfairly discriminatory. Rather, the

evidence of circumstances as they existed through the final

hearing is either variable or ambiguous, and therefore neither

credible nor persuasive to the fact-finder; or the evidence is

insufficient for the fact-finder to make the findings

statutorily required to approve either the indicated or

requested rate.

21. A preponderance of the evidence does show that State

Farm Florida determined the factors used in the rate filing in a

manner that is consistent with standard actuarial techniques or

practices and that those factors are based on reasonable

actuarial judgment within the meaning of Subsection

627.0612(2)(a). However, a finding of actuarial reasonableness

does not end the inquiry. The principal purpose of statutory

review is to facilitate an independent determination of whether

indicated or requested rates which are formulated in accordance

with standard actuarial techniques are nevertheless excessive,

inadequate, or unfairly discriminatory.

22. Several evidential issues of credibility or

insufficiency prevent the fact-finder from determining from a

preponderance of the evidence that the indicated and requested

rates are not excessive, inadequate, or unfairly discriminatory.

The relevant evidential issues are discussed in paragraphs 23

through 65.

23. Non-renewal of policies by State Farm Florida is one

reason for a decline in premium revenue. State Farm Florida is

voluntarily limiting new property insurance business in the

state to in-state transfers of business to inland locations

(transfer business).

24. The fact-finder is unable to determine from a

preponderance of the evidence whether the portion of the

indicated or requested rate which is attributable to transfer

business is excessive or reasonable. State Farm Florida has not

quantified the number of policyholders that the transfer

business entails.

25. For one year, beginning in March 2008, State Farm

Florida will decline to renew (non-renew) policyholders. State

Farm Florida will also ex-wind renewed policies.

26. The fact-finder is unable to determine from a

preponderance of the evidence whether the portions of the

indicated or requested rates which are attributable to non-

renewal and ex-winding is excessive or reasonable. Evidence of

the number of non-renewed and ex-winded policies is ambiguous.

After Petitioner submitted the rate filing, the number of non-

renewed and ex-winded policies increased from 50,000 to 85,000

through the administrative hearing. Such variability in the

evidence is neither credible nor persuasive to the fact-finder.

27. The number of non-renewals and ex-winded policies is

important because much of the requested rate increase is based

upon forecasts of lower direct written premium. Fewer

policyholders and less coverage will naturally generate lower

premium.

28. Another “significant contributing factor to the

indicated rate need” is the number of policyholders receiving

wind-mitigation discounts. Petitioner asserts that wind-

mitigation discounts are greater than loss outputs.

29. The fact-finder is unable to determine from a

preponderance of the evidence the amount of wind-mitigation

discounts. The cross-examination of rebuttal testimony offered

by State Farm Florida illustrates the evidential ambiguity.

Q. Where in the filing or supplemental

materials can I find that the discounts are

greater than the loss output?

A. Exhibit 5 develops the savings

associated with the wind-mitigation

discounts. They are part of our projected

hurricane losses, and the premium savings

are part of our projected premiums that were

outlined in Exhibit 2.

Q. Can I find them stated separately, or

you are saying they are part of this exhibit

and part of the other exhibit you mentioned?

A. State separately?

Q. That the discounts are greater than the

losses. Can you show me a place where the

discounts are greater?

A. There is not a specific statement that

says that. It does not say that premium –

our premium decline is due to – it discusses

several things with regard to wind

mitigation discounts. . . . It is implied

in the statement that premium is declining

due to application of the mitigation

discounts. If the reduction in losses were

equivalent to the decline in premium, there

wouldn’t be a need to increase the premiums

to reflect the fact that the savings do not

match those discounts.

Transcript (TR) at 828-829.

30. As with non-renewals, evidence of the number of

policyholders receiving wind-mitigation discounts and the dollar

amount of the discounts is variable and less than credible and

persuasive to the fact-finder. 3 Although State Farm Florida

identified wind-mitigation discounts as the “primary cause of

reduction in premium per policy,” the evidence does not credibly

quantify the discounts.

31. The fact-finder is unable to determine from a

preponderance of the evidence whether the rate filing is based

on a calculation of wind-mitigation for premiums that is

different than the calculation of wind-mitigation discounts for

losses. Wind-mitigation discounts must be equal for premiums

and losses to avoid being unfairly discriminatory. State Farm

Florida gives a discount of 65.0 percent for the hurricane

portion of the premium but realizes only a 28.0 percent savings.

State Farm Florida may be recovering what it claims to be losing

on the wind-mitigation discounts by charging all policyholders

equally even though a significantly larger portion of those

policyholders do not qualify for the wind-mitigation discounts.

To raise rates for all policyholders may negate the savings the

discounts were intended to create.

32. By Consent Order dated September 9, 2008, State Farm

Florida conceded that it had failed to implement necessary

procedures to comply with statutory and administrative rule

requirements. State Farm Florida implemented refunds and

credits to 98,000 current and former policyholders in the amount

of $120 million and paid an additional $1.02 million to the

Regulatory Trust Fund.

33. The fact-finder cannot determine from a preponderance

of the evidence whether the cost of reinsurance is reasonable or

excessive within the meaning of Subsection 627.0612(2)(c).

State Farm Florida purchased reinsurance coverage for a probable

maximum loss (PML) equal to the difference between $9.25 billion

and a retained risk by State Farm Florida of $175 million.

34. Non-renewals, ex-winded policies, and loss savings

from wind-mitigation improvements to covered property decreased

the PML to $7.1 billion. However, State Farm Florida increased

the amount of catastrophe reinsurance that it purchased to cover

PML from $7.4 billion in the previous rate filing to

$9.25 billion in the current rate filing. State Farm Florida is

paying a significant portion of the PML premium to its parent,

State Farm Mutual.

35. State Farm Florida retained approximately $175 million

of the $9.25 billion in PML. State Farm Florida purchased

reinsurance coverage for the remainder of the PML from State

Farm Mutual, other private re-insurers, the Florida Hurricane

Catastrophe Fund (the Cat Fund), and the temporary increase in

coverage limit (TICL). 4

36. State Farm Florida also paid State Farm Mutual

$12.8 million for a credit risk provision. The credit risk

provision will pay losses that the Cat Fund is contracted to pay

but may be unable to pay.

37. The Cat Fund announced in October 2008 that it

anticipated a bonding shortfall of $14.5 billion in the event

the Cat Fund were called upon to pay all of its reinsurance

obligations. State Farm Florida would receive only one-half of

the reinsurance coverage it purchased from the Cat Fund in the

event of a $14.5 billion bonding shortfall.

38. State Farm Florida paid $842 million for reinsurance

coverage. State Farm Florida paid $142 million for reinsurance

coverage from the Cat Fund and TICL layer provided by the state

and paid approximately $700 million for reinsurance coverage by

private re-insurers, including State Farm Mutual. 5

39. Of the total $700 million paid to private re-insurers,

State Farm Florida paid approximately $151 million to private

re-insurers other than State Farm Mutual. State Farm Florida

paid $549 million to its parent company, State Farm Mutual.

40. It is undisputed that the $151 million State Farm

Florida paid to private re-insurers other than State Farm Mutual

is reasonable. Payments to unrelated private re-insurers

represent arms-length transactions between a willing buyer and

willing seller of reinsurance coverage. However, the fact-

finder is unable to determine from a preponderance of the

evidence whether either the cost of reinsurance purchased from

State Farm Mutual or the cost of the credit risk provision

purchased from State Farm Mutual is excessive or reasonable

within the meaning of Subsection 627.0612(2)(c).

41. The economic reality is that State Farm Florida is

merely the legal form in which State Farm Mutual chooses to do

business in Florida. State Farm Mutual and its wholly-owned

subsidiaries, including State Farm Florida, comprise a "group or

combination" that the Legislature defines as a "person" in

Subsection 1.01(3) or a joint underwriting association defined

as a person in Section 624.04 ( See 1976 Fla. Atty. Gen,

Lexis 130).

ansactions between State Farm Mutual and State Farm

Florida for reinsurance and credit risk provisions totaling

approximately $561.8 million, when viewed in the light of

economic reality, Subsection 1.01(3), or Section 624.04, may be

transactions which State Farm Mutual engages in with itself and

which lack any independent economic significance. 6 Transactions

with no independent economic significance would be sham

transactions which may distort the economic costs of the

reinsurance and credit risk provisions purchased from State Farm

Mutual. Such economic distortions may enable the group to

derive a rate advantage from the legal form in which State Farm

Mutual chooses to do business in Florida. 7

43. The reinsurance and credit risk provision which State

Farm Florida purchased from State Farm Mutual for approximately

$561.8 million may be the economic equivalent of a retained risk

amount by State Farm Mutual or the group. The fact-finder

cannot determine from a preponderance of the evidence whether

the economic cost attributable to a retained risk by State Farm

Mutual or the group is more or less than the amount State Farm

Mutual charged State Farm Florida for the reinsurance and credit

risk coverages.

44. Even if State Farm Florida and State Farm Mutual were

distinct persons, State Farm Florida exists for the convenience

of State Farm Mutual. State Farm Mutual conducted business in

Florida, either directly or through some other member of the

group, before State Farm Florida emerged from State Farm Mutual

in 1998 with an initial capitalization of $607,500,000.00.

State Farm Mutual re-capitalized State Farm Florida with

$750,000,000.00 in loans after the 2004 hurricane season. State

Farm Mutual owns all of the stock of State Farm Florida. There

is no economic, or legal, impediment to State Farm Mutual

liquidating State Farm Florida at the convenience of State Farm

Mutual and doing business in Florida as it did before it created

State Farm Florida in 1998.

45. State Farm Mutual has sustained an annual loss from

the reinsurance sold to State Farm Florida from 1998 through

2007. State Farm Mutual can easily end the losses, as well as

the costs to State Farm Florida, by liquidating State Farm

Florida and doing business in Florida directly.

46. Issues of variability, ambiguity, and credibility

pertaining to the reasonableness of the cost of reinsurance is

illustrated in testimony during cross-examination of one of the

witnesses for State Farm Florida.

Q. Am I assuming correctly, then, that, I

mean, it’s described on the page. But is

there something in this page that indicates

to you that it’s a reasonable coverage

limit, other than it’s there?

A. It would be other than that it’s there,

and State Farm [Florida] has chosen that

level as a limit that they deem to be

reasonable.

Q. Okay. So your opinion that it’s a

reasonable coverage limit is informed by

State Farm [Florida] believing it’s a

reasonable coverage limit?

A. I suppose that’s the way to say it, yes.

Q. You don’t have any independent reason to

think it’s either reasonable or

unreasonable, other than State Farm

[Florida] has it on the page that describes

it such as it is?

A. I would say that’s correct.

TR at 555-556.

47. Another issue of variability, ambiguity, and

credibility emerges from the hurricane models used by State Farm

Mutual to project PML. State Farm Florida used hurricane models

to project both hurricane losses and PML. 8 Each model is

approved by the Florida Commission on Hurricane Loss Projection

Methodology (the Commission) pursuant to Section 627.0628.

However, State Farm Florida projected hurricane losses using

storm sets identified in the record as “cold water” or “long

term” storm sets and projected PML using storm sets identified

in the record as “warm water” or “short term” storm sets.

48. It is undisputed that the use of warm water storm sets

increases the estimated storm frequency and risk. For example,

State Farm Florida justified the requested rate of 47.1 percent,

in relevant part, by using cold water storm sets to reduce

stated PML by approximately $1.65 billion.

49. State Farm Florida utilized three hypothetical

adjustments to reduce the indicated rate of 67.0 percent to the

requested rate of 47.1 percent. First, State Farm Florida

calculated the impact on the cost of private reinsurance,

including that provided by State Farm Mutual, based on the non-

renewal and ex-winding activity. That adjustment reduced PML

from $9.25 billion to $7.8 billion. Wind-mitigation discounts

reduced PML another $700 million to $7.1 billion. The use of

cold water, or long term, storm sets to project PML reduced PML

another $1.65 billion to $5.45 billion.

50. State Farm Florida is actually purchasing

$9.25 billion in re-insurance coverage, less the retained risk

by State Farm Florida in the amount of $175 million. If the

actual cost of private reinsurance were to justify an indicated

rate of 67.0 percent, a requested rate of 47.1 percent would

appear to be inadequate, and State Farm Florida would soon

return with an additional rate filing.

51. State Farm Florida argues that the use of warm water,

or short term, storm sets to determine the actual PML of

$9.25 billion is appropriate. The evidence is clear that the

global reinsurance market demands and uses warm water models to

evaluate risk and to price reinsurance. Warm water storm sets

may be the gold standard for re-insurers, but it is also

axiomatic that use of the gold standard increases the price of

re-insurance and the resulting profit to re-insurers. A

preponderance of the evidence does not enable the fact-finder to

independently determine that the use of warm water storm sets to

project PML is not excessive, inadequate, or unfairly

discriminatory.

52. The issue of whether Florida is in a warm water cycle

or cold water cycle is not resolved by a preponderance of the

evidence. Moreover, State Farm Florida did not provide

Respondent with the near term frequency storm set used by State

Farm Florida to project PML. Respondent could not independently

evaluate the storm sets utilized by State Farm Florida.

53. State Farm Florida argues, in relevant part, that the

use of warm water models to estimate PML is justified because

the Commission has previously evaluated hurricane models for the

sole purpose of estimating hurricane losses, has never evaluated

hurricane models for the purpose estimating PML, and legislative

authority in Subsection 627.0628(3)(b) for the Commission to

evaluate hurricane models used to project PML was not enacted

until July 1, 2008.

54. Respondent has a different statutory interpretation.

Respondent interprets its legislative authority to mean that the

absence of the Commission’s approval of a warm water model to

project hurricane losses requires State Farm Florida to use cold

water, or long term, storm sets to project PML.

55. Any doubt as to an agency’s statutory authority to act

in a manner that accepts warm water storm sets to project PML

should be resolved in favor of refusing to exercise the

questionable authority. Moreover, the use of storm sets in

hurricane models is a matter within the substantive expertise of

Respondent. A statutory interpretation involving a matter

within an agency’s substantive expertise is entitled to great

deference when, as in this proceeding, the agency explicates in

the record reasons for such deference.

56. State Farm Florida includes an overall rate of return

of 12.2 percent in the rate filing. The fact-finder is unable

to determine from a preponderance of the evidence whether the

factor used by State Farm Florida for underwriting profit and

contingency is reasonable or excessive within the meaning of

Subsection 627.0612(2)(b).

57. The Legislature gave the fact-finder authority in

Subsection 627.0612(2)(b) to determine whether a factor for

underwriting profit and contingencies (a profit factor) is

reasonable or excessive. However, the evidence from State Farm

Florida is expressed in terms of a rate of return rather than a

statutorily authorized profit factor. The rate filing includes

a profit of 5.0 percent, a contingency of 2.0 percent, and a

retained risk factor of 9.0 percent for a total profit factor of

16.0 percent, but the rate filing uses a rate of return of

12.2 percent. Testimony elicited by counsel for State Farm

Florida during the cross-examination of Respondent’s witness

illustrates the variability between a 16.0 percent profit factor

and 12.2 percent rate of return.

Q. Whether it is called retained risk or it

is included in profit and contingency, you

get the same rate of return, isn’t that

correct?

A. The rate of return – rate of return or

rate indication –

Q. Rate of return.

A. Rate of return, I would say yes to that.

Q. And the placement in the filing has no

effect whether the rates are excessive,

isn’t that correct?

A. That’s correct.

Q. The issue of excessiveness is determined

by the overall rate of return, not the

particular derivation of the 9 percent

retained risk, isn’t that right?

A. That’s one of the items.

Q. Is that a yes?

A. Yes.

TR at 793-794.

58. The profit factor contemplated by the Legislature and

the rate of return utilized by State Farm Florida are distinct

investment concepts. Paragraph 72 of the PRO filed by State

Farm Florida states that when the income on investments is taken

into account the rate of return is 12.2 percent, effectively

amending the statutory reference to a profit factor in

Subsection 627.0612(2)(b), which is 16.0 percent in this case. 9

The Legislature has found in Subsection 627.062(2)(e)2. that

rates are excessive if, among other things:

[T]he rate structure established by a stock

insurance company provides for replenishment

of surpluses from premiums, when the

replenishment is attributable to investment

losses.

59. The retained risk of 9.0 percent by State Farm Florida

is a “retained hurricane risk.” State Farm Florida claims the

retained risk is a necessary cost of writing homeowners

insurance in Florida. However, State Farm Florida applies the

9.0 percent factor to the entire premium, not just the portion

of the premium attributable to a retained hurricane risk.

Moreover, legislation identified in the record as Senate

Bill 2860 (SB 2860) removed from former Subsection

a “retained risk” provision.

60. The fact-finder is unable to determine from a

preponderance of the evidence whether State Farm Florida passed

along to policyholders premium savings attributable to an

expansion of the Cat Fund from $16 billion to $28 billion. The

Legislature intends in HB 1A that all premium savings resulting

from the expansion of the Cat Fund are to be passed along to

policyholders.

61. State Farm Florida assumed a zero net-cost of

reinsurance purchased from the state. The net-cost of

reinsurance, including previously discussed private re-

insurance, takes into account the premium paid, the amount of

coverage, and the expected recoveries.

62. State Farm Florida paid approximately $700 million for

reinsurance from State Farm Mutual and private re-insurers and

determined that expected recoveries would amount to slightly

more than $106 million. The cost of coverage provided by the

Cat Fund and the expected recoveries from the Cat Fund were not

included in the determination of the net-cost of reinsurance.

63. The fact-finder is unable to determine from a

preponderance of the evidence whether the failure to include the

cost of coverage minus the expected recoveries from the Cat Fund

led to a cost of that reinsurance which is greater than the

services rendered in violation of Section 627.062. Because the

Cat Fund makes no profit, has minimal expenses, and has a very

large investment income credit due to its tax exempt status,

recoveries may, in certain circumstances, be significantly

higher than the premiums paid to the Cat Fund.

64. The fact-finder is unable to determine from a

preponderance of the evidence whether expenses attributable to

agent commissions are reasonable or excessive. State Farm

Florida assumes a 13.0 percent commission based on historical

commission ratios. However, historical ratios may not

accurately predict future costs because State Farm Florida is

reducing business through non-renewals and reducing coverage

through ex-winding and wind-mitigation discounts. Agent

services are rendered either to obtain new business or to

service existing policyholders. The voluntary limitation of new

business to transfer business may reasonably be expected to

reduce agent services attributable to new business.

65. The fact-finder is unable to determine from a

preponderance of the evidence whether costs attributable to

advertising and marketing are reasonable or excessive. State

Farm Mutual advertises for “branding purposes” and allocates a

portion of those costs to State Farm Florida. The benefit of

advertising for “branding purposes” is the retention of business

and the acquisition of new business. However, State Farm

Florida is limiting new business to transfer business, and it is

unclear what portion, if any, of the cost of branding incurred

by State Farm Mutual is misallocated to new business that State

Farm Florida is not creating.

66. State Farm Florida made adjustments to hurricane

models including the averaging of three models. A preponderance

of evidence shows that averaging, by itself, did not materially

affect the rate filing because averaging reduced variability

between the models.

67. The rate filing includes a factor identified in the

record as a sinkhole presumed factor. State Farm Florida

corrected a deficiency in the original filing by providing in

Petitioner’s Exhibit 11 the calculation required by Respondent.

68. The rate filing included a 10.0 percent loss

adjustment factor for hurricane losses. The information

included in the initial filing did not support the 10.0 percent

factor, but the factor is supported by a preponderance of the

post-filing evidence.

69. Respondent’s PRO discusses several alleged violations

of Florida Administrative Code Rules 69O-170.0135, 69O-170.014,

and 69O-170.003. However, the ALJ concludes that Respondent has

the burden of proving the affirmative allegation that State Farm

Florida violated an administrative rule. 10 Respondent’s

insistence on confining the evidence to that submitted with the

initial filing makes it unclear whether Respondent disputes the

issue of whether the post-filing evidence cures any violations

in the initial filing. The fact-finder cannot determine from a

preponderance of the evidence as a whole whether Petitioner

violated any administrative rule.

CONCLUSIONS OF LAW

70. DOAH has jurisdiction over the subject matter of and

the parties to this proceeding. §§ 120.569 and 120.57(1) and

Ch. 627. DOAH provided the parties with adequate notice of the

administrative hearing.

71. State Farm Florida has the burden of proof in this

proceeding. State Farm Florida must show by a preponderance of

the evidence that the rate filing is not excessive, inadequate,

or unfairly discriminatory. § 627.062(2)(b) and (g).

72. State Farm Florida is not limited to information

contained in the initial filing. State Farm Florida may rely on

evidence of circumstances as they existed through the

administrative hearing in order to satisfy the requisite burden

of proof. Florida courts have long held that a proceeding

conducted pursuant to Subsection 120.57(1) (a 120.57 proceeding)

is a de novo proceeding in which:

The [ALJ's] decision to permit evidence of

circumstances as they existed at the time of

hearing was correct. . . . Section 120.57

proceedings are intended to formulate final

agency action, not to review action taken

earlier and preliminarily.

McDonald v. Department of Banking and Finance , 346 So. 2d 569,

584 (Fla. 1st DCA 1977).

73. This proceeding is conducted to formulate final agency

action. State Farm Florida is entitled to present new and

additional information not contained in the initial filing.

Florida Insurance Council, Inc. v. Office of Insurance

Regulation, et al. , DOAH Case No. 05-2609RP, 2006 Fla. Div. Adm.

Hear., aff'd , 951 So. 2d 833 (Fla. 1st DCA 2007)(rejecting as

invalid the Respondent’s proposed rule containing an evidentiary

exclusion that was virtually identical to the one Respondent now

advocates). See also Young v. Department of Community Affairs ,

625 So. 2d 831, 838 (Fla. 1993); Hamilton County Board of County

Commissioners v. Department of Environmental Regulation , 587 So.

2d 1378, 1378-88 (Fla. 1st DCA 1991); Beverly Enterprises-

Florida, Inc. v. Department of Health and Rehabilitative

Services , 573 So. 2d 19 (Fla. 1st DCA 1990).

74. After Florida Insurance Council , 951 So. 2d at 833,

Respondent attempted to effectuate the exclusion of evidence not

contained in an initial filing through a proposed 2007 amendment

to Subsection 627.062(9). The Legislature chose not to adopt

the exclusionary rule of evidence proposed by Respondent.

75. Respondent argues that the certification requirement

in Subsection 627.062(9)(a)(the Certification Law) mandates that

the evidence be limited to the information included in the

initial filing. The Certification Law states, in pertinent

part:

The chief executive officer or chief

financial officer of a property insurer and

the chief actuary of a property insurer must

certify under oath and subject to the

penalty of perjury, on a form approved by

the commission, the following information,

which must accompany a rate filing:

1. The signing officer and actuary have

reviewed the rate filing;

2. Based on the signing officer's and

actuary's knowledge, the rate filing does

not contain any untrue statement of a

material fact or omit to state a material

fact necessary in order to make the

statements made, in light of the

circumstances under which such statements

were made, not misleading;

3. Based on the signing officer's and

actuary's knowledge, the information and

other factors described in paragraph (2)(b),

including, but not limited to, investment

income, fairly present in all material

respects the basis of the rate filing for

the periods presented in the filing;

and . . .

§ 627.062(9)(a).

76. The statutorily required certifications are fairly

construed to be limited to knowing misstatements, or omissions

that make a statement misleading or that result in unfair

presentation of information. There is no language in

Certification Law that could be reasonably interpreted as

limiting the scope of this rate hearing before DOAH.

77. The exclusionary rule that Respondent proposes in this

proceeding was previously rejected in another proceeding.

Hartford Fire Ins. Co. et al. v. Office of Insurance Regulation ,

Case Nos. 07-5185 through 07-5188 (DOAH March 28, 2008). In

Hartford , the ALJ concluded:

102. . . . OIR asserts that the amendments

to Section 627.0[62] make it a requirement

that all documentation must be included in

the filing, and therefore there is no longer

a place for a clarification letter in the

rate review process.

103. . . . OIR bases its position on the

addition of Subsection 627.062(9), Florida

Statutes, . . .

104. Contrary to the OIR’s assertions,

nothing in this amendment requires that all

documentation upon which an insurer might

possibly rely must be included in the filing

itself. The amendment does require that the

insurer closely scrutinize its filings and

insure that all factors identified in

Section 627.062(2)(b) “ fairly present in all

material respect the basis for the filing .”

The filing cannot, by commission or

omission, make any misleading or untrue

statements. Florida Administrative Code

Rule 69O-170.013(5) clearly makes it the

insurer’s responsibility to include all

information it wants considered to support

the rate filing, and this requirement is not

new. However, other parts of Section

627.0[62] which the Legislature chose not to

delete still clearly allow for additional

information to be provided to the OIR upon

request, and the OIR’s rules still

contemplate such a process . . . . (Emphasis

added)

78. Respondent adopted the quoted conclusions of law in

its May 30, 2008, Final Order in Hartford , Case No. 94940-08-FO.

Respondent is bound by the doctrine of administrative stare

decisis to follow its final orders in cases involving similar

facts and law. Gessler v. Dept. of Business and Professional

Regulation , 627 So. 2d 501 (Fla. 4th DCA 1993).

79. The Certification Law is not reasonably construed to

amend Chapter 120 by implication. Amendment by implication is

not favored by the courts. In State v. J.R.M. , 388 So. 2d 1227

(Fla. 1980), the court stated:

It is well established that amendment by

implication is not favored and will not be

upheld in doubtful cases. Miami Water Works

Local No. 654 v. City of Miami , 157 Fla.

445, 26 So. 2d 194 (Fla. 1946). Amendment

by implication occurs when it appears the

latter statute was intended as a revision of

the subject matter of the former or when

there is an irreconcilable repugnancy

between the two, so that there is no way the

former rule can operate without conflicting

with the latter.”

80. For reasons stated in the Findings of Fact, State Farm

Florida did not show by a preponderance of the evidence that the

indicated and requested rates are not excessive, inadequate, or

unfairly discriminatory. As explained in the Findings of Fact,

a finding that State Farm Florida did not satisfy its burden of

proof is not tantamount to a finding that either the indicated

rate and requested rate is excessive, inadequate, or unfairly

discriminatory.

81. The determination by Respondent that hurricane models

used to project PML must use cold water, or long term, storm

sets is entitled to great deference. The statutory

interpretation is within the substantive expertise of the

agency. The evidentiary record supports a finding that an

interpretation of statutory terms requires special agency

insight or expertise. The agency has articulated in the record

underlying technical reasons for deference to agency expertise,

and the agency's interpretation is not clearly erroneous.

Johnston, M.D. v. Department of Professional Regulation, Board

of Medical Examiners , 456 So. 2d 939, 943-944 (Fla. 1st DCA

1984). Insurance rate-making is a technical, complicated, and

involved process. Travelers Indemnity Company v. Williams ,

190 So. 2d 27 (Fla. 1st DCA 1966); Mutual Insurance Rating

Bureau v. Williams , 189 So. 2d 389, 390 (Fla. 1st DCA 1966);

Nationwide Mutual Insurance Company v. Williams , 188 So. 2d 368,

372 (Fla. 1st DCA 1966).

RECOMMENDATION

Based on the foregoing Findings of Fact and Conclusions of

Law, it is

RECOMMENDED that Respondent enter a final order determining

that State Farm Florida did not show by a preponderance of the

evidence that either the indicated rate or requested rate in the

rate filing is not excessive, inadequate, or unfairly

discriminatory.

DONE AND ENTERED this 12th day of December, 2008, in

Tallahassee, Leon County, Florida.

S

DANIEL MANRY

Administrative Law Judge

Division of Administrative Hearings

The DeSoto Building

1230 Apalachee Parkway

Tallahassee, Florida 32399-3060

[phone]

Fax Filing [phone]

www.doah.state.fl.us

Filed with the Clerk of the

Division of Administrative Hearings

this 12th day of December, 2008.

ENDNOTES

1/ References to subsections, sections, and chapters are to

Florida Statutes (2008), unless otherwise stated.

2/ Subsection 120.52(8) defines an “invalid exercise of

delegated legislative authority” as “[agency] action which goes

beyond the powers, functions, and duties delegated by the

Legislature.” The statute proceeds to describe circumstances

in which agency action in the form of rulemaking goes beyond the

powers, functions, and duties delegated by the Legislature. The

statutory definition of agency action that goes beyond the power

delegated by the Legislature is not confined to agency action in

the form of rulemaking but also reaches agency action undertaken

through the adjudication of individual cases. A contrary

interpretation would effectively authorize an agency to

accomplish through adjudication of individual cases that which

the Legislature prohibits the agency from accomplishing through

rulemaking. The powers that an agency exercises through either

adjudication of individual cases or rulemaking must be

coextensive with the powers, functions, and duties delegated by

the Legislature in the terms of the enabling statute.

3/ State Farm Florida claims that at the end of 2006, when the

previous rate increase went into effect, 112,000 policyholders

qualified for wind-mitigation discounts, but by August 2008 the

number of policyholders receiving the discounts rose to 264,000.

4/ The TICL was authorized by the Legislature in Chapter 2007-1,

Section 2(17)(d)4, at 17, Laws of Florida, which the parties

refer to in the record as House Bill 1A (HB 1A). HB 1A is

reported in its entirety in Respondent’s Exhibit 11.

5/ The respective amounts of reinsurance are summarized in

Tab 17 of Petitioner’s Exhibit 1.

6/ The absence of any economically significant distinction

between State Farm Florida, State Farm Mutual, and the other

members of the affiliated group is illustrated in paragraph 70

of the PRO filed by State Farm Florida.

The 5% profit is a typical profit that SFF

[State Farm Florida] uses in most states

[sic] and it is the profit needed for doing

business in an average state.

State Farm Florida does not do business in “most states.” It

only does business in Florida. State Farm Mutual and Fire and

Casualty are the members of the affiliated group that conduct

the business of insurance in “most states.”

7/ The record does not disclose whether the annual loss

experienced by State Farm Mutual resulted in a tax benefit, such

as a reduction in taxable income, for purposes of the federal

and state income tax. Federal tax law disregards certain

transactions between members of an affiliated group so that a

single company organized into separate divisions does not enjoy

a tax advantage over an affiliated group organized into separate

companies with a common parent. The state corporate income tax

“piggybacks” the federal income tax. Similarly, state sales tax

systems generally provide resale exemptions that, in relevant

part, provide equal tax consequences for transactions between

related entities within an affiliated group and divisions within

a single corporation. An analogous argument can be made that

State Farm Mutual should not enjoy a rate advantage from the

legal form in which it chooses to do business in Florida. One

way to determine whether State Farm Mutual enjoys a rate

advantage by doing business in Florida through State Farm

Florida is to compare the economic cost of a retained risk

provision with the costs of reinsurance and the credit risk

provision at issue in this proceeding.

8/ The $9.25 billion reinsurance amount for PML represents State

Farm Florida’s estimate of the 1-250 year PML. The 1-250 year

assumption does not assume that such an event will occur once

every 250 years. Rather, the assumption is that a 1 in 250 year

event has a 0.4 percent chance of occurring in any given year.

9/ Some evidence suggests the actual rate of return may be

20.0 percent. See discussion in paragraph 54 of Respondent’s

PRO.

10/ Florida Department of Transportation v. J.W.C. , 396 So. 2d

778 (Fla. 1st DCA 1981).

COPIES FURNISHED :

Vincent J. Rio, Esquire

State Farm Insurance Companies

One State Farm Plaza, A-3

Bloomington, Illinois 61701-4300

S. Marc Herskovitz, Esquire

Elenita Gomez, Esquire

Office of Insurance Regulation

Legal Services Office

200 East Gaines Street

Tallahassee, Florida 32399-0333

C. Ryan Reetz, Esquire

Mia B. Fraser, Esquire

Squire, Sanders & Dempsey, LLP

200 South Biscayne Boulevard, Suite 4000

Miami, Florida 33131

Cynthia S. Tunnicliff, Esquire

Brian A. Newman, Esquire

Pennington, Moore, Wilkinson,

Bell & Dunbar, P.A.

215 South Monroe Street, Second Floor

Post Office Box 10095

Tallahassee, Florida 32302-2095

Kevin M. McCarty, Commissioner

Office of Insurance Regulation

200 East Gaines Street

Tallahassee, Florida 32399-0305

Steve Parton, General Counsel

Office of Insurance Regulation

200 East Gaines Street

Tallahassee, Florida 32399-0305

NOTICE OF RIGHT TO SUBMIT EXCEPTIONS

All parties have the right to submit written exceptions within

15 days from the date of this Recommended Order. Any exceptions

to this Recommended Order should be filed with the agency that

will issue the Final Order in this case.