"Insurance company." That seemingly benign term is at the crux of a legal fight waged by State Farm Insurance against an order that it repay more than $100 million in overcharges imposed on its homeowner insurance customers dating back to mid-2015.
The issue in the lawsuit State Farm has brought against California Insurance Commissioner Dave Jones boils down to "What is an insurance company?"
That's not a metaphysical question, like "What is reality?" It's a question of definition, specifically whether the term "insurance company" in California law means a relatively small company that only writes homeowner policies in this single state, or the big, nationwide insurance group that owns it lock, stock and barrel.
If it's the former, then State Farm may have been justified in receiving the 6.9% increase in homeowners insurance premiums it applied for in 2014. If the latter, then Commissioner Jones may have been justified in 2016 in rolling back State Farm's rates by 7% as of mid-2015, and ordering the company to refund $100 million in excess premiums.
San Diego County Superior Court Judge Katharine Bacal has scheduled a hearing in State Farm's lawsuit for March 9, when she might even issue a tentative decision on the insurer's request that Jones be ordered to reverse the rate reduction, cancel the refund and reexamine or approve the company's rate increase.
There's more at stake in this battle than one insurance group's premiums. To consumer advocates, State Farm's lawsuit is merely the latest salvo fired in the insurance industry's 30-year campaign to overturn Proposition 103. That's the 1988 ballot measure that created the insurance commissioner's position as an elected post, made homeowner and auto insurance premiums subject to the commissioner's prior approval, and rolled back existing rates by 20%.
The insurance industry has been at war with Proposition 103 ever since its passage. The industry filed more than 100 lawsuits to overturn it wholly or in part, according to a tally by Harvey Rosenfield, the author of Proposition 103 and founder of the advocacy group Consumer Watchdog. But the measure was upheld by the state Supreme Court, as were regulations to implement it. The U.S. Supreme Court turned down an appeal.
Insurers — notably Mercury Insurance, whose billionaire founder George Joseph is a sworn enemy of the law — got state Sen. Don Perata to introduce a bill in 2002 undermining Proposition 103. But after it passed it was vetoed by then-Gov. Gray Davis. Perata reintroduced the bill in 2003, and this time Davis, who was fighting for his political life in a recall election and received big contributions from Mercury, signed it. The law later was overturned by the State Supreme Court
Mercury then attempted to erode Proposition 103 via initiative campaigns launched in 2010 and 2012. Both lost at the ballot box.
The "true challenge" posed by State Farm in its lawsuit, Consumer Watchdog says in a brief in the case, "is to the voters' decision to regulate insurance rates in California. It lost that case at the ballot box nearly 30 years ago."
Curiously, the issue of whether an insurance commissioner could order a refund of already-approved rates under Proposition 103 seems never to have been tested in court; previous refunds have been arranged through settlements before an order was necessary. Also a bit murky is whether the insurance department is bound to consider a parent company's entire investment portfolio in setting rates for an affiliate. Rosenfield says the law is settled that it must, but no previous court case appears to have dealt with an entity quite as large or complex as State Farm.
Proposition 103, Rosenfield says, has kept nearly $4 billion in ostensibly excessive rate increases from going into effect, so "insurers have billions of dollars in incentives" to keep fighting the law. With the latest lawsuit, Rosenfield says, the insurers are "trying again to upend the system."
State Farm's case deals with the relationship between State Farm Mutual Automobile Insurance Co., the largest home insurer in the country, and State Farm General, the largest home insurer in California, which accounted for about 9% of the company's $57 billion in homeowner premiums nationwide in 2014.
The California affiliate requested a 6.9% homeowners premium increase in December 2014, to be effective the following July 15. Consumer Watchdog and the Consumer Federation of California challenged the request, and an administrative law judge conducted a yearlong hearing before rejecting the increase and ordering the rollback of rates and the refund in October 2016, retroactive to 2015.
Commissioner Jones accepted the decision on Nov. 7, and State Farm sued to overturn his decision two weeks later. In the meantime, Jones has threatened State Farm with fines for failing to reduce rates as he ordered.
State Farm's main argument involves the state's method of calculating its investment yield in setting the appropriate premiums. That's standard practice nationwide — the more a company earns from its stock and bond portfolios, the less it needs to collect in premiums.
In this case, the administrative law judge applied the 5.84% gain earned by the giant Bloomington, Ill.-based State Farm Mutual Automobile Insurance Co., the parent company, which has more than $250 billion in assets. State Farm says the proper calculation should include only State Farm General's investment gain. That was a meager 2.4% in the period at issue, chiefly because General only owns bonds; these have produced lower gains in recent years than Mutual's portfolio, which is 40% in stocks. A lower yield would allow drastically higher premiums to be charged by State Farm General.
State Farm says the California firm is a separate company from Mutual, so their portfolios shouldn't be lumped together — and that General is the "insurance company" referred to in regulations that govern whose portfolio to assess.
California says that's balderdash. State Farm General is 100% owned by the big Mutual, the administrative judge pointed out. It's also headquartered in Bloomington, and managed entirely by Mutual employees, who also comprise its board of directors. General, in fact, has no employees of its own.
The state points out that its insurance regulation explicitly calls for investment calculations to be based on a company's "consolidated statutory annual statement."
State Farm itself cited its consolidated portfolio in a 2014 rate case involving auto premiums. State Farm lumped General's and Mutual's portfolios together because General's bond portfolio dragged down the total yield, justifying a higher premium for auto policies. A State Farm spokesman says that has nothing to do with the present case.
State Farm maintains that Jones is trying to dictate how it organizes its business and structures its portfolio. Jones, it says, "second guesses" General's "prudent decision to invest solely in bonds." The alternative, it says, "is to invest in stocks that can quickly lose value in the stock market."
But Jones is plainly agnostic about State Farm's corporate or portfolio design; he's only arguing that whatever the design is, the investment results of the entire Mutual company are what count. He observes that allowing insurers to carve some affiliates' portfolios off from the consolidated holdings would invite them to game rates ruthlessly.
The only way around that, he argues, is to treat all affiliates as parts of the whole, and assess the investment results of the combined portfolios.
He's right. There are undoubtedly sound reasons for State Farm organizing its business in pieces, but manipulating premium rates shouldn't be among them. Judge Bacal has her work cut out for her in unwinding this complicated arrangement, but her conclusion should be an easy call.