A Report on the Liability Insurance Crisis in the State of California

---------------------------------------------- -12- or are now pending in other states. Exhibit 111-1, on the next page, provides a summary of some other states that have recently enacted caps on compensatory damages. This exhibit shows that currently adopted caps on compensatory damages for pain and suffering range from $200,000 in Ohio to $573,000 in Washington. While California has a $250,000 limit on medical malpractice claims under the Medical Injury Compensation Reform Act (MICRA), California has not adopted a uniform cap for non-economic damages. Finding 115 The Joint and Several Rule That Was Partially Repealed by Proposition 51 is Unfair to Low-Fault Defendants The operation of the common law rule of joint and several liability has been inconsistent with the proportionate fault system in California. As a result, deep-pocket defendants have been subjected to major inequities when juries have found deep-pocket defendants either minimally at fault or less at fault than the plaintiff. The recent passage of Proposition 51, which eliminated joint liability for non-economic damages, should address this inequity to some extent. However, Proposition 51 does not address cases against low-fault defendants and contributorily negligent plaintiffs. Until the recent passage of Proposition 51, California followed the traditional version of the joint and several liability rule. Under this rule, a plaintiff who was adjudged to have been injured by multiple defendants was permitted to recover full payment of the judgement by any of the defendants regardless of the share of the fault the jury assigned to that defendant. The plaintiff could do this only once, so that double payment could not occur, and the defendant who paid had the right to require other defendants to reimburse him in shares equal to their respective adjudged fault under a related common law rule called contribution. The problem arose if anyone of these co-defendants was insolvent, as is frequently the case, because under the joint and several rule the "deep pocket" defendant then must bear the entire brunt of the judgement. The rationale of the joint and several rule has always been that as between a partially culpable defendant and an innocent plaintiff, that defendant should properly bear the risk of another defendant's insolvency. At the time this rule was developed in the Middle Ages, however, no plaintiff could recover damages if the jury found that his or her own negligence had contributed in any degree to bringing about the lnJury. This rule effectively discouraged plaintiffs with a minor degree of fault from drawing the jury's attention to this fact by suing defendants who also were at fault to a minor degree. This model of innocent plaintiff/guilty defendant became outmoded overnight, however, in 1975, when the California Supreme Court replaced the rule of contributory negligence with comparative fault, so that even a plaintiff who had contributed to his own injury could recover damages to the extent that the fault assigned to the defendant (s) also contributed. The disincentive to name "deep pocket" low fault defendants was removed, giving the plaintiff a powerful incentive to include low-fault defendants in a lawsuit as the plaintiff's only practical hope for recovering any substantial compensation. -16- task force of ten federal agencies and the White House, recommended earlier this year with regard to publicly provided collateral sources of compensation that there should be an automatic offset against plaintiff's recovery of tort damages for the same injury. Finding # 9 - The Cost of Administering the Civil Justice System is Excessive and Creates a Burden to Plaintiffs and Defendants The costs of intolerable level. fees into account, liability carriers. administering the civil justice system have reached an The expense of litigation, taking both sides attorneys' eats into plaintiffs' recoveries and adds to the strain on Based on information provided by the Rand Corporation, the Commission established that nearly 54 cents of every premium dollar paid by an insurance company goes to cover the sum of the defendant's and plaintiff's legal costs. In addition, the increased complexity of trials and multiplication of the parties, caused in part by abrogation of the contributory negligence rule and retaining the jo~t and several rule, have exacerbated the problem. A Rand Corporation study of the Civil Justice System nationwide concluded that $320 million was spent in 1982 as the public cost incurred by the State and Federal courts in administering personal injury litigation. The Commission understands that, while the prevailing contingency fee is 33 1/3 percent of plaintiff's recovery, and insurance defense attorneys normally charge $65 to $100 per hour, some plaintiff's attorneys take a higher contingency fee for cases with less merit and some "deep pocket" defense lawyers command a much higher hourly rate. While the Commission recognizes that litigation costs are essential to the operation of the tort system, and that only through the mechanism of the contingency fee can many plaintiffs afford to litigate their claims at all, the Commission has heard testimony that attorney fees for both sides are increasing at a rate even faster than the size of jury verdicts and that attorneys for both sides engage in wasteful, unnecessary and even frivolous pre-trial motions. Finding itlo - Payment of Lump Sum Awards for Future Damages at the Time of Judgement Hurts Both Parties The current judicial practice of awarding the prevailing plaintiff all of his future damages, including medical bills, loss of earnings, pain, suffering and emotional distress, in a lump sum discounted for present value upon entry of judgement is not in the interest of either party. 4Costs of the Civil Justice System: Court Expenditures for Processing Tort Cases by James S. Kahalil and Abby E. Robyn -17- The payment of a large award for future damages at the end of a trial places a heavy burden on a defendant or its insurer and compensates the plaintiff for damages he has not yet suffered. Currently, 18 states have adopted some form of periodic payment legislation to authorize future damage awards to be stretched out over a period of years to reduce that burden. The periodic payment provision in MICRA may be one of the reasons the rate of increase in medical malpractice premiums in California is only half that of the national average. From the plaintiff's perspective, many of his damages, like future wage losses and medical bills, have not yet occurred, and periodic payments enhance the probability that the plaintiff will have money available for those damages when they do occur. As long as the award of future damages is not made assignable or discounted for present value, a reasonable rate of return during the period of the payments is provided for, and the economic portion of plaintiff's loss remains payable to plaintiff's dependents or estate if he dies while periodic payments are still due, there are no compelling reasons for not adopting a periodic payment plan in large damages cases. Possible damages and inequities for the plaintiff of a periodic payments schedule include the following: (1) unless a substantial amount of the award is paid at judgement the plaintiff could be forced to sell his future damages award at a discount in a secondary market just to pay expenses; (2) the defendant could receive an unfair double windfall if the plaintiff is not given a reasonable rate of return during the period of the payments; and (3) the defendant could receive a triple windfall if the plaintiff dies while a substantial number of payments are still due. -18- CHAPTER IV POLICIES AND PRACTICES OF THE LIABILITY INSURANCE INDUSTRY The recent poor financial condition of the liability insurance industry largely reflects self-inflicted wounds over the last several years resulting from the industry's marketing and pricing practices during the past decade. Insurers use premiums to generate investment income. When interest rates and investment income are high, as they were during the late 1970' s and early 1980' s, insurers are able to utilize the income to subsidize underwriting operations. From the consumers perspective this subsidy is beneficial because it produces declining commercial insurance prices. However, the scale that so carefully balances investment income and premiums was tipped out of balance during the early 1980's because of unsound pricing and underwriting practices by the insurance industry. In SMARTS Insurance Bulletin, an industry trade paper published in early 1986, the editor stated: The insurers and reinsurers created their own brutal price war over the past five years. No one other than they themselves forced any underwriters to cut prices, meet or beat a quote, throw in coverage after coverage with no charge, or throwaway the underwriting book. Therefore, the current problems can be partially understood by looking at both the unique issues of the early 1980' s and the long-term "insurance cycle" including the accounting, casualty underwriting, and reinsurance processes. FINDING 1111 - The Liability Insurance Industry is Cyclical Which Results in Periodic Affordability and Availability Problems The liability insurance industry is affected by an interest-sensitive rate-making structure and unique accounting practices. This makes the industry cyclical in nature. Without intervention in the current insurance crisis, the industry will probably recover. However, the next cycle may even be more extreme and prolonged due to forces affecting the insurance industry. The liability insurance industry is highly cyclical. This is due to a combination of factors including the interest-sensitive ratemaking structure and some unusual aspects of insurance accounting practices. However, the current cycle within the insurance industry is deeper and more debilitating than any other cycle in the past. Therefore, without any action to soften the cycle, the next cycle may be more severe and prolonged. The fluctuations of the liability insurance industry have long been known, at least within the industry, to constitute an ongoing cycle of both profitability and availability. Exhibit IV-1, on the next page, displays the combined underwriting ratios for liability stock companies during a 36-year period beginning in 1950. As shown in Exhibit IV-I, the insurance industry had underwriting gains in 1977, 1978 and 1979 followed by underwriting losses beginning in 1980. -19- However, it should be noted that the graph is only a partial picture of the industry I s profitability since investment income, the other major source of revenue, is not included. When a policy is written, premiums received are invested to produce additional revenue. This invested income is used to offset administrative costs and pay losses. The actual cost of insurance is therefore paid by a combination of premiums and investment income. When investment income is high, as it was from 1976 through 1983, insurance premiums constitute a smaller portion of underwriting costs. Conversely, when interest rates drop, premiums must be increased to cover anticipated or actual losses. From the consumer's perspective, the drop in premiums during the late 1970's and early 1980's was beneficial, since purchasers of liability insurance were able to take advantage of both the industry's reliance upon investment income from the premium dollar to offset part of the cost of claim losses, as well as benefit from the insurer's price war. However, with the decline in the interest rate in 1983, and with the increase in losses and administrative expenses which began in 1980, this particular portion of the cycle came to an abrupt end. The insurance companies stated that, in order to cover their rising expenditures, they would have to raise premiums to cover both lost investment income and also the rise in the actual "losses" caused by faulty underwriting. Different Methods Exist for Determining Profitability in the Insurance Industry The property casualty insurers have stated that they are currently earning a return on net worth well under that of the Fortune 500, are becoming insolvent in record numbers, and generally are in dire financial conditions. However, some experts believe that the term "losses" used within the insurance industry is not synonymous with the term "losses" in other industries. These experts state that the Best Property Casualty Index rose by 50 percent in 1985, almost doubling the rise of the Dow Industrial Average, and has risen another 26 percent during the first quarter of 1986, again, almost double the Dow. Since 1975, the insurance stock index has risen more than 500 percent, more than 5 times the rise of the Dow. Mr. Robert Hunter, President of the National Insurance Consumer Organization has an explanation for the discrepancy. Specifically, he states in his paper "And Now The Real Facts; A Response to the Insurance Services Office-Insurer Profitability -- The Facts" that, "The key to understanding the performance of the insurance industry and the performance of the insurance industry stocks is the way the industry does its accounting." The report goes on to state that "in 1985, the property casualty industry took in about $142 billion in premiums, paid out about $130 billion in claims and expenses, and yet declared about a $25 billion underwriting loss." The reason is that State Insurance Commissioners require that insurance companies report their profit or loss each year based on "worst case" assumptions. Specifically, they require insurance companies to "assume that after the end of the year, (1) all policies are cancelled so that all policy holders receive that part of the premium that the insurer has not earned, and (2) all claims known and unknown will be paid at full value." -20- To test the solvency of insurers in this manner makes sense, but to add profits or losses arrived at based on these assumptions and to report them as a measure of the industry's profitability is misleading. First, in order to pay out a dollar in 10 years, one needs to set aside much less than a dollar today, since money set aside will earn interest. However, insurers set up a reserve which they carry as a liability for the full amount they estimate they will eventually payout in the future. This practice, which has been strongly criticized by the Federal General Accounting Office, is the major reason why liability insurers consistently earn substantial profits but pay no Federal income tax. Between 1975 and 1984, for example, according to a recent GAO study, the industry had net gains of $75 billion, yet faid no Federal income tax and actually received a tax refund of $125 million. Secondly, the amount of unearned premium that policy holders are assumed to receive back from the insurer at the end of the year is overstated, since the insurer would also receive a part of the commission from the agent and a part of its premium taxes from the State. If these adjustments were made, Mr. Hunter estimates that the property casualty industry would show an underwriting loss of $19.5 billion rather than $25 billion in 1985. In addition, in 1985 the industry had investment income of $19.7 billion, realized capital gains of $5.3 billion, and federal tax credits of $1.9 billion. Thus, the property casualty industry's total profit could be estimated in 1985 to be $7.4 billion, a net return of approximately 11 percent. Insurance Industry Has Not Always Used Sound Underwriting Practices An understanding of the process used to calculate premiums, or the "underwriting" process, is also necessary to fully comprehend the current crisis. Liability insurance premiums are calculated using a number of different factors. Among these factors are the professional judgements by actuaries regarding the anticipated probability of payment for claims made against a policy, and the anticipated cost of those claims, known as risk assessment. The primary process of risk assessment and evaluation is usually handled jointly by all liability insurance companies through the auspices of a separate industry funded organization, the Insurance Services Office (ISO). ISO's purpose is to construct base rates for liability insurance and to gather the statistics and other information necessary to construct those rates, the "benchmark" for most lines of insurance. To assess risk for a particular line of insurance, actuaries will take into account the prior histories of all claims filed and paid, on a regional basis, usually going back over a period of two to five years. The actuaries also attempt to determine, based upon statistical models, the length of time during which it is likely claims mayor will be filed and paid against the policy. This period of time is known as the "claims tail" and may vary from as little as 6-9 months in the case of auto liability insurance to 7-8 years in medical malpractice insurance, and in some areas such as product liability, as long as 20-25 years. The actuary will also make a determination of the size of future claims losses based upon the relevant legal doctrines currently in 5U. S . General Accounting Office, Tax Administration: Information on How the Property/Casualty Insurance Industry is Taxed (October, 1985) -21- place. The actuary then makes a determination as to the presumed investment return available over the life of the policy which would allow portions of the premium to be invested. This amount is then discounted depending upon the amount of money and the period of time in the "claims tail" necessary to make all loss payments. Finally, the actuary will add administrative and brokerage costs, taxes and a profit factor. In California, these additional factors total approximately 46% of the "benchmark" rate. Once the ISO rate is developed, it is provided to the subscribers and members of the ISO, who at this time write approximately 80% of the liability premiums in California. These primary insurers may modify the benchmark rate based upon their own assumptions, including the risk assessment factors used to reflect a "better than average" risk client, assumptions regarding the administrative cost and brokerage fees which reflect their own experience, and possibly entirely different judgements regarding the anticipated income to be made from the premiums charged. The individual companies will also, of course, be aware of the competition of other companies for the same clients, and may, as previously noted, reduce premiums in order to retain their share of the market. The result of such "modification" or "adjustment" can be a premium rate which is as little as 20 percent to 30 percent of the ISO rate. Such rates were not uncommon during the period from 1977 through 1983, and are reflective of the liability carriers' actuarially unsound pricing practices. Left to itself, the liability insurance industry will presumably right itself and, at some future point, begin the cycle allover again. However, in the absence of any attempt to dampen the extremes of fluctuation, it is entirely possible that the current stage of the cycle will be more prolonged than usual, and recovery to the next stage much slower. The Commission believes that this may mean that many more liability carriers, both primary insurers and reinsurers, will be irreversibly damaged and may withdraw from the marketplace, so that many more businesses and public entities will curtail functions, or will cease functioning entirely. FINDING #12 - A Significant Number of Reinsurance Underwriters Have Withdrawn from the Reinsurance Market thus Limiting Insurance Availability Almost one half of the reinsurance underwriters in the nation have partially or entirely withdrawn from the reinsurance market because of the uncertainty and unpredictability that exists in the marketplace. Since the reinsurance market acts as a safety net for the industry by expanding the available insurance capacity, the withdrawal of reinsurance underwriters from the market has severely restricted the availability and affordability of insurance. One of the major reasons the current crisis has been so devastating has been the almost complete disappearance of one of the most vital, and yet least understood parts of the liability underwriting process. This is reinsurance, or "insurance for the insurers." The reinsurance market acts as a "backstop" or "safety net" for the entire liability insurance market. Reinsurance is basically a transaction wherein a secondary insuring company will, for a fee or secondary premium, agree to indemnify the primary carrier for part of the loss incurred. It is used to expand coverage capacity -22- of the primary insurers. The liability underwriter's risk assumptions are limited by a number of factors, including the need for his company to achieve diversity in a particular line, the adequacy of pricing and return on investment, and the amount of surplus capacity available to write new business or to offer higher limits of coverage on old business. In order to protect the consumer and public, insurance regulatory practices have restricted the leverage an insurance company may use to expand capacity. Traditionally, a two to one (2:1) ratio of premiums to retained surplus is desirable, and a three to one (3:1) ratio may be acceptable. An insurer who is more highly leveraged may be ordered to cease assuming additional risks and to write no new coverage until his ratio returns to an acceptable level. One method of expanding capacity and thus bringing in more premiums for investment is to transfer a portion of the risk to another insurer by entering into a reinsurance contract. This allows the primary carrier to expand its capacity by passing a portion of the risk along, stabilize operating costs, reduce exposure in certain risky areas, and develop new business opportunities. Reinsurers usually assume the risk for the "high end" portion of a policy coverage written by the primary insurers. This is particularly important to corporations and public entities who may need or require coverage limits in the millions or tens of millions of dollars. It has been common practice for primary carriers to pass through a large portion of the assumed risk, in some cases up to 90 or 95 percent, through a reinsurer if such reinsurance could be obtained. From the late 1970's through 1983, the reinsurance market was extremely active due to the high rate of interest obtainable on invested premiums and the relatively low losses. Particularly because of the high interest rates available, much of the reinsurance was undertaken on only a marginal and inadequate portion of the primary insurers premium. Those premiums, as already noted, were inadequate to cover losses during that period, and the process of reinsurance only passed the more drastic effects along to the reinsurer. As an example, the primary carrier would write a policy for $1 million in liability coverage with the premium charged totaling $10,000. In an attempt to spread the risk the primary carrier would request that a reinsurer assume one half of the liability on the policy in return for $4,000 or 40 percent of the original premium, since the likelihood of the settlement cost breaching the reinsurance limits is low. However, given that the original premium charged by the primary carrier is not adequate by itself to cover anticipated claims on the policy, the reinsurer is in essence accepting an unrealistic liability potential for the amount of premium received. In the last several years, according to 6several studies by the Institute for Civil Justice of the Rand Corporation, there has been a significant increase in both the number and size of the largest liability awards and 6Comparative Justice: Civil Jury Verdicts in San Francisco and Cook Counties, 1959-1980, Michael G. Shanley and Mark A. Peterson The Civil Jury: Trends in Trials and Verdicts, Cook County Illinois, 1960-1979, Mark A. Peterson and George L. Priest -23- settlements. Thus, when the loss surge began to result in larger awards, which were passed through to the reinsurer by the primary carrier, the losses to the reinsurance companies quickly began to outstrip both the reinsurers fees and interest earned. The Reinsurance Association of America has indicated that, in 1984, its member companies reported a decrease in aggregate surplus of $400 million due to paid losses. Although there was an increase in aggregate surplus in 1985, they state that it was due almost entirely to an infusion of funds from the reinsurer's parent and holding companies, done as an effort to shore up the secondary market. These losses, and the problems associated with risk assessment of reinsurance agreements, which were primarily written on "long tail" lines and in many cases on high risk industries such as toxic materials or pharmaceuticals, have compelled reinsurers to either raise their premiums to a level which could not be afforded by the primary carriers or to withdraw entirely from the reinsurance marketplace. From January 1984 to December 1985, 90 reinsurance underwriters, or approximately 45 percent of the total number of companies offering reinsurance in the nation had partially or entirely withdrawn from the market. This constriction of the secondary market for liability insurance has had the direct effect of denying coverage to many businesses and public entities. Since most primary insurers are not willing to write policies and retain the total risk at necessary levels of coverage, they are often not willing to write any coverage at all, causing the crisis of availability. There is little indication at this point of when or under what conditions this vital portion of the market may reconstitute itself. It is entirely possible that, due to prior losses and the continued perception of rising losses by reinsurers, there may be no significant degree of return by reinsurers to the United States market for several years. This lack of reinsurance availability may cause the primary market to remain extremely restricted at any level of premium, regardless of any tort reform, and may resul t in a nonexistent market for perceived "high risks," such as public entities. -24- CHAPTER V THE INSURANCE COMMISSIONER'S ROLE IN PROVIDING STABILITY IN THE INSURANCE MARKETPLACE The California Department of Insurance was established to protect insurance policy holders in the State. To accomplish this obj ective, the Department conducts examinations of insurance companies and producers to ensure that operations are consistent with State law. Specifically, the examinations and reviews by the Department of Insurance are used to regulate insurance companies to ensure that losses to policy holders, beneficiaries or the public due to insolvency of the insurers are prevented; to ensure that the industry's practices are not unlawful or fraudulent; and to ensure that the general public and policyholders are not discriminated against with regard to the sale of insurance. Since the federal government neither regulates nor monitors the insurance industry, and since private individuals cannot sue insurance companies for price fixing under the anti-trust laws, the only entities with authority to control insurance company practices within the United States are the state Insurance Commissioners or the Departments of Insurance. But the willingness and ability of the state Insurance Commissioners to meaningfully regulate the industry has been questioned. In 1979, for example, the General Accounting Office (GAO) conducted a study and found that "there are serious shortcomings in state laws and regulatory activities with respect to protecting the interest of insurance consumers in the United States." They specifically found that "most states do not have specialized examiners, and few states have the capacity to do computerized audits." Further, they determined that "the degree of scrutiny given important premium increase requests was not adequately reviewed and that insurance regulation is not characterize~ by an arms-length relationship between the regulators and the regulated." The Commission has found that California is no exception. The California Insurance Commissioner's role in the regulation of insurance regarding the rating process is extremely limited. FINDING #13 The State Insurance Commissioner's Regulatory Powers in California are More Limited Than in Other States The balance between regulation and the free market in the insurance industry is unlike that of any other major industry. While there are distinctions between the insurance industry and other regulated industries, the consumer does not have the same form of protection mechanisms in insurance as he does in other regulated industries. Specifically, other industries that are 7U. S . General Accounting Office: "Issues and Needed Improvement in State Regulation of the Insurance Business," October 1979. -25- exempted from restraint of trade and anti-monopoly provisions of anti-trust laws have regulated rates. The insurance industry is a hybrid with the benefits of both species. Unlike a public utility, its rate process is not controlled by the State, and unlike all other major industries, it is exempted from federal and State anti-trust laws. As a result, the insurance industry has considerably less regulation than other industries which potentially exposes the consumer to problems. The framework for regulating the insurance industry is unlike that of any other major industry. In 1945, Congress passed the McCarran-Furgueson Act, in which it subordinated its authority to impose controls of any significant kind on the industry to the states. It expressly exempted the business of insurance from the operation of most of the federal anti-trust laws, including the Sherman Act, the Clayton Act and the Federal Trade Commission Act, so long as such business was regulated by the states. Shortly thereafter, in 1948, in response to the McCarran Act and in an effort to attract insurance companies who were then badly under-represented in the State, California enacted the McBride-Grunsky Act. Its purpose was to regulate insurance rates "to the end that they shall not be excessive, inadequate or unfairly discriminatory," to authorize the use by insurance companies of rating organizations, and to authorize cooperation between insurers in rate making and related matters. The McBride Act did not empower the Insurance Commissioner to set rates, approve rates or even file rates. On the contrary, it expressly authorized insurers to act in concert among themselves or with the aid of rating and advisory organizations, to establish rates, policy forms and underwriting rules, and to share any statistical information designed to achieve those objectives. What sets this method of operation apart from other industries which have similarly been exempted from anti-trust laws and authorized to form cartels, such as utilities and the communications industry, is the Department of Insurance's lack of control over the rate process. Most state statutes require insurance companies to seek prior approval before setting or changing their rates. Some states only require companies to file their rates; however, California is the only State in which insurance companies have no such obligations. Instead, the Act requires only that insurers and rating organizations maintain certain statistical data to record their losses and expense experience on a nationwide basis and make such records available to the Commission on an annual basis. Thus, the insurance industry is benefiting from the free market unlike a public utility and is exempted from the anti-trust laws similar to a public utility. Therefore, to a considerable extent, the insurance industry, unlike any other major industry, has the "best of both worlds" and accountability is extremely limited. As a result, the consumer does not have the regulatory protections that exist in other industries. FINDING #14 - The Insurance Commissioner Does Not Have the Authority to Collect Adequate Data to Monitor Trends in the Insurance Industry Although the Insurance Commissioner collects adequate data to determine whether a company is solvent or not, the Commissioner does not collect, nor -26- have the authority to collect, adequate information regarding insurance rates. As a result, the Commissioner cannot comply with his mandate and determine whether a rate is "excessive, inadequate or unfairly discriminatory." The Department of Insurance collects financial data for each of the 1,544 licensed insurers participating in California. The financial status of each is presented in the annual statement prepared by each company on a nationwide basis. While the 65-page document provides a good basis for determining the overall solvency of a corporation, it doesn't provide adequate data to determine the company's actual payouts, how much they actually take in on a year-by-year, line-by-line, and state-by-state basis. Specifically, the information doesn't provide the amount insurance companies pay each year for jury verdicts, settlements or related attorney fees. The lack of Statewide information makes it difficult, if not impossible, to determine whether a rate is excessive or inadequate for a given line of insurance. Additionally, the information accumulated and compiled by the Department of Insurance does not provide for the determination of how victims fare under the present legal system. In evaluating the appropriateness of no-fault automobile insurance, for example, the Federal administration found that under the tort system claimants with small economic losses collected five times their economic damages on the average, while those with substantial losses collected only half their economic damages. In these instances, caps on awards would have been inappropriate since they would lower payments to the seriously injured who were already being under-compensated. On the other hand, an alternative system in which people with limited damages give up their traditional right to sue, but in exchange, receive a right to a limited recovery without having to prove fault, made sense. Currently the only aggregate rate information is collected by Insurance Services Organization (ISO), the association which collects insurance industry trade data. The information collected by ISO is provided on a voluntary basis and therefore only represents a percentage of the Statewide insurance history. In one area the Department does require additional information. Current reporting requirements for products liability state that insurers issuing a policy of products liability insurance in this State are required to transmit the following information to the department each year in an annual report: (1) premiums written; (2) premiums earned; (3) unearned premiums; (4) the dollar amount of claims paid; (5) the amount of outstanding claims; (6) net loss reserves for outstanding claims excluding claims incurred but not reported; (7) net loss reserves for claims incurred but not reported; (8) losses incurred as a percentage of premiums earned; (9) net investment gain or loss and other income or gain or loss allocated to products liability lines; (10) net income for Federal and foreign income taxes; and (11) expenses incurred including the loss adjustment expense commission and brokerage expense, other acquisition expenses and general expense. This type of reporting information for each State provides a true picture of the insurance coverage and the cost of that coverage by specific line of insurance and would be very beneficial for all other liability categories. Another data collection option would be to obtain general liability information similar to that currently obtained for State workers' compensation insurance. Specifically, the State currently collects data on the workers -27- compensation system through the Workers Compensation Insurance Rating Bureau, a non-profit corporation. All companies writing workers compensation insurance are required by law to submit all policies written for review by the Bureau, as well as submitting periodic statistical reports. These reports, submitted at 18-month intervals, must include premium and loss information for each policy, a listing of losses by job classification and type of injury, and the current status of any outstanding claims. Without good information, sound decision making is difficult. The Insurance Commissioner must have appropriate information available before the excessiveness or adequacy of rates within California can be fully ascertained. Without adequate information, the role of the Insurance Commissioner can only be reactive. FINDING #15 - The Insurance Commissioner Does Not Fully Utilize His Authority to Make Insurance Available The Insurance Commissioner has sufficient authority to establish voluntary programs to provide insurance to all entities at an affordable price. However, the Insurance Commissioner has not fully exercised this authority. As a result, currently public entities, nurse midwives and free standing birthing centers can not obtain insurance at any price. Therefore alternative programs should be fully explored. The authority and responsibility of the Department of Insurance in responding to an insurance crisis is controlled by applicable statutes and is quite restrictive in nature. The Insurance Commissioner has no statutory authority to compel any licensed insurer to underwrite a particular risk or any particular classification of risk which it does not choose to underwrite. There is one exception, the California Automobile Assigned Risk Plan, which provides the equitable apportionment among insurers admitted to transact liability insurance of those applicants for automobile bodily lnJury and property damage liability insurance who are in good faith entitled to, but unable to procure through ordinary methods, insurance in the marketplace. However, the Insurance Commissioner does have the authority to request that insurance companies participate in voluntary plans. For example, in late 1985, an affordability and availability crisis for licensed day care providers developed. The Department of Insurance established a market assistance program (MAP) to provide a marketplace for these risks at affordable levels. This program is a voluntary effort by insurers, agents and brokers working under the leadership of the Department to match insurance demand with insurance supply. The MAP for day care providers has been in operation for a few months, and has attracted about 20 insurer participants who individually underwrite each risk submitted. The California Market Assistant Program received 434 completed applications during its first 7 months of operation. Of this amount, 340 were completed and distributed to insurance companies for quotes. As of the May 15, 1986, 254 day care centers have received at least one quote'1ind 83 have secured new insurance. The State of New York recently organized a MAP for governmental entities and a separate one for day care providers. It reports that as of mid-February, the public entity MAP, also after 4 months of operation, had received 164 -28- completed applications and that all of these applicants had either insurance or had received extensions from their existing carriers. State, no public entity that had applied to the MAP was known to coverage. secured new In New York be bare of Since these voluntary programs have been successful for day care providers in California and public entities and day care providers in New York, the Department could potentially explore a similar program for cities, counties, nurse midwives, free-standing birth centers and other groups that are also suffering from a liability insurance crisis. Another area that could be more fully explored is joint underwriting associations. Joint underwriting associations already exist for medical malpractice insurance, automobile liability coverage and for some forms of fire insurance. Specifically, the Insurance Commissioner is not empowered to mandate, but could request that within the California liability insurance market, all insurers write all lines of insurance. This would reflect the premise that insurance for entire communities is a function of vital concern to the public interest. Given that general liability lines, the major "crisis" area in California, and the nation, represent a relatively small portion of the industry, accounting for less than eight percent of all the premiums written, a program of this nature would be possible if the risk was equally shared among all carriers. Although the explicit authority to mandate these programs is not available to the Insurance Commissioner, a request by the Commissioner given his stature in the community may result in voluntary solutions to the crisis. If not, additional authority to mandate these solutions may be warranted. FINDING 1116 The Insurance Commissioner Does Not Have Legal Authority to Control Rates The Insurance Commissioner does not have sufficient authority to regulate the rates and availability of insurance. While the Commissioner does have authority in some areas, the penalties and fines that exist for noncompltance are insufficient and therefore do not act as an adequate deterrent. Moreover, since the enactment of the statute in 1948 the Insurance Commissioner has never fined an insurance company for excessive rates. In California, the role of the Commissioner with regard to the liability insurance crisis is very limited. As previously discussed, the Insurance Commissioner has no statutory authority to compel a license insurer to underwrite a particular risk on any particular classification of risk which it does not voluntarily choose to underwrite. The Commissioner is authorized to inspect records periodically in order to determine whether a particular rate or rating system complies with the requirements of prohibiting excessive, inadequate, or discriminatory rates. In defining rates that are excessive or inadequate, the State law specifically indicates: no rate shall be held to be excessive unless: (1) such rate is unreasonably high for the insurance provided; and, (2) a reasonable -29- degree of competition: does not exist in the area with respect to the classification to which such rate is applicable. No rate shall be held to be inadequate unless: (1) such rate is unreasonably low for insurance provided and (2) the continued use of such rate endangers the solvency of the insurer the rate, or unless (3) such rate is unreasonably low for the insurance provided and the use of such rate by the insurer using same has, or if continued will have, the effect of destroying competition or creating a monopoly. But given the vagueness of the guidelines, the Commission was unable to find a single formal determination made by the Department in the past 25 years that a rate is excessive. However, the Department indicates that it has successfully requested rate reductions informally. Given the vagueness in the law and the limited authority and information available to the Commissioner, a formal determination that a rate is excessive would be very difficult to ascertain. And even if a determination could be made, the enforcement powers of the Commissioner "when the department's own inspection demonstrates non-compliance or if an individual aggrieved by any rate charged files a complaint," are weak. Specifically, the law states that if there is good cause to believe that the insurer has not complied with the requirements, the Commissioner may within ten days, serve the insurer with a notice of non-compliance. If there is no agreement to correct the non-compliance, the next step is the levying of sanctions. However, sanctions or penalties available to the Insurance Commissioner are unrealistically low and therefore prove to be ineffective. For example, if the insurer ignores the Commissioner's order to reduce a given rate, State law provides for a penalty of "not to exceed $1,000 for each day such person or organization fails to comply with the prOV1S10ns for such Order. Such penalties shall not exceed in aggregate the sum of $30,000." The other "major" penalty that the Commissioner can enforce, as delineated in Section 1859 of the Insurance Code, states that "any person or organization that fails to comply with a final order of the Commissioner shall be liable to the State in the amount of $50." As previously discussed, the McBride Act empowers the Commissioner to gather information from insurers, initiate investigation into their rating practices, hold hearings to determine if rates are excessive, inadequate or discriminatory, and penalize insurers who are found to be in violation of the Act. None of the Commissioner's power, however, impose an affirmative duty on the Commissioner to perform any of these functions. They are largely discretionary in practice, and some of these functions have never been performed. For example, since the enactment of the statute in 1948, the Insurance Commissioner has only held one public hearing and has never fined an insurance company for excessive rates. Penalties for violations, which range from $50 for failure to comply with the Commissioner's order, to an absolute maximum of $30,000 for non-compliance with rating standards, are also inadequate. Considering the size of the insurance industry, the current penalties do not appear to be sufficient to deter insurers from charging inappropriate rates. -30- CHAPTER VI CONCLUSIONS AND RECOMMENDATIONS CONCLUSION Over the past two years the cost of liability insurance coverage for different groups in California has increased from 100 to 9000 percent. In addition, other major groups, including public entities, have been unable to secure insurance coverage. The soaring cost and worsening shortage of liability insurance is taking its toll on businesses, individuals and governmental agencies throughout the State. This crisis is affecting the daily lives of all Californians with the closure of parks, day care centers, and small businesses, and the reduction in essential services, such as police and fire protection. Further it has compromised the very goal of liability insurance which is to provide public safety and ensure the availability of goods and services. In general, the Commission believes that there are a multitude of interrelated causes of the crisis and all involved parties must share the responsibility for the excessive price and unavailability of insurance. Specifically, the Commission found that the liability crisis has resulted from uncertainty in the insurance industry which is primarily due to the following problems: o o o o o The evolution of tort law has expanded the bases of liability exposing insurance companies, public entities and other "deep-pocket" defendants to new and unpredictable risks. The lack of predictability in risk assessment has made it difficult to forecast the size of claims for a particular exposure. Unsound pricing practices of the insurance industry as demonstrated by the price war of the late 1970's and early 1980's. The withdrawal of the reinsurance market which has significantly limited the available insurance capacity. The limited authority of the Insurance Commissioner in the rate-setting process. The Commission's study found that the insurance crlS1S is threatening the quality of life enjoyed by all Californians by reducing the availability of goods and services and increasing costs. RECOMMENDATIONS The Commission recommends a comprehensive reform package for solving the insurance crisis to address the multiple problems that have created the crisis. The Commission believes that its recommendations will protect individual businesses and public entities that are struggling to afford insurance while -31- maintaining the rights of individuals to seek fair compensation for damages. Therefore, the Commission submits the following recommendations: 1. Establish a Cap on the Recovery of Compensatory Damages o The Governor and the Legislature should, except in the case of intentional torts, and excluding economic damages, adopt legislation that limits recovery for compensatory damages in personal injury action to $500,000 with a cost of living adjustment. 2. Prohibit Collusion between Plaintiff and Settling Defendants o The Governor and the Legislature should modify State law to prohibit agreements between a plaintiff and a settling defendant to cooperate in prosecuting plaintiff's claim against the remaining defendants in consideration for a reduction in the settlement amount. When one defendant settles with a plaintiff, who subsequently prevails at trial, the rema1n1ng defendants should be liable only for their proportionate share of the liability. 3. Establish a Stricter Burden of Proof for Punitive Damages o The Governor and the Legislature should modify State law to require juries to be instructed that in order to award punitive damages against a defendant, except in the case of intentional torts, the plaintiff must establish by clear and convincing proof that the defendant was guilty of oppression, fraud, or malice and acted in conscious disregard of the plaintiff's rights. 4. Limit Damages Incurred While in the Process of Committing a Felony The Governor and the Legislature should enact legislation that stipulates that a person has no cause of action for damages for injuries incurred while in the process of committing a felony. 5. Place Limitations on the Cost of the Civil Justice System The Governor and the Legislature should establish limits on the cost of litigation in the following areas: o o Plaintiffs' attorney fees should be limited to the prevailing rate of one-third of plaintiffs recovery. A mechanism should be developed in consultation with affected parties to place reasonable limits on defendants' attorney fees that are comparable with the limitation on plaintiffs' attorney fees. -------------------------~ --------- o -32- Penalties should be imposed against plaintiffs and defendants for asserting frivolous claims and defenses by awarding the prevailing party costs and reasonable attorney fees not exceeding $10,000 for such frivolous claims or defenses. For a claim or defense to be considered frivolous, it would have to be: (1) made in bad faith, either for the purpose of delaying or prolonging the resolution of the litigation and to harass another; or (2) without any reasonable basis in law or fact and lacking any good faith argument for an extension, modification, or reversal of existing law. 6. Modify the Collateral Source Rule o The Governor and the Legislature should modify the collateral source rule to provide that following a jury verdict for a plaintiff, the plaintiff's recovery should be offset by the amount of any public benefits that the plaintiff has been or is scheduled to receive from collateral sources. 7. Establish Requirements for Periodic Payments o The Governor and the Legislature should enact legislation that allows for periodic payments by insurance companies. Specifically, when the future damages awarded by the jury to the plaintiff in a personal injury case exceeds the sum of $100,000, that portion of the award over $100,000 should be paid in unassignable periodic installments with a reasonable rate of return to the plaintiff, unless the parties agree otherwise. If a plaintiff dies while periodic payments are still due, the payments should terminate, except that the portion of damages attributable to loss of future earnings should remain payable to the plaintiffs' dependents, if any, or his estate. 8. Establish a Reinsurance Pool for Public Entities o The Governor and Legislature should establish a Statewide reinsurance pool to offer reinsurance to primary carriers writing liability coverage for public entities. Provisions of the pool should include: o o o A specified deductible amount; A requirement that the primary insurer will retain a significant portion of the total liability coverage; and A requirement that the pool is to be funded by a bond issue and the creation of a reinsurance authority under the control of the State Treasurer. The fund would be guaranteed by the revenues it earned only. Specifically, there would be no use of State funds or the use of the State's credit. -33- 9. Undertake Market Assistance Plans and Joint Underwriting Authorities or FAIR Plans o o The Governor and the Legislature should consider providing the Insurance Commissioner with sufficient legal authority to form voluntary market assistance programs and joint underwriting authorities or FAIR plans. If voluntary industry participation is deemed inadequate, the Governor and Legislature should consider providing the Commissioner with the authority to compel appropriate insurers to participate. 10. Develop Insurance Rates Based on Experience o The Governor and the Legislature should require insurance companies to consider prior practices and claims history when establishing rates or denying coverage. Because insurance companies today often lump all insureds in a category together, regardless of how often any individual has been sued, good risks subsidize bad risks. Experience rating would bring down premiums for day care centers, non-profit organizations and other insureds in which experience is virtually non-existent. 11. Conduct a Review of the Insurance Commissioner's Office and of the Department of Insurance o An independent study should be conducted regarding the operations of the Insurance Commissioner's Office and the Department of Insurance aimed at determining whether any barriers exist in California which unnecessarily prevent competition in the marketplace. 12. Require Disclosure of Loss Data by Insurance Companies o The Governor and the Legislature should require that insurance companies disclose their loss data for California on a line-by-line and state-by-state basis similar to the current requirements for product liability. Given that California is the largest insurance market in the nation, a data collection and statistical information base should be designed to monitor California's underwriting experience. 13. Consider Requiring Prior Approval of Insurance Rate Increases o The Governor and the Legislature should consider enacting legislation requiring prior approval by the Insurance Commissioner of insurance rate increases in excess of 15 percent. In addition, such legislation should require the Insurance Commissioner to act upon these requests within 60 days. -34- 14. Increase Penalties and Fines in the Insurance Industry o The Governor and the Legislature should increase penalties and fines against the industry for non-compliance. Most of the various penalties and fines promulgated in the Insurance Code have not changed since their enactment. 15. Consider Establishing an Insurance Commission o The Governor and the Legislature should consider establishing a bipartisan independent five-member part-time commission, with staggered terms to replace the Insurance Commissioner. 16. Continue to Monitor Product Liability o The State Insurance Commissioner should continue to monitor Federal actions in the area of product liability. APPENDIX A LIABILITY INSURANCE PERTINENT TORT LAW PROVISIONS. California , .. V.,.,.P .... UIlO ...... --1_ .............. 1. Joint and Liability is Several several for Liability non-economic damages only; all others are joint 2. Cap on None non-economic damages 3. Co 118 tera1 Evidence may Rource not be rule introduced 4. Periodic No provision payments 5. Attorney's No limit contingent fee limits 6. Statute of 1 year from Limitations date of incident 7. Punitive No limit Awards 8. Sovereign No general Immunity immunity California * .. -.... ~. Liability is several for non-economic damages only; all others are joint Maximum of $250,000 May be introduced Mandatory for future economic damages over $50,000 Sliding scale ranging from 10% to 40% 3 years from date of incident or reasonable knowledge No limit No general immunity h .. _- .. ~- _ .. _ .. - Ohi _ .. _- Joint and Ltabili ty is Several joint in certain liability CA8es abolished Maximum of Maximum of $250,000 $850,000 for government agencies except in wrongful death cases Evidence may Must be subtracted not he from judgement in introduced In public entity caDes No proviSion Optional No limit No limit 3 years from 1 year from date date of of incident or incident or reasonable reasonable knowledge knowledge No punitive No limit damages awarded Cap of $500,000 Immuni ty for on civil limited liabili ty cases only This cbart summarizes only the primary prOVisions of the relevant statutes, most of which contain significant exceptions. •• MICRA - Medical Injury Compensation Reform Act of 1975 SOURCES - National Association of Insurance Commissioners National Conference of State Legislatures h . -- ....... ~-......... -.. -~ If plaintiff is at least 51% at fault no award; if less, award is reduced by percentage then joint and several None May be introduced at the diRcretion of the trial judge No provision No limit 3 years from date of incident No punitive damages awarded Cap of $100,000 per claim for public entities k .. _- ......... ~ Washi .. __ .. _ .. -_ .. Liability Eliminated when is joint plaintiff at fault; except toxics, business torts and some product liability Limits in Sliding scale; worker's ranging $117,500 compensation to $573,000; and automobile cash Evidence may not Evidence may not be introduced be introduced No provision Mandatory if future economic losses $100,000 or more No limit Court review for reasonableness 1 to 4 years 8 years for depending medical on cause malpractice only No limit No limit No provision Sovereign immunity except in cases of gross _._- negligence Florid . -..... --- Minor limitations for public entities Maximum of $450,000 May not be introduced, except in automobile accident cases Opt lunal by agreement of parties No limit 4 years from incident in negligence cases only No limit Cap of $100,000 per claim, per person for public entities - -- I I I W \.n I