In November last year, the State Farm Mutual Automobile Insurance Co. requested a 9.8 percent increase of its car insurance prices from the Maryland Insurance Division, the agency charged with controlling the cost of insurance.
State examiners had one meeting with State Farm to hear a "presentation" on the proposed rate increase in January, and checked the mathematics involved in the company's calculations. Then, without further examination, they recommended approval.
Three days later, Commissioner Edward Birrane granted the increase, thus raising insurance rates for some 14 percent of the state's auto market. There was no public hearing, though insurance officials, who did not advertise the State Farm presentation, say citizens could have attended the session had they known about it.
As it turned out, the State Farm case became an unusual one for the insurance division -- for instead of quietly going into effect, State Farm's rates were challenged by a national insurance consumer organization, forcing the department to reopen the case. The consumer group's actuaries charged that, instead of a 10 percent increase, State Farm's rates should have been reduced by 6.1 percent.
In every other respect, however, State Farm's rate increase -- and its handling -- was typical of the way this state agency goes about regulating some 900 insurance property insurance companies worth $174 billion. A review of the division's activities and several in-depth audits of its work by state agencies showed that the insurance division is plagued by backlogs of work and inadequate resources in every area, problems that have helped make Maryland's insurance -- and in particular state-required auto insurance -- unaffordable for an increasing number of drivers. For example:
* Licensing of companies lags far behind "the reasonable period" of review allowed by law, slowing the entry of new firms into the marketplace.
* Audits of companies for solvency -- the only check consumers have on their interests in insurance companies -- often are delayed and the methods of those that are done have been frequently questioned by national insurance groups.
* Monitoring of auto insurance abuses in underwriting and claims is piecemeal and weak. And, according to Insurance Commissioner Birrane, the examination of rate increases for auto and other property-casualty insurance, perhaps the most important job of the insurance division from the consumer's view, frequently amounts to little more than "checking the math" of the companies' presentations, without any independent calculations to determine if the requested rates are fair or justified.
* Meanwhile, entire areas of activity by insurance companies that directly affect consumers go unmonitored by the state agency, even though officials have been granted direct authority by the legislature to probe such activities as auto insurance rating mechanisms and surcharges.
Birrane and other insurance division officials acknowledge their shortcomings and blame them on a lack of funding that has prevented them from hiring enough staff or modernizing operations to keep up with the gigantic, billion-dollar insurance companies. "Hey, we're not the FTC Federal Trade Commission ," Deputy Commissioner Tom Reimondi said in explaining the shortage of common regulatory procedures. "Just look at our budget."
The weakness of the state's insurance division is particularly significant, for since 1945, insurance has been the largest national industry to be regulated primarily by the states. The state office in downtown Baltimore thus largely represents the first and last check consumers have on a product they are now compelled to buy in order to drive.
The problems of Maryland's insurance office, in fact, raise questions about the quality of insurance regulation as a whole and state control of a national industry. For Maryland, with all its lack of resources, is not lagging behind other states in monitoring insurance practices; in fact, its department appears to be better staffed and more thorough than many other states. Only a few states, primarily in the Northeast, have significantly stronger staffs or more aggressive practices.
In Maryland and most other states, the primary work of regulation is focused on checks of the companies' financial health. Aggressive regulation in other areas, such as rates, is often curtailed with the explanation that "solvency must not be endangered," as Birrane puts it.
In the years since the states gained control of insurance regulation, however, state insurance offices have found it hard to complete even this central task. Where once hundreds of small, regional insurance companies flourished, now the vast majority of the business is done by large national operations, with assets in the billions and resources that dwarf those of any state agency.
As a result, the Maryland office, with funds and manpower that have been shrinking every year by comparison to the industry, has come to see less of what goes on in insurance company finances and frequently falls behind in attempting to complete what it does take on.
Under state law and the national system for auditing insurance company finances developed by the National Association of Insurance Commissioners (NAIC), Maryland is supposed to perform comprehensive studies of the books of Maryland-based companies selling auto insurance every three years. But the audits have not always been done that way. In July 1978, for example, the insurance division was a full two years behind in its auditing schedule -- meaning that the finances of companies supposed to be checked every three years were going five years without a review.
"This deficiency," legislative auditors noted in a report last year, "could result in the untimely discovery of statutory violations, financial problems, and situations that jeopardize the interest of policyholders."
Now, insurance division officials say they have caught up on their auditing schedule, in part because they hired more field examiners. But, with audits for major firms coming up and the examiner staff recently reduced, they say they expect to fall behind again next year.
Even the audits that are done on time by Maryland officials are not done in accordance with widely recognized methods or even the standards adopted by the NAIC. For example, the NAIC has recommended and many states have adopted rules that require CPA audits of companies in the intervals between government audits, but Maryland has no such requirement.
The NAIC also recognized several years ago that the practice of having companies pay for the costs of their own audits was a bad one, in part because it meant that only the companies that were financially strongest -- and thus least in need of solvency checks -- could afford to pay for a thorough examination. Nevertheless, Maryland has continued the practice.
These auditing problems extend to the financial checks on companies applying for "certificates of authority" to sell insurance in Maryland. The legislative auditors found that the insurance division had no established procedures for reviewing new companies and that certificates had been granted without proper documentation. In addition, the agency frequently lags in making decisions, unnecessarily restricting new competition. At the end of April, for instance, 97 applications by new companies were pending with the state, of which 13 were more than two years old. One dated from 1973.
The financial checks on companies are probably the most complete work the agency does, however. When it comes to approvals of auto insurance and other property company rate increases and rating plan alterations, the review is almost perfunctory.
When insurance companies ask for rate increases in Maryland, the company submits a case for its increase based on statistics showing its gains in consumer premiums and losses in claims and using established margins for profit and other financial considerations.
For the most part, if the companies' supplied figures are properly calculated by the established formulas, the increase is granted. There is never an independent review of the figures or an independent calculation of whether higher rates are needed or justified. Only occasionally does the department even call for hearing in which the company sends a team to the insurance division to make a presentation and answer questions. When such hearings occur, they are not advertised, and no permanent record of them is kept.
In essence, Birrane says, his department merely "checks the companies math," although he adds, "sometimes the math is wrong."
So curtailed is this procedure that the average time it takes to approve even major auto insurance rate increases in Maryland is a few weeks. And in fact, the legislative auditors found that when requests for policy changes and other alterations in company procedures were added to rate increase requests, the insurance division spent an average of only 2 1/4 hours studying each one.
The most commonly cited example of how regulators in Maryland and elsewhere have fallen behind relates to investment income, a key element in insurance company profits. Although auto insurance companies are expected to collect enough in premiums to cover claims costs and administrative expenses and still make a profit, they have another huge source of income from investments made on their customers' premium dollars, which they hold and use the way that banks use customers' savings.
In recent years, as interest rates have soared, these profits have risen by sharply -- so much so, in fact, that although the property-casualty insurance industry actually lost money on underwriting in 1979, it made nearly $10 billion on investments. This gave the industry an overall $8.6 billion pre-tax profit, which represented a 17 percent return on net worth, higher than the banking and utility industries as well as American industry as a whole. The same trend held true in the first quarter of this year. But, like most states, Maryland pays little attention to the investment income of insurance companies during the rate review process.
It was investment income considerations, in part, that caused the Alexandria-based National Insurance Consumers Organization (NICO) to challenge the 9.8 percent increase the insurance division gave State Farm last winter, forcing state officials to reopen the case.
Investment income was taken into account by the state in the State Farm case. But it was done, as in all such cases, using a formula developed by the insurance industry that factors in a 12-year average of investment profits, rather than the actual return the company is making. Also, even this reduced figure is only indirectly added into the rate calculations under the industry's formula.
State Farm used an investment income return of 6.1 percent in making their case for higher rates; while NICO's actuaries calculated that the company's actual rate of return on investments is closer to 12 percent, a figure that all but destroys State Farm's case for a rate increase. NICO maintained, in fact, that if investment income were properly accounted for, State Farm's rate increase should have been 3.1 percent instead of 9.8 percent.
Overall, NICO said that if State Farm's finances were fairly judged, the auto rates could now be reduced by 6.4 percent and the company would still make a profit. State Farm provided a detailed rebuttal of that case, and stressed that it had not asked for the total increase it was allowed by law, according to the company's associate general counsel, Pete Ingham.
Ingham did not dispute NICO's calculations on investment income, but said the company's investments had to be considered differently because many of them were in long-term bonds. If current investment income is used in determining rates, he argued, State Farm should be able to count their bonds on the basis of their current cash-in value rather than their long-term yield. If this were done, he said, State Farm's calculated assets would decline considerably, allowing a rate increase "at least equal to the decrease NICO wants."
A decision on NICO's appeal is expected this month.
"On investment income," Birrane acknowledges, "the rule frankly says that we will take a portion of it into consideration, and it comes out substantially below what they were getting." But Birrane says that this widening discrepancy does not trouble him because he expects competition among companies to keep rates down and because "I was here in 1974 when the insurance industry was hard hit by a national recession . I have to worry about solvency."
This attitude is also evident in the insurance division's handling of the some 20,000 complaints that pour in each year from consumers about insurance company practices, many of them under a chapter of Maryland law that allows consumers to protest cancellations or non-renewals of their auto insurance policies.
The consumer law was enacted in 1973 as a way of curtailing discrimination and unfair practices by companies selling state-required auto insurance. The consumer complaints are supposed to be investigated by the insurance division, which has the authority to hold a hearing and order reinstatement of policies or refunds. Currently, however, only two staff members are available to handle the estimated 7,000 annual complaints for cancellation and nonrenewal, and a dozen handle the other 14,000, which include charges of unfair underwriting practices and premium increases.
Despite the huge number of complaints and the number of them that are deemed legitimate -- the insurance division ordered 2,000 reinstatements of policies in 1980 and returned $3.5 million in unfair charges to consumers -- the insurance division avoids publicizing either the complaint procedure or its results and does not follow up on company abuses unless they have a specific complaint to act on.
"We're not emphasizing the number of complaints," said John Riggle, the chief of the investigative section. And we don't want publicity when we fine the companies, either. We don't want to give the companies a feeling that we're one-sided."
There are never insurance division reports -- or even internal calculations -- of which companies have the most complaints or which have a consistent pattern of unfair practices. A consumer education section that used to publicize the complaint procedures and other consumer rights has been reduced in recent years from a staff of five to one official who also doubles as a public relations officer.
The National Association of Insurance Commissioners recommends that insurance departments keep statistics on the complaints received about companies in order to single out consistent abusers and detect overall patterns. Maryland's agency has never done this, nor has it ever launched an independent investigation of territorial rating or other surcharge practices by companies even though the legislature granted it specific authority to conduct such a review eight years ago.
In acknowledging these deficiencies, Birrane and other insurance division officials have one common explanation: consistent state budget cuts that have prevented the agency from keeping the resources it has, much less expand. Budget summaries drawn up by the department show its requested budgets being cut by hundreds of thousands of dollars every year. The current budget is slightly less than $3 million.
The budget problems, which insurance division officials and legislators blame in part on political feuding between Birrane and the staff of Gov. Harry Hughes, might be seen as a difficulty peculiar to Maryland. In fact, however, Maryland's problems are typical of states around the country, which consistently lack staff, resources, and procedures to monitor insurance practices.
Maryland in 1978 ranked 26th among 43 states surveyed in the amount of its insurance department budget as a percentage of the total state budget and 20th of 44 states in insurance budget as a percentage of amount of insurance sold, according to a report by Congress' General Accounting Office. It also ranked 13th among the states in the number of its insurance division staff.
That GAO report also showed that most states lacked the standards or financial monitoring procedures recommended by the NAIC, and pointed out that only two states, Massachusetts and Texas, compiled independent analyses of rates to determine what increases were justified. It further noted that none of the states examined by GAO auditors properly monitored either claims practices or auto rate surcharge plans, and that consumer interests in obtaining insurance were not fully protected by state insurance departments, which, it said, were "not characterized by an arms-length relationship between the regulators and the regulated."