Aetna Ins. Co. v. Hyde , 315 Mo. 113 ( 1926 )

I am unable to concur in some of the conclusions reached in the majority opinion. The questions involved are not only of present moment, but as time goes on will become increasingly important. For that reason I feel it incumbent upon me to set forth in some measure the grounds of my dissent. For lack of time to prepare a dissenting opinion which accords with conventional standards I shall content myself by quoting from the opinion prepared by me soon after the submission of the case three paragraphs, dealing respectively with the questions of investment earnings, interest on unearned premiums and the proper method of determining profits — whether on the basis of earned premiums or that of premiums received — and then adding very briefly the specific grounds on which I base my non-concurrence.

"I. The assumption by the State of the power to regulate the rates which may be charged for insurance, on the ground that the business is clothed with a public interest, is of comparatively recent origin, the first statute in this StateEarnings on having that end in view (Secs. 6283 and 6284, R.S.Investments. 1919) having been enacted in 1915. Whether investment earnings of the insurers should be taken into account in determining rates, as well as many other questions having a bearing on rate regulation, must therefore be resolved upon a consideration of the nature of the business of underwriting and the application of general principles rather than upon precedent.

"The underlying economic principle of all insurance is the distribution of loss resulting from designated perils among a great many persons so that the loss to the individual will be thereby minimized. The business of fire insurance contemplates the existence of a known danger to which all property owners are exposed, but from which only a few will suffer loss. The function of the insurer is to collect from the great number exposed to the peril a sufficient sum to reimburse the few who actually suffer loss therefrom. And this is true whether the insurer be a mutual company, or a stock company. There are certain fundamental differences, however, between a mutual company and a stock company which affect the amount of premiums which each may rightfully collect from its policyholders. Speaking generally, a mutual company may collect from the persons insured only such sums as in the aggregate will cover the losses, which under the law of average can with reasonable certainty be forecast, and in addition thereto such further sums as are necessary to meet the expense of conducting the business. If such sums prove to be inadequate the insured persons are subject to assessments to the extent necessary to make up the deficit. The policyholders of stock companies on the other hand are not subject to any such contingent liability. In consideration of definite and fixed premiums these companies assume all liability, including that for losses resulting from an abnormal experience. For its services in underwriting, that is, collecting from the many a fund with which to pay, and paying, the losses of the few, and the assumption of all liability for losses, a stock company is entitled to remuneration. Consequently it may rightfully exact premiums which in addition to paying losses and expenses will be sufficient to yield a reasonable profit. The securing of such an underwriting profit is in fact the fundamental purpose for which all stock companies are organized.

"In the case af a mutual company the contingent liability of all the persons holding similar contracts is deemed a sufficient guaranty that the funds necessary to pay the losses suffered by the few will in any event be forthcoming. But as the contracts of a stock company have no such security behind them, such a company is required by economic as well as by municipal law to have at hand at all times a sufficient fund, in cash or prescribed securities, to discharge in full every liability which it has assumed or incurred. Such fund is made up for the most part of capital stock and surplus, the surplus in the first instance as well as the capital stock being contributed by the stockholders of the company. This fund is not in any proper sense employed in the business of underwriting. It is in the nature of a pledge put up by the insurer to secure the performance on its part of its several undertakings, and if in an emergency the fund be called upon for the payment of losses or expenses to such an extent that it no longer covers the company's maximum liability, it must be immediately repaired by contributions from the stockholders, or else the company must cease business. The capital and surplus being therefore a guaranty fund must at all times be kept intact. It is not, however, permitted to remain inactive, but is invested in interest bearing securities. The earnings from these investments are a by-product, so to speak, of the business of underwriting, a business always initiated and prosecuted for the purpose of making and underwriting profit. As already pointed out a stock company is clearly entitled to a reasonable underwriting profit on account of the service it renders and the liability it assumes. Can there be any reason why it is not entitled to receive in addition such returns as it may be able to secure from the funds it has been compelled to withdraw from the active channels of trade and commerce in order merely to furnish the requisite guaranty that it will perform its contracts as an insurer? On what theory of law or morals can it be compelled to accept earnings on its own capital independently employed in lieu of the reasonable profit it is entitled to derive from the business of writing insurance, or even in reduction of that profit?

"Impressed with the great peril of conflagrations, such as the Chicago Fire and later the San Francisco Fire, the majority of stock companies began a number of years ago to largely augment their capital and surplus. This was accomplished through additional contributions by the stockholders and the passing to the surplus, earnings of all kinds instead of distributing them as profits. Through this process millions of dollars were in the course of time added to the surplus of most of the companies. As a consequence the interest earnings on the capital and surplus now yield in many instances dividends which, if computed on the basis of capital stock, are enormous, and are more than generous if reckoned on combined capital and surplus. To take these investment earnings into consideration in determining insurance rates is equivalent to the State saying to the companies: inasmuch as the returns on your investments are now sufficient to yield you a reasonable profit, you must hereafter write insurance and subject your accumulated capital to its hazards without compensation.

"Appellant in support of his argument that the investment earnings of insurance companies must be taken into account in determining rates cites cases holding in effect that the owner of private capital who employs it in the public service is entitled to a reasonable return thereon and nothing more. These cases are without application. The insurance companies are not asking for any return on their private funds, even if they be deemed to be employed in the business of writing insurance. They are satisfied with the returns accruing to them from an independent source and the State cannot confiscate those returns under the guise of regulating rates of insurance.

"There appears to be some apprehension on the part of appellant lest policyholders in this State be charged with rates which are based in part on losses arising from the unsafe investment of funds. If in the foregoing we have set forth a proper conception of the relation of the capital and surplus of a stock company to its business of writing insurance, it follows inevitably that investment losses cannot be recouped through increased underwriting charges, but must be made good, if at all, by contributions from the stockholders.

"II. Fire insurance policies are ordinarily written for terms of one, three or five years. A single premium is paid in advance for the insurance for the full term, whatever it may be. Under the provisions of all policies an insured may at anyUnearned time during the term, if he so elects, present hisPremium policy for cancellation and demand a return of theReserve. unearned premium. The unearned premium, theoretically at least, is that proportion of the whole premium which the unexpired time the policy has to run bears to the full term for which it was written. According to legal standards, and perhaps economic as well, a stock company is solvent when, and only when, it has sufficient assets to pay all of its incurred losses and expenses and return as upon cancellation the unearned premium on all of its policies.

"The liability growing out of the obligation to return unearned premium is of course contingent upon the insured tendering his policy for cancellation. In order to ascertain the exact extent of this contingent liability of an individual company at a given time, it would be necessary to make the computation on each of its outstanding policies. This being manifestly impracticable where there is a large volume of insurance in force to which new policies are being added daily and with respect to which the unearned premium is constantly changing through the lapse of time, arbitrary standards have been set up for determining the unearned premium liability. Under the Missouri statute it is `estimated by taking fifty per cent of the gross premiums on all unexpired fire risks that have less than one year to run, and apro rata of all those premiums on risks that have more than one year to run.' [Sec. 6222, R.S. 1919.] In insurance parlance `a reserve' is maintained to cover unearned premium liability. But such a `reserve' is purely a bookkeeping fiction. The rates are not loaded for the purpose of creating such a separate fund. None in fact exists. The phrase `unearned premium reserve' merely designates the amount of the contingent liability to which all the assets of a company are subject. Of course if those assets are not sufficient both to discharge incurred liabilities and to cover the contingent liability a proper `reserve' is not being maintained.

"All the assets of a stock fire insurance company, by whatever name designated, are its absolute property, and so long as it is a solvent going concern its policyholders have no more interest therein than the creditors, actual and potential, of a trading corporation have in its assets under similar conditions. They are not entitled therefore to appropriate earnings arising from the investment of any part of the company's assets to the reduction of the cost of their insurance below a figure that will yeild a reasonable underwriting profit.

"III. Section 6282, Revised Statutes 1919, is in pariamateria with Section 6283 heretofore set out. A reading of the two sections together makes it clear that the `earnings in this State' referred to in the latter are to be determined from `the aggregate amount of . . . premiums, losses and expenses for or on account of business within the State for the five preceding years . . . and in addition thereto . . . earnings on unearned premiums.' For constitutional reasons indicated in a preceding paragraph `earnings on unearned premiums' must be eliminated from consideration. The intent of the statute in other respects must, if it can be ascertained, be given effect.

"As heretofore stated it is the contention of the companies that the earnings of a given period on which underwriting profit can be predicated are determined by deducting from the premiums earned during that time the losses and expenses incurred. The method employed for ascertaining the amount of premiums earned is this: Add the unearned premiums at the beginning of the period to the aggregate net premiums received during that time and deduct from the sum the premiums unearned at the end of the period. Incurred losses and expenses are arrived at in this way: Subtract the outstanding incurred losses and expenses at the beginning of the period from the losses and expenses paid during that time and then add the losses and expenses unpaid and outstanding at the end of the period. According to the method of determining earnings just outlined respondents lost during the period in question in their underwriting business $7,010,200. During the entire period their business was steadily expanding, the rate of increase being pronounced. As a consequence the figure indicating unearned premium at the end of the period was much larger than the one representing unearned premium at the beginning. Had those figures been transposed, that is, if the larger one had represented the unearned premiums at the beginning of the period and the smaller one the unearned premiums at its close, according to the method of computing earnings just described the companies would have had an underwriting profit of more than $9,000,000. To express it differently: when the companies are prosperous and increasing the volume of their business, according to this method of computing earnings, they are losing money; when their underwriting is falling off they are piling up profit. It should not be forgotten that `unearned premium' is but an arbitrary measure of contingent liability. Such liability while it necessarily increases with an expanding business is by no means a true exponent of underwriting earnings. An insurance accountant of many years experience, testifying for respondents, stated that while the fire insurance business had been rapidly increasing in volume during the last twenty years, the companies according to the method of computing earnings which they now invoke had during the whole of that time made an underwriting profit of less than one per cent. It was the witness's theory that the huge surpluses which they have managed to accumulate during that time resulted from investment earnings, but it is unbelievable that corporations organized for profit would have continued for such length of time to hazard their capital in a business of underwriting if that business in fact yielded no profit. The method of determining profit which respondents seek to have applied is clearly unsound.

"In their bookkeeping the companies at the close of each year strike what their accountants term a trade balance. This balance is derived by deducting from the aggregate net premiums received during the year the total losses and expenses paid during that time. The net premiums consist of all premiums received less thepro-rata returned upon cancellation and sums paid for reassurance. When a loss occurs an estimate of the amount is entered upon the books as an `incurred loss.' When the loss is subsequently adjusted it is paid. The amount paid is frequently reduced by salvage or recoverable reinsurance. But losses regardless of when they occurred are paid out of current premium receipts. The distinction between incurred expenses and paid expenses is negligible. All expenses with the exception of taxes are ordinarily paid within the year in which they are incurred.

"The annual trade balance of a company engaged in a continuing business, being the difference between its receipts on the one hand and its expenditures on the other, during the preceding year, must necessarily reflect with a fair degree of accuracy its earnings for that period. To be sure such balance would not be indicative of solvency as heretofore defined, nor would it properly represent net earnings if the distribution of assets upon dissolution were involved, but nevertheless it cannot be gainsaid that it does in fact constitute the clear earnings of the period embraced, if that period be considered a part from those which preceded it and those which follow, as is the case where a basis for rate regulation under the statute is sought.

"Based on the conclusions reached in the preceding paragraphs we are of the opinion that the `aggregate amount of . . . premiums, losses and expenses for or on account of business within this State . . . for . . . five years next preceding' intended by the Legislature were the aggregate net premiums received and the losses and expenses paid during the five-year period. That is the construction which has been placed upon the statute by the Insurance Department of the State at all times since its enactment, and the construction which the plaintiff companies themselves have heretofore acquiesced in and acted upon in their applications for increase of rates. The stand now taken by them has the appearance therefore of having been contrived by ingenious counsel, or by possibly more ingenious insurance accountants, for the purposes of this case. On the basis of premiums received and reported losses and expenses paid the companies earned during the test period in question an underwriting profit of $3,341,124, or four per cent of the aggregate net premiums."

The only material divergence between the foregoing and the majority opinion dealing with the same subject-matter is in respect to Paragraph II. The latter opinion holds that in determining the underwriting profits of the companies interest on unearned premiums must be taken into account. The argument through which this conclusion is derived is in substance this: Unearned premium must, constructively at least, be segregated and kept apart from the other funds of the companies and held intact so that until it is earned it will at all times be available for return to the policyholder if cancellation be demanded, or for re-insuring if the insurer becomes insolvent or quits business, and as the unearned premium cannot be distributed among the stockholders as profits, but must be kept on hand until earned, the interest accruing on it is attributable to the underwriting business and is therefore one of the profit-making elements of that business. This reasoning seems to me to be specious. There is no magic in the word "attributable." The interest earnings on so much of the companies' assets as would be consumed in re-insuring all of their risks are no more attributable to the underwriting business than are the earnings on the remainder of their assets, and it is conceded by the opinion that the latter cannot be taken into consideration in determining underwriting profits. If, however, the view that interest on unearned premiums should be charged up to the insurer in determining his underwriting profits be the correct one, then the method of arriving at profits which takes unearned premiums into account is wrong. Unearned premium, in whole or in part, cannot be reckoned as profit and at the same time the insurer be required to pay interest on it to the policyholder.

There is but one theory consistent with the companies' constitutional rights upon which it can be held that they must account for interest on unearned premiums, namely: that the premiums, being paid in advance, must be regarded as in a sense the moneys of the policyholders until earned by the elapse of time. For if the premiums as soon as they are received by an insurer become without qualification his absolute property, then certainly he cannot be required to pay to the policyholders interest on them, or what is tantamount thereto, apply such interest to the reduction of the cost of their insurance. Such a requirement in that view would be plain confiscation. And if the premiums belong to the policyholders until earned, then until that time arrives the insurer cannot strike a balance for the purpose of ascertaining his profits. In other words, if the interest on unearned premiums enter into underwriting profits, such profits must be determined upon the earned premium basis.

For many years antedating the enactment of our rate statute it was the universal custom and practice of stock fire insurance companies to compute their underwriting profits on the basis of earned premiums. And that is the basis for determining the net income accruing from the business of underwriting as recognized in the income tax laws both of England and the United States. It is therefore entirely possible that our rate statute contemplates the same method of ascertaining underwriting earnings and profits, and, if so, that the statute be upheld with respect to its provision that the earnings on unearned premiums shall be taken into account. But be that as it may, it is clear to my mind that the majority opinion is wrong in holding on the one hand that underwriting profits must be determined upon the basis of premiums received, which includes both the earned and unearned, and on the other hand that interest on unearned premiums must be taken into account.

The majority opinion further holds that the increase of rates ordered in 1920, and which had not become effective at the time the reduction order was made, should be taken into consideration. To this I do not agree. The power as well as the duty, to order a reduction of rates is predicated by the statute upon this fact: that "it appears that the result of the earnings . . . for fiveyears next preceding such investigation shows there has been an aggregate profit . . . in excess of what is reasonable." In the face of this plain and unambiguous language how can it be held that the estimated earnings of a future period may be made the basis of such an order? There is no call for either a strict or a liberal construction of the statute. If its words be taken in their usual and ordinary sense there can be no mistake as to its meaning. The so-called liberal construction employed in the opinion merely masks the attempt to judicially improve (?) the handiwork of the Legislature. Blair, C.J., concurs.