press release

Statement of Consumers Union
Regarding RH-386
Proposed Rate Regulations Governing
Credit Property Insurance and Credit Unemployment Insurance

January 10, 2001

Consumers Union offers the following statement regarding proposed California Code of Regulation (CCR) §§2670.1 through 2670.27.

1. Organization and Qualifications

Consumers Union is a nonprofit membership organization chartered in 1936 under the laws of the State of New York to provide consumers with information, education and counsel about goods, services, health, and personal finance; and to initiate and cooperate with individual and group efforts to maintain and enhance the quality of life for consumers. Consumers Union's income is solely derived from the sale of Consumer Reports, its other publications and from noncommercial contributions, grants and fees. In addition to reports on Consumers Union's own product testing, Consumer Reports with over 4 million paid circulation, regularly carries articles on health, product safety, marketplace economics and legislative, judicial and regulatory actions which affect consumer welfare. Consumers Union's publications carry no advertising and receive no commercial support.

This statement was prepared by Norma P. Garcia of Consumers Union West Coast Regional Office and by Birny Birnbaum and D.J. Powers. Norma P. Garcia is a Senior Attorney at Consumers Union's West Coast Regional Office of Consumers Union, nonprofit publisher of Consumer Reports magazine. Since joining Consumers Union in 1992, Ms. Garcia has concentrated on legislative and regulatory advocacy on behalf of low-income consumers especially in the areas of credit and finance and insurance. Ms. Garcia leads the office's legislative advocacy efforts on property and casualty insurance issues. Ms. Garcia received her law degree in 1982 from the University of California, Hastings College of the Law and her BA from the University of California at Irvine in 1979.

Mr. Birnbaum is a consulting economist specializing in, among other things, consumer credit insurance. Mr. Birnbaum has been accepted as an expert on both economic and actuarial matters in two Texas contested-case credit insurance rate hearings, as well as in rate cases for automobile insurance, residential property insurance and title insurance. He has served as the Chief Economist of the Texas Office of Public Insurance Counsel (OPIC) and as the Chief Economist and Associate Commissioner for Policy and Research at the Texas Department of Insurance (TDI). At OPIC, Mr. Birnbaum analyzed and testified on credit insurance rates and regulations. At TDI, Mr. Birnbaum was responsible for reviewing and approving credit unemployment rates and participated on behalf of TDI on all credit insurance-related National Association of Insurance Commissioner (NAIC) committees and working groups. While at TDI, Mr. Birnbaum worked extensively with the NAIC Credit Insurance Experience Exhibit and developed a special call for information on credit property insurance issued by TDI. Since 1996, Mr. Birnbaum has worked extensively on credit insurance rate and policy form issues. He has reviewed dozens of credit unemployment and credit property rate filings in Texas and other states on behalf of the Center for Economic Justice (CEJ). Based upon Mr. Birnbaum's work, CEJ has challenged several credit insurance rate filings in Texas, leading to lower rates. Mr. Birnbaum prepared and delivered testimony on a credit property insurance regulation in Texas in 1998 and has submitted comments to over ten states regarding proposed credit insurance rates and regulations. Mr. Birnbaum is the author of the Consumers Union / Center for Economic Justice report cited in the RH-386 Notice of Proposed Action. Mr. Birnbaum serves on the NAIC Consumer Board of Trustees and has provided testimony to the NAIC on credit insurance issues several times in the past two years. Mr. Birnbaum currently participates in the NAIC Credit Property Insurance Working Group, which is developing a model law for credit personal property insurance. Mr. Birnbaum was educated at Bowdoin College and the Massachusetts Institute of Technology, where he received two Masters Degrees.

D.J. Powers is an attorney specializing in insurance and utility issues on behalf of consumers. Mr. Powers was lead counsel on behalf of the Center for Economic Justice (CEJ) in the 1999 credit life and credit disability insurance rate case in Texas. On behalf of CEJ, he has reviewed numerous credit insurance rate and form filings, resulting in challenges to some of those filings by the CEJ. Mr. Powers served as General Counsel at the Texas Department of Insurance, where he advised the Commissioner on all legal and policy matters and drafted and amended rules, contested case decisions, letters, legislation, speeches, press releases and policy statements. Mr. Powers also served as a staff attorney for the Texas Office of Public Insurance Counsel, a state agency dedicated to advocacy on behalf of insurance consumers. Among other things, Mr. Powers was the lead counsel for the office in the 1992 credit life and credit disability insurance rate case and a major rulemaking hearing on credit insurance. Mr. Powers was also the primary author of the Texas Bill of Rights for Credit Insurance, a document that is attached to every policy and certificate of credit insurance issued in Texas. Mr. Powers received his law degree from the University of Texas.

2. Reverse Competition in Credit Insurance Markets

In the marketing of credit insurance, the inferior bargaining position of the debtor creates a "captive market" in which, without appropriate regulation of such insurance, the creditor can dictate the choice of coverages, premium rates, insurer and agent, with such undesirable consequences as: excessive coverage (both as to amount and duration); excessive charges (including payment for nonessential items concealed as unidentifiable extra charges under the heading of insurance); failure to inform debtors of the existence and character of their credit insurance and the charges therefor, and consequent avoidance of the protection provided the debtor by such coverage.

In the absence of regulation, premium rates and compensation for credit insurance tend to be set at levels determined by the rate of return desired by the creditor in the form of dividends or retrospective rate refunds, commissions, fee or other allowances, instead of on the basis of reasonable cost. Such "reverse competition," unless properly controlled, results in insurance charges to debtors that are unreasonably high in relation to the benefits provided to them. (New York State Insurance Department Regulation 27A -- 11NYCCR 185)

These statements describe the most important characteristic of credit insurance markets - reverse competition.

· Credit insurance is sold to a lender who, in turn, sells the credit insurance to borrowers.
· Credit insurers rely upon lenders to present and sell credit insurance to borrowers.
· Credit insurers compete for the lenders' business by offering more compensation and commission to the lenders.
· Credit insurance is typically sold as a package of products, or coverages.
· The lender selects the package of coverages to be offered to the consumer.(1)

The detrimental results of reverse competition on credit insurance consumers is demonstrated in Attachment 1 which shows the 1995-1999 California credit insurance experience. In 1999, California credit insurance consumers were overcharged by at least $230 million. Stated differently, California credit insurance consumers should have paid about $200 million for credit insurance in 1999, based upon a modest 60% loss ratio standard. Instead, these consumers paid over $430 million - an overcharge of over 110%. Credit unemployment insurance was particularly egregious as unemployment premiums grew dramatically - overtaking credit disability as the coverage with the most premium - while unemployment loss ratios dropped to less than 10%. In 1999 unemployment premiums were excessive by over 650%.

Commissioner Low has the authority and the responsibility to carry out the legislative intent of AB 1456 to halt credit insurance abuses.

The proposed revisions to the Department's credit life and credit disability rates and the proposed credit unemployment and credit property rate regulations that are the subject of today's hearing are essential actions by the Department to protect California credit insurance consumers.

3. The Loss Ratio Standard in California Insurance Code §779.36

Insurance Code §779.36 requires the commissioner to promulgate presumptive loss ratios and prima facie rates by coverage and class of business based upon these presumptive loss ratios. The most important issue in implementing this statutory provision is to determine what the legislature intended by including 60% in this section. As discussed below, it is clear that the most reasonable interpretation of this section is that 60% is intended as a minimum presumptive loss ratio. The industry's interpretation - that this section calls for a pure component rating approach - renders the legislature's inclusion of the 60% figure meaningless. Further, the industry's contention that the statutory caps on compensation paid, in Insurance Code §779.32, must be used in the development of presumptive loss ratios is incorrect and contradicts the legislative intent in Insurance Code §779.36. The remainder of this section discusses these issues.

3.1 The statutory cap on compensation relates to the commission amounts actually paid, not to the setting of a prima facie rate.

Insurance Code § 779.36 provides that the commissioner in the ratemaking process shall consider "acquisition costs, including commissions and other forms of compensation." Insurance Code § 779.36 (a). Insurance Code § 779.32 has two subsections that discuss commissions. Subsection (a) defines "compensation" very broadly to include both commissions and any other consideration paid to the producer. Subsection (b) provides that "the maximum amount of total compensation … payable by any insurer shall not exceed 35 percent of the prima facie credit life insurance rates and 30 percent of the prima facie disability insurance rates."

Read together, it is clear that the legislature did not intend the commissioner to use the maximum compensation caps provided in Insurance Code §779.32 (b) in setting the prima facie rates. Numerous arguments, set out below, show that the there is no legal requirement for the commissioner to use the maximum compensation caps in setting the prima facie rates. On the contrary, the legislature clearly intended the commissioner to consider a reasonable compensation rate in setting the prima facie rates. The caps set out in Insurance Code §779.32 (b) do not apply to the setting of the prima facie rate; they only apply to the actual agreements between insurers and producers in the marketplace.

First, the compensation caps in Insurance Code §779.32 (b) apply by their express terms only to credit life and credit disability insurance; they do not apply to credit property and credit unemployment insurance. Thus, the compensations caps cannot be used in the setting of credit property and credit unemployment insurance prima facie rates.

Second, the 1999 legislative change demonstrates the legislative intent that the compensation caps do not apply to the setting of the prima facie rates. If the legislature intended the caps to apply to the setting of the prima facie rates, it would have decreased the compensation caps at the same time it raised the loss ratio from 55% to 60%. Their decision not to do so shows their intent that the compensation cap statute does not apply to the setting of the prima facie rate. Moreover, had the legislature intended the caps to be used in the setting of the prima facie rates, they would have promulgated compensation caps for credit property and credit unemployment insurance at the same time they required the commissioner to set prima facie rates for those two products. Their decision not to do so again shows their intent that the compensation caps do not apply to the setting of prima facie rates.

Third, if the legislature wanted to require the commissioner to consider the maximum compensation caps in setting the prima facie rate, it could have easily done so in language other than the language it selected. The legislature required that the commissioner consider "acquisition costs, including commissions and other forms of compensation." The legislature did not require consideration of either "actual" compensation rates or the compensation caps. Had the legislature intended the commissioner to use the maximum compensation percentages, it would have required the commissioner to consider "the maximum amount of total compensation permitted under this article." The legislature's choice not to employ that language clearly establishes that it did not intend the commissioner to use the compensation caps in the setting of the prima facie rates.

Fourth, applying the compensation caps to the actual agreements in the market and not to the setting of the prima facie rates is the only way to give the statute meaning and not render the 60% loss ratio language mere surplusage. If the law requires the commissioner to include a 35% compensation factor in setting the prima facie rate for credit life insurance, for instance, then it is impossible to also have a 60% target loss ratio. The industry's argument that the commissioner must include the maximum compensation cap in setting the prima facie rates requires the commissioner to conclude that the legislature passed a contradictory statute. But the legislature did not; the two statutes apply to different situations: the 60% loss ratio applies to the setting of prima facie rates and the compensation caps apply to the actual agreements by insurers. Because the compensation caps do not apply to the setting of prima facie rates, the statute is consistent and all provisions have meaning and purpose.

Fifth, the legislative history of the 1999 amendment shows that the legislature did not intend the compensation caps to apply to the setting of the prima facie rates. The legislative history demonstrates a legislative intent to do, among other matters, two important things: (1) establish a minimum 60% loss ratio and (2) substantially reduce rates for credit insurance. The bill analysis provides:

The author introduced [AB 1456] to stem losses experienced by consumers as a result of excessive credit insurance rates. This measure is designed to clarify the standard for credit insurance rates to ensure that the standard is applied to all lines of credit insurance. 1992 legislative was intended to set rates at a standard based on a minimum 60% loss ratio. As finally adopted, however, the law resulted in a "cap" of 60% loss ratios so the Insurance Commissioner could not approve higher loss ratios. A March 1999 Consumers Union report underscores the problem with the current law - lack of adequate regulation has resulted in a loss of $460.5 million to California consumers for the period of 1995-1997

Analysis of AB 1456, Concurrence in Senate Amendments, As Amended June 23, 1999 (emphasis added). On the first matter, the intent is clear to clarify the intent of the 1992 law to have a minimum 60% loss ratio. On the second matter, the intent is equally clear that the legislature intended a significant rate reduction to stop the $460.5 million in overcharges paid by California consumers. Thus, the legislature did not intend the commissioner to set rates based on the current levels of compensation.

Sixth, using the compensation caps in setting the prima facie rates would be inconsistent with Insurance Code §779.1. The industry's argument for using the compensation caps in setting the prima facie rates is that reverse competition will force them to pay the maximum compensation. Yet, Insurance Code §779.1 provides that "nothing in this article is intended to prohibit or discourage reasonable competition." Interpreting the statute to require the use of the maximum compensation in setting the prima facie rate would discourage competition and reward the lack of competition in credit insurance. Only a reduction of credit insurance rates will promote competition by forcing producers to accept lower compensation. The industry's argument is based on the premise that the legislature required the commissioner to use the maximum compensation in setting the prima facie rates because the lack of competition forces higher compensation rates. Insurance Code § 779.1 demonstrates the fallacy of the industry's argument that the industry should be rewarded with excessive prima facie rates because of the effects of reverse competition.

3.2 The statute requires the Commissioner to set a prima facie rate based on a reasonable commission level.

Insurance Code §779.36 provides that the commissioner in the ratemaking process shall consider "acquisition costs, including commissions and other forms of compensation." The legislature did not require the commissioner to consider actual acquisition costs; they did not include the word "actual" in the statute. Instead, the applicable statutes require the commissioner to consider only a reasonable compensation component in setting prima facie rates.

First, Insurance Code § 779.36 (a) provides that the purpose of considering the listed rate components is to provide an opportunity for a fair and reasonable rate of return; considering unreasonable amounts for components in the setting of prima facie rates would result in an unfair and unreasonable rate of return. The statute expressly sets out the purpose of considering the rate components: "in order to provide insurers an opportunity to earn a fair and reasonable rate of return." It necessarily follows that the commissioner must, therefore, consider a fair and reasonable amount for each component. For if the commissioner sets prima facie rates based on an unreasonable component, whether the component is compensation, expenses, profits, loss ratios, reserves or other consideration, then he will have provided insurers with the opportunity to earn an unfair and unreasonable rate of return.

Second, the legislature further showed its intent that the commissioner should only consider reasonable amounts for each rate component when it ended the list by including "and other reasonable actuarial considerations." This language demonstrates the legislative intent that the other components must be reasonable. Had the legislature intended only the actuarial components to be reasonable, then it would have said simply "and reasonable actuarial components." By including the word "other" before "reasonable," the legislature could only have meant that it intended the other rate components to be reasonable.

Third, allowing the commissioner to consider unreasonable rate components would lead to absurd results. For instance, if part of the reported expenses includes fines and the expenses associated with illegal activity, it would be absurd to include those unreasonable costs in the setting of prima facie rates. Assume a case, for example, where an insurer was sued for bad faith in its denial of a claim and that the consumer was awarded punitive damages. Surely the legislature did not intend the insurer to be able to pass the punitive damage award and the costs associated with that illegal activity to consumers by including those expenses in the determination of prima facie rates.

Fourth, allowing the commissioner to consider unreasonable rate components would directly violate the legislative intent to end the overcharges of California consumers. As set out above, one of the key intents of the legislature with the new statute was to drastically reduce credit insurance rates. Permitting insurers to recoup unreasonable expenses does not further that intent; it thwarts that intent.
Finally, Insurance Code §1861.05 requires the rate components to be reasonable. That statute provides that "no rate shall be approved . . . which is excessive . . .." A rate is excessive if it includes a component that is unreasonably high. Thus, the statute prohibits the commissioner from considering unreasonable rate components, including the compensation level, in the setting of prima facie rates.

3.3. Creditor compensation provisions below the statutory caps do not discourage reasonable competition.

Utilizing a creditor compensation provision of less than the statutory caps in developing the presumptive loss ratios for prima facie rates does not discourage reasonable competition among credit insurers. Nor does it disadvantage one or more credit insurers compared to other credit insurers.

The principal effect of utilizing a creditor compensation provision of less than 35% for credit life and less than 30% for credit disability is to create higher presumptive loss ratios than if the 35% and 30% were utilized, respectively. Higher presumptive loss ratios yield lower prima facie rates. Assuming all other rate components stay the same, lower prima facie rates mean a smaller portion of the premium dollar is available for creditor compensation. Because of reverse competition, credit insurers will continue to pay as much of the premium dollar to creditors as possible - but that amount will simply be less. In that way, regulation causes the same effect on compensation that reasonable competition would have caused in the absence of reverse competition. Such an effect is not discouraging reasonable competition, but limiting the negative effects of unreasonable reverse competition. Because all credit insurers are working with the same prima facie rate, no credit insurer is disadvantaged compared to other credit insurers.

4. Development of Presumptive Loss Ratio - Component Rating Analysis

Insurance Code §779.36 requires the Commissioner to establish prima facie rates based upon presumptive loss ratios, which should be 60% or other loss ratio as determined by a component rating analysis. As discussed above, the clear intent of the statute is for 60% to be a minimum presumptive loss ratio. In this section, we develop presumptive loss ratios through a component rating analysis.

The major rate development components are:

· Acquisition costs, including credit commission and other compensation;
· Administrative Expenses
· Losses
· Taxes, Licenses and Fees
· Profit, including consideration of investment income on surplus and reserves

Credit unemployment coverages are very similar to credit disability coverages. Both generally provide for monthly benefit payments in the event that the borrower's ability to work is impaired - by disability or involuntary unemployment, respectively. We start with the development of a presumptive loss ratio for credit disability because of the availability of reliable rate development information for that component. Building on the credit disability analysis, we then move on to the development of credit unemployment and credit property presumptive loss ratios.

In developing the credit disability presumptive loss ratio, we will reference the Texas Insurance Commissioner's Order 00-0214 of February 23, 2000 regarding Presumptive Premium Rates For Credit Life And Credit Accident And Health Insurance. The order is included as Attachment 3 to this testimony and is available at the following Internet address: http://www.tdi.state.tx.us/commish/co-00-0214.html.

The Texas rate proceeding and decision provide useful and relevant information for three important reasons. First, the Texas rate proceeding represents the most thorough hearing on credit life and disability insurance rates ever held. While we disagree with some of the ultimate decisions, the hearing included:

· The provision of detailed experience and expense statistics by the Texas Department of Insurance;
· Prefiled testimony (direct, rebuttal, redirect) by five parties, including two credit insurance industry trade associations;
· Live testimony and cross examination of five expert witnesses before two administrative law judges over three days;
· Post hearing briefs and replies to post hearing briefs by the parties;
· A proposal for decision by the administrative law judges;
· Exceptions to the PFD and replies to exceptions by the parties;
· A hearing before the commissioner; and
· A decision by the commissioner that included over one hundred findings of fact.

Second, the Texas Department of Insurance issued data calls for expense experience of credit insurers and those data were included and analyzed in the rate hearing. Attachment 4 is a copy of the data call and Attachment 5 shows summary results of the expense call for the years 1994-1997.

4.1 Credit Disability

4.1.1 Creditor Commissions

One of the most critical results of the reverse competitive structure of credit insurance markets is that there can be no assumption or belief that actual dollars paid by credit insurers for commissions or expenses are reasonable for purposes of establishing prima facie rates.

Reasonable creditor compensation is, at most, an amount to cover the creditor's expenses for presenting and servicing the credit insurance product plus a reasonable profit associated with those expenses. We say "at most" because the creditor receives significant benefits from the sale of credit insurance to borrowers, even in the absence of any commission - loan protection, avoidance of debt collection costs and additional interest income. On the other hand, the activities performed by creditors in selling the product - and the cost of those activities - appear minimal. There is little cost in obtaining and maintaining the necessary agent licensing. The sales pitch for credit insurance is brief and there is no underwriting. The sale of credit insurance is part of the overall lending transaction and typically requires checking of a box on a computer terminal to process. The credit insurer and/or lenders often provide producers who are not lenders with turn-key computer systems to process loan and insurance transactions. Because of reverse competition, most lenders will demand as much commission from credit insurers as can be squeezed out of the premium dollar regardless of the costs - or lack of costs - of the lender.

The exception to lenders demanding the maximum commission from credit insurers is credit unions. The following statements were made by Mike Medland, Associate General Counsel of CUNA Mutual Group at the September 6, 2000 hearing regarding proposed changes in the California credit life and disability regulation (pages 17-19 of transcript).

We [CUNA Mutual Insurance Society] write our coverages exclusively in the credit union market. Credit unions are also not-for-profit cooperative financial institutions owned by their members, democratically run by an elected board of directors, noncompensated board of directors; and they run exclusively for the benefit of their members.

Our historic loss ratios in California and elsewhere are consistently among the most favorable in the industry. For the three years, 1997 through 1999, for example, our credit disability incurred loss ratio in California was 73%, and the average premium rate on credit disability insurance were [sic] approximately 20 percent below the prima facie rate . . ..

More than 99 percent of our business is written using the monthly outstanding balance premium basis. Only one percent - less than one percent is on a single premium basis. And in comparison, financing at single premium in monthly outstanding is generally more cost favorable to consumers, but it is considerably more expensive for creditors to administer.

In addition, approximately two-thirds of our credit disability insurance business is written on a 30-day nonretroactive benefit plan, which is the least costly plan to consumers, and only about two percent is written on the 14 retro plan, which is the most costly to consumers.

These facts amply demonstrate, I believe, that the CUNA Mutual and California's credit unions are dedicated to providing credit union members with consistently high-value products at the lowest possible cost consistent with sound business practices.

The commission paid by CUNA Mutual to credit unions selling credit insurance is the best estimate of the reasonable costs to lenders to sell and service credit insurance. The table below shows the commission paid by CUNA Mutual for credit disability in California for the period 1997-1999, expressed as a percentage of prima facie earned premiums. These represent a reasonable provision for creditor compensation to use in developing presumptive loss ratios.

It has been argued that credit unions are not-for-profit organizations and, therefore, the credit union commissions do not include a profit for the lender. We would argue that because of credit unions much greater concern for treating their borrowers fairly than other lenders and because of the predominant use of monthly outstanding balance products (instead of single premium products), the credit insurance expenses for credit unions is likely higher than for other types of lenders.

However, even if we add a profit load to the credit union commission percentage, the resulting figures are still considerably less than the statutory caps on credit disability commissions. Profit is typically measured as a return on equity - net income divided by capital supporting the enterprise. Let us make the assumption that creditors have capital supporting the credit insurance operation equal to their credit insurance expenses. This is a generous assumption for lenders because the capital costs to support credit insurance are quite small - perhaps a modest marginal addition to existing systems and some training for staff. Let us assume a generous 20% return on equity (ROE) supporting the lenders' credit insurance activity. This ROE is high to avoid arguments about a reasonable ROE. As the table below shows, the resulting commission provision is 15.6% -- reasonable costs to present and service the credit insurance plus a profit load.

CUNA Mutual Credit Disability Creditor Compensation in California, 1997-99

Based upon this analysis, a provision of about 16% for creditor compensation for credit disability is reasonable. Utilizing a provision of 20% is more than reasonable. A 20% commission provision would reflect a 54% ROE on creditor expenditures.

4.1.2 Expenses

As mentioned above, and shown in Attachments 4 and 5, the Texas Department of Insurance collects general expense information for credit life and credit disability insurance from credit insurers. The Texas Insurance Commissioner relied upon these expense data to establish expense provisions in the component rating process. Attachment 6 demonstrates the calculation of the expense provision and Findings of Fact 46-49 and 74-75 in Attachment 3 explain the calculation. The resulting expense provision for a 36-month term, single premium reducing term 14-day retro credit disability is $0.5457.

The $0.5457 expense provision must be considered a maximum because all reported expenses were included in the calculation. However, because of reverse competition, we must conclude that some portion of these actual expenses are unreasonable expenses for purposes of developing a presumptive loss ratio.

4.1.3 Profit Provision

The Texas hearing included detailed testimony regarding a reasonable profit provision for credit disability insurance. That testimony included analysis of a reasonable after-tax target rate of return on the credit insurance business, estimates of investment income on reserves and on surplus, and analysis of the appropriate ratio of premium to surplus. The Texas Commissioner determined that a -4% profit provision was reasonable and was high enough for credit insurers to add a single premium discount factor. Attachment 3 (Order), FOF 50-64, 76-77, 96-101 and 108-111 discuss the issue. The Commissioner adopted the testimony of Birny Birnbaum and his detailed testimony and analyses are included as Attachment 7.

It is important to note that the Texas Commissioner adopted a single premium discount factor to reduce the single premium rate on credit life and credit disability insurance as the term of coverage increased. The purpose of the single premium discount factor is to reflect the additional investment income earned by credit insurers from single premium products compared to monthly outstanding balance products. The combination of the credit disability profit provision of -4% and the single premium discount factor provided a reasonable profit for insurers writing credit disability. The addition of the single premium discount factor increased the target loss ratio by about 3%. Stated differently, the target loss ratio for single premium products should be about 5% higher than for monthly outstanding balance products.

4.1.4 Claim Costs

The claim cost for developing an average credit disability presumptive loss ratio is based upon a 36-month term, single premium decreasing term 14 day retro credit disability rate and the 1999 average California loss ratio at prima facie rates of about 40%. The 36-month product was selected because the provisions developed in the Texas rate hearing were based upon the same product and because the 36 months is about the average term of credit insurance coverages.

4.1.5 Credit Disability Presumptive Loss Ratio

Attachment 8 shows the development of the presumptive loss ratio for credit disability based upon the formula:

(Expected Claim Costs + Expenses) /
(1 - Commission - Taxes Licenses and Fees - Profit)

A provision of 3% was used for Taxes, Licenses and Fees and a provision of 20% was used for Commissions. The indicated California average credit disability presumptive loss ratio is about 64% to 65% after consideration of the single premium discount factor.

4.4 Credit Unemployment

Because credit unemployment is very similar to credit disability in terms of both benefits paid and plans of business (monthly outstanding balance, single premium, waiting periods), a reasonable starting point for credit unemployment presumptive loss ratios is the 65% credit disability average presumptive loss ratio.

There are two important characteristics of credit unemployment insurance sales in California that affect the development of presumptive loss ratios. First, credit unemployment is rarely sold as a stand-alone product. Rather, credit unemployment is almost always sold as part of a package with credit life and credit disability. Second, the vast majority of credit unemployment insurance is sold on a monthly outstanding balance (MOB) basis, typically as part of a credit card credit insurance package. Less than 8% of the credit unemployment earned premium for the years 1997-1999 in California was single premium credit unemployment.

4.4.1 Commissions

Credit life and credit disability rates are established to provide a reasonable compensation to the creditor for selling and servicing those credit insurance coverages. When credit unemployment is added to the package of coverages, the additional costs to the creditor are less than the costs to sell credit life and credit disability. Adding credit unemployment builds on the infrastructure developed for the sale of credit life and disability. For example, once the creditor's systems are set up to sell credit life and credit disability with the loan, the cost of adding credit unemployment to those systems is relatively small. Consider a bank offering credit card revolving debt and establishing a system for credit life and credit disability insurance. The cost of adding credit unemployment to the credit card brochure and to the systems for calculating credit insurance premium is much less than the cost to create the brochure and establish the systems in the first place. Thus, the commission provision for credit unemployment should be less than for credit disability.

4.4.2 Expenses

The additional expenses to the credit insurer to add credit unemployment to the sale of credit life and credit disability are also less than the expenses associated with credit disability insurance. Credit insurers have significant fixed expenses and the addition of credit unemployment provides more premium over which to spread those fixed expenses. For example, a credit insurer does not need to hire additional sales and marketing people to sell credit unemployment with credit life and credit disability. As stated by Gary Fagg, in his book at page 18, An Introduction to Credit-Related Insurance, "To generate more premium income to cover the fixed processing costs, credit insurers began to consider the last contingency that could impair the 'collateral' of consumer credit. Since voluntary acts are generally not insurable, the product that was introduced only protected against the contingency of involuntary unemployment. . . ."

Thus, the expense provision for credit unemployment should be less than the expense provision for credit disability insurance.

4.4.3 Profit

Because the presumptive loss ratio for credit unemployment is higher than the presumptive loss ratio for credit disability, the credit insurer has greater loss reserves upon which the insurer can earn investment income. Greater investment income results in a lower profit provision. Thus, the because credit unemployment should have a higher presumptive loss ratio than credit disability, the profit provision for credit unemployment should be lower than the profit provision for credit disability.

4.4.4 Presumptive Loss Ratio

A reasonable presumptive loss ratio for credit unemployment is higher than
than the presumptive loss ratio for credit disability because a smaller commission provision, a smaller expense provision and a higher profit provision are warranted. For credit unemployment, on average, a reasonable presumptive loss ratio is 75%.

4.4.5 Claim Costs and Prima Facie Rates

We understand that claim costs for the credit unemployment benchmark programs were developed by applying the three-year overall average credit unemployment loss ratio to the rates for the benchmark programs. Because unemployment rates have declined over the last several years, this method overstates expected credit unemployment claim costs. Attachment 9 shows credit unemployment experience by major coverage by company by year for the 1997-1999 period. Attachment 10 shows California unemployment experience as reported by the United States Bureau of Labor Statistics. As we would expect, the claim costs (and loss ratios) decline as the unemployment rate declines.

Attachment 9 shows that this pattern of credit unemployment loss ratios declining from 1997 through 1999 is generally consistent across major coverages and most companies.

The proposed use of a three-year average loss ratio during a period of declining unemployment rates inappropriately overstates expected claim costs, particularly for MOB business, which is the vast majority of credit unemployment business. The best estimate of unemployment rates in 2001 is the current unemployment rate. Therefore, the best estimate of 2001 credit unemployment claim costs is the claim costs associated with current unemployment rates - not the claim costs associated with higher unemployment rates from a few years ago. Thus, the overall loss ratio to use to develop expected claim costs is 7.8%, which is the loss ratio from 1999 when the unemployment rate was about the same as today.

Insurers have attempted to utilize and justify the use of a multi-year historical average loss ratio - even though unemployment rates were significantly higher during the historical period than the current period - by alleging that unemployment experience is volatile and that the more recent experience was a time of "unprecedented" low unemployment. This rationale fails for at least two reasons. First, the provision for claim costs in the rate development is the expected claim cost during the period the rates will be in effect. The best estimate for unemployment rates, and therefore credit unemployment claim costs, is current unemployment rate levels. In contrast, the use of a three-year average assumes that near-term claim costs will be 50% higher than current claim costs. This is clearly incorrect.

Second, the claim of volatility appears to be a single-edged sword to the detriment of consumers. Even if we accept the premise that 1992 through 1999 was a period of "unprecedented" low unemployment, insurers made no attempt to lower its rates to reflect this far better-than-expected claim experience. Rather, because of reverse competition, insurers simply paid out additional commissions or pocketed additional profit while keeping rates at an excessive level. This is exactly what credit insurers did in California and across the nation over the past several years. When insurers made the original credit unemployment filings in the early and mid 1990's, they proposed target loss ratios of 50% or more. Yet, despite year after year of actual loss ratios in the teens or single digits, credit insurers made no move to lower rates to reflect the low loss experience. To this day, credit insurers continue to use grossly excessive rates unless challenged by insurance regulators.

By relying upon a long experience period and arguing that unemployment is volatile, insurers effectively ask for a cushion in the provision for claim costs in the event that unemployment rates increase. The implication is that the insurers will continue to write the business at these rates even if unemployment rates increase and that over a longer period the periods of good and bad claim experience will even out. This argument is unreasonable and should not be adopted by regulators. It is not reasonable to expect that insurers will continue to sell the coverage at the same rates if unemployment rates increase substantially. Insurers can and will file for new rates to reflect the more current higher claim costs. Insurers can and will stop writing the business if it becomes unprofitable. It is, however, unreasonable to believe that insurers will continue to write the business for a loss. And yet, that is exactly the premise behind the long-term average approach to developing a provision for claim costs.

The table below shows the indicated prima facie rates by credit unemployment benchmark program. We recommend that rates be established to the tenth of a cent.

Some insurers may argue that rates of 2 or 3 cents per hundred are too low to cover expenses. Attachment 11 shows a recent filing by Allstate Insurance Company in Iowa, in which Allstate reduced its credit unemployment rates to 1 and 2 cents per $100 of MOB per month on credit unemployment and credit property coverages. Thus, our recommended prima facie rates are adequate to cove expenses, as well as to provide a reasonable compensation and profit.

4.4.6 Joint Unemployment Factor

We recommend an initial joint unemployment factor of 1.42 of the single debtor credit unemployment rate. The first step is to estimate the difference in claim costs for a joint credit unemployment policy compared to a single debtor credit unemployment policy. The joint policy claim cost should be significantly less than twice the single debtor claim cost because of the large number of joint debtors - spouses - for which one of the debtors does not meet the work requirements for coverage. Stated differently, in many couples, only one member of the couple is employed in a manner that qualifies for credit unemployment insurance. We select a joint claim cost of 150% of the single debtor claim cost.

Next, based upon the 75% loss ratio, we select 15% as fixed expense and 10% as variable expense. The indicated joint rate would be ((150% of 75) + 15) / (1- .10) which equals about 142% of the single debtor rate.

4.5 Property

Credit property insurance is typically sold on a MOB basis in conjunction with open-end loans, such as credit card credit insurance, or on a single premium basis in conjunction with closed-end installment loans.

A reasonable presumptive loss ratio for credit property insurance is 75%.

For credit property sold as part of a package of coverages, the analysis for credit property is the same as the analysis for credit unemployment - the presumptive loss ratio for credit property should be greater than the credit disability presumptive loss ratio because of the relatively small additional costs of adding the credit property coverage to the package of coverages.

For single premium credit property insurance, we base our analysis on a recent filing by Standard Guaranty Insurance Company in West Virginia for single premium Dual Interest Personal Property Insurance sold in conjunction with installment loans. The filing is provided as Attachment 12. The Standard Guaranty Filing is similar to, and representative of, other recent credit property insurance rate filings in various states. Standard Guaranty has made this same filing in a number of states.

The table below shows the development of the target loss ratio Standard Guaranty used in its rate filing. The table also shows an adjusted target loss ratio development based on three changes - a reduction in the commission and brokerage provision from 30% to 20%, an increase in Taxes Licenses and Fees from 2% to 3% and a decrease in the profit provision from 6% to -4%. The reasonable adjusted target loss ratio is 74%.

As discussed above for credit disability, a reasonable provision for commissions is no more than 20%. Attachment 13 shows Standard Guaranty's development of its underwriting profit provision and a revised analysis based upon two changes. The first change is a reduction in target after-tax rate of return from 15% to 12%. The 12% figure is more reasonable, based upon recent rate hearings in Texas in which the Texas Insurance Commissioner has selected a target after-tax rate of return of about 12% for residential property insurance. The second change is the premium to surplus ratio from .728 to 1.000. The leverage ratio used by Standard Guaranty is too low, indicating an unreasonably large amount of surplus supporting the business. Reasonable leverage ratios for residential property insurance easily meet or exceed 1.00.

4.5.5 Claim Costs and Prima Facie Rates

Attachment 14 shows the credit property results in California by company for the years 1997-1999 broken out by the NAIC Credit Insurance Experience Exhibit categories of Fire / Extended Coverage and Other. It is difficult to match the NAIC CIEE experience to the benchmark programs for many companies. For example, American Bankers writes a number of credit property programs - MOB and single premium - but all are reported in one CIEE category. Generally, the Other CIEE category is credit property sold on a MOB basis with credit card credit insurance. However, a large part of the California Other credit property experience is from Ace American and we do not know what type of credit property insurance that company writes. In addition, the total industry 1998 Other experience is distorted by unusual results of one company - Bankers Standard - that reported negative earned premiums and over $12 million in losses.

We do know that the Allstate experience reported in the Other category is for credit card credit property insurance - benchmark program 1. Based upon the Allstate three-year loss ratio of 4.5% and the Allstate rate of $.28 per hundred of outstanding balance per month, the expected claim cost for benchmark program 1 is $0.125. For the other benchmark programs, we apply a 20% loss ratio to current rates to develop expected claim costs. The 20% figure is higher than the overall average credit property loss ratio to balance with the lower-than-average loss ratio used for benchmark program one loss cost development.

4.5.6 Joint Property Factor

The joint property factor should be 1.0. Stated differently, there should be no difference in the rate between single debtor credit property and joint debtor credit property. There is no difference in rates because there is no difference in expected claim costs. For credit property, the cause of a claim is unrelated to the debtor. The cause of a claim is theft, weather or some other covered event that is unrelated to the number of debtors on the credit property policy.

5. Basis for Premium Calculations and Coverage Limitations

It is very important to clearly specify not only the prima facie rate, but also the basis for premium calculations for credit unemployment and credit property coverages. For monthly outstanding balance credit unemployment coverage, the basis for the premium calculation should be the monthly outstanding balance. Stated differently, the premium is calculated by applying the rate to the monthly outstanding balance. It is important to specify that how the monthly outstanding balance will be determined - either end-of-month balance or average monthly balance.

For single premium unemployment with monthly benefits, the basis for premium calculation should be the initial gross debt - the total principal and scheduled interest payments.

For single premium unemployment with lump-sum benefit, the basis for premium calculation should be the initial net debt - the original amount borrowed less any unearned interest and finance charges.

For credit property insurance, the premium calculation should be limited to the value of covered items only. As described in the Consumers Union / Center for Economic Justice report, a major problem with the sale of credit property insurance is phantom coverage. Phantom coverage occurs with single premium products when the amount of coverage sold is greater than the value of the property insured and with MOB (credit card) credit property insurance when the premium is based upon non-covered items. For example, when the credit card credit property insurance premium is based on the monthly outstanding balance, but the monthly outstanding balance includes finance charges, insurance charges, meals, gasoline, services and other non-covered items, the consumer is paying for coverage that does not exist.

To address the problem of phantom coverage, for single premium credit property coverage secured by property other than property purchased with the loan, the amount of coverage, and the basis for premium calculation, should be an amount no greater than the net debt less any insurance charges. This ensures that consumers will not be paying for coverage beyond that needed to protect the collateral supporting the loan. Further, for single premium credit property insurance covering property purchased with the loan, the amount of coverage, and the basis for premium calculation, should be the lesser of the purchase price of the covered items or the net debt less any insurance charges. Further, for single premium credit property insurance covering property purchased with the loan, the amount of coverage and the basis for premium calculation should be limited to covered items only.

For MOB credit property insurance, the basis for premium calculation should be the amount of debt associated only with covered items. Insurers have argued that such a limitation is difficult or impossible for retailers to implement because the retailers do not have the ability to distinguish covered items from non-covered items in the credit card debt. We disagree. Attachment 15 shows how banks currently have the ability to identify different types of transactions charged on a credit card. Further, the credit property policies provide that purchased items are covered for a limited period - 36 months in the benchmark program 1. It seems logical that a bank that can track when a particular item has been purchased can add flags to particular items to distinguish covered items from non-covered items. Further evidence of the feasibility of limiting credit property charges to covered items is the ability of retailers to distinguish between items subject to sales tax versus items not subject to sales tax. While we agree that credit insurers and retailers may need reasonable lead time to implement a restriction on premium charges to covered items on a credit card, such a provision is clearly feasible. On the other hand, restricting coverage and charges to covered items on single premium credit property should be implemented immediately and has been ordered in at least two states - Colorado and Texas.

______

Footnotes:

(1) The reverse-competitive structure of credit insurance markets is discussed on pages 9 thrugh 17 of the Consumers Union / Center for Economic Justice Report cited in the notice for this hearing. Attachment 2 to these comments, testimony given by Birny Birnbaum to the National Association of Insurance Commissioners (NAIC) Credit Insurance Working Group in 1999, provides additional information demonstrating that credit insurers spend money - through commissions, profit-sharing or services to the lender - to get the lender to sell credit insurance on behalf of the credit insurer.

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