NORTH CAROLINA DEPARTMENT OF INSURANCE …11-11 Morning Hearing... · north carolina department of...

NORTH CAROLINA DEPARTMENT OF INSURANCE

RALEIGH, NORTH CAROLINA

)IN THE MATTER OF THE FILING ) BEFORE THEDATED JANUARY 3, 2014 BY THE ) COMMISSIONER OFNORTH CAROLINA RATE BUREAU ) INSURANCEFOR REVISED HOMEOWNERS' )INSURANCE RATES AND TERRITORY) DOCKET NO. 1719DEFINITIONS ) )

BEFORE: WAYNE GOODWIN, COMMISSIONER OF INSURANCE

TRANSCRIPT

OF

HEARING

VOLUME XI - A.M. SESSION

Raleigh, North Carolina

Tuesday, November 11, 2014

10:06 a.m.

_______________________________________

Vol XI AM SESSION Session Date: 11/11/2014

Noteworthy Reporting Services, LLC www.noteworthyreporting.com(919) 556-3961

192

1 A P P E A R A N C E S

2 On behalf of the North Carolina Rate Bureau:

3 GLENN C. RAYNOR, ESQ. MARVIN M. (MICKEY) SPIVEY, JR., ESQ.

4 R. MICHAEL STRICKLAND, ESQ. Young, Moore and Henderson, P.A.

5 3101 Glenwood Avenue Raleigh, North Carolina 27612

6 (919)782-6860 [email protected]

7 [email protected] [email protected]

8On behalf of the North Carolina Department of

9 Insurance:

10 SHERRI L. HUBBARD North Carolina Department of Insurance

11 430 North Salisbury Street Raleigh, North Carolina 27603-5926

12 (919)807-6092 [email protected]

13 Also Present:

14 Kevin Conley Robert Croom

15 Tricia Ford Benjamin Popkin

16 William Hale

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Page 2193

1 Hearing in the matter of the filing

2 dated January 3, 2014 by the North Carolina Rate

3 Bureau for revised homeowners' insurance rates and

4 territory definitions, at North Carolina

5 Department of Insurance, Dobbs Building, 430 North

6 Salisbury Street, Raleigh, North Carolina, on the

7 11th day of November, 2014, at 10:06 a.m., before

8 Tammy Johnson, CVR-CM-M, Certified Verbatim

9 Reporter and Notary Public.

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Page 2194

1 INDEX OF EXAMINATIONS

2

3 THE WITNESS: ROBERT CURRY EXAMINATION

4 Examination, by Mr. Strickland . . . . . .2219

5

6 THE WITNESS: MARY LOU O'NEIL EXAMINATION

7 Direct Rebuttal, by Ms. Hubbard. . . . . .2228

8

9

10 INDEX OF EXHIBITS

11

12 EXHIBIT ADMITTED

13 RB-1 TO RB-41. . . . . . . . . . . . . . . . .2227

14 (Excluding RB-35)

15 RB-25A . . . . . . . . . . . . . . . . . . . .2227

16 RB-31A . . . . . . . . . . . . . . . . . . . .2227

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Page 2195

1 P R O C E E D I N G S

2 * * * * *

3 COMMISSIONER GOODWIN: We are back on

4 the record and we welcome everybody back. As

5 it is certainly not usual for us to conduct

6 official business on a holiday such as this,

7 however, procedurally and statutorily and for

8 scheduling reasons predominantly, it was

9 necessary. I commend everyone for being here

10 today. I know everyone has been working hard

11 to get us to this point in the schedule.

12 As I insisted when this date was known

13 as a hearing date, we will not commence

14 further until the following statement and

15 appropriate moment of silence and reflection

16 occurs: Veterans Day honors all people who

17 have served in the U.S. Armed Forces,

18 soldiers, sailors, airmen, Marines and Coast

19 Guard. Originally named Armistice Day and

20 established to honor those who died in World

21 War I, in 1954 Congress correctly changed

22 this holiday to honor all American veterans

23 who have served and are currently serving.

24 President John F. Kennedy himself was a

25 decorated war veteran and hero of the PT-109



Page 2196

1 incident during World War II. He later said

2 after he was president the following about

3 Veterans Day: "As we express our gratitude,

4 we must never forget that the highest

5 appreciation is not to utter words, but to

6 live by them."

7 And as we take this moment of silence

8 and follow the lead of President Kennedy

9 himself, let us reflect upon what words we

10 shall live by and not merely utter - honor,

11 duty, country, liberty, freedom, equality,

12 respect, and peace. We will now have our

13 moment of silence and reflection.

14 (MOMENT OF SILENCE OBSERVED.)

15 COMMISSIONER GOODWIN: Thank you. I do

16 believe we have several matters we wish to

17 address before we call the first rebuttal

18 witness. I do believe we had a matter

19 pertaining to Mr. Curry and some ISO

20 documents. Do counsel for either or both

21 parties wish to apprise me of any

22 developments in that? And I do see Mr. Curry

23 is here.

24 MS. HUBBARD: It's my understanding,

25 Mr. Commissioner, that we have resolved most



Page 2197

1 of that issue. The Bureau has furnished a

2 new copy of that exhibit with corrected page

3 numbers, and maybe just to clear up the

4 record, it might help to have Mr. Curry on

5 the stand for just a couple of seconds

6 explaining the problem. And then I presume

7 we were going to mark this and replace the

8 old exhibit with this since --

9 MR. STRICKLAND: That would be fine.

10 MS. HUBBARD: Okay. Just to clean up

11 the record to make sure that everyone is on

12 the same page, if that's okay with you.

13 COMMISSIONER GOODWIN: That is

14 certainly okay. I certainly want to make

15 sure that the record is clear on any points

16 of the dispute. Anything further on that

17 before we call or recall Mr. Curry?

18 MR. STRICKLAND: Do you want to just

19 mark this Exhibit 25 and mark that A --

20 MS. HUBBARD: No. Is there --

21 COMMISSIONER GOODWIN: So you're

22 marking it 25 or 25A, or what?

23 MS. HUBBARD: I think we'll just mark

24 it RB-25 and just replace the -- I mean, is

25 there a reason to keep the -- it's up to you.



Page 2198

1 MR. STRICKLAND: That's fine.

2 MR. SPIVEY: It doesn't matter to us.

3 It's just a question of whether you're

4 comfortable with that. I mean, once he's on

5 the stand, he can explain what happened. I

6 mean, it -- the resolution, Mr. Commissioner,

7 as I understand it, is all the data did come

8 from the circular that we were all

9 discussing. There were no other sources for

10 it, and there was just some problems with the

11 page numbering because of a page macro

12 function in Excel that didn't work right when

13 they got that data included in the

14 spreadsheet.

15 COMMISSIONER GOODWIN: Well, I know on

16 an earlier discussion on a different matter I

17 believe that we had an original document in

18 so that we actually knew what we were talking

19 about when the -- when the objections and

20 discussions arose. Otherwise, if we just

21 replace it whole -- you know, replace it

22 completely, then it'll make those prior

23 comments not match up. So maybe we can have

24 the original exhibit and then also have this

25 one in there too.



Page 2199

1 MS. HUBBARD: We can do that. We can

2 mark this RB-25A, if you'd prefer.

3 COMMISSIONER GOODWIN: I think that

4 would be better.

5 MS. HUBBARD: Okay.

6 COMMISSIONER GOODWIN: That way it

7 makes sense to persons reading the earlier

8 portions of the transcript.


10 (EXHIBIT RB-25A MARKED.)

11 COMMISSIONER GOODWIN: All right. So,

12 Mr. Curry, I guess he needs to come forward.

13 Welcome back. Oh, actually, hold on a

14 second.

15 MR. SPIVEY: Were there other

16 preliminary matters you wanted to address

17 before -- before we did that? I thought you

18 had mentioned --

19 COMMISSIONER GOODWIN: Okay. That's

20 true. Let's go ahead and knock out the

21 preliminary matters and then we'll address

22 that. It's my understanding that

23 Mr. Schwartz's mother did pass. Ms. Hubbard,

24 do you wish to speak to that?

25 MS. HUBBARD: We were notified late



Page 2200

1 Friday afternoon that Mr. Schwartz's mother

2 had passed away somewhat unexpectedly. And

3 he was supposed to provide rebuttal testimony

4 for the Department yesterday, but given the

5 circumstances, we have decided to just rely

6 on Mr. Schwartz's prefiled testimony and his

7 direct when he was here, and he will not be

8 providing rebuttal testimony. That,

9 unfortunately, kicked off of a series of

10 unfortunate events having to do with travel

11 plans, computer problems, family emergencies,

12 so if the Department and its witness seem a

13 little scattered today, we apologize in

14 advance.

15 COMMISSIONER GOODWIN: Duly noted. I

16 think we all probably will be exhibiting

17 similar things, given all the circumstances.

18 So does that mean that Ms. O'Neil will be

19 called upon today?

20 MS. HUBBARD: Ms. O'Neil is here and

21 she will be called upon as our only rebuttal

22 witness.

23 COMMISSIONER GOODWIN: All right. The

24 only other matter I know of other than

25 scheduling, which we'll deal with, I guess,



Page 2201

1 when we conclude today, pertaining to the

2 source documents for the -- for the Bermuda

3 insurance survey and objections related to

4 that, I think, involving Dr. Appel's

5 testimony; is that correct?

6 MS. HUBBARD: Yes, and I believe

7 Dr. Appel -- we were, in fact, given the

8 source documents for the Bermuda -- whatever

9 that document he put together was.

10 MR. SPIVEY: I think you're speaking of

11 the documents that were the underlying

12 material for RB-31.

13 COMMISSIONER GOODWIN: Yes, sir.

14 MR. SPIVEY: And Dr. Appel was asked to

15 provide those when he was testifying on

16 Thursday, and I believe we sent those to the

17 Department somewhere around 11:00 a.m. on

18 Friday. So my recollection is it's roughly

19 27 pages of backup information.

20 COMMISSIONER GOODWIN: And will those

21 become part of the record or not?

22 MS. HUBBARD: Well, that actually is a

23 good point. Perhaps we can have it -- those

24 were the source documents for RB-31. Can we

25 have those documents attached to RB-31, by



Page 2202

1 chance?

2 MR. SPIVEY: How about we mark those

3 RB-31A?

4 MS. HUBBARD: Okay. We can do that.

5 COMMISSIONER GOODWIN: I see a pattern

6 here.

7 MR. SPIVEY: I mean, literally, you

8 know, down the road ultimately we'll be

9 deciding what we need and what we don't need,

10 and we may not need all this stuff.

11 COMMISSIONER GOODWIN: All right. So--

12 all right. That will be accepted as 31A and

13 will be appended to 31.

14 (EXHIBIT RB-31A MARKED.)


16 MR. SPIVEY: And so we're -- that's

17 being put into the record as Exhibit RB-31A?

18 MS. HUBBARD: RB-31A, uh-huh.

19 COMMISSIONER GOODWIN: 31A?

20 MS. HUBBARD: Okay. And do we -- do we

21 have those documents?

22 COMMISSIONER GOODWIN: Does that

23 include that particular item? And correct me

24 if I'm wrong, but do we still have the matter

25 pertaining to RB-41?



Page 2203

1 MS. HUBBARD: I think that was -- if

2 that's what I'm thinking, is that was a

3 decision you were going to make.

4 MR. SPIVEY: Right.

5 COMMISSIONER GOODWIN: Yes. Yes. All

6 right. And I need -- that's a decision I had

7 to make prior to -- prior to closing

8 statements or prior to closing the record?

9 MR. SPIVEY: I think you need to make

10 that decision before we close our rebuttal

11 evidence.

12 COMMISSIONER GOODWIN: Okay.

13 MR. SPIVEY: Because we offered that in

14 our evidence.

15 COMMISSIONER GOODWIN: Right. And that

16 is the -- I believe I have a copy of that in

17 front of me here, and it has Bryon Ehrhart's

18 testimony from 2011; is that correct?

19 MR. SPIVEY: Correct.

20 COMMISSIONER GOODWIN: All right. And

21 you mean before closing of all rebuttal

22 evidence; is that what --

23 MR. SPIVEY: I'm sorry?

24 COMMISSIONER GOODWIN: You were saying

25 before closing of all rebuttal evidence?



Page 2204

1 MR. SPIVEY: No, before the Rate Bureau

2 closes. We offered it as part of our case

3 and -- I mean, I guess I'm thinking if you

4 were -- if you were -- if you admit it, which

5 is what I think should happen, then we're

6 fine. If you were to exclude it, then

7 perhaps we have to do something different.

8 COMMISSIONER GOODWIN: All right.

9 Let's do this because we've had a lot of

10 things happen procedurally and

11 testimony-wise, as well as pertaining to

12 documents. I'd like for the parties to

13 briefly make their points for and against

14 this exhibit again.

15 MR. RAYNOR: And, again,

16 Mr. Commissioner -- and I'm stepping up

17 because I was the one that argued this last

18 week.

19 COMMISSIONER GOODWIN: If you'll speak

20 up, please.

21 MR. RAYNOR: Yes, sir. We are moving

22 that it be admitted on the grounds that

23 Dr. Appel testified during his rebuttal

24 testimony that he relied on statements of

25 Mr. Ehrhart which were not made in court but



Page 2205

1 also relied upon the sworn testimony

2 consistent with those statements that

3 Dr. Appel's model for projecting a

4 reinsurance cost to be included within these

5 rates was one which was reasonable and which

6 reflected the realities of the marketplace

7 which he was aware of and which he testified

8 under oath he had reason to be aware of

9 because his job is putting together and

10 pricing reinsurance in the marketplace on a

11 daily basis.

12 And so for the purposes of, A, serving

13 as a foundation in part for Dr. Appel's

14 expert opinion that this net cost of

15 reinsurance is a reasonable one to be

16 included in these rates, it is admissible

17 and, you know, we talked about black letter

18 standards for what our appellate courts have

19 said is required for out-of-court statements

20 of another person to be admitted as

21 foundation for an expert's opinion. It

22 doesn't matter if they would otherwise be

23 hearsay or not so long as they are the type

24 of information that an expert of, you know,

25 in this case, Dr. Appel's expertise would



Page 2206

1 rely upon.

2 And he specifically addressed that in

3 his testimony. He said he did, in fact, rely

4 upon the testimony of Mr. Ehrhart and it was

5 a reasonable thing that someone like he as an

6 economist would rely upon. It is actual

7 information about how the market operates

8 that pertains to the very subject that he was

9 testifying about, so and I think we --

10 Mr. Croom and I, in using different language,

11 agreed that we are not offering it for the

12 purpose of, you know, asking you to base any

13 finding of fact or conclusion of law on

14 Mr. Ehrhart's testimony, per se, in this

15 case, but the fact that he said what he said

16 under oath does relate to the reasonableness

17 of Dr. Appel's relying on it as a partial

18 basis for his expert opinions.

19 So that, in a nutshell, are the reasons

20 that I think tangentially it also

21 corroborates Dr. Appel's testimony that he

22 had discussions with Mr. Ehrhart outside of

23 the context of the dwelling hearing in which

24 Mr. Ehrhart conveyed those opinions to him

25 that the model he has for reinsurance cost is



Page 2207

1 reasonable because Mr. Ehrhart said here

2 under oath the same thing that Dr. Appel

3 attributed to him from an out-of-court

4 statement. So I think it also would be

5 admissible for that corroborative purpose.

6 Well, and I -- Mr. Strickland is also

7 noting tangentially as well that I think the

8 Department's witness, Mr. Bennett, indicated

9 that to some degree he reviewed -- we don't

10 know the level to which he replied upon, but

11 he said he reviewed Mr. Ehrhart's testimony

12 in formulating his opinions relating to

13 Dr. Appel's model, so I think it has

14 additional potential relevance from that

15 perspective in terms of our assessing or

16 arguing about what Mr. Bennett's credibility

17 may or may not have been in terms of

18 vis-a-vis what he has looked at in the case.

19 So those are in somewhat a synoptic fashion

20 the reasons that we believe it should be

21 admitted for those purposes I articulated.

22 COMMISSIONER GOODWIN: All right. Does

23 the Department wish to be heard on this?

24 MS. HUBBARD: Just briefly,

25 Mr. Commissioner, because I'm not even quite



Page 2208

1 sure if I can remember what we talked about

2 last week, but I do recall Mr. Ehrhart's

3 testimony, and I believe our argument is a

4

5 couple of things.

6 Mr. Ehrhart could have been entered as

7 a witness in this case -- or not entered,

8 brought in as a witness to this case and they

9 elected not to do that. His testimony from

10 dwelling fire we believe is actually

11 irrelevant because it was, in fact, a

12 different case for a different line of

13 business.

14 There's been testimony in this case

15 that the reinsurance market which is not --

16 which is a somewhat volatile market as we

17 understand it, that the reinsurance market

18 has changed considerably since Mr. Ehrhart

19 testified in 2011, and there -- of course,

20 there were issues involved with the level of

21 cross examination he was subjected to because

22 of his time constraints when he was here

23 three years ago, and the Department was only

24 able to have him on the witness stand a

25 couple of hours or so.



Page 2209

1 Given all of that and particularly

2 because this was entered late in the day

3 after Dr. Appel's rebuttal as opposed to

4 being offered in support either in the filing

5 or in response to discovery requests, we

6 don't feel that his testimony is the least

7 bit relevant.

8 And with respect to the comments about

9 Mr. Bennett, I don't recall Mr. Bennett

10 saying anything about relying on

11 Mr. Ehrhart's testimony. I do recall him

12 saying that he looked at it for background

13 material but that he never finished it. So I

14 don't really think that Mr. Bennett's

15 statements regarding Mr. Ehrhart's testimony

16 should be used to support an opinion that

17 Mr. Ehrhart's testimony is somehow relevant

18 in this case because certainly it isn't.

19 I believe that is probably the gist of

20 what our arguments were last week that I can

21 recall, and certainly there's still -- those

22 comments are still applicable to the issue

23 before you, Mr. Commissioner.

24 MR. RAYNOR: And if I might just very

25 briefly respond to just those arguments, my



Page 2210

1 take, given the purposes for which we're

2 offering introduction of that testimony, I

3 think Ms. Hubbard's arguments would all be

4 available arguments to her to contend to you

5 and/or to, you know, an appellate review that

6 the reasons she articulated are reasons that

7 Dr. Appel should not have reasonably relied

8 upon Mr. Ehrhart's testimony, and she can

9 draw those distinctions in terms of the

10 reasonableness of his decision to do so and,

11 in turn, the reasonableness of his opinions

12 that were based on that. But that goes to

13 those issues as opposed to the admissibility.

14 And then as -- you know, again, as to

15 Mr. Bennett and really as to the relevance

16 overall of the testimony as it relates to

17 Dr. Appel's opinions, the gist of the

18 Department witnesses and Mr. Bennett

19 specifically, testimony against Dr. Appel's

20 reinsurance model is that it has no grounding

21 in reality; it is purely a hypothetical

22 creation of Dr. Appel, and I think

23 Mr. Bennett said he should have validated it

24 in some way with the marketplace. Well, one

25 of the ways he said he validated it was



Page 2211

1 through his communications with Mr. Ehrhart

2 and testimony Mr. Ehrhart provided.

3 So, you know, I think for the limited

4 purposes for which we're offering it, it is

5 clearly admissible, and I understand that

6 Ms. Hubbard will have available to her those

7 arguments as to the weight it should be given

8 and the reasonableness of Dr. Appel's

9 reliance on it.

10 COMMISSIONER GOODWIN: Do you wish to

11 be heard further?

12 MR. CROOM: If I can just say one thing

13 briefly, so if it's not being offered for the

14 truth of the matter asserted that Dr. Appel

15 has testified that he's relied on it, it

16 seems like the introduction of the actual

17 testimony isn't relevant because it's not

18 like he can go and look at the testimony and

19 say, "Oh, but Mr. Ehrhart said that this is

20 the attachment point" or something like that

21 because then that's being offered for the

22 truth of the matter asserted.

23 I think the only thing that is really

24 required is Dr. Appel said he relied on it;

25 he's already said that he relied on this



12

1 testimony, but do we need to see the

2 testimony if that's what he's relied on? If

3 the testimony is corroborating conversations

4 that he had with Mr. Ehrhart, those

5 conversations would be hearsay as well. So

6 offering the testimony to corroborate other

7 hearsay statements, it's just not relevant.

8 I think, as Ms. Hubbard said earlier, I don't

9 think it's relevant. But if you're going --

10 but we'll leave it in your discretion and

11 just ask that you give it the weight you feel

12 appropriate.


14 We're going to go off the record for a moment

15 while I cogitate further on this matter.

16 (RECESS TAKEN FROM 10:27 A.M. TO 10:48 A.M.)

17 COMMISSIONER GOODWIN: All right. We

18 are back on the record. I don't get to use

19 my legal skills as often as I've used them in

20 the last few weeks, so it's good to have this

21 practice today.

22 First I will say this: Again, this

23 relates to the objection made by the

24 Department on Exhibit RB-41. I want to begin

25 by indicating that counsel for both parties



Page 2213

1 have made compelling arguments relying upon

2 Rules of Evidence and Rules of Civil

3 Procedure, as well as the facts and

4 circumstances pertaining to the Ehrhart

5 testimony from 2011, as well as the testimony

6 from this hearing which has led to this

7 analysis presently.

8 Second, what I must consider is that

9 the testimony involved here with Dr. Appel

10 pertains to an expert witness's testimony and

11 not merely that of a nonexpert. The bases

12 for an expert witness's testimony, noting

13 that it is an expert whose expertise has been

14 stipulated to, involve a different degree of

15 analysis than perhaps the testimony of

16 someone who is not an expert witness in a

17 matter.

18 Third, there have been opportunities

19 for the Department to cross examine Dr. Appel

20 and an upcoming opportunity to provide

21 rebuttal testimony to him. Fourth, the rules

22 of hearsay being what they are, and noting

23 that it is certainly an area of the law that

24 has been discussed quite thoroughly and quite

25 ferociously by many people over the decades,



Page 2214

1 it appears that the Bureau is not offering

2 this exhibit for any other purpose than to

3 indicate what exactly Dr. Appel relied upon

4 and most specifically, relating only to the

5 issue of the reasonableness of Dr. Appel to

6 rely upon it in developing an expert opinion.

7 The Department, so it appears from the

8 arguments of counsel, contend that it has

9 several reasons why reliance by Dr. Appel on

10 that exhibit is not reasonable or -- or and

11 it also appears that the Department contends

12 that this exhibit should be given less than

13 full weight or no weight at all on the issues

14 of reasonableness of Dr. Appel to rely upon

15 that exhibit for his expert testimony.

16 Fifth, I must also keep in mind that

17 other documents from other filings prior to

18 this homeowners' insurance hearing have been

19 available for admission into evidence, and if

20 memory serves, some of those documents have

21 come in or at least been relied upon during

22 the testimony in this current hearing.

23 Sixth, as counsel for the parties know,

24 and I have stated explicitly time and again,

25 I do favor transparency in allowing the



Page 2215

1 parties to make their best cases relying upon

2 as much testimony and evidence as possible.

3 That gives me as the Hearing Officer and any

4 other tribunals that may have the evidence

5 before them, including this transcript and

6 decision, to have a full record to the best

7 of our ability.

8 Finally, it is ultimately up to me as

9 the Hearing Officer to decide what amount of

10 weight to provide, if any, to the exhibit in

11 question. Even if it is allowed in for the

12 limited purposes asserted, similarly, it is

13 ultimately me as the Hearing Officer as well

14 to decide what amount of weight to provide,

15 if any, to the testimony of any witness or

16 any documents before me as the Hearing

17 Officer.

18 Therefore, again, noting that arguments

19 have made very compelling statements on both

20 sides of the question, the objection is

21 overruled in this instance and Exhibit RB-41

22 is allowed in, but not, I repeat, not for any

23 other purpose than the issue of whether

24 Dr. Appel's expert opinion was reasonable or

25 not on the point in question during that time



Page 2216

1 of hearing. The issues of relevance, scope

2 of that exhibit to be used and the

3 reasonableness of that exhibit to be used in

4 this hearing are certainly available if so

5 selected by counsel for discussion during the

6 Department's rebuttal phase, during closing

7 arguments, and in the legal briefs of the

8 parties now and in the future.

9 As the Hearing Officer, I do note

10 specifically as the Hearing Officer that was

11 present during the 2011 hearing, that

12 Mr. Ehrhart is not a sworn witness in this

13 hearing. Three years have passed since his

14 testimony and Ms. Hubbard and the Department

15 did have limited cross examination of

16 Mr. Ehrhart in 2011. Again, that being said,

17 the objection is overruled and Exhibit RB-41

18 is allowed in in the manner in which I have

19 stated. Did counsel for either side wish to

20 comment further on this issue?

21 MR. RAYNOR: No, sir.

22 MS. HUBBARD: No, Mr. Commissioner.

23 COMMISSIONER GOODWIN: All right. Are

24 there any other preliminary matters that we

25 need to cover before we proceed with what I



Page 2217

1 believe will be Mr. Curry's return to the

2 witness stand?

3 MR. STRICKLAND: One, Mr. Commissioner.

4 COMMISSIONER GOODWIN: Okay. What is

5 that?

6 MR. STRICKLAND: Sort of a sub-issue

7 with respect to Mr. Curry was the matter of

8 the confidentiality of a circular that ISO

9 had and was negotiating with the Department

10 and its witnesses as to how it could be used,

11 under what circumstances it's to be used,

12 and, Mr. Hale, I'm certain you will correct

13 me if I'm in error, but it's my understanding

14 that the Department advised ISO that they no

15 longer wish to use the circular, and so

16 whether it was confidential or not was no

17 longer an issue before the Commissioner. Is

18 that your understanding?

19 MR. HALE: I'm not sure I was involved

20 in that.

21 MR. STRICKLAND: I thought you got an

22 e-mail from Ms. VanSise.

23 COMMISSIONER GOODWIN: He did receive

24 an e-mail, but the discussion about whether

25 to use the exhibit or not, that was



Page 2218

1 Ms. Hubbard.

2 MS. HUBBARD: Correct. And I believe

3 when I informed both counsel and the

4 Commissioner and his attorneys on Friday that

5 Mr. Schwartz would not be offering rebuttal

6 testimony, that any confidentiality

7 agreements or issues relating to the ISO

8 document needn't be explored further because

9 we wouldn't be using that document on

10 Ms. O'Neil's rebuttal, so.

11 COMMISSIONER GOODWIN: So is the need--

12 is the need for Mr. Curry just to explain the

13 pagination concerns? Is that -- for this

14 exhibit?

15 MR. STRICKLAND: Yes, sir. We're just

16 talking about the exhibit today, but I wanted

17 to make sure the record was clear because you

18 did ask Mr. Hale to go talk to ISO and we

19 were involved in the communications, and I

20 wanted the record to be clear that issue was

21 now off to the side and not be a problem in

22 this case.

23 COMMISSIONER GOODWIN: That is my

24 understanding, that that issue is no longer

25 on the table and is a nonissue, as far as I'm



Page 2219

1 concerned.

2 MS. HUBBARD: That is correct.

3 MR. STRICKLAND: And, Mr. Curry, if you

4 could -- I believe that's everything. If

5 Mr. Curry could take the stand.


7 Mr. Curry, welcome back.

8 MR. CURRY: Thank you.

9 COMMISSIONER GOODWIN: I'm going to

10 remind you procedurally that you still remain

11 under oath.

12 MR. CURRY: Yes.

13 Whereupon,

14 ROBERT CURRY,

15 having previously been duly sworn, remained under

16 oath, was examined and testified as follows:

17 COMMISSIONER GOODWIN: Counsel may

18 proceed.

19 DIRECT REBUTTAL EXAMINATION

20 BY MR. STRICKLAND:

21 MR. STRICKLAND: May I approach the

22 witness, Mr. Commissioner?

23 COMMISSIONER GOODWIN: You may

24 approach.

25 Q. Mr. Curry, if you recall, there was --



Page 2220

1 you weren't here for it, but there was

2 considerable discussion with respect to the

3 pagination on Exhibit RB-25 as it was offered into

4 evidence as it related to the circular from which

5 it came. And let me hand you a document that was

6 marked Exhibit RB-25 and a document marked Exhibit

7 25A, which has previously been furnished to

8 counsel.

9 (COUNSEL FOR THE RATE BUREAU

10 HANDS COMMISSIONER GOODWIN DOCUMENT.)

11 COMMISSIONER GOODWIN: Thank you, sir.

12 Q. And could you explain for the record

13 the origins of 25 and 25A and the pagination

14 issues on 25?

15 A. Yes, I can. Before I do that, I would

16 like to apologize to the Commissioner, to

17 Ms. Hubbard and whoever else was in the courtroom

18 on Thursday for not being here. I imagine if I

19 was here, maybe not as much time would've needed

20 to be spent on this issue, so I do apologize for

21 not being here.

22 So as far as the two documents go, the

23 original RB-25 document that was -- that I

24 provided as part of my rebuttal last week, this

25 document was actually undergoing changes while I



Page 2221

1 was in transit to North Carolina. You may recall

2 the schedule of when I was going to do my

3 rebuttal. I originally thought my rebuttal was

4 going to be on Thursday. I think things moved

5 along quicker than anticipated, so it was

6 requested that I be on the stand Wednesday

7 afternoon.

8 While I was in transit, I was having

9 discussions with Mr. Strickland about what this

10 exhibit should include, and while we initially

11 started with it just being the three pages from

12 the circular as they appeared in the circular,

13 subsequent discussions with Mr. Strickland, we

14 decided to include a three-year and a four-year

15 fit on the exhibits which were not included in the

16 original circular.

17 So in order to do that, someone in my

18 staff needed to get access to the original data

19 underlying that circular and they inserted lines

20 to show the three- and four-year fits. In the

21 course of doing that, this particular document,

22 again, because of the timeframes, didn't get our

23 usual level of scrutiny and due diligence, so

24 there were some impacts on both the page numbers

25 and some of the graphs where the cell references



Page 2222

1 for the graphs and then the macro for creating the

2 page numbers.

3 What happens sometimes when you copy

4 things from Excel or Word into another version,

5 sometimes the page numbering doesn't -- doesn't

6 copy over correctly. So the data in the tables on

7 all three pages is identical between the original

8 RB-25 that I provided and what was in the

9 circular, the circular that Ms. O'Neil did

10 receive.

11 The differences I'll outline just so we

12 have it. The differences between what was

13 originally in RB-25 and now the amended version,

14 there are no changes on the first page, page

15 number 174. The graph there is fine. All the --

16 as I said, all the data on page 174 is fine. On

17 the page now numbered 175, which initially was

18 also numbered 174 but is the page showing severity

19 and frequency, again, all the numbers in the

20 tables are correct. The two bar charts on the far

21 right wound up pointing to incorrect data when the

22 three- and four-year fits were put in. In the

23 original document for where the severity -- the

24 top part of the exhibit, when the additional fits

25 for three- and four-year were put in, the actual



Page 2223

1 cell reference for the chart for year ended

2 6/30/2013 points -- was actually pointing to a

3 blank line, so that's why that particular chart

4 you'll notice in the original only has a yellow

5 bar. There was is no -- there is no greenish bar.

6 The new version is showing the green bar and it is

7 pointing to the five-year -- the five-year fit.

8 For the frequency, the frequency was

9 the situation we actually -- I think we actually

10 -- was that the one we got -- okay, now, that one

11 also -- that one was pointing to one of the fits.

12 It was pointing to the four-year fit. So the bar

13 showed up in the original document but rather than

14 showing the five-year fits, it was showing the

15 four-year fits.

16 Then finally on the last page with the

17 pure premium data, again, the pure premium data in

18 the tables was correct. There was nothing wrong

19 with the data. The chart for the pure premium, we

20 got lucky there. Even though the lines were

21 inserted, it was pointing to the 5-year fits so

22 that the graph is actually -- was correct in the

23 original for the pure premium, and so that really

24 is not a change in the top part of the page. The

25 graph and the bar chart on the bottom of the page



Page 2224

1 which is now numbered 176, there were -- there

2 were more involved cell reference problems there,

3 but it's the same basic story that there were

4 incorrect references, so all of the -- all of the

5 points there in the original -- you know, the

6 current points for the purple bars there and some

7 of the yellow bars were not correct, but they've

8 all been corrected in what we just provided as the

9 amended version of RB-25.

10 Q. Mr. Curry, just so I'm clear, is it

11 correct that rather than copying the page out of

12 the circular and typing in the annual changes for

13 the three- and four-year fits, that you downloaded

14 the data to an Excel file, and that's where all

15 the problems started?

16 A. Yes. Someone on my staff was working

17 with it in Excel and by adding in -- adding in

18 some lines here or there and not recognizing that

19 the graphs were referencing particular points,

20 missed that, the fact that that moved things

21 around.

22 Q. And is that correct that there was no

23 update to the circular in question?

24 A. That's correct. This circular was --

25 the ASHO 2014 010 circular was issued initially,



Page 2225

1 and there has been no update to that circular.

2 MR. STRICKLAND: Mr. Commissioner, I'm

3 Not certain we were on or off the record, but

4 we would offer into evidence Exhibit RB-25A.

5 COMMISSIONER GOODWIN: Okay. First,

6 does Ms. Hubbard wish to ask Mr. Curry

7 questions on this matter?

8 MS. HUBBARD: I don't believe so at

9 this time, Mr. Commissioner.

10 COMMISSIONER GOODWIN: Any objections

11 to Exhibit 25A?

12 MS. HUBBARD: No.


14 MR. STRICKLAND: I have no further

15 questions of Mr. Curry.

16 COMMISSIONER GOODWIN: All right. I

17 believe, Mr. Curry, you may step down.

18 THE WITNESS: Thank you.

19 MR. SPIVEY: Mr. Commissioner, I think

20 at this point, again, just out of an

21 abundance of caution, I just want to make

22 sure all of the Rate Bureau exhibits that we

23 believe have been offered and admitted are,

24 in fact, in. Unfortunately, I don't know

25 that I have a complete set in my mind, but



Page 2226

1 it's RB-1 through 17 are in the filing.

2 Those have been admitted, I believe. I will

3 include those in my offer now as well. Then

4 RB-18 through, as I understand it, 41 -- I

5 believe we have no numbers beyond that. And

6 I believe it's the case that RB-35 that we

7 did not use. And I think Ms. Ford, she's

8 got a better list than I do right now.

9 So, again, 18 through 41, including now

10 25A and 31A, but excluding RB-35, we would,

11 again, offer those into evidence. As I

12 recall, there were certain objections or

13 objections to certain exhibits which you

14 ruled on last week, but I believe all of

15 those are appropriate to be admitted into the

16 record, and I offer them once again just,

17 again, out of an abundance of caution.

18 COMMISSIONER GOODWIN: Ms. Hubbard, is

19 that a fair summary of the -- as you know it

20 regarding the exhibits offered by the Bureau?

21 MS. HUBBARD: That is my recollection

22 as to what was offered, and Mr. Spivey is

23 correct that we had a lengthy discussion on

24 certain objections I made previously, and

25 those have already been resolved, so.



Page 2227


2 Based upon Ms. Hubbard's response and based

3 upon the assertion that there are no more

4 exhibits requiring a ruling by me that were

5 objected to -- let me back up.

6 Based upon Ms. Hubbard's response and

7 the fact that it appears that all objections

8 to certain exhibits have been ruled upon

9 either today or prior to today, the following

10 exhibits are allowed into evidence, 1 through

11 17, 18 through 41, plus 25A plus 31A, but

12 excluding Exhibit 35, which was not used.

13 Any response or objections to that?

14 MS. HUBBARD: No, Mr. Commissioner.

15 COMMISSIONER GOODWIN: They remain in

16 and have been received.

17 (EXHIBITS RB-1 THROUGH RB-41,

18 EXCLUDING RB-35, RECEIVED INTO EVIDENCE.)

19 (EXHIBITS RB-25A AND RB-31A

20 RECEIVED INTO EVIDENCE.)

21 MR. SPIVEY: That's correct. Thank

22 you, Commissioner. With that, the Rate

23 Bureau rests its rebuttal case.

24 MR. STRICKLAND: And off the record.

25 COMMISSIONER GOODWIN: Off the record.



Page 2228

1 (DISCUSSION OFF THE RECORD FROM

2 11:06 A.M. TO 11:06 A.M.)

3 COMMISSIONER GOODWIN: We are now back

4 on the record. Ms. Hubbard, I believe we're

5 at that point in the testimony where you may

6 wish to present rebuttal.

7 MS. HUBBARD: Yes. We would like to

8 have Mary Lou O'Neil take the witness stand

9 again.

10 COMMISSIONER GOODWIN: Ms. O'Neil, if

11 you will approach the witness stand. Welcome

12 back. And as I've reminded all witnesses

13 that have been sworn, I'm reminding you that

14 you remain under oath.

15 Whereupon,

16 MARY LOU O'NEIL,

17 having previously been duly sworn, remained under

18 oath, was examined and testified as follows:

19 COMMISSIONER GOODWIN: Ms. Hubbard, you

20 may proceed.

21 MS. HUBBARD: Ms. O'Neil, if you'll let

22 me know when you are ready.

23 THE WITNESS: All right. I believe I

24 am set up as much as can be.




Page 2229

1 DIRECT REBUTTAL EXAMINATION

2 BY MS. HUBBARD:

3 Q. Ms. O'Neil, you were here in person, I

4 believe, for the rebuttal testimony of all the

5 Rate Bureau witnesses; is that correct?

6 A. That's correct.

7 Q. Okay. Now, with regards to Mr. Curry,

8 did you hear Mr. Curry state or indicate on

9 rebuttal that you used Fast Track trend to

10 determine your LTA factor?

11 A. Yes. I believe he did say that.

12 That's correct.

13 Q. Okay. And do you agree with that

14 statement?

15 A. No, I do not. I used Fast Track trend

16 as described in my prefiled testimony where it was

17 something that I looked at to support my findings

18 which were based on the data for the MCPI, the

19 external indices, and the internal data that were

20 provided by the Rate Bureau for five historical

21 data points. I critiqued the data that were

22 provided for internal trend data. Nevertheless,

23 based on that data, I concluded that there was the

24 possibility of a turning point in the direction of

25 the trend. And on those factors, I made my



Page 2230

1 selection of a zero percent LTA, and then I looked

2 at Fast Track data to confirm that decision or

3 selection.

4 Q. Okay. And you referenced your prefiled

5 testimony. Would that be page 22?

6 A. I believe it is. I could just take a

7 look. Yes, it's page 22, which shows the table

8 wherein I made calculations related to the

9 internal trend data presented by the Rate Bureau.

10 Q. Okay. And I believe you indicated that

11 you found there to be problems with the internal

12 trend data; is that correct?

13 A. Yes. I describe those issues in my

14 prefiled testimony when I state that a five-year

15 history was inadequate and five data points

16 resulting from that was inadequate to form a

17 statistically reliable projection for trend

18 values. And I noticed that, indeed, the rate of

19 increase and these indications was declining. And

20 I believe from that information, as inadequate as

21 it was, that there was the possibility of a

22 turning point towards lesser trend values or

23 declining trend values based on this information.

24 Q. Okay. And so you utilized Fast Track

25 not as -- not to rely on the data that was



Page 2231

1 included in Fast Track, but to note that it

2 supported the testimony that you had already put

3 together from the internal trend data; is that

4 correct?

5 A. That's correct. That is shown on page

6 23 where I discuss -- let me just see if it's 23.

7 Yes, it is 23, I believe, where I discuss the Fast

8 Track trend and the problems related to Fast Track

9 trends and its consistency. Those issues were

10 reiterated by Mr. Curry. Nonetheless, I observed

11 that those data supported my selections that I had

12 made based on the other data for internal trend in

13 the MCPI.

14 Q. Okay. And would using Fast Track data

15 just as a means of support be unusual for an

16 actuary?

17 A. I don't know about that. I personally

18 believe that the Fast Track data have too many

19 deficiencies to rely on in and of themselves. If,

20 indeed, that were the only data source that were

21 available, that would be something then that would

22 need to be considered further. But in this case,

23 we do have other information from external sources

24 and from internal sources. As inadequate as it

25 may be, we do have that other information.



Page 2232

1 Q. Okay. Now, do you recall Mr. Curry

2 saying that three data points and four data points

3 are statistically too few to estimate trend, yet

4 somehow five data points are adequate?

5 A. Yes. I do believe he mentioned that.

6 I'm not sure in the context. I believe the

7 context was related to the additional data from

8 the circular that Mr. Curry presented. I was

9 surprised to find that the additional data point

10 would make that much of a difference. And I did

11 note that if you look at -- I believe it's RB-24

12 which has the Fast Track data on it, that there

13 are four-point trend indications on those pages.

14 And in that case, those are four quarterly

15 data points, so that's a very, very short

16 inadequate period to look at, I believe. But

17 certainly five data points are not much better.

18 Q. So is it correct that you do not see

19 any significant distinction between four and five

20 data points?

21 A. From a statistical viewpoint, I do not

22 see that much of a distinction particularly in the

23 case that we are looking at five data points of

24 internal trend data for a five-year history. So

25 we're going back to 2007 through 2011, and that



Page 2233

1 time period also had other issues with it

2 regarding the financial and economic crisis that

3 we were in at that time. So that aside of the

4 issue of five data points, these are also five

5 data points from an older period of time.

6 Q. Okay. Now, moving to Mr. Newbold,

7 Ms. O'Neil, did you hear Mr. Newbold make comments

8 on rebuttal on the CCM course offered by AIR?

9 A. Yes.

10 Q. Okay. And I believe in your CV, or at

11 least in your testimony, you have taken that

12 course; is that correct?


14 Q. Okay. And what kind of details did you

15 study at the CCM course?

16 A. The CCM course was a five-day course.

17 It's very broad. It's -- the presenters provide

18 information related to all aspects of the AIR

19 Worldwide models. Those models apply to all types

20 of catastrophes, hurricanes, earthquakes. In some

21 areas they call them typhoons. And it's a

22 worldwide type of model. So it's not just

23 hurricanes, not just hurricanes from the Atlantic

24 basin. It's -- and so that said, the course then

25 focuses on the building blocks to evaluate the



Page 2234

1 results for all of those types of catastrophes.

2 The presentation focused on generating

3 frequencies. It focused on generating damage

4 functions. The presenters for those were --

5 different aspects of the model -- were scientists

6 related to predictions for weather, scientists

7 related to geological issues regarding predictions

8 of earthquake frequency. There were engineers

9 that spoke about damage functions and the creation

10 of damage functions. So over the five days,

11 various aspects of building the model were

12 presented by a number of scientists and engineers

13 that specialized in each of those areas.

14 Q. Okay. And was the course held at AIR's

15 offices in Boston?

16 A. Yes, it was.

17 Q. Okay. Did you have an opportunity to

18 actually view the model in the offices?

19 A. Actually, details of the specific

20 distributions that underlie the model for

21 frequency or severity were not presented.

22 Nevertheless, what was presented was how those

23 were -- not exactly how they were determined, but

24 how they were parameterized in terms of

25 retrospective fits from a statistical point of



Page 2235

1 view.

2 And in terms of the operation of the

3 model, we were presented with the ability to enter

4 hypothetical data into the model, view what

5 possible assumptions could be changed and what

6 that might that do to the model. It wasn't state

7 specific, so it certainly wouldn't have focused on

8 North Carolina or any other particular

9 geographical area.

10 So we did have a little hands-on

11 practice with being an end user of the model.

12 Most of the course, though, was teaching in terms

13 of the underlying forces that would help the

14 modelers to determine what the appropriate

15 parameters and what the appropriate statistical

16 distributions were to underlie the model.

17 Q. Do you by chance know who the other

18 attendees were at the class that you took?

19 A. I do. It was a very small class. I

20 don't have their names with me now, but I know

21 there were attendees from reinsurers from Bermuda.

22 There was an attendee from Germany. So there were

23 attendees literally worldwide and all with

24 different reasons for attending the course to

25 enhance their work experience or abilities to



Page 2236

1 contribute to their employer.

2 Q. Okay. And did you hear Mr. Newbold say

3 that you did not complete your certification, the

4 certification process?

5 A. That's correct. The certification

6 process to actually use the initial CCM requires a

7 written test which includes two parts. One part

8 is a multiple choice part related to the class

9 teachings itself. The other part would be a short

10 essay part related to attendance at a AIR

11 Worldwide seminar. And that's -- the cost of that

12 seminar, excluding travel, was included in the

13 course registration fee. So that -- in order to

14 complete that, I would need to attend the seminar

15 which actually is offered in the United States

16 once a year and some other country the other time

17 in the year.

18 So that being said, I got very busy

19 with work right after the seminar and did not

20 attend the immediately-following out of the

21 country -- or actually in the country seminar in

22 May, and I didn't attend the one in the fall. So

23 having been as busy as I was, and given the

24 breadth of the course, I have not returned yet to

25 take that examination. I expect I should be able



Page 2237

1 to do so in the near-term.

2 Q. Okay. Now, is it correct that

3 Mr. Newbold said that you stated you could create

4 damage functions as a result of the CCM training;

5 is that correct?

6 A. I believe there was possibly some

7 misinterpretation in my cross examination

8 regarding that. I think when I was asked about

9 damage functions, I was -- I responded that I had

10 been to the course, but I did not intend to convey

11 the idea that I, myself, could create a damage

12 function.

13 At that time, damage functions were

14 being brought up as to why I would have either

15 made a comment about it or what did I know about

16 it. And from the class, I'm aware that the damage

17 functions are created by sophisticated engineers

18 and scientists, and I am capable of reviewing how

19 that might apply in a particular area. I have a

20 better understanding. And so I was looking in

21 this case to see how the model would be

22 specifically applicable here in North Carolina in

23 that aspect. So, no, I did not intend to convey

24 any ideas that I, myself, might create a damage

25 function.



Page 2238

1 Q. And did you recommend any changes to

2 the damage function found in the filing in this

3 case?

4 A. No, I did not. I merely was

5 questioning or verifying how the models -- damage

6 functions that fit the overall model would fit in

7 North Carolina just to verify that those things

8 are consistent.

9 Q. Okay. Now, did Mr. Newbold emphasize

10 that model is based on 110 years of history and

11 100,000 years of simulations, and that it is

12 therefore stable and not biased?

13 A. Yes, I believe he did say that.

14 Q. Is it clear how Mr. Newbold defines

15 stability?

16 A. I'm not sure I'm a hundred percent

17 clear, but I believe he was defining it in the

18 sense that at least at this point in time the

19 model is not changing significantly year to year.

20 Early on, the model did have significant changes

21 or updates. I believe it's -- it seems that the

22 model has settled down so that there are not as

23 many significant updates. So I believe that's

24 what he's referring to, is that, you know, the

25 numbers are somewhat more stable than they had



Page 2239

1 been previously.

2 Q. Okay. And do you know what his measure

3 of bias might have been?

4 A. I believe there was some retrospective

5 measure in terms of fits to actual historical

6 data, and that these fits were not in one

7 direction solely or another direction solely. For

8 example, they did not overstate frequency on a

9 consistent basis or understate frequency on a

10 consistent basis. There may have been some

11 differences, but they kind of averaged out so that

12 there didn't appear to be any bias in one

13 direction or another.

14 Q. Okay. Do you believe the model

15 reasonably replicates the available history?

16 A. The model does reasonably replicate the

17 available history overall. However, it does not

18 totally replicate the history in North Carolina.

19 I did point out some differences by Saffir-Simpson

20 category where there were some understatements for

21 some categories, overstatements for others. So

22 once again, my questions were -- arose based on

23 how does the model fit for North Carolina,

24 specifically compared to its overall efficacy in

25 general.



Page 2240

1 Q. Okay. Do you believe that the

2 available history of 110 years is sufficient for

3 modeling purposes?

4 A. Well, indeed, the only database that is

5 available is 110 years. Nevertheless, in

6 geological time, that's very brief. And we do

7 know that of that 110 years, the early part of

8 that history is somewhat incomplete. The early

9 period in that history, many of the storms were

10 reported by ships, you know, that would observe

11 the storm. They're not very good measures of wind

12 speeds and central pressures and things of that

13 nature, so that the earlier history is not as good

14 as the more recent history. We have better

15 measurements. So that's the best there is, but,

16 you know, obviously any modeler would want more

17 data. If we had a thousand years of actual data,

18 or 10,000 years of actual data, we would probably

19 have a better result.

20 Q. Now, did you hear Mr. Newbold express

21 uncertainty regarding the Guy Carpenter

22 application and the licensed AIR model?

23 A. Yes. We looked at that, the results

24 for the Beach Plan wherein Guy Carpenter presented

25 results of the model generated by AIR and another



Page 2241

1 modeling firm, RMS. Regarding the AIR results for

2 the Beach Plan, Mr. Newbold stated that actually

3 that Guy Carpenter licenses the model and

4 therefore he was not sure how they might have used

5 it or how they might have generated the results

6 shown on those exhibits.

7 Q. Okay. Do you consider Guy Carpenter to

8 be a reliable major reinsurance intermediary --

9 reinsurance intermediary?

10 A. Yes. Guy Carpenter, I believe, is one

11 of the primary reinsurance intermediaries. They

12 have been in business for quite some time. I

13 believe their intention -- in fact, not only

14 intention, but they have been intermediaries in a

15 number of situations between primary carriers and

16 reinsurers, so both parties need to be able to

17 rely on the information which they provide in

18 negotiating a reinsurance contract. You know, if

19 that service was not adequate, they would not be

20 in business for the length of time that they have

21 been in business. Therefore, I believe that both

22 parties rely on them to reduce the best estimates

23 possible for the basis of the negotiations of the

24 reinsurance contracts, the terms and the pricing.

25 Q. Okay. Now, you indicated that Guy



Page 2242

1 Carpenter reviewed for the Beach Plan both the RMS

2 and the AIR model; is that correct?

3 A. Yes. Guy Carpenter assembled a package

4 of results from both the AIR model and the RMS

5 model in preparation for renewal of the Beach

6 Plan's reinsurance program.

7 Q. Okay. And can you explain to us what

8 blending is?

9 A. Yes. I referenced in my prefiled

10 testimony that Guy Carpenter, for one -- I'm sure

11 there are others, but this was one example I used

12 -- Guy Carpenter released -- I believe it's an

13 issue paper talking about model variability. And

14 regardless of how well the models today replicate

15 prior history, they all have -- still have model

16 uncertainty. Guy Carpenter presented a range of

17 that uncertainty and they have found, and I

18 believe that's verified by statisticians, that

19 when blending models in some way, that reduces the

20 uncertainty. Blending might be just a simple

21 average or some other fashion of blending the

22 results of two models. But, nonetheless, the

23 overall uncertainty in the results is reduced by

24 blending.

25 Q. Is that what your understanding is of



Page 2243

1 what Guy Carpenter did with the RMS and the AIR

2 model for the Beach Plan?

3 A. Yes. They show the two model results

4 separately, and I believe they might have averaged

5 those. I'm not sure if they actually showed the

6 average, but that could easily be accomplished.

7 They may not have actually shown that, that there

8 were two separate reports with the AIR results and

9 the RMS results, but that would be my reading of

10 having them have prepared both of those sets of

11 exhibits in the same identical format, so that it

12 would be possible to blend those results to reduce

13 the uncertainty in the estimates.

14 Q. Okay. Can we hand you --

15 MS. HUBBARD: Can we approach,

16 Mr. Commissioner?


18 approach.

19 Q. -- hand you a copy of -- well, actually

20 RB-21 which are the Guy Carpenter runs that were

21 introduced on rebuttal?

22 MS. FORD: RB-21. You have that.

23 Q. Do you have that, Ms. O'Neil?

24 A. Yes.

25 Q. Okay. In looking at RB-21, did you use



Page 2244

1 these data for any part of your analysis of the

2 hurricane model results?

3 A. Yes, these are the two parts of the Guy

4 Carpenter presentation. The first -- as this is

5 put together, the first part relates to -- the

6 first five -- pages numbers 1 through 5 relate to

7 the AIR results, and the latter portion numbered 1

8 to 5 relate to the RMS model results. And if you

9 note, each page has identical format. And at the

10 bottom of the page, there's an exposure summary to

11 show that both modelers were using the same

12 exposures in the premium policy count and so on so

13 that, indeed, the models results could be

14 compared, combined or whatever the user would find

15 relevant.

16 Q. Okay. And how did you use the results

17 from that -- the data from that exhibit?

18 A. Well, as I explained in my prefiled

19 testimony, I went to page 4 in each of these

20 exhibits and utilized the second from the right

21 column and the bottom half of the page marked

22 "Personal" and looked at the average annual loss,

23 which for AIR is 247,414,769. And I looked at the

24 average annual loss for RMS of the corresponding

25 page, again, at the second column marked



Page 2245

1 "Personal" in the second block of numbers, and the

2 average annual loss there was 141,048,309.

3 I averaged these average annual loss

4 values and took a ratio to the average to see what

5 the difference between the average in the AIR

6 model was because these results are fairly

7 disparate, and found that AIR was 27.4 percent

8 higher than average.

9 Q. Okay. And I believe you reference your

10 prefiled testimony. Would that be pages 85 and

11 86?

12 MR. SPIVEY: I'm sorry. What were the

13 page numbers?

14 MS. HUBBARD: 85 and 86.

15 Q. Is that correct?

16 A. I'm looking. Yes. The table on page

17 85 displays the numbers I just read for AIR and

18 RMS and shows the relativity of each of those

19 results to the average. And then page 86, I go on

20 to mention that, you know, AIR is 27.4 percent

21 higher than the average. And so the application

22 of these two individual results might be to

23 average them, one way to blend them, to estimate

24 hurricane losses.

25 Q. Okay. Now, did you hear Mr. Newbold



Page 2246

1 state that the average difference between the AIR

2 results and the RMS models for the Beach Plan

3 could not be extrapolated in the manner that you

4 just discussed?

5 A. Yes. Mr. Newbold pointed out that page

6 4 in these respective exhibits -- let me just see

7 where that label is. Right. Page 4 in these

8 respective exhibits, if you see footnote 1, states

9 that these are the WSST modeled results.

10 Mr. Newbold believed that it wasn't appropriate to

11 utilize the combination of WSST model results in

12 the way I did to modify the STD results in the

13 filing from the standard model.

14 Q. Okay. And do you believe that's

15 correct?

16 A. Actually, no, I don't. I'm looking

17 through these exhibits, and what I find, Mr. -- I

18 believe Mr. Newbold suggested that I use page 1,

19 if anything. But I'm not sure if I recall

20 correctly now. Let me just look. Yes. I believe

21 he suggested I use the box values actually on

22 RB-21 which fall on page 1 for the AIR standard

23 view.

24 I have not recalculated it, but my

25 recollection is that the difference using page 1



Page 2247

1 would be something like 14.5 percent. However,

2 the problem with using page 1 as Mr. Newbold

3 suggests is that page 1 is for the IUA and JUA

4 combined. Page 1 is also for commercial and

5 personal risk combined. All right. So we don't

6 know, therefore, why the difference on this page

7 is different than the difference on the page 4

8 that I used. Is it because it's the Standard

9 model versus the WSST, or is it because there's a

10 different underlying database of both plans and

11 personal and commercial combined?

12 So we look through other pages to see

13 if they're of any help, and we see that page 2 is

14 also for the two pools combined. There is some

15 separation for personal and commercial, but once

16 again, this is, as you see in the footnote, a WSST

17 view. And we look on page 3. That is for the

18 FAIR plan which is not relevant at all to our case

19 here.

20 Then we come to page 4 which I used.

21 Then we come to page 5 which is just notes. So we

22 do not have an appropriate other place in this

23 document to actually look. The page I used was

24 the only place where you could see results for

25 just the Beach Plan and you could also isolate



Page 2248

1 personal from commercial.

2 Q. Okay. Now, you indicated that your

3 calculations yield an indicated difference value

4 of 27.4 percent between the AIR and the RMS

5 models; is that correct?


7 Q. And does that somehow -- that average

8 between the AIR and the RMS models somehow inform

9 the reduction you made in your prefiled testimony

10 to the AIR modeled results?

11 A. Yes, it does. I'll go back to my

12 prefiled testimony where -- I believe it's page 86

13 -- where I show that the implied overstatement

14 from this methodology was 27.4 percent. In

15 addition, I recommended removing demand surge that

16 was worth 5.7 percent. The combination of these

17 two values resulted in a possible reduction in the

18 results of 35 percent. I did not select 35

19 percent. I decided to be conservative and select

20 25 percent for the reduction or adjustment to the

21 AIR results for this case.

22 That said, assuming that the 5.7

23 percent stands, which it does, that would imply

24 that I actually only reduced the AIR model results

25 by 18 percent, which is pretty close to



Page 2249

1 Mr. Newbold's 14 percent that he obtained from

2 using page 1 of the Beach Plan results. So that's

3 basically my analysis on page 86.

4 Q. Okay. And did you just indicate that

5 in coming up to your 25 percent reduction, that

6 you considered the full removal of demand surge of

7 5.7 percent?

8 A. Yes, I did.

9 Q. Okay. Now, did you hear Mr. Newbold's

10 testimony on demand surge?

11 A. Yes.

12 Q. Okay. Did you find that relevant to

13 North Carolina?

14 A. I continue to -- I did hear what

15 Mr. Newbold said. However, I continue to believe

16 that the legislature in North Carolina who enacted

17 that statute did so with knowledge of supply and

18 demand and the effects of emergencies on supply

19 and demand. And even the 45-day time period which

20 has been questioned in this case, I believe the

21 legislature recognized that after that point,

22 supply and demand, if it is abnormal, would return

23 to normal levels by that point in time.

24 So I have to believe that the

25 legislature understood the problem and applied an



Page 2250

1 appropriate remedy and therefore rate payers in

2 the state should now have to pay for that

3 additional element in the rates.

4 Q. Okay. And you're -- you were

5 discussing the North Carolina statute that

6 prohibits increasing prices following disasters;

7 is that what you're referring to?

8 A. Yes.

9 Q. And so are you saying, then, that

10 Mr. Newbold's discussion of the demand surge you

11 don't find to be relevant to North Carolina

12 because of that statute? Is that what you're

13 trying to say?

14 A. Well, I believe that Mr. Newbold

15 addressed calculation of the demand surge values

16 were based on other states from the observation of

17 distortions in supply/demand and pricing and maybe

18 labor costs in other states following disasters.

19 Nonetheless, we don't have any specific data in

20 North Carolina that would support the 5.7 percent

21 being applied in this model.

22 Q. Okay.

23 MS. HUBBARD: May we approach,





Page 2251

1 approach.

2 Q. Ms. O'Neil, we're going to hand you up

3 a chart that Dr. Appel produced marked RB-36. Do

4 you have that?

5 A. Yes, I do.

6 Q. Okay. Does that --

7 MR. SPIVEY: What --

8 MS. HUBBARD: RB-36. Have I got a

9 wrong number?

10 MR. SPIVEY: Just a second. Thank you.

11 Q. Okay. Now, Ms. O'Neil, is that a chart

12 showing hypothetical hurricane frequency skewed

13 distributions?

14 A. Yes. That's the title. It says,

15 "Illustrations of Characteristics of Statistical

16 Distribution, Skewed Distribution Frequency by

17 Hurricane Category."

18 Q. Okay. And can you tell us what a

19 skewed distribution is?

20 A. A skewed distribution would look a lot

21 like the one shown here. It would have very high

22 numbers at one end and very low at the other so

23 that it kind of forms a parabola going to the

24 right.

25 Q. And do you believe that that Exhibit



Page 2252

1 RB-36 is relevant to the hurricane frequency

2 distribution that has been produced in this -- for

3 the model in this case?

4 A. I believe that presenting this exhibit

5 with the example of hurricane frequency could be

6 quite misleading is this case because there are

7 many exhibits provided by AIR that address the

8 actual hurricane frequency and modeled hurricane

9 frequency, and someone looking at this chart might

10 just happen to bypass the idea of illustration of

11 characteristics of statistical distributions. Any

12 item could have been used. Frequency of anything

13 other than hurricanes would have been much more

14 appropriate to utilize in this case for an

15 illustration of a statistical concept.

16 Q. And do you believe that exhibit to have

17 any relevance at all to the filing in general?

18 A. No. This is a presentation of

19 hypothetical data and, therefore, is irrelevant

20 for the filing as we have it.

21 Q. Okay. And just to be clear,

22 Ms. O'Neil, do you have any background in

23 statistics?

24 A. Yes, I do have a master's degree in

25 statistics.



Page 2253

1 Q. Okay. Now, moving to the discussion on

2 the net cost of reinsurance, can you tell us what

3 the net cost of reinsurance is?

4 A. The net cost of reinsurance is meant to

5 reflect the transaction cost of the reinsurer

6 expenses and profit.

7 Q. Okay. So mathematically, the net cost

8 of reinsurance for the primary insurer in

9 simplified form would be reinsurance premium less

10 the expected reinsurance recoveries?

11 A. Yes. That's -- that's one way to look

12 at it. Or you can say to yourself that premium

13 equals loss cost expense for the reinsurer. And

14 so the equation you just mentioned was just

15 rearranging that to say premium minus loss equals

16 the reinsurance transaction costs, which can be

17 looked at in -- as a whole or in two pieces, the

18 expenses and the cost of capital.

19 Q. Okay. Now, is the net cost of

20 reinsurance value readily available?

21 A. No, it is not. The reinsurer would

22 have its own worksheets wherein it agreed to a

23 price that was negotiated for the reinsurance

24 coverage to be afforded to the primary company.

25 The primary company would know the premium and the



Page 2254

1 loss. It may know its expected loss values, but

2 it would not know what provision the reinsurer

3 actually put in for expected losses, nor would it

4 know the amounts the reinsurer estimated for

5 expenses and how much the reinsurer loaded for

6 profits.

7 Q. So in order for a primary insurer to

8 include the net cost of reinsurance in a proposed

9 rate, what would that company have to do?

10 A. The company knows its premium and they

11 know their reinsurance program, of course, since

12 they purchased it. And they would have to make

13 some sort of estimate of the expected ceded

14 losses.

15 Q. Okay.

16 MS. HUBBARD: Mr. Commissioner,

17 can we approach?


19 approach.

20 Q. RB-32. Ms. O'Neil, Ms. Ford has a --

21 or I guess the exhibit the Rate Bureau introduced

22 as RB-32; is that correct?

23 A. Yes.

24 Q. And is that the paper that Dr. Appel

25 presented entitled "Using a Simulation Model to



Page 2255

1 Incorporate the Cost of Catastrophe Excess

2 Reinsurance into the Property Rate Level

3 Indication Using the Net Cost of Reinsurance

4 Method; or How I learned to Stop Worrying and Love

5 the Net Cost of Reinsurance Method"? Is that the

6 title of that paper?

7 A. Yes. That is the title of that paper.

8 I'll note that it's by Eric Huls, H-U-L-S, who is

9 a fellow at the Casualty Actuarial Society.

10 Q. Okay. And where was that paper

11 published?

12 A. This paper says, I guess, on the bottom

13 of some of the pages -- let me see. I believe

14 starting on the second page here, it shows at the

15 bottom that this was published by the Casualty

16 Actuarial Society Forum in the fall of 2005.

17 Q. Okay. And can you tell us what the

18 Casualty Actuarial Society Forum is?

19 A. Historically, the Casualty Actuarial

20 Society had one publication which was called the

21 "CAS Proceedings." That's a refereed journal

22 where people submitted papers that went --

23 underwent extensive review. Oftentimes, it took

24 several years to get a paper published in the

25 proceedings.



Page 2256

1 So I forgot what year it was, but there

2 was a desire to have to papers be more readily

3 available, ideas be more readily circulated, so

4 the CAS decided to create the publication called

5 "The Forum" which was someplace where authors

6 could submit papers that did not go -- undergo an

7 extensive review of peer review. They could

8 easily and quickly be published in these

9 publications.

10 Q. Okay. So is the forum -- did you say

11 it was a nonrefereed publication of the CAS?

12 A. Correct. I mean, there may have been

13 some paper reviewers, but, if so, it was very

14 modest, and the scrutiny for the papers was very

15 modest, if any.

16 Q. Okay. And if an author had a paper

17 published in The Forum, should it be assumed that

18 it represented accepted methods or standards by

19 fellow actuaries?

20 A. No. These papers were generally

21 presented in order to promulgate ideas on current

22 issues, or sometimes just an idea that someone

23 wanted to put forth because it was something they

24 were working on. So it was not meant to be

25 something specific that anyone should use. They



Page 2257

1 may decide to adopt what is in a paper, but it's

2 not meant to be anything that is a method that

3 must be used or standard or anything like that.

4 Q. Okay. But you did, in fact, provide

5 the name of this paper as a reference regarding

6 recent literature on reinsurance that you

7 mentioned at page 90 of your prefiled; is that

8 correct?

9 A. Correct. When I was reviewing the net

10 cost of reinsurance for this -- examining this

11 filing, I first went back to see what literature

12 was available on the subject. And at page 90, I

13 note that historically there had not been any

14 provision in rates for the net cost of reinsurance

15 and now there is a provision. And I wanted to see

16 when the change came about or why the change came

17 about and what anyone else had to say about that

18 issue.

19 So I did some research, and this is one

20 of the papers which I found. And this paper does

21 discuss the history of the net cost of reinsurance

22 where it was not initially or for many years

23 included as an explicit factor in the rates and it

24 now is and should be, according to this author,

25 included as an explicit factor in the rates.



Page 2258

1 MS. HUBBARD: May we approach again,

2 Mr. Commissioner?


4 approach.

5 A. I might add that there were other

6 papers, of course. This was one example.

7 Q. Okay. Ms. O'Neil, we are handing you

8 an exhibit marked DOI-13. Now, did you prepare

9 this exhibit?

10 A. Yes.

11 Q. And can you tell us what this exhibit

12 purports to describe?

13 A. This exhibit consists of three pages.

14 It's mostly talking points. I wouldn't really

15 have had to present an exhibit. The idea was to

16 present talking points related to -- first on page

17 1 to what the Huls paper actually states in terms

18 of methodologies. And then the next two pages

19 were an attempt to compare what the Rate Bureau

20 methodology is in comparison to the paper. And

21 the reason for that comparison was because

22 Dr. Appel said that his model within the filing

23 exactly replicates the model proposed in this

24 paper.

25 Q. Okay. Did Dr. Appel actually state



Page 2259

1 that he used this paper as the basis for his model

2 which calculates the net cost of reinsurance in

3 the filing?

4 A. I don't recall his exact words. I do

5 recall him saying something about that the

6 methodology he has included in this rate filing is

7 exactly what was proposed or presented in this

8 paper. I know -- I recall the word "exact," but

9 I'm not exactly sure of the words around it, so

10 we'd have to look at the transcript for that.

11 Q. Now, did the Huls paper actually

12 include the method that the Rate Bureau used to

13 calculate the net cost of reinsurance in the

14 filing?

15 A. I would say that it -- the Huls paper

16 included the Rate Bureau methodology in part.

17 Q. Okay. Does the paper suggest that an

18 explicit net cost of reinsurance be used in rate

19 calculations?

20 A. Yes. The paper does recommend using an

21 explicit value for the net cost of reinsurance in

22 the rate filings because of the large increases in

23 the net cost of reinsurance for companies over

24 time.

25 Q. Okay. And you indicated that the



Page 2260

1 author in that paper presents a brief overview of

2 prior practice where the net cost of reinsurance

3 was included implicitly in the rate as a part of

4 profit or perhaps was ignored all together?

5 A. Yes.

6 Q. Okay. And is that one of the reasons

7 why you reference this in your testimony?

8 A. Well, actually, my initial research

9 which led me to this paper was for history aspects

10 of it. It was an additional bonus to see a

11 proposal as to how the net cost of reinsurance

12 might actually be calculated. Some of the other

13 papers that I looked at were not so explicit in

14 presenting possible ways to calculate the net cost

15 of reinsurance.

16 Q. And does this paper conclude that the

17 net cost of reinsurance should be included in the

18 rate?

19 A. Yes.

20 Q. And does the paper suggest in any

21 particular way that the net cost of reinsurance be

22 included in the rate?

23 A. The paper presents two methods for

24 possibly including net cost of insurance in the

25 rate.



Page 2261

1 Q. Okay. And could you describe those two

2 methods, please?

3 A. Well, I'd have to refresh my memory

4 here for a moment on the paper for the one. I'm

5 much more in tune with the other one that is more

6 close to what the Rate Bureau has proposed. Let

7 me just look here. Okay. The author gives a

8 brief description at the top of page 150 stating

9 the first method to include the cost of

10 reinsurance in the indications simply add the

11 transaction cost of the contract as an expense and

12 leaves the expected losses unadjusted. This is

13 called the net cost of reinsurance method.

14 The second method has the entire

15 reinsurance premium as an expense and reduces the

16 amount of expected loss by expected reinsurance

17 benefits. To preserve consistency within the

18 actuarial literature, Homan's terminology will be

19 used, and that this is called the net loss plus

20 reinsurance method.

21 Q. Okay. And does the paper provide any

22 illustrations of those two methods?

23 A. Yes. There are some little examples

24 beginning on page 151 and demonstrating that the

25 two methods should arrive at the same result.



Page 2262

1 Q. Now, you indicated that Dr. Appel

2 stated that he -- stated roughly that he used the

3 exact same method to calculate the net cost of

4 reinsurance as suggested in this paper; is that

5 correct?

6 A. Yes.

7 Q. And do you believe that Dr. Appel was

8 correct that his method is exactly the same as

9 presented in the paper?

10 A. No. I believe it is correct only in

11 part, so in other words, it's not correct.

12 Q. Okay. And can you tell us why it is

13 not exactly correct?

14 A. Well, we could -- let me just -- let me

15 just ponder that for a moment what's the best way

16 to express that. Okay. The paper -- the author

17 of the paper assumed that the net cost of

18 reinsurance was being calculated for an insurer.

19 The assumption was that the insurer had negotiated

20 a reinsurance program with a reinsurer and they

21 had arrived at a price of premium value.

22 Therefore, that said, the primary

23 carrier knows its attachment point, limit, copay,

24 reinstatement, and all other provisions related to

25 the reinsurance contract. The primary company



Page 2263

1 also knows how much it paid for that reinsurance

2 so it knows the premium value. Now, we just

3 discussed previously the fundamental equations

4 that the premium equals the expected loss plus the

5 transaction costs. So we need to find the

6 transaction costs which are equal to the premium

7 minus expected losses.

8 So if you are the primary company, you

9 already know the premium. All you need to do is

10 estimate the expected losses and you have the

11 resulting transaction costs. That's not the case

12 for the Rate Bureau. The Rate Bureau doesn't have

13 the premium either. And it doesn't have the

14 specifics of the reinsurance program. It has

15 proposed a hypothetical reinsurance program and

16 then estimated premium from a variety of

17 parameters, which I'll get into in detail.

18 Q. Okay. So it appears, then, is what you

19 were saying, that the difference -- the major

20 difference between the paper and what Dr. Appel

21 used in his methodology in this filing is that the

22 paper talks about actual known reinsurance

23 programs and costs versus the hypotheticals that

24 have been presented in this -- in the filing in

25 this case; is that correct?



Page 2264

1 A. Correct. I could describe that better

2 by looking at RB-15, the Rate Bureau net cost of

3 reinsurance calculation page.

4 Q. Okay. Do you have that in front of

5 you?

6 A. Well, I have a little tiny excerpt of

7 those two pages, but --

8 Q. Okay.

9 A. Because, otherwise, I would have to

10 look at this monstrous book. I guess that's what

11 everyone else will have to do.

12 COMMISSIONER GOODWIN: Do we have the

13 actual RB-15?

14 MR. SPIVEY: If you're going to ask

15 about that, can I have a moment to get to it?

16 MS. HUBBARD: Uh-huh.

17 COMMISSIONER GOODWIN: We're off the

18 record.

19 (RECESS TAKEN FROM 12:00 P.M. TO 12:01 P.M.)

20 A. All right. Going back a moment before

21 I go directly to RB-15, the Huls paper presented a

22 more detailed way to estimate the ceded losses.

23 The paper stated that the insurer might utilize

24 the output of the hurricane model, apply the

25 parameters of the reinsurance program, and arrive



Page 2265

1 at its estimate of ceded losses. This is -- this

2 sort of mimics what the Rate Bureau did using the

3 AIR results, applying specifications of the

4 reinsurance program except that, of course, the

5 Rate Bureau's reinsurance program is not an actual

6 program -- it's a hypothetical one -- and then

7 came up with ceded losses. But the mechanics of

8 estimating the ceded losses appear to be the same.

9 I can't say for sure because I haven't looked at

10 the actual model that the Rate Bureau used because

11 it's proprietary.

12 Okay. So that said, that's the first

13 part of RB-15. If you look at RB-15, we are shown

14 in line 1 the hurricane losses which is a result

15 of that process which I just described, which is

16 taking the model results, apply the reinsurance

17 program, and one could derive the hurricane

18 losses. There may be some other small steps in

19 there which I'm eliminating for purposes of the

20 presentation here.

21 Then at line 2 on RB-15, a loss

22 adjustment expense factor is shown, and that is

23 applied to line 1 to get line 3. So now we have

24 at line 3 the hurricane loss and loss adjustment

25 expenses for those claims. Then line 4, we have



Page 2266

1 percent reinsured, which would also be derived

2 from the same model. And, therefore, in line 5,

3 we can multiply those two values and obtain the

4 reinsured loss and loss expense.

5 Now, I would draw a line under that

6 because that is the end of where the Rate Bureau

7 procedure is similar to what is in -- the same as

8 or close to the same as what's in the Huls paper,

9 except for the differences I noted regarding the

10 hypothetical program is being applied.

11 The rest of these lines are based on

12 various selected factors in order to arrive at the

13 net cost of reinsurance. If we look at line 6, we

14 have the reinsurance expense factor, which is the

15 expenses divided by the loss and loss adjustment

16 expense. It's a selected factor which was

17 discussed in my prefiled testimony and was

18 discussed in rebuttal by Dr. Appel. That factor

19 is a very important number because that factor

20 from line 6 goes right into line 7 where it is

21 used -- where it is used to calculate the

22 reinsurance loss and expense. As you can see,

23 line 5 divided by line 6, so we've taken the

24 losses from model, the output, and we divided by

25 the reinsurance expense factor, which is a chosen



Page 2267

1 selected parameter.

2 Okay. And then if we look down to line

3 12, we'll see the reinsurance expense cost is

4 equal to line 7 which we just calculated because

5 we grossed up the losses to include expenses. We

6 subtract the losses off again and now we have the

7 reinsurance expense cost all based on that .7

8 factor that was selected. So the factor is very

9 important in determining the reinsurance expense

10 cost which is one of the pieces of the net cost of

11 reinsurance.

12 So now we'll go to lines 8, 9, 10,

13 okay. Line 8 -- lines 8, 9, 10 are, again,

14 individual parameters that greatly affect the

15 results of this calculation. Line 8 is a premium

16 to surplus ratio and it's shown here at .3. Now,

17 in my prefiled testimony, I had a critique of this

18 value. I thought it should be higher for various

19 reasons, and that will be covered in another one

20 of my exhibits.

21 The next line, line 8 is a calculation

22 that Dr. Appel completes because he ties the

23 reinsurer underwriting return as a percent of

24 surplus to an 11 percent total return that he

25 believes is appropriate for the reinsurer. So



Page 2268

1 that's a calculated item based on the assumption

2 of an 11 percent total return. Those two values

3 are utilized to derive line 10. Just by dividing

4 the two, we find that Dr. Appel is asserting that

5 the reinsurer underwriting return as a percent of

6 premium is 52 percent. So we are now to assume

7 that the reinsurer has included in its rate a

8 profit loading of 52 percent. Now, again, if you

9 were to change either line 8 or line 9, you

10 certainly would get a significant difference in

11 line 10. So when I revise my value for line 8, I

12 have a quite different answer in line 10.

13 Now, what happens to the values in line

14 10? Where are they used? Let's look down at line

15 -- let's see here -- line 11. Okay. Now, we've

16 already calculated at line 7 the reinsurer loss

17 and expense. Now all we're going to do is load it

18 for 1 minus the underwriting profit, so we're

19 going to load it now for the profit. So that 52

20 percent means we're basically doubling everything

21 almost. So that line 7 at 372 million now becomes

22 776 million. So the reinsurance premium in this

23 case is derived by utilizing a factor which was

24 selected at line 6 and utilizing a bunch of

25 factors here to get to the 52 percent loading to



Page 2269

1 come up with a total premium of $776 million.

2 All right. Now, we have a premium now

3 that we've estimated based on a lot of external

4 things. There's some relevance of the losses

5 above, but those external factors are really key

6 into the magnitudes of these numbers. So now we

7 look at line 13, the cost of reinsurer capital.

8 How is that calculated? That is calculated now by

9 looking at the reinsurance premium which we just

10 derived, subtracting off expected losses, line 5A

11 -- but we'll talk about that in a moment -- and

12 then subtracting off line 12, the reinsurance

13 expense cost. So now we've gotten cost of capital

14 by subtracting off the other two items which we've

15 estimated based on a lot of parameters.

16 Now, the significance of using line 5A,

17 which is a subdivision of line 5 which are the

18 losses -- the losses have been shown in two parts.

19 The losses in 5A are based on the STD or standard

20 model, and the losses in 5B are the additional

21 WSST loss and LAE. So in line 13, when the losses

22 from line A are subtracted, the presumption is

23 that, well, these are the losses that the primary

24 company would estimate for itself because it might

25 use the standard model whereas the reinsurer used



Page 2270

1 the WSST model so we can't subtract those off here

2 to get part of our cost of capital. So that's why

3 we have the cost of reinsurer capital equals this

4 formula.

5 Now, that is my interpretation as to

6 the rationale because the specific rationale for

7 this calculation wasn't provided. But this

8 formula has changed. I believe there was a

9 formula in prior filings where the entire amount

10 in line 5 was subtracted. That's not relevant

11 here right now.

12 All right. So now we look at line 14,

13 which is the final answer, reinsurer expenses plus

14 cost of reinsurer capital. Now we can add the

15 reinsurer expense cost and the cost of reinsurer

16 capital from lines 12 and 13. The problem is,

17 though, that these numbers are based in large part

18 on the factors in line 6 that we discussed. The

19 .7 helped us to figure out what the expenses are.

20 Very highly dependent on that. And the factors in

21 lines 8, 9 and 10, the result is very highly

22 dependent on that.

23 So what the Rate Bureau has done

24 different from a company is all these items in

25 line 6 through 14, the company would not have to



Page 2271

1 do because the company knows its premium. The

2 company could take lines 1 through 5, subtract it

3 from its known premium and come up with its net

4 cost of reinsurance.

5 So, admittedly, this case is different

6 because we don't have an actual company, an actual

7 contract. But the point is, is that Dr. --

8 Dr. Appel's methodology is not what is in the Huls

9 paper because the Huls paper is assuming that

10 there is an actual premium and an -- and an actual

11 model run and so on that we can actually make this

12 subtraction. We don't have to also estimate the

13 premium using a lot of external factors because

14 that makes the model more sensitive to what source

15 you might use for those factors and so on.

16 So that was the comparison basically on

17 line-by-line items to what is presented in the

18 Huls paper and why I don't agree that the Rate

19 Bureau method exactly follows what's in the Huls

20 paper.

21 Q. Okay.

22 MS. HUBBARD: Mr. Commissioner, can we

23 approach?


25 approach.



Page 2272

1 Q. Ms. O'Neil, we would like to hand you

2 exhibit marked -- an exhibit marked DOI-17. Okay.

3 Do you have that exhibit?

4 A. Yes.

5 Q. And did you prepare this exhibit?

6 A. Yes.

7 Q. Can you tell us what this exhibit

8 purports to show?

9 A. This exhibit was attempting to show

10 several things. It calculates the rate online

11 implied by the Rate Bureau calculations in

12 historical filings since 2002 when the net cost of

13 reinsurance was first included. Rate online is

14 equal to the reinsurance premium divided by the

15 reinsurance coverage limits. So it is a measure

16 of the cost paid for insurance such that it can

17 therefore be compared to itself historically and

18 to other programs.

19 So with that said, let's look at the

20 table at the top which shows historical Rate

21 Bureau values. Reinsurance coverage is the first

22 column and it shows from the proposed reinsurance

23 program in each of those Rate Bureau filings

24 identified on the left what the coverage was. And

25 I calculated that by limit minus attachment point



Page 2273

1 multiplied by the coparticipation that was

2 specified in the filing.

3 The next column shows the estimated

4 reinsurance premium that would have been shown in

5 the filing at RB-15 or comparable exhibit in the

6 older filings. The implied rate online was the

7 ratio I just described, the reinsurance premium

8 divided by the reinsurance coverage limits. So we

9 see that the implied rate online in the historical

10 Rate Bureau filings went from 6.9 percent in 2002.

11 It rose for the next two years. There was a small

12 drop in 2008. And then it rose again. And then I

13 calculated the year-to-year changes. There was a

14 big jump between 2005 and 2006, which I've

15 discussed at length in my prefiled testimony for a

16 variety of reasons including changes in formulas

17 and so on that the Rate Bureau did. We have that

18 85.9 percent increase. Then there was a slight

19 drop and another increase. And now we have a

20 little stability between 2012 and 2014.

21 So we look at the cumulative change,

22 and the cumulative change in the rate online is

23 about 84 percent. Now, that is compared to the

24 Guy Carpenter rates online in the next columns.

25 Now, Guy Carpenter publishes a graphic with the



Page 2274

1 rate online for a period of years. They do not

2 publish actual values. They publish an index. So

3 it would not have been helpful to show the index.

4 I just showed the changes. And since 2002, the

5 Guy Carpenter rate online index has increased by 9

6 percent. And over the same period, the Rate

7 Bureau's has increased 84 percent. These same

8 data are reflected in the graphic below. And you

9 can see that the -- I believe everyone has color.

10 Q. We don't.

11 A. Red line --

12 Q. No, we don't.

13 A. Okay. The --

14 Q. Could you identify which of those lines

15 is --

16 A. I will, yes. The line that only has

17 one change, which is -- goes up steeply and drops

18 back down steeply is the total industry as

19 depicted by Guy Carpenter. The other line that

20 goes up, slightly down, and then back up is the

21 Rate Bureau implied rate online values. You can

22 see that total -- rate online for the total

23 industry reached a peak in 2008 and has fallen

24 significantly since. From 2008 forward, however,

25 the Rate Bureau has gone in the opposite



Page 2275

1 direction. It's gone up, and it's not reflective

2 of changes in the market. So that's the purpose

3 of this graph and tables.

4 Q. Okay. And this exhibit has two

5 additional pages?

6 A. Yes. The next page provides comparison

7 -- actually, this page actually doesn't provide.

8 It just shows the Beach Plan rate online, okay.

9 Reinsurance coverage in the Beach Plan is shown in

10 the first table of this page at the top,

11 Historical Beach Plan. It shows reinsurance

12 coverage as provided by the Beach Plan. It shows

13 the estimated reinsurance premium as divided by

14 the Beach Plan, the implied rate online, the

15 year-to-year changes, and the cumulative change.

16 Now, the Beach Plan's changes, although I didn't

17 provide a graphic, are more closely in line with

18 the rate online shown by Guy Carpenter, the

19 changes in that rate online by Guy Carpenter.

20 The next portion of this exhibit, being

21 aware that the coverage in the Beach Plan is

22 somewhat different than the program proposed by

23 the Rate Bureau for state-wide, provides an

24 additional cost that might have been incurred by

25 the Beach Plan if they had purchased reinsurance



Page 2276

1 for the $1 billion layer. I obtained this

2 estimated $200 million additional cost by looking

3 at -- I do have a footnote somewhere, I believe.

4 I was looking at Dr. Appel's RB-17, page 8, which

5 showed about $100 cost for that layer times 2

6 million exposures. So I added $200 million as an

7 approximate possible cost for that layer for the

8 middle chart on this page to see what the implied

9 rate online would be for the Beach Plan if it had

10 paid that much more money for its program. Okay.

11 So these are the rates online that we have here in

12 the middle. They're much higher than they were

13 before.

14 Then I -- then I look at the fact that

15 in the last part of this table that, in fact, the

16 values that the Beach Plan has provided here are

17 for the full Beach Plan which includes the FAIR

18 Plan and the Beach Plan which includes

19 homeowners'. And in that -- in the Beach Plan

20 area that includes homeowners', there are also

21 other lines of business including commercial

22 lines. So I applied a factor of 60 percent to the

23 values in the prior table to reduce the amounts

24 paid by the Beach Plan that would relate only to

25 homeowners' coverage. And the rates online don't



Page 2277

1 go all the way back down, but they go back down to

2 magnitudes in the 10, 11 percent range. And they

3 do fall also similar to the market.

4 Now, the last page of this exhibit

5 which is kind of tiny print is an attempt to put

6 this information together. The top table brings

7 forward the historical Rate Bureau values for rate

8 online that we saw on page 1. So we see that for

9 2014 which is the current filing which would

10 really have been 2013 values. The rate online

11 applied by the Rate Bureau was 12.8 percent.

12 The next table shows the adjusted Beach

13 Plan which we just looked at with the additional

14 $200 million and adjusted the homeowners' only.

15 And for comparison, the two tables can be compared

16 then. I would compare the 2013 value for the

17 Beach Plan of 11.0 to the 2014 filing of the Rate

18 Bureau at 12.8 percent. And that's because,

19 obviously, the 2014 values weren't available to

20 the Rate Bureau at the time of creation of the

21 filing.

22 Now, another calculation appears there,

23 and that is the implied remainder of state rate

24 online. If you were to assume that the Rate

25 Bureau is, indeed, providing coverage for the



Page 2278

1 entire state, and this is the cost that the Rate

2 Bureau states would be incurred for purchasing the

3 reinsurance program it's proposed for the entire

4 state, is $776 million. So that being the case,

5 we see that the Beach Plan has -- is part of that,

6 and it has its own underlying coverage. We can

7 calculated an estimate of what is actually being

8 the rate online for the remainder of state. Now,

9 these two tables imply a remainder of state rate

10 online of 13.0 percent which doesn't make a lot of

11 sense when you can assume that most of the risk

12 for hurricanes and other disasters is actually in

13 the Beach Plan. So why would we pay more for

14 reinsurance relatively speaking in the remainder

15 of state?

16 Now, the last table on this page

17 adjusts the Beach Plan information further because

18 -- and I believe it was in rebuttal testimony, Dr.

19 Appel stated that actually the Beach Plan would

20 have to pay between $300 and $400 million for that

21 $1 billion of insurance. So I used the average of

22 $350 million and included that as -- in the Beach

23 Plan cost and adjusted it again to homeowners' and

24 come up with -- and I came up with much higher

25 rates -- implied rates online for the Beach Plan.



Page 2279

1 Then I again did the calculation for the implied

2 rate online for 2013 for the remainder of state.

3 It remains at 12.5 percent. It is slightly less

4 now than the Beach Plan, but certainly not as much

5 less as one would expect for the remainder of

6 state given that the Beach Plan has the riskiest

7 portion of the business.

8 Q. Okay. Now, Ms. O'Neil, did Dr. Appel

9 make any comparisons of the rates online to the

10 results of his net cost of reinsurance?

11 A. I don't believe I've seen any.

12 Q. Okay. Did he on rebuttal do comparison

13 of loss ratios?

14 A. Yes, he did.

15 Q. And do you consider the comparison of

16 loss ratios to be a valid comparison?

17 A. I believe I recall Dr. Appel comparing

18 the implied loss ratio from his model to the

19 implied loss ratio for some catastrophe bonds. I

20 don't consider the implied loss ratio to be a

21 valid comparison because both the numerator and

22 the denominator are variables. So you can have a

23 loss ratio with a numerator and denominator both

24 five times greater and you have the same loss

25 ratio, or you could have other variations. But



Page 2280

1 the main one, you can have the same loss ratio

2 with vastly different premium amounts, and are

3 both valid? No.

4 Q. Okay. Did you prepare an exhibit

5 illustrating your point? And would that exhibit

6 be DOI-14?

7 A. Yes.

8 MS. HUBBARD: Mr. Commissioner, can we

9 approach?


11 approach.

12 MR. SPIVEY: What number?

13 MS. HUBBARD: 14.

14 Q. Okay. And, Ms. O'Neil, is DOI-14

15 something you prepared as a response to

16 Dr. Appel's Exhibit RB-30?

17 A. Yes. I believe RB-30 was the exhibit.

18 Let me just see if I have a copy of RB-30 here.

19 Yes. RB-30 was Dr. Appel's exhibit which showed

20 data from Lane Financial of cat bonds issued by

21 layer, average yield spreads, and implied loss

22 ratios. He also handed out another exhibit, I

23 believe, for the one specific bond. I've

24 forgotten the name of it offhand right now.

25 Q. Was it EvergladesRe?



Page 2281

1 A. EvergladesRe, yes, correct. So,

2 anyway, Dr. Appel compared the loss ratio implied

3 in his net cost of reinsurance analysis where he

4 took the $260 million of loss divided by the

5 estimated $776 million of premium to arrive at a

6 33.6 implied loss ratio and compared that to the

7 loss ratios in the various bonds. In particular

8 on RB-30, he actually illustrated that the implied

9 loss ratios for these bonds were less than his

10 and, therefore, his cost of net reinsurance -- his

11 cost of reinsurance would be less than it would be

12 for the bonds.

13 So, nonetheless, going back to the use

14 of the loss ratio as a method for comparison, we

15 look at the simple example which I showed here, is

16 if we were to multiply the numerator and

17 denominator of Dr. Appel's values, we would get

18 $1.3 billion for the reinsured loss and $3.9

19 billion for the estimated premium. We would still

20 have a 33.6 percent loss ratio, so now someone

21 could say, gee, maybe the net cost of reinsurance

22 should be five times greater because the loss

23 ratio remains at 33.6 percent and looks good

24 compared to these other loss ratios.

25 Q. Okay.



Page 2282

1 MS. HUBBARD: Mr. Commissioner, could

2 we approach again?

3 COMMISSIONER GOODWIN: You may.

4 Q. Ms. O'Neil, we are handing you Exhibit

5 DOI-16. Do you have DOI-16 in front of you?

6 A. I do.

7 Q. And did you prepare this exhibit in

8 response to Dr. Appel's Exhibit RB-31; is that

9 correct?

10 A. I did. Once again, this exhibit, as

11 the last exhibits, was pretty much the talking

12 points, but it does provide some technical

13 information.

14 Q. Okay. Could you tell us what this

15 exhibit shows?

16 A. Well, in the filing, Dr. Appel

17 presented, as we just looked at on line 8 of

18 RB-15, the selected premium to surplus ratio of

19 .3. When asked for background for that premium to

20 surplus ratio, the justification provided was

21 A.M. Best's reinsurer composite. That response

22 came through RF -- the Request for Production of

23 Documents number 1, item 59, and also through data

24 request 1, items 179. So that is the only

25 justification or support that was provided to the



Page 2283

1 Department in the course of the hearing. On

2 rebuttal, Dr. Appel provided additional

3 justification in RB-31.

4 Now, looking at RB-31, this exhibit is

5 for a small sample of Bermuda reinsurers of about

6 20 companies. The categories established were for

7 those that are predominantly property catastrophe,

8 significant property cat, or little or no property

9 cat. These categories were designed by Dr. Appel

10 in terms of what the criteria were for a company

11 falling into a category. He states that at the

12 bottom of the page in terms of the criteria as a

13 percentage of net written premium for property

14 catastrophe reinsurance.

15 Now, the end result of that

16 categorization was that only two companies fell in

17 the predominantly property cat bucket. Those two

18 companies were Renaissance and Tokyo. Looking at

19 the underlying data furnished subsequently, those

20 two companies only represent about 3 percent of

21 the market share. So they're very -- Tokyo in

22 particular is very small in terms of writing. So

23 it must be assumed that generally property

24 catastrophe coverage is provided by companies

25 writing more broad based reinsurance portfolio,



Page 2284

1 and as such, their surplus protects all of their

2 writings.

3 So, nonetheless, in addition, when I

4 looked at a different selection of companies

5 that's published by RAA, as I mentioned in my

6 prefiled testimony, I found that the Best data are

7 distorted in terms of premium to surplus ratio by

8 one company, National Indemnity, which has a very

9 odd and low premium to surplus ratio such that

10 even RAA, which is Reinsurance Association of

11 America, excludes that company when calculating

12 various statistics such as premium to surplus

13 ratio. If that company is removed from the Best

14 data, we have a premium surplus ratio of .482.

15 Now, going back to RB-15 that we just

16 looked at, that would replace line 8, the .3 value

17 with .482, which would make a very significant

18 difference in the proposed reinsurer underwriting

19 return as a percent of premium on line 10 because

20 it's a ratio. So this is an important parameter

21 in the Rate Bureau's model. And so it is not

22 conclusive to look at either Best or RB-31 based

23 on the information shown on this page because it

24 is only two companies on RB-31 that produce a

25 value similar to the one used by the Rate Bureau.



Page 2285

1 The other categories are well above what the Rate

2 Bureau selected.

3 Q. Okay. And just to clarify the record,

4 I believe you said the Best data was distorted; is

5 that correct?

6 A. Yes, because A.M. Best doesn't show

7 data separately by company such that one could see

8 that distortion for National Indemnity, whereas

9 RAA does show that data. So those data are

10 distorted, but you have to look at individual

11 company statistics to find out what that

12 distortion is.

13 Q. Okay. And understand that, but I

14 wanted to make sure the court reporter understood

15 that you meant A.M. Best's data was distorted, not

16 little b-e-s-t.

17 A. Oh, yes. Correct. Data from A.M.

18 Best, which the Rate Bureau utilized as support in

19 the filing for its .30 premium to surplus ratio,

20 was distorted when you look at more detailed

21 information by underlying company, in particular

22 National Indemnity.

23 Q. Okay.

24 MS. HUBBARD: May we approach again?




Page 2286

1 Q. Ms. O'Neil, I'm going to -- or Ms. Ford

2 is handing you an exhibit marked DOI-18. Okay.

3 And do you have that in front of you?

4 A. I do.

5 Q. And can you tell us what this exhibit

6 shows, please?

7 A. Once again, this is a talking point

8 exhibit which discusses some things that were

9 included in my prefiled testimony as to how I

10 developed the net cost of reinsurance proposed in

11 my recommendations in this case. At pages 163

12 through 170 of my prefiled testimony, I developed

13 a range of possible values for the net cost of

14 reinsurance of $25 to $60 per policy. I developed

15 that range using various assumptions within the

16 Rate Bureau methodology modifying some of those

17 parameters that we just discussed to see what

18 might result.

19 I also looked at various other data

20 sources including the Beach Plan's actual premium

21 values, the AIR modeled values for the beach and

22 non-beach areas and their relationship, and the

23 actual premium paid by Allstate on a country-wide

24 all-lines basis, and the fact that 12 percent of

25 homeowners' premium is written in the Beach Plan.



Page 2287

1 From all this information, I made a

2 selection. My selected value for the net cost of

3 reinsurance was $50 per policy. This compares to

4 the Rate Bureau's $174 per policy which included

5 in the filing. I assumed that my $50 per policy

6 was on the same basis and comparable to the Rate

7 Bureau's $174 value. Therefore, I utilized the

8 equations in Mr. Curry's testimony at RB-3, page

9 28 to back into the dollar value of the net cost

10 of reinsurance that my $50 would imply, and it's

11 about $185 million.

12 All right. Now, I will look again at

13 the reasonability of Dr. Appel's results in his

14 prefiled -- not his -- in his -- in his rebuttal

15 testimony at pages 1936 to 1947. Dr. Appel

16 compared the applied loss ratios for the

17 EvergladesRe CAT bond, which was 31 percent, to

18 the implied loss ratio in the Rate Bureau net cost

19 of reinsurance model of 33.6 percent. He

20 concluded that because his loss ratio in his model

21 was higher than that included in the CAT bond,

22 that his value was reasonable, in fact, that the

23 cost of the CAT bond actually was higher than his

24 model. He also presented RB-30, which we just

25 looked at, to again show that the implied loss



Page 2288

1 ratios were well below his implied value of 33.6

2 percent.

3 I decided to see if there were any

4 other data sources which might have information

5 that was relevant to this. First, of course,

6 reminding everyone that I believe loss ratio isn't

7 a proper comparison, but nevertheless, I still

8 looked for additional information. And I found a

9 publication called "Lane Financial Trade Notes."

10 On page 17 of this document, there are

11 -- it would be nice to actually see that document.

12 I have it somewhere in here. There are yield

13 spreads and other information from which one can

14 calculate a loss ratio, an implied loss ratio

15 within all catastrophe bonds, not just one

16 catastrophe bond such as Everglades. Using that

17 data, I calculated implied loss ratios for all

18 catastrophe bonds, and the values for 2012 were

19 similar to Dr. Appel's. But the values for 2013

20 were 45 percent, which is above Dr. Appel's value,

21 suggesting that he actually is more expensive than

22 the CAT bonds.

23 Then I utilized those data to estimate

24 what my premium would be given the net cost of

25 reinsurance value that I proposed. Assuming the



Page 2289

1 45 percent loss ratio for 2013, I would calculate

2 that my estimated premium value is $336 million,

3 which implies a rate online of 5.5 percent, which

4 compared to the Rate Bureau's rate online that we

5 looked at before of 12.8 percent, so there's quite

6 a difference there.

7 Now, when I used the value that I just

8 proposed, the 5.5 percent for the state-wide rate

9 online and calculate what the value would be for

10 the remainder of state, that would be 4.7 percent.

11 And when you compare that to the Beach Plan value

12 of 11 percent, that's much more realistic because

13 now we have the three pieces, the Beach Plan at

14 11, the remainder of state at 4.7, and state-wide

15 at 5.5. So I find that much more realistic than

16 Dr. Appel's values which are almost the same for

17 all three market segments. So I believe that

18 these comparisons demonstrate that the Rate Bureau

19 net cost of reinsurance value of $569 million is

20 excessive and that the value I propose of $185

21 million is much more realistic.

22 Q. Okay.

23 COMMISSIONER GOODWIN: And,

24 Ms. Hubbard, I see here that we have our next

25 court reporter in the courtroom. Do you



Page 2290

1 envision a natural breaking point for us to

2 switch court reporters and/or have a lunch

3 break?

4 MS. HUBBARD: I'm actually hoping to

5 wrap up in the next 20 minutes or so.

6 COMMISSIONER GOODWIN: And then perhaps

7 we can take our break and restart after lunch

8 with cross examination?

9 MR. SPIVEY: That's fine.

10 MS. HUBBARD: Okay. Does the court

11 reporter need a break now?

12 THE COURT REPORTER: (Shakes head

13 negatively.)

14 MS. HUBBARD: You're okay?

15 THE COURT REPORTER: (Nods head

16 affirmatively.)


18 will proceed.

19 BY MS. HUBBARD:

20 Q. Okay. Ms. O'Neil, do you recall

21 Dr. Vander Weide's rebuttal testimony indicating

22 that since you only looked at historical returns

23 that it was his interpretation as an economist

24 that your methodology is inconsistent with the

25 Hope and Bluefield cases?



Page 2291

1 A. I do recall him making that statement.

2 MS. HUBBARD: Okay. And if we could

3 approach, Mr. Commissioner.


5 Q. Ms. O'Neil, we are handing you an

6 exhibit marked DOI-19. Can you identify DOI-19

7 for us, please?

8 A. Yes. This is a one-chapter excerpt

9 from a book. The title of the book shown on the

10 first page of DOI-19 is "Actuarial Considerations

11 Regarding Risk and Return in Property-Casualty

12 Insurance Pricing." The editor is Oakley E. Van

13 Slyke. Mr. Slyke -- Van Slyke, I guess, is an

14 actuary. The publication date is stated as May

15 1999. On the second page of this DOI-19, the

16 chapter that we are looking at is chapter 1

17 entitled "The Legal Perspective: Appropriate

18 Profit Margins in Property and Casualty Insurance

19 Rates" by Judith Mintel, and Ms. Mintel is an

20 attorney.

21 Q. Okay. Do you know if Ms. Mintel has

22 any experience with property-casualty insurance?

23 A. Yes, she does. I actually met her a

24 number of years ago. She was at that time

25 representing State Farm. She was on staff at



Page 2292

1 State Farm. Subsequent to that time, I believe

2 she served as a Deputy Commissioner or some other

3 capacity as a regulator. And after that, I

4 believe she became a professor of law, and she has

5 also written a book related to insurance laws and

6 regulations which is part of the Casualty

7 Actuarial Society syllabus, or it was.

8 Q. Okay. Now, what did you observe from

9 Ms. Mintel's chapter out of the actuarial book?

10 A. Well, there are 11 pages here. It

11 would be hard to put everything into one compact

12 statement, but I'll put -- I'll just make a

13 summary statement. Ms. Mintel examines the

14 history of applicable laws and court cases

15 applying to profit margins and insurance rates.

16 She looks at the Hope case and a number of other

17 cases and in essence concludes that there remains

18 controversy as to what the appropriate methodology

19 is for reflecting and calculating underwriting

20 profit in insurance rates. She states that these

21 other cases show that it is not clear that a total

22 return methodology is necessary to satisfy the

23 conditions of Hope and that the cost of capital --

24 I don't know if she directly addresses the way a

25 total return methodology is calculated or not.



Page 2293

1 But she does state that there is not -- that

2 there's two sides to the story, or many sides to

3 the story in terms of how the underwriting profit

4 should indeed be calculated and included in a rate

5 in order to earn the fair and reasonable return

6 required by the Constitution and the Hope case.

7 Q. Okay. And you indicated she noted the

8 Hope case in this paper; is that correct?

9 A. Yes.

10 Q. And that's the Hope case that

11 Dr. Vander Weide has mentioned several times

12 during his testimony; is that correct?

13 A. Yes.

14 Q. And was the Hope case a public utility

15 case?

16 A. Yes. When we say Hope case, it's

17 because it's a standard case that most people

18 represent, but it's actually Federal Power

19 Commission versus Hope Natural Gas Company from

20 1944.

21 Q. Okay. And is that a -- do you know

22 what court that's from?

23 A. It says 320 U.S. 591. I believe that's

24 the United States Supreme Court.

25 Q. Okay. So the Hope case is a public



Page 2294

1 utility case. Does Ms. Mintel have anything to

2 say about relating the Hope case to regulated

3 insurance cases, or insurance cases which are part

4 of the regulated industry?

5 A. Well, Ms. Mintel cites a number of

6 different cases, both noninsurance and insurance

7 and then opined as to what this means for

8 insurance.

9 Q. Okay. Were there any cases at all that

10 you found related to our case here?

11 A. Well, I can point to a couple in her

12 paper here or chapter. We -- the first one of

13 note would be on page 4 which was Market Street

14 versus Railroad Commission.

15 Q. Okay. Is that an insurance case or a

16 public utility case?

17 A. That would be a public utility case. I

18 don't think either one of those are insurers.

19 Q. Okay. But we were -- I asked whether

20 or not she related the Hope case to any insurance

21 cases.

22 A. Oh, yes, she does. That's later, I

23 believe, in this document.

24 Q. Okay. Does she, by chance, mention any

25 North Carolina cases?



Page 2295

1 A. Actually, she does. Let me just find

2 that. On page 10 of the chapter at the second --

3 or the first full paragraph, she mentions a case

4 from 1979, the Commissioner versus the North

5 Carolina Rate Bureau, affirmed -- I guess I'll

6 just note this paragraph here. She just says,

7 "For example," and then she cites the case,

8 "Affirmed, the North Carolina courts held that it

9 is not proper to consider investment earnings on

10 capital or stockholder supplied funds in

11 rate-making, although investment earnings from

12 funds attributable to insurance operations is

13 appropriate. The North Carolina rating law

14 required consideration of investment income earned

15 or realized from unearned premium and loss and

16 loss expense reserve funds generated from business

17 within this state in the rate approval process."

18 Q. Okay. Does Ms. Mintel make any

19 conclusions about the use of the cost of capital

20 as it relates to the Hope decision?

21 A. I know she does. I -- give me just a

22 moment to see where in the document that may

23 appear because I have -- yes. There's a

24 conclusionary paragraph at the bottom of page 10.

25 It's a little bit long but it might be helpful



Page 2296

1 just to read that. She states, "The foregoing

2 discussion of the legal standards applicable to

3 insurance profit margins should be adequate to

4 communicate the fact that the legal and regulatory

5 communities are no more in agreement on the

6 appropriate approach to insurance rate profit

7 provisions than are the actuarial and financial

8 communities. Many regulators and legislators

9 prefer not to deal with the issue. Instead, they

10 rely on the competitive market to produce

11 appropriate profit margins. A few regulators,

12 legislatures and reviewing courts require an

13 evaluation of rates using a total return analysis

14 by finding it necessary to calculate the cost of

15 capital and to compare insurance returns by line

16 by state with returns in other industries of

17 comparable risk. Others focus on the return from

18 current insurance operations and insist that any

19 proper evaluation indicate whether this return is

20 positive. Some seem to refer to more than one

21 type of profit margin as they articulate the

22 applicable legal standards."

23 Q. Okay.

24 MS. HUBBARD: May we approach,




Page 2297


2 Q. Okay. Ms. O'Neil, we are handing you a

3 copy of -- a copy -- we are handing you an exhibit

4 that is marked DOI-20. Before we get to DOI-20,

5 Ms. O'Neil, I should have you clarify whether or

6 not you consider this chapter to -- and Ms. Mintel

7 to be a reliable authority on the state of case

8 law with regard to the cost of capital and --

9 A. Well, I do because, actually, as I

10 said, I personally met Ms. Mintel in her capacity

11 as representing State Farm. She has written a

12 textbook on legal matters related to insurance,

13 and she has served as a regulator for an insurance

14 department. Those credentials are fairly broad,

15 and I believe, therefore, her to be an expert in

16 this area.

17 Q. Okay. And did you indicate that her

18 textbook was at one -- at least at one time a

19 required reading at the CAS?

20 A. Yes, that's correct. It was on the

21 syllabus for a number of years. I don't really

22 know if it is anymore because I haven't looked at

23 the syllabus because I don't need to.

24 Q. Okay. Now, getting back to DOI-20, did

25 you prepare this exhibit?



Page 2298

1 A. Yes.

2 Q. And does this -- does Exhibit DOI-20

3 address some of Dr. Vander Weide's legal concerns

4 with your testimony?

5 A. Well, I hope it does. What I tried to

6 show here is basically how we got to where we are

7 in this issue. So, I mean, it might not be a

8 complete list of everything, but, to me, for my

9 purposes, it encapsulates the process. So at the

10 top part of the page it's labeled "General" and it

11 talks about the underwriting profit provision from

12 the approximate dates of 1921 to about the mid

13 1960's. There was a 1921 NAIC profit formula

14 which specified a pretax, 5 percent of premium

15 without consideration of investment income. That

16 was used pretty but without much question for a

17 number of years.

18 Then in the '60s through the '70s,

19 there was some concern by investment income, and

20 that perhaps it should be considered. So in 1967,

21 there was a study by the consulting firm, Arthur

22 D. Little, which a very significant study at the

23 time, and it suggested utilization of a total

24 return methodology or income from all sources,

25 meaning including income from investments.



Page 2299

1 So there were hearings in states like

2 Texas and Supreme Court decisions in other states

3 such as Virginia, New Jersey, and Oklahoma, and

4 there were additional publications by others on

5 this issue.

6 In 1984, there was another NAIC

7 profitability study, and this study concluded that

8 underwriting profit should include income from all

9 sources and be based on a total rate of return.

10 Both of these studies that I'm referencing in here

11 state that a total return methodology includes

12 reflection of income from all sources,

13 underwriting and investments. So that -- going on

14 from 1985 to the present, there continue to be

15 numerous studies and analyses of what is the

16 appropriate way to derive the underwriting profit

17 to be loaded into the rates.

18 So with that background, I looked at

19 North Carolina and what has been my experience

20 with calculating an underwriting profit to be

21 included in the rates. First, I'm looking to the

22 statutory language related to insurance rates.

23 The statute provides that rates shall not be

24 excessive, inadequate, or unfairly discriminatory.

25 It also provides that due consideration shall be



Page 2300

1 given to a reasonable provision for underwriting

2 profit and contingencies for investment income

3 earned or realized by insurers from their unearned

4 premium loss and loss expense reserve funds

5 generated from business within this state.

6 Now, that was very specific because it

7 stated "investment income earned or realized by

8 insurers from their unearned premium loss and loss

9 expense reserve funds." Those are policyholder

10 supplied funds. There's no mention that

11 investment income from stocks or -- should be

12 considered -- from capital and surplus is what I

13 meant to say.

14 Okay. So going on, I outlined a few

15 court decisions. I know there are many court

16 decisions on this issue. These are the ones I'm

17 most familiar with because I participated in a

18 number of these cases. Obviously, not the early

19 ones in 1980, but in these later cases that I show

20 here, oftentimes those earlier cases were cited.

21 So I can't say that I've studied and read and

22 understood every exact word that is in these

23 cases, but as an actuary in attempting to apply

24 the law in this state, I refer to these cases, and

25 these are certain quotes or excerpts from the



Page 2301

1 decisions in these cases that I've used in coming

2 up with the methodology which I proposed in this

3 case.

4 Some of these state that, indeed, it is

5 not appropriate to select an underwriting profit

6 and add on investment income from policyholder

7 supplied funds, investment income from capital and

8 surplus, and test the result against the total

9 return. Some of these also state you can't go the

10 other direction. You can't calculate a total

11 return and subtract out investment income and

12 capital and surplus. In either case, the Court

13 has said, no, you cannot; that does not comply

14 with the law; you must calculate the underwriting

15 profit provision without considering investment

16 income from capital and surplus.

17 So in various places in my prefiled

18 testimony, I have quoted some of these excerpts as

19 reasons for the methodology which I have developed

20 which includes selection of an underwriting profit

21 factor based on a long-term history of realized

22 underwriting profit provisions excluding any

23 investment income on capital and surplus. I

24 believe that methodology complies with the

25 requirements of North Carolina statute. And any



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1 other methodology that utilizes total returns

2 would not comply with the statute because, as we

3 noted earlier, total return includes income from

4 all sources, which means for an insurance company

5 that would include -- investment income on capital

6 and surplus. So that's my summary of that page.

7 Q. Okay. And is it, in fact, the case,

8 Ms. O'Neil, that several auto cases back -- you at

9 one time did employ a total return methodology; is

10 that correct?

11 A. That's correct. I believe if these

12 cases actually referenced here, I previously

13 utilized the total return methodology much in the

14 same manner as the Rate Bureau does now to derive

15 the underwriting profit. And after these court

16 decisions came out, I developed the method which

17 I'm using now because I believe that the Court

18 stated that the prior method did not comply with

19 the statute.

20 Q. Okay. And as an actuary, do you

21 generally review legal cases in your work?

22 A. I would certainly read what the case

23 said, and as an actuary, attempt to comply with

24 whatever the requirements were of the statute.

25 This is no different than looking at the Hope case



Page 2303

1 and saying that it requires a certain standard for

2 earnings. It's the same idea. One would look at

3 a case from their professional perspective and

4 apply it to the best of their ability, and then

5 the Court would determine if that is appropriate

6 or not.

7 Q. Okay. And is there an actuarial

8 standard of practice that deals with complying

9 with pertinent laws and regulations?

10 A. The actuarial standards of practice are

11 very clear that any prevailing laws supersede the

12 standards.

13 Q. Okay. Do you know actuarial standard

14 practice that might be?

15 A. The one that has been mentioned often

16 in this case is actuarial standard of practice

17 number 30.

18 Q. Okay.

19 MS. HUBBARD: And with that,

20 Mr. Commissioner, I believe we are ready for

21 a break.

22 COMMISSIONER GOODWIN: And does this

23 mean that you are concluded with this

24 witness, or does it mean you're at a breaking

25 point?



Page 2304

1 MS. HUBBARD: At this time, we are

2 concluded with this witness.

3 COMMISSIONER GOODWIN: All right. How

4 much time would the parties wish to have for

5 lunch, an hour or longer? I do note that the

6 snack bars are not open in this building or

7 any other state building today if that

8 factors into your calculation.

9 MR. SPIVEY: Mr. Commissioner, we do

10 need some time to digest some of the exhibits

11 and that sort of thing. I guess I would ask

12 for an hour and a half.

13 COMMISSIONER GOODWIN: 2:30, is that

14 sufficient? Will that work into everyone's

15 schedules for today? I know we're trying to

16 keep the schedule we've set out.

17 Ms. Hubbard, do you have any objection to

18 2:30? That's an hour and a half.

19 MS. HUBBARD: No. That will be fine.


21 will resume at 2:30. Again, we are keeping

22 in mind that there are no dining facilities

23 available within close proximity of this

24 hearing, so that also allows some time to not

25 only digest the testimony but actually digest



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1 some lunch offsite. We will resume at 2:30.

2 (LUNCH RECESS TAKEN FROM 1:02 P.M. TO 2:41 P.M.)

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NORTH CAROLINA DEPARTMENT OF INSURANCE …11-11 Morning Hearing... · north carolina department of...

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