Original jurisdiction in case of Commonwealth of Pennsylvania, Insurance Department, and Herbert S. Denenberg, Insurance Commissioner, v. Safeguard Mutual Insurance Company.
Barton Isenberg, General Counsel, with him James D. Keeney, Assistant Attorney General, and Israel Packel, Attorney General, for petitioners.
Malcolm H. Waldron, Jr., for respondent.
President Judge Bowman and Judges Crumlish, Jr., Wilkinson, Jr., Mencer, Rogers and Blatt. Judge Kramer did not participate. Opinion by President Judge Bowman.
[ 18 Pa. Commw. Page 199]
The prolonged and bitter conflict between the Pennsylvania Department of Insurance (Department) and Safeguard Mutual Insurance Company (Safeguard) has reached its Armageddon. While the appropriateness of such a characterization may be questioned, particularly where the field of battle is a courtroom, the postures of the respective parties must be perceived in terms of a "life or death" confrontation. At stake here is whether Safeguard may continue to exist as a privately owned and operated business or whether it is destined to become a "ward of the state."
Safeguard was organized as a domestic mutual fire insurance company in 1938. Prior to 1967, Safeguard's history had been relatively uneventful. For the past eight years, however, the company has more than atoned for the ennui of its early life. Since its 29th birthday, Safeguard has been suspended, reinstated and suspended once
[ 18 Pa. Commw. Page 200]
again. This period has also witnessed a change in the nature (from nonassessable to assessable) of the policies the company is permitted to write and an almost uninterrupted series of disputes and negotiations with the Department. The presence of the parties before this Court more than adequately reflects the degree of conciliation and compromise attained through these negotiations.
The event which precipitated this most recent dispute between the parties was the filing of Safeguard's June 20, 1973, quarterly statement with the Department. Sensing that Safeguard's presentation of its financial condition fell somewhat short of strict adherence to the law and to conservative accounting principles, the Insurance Commissioner ordered the performance of a field audit of this statement and a complete examination of the affairs and condition of Safeguard for the period October 1, 1970 through June 30, 1973.*fn1 This examination was conducted on Safeguard's premises from September 11 to October 29, 1973. As a result of the examination, a report was prepared which concluded that Safeguard was insolvent as of June 30, 1973. At this time, the Commissioner could rightfully have chosen to suspend Safeguard from any further conduct of its business pursuant to section 502 of the Insurance Department Act, 40 P.S. § 202. Instead, a formal departmental hearing was held, commencing on January 25 and concluding on January 31, 1974.*fn2 Although the primary questions raised at the hearing related to Safeguard's financial condition on June 30, 1973,
[ 18 Pa. Commw. Page 201]
both sides, and, in particular, Safeguard, presented evidence relevant to a possible change in such condition subsequent to that date. Thereafter, on February 22, 1974, the Commissioner issued an adjudication, finding Safeguard to be insolvent and/or in hazardous condition, and suspending the entire business of the company.
After further and fruitless negotiation, the Commissioner, on March 19, 1974, applied to this Court for an order directing Safeguard to show cause why its business should not be closed and the Commissioner should not take possession of its property and conduct its business.*fn3 The rule to show cause was granted on March 22, 1974. An evidentiary hearing was held in this Court during May and July of 1974. At the close of the Department's case, Safeguard moved for a compulsory non-suit, which motion was denied by an Order dated June 13, 1974.
Although proceedings under section 502 of the Insurance Department Act are in the nature of a statutory equity action, arguments on the merits were heard by the Court en banc.*fn4 This "shortcut" was followed in order to expedite the attainment of a final resolution of the very complex issues here involved, while, at the same time, giving full consideration to the dictates of justice and fairness.
The fundamental questions to which we must respond are whether Safeguard was insolvent and/or in hazardous condition on June 30, 1973, and, if so, whether there was an improvement in Safeguard's financial condition subsequent to that date. However, before undertaking consideration of these substantive issues, the respective
[ 18 Pa. Commw. Page 202]
roles of the parties must be clearly understood. The Department's decision to suspend Safeguard was based upon the examination conducted in the fall of 1973 and, ultimately, upon the company's status as of June 30, 1973. The Department being the moving party, we believe that it bears the burden of proving Safeguard to be insolvent and/or in hazardous condition on that date. Should the Department thus persuade this Court that Safeguard was insolvent and/or in hazardous condition on June 30, 1973, the onus would then fall upon Safeguard to show a subsequent change in its condition, which change resurrected the company.
I. INSOLVENT/HAZARDOUS CONDITION
Section 502 of the Insurance Department Act, 40 P.S. § 202, authorizes the Commissioner to suspend the entire business of an insurance company should an examination reveal the company to be "insolvent" or "in such condition that its further transaction of business will be hazardous to its policyholders, or to its creditors, or to the public."*fn5 Neither the Pennsylvania insurance laws nor the case law interpreting them provide a definition of "insolvent" or of "hazardous condition" as those terms are used in section 502. While several Pennsylvania statutes contain definitions of "insolvent" in a noninsurance context, the most comprehensive and practical definition, for insurance company purposes, appears in section 1-201(23) of the Uniform Commercial Code.*fn6 That section reads:
"(23) A person is 'insolvent' who either has ceased to pay his debts in the ordinary course of business or cannot pay his debts as they become due or
[ 18 Pa. Commw. Page 203]
is insolvent within the meaning of the federal bankruptcy law."
The federal law defines "insolvent" as follows:
"(19) A person shall be deemed insolvent within the provisions of this title whenever the aggregate of his property . . . shall not at a fair valuation be sufficient in amount to pay his debts";*fn7
The actual test of insolvency under the federal law is a simple balance sheet test; that is, where, at a fair valuation, a person's assets exceed his liabilities, that person is solvent. Ackman v. Walter E. Heller & Co., 307 F. Supp. 958 (S.D.N.Y. 1968), motion denied, 307 F. Supp. 971, aff'd, 420 F.2d 1380 (2d Cir. 1969).
From the above, it is possible to formulate a hybrid definition of "insolvent," applicable to Pennsylvania insurance companies. An insurance company is "insolvent" under section 502 of the Insurance Department Act when either it has ceased to pay its debts, in particular, claims, in the ordinary course of business, or it cannot pay its debts, in particular, claims, as they become due, or, taken at a fair valuation, its assets are lesser in amount than its liabilities.
Since the Department has neither alleged nor attempted to prove a nonpayment of debts or an inability to pay debts on the part of Safeguard, the decision regarding insolvency in this case will rest upon a comparison of Safeguard's assets and liabilities.
The term "in hazardous condition" is less receptive to guidance in framing a definition. Cases from other jurisdictions suggest that "hazardous condition" is not limited to financial considerations, and includes such matters as mismanagement, fraud, and public policy. However, for the purposes of this case, where the only allegations are directed to the financial condition of Safeguard, "hazardous condition" may best be defined as
[ 18 Pa. Commw. Page 204]
imminent insolvency, a state in which there is a dwindling surplus and a substantial likelihood, based on recent trends within the company, that a condition of actual insolvency will be reached in the near future.
While Safeguard's June 30, 1973 quarterly report indicated an excess of assets over liabilities (surplus) of about two million dollars, the Department, based upon its examination, found a negative surplus of at least $500,000 on that date. This discrepancy primarily resulted from the Department's refusal to consider certain items as assets, and its conclusion that Safeguard's reserves were understated. During the remainder of this opinion, each of these accounts, and the legal principles pertinent thereto, will be separately analyzed.
II. UNEARNED PREMIUM RESERVE
When an insurance company writes a policy and collects the premium thereon prior to the expiration of the term of the policy, a pro rata portion of the premium is considered unearned. By way of illustration, if an insurance company collects a $60 premium on a six month policy, after the first month of the term has elapsed, $10 is earned premium and $50 is unearned and will become earned only as the remainder of the policy term expires. At any point in time, the total amount of unearned premiums on all policies written by an insurance company constitutes that company's unearned premium reserve. As are most reserves, the unearned premium reserve is a contingency fund. The contingency for which it exists is that some or all of the policies may be cancelled (by the insurer or the insured) prior to the expiration of their terms. When such a cancellation occurs, the company is responsible for the return of the unearned portion of the premium to the insured, and the existence of an unearned premium reserve guarantees the availability of funds for that purpose.
[ 18 Pa. Commw. Page 205]
Of course, the unearned premium reserve is merely an accounting concept unless its maintenance is statutorily imposed upon an insurance company. Section 310 of the Insurance Department Act, 40 P.S. § 91, is the primary statutory provision relating to the unearned premium reserve. That section authorizes the Commissioner to determine the amount "any insurance company . . . should hold as an unearned premium liability."*fn8
Because it refers to "any insurance company," section 310 would have clearly obligated Safeguard to maintain an unearned premium reserve, unless Safeguard was otherwise excepted from its application. Safeguard is a domestic mutual fire insurance company which issues assessable policies. Section 807 of The Insurance Company Law of 1921,*fn9 40 P.S. § 917, contains an important exception, which eliminates the unearned premium reserve requirement of certain of such companies.
" Except when cash premiums are payable in advance, the provisions relating to unearned premium reserve shall not apply to policies issued by a domestic mutual fire insurance company which policies set forth therein, or in the promissory note attached thereto, a limited or unlimited liability to assessment." (Emphasis added.)
In terms of the amount of funds in dispute, the unearned premium reserve is the single most important issue raised by this litigation, and its resolution is wholly dependent upon the interpretation given the phrase "cash premiums payable in advance." That phrase lends itself to two possible interpretations:
1. Cash premiums are payable in advance when the insurance contract permits the insurer to demand all or part of the premium prior to the provision of
[ 18 Pa. Commw. Page 206]
adoption of this second interpretation would render the section 807 exception meaningless, a result which this, or any, Court is expressly forbidden to foster. "The Legislature cannot be deemed to intend that its language be superfluous and without import." Daly v. Hemphill, 411 Pa. 263, 273, 191 A.2d 835, 842 (1963). Thus, to give meaning to this language, we must adopt the first postured interpretation. Therefore, "cash premiums are payable in advance," within the meaning of section 807 of the Insurance Company Law, when, and only when, the insurance contract permits the insurer to demand all or part of the premium prior to the commencement of the policy term. In all other cases, the insurer, if a domestic mutual fire insurance company issuing assessable policies, will not be bound by the provisions relating to unearned premium reserve and, in particular, section 310. The only pertinent evidence introduced at the hearing clearly established that premiums were not payable in advance to Safeguard under its contracts of insurance. Safeguard thus qualified under the exception contained in section 807 and need not have maintained an unearned premium reserve on June 30, 1973.
For the purpose of giving this issue as complete a disposition as possible, we feel compelled to consider other arguments raised by the Department relating to the maintenance of an unearned premium reserve. The Department, perhaps reluctant to place its sole reliance upon the general mandate of section 310, has also cited section 202(f) of the Insurance Company Law*fn11 as authority for the imposition of this reserve requirement upon Safeguard. That section provides:
[ 18 Pa. Commw. Page 208]
"(f) Domestic stock and mutual insurance companies . . . may transact any or all of the kinds of insurance included in subdivisions (b) and (c) of this section upon compliance with all of the financial Page 208} and other requirements prescribed by the laws of this Commonwealth for fire, marine, fire and marine, and casualty insurance companies transacting such kinds of insurance." (Emphasis added.)
As of June 30, 1973, Safeguard was transacting certain types of insurance which are among those enumerated in sections 202(b) and (c), namely, automobile liability, comprehensive and collision. Having taken advantage of section 202(f), Safeguard was bound to comply with the "financial and other requirements" directed by that section. The Department has advocated the inclusion of the unearned premium reserve as an element of the ambiguous phrase "financial and other requirements." Despite section 807's specific exemption of certain domestic mutual fire insurance companies, the Department has apparently contended that section 202(f) preempts section 807 and revitalizes the applicability of section 310. Two Pennsylvania decisions belie the validity of this contention. Although neither decision offers a clue as to the exact scope of section 202(f), both impliedly exclude the unearned premium reserve from the "financial and other requirements" imposed thereby. In Bunker Hill Mutual Insurance Co. v. Leslie, 382 Pa. 356, 115 A.2d 378 (1955) and Commonwealth ex rel. Chidsey v. Urban Mutual First Insurance Co., 72 Pa. D. & C. 123 (1950), the matter before the courts was the unearned premium reserve requirement of a domestic mutual fire insurance company. Opposite results were reached, based upon the applicability of the section 807 exception. However, the significance of the two decisions lies in both courts' failure to cite section 202(f) as relevant in determining whether a particular domestic mutual fire insurance company was subject to the reserve requirement of section 310. Section 807 was viewed as the fulcrum upon which the resolution of the issue would turn. By ignoring section 202(f), the courts impliedly limited its scope to "financial and other requirements" apart from the unearned premium reserve.
[ 18 Pa. Commw. Page 209]
The Department's final salvo was also its weakest. Section 316 of the Insurance Department Act, 40 P.S. § 115, vests in the Commissioner the discretionary power to require the maintenance of additional reserves by an insurance company. Since section 316 refers solely to "liability or compensation loss reserves," it is manifestly inappropriate in the context of unearned premium reserves.
To summarize, sections 310 and 807 are the only statutory provisions relevant to a resolution of this issue. Section 310 requires every insurance company to maintain an unearned premium reserve. Section 807 contains a narrow exception to section 310, and Safeguard qualifies under that exception. Therefore, in our determination of whether Safeguard was insolvent and/or in hazardous condition on June 30, 1973, Safeguard will be considered as having had no liability for an unearned premium reserve.
III. UNEARNED BROKERS' COMMISSIONS
On its June 30, 1973, quarterly, Safeguard reported its liability for unearned premium reserve as $988,884.88. In the examination report which contained the initial finding of insolvency, the Department assessed this same liability at $1,519,590.51. The parties have agreed that the total amount of Safeguard's unearned premiums on June 30, 1973, was equal to the higher figure. The discrepancy in evaluating the unearned premium reserve liability resulted from Safeguard's establishment of a contra liability in reduction of its full statutory liability. This contra liability had as its basis the so-called "unearned commissions" of Safeguard's brokers. Although no longer relevant to a disposition of this case, the validity of this setoff procedure should be determined.
Safeguard has postulated that the commission received by a broker upon his writing of a policy must be prorated over the life of the policy in the same way that
[ 18 Pa. Commw. Page 210]
premiums collected by the insurer are prorated.*fn12 Further, Safeguard has contended that, upon premature cancellation of a policy, the broker is legally obligated to return the unearned portion of his commission to the insurer, who then remits the full amount of the unearned premium (including the broker's share) to the insured. Under this theory, the "unearned brokers' commissions" would serve to reduce the potential liability of the insurer when cancellations occur. Although Safeguard failed to offer support for this theory, it is the opinion of this Court that a pro rata portion of the commissions received by an insurance company's brokers may be established as a contra liability to the company's unearned premium reserve, if the brokers are contractually bound, upon the cancellation of a policy, to make repayment to the company.
As a general rule, an insurance broker's commission is fully earned immediately upon the writing of the policy. Schlesinger v. Star Ins. Co. of America, 100 Pa. Superior Ct. 584 (1931). In addition, the broker's right to the entire commission is unaffected by a premature cancellation of the policy. Id. However, the broker is free to contractually waive this right. Id. In Hammonton Investment & Mortgage Co. v. Empire Mutual Fire Insurance Co. of Pennsylvania, 387 Pa. 382, 128 A.2d 73 (1956), the court found such a waiver where the broker agreed, pursuant to a clause in his contract, to repay his commissions pro rata in cases of cancellations. Also, the Hammonton court held that the broker's duty to return his commission to the company arose concurrently with the company's duty to return its unearned premium to the canceling policy-holder. The act of cancellation simultaneously triggered both duties. Thus, when properly contracted for, the right of the company to the "unearned brokers' commissions"
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is no more contingent than the duty of the company to remit the unearned premium, and this right may be correctly set off against the company's unearned premium reserve liability.
Had an application of these principles been essential to this decision, Safeguard's treatment of the "unearned brokers' commissions" as a contra liability would have been invalidated. While Safeguard did introduce evidence that its brokers customarily remitted portions of their commissions to the company when cancellations ...