ADOPTED RULES An agency may take final action on a section 30 days after a proposal has been published in the Texas Register. The section becomes effective 20 days after the agency files the correct document with the Texas Register, unless a later date is specified or unless a federal statute or regulation requires implementation of the action on shorter notice. If an agency adopts the section without any changes to the proposed text, only the preamble of the notice and statement of legal authority will be published. If an agency adopts the section with changes to the proposed text, the proposal will be republished with the changes. TITLE 16. ECONOMIC REGULATION Part IV. Texas Department of Licensing and Regulation Chapter 75. Air Conditioning and Refrigeration Contractor License Law 16 TAC sec.sec.75.10, 75.21, 75.70 The Texas Department of Licensing and Regulation adopts amendments to sec.sec.75.10, 75.21, and 75.70, concerning licensing for air conditioning and refrigeration contractors. Section 75.70 is adopted with changes to the proposed text as published in the December 2, 1994, issue of the Texas Register (19 TexReg 9439). Section 75.10 and sec.75.21 are adopted without changes and will not be republished. The justification for the new and amended definitions is that contractors will have a clearer understanding of how they can meet the requirements of the rules. The justification for the addition of the rule on cheating is that the public will be protected from contractors who may not be technically competent if they resort to cheating to gain a license. The justification for the amendment to sec.75.70(c) is that consumers will have more protection because when all parts of a job are subcontracted to an unlicensed individual or firm, there is no personal supervision by the licensed contractor. This makes it difficult for the consumer to identify the person or firm responsible for the completion, technical quality, and insurance coverage of a job. The justification of the amendment to sec.75.70(j) is that it will give relief to national companies for advertising expense without degrading consumer protection. The amendments will function by increasing program integrity. No comments were received regarding sec.75.10 and sec.75.21 during the comment period. A comment was received objecting to the extension of the prohibition of subcontracting all work requiring a license to unlicensed persons or firms because this would exclude firms engaged in such work as microbiological remediation in the field of management of indoor air quality. While some of the tasks performed by such firms are outside the scope of Article 8861, some are clearly within it, and should be regulated as such. The department believes that changing the subsection to state the circumstances under which work may be subcontracted to an unlicensed person or firm, and proposing an addition to sec.75.100(d) concerning Duct Cleaning will protect the public while placing less of a burden on firms that engage only in limited aspects of indoor air quality management. The amendments are adopted under Texas Civil Statutes, Article 8861, which authorize the department to license and regulate air conditioning and refrigeration contractors. sec.75.70. Responsibilities of the Licensee. (a)-(b) (No change.) (c) A licensed air conditioning and refrigeration contractor may subcontract portions of work requiring a license under the act to unlicensed persons, firms, or corporations so long as: (1) such licensed contractor actively provides work or services requiring a license, either in person or with the contractor's bona fide employees; (2) the work provided in person or with the licensed contractor's bona fide employees consists of more than accepting a contract or request for service, scheduling the work, and providing supervision of the work; and (3) the licensed contractor is ultimately responsible to the customer for all work performed by the subcontractor. (d)-(i) (No change.) (j) All advertising by contractors requiring a license under the Act designed to solicit business shall include the contractor's license number. Advertising which requires the license number shall include printed material, television ads, newspaper ads, yellow pages, business cards, billboards, solicitations, proposals, quotations, and invoices. Other items for the purpose of attracting business, other than promotional items of value such as ball caps, tee shirts, and other gifts, must include the license number. Yellow page listings that do not contain any information except the name, address, and telephone number are not required to contain the contractor's license number. In nationally placed television advertising, a statement indicating that license numbers are available upon request may be used in lieu of the contractor's license number. Letterheads and printed forms for office use are not required to have the license number included. Signs located outside the contractor's permanent business location are not required to have the license number displayed. (k)-(l) (No change.) This agency hereby certifies that the rule as adopted has been reviewed by legal counsel and found to be a valid exercise of the agency's legal authority. Issued in Austin, Texas, on January 19, 1995. TRD-9500787 Jack W. Garison Executive Director Texas Department of Licensing and Regulation Effective date: February 9, 1995 Proposal publication date: December 2, 1994 For further information, please call: (512) 463-7357 TITLE 19. EDUCATION Part II. Texas Education Agency Chapter 137. Professional Educator Preparation and Certification Subchapter N. Certificate Issuance Procedures 19 TAC sec.137.436 The Texas Education Agency (TEA) adopts an amendment to sec.137.436, concerning the schedule of fees for certification services, with changes to the proposed text as published in the October 21, 1994, issue of the Texas Register (19 TexReg 8340). The amendment is necessary to provide additional resources that will fund enhanced certification services and development of a new educator appraisal system. The change, located in implied subsection (a), corrects an editorial error by changing the effective date specified in the rule for implementing the schedule of certification fees from January 1, 1995, to March 1, 1995. The amendment will help generate revenue by increasing the fees for some certification services and establishing a new probationary certificate and related fee. No comments were received regarding adoption of the amendment. The amendment is adopted under the Texas Education Code, sec.13.032(h), which authorizes the State Board of Education to fix and require payment of a fee as a condition to the issuance of a teaching certificate. sec.137.436. Schedule of Fees for Certification Services. Effective March 1, 1995, an applicant for a certificate or a school district requesting a permit shall pay the applicable fee from the following list. (1) Paraprofessional certificate-$30. (2) Provisional and professional certificates, additional specialization, teaching field, or endorsement/delivery system, based on recommendation by an approved teacher preparation entity or Texas Education Agency (TEA) authorization; or extension or conversion of certificate-$75. (3) Probationary certificate based on recommendation by an approved teacher preparation entity or Texas public school district-$50. (4) Duplicate of certificate or change of name on certificate -$45. (5) Review of credentials requiring analysis and research of test history on the Examination for the Certification of Educators in Texas (ExCET) and eligibility for certification under sec.137.437 of this title (relating to Issuance of Certificates Based on Examination) (nonrefundable)-$75. (6) Review of credentials requiring analysis and research of college transcripts and/or out-of-state certificate programs (nonrefundable)-$75. (7) Addition of certification based on completion of appropriate examination and/or internship requirements specified in sec.137.437 of this title (includes the nonrefundable credential review fee of $75)-$150. (8) Initial certificate based on certificate issued by another state department of education (includes the nonrefundable credential review fee of $75)-$125. (9) Initial permit, initial noncertified instructor's permit, reassignment on permit with a change in level of target certificate, or renewal of permit on a hardship basis (nonrefundable) -$75. (10) Renewal in the school district of a permit at the same target certificate level and initial activation, or renewal in the same school district of a temporary classroom assignment permit-no fee. This agency hereby certifies that the rule as adopted has been reviewed by legal counsel and found to be a valid exercise of the agency's legal authority. Issued in Austin, Texas, on January 23, 1995. TRD-9500920 Criss Cloudt Executive Associate Commissioner, Policy Planning and Information Management Texas Education Agency Effective date: February 13, 1995 Proposal publication date: October 21, 1994 For further information, please call: (512) 463-9701 TITLE 28. INSURANCE Part I. Texas Department of Insurance Chapter 21. Trade Practices Subchapter J. Prohibited Trade Practices 28 TAC sec.21.1002 The Texas Department of Insurance adopts new sec.21.1002, concerning the use of unfair underwriting guidelines for private passenger automobile and residential property insurance, with changes to the proposed text as published in the November 15, 1994, issue of the Texas Register (19 TexReg 8935). A public hearing on the proposed section was held January 4-5, 1995. The new section is necessary to prevent the use of unfair underwriting guidelines for private passenger automobile and residential property insurance. Underwriting guidelines are defined as being unfair unless they are actuarially sound or are deemed to be in compliance with the rule under a safe harbor provision. Use of unfair underwriting guidelines causes consumers to either be denied insurance or be placed in insurance companies with higher rates than those companies for which they would otherwise qualify. The Department has made several non-substantive changes to the proposed rule: Changes to proposed subsection (a): The prohibition in subsection (a) was amended to apply only to actions taken after June 1, 1995. The wording of the first sentence in subsection (a) was rearranged to clarify that the rule applies only to the sale of private passenger automobile and residential property insurance. The phrase "unless otherwise expressly authorized by law" was deleted because the rule was changed to require that underwriting guidelines be actuarially sound. Sound actuarial principles require compliance with the law. Changes to proposed subsection (b): The wording was changed and the word "or" was added to the end of subsection (b)(1) to enhance readability. The two subsections, (b)(1) and (b)(2), were changed to clarify that an underwriting guideline is unfair unless actuarially sound or deemed to be in compliance with the rule under a safe harbor provision. Race, color, religion, national origin, and familial status were removed from the rule. Changes to proposed subsection (c): The entire section was replaced with a definition of the term "actuarially sound" to reflect the changes to subsection (b). Changes to proposed subsection (d): The phrase "an insurer subject to subsection (a)" was changed to "an insurer or agent subject to subsection (a)" to clarify that an agent is not required to obtain prior approval of underwriting guidelines. The Department changed subsection (d)(1)(B) from "was substantially at fault" to "can reasonably be considered to have been at fault." The safe harbor for underwriting guidelines based on a conviction for arson was changed to eliminate the conviction requirement. The safe harbor for physical hazards was deleted because it was repetitive of the safe harbor for underwriting guidelines based on the physical condition of the premises. Changes were also made to typographical errors in subsection (d)(3) of the proposed version of the rule. Subsection (d)(3)(A) was amended to provide that the safe harbor period for underwriting guidelines filed with the Department begins 60 days prior to the date of filing with the Department. This change was made to address those rare instances mentioned by several commenters wherein an agent or insurer has a legitimate and fair reason for rejecting an applicant but did not foresee the need for such an underwriting guideline and cannot collect sufficient data to justify the guideline based on sound actuarial principles. This change gives the insurer or agent 60 days to file a request that the new underwriting guideline be added to the safe harbor list. Such a filing will protect the agent or insurer from liability for the use of such guideline. If the Department, however, determines that the guideline is not fair, its ruling will then protect future consumers from being subjected to that unfair guideline. A provision was added to subsection (d)(3)(A) for filing a request to add an additional underwriting guideline to the list of safe harbor guidelines to provide that once one person files the request, any person using the underwriting guideline obtains the safe harbor protections and to provide for a public listing of the underwriting guidelines under consideration. Subsection (d)(3)(B) was amended to clarify ways the Department can collect data. A provision was added as subsection (d)(3)(C) to provide that the name of an insurer who files such a request will not be released publicly, unless the insurer consents in writing to the identification. Changes to proposed subsection (e): The words "renew" and "nonrenew" were added to subsection (e) to clarify that the decision whether to accept or reject a consumer applies to the decision whether to renew a policy. The word "groupings" was changed to "classes." Changes to proposed subsection (g): This subsection was deleted because it defined a term used in the definition of related to risk or expense and that definition was deleted from the rule. Subsections added: A definition of the term "private passenger automobile insurance" was added as subsection (g). A partial exemption for agents to the extent they act solely at the direction of an insurer was added as subsection (h). No changes were made to proposed subsections (f) or (h), other than changing the letter of subsection (h) to subsection (i). This reasoned justification is organized as follows: 2.1 The Purpose of the Rule 2.2 Unfair Discrimination and Insurance Availability 2.2.1 Insurance Availability 2.2.2 The availability of insurance is important for individuals and businesses 2.2.3 This rule does not envision nor create a subsidy among classes of consumers 2.2.4 Studies of Availability Problems in Texas Insurance Markets 2.2.4.1 1993 Office of Public Insurance Counsel (OPIC) Study of the Geographic Distribution of Private Passenger Automobile Insurance Assigned Risks 2.2.4.2 1993 OPIC Study of the Location by ZIP Code of State Farm Agents 2.2.4.3 1993 Texas Department of Insurance (TDI) Study of TAIP and Homeowners Markets 2.2.4.4 1994 OPIC Studies of Private Passenger Automobile and Homeowners Insurance Underwriting Guidelines 2.2.4.5 1994 TDI Analysis of NAIC/Texas Special Call Data 2.2.4.6 1994 Study of the NAIC/Texas Special Call Data by the Austin American Statesmen 2.2.4.7 The insurance industry acknowledges availability problems 2.3 Risk Classifications, Underwriting Guidelines and Market Failures 2.3.1 No Natural Groupings of Risk 2.3.2 Unfair Discrimination and Availability Problems Represent Market Failures 2.4 Unfair Underwriting Guidelines and Unfair Discrimination 2.4.1 Underwriting guidelines are inherently unfair if they are inconsistent with public policy expressions of social and economic fairness 2.4.2 Underwriting Guidelines Are Unfair If They Do Not Distinguish Groups of Consumers on the Basis of Expected Costs Associated With the Transfer of Risk 2.5 Regulation is necessary to address unfair underwriting guidelines and is consistent with beneficially competitive insurance markets 2.5.1 Insurance regulation expresses public policy regarding social and economic fairness of certain underwriting guidelines 2.5.2 Insurance regulation can address the market failures caused by unfair underwriting guidelines 2.6 The Department has developed rules to prohibit unfair underwriting guidelines consistent with the role of regulation and appropriate to address failures of insurance markets represented by unfair underwriting practices 2.6.1 The practices prohibited by this rule are unfair 2.6.2 Other new underwriting rules 2.6.3 Previous Department Underwriting Rules 2.7 The Department has authority to promulgate this rule 2.7.1 Article 21.21, sec.13(a) 2.7.2 The private cause of action 2.7.3 Article 5.98 2.1 The Purpose of the Rule The purpose of this rule is to eliminate unfair underwriting practices in the business of insurance. The unfair practices prohibited by this rule have an adverse impact on the availability and affordability of insurance to consumers. 2.2 Unfair Discrimination and Insurance Availability Consumers who encounter unfair discrimination in the purchase of insurance are either denied coverage completely or denied coverage at the rates for which they would legitimately qualify in the absence of the unfair discrimination. The availability of appropriately-priced insurance is unfairly denied these consumers as a result of the use of unfair underwriting guidelines. The elimination of unfair underwriting guidelines will cause consumers to be treated more fairly in the business of insurance and thereby increase the availability of appropriately-priced insurance. 2.2.1 Insurance Availability To better understand the problems caused by unfair underwriting guidelines, a general description of insurance markets is necessary. Most insurance markets consist of three submarkets: preferred, standard and substandard. Preferred companies have the lowest rates and sell to the consumers perceived to represent the lowest risk. Standard companies sell to consumers perceived to represent average risks. Substandard companies (including residual market mechanisms) have the highest rates and sell to consumers perceived to represent the highest risk. For consumers forced into substandard companies, insurance is unavailable in standard and preferred markets. This availability problem for consumers forced into substandard companies may be two-fold: the consumer is unfairly charged higher rates (which he or she may not be able to afford) and/or the product sold is inferior to the product available in the standard or preferred markets (e.g. offers less coverages or is not covered by the state's guaranty association). It is through the use of unfair underwriting guidelines that consumers are unfairly denied coverage in standard and preferred companies and forced to go without insurance or purchase higher-cost insurance in substandard or residual markets. 2.2.2 The availability of insurance is important for individuals and businesses. President Johnson's Commission on Insurance Availability, formed in the aftermath of the Los Angeles rioting in the 1960s, found that "communities without insurance are communities without hope." This statement is no less true today. Consumers may not operate a car without automobile liability insurance (pursuant to the financial responsibility law) and cannot purchase a car on credit without automobile physical damage insurance. Consumers unable to purchase homeowners insurance are unable to obtain a loan to purchase a home. In addition to the harm caused to the individual consumers who are unfairly denied insurance, denying insurance to citizens and small businesses in economically underdeveloped areas contributes to the problems of inadequate economic opportunity and social decay that plague these areas. 2.2.3 This rule does not envision nor create a subsidy among classes of consumers. In this Order, the term "affordability" is used strictly in terms of consumers having fair and legitimate access to standard and preferred companies; that is, making the more affordable standard and preferred rates available to those consumers who would otherwise be unfairly relegated to higher cost, non-standard insurers or assigned risk markets. The Department's discussion of affordability does not imagine or propose a subsidy for those people who cannot afford insurance offered at fair rates commensurate with the expected costs associated with the transfer of risk. Nor does the rule create a right for those consumers posing higher expected costs associated with the transfer of risk who are fairly placed in substandard markets to receive lower rates in standard or preferred companies. 2.2.4 Studies of Availability Problems in Texas Insurance Markets There has been substantial data collection and analysis concerning insurance availability in Texas over the past few years. These studies, based on data supplied by insurers and from other sources, show that the availability of insurance in Texas varies dramatically by geographic area and that variation is statistically related to race. Copies of the studies and documents discussed in this section are available from the Department. 2.2.4.1 1993 Office of Public Insurance Counsel (OPIC) Study of the Geographic Distribution of Private Passenger Automobile Insurance Assigned Risks In testimony filed in February 1993, OPIC analyzed the distribution of automobile insurance assigned risks written through the Texas Automobile Insurance Plan (TAIP), the predecessor of the current Texas Automobile Insurance Plan Association (TAIPA). OPIC analyzed the number of TAIP insureds by ZIP Code compared to the driving age population in the ZIP Code. The study showed that many areas of the state had availability problems, as measured by significantly higher-than-average concentrations of TAIP assignments. If only high-risk drivers were being relegated to the TAIP, as theoretically should have been the situation, there would have been an expectation of a more even geographic distribution of TAIP assignments by ZIP Code. There would be no expectation that bad drivers live together in certain ZIP Codes. The analysis also showed that those ZIP Codes with high minority populations were the ones more likely to be have, on average, greater-than-average concentrations of TAIP assignments. The study is included in the Supplemental Direct Testimony of David "Birny" Birnbaum in Docket 1932, styled Texas Automobile Insurance Plan For Private Passenger and Commercial Automobile Rate Case. 2.2.4.2 1993 OPIC Study of the Location by ZIP Code of State Farm Agents This study examined the ZIP Code location of State Farm agents in three major metropolitan areas: Harris, Bexar and Travis counties. State Farm is the largest automobile and homeowners insurance writer in Texas, with over one-third of the standard and preferred automobile and homeowners insurance markets. With such a large share of the market, the location of State Farm agents may be an important availability factor. The study showed a striking difference in the average minority population and median housing value in those ZIP Codes with State Farm agents when compared to those ZIP Codes without State Farm agents. For example, in Harris County there were 22 ZIP Codes with populations greater than 20,000 each without any State Farm agents compared to 54 ZIP Codes with populations greater than 20,000 with State Farm agents. The 54 ZIP Codes had a total of 206 agents. The minority population of the 22 ZIP Codes without State Farm agents was 53.6% compared to 29.2% in the 54 ZIP Codes with the State Farm agents. In addition, the location of State Farm agents was highly correlated to the incidence of TAIP assignments from the earlier study. Those ZIP Codes without State Farm agents also tended to be the same ZIP Codes with higher-than-average TAIP assignments. The location of State Farm agents is important because the absence of agents able to write business in standard or preferred companies is also an indicator of both automobile and homeowners insurance availability. 2.2.4.3 1993 Texas Department of Insurance (TDI) Study of TAIP and Homeowners Markets The next study, dated August 1993, was a Department report entitled "Analysis of Texas Automobile Insurance Plan (TAIP) and Homeowners Markets." Dr. Mark Crawshaw, a consulting actuary to the Department, used an updated automobile insurance assigned risk data set to perform a regression analysis to analyze the distribution of TAIP assignments in Houston. The regression analysis controlled for other relevant factors, including housing value and the percentage of renters in a ZIP Code. The study showed that, after controlling for these other factors, a consumer in a high minority ZIP Code was three to four times more likely to be placed in TAIP than residents in low-minority ZIP Codes. Thus, even after removing the contribution of median housing value and percentage of renters as explanatory characteristics, the minority population of a ZIP Code was a significant predictor of the likelihood of being placed in the assigned risk plan. These findings are reported in Exhibit A, Sheet 5 of the report. Dr. Crawshaw did a similar analysis for the price of homeowners insurance in Houston. He found that, while holding median housing value constant, consumers in ZIP Codes with high minority populations are insured through companies with average homeowners rates that are about 10% higher than the average rates of homeowners insurance for companies insuring consumers in ZIP Codes with low minority populations. Thus, even controlling for the principal factor in the price of insurance-housing value-the analysis found that minority population in a ZIP Code correlated to differences in prices charged for homeowners insurance. These findings are reported in Exhibit C, Sheet 4 of the report. 2.2.4.4 1994 OPIC Studies of Private Passenger Automobile and Homeowners Insurance Underwriting Guidelines In studies entitled "A Review of Homeowners Insurance Underwriting Guidelines Used in Texas" and "A Review of Auto Insurance Underwriting Guidelines Used in Texas," released in February and June 1994 respectively, OPIC reviewed and analyzed underwriting guidelines of Texas homeowners and private passenger automobile insurers. The OPIC studies revealed a variety of underwriting guidelines which restrict insurance availability in certain parts of Texas. From these studies and testimony at the redlining hearings held by the Department, it was shown that consumers may be denied coverage for a variety of reasons, including geographic location. These studies also found that 29% of the homeowners insurance market has a underwriting guideline for lifestyle. These guidelines exclude any couples, families and friends who are not married or related by blood and decide to combine households for financial, health or other reasons. The studies identified numerous other underwriting guidelines that have an adverse impact on the affordability and availability of insurance and which do not appear to be related to risk. For automobile insurance, for example, 56% of the market has occupation restrictions and 51% of the market has employment stability restrictions. Other automobile insurance guidelines include home ownership and length at residence requirements. Homeowners insurance guidelines include minimum coverage requirements, age of house restrictions, occupation restrictions, location restrictions, and employment stability restrictions. One Texas automobile insurer's underwriting guideline discriminates against persons with disabilities, regardless of the disability or whether it affects driving skills: "Risks which show no apparent means of support or show disability as the occupation." Several homeowners insurance guidelines involve the age of the consumer, without any apparent showing of a relation to risk or expense. The Department has also received complaints from consumers regarding underwriting practices that the consumers claimed are not related to risk. 2.2.4.5 1994 TDI Analysis of NAIC/Texas Special Call Data In March and November 1994 the Department released studies of private passenger insurance availability based upon ZIP Code level premium, exposure and agent information submitted by the top 40 insurers for the NAIC/Texas Special Data Call. In these studies, the measure of insurance availability was defined as the share of exposures written in the TAIP (assigned risk) plus substandard companies (mostly county mutuals) as a percentage of all exposures written in the ZIP Code. A high percentage indicates more people insured in substandard companies and the assigned risk plan, while a low percentage indicates more people insured in the standard and preferred markets. The lower the share of TAIP and substandard exposures, the better the availability of automobile insurance. This share of TAIP plus nonstandard to total exposures is an excellent measure of private passenger automobile insurance availability because the measure identifies the share of all consumers who sought automobile insurance, could afford it, paid for it and, yet, were rejected by standard and preferred companies. Substandard company rates are typically substantially higher than rates from standard and preferred insurers. TAIP consumers were not eligible for coverage through TAIP unless they were unable to obtain coverage in the standard or preferred market. Therefore, the class of consumers insured through TAIP or by substandard companies constitutes a class of consumers for whom coverage in the standard and preferred market was not available. The chart entitled "NAIC/Texas Special Call-Texas Statewide Results" shows the summary results of the study. As the minority population of the ZIP Codes increases, insurance availability worsens. For example, for those 97 ZIP Codes with TAIP plus non-standard shares 51% to 75% above the statewide average, the average of the minority population percentages was 141% above the statewide average. For those 391 ZIP Codes with TAIP plus non-standard shares 26% to 50% below the statewide average, the average of the minority population percentages was 44% below the stateside average. The chart shows a remarkable relationship between the minority population of a ZIP Code and the availability of automobile insurance in that ZIP Code. FIGURE 1: 28 TAC sec.21.1002 (Preamble) The Department also performed a regression analysis on the data set of about 1400 ZIP Codes. Even after the contribution of median housing value as an explanatory factor for insurance availability was statistically removed, the minority population of a ZIP Code remains a significant predictor of insurance availability at the 99% confidence level. If median household income is held constant, the share of TAIP plus non-standard is 25% to 70% higher in high minority ZIP Codes compared to low minority ZIP Codes. The Department developed maps for several counties in Texas to present the ZIP Code level data more graphically. The first maps show insurance availability factors and minority population factors in Dallas County. These maps look very similar because those ZIP Codes with poor insurance availability are, in most cases, the same ZIP Codes with high minority populations. Maps of Harris, Tarrant, Bexar and Travis Counties demonstrate similar findings. The Department also developed ZIP Code detail maps for these five counties showing the total population in the ZIP Code and the number of agents located in those ZIP Codes who are able to write business in nine of the top standard or preferred companies. These nine insurers represent the vast majority of business written by standard and preferred companies who utilize agents. The maps show that the location of agents varies dramatically by ZIP Code and that variation is also related to insurance availability. On the map of Dallas county, a cluster of seven adjacent ZIP Codes in south central Dallas County with poor insurance availability shows a total of three standard agents serving a population of over 191,000 people. In comparison, a cluster of nine adjacent ZIP Codes in north central Dallas County shows 366 agents serving a population of about 275,000 people. The maps of Bexar, Harris, Travis and Tarrant counties show similar disparities in the location of agents. This is an important finding because the absence of agents able to write business in standard or preferred companies is also an indicator of homeowners insurance availability problems. 2.2.4.6 1994 Study of the NAIC/Texas Special Call Data by the Austin American Statesmen A study by the Austin American Statesman also analyzed the NAIC special call data. The Statesman concluded that "minority Texans were far more likely than affluent or white Texans to be charged the highest rates for automobile insurance, according to industry data." In particular, the Statesman found that, as the percentage of minorities in a ZIP Code increased, so did the percentage of substandard and assigned risk policies. The article statewide about 20% of the automobile insurance policies written are in county mutuals or written through TAIP, in ZIP Codes where at least two-thirds of the residents were minorities, 37% of the policies were substandard or TAIP. In ZIP Codes where at least two-thirds of the residents were white, only 15% of the polices were in the high-cost categories. The analysis showed that, where more than 90% of the residents were African American or Hispanic, three of every seven policyholders were in higher priced county mutual insurers or insured through TAIP. By contrast, where more than 90% of the residents were white, only one of seven policyholders were insured through county mutuals or TAIP. The article in which the results of that analysis were published appeared in the September 30, 1994 edition. As reported in that same Austin American-Statesman article, the Texas Department of Public Safety (DPS) reports that minorities are no more likely than whites to have been involved in traffic accidents. In 1992, DPS reports show that, of the drivers involved in accidents in Texas, 61% were white, 20% were Hispanic, 12% were African American and 7.0% were unknown or of another background. The state's population is 61% white, 25% Hispanic, 12% African American and 2.0% other. The Department has reviewed both DPS and Census data and confirmed the numbers reported in the Statesman. The finding that minorities are not over-represented in their involvement in automobile accidents is important. If the reason for poor availability in minority areas is, as some insurers assert, higher losses in those areas, we would expect a disproportionate share of minority involvement in automobile accidents. The actual data on minority involvement in accidents casts doubt on this theory and justification for availability problems in minority areas. 2.2.4.7 The insurance industry acknowledges availability problems The results of these many studies show clearly that insurance availability problems exist in Texas and those availability problems are typically related to the minority population of an area. Many insurers, agents and industry trade associations have acknowledged to the Department that availability problems exist. In addition, when Senator Rodney Ellis and the Department brought interested parties together to address availability problems in Houston in what came to be called the Houston Redlining Task Force, all members of the task force agreed to this basic covenant: The purpose of the redlining task force is to increase the availability of affordable insurance to Texas consumers. All task force participants agree that some areas and groups of consumers are underserved in the personal lines and small commercial insurance markets. The purpose of the task force is to solve the problem, not discuss whether a problem exists. Members of the task force included State Farm, Allstate, Farmers, ITT Hartford, the Texas Association of Insurance Agents, the National Association of Independent Insurers, and the American Insurance Association, as well as the Department of Insurance, the Office of Public Insurance Counsel, legislators, community organizations and consumer groups. Insurance availability is important because insurance is essential for consumers to meaningfully participate in society and for economic development to occur in those areas currently lacking in economic opportunity. The opportunity for economic improvement is intimately tied to the opportunity to purchase necessary insurance. To the extent that insurance is not available because of unfair underwriting guidelines, this rule is necessary to prevent such unfair practices. 2.3 Risk Classifications, Underwriting Guidelines and Market Failures The purpose of insurance is to protect consumers through the transfer of risk to insurers and through that process to spread aggregate risk among many consumers. The most fundamental insurance decision is how the population of consumers will be grouped into subsets of the population for the purpose of grouping similar risks and setting prices for consumers. As a society, we have decided that some grouping of risks is appropriate and desirable. We do not make people completely pay for their own accidents (no insurance) nor do we as a society pool the entire population so everyone pays the same average rate. The choice of underwriting guidelines, in conjunction with other rating factors, represent decisions about the grouping of risk. 2.3.1 No Natural Groupings of Risk There are no natural groupings of risk. In fact, there are many ways to group risk to create actuarially-sound risk classifications in the sense that total premiums for each class of consumers adequately, but not excessively, covers the costs associated with each class of consumers. While it is typical for insurers to review the appropriateness of rates for each class of consumers, it is less common, and in many cases impossible, to analyze the intra-class fairness. While the rates for the class of consumers may be fair in aggregate, the class may consist of heterogeneous risks and represent a subsidy by some risks in the class of other risks in the class. It is important to emphasize that there are no natural groupings of risk. The choice of risk classifications represents a combination of public policy expressions through regulation and individual insurer underwriting decisions. 2.3.2 Unfair Discrimination and Availability Problems Represent Market Failures Availability problems represent market failures-the insurance markets have failed to provide consumers with equal opportunity to purchase necessary insurance. These availability problems may be caused by unfair discrimination, representing a classic economic problem of irrational behavior. Availability problems may also be caused by insurers acting rationally, but because of structural market failures, these rational market decisions produce not the beneficial results of Adam Smith's invisible hand, but perverse outcomes for consumers. 2.4 Unfair Underwriting Guidelines and Unfair Discrimination Underwriting guidelines determine whether a consumer will be written by a preferred, standard, or substandard company, or denied coverage entirely. More specifically, underwriting guidelines are the rules, standards, marketing decisions, guidelines, or practices, whether written, oral or electronic, used by an insurer or its agent to examine, bind, accept, reject, renew, nonrenew, or cancel consumers or limit the coverages made available to consumers. Not all availability problems are unfair; however, to the extent that a lack of availability is based on unfair underwriting guidelines, the lack of availability is unfair. An underwriting guideline is unfair if it is either inherently unfair or actuarially unsound. Underwriting guidelines are inherently unfair if they are inconsistent with public policy expressions of social and economic fairness. Underwriting guidelines are also unfair if the guideline does not actually distinguish consumers of different expected costs associated with the transfer of risk. If there is no sound actuarial basis for the discrimination among consumers based upon a particular underwriting guideline, consumers of similar risk are being treated differently and, for at least one class of consumers, unfairly. 2.4.1 Underwriting guidelines are inherently unfair if they are inconsistent with public policy expressions of social and economic fairness Some groupings of risk are inherently unfair, regardless of the loss experience associated with the risk classification differentiating the groups. Professors Keeton and Widiss, in their treatise on Insurance Law, recognize that, even if correlations to higher losses could be shown, open competition that would allow certain kinds of discrimination is not beneficial and would violate fundamental public policy interests: [P]ublic policy interests of various types (including policies against discrimination based on race, sex, and other individual characteristics over which the individual has no control) sometimes weigh against use of insurance rating categories that might be "nondiscriminatory" in a sense concerned only with correlation between loss experience and selected individual characteristics. Keeton and Widiss, Insurance Law, A Guide to Fundamental Principles, Legal Doctrines, and Commercial Practices, 956-957 (West 1988). In their comments on Rule sec.21.1002, State Farm agreed that "when racial, ethnic or religious discrimination [is occurring,] government intervention is appropriate to eliminate such deplorable practices." The Department agrees with these commentators. 2.4.2 Underwriting Guidelines Are Unfair If They Do Not Distinguish Groups of Consumers on the Basis of Expected Costs Associated With the Transfer of Risk An underwriting guideline is unfair if the characteristic is not related to differences in the costs associated with the transfer of risk. A fair underwriting guideline identifies a characteristic of the consumer, vehicle, property or business which accurately distinguishes consumers on the basis of differences in expected costs associated with the transfer of risk. The term "sound actuarial principle" is used to describe both the standard for fairness and the methodology to test for the standard of fairness. As a standard, sound actuarial principles means that the underwriting guideline or rating factor in question accurately distinguishes consumers on the basis of differences in expected costs associated with the transfer of risk. As a methodology, sound actuarial principles mean an analysis consistent with the actuarial standards of practice and compliance guidelines promulgated by the Actuarial Standards Board of the American Academy of Actuaries. In simpler terms, an underwriting guideline is unfair if it causes two consumers of similar characteristics to be treated differently. An underwriting guideline is actuarially sound if it causes consumers of similar characteristics to be treated similarly. A class of consumers should be treated differently from another class of consumers only if the costs associated with the transfer of risk for the first class are different than for the second class. If the estimated costs associated with the transfer of risk is the same for both classes, then it would be unfair to treat the two classes differently in the underwriting decision. In determining if an underwriting guideline is actuarially sound, it is vitally important that the analysis control for all other known risk factors and identify the unique contribution of the underwriting guideline to any explanation of differences in expected costs associated with the transfer of risk between the groups created by the underwriting guideline. Sound actuarial principles require the analysis of the unique contribution of the rating factor or characteristic in question. Surrogate underwriting guidelines, those that do not identify a cost difference but are a mere surrogate for a real risk factor, are not actuarially sound. Allstate's expert witnesses, Drs. Harrington and Appel, agreed that underwriting guidelines should be based on cost-either losses or expenses. They argued that cost-based underwriting is essential for a competitive market. They further asserted that the use of non-cost based underwriting guidelines is anti- competitive. The Department agrees. This is yet another reason to prohibit underwriting guidelines that are not actuarially sound: such guidelines are anti-competitive and are counter to one of the primary purposes of Article 21.21 to prohibit unfair competition. 2.5 Regulation is necessary to address unfair underwriting guidelines and is consistent with beneficially competitive insurance markets In Texas, insurance regulation is moving towards much greater reliance on market forces to encourage competition among insurers in a way which benefits consumers. The regulatory goal is for markets to move more towards the classic competitive model whereby insurers are forced to move to their most efficient level selling independent of one another to well-informed and knowledgeable consumers who have a wide range of choice. Reliance on market mechanisms, however, does not equate to deregulation. Deregulation does not always yield more beneficial competition-i.e., competition that approaches the competitive market ideal and benefits consumers. In some cases, greater competition requires less regulation, such as movement away from cartel pricing. A competitive market forces insurers to price their product on their cost of service, rather than on a state-set base rate. In other cases, regulation enhances the market mechanism and promotes competition. The Department provides both sellers and buyers with information they need to make wiser decisions. The Department's independent data initiative is a key ingredient in the move to more competitive insurance markets. More informed buyers and sellers will improve the competitive nature of a market. Regulation can also provide incentives to encourage competition where there are market failures. The Department's new rule 5.206 provides such an incentive for insurers to write in areas which have been underserved by standard and preferred automobile insurers. In these underserved areas, the market forces have failed. Where reliance on voluntary action is insufficient, regulatory statutes and rules can be used to enhance competition. Regulatory mandates are necessary when the public cannot rely upon insurers to voluntarily take actions which they do not see as in their self interest. The promulgation of standard policy forms, which enables consumers to better shop based on price, service and solvency, is an example of how regulation enhances competition. Without standard policy forms, consumers cannot effectively compare price and service between companies. Minimum capital and surplus requirements represent regulations which promote beneficial competition. In the absence of such standards, some insurers would try to compete by stretching limited surplus over excessive premiums and exposures. While these insurers may be able to charge lower prices because they have less capital to support, consumers are not well served by the great danger of insolvency faced by these insurers. 2.5.1 Insurance regulation expresses public policy regarding social and economic fairness of certain underwriting guidelines Professors Keeton and Widiss recognize the failures of competition in a deregulated insurance market: [C]ompetition will not always provide adequate protection against discriminatory premium rates. Even when competition is functioning well, there almost always will be collateral factors that make some policyholders more or less attractive on grounds apart from a pure assessment of the rated risk. Keeton and Widiss, Insurance Law, A Guide to Fundamental Principles, Legal Doctrines, and Commercial Practices, 955 (West 1988). As quoted above, they go on to state that public policy considerations require government intervention to prevent the use of certain characteristics as underwriting guidelines even if the characteristic is related to risk. Several commenters at the hearing agreed that government intervention is appropriate to express public policy considerations in some instances, such as racial considerations. The Legislature has expressed its intent that certain risk classifications are impermissible. For instance, it has prohibited risk classifications based on race, color, religion and national origin. Insurance Code, Article 21.21-5. It has prohibited underwriting guidelines regarding cancellation and nonrenewal based on whether the consumer is an elected official. Insurance Code, Article 21.49-2D. Thus, the Legislature has recognized that certain risk classifications are inherently unfair, regardless of differences in the expected costs associated with the transfer of risk. 2.5.2 Insurance regulation can address the market failures caused by unfair underwriting guidelines In those instances where market failures are caused by unfair underwriting guidelines, it is not feasible to rely upon voluntary efforts of insurers because these voluntary efforts cannot address a structural problem with the market. If one insurer sees an advantage through use of an unfair trade practice, that insurer will obtain an unfair competitive advantage over other insurers who try to do the right thing for consumers. In a competitive market, such a disparity cannot last and the unfair practices will continue. Regulation ensures that insurers operate by the same rules and minimum standards. The prohibition of certain unfair underwriting guidelines causes all insurers to stop using those guidelines and removes an impediment to the beneficially competitive operation of insurance markets and encourages insurers towards other bases of competition, such as service or expense efficiencies. 2.6 The Department has developed rules to prohibit unfair underwriting guidelines consistent with the role of regulation and appropriate to address failures of insurance markets represented by unfair underwriting practices The various rules adopted by the Department prohibiting unfair underwriting practices are solidly grounded in the theory, practice and tradition of public intervention in insurance markets to make public policy expressions of social and economic fairness and to promote more beneficially competitive insurance markets. 2.6.1 The practices prohibited by this rule are unfair This rule provides that underwriting guidelines must be based on sound actuarial principles or deemed to be in compliance with the rule under a safe harbor provision. This rule is based upon the principle that underwriting guidelines must based on differences in the expected costs associated with the transfer of risk. The rule describes the standard and methodology to demonstrate the fairness of underwriting guidelines. Moreover, the rule allows the Commissioner to collect data necessary to help insurers adequately evaluate certain underwriting guidelines. In this way, small insurers gain a greater ability to independently evaluate underwriting guidelines by gaining access to data sets larger than a small company could produce on its own. Such a mechanism not only ensures the use of fair underwriting guidelines, but promotes greater competition in insurance markets. Rule 21.1002 is a rule of prohibition, not a rule of authorization. That is, the rule provides that certain unfair underwriting guidelines may not be used. The rule does not provide permission to use underwriting guidelines that are risk related even if such guidelines are prohibited by statute or rule. In fact, the last section of that rule specifically provides: Other Laws Not Excepted. Compliance with subsection (a) of this section does not constitute an exemption from other rules or regulations of the department or statutory requirements. Other rules and statutes prohibit the use of inherently unfair underwriting guidelines. This rule does not permit the use of these inherently unfair underwriting guidelines. Because the practices prohibited by this rule are unfair practices, the Department finds it necessary to promulgate this rule to achieve the purposes of Insurance Code, Article 21.21. In addition, these unfair practices and unfair methods of competition create insurance availability problems for Texas consumers and harm the competitive nature of insurance markets. 2.6.2 Other new underwriting rules. Based on the three years of studies of insurance availability in Texas, the Department has promulgated two additional rules to prevent unfair underwriting practices. Rule 21.1004 prohibits intentional discrimination based upon race, color, religion or national origin and, to the extent not justified by sound actuarial principles, geographic location, disability, sex or age. This rule represents the expression that certain underwriting guidelines-those based on race, color, religion or national origin-are not consistent with public policies of social and economic fairness. Rule 21.1004 also reflects the principle that certain other underwriting guidelines-geographic location, disability, sex or age-are fair only if they are demonstrably related to the expected costs associated with the transfer of risk. A class of consumers identified by geographic location, disability, sex or age should be treated differently from another class of consumers only if the estimated costs associated with the transfer of risk for the first class are different than for the second class. If the estimated costs associated with the transfer of risk is the same for both classes, then it would be unfair to treat the two classes differently in the underwriting decision. Rule 21.1005 prohibits the use of underwriting guidelines in the business of private passenger automobile insurance based on the purchase of types or amounts of coverage in excess of the minimum automobile liability coverage required by law. This guideline is prohibited because it is inherently unfair. By statute, the state has required drivers to purchase certain minimum amounts of automobile insurance coverage. It is fundamentally unfair for sellers to then require these drivers to obtain additional amounts of insurance that the drivers do not need or desire to qualify for standard or preferred rates. 2.6.3 Previous Department Underwriting Rules Regulation which limits the use of unfair underwriting guidelines improves the insurance market mechanism and promotes competition. Moreover, such prohibitions are not radical actions. There is a tradition of limiting and guiding the grouping of risk for insurance purposes in a manner consistent with public policy expressions of social and economic fairness. The Department has passed other rules, several of which were promulgated under Article 21.21, prohibiting unfair underwriting guidelines. Rule 5.401(c) prohibits insurers from denying automobile insurance on the basis that the consumer had previously been insured by a nonstandard insurer or through the TAIP. Rule 5.7016 prohibits insurers from nonrenewing automobile insurance coverage based on certain types of claims that were not the fault of the consumer. Rule 21.404 prohibits underwriting guidelines based on sex or marital status for all lines of insurance. Rule 21.1000 prohibits the use of an underwriting guideline by any insurer or agent based on whether another insurer previously declined coverage to the consumer. Rule 21.1003 prohibits automobile insurance underwriting guidelines based on the number of vehicles to be insured or the purchase of other policies. Rule 21.704 prohibits underwriting guidelines by life and health insurers based on sexual orientation. Thus, the Department's actions to prohibit the unfair underwriting guidelines identified in this rule is based on a long-standing policy to prohibit unfair underwriting practices. 2.7 The Department has authority to promulgate this rule 2.7.1 Article 21.21, sec.13(a) The rule is promulgated under the authority of Insurance Code, Article 21. 21, sec.13(a), which provides that the Department: is authorized to promulgate and may promulgate and enforce reasonable rules and regulations and may order such provision as is necessary in the accomplishment of the purposes of this Article including, but not limited to, such express provision within the purposes of these Articles as it deems necessary This rule is adopted to accomplish the purposes of Article 21.21. Section 1 of Article 21.21 sets out the purposes of the Article 21.21: The purpose of this Act is to regulate trade practices in the business of insurance by defining, or providing for the determination of, all such practices in this state which constitute unfair methods of competition or unfair or deceptive acts or practices and by prohibiting the trade practices so defined or determined. (emphasis added) The Legislature clearly contemplated that the Act would prohibit both those unfair and deceptive trade practices set out in the statute and those that are determined by the Department, pursuant to its authority under Section 13, to be unfair or deceptive practices. Article 21.21, sec.16 also evidences legislative intent that the Department has the authority to determine that practices are unfair and promulgate rules prohibiting such practices. That section provides: Any person who has sustained actual damages as a result of another's engaging in an act or practice declared in Section 4 of this Article or in rules or regulations lawfully adopted by the Board under this Article to be ... unfair or deceptive acts or practices in the business of insurance ... may maintain an action against the person or persons engaging in such acts or practices. (emphasis added) Similar references to either a violation of the Insurance Code or rules or regulations adopted by the Board under Article 21.21 appear in the Insurance Code, Articles 1.10A, sec.2(a)(1) and 1.14-1, sec.3A(a). These provisions are meaningless unless the Department has the authority to promulgate rules and regulations declaring practices to be unfair. Again, there is a clear legislative purpose in the adoption of Article 21.21 that the Department have the authority to promulgate rules prohibiting such unfair practices. The Austin Court of Appeals has held that the Department has authority to declare underwriting acts or practices to be unfair and to promulgate rules prohibiting such acts and practices. National Association of Independent Insurers, et al., v. Texas Department of Insurance, et al., No. 94-181-CV, p. 5 (Tex. App.-Austin, November 16, 1994) (NAII) (citing as additional authority Allstate v. Watson, 876 S.W.2d 145, 147 (Tex. 1994)). The NAII court also expressly held that the Department may promulgate a rule under Article 21.21 prohibiting an unfair practice even if there is no evidence that the practice is occurring. Id. at 8. Neither the Administrative Procedure Act nor Article 21.21 requires the Department to refrain from acting to protect consumers from unfair and deceptive practices until consumers have been harmed. The mere possibility of an unfair practice provides adequate justification for the Department to act. For instance, the Department should not wait to promulgate a rule prohibiting racial discrimination until an insurer or agent harms a consumer. The Court of Appeals held that Article 21.21 permits the Department to take prophylactic measures to prevent unfair practices: "The board has the authority to promulgate such rules as it deems necessary to advance the objectives of article 21.21, and it need not passively wait for harm to occur before it enacts regulations." Id. at 8. Nevertheless, as has been shown, the Department is aware of ample evidence that the practices which are prohibited by this rule are occurring. 2.7.2 The private cause of action The Legislature created the private cause of action and expressly empowered the Department to identify those practices which should be designated as unfair. The Legislature has determined that a private cause of action should exist against those persons and entities in the business of insurance that engage in unfair practices identified by the Department. The Department is exercising its statutory duty to identify those unfair and deceptive practices. The NAII court held that the availability of treble damage lawsuits is an insufficient reason to find that a rule declaring an underwriting practice to be unfair is unnecessary or arbitrary and capricious because the statute, not the Department, authorizes this type of suit. NAII at 9. The Department, however, agrees with the Legislature that it is appropriate that a private cause of action exist for violations of this rule because a private cause of action serves several important enforcement purposes. First, a consumer who is harmed as a result of these types of unfair discrimination should have a means by which he or she may recover their damages, including any overcharges resulting from being placed in a substandard company, from the person or company that engaged in the unfair practice. Second, prohibitions against individual instances of unfair discrimination are usually proved on a case by case basis. The Department does not have the resources to take enforcement actions for all individual instances of unfair practices. Rather, the Department's enforcement actions, due to limited resources, must be focused on large patterns of unfair practices. A private cause of action is necessary to ensure that individual consumers who are victims of unfair discrimination have the opportunity to seek redress for their damages. Third, a private cause of action provides individuals not only with the means to discourage deceptive and unfair practices, but also with the incentive to do so. NAII at 9. Finally, the threat of treble damage lawsuits provides insurers and agents with a strong disincentive to rely on this type of unfair discrimination in making their decisions to insure. Id. Past rules promulgated under Article 21.21, for which there is also a private cause of action, have not resulted in any private litigation, to the Department's knowledge based on questions to several large insurers and insurance company trade associations. These rules include a prohibition against the use of marital status, sec.21.404, a prohibition against blacklisting, sec.21.1000, and a prohibition against tying, sec.21.1003. Thus, the existence of a private cause of action is not calculated to cause excessive litigation costs for insurers or agents. If a consumer were to file a frivolous lawsuit under Article 21.21, sec.16, alleging a violation of this rule, the defendants in the suit have a remedy. Article 21.21, sec.16(c) provides that if the court finds that an action was groundless and brought in bad faith or brought for the purpose of harassment, the court shall award to the defendants reasonable and necessary attorney's fees. 2.7.3 Article 5.98. The rule is also promulgated under the authority of Insurance Code, Article 5.98. Article 5.98 authorizes the Department to adopt reasonable rules that are appropriate to accomplish the purposes of Insurance Code, Chapter 5, including Article 5.09. Article 5.09 prohibits any distinction or discrimination in favor of an insured having a like hazard, which occurs when an underwriting guideline that is not actuarially sound is used to place a consumer in a different company within a company group. For instance, if an insurer group has three companies, a preferred company, a standard company and a substandard company, Article 5.09 is violated if insureds having a like hazard are placed in different companies within the group and charged different rates. The rule is necessary, in part, to accomplish the purposes of Article 5.09 to prohibit discrimination in favor of consumers of like hazard when the insurer group places those consumers in different companies within the group. Subsection (a) of the adopted rule prohibits the use of unfair underwriting guidelines for private passenger automobile and residential property insurance. Subsection (b) of the adopted rule provides a definition of "unfair underwriting guideline." Subsection (c) of the adopted rule provides a definition of "actuarially sound." Subsection (d) of the adopted rule provides safe harbors that are deemed to be in compliance with the rule. Subsection (e) of the adopted rule provides a definition of "underwriting guideline." Subsection (f) of the adopted rule provides a definition of "consumer." Subsection (g) of the adopted rule provides a definition of "private passenger automobile insurance." Subsection (h) of the adopted rule provides a partial exemption to the prohibition against the use of unfair underwriting guidelines for agents. Subsection (i) of the adopted rule provides that compliance with this rule does not exempt an insurer or agent from the requirements of other rules or statutes. Written comments in favor of adoption of the proposed rule were received prior to the hearing from Mark L. Kincaid (Public Counsel for the Office of Public Insurance Counsel), James H. Davis (Silver-Haired Legislature), ADAPT of Texas (a grass roots disability rights organization), Patricia Anderson (United Cerebral Palsy of Texas, Inc.), Katherine Stark (Austin Tenant's Counsil), Robert F. Schneider (Consumers Union), Nina Yager (individually and on behalf of Texas Citizen Action), Kay Allison (Association of Community Organizations for Reform Now), Jacquiline Shannon (Texas Alliance for the Mentally Ill), Gilberto Moreno (Association for the Advancement of Mexican Americans), S. Sanghee Y., W. R. Delahunty Jr., Mary E. Mcclendon, Martha White, Stan Mills, James P. Cook, Mark Young, M. Shea Smith, Dorothy P. Compost, Sandra E. Hippman, L.P. Hall, Gary C. Heape, Britt Winn, Barbara Paceth, Diana Hund, Mary Ann Barry, Mary Spachman, Rose Bianchini, Linda J. Walker, John Pinkerton, Barbara Pinkerton, Dawn M. Smith, Paul Saxton, Judy J. Smith, T.G. Muppey, Thomas A. Demer, Betty L. Taylor, Kay Fox, and R.D. Darroch. Written comments against adoption of the rule were received prior to the hearing from Kimberly Yelkin/Pati Fuller (National Association of Independent Insurers), Robert L. Watkins (State Farm Insurance Companies), Fred B. Werkenthin (Farmers Insurance Group of Companies), Jay A. Thompson (Association of Fire and Casualty Companies in Texas), Rick Clements (Texas Association of Insurance Agents), Bryan R. Davis (on behalf of several unidentified small to medium-sized domestic insurers), George Joy (USAA), Joanne M. Derrig/Scott Harrington/David Appel (Allstate), Elizabeth Wilson (CNA Insurance Companies), James Langford (Texas Farm Bureau Insurance Companies), and David Snyder (American Insurance Association). In addition to those persons making written comments, oral testimony at the hearing in favor of the adoption of the proposed rule was received from Senator Rodney Ellis, Senator Royce West, Representative Glen Maxey, Representative- Elect Dawnna Dukes, Enrique Valdivia (Texas Rural Legal Aid), Tim Curtis (Texas Citizen Action), Lance Winters, Jim Mallett, Angelyque Campbell (Texas Community Reinvestment Coalition), Frederick Jarmon (Texas Citizen Action), Jesse Romero/Luis Wilmot (Mexican American Legal Defense and Education Fund), Martha Fitzwater, and Fred Lewis. In addition to those persons making written comments, oral testimony at the hearing against the adoption of the proposed rule was received from Representative Robert Duncan, Wade Spillman (Texas Association of Insurance Agents), Charles Wirth (State Farm Insurance Companies), Richard Smith (Allstate Insurance Company), Richard Geiger (Association of Fire and Casualty Companies in Texas and Texas Automobile Insurance Service Office), Finis Welch (Farmers Insurance Companies), Jonna Kay Hogeland (National Association of Independent Insurers, Liberty Mutual Insurance Company, the Texas Surplus Lines Association, and the Texas HMO Association), and Burnie Burner (Texas Association of Mutual Insurance Companies). The written and oral comments received by the Department fall into 13 general categories: 1. Comments that show a need for the rule. 2. Comments that the rule is ambiguous. 3. Comments that the rule will adversely affect the market. 4. Comments on the costs to comply with the rule. 5. Comments on niche markets. 6. Comments concerning the related to risk or expense requirement. 7. Comments regarding how a company can show compliance. 8. Comments on the safe harbors. 9. Comments on the application of the rule to special types of companies. 10. Comments on the consistency of the rule with other laws. 11. Comments regarding the Department's statutory authority to promulgate the rule. 12. Comments regarding the private cause of action. 13. Miscellaneous comments. 5.1 Comments That Show A Need For The Rule. COMMENT: Commenters argued that it is unfair for insurers to refuse insurance coverage to consumers based on factors unrelated to risk. The commenters pointed out that if insurance companies use secret underwriting guidelines without regard to risk, large segments of the Texas population could be excluded from the insurance market place. Commenters argued that the use of unfair underwriting guidelines that are not related to risk which cause persons with disabilities to either be arbitrarily denied insurance or be placed in insurance companies with higher rates than those companies for which the consumer would otherwise qualify. A commenter argued that fairness in underwriting decisions is an appropriate public policy goal and that the rule provides a fair balance between the public interest of ending underwriting practices unrelated to risk and the interest of insurers in using their own underwriting guidelines. A commenter argued that it is reasonable to put the burden of proof on insurers to show that their guidelines are related to risk. The commenter pointed out that insurers have superior access to data to justify their own guidelines and that it is illogical to require the Department or consumers to prove a negative-that a particular guideline is not related to risk. One commenter argued that homeowners insurers should not be permitted to discriminate against an applicant with a home that has been made accessible for the disabled, citing ramps as an example. Commenters argued that many underwriting guidelines that are unrelated to risk or expense have an adverse impact on minorities, making automobile and homeowners insurance less affordable and available for these groups. DEPARTMENT'S RESPONSE: For the reasons set out in the section entitled "Reasoned Justification," the Department agrees with these commenters that adoption of this rule is necessary. COMMENT: A commenter argued that the proposed rule creates requirements which are not contained in existing laws. DEPARTMENT'S RESPONSE: The Department agrees that the rule contains prohibitions against practices that are not prohibited by existing laws, as shown above. Because the practices prohibited by this rule are unfair practices in the business of insurance, the Department has determined that these additional prohibitions are necessary. One of the purposes of Article 21.21 is to provide for the determination and prohibition of unfair practices in the business of insurance. If the Department's rulemaking authority were limited to only those practices that are already prohibited by statute, the rulemaking authority would be meaningless. Article 21.21 mandates a broad reading of the Department's authority to promulgate rules, even if the particular practice has not been declared illegal by statute. The plain language of Article 21.21 permits the Department to promulgate rules prohibiting unfair conduct. There is no limitation on the Department's authority to declare practices to be unfair simply because they are not specifically prohibited by statute. Article 21.21, sec.1(b) states that Article 21.21 "shall be liberally construed and applied." The clear intent is to give the Department broad, and not limited, authority. Therefore, the Department has the authority to declare practices to be unfair under its rulemaking authority even if the practice is not prohibited by another statute. COMMENT: An insurer trade association argued that the rule eliminates underwriting guidelines now used in Texas and elsewhere. DEPARTMENT'S RESPONSE: Since the rule only prohibits underwriting guidelines that are not actuarially sound and are not deemed to be in compliance with the rule under a safe harbor provision, this comment implies that there are underwriting guidelines in the Texas market that are unfair. This would imply a need for the rule. COMMENT: One commenter argued that competition among insurers should force insurers to use cost-based pricing and fair underwriting guidelines. The commenter argued that availability problems cannot be the result of unfair underwriting guidelines because insurers who use unfair underwriting guidelines would be at a competitive disadvantage to those who use fair, cost-based underwriting guidelines. A commenter argued that the free market is the best way to ensure that individuals pay insurance premiums commensurate with the risks they present. DEPARTMENT'S RESPONSE: The Department disagrees because there is considerable evidence that the operation of insurers in Texas residential property and private passenger automobile insurance markets does not approach the competitive ideal which will produce the benefits to consumers described by these commenters. Instead of a market characterized by a number of producers making independent business decisions based upon their production costs, the operation of these insurance markets in Texas is characterized by insurers mimicking the practices of others. The lack of independent actions by insurers is, in part, a legacy of the historical structure of the insurance industry which included cartel pricing and advisory organizations making collective industry decisions. While perfect competition is generally impossible, the desirable effects of a competitive model are for market forces to compel independent decision-making producers to achieve increasing standards of efficiency and service and allow consumers to have meaningful choices. The model of perfect competition is one of beneficial competition in which the rational, profit-seeking actions of producers generate, through the invisible hand, the maximum overall benefit for consumers. The Texas personal lines insurance markets exhibit characteristics which are inconsistent with beneficial competition. The residential property and private passenger automobile markets are extremely concentrated-a few companies sell the vast majority of policies in the standard and preferred personal lines markets. State Farm, Farmers and Allstate control over 60% of these markets, with State Farm alone at 35% to 40% of the market. Market concentration has increased dramatically over the past five years. Of particular concern to the Department is the apparently non-competitive operation of major insurance markets in which insurers mimic the business decisions of other insurers and do not make the independent business decisions associated with beneficially competitive markets. For example, the Department has investigated insurers' use of credit reports as an underwriting guideline for residential property and private passenger automobile insurance. Although several insurers admitted to the use of credit history as an underwriting guideline, only one insurer claimed to have independently gathered and analyzed data on the relationship between credit history and risk of loss. Two of the largest writers of personal lines insurance, those insurers with the greatest ability to provide relevant data and analysis, cited, as the justification for using credit history, an article on the subject written by the marketing managers of two companies who sell credit histories (Equifax) and the software to use credit history as an underwriting tool (Fair Isaac). The mass use of the same underwriting guideline by insurers with no independent analysis by insurers is simply not consistent with the operation of competitive markets. Another example of insurers relying upon other insurers' decisions without independent analysis and judgment comes from the Department's investigation into the ZIP-Code based rating territories of county mutual automobile insurers. The Department found a correlation between higher-priced ZIP Codes and high minority population in the ZIP Code in the rating territories of several county mutual insures. The Department requested an explanation of the development of rating territories from county mutual insurers whose rating territories differed from those promulgated by the Department for rate-regulated insurers and whose rating territories consisted of groupings of ZIP Codes. The Department also requested loss data and other information these companies relied upon for determining their rating territories. Responses from three county mutual insurers demonstrate the non-competitive operation of these insurers. The county mutuals said they did not have ZIP Code loss data, but rather they based their rates and rating territories on those of other county mutuals. To date they have not relied upon their own data or done their own analysis. They also stated that "several judgment factors are considered." In summary, the Department disagrees with this commenter that Texas personal lines insurance markets approach the competitive ideal sufficiently to preclude the possibility that insurers may use unfair underwriting guidelines in Texas. Rather, the actual structure and operation of these insurance markets strongly indicates that insurers use a variety of underwriting guidelines without any effort to demonstrate that these guidelines are related to costs of production. The actual, non-competitive, operation of Texas personal lines insurance markets is powerful evidence of the need for this rule because this rule requires that insurers use underwriting guidelines related to expected costs associated with the transfer of risk, that insurers be able to demonstrate this standard of fairness using sound actuarial principles and that the Commissioner help any insurer collect the relevant data to ensure that a particular underwriting guideline meets the standard of fairness. This rule enables and forces insurers to move toward the use of cost-based underwriting and helps consumers by prohibiting unfair practices and promoting more beneficially competitive insurance markets. COMMENT: One commenter argued that availability problems are not the result of unfair underwriting guidelines or unfair discrimination, but the result of higher losses in certain areas, price regulation that discourages supply and compulsory insurance requirements which force poor people to buy costly insurance. DEPARTMENT'S RESPONSE: The Department disagrees with this comment. For higher losses in certain areas to be a cause of availability problems, insurers would presumably have to know that those areas within major Texas metropolitan areas do, in fact, generate higher losses. The Department knows of no available insurance loss information detailed by ZIP Code in Texas. As the statements of the county mutual insurers, cited above, demonstrate, even those companies that actually create ZIP Code-based rating territories which create higher rates for minority neighborhoods in Texas cities have no loss data to justify the actions. Nor could the standard and preferred insurers who shun writings in certain portions of Texas communities have any loss data to justify this commenter's statement because there can be no loss data for those areas where no policies are written. Finally, the smallest level of geographic detail that the industry- owned and -controlled statistical agents who, until recently, collected premium and loss experience from insurers for private passenger automobile, was at the rating territory level. Thus, there has been no industry-aggregate or any other kind of ZIP Code level loss cost information available for insurers to even examine, let alone verify, the commenter's assertion that the underserved, minority areas all cause higher losses than the nearby non-minority areas within the communities of Texas. The commenter's assertion that price regulation is a cause of availability problems in Texas is equally without basis. The rate regulation systems for residential property and private passenger automobile insurance in Texas in recent history have provided virtually unlimited freedom for insurers to use the rates they deem appropriate. Both residential property and private passenger automobile insurance in Texas contain rate-regulated and non-rate regulated market segments. The non-rate regulated segments can charge whatever rates they want and can use whatever rating classifications they want. The non-rate regulated segment represents about two-thirds of the residential property insurance market and about one-fifth of private passenger automobile market in Texas. The rate-regulated segments of these markets are currently subject to flex-rating. In this regulatory system, the Commissioner establishes a benchmark rate with flexibility bands above and below the benchmark rate. Within these flexibility bands, insurers can simply file and use rates. No approval is necessary before using these rates and neither the Commissioner and the State Board of Insurance have ever challenged a rate filing within the flex bands since the onset of flex rating in the spring of 1992. The flexibility bands have generally been set at 30% above and below the benchmark, thereby giving insurers a substantial range of rates for file and use. Even if an insurer wants to use a rate outside the flex bands, the insurer can do so with prior approval. Nor has this prior approval process proved to be a barrier to insurers using the rates they deem appropriate. There have been over 30 filings for rates outside the flex band since 1992, most of which have been for private passenger automobile insurance. All but one of the filings was approved. For the one filing that was disapproved, only the physical damage rates were disapproved. The rates outside the flex band for liability coverages were approved. Prior to flex rating, all rate-regulated rate filings were subject to prior approval. In practice, virtually all filings were routinely approved as the State Board of Insurance. Again, even rate-regulated insurers were not constrained in their ability to use the rates they deemed appropriate. In addition, any rate-regulated insurer who felt that the promulgated rating territories combined heterogeneous areas and desired to use different rating territories could have petitioned the Department to change the manual rating territories. No insurer, insurer trade association or advisory organization has made such a proposal. Since Texas regulatory systems have in no way prevented insurers from using rates the insurers deem appropriate, price regulation is clearly not a cause of the availability problems in Texas. The commenter's third reason for insurance availability problems in Texas- mandatory insurance-is as without merit as the other two reasons offered. The commenter seems to imply that those people who purchase insurance only because they are required to do so by state law represent bad risks and these bad risks live together in certain ZIP Codes. Such a proposition is implausible from both a common-sense and economic theory level. From economic theory, those people who are more likely to cause accidents or claims would rationally choose the protection of insurance. Those people who felt confident that they could avoid losses would be more likely to forego insurance, even if they could afford to purchase the product. The Department's and other availability studies show clearly that availability problems in Texas are a problem of supply, not of consumer demand as implied by the commenter's third reason. The Department's analyses evaluated the geographic distribution of drivers in standard and preferred versus non-standard and assigned risk markets. This analysis looked only at drivers who actually purchased insurance and showed dramatic differences in availability by ZIP Code. 5.2 Comments That The Rule Is Ambiguous. COMMENT: Commenters argued that the term "private passenger automobile insurer" creates ambiguity in two respects: it is ambiguous as to which types of automobile insurance it applies and it is unclear whether the rule applies only to the sale of automobile insurance or to the sale of any type of insurance by an insurer that also writes automobile insurance. A commenter argued that the rule should be clarified to allow a company in writing an umbrella policy to require higher than minimum limits and primary insurance with the same company. DEPARTMENT'S RESPONSE: The Department agrees that the phrasing of the proposed rule was overbroad because it applied to the sale of any type of insurance by an insurer that writes private passenger automobile or residential property insurance. The intent of the rule was to apply only to the sale of private passenger auto and residential property insurance. Therefore, the wording of the first sentence in subsection (a) was rearranged to clarify that the rule applies only to the sale of these two types of insurance. "Private passenger automobile insurance" is then defined in a new subsection. As amended, the rule would not apply to the sale of other types of insurance, including an umbrella policy. COMMENT: A commenter questioned whether the term "familial status" is clear. DEPARTMENT'S RESPONSE: The Department believes the term is clear. The term refers to family characteristics. However, the term has been deleted from the adopted rule and therefore this comment is no longer applicable. COMMENT: A commenter argued that the definition of "underwriting guideline" should explicitly state that underwriting guidelines include criteria used by insurers in "renewal" or "nonrenewal" of coverage. DEPARTMENT'S RESPONSE: The rule does prohibit unfair discrimination in the decision whether to accept or reject a consumer for insurance, which would include the decision to renew or nonrenew a consumer's policy. However, to clarify the rule, the Department has added these two terms to the definition of "underwriting guideline." COMMENT: Commenters argued that the term "underwriting guideline" is defined too broadly, that it ties to virtually every business decision that is made within an insurance company. DEPARTMENT'S RESPONSE: The Department disagrees. The definition is broad for a reason. Any decision regarding the sale or cancellation of insurance should not be based on the unfair underwriting guidelines that are prohibited by this rule. Although broad, the definition is not vague or ambiguous. It is intended to prohibit these unfair practices from all decisions related to the sale of insurance by the insurance company or agent, and the commenter has confirmed that this intent has been accomplished. COMMENT: A commenter argued that the term "in whole or in part" is undefined and that it is impossible to determine what the term means. Another commenter argued that the term is at best confusing and at worst totally unintelligible as to its meaning. DEPARTMENT'S RESPONSE: The Department disagrees. The term "in whole or in part," as used in the proposed rule, is clear: it means "not at all." However, due to other changes to the rule, the term "in whole or in part" was deleted from the adopted rule. COMMENT: A commenter argued that the requirement to hold all other factors constant is unclear. DEPARTMENT'S RESPONSE: The Department disagrees. In determining whether an underwriting guideline differentiates among consumers who have different expected costs associated with the transfer of risk, it is necessary to identify the unique contribution of the underwriting guideline to the expected differences in costs. The term "controlling for other factors" is clear: all other factors should be held constant. All characteristics of the two classes, the class that satisfies the underwriting guideline and the class that does not, must be the same. Procedures to hold other factors constant or statistically control for other variables are standard actuarial, statistical and econometric practices. Allstate witnesses Appel and Harrington discussed the need to identify and control for other risk factors in evaluating the relationship between credit history and expected losses as well as in evaluating the relationship between the minority population of a ZIP Code and the availability of insurance in the ZIP Code. The Department, therefore, disagrees that the term "controlling for other factors" is vague or ambiguous. However, the allegedly ambiguous language has been deleted from the rule. The Department has clarified the use of sound actuarial principles as used in the rule to be both the standard of fairness and the methodology to demonstrate that an underwriting guideline meets that standard. There is no longer a need to specify the requirement to control for other factors in the rule because sound actuarially principles already contain this requirement. COMMENT: A commenter argued that the definition of "related to risk or expense" is set forth in the negative. DEPARTMENT'S RESPONSE: The Department agrees that the phrasing was in the negative. However, the Department has eliminated this phrase from the rule so the comment is no longer relevant. COMMENT: Commenters argued that the phrase "sound actuarial principles" should be defined. Another commenter argued that applicants should be pooled into large, "sound" groups with statistically predictable costs. Another commenter challenged the Department to produce the sound actuarial principles that the Department would have the industry follow. That commenter pointed to differences of opinion among actuaries. DEPARTMENT'S RESPONSE: The legislature has used the term "sound actuarial principles" in the Insurance Code without definition in at least three separate statutes: Insurance Code, Articles 21.21-3, 21.21-5, and 26.41(b). In the context used in this rule and those statutes, the term is commonly understood to mean both a specific standard of fairness and a methodology to test for that standard. The standard of sound actuarial principles is that an underwriting guideline is fair if that guideline is demonstrably related to differences among consumers in the expected costs associated with the transfer of risk. To clarify the rule, the Department has included this commonly understood definition. The Department also agrees with several of the commenters that the methodology for determining whether there are differences in the expected costs associated with the transfer of risk should be consistent with the actuarial standards of practice and compliance guidelines promulgated by the Actuarial Standards Board of the American Academy of Actuaries, and has amended the rule accordingly. The January 1, 1995 date was set to ensure that the Department can review and approve the application of any changes to those standards and guidelines to this rule. COMMENT: A commenter argued that the Department has failed to provide sufficient notice of what constitutes "sound actuarial principles" because it may disregard an insurer's actuarial support if the Department dislikes the effect of an underwriting guideline. DEPARTMENT'S RESPONSE: The Department disagrees with this comment. First, in response to the previous comments, the Department has included a definition of the term "actuarially sound". The commenter seems to imply that a rule should not be promulgated if it could be misapplied, either by the Department or a court. The Department disagrees with this argument. Any rule promulgated by any agency could potentially be misapplied. That is not a reason to reject the rule. The Department is confident that the Department and courts will not misapply this rule. Moreover, to the extent that the Department or a court do misapply the rule, those parties who are the subject of the misapplication have judicial remedies to correct the error. COMMENT: A commenter asked whether the definition of "rating factors," which includes rate differentials promulgated and approved by the Department, comes within the "carveout" clause of subsection (a). DEPARTMENT'S RESPONSE: Both the term "rating factor" and the "carveout" clause have been omitted from the adopted rule. Therefore, this comment is no longer relevant. COMMENT: A commenter asked whether a practice used to bind encompasses practices that result in refusing to bind. DEPARTMENT'S RESPONSE: The refusal to bind based on an unfair underwriting guideline would be a violation of the rule. An agent or insurer that refuses to bind a consumer has clearly examined and rejected that consumer for immediate coverage. The guideline on which such examination and rejection was based, therefore, is an underwriting guideline as defined by the rule. COMMENT: Commenters argued that the rule is vague and unclear. The commenters did not identify any portion of the rule, other than the terms discussed above, that the commenters believed is vague. DEPARTMENT'S RESPONSE: The Department disagrees that the rule is vague. The rule clearly defines the conduct which is prohibited and the scope of the rule. Without any identification of the portions of the rule the commenters believe to be vague, the Department is unable to respond any further to this comment. 5.3 Comments That The Rule Will Adversely Affect The Market. COMMENT: Commenters argued that the rule is anti-competitive. DEPARTMENT'S RESPONSE: The Department disagrees. As discussed in the reasoned justification and responses to other comments, this rule is consistent with and promotes beneficially competitive insurance markets. The rule specifically addresses unfair practices in the business of insurance which are not consistent with beneficially competitive insurance markets. The rule promotes cost-based pricing which, as several witnesses testified, is a foundation for competitive markets. COMMENT: A commenter argued that the proposed rule constitutes an initial attempt to codify underwriting guidelines. DEPARTMENT'S RESPONSE: The Department disagrees that the proposed rule constitutes an initial attempt to codify underwriting guidelines. The express purpose of the rule is to eliminate those unfair practices identified in the rule. The prohibition against using unfairly discriminatory underwriting guidelines does not equate to a codification of underwriting guidelines. Insurers and agents are not prohibited under this rule from using any underwriting guideline they deem appropriate, as long as the guideline is actuarially sound or deemed to be in compliance with the rule under a safe harbor provision. The NAII court rejected the argument that a prohibition against the use of unfair underwriting guidelines prohibits insurers from accepting and rejecting risks. NAII at 11. The Court held that the rule at issue in that case "does not prevent insurers from accepting and rejecting risks; it merely prohibits the use of inaccurate substitutes ... for real risk factors." Id. That analysis is equally applicable to this rule; the rule does not prevent insurers from using their own underwriting guidelines. Nor does it require them to use any guidelines at all, codified or not. Rather, the rule simply prohibits insurers from using underwriting guidelines that are not actuarially sound or deemed to be in compliance with the rule under a safe harbor provision. COMMENT: A commenter argued that the rule should not be adopted because it will cause rates to increase for other consumers who are not in the classes protected by this rule. DEPARTMENT'S RESPONSE: The Department disagrees. Insurers may continue to apply fair underwriting guidelines to evaluate potential consumers under this rule. Since any additional consumers written as a result of this rule will have the same estimated costs associated with the transfer of risk as current consumers, the rule will not cause rates to increase. COMMENT: A commenter argued that the proposed rule would have a negative impact on the Texas insurance market. Another commenter argued that the rule will adversely affect the availability and affordability of insurance to the citizens of Texas. The commenters did not offer any specifics as to how the rule would have a negative impact. DEPARTMENT'S RESPONSE: The Department disagrees. As shown in the Reasoned Justification, the elimination of these unfair underwriting guidelines will have a positive impact on the Texas insurance market. COMMENT: A commenter was concerned that the proposed rule will harm the commenter's efforts to expand personal lines markets in Texas. Another commenter argued that the rule will drive insurers to withdraw from lines of insurance, markets, or the state. DEPARTMENT'S RESPONSE: The Department does not believe that a prohibition against the types of unfair practices prohibited by this rule will cause insurers to avoid Texas insurance markets or to leave those markets. The effect of the rule, instead, will be to cause insurers to use only fair underwriting guidelines. The Department rejects the argument that insurance availability is only possible if insurers are allowed to unfairly discriminate against consumers. The Department assumes insurers will react rationally to this rule by simply ceasing any underwriting practices that would violate the rule and serve Texas insurance markets using fair underwriting guidelines. COMMENT: A commenter argued that an industry vital to a free-enterprise nation could be destroyed if forced to "accommodate" the uninsurable, as measured by insurer management. The commenter went on to argue that the risk of insuring consumers without such distinctions should be left to insurer management and not imposed by law. DEPARTMENT'S RESPONSE: The Department disagrees with this comment. To the extent that an insurer or agent shows that underwriting guidelines are based on sound actuarial principles, the rule does not prohibit the use of such guidelines. Thus, if a specific group is shown to incur higher losses and is therefore "uninsurable," there is no requirement to write those consumers. However, if no distinction can be shown based on sound actuarial principles, then the prohibition against the use of the unfair underwriting guideline will not affect, and will certainly not destroy, insurers or the insurance industry. The Austin Court of Appeals upheld the Department's right to prevent another unfair underwriting proxy, stating: Rule 1003 does not prevent insurers from accepting and rejecting risks; it merely prohibits the use of inaccurate substitutes ... for real risk factors. ... Rule 1003 prohibits the use of proxies for real risk factors. NAII at 11-12. Similarly, this rule does not prohibit insurers and agents from denying coverage based on true risk factors, but it does prevent the use of inaccurate substitutes. The Department also disagrees that the decision whether to use unfair underwriting guidelines should be left to insurer or agent management. Such practices are unfair and the Legislature has charged the Department with the duty to promulgate rules that identify and prohibit unfair practices like the practices identified in this rule. Nor does the Department agree that insurer management should be permitted to determine "uninsurability" based on unfair factors. The Legislature has determined that insurers should be limited in their decision as to which consumers are insurable. The Legislature passed Article 21.21 for the express purpose of prohibiting insurer management and agents from engaging in unfair and deceptive practices, even if management believes such unfair or deceptive practices are appropriate. COMMENT: A commenter argued that the rule will lead to tightened underwriting guidelines and a more restricted insurance market, causing continued growth in the assigned risk market. DEPARTMENT'S RESPONSE: The Department disagrees. To the extent that insurers use cost-based underwriting guidelines, the rule will not cause these insurers to abandon these underwriting guidelines. The rule will require insurers to stop using unfair underwriting guidelines-those guidelines that are not actuarially sound and are not deemed to be in compliance with the rule under a safe harbor provision. Thus, the result of the rule will be a diminution in the number of underwriting guidelines by the number of unfair underwriting guidelines which insurers cease to use. Fewer underwriting guidelines means a loosening of underwriting, not a tightening as the commenter suggests. It is the prohibition of the use of unfair underwriting guidelines which will cause greater availability in automobile insurance markets and a reduction in the size of the assigned risk market. COMMENT: A commenter argued that the proposed rule would remove all discretion from the business entity and force the business to underwrite a risk that they either feel they cannot financially withstand or assume a risk that they did not contemplate assuming when they entered the market. The commenter went on to argue that, if companies are unable to obtain approval for the rates they feel are necessary to adequately cover the risks which are being thrust upon them, many will feel a compelling need to withdraw from the market. DEPARTMENT'S RESPONSE: The Department disagrees with this comment. The rule would not remove all discretion from the business entity. Under this rule, the company is not prohibited from exercising discretion in its choice of consumers, nor is it forced to underwrite any risk, as long as that choice is not based on unfair underwriting guidelines-those that are not actuarially sound and not deemed to be in compliance with the rule under a safe harbor provision. The rule clearly allows discretion in the decision about classes of consumers the insurer or agent wishes to insure. If the commenter understands business discretion to mean the arbitrary and unfair treatment of individual consumers, this rule does prohibit that type of "business discretion." The commenter's argument regarding rates is inconsistent with the Texas rate regulatory scheme. For automobile and homeowners insurance, the Department sets a flexibility band in which insurers may file and use the rates that they deem appropriate to cover the risks they will insure. For those companies that can show a need for rates outside those bands, the statute permits the approval of such rates. Therefore, the Department disagrees with the comment that companies will be unable to set adequate rates as a result of this rule. COMMENT: A commenter argued that the rule will prohibit the application of judgment in the underwriting process. DEPARTMENT'S RESPONSE: The Department disagrees. The rule does not prohibit the application of judgment in the underwriting process, it merely prohibits judgment based on factors that are not actuarially sound and not deemed to be in compliance with the rule under a safe harbor provision. There is no limitation on the myriad of other underwriting judgment factors which a company or agent may use. COMMENT: A commenter argued that the rule outlaws or at least hinders underwriting guidelines that make sense, are used virtually everywhere else and are inherently fair. DEPARTMENT'S RESPONSE: The Department disagrees with this comment. The rule only prohibits underwriting guidelines that are not actuarially sound and not deemed to be in compliance with the rule under a safe harbor provision. The rule specifically seeks to move the use of underwriting guidelines from a basis of "guidelines that make sense" to guidelines that are fair. The rule makes a specific provision for insurers to propose, and for the Commissioner to approve, underwriting guidelines which are inherently fair, including guidelines for which it may be difficult or impossible to secure the necessary information to test if the guideline is actuarially sound. The fact that an underwriting guideline is used virtually everywhere provides no evidence that the guideline is actuarially sound or inherently fair. COMMENT: A commenter argued that the rule eliminates underwriting guidelines. DEPARTMENT'S RESPONSE: The Department disagrees. The rule prohibits the use of unfair underwriting guidelines, but offers no constraint on the development and application of fair underwriting guidelines. COMMENT: A commenter argued that competition in underwriting may be reduced as a result of the rule, that added costs and expenses for insurers will discourage competition, and that insurance will be less fair because high risk policyholders will be subsidized as a result of the constraints placed on underwriting. DEPARTMENT'S RESPONSE: The Department disagrees with this comment. Consumers do not always benefit from rate selection competition. To the extent that such competition is limited to cost-based underwriting guidelines, the competition may be beneficial. Competition relying upon guidelines that are not cost-based does not benefit consumers as a whole and is not consistent with beneficially competitive markets. The rule will promote greater fairness in the business of insurance because the rule requires and promotes the use of cost-based underwriting guidelines, thereby ensuring that insurers' risk classification decisions will be actuarially sound and fair. COMMENT: A commenter argued that the proposed regulation will constrain the use of underwriting guidelines which are related to risk and thereby cause many Texas consumers to pay higher rates because insurers will not be able to charge prices commensurate with the prohibited underwriting guidelines. The commenter argued that insurers will not be able to use cost-based underwriting guidelines because the standard for fairness in the rule is arbitrary, excessively stringent and unworkable and because the rule specifically prohibits the use of some information that may have a substantive impact on the expected costs of providing coverage. DEPARTMENT'S RESPONSE: The Department disagrees with this comment. The argument that some consumers will pay more to subsidize bad risks is based upon the assertion that the rule will hinder insurers from using cost-based underwriting guidelines. The commenter argues this outcome will result because the standard of fairness is arbitrary, excessively stringent and unworkable. The Department disagrees. The standard of fairness is clearly none of these things. Sound actuarial principles as both a standard of fairness and a methodology to test that standard are used by virtually every state in determining fairness for rates. Since all actuaries seek to comply with these principles, they are clearly workable. Finally, the Department disagrees that the standard is excessively stringent as sound actuarial principles have been developed by actuarial organizations whose membership is dominated by actuaries who work for the insurers who will rely upon these principles. If the commenter is referring to the original requirements that guidelines must be shown to be related to risk of loss or size of expense at the 95% confidence level by employing a statistical procedure which controls for all other known underwriting guidelines and rating factors, the Department disagrees that these requirements are arbitrary, excessively stringent and unworkable. However, the Department has modified the test for demonstrating an underwriting guideline is related to differences in the expected costs associated with the transfer of risk to address these concerns. COMMENT: One commenter argued that the rule will limit insurer's ability to use cost-based underwriting guidelines and will thereby likely cause total claims to increase. The inability to use cost-based underwriting will lead to distortions in pricing which, in turn, will lead to lessened incentives for risk-reducing activities by consumers. These undesirable distortions in consumer behavior will cause total claims to increase. DEPARTMENT'S RESPONSE: The foundation of this commenter's argument is that the rule will limit insurer's ability to use cost-based underwriting guidelines. In fact, the rule will require and promote the use of cost-based underwriting guidelines. Because the commenter's basic assumption is incorrect, the Department disagrees with this comment. COMMENT: One commenter argued that the rule will cause some insurers to suffer losses and increase the risk of writing coverages, thereby making Texas a more costly and less attractive place to write business. Such outcomes will decrease insurance availability. DEPARTMENT'S RESPONSE: The basis for the argument that some insurers will suffer losses is the assertion that the rule will prohibit the use of cost-based underwriting guidelines, thereby causing insurers to write risky consumers they would have rejected in the absence of the rule. The Department disagrees with the premise of the argument. The rule will not limit the use of cost-based underwriting guidelines. Rather, the rule will require and promote the use of guidelines which are demonstrably related to the expected differences in the costs associated with the transfer of risk. COMMENT: A commenter argued that the proposed regulation will increase claim costs by making it more difficult for insurers to introduce new underwriting guidelines that could provide consumers with additional incentives to take actions to control costs. This will occur because the regulations will reduce the incentives for insurers to take these actions. DEPARTMENT'S RESPONSE: The Department disagrees. The rule causes no change in the prudent business practices necessary to introduce a new underwriting guideline. Any insurer trying to determine if a proposed underwriting guideline were cost-based would determine if the guideline was actuarially sound. The rule simply requires and promotes this activity to ensure that underwriting guidelines used by insurers are, in fact, cost-based. The rule does nothing to change an insurer's incentive to develop risk classifications that will provide consumers with additional incentive to control costs. To provide incentives to consumers to control costs and reduce losses, the guideline must be related to risk of loss, must be structured in a way to provide an incentive to the consumer for avoiding risky behavior and must be known to the consumer so the consumer knows how to achieve the incentive. The rule provides no disincentive for any of these factors. Rather, the rule requires and promotes the use of risk-based underwriting guidelines. COMMENT: A commenter argued that the rule will cause owners of insurers to suffer losses on prior investments in developing and implementing underwriting guidelines. DEPARTMENT'S RESPONSE: The Department disagrees. Based upon this commenter's earlier arguments that insurers have an incentive to use cost-based underwriting guidelines, it is reasonable to expect that any insurer's prior investment in developing existing underwriting guidelines focused on the analysis and determination that the underwriting guideline actually differentiated consumers on the basis of expected differences in the costs associated with the transfer of risk. To the extent that prior investments in developing and implementing underwriting guidelines included provisions to ensure that the guidelines were actuarially sound and the guidelines proved to be actuarially sound, the owners of the insurer will suffer no loss on that investment. To the extent that prior investments were made in developing and implementing unfair underwriting guidelines, the owners of the insurer will suffer losses. It is important to point out that any owner of an insurer will suffer losses on efforts to develop underwriting guidelines which are not related to expected differences in the transfer of risk because such guidelines do not help an insurer make effective cost-based underwriting and pricing decisions, as Allstate witness Harrington has testified. Thus, even in the situation of losses suffered on developing and implementing underwriting guidelines which insurers discover not to be related to differences in the expected cost of the transfer of risk, the rule does not cause the owners of insurers to suffer losses they would not have otherwise incurred in the absence of the rule. COMMENT: A commenter argued that the proposed regulation will create greater uncertainty for insurers in Texas leading to a greater required rate of return for insurers doing business in Texas leading to decreased insurance availability. DEPARTMENT'S RESPONSE: The Department disagrees. The rule will provide greater certainty that underwriting guidelines are cost-based. Further, the rule clearly articulates the Department's expectations about insurer behavior and performance in the market place, thereby providing greater certainty than in the absence of the rule. The Department disagrees that the rule will affect required rates of return. COMMENT: A commenter argued that the rule will increase costs and reduce options for many Texans because it will encourage the relative expansion of insurers that employ less selective underwriting guidelines but that have higher distribution expenses. DEPARTMENT'S RESPONSE: The Department disagrees with this comment. The commenter asserts without basis that insurers who employ less selective underwriting guidelines have higher distribution costs. By distribution costs, the Department assumes that the commenter is referring to the type and use of agents by insurers. Insurers who do not use agents typically have the lowest distribution cost because they pay no agent's commission. The commenter has offered no evidence, nor is the Department aware of any evidence, to suggest that those insurers without agents use more selective underwriting guidelines than insurers who use captive or independent agents. Moreover, the Department has reviewed the residential property and private passenger automobile underwriting guidelines of Texas insurers and has not found that insurers who use independent agents (and typically incur higher distribution costs than insurers who use captive agents) employ less selective underwriting guidelines than insurers who use captive agents. Instead of the outcome argued by the commenter, the rule will promote greater options at more affordable prices for Texas consumers because more consumers will be offered insurance in the standard and preferred companies for which they legitimately qualify. 5.4 Comments On The Costs To Comply With The Rule. COMMENT: A commenter argued that the proposed rule fails to accurately reflect the cost to insurers in complying with the rule. The commenter argued that the cost of defending potential litigation would exceed by more than 25% the costs stated in the proposed rule. Another commenter argued that the rule will add significant additional compliance overhead to the industry's cost of doing business (although the commenter failed to explain what those additional costs will be or how they were determined). Another commenter argued that the costs of litigation will exceed the estimate of no costs set out in the notice. DEPARTMENT'S RESPONSE: The Department disagrees that the actual costs to comply with the rule will exceed the cost estimate contained in the notice of the proposed rule by more than 25%. First, these commenters misunderstand the cost estimates required under the Government Code, sec.2001.024(5)(B). The public cost estimates contained in the proposed rule constitute the costs to comply with the rule; the estimate does not-and the agency is not required by statute -to include defense costs, damages, and penalties to be paid as a result of a violation of the rule. It would be impossible for the Department, or any agency, to estimate the number of times regulated entities will violate a rule and the fines and penalties that will result. The commenter's argument is based on the premise that the cost estimate must include the estimated fines and penalties, in addition to the litigation expenses, that will be incurred by all regulated entities that choose to violate the rule. The Legislature could not have intended such an absurd result. The Department properly complied with the statutory requirement to estimate the costs necessary to comply with the rule, not the costs associated with a violation of the rule. Second, the Department does not anticipate extensive litigation as a result of this rule. As shown previously, several other rules promulgated by the Department under Article 21.21 have not generated any private litigation, legitimate or frivolous. The commenters have not shown any reason to believe that the experience under this rule will be any different. The Department certainly believes, as did the Legislature when it created a private cause of action, that the possibility of litigation will be enough to cause insurers and agents to refrain from engaging in the unfair practices that are prohibited by this rule so that there will not be extensive litigation. Third, as to the alleged costs association with frivolous lawsuits, this rule does not permit frivolous lawsuits. To the extent that frivolous lawsuits may theoretically result from the promulgation of a rule, that potential exists for any rule promulgated by an agency. Yet no agency includes the costs of potential frivolous suits in its cost estimate. Moreover, it would be impossible for an agency to estimate how many claimants will bring a frivolous suit citing the proposed rule or the cost associated with defending potential frivolous suits. Again, the Legislature could not have intended such an absurd requirement for the cost estimate. Fourth, some of the commenters are incorrect in their interpretation of Insurance Code, Article 1.03B. That statute provides that a rule is void only if the reasonable actual costs exceed the costs stated by at least 25% of the costs stated. Only reasonable actual costs count; costs related to a violation of the rule are not reasonable costs and should not be included in the determination. In addition, the costs referred to in Article 1.03B are the total costs estimated by the Department. Some commenters erroneously contended that the statute applies if any element of the cost estimate is too low. In this instance, the estimate for each company was up to $300,000. Fifth, if a consumer were to file a frivolous lawsuit under Article 21.21, sec.16, alleging a violation of this rule, the defendants in the suit have a remedy to recover their costs. Article 21.21, sec.16(c) provides that if the court finds that an action was groundless and brought in bad faith or brought for the purpose of harassment, the court shall award to the defendants reasonable and necessary attorney's fees. Finally, the "economic cost" associated with the rule is not simply the expense associated with the rule, it is the balance of the economic benefits and the expenses associated with compliance. For those companies and agents who currently engage in the practices prohibited by this rule, they will incur an administrative expense for the elimination of their current underwriting guideline. However, they will also receive the benefit of additional business from consumers of the same risk as those consumers that they currently insure. The profit resulting from this additional business will to some extent offset any expenses associated with the elimination of the underwriting guideline. COMMENT: A commenter argued that insurers will incur costs to determine if their guidelines meet the rule's standard of fairness and in responding to any challenges that the guidelines do not meet the standards. A commenter argued that the costs involved in programming for the calculations required by the rule will be substantial and that this cost is not included in the estimate of costs. A commenter asserted that underwriting guidelines based upon the safe harbors- substantially at fault or arising out of consumer negligence-could easily produce costly disputes between consumers and insurers because of the difficulty in interpreting these standards. DEPARTMENT'S RESPONSE: The Department agrees that insurers will incur a cost to comply with the rule but disagrees that those costs will exceed the maximum cost estimate of $300,000 per insurer contained in the notice of proposed rulemaking, and will likely be substantially less. For those insurers currently using underwriting guidelines that differentiate between classes of consumers with different expected costs associated with the transfer of risk, there will be no additional costs. Presumably an analysis has been performed using sound actuarial principles, since those principles are the standard guides to actuarial and statistical analysis in insurance. Without such an analysis, use of the guideline would be arbitrary and capricious and irrational. These insurers will not incur additional costs to comply with this rule because there will be no additional analysis necessary. For those underwriting guidelines for which there has been no such analysis and the guideline is not deemed to be in compliance with the rule under a safe harbor provision, insurers may incur a cost to comply with the rule, which is estimated not to exceed $300,000 per company. An insurer in such a situation has three choices. First, it can perform an actuarial analysis to determine whether the guideline is actuarially sound. An estimate of this cost was included in the Department's cost estimate. Second, it can discontinue the use of the guideline. The cost to notify agents and others of the discontinuance of the guideline was included in the cost estimate. Finally, it can file the guideline with the Department and request that the guideline be added to the safe harbor provisions. This estimated cost was also included in the cost estimate. The Department disagrees that underwriting guidelines based on the safe harbors will produce costly disputes between consumers and insurers. First, previous rules under Article 21.21 regarding unfair underwriting guidelines, as shown above, have not resulted in any private litigation, to the Department's knowledge. Second, if an insurer believes a safe harbor is vague, it can either request an amendment to that safe harbor, not rely on the particular safe harbor, or propose a new safe harbor. Third, to the extent such a challenge is frivolous, insurers have a means to recoup those costs from the person making the claim. Finally, insurers can avoid the costs associated with legitimate challenges by simply complying with the rule. 5.5 Comments On Niche Markets. COMMENT: A commenter argued that, to the extent the rule prohibits classification or underwriting judgment in some lines of insurance, the availability and affordability of insurance would likely be jeopardized. The commenter argued that the ability of insurers to develop and market their products in niche markets may be adversely affected, insureds in those niche markets will likely be forced to pay more for insurance, and that in many cases these niche markets would disappear. DEPARTMENT'S RESPONSE: The Department disagrees with this comment. A niche market, by definition, is a subset of the population defined by certain characteristics of the consumers to be insured. While niche markets are most often thought of as small subsets of the population, the fact is that virtually every insurer defines its target market in terms of the characteristics of the consumers to be insured. Thus, the smallest insurer is no different than the largest insurer in defining its target market based upon a set of consumer characteristics. The rule therefore will not disproportionately affect any one type of insurer, no matter what size market the insurer targets. The Department disagrees that the ability of insurers to develop and market their products in niche markets will be adversely affected or that insureds in those niche markets will be forced to pay more for insurance. The Department also disagrees that niche markets will disappear as a result of the adoption of this rule, except any niche markets based on underwriting guidelines that are not justified by sound actuarial principles. Moreover, for the reasons set out above, there is no reason to believe that insurance rates in niche markets will increase. Because the rule does not prohibit the use of cost-based underwriting guidelines, niche market insurers will only be affected by this rule to the extent any additional consumers meet the insurer's underwriting guidelines and thereby do not increase the insurer's average losses or expenses. Thus, the insurer will not need to raise its rates. The rule does not prohibit underwriting judgment. To the extent that certain underwriting guidelines and risk classifications not related to differences in expected costs associated with the transfer of risk are prohibited, insurance affordability and availability will improve, as described in the reasoned justification, as a result of this rule. For those consumers who are either denied insurance or charged higher rates based on underwriting guidelines which are not actuarially sound, this rule will increase the affordability and availability of insurance. If an insurer is able to write a class of additional consumers without increasing its average losses or expenses, then that insurer will not need to raise its rates. The rule does not prohibit the use of other guidelines that are true indicators of risk. The rule simply requires an insurer to use underwriting guidelines that are related to risk or expense. COMMENT: A commenter argued that it is fair for an insurer to require consumers to be a member of some organization in order to be eligible to apply for insurance. Examples given include membership in fraternal groups, lodges, secret societies, credit unions, government employees. DEPARTMENT'S RESPONSE: The Department disagrees. The rule only prohibits the membership requirement if it is not actuarially sound and not deemed to be in compliance with the rule under a safe harbor provision. Thus, if an insurer restricts its sales to members of the group because the group has lower losses or because the average expenses associated with insuring the group would increase if non-members were insured, then such discrimination would be based on differences in the expected costs associated with the transfer of risk and would not violate the rule. However, if non-members have the same expected costs associated with the transfer or risk as members, then there is no justifiable business reason to deny coverage. As Dr. Appel testified on behalf of Allstate, there is overwhelming public support for controlling the ability of insurers to use information that is not related to costs. Tr. at 350. That is exactly what this rule does: it prohibits insurers and agents from denying coverage to non- members of a group if membership is not related to cost. In that instance, the discrimination based on the applicant's failure to meet membership requirements would be unfair. 5.6 Comments Concerning The Related To Risk Or Expense Requirement COMMENT: A commenter argued that the provision in the proposed rule that provides that underwriting guidelines that are related to expense are fair is inconsistent with the Department's position that the multicar guideline is unfair even though related to risk. DEPARTMENT'S RESPONSE: The Department disagrees. This rule does not provide that all underwriting guidelines that are actuarially sound are fair. Rather, it provides that all guidelines that are not actuarially sound and not deemed to be in compliance with the rule under a safe harbor provision are unfair. As discussed in the Reasoned Justification, some underwriting guidelines are unfair even if they are related to risk or expense. The multicar underwriting guideline is one of those guidelines. COMMENT: A commenter argued that it is fair for a company to make a business decision not to serve a geographic area, even if the decision is not risk related or expense related. DEPARTMENT'S RESPONSE: The Department disagrees. If the estimated cost associated with the transfer of risk for consumers in a different geographic location is the same as for the geographic locations the insurer is willing to insure, then there is no justification for denying coverage to those consumers because of where they happen to live. As Dr. Appel testified on behalf of Allstate, there is overwhelming public support for controlling the ability of insurers to use information that is not related to costs. Tr. at 350. If a consumer lives in an inner-city neighborhood and the risk and expense for insuring that consumer are the same as the risk and expense of insuring a consumer in the suburbs, it would be unfair for an insurer to insure one and deny coverage to the other. COMMENT: Commenters argued that the statistical procedure is vague, arbitrary, untried and expensive. DEPARTMENT'S RESPONSE: The Department believes these comments were directed at the requirements that the statistical procedure must control for all other known underwriting guidelines and rating factors and that the procedure must show at a 95% confidence level that consumers who satisfy the underwriting guideline have, on average, lower losses or cause the insurer to incur lower expenses than consumers who do not meet the underwriting guideline. The Department disagrees with the comments that these statistical procedures are vague, arbitrary, untried and expensive. However, to clarify the standard for fairness and the methodology for testing that standard, as well as to make the standard consistent with that contained in other rules, the rule has been modified to make sound actuarial principles both the standard of fairness and the principles with which any procedure to test that standard must be consistent. The standard of fairness of, and procedures to test that standard consistent with, sound actuarial procedures are not vague, arbitrary, untried and expensive. Sound actuarial principles as both a standard of fairness and a methodology to test that standard are used by virtually every state in determining that fairness for rates. Since all actuaries seek to comply with these principles, they are clearly not "untried." Sound actuarial principles can hardly be characterized as arbitrary by insurers since they have been developed by actuarial organizations whose membership is dominated by actuaries who work for the insurers who will rely upon these principles. controlling for all other underwriting guidelines and the 95% confidence level- are not vague, arbitrary, untried and expensive. First, neither standard is vague. Several witnesses at the hearing referred to the importance of controlling for other known risk factors in evaluating whether a particular characteristic causes a certain outcome. The Allstate witnesses discussed this issue both in regard to the causes of availability problems in minority areas and to the unique relationship of credit history to risk of loss. Controlling for other risk factors is a requirement of sound actuarial principles. Further, Allstate witness Smith used the term "confidence level" in describing his actuarial analysis of credit history as an underwriting guideline. Allstate witness Harrington also discussed the term confidence level with understanding. Confidence level is a common and standard statistical tool and is not vague to anyone who has had even minimal statistical training. Allstate witness Harrington described the 95% confidence interval as arbitrary. But when asked what figure would be reasonable, he replied, "I don't really accept the notion that there should be a particular number that is used here." Tr. 321. In combination with Dr. Harrington's earlier comment, it is clear that he does not believe any standard of fairness other than the result of market outcomes is fair, "Well, my recommendation would be that to the greatest extent possible that the standards that are allowed be determined by competition, and that is if companies compete and they find that certain standards are useful in identifying lower cost consumers, then those standards should be allowed." Tr. 320. The argument against the 95% confidence level was not that 95% was arbitrary, but that any standard promulgated by the Commissioner would be arbitrary. Dr. Harrington says that the only non-arbitrary standard of fairness is the outcome of market activity. The Department disagrees. If all market outcomes were fair, there would be no need for the regulation of insurance. There is clearly a need for insurance regulation to protect consumers from the those market outcomes which are not fair to consumers and which may result from structural market failures. The 95% confidence level is fair and is not arbitrary. Dr. Harrington admitted that 95% was a common standard for testing scientific hypotheses. Since the proposal of the 95% confidence level was published for public comment and a public hearing was held to allow interested parties to provide further comments to the Commissioner on the standard, it can hardly be asserted that the adoption of the standard is arbitrary. No witness pointed out why 95% would be arbitrary, including Dr. Harrington whose sole argument was that any standard promulgated by the Commissioner would arbitrary. The Department rejects these arguments. COMMENT: Commenters argued that the statistical procedure is unreasonable because it requires companies to prove an underwriting guideline with data that it has never collected before because the use of the guideline caused the rejection of applicants who failed to satisfy the guideline. DEPARTMENT'S RESPONSE: The Department disagrees. The commenter implies that the insurer is using an underwriting guideline to exclude certain consumers without any analysis that the underwriting guideline actually identifies differences in expected costs associated with the transfer of risk. To the extent that the insurer is not able to generate the necessary data internally to test the underwriting guideline, the insurer can petition the Commissioner to add the underwriting guidelines to the safe harbor provisions while the Commissioner helps the insurer obtain the data necessary to test the underwriting guideline. The ability of insurers to enlist the Commissioner's assistance in obtaining necessary data to test underwriting guidelines will allow small and medium sized insurers greater independence in business decision-making and promote greater competition in insurance markets. COMMENT: A commenter argued that customer selection and retention and other marketing practices should not need to be risk or expense related. Department's response: The Department disagrees. Two consumers of like characteristics should be treated in the same way by an insurer. If these two consumers with the same expected cost associated with the transfer of risk are treated differently, at least one of the consumers is being unfairly discriminated against. Insurers have great freedom, with certain exceptions, to establish the qualifications a consumer must meet for the insurer to sell insurance to the consumer. But if a consumer meets those qualifications, then the insurer should sell insurance to the consumer. The insurer is not harmed by selling insurance to consumers who meet the insurer's fair underwriting guidelines. COMMENT: A commenter argued that the collection of data required by the rule will require new processes and procedures at the agent level. DEPARTMENT'S RESPONSE: The Department disagrees. In the event that an insurer uses an underwriting guideline and does not have the data to test whether that guideline is actuarially sound, the insurer may either file a petition to add the underwriting guidelines to the safe harbor provisions or to collect additional data to do so. There is no requirement to collect data under this rule. Any changes in procedures or processes will happen at the insurer level. At the agent level, the only change may be for the agent to collect some additional information on the application form. Since the agent spends a good deal of his or her time and expertise obtaining information from applicants, the requirement by the insurer that the agent obtain some additional information is clearly not a new process or procedure at the agent level. 5.7 Comments Regarding How A Company Can Show Compliance COMMENT: Commenters argued that an insurer who is challenged on the basis of the test to control for all other factors can only defend itself by publicly revealing all of its underwriting guidelines. DEPARTMENT'S RESPONSE: The Department disagrees. Article 1.24D specifically provides that underwriting guidelines can be used to prosecute a violation of the Insurance Code. Since any Department or private action based on this section would be an action to prosecute a violation of Article 21.21, sec.16, the exception to Article 1.24D would apply. That statute also provides that the guidelines shall remain confidential during the pendency of the action, so any confidentiality claims would be protected. In addition, the rule does not prohibit an insurer or agent from obtaining a protective order when appropriate from the administrative law judge or district court judge to protect any alleged trade secrets. COMMENT: Commenters argued that rule eliminates the use of any underwriting guidelines not listed in the safe harbors. The commenters claimed the rule adopts a "take all comers" approach to insurance. Commenters argued that the Department has determined that underwriting guidelines not listed in the safe harbors provisions have been determined not to meet the statistical test set out in the rule. DEPARTMENT'S RESPONSE: The Department disagrees. The rule only prohibits the use of guidelines which are not actuarially sound and which are not deemed to be in compliance with the rule under a safe harbor provision. All actuarially sound underwriting guidelines are permitted, except as specifically prohibited by other statutes. A "take all comers" approach implies that no underwriting is permissible. Such an outcome is not the case with this rule as the rule does not eliminate all underwriting guidelines. The fact that an underwriting guideline is not listed in the safe harbors does not mean that the Department has made any determination whether the guideline is actuarially sound. The Department believes that underwriting guidelines are currently in use which can be demonstrated to be actuarially sound and are therefore fair as defined by the rule. Nor does inclusion of an underwriting guideline in the safe harbors mean that the guideline has been proven to be actuarially sound. Guidelines can be placed in the safe harbor because they are actuarially sound or because they are inherently fair. COMMENT: Commenters argued that the proposed statistical procedure would prohibit insurers and agents from refusing to offer coverage to applicants who are intoxicated, make material misrepresentations or omissions on applications, have cars with obvious safety hazards, have vision impairments or seizures, have convictions for intentional damage to property, who have been held liable for arson in a civil trial, owns a vicious dog, owns a swimming pool or trampoline in a residential area without fencing, stores gasoline or gunpowder in a garage, operates a vehicle that does not pass state inspection, or does not cooperate in the handling of a claim. The commenters argued that it would be impossible to collect data to justify these underwriting guidelines. Another commenter argued that the rule would preclude factors related to risk of loss which cannot be actuarially shown to have higher losses or expenses. DEPARTMENT'S RESPONSE: The commenters offer a list of circumstances in which the applicant represents an imminent peril to the agent or a dramatic moral hazard to the insurance company or some other circumstance in which common sense would presumably indicate that it is fair and reasonable to deny coverage to the applicant. The concern of the commenters is that if the insurer has not previously imagined the particular circumstance and not filed a related underwriting guideline, the insurer would be required to write the "obviously" bad risk. The commenters are also concerned that because such circumstances are rare and because they never write such risks, the insurer would have no data to show that denial of the risk was based upon an actuarial sound decision. The rule comprehensively addresses the concern over these potential applicants or insureds. First, insurers have ample time to submit a petition for including certain underwriting guidelines in the safe harbors. Insurers have ample experience with the variety of applicants who seek insurance and should therefore be able to craft underwriting guidelines which cover almost all of these potential applicants. The Commissioner can, by rule, adopt these underwriting guidelines into the safe harbors because they are inherently fair. The adoption of an underwriting guideline as inherently fair is a public policy expression that the underwriting guideline is a reasonable factor for insurers to use in classifying risks. The safe harbor procedures allow the Commissioner to adopt certain underwriting guidelines as inherently fair in situations where data to determine if the underwriting guideline is actuarial sound is impossible to develop. The rule also provides for those instances in which a such an applicant seeks insurance, but for which the insurer has not filed a petition for an underwriting guideline which would cover these unforeseen applicants. Subsection (d)(3)(A) was amended to provide that the safe harbor period for underwriting guidelines filed with the Department begins 60 days prior to the date of filing with the Department. This change was made to address those rare instances wherein an agent or insurer has a legitimate and fair reason for rejecting an applicant but did not foresee the need for such an underwriting guideline and can not collect sufficient data to justify the guideline based on sound actuarial principles. This change gives the insurer or agent 60 days to file a request that the new underwriting guideline be added to the safe harbor list. Such a filing will protect the agent or insurer from liability for the use of such guideline. If the Department, however, determines that the guideline is not fair, its ruling will then protect future consumers from being subjected to that unfair guideline. COMMENT: Commenters argued that the requirement for the analysis to be conducted based on sound actuarial principles fails to recognize the distinctions between underwriting, statistics and actuarial science. DEPARTMENT'S RESPONSE: The Department disagrees. The three disciplines are very related. Actuarial science is built upon a foundation of statistical analysis, while underwriting, as the Allstate witnesses testified, is an attempt to identify factors related to expected differences in the costs associated with the transfer of risk. Actuarial science and sound actuarial principles are the tools to investigate those differences. COMMENT: Commenters argued that the rule would preclude the use of engineering data, building codes, and fire department statistics that do not meet the standards set out in the rule. DEPARTMENT'S RESPONSE: The Department disagrees. Any data not consistent with sound actuarial principles would be precluded from procedures which test an underwriting guideline to be actuarially sound. However, none of the data listed by the commenter would be precluded from an analysis consistent with sound actuarial principles. COMMENT: A commenter questioned how individual companies and agents will satisfy themselves before using their underwriting guidelines that they are in compliance with the rule. The commenter argued that the threat of losing a lawsuit, even if a company or agent believes they have complied with the rule, will cause companies to abandon guidelines that are risk related. DEPARTMENT'S RESPONSE: The Department disagrees. The rule provides specific provisions for insurers to use underwriting guidelines without threat of lawsuit while the insurer, or the insurer with the assistance of the Commissioner, tests to determine if the underwriting guideline is actuarially sound. Given that insurers can use underwriting guidelines during the period the insurer's petition is being considered without fear of penalty or lawsuit, there is no reason to abandon risk-related underwriting guidelines. COMMENT: A commenter argued there is a problem with collecting data for credibility purposes, especially for small companies. The commenter questioned how subsection (d)(3)(B) would work regarding the collection of data. DEPARTMENT'S RESPONSE: The Department disagrees. The rule contains a specific provision to allow the Commissioner to assist the insurer in collecting insurance or other relevant data to determine if the underwriting guideline is actuarially sound. This provision provides specific benefits to small and medium sized companies whose book of business is not large enough to generate sufficient insurance data on its own. Such a provision helps small and medium sized insurers compete with the largest insurers. The Commissioner may provide assistance in collecting or generating relevant data in a variety of ways. The Commissioner may simply ask the Department's statistical agent to provide a detailed report regarding the relevant factor. For example, because the Department's residential property and private passenger automobile statistical plans provide for detailed ZIP Code level premium and loss reporting, the Commissioner will be able to provide industry-aggregate premium and loss experience at the ZIP Code level. Thus, the county mutual insurers described previously as saying they had no access to the ZIP Code level data upon which they wanted to base their rating territories would have access to the data they need. The Commissioner may opt to add data elements to statistical plans, issue special calls, or seek other sources of non-insurance data. 5.8 Comments On The Safe Harbors. COMMENT: A commenter argued that the safe harbors were not shown to meet the statistical tests for being related to risk or expense. DEPARTMENT'S RESPONSE: The Department has not tested the underwriting guidelines in the safe harbors to determine if these guidelines are actuarially sound. These guidelines are included in the safe harbor because, as a matter of public policy, they are inherently fair. While some commenters questioned whether the Department had subjected these underwriting guidelines to the statistical test, no commenter argued that any of the safe harbor underwriting guidelines were unfair. COMMENT: A commenter argued that the homeowners insurance safe harbor for underwriting guidelines based on the physical condition of the property is ambiguous. The commenter questioned how this safe harbor is to be distinguished from the safe harbor for physical hazards. DEPARTMENT'S RESPONSE: The commenter implies that there is ambiguity because there is overlap between these two safe harbors. The Department disagrees that any overlap between these two safe harbors creates an ambiguity. However, the Department agrees that any underwriting guidelines regarding a physical hazard would be covered by the safe harbor for physical condition of the property. Therefore, the physical hazard safe harbor was deleted. COMMENT: A commenter argued that the safe harbor provision regarding fraudulent claims is unclear as to whether it applies to suspected fraudulent claims. DEPARTMENT'S RESPONSE: The Department disagrees. The provision provides a safe harbor for an underwriting guideline based on "the making of a fraudulent claim." Suspicion that a consumer has or may in the future make a fraudulent claim is not enough under this standard; the consumer must have made a fraudulent claim. COMMENT: A commenter argued that the term "consumer negligence" in the safe harbor provisions is vague. Another commenter questioned what claims system tracks consumer negligence. DEPARTMENT'S RESPONSE: The Department disagrees. "Negligence" is a well-defined term in insurance law. The term "consumer" is defined in the rule to include both applicants and existing insureds. Thus, the term "consumer negligence" refers to negligence by the consumer and is not vague. This safe harbor provision may be used whether or not a claim tracking system is used. COMMENT: A commenter argued that the term "substantially at fault" used in the safe harbor provisions is vague. DEPARTMENT'S RESPONSE: The Department disagrees that the term is vague. However, the Department changed subsection (d)(1)(B) from "was substantially at fault" to "can reasonably be considered to have been at fault." This new standard is the same as that used in Rule 5.7016, for which there has been no complaint that the term is vague. In fact, insurers and agent associations agreed on the language of that rule and the Department assumes the language is easily understood. Moreover, the Department has received no complaints regarding any ambiguity regarding that term in that rule. COMMENT: A commenter argued that the term "specific and objective measures" is unclear. DEPARTMENT'S RESPONSE: The Department disagrees. The term is used in the safe harbor, "the physical condition of the property to be insured, provided the underwriting guideline has specific and objective measures to evaluate the risk." While the Department recognizes that underwriting based upon the physical condition of the property to be insured is a relevant factor for the insurer to consider, the Department is concerned that such a guideline applied inconsistently and subjectively would be an unfair underwriting guideline. The term "specific and objective measures" simply adds the requirement that any underwriting guideline related to the physical condition of the property to be insured be crafted in such a way that different agents or underwriters would apply that guideline the same way under the same circumstances. The relevance and clarity of the term "specific and objective measures" is demonstrated with the following quote from the section "Function of Guidelines" from one Texas insurer's underwriting guidelines manual: "Exposures that are identical in every respect should elicit the same underwriting response. The Underwriting Guidelines help to ensure that selection decisions are made on a uniform and consistent basis throughout all geographic regions. Because some individual risks have their own unique set of hazards and exposures, the insights and lessons of the more mature Underwriters can be made available to those less familiar with the particulars. The Underwriting Guidelines provide an accumulation of these pertinent observations from the company's past experience. Many underwriting situations occur repetitively. By setting out the problems of a particular case which have been identified and solved, the Underwriting Guidelines present the solution to all identical situations recurring in the future." COMMENT: A commenter argued that the term "significant risk of loss" used in the safe harbor provisions is vague. DEPARTMENT'S RESPONSE: The Department disagrees. However, the term was deleted from the rule, so the comment is no longer relevant. COMMENT: Commenters argued that the safe harbor provision wherein companies may request that underwriting guidelines be added to the safe harbor list would violate Article 1.24D. DEPARTMENT'S RESPONSE: The provision for filing a request to add an additional underwriting guideline to the list of safe harbor guidelines was amended to provide that once one person files the request, any person using the request obtains the safe harbor protections. The provision was also changed to provide that the name of an insurer who files such a request will not be released publicly, unless the insurer consents in writing to the identification, and to provide for a public listing of the underwriting guidelines under consideration. These changes fully address the concerns of the commenter. COMMENT: Commenters argued that the rule would prohibit a company from giving preferential underwriting treatment to a long time member who has a history and relationship with the company. DEPARTMENT'S RESPONSE: To the extent that the preferential treatment envisioned by this commenter is justified by sound actuarial principles, the rule would not prevent such a guideline. Further, data to test such different underwriting practices should be available to the insurer. In addition, an underwriting guideline which provides differential treatment to insureds similar in all but the number of years insured with a company may be submitted to the Commissioner for consideration as an underwriting guideline which is inherently fair and included in the safe harbor. COMMENT: A commenter asked why no prior guidelines have not been included in the safe harbor provisions. DEPARTMENT'S RESPONSE: The Department does not believe that underwriting guidelines based upon the fact that a consumer had or did not have prior insurance is inherently fair. Any company or interested party can file a petition to add such an underwriting guideline to the safe harbors and the Department will help collect relevant data as necessary. If a company can already demonstrate that such a guideline is actuarially sound, the company may use that guideline under this rule. COMMENT: A commenter argued that the safe harbors are inconsistent regarding moral hazards. The commenter questioned why other moral hazards are not included. The commenter questioned why there must be a conviction for arson but not for insurance fraud. DEPARTMENT'S RESPONSE: There is no inconsistency in the safe harbors because the rule does not prohibit underwriting guidelines simply because they are not listed in the safe harbor provisions. There may be additional underwriting guidelines that are appropriate safe harbors. The rule provides safe harbor protections for any additional safe harbor provisions that are petitioned to be added. Thus, the commenter is free to use underwriting guidelines based on other moral risks to the extent such guidelines are actuarially sound or the commenter may avail itself of the safe harbor protection that permits it to file a petition to add these other underwriting guidelines to the safe harbor provisions. Regarding the conviction for arson, the Department has deleted the conviction requirement. COMMENT: A commenter questioned whether "hazard" in subsection (d)(2)(A) encompasses moral hazards or risks or simply physical hazards. DEPARTMENT'S RESPONSE: The term refers only to physical hazards associated with the physical condition of the property. The subsection does not express or imply a reference to moral hazards. COMMENT: A commenter asked why guidelines based upon Department rate classifications have not been included as safe harbors. DEPARTMENT'S RESPONSE: Since Department promulgated rate classifications must, by law, be actuarially sound, there is no need to include them in the safe harbors. The fact that they are not listed in the safe harbor provisions does not mean that the classifications cannot be used. Where the Department has promulgated a rate differential between two classes, then the discrimination between the two classes is actuarially sound. The Department is prohibited from promulgating rate differentials that are not actuarially sound. Thus, if the Department has promulgated a rate differential between two classes (regardless of the amount of the differential), and the underwriting guideline is not otherwise prohibited, then an insurer who discriminates between those two identical classes in the underwriting decision has done so based on sound actuarial principles. COMMENT: A commenter asked how the safe harbor guideline for accidents in which the consumer is "substantially at fault" meshes with the Department's not-at- fault rule, sec.5.7016. The commenter argues that rule strongly implies that two or more not-at-fault claims may be used as a basis for nonrenewal. DEPARTMENT'S RESPONSE: This safe harbor was changed to use the same standard as used in the not-at-fault rule. Thus, the two rules are consistent. The not-at- fault rule, like this rule, is a rule of prohibition, not a rule of authorization. The Department, therefore, disagrees that the rule permits the use of any underwriting guideline. Moreover, this rule does not prevent the use of a guideline based on two or more not-at-fault claims simply because it is not listed in the safe harbor provisions. If such a guideline is actuarially sound, it is not prohibited by this rule. Therefore, there is no inconsistency between this rule and the not-at-fault rule. COMMENT: A commenter asked whether a petitioner for an addition to the safe harbors must submit proof as required by the standards in subsection (c). DEPARTMENT'S RESPONSE: A petitioner may file a petition and come within the safe harbor provisions by simply filing the petition and identifying the underwriting guideline. No data, actuarial analysis or statistical analysis is required to file a petition. 5.9 Comments On The Application Of The Rule To Special Types Of Companies COMMENT: A commenter argued that the rule violates constitutional rights of association and statutory provisions contained in Insurance Code, Chapter 19. Another commenter asked how the rule would affect insurers that insure only current and retire military officers. DEPARTMENT'S RESPONSE: The Department disagrees. Although Article 19.01 permits the exchange of reciprocal and inter-exchange contracts, the Insurance Code must be read as a whole. When read as a whole, it is clear that the Legislature did not intend this right to be an absolute right. The Legislature did not permit subscribers to deny membership in the reciprocal or inter-exchange if such denial is legally prohibited. For instance, Insurance Code, Article 21.21-5 prohibits a reciprocal and inter- exchange from denying membership to a person based on race, color, religion or national origin, and to the extent not justified by sound actuarial principles, on geographic location, age, sex or disability. Insurance Code, Article 21.49-2D provides that an insurer cannot cancel or non-renew a policy based on the fact that the policyholder is an elected official. Article 21.21, sec.4(7)(c) prohibits the refusal to renew or cancel a property insurance policy governed by Insurance Code, Chapter 5, Subchapter C, including residential property policies, because of geographic location, with certain exceptions. Thus, there is clear legislative intent that the right to refuse to exchange reciprocal and inter-exchange contracts is not an absolute right. An additional limitation on the right to exchange reciprocal and inter-exchange contracts is the prohibition against unfair practices in Article 21.21. Reciprocals and inter-exchanges are expressly made subject to Article 21.21 in Insurance Code, Article 19.12(b). A refusal to exchange reciprocal or inter- exchange contracts is prohibited if such refusal would constitute a violation of Article 21.21, sec.16. Other rules passed under Article 21.21 are also limitations on the right to refuse to exchange reciprocal and inter-exchange contracts. Rule 21.404 has never been challenged since its passage in 1978. Rules 21.1000 and 21.1003 were upheld as a valid exercise of the Department's authority by the Austin Court of Appeals. Thus, it is clear that the right to refuse to exchange reciprocal and inter- exchange contracts is a limited right that cannot be exercised if refusal to enter a reciprocal or inter-exchange contract would violate another law, including Article 21.21, sec.16, which prohibits practices declared by the Department by rule to be unfair. The Department also disagrees that there is a constitutional right to unfairly discriminate by refusing to enter a reciprocal or inter-exchange contract. The right to enter such contracts is a statutory right, not a constitutional right. In creating the right to enter into such contracts, the Legislature was within its constitutional powers when it limited the exercise of that right. Thus, the prohibition against refusing to enter a reciprocal or inter-exchange contract based on underwriting guidelines that are not actuarially sound is constitutional, just as the other limitations, such as Articles 21.21-5, 21.21, sec.4(7)(c), and 21.49-2D and rules 21.404, 21.1000, and 21.1003 are constitutional limitations on the right to refuse to enter a reciprocal or inter-exchange contracts. Although the rule does not violate statutory or constitutional rights of association, reciprocals and inter-exchanges are not prohibited by this rule from refusing to enter a reciprocal or inter-exchange contract if the underwriting guideline on which membership is based is actuarially sound or comes within the safe harbor protections of the rule. Thus, if a reciprocal insurer has a membership requirement that it only insures current and retired military officers, that requirement does not violate this rule to the extent that current and retired military officers have a demonstrably different expected cost associated with the transfer of risk than do non-military officers. COMMENT: A commenter argued that insurers licensed under Insurance Code, Chapter 16 are not permitted to offer insurance to non-members. DEPARTMENT'S RESPONSE: The Department disagrees. Although farm mutual insurers are governed by Chapter 16, the Insurance Code must be read as a whole. When read as a whole, it is clear that the Legislature did not intend the right to form and operate a farm mutual to be an absolute right. The Legislature did not permit farm mutuals to deny membership if such denial is legally prohibited. For instance, Insurance Code, Article 21.21-5 prohibits a farm mutual from denying membership to a person based on race, color, religion or national origin, and to the extent not justified by sound actuarial principles, on geographic location, age, sex or disability. Insurance Code, Article 21.49-2D provides that an insurer cannot cancel or non-renew a policy based on the fact that the policyholder is an elected official. Article 21.21, sec.4(7)(c) prohibits the refusal to renew or cancel a property insurance policy governed by Insurance Code, Chapter 5, Subchapter C, including residential property policies, because of geographic location, with certain exceptions. Thus, there is clear legislative intent that the right of farm mutuals to deny membership is not an absolute right. An additional limitation on the right of farm mutuals to deny membership is the prohibition against unfair practices in Article 21.21. Farm mutuals are expressly made subject to Article 21.21 in Insurance Code, Article 16.24(b). Denial of membership by a farm mutual is prohibited if such denial would constitute a violation of Article 21.21, sec.16. Other rules passed under Article 21.21 are also limitations on the right of farm mutuals to deny membership. Rule 21.404 has never been challenged since its passage in 1978. Rules 21.1000 and 21.1003 were upheld as a valid exercise of the Department's authority by the Austin Court of Appeals. Thus, it is clear that the right of farm mutuals to deny membership under is a limited right that cannot be exercised if denial would violate another law, including Article 21.21, sec.16, which prohibits practices declared by the Department by rule to be unfair. Assuming arguendo that a farm mutual insurer were legally prohibited from insuring consumers who do not meet eligibility requirements, the rule would still not be in violation of any statutory or constitutional provisions. A standard actuarial principle provides that all applicable laws and regulations must be complied with. See, e.g., Section 5.6 of Actuarial Standard No. 12 of the Actuarial Standards Board. Therefore, if a farm mutual were prohibited by law from insuring non-members, its refusal to do so would be based on sound actuarial principles and, therefore, would not be in violation of the rule. Although the rule does not violate statutory or constitutional rights of association, farm mutuals are not prohibited by this rule from denying membership if the underwriting guideline on which membership is based is actuarially sound. Thus, if a membership requirement identifies a class of consumers who have a demonstrably different expected cost associated with the transfer of risk than do non-members, then the underwriting guideline would not violate this rule. However, to the extent that the membership requirement of the farm mutual is not actuarially sound or deemed to be in compliance with the rule under a safe harbor provision, the rule would prohibit the membership requirement. Such requirements are unfair whether deemed an underwriting guideline or a membership requirement. The net result would be that a consumer is unfairly denied insurance. While farm mutuals may certainly market to different classes of consumers, it is unfair and unjust to deny insurance to non-members who have the same expected cost associated with the transfer of risk as those who the farm mutual is willing to offer membership. 5.10 Comments On The Consistency Of The Rule With Other Laws COMMENT: Commenters argued that Insurance Code, Article 21.49-2B permits an insurer to cancel an automobile policy for any reason within the first 60 days of the policy's effective date and a homeowners policy within the first 90 days of the policy's effective date. DEPARTMENT'S RESPONSE: The Department disagrees that Article 21.49-2B permits the cancellation of a policy during that initial period even if the cancellation would otherwise be prohibited. The Insurance Code must be read as a whole. When read as a whole, it is clear that the Legislature did not intend the right to cancel during this period to be an absolute right. The Legislature did not permit such cancellations when the cancellation is otherwise prohibited. For instance, Insurance Code, Article 21.49-2D provides that an insurer cannot cancel a policy based on the fact that the policyholder is an elected official. Article 21.21, sec.4(7)(c) prohibits an insurer from canceling a property insurance policy governed by Insurance Code, Chapter 5, Subchapter C, including residential property policies, because of geographic location, with certain exceptions. Similarly, Article 21.21-3 prohibits an insurer from refusing to continue to insure a consumer because of a handicap or partial handicap unless based on sound actuarial principles. Thus, there is clear legislative intent that the right to cancel under Article 21.49-2B is not an absolute right. An additional limitation on an insurer's right to cancel under Article 21. 49- 2B is the prohibition against unfair practices in Article 21.21. An insurer may not cancel a policy under Article 21.49-2B if such cancellation would constitute a violation of Article 21.21, sec.16. Other rules passed under Article 21.21 are also limitations on the alleged absolute right to cancel under Article 21.49-2B. Rule 21.404 has never been challenged since its passage in 1978. Rules 21.1000 and 21.1003 were upheld as a valid exercise of the Department's authority by the Austin Court of Appeals. Thus, it is clear that the right to cancel under Article 21.49-2B is a limited right that cannot be exercised if cancellation would violate another law, including Article 21.21, sec.16, which prohibits practices declared by the Department by rule to be unfair. COMMENT: A commenter argued that the rule does not take into consideration the differences in treatment in Article 21.49-2B between cancellation and nonrenewal. DEPARTMENT'S RESPONSE: This rule is not passed under the rulemaking authority of Article 21.49-2B; it is passed under the rulemaking authority of Article 21.21. Article 21.21 authorizes the Department to promulgate rules identifying and prohibiting unfair practices. The use of underwriting guidelines that are not actuarially sound or deemed to be in compliance with the rule under a safe harbor provision are unfair. These practices are unfair whether used as a basis for rejection, cancellation or nonrenewal. Thus, there is no justification for permitting such unfair practices for nonrenewal but not for cancellation, or vice versa. 5.11 Comments Regarding The Department's Statutory Authority To Promulgate The Rule. COMMENT: Commenters argued that the Department of Insurance lacks the requisite statutory and regulatory authority to adopt the proposed rule. DEPARTMENT'S RESPONSE: The Department disagrees for the reasons set out above in section 2, "Reasoned Justification" entitled "The Department has authority to promulgate this rule." COMMENT: A commenter argued that adoption of the proposed rule would violate Insurance Code, Article 1.03A because there is no express grant of rulemaking authority to adopt this rule. DEPARTMENT'S RESPONSE: The Department disagrees. Adoption of the proposed rule does not violate Insurance Code, Article 1.03A because Article 21.21, sec.13 provides the express statutory authority to identify and prohibit unfair practices in the business of insurance. The Department is also expressly authorized to promulgate this rule under Article 5.98 as it relates to auto insurance. COMMENT: A commenter argued that there is no demonstration of the necessity to enact such a rule in order to carry out the purposes of Article 21.21. A commenter argued that there has been no indication that the practices to be prohibited by the rule are occurring or threatened or that consumers have suffered injury or are likely to suffer injury as a result of the prohibited practices. A commenter argued that the Department's August 1993 study does not show that the rule is necessary or that unfair discrimination exists. The commenter recommends that the Department engage in further studies. Another commenter argued that there has been no showing that substantial harm to consumers is occurring under current practices and would be alleviated by the rule. DEPARTMENT'S RESPONSE: The Department disagrees. The NAII court held that the Department may promulgate a rule under Article 21.21 prohibiting an unfair practice even if there is no evidence that the practice is occurring. NAII at 8. Neither the Administrative Procedure Act nor Article 21.21 requires the Department to refrain from acting to protect consumers from unfair and deceptive practices until consumers have been harmed. The mere possibility of an unfair practice provides adequate justification for the Department to act. The Court of Appeals held that Article 21.21 permits the Department to take prophylactic measures to prevent unfair practices: "The board has the authority to promulgate such rules as it deems necessary to advance the objectives of article 21.21, and it need not passively wait for harm to occur before it enacts regulations." Id. at 8. Nevertheless, as has been shown, the Department is aware of ample evidence that the practices prohibited by this rule are occurring in the Texas insurance market. Although the Department has the authority to promulgate this rule even in the absence of consumer harm, the evidence identified above demonstrates the necessity to enact this rule to carry out the purposes of Article 21.21. The evidence shows that some insurers are using underwriting guidelines that are not actuarially sound, that insurance availability problems exist, and that the consumers who are subject to these practices are either denied necessary insurance or are charged higher rates for that insurance. As set out in the reasoned justification section, insurance is necessary to operate or buy a car and own a home. Because the practices prohibited by this rule are unfair, create insurance availability problems for Texas consumers, and harm the competitive nature of insurance markets, the Department finds it necessary to promulgate this rule to achieve the purposes of Insurance Code, Article 21.21. COMMENT: A commenter argued that the rule adds to the strain already placed on the Department's rulemaking authority by its prior experiments in social policy over the past four years and thereby invites a responsive elected Legislature to question whether the agency should continue to have power to make legislative rules at all. DEPARTMENT'S RESPONSE: The Department disagrees. First, there is no "strain" on the Department's authority to promulgate rules prohibiting the use of unfair underwriting guidelines. The court of appeals in the NAII case, as well as the district court, held that the Department has clear authority to prohibit unfair underwriting practices. The Department has set out, at length, its statutory authority to promulgate this rule and will not repeat those statements here. Second, the Department does not consider this rule to be an "experiment in social policy." The basis of this rule, that all persons should be treated fairly in the underwriting process by requiring underwriting guidelines to be cost based, is an old and traditional insurance standard. Finally, the Legislature has made the determination that the Department should have the authority to identify and prohibit unfair practices through rules. While the commenter may disagree with this authority, the Legislature has determined otherwise. COMMENT: A commenter argued that Insurance Code, Article 5.09 does not provide statutory authority to promulgate this rule. DEPARTMENT'S RESPONSE: The Department agrees that Article 5.09 does not include a grant of rulemaking authority. The Department's citation to Article 5.09 was in reference to Article 5.98 as it applies to the portion of this rule dealing with auto insurance. Article 5.98 authorizes the Department to adopt reasonable rules that are appropriate to accomplish the purposes of Insurance Code, Chapter 5, including Article 5.09. Article 5.09 prohibits any distinction or discrimination in favor of an insured having a like hazard, which occurs when an actuarially unsound underwriting guideline is used to place a consumer in a different company within a company group. For instance, if an insurer group has three companies, a preferred company, a standard company and a substandard company, Article 5.09 is violated if insureds having a like hazard are placed in different companies within the group and charged different rates. The rule is necessary, in part, to accomplish the purposes of Article 5.09 because some insurers have attempted to interpret Article 5.09 to not apply to discrimination against consumers of like hazard when the insurer group places those consumers in different companies within the group. COMMENT: A commenter argued that Insurance Code, Article 5.98 does not apply to life, accident and health insurance and does not provide statutory authority for the rule. DEPARTMENT'S RESPONSE: The Department agrees that Article 5.98 does not apply to life, accident and health insurance. However, the rule does not apply to life, accident and health insurance; it applies only to private passenger auto insurance and residential property insurance. COMMENT: A commenter argued that the specific actions by the Legislature determining by statute which activities must be risk related evidences a legislative intent that the Department does not have the authority to expand those consumer protections. DEPARTMENT'S RESPONSE: The Department disagrees. The Legislature promulgated Article 21.21, sec.13 for the express purpose of authorizing the Department to expand consumer protections against unfair practices. Underwriting guidelines that are not actuarially sound and not deemed to be in compliance with the rule under a safe harbor provision are unfair. Moreover, the Legislature delegated rulemaking authority to the Department to ensure that all unfair practices in the business of insurance would be prohibited. The Legislature recognized that the limitations on the Legislative process and the inventiveness of those who would engage in unfair practices make it impractical for the Legislature to identify all unfair practices. Thus, it gave the Department the authority to also identify and prohibit unfair practices to ensure that the public will be protected from unfair practices. One of the purposes of Article 21.21 is to provide for the determination and prohibition of unfair practices in the business of insurance. If the Department's rulemaking authority were limited to only those practices that are already prohibited by statute, the rulemaking authority would be meaningless. Article 21.21 mandates a broad reading of the Department's authority to promulgate rules, even if the particular practice has not been declared illegal by statute. The plain language of Article 21.21 permits the Department to promulgate rules prohibiting unfair conduct. There is no limitation on the Department's authority to declare practices to be unfair simply because they are not specifically prohibited by statute. Article 21.21, sec.1(b) states that Article 21.21 "shall be liberally construed and applied." The clear intent is to give the Department broad, and not limited, authority. Other rules passed under Article 21.21 are also expansions of consumer protections relating to the use of unfair underwriting guidelines. Rule 21.404 has never been challenged since its passage in 1978. Rules 21.1000 and 21.1003 were upheld as a valid exercise of the Department's authority by the Austin Court of Appeals. Thus, the Department has the authority under Article 21.21 to expand consumer protections relating to the use of unfair underwriting guidelines. 5.12 Comments Regarding The Private Cause Of Action. COMMENT: Commenters argued that only the Department should enforce violations of the rule and that there should not be a private cause of action for violations of the rule. Commenters argued that the proposed rule would give rise to frivolous lawsuits. Commenters argued that private lawsuits will not create a deterrent to illegal discrimination but will only encourage members of the protected class to bring a lawsuit whenever they are denied coverage, regardless of the merit of their position. A commenter argued that reliance on private lawsuits to regulate insurers is bad public policy, is an inconsistent and unpredictable way to achieve a regulatory goal, and subverts state administrative regulation of insurance. DEPARTMENT'S RESPONSE: The Department disagrees with these comments. The Legislature, not the Department, has determined that unfair practices in the business of insurance should be policed through both Department enforcement actions and though private actions. Section 16 of Article 21.21 provides for a private cause of action for the violation of any rule promulgated under the authority of Article 21.21 and determined by the Department to be an unfair or deceptive practice in the business of insurance. The commenters are incorrect in assuming that the Department has the authority to deny a private cause of action granted by statute for a practice determined pursuant to Article 21.21 to be an unfair practice. Nevertheless, the Department agrees with the Legislature that public policy mandates that there be a private cause of action for violations of this rule. To the extent a consumer is damaged by unfair practices, the wrongdoer should compensate the consumer for those damages. Moreover, as the NAII court recognized, the private treble damage lawsuit serves two important enforcement purposes. First, it provides individuals not only with the means to discourage deceptive and unfair practices, but also with the incentive to do so. NAII at 9. Second, the threat of treble damage lawsuits provides insurers and agents with a strong disincentive to rely on this type of unfair discrimination in making their decisions to insure. Id. Third, individual instances of unfair practices are usually proved on a case by case basis. The Department does not have the resources to take enforcement actions for all individual instances of unfair practices. Rather, the Department's enforcement actions, due to limited resources, must be focused on large patterns of unfair practices. Thus, the private cause of action provided by the Legislature is necessary to ensure that individual consumers who are victims of unfair practices have the opportunity to seek redress for their damages. As for the filing of frivolous suits, the Department disagrees that the rule permits the filing of frivolous suits. The Department also disagrees that the threat or possibility of frivolous suits should be a basis for permitting the unfair discrimination prohibited by this rule or the denial of redress for those consumers with legitimate claims. The NAII court expressly held that the availability of treble damage lawsuits is an insufficient reason to find that a rule declaring an underwriting practice to be unfair is unnecessary or arbitrary and capricious, because the statute, not the Department, authorizes this type of suit. NAII at 9. Undoubtedly the legislature weighed the cost of potentially frivolous suits against the benefits of providing a private cause of action for unfair practices and determined that the benefits outweighed the possible costs of frivolous lawsuits. The Department disagrees that consumers will bring a lawsuit whenever they are denied coverage, regardless of the merit of their position. Conversely, the failure to adopt the rule would mean that those consumers who do have a legitimate claim would be denied the right to take any action against the wrongdoer to be compensated for any damages caused by the unfair practices. The threat of frivolous lawsuits already exists. A consumer who unjustifiably claims that he or she was denied coverage based on an underwriting guideline that is not actuarially sound may sue for damages without the passage of this rule. The rule does not permit these frivolous suits. What the rule does do is permit those with legitimate claims who do not have the right to sue without the rule to sue for their damages. The Department agrees with the Legislature that any threat or cost of frivolous lawsuits is far outweighed by the benefits resulting from the right of legitimate claimants to seek redress for their grievances. Moreover, if a consumer were to file a frivolous lawsuit under Article 21. 21, sec.16, alleging a violation of this rule, the defendants in the suit have a remedy. Article 21.21, sec.16(c) provides that if the court finds that an action was groundless and brought in bad faith or brought for the purpose of harassment, the court shall award to the defendants reasonable and necessary attorney's fees. Finally, as noted previously, past rules promulgated under Article 21.21, for which there is also a private cause of action, have not resulted in any private litigation, to the Department's knowledge. Thus, the existence of a private cause of action is not calculated to cause excessive litigation costs for insurers or agents. COMMENT: Commenters argued that the proposed rule constitutes an attempt to usurp the authority of the legislature to determine when a private cause of action is appropriate. DEPARTMENT'S RESPONSE: The Department disagrees. The Legislature, not the Department, has determined that unfair practices in the business of insurance should be policed through both Department enforcement actions and though private actions. In fact, if the Department determines by rule that these practices are unfair, the Department does not even have the authority to deny a cause of action because that right is determined by statute. The Department is not usurping any powers of the Legislature. On the contrary, the Department is exercising the powers and duties to prohibit unfair trade practices in the business of insurance that have been delegated to it by the Legislature. 5.13 Miscellaneous Comments. COMMENT: A commenter argued that the rule discriminates against independent agency companies that do not write sufficient premium volume in Texas to justify the underwriting and claims resources required to write all types of coverages in all areas of the state. DEPARTMENT'S RESPONSE: The Department disagrees. First, the proposed rule does not require a company to rely solely on Texas data to show that an underwriting guideline is actuarially sound. Nor does the rule require the insurer to rely solely on its own data. Second, the rule specifically contemplates the need of small insurers to collect data. The safe harbor provision of the rule sets out underwriting guidelines that are deemed to comply with the rule. For those guidelines that are not listed, an insurer may file a request that the guideline be added to the rule. At the request of the insurer, the Department may postpone action on the request until such time as the insurer, Department, or any other person collects data on the guideline. The rule specifically mentions the possibility that data elements could be added to the respective statistical plan as a means to collect a sufficient volume of relevant data. In addition, the Department has the ability to perform special data calls to more timely collect data on a specific guideline. Therefore, the Department believes the rule adequately addresses the needs of all insurers to comply with the rule. Moreover, the rule provides a benefit for small insurers that does not currently exist. Small companies that cannot develop their own underwriting guidelines due to insufficient data are forced to either mimic larger companies or guess whether an underwriting guideline is cost based. This rule provides a method whereby small insurers may seek the Department's help in evaluating an underwriting guideline and thereby make better business decisions. Discrimination based on geographic location is only prohibited to the extent not justified by sound actuarial principles. Discrimination based on geographic location, therefore, is permitted if doing business in another location would increase the estimated cost associated with the transfer of risk. The rule would not prohibit discrimination if, for example, the insurer would incur higher expenses because it is not set up to service a particular portion of the state. If, however, the estimated cost associated with the transfer of risk for consumers in a different geographic location is the same as for the geographic locations the insurer is willing to insure, then there is no justification for denying coverage to those consumers. COMMENT: A commenter argued that the rule unfairly holds independent agents, who have no control over underwriting guidelines instituted by insurance companies they represent, accountable for underwriting guidelines they apply on behalf of their companies. DEPARTMENT'S RESPONSE: The Department agrees in part and disagrees in part with this comment. The Department believes that a limited exception for agents is appropriate. An agent cannot easily determine whether an underwriting guideline is actuarially sound. Unlike the insurer who chooses to use the underwriting guideline and therefore should analyze whether it is actuarially sound, the agent is simply told to apply the guideline. However, to the extent an agent decides on his or her own to apply an underwriting guideline and not because of instructions from an insurer, then the agent should be under a duty to determine whether the guideline is actuarially sound. Therefore, the Department agrees that a partial exemption to the prohibition against unfair underwriting guidelines should be created for agents. The Department has, therefore, added a subsection to the rule to create this partial exemption. COMMENT: A commenter asked what impact the rule will have on value of home underwriting guidelines where market values are substantially lower than replacement values. Another commenter raised the issue of the Department's "no prior" rule and questioned whether use of such a guideline would subject the company to liability. A commenter argued that the rule will eliminate the ability to take into consideration the type of vehicle, e.g. sports/performance vs. standard. The commenter pointed out that such a guideline should be permitted based on studies that show a relationship between loss and vehicle type. A commenter argued that claim history and frequency of loss should be permitted, even if there is no negligence. A commenter argued that the rule would prohibit underwriting guidelines based on a combination of young driver and high performance car for automobile insurance and the use of Protection Classes in homeowners insurance. A commenter argued that the rule would eliminate the use of agency terminations as a reason for nonrenewal. A commenter argued that the rule will eliminate all subjective underwriting guidelines. A commenter asks why it is unfair to reject an applicant with a lack of due regard to the safe maintenance of the premises. DEPARTMENT'S RESPONSE: These underwriting guidelines should be evaluated in the same manner as any other underwriting guideline. The fact that they are not listed in the safe harbor provisions of the rule does not mean that they are unfair or prohibited by the rule. First, if the underwriting guideline is specifically prohibited by a rule or statute, then use of the underwriting guideline would be prohibited. For instance, if the underwriting guideline is based, in whole or in part, on marital status, race, color, religion, national origin, declination of coverage by another insurer, the purchase of additional coverages, the purchase of additional policies, or the number of cars to be insured, the underwriting guideline would be prohibited. Second, the underwriting guideline should be analyzed, consistent with the actuarial standards of practice and compliance guidelines promulgated by the Actuarial Standards Board of the American Academy of Actuaries and in effect on January 1, 1995, to determine whether it differentiates among consumers with different expected costs associated with the transfer of risk. If such a showing can be demonstrated, the use of the underwriting guideline is not prohibited. If such a showing cannot be demonstrated, then the insurer has two choices: it can discontinue the use of the underwriting guideline or it can petition the Department to add the guideline to the list of safe harbors. COMMENT: A commenter argued the justification assumes insurance industry responsibility for consumer problems arising out of the Safety Responsibility Law. DEPARTMENT'S RESPONSE: The Department disagrees. The rule assumes only that the law prohibits insurers from engaging in unfair practices. Underwriting guidelines that are not actuarially sound are unfair. While these unfair practices prohibit some consumers from obtaining the coverage necessary to comply with the financial responsibility law, the practices affect the purchase of all types of automobile and homeowners insurance. COMMENT: A commenter argued that the rule is punitive (although it did not state how the rule is punitive or to whom the rule is punitive) and unnecessary. DEPARTMENT'S RESPONSE: The Department disagrees. The Department has set out the necessity of the rule in the "reasoned justification" section and in response to other comments and will not repeat those statements here. The rule is punitive only against those who engage in these types of unfair discrimination. By definition, any rule that prohibits an unfair practice and provides enforcement mechanisms could be considered punitive against those that engage in the unfair conduct. The Legislature has determined that remedial measures for victims of unfair and deceptive practices are appropriate. Although the rule is clearly remedial as it relates to unfair discrimination, the rule is not punitive as to any other person or entity that is not engaging in unfair discrimination. COMMENT: A commenter argued that the Department will not offer assurances that data provided to it will be kept confidential or honored as proprietary and trade secret. DEPARTMENT'S RESPONSE: The Department is required to comply with the Texas Open Records Law, Government Code, Chapter 552. If the material provided by a company is confidential under that statute, the Department will not produce the information to the public. If the material is open under the statute, the Department must release the information upon request. The Department cannot make a determination regarding whether data is confidential under the statute without reviewing the data. Thus, it would be inappropriate for the Department to make a determination on whether data should be open to the public without reviewing the data and the company's claim of confidentiality. COMMENT: A commenter argued that "it is disingenuous, if not plain cynical, for the Department of Insurance to propose these pointless new burdens." DEPARTMENT'S RESPONSE: The Department disagrees. The rule is intended solely to prohibit unfair practices in the business of insurance. There is nothing disingenuous or cynical about the Department's policy, based on statutory authority, to seek the elimination of unfair practices like the practices which are prohibited by this rule. Nor does the Department believe the prohibitions set out in this rule are pointless. On the contrary, as shown previously, the prohibitions are necessary. Although the Department has the authority to promulgate this rule even in the absence of consumer harm, the evidence identified previously demonstrates the necessity to enact this rule to carry out the purposes of Article 21.21. The evidence shows that some insurers are using underwriting guidelines that are not actuarially sound and not deemed to be in compliance with the rule under a safe harbor provision, that insurance availability problems exist based on these underwriting guidelines, and that the consumers who are subject to these practices are either denied insurance or are charged higher rates for that insurance. Insurance is necessary to operate or buy and operate a car and own a home. Because the practices prohibited by this rule are unfair, create insurance availability problems for Texas consumers, and harm the competitive nature of insurance markets, the Department finds that the rule is appropriate. COMMENT: Commenters argued that the Department is moving too quickly on the proposed rule, is acting "at the 11th hour," and should spend more time studying the proposed rule. Commenters argued that the Department should not act on this rule until the Commissioner appointed by Governor-elect Bush is confirmed by the Senate and has a chance to study the rule. DEPARTMENT'S RESPONSE: The Department disagrees for two reasons. First, the Department has thoroughly investigated the underwriting practices of insurers and availability problems discussed herein over a period of three years. Moreover, the Department has carefully analyzed the proposed rule and the comments provided both in writing and at the hearing. After careful consideration and deliberation, the Department has made some non-substantive changes to ensure that the rule is clear and unambiguous. However, the Department has concluded that the rule is necessary and appropriate. The Department does not believe there is a need for further analysis. Second, the consumers who are the victims of the unfair practices that are prohibited by this rule have suffered long enough. There is no justification for permitting these practices to continue. The chronology of Department activities on the issues of insurance availability and unfair discrimination set out in the Reasoned Justification shows a long- term involvement and commitment by the Department. Department staff have worked on this rule for many months prior to its publication. However, in response to these concerns, the Department has amended the rule to apply only to actions taken after June 1, 1995. If the new commissioner believes amendments to the rule or repeal of the rule are necessary, then that commissioner will have the opportunity to do so. This delay will also give those persons subject to the rule sufficient time to make any changes in their practices that are necessary to comply with the rule and request additions to the safe harbor lists. COMMENT: A commenter argued that the rule does not address the root causes of losses and costs in insurance. DEPARTMENT'S RESPONSE: The proposed rule is not aimed at reducing the root causes of losses and costs in insurance. Rather, the rule is intended to eliminate unfair practices. While the Department has taken steps to address the problems of losses and costs in insurance, such as through the creation of its safety unit, those efforts are not the subject of this rule. The Department disagrees that this concern should be a basis for rejecting this rule. COMMENT: A commenter argued that insurance companies are free to determine the types and kinds of risk they will accept. The commenter argued that the legislature has expressed its policy that insurance companies are free to reject applicants for any reason whatsoever, other than reasons prohibited by other provisions of the Insurance Code or the federal laws such as those regarding discrimination. A commenter argued that federal unfair trade practices laws do not apply to "refusal to deal" and that the Restatement of Torts confirms that principle. Commenters argued that the determination of what constitutes risk should be left to the person taking the risk. DEPARTMENT'S RESPONSE: The Department disagrees with this comment. The Legislature has determined that insurers should be limited to making fair business decisions. The Legislature passed Article 21.21 for the express purpose of prohibiting insurer management and agents from engaging in unfair and deceptive practices, even if management believes such unfair or deceptive practices are appropriate. Thus, while there is a general right to refuse to sell a product in some circumstances, the Legislature has created an exception to that right: insurers may not unfairly refuse to deal with consumers. The commenter recognizes the Legislature's authority to intervene with the right to refuse to deal, as does the Restatement of Torts. Moreover, the NAII court upheld another rule which limited the right of management of insurance companies to reject applicants: Rule 1003 does not prevent insurers from accepting and rejecting risks; it merely prohibits the use of inaccurate substitutes ... for real risk factors. ... Rule 1003 prohibits the use of proxies for real risk factors. Similarly, the prohibition against rejection based on the underwriting guideline that is the subject of this rule is appropriate and within the Department's statutory authority. COMMENT: A commenter argued that the rule is similar to Rule 21.7 which was invalidated by a Travis County district court. The commenter also claimed that the district court's judgment was not appealed and that the decision not to appeal was the agency's decision. The commenter argued that this rule may be an attempt to proceed with prior Rule 21.7. DEPARTMENT'S RESPONSE: The Department disagrees. This rule and Rule 21.7 are fundamentally different. Most importantly, this rule does not apply to instances of disparate impact. The Department also disagrees that the decision whether to appeal a district court ruling on a rule is the agency's decision. On the contrary, the Attorney General makes the decision whether to appeal such a ruling. This rule does not constitute an attempt to proceed with Rule 21.7 because this rule applies underwriting practices that are not actuarially sound. The rule does not prohibit underwriting guidelines that are actuarially sound but which have a disparate impact on minorities. COMMENT: A commenter argued that there was a lack of notice in scheduling the hearing and that the record should therefore be left open for a minimum of 30 days. DEPARTMENT'S RESPONSE: The Department disagrees. First of all, there is no 30- day requirement for notice of a hearing on a proposed rule, as the commenter implies. Nevertheless, the Department gave notice of a December 16, 1994 hearing in the November 15, 1994 issue of the Texas Register (19 TexReg 9049). Thus, the public was given 30 days notice of the hearing. After the commenter filed this comment, the hearing was postponed an additional 19 days until January 4, 1995. Thus, there was more than adequate time for the commenter to provide comments and prepare for the hearing. The new rule is adopted under Insurance Code, Articles 1.03A, 5.98, and 21. 21, sec.13. Article 1.03A authorizes the Commissioner to adopt rules and regulations for the conduct and execution of the duties and functions of the department as authorized by statute. Article 21.21, sec.13 authorizes the Department to promulgate rules and regulations to accomplish the purposes of Insurance Code, Articles 21.20 and 21.21. Article 5.98 authorizes the Department to adopt reasonable rules that are appropriate to accomplish the purposes of Insurance Code, Chapter 5, including Article 5.09 (prohibiting any distinction or discrimination in favor of an insured having a like hazard, which occurs when an underwriting guideline unrelated to risk or expense is used to place a consumer in a different company within a company group). Additional discussion of the Department's statutory authority to promulgate this rule is contained in the Reasoned Justification section entitled "The Department has authority to promulgate this rule." The following Articles of the Insurance Code are affected by this rule: sec.21.1002-Articles 5.09 and 21.21. sec.21.1002. Unfair Underwriting Guidelines. (a) Prohibition. After June 1, 1995, an insurer or agent shall not use an unfair underwriting guideline for private passenger automobile or residential property insurance in making a decision to cancel, non-renew, limit the coverages made available to, or refuse to issue a policy to a consumer. The failure to comply with this subsection constitutes an unfair practice in the business of insurance in violation of the Insurance Code, Article 21.21, and shall be subject to the provisions thereof. (b) Definition of "unfair underwriting guideline." An underwriting guideline is unfair unless either: (1) the underwriting guideline is actuarially sound; or (2) the underwriting guideline is deemed to be in compliance with subsection (a) of this section under the safe harbor provisions of subsection (d) of this section. (c) Definition of "actuarially sound." An underwriting guideline is "actuarially sound" if the underwriting guideline is shown to differentiate among consumers who have different expected costs associated with the transfer of risk. The methodology for demonstrating whether an underwriting guideline differentiates among consumers with different expected costs associated with the transfer of risk shall be consistent with the actuarial standards of practice and compliance guidelines promulgated by the Actuarial Standards Board of the American Academy of Actuaries and in effect on January 1, 1995. (d) Safe Harbors. An underwriting guideline that meets the requirements of one of the safe harbors set out in paragraphs (1), (2), or (3) of this subsection is deemed to be in compliance with subsection (a) of this section. However, an insurer or agent subject to subsection (a) of this section is not required to obtain the prior approval of the Department or rely on the safe harbor protections of this subsection to use an underwriting guideline. (1) Underwriting guidelines for private passenger automobile insurance based on the following characteristics comply with subsection (a) of this section: (A) average miles driven in a year or other specified time period; (B) accidents in which a person to be insured under the policy can reasonably be considered to have been at fault and which resulted in bodily injury or property damage; (C) a final conviction in any court in the United States, forfeiture of bond, or payment of a fine or an amount accepted by the court if the conviction, forfeiture or payment was a result of an allegation that a violation of a law regulating the operation of motor vehicles was committed; (D) the making of a fraudulent insurance claim; (E) number of years of driving experience or number of years licensed to drive. (2) Underwriting guidelines for residential property insurance based on the following characteristics comply with subsection (a) of this section: (A) the physical condition of the property to be insured, provided the underwriting guideline has specific and objective measures to evaluate the hazard; (B) claim experience on a residential property policy arising out of the consumer's negligence; (C) if a structure to be insured is vacant or unoccupied for more than 60 days; (D) the making of a fraudulent insurance claim; (E) an act of arson. (3) Additional underwriting guidelines may be added to the lists in subsection (d)(1) and (2) of this section pursuant to the rulemaking procedures under the Government Code, Chapter 2001. The provisions set out in subparagraphs (A)-(C) of this paragraph shall also apply to a petition to amend this section. (A) Once such a petition is filed, the use of the underwriting guideline by any insurer or agent shall not be a violation of subsection (a) of this section for the period beginning the 60th day prior to the date the petition for rulemaking is filed with the Department. If the rule is not adopted, the safe harbor ends 30 days after either the entry of an order denying the petition or withdrawal of the proposed rule. The Department shall maintain a publicly available list of all underwriting guidelines which have been requested to be added to the lists in subsection (d)(1) and (2) of this section. The list shall be updated weekly and shall indicate whether or not the Department has ruled on the petition. (B) If requested by the petitioner, the commissioner may postpone ruling on the petition to permit any interested person to collect data on the underwriting guideline for such period as the commissioner deems necessary. The commissioner may also add data elements to any applicable statistical plan or otherwise collect data as necessary. (C) Notwithstanding any other rule of the Department to the contrary, if the petitioner is an insurer governed by Insurance Code, Article 1.24D, the name of the petitioner shall not be revealed to any person unless the petitioner consents in writing to the identification. (e) Definition Of "Underwriting Guideline." For the purposes of this rule, an "underwriting guideline" is a rule, standard, marketing decision, guideline, or practice, whether written, oral or electronic, used by an insurer or its agent to examine, bind, accept, reject, renew, nonrenew cancel or limit coverages made available to classes of consumers. (f) Definition Of "Consumer." For the purposes of this rule, a "consumer" is the person making the application to insure a person, property or vehicle. A "consumer" includes both existing insureds and applicants for insurance. (g) Definition of "Private Passenger Automobile Insurance." For the purposes of this rule, "private passenger automobile insurance" is the insurance for which a personal auto policy is issued. (h) Partial exemption for agents. The prohibition against the use of unfair underwriting guidelines contained in this section shall not apply to an agent if the agent is using the underwriting guideline solely at the direction of an insurer. (i) Other Laws Not Excepted. Compliance with subsection (a) of this section does not constitute an exemption from other rules or regulations of the department or statutory requirements. This agency hereby certifies that the rule as adopted has been reviewed by legal counsel and found to be a valid exercise of the agency's legal authority. Issued in Austin, Texas, on January 23, 1995. TRD-9500922 D. J. Powers Chief Clerk and General Counsel Texas Department of Insurance Effective date: February 13, 1995 Proposal publication date: November 15, 1994 For further information, please call: (512) 463-6327 28 TAC sec.21.1004 The Texas Department of Insurance adopts new sec.21.1004, which prohibits discrimination on the basis of race, color, religion, or national origin and, to the extent not justified by sound actuarial principles, on the basis of geographic location, disability, sex, or age, in making a decision whether to sell or cancel a policy or certificate of insurance, with changes to the proposed text as published in the November 15, 1994, issue of the Texas Register (19 TexReg 8936). A public hearing on the proposed section was held January 4-5, 1995. The new section is necessary to prevent the unfair practice in the business of insurance of intentional discrimination based on race, color, religion, or national origin and, to the extent not justified by sound actuarial principles, on the basis of geographic location, disability, sex, or age, in making a decision whether to bind, accept, reject, renew, nonrenew, cancel or limit coverages made available to a consumer and thereby causing the consumer to either be denied insurance or be charged higher rates. In response to comments, the Department has made several non-substantive changes to the proposed rule. The word "intentionally" was added before the word "discriminate" in the rule to clarify that the rule applies only to intentional discrimination and does not apply to non-intentional discrimination which results in a disparate impact against a protected class. The first sentence of subsection (a) was rearranged to enhance readability. The words "renew" and "nonrenew" were added to subsection (a) to clarify that the decision whether to accept or reject a consumer applies to the decision whether to renew a policy. The prohibition in subsection (a) was amended to apply only to actions taken after June 1, 1995. The term "sound actuarial principles" was defined to clarify its meaning. The term "disability" was defined to clarify its meaning. Finally, a partial exemption to the prohibition against discrimination based on geographic location, disability, sex or age has been created for agents. This reasoned justification is organized as follows: 2.1 The Purpose of the Rule 2.2 Unfair Discrimination and Insurance Availability 2.2.1 Insurance Availability 2.2.2 The availability of insurance is important for individuals and businesses. 2.2.3 This rule does not envision nor create a subsidy among classes of consumers 2.2.4 Studies of Availability Problems in Texas Insurance Markets 2.2.4.1 1993 Office of Public Insurance Counsel (OPIC) Study of the Geographic Distribution of Private Passenger Automobile Insurance Assigned Risks 2.2.4.2 1993 OPIC Study of the Location by ZIP Code of State Farm Agents 2.2.4.3 1993 Texas Department of Insurance (TDI) Study of TAIP and Homeowners Markets 2.2.4.4 1994 OPIC Studies of Private Passenger Automobile and Homeowners Insurance Underwriting Guidelines 2.2.4.5 1994 TDI Analysis of NAIC/Texas Special Call Data 2.2.4.6 1994 Study of the NAIC/Texas Special Call Data by the Austin American Statesmen 2.2.4.7 The insurance industry acknowledges availability problems 2.2.5 Other Evidence of Availability Problems and Unfair Discrimination 2.3 Risk Classifications, Underwriting Guidelines and Market Failures 2.3.1 No Natural Groupings of Risk 2.3.2 Unfair Discrimination and Availability Problems Represent Market Failures 2.4 Unfair Underwriting Guidelines and Unfair Discrimination 2.4.1 Underwriting guidelines are inherently unfair if they are inconsistent with public policy expressions of social and economic fairness 2.4.2 Underwriting guidelines are unfair if they do not distinguish groups of consumers on the basis of expected costs associated with the transfer of risk 2.5 Regulation is necessary to address unfair underwriting guidelines and is consistent with beneficially competitive insurance markets 2.5.1 Insurance regulation expresses public policy regarding social and economic fairness of certain underwriting guidelines 2.5.2 Insurance regulation can address the market failures caused by unfair underwriting guidelines 2.6 The Department has developed rules to prohibit unfair underwriting guidelines consistent with the role of regulation and appropriate to address failures of insurance markets represented by unfair underwriting practices 2.6.1 The practices prohibited by this rule are unfair 2.6.2 Other new underwriting rules 2.6.3 Previous Department Underwriting Rules 2.7 The Department has authority to promulgate this rule 2.7.1 Article 21.21, sec.13(a) 2.7.2 The private cause of action 2.8 Existing Laws Are Not Clear Prohibitions Against All Forms of Unfair Discrimination That Would Be Prohibited By This Rule 2.8.1 Insurance Code Provisions 2.8.2 Other Laws 2.8.3 Need for the rule 2.1 The Purpose of the Rule The purpose of this rule is to eliminate unfair underwriting practices in the business of insurance. The unfair practices prohibited by this rule have an adverse impact on the availability and affordability of insurance to consumers. 2.2 Unfair Discrimination and Insurance Availability Consumers who encounter unfair discrimination in the purchase of insurance are either denied coverage completely or denied coverage at the rates for which they would legitimately qualify in the absence of the unfair discrimination. The availability of appropriately-priced insurance is unfairly denied these consumers as a result of the use of unfair underwriting guidelines. The elimination of unfair underwriting guidelines will cause consumers to be treated more fairly in the business of insurance and thereby increase the availability of appropriately-priced insurance. 2.2.1 Insurance Availability To better understand the problems caused by unfair underwriting guidelines, a general description of insurance markets is necessary. Most insurance markets consist of three submarkets: preferred, standard and substandard. Preferred companies have the lowest rates and sell to the consumers perceived to represent the lowest risk. Standard companies sell to consumers perceived to represent average risks. Substandard companies (including residual market mechanisms) have the highest rates and sell to consumers perceived to represent the highest risk. For consumers forced into substandard companies, insurance is unavailable in standard and preferred markets. This availability problem for consumers forced into substandard companies may be two-fold: the consumer is unfairly charged higher rates (which he or she may not be able to afford) and/or the product sold is inferior to the product available in the standard or preferred markets (e.g. offers less coverages or is not covered by the state's guaranty association). It is through the use of unfair underwriting guidelines that consumers are unfairly denied coverage in standard and preferred companies and forced to go without insurance or purchase higher-cost insurance in substandard or residual markets. 2.2.2 The availability of insurance is important for individuals and businesses. President Johnson's Commission on Insurance Availability, formed in the aftermath of the Los Angeles rioting in the 1960s, found that "communities without insurance are communities without hope." This statement is no less true today. Consumers without health insurance have little hope of obtaining basic health care. Consumers may not operate a car without automobile liability insurance (pursuant to the financial responsibility law) and cannot purchase a car on credit without automobile physical damage insurance. Consumers unable to purchase homeowners insurance are unable to obtain a loan to purchase a home. Consumers unable to purchase commercial insurance coverages may be unable to own or operate a business. In addition to the harm caused to the individual consumers who are unfairly denied insurance, denying insurance to citizens and small businesses in economically underdeveloped areas contributes to the problems of inadequate economic opportunity and social decay that plague these areas. 2.2.3 This rule does not envision nor create a subsidy among classes of consumers In this Order, the term "affordability" is used strictly in terms of consumers having fair and legitimate access to standard and preferred companies; that is, making the more affordable standard and preferred rates available to those consumers who would otherwise be unfairly relegated to higher cost, non-standard insurers or assigned risk markets. The Department's discussion of affordability does not imagine or propose a subsidy for those people who cannot afford insurance offered at fair rates commensurate with the expected costs associated with the transfer of risk. Nor does the rule create a right for those consumers posing higher expected costs associated with the transfer of risk who are fairly placed in substandard markets to receive lower rates in standard or preferred companies. 2.2.4 Studies of Availability Problems in Texas Insurance Markets There has been substantial data collection and analysis concerning insurance availability in Texas over the past few years. These studies, based on data supplied by insurers and from other sources, show that the availability of insurance in Texas varies dramatically by geographic area and that variation is statistically related to race. Copies of the studies and documents discussed in this section are available from the Department. 2.2.4.1 1993 Office of Public Insurance Counsel (OPIC) Study of the Geographic Distribution of Private Passenger Automobile Insurance Assigned Risks In testimony filed in February 1993, OPIC analyzed the distribution of automobile insurance assigned risks written through the Texas Automobile Insurance Plan (TAIP), the predecessor of the current Texas Automobile Insurance Plan Association (TAIPA). OPIC analyzed the number of TAIP insureds by ZIP Code compared to the driving age population in the ZIP Code. The study showed that many areas of the state had availability problems, as measured by significantly higher-than-average concentrations of TAIP assignments. If only high-risk drivers were being relegated to the TAIP, as theoretically should have been the situation, we would have expected a more even geographic distribution of TAIP assignments by ZIP Code. We would not expect that bad drivers live together in certain ZIP Codes. The analysis also showed that those ZIP Codes with high minority populations were the ones more likely to be have, on average, greater- than-average concentrations of TAIP assignments. The study is included in the Supplemental Direct Testimony of David "Birny" Birnbaum in Docket 1932, styled Texas Automobile Insurance Plan For Private Passenger and Commercial Automobile Rate Case. 2.2.4.2 1993 OPIC Study of the Location by ZIP Code of State Farm Agents This study examined the ZIP Code location of State Farm agents in three major metropolitan areas: Harris, Bexar and Travis counties. State Farm is the largest automobile and homeowners insurance writer in Texas, with over one-third of the standard and preferred automobile and homeowners insurance markets. With such a large share of the market, the location of State Farm agents may be an important availability factor. The study showed a striking difference in the average minority population and median housing value in those ZIP Codes with State Farm agents when compared to those ZIP Codes without State Farm agents. For example, in Harris County there were 22 ZIP Codes with populations greater than 20,000 each without any State Farm agents compared to 54 ZIP Codes with populations greater than 20,000 with State Farm agents. The 54 ZIP Codes had a total of 206 agents. The minority population of the 22 ZIP Codes without State Farm agents was 53.6% compared to 29.2% in the 54 ZIP Codes with the State Farm agents. In addition, the location of State Farm agents was highly correlated to the incidence of TAIP assignments from the earlier study. Those ZIP Codes without State Farm agents also tended to be the same ZIP Codes with higher-than-average TAIP assignments. 2.2.4.3 1993 Texas Department of Insurance (TDI) Study of TAIP and Homeowners Markets The next study, dated August 1993, was a Department report entitled "Analysis of Texas Automobile Insurance Plan (TAIP) and Homeowners Markets." Dr. Mark Crawshaw, a consulting actuary to the Department, used an updated automobile insurance assigned risk data set to perform a regression analysis to analyze the distribution of TAIP assignments in Houston. The regression analysis controlled for other relevant factors, including housing value and the percentage of renters in a ZIP Code. The study showed that, after controlling for these other factors, a consumer in a high minority ZIP Code was three to four times more likely to be placed in TAIP than residents in low-minority ZIP Codes. Thus, even after removing the contribution of median housing value and percentage of renters as explanatory characteristics, the minority population of a ZIP Code was a significant predictor of the likelihood of being placed in the assigned risk plan. These findings are reported in Exhibit A, Sheet 5 of the report. Dr. Crawshaw did a similar analysis for the price of homeowners insurance in Houston. He found that, while holding median housing value constant, consumers in ZIP Codes with high minority populations are insured through companies with average homeowners rates that are about 10% higher than the average rates of homeowners insurance for companies insuring consumers in ZIP Codes with low minority populations. Thus, even controlling for the principal factor in the price of insurance-housing value-the analysis found that minority population in a ZIP Code correlated to differences in prices charged for homeowners insurance. These findings are reported in Exhibit C, Sheet 4 of the report. 2.2.4.4 1994 OPIC Studies of Private Passenger Automobile and Homeowners Insurance Underwriting Guidelines In studies entitled "A Review of Homeowners Insurance Underwriting Guidelines Used in Texas" and "A Review of Auto Insurance Underwriting Guidelines Used in Texas," released in February and June 1994 respectively, OPIC reviewed and analyzed underwriting guidelines of Texas homeowners and private passenger automobile insurers. The OPIC studies revealed a variety of underwriting guidelines which restrict insurance availability in certain parts of Texas. From these studies and testimony at the redlining hearings held by the Department, it was shown that consumers may be denied coverage for a variety of reasons, including geographic location. These studies also found that some automobile and homeowners insurers use an underwriting guideline that excludes foreign nationals. For automobile insurance, companies who write 58% of the market restrict sales to foreign nationals, either by requiring driving experience in the U.S. or Canada or by maintaining strict residency requirements for non-U.S. citizens. One Texas automobile insurer's underwriting guideline discriminates against persons with disabilities, regardless of the disability or whether it affects driving skills: "Risks which show no apparent means of support or show disability as the occupation." Several homeowners insurance guidelines involve the age of the consumer, without any apparent showing of a relation to risk or expense. A commenter at the hearing who has a disability testified that he was denied auto insurance because of his disability and that the company was unwilling to write him whether or not the disability was related to his ability to drive a car. Tr. 101-104. 2.2.4.5 1994 TDI Analysis of NAIC/Texas Special Call Data In March and November 1994 the Department released studies of private passenger insurance availability based upon ZIP Code level premium, exposure and agent information submitted by the top 40 insurers for the NAIC/Texas Special Data Call. In these studies, the measure of insurance availability was defined as the share of exposures written in the TAIP (assigned risk) plus substandard companies (mostly county mutuals) as a percentage of all exposures written in the ZIP Code. A high percentage indicates more people insured in substandard companies and the assigned risk plan, while a low percentage indicates more people insured in the standard and preferred markets. The lower the share of TAIP and substandard exposures, the better the availability of automobile insurance. This share of TAIP plus nonstandard to total exposures is an excellent measure of private passenger automobile insurance availability because the measure identifies the share of all consumers who sought automobile insurance, could afford it, paid for it and, yet, were rejected by standard and preferred companies. Substandard company rates are typically substantially higher than rates from standard and preferred insurers. TAIP consumers were not eligible for coverage through TAIP unless they were unable to obtain coverage in the standard or preferred market. Therefore, the class of consumers insured through TAIP or by substandard companies constitutes a class of consumers for whom coverage in the standard and preferred market was not available. The chart entitled "NAIC/Texas Special Call-Texas Statewide Results" shows the summary results of the study. As the minority population of the ZIP Codes increases, insurance availability worsens. For example, for those 97 ZIP Codes with TAIP plus non-standard shares 51% to 75% above the statewide average, the average of the minority population percentages was 141% above the statewide average. For those 391 ZIP Codes with TAIP plus non-standard shares 26% to 50% below the statewide average, the average of the minority population percentages was 44% below the stateside average. The chart shows a remarkable relationship between the minority population of a ZIP Code and the availability of automobile insurance in that ZIP Code. FIGURE 1: 28 TAC sec.21.1004 (Preamble) The Department also performed a regression analysis on the data set of about 1400 ZIP Codes. Even after the contribution of median housing value as an explanatory factor for insurance availability was statistically removed, the minority population of a ZIP Code remains a significant predictor of insurance availability at the 99% confidence level. If median household income is held constant, the share of TAIP plus non-standard is 25% to 70% higher in high minority ZIP Codes compared to low minority ZIP Codes. The Department developed maps for several counties in Texas to present the ZIP Code level data more graphically. The first maps show insurance availability factors and minority population factors in Dallas County. These maps look very similar because those ZIP Codes with poor insurance availability are, in most cases, the same ZIP Codes with high minority populations. Maps of Harris, Tarrant, Bexar and Travis Counties demonstrate similar findings. The Department also developed ZIP Code detail maps for these five counties showing the total population in the ZIP Code and the number of agents located in those ZIP Codes who are able to write business in nine of the top standard or preferred companies. These nine insurers represent the vast majority of business written by standard and preferred companies who utilize agents. The maps show that the location of agents varies dramatically by ZIP Code and that variation is also related to insurance availability. On the map of Dallas county, a cluster of seven adjacent ZIP Codes in south central Dallas County with poor insurance availability shows a total of three standard agents serving a population of over 191,000 people. In comparison, a cluster of nine adjacent ZIP Codes in north central Dallas County shows 366 agents serving a population of about 275,000 people. The maps of Bexar, Harris, Travis and Tarrant counties show similar disparities in the location of agents. This is an important finding because the absence of agents able to write business in standard or preferred companies is also an indicator of homeowners insurance availability. 2.2.4.6 1994 Study of the NAIC/Texas Special Call Data by the Austin American Statesmen A study by the Austin American Statesman also analyzed the NAIC special call data. The Statesman concluded that "minority Texans were far more likely than affluent or white Texans to be charged the highest rates for automobile insurance, according to industry data." In particular, the Statesman found that, as the percentage of minorities in a ZIP Code increased, so did the percentage of substandard and assigned risk policies. The article statewide about 20% of the automobile insurance policies written are in county mutuals or written through TAIP, in ZIP Codes where at least two-thirds of the residents were minorities, 37% of the policies were substandard or TAIP. In ZIP Codes where at least two-thirds of the residents were white, only 15% of the polices were in the high-cost categories. The analysis showed that, where more than 90% of the residents were African American or Hispanic, three of every seven policyholders were in higher priced county mutual insurers or insured through TAIP. By contrast, where more than 90% of the residents were white, only one of seven policyholders were insured through county mutuals or TAIP. The article in which the results of that analysis were published appeared in the September 30, 1994 edition. As reported in that same Austin American-Statesman article, the Texas Department of Public Safety (DPS) reports that minorities are no more likely than whites to have been involved traffic accidents. In 1992, DPS reports show that, of the drivers involved in accidents in Texas, 61% were white, 20% were Hispanic, 12% were African American and 7.0% were unknown or of another background. The state's population is 61% white, 25% Hispanic, 12% African American and 2.0% other. The Department has reviewed both DPS and Census data and confirmed the numbers reported in the Statesman. The finding that minorities are not over-represented in their involvement in automobile accidents is important. If the reason for poor availability in minority areas is, as some insurers assert, higher losses in those areas, we would expect a disproportionate share of minority involvement in automobile accidents. The actual data on minority involvement in accidents casts doubt on this theory and justification for availability problems in minority areas. 2.2.4.7 The insurance industry acknowledges availability problems The results of these many studies show clearly that insurance availability problems exist in Texas and those availability problems are typically related to the minority population of an area. Many insurers, agents and industry trade associations have acknowledged to the Department that availability problems exist. In addition, when Senator Rodney Ellis and the Department brought interested parties together to address availability problems in Houston in what came to be called the Houston Redlining Task Force, all members of the task force agreed to this basic covenant: The purpose of the redlining task force is to increase the availability of affordable insurance to Texas consumers. All task force participants agree that some areas and groups of consumers are underserved in the personal lines and small commercial insurance markets. The purpose of the task force is to solve the problem, not discuss whether a problem exists. Members of the task force included State Farm, Allstate, Farmers, ITT Hartford, the Texas Association of Insurance Agents, the National Association of Independent Insurers, and the American Insurance Association, as well as the Department of Insurance, the Office of Public Insurance Counsel, legislators, community organizations and consumer groups. 2.2.5 Other Evidence of Availability Problems and Unfair Discrimination The Department is aware of several practices of intentional discrimination by some insurers. However, the Department recognizes that it is difficult to detect intentional discrimination. An insurer that wants to discriminate against minorities, for instance, will most likely not state that policy in its written underwriting guidelines. Discrimination of this sort is more often proved on a case-by-case basis. The need to prove intentional discrimination on a case by case basis is yet another reason why this rule is necessary. Individual consumers will have the means to prove intentional discrimination. The Department has received anecdotal evidence of intentional discrimination. Representatives of the Department have heard from consumers and agents who have alleged that some insurers have engaged in intentional discrimination based on race. The Department also heard testimony regarding redlining in public hearings held in Dallas, Houston and San Antonio during 1994. Commenters on this rule reported discrimination based on disabilities in the sale of health, auto, life and homeowners insurance. Staff for the Department has also been told by insurance agents that large property and casualty insurers in Texas discriminate both on the basis of race and the racial makeup of a geographic location. These agents have reported that insurer management has instructed them to use more stringent underwriting guidelines for minority applicants than for white applicants and for residents of minority neighborhoods than for residents of white neighborhoods. The Department has found underwriting guidelines for health insurers that may constitute intentional discrimination. Several companies refuse coverage to non- U.S. citizens. One company has an underwriting guideline that clearly discriminates against women in its treatment of casino employees: it will write "croupiers, dealers, pit bosses: well established family men who are homeowners" but will not write "change girls." Forty-three percent of the automobile insurance market requires up to three years of driving experience in the U.S. or Canada for any applicant to be acceptable. Although driving experience in Canada is acceptable to almost all of these insurers, driving experience in Mexico is not. The Department believes this distinction may constitute intentional discrimination against Mexicans based on national origin. No insurer has shown that driving experience is less valuable in Mexico than in Canada. While insurers argue that complete driving records may not be obtainable from Mexico, the underwriting guidelines in question all refer to driving experience, not the availability of driving records. A non-discriminatory way to ensure adequate driving records is to require adequate driving records, regardless of whether the record is available from a U.S. state, Canada or elsewhere. Current guidelines would permit coverage for a Canadian driver even though a driving history is not available and deny coverage to a Mexican driver even though the previous insurer has a complete accident record on the driver. In addition, Texas driving records are woefully incomplete: less than one-half of all accidents actually appear on a driver's motor vehicle report, according to a study by the Insurance Research Council. The Texas Department of Public Safety (DPS) did not contest this finding when the Department investigated this issue. DPS informed the Department that driving records are incomplete because the following information is not included in motor vehicle reports, either by law or police department practice: most minor accidents occurring in large metropolitan areas, accidents where there is no injury and property damage is less than $500, accidents in which the peace officer does not investigate or fails to file a report (even if the drivers file a report with DPS), accidents occurring on private property, accidents over three years old, and accidents in which the driver did not receive a ticket. It is clear that the majority of accidents would not be reported under these criteria. Moreover, the Insurance Research Council study found that only 7.0% of convictions for a driving offense related to an accident with vehicle damage above $500 appeared in motor vehicle reports. The national averages for accidents and convictions appearing on motor vehicle report under the study were shown to be similar to those of Texas. For those drivers from New Mexico, the Insurance Research Council reports that only 1.0% of all accidents appeared on motor vehicle reports. For drivers from Idaho, Montana, Maryland and Missouri, less than 5.0% of all accidents appeared on motor vehicle reports. Although there is virtually no official driving record on drivers from these states, insurers are still willing to insure them. In addition, no driving record is available for Texas drivers for experience that is three to five years old, even though many insurer guidelines require five years of driving experience. Therefore, the lack of driving record for driving experience more than three years old applies equally to Texas drivers as it does to Mexican drivers. Yet these insurers discriminate by only refusing to insure Mexican drivers. Insurers often determine a driver's record, however, through other sources. One main source of information is the Comprehensive Loss Underwriting Exchange, or CLUE, report. These reports provide the loss history of individual consumers based on loss data provided by insurers who previously insured the driver. Most insurers rely on information from previous insurers because it is more complete (all claims are reported, regardless of the amount of damage). Yet this same information is often available from the previous insurer of a driver who previously drove in Mexico. Moreover, if the consumer requests the previous insurer to forward the accident history to the prospective insurer, the prospective insurer will avoid the expense of obtaining a CLUE report. Finally, denial of automobile insurance due to the lack of a complete driving record assumes that drivers will lie about their driving experience. Although insurers cannot obtain complete reports based on driving experience in Texas or Mexico, there is no evidence to show that those drivers with driving experience in Mexico will lie about their driving history more often than those with Texas driving experience. Several studies have shown that minorities are less likely to have health insurance. A 1989 study of 1987 data by the U.S. Department of Health and Human Services entitled "A Profile of Uninsured Americans" found that 32.9% of Hispanics are uninsured, 23.8% of African Americans are uninsured, and 14.2% of whites are uninsured. A 1992 report prepared by the National Council of La Raza and the Labor Council for Latin American Advancement found that 33% of Hispanics were uninsured in 1990, compared to 19.7% of African Americans and 12.9% of whites. The National Institute on Disability and Rehabilitation Research October 1993 report entitled "Disability Statistics Report" found that the disabled population has significantly less access to private health insurance. Unlike the studies for automobile and homeowners insurance set out above, however, these studies do not control for consumers who are unable to afford insurance. Many of the uninsured minorities are uninsured either due to inadequate income or the lack of employment that provides health insurance. However, to the extent that these results are based on intentional discrimination by insurers or agents against minorities, such practices are unfair and should be prohibited. Insurance availability is important because insurance is essential for consumers to meaningfully participate in society and for economic development to occur in those areas currently lacking in economic opportunity. The opportunity for economic improvement is intimately tied to the opportunity to purchase necessary insurance. To the extent that insurance is not available because of unfair underwriting guidelines, this rule is necessary to prevent such unfair practices. 2.3 Risk Classifications, Underwriting Guidelines and Market Failures The purpose of insurance is to protect consumers through the transfer of risk to insurers and through that process to spread aggregate risk among many consumers. The most fundamental insurance decision is how the population of consumers will be grouped into subsets of the population for the purpose of grouping similar risks and setting prices for consumers. As a society, we have decided that some grouping of risks is appropriate and desirable. We do not make people completely pay for their own accidents (no insurance) nor do we as a society pool the entire population so everyone pays the same average rate. The choice of underwriting guidelines, in conjunction with other rating factors, represent decisions about the grouping of risk. 2.3.1 No Natural Groupings of Risk There are no natural groupings of risk. In fact, there are many ways to group risk to create actuarially-sound risk classifications in the sense that total premiums for each class of consumers adequately, but not excessively, covers the costs associated with each class of consumers. While it is typical for insurers to review the appropriateness of rates for each class of consumers, it is less common, and in many cases impossible, to analyze the intra-class fairness. While the rates for the class of consumers may be fair in aggregate, the class may consist of heterogeneous risks and represent a subsidy by some risks in the class of other risks in the class. It is important to emphasize that there are no natural groupings of risk. The choice of risk classifications represents a combination of public policy expressions through regulation and individual insurer underwriting decisions. 2.3.2 Unfair Discrimination and Availability Problems Represent Market Failures Availability problems represent market failures-the insurance markets have failed to provide consumers with equal opportunity to purchase necessary insurance. These availability problems may be caused by unfair discrimination, representing a classic economic problem of irrational behavior. Availability problems may also be caused by insurers acting rationally, but because of structural market failures, these rational market decisions produce not the beneficial results of Adam Smith's invisible hand, but perverse outcomes for consumers. 2.4 Unfair Underwriting Guidelines and Unfair Discrimination Underwriting guidelines determine whether a consumer will be written by a preferred, standard, or substandard company, or denied coverage entirely. More specifically, underwriting guidelines are the rules, standards, marketing decisions, guidelines, or practices, whether written, oral or electronic, used by an insurer or its agent to examine, bind, accept, reject, renew, nonrenew, or cancel consumers or limit the coverages made available to consumers. Not all availability problems are unfair; however, to the extent that a lack of availability is based on unfair underwriting guidelines, the lack of availability is unfair. An underwriting guideline is unfair if it is either inherently unfair or actuarially unsound. Underwriting guidelines are inherently unfair if they are inconsistent with public policy expressions of social and economic fairness. Underwriting guidelines are also unfair if the guideline does not actually distinguish consumers of different expected costs associated with the transfer of risk. If there is no sound actuarial basis for the discrimination among consumers based upon a particular underwriting guideline, consumers of similar risk are being treated differently and, for at least one class of consumers, unfairly. 2.4.1 Underwriting guidelines are inherently unfair if they are inconsistent with public policy expressions of social and economic fairness Some groupings of risk are inherently unfair, regardless of the loss experience associated with the risk classification differentiating the groups. Professors Keeton and Widiss, in their treatise on Insurance Law, recognize that, even if correlations to higher losses could be shown, open competition that would allow certain kinds of discrimination is not beneficial and would violate fundamental public policy interests: [P]ublic policy interests of various types (including policies against discrimination based on race, sex, and other individual characteristics over which the individual has no control) sometimes weigh against use of insurance rating categories that might be "nondiscriminatory" in a sense concerned only with correlation between loss experience and selected individual characteristics. Keeton and Widiss, Insurance Law, A Guide to Fundamental Principles, Legal Doctrines, and Commercial Practices, 956-957 (West 1988). In their comments on Rule sec.21.1002, State Farm agreed that "when racial, ethnic or religious discrimination [is occurring,] government intervention is appropriate to eliminate such deplorable practices." The Department agrees with these commentators. 2.4.2 Underwriting guidelines are unfair if they do not distinguish groups of consumers on the Basis of Expected Costs Associated With the Transfer of Risk An underwriting guideline is unfair if the characteristic is not related to differences in the costs associated with the transfer of risk. A fair underwriting guideline identifies a characteristic of the consumer, vehicle, property or business which accurately distinguishes consumers on the basis of differences in expected costs associated with the transfer of risk. The term "sound actuarial principle" is used to describe both the standard for fairness and the methodology to test for the standard of fairness. As a standard, sound actuarial principles means that the underwriting guideline or rating factor in question accurately distinguishes consumers on the basis of differences in expected costs associated with the transfer of risk. As a methodology, sound actuarial principles mean an analysis consistent with the actuarial standards of practice and compliance guidelines promulgated by the Actuarial Standards Board of the American Academy of Actuaries. In simpler terms, an underwriting guideline is unfair if it causes two consumers of similar characteristics to be treated differently. An underwriting guideline is actuarially sound if it causes consumers of similar characteristics to be treated similarly. A class of consumers should be treated differently from another class of consumers only if the costs associated with the transfer of risk for the first class are different than for the second class. If the estimated costs associated with the transfer of risk is the same for both classes, then it would be unfair to treat the two classes differently in the underwriting decision. In determining if an underwriting guideline is actuarially sound, it is vitally important that the analysis control for all other known risk factors and identify the unique contribution of the underwriting guideline to any explanation of differences in expected costs associated with the transfer of risk between the groups created by the underwriting guideline. Sound actuarial principles require the analysis of the unique contribution of the rating factor or characteristic in question. Surrogate underwriting guidelines, those that do not identify a cost difference but are a mere surrogate for a real risk factor, are not actuarially sound. Allstate's expert witnesses, Mrs. Harrington and Appel, agreed that underwriting guidelines should be based on cost-either losses or expenses. They argued that cost-based underwriting is essential for a competitive market. They further asserted that the use of non-cost based underwriting guidelines is anti- competitive. The Department agrees. This is yet another reason to prohibit underwriting guidelines that are not actuarially sound: such guidelines are anti-competitive and are counter to one of the primary purposes of Article 21.21 to prohibit unfair competition. 2.5 Regulation is necessary to address unfair underwriting guidelines and is consistent with beneficially competitive insurance markets In Texas, insurance regulation is moving towards much greater reliance on market forces to encourage competition among insurers in a way which benefits consumers. The regulatory goal is for markets to move more towards the classic competitive model whereby insurers are forced to move to their most efficient level selling independent of one another to well-informed and knowledgeable consumers who have a wide range of choice. Reliance on market mechanisms, however, does not equate to deregulation. Deregulation does not always yield more beneficial competition-i.e., competition that approaches the competitive market ideal and benefits consumers. In some cases, greater competition requires less regulation, such as movement away from cartel pricing. A beneficially competitive market forces insurers to price their product on their cost of service, rather than on a state-set base rate. In other cases, regulation enhances the market mechanism and promotes competition. The Department provides both sellers and buyers with information they need to make wiser decisions. The Department's independent data initiative is a key ingredient in the move to more competitive insurance markets. More informed buyers and sellers will improve the competitive nature of a market. Regulation can also provide incentives to encourage competition where there are market failures. The Department's new rule 5.206 provides such an incentive for insurers to write in areas which have been underserved by standard and preferred automobile insurers. In these underserved areas, the market forces have failed. Where reliance on voluntary action is insufficient, regulatory statutes and rules can be used to enhance competition. Regulatory mandates are necessary when the public cannot rely upon insurers to voluntarily take actions which they do not see as in their self interest. The promulgation of standard policy forms, which enables consumers to better shop based on price, service and solvency, is an example of how regulation enhances competition. Without standard policy forms, consumers cannot effectively compare price and service between companies. Minimum capital and surplus requirements represent regulations which promote beneficial competition. In the absence of such standards, some insurers would try to compete by stretching limited surplus over excessive premiums and exposures. While these insurers may be able charge lower prices because it has less capital to support, consumers are not well served by the great danger of insolvency faced by this insurer. 2.5.1 Insurance regulation expresses public policy regarding social and economic fairness of certain underwriting guidelines Professors Keeton and Widiss recognize the failures of competition in a deregulated insurance market: [C]ompetition will not always provide adequate protection against discriminatory premium rates. Even when competition is functioning well, there almost always will be collateral factors that make some policyholders more or less attractive on grounds apart from a pure assessment of the rated risk. Keeton and Widiss, Insurance Law, A Guide to Fundamental Principles, Legal Doctrines, and Commercial Practices, 955 (West 1988). As quoted above, they go on to state that public policy considerations require government intervention to prevent the use of certain characteristics as underwriting guidelines even if the characteristic is related to risk. Several commenters at the hearing agreed that government intervention is appropriate to express public policy considerations in some instances, such as racial considerations. The Legislature has expressed its intent that certain risk classifications are impermissible. For instance, it has prohibited risk classifications based on race, color, religion and national origin. Insurance Code, Article 21.21-5. It has prohibited underwriting guidelines regarding cancellation and nonrenewal based on whether the consumer is an elected official. Insurance Code, Article 21.49-2D. Thus, the Legislature has recognized that certain risk classifications are inherently unfair, regardless of differences in the expected costs associated with the transfer of risk. 2.5.2 Insurance regulation can address the market failures caused by unfair underwriting guidelines In those instances where market failures are caused by unfair underwriting guidelines, it is not feasible to rely upon voluntary efforts of insurers because these voluntary efforts cannot address a structural problem with the market. If one insurer sees an advantage through use of an unfair trade practice, that insurer will obtain an unfair competitive advantage over other insurers who try to do the right thing for consumers. In a competitive market, such a disparity cannot last and the unfair practices will continue. Regulation ensures that insurers operate by the same rules and minimum standards. The prohibition of certain unfair underwriting guidelines causes all insurers to stop using those guidelines and removes an impediment to the beneficially competitive operation of insurance markets and encourages insurers towards other bases of competition, such as service or expense efficiencies. 2.6 The Department has developed rules to prohibit unfair underwriting guidelines consistent with the role of regulation and appropriate to address failures of insurance markets represented by unfair underwriting practices The various rules adopted by the Department prohibiting unfair underwriting practices are solidly grounded in the theory, practice and tradition of public intervention in insurance markets to make public policy expressions of social and economic fairness and to promote more beneficially competitive insurance markets. 2.6.1 The practices prohibited by this rule are unfair This rule prohibits intentional discrimination based upon race, color, religion or national origin and, to the extent not justified by sound actuarial principles, geographic location, disability, sex or age. The rule represents the expression that certain underwriting guidelines-those based on race, color, religion or national origin-are not consistent with the Legislature's public policy expression of social and economic fairness. Industry witnesses agreed at the hearing that discrimination based on race is unfair even if it were shown to be related to risk of loss. For instance, Allstate's witness Dr. Harrington testified: I do not think that our society really would want a system where if you found if there were certain differences that were truly related to race we would want insurance companies to underwrite them especially when you are requiring consumers to buy coverage. Tr. at 325. This testimony confirms the Department's test of fairness: there are some characteristics that society has deemed to be unfair to use in underwriting regardless of whether discrimination based on the characteristic can be shown to be actuarially sound. More directly, the testimony supports the Department's determination that discrimination based on race is an unfair practice. This rule also reflects the principle that certain other underwriting guidelines-geographic location, disability, sex or age -are fair only if they are demonstrably related to the expected costs associated with the transfer of risk. A class of consumers identified by geographic location, disability, sex or age should be treated differently from another class of consumers only if the estimated costs associated with the transfer of risk for the first class are different than for the second class. If the estimated costs associated with the transfer of risk is the same for both classes, then it would be unfair to treat the two classes differently in the underwriting decision. Allstate's expert witnesses, Drs. Harrington and Appel, agreed that underwriting guidelines should be based on cost-either losses or expenses. As David Appel testified based on the 1994 Equifax-Harris Consumer Privacy Survey, there is overwhelming public support for basing insurance prices on expected costs. Tr. at 350. More importantly, he went on to state that there is overwhelming public support for controlling the ability of insurers to use information that is not related to costs. Tr. at 350. This is particularly true in the case of information based on geographic location, age, sex and disability. The Austin Court of Appeals has upheld other Department prohibitions under Insurance Code, Article 21.21 against the use of unfair underwriting guidelines that are not true risk factors. National Association of Independent Insurers, et al., v. Texas Department of Insurance, et al., Number 94-181-CV (Tex. App.- Austin, November 16, 1994) (NAII). Regarding one of the rules at issue in that case, Rule sec.21.1003, the Court stated: Rule 1003 does not prevent insurers from accepting and rejecting risks; it merely prohibits the use of inaccurate substitutes ... for real risk factors. ... Rule 1003 prohibits the use of proxies for real risk factors. Id. at 11-12. The Department agrees that the use of surrogate underwriting factors for real risk factors is an unfair practice. Because the practices prohibited by this rule are unfair practices, the Department finds it necessary to promulgate this rule to achieve the purposes of Insurance Code, Article 21.21. In addition, these unfair practices and unfair methods of competition create insurance availability problems for Texas consumers and harm the competitive nature of insurance markets. 2.6.2 Other new underwriting rules Based on the three years of studies of insurance availability in Texas, the Department has promulgated two additional rules to prevent unfair underwriting practices. Rule 21.1002 requires insurers to demonstrate that underwriting guidelines are related to risk or size of expense for private passenger automobile and residential property insurance. This rule is based upon the principle that underwriting guidelines must be actuarially sound, i.e., distinguish classes of consumers through a difference in the expected costs associated with the transfer of risk. That rule describes the standard and methodology to demonstrate the fairness of underwriting guidelines. Moreover, the rule allows the Commissioner to collect data necessary to help insurers adequately evaluate certain underwriting guidelines. In this way, small insurers gain a greater ability to independently evaluate underwriting guidelines by gaining access to data sets larger than a small company could produce on its own. Such a mechanism not only ensures the use of fair underwriting guidelines, but promotes greater competition in insurance markets. Rule 21.1002 is a rule of prohibition, not a rule of authorization. That is, the rule provides that certain unfair underwriting guidelines may not be used. The rule does not provide permission to use underwriting guidelines that are risk related even if such guidelines are prohibited by statute or rule. In fact, the last section of that rule specifically provides: Other Laws Not Excepted. Compliance with subsection (a) of this section does not constitute an exemption from other rules or regulations of the department or statutory requirements. Other rules and statutes prohibit the use of inherently unfair underwriting guidelines. Rule 21.1002 does not permit the use of these inherently unfair underwriting guidelines. Rule 21.1005 prohibits the use of underwriting guidelines in the business of private passenger automobile insurance based on the purchase of types or amounts of coverage in excess of the minimum automobile liability coverage required by law. This guideline is prohibited because it is inherently unfair. By statute, the state has required drivers to purchase certain minimum amounts of automobile insurance coverage. It is fundamentally unfair for sellers to then require these drivers to obtain additional amounts of insurance that the drivers do not need or desire to qualify for standard or preferred rates. 2.6.3 Previous Department Underwriting Rules Regulation which limits the use of unfair underwriting guidelines improves the insurance market mechanism and promotes competition. Moreover, such prohibitions are not radical actions. There is a tradition of limiting and guiding the grouping of risk for insurance purposes in a manner consistent with public policy expressions of social and economic fairness. The Department has passed other rules, several of which were promulgated under Article 21.21, prohibiting unfair underwriting guidelines. Rule 5.401(c) prohibits insurers from denying automobile insurance on the basis that the consumer had previously been insured by a nonstandard insurer or through the TAIP. Rule 5.7016 prohibits insurers from nonrenewing automobile insurance coverage based on certain types of claims that were not the fault of the consumer. Rule 21.404 prohibits underwriting guidelines based on sex or marital status for all lines of insurance. Rule 21.1000 prohibits the use of an underwriting guideline by any insurer or agent based on whether another insurer previously declined coverage to the consumer. Rule 21.1003 prohibits automobile insurance underwriting guidelines based on the number of vehicles to be insured or the purchase of other policies. Rule 21.704 prohibits underwriting guidelines by life and health insurers based on sexual orientation. Thus, the Department's actions to prohibit the unfair underwriting guidelines identified in this rule is based on a long-standing policy to prohibit unfair underwriting practices. 2.7 The Department has authority to promulgate this rule 2.7.1 Article 21.21, sec.13(a) The rule is promulgated under the authority of Insurance Code, Article 21. 21, sec.13(a), which provides that the Department: is authorized to promulgate and may promulgate and enforce reasonable rules and regulations and may order such provision as is necessary in the accomplishment of the purposes of this Article ... including, but not limited to, such express provision within the purposes of these Articles as it deems necessary ... This rule is adopted to accomplish the purposes of Article 21.21. Section 1 of Article 21.21 sets out the purposes of the Article 21.21: The purpose of this Act is to regulate trade practices in the business of insurance by defining, or providing for the determination of, all such practices in this state which constitute unfair methods of competition or unfair or deceptive acts or practices and by prohibiting the trade practices so defined or determined. (emphasis added) The Legislature clearly contemplated that the Act would prohibit both those unfair and deceptive trade practices set out in the statute and those that are determined by the Department, pursuant to its authority under Section 13, to be unfair or deceptive practices. Article 21.21, sec.16 also evidences legislative intent that the Department has the authority to determine that practices are unfair and promulgate rules prohibiting such practices. That section provides: Any person who has sustained actual damages as a result of another's engaging in an act or practice declared in Section 4 of this Article or in rules or regulations lawfully adopted by the Board under this Article to be ... unfair or deceptive acts or practices in the business of insurance ... may maintain an action against the person or persons engaging in such acts or practices. (emphasis added) Similar references to either a violation of the Insurance Code or rules or regulations adopted by the Board under Article 21.21 appear in the Insurance Code, Article 1.10A, sec.2(a)(1) and Article 1.14-1, sec.3A(a). These provisions are meaningless unless the Department has the authority to promulgate rules and regulations declaring practices to be unfair. Again, there is a clear legislative purpose in the adoption of Article 21.21 that the Department have the authority to promulgate rules prohibiting such unfair practices. The Austin Court of Appeals has held that the Department has authority to declare underwriting acts or practices to be unfair and to promulgate rules prohibiting such acts and practices. NAII at 5 (citing as additional authority Allstate v. Watson, 876 S.W.2d 145, 147 (Tex. 1994) ). The NAII court also expressly held that the Department may promulgate a rule under Article 21.21 prohibiting an unfair practice even if there is no evidence that the practice is occurring. Id. at 8. Neither the Administrative Procedure Act nor Article 21.21 requires the Department to refrain from acting to protect consumers from unfair and deceptive practices until consumers have been harmed. The mere possibility of an unfair practice provides adequate justification for the Department to act. For instance, the Department should not wait to promulgate a rule prohibiting racial discrimination until an insurer or agent harms a consumer. The Court of Appeals held that Article 21. 21 permits the Department to take prophylactic measures to prevent unfair practices: "The board has the authority to promulgate such rules as it deems necessary to advance the objectives of article 21.21, and it need not passively wait for harm to occur before it enacts regulations." Id. at 8. Nevertheless, as has been shown, the Department is aware of ample evidence that the practices which are prohibited by this rule are occurring. 2.7.2 The private cause of action The Legislature created the private cause of action and expressly empowered the Department to identify those practices which should be designated as unfair. The Legislature has determined that a private cause of action should exist against those persons and entities in the business of insurance that engage in unfair practices identified by the Department. The Department is exercising its statutory duty to identify those unfair and deceptive practices. The NAII court held that the availability of treble damage lawsuits is an insufficient reason to find that a rule declaring an underwriting practice to be unfair is unnecessary or arbitrary and capricious because the statute, not the Department, authorizes this type of suit. NAII at 9. The Department, however, agrees with the Legislature that it is appropriate that a private cause of action exist for violations of this rule because a private cause of action serves several important enforcement purposes. First, a consumer who is harmed as a result of these types of unfair discrimination should have a means by which he or she may recover their damages, including any overcharges resulting from being placed in a substandard company, from the person or company that engaged in the unfair practice. Second, as pointed out previously, prohibitions against intentional discrimination are usually proved on a case by case basis. The Department does not have the resources to take enforcement actions for all individual instances of discrimination. Rather, the Department's enforcement actions, due to limited resources, must be focused on large patterns of intentional discrimination. A private cause of action is necessary to ensure that individual consumers who are victims of intentional discrimination have the opportunity to seek redress for their damages. Third, a private cause of action provides individuals not only with the means to discourage deceptive and unfair practices, but also with the incentive to do so. NAII at 9. Finally, the threat of treble damage lawsuits provides insurers and agents with a strong disincentive to rely on this type of unfair discrimination in making their decisions to insure. Id. Past rules promulgated under Article 21.21, for which there is also a private cause of action, have not resulted in any private litigation, to the Department's knowledge based on questions to several large insurers and insurance company trade associations. These rules include a prohibition against the use of marital status, sec.21.404, a prohibition against blacklisting, sec.21.1000, and a prohibition against tying, sec.21.1003. Thus, the existence of a private cause of action is not calculated to cause excessive litigation costs for insurers or agents. If a consumer were to file a frivolous lawsuit under Article 21.21, sec.16, alleging a violation of this rule, the defendants in the suit have a remedy. Article 21.21, sec.16(c) provides that if the court finds that an action was groundless and brought in bad faith or brought for the purpose of harassment, the court shall award to the defendants reasonable and necessary attorney's fees. 2.8 Existing Laws Are Not Clear Prohibitions Against All Forms of Unfair Discrimination That Would Be Prohibited By This Rule 2.8.1 Insurance Code Provisions Several sections in the Insurance Code address the evils of intentional discrimination, but existing statutory provisions lack the clarity to prohibit all forms of intentional discrimination that would be prohibited under this comprehensive rule. Existing statutes are either limited in scope or are subject to differences of interpretation as to their meaning. This rule is necessary to provide a clear prohibition against all forms of unfair discrimination set out in the rule in the sale and cancellation of insurance, to provide unequivocal notice to the insurance industry that such intentional discrimination is unfair and will not be permitted, provide a means by which the Department may take enforcement actions against companies, agents and others who discriminate on the bases listed in the rule, and to further the purposes of Article 21.21 to prohibit unfair practices and unfair methods of competition. Article 21.21-5(b) prohibits discrimination based on race, color, religion or national origin. That statute also prohibits discrimination based on geographic location, disability, sex or age unless justified by sound actuarial principles. However, the statute applies to "the use of rates or rating manuals and in the nonrenewal of polices." While the Department has asserted that the language "use of rating manuals" prohibits the refusal to sell insurance based on the these protected classes, insurers have argued that this section does not apply to the refusal to sell a policy. They point to the title of the article, "Discrimination in rates or renewal" as evidence that this section was intended to apply only to rate differences and renewals, but not to the initial decision as to whether to offer a policy or the decision whether to cancel a policy. No court has resolved this conflict of interpretations. In addition, the language of the statute would not apply to an agent or other person engaged in the business of insurance unless that person was acting as the agent of an insurer. For instance, insurers have argued that the statute would not apply to an independent agent who represents several insurers but refuses to submit an application to any of those insurers because of his or her personal refusal to serve minorities. Intentional discrimination based on the characteristics identified in the rule is unfair. Because this statute is subject to different interpretations and is not a clear prohibition against all types of intentional discrimination based on these factors, it is necessary for the Department to promulgate a rule which provides a comprehensive and unequivocal prohibition against these types of discrimination. Geographic redlining is also directly addressed by Article 21.21, sec.4(7)(c) . That statute prohibits the unfair discrimination in refusing to renew, canceling or limiting the amount of coverage on a residential property policy because of geographic location unless based on a business purpose that is not a mere pretext for unfair discrimination or is required by law or regulatory mandate. This statute does not address all of the types of unfair discrimination prohibited by the rule for several reasons. First, it only applies to residential property insurance. The Department has seen substantial geographic availability problems in the automobile insurance market, yet this statute would not apply to that problem. Second, some insurers have argued that the statute does not prohibit the outright refusal to sell a policy based on geographic location. The language "limit the amount of coverage," they argue, does not include the refusal to offer any coverage. Furthermore, they Association of Insurance Commissioners (NAIC) model act, from which this section was drafted, expressly applies to the sale of insurance and that language was not included in this statute. Article 21.49-2b, sec.6(a) prohibits discrimination based on age for renewals. That statute, however, is limited to automobile insurance. More importantly, the statute only prohibits discrimination based solely on age. If not justified by sound actuarial principles, age should not be a reason for the denial of insurance at all, whether as the sole reason or one of several reasons. This statute does not permit an insurer to use age as one of two or more reasons for the refusal to sell insurance. The rule regulates unfair practices not addressed by this statute because it applies to all lines of insurance, applies to agents, prohibits discrimination based on age at all (unless justified by sound actuarial principles), applies to the initial decision whether to sell insurance, and applies to the decision whether to cancel a policy. Article 21.21-3 prohibits discrimination against persons with a handicap, unless based on sound actuarial principles or reasonably anticipated experience. Unlike any of the other statutes discussed, this statute clearly and undeniably applies to the sale of insurance: an insurer "may not refuse to insure, refuse to continue to insure, limit the amount, extent, or kind of coverage available to an individual" under this statute. However, like Article 21.49-2b, sec.6(a), this statute only prohibits an insurer from discriminating based solely on a handicap. As with Article 21.49-2b, sec.6(a), this statute does not address discrimination based, in part, on disability, if the discrimination is based, in part, on another valid reason. This unfair discrimination should never be permitted. The rule is necessary because it prohibits discrimination based on disability at all, whether as the sole reason or one of several reasons, in the decision whether to sell insurance, unless justified by sound actuarial principles. The rule also applies to agents and insurers who are exempted from Article 21.21-3, such as county mutual insurers. Article 5.09 prohibits "any distinction or discrimination in favor of the insured having a like hazard, in the matter of the charge of premiums for insurance." This statute does not clearly apply to the outright refusal to sell or cancel a policy. It is also limited to automobile insurance. The rule addresses matters that are not covered by this statute. Article 21.21, sec.4(7)(a) prohibits unfair discrimination between individuals of the same class and equal expectation of life in the rates charged for any contract of life insurance or of life annuity or in the dividends or other benefits payable thereon, or in any of the terms and conditions of such contract. This Article is limited to life insurance and life annuities. More importantly, this Article does not address any of the decisions which are covered by this rule, including the decision whether to sell a policy and the decision to cancel a policy. Article 21.21, sec.4(7)(b) prohibits unfair discrimination between individuals of the same class and of essentially the same hazard in the amount of premium, policy fees, or rates charged for any policy contract of accident or health insurance or in the benefits available thereunder, or in any of the terms or conditions of such contract, or in any other manner whatever. This statute, however, is limited to accident and health insurance. Although the language mirrors that of sec.4(7)(a) and its limitation as to scope noted above, the additional language "or in any other manner whatever" can be interpreted to apply to the decisions to sell or cancel a policy. The application of the rule to accident and health polices is necessary for several reasons. First, no court has ruled on the Department's interpretation of the "or in any manner whatever" language as applying to the decision whether to sell or cancel a policy. The rule clarifies the statute and provides notice to the public of the Department's interpretation. Second, the statute is limited to discrimination against individuals of "essentially the same hazard." It is possible that an insurer may allege that consumers of different races, colors, religions, or national origins are not of essentially the same hazard. Such an insurer may attempt to justify intentional discrimination based on an argument that the loss experience of consumers of different races, colors, religions, or national origins are such that the statute does not apply. The rule provides that intentional discrimination is prohibited, whether or not consumers of different races, colors, religions, or national origins are of "essentially the same hazard." Third, a representative of the life and health insurance industry argued at the hearing that this section does not apply to the sale of insurance. Testimony of Will Davis, Tr. at 403. Thus, the rule is necessary to resolve this difference of interpretations. 2.8.2 Other Laws Several federal laws and state laws outside the Insurance Code do apply to some of the conduct prohibited by this rule. However, the Department only has the statutory authority to enforce insurance laws, which include both the provisions of the Insurance Code and the rules and regulations promulgated by the Department. Insurance Code, Article 1.10(7) provides that the Commissioner may order sanctions against an insurer or agent if the holder of the license "is found to be in violation of, or to have failed to comply with, a specific provision of the Code or any duly promulgated rule or regulation of the Commissioner." The Department is not authorized to enforce federal laws or other state laws. For the Commissioner to be able to take enforcement actions against an insurer or agent who engages in the unfair practices prohibited by this rule, the prohibition must be found in either the Insurance Code or a rule promulgated by the Department. For those unfair practices covered by this rule that are not prohibited by a provision of the Insurance Code, a rule is necessary for the Department to take disciplinary action against companies and agents who engage in these unfair practices. 2.8.3 Need for the rule The existence of these statutory provisions does not prohibit the Department from promulgating this clear and comprehensive prohibition against all of the types of discrimination identified in the rule, for several reasons. First, Article 21.21 mandates a broad reading of the Department's authority to promulgate rules, whether or not the particular practice has been declared illegal by statute. The plain language of Article 21.21 permits the Department to promulgate rules prohibiting unfair conduct. There is no limitation on the Department's authority to declare practices to be unfair simply because they are or are not specifically prohibited by statute. Article 21.21, sec.1(b) states that Article 21.21 "shall be liberally construed and applied." The clear intent is to give the Department broad, and not limited, authority. Therefore, the Department has the authority to declare practices to be unfair under its rulemaking authority even if the practice is prohibited by another statute. Second, these other laws are not clear and unequivocal prohibitions against all of the types of discrimination that would be prohibited by this rule. Many insurers deny the applicability of these statutes to the sale of insurance. In addition, these statutes do not address all areas of unfair discrimination that would be prohibited by this rule. Third, the Legislature has determined that laws which specifically apply to insurance are appropriate, even if other laws prohibiting the same conduct exist. Some of the same national and state laws referred to by commenters prohibit some of the conduct which is prohibited by Insurance Code, Articles 21.21-3 and 21.21-5. Yet the Legislature felt it appropriate to pass statutes that specifically apply to insurance. The Legislature's action shows an intent that repetitive prohibitions can be necessary and are not arbitrary or capricious. Moreover, there is a benefit to having overlapping consumer protection statutes, as the Texas Supreme Court has held: A broad interpretation [which would create an overlap] is warranted, however, due to human inventiveness in engaging in deceptive or misleading conduct. The legislature did not intend its express purpose of protecting consumers from false trade practices to be circumvented by those who would seek out loopholes in the Act's provisions. Pennington v. Singleton, 606 S.W.2d 682, 688 (Tex. 1980). Fourth, the Department believes in state regulation of insurance and that the states should not simply rely on the federal government to protect its citizens in the business of insurance. States should take a proactive role in the elimination of unfair insurance practices and not simply rely on the federal government's discretion whether to enforce anti-discrimination laws as they apply to insurance. Subsection (a) of the adopted rule prohibits the intentional discrimination, in whole or in part, on the basis of race, color, religion, or national origin and, to the extent not justified by sound actuarial principles, on the basis of geographic location, disability, sex, or age, in making a decision whether to bind, accept, reject, renew, nonrenew, cancel or limit coverages made available to a consumer. Subsection (b) of the adopted rule provides that the rule applies to any person or entity licensed by the Department to engage in the business of insurance, including all insurers and agents. Subsection (c) provides definitions of the terms "sound actuarial principles" and "disability" as used in the rule. Subsection (d) provides a partial exemption to the prohibition against discrimination based on geographic location, disability, sex or age for agents. Written comments in favor of adoption of the proposed rule were received from Representative Irma Rangel (Mexican American Legislative Caucus, Texas House of Representatives), Mark L. Kincaid (Public Counsel for the Office of Public Insurance Counsel), James H. Davis (Silver-Haired Legislature), ADAPT of Texas (a grass roots disability rights organization), Patricia Anderson (United Cerebral Palsy of Texas, Inc.), Stephen Yelnosky (Advocacy, Incorporated), Nancy E. Epstein (The Disability Policy Consortium), Katherine Stark (Austin Tenant's Counsil), Jacquiline Shannon (Texas Alliance for the Mentally Ill), Frederick Jarmon (Texas Citizen Action), Robert F. Schneider (Consumers Union), Nina Yager (individually and on behalf of Texas Citizen Action), Kay Allison (Association of Community Organizations for Reform Now), George Kraehe, and Gilbert Moreno (Association for the Advancement of Mexican Americans). Written comments against adoption of the rule were received from David Huff, David K. Nelson (Northwestern Mutual Life), Kimberly Yelkin/Pati Fuller (National Association of Independent Insurers), Robert L. Watkins (State Farm Insurance Companies), Fred B. Werkenthin (Farmers Insurance Group of Companies) , Jay A. Thompson (Texas Life Insurance Association), Rick Clements (Texas Association of Insurance Agents), Bryan R. Davis (on behalf of several unidentified small to medium-sized domestic insurers), Elizabeth Wilson (CNA Insurance Companies), James Langford (Texas Farm Bureau Insurance Companies), Joanne Derrig/Scott Harrington/David Appel (Allstate Insurance Company), and David Snyder (American Insurance Association). Written comments which were neither in support of nor against adoption of the proposed rule were received from Dwight D. Herron (Old Surety Life Insurance Company). In addition to those persons making written comments, oral testimony at the hearing in favor of the adoption of the proposed rule was received from Senator Rodney Ellis, Senator Royce West, Representative Glen Maxey, Representative- Elect Dawnna Dukes, Helene Immenschuh, Enrique Valdivia (Texas Rural Legal Aid), Tim Curtis (Texas Citizen Action), Lance Winters, Jim Mallett, Angelyque Campbell (Texas Community Reinvestment Coalition), Tom Billings, John Henneberger (Texas Low Income Housing Information Service), Jesse Romero/Luis Wilmot (Mexican American Legal Defense and Education Fund), Martha Fitzwater, Mary Tallman, and Fred Lewis. In addition to those persons making written comments, oral testimony at the hearing against the adoption of the proposed rule was received from Representative Robert Duncan, Wade Spillman (Texas Association of Insurance Agents), Charles Wirth (State Farm Insurance Companies), Richard Smith (Allstate Insurance Company), Roger Parker (Allstate Insurance Company), Richard Geiger (Association of Fire and Casualty Companies in Texas and Texas Automobile Insurance Service Office), Jay Thompson (Association of Fire and Casualty Companies in Texas, the Texas Insurance Advisory Association, and the American Council of Life Insurance), David Leonard (Southwestern Life Insurance Company), Finis Welch (Farmers Insurance Companies), Robert Clines, Will Davis (Texas Legal Reserve Officials Association), Robert Sneed (Texas Land Title Association and the Texas Association of Insurance Officials), Jonna Kay Hogeland (National Association of Independent Insurers, Liberty Mutual Insurance Company, the Texas Surplus Lines Association, and the Texas HMO Association), and Burnie Burner (Texas Association of Mutual Insurance Companies). The written and oral comments received by the Department fall into ten general categories: 1. Comments that show a need for the rule. 2. Comments that the rule is ambiguous. 3. Comments that the rule will adversely affect the market. 4. Comments on the costs to comply with the rule. 5. Comments on niche markets. 6. Comments on discrimination based on geographic location. 7. Comments regarding the Department's statutory authority to promulgate the rule. 8. Comments regarding the private cause of action. 9. Comments that existing laws already prohibit the conduct which is prohibited under this rule. 10. Miscellaneous comments. 5.1 Comments That Show A Need For The Rule COMMENT: Several commenters argued that adoption of the proposed rule is necessary and will eliminate unfair practices in the business of insurance in this state. Commenters noted that the rule prohibits types of discrimination that have existed for some time. These commenters also argued in support of the provision for private enforcement actions for violations of the rule. One commenter argued that homeowners insurers should not be permitted to discriminate against an applicant with a home that has been made accessible for the disabled, citing ramps as an example. Commenters also pointed out that underwriting guidelines used by health insurers to deny coverage to persons with disabilities are often based on outdated information and consumers with disabilities are denied health insurance by insurers even though they represent the same health risk as other consumers the company is willing to insure. Commenters argued that insurers use underwriting guidelines that unfairly discriminate based on age, nationality, ethnic background, geography, and disability and should be prohibited from doing so. These commenters stated that consumers who are the subject of these unfair underwriting guidelines are forced to pay higher rates then they would otherwise pay or are denied coverage altogether. Commenters pointed out that studies by the Office of Public Insurance Counsel and the Austin American Statesman show a correlation between the availability of automobile and homeowners insurance and race. Commenters cited the testimony from public hearings held in Houston, Dallas and San Antonio wherein individual consumers who were affected by unfair underwriting practices testified as to their inability to purchase insurance in standard and preferred companies. DEPARTMENT'S RESPONSE: For the reasons set out in the section entitled "Reasoned Justification," the Department agrees with these commenters that adoption of this rule is necessary. COMMENT: A commenter (a consultant to insurers) argued that he was concerned because the proposed rule would place restrictions on the discrimination which occurs as a natural part of the underwriting process. DEPARTMENT'S RESPONSE: To the extent that the intentional discrimination which is prohibited by this rule occurs in the underwriting process, the Department believes this comment supports the need for this rule. Intentional discrimination based on the characteristics identified in this rule should have no place in the underwriting process. This comment, which implies that intentional discrimination does occur in the underwriting process, shows that the prohibitions in this rule are necessary to eliminate this unfair practice in the business of insurance. If the commenter intended to mean that underwriting actions create an unintended disparate impact against minorities, the rule does not apply to that situation. The word "intentional" was added to clarify that the rule only applies to instances of intentional discrimination and not to instances of non-intentional disparate impact. If the commenter intended to mean the fair discrimination associated with fair underwriting guidelines and rating factors, the rule creates no restrictions on the use of fair activities in the underwriting process. COMMENT: Several commenters argued that the prohibitions in Insurance Code, Article 21.21-5 do not extend to the decision whether to bind, accept, reject, cancel or limit coverages made available to a consumer. These commenters argued that only insurers, not agents or other persons set out in the rule, are prohibited from engaging in the unfair discrimination prohibited by that statute. One commenter stated that the Department would not be able to take an enforcement action under current law against an insurer who admits to discrimination based on race in the sale of insurance. DEPARTMENT'S RESPONSE: The Department believes that these comments support the need for the rule. To the extent that Article 21.21-5 does not address or is ambiguous regarding the decision whether to bind, accept, reject, cancel or limit coverages made available to a consumer, or to agents in any circumstance, there is a need to prohibit this unfair practice through the rulemaking authority of Article 21.21. These comments show that guidance to insurers is necessary to at least clarify that such practices are not permitted, and, if the commenters are correct, provide a prohibition against such intentional discrimination. The Legislature did not permit insurers and agents to intentionally discriminate in the sale or cancellation of insurance based on race, color, religion or national origin. The Legislature never determined that such practices are fair. Therefore, the Department disagrees with the commenter's assertion that the absence of a statutory prohibition prohibits the Department from determining that the practice is unfair. The Department is not limited to promulgating rules regarding practices that are already prohibited by statute. Several of these same commenters argued that the Department may not promulgate a rule if the practice is already prohibited by statute. Thus, the commenters' position is that the Department may not pass rules under Article 21.21 that are either already prohibited by statute or that are not already prohibited by statute. This circular reasoning would render the Legislature's grant of rulemaking authority to the Department meaningless. The Department disagrees with the commenters' assertions. Therefore, the Department believes the rule is necessary to provide unambiguous notice to insurers and agents as to the types of intentional discrimination that will not be permitted in Texas. COMMENT: A commenter argued that Insurance Code, Article 21.21-5 is ambiguous as to its application to the sale or cancellation of insurance and that the ambiguity should be resolved through an enforcement action against a company or agent rather than through rulemaking. DEPARTMENT'S RESPONSE: The Department disagrees. Any ambiguity in the statute shows a need for this rule to resolve the ambiguity. The Department disagrees that interpretation of the statute through an enforcement proceeding is more appropriate than interpreting the statute through the rulemaking process. The rulemaking process allows for public comment, puts the public on notice as to the Department's interpretation of the statute and resolves the issue for all parties. Conversely, an enforcement action limits the input available to the Commissioner, does not provide for notice of the Department's interpretation to the Respondent in the disciplinary hearing, and does not resolve the ambiguity for all parties. Thus, the Department believes that the ambiguity raised by the commenter is more appropriately resolved through the rulemaking process and adoption of this rule. COMMENT: A commenter argued that the proposed rule resolves any ambiguity in Texas law regarding whether a prohibition exists against discrimination based on race, color, religion or national origin in the sale of insurance. DEPARTMENT'S RESPONSE: The Department agrees with this comment. COMMENT: A commenter argued that the proposed rule creates requirements which are not contained in existing laws. DEPARTMENT'S RESPONSE: The Department agrees that the rule contains prohibitions against practices that are not prohibited by existing laws, as shown above. Because all of the practices prohibited by this rule are unfair practices in the business of insurance, the Department has determined that these additional prohibitions are necessary. One of the purposes of Article 21.21 is to provide for the determination and prohibition of unfair practices in the business of insurance. If the Department's rulemaking authority were limited to only those practices that are already prohibited by statute, the rulemaking authority would be meaningless. Article 21.21 mandates a broad reading of the Department's authority to promulgate rules, even if the particular practice has not been declared illegal by statute. The plain language of Article 21.21 permits the Department to promulgate rules prohibiting unfair conduct. There is no limitation on the Department's authority to declare practices to be unfair simply because they are not specifically prohibited by statute. Article 21.21, sec.1(b) states that Article 21.21 "shall be liberally construed and applied." The clear intent is to give the Department broad, and not limited, authority. Therefore, the Department has the authority to declare practices to be unfair under its rulemaking authority even if the practice is not prohibited by another statute. COMMENT: A commenter argued that insurers exist in the market today that have their entire policyholder group defined by some of the prohibited classes. DEPARTMENT'S RESPONSE: The practices that are prohibited by this rule are unfair. To the extent that the commenter is correct that there are insurers in the market that engage in the types of discrimination that are prohibited by this rule, this comment indicates a need for this rule to end such unfair practices. 5.2 Comments That The Rule Is Ambiguous. COMMENT: A commenter argued that it is unclear whether the proposed rule would apply solely to intentional discrimination or whether it would also apply to instances of disparate impact. The commenter also questioned whether the business justification defense would be available if the rule applied to instances of disparate impact. The commenter questioned how the proposed rule would operate in relation to proposed rule 21.1002 if the proposed rule applied to instances of disparate impact. DEPARTMENT'S RESPONSE: The Department believes the proposed rule clearly applies only to instances of intentional discrimination. However, to clarify any confusion, the Department has added the word "intentional" before the word "discrimination" in subsection (a) of the rule. Since the rule does not apply to instances of disparate impact, the remaining comments do not apply to the rule. COMMENT: A commenter argued that the definition of "underwriting guideline" should explicitly state that underwriting guidelines include criteria used by insurers in "renewal" or "nonrenewal" of coverage. DEPARTMENT'S RESPONSE: The rule does not contain a definition of underwriting guidelines, nor does it use the term "underwriting guidelines." The rule does prohibit discrimination in the decision whether to accept or reject a consumer for insurance, which would include the decision to renew or non renew a consumer's policy. However, to clarify the rule, the Department has added these two terms to subsection (a). COMMENT: A commenter argued that the term "disability" should be defined. DEPARTMENT'S RESPONSE: Disability is used by the Legislature in Article 21. 21- 5 without a definition and the use of the term "disability" in the rule has the same meaning as that used by the Legislature. A disability is a "physical or mental impairment." That term is defined in rule 21.703 and that definition applies to disability as used in this rule: The words "physical or mental impairment" include, but are not limited to, any psychological disorder or condition, cosmetic disfigurement or anatomical loss affecting one or more of the following bodily systems: neurological, musculoskeletal, special sense organs, respiratory and speech organs, cardiovascular, reproductive, digestive, genito-urinary, hemic and lymphatic, skin, and endocrine system or any mental or physical disorder such as mental retardation, organic brain syndrome, emotional or mental illness, and specific learning disabilities. There is no need to repeat this definition in this rule. However, to avoid any ambiguity, the Department has added a reference to sec.21.703 to define "disability." COMMENT: A commenter argued that there is no definition of "discrimination" in the rule. DEPARTMENT'S RESPONSE: The word "discrimination" does not appear in the proposed rule. The proposed rule does include the verb "discriminate" without a definition. However, the Department believes the word discriminate has a clear meaning and does not need to be defined in the rule. Moreover, the Legislature used the term in Insurance Code, Article 21.21-5 without definition and the Department is unaware of any disagreements as to its meaning. "Discriminate" means to make a difference in treatment. The Department disagrees that there is a need to provide a definition of "discriminate" in the rule. COMMENT: Commenters argued that the phrase "sound actuarial principles" should be defined. One commenter recommended that the phrase should be defined based on the current version of Actuarial Standard of Practice No. 12, "Concerning Risk Classification," adopted on October 12, 1989 by the Actuarial Standards Board of the American Academy of Actuaries. Another commenter argued that applicants should be pooled into large, "sound" groups with statistically predictable costs. Another commenter challenged the Department to produce the sound actuarial principles that the Department would have the industry follow. That commenter pointed to differences of opinion among actuaries. DEPARTMENT'S RESPONSE: The legislature has used the term "sound actuarial principles" in the Insurance Code without definition in at least three separate statutes: Insurance Code, Articles 21.21-3, 21.21-5 and 26.41(b). In the context used in this rule and those statutes, the term is commonly understood to mean both a specific standard of fairness and a methodology to test for that standard. The standard of sound actuarial principles is that an underwriting guideline is fair if that guideline is demonstrably related to differences in the expected costs associated with the transfer of risk. To clarify the rule, the Department has included this commonly understood definition. The Department also agrees with several of the commenters that the methodology for determining whether there are differences in the expected costs associated with the transfer of risk should be consistent with the actuarial standards of practice and compliance guidelines promulgated by the Actuarial Standards Board of the American Academy of Actuaries, and has amended the rule accordingly. The January 1, 1995 date was set to ensure that the Department can review and approve the application of any changes to those standards and guidelines to this rule. COMMENT: A commenter argued that the Department has failed to provide sufficient notice of what constitutes "sound actuarial principles" because it may disregard an insurer's actuarial support if the Department dislikes the effect of an underwriting guideline. DEPARTMENT'S RESPONSE: The Department disagrees with this comment. First, in response to the previous comments, the Department has included a definition of the term "sound actuarial principles". The commenter seems to imply that a rule should not be promulgated if it could be misapplied, either by the Department or a court. The Department disagrees with this argument. Any rule promulgated by any agency could potentially be misapplied. That is not a reason to reject the rule. The Department is confident that the Department and courts will not misapply this rule. Moreover, to the extent that the Department or a court do misapply the rule, those parties who are the subject of the misapplication have judicial remedies to correct the error. COMMENT: A commenter argued that the phrase "sound actuarial principles" should be broadened to include "or reasonably anticipated experience." The commenter recognized that Texas law generally does not include this additional phrase, but felt that phrase could be implied in some statutes and pointed out that the phrase was used in Department rule sec.21.406. DEPARTMENT'S RESPONSE: The Department disagrees that the term "or reasonably anticipated experience" should be added to the rule. The Department also disagrees that the phrase is used in Department rule sec.21.406. The Department does agree that Texas law does not generally include this phrase. Nor should Texas law include such a phrase. Sound actuarial principles deal, by definition, with anticipated experience. The purpose of sound actuarial principles is to provide a justifiable basis upon which a judgment of anticipated experience is made. Sound actuarial principles, therefore, require data and other justifications for making a judgment about anticipated experience. The purpose of these principles is to avoid arbitrary and subjective estimates, however reasonable they may appear. For instance, at one time it appeared reasonable to virtually all automobile insurance underwriters that senior citizens were risky drivers. Insurers charged higher rates based on this "reasonably anticipated experience." When loss experience of senior drivers was examined using sound actuarial principles, the "reasonable" assumptions turned out to be incorrect. Senior drivers caused few losses per exposure. As a result, many companies now offer discounts to senior drivers. Sound actuarial principles are intended to reject these sorts of subjective prejudices against classes of consumers that would be permitted under a "reasonably anticipated experience" standard. The Department, therefore, disagrees that this phrase should be added to the rule. COMMENT: A commenter argued that the term "in whole or in part" is undefined and that it is impossible to determine what the term means. Another commenter argued that the term is at best confusing and at worst totally unintelligible as to its meaning. DEPARTMENT'S RESPONSE: The Department disagrees. The term "in whole or in part," as used in the rule, is clear: it means "not at all." The prohibited bases of discrimination cannot be a reason, either the sole reason or one of multiple reasons, for denying coverage to a consumer. The term is used over thirty times by the Legislature throughout the Insurance Code. See, e.g., Insurance Code, Articles 1.10A, sec.3(f), 1.14-1, sec.11(a), 1.14-2, sec.3(b), 1. 15AA, sec.12(c), 2.08, sec.4, 2.10, sec.9, 3.33, sec.4(g)(1), 3.39, sec.C4(a), 3.50, sec.1(3)(b), 3.51, sec.1(a), 3.51-8, 3.53, sec.2(2), 3.70-3, sec.5, 5.01-1(c), 5. 03(a), 5.23, 5.55C(e), 5.101, sec.3(g)(2), 8.19, 9.48, sec.7(c), 14.51, 20A.13(g) , 20A.36(c), 21.07-3, sec.5(h), 21.07-7, sec.6(h), 21.21, sec.4(8)(i), 21.28, sec.3(h), 21.28-C, sec.8(c), 21.28-D, sec.9(i), 21.49a(iii), and 21.79D, sec.5(a). Insurers have also been held to an "in whole or in part" standard in their underwriting practices for over twenty years by the federal law regulating consumer credit. That statute provides: Whenever ... insurance ... involving a consumer is denied or the charge for such ... insurance is increased either wholly or partly because of information contained in a consumer report ... the user of the consumer report [i.e. the insurer] shall so advise the consumer against whom such adverse action has been taken ... 15 U.S.C.A., sec.sec.1681m(a) (emphasis added). The Department is unaware of any difficulties insurers have had in following this directive, yet it is the very same standard some insurers now contend they cannot follow. As the court of appeals agreed in NAII, public policy supports the choice of the "in whole or in part" standard, rather than a standard that would only prohibit discrimination based "solely" on the characteristics listed in the rule: The language "in whole or in part" does not render [the rule] arbitrary and capricious. To allow insurers to rely on the improper factors "in part" would emasculate the statute because it would protect insurers who use improper grounds in reaching their decisions. Eliminating the "in part" language would protect an insurer who relies, however slightly, on some proper ground for denial. The board acted reasonably by refusing to allow insurers access to such an easily manufactured defense. NAII at 9. The court also dismissed insurers' concerns that the "in part" language exposes insurers to the risk of treble damage lawsuits and strict administrative penalties since the mere consideration of the prohibited basis for a decision may be sufficient to impose liability. Id. at 9. The "in part" language does not entitle a consumer to sue if, in fact, the prohibited bases were not considered. However, if illegal discrimination was one of the factors in the decision, even if only a small part of the decision, the reliance on the prohibited factor is unfair and should be prohibited. The rule only prohibits discrimination based, in whole or in part, on the specified characteristics. The rule does not make it illegal for an insurer to know the race, color, religion, national origin, age, sex, disability or geographic location of a consumer. Commenters who assert that the "in whole or in part" language will make them liable for any declination of coverage if they knew that the consumer is a member of one of the protected classes are incorrect. The rule specifically provides that the insurer or agent must not only know that the consumer is a member of the protected class, it must also intentionally discriminate on that basis to be in violation of the rule. The Department, therefore, disagrees that the language "in whole or in part" should be eliminated from the rule or further defined. COMMENT: Commenters argued that the terms "binding, accepting, rejecting, canceling or limiting coverages" is too broad and that the terms tie to virtually every business decision that is made within an insurance company. DEPARTMENT'S RESPONSE: The Department disagrees that the rule is too broad. The prohibition is broad for a reason. Any decision regarding the sale or cancellation of insurance should not be based, in whole or in part, on the factors set out in the rule. Although broad, the prohibition is not vague or ambiguous. It is intended to prohibit this unfair discrimination from all decisions of the insurance company or agent, and the commenter has confirmed that this intent has been accomplished. COMMENT: Commenters argued that the rule is vague and unclear. The commenters did not identify any portion of the rule, other than the terms discussed above, that the commenters believed is vague. DEPARTMENT'S RESPONSE: The Department disagrees that the rule is vague. The rule clearly defines the conduct which is prohibited and the scope of the rule. Without any identification of the portions of the rule the commenter believes to be vague, the Department is unable to respond any further to this comment. COMMENT: A commenter argued that it is unclear whether the use of TDI factors, classifications and rules would be generally protected if used. The commenter argued that "carve out language" should be included in the rule for such TDI factors, classifications and rules. DEPARTMENT'S RESPONSE: The Department disagrees that there is any ambiguity based on this comment. The Department notes that there is no such "carve out language in Article 21.21-5, even though companies are required to use TDI factors, classifications and rules. The comment appears to erroneously assume that the rule applies to instances of disparate impact. Moreover, the Department does not promulgate factors, classifications or rules permitting underwriting factors based in whole or in part on race, color, religion or national origin. Any Department classifications and rules relating to geographic location, age, sex or disability relate to rating decisions and do not apply to underwriting guidelines, as defined in the rule. Where the Department has promulgated a rate differential between two classes based on geographic location, age, sex or disability, however, then the discrimination between the two classes is actuarially sound. The Department is prohibited from promulgating rate differentials based on geographic location, age, sex or disability that are not actuarially sound. Rate differentials on these grounds may only be made to the extent justified by sound actuarial principles, pursuant to Insurance Code, Article 21.21-5. Thus, if the Department has promulgated a rate differential between two classes based on geographic location, age, sex or disability (regardless of the amount of the differential) , then an insurer who discriminates between those two identical classes in the underwriting decision has done so based on sound actuarial principles and has not violated either this rule or Article 21.21-5. COMMENT: A commenter argued that the sentences in the rule are too long and difficult to understand. DEPARTMENT'S RESPONSE: The Department disagrees as to subsection (b). The sentence contained in that section is simply a list of the types of insurers to which the rule applies. As for subsection (a), the Department has rewritten the first sentence to make it easier to read. 5.3 Comments The Rule Will Have An Adverse Impact On The Market COMMENT: A commenter argued that the proposed rule constitutes an initial attempt to codify underwriting guidelines. DEPARTMENT'S RESPONSE: The Department disagrees that the proposed rule constitutes an initial attempt to codify underwriting guidelines. The express purpose of the rule is to eliminate those unfair practices identified in the rule. The prohibition against using unfairly discriminatory underwriting guidelines does not equate to a codification of underwriting guidelines. Insurers and agents are not prohibited under this rule from using any appropriate underwriting guideline, as long as the guideline does not intentionally discriminate, in whole or in part, on the basis of race, color, religion, or national origin and, to the extent not justified by sound actuarial principles, on the basis of geographic location, disability, sex, or age. The NAII court rejected the argument that a prohibition against the use of unfair underwriting guidelines prohibits insurers from accepting and rejecting risks. NAII at 11. The Court held that the rule at issue in that case "does not prevent insurers from accepting and rejecting risks; it merely prohibits the use of inaccurate substitutes ... for real risk factors." Id. That analysis is equally applicable to this rule; the rule does not prevent insurers from using their own underwriting guidelines. Nor does it require them to use any guidelines at all, codified or not. Rather, the rule simply prohibits insurers from using underwriting guidelines that are inaccurate substitutes, like race, color, religion and national origin, for real risk factors. COMMENT: A commenter argued that the rule should not be adopted because it will cause rates to increase for other consumers who are not in the classes protected by this rule. DEPARTMENT'S RESPONSE: The shift in rates among consumers described by this commenter would occur only if the factors of race, color, religion or national origin were uniquely associated with differences in expected costs of the transfer of risk. The Department has seen no evidence that any of these factors are uniquely associated with such differences. The Department therefore disagrees that rates for other consumers will increase as a result of the adoption of this rule. Insurers may continue to apply fair underwriting guidelines to potential consumers under this rule to ensure that the consumers they insure as a result of this rule have the same estimated cost associated with the transfer of risk as do its current customers. For instance, the rule does not require an insurer to write all Hispanics; it only prohibits insurers from denying coverage to Hispanics who otherwise meet the insurer's underwriting guidelines. Thus, any additional consumers written as a result of this rule will be the same risk as the insurer's current consumers and have the same estimated cost associated with the transfer of risk. Therefore, the rule as it applies to race, color, religion and national origin will not cause rates to increase. If race, color, religion or national origin were uniquely related to expected differences in the transfer of risk, the prohibition of the use of these underwriting guidelines would cause rates to go up for some consumers and go down for other consumers. Even if this were the case, the use of these underwriting factors would still be unfair because the Legislature's expression of public policy clearly states that whether or not these factors distinguish among the expected risk of consumers, such market segmentation is not socially or economically fair. It is inherently unfair to charge different rates based upon these factors, regardless of differences in expected costs of the transfer of risk. Because the other underwriting guidelines-geographic location, disability, age or sex-may be used when justified by sound actuarial principles, the Department disagrees with the commenter in regard to these underwriting guidelines. To the extent that insurers currently use these guidelines fairly, the rule will not cause shifts in premium as the commenter suggests. To the extent that insurers currently use these guidelines unfairly, the rule will cause premium shifts, but those premium shifts will result in fair treatment of consumers where they had previously been treated unfairly. COMMENT: A commenter argued that the proposed rule would have a negative impact on the Texas insurance market. Another commenter argued that the rule will adversely affect the availability and affordability of insurance to the citizens of Texas. The commenters did not offer any specifics as to how the rule would have a negative impact. DEPARTMENT'S RESPONSE: The Department disagrees. As shown in the Reasoned Justification, the elimination of these unfair underwriting guidelines will have a positive impact on the Texas insurance market. COMMENT: A commenter was concerned that the proposed rule will harm the commenter's efforts to expand personal lines markets in Texas. Another commenter argued that the rule will drive insurers to withdraw from lines of insurance, markets, or the state. DEPARTMENT'S RESPONSE: The Department does not believe that a prohibition against the types of unfair practices prohibited by this rule will cause insurers to avoid Texas insurance markets or to leave those markets. The effect of the rule, instead, will be to cause insurers not to intentionally discriminate based on these unfair underwriting guidelines. The Department rejects the argument that insurance availability is only possible if insurers are allowed to unfairly discriminate against consumers. The Department assumes insurers will react rationally to this rule by simply ceasing any underwriting practices that would violate the rule and serve Texas insurance markets using fair underwriting guidelines. COMMENT: A commenter argued that an industry vital to a free-enterprise nation could be destroyed if forced to "accommodate" the uninsurable, as measured by insurer management. The commenter argued that distinctions based on age and disability that the rule declares to be unfair exist because actuaries have found them reliably reflective of life and behavior in this society. The commenter went on to argue that the risk of insuring consumers without such distinctions should be left to insurer management and not imposed by law. DEPARTMENT'S RESPONSE: The Department disagrees with this comment. To the extent that an insurer or agent shows that distinctions based on age and disability exist, based on sound actuarial principles, the rule does not prohibit discrimination based on age or disability. Thus, if a specific age group or disability group is shown to incur higher losses and is therefore "uninsurable," there is no requirement to write those consumers. However, if no distinction can be shown based on sound actuarial principles, then the prohibition against discriminating against the class of consumers will not affect, and will certainly not destroy, insurers or the insurance industry. The Austin Court of Appeals upheld the Department's right to prevent another unfair underwriting proxy, stating: Rule 1003 does not prevent insurers from accepting and rejecting risks; it merely prohibits the use of inaccurate substitutes ... for real risk factors. ... Rule 1003 prohibits the use of proxies for real risk factors. NAII at 11-12. Similarly, this rule does not prohibit insurers and agents from denying coverage based on true risk factors, but it does prevent the use of inaccurate substitutes. The Department also disagrees that the decision whether to discriminate on the basis of race, color, religion, or national origin and, to the extent not justified by sound actuarial principles, on the basis of geographic location, disability, sex, or age, in making a decision whether to bind, accept, reject, renew, nonrenew, cancel or limit coverages made available to a consumer should be left to insurer or agent management. Such practices are unfair and the Legislature has charged the Department with the duty to promulgate rules that identify and prohibit unfair practices like the practices identified in this rule. Nor does the Department agree that insurer management should be permitted to determine "uninsurability" based on race, color, religion, or national origin and, to the extent not justified by sound actuarial principles, on the basis of geographic location, disability, sex, or age. The Legislature has determined that insurers should be limited in their decision as to which consumers are insurable. The Legislature passed Article 21.21 for the express purpose of prohibiting insurer management and agents from engaging in unfair and deceptive practices, even if management believes such unfair or deceptive practices are appropriate. COMMENT: A commenter argued that the proposed rule would remove all discretion from the business entity and force the business to underwrite a risk that they either feel they cannot financially withstand or assume a risk that they did not contemplate assuming when they entered the market. The commenter went on to argue that, if companies are unable to obtain approval for the rates they feel are necessary to adequately cover the risks which are being thrust upon them, many will feel a compelling need to withdraw from the market. DEPARTMENT'S RESPONSE: The Department disagrees with this comment. The rule would not remove all discretion from the business entity. Under this rule, the company is not prohibited from exercising discretion in its choice of consumers, nor is it forced to underwrite any risk, as long as that choice is not based on race, color, religion, or national origin and, to the extent not justified by sound actuarial principles, on the basis of geographic location, disability, sex, or age. The rule clearly allows discretion in the decision about classes of consumers the insurer or agent wishes to insure. If the commenter understands business discretion to mean the arbitrary and unfair treatment of individual consumers, this rule does prohibit that type of "business discretion." The commenter's argument regarding rates is inconsistent with the Texas rate regulatory scheme. For many lines of insurance, rates are not regulated by the Department and, therefore, the company is not constrained in the setting of its rates. In other lines, the Department sets rates based on statutory criteria which require the rates to be adequate. Finally, in the automobile and homeowners insurance lines, the Department sets a flexibility band in which insurers may file and use the rates that they deem appropriate to cover the risks they will insure. For those companies that can show a need for rates outside those bands, the statute permits the approval of such rates. Therefore, the Department disagrees with the comment that companies will be unable to set adequate rates as a result of this rule. COMMENT: A commenter argued that the rule will prohibit the application of judgment in the underwriting process. DEPARTMENT'S RESPONSE: The Department disagrees. The rule does not prohibit the application of judgment in the underwriting process. It requires that those judgments be fair and fairly applied. The rule does prohibit judgments based on race, color, religion, and national origin, but the rule does not prohibit fair judgment based upon geographic location, age, sex and disability. 5.4 Comments On The Costs To Comply With The Rule. COMMENT: A commenter argued that the proposed rule fails to accurately reflect the cost to insurers in complying with the rule. The commenter argued that the cost of defending potential litigation would exceed by more than 25% the costs stated in the proposed rule. Another commenter argued that the rule will add significant additional compliance overhead to the industry's cost of doing business (although the commenter failed to explain what those additional costs will be or how they were determined). Another commenter argued that the costs of litigation will exceed the estimate of no costs set out in the notice. DEPARTMENT'S RESPONSE: The Department disagrees that the actual costs to comply with the rule will exceed the cost estimate contained in the notice of the proposed rule by more than 25%. First, these commenters misunderstand the cost estimates required under the Government Code, sec.2001.024(5)(B). The public cost estimates contained in the proposed rule constitute the costs to comply with the rule; the estimate does not-and the agency is not required by statute to-include defense costs, damages, and penalties to be paid as a result of a violation of the rule. It would be impossible for the Department, or any agency, to estimate the number of times regulated entities will violate a rule and the fines and penalties that will result. The commenter's argument is based on the premise that the cost estimate must include the estimated fines and penalties, in addition to the litigation expenses, that will be incurred by all regulated entities that choose to violate the rule. The Legislature could not have intended such an absurd result. The Department properly complied with the statutory requirement to estimate the costs necessary to comply with the rule, not the costs associated with a violation of the rule. Second, the Department does not anticipate extensive litigation as a result of this rule. As shown above, several other rules promulgated by the Department under Article 21.21 have not generated any private litigation, legitimate or frivolous. The commenters have not shown any reason to believe that the experience under this rule will be any different. The Department assumes, as did the Legislature when it created a private cause of action, that the possibility of litigation will be enough to cause insurers and agents to refrain from engaging in the unfair practices that are prohibited by this rule so that there will not be extensive litigation. Third, as to the alleged costs associated with frivolous lawsuits, this rule does not permit frivolous lawsuits. To the extent that frivolous lawsuits may theoretically result from the promulgation of a rule, that potential exists for any rule promulgated by an agency. Yet no agency includes the costs of potential frivolous suits in its cost estimate. Moreover, it would be impossible for an agency to estimate how many claimants will bring a frivolous suit citing the proposed rule or the cost associated with defending potential frivolous suits. Again, the Legislature could not have intended such an absurd requirement for the cost estimate. Fourth, some of the commenters are incorrect in their interpretation of Insurance Code, Article 1.03B. That statute provides that a rule is void only if the reasonable actual costs exceed the costs stated by at least 25% of the costs stated. Only reasonable actual costs count; costs related to a violation of the rule are not reasonable costs and should not be included in the determination. In addition, the costs referred to in Article 1.03B are the total costs estimated by the Department. Some commenters erroneously contended that the statute applies if any element of the cost estimate is too low. In this instance, the estimate for each company was up to $100,000. Fifth, if a consumer were to file a frivolous lawsuit under Article 21.21, sec.16, alleging a violation of this rule, the defendants in the suit have a remedy to recover their costs. Article 21.21, sec.16(c) provides that if the court finds that an action was groundless and brought in bad faith or brought for the purpose of harassment, the court shall award to the defendants reasonable and necessary attorney's fees. Finally, the "economic cost" associated with the rule is not simply the expense associated with the rule, it is the balance of the economic benefits and the expenses associated with compliance. For those companies and agents who currently engage in the practices prohibited by this rule, they will incur an administrative expense for the elimination of their current underwriting guideline. However, they will also receive the benefit of additional business from consumers of the same risk as those consumers that they currently insure. The profit resulting from this additional business will to some extent offset any expenses associated with the elimination of the underwriting guideline. 5.5 Comments On Niche Markets. COMMENT: A commenter argued that the availability and affordability of insurance would likely be jeopardized. The commenter argued that the ability of insurers to develop and market their products in niche markets may be adversely affected, insureds in those niche markets will likely be forced to pay more for insurance, and that in many cases these niche markets would disappear. DEPARTMENT'S RESPONSE: The Department disagrees with this comment. A niche market, by definition, is a subset of the population defined by certain characteristics of the consumers to be insured. While niche markets are most often thought of as small subsets of the population, the fact is that virtually every insurer defines its target market in terms of the characteristics of the consumers to be insured. Thus, the smallest insurer is no different than the largest insurer in defining its target market based upon a set of consumer characteristics. The rule therefore will not disproportionately affect any one type of insurer, no matter what size market the insurer targets. As stated previously, the rule does not prohibit underwriting judgment. To the extent that certain underwriting guidelines and risk classifications are prohibited, insurance affordability and availability will improve, as described in the reasoned justification, as a result of this rule. For those consumers who are the victims of intentional discrimination and who are either denied insurance or charged higher rates based on their race, color, religion, or national origin and, to the extent not justified by sound actuarial principles, on the basis of geographic location, disability, sex, or age, this rule will increase the affordability and availability of insurance. If an insurer is able to write a class of additional consumers without increasing its average losses or expenses, then that insurer will not need to raise its rates. Because the classifications of race, color, religion and national origin are not true risk factors, there should be no effect on companies' rates as a result of complying with this rule. The Department disagrees that the ability of insurers to develop and market their products in niche markets will be adversely affected or that insureds in those niche markets will be forced to pay more for insurance. The Department also disagrees that niche markets will disappear as a result of the adoption of this rule, except any niche markets based on race, color, religion, or national origin and, to the extent not justified by sound actuarial principles, on the basis of geographic location, disability, sex, or age. The rule simply prohibits insurers from discriminating on the basis of race, color, religion, or national origin and, to the extent not justified by sound actuarial principles, on the basis of geographic location, disability, sex, or age against consumers who otherwise meet the insurer's underwriting guidelines. Moreover, for the reasons set out above, there is no reason to believe that insurance rates in niche markets will increase. Because the prohibition against discrimination based on geographic location, disability, sex or age does not apply when such discrimination is justified by sound actuarial principles, niche market insurers will only be affected by this rule to the extent these classes do not increase the insurer's average losses or expenses. Thus, the insurer will not need to raise its rates. The rule does not prohibit the use of other guidelines that are true indicators of risk. The rule simply requires an insurer to apply its underwriting guidelines in the same manner to all consumers, regardless of the race, color, religion or national origin of the consumer. COMMENT: Commenters argued that the rule impermissibly prohibits insurers from discriminating based on race or sex, especially in instances when the policyholders own the insurance company. One commenter argued that it would be arbitrary and capricious to prohibit an insurer from denying coverage unless the consumer is the member of a fraternity or sorority, Hispanic, or African American. DEPARTMENT'S RESPONSE: The Department disagrees. Insurers are not prohibited under this rule from marketing to these or any other groups. If an insurer wants to market to the African American community, for instance, it may do so under this rule. However, it is just as unfair for that company to reject other applicants based on race, whether white, Hispanic or other, as it is unfair for a company that markets to white applicants to deny coverage to African Americans. It is neither arbitrary or capricious to prohibit insurers and agents from denying coverage based on a person's race, color, religion or national origin, or to the extent not based on sound actuarial principles, on geographic location, age, sex or disability. This is true even when the policyholders own the insurer. A group of white men, for instance, should not be permitted to form a policyholder-owned insurer that refuses to sell to African Americans. Nor should a group of African Americans be permitted to form an insurer that refuses to insure white applicants. The unfairness is the same: race, color, religion and national origin should not be used in the determination whether to sell or cancel insurance policies. To the extent not justified by sound actuarial principles, the same is true for discrimination based on gender. COMMENT: A commenter argued that it is fair for an insurer to require consumers to be a member of some organization in order to be eligible to apply for insurance. Examples given include membership in fraternal groups, lodges, secret societies, credit unions, and government employees. The commenter stated that some of these groups may have membership requirements based on religion or national origin. Another commenter questioned whether an insurer would be prohibited from selling only to a group like the American Association of Retired Persons (AARP) because membership is based on age. DEPARTMENT'S RESPONSE: The Department disagrees. First, discrimination based on lack of membership in most of these organizations would not violate the rule because membership is not based on race, color, religion, or national origin. However, to the extent that membership is based on any of these classifications, the rule would prohibit the membership requirement. Such requirements are unfair whether deemed an underwriting guideline or a membership requirement. The net result would be that a consumer is denied insurance based on their race, color, religion, national origin. Our society does not condone businesses that serve only one race, color, national origin, or religion, to the exclusion of all others. While businesses may certainly market to these different classes of consumers, it is unfair and unjust to deny goods or services to consumers of other races, colors, national origins or religions. For membership requirements based on age, sex, disability or geographic location, (e.g. AARP, sororities, and fraternities) the rule only prohibits the membership requirement if it is not based on sound actuarial principles. Thus, if an insurer restricts its sales to members of the group because the group has lower losses or because the average expenses associated with insuring the group would increase if non-members were insured, then such discrimination would be based on sound actuarial principles and would not violate the rule. However, if non-members have the same estimated cost associated with the transfer of risk as members, then there is no justifiable business reason to deny coverage. As Dr. Appel testified on behalf of Allstate, there is overwhelming public support for controlling the ability of insurers to use information that is not related to costs. Tr. at 350. That is exactly what this rule does: it prohibits insurers and agents from denying coverage to non-members of a group if membership is not related to cost. In that instance, the discrimination based on the applicant's failure to meet age, sex, disability or geographic requirements would be unfair. COMMENT: A commenter argued that it is not unfair for insurers to have their entire policyholder group defined by some religion. These insurers may be policyholder owned or stock owned but limit their sales to members of specific religions. DEPARTMENT'S RESPONSE: The rule does not prohibit an insurer from marketing to members of a specific religion. However, if a consumer who is not a member of a specified religion applies for insurance and meets all other underwriting criteria of the insurer, it would be unfair for the insurer to deny coverage on the basis of the consumer's religious beliefs. The religious freedoms on which this country is based have long supported the belief that it is fundamentally unfair for a business to refuse to serve a consumer based on the consumer's religious beliefs. The purpose of these rules is to ensure that consumers posing the same expected costs of the transfer of risk are treated similarly by an insurer. An insurer is not harmed by treating similar risks in a similar fashion. 5.6 Comments On Discrimination Based On Geographic Location. COMMENT: A commenter argued that agents and insurers who write only in one geographic area will be required to write all over the state. DEPARTMENT'S RESPONSE: The Department disagrees. Discrimination based on geographic location is only prohibited to the extent not justified by sound actuarial principles. Discrimination based on geographic location, therefore, is permitted if doing business in another location would increase the estimated cost associated with the transfer of risk. The rule would not prohibit discrimination if, for example, the insurer would incur higher expenses because it is not set up to service a particular portion of the state. If, however, the estimated cost associated with the transfer of risk for consumers in a different geographic location is the same as for the geographic locations the insurer is willing to insure, then there is no justification for denying coverage to those consumers. The same applies to an agent. If the estimated cost associated with the transfer of risk for a consumer is the same, regardless of the location of the insured, then it would be unfair to deny coverage based on the consumer's location. Conversely, if it would be more expensive for the agent to serve a consumer in another geographic location, the rule would not prohibit discrimination on that basis. COMMENT: A commenter argued that it is fair for a company to make a business decision not to serve a geographic area, even if the decision is not risk related or expense related. DEPARTMENT'S RESPONSE: The Department disagrees. If the estimated cost associated with the transfer of risk for consumers in a different geographic location is the same as for the geographic locations the insurer is willing to insure, then there is no justification for denying coverage to those consumers because of where they happen to live. If a consumer lives in an inner-city neighborhood and the risk and expense for insuring that consumer are the same as the risk and expense of insuring a consumer in the suburbs, it would be unfair for an insurer to insure one and deny coverage to the other. COMMENT: A commenter argued that the rule would require Health Maintenance Organizations to write insurance outside of their state-approved service area, which would violate other laws. DEPARTMENT'S RESPONSE: The Department disagrees. Although the rule prohibits an HMO from discriminating based on geographic location, a standard actuarial principle provides that all applicable laws and regulations must be complied with. See, e.g., Section 5.6 of Actuarial Standard No. 12 of the Actuarial Standards Board. Therefore, if an HMO is prohibited by law from selling coverage in a geographic area, its refusal to sell in that area would be based on sound actuarial principles and, therefore, would not be in violation of the rule. COMMENT: A commenter argued that health insurers may not want to write in a geographic area because there is only one hospital provided in the area and the provider's charges are unreasonably high or the insurer simply is unable to deal with the provider. DEPARTMENT'S RESPONSE: Discrimination based on geographic location is not prohibited under this rule if based on sound actuarial principles. The situation identified by the commenter would result in higher losses or insurer expenses for servicing that particular geographic area. Since the estimated cost associated with the transfer of risk for consumers in that geographic area would be higher than in other areas, a refusal to insure consumers in that area would be based on sound actuarial principles and would not violate this rule. COMMENT: A commenter questioned how the rule would apply to preferred provider organizations (PPOs). The commenter stated that most PPOs serve a geographic area, not the entire state. The commenter questioned whether the PPO would be permitted to reject applicants who live outside of that service area. DEPARTMENT'S RESPONSE: Discrimination based on geographic location is not prohibited under this rule if based on sound actuarial principles. The cost for a PPO to insure a consumer outside its service area will be higher because the costs associated with emergencies will be higher for groups of consumers outside the service area. Since consumers outside the service area will not have PPO providers to serve them in an emergency, the costs associated with the emergency will be higher for the group of consumers outside the service area. Since the estimated cost associated with the transfer of risk for consumers outside the service area would be higher than within the service area, a refusal to insure consumers outside the PPO's service area would be based on sound actuarial principles and would not violate this rule. 5.7 Comments On The Department's Statutory Authority COMMENT: Commenters argued that the Department of Insurance lacks the requisite statutory and regulatory authority to adopt the proposed rule. DEPARTMENT'S RESPONSE: The Department disagrees for the reasons set out above in section 2, "Reasoned Justification," entitled "the Department has the statutory authority to promulgate this rule." COMMENT: A commenter argued that the proposed rule is broader than the statutory prohibitions because of the language "in whole or in part" in the proposed rule. DEPARTMENT'S RESPONSE: The Department agrees that the rule is broader than some statutory prohibitions that apply only to discrimination based "solely" on the prohibited classifications because of the "in whole or in part" language. The types of discrimination prohibited by this rule should not be used at all, either as the sole reason for denial of insurance or as one of multiple reasons. Moreover, the fact that the rule identifies and prohibits unfair conduct that is not prohibited by statute is a reason to adopt the rule, not reject it. The purpose of Article 21.21 is to prohibit unfair practices. COMMENT: A commenter argued that adoption of the proposed rule would violate Insurance Code, Article 1.03A because there is no express grant of rulemaking authority to adopt this rule. DEPARTMENT'S RESPONSE: The Department disagrees. Adoption of the proposed rule does not violate Insurance Code, Article 1.03A because Article 21.21, sec.13 provides the express statutory authority to adopt this rule. The Department is not attempting to exercise any rulemaking authority under Insurance Code, Article 21.21-5 or any statute other than Article 21.21. Rather, the Department is exercising its express authority under Article 21.21 to identify and prohibit unfair practices in the business of insurance. COMMENT: A commenter argued that Insurance Code, Article 5.09 does not include a grant of rulemaking authority to the Department. DEPARTMENT'S RESPONSE: The Department agrees. However, the Department did not cite Article 5.09 in its Notice of Proposed Rulemaking, nor has it relied on that statute as a basis for the adoption of the rule. COMMENT: A commenter argued that Insurance Code, Article 5.98 does not apply to life, accident and health insurance and does not provide statutory authority for the rule. DEPARTMENT'S RESPONSE: The Department agrees. However, the Department did not cite Article 5.98 in its Notice of Proposed Rulemaking, nor has it relied on that statute as a basis for the adoption of the rule. COMMENT: A commenter argued that there is no demonstration of the necessity to enact such a rule in order to carry out the purposes of Article 21.21. A commenter argued that there has been no indication that the practices to be prohibited by the rule are occurring or threatened or that consumers have suffered injury or likely to suffer injury as a result of the prohibited practices. A commenter argued that the Department's August 1993 study does not show that the rule is necessary or that unfair discrimination exists. The commenter recommends that the Department engage in further studies. DEPARTMENT'S RESPONSE: The Department disagrees. The NAII court held that the Department may promulgate a rule under Article 21.21 prohibiting an unfair practice even if there is no evidence that the practice is occurring. NAII at 8. Neither the Administrative Procedure Act nor Article 21.21 requires the Department to refrain from acting to protect consumers from unfair and deceptive practices until consumers have been harmed. The mere possibility of an unfair practice provides adequate justification for the Department to act. The Court of Appeals held that Article 21.21 permits the Department to take prophylactic measures to prevent unfair practices: "The board has the authority to promulgate such rules as it deems necessary to advance the objectives of Article 21.21, and it need not passively wait for harm to occur before it enacts regulations." Id. at 8. Nevertheless, as has been shown, the Department is aware of ample evidence that the practices prohibited by this rule are occurring in the Texas insurance market. Although the Department has the authority to promulgate this rule even in the absence of consumer harm, the evidence identified previously, which includes intentional discrimination, demonstrates the necessity to enact this rule to carry out the purposes of Article 21.21. The evidence shows that some insurers are intentionally discriminating based on the prohibited classifications, that insurance availability problems exist based on these classifications, and that the consumers who are subject to these practices are either denied necessary insurance or are charged higher rates for that insurance. As set out in the reasoned justification section, insurance is necessary to operate or buy a car, own a home, purchase or operate a business, obtain health care and engage in other economic activities. Because the practices prohibited by this rule are unfair, create insurance availability problems for Texas consumers, and harm the competitive nature of insurance markets, the Department finds it necessary to promulgate this rule to achieve the purposes of Insurance Code, Article 21.21. COMMENT: A commenter argued that, although the rule is couched in terms of preventing "unfair trade practices," in reality the rule focuses entirely upon the evils of discrimination in the categories covered by the rule. DEPARTMENT'S RESPONSE: The Department disagrees with this comment because it implies that the evils of discrimination in the categories covered by the rule do not constitute unfair practices. The evils of discrimination prohibited by the rule are the epitome of unfair trade practices. It is inherently unfair to discriminate, in whole or in part, on the basis of race, color, religion, or national origin and, to the extent not justified by sound actuarial principles, on the basis of geographic location, disability, sex, or age, in making a decision whether to bind, accept, reject, renew, nonrenew, cancel or limit coverages made available to a consumer. Therefore, the Department has focused on the statutory factor-whether the practice is unfair. COMMENT: A commenter claimed the rule is not limited to unfair discrimination and that the word "unfair" does not show up anywhere in the rule. DEPARTMENT'S RESPONSE: The Department disagrees. The practices which are prohibited by the rule are inherently unfair. The rule expressly finds that the prohibited practices are unfair and the word "unfair" is included in subsection (a) of the rule: "The failure to comply with this subsection constitutes an unfair trade practice in the business of insurance ... ." (emphasis added). COMMENT: Commenters argued that the passage of Insurance Code, Article 21. 21-5 in 1991 pre-empts the passage of rules addressing the same subject. A commenter argued that the legislative history of Article 21.21-5 demonstrates the deprivation of authority for the Department to pass rules regarding discrimination. DEPARTMENT'S RESPONSE: The Department disagrees. The Department is not relying on any rulemaking authority from Article 21.21-5. Rather, the Department is relying solely on its authority to identify and prohibit unfair trade practices under Article 21.21, sec.13. The legislative intent, as shown above, is clear that the Department has the authority to promulgate rules under Article 21.21 prohibiting unfair practices in the business of insurance. It is equally clear that intentional discrimination based on the categories in this rule is unfair. Therefore, the Department has the authority to promulgate this rule to prohibit these unfair practices. Any decision by the Legislature not to provide yet another statutory basis for promulgating rules against unfair practices does not negate the undeniable statutory authority in Article 21.21. COMMENT: A commenter argued that the rule adds to the strain already placed on the Department's rulemaking authority by its prior experiments in social policy over the past four years and thereby invites a responsive elected Legislature to question whether the agency should continue to have power to make legislative rules at all. DEPARTMENT'S RESPONSE: The Department disagrees. First, there is no "strain" on the Department's authority to promulgate rules prohibiting the use of unfair underwriting guidelines. The court of appeals in the NAII case, as well as the district court, held that the Department has clear authority to prohibit unfair underwriting practices. The Department has set out, at length, its statutory authority to promulgate this rule and will not repeat those statements here. Second, the Department does not consider this rule to be an "experiment in social policy." The basis of this rule, that people should not be treated differently based on race, color, religion or national origin, is a well- accepted tenet in our jurisprudence. Finally, the Legislature has made the determination that the Department should have the authority to identify and prohibit unfair practices through rules. While the commenter may disagree with this authority, the Legislature has determined otherwise. COMMENT: A commenter argued that the proposed rule is inconsistent with and conflicts with existing laws. The commenter did not identify any laws which it believed to be inconsistent with or in conflict with the proposed rule. DEPARTMENT'S RESPONSE: The Department has reviewed other laws pertaining to the subject matter of this rule and has not found any inconsistency or conflict. The Department is unable to comment further because the commenter did not identify the laws it contends conflict with or are inconsistent with the rule. COMMENT: A commenter argued that the Department's rulemaking authority does not extend to surplus lines carriers. The commenter states that regulation of surplus lines insurance business is accomplished through the regulation of surplus lines agents. The commenter implies that the Department does not have regulatory control over surplus lines carriers. DEPARTMENT'S RESPONSE: The Department disagrees. "Person" is defined in Insurance Code, Article 21.21 to include "any other legal entity engaged in the business of insurance." A surplus lines carrier operating in Texas is engaged in the business of insurance because they are entering insurance contracts. The very title of the statute on surplus lines insurers includes the term "insurance." The business of a surplus lines insurer undeniably constitutes the business of insurance. The Department also disagrees that it lacks regulatory control over surplus lines carriers. Insurance Code, Article 1.14-2 is replete with requirements regarding surplus lines carriers. Moreover, the Department has promulgated other rules regulating surplus lines carriers. See, e.g., sec.sec.15.1-15.101. Finally, the prohibitions contained in Article 21. 21-5 expressly apply to surplus lines insurers. 5.8 Comments On The Private Cause Of Action COMMENT: Commenters argued that only the Department should enforce violations of the rule and that there should not be a private cause of action for violations of the rule. Commenters argued that the proposed rule would give rise to frivolous lawsuits. Commenters argued that private lawsuits will not create a deterrent to illegal discrimination but will only encourage members of the protected classes to bring a lawsuit whenever they are denied coverage, regardless of the merit of their position. A commenter argued that reliance on private lawsuits to regulate insurers is bad public policy, is an inconsistent and unpredictable way to achieve a regulatory goal, and subverts state administrative regulation of insurance. DEPARTMENT'S RESPONSE: The Department disagrees with these comments. The Legislature, not the Department, has determined that unfair practices in the business of insurance should be policed through both Department enforcement actions and though private actions. Section 16 of Article 21.21 provides for a private cause of action for the violation of any rule promulgated under the authority of Article 21.21 and determined by the Department to be an unfair or deceptive practice in the business of insurance. The commenters are incorrect in assuming that the Department has the authority to deny a private cause of action granted by statute for a practice determined pursuant to Article 21.21 to be an unfair practice. Nevertheless, the Department agrees with the Legislature that public policy mandates that there be a private cause of action for violations of this rule. To the extent a consumer is damaged by intentional discrimination, the wrongdoer should compensate the consumer for those damages. Moreover, as the NAII court recognized, the private treble damage lawsuit serves two important enforcement purposes. First, it provides individuals not only with the means to discourage deceptive and unfair practices, but also with the incentive to do so. NAII at 9. Second, the threat of treble damage lawsuits provides insurers and agents with a strong disincentive to rely on this type of unfair discrimination in making their decisions to insure. Id. Third, as pointed out previously, prohibitions against intentional discrimination are usually proved on a case by case basis. The Department does not have the resources to take enforcement actions for all individual instances of discrimination. Rather, the Department's enforcement actions, due to limited resources, must be focused on large patterns of intentional discrimination. Thus, the private cause of action provided by the Legislature is necessary to ensure that individual consumers who are victims of intentional discrimination have the opportunity to seek redress for their damages. As for the filing of frivolous suits, the Department disagrees that the rule permits the filing of frivolous suits. The Department also disagrees that the threat or possibility of frivolous suits should be a basis for permitting the unfair discrimination prohibited by this rule or the denial of redress for those consumers with legitimate claims. The NAII court expressly held that the availability of treble damage lawsuits is an insufficient reason to find that a rule declaring an underwriting practice to be unfair is unnecessary or arbitrary and capricious, because the statute, not the Department, authorizes this type of suit. NAII at 9. Undoubtedly the legislature weighed the cost of potentially frivolous suits against the benefits of providing a private cause of action for unfair practices and determined that the benefits outweighed the possible costs of frivolous lawsuits. The Department disagrees that members of the protected classes will bring a lawsuit whenever they are denied coverage, regardless of the merit of their position. Conversely, the failure to adopt the rule would mean that those members of the protected classes who do have a legitimate claim would be denied the right to take any action against the wrongdoer to be compensated for any damages caused by the unfair discrimination. The threat of frivolous lawsuits already exists. A person who unjustifiably claims unfair discrimination based on one of the protected categories occurred may sue for damages without the passage of this rule. The rule does not permit these frivolous suits. What the rule does do is permit those with legitimate claims who do not have the right to sue without the rule to sue for their damages. The Department agrees with the Legislature that any threat or cost of frivolous lawsuits is far outweighed by the benefits resulting from the right of legitimate claimants to seek redress for their grievances. Moreover, if a consumer were to file a frivolous lawsuit under Article 21. 21, sec.16, alleging a violation of this rule, the defendants in the suit have a remedy. Article 21.21, sec.16(c) provides that if the court finds that an action was groundless and brought in bad faith or brought for the purpose of harassment, the court shall award to the defendants reasonable and necessary attorney's fees. Finally, as noted previously, past rules promulgated under Article 21.21, for which there is also a private cause of action, have not resulted in any private litigation, to the Department's knowledge. Thus, the existence of a private cause of action is not calculated to cause excessive litigation costs for insurers or agents. COMMENT: Commenters argued that the failure of the legislature to provide a private cause of action for violations of Insurance Code, Article 21.21-5 prohibits the Department from providing a private cause of action under Article 21.21. DEPARTMENT'S RESPONSE: The Department disagrees. The legislative intent, as shown above, is clear that the Department has the authority to promulgate rules under Article 21.21 prohibiting unfair practices in the business of insurance. It is equally clear that intentional discrimination based on the categories in this rule is unfair. Therefore, the Department has the authority to promulgate this rule to prohibit these unfair practices. The absence of any decision by the Legislature to provide yet another statutory basis for promulgating rules against unfair practices, or another basis for a cause of action, does not negate the undeniable statutory authority in Article 21.21 or the fact that Article 21.21, sec.16 provides a private cause of action for violations of a rule determining a practice to be unfair. In addition, several insurers claim that the practices prohibited by the rule are not prohibited by Article 21.21-5. To the extent that the rule covers areas of unfair discrimination not prohibited by that statute, the inapplicability of the statute to those practices cannot be interpreted as a prohibition against the Department's authority to prohibit the unfair conduct. Finally, as shown above, the Department's authority to promulgate rules shall be liberally construed and there is no express or implied limitation in the Department's authority against declaring the violation of another statute to be unfair. COMMENT: A commenter argued that the proposed rule constitutes an attempt to usurp the authority of the legislature to determine when a private cause of action is appropriate. DEPARTMENT'S RESPONSE: The Department disagrees. The Legislature, not the Department, has determined that unfair practices in the business of insurance should be policed through both Department enforcement actions and though private actions. In fact, if the Department determines by rule that these practices are unfair, the Department does not even have the authority to deny a cause of action because that right is determined by statute. The Department is not usurping any powers of the Legislature. On the contrary, the Department is exercising the powers and duties to prohibit unfair trade practices in the business of insurance that have been delegated to it by the Legislature. 5.9 Comments That Other Laws Prohibit Discrimination COMMENT: A commenter argued that existing state and federal civil rights laws provide protections against the forms of discrimination prohibited by the proposed rule. One commenter argued that the Legislature did not make Article 21.21-5 apply to the sale or cancellation of insurance due to the existence of other state and federal laws. DEPARTMENT'S RESPONSE: The Department disagrees that the existence of other laws renders this rule unnecessary. As discussed previously, the Department is not authorized to enforce federal laws or non-insurance laws. For the Commissioner to be able to take enforcement actions against an insurer or agent who engages in the unfair practices prohibited by this rule, the prohibition must be found in either the Insurance Code or a rule promulgated by the Department. Some of the practices prohibited by this rule are not prohibited by a provision of the Insurance Code, so a rule is necessary for the Department to take disciplinary action against companies and agents who engage in these unfair practices. Article 21.21 mandates a broad reading of the Department's authority to promulgate rules, whether or not the practice has been declared illegal by statute. The plain language of Article 21.21 permits the Department to promulgate rules prohibiting unfair conduct. There is no limitation on the Department's authority to declare practices to be unfair simply because they are or are not specifically prohibited by statute. On the contrary, the Department's authority should be read broadly, not limited, under the mandate of Article 21.21, sec.1(b) that Article 21.21 "shall be liberally construed and applied." Therefore, the Department has the authority to declare practices to be unfair under its rulemaking authority even if the practice is prohibited by another statute. In addition, these other laws are not comprehensive and unequivocal prohibitions against all of the types of discrimination that would be prohibited by this rule. Many insurers deny the applicability of these statutes to the sale of insurance. In addition, these statutes do not address all areas of unfair discrimination that would be prohibited by this rule. COMMENT: A commenter argued that the rule is redundant with proposed rule 21.1002 in as much as it relates to automobile and homeowners insurance. DEPARTMENT'S RESPONSE: The rule is not redundant as to lines of insurance other than automobile and homeowners. In addition, rule 21.1002 was amended to take out the references to race, color, religion and national origin. Furthermore, there is no inconsistency between the two rules. The fact that some of the actions prohibited by this rule are prohibited by another rule, or even another statute, does not eliminate the unfairness of the practices or the Department's authority to promulgate the rule. Furthermore, as shown above, there is no prohibition on the Department's statutory authority to promulgate rules that are duplicative of other legal prohibitions. 5.10 Miscellaneous Comments COMMENT: A commenter questioned how the proposed rule will affect the marketing and issuing of Medicare Supplement policies. The commenter noted that most companies write only the 65 and over market because of the high claims in the under 65 market. However, some insurers do additional marketing in the under 65 market. Specifically, the commenter raised four questions. (1) Will companies still be allowed the option of marketing to the "under age 65" segment? (2) Will companies who are active in the "under age 65" market still be able to underwrite such applicants? (3) Will companies who are active in the "under age 65" market still be able to rate this block of policies separate from the "65 and over" market or will they be forced to lump them together and thereby drive up the rates for the older group? (4) How does this proposal coincide with the Social Security Act Amendment of 1994, P.L. 103-432 (H.R. 5252) regarding the inclusion of the "under age 65" individuals in reference to the "open enrollment period?" DEPARTMENT'S RESPONSE: (1) Yes. A company that is marketing to consumers over 65 and under 65 is not discriminating based on age so the rule would not apply. Nor would the rule prohibit a company from selling solely to the age 65 and over class to the extent the under 65 class has different claims costs. (2) Yes, to the extent the underwriting is not based on the prohibited classes set out in the rule. As stated in answer number one, the fact that the company is also marketing to the under age 65 market does not constitute age or disability discrimination. (3) Yes. First, discrimination based on age is only prohibited under the rule to the extent not justified by sound actuarial principles. Assuming the commenter is correct that claim costs are higher for the under 65 class, the rule would not apply to discrimination against those persons who are under 65. Second, the rule does not apply to discriminations in the rating of policies; it only applies to the decision whether to bind, accept, reject, renew, nonrenew, cancel or limit coverages made available to a consumer. (4) The Department does not believe the rule has any effect on that statute. If there were any conflict between the statute and the rule, the statute would govern under the supremacy clause of the U.S. Constitution. COMMENT: A commenter argued that it is unfair to hold independent agents, who have no control over underwriting guidelines instituted by insurance companies they represent, accountable for underwriting guidelines they apply on behalf of their companies. DEPARTMENT'S RESPONSE: The Department disagrees with respect to intentional discrimination based on race, color, religion or national origin. First, some agents may unfairly discriminate on their own, even without direction from any insurer. Although the agent may not be acting on behalf of any insurer, the practice is still unfair and should be prohibited. For instance, if an independent agent, who represents several insurers who do not discriminate based on race, refuses to serve a minority consumer, that practice is unfair. Second, the fact that the insurer instructs an agent to engage in illegal conduct does not justify the conduct by the agent. For instance, an agent should not avoid responsibility for misrepresenting a policy to a consumer simply because the insurer instructed the agent to misrepresent the policy. An agent should not avoid responsibility for misappropriating or converting money belonging to a consumer simply because an insurer instructs the agent to do so. An agent should not avoid responsibility for violations of the Insurance Code simply because an insurer instructed the agent to do so. Similarly, an agent should not intentionally discriminate against consumers based on race, color, religion or national origin simply because the insurer instructs him or her to do so. The agent should just say no to the insurer and refuse to engage in the illegal conduct. If an applicant meets all underwriting guidelines of the insurer, other than the illegal guideline, the agent should submit the application even if the consumer does not meet the guideline that violates this section. In that way the agent will not violate the rule. The fact that an agent's contract may require the agent to engage in illegal conduct is not sufficient grounds to permit the agent to do so. However, to the extent the rule applies to discrimination based on geographic location, disability, sex or age, the Department believes that a limited exemption for agents is appropriate. Unlike discrimination based on race, color, religion, or national origin, the agent cannot easily determine whether an underwriting guideline is based on sound actuarial principles. Unlike the insurer, who chooses to use the underwriting guideline and should therefore analyze whether it is based on sound actuarial principles before using the underwriting guideline, the agent is simply told to apply the guideline. To the extent an agent decides on his or her own to discriminate based on geographic location, disability, sex or age, and not because of instructions from an insurer, then the agent should be under a duty to determine whether the guideline is based on sound actuarial principles. A representative of the Texas Association of Insurance Agents, the entity that made this comment, agreed at the hearing: I can understand that if an agent has underwriting guidelines separate and apart from his company, they must be subject to some kind of rule if we're to have a rule in this regard. Testimony of Wade Spillman, Tr. p. 196. Therefore, the Department agrees that a partial exemption to the prohibition against discrimination based on geographic location, disability, sex or age should be created for agents. The Department has, therefore, added subsection (d) to the rule to create this partial exemption. COMMENT: A commenter questioned whether the rule applies to future policies or claims payments. For instance, the commenter questioned whether maternity benefits would be automatically added to all health policies, regardless of the age of the consumer. DEPARTMENT'S RESPONSE: The rule only applies to the decision whether to bind, accept, reject, renew, nonrenew, cancel or limit coverages made available to a consumer. The rule only applies to existing policies in the decision whether to cancel or non-renew the policy. The rule does not provide for any changes to existing contracts. Thus, policies are not rewritten under this rule and companies are not required to pay for coverages that are not included in existing policies. COMMENT: A commenter argued that the rule is punitive (although it did not state how the rule is punitive or to whom the rule is punitive) and unnecessary. DEPARTMENT'S RESPONSE: The Department disagrees. The Department has set out the necessity of the rule in the "reasoned justification" section and in response to other comments and will not repeat those statements here. The rule is punitive only against those who engage in these types of unfair discrimination. By definition, any rule that prohibits an unfair practice and provides enforcement mechanisms could be considered punitive against those that engage in the unfair conduct. The Legislature has determined that remedial measures for victims of unfair and deceptive practices are appropriate. Although the rule is clearly remedial as it relates to unfair discrimination, the rule is not punitive as to any other person or entity that is not engaging in unfair discrimination. COMMENT: A commenter argued that "it is disingenuous, if not plain cynical, for the Department of Insurance to propose these pointless new burdens." DEPARTMENT'S RESPONSE: The Department disagrees. The rules are intended solely to prohibit unfair practices in the business of insurance. There is nothing disingenuous or cynical about the Department's policy, based on statutory authority, to seek the elimination of unfair practices like the practices which are prohibited by this rule. Nor does the Department believe the prohibitions set out in this rule are pointless. On the contrary, as shown above, the prohibitions are necessary. Although the Department has the authority to promulgate this rule even in the absence of consumer harm, the evidence identified above, which includes intentional discrimination, demonstrates the necessity to enact this rule to carry out the purposes of Article 21.21. The evidence shows that some insurers are intentionally discriminating based on the prohibited classifications, that insurance availability problems exist based on these classifications, and that the consumers who are subject to these practices are either denied insurance or are charged higher rates for that insurance. Insurance is necessary to operate or buy a car, own a home, purchase or operate a business, obtain health care and engage in other economic activities. Because the practices prohibited by this rule are unfair, create insurance availability problems for Texas consumers, and harm the competitive nature of insurance markets, the Department finds that the rule is appropriate. COMMENT: A commenter argued that the rule should prohibit discrimination based on "sexual orientation" and "family status." DEPARTMENT'S RESPONSE: The Department agrees that discrimination based on these two guidelines is inherently unfair. The Department does note that Rule sec.21.1002 prohibits the use of familial status and, to the extent not shown to be related to risk or expense, sexual orientation, in underwriting for automobile and homeowners insurance. Rule sec.21.704 prohibits the use of sexual orientation in underwriting for life and health insurance. Use of these underwriting guidelines, however, should be prohibited in any line of insurance. These prohibitions should be published as an amendment to this rule or as a separate rule to provide for public comment on the addition of these prohibitions. COMMENT: A commenter argued that the rule does not require that underwriting decisions be based upon actuarial data. DEPARTMENT'S RESPONSE: The Department disagrees. To the extent an insurer wants to discriminate based on geographic location, age, sex or disability, the insurer may only do so based on sound actuarial principles. Thus, the rule would apply to discrimination by a health insurer against persons with disabilities to the extent the discrimination is not based on sound actuarial principles. COMMENT: A commenter argued that the rule is similar to rule 21.7 which was invalidated by a Travis County district court. The commenter also claimed that the district court's judgment was not appealed and that the decision not to appeal was the agency's decision. DEPARTMENT'S RESPONSE: The Department disagrees. This rule and Rule 21.7 are fundamentally different. Most importantly, this rule does not apply to instances of disparate impact. The Department also disagrees that the decision whether to appeal a district court ruling on a rule is the agency's decision. On the contrary, the Attorney General makes the decision whether to appeal such a ruling. COMMENT: Commenters argued that the Department is moving too quickly on the proposed rule, is acting "at the eleventh hour," and should spend more time studying the proposed rule. Commenters argued that the Department should not act on this rule until the Commissioner appointed by Governor-elect Bush is confirmed by the Senate and has a chance to study the rule. DEPARTMENT'S RESPONSE: The Department disagrees for two reasons. First, the Department has thoroughly investigated the underwriting practices of insurers and availability problems discussed herein over a period of three years. Moreover, the Department has carefully analyzed the proposed rule and the comments provided both in writing and at the hearing. After careful consideration and deliberation, the Department has made some non-substantive changes to ensure that the rule is clear and unambiguous. However, the Department has concluded that the rule is necessary and appropriate. The Department does not believe there is a need for further analysis. Second, the consumers who are the victims of the unfair practices that are prohibited by this rule have suffered long enough. There is no justification for permitting these practices to continue. In the face of the evidence of unfair discrimination, the Department not only has the authority to act pursuant to Article 21.21, it has the duty to act. As Mary McLeod Bethune pointed out: If we accept and acquiesce in the face of discrimination, we accept the responsibility ourselves and allow those responsible to salve their conscience by believing that they have our acceptance and concurrence. We should, therefore, protest openly everything ... that smacks of discrimination ... Quoted in Bartlett, Familiar Quotations, p. 753 (Little Brown 1980). Ms. Bethune's statement is all the more applicable to a governmental agency, such as the Department, that is charged with regulating those businesses that engage in unfair discrimination. Through the adoption of this rule and the rigorous enforcement of any violations of this rule, the Department can take action to help eliminate this unfair practice. The chronology of Department activities on the issues of insurance availability and unfair discrimination set out in the Reasoned Justification shows a long- term involvement and commitment by the Department. Department staff have worked on this rule for many months prior to its publication. However, in response to these concerns, the Department has amended the rule to apply only to actions taken after June 1, 1995. If the new commissioner believes amendments to the rule or repeal of the rule are necessary, then that commissioner will have the opportunity to do so. This delay will also give those persons subject to the rule sufficient time to make any changes in their practices that are necessary to comply with the rule. COMMENT: A commenter raised the issue of the Department's "no prior" rule and questioned how that experience would be used in interpreting this rule. The commenter also implied that the Department considers the no prior underwriting guideline unfair even if related to risk. The commenter also argued that this rule may be an attempt to proceed with prior rule 21.7. Finally, the commenter raises concerns that companies and agents could not use prior insurance underwriting guideline without subjecting themselves to potential liability. DEPARTMENT'S RESPONSE: The Department disagrees that the no prior rule or earlier rule 21.7 have any relevance to this rule. Nor does the Department's position as to the relationship of prior insurance coverage to expected costs associated with the transfer bear any relevance to this rule. Discrimination against drivers without prior insurance is not prohibited by this rule. The rule does not apply to instances of disparate impact so the concerns raised by the commenter are unfounded. COMMENT: A commenter argued that the rule does not address the root causes of losses and costs in insurance. DEPARTMENT'S RESPONSE: The proposed rule is not aimed at reducing the root causes of losses and costs in insurance. Rather, the rule is intended to eliminate unfair practices. While the Department has taken steps to address the problems of losses and costs in insurance, such as through the creation of its safety unit, those efforts are not the subject of this rule. The Department disagrees that this concern should be a basis for rejecting this rule. COMMENT: A commenter argued that the rule is unfair because it requires insurers to continue writing policies after the insurer has reached its "capacity." The commenter asserted that forcing insurers to exceed their capacity would impose exceptional costs on the insurer. DEPARTMENT'S RESPONSE: The Department disagrees. The rule does not require any insurer to write policies. The rule only prohibits insurers from unfairly denying coverage to consumers based on race, color, religion, or national origin, and to the extent not justified by sound actuarial principles, geographic location, disability, sex, or age. If the insurer is at capacity, the insurer is unable to write any more business. This is fair. No matter what the characteristics of the consumer, the insurer will decline coverage. All consumers will be treated similarly and fairly, regardless of their race, color, religion, national origin, geographic location, disability, sex, or age. Thus, there would be no violation of this rule. COMMENT: Several commenters argued that the availability studies presented by the Department at the hearing did not prove intentional discrimination by insurers against minorities. DEPARTMENT'S RESPONSE: The purpose of the presentation of the studies was to demonstrate that insurance availability problems exist. These studies do so conclusively. The Department does assert that availability problems represent market failures which disproportionately affect areas with high minority populations. The market failures causing availability problems can be addressed in part by prohibiting the use of unfair underwriting guidelines. COMMENT: A commenter questioned how the term "sound actuarial principles" would apply to title insurers and agents and recommended that the term refer to a title opinion based on a title examination. DEPARTMENT'S RESPONSE: The Department notes that the Legislature has held title insurers to the same "sound actuarial principles" standard as other insurers in Article 21.21-5; no exception was provided for title insurers or agents. The Department's definition and methodology for sound actuarial principles is the same as the Legislature's and is equally applicable to title insurers. Title defects, whether based on age, disability, geographic location, sex, or other matter, identify higher expected costs associated with the transfer of risk. Thus, to the extent a title opinion based on a title examination limits or denies coverage based on a title defect, the title insurer and agent would be discriminating based on sound actuarial principles and would not be in violation of the rule. Sound actuarial principles specify that legal requirements take precedent over the results of statistical analysis. To the extent that title insurers deny or modify coverages because of legal requirements related to geographic location, disability or age, those discriminatory actions are fair and do not violate the rule. The new rule is adopted under Insurance Code, Articles 1.03A and 21.21, sec.13. Article 1.03A authorizes the Commissioner to adopt rules and regulations for the conduct and execution of the duties and functions of the department as authorized by statute. Article 21.21, sec.13 authorizes the Department to promulgate rules and regulations to accomplish the purposes of Insurance Code, Articles 21.20 and 21.21. Additional discussion of the Department's statutory authority to promulgate this rule is contained in the Reasoned Justification section entitled "The Department has authority to promulgate this rule." The following Article of the Insurance Code is affected by this rule: sec.21. 1004-Insurance Code, Article 21.21. sec.21.1004. Discrimination in the Sale of Insurance. (a) Prohibition. The failure to comply with this subsection constitutes an unfair trade practice in the business of insurance in violation of the Insurance Code, Article 21.21, and shall be subject to the provisions thereof. After June 1, 1995, an insurer, agent, or other person licensed to engage in the business of insurance shall not intentionally discriminate in making a decision whether to bind, accept, reject, renew, nonrenew, cancel or limit coverages made available to a consumer, in whole or in part, on the basis of: (1) race, color, religion, or national origin; and (2) to the extent not justified by sound actuarial principles, geographic location, disability, sex, or age. (b) Scope. This section applies to any person or entity licensed by the department to engage in the business of insurance in this state, including, but not limited to, agents, property and casualty insurers, life, health and accident insurers, title insurers, capital stock companies, mutual companies, county mutual companies, fraternal benefit societies, local mutual aid associations, statewide mutual assessment companies, Lloyd's plan companies, reciprocal or inter insurance exchanges, stipulated premium insurance companies, group hospital service companies, health maintenance organizations, farm mutual insurance companies, risk retention groups, and surplus lines carriers. (c) Definitions. (1) "Sound actuarial principles." The term "sound actuarial principles" as used in this rule means a difference in the expected costs associated with the transfer of risk. The methodology for determining whether there are differences in the expected costs associated with the transfer of risk shall be consistent with the actuarial standards of practice and compliance guidelines promulgated by the Actuarial Standards Board of the American Academy of Actuaries and in effect on January 1, 1995. (2) "Disability." The term "disability" as used in this rule means a "physical or mental impairment" as defined in sec.21.703 of this title (relating to definitions concerning discrimination). (d) Partial exemption for agents. The prohibition against discrimination based on geographic location, disability, sex or age, to the extent not justified by sound actuarial principles, contained in subsection (a)(2) of this section shall not apply to an agent or other person licensed to engage in the business of insurance under Insurance Code, Chapter 21, Subchapter A, if, and only if, the agent or other person is discriminating solely at the direction of an insurer or health maintenance organization. This agency hereby certifies that the rule as adopted has been reviewed by legal counsel and found to be a valid exercise of the agency's legal authority. Issued in Austin, Texas, on January 19, 1995. TRD-9500814 D. J. Powers Chief Clerk and General Counsel Texas Department of Insurance Effective date: February 9, 1995 Proposal publication date: November 15, 1994 For further information, please call: (512) 463-6327 28 TAC sec.21.1005 The Texas Department of Insurance adopts new sec.21.1005, which prohibits the use of underwriting guidelines by private passenger automobile insurers based on the purchase of types or amounts of coverage in excess of the minimum automobile liability coverage required by law, with changes to the proposed text as published in the November 15, 1994 issue of the Texas Register (19 TexReg 8937). A public hearing on the proposed section was held January 4-5, 1995. The new section is necessary to prevent the unfair practice in the business of insurance of using underwriting guidelines based on the purchase of types or amounts of coverage in excess of the minimum automobile liability coverage required by law and thereby causing consumers to either be denied insurance or charged higher rates. This rule was originally proposed in a petition for rulemaking by James Mallett of Dallas, Texas. In response to comments, the Department has made several non-substantive changes to the proposed rule. The prohibition in subsection (a) was amended to apply only to actions taken after June 1, 1995.The wording of the first sentence in subsection (a) was rearranged to clarify that the rule applies only to the sale of private passenger automobile insurance. The Department has added the words "renew" and "nonrenew" to subsection (b) to clarify that the decision whether to accept or reject a consumer applies to the decision whether to renew a policy. The word "groupings" in subsection (b) was changed to "classes. "A section was added to provide a definition of the term "private passenger automobile insurance. " This reasoned justification is organized as follows: 2.1 The Purpose of the Rule 2.2 Unfair Discrimination and Insurance Availability 2.2.1 Insurance Availability 2.2.2 The availability of insurance is important for individuals and businesses. 2.2.3 This rule does not envision nor create a subsidy among classes of consumers 2.2.4 Studies of Availability Problems in Texas Insurance Markets 2.2.4.1 1994 OPIC Studies of Private Passenger Automobile and Homeowners Insurance Underwriting Guidelines 2.2.4.2 1993 Office of Public Insurance Counsel (OPIC) Study of the Geographic Distribution of Private Passenger Automobile Insurance Assigned Risks 2.2.4.3 1993 OPIC Study of the Location by ZIP Code of State Farm Agents 2.2.4.4 1993 Texas Department of Insurance (TDI) Study of TAIP and Homeowners Markets 2.2.4.5 1994 TDI Analysis of NAIC/Texas Special Call Data 2.2.4.6 1994 Study of the NAIC/Texas Special Call Data by the Austin American Statesmen 2.2.4.7 The insurance industry acknowledges availability problems 2.3 Risk Classifications, Underwriting Guidelines and Market Failures 2.3.1 No Natural Groupings of Risk 2.3.2 Unfair Discrimination and Availability Problems Represent Market Failures 2.4 Unfair Underwriting Guidelines and Unfair Discrimination 2.4.1 Underwriting guidelines are inherently unfair if they are inconsistent with public policy expressions of social and economic fairness 2.5 Regulation is necessary to address unfair underwriting guidelines and is consistent with beneficially competitive insurance markets 2.5.1 Insurance regulation expresses public policy regarding social and economic fairness of certain underwriting guidelines 2.5.2 Insurance regulation can address the market failures caused by unfair underwriting guidelines 2.6 The Department has developed rules to prohibit unfair underwriting guidelines consistent with the role of regulation and appropriate to address failures of insurance markets represented by unfair underwriting practices 2.6.1 The practices prohibited by this rule are unfair 2.6.2 Other new underwriting rules 2.6.3 Previous Department Underwriting Rules 2.7 The Department has authority to promulgate this rule 2.7.1 Article 21.21 sec.13(a) 2.7.2 The private cause of action 2.7.3 Article 5.98 2.1 The Purpose of the Rule The purpose of this rule is to eliminate unfair underwriting practices in the business of insurance. The unfair practices prohibited by this rule have an adverse impact on the availability and affordability of insurance to consumers. 2.2 Unfair Discrimination and Insurance Availability Consumers who encounter unfair discrimination in the purchase of insurance are either denied coverage completely or denied coverage at the rates for which they would legitimately qualify in the absence of the unfair discrimination. The availability of appropriately-priced insurance is unfairly denied these consumers as a result of the use of unfair underwriting guidelines. The elimination of unfair underwriting guidelines will cause consumers to be treated more fairly in the business of insurance and thereby increase the availability of appropriately-priced insurance. 2.2.1 Insurance Availability To better understand the problems caused by unfair underwriting guidelines, a general description of insurance markets is necessary. Most insurance markets consist of three submarkets:preferred, standard and substandard. Preferred companies have the lowest rates and sell to the consumers perceived to represent the lowest risk. Standard companies sell to consumers perceived to represent average risks. Substandard companies (including residual market mechanisms) have the highest rates and sell to consumers perceived to represent the highest risk. For consumers forced into substandard companies, insurance is unavailable in standard and preferred markets. This availability problem for consumers forced into substandard companies may be two-fold:the consumer is unfairly charged higher rates (which he or she may not be able to afford) and/or the product sold is inferior to the product available in the standard or preferred markets (e.g. offers less coverages or is not covered by the state's guaranty association).It is through the use of unfair underwriting guidelines that consumers are unfairly denied coverage in standard and preferred companies and forced to go without insurance or purchase higher- cost insurance insubstandard or residual markets. 2.2.2 The availability of insurance is important for individuals and businesses. President Johnson's Commission on Insurance Availability, formed in the aftermath of the Los Angeles rioting in the 1960's, found that "communities without insurance are communities without hope. "This statement is no less true today. Drivers are required by the financial responsibility law to carry a minimum amount of automobile liability insurance coverage to operate a car. Thus, auto insurance is essential to most Texans who rely on automobiles as their main means of transportation. In addition to the harm caused to the individual consumers who are unfairly denied insurance, denying insurance to citizens and small businesses in economically underdeveloped areas contributes to the problems of inadequate economic opportunity and social decay that plague these areas. 2.2.3 This rule does not envision nor create a subsidy among classes of consumers In this Order, the term "affordability" is used strictly in terms of consumers having fair and legitimate access to standard and preferred companies;that is, making the more affordable standard and preferred rates available to those consumers who would otherwise be unfairly relegated to higher cost, non-standard insurers or assigned risk markets. The Department's discussion of affordability does not imagine or propose a subsidy for those people who cannot afford insurance offered at fair rates commensurate with the expected costs associated with the transfer of risk. Nor does the rule create a right for those consumers posing higher expected costs associated with the transfer of risk who are fairly placed in substandard markets to receive lower rates in standard or preferred companies. 2.2.4 Studies of Availability Problems in Texas Auto Insurance Markets There has been substantial data collection and analysis concerning auto insurance availability in Texas over the past few years. These studies, based on data supplied by insurers and from other sources, show that the availability of auto insurance in Texas varies dramatically by geographic area and that variation is statistically related to race. Copies of the studies and documents discussed in this section are available from the Department. 2.2.4.1 1994 OPIC Study of Private Passenger Automobile Insurance Underwriting Guidelines In study entitled "A Review of Auto Insurance Underwriting Guidelines Used in Texas," released in June 1994, OPIC reviewed and analyzed underwriting guidelines of Texas private passenger automobile insurers. The OPIC studies revealed a variety of underwriting guidelines which restrict insurance availability in certain parts of Texas. From these studies and testimony at the redlining hearings held by the Department, it was shown that consumers may be denied coverage for a variety of reasons, including the failure to buy additional amounts and types of coverage. The study shows that companies writing 38% of the Texas private passenger automobile insurance market require an applicant to purchase more than basic the minimum automobile insurance required by law to obtain coverage. Examples of the guidelines include:"liability only policies are not acceptable,""the preferred risk ... has financial needs that require more than basic level of protection," "both Comprehensive and Collision coverages must be purchased on at least one vehicle," "minimum liability:50/100/25," and "one car must have full coverage. "Additional excerpts from underwriting guidelines are attached to the comments on this rule filed by the Office of Public Insurance Counsel. The Department has received complaints from consumers regarding this underwriting practice. These consumers were denied insurance because they requested liability-only policies. One of the largest writers of private passenger automobile insurance in Texas filed comments and testified at the hearing that they have an underwriting guideline that requires at least one vehicle to carry physical damage coverages unless all vehicles are more than ten years old or at least one operator (insured or spouse) is retired and age 50 or older. This comment shows both that the practice is occurring and that the practice is unfair. By the commenter's own admission, it apparently believes some customers (retired consumers and those with cars ten years or more old) do not need comprehensive and collision coverage and are exempted from the commenter's underwriting guideline requiring purchase of physical damage coverage. Although this company appears to believe that it has the right to determine which consumers do not need full coverage, the Department believes consumers should have the right to make that choice without being penalized with higher rates for making that choice. 2.2.4.2 1993 Office of Public Insurance Counsel (OPIC) Study of the Geographic Distribution of Private Passenger Automobile Insurance Assigned Risks In testimony filed in February 1993, OPIC analyzed the distribution of automobile insurance assigned risks written through the Texas Automobile Insurance Plan (TAIP), the predecessor of the current Texas Automobile Insurance Plan Association (TAIPA).OPIC analyzed the number of TAIP insureds by ZIP Code compared to the driving age population in the ZIP Code. The study showed that many areas of the state had availability problems, as measured by significantly higher-than-average concentrations of TAIPassignments. If only high-risk drivers were being relegated to the TAIP, as theoretically should have been the situation, we would have expected a more even geographic distribution of TAIP assignments by ZIP Code. We would not expect that bad drivers live together in certain ZIP Codes. The analysis also showed that those ZIP Codes with high minority populations were the ones more likely to be have, on average, greater- than-average concentrations of TAIP assignments. The study is included in the Supplemental Direct Testimony of David "Birny" Birnbaum in Docket 1932, styled Texas Automobile Insurance Plan For Private Passenger and Commercial Automobile Rate Case. 2.2.4.3 1993 OPIC Study of the Location by ZIP Code of State Farm Agents This study examined the ZIP Code location of State Farm agents in three major metropolitan areas:Harris, Bexar and Travis counties. State Farm is the largest automobile insurance writer in Texas, with over one-third of the standard and preferred automobile insurance market. With such a large share of the market, the location of State Farm agents may be an important availability factor. The study showed a striking difference in the average minority population and median housing value in those ZIP Codes with State Farm agents when compared to those ZIP Codes without State Farm agents. For example, in Harris County there were 22 ZIP Codes with populations greater than 20,000 each without any State Farm agents compared to 54 ZIP Codes with populations greater than 20,000 with State Farm agents. The 54 ZIP Codes had a total of 206 agents. The minority population of the 22 ZIP Codes without State Farm agents was 53.6% compared to 29.2% in the 54 ZIP Codes with the State Farm agents. In addition, the location of State Farm agents was highly correlated to the incidence of TAIP assignments from the earlier study. Those ZIP Codes without State Farm agents also tended to be the same ZIP Codes with higher-than-average TAIP assignments. 2.2.4.4 1993 Texas Department of Insurance (TDI) Study of TAIP Market The next study, dated August 1993, was a Department report entitled "Analysis of Texas Automobile Insurance Plan (TAIP) and Homeowners Markets. "Dr. Mark Crawshaw, a consulting actuary to the Department, used an updated automobile insurance assigned risk data set to perform a regression analysis to analyze the distribution of TAIP assignments in Houston. The regression analysis controlled for other relevant factors, including housing value and the percentage of renters in a ZIP Code. The study showed that, after controlling for these other factors, a consumer in a high minority ZIP Code was three to four times more likely to be placed in TAIP than residents in low-minority ZIP Codes. Thus, even after removing the contribution of median housing value and percentage of renters as explanatory characteristics, the minority population of a ZIP Code was a significant predictor of the likelihood of being placed in the assigned risk plan. These findings are reported in Exhibit A, Sheet 5 of the report. 2.2.4.5 1994 TDI Analysis of NAIC/Texas Special Call Data In March and November 1994 the Department released studies of private passenger insurance availability based upon ZIP Code level premium, exposure and agent information submitted by the top 40 insurers for the NAIC/Texas Special Data Call. In these studies, the measure of insurance availability was defined as the share of exposures written in the TAIP (assigned risk) plus substandard companies (mostly county mutuals) as a percentage of all exposures written in the ZIP Code. A high percentage indicates more people insured in substandard companies and the assigned risk plan, while a low percentage indicates more people insured in the standard and preferred markets. The lower the share of TAIP and substandard exposures, the better the availability of automobile insurance. This share of TAIP plus nonstandard to total exposures is an excellent measure of private passenger automobile insurance availability because the measure identifies the share of allconsumers who sought automobile insurance, could afford it, paid for it and, yet, were rejected by standard and preferred companies. Substandard company rates are typically substantially higher than rates from standard and preferred insurers. TAIP consumers were not eligible for coverage through TAIP unless they were unable to obtain coverage in the standard or preferred market. Therefore, the class of consumers insured through TAIP or by substandard companies constitutes a class of consumers for whom coverage in the standard and preferred market was not available. The chart entitled "NAIC/Texas Special Call-Texas Statewide Results" shows the summary results of the study. As the minority population of the ZIP Codes increases, insurance availability worsens. For example, for those 97 ZIP Codes with TAIP plusnon-standard shares 51% to 75% above the statewide average, the average of the minority population percentages was 141% above the statewide average. For those 391 ZIP Codes with TAIP plus non-standard shares 26% to 50% below the statewide average, the average of the minority population percentages was 44% below the stateside average. The chart shows a remarkable relationship between the minority population of a ZIP Code and the availability of automobile insurance in that ZIP Code. FIGURE 1:28 TAC sec.21.1005 (Preamble) The Department also performed a regression analysis on the data set of about 1400 ZIP Codes. Even after the contribution of median housing value as an explanatory factor for insurance availability was statistically removed, the minority population of a ZIP Code remains a significant predictor of insurance availability at the 99% confidence level. If median household income is held constant, the share of TAIP plus non-standard is 25% to 70% higher in high minority ZIP Codes compared to low minority ZIP Codes. The Department developed maps for several counties in Texas to present the ZIP Code level data more graphically. The first maps show insurance availability factors and minority population factors in Dallas County. These maps look very similar because those ZIP Codes with poor insurance availability are, in most cases, the same ZIP Codes with high minority populations. Maps of Harris, Tarrant, Bexar and Travis Counties demonstrate similar findings. The Department also developed ZIP Code detail maps for these five counties showing the total population in the ZIP Code and the number of agents located in those ZIP Codes who are able to write business in nine of the top standard or preferred companies. These nine insurers represent the vast majority of business written by standard and preferred companies who utilize agents. The maps show that the location of agents varies dramatically by ZIP Code and that variation is also related to insurance availability. On the map of Dallas county, a cluster of seven adjacent ZIP Codes in south central Dallas County with poor insurance availability shows a total of three standard agents serving a population of over 191,000 people. In comparison, a cluster of nine adjacent ZIP Codes in north central Dallas County shows 366 agents serving a population of about 275,000 people. The maps of Bexar, Harris, Travis and Tarrant counties show similar disparities in the location of agents. 2.2.4.6 1994 Study of the NAIC/Texas Special Call Data by the Austin American Statesmen A study by the Austin American Statesman also analyzed the NAIC special call data. The Statesman concluded that "minority Texans were far more likely than affluent or white Texans to be charged the highest rates for automobile insurance, according to industry data. "In particular, the Statesman found that, as the percentage of minorities in a ZIP Code increased, so did the percentage of substandard and assigned risk policies. that, although statewide about 20% of the automobile insurance policies written are in county mutuals or written through TAIP, in ZIP Codes where at least two-thirds of the residents were minorities, 37% of the policies were substandard or TAIp. In ZIP Codes where at least two-thirds of the residents were white, only 15% of the polices were in the high-cost categories. The analysis showed that, where more than 90% of the residents were African American or Hispanic, three of every seven policyholders were in higher priced county mutual insurers or insured through TAIp. By contrast, where more than 90% of the residents were white, only one of seven policyholders were insured through county mutuals or TAIp. The article in which the results of that analysis were published appeared in the September 30, 1994 edition. As reported in that same Austin American-Statesman . article, the Texas Department of Public Safety (DPS) reports that minorities are no more likely than whites to have been involved traffic accidents. In 1992, DPS reports show that, of the drivers involved in accidents in Texas, 61% were white, 20% were Hispanic, 12% were African American and 7% were unknown or of another background. The state's population is 61% white, 25% Hispanic, 12% African American and 2% other. The Department has reviewed both DPS and Census data and confirmed the numbers reported in the Statesman. The finding that minorities are not over-represented in their involvement in automobile accidents is important. If the reason for poor availability in minority areas is, as some insurers assert, higher losses in those areas, we would expect a disproportionate share of minority involvement in automobile accidents. The actual data on minority involvement in accidents casts doubt on this theory and justification for availability problems in minority areas. 2.2.4.7 The insurance industry acknowledges availability problems The results of these many studies show clearly that insurance availability problems exist in Texas and those availability problems are typically related to the minority population of an area. Many insurers, agents and industry trade associations have acknowledged to the Department that availability problems exist. In addition, when Senator Rodney Ellis and the Department brought interested parties together to address availability problems in Houston in what came to be called the Houston Redlining Task Force, all members of the task force agreed to this basic covenant: The purpose of the redlining task force is to increase the availability of affordable insurance to Texas consumers. All task force participants agree that some areas and groups of consumers are underserved in the personal lines and small commercial insurance markets. The purpose of the task force is to solve the problem, not discuss whether a problem exists. Members of the task force included State Farm, Allstate, Farmers, ITT Hartford, the Texas Association of Insurance Agents, the National Association of Independent Insurers, and the American Insurance Association, as well as the Department of Insurance, the Office of Public Insurance Counsel, legislators, community organizations and consumer groups. Insurance availability is important because insurance is essential for consumers to meaningfully participate in society and for economic development to occur in those areas currently lacking in economic opportunity. The opportunity for economic improvement is intimately tied to the opportunity to purchase necessary insurance. To the extent that insurance is not available because of unfair underwriting guidelines, this rule is necessary to prevent such unfair practices. 2.3 Risk Classifications, Underwriting Guidelines and Market Failures The purpose of insurance is to protect consumers through the transfer of risk to insurers and through that process to spread aggregate risk among many consumers. The most fundamental insurance decision is how the population of consumers will be grouped into subsets of the population for the purpose of grouping similar risks and setting prices for consumers. As a society, we have decided that some grouping of risks is appropriate and desirable. We do not make people completely pay for their own accidents (no insurance) nor do we as a society pool the entire population so everyone pays the same average rate. The choice of underwriting guidelines, in conjunction with other rating factors, represent decisions about the grouping of risk. 2.3.1 No Natural Groupings of Risk There are no natural groupings of risk. In fact, there are many ways to group risk to create actuarially-sound risk classifications in the sense that total premiums for each class of consumers adequately, but not excessively, covers the costs associated with each class of consumers. While it is typical for insurers to review the appropriateness of rates for each class of consumers, it is less common, and in many cases impossible, to analyze the intra-class fairness. While the rates for the class of consumers may be fair in aggregate, the class may consist of heterogeneous risks and represent a subsidy by some risks in the class of other risks in the class. It is important to emphasize that there are no natural groupings of risk. The choice of risk classifications represents a combination of public policy expressions through regulation and individual insurer underwriting decisions. 2.3.2 Unfair Discrimination and Availability Problems Represent Market Failures Availability problems represent market failures-the insurance markets have failed to provide consumers with equal opportunity to purchase necessary insurance. These availability problems may be caused by unfair discrimination, representing a classic economic problem of irrational behavior. Availability problems may also be caused by insurers acting rationally, but because of structural market failures, these rational market decisions produce not the beneficial results of Adam Smith's invisible hand, but perverse outcomes for consumers. 2.4 Unfair Underwriting Guidelines and Unfair Discrimination Underwriting guidelines determine whether a consumer will be written by a preferred, standard, or substandard company, or denied coverage entirely. More specifically, underwriting guidelines are the rules, standards, marketing decisions, guidelines, or practices, whether written, oral or electronic, used by an insurer or its agent to examine, bind, accept, reject, renew, nonrenew, or cancel consumers or limit the coverages made available to consumers. Not all availability problems are unfair; however, to the extent that a lack of availability is based on unfair underwriting guidelines, the lack of availability is unfair. An underwriting guideline is unfair if it is either inherently unfair or actuarially unsound. Underwriting guidelines are inherently unfair if they are inconsistent with public policy expressions of social and economic fairness. Underwriting guidelines are also unfair if the guideline does not actually distinguish consumers of different expected costs associated with the transfer of risk. If there is no sound actuarial basis for the discrimination among consumers based upon a particular underwriting guideline, consumers of similar risk are being treated differently and, for at least one class of consumers, unfairly. 2.4.1 Underwriting guidelines are inherently unfair if they are inconsistent with public policy expressions of social and economic fairness Some groupings of risk are inherently unfair, regardless of the loss experience associated with the risk classification differentiating the groups. Professors Keeton and Widiss, in their treatise on Insurance Law, recognize that, even if correlations to higher losses could be shown, open competition that would allow certain kinds of discrimination is not beneficial and would violate fundamental public policy interests: [P]ublic policy interests of various types (including policies against discrimination based on race, sex, and other individual characteristics over which the individual has no control) sometimes weigh against use of insurance rating categories that might be "nondiscriminatory" in a sense concerned only with correlation between loss experience and selected individual characteristics. Keeton and Widiss, Insurance Law, A Guide to Fundamental Principles, Legal Doctrines, and Commercial Practices, 956-957 (West 1988).In their comments on Rule sec.21.1002, State Farm agreed that "when racial, ethnic or religious discrimination [is occurring,] government intervention is appropriate to eliminate such deplorable practices. "The Department agrees with these commentators. The Department adopts this rule because underwriting guidelines based on the purchase of additional types or amounts of coverage are inherently unfair. 2.5 Regulation is necessary to address unfair underwriting guidelines and is consistent with beneficially competitive insurance markets In Texas, insurance regulation is moving towards much greater reliance on market forces to encourage competition among insurers in a way which benefits consumers. The regulatory goal is for markets to move more towards the classic competitive model whereby insurers are forced to move to their most efficient level selling independent of one another to well-informed and knowledgeable consumers who have a wide range of choice. Reliance on market mechanisms, however, does not equate to deregulation. Deregulation does not always yield more beneficial competition-i.e. , competition that approaches the competitive market ideal and benefits consumers. In some cases, greater competition requires less regulation, such as movement away from cartel pricing. A beneficially competitive market forces insurers to price their product on their cost of service, rather than on a state-set base rate. In other cases, regulation enhances the market mechanism and promotes competition. The Department provides both sellers and buyers with information they need to make wiser decisions. The Department's independent data initiative is a key ingredient in the move to more competitive insurance markets. More informed buyers and sellers will improve the competitive nature of a market. Regulation can also provide incentives to encourage competition where there are market failures. The Department's new rule 5.206 provides such an incentive for insurers to write in areas which have been underserved by standard and preferred automobile insurers. In these underserved areas, the market forces have failed. Where reliance on voluntary action is insufficient, regulatory statutes and rules can be used to enhance competition. Regulatory mandates are necessary when the public cannot rely upon insurers to voluntarily take actions which they do not see as in their self interest. The promulgation of standard policy forms, which enables consumers to better shop based on price, service and solvency, is an example of how regulation enhances competition. Without standard policy forms, consumers cannot effectively compare price and service between companies. Minimum capital and surplus requirements represent regulations which promote beneficial competition. In the absence of such standards, some insurers would try to compete by stretching limited surplus over excessive premiums and exposures. While these insurers may be able charge lower prices because it has less capital to support, consumers are not well served by the great danger of insolvency faced by this insurer. 2.5.1 Insurance regulation expresses public policy regarding social and economic fairness of certain underwriting guidelines Professors Keeton and Widiss recognize the failures of competition in a deregulated insurance market: [C]ompetition will not always provide adequate protection against discriminatory premium rates. Even when competition is functioning well, there almost always will be collateral factors that make some policyholders more or less attractive on grounds apart from a pure assessment of the rated risk. Keeton and Widiss, Insurance Law, A Guide to Fundamental Principles, Legal Doctrines, and Commercial Practices, 955 (West 1988).As quoted previously, they go on to state that public policy considerations require government intervention to prevent the use of certain characteristics as underwriting guidelines even if the characteristic is related to risk. Several commenters at the hearing agreed that government intervention is appropriate to express public policy considerations in some instances, such as racial considerations. The Legislature has expressed its intent that certain risk classifications are impermissible. For instance, it has prohibited risk classifications based on race, color, religion and national origin. Insurance Code, Article 21.21-5. It has prohibited underwriting guidelines regarding cancellation and nonrenewal based on whether the consumer is an elected official. Insurance Code, Article 21.49-2d. Thus, the Legislature has recognized that certain risk classifications are inherently unfair, regardless of differences in the expected costs associated with the transfer of risk. 2.5.2 Insurance regulation can address the market failures caused by unfair underwriting guidelines In those instances where market failures are caused by unfair underwriting guidelines, it is not feasible to rely upon voluntary efforts of insurers because these voluntary efforts cannot address a structural problem with the market. If one insurer sees an advantage through use of an unfair trade practice, that insurer will obtain an unfair competitive advantage over other insurers who try to do the right thing for consumers. In a competitive market, such a disparity cannot last and the unfair practices will continue. Regulation ensures that insurers operate by the same rules and minimum standards. The prohibition of certain unfair underwriting guidelines causes all insurers to stop using those guidelines and removes an impediment to the beneficially competitive operation of insurance markets and encourages insurers towards other bases of competition, such as service or expense efficiencies. 2.6 The Department has developed rules to prohibit unfair underwriting guidelines consistent with the role of regulation and appropriate to address failures of insurance markets represented by unfair underwriting practices The various rules adopted by the Department prohibiting unfair underwriting practices are solidly grounded in the theory, practice and tradition of public intervention in insurance markets to make public policy expressions of social and economic fairness and to promote more beneficially competitive insurance markets. 2.6.1 The practices prohibited by this rule are unfair This rule prohibits the use of underwriting guidelines in the business of private passenger automobile insurance based on the purchase of types or amounts of coverage in excess of the minimum automobile liability coverage required by law. This guideline is prohibited because it is inherently unfair. By statute, the state has required drivers purchase certain minimum amounts of automobile insurance coverage. It is fundamentally unfair for sellers to then require these drivers to obtain additional amounts of insurance that the drivers do not need or desire to qualify for standard or preferred rates. In addition, this underwriting guideline is inherently unfair because it is inconsistent with the beneficially competitive operation of insurance markets. Texas consumers are harmed by this practice in several ways. First, those consumers who want and need only minimum limits coverage are either denied insurance or are forced to pay higher rates than they would have to pay without this underwriting guideline. The higher rates may be caused by the requirement to purchase additional coverages not needed by the consumer or by the denial of coverage in standard and preferred companies. Second, the public at large, the intended beneficiaries of the financial responsibility act, is harmed to the extent the practice prevents some consumers from being able to purchase the minimum liability limits required by law. While the Department recognizes that those drivers without insurance are prohibited from driving without insurance, in reality over 20% of the drivers in Texas drive without insurance. For each one of those drivers who would have been insured, but for this underwriting practice, the public is deprived of the benefits and protections of the mandatory insurance law. Third, to the extent the practice causes consumers to drive without insurance, the costs for uninsured motorist coverage increases for other consumers. This unfairly burdens the drivers who carry uninsured motorist coverage. Because the practices prohibited by this rule are unfair practices, the Department finds it necessary to promulgate this rule to achieve the purposes of Insurance Code, Article 21.21. In addition, these unfair practices and unfair methods of competition create insurance availability problems for Texas consumers and harm the competitive nature of insurance markets. 2.6.2 Other new underwriting rules Based on the three years of studies of insurance availability in Texas, the Department has promulgated two additional rules to prevent unfair underwriting practices. Rule 21.1002 requires insurers to demonstrate that underwriting guidelines are related to risk or size of expense for private passenger automobile and residential property insurance. This rule is based upon the principle that underwriting guidelines must be actuarially sound, i.e. , distinguish classes of consumers through a difference in the expected costs associated with the transfer of risk. This rule describes the test and methodology to demonstrate the fairness of underwriting guidelines. Moreover, the rule allows the Commissioner to collect necessary data to help insurers adequately evaluate certain underwriting guidelines. In this way, small insurers gain a greater ability to independently evaluate underwriting guidelines by gaining access to data sets larger than a small company could produce on its own. Such a mechanism not only ensures the use of fair underwriting guidelines, but promotes greater competition in insurance markets. Rule 21.1002 is a rule of prohibition, not a rule of authorization. That is, the rule provides that certain unfair underwriting guidelines may not be used. The rule does not provide permission to use underwriting guidelines that are risk related even if such guidelines are prohibited by statute or rule. In fact, the last section of that rule specifically provides: Other Laws Not Excepted. Compliance with subsection (a) of this section does not constitute an exemption from other rules or regulations of the department or statutory requirements. Other rules and statutes prohibit the use of inherently unfair underwriting guidelines. Rule 21.1002 does not permit the use of these inherently unfair underwriting guidelines. Rule 21.1004 prohibits intentional discrimination based upon race, color, religion or national origin and, to the extent not justified by sound actuarial principles, geographic location, disability, sex or age. This rule expresses the public policy that certain underwriting guidelines-those based on race, color, religion or national origin-are not consistent with social and economic fairness. Rule 21.1004 also reflects the principle that certain other underwriting guidelines-geographic location, disability, sex or age-are fair only if they are demonstrably related to the expected costs associated with the transfer of risk. A class of consumers identified by geographic location, disability, sex or age should be treated differently from another class of consumers only if the estimated costs associated with the transfer of risk for the first class are different than for the second class. If the estimated costs associated with the transfer of risk is the same for both classes, then it would be unfair to treat the consumers in the two classes differently in the underwriting decision. 2.6.3 Previous Department Underwriting Rules Regulation which limits the use of unfair underwriting guidelines improves the insurance market mechanism and promotes competition. Moreover, such prohibitions are not radical actions. There is a tradition of limiting and guiding the grouping of risk for insurance purposes in a manner consistent with public policy expressions of social and economic fairness. The Department has passed other rules, several of which were promulgated under Article 21.21, prohibiting unfair underwriting guidelines. Rule 5.401(c) prohibits insurers from denying automobile insurance on the basis that the consumer had previously been insured by a nonstandard insurer or through the TAIp. Rule 5.7016 prohibits insurers from nonrenewing automobile insurance coverage based on certain types of claims that were not the fault of the consumer. Rule 21.404 prohibits underwriting guidelines based on sex or marital status for all lines of insurance. Rule 21.1000 prohibits the use of an underwriting guideline by any insurer or agent based on whether another insurer previously declined coverage to the consumer. Rule 21.1003 prohibits automobile insurance underwriting guidelines based on the number of vehicles to be insured or the purchase of other policies. Rule 21.704 prohibits underwriting guidelines by life and health insurers based on sexual orientation. Thus, the Department's actions to prohibit the unfair underwriting guidelines identified in this rule is based on a long-standing policy to prohibit unfair underwriting practices. 2.7 The Department has authority to promulgate this rule 2.7.1 Article 21.21 sec.13(a) The rule is promulgated under the authority of Insurance Code, Article 21. 21 sec.13(a), which provides that the Department: is authorized to promulgate and may promulgate and enforce reasonable rules and regulations and may order such provision as is necessary in the accomplishment of the purposes of this Article ... including, but not limited to, such express provision within the purposes of these Articles as it deems necessary ... This rule is adopted to accomplish the purposes of Article 21.21. Section 1 of Article 21.21 sets out the purposes of the Article 21.21: The purpose of this Act is to regulate trade practices in the business of insurance by defining, or providing for the determination of, all such practices in this state which constitute unfair methods of competition or unfair or deceptive acts or practices and by prohibiting the trade practices so defined or determined. (emphasis added) The Legislature clearly contemplated that the Act would prohibit both those unfair and deceptive trade practices set out in the statute and those that are determined by the Department, pursuant to its authority under Section 13, to be unfair or deceptive practices. Article 21.21, sec.16 also evidences legislative intent that the Department has the authority to determine that practices are unfair and promulgate rules prohibiting such practices. That section provides: Any person who has sustained actual damages as a result of another's engaging in an act or practice declared in Section 4 of this Article or in rules or regulations lawfully adopted by the Board under this Article to be ... unfair or deceptive acts or practices in the business of insurance ... may maintain an action against the person or persons engaging in such acts or practices. (emphasis added) Similar references to either a violation of the Insurance Code or rules or regulations adopted by the Board under Article 21.21 appear in the Insurance Code, Articles 1.10A, sec.2(a)(1) and 1.14-1 sec.3A(a).These provisions are meaningless unless the Department has the authority to promulgate rules and regulations declaring practices to be unfair. Again, there is a clear legislative purpose in the adoption of Article 21.21 that the Department have the authority to promulgate rules prohibiting such unfair practices. The Austin Court of Appeals has held that the Department has authority to declare underwriting acts or practices to be unfair and to promulgate rules prohibiting such acts and practices. NAII at 5 (citing as additional authority Allstate v. Watson, 876 s. w. 2d 145, 147 (Tex. 1994)). The NAII court also expressly held that the Department may promulgate a rule under Article 21.21 prohibiting an unfair practice even if there is no evidence that the practice is occurring. Id. at 8.Neither the Administrative Procedure Act nor Article 21.21 requires the Department to refrain from acting to protect consumers from unfair and deceptive practices until consumers have been harmed. The mere possibility of an unfair practice provides adequate justification for the Department to act. For instance, the Department should not wait to promulgate a rule prohibiting racial discrimination until an insurer or agent harms a consumer. The Court of Appeals held that Article 21. 21 permits the Department to take prophylactic measures to prevent unfair practices: "The board has the authority to promulgate such rules as it deems necessary to advance the objectives of article 21.21, and it need not passively wait for harm to occur before it enacts regulations. "Id. at 8. Nevertheless, as has been shown, the Department is aware of ample evidence that the practices which are prohibited by this rule are occurring. 2.7.2 The private cause of action The Legislature created the private cause of action and expressly empowered the Department to identify those practices which should be designated as unfair. The Legislature has determined that a private cause of action should exist against those persons and entities in the business of insurance that engage in unfair practices identified by the Department. The Department is exercising its statutory duty to identify those unfair and deceptive practices. The NAII court held that the availability of treble damage lawsuits is an insufficient reason to find that a rule declaring an underwriting practice to be unfair is unnecessary or arbitrary and capricious because the statute, not the Department, authorizes this type of suit. NAII at 9. The Department, however, agrees with the Legislature that it is appropriate that a private cause of action exist for violations of this rule because a private cause of action serves several important enforcement purposes. First, a consumer who is harmed as a result of these types of unfair discrimination should have a means by which he or she may recover their damages, including any overcharges resulting from being placed in a substandard company, from the person or company that engaged in the unfair practice. Second, the Department does not have the resources to take enforcement actions for all individual instances of unfair discrimination. Rather, the Department's enforcement actions, due to limited resources, must be focused on large patterns of intentional discrimination. A private cause of action is necessary to ensure that individual consumers who are victims of intentional discrimination have the opportunity to seek redress for their damages. Third, a private cause of action provides individuals not only with the means to discourage deceptive and unfair practices, but also with the incentive to do so. NAII at 9.Finally, the threat of treble damage lawsuits provides insurers and agents with a strong disincentive to rely on this type of unfair discrimination in making their decisions to insure. Id. Past rules promulgated under Article 21.21, for which there is also a private cause of action, have not resulted in any private litigation, to the Department's knowledge based on questions to several large insurers and insurance company trade associations. These rules include a prohibition against the use of marital status, sec.21.404, a prohibition against blacklisting, sec.21.1000, and a prohibition against tying, sec.21.1003.Thus, the existence of a private cause of action is not calculated to cause excessive litigation costs for insurers or agents. If a consumer were to file a frivolous lawsuit under Article 21.21, sec.16, alleging a violation of this rule, the defendants in the suit have a remedy. Article 21.21, sec.16(c) provides that if the court finds that an action was groundless and brought in bad faith or brought for the purpose of harassment, the court shall award to the defendants reasonable and necessary attorney's fees. 2.7.3 Article 5.98. The rule is also promulgated under the authority of Insurance Code, Article 5.98.Article 5.98 authorizes the Department to adopt reasonable rules that are appropriate to accomplish the purposes of Insurance Code, Chapter 5, including Article 5.09.Article 5.09 prohibits any distinction or discrimination in favor of an insured having a like hazard, which occurs when an underwriting guideline unrelated to risk or expense is used to place a consumer in a different company within a company group. For instance, if an insurer group has three companies, a preferred company, a standard company and a substandard company, Article 5.09 is violated if insureds having a like hazard are placed in different companies within the group and charged different rates. The rule is necessary, in part, to accomplish the purposes of Article 5.09 to prohibit discrimination in favor of consumers of like hazard when the insurer group places those consumers in different companies within the group. Subsection (a) of the adopted rule prohibits the use of underwriting guidelines by private passenger automobile insurers based on the purchase of types or amounts of coverage in excess of the minimum automobile liability coverage required by law. Subsection (b) of the adopted rule provides a definition for the term "underwriting guideline".Subsection (c) of the adopted rule provides a definition of the term "private passenger automobile insurance. " Written comments in favor of adoption of the proposed rule were received from Mark l. Kincaid (Public Counsel for the Office of Public Insurance Counsel), James h. Davis (Silver-Haired Legislature), ADAPT of Texas (a grass roots disability rights organization), Patricia Anderson (United Cerebral Palsy of Texas, Inc. ), Katherine Stark (Austin Tenant's Counsil), Robert f. Schneider (Consumers Union), Nina Yager (individually and on behalf of Texas Citizen Action), Gilbert Moreno (Association for the Advancement of Mexican Americans), and Kay Allison (Association of Community Organizations for Reform Now). Written comments against adoption of the rule were received from Kimberly Yelkin/Pati Fuller (National Association of Independent Insurers), Robert l. Watkins (State Farm Insurance Companies), Fred b. Werkenthin (Farmers Insurance Group of Companies), Jay a. Thompson (Texas Life Insurance Association), Rick Clements (Texas Association of Insurance Agents), Bryan r. Davis (on behalf of several unidentified small to medium-sized domestic insurers), Elizabeth Wilson (CNA Insurance Companies), James Langford (Texas Farm Bureau Insurance Companies), Joanne Derrig (Allstate Insurance Company), and David Snyder (American Insurance Association). In addition to those persons making written comments, oral testimony at the hearing in favor of the adoption of the proposed rule was received from Senator Rodney Ellis, Senator Royce West, Representative Glen Maxey, Representative- Elect Dawnna Dukes, Enrique Valdivia (Texas Rural Legal Aid), Tim Curtis (Texas Citizen Action), Jim Mallett, Angelyque Campbell (Texas Community Reinvestment Coalition), Jesse Romero/Luis Wilmot (Mexican American Legal Defense and Education Fund), Fred Jarman (Texas Citizen Action), Mary Tallman, and Fred Lewis. In addition to those persons making written comments, oral testimony at the hearing against the adoption of the proposed rule was received from Representative Robert Duncan, Wade Spillman (Texas Association of Insurance Agents), Charles Wirth (State Farm Insurance Companies), Richard Smith/Scott Harrington/Roger Parker (Allstate Insurance Company), Richard Geiger (Association of Fire and Casualty Companies in Texas and Texas Automobile Insurance Service Office), Jay Thompson (Association of Fire and Casualty Companies in Texas, the Texas Insurance Advisory Association, and the American Council of Life Insurance), Finis Welch (Farmers Insurance Companies), Jonna Kay Hogeland (National Association of Independent Insurers, Liberty Mutual Insurance Company, the Texas Surplus Lines Association, and the Texas HMO Association), and Burnie Burner (Texas Association of Mutual Insurance Companies). The written and oral comments received by the Department fall into eight general categories: 1.Comments that show a need for the rule. 2.Comments that the rule is ambiguous. 3.Comments that the rule will adversely affect the market. 4.Comments on the costs to comply with the rule. 5.Comments on agents' liability. 6.Comments regarding the Department's statutory authority to promulgate the rule. 7.Comments regarding the private cause of action. 8.Miscellaneous comments. 5.1 Comments That Show A Need For The Rule. COMMENT: Commenters argued that the rule is necessary to eliminate the unfair practice by insurers and agents of denying coverage to a consumer or placing a consumer in a higher-priced company because the consumer seeks to purchase only minimum liability limits. Commenters argued that the guideline that is prohibited by this rule unfairly discriminates against some consumers for reasons not based on risk. Commenters argued that the underwriting guideline unfairly discriminates against low income Texans who want to comply with the financial responsibility act but who need and want only the amount and type of coverage required by statute. Commenters argued that the underwriting guideline harms the public at large who are the intended beneficiaries of the financial responsibility act. Commenters argued that the underwriting guideline harms other consumers who are forced to pay higher uninsured motorist rates because the underwriting guideline causes some drivers to go without insurance. Commenters argued that the underwriting guideline unfairly discriminates against young and senior drivers who tend to own a higher%age of older cars that do not need physical damage coverage. Commenters argued that people with older cars only want minimum liability coverage and do not need additional coverages. Commenters argued that the amount of insurance purchased should not determine whether a consumer can get into a preferred company. Commenters argued that people on fixed incomes with few assets have no need for excess liability limits. Commenters argued that the decision as to the amount and types of coverage purchased should be made by the consumer, not the insurer or agent. DEPARTMENT'S RESPONSE: For the reasons set out in the section entitled "Reasoned Justification," the Department agrees with these commenters that adoption of this rule is necessary. COMMENT: A commenter argued that the proposed rule creates requirements which are not contained in existing laws. DEPARTMENT'S RESPONSE: The Department agrees that the rule contains prohibitions against practices that are not prohibited by existing laws, as shown previously. Because the practices prohibited by this rule are unfair practices in the business of insurance, the Department has determined that these additional prohibitions are necessary. One of the purposes of Article 21.21 is to provide for the determination and prohibition of unfair practices in the business of insurance. If the Department's rulemaking authority were limited to only those practices that are already prohibited by statute, the rulemaking authority would be meaningless. Article 21.21 mandates a broad reading of the Department's authority to promulgate rules, even if the particular practice has not been declared illegal by statute. The plain language of Article 21.21 permits the Department to promulgate rules prohibiting unfair conduct. There is no limitation on the Department's authority to declare practices to be unfair simply because they are not specifically prohibited by statute. Article 21.21 sec.1(b) states that Article 21.21 "shall be liberally construed and applied. "The clear intent is to give the Department broad, and not limited, authority. Therefore, the Department has the authority to declare practices to be unfair under its rulemaking authority even if the practice is not prohibited by another statute. 5.2 Comments That The Rule Is Ambiguous. COMMENT: A commenter argued that the definition of "underwriting guideline" should explicitly state that underwriting guidelines include criteria used by insurers in "renewal" or "nonrenewal" of coverage. DEPARTMENT'S RESPONSE: The rule does prohibit discrimination in the decision whether to accept or reject a consumer for insurance, which would include the decision to renew or non renew a consumer's policy. However, to clarify the rule, the Department has added these two terms to the definition of "underwriting guideline. " COMMENT: Commenters argued that the term "private passenger automobile insurer" creates ambiguity in two respects:it is ambiguous as to which types of automobile insurance it applies and it is unclear whether the rule applies only to the sale of automobile insurance or to the sale of any type of insurance by an insurer that also writes automobile insurance. A commenter argued that the rule should be clarified to allow a company in writing an umbrella policy to require higher than minimum limits and primary insurance with the same company. DEPARTMENT'S RESPONSE: The Department agrees that the phrasing of the proposed rule was overbroad because it applied to the sale of any type of insurance by an insurer that writes private passenger automobile insurance. The intent of the rule was to apply to coverage by means of personal auto policies. Therefore, the wording of the first sentence in subsection (a) was rearranged to clarify that the rule applies only to the sale of private passenger automobile insurance. "Private passenger automobile insurance" is then defined in a new subsection. As amended, the rule would not apply to the sale of other types of insurance, including an umbrella policy. COMMENT: Commenters argued that the term "underwriting guideline" is defined too broadly, that it ties to virtually every business decision that is made within an insurance company. DEPARTMENT'S RESPONSE: The Department disagrees. The definition is broad for a reason. Any decision regarding the sale or cancellation of insurance should not be based, in whole or in part, on whether the consumer desires to purchase additional amounts or types of coverage beyond that required by state law. Although broad, the definition is not vague or ambiguous. It is intended to prohibit this unfair factor from all decisions related to the sale of insurance by the insurance company or agent, and the commenter has confirmed that this intent has been accomplished. COMMENT: A commenter argued that the term "in whole or in part" is undefined and that it is impossible to determine what the term means. Another commenter argued that the term is at best confusing and at worst totally unintelligible as to its meaning. DEPARTMENT'S RESPONSE: The Department disagrees. The term "in whole or in part," as used in the rule, is clear:it means "not at all. "The prohibited bases of discrimination cannot be a reason, either the sole reason or one of multiple reasons, for denying coverage to a consumer. The term is used over thirty times by the Legislature throughout the Insurance Code. See, e.g. , Insurance Code, Articles 1.10A, sec.3(f), 1.14-1, sec.11(a), 1.14-2, sec.3(b), 1. 15AA, sec.12(c), 2.08, sec.4, 2.10, sec.9, 3.33, sec.4(g)(1), 3.39, sec.C4(a), 3.50, sec.1(3)(b), 3.51, sec.1(a), 3.51-8, 3.53, sec.2(2), 3.70-3, sec.5, 5.01-1(c), 5. 03(a), 5.23, 5.55C(e), 5.101, sec.3(g)(2), 8.19, 9.48, sec.7(c), 14.51, 20a. 13(g), 20a. 36(c), 21.07-3, sec.5(h), 21.07-7, sec.6(h), 21.21, sec.4(8)(i), 21. 28, sec.3(h)(c), 21.28-D, sec.9(i), 21.49a(iii), and 21.79D, sec.5(a). Insurers have also been held to an "in whole or in part" standard in their underwriting practices for over twenty years by the federal law regulating consumer credit. That statute provides: Whenever ... insurance ... involving a consumer is denied or the charge for such ... insurance is increased either wholly or partly because of information contained in a consumer report ... the user of the consumer report [i.e. the insurer] shall so advise the consumer against whom such adverse action has been taken ... 15 u. s. c. a. sec.sec.1681m(a)(emphasis added).The Department is unaware of any difficulties insurers have had in following this directive, yet it is the very same standard some insurers now contend they cannot follow. As the court of appeals agreed in NAII, public policy supports the choice of the "in whole or in part" standard, rather than a standard that would only prohibit discrimination based "solely" on the characteristics listed in the rule: The language "in whole or in part" does not render [the rule] arbitrary and capricious. To allow insurers to rely on the improper factors "in part" would emasculate the statute because it would protect insurers who use improper grounds in reaching their decisions. Eliminating the "in part" language would protect an insurer who relies, however slightly, on some proper ground for denial. The board acted reasonably by refusing to allow insurers access to such an easily manufactured defense. NAII at 9.The court also dismissed insurers' concerns that the "in part" language exposes insurers to the risk of treble damage lawsuits and strict administrative penalties since the mere consideration of the prohibited basis for a decision may be sufficient to impose liability. Id. at 9.The "in part" language does not entitle a consumer to sue if, in fact, the prohibited bases were not considered. However, if illegal discrimination was one of the factors in the decision, even if only a small part of the decision, the reliance on the prohibited factor is unfair and should be prohibited. The rule only prohibits underwriting guidelines based, in whole or in part, on the specified characteristics. The rule does not make it illegal for an insurer to know that a consumer seeks to purchase only minimum limits liability coverage. Commenters who assert that the "in whole or in part" language will make them liable for any declination of coverage if they knew that the consumer sought to purchase only minimum limits liability coverage are incorrect. The rule provides that the insurer or agent must not only know that the consumer seeks to purchase only minimum limits liability coverage, it must also deny coverage on that basis to be in violation of the rule. The Department, therefore, disagrees that the language "in whole or in part" should be eliminated from the rule or further defined. COMMENT: Commenters argued that the rule is vague and unclear. The commenters did not identify any portion of the rule, other than the terms discussed above, that the commenters believed is vague. DEPARTMENT'S RESPONSE: The Department disagrees that the rule is vague. The rule clearly defines the conduct which is prohibited and the scope of the rule. Without any identification of the portions of the rule the commenter believes to be vague, the Department is unable to respond any further to this comment. 5.3 Comments That The Rule Will Adversely Affect The Market. COMMENT: A commenter argued that the proposed rule constitutes an initial attempt to codify underwriting guidelines. DEPARTMENT'S RESPONSE: The Department disagrees that the proposed rule constitutes an initial attempt to codify underwriting guidelines. The express purpose of the rule is to eliminate those unfair practices identified in the rule. The prohibition against using unfairly discriminatory underwriting guidelines does not equate to a codification of underwriting guidelines. Insurers and agents are not prohibited under this rule from using any appropriate underwriting guideline, as long as the guideline is not based, in whole or in part, on the purchase of additional types or amounts of coverage beyond that required by state law. The NAII court rejected the argument that a prohibition against the use of unfair underwriting guidelines prohibits insurers from accepting and rejecting risks. NAII at 11.The Court held that the rule at issue in that case "does not prevent insurers from accepting and rejecting risks;it merely prohibits the use of inaccurate substitutes ... for real risk factors. "Id. That analysis is equally applicable to this rule;the rule does not prevent insurers from using their own underwriting guidelines. Nor does it require them to use any guidelines at all, codified or not. Rather, the rule simply prohibits insurers from using underwriting guidelines that are inaccurate substitutes, like the purchase of additional coverages, for real risk factors. COMMENT: A commenter argued that the rule should not be adopted because it will cause rates to increase for other consumers who are not in the classes protected by this rule. DEPARTMENT'S RESPONSE: The shift in rates among consumers described by this commenter would occur only if the decision to purchase minimum limits coverage only was a factor uniquely associated with differences in expected costs of the transfer of risk. Despite requests for such information, the Department has seen no evidence that any of these factors are uniquely associated with such differences. The loss experience presented in written comments does not support the assertion that this factor is associated with the expected costs of the transfer of risk. The Department therefore disagrees that rates for other consumers will increase as a result of the adoption of this rule. Insurers may continue to apply fair underwriting guidelines to potential consumers under this rule to ensure that the consumers they insure have the same estimated cost associated with the transfer of risk as do its current customers. For instance, the rule does not require an insurer to write all consumers who seek only minimum limits liability insurance;it only prohibits insurers from denying coverage to those consumers seeking only minimum limits liability insurance who otherwise meet the insurer's underwriting guidelines. Thus, any additional consumers written as a result of this rule will be the same risk as the insurer's current consumers and have the same estimated cost associated with the transfer of risk. In the event that purchase of minimum limits liability insurance only is uniquely related to expected differences in the transfer of risk, the prohibition of the use of these underwriting guidelines would cause rates to go up for some consumers and go down for other consumers. Even if this were the case, the use of these underwriting factors would still be unfair becausewhether or not this factor distinguishes among the expected risk of consumers, such market segmentation is not socially or economically fair. It is inherently unfair to charge a consumer higher rates simply because he or she wants only to purchase only the minimum coverage required by law. COMMENT: A commenter argued that the proposed rule would have a negative impact on the Texas insurance market. Another commenter argued that the rule will adversely affect the availability and affordability of insurance to the citizens of Texas. The commenters did not offer any specifics as to how the rule would have a negative impact. DEPARTMENT'S RESPONSE: The Department disagrees. As shown in the Reasoned Justification, the elimination of these unfair underwriting guidelines will have a positive impact on the Texas insurance market. COMMENT: A commenter was concerned that the proposed rule will harm the commenter's efforts to expand personal lines markets in Texas. Another commenter argued that the rule will drive insurers to withdraw from lines of insurance, markets, or the state. DEPARTMENT'S RESPONSE: The Department does not believe that a prohibition against the types of unfair practices prohibited by this rule will cause insurers to avoid Texas insurance markets or to leave those markets. The effect of the rule, instead, will be to cause insurers not to unfairly discriminate against consumers who seek only the minimum coverage required by law. The Department rejects the argument that insurance availability is only possible if insurers are allowed to unfairly discriminate against consumers. The Department assumes insurers will react rationally to this rule by simply ceasing any underwriting practices that would violate the rule and serve Texas insurance markets using fair underwriting guidelines. COMMENT: A commenter argued that an industry vital to a free-enterprise nation could be destroyed if forced to "accommodate" the uninsurable, as measured by insurer management. The commenter went on to argue that the risk of insuring consumers without such distinctions should be left to insurer management and not imposed by law. DEPARTMENT'S RESPONSE: The Department disagrees with this comment. The rule does not require insurers to sell insurance to consumers who do not meet other underwriting guidelines. As described above, the Department has seen no evidence to suggest that consumers seeking only the minimum coverage required by law are "uninsurables. " The Austin Court of Appeals upheld the Department's right to prevent another unfair underwriting proxy, stating: Rule 1003 does not prevent insurers from accepting and rejecting risks; it merely prohibits the use of inaccurate substitutes ... for real risk factors. ...Rule 1003 prohibits the use of proxies for real risk factors. NAII at 11-12.Similarly, this rule does not prohibit insurers and agents from denying coverage based on true risk factors. The Department also disagrees that the decision whether to unfairly discriminate in making a decision whether to bind, accept, reject, renew, nonrenew, cancel or limit coverages made available to a consumer should be left to insurer or agent management. Such practices are unfair and the Legislature has charged the Department with the duty to promulgate rules that identify and prohibit unfair practices like the practices identified in this rule. The Legislature has determined that insurers should be limited in their decision as to which consumers are insurable. The Legislature passed Article 21.21 for the express purpose of prohibiting insurer management and agents from engaging in unfair and deceptive practices, even if management believes such unfair or deceptive practices are appropriate. COMMENT: A commenter argued that the proposed rule would remove all discretion from the business entity and force the business to underwrite a risk that they either feel they cannot financially withstand or assume a risk that they did not contemplate assuming when they entered the market. The commenter went on to argue that, if companies are unable to obtain approval for the rates they feel are necessary to adequately cover the risks which are being thrust upon them, many will feel a compelling need to withdraw from the market. DEPARTMENT'S RESPONSE: The Department disagrees with this comment. The rule would not remove all discretion from the business entity. Under this rule, the company is not prohibited from exercising discretion in its choice of consumers, nor is it forced to underwrite any risk, as long as that choice is not based on the purchase of additional types or amounts of coverage. The rule clearly allows discretion in the decision about classes of consumers the insurer or agent wishes to insure. If the commenter understands business discretion to mean the arbitrary and unfair treatment of individual consumers, this rule does prohibit that type of "business discretion. " The commenter's argument regarding rates is inconsistent with the Texas rate regulatory scheme. For automobile insurance, the Department sets a flexibility band in which insurers may file and use the rates that they deem appropriate to cover the risks they will insure. For those companies that can show a need for rates outside those bands, the statute permits the approval of such rates. Therefore, the Department disagrees with the comment that companies will be unable to set adequate rates as a result of this rule. COMMENT: A commenter argued that the rule will prohibit the application of judgment in the underwriting process. DEPARTMENT'S RESPONSE: The Department disagrees. The rule does not prohibit the application of judgment in the underwriting process, it merely prohibits an underwriting judgment based on the amounts or types of coverage a consumer purchases. The rule requires that those judgments be fair and fairly applied. COMMENT: A commenter argued that this underwriting guideline allows a company to better price the risk of its consumers, reduces subsidies between dissimilar classes of consumers, and allows companies to deal with the Texas rating flexibility bands. The insurer wrote that its underwriting guidelines require at least one vehicle to carry physical damage coverage unless all vehicles are more than ten years old or at least one operator is retired and aged 50 or older. The commenter claims that it has high loss ratios for liability coverages and low loss ratios for physical damage coverages. By requiring the consumer to purchase physical damage coverage, the company argues that it can leverage the poor liability results aginst the better physical damage results. The commenter claimed that it was prohibited from raising its liability coverage rates because its rates are at the top of the flexibility band and that obtaining prior approval for rates outside the band would be onerous and unreasonable. The commenter argued that the rule will cause rates to increase for many Texans. DEPARTMENT'S RESPONSE: The Department disagrees with this comment. This comment shows both that the practice is occurring and that the practice is unfair. By the commenter's own admission, it apparently believes some customers (retired consumers and those with cars ten years or more old) do not need comprehensive and collision coverage and are exempted from the commenter's underwriting guideline requiring purchase of physical damage coverage. Although this company appears to believe that it has the right to determine which consumers do not need full coverage, the Department believes consumers should have the right to make that choice without being penalized with higher rates for making that choice. Based on the information provided by the commenter, many policyholders would see lower premiums as a result of this rule. Instead of mispricing the various coverages, the rule would encourage the commenter to price each coverage correctly. For most customers currently insured in the commenter's companies- those with liability and physical damage coverage-there would be no net change in premiums as higher liability rates would be offset by lower physical damage rates. But those customers previously relegated to the commenter's county mutual company or other higher-cost carriers simply because they wanted only to comply with the financial responsibility law would no longer be arbitrarily and unfairly denied coverage in the commenter's standard or preferred company and would see lower rates. Finally, the Department disagrees that the commenter is prohibited from raising its liability rates. Insurance Code, Article 5.101 permits and requires automobile insurers to file rates that are just, reasonable, adequate and not excessive. The commenter is not only permitted to set its liability rates at a just, reasonable and adequate level, it is required to do so. Each rate filed under that statute must meet this requirement. Therefore, the commenter must file adequate liability rates regardless of the level of its physical damage rates. Otherwise the rates would be unfairly discriminatory, as is evidenced by the commenter's own testimony-liability-only consumers who meet the exception are allegedly paying inadequate premiums and being subsidized by the consumers who pay allegedly excessive physical damage rates. The Department also disagrees that the prior approval scheme set by the Legislature for rates outside the flexibility bands is onerous. Of the more than thirty requests for prior approval for private passenger automobile insurance rates outside the flexibility bands since the inception of that statute, only one has been denied by the Department. Moreover, the Department approved the liability rates in that filing and only disapproved the physical damage rates. 5.4 Comments On The Costs To Comply With The Rule. COMMENT: A commenter argued that the proposed rule fails to accurately reflect the cost to insurers in complying with the rule. The commenter argued that the cost of defending potential litigation would exceed by more than 25% the costs stated in the proposed rule. Another commenter argued that the rule will add significant additional compliance overhead to the industry's cost of doing business (although the commenter failed to explain what those additional costs will be or how they were determined).Another commenter argued that the costs of litigation will exceed the estimate of no costs set out in the notice. DEPARTMENT'S RESPONSE: The Department disagrees that the actual costs to comply with the rule will exceed the cost estimate contained in the notice of the proposed rule by more than 25%. First, these commenters misunderstand the cost estimates required under the Government Code sec.2001.024(5)(B).The public cost estimates contained in the proposed rule constitute the costs to comply with the rule;the estimate does not-and the agency is not required by statute to-include defense costs, damages, and penalties to be paid as a result of a violation of the rule. It would be impossible for the Department, or any agency, to estimate the number of times regulated entities will violate a rule and the fines and penalties that will result. The commenters' argument is based on the premise that the cost estimate must include the estimated fines and penalties, in addition to the litigation expenses, that will be incurred by all regulated entities that choose to violate the rule. The Legislature could not have intended such an absurd result. The Department properly complied with the statutory requirement to estimate the costs necessary to comply with the rule, not the costs associated with a violation of the rule. Second, the Department does not anticipate extensive litigation as a result of this rule. As shown previously, several other rules promulgated by the Department under Article 21.21 have not generated any private litigation, legitimate or frivolous. The commenters have not shown any reason to believe that the experience under this rule will be any different. The Department assumes, as did the Legislature when it created a private cause of action, that the possibility of litigation will be enough to cause insurers and agents to refrain from engaging in the unfair practices that are prohibited by this rule so that there will not be extensive litigation. Third, as to the alleged costs association with frivolous lawsuits, this rule does not permit frivolous lawsuits. To the extent that frivolous lawsuits may theoretically result from the promulgation of a rule, that potential exists for any rule promulgated by an agency. Yet no agency includes the costs of potential frivolous suits in its cost estimate. Moreover, it would be impossible for an agency to estimate how many claimants will bring a frivolous suit citing the proposed rule or the cost associated with defending those frivolous suits. Again, the Legislature could not have intended such an absurd requirement for the cost estimate. Fourth, some of the commenters are incorrect in their interpretation of Insurance Code, Article 1.03b. That statute provides that a rule is void only if the reasonable actual costs exceed the costs stated by at least 25% of the costs stated. Only reasonable actual costs count;costs related to a violation of the rule are not reasonable costs and should not be included in the determination. In addition, the costs referred to in Article 1.03B are the total costs estimated by the Department. Some commenters erroneously contended that the statute applies if any element of the cost estimate is too low. In this instance, the estimate for each company was up to $100,000. Fifth, if a consumer were to file a frivolous lawsuit under Article 21.21, sec.16, alleging a violation of this rule, the defendants in the suit have a remedy to recover their costs. Article 21.21, sec.16(c) provides that if the court finds that an action was groundless and brought in bad faith or brought for the purpose of harassment, the court shall award to the defendants reasonable and necessary attorney's fees. Finally, the "economic cost" associated with the rule is not simply the expense associated with the rule, it is the balance of the economic benefits and the expenses associated with compliance. For those companies and agents who currently engage in the practices prohibited by this rule, they will incur an administrative expense for the elimination of their current underwriting guideline. The profit resulting from this additional business will to some extent offset any expenses associated with the elimination of the underwriting guideline. 5.5 Comments On Agents' Liability. COMMENT: Commenters argued that an agent or company who rejects a consumer who is seeking only minimum limits coverage for a legitimate reason will be wrongly accused of violating this rule. These commenters claim that agents and insurers will fear having a frank discussion with the consumer about the merits of minimum limits coverage. DEPARTMENT'S RESPONSE: The Department disagrees. The rule does not prohibit the use of other legitimate underwriting guidelines. Nor does the rule permit a consumer to make a claim against an insurer or agent when the insurer or agent has not violated the rule but, instead denied coverage based on legitimate reasons. Any fear that the rule prohibits an agent or insurer from ensuring that a consumer makes an informed choice to purchase only minimum limits coverage is unfounded. The rule prohibits only the requirement of additional amounts or types of coverage;it does not prohibit full disclosure by agents and insurers, full disclosure and discussion by the agent of the consumer's insurance needs, recommendations regarding additional amounts or types of coverage, or any other conduct. Texas law provides that any applicant rejected for coverage by an insurer may request the reason for being denied coverage. The agent or insurer need simply provide the legitimate reason to the consumer for denying coverage. The Department also disagrees that this rule will prevent agents from discussing the merits of minimum limits coverage with consumers. Upon reading the rule, agents and insurers will know that discussing a consumerss insurance needs can not be seen as a violation of the rule. Thus the rule clearly does not prohibit discussions or recommendations concerning the purchase of additional types or amounts of coverage. COMMENT: A commerter argued that it is unfair to hold independent agents, who have no control over underwriting guidelines instituted by insurance companies they represent, accountable for underwriting guidelines they apply on behalf of their companies. DEPARTMENT'S RESPONSE: The Department disagrees. First, some agents may unfairly discriminate on their own, even without direction from any insurer. Although the agent may not be acting on behalf of any insurer, the practice is still unfair and should be prohibited. For instance, an independent agent, who represents several insurers who do not underwrite based on the amounts or types of coverage purchased, may reject an applicant on this basis on his or her own. That practice is unfair. A representative of the Texas Association of Insurance Agents, the entity that made this comment, agreed at the hearing that an agent that imposes his or her own underwriting guideline based on the amount of types of coverage, independent from a company underwriting guideline, should be held responsible for a violation of the rule: I can understand this conceptually being responsible for those things we [agents] invoke in the process ... Testimony of Wade Spillman, Tr. p. 201. Second, the fact that the insurer instructs an agent to engage in illegal conduct does not justify the conduct by the agent. For instance, an agent should not avoid responsibility for misrepresenting a policy to a consumer simply because the insurer instructed the agent to misrepresent the policy. An agent should not avoid responsibility for misappropriating or converting money belonging to a consumer simply because an insurer instructs the agent to do so. An agent should not avoid responsibility for violations of the Insurance Code simply because an insurer instructed the agent to do so. Similarly, an agent should not engage in the unfair practices prohibited by the rule simply because the insurer instructs him or her to do so. The agent should just say no to the insurer and refuse to engage in the illegal conduct. If an applicant meets all underwriting guidelines of the insurer, other than the illegal guideline, the agent should submit the application even if the consumer does not meet the guideline that violates this section. In that way the agent will not violate the rule. The fact that an agent's contract may require the agent to engage in illegal conduct is not sufficient grounds to permit the agent to do so. 5.6. Comments Regarding The Department's Statutory Authority To Promulgate The Rule. COMMENT: Commenters argued that the Department of Insurance lacks the requisite statutory and regulatory authority to adopt the proposed rule. DEPARTMENT'S RESPONSE: The Department disagrees for the reasons set out previously in section 2, "Reasoned Justification," entitled "the Department has the statutory authority to promulgate this rule. " COMMENT: A commenter argued that adoption of the proposed rule would violate Insurance Code, Article 1.03A because there is no express grant of rulemaking authority to adopt this rule. DEPARTMENT'S RESPONSE: The Department disagrees. Adoption of the proposed rule does not violate Insurance Code, Article 1.03A because Article 21.21 sec.13 provides the express statutory authority to identify and prohibit unfair practices in the business of insurance. The Department is also expressly authorized to promulgate this rule under Article 5.98. COMMENT: A commenter argued that there is no demonstration of the necessity to enact such a rule in order to carry out the purposes of Article 21.21.A commenter argued that there has been no indication that the practices to be prohibited by the rule are occurring or threatened or that consumers have suffered injury or likely to suffer injury as a result of the prohibited practices. The commenter recommends that the Department engage in further studies. Another commenter argued that the consumer who originally petitioned for the rule offered no data that the guideline in question causes consumers to be unfairly denied coverage. DEPARTMENT'S RESPONSE: The Department disagrees. The NAII court held that the Department may promulgate a rule under Article 21.21 prohibiting an unfair practice even if there is no evidence that the practice is occurring. NAII at 8.Neither the Administrative Procedure Act nor Article 21.21 requires the Department to refrain from acting to protect consumers from unfair and deceptive practices until consumers have been harmed. The mere possibility of an unfair practice provides adequate justification for the Department to act. The Court of Appeals held that Article 21.21 permits the Department to take prophylactic measures to prevent unfair practices: "The board has the authority to promulgate such rules as it deems necessary to advance the objectives of article 21.21, and it need not passively wait for harm to occur before it enacts regulations. "Id. at 8.Nevertheless, as has been shown, the Department is aware of ample evidence that the practices prohibited by this rule are occurring in the Texas automobile insurance market. Although the Department has the authority to promulgate this rule even in the absence of consumer harm, the evidence identified previously that over one-third of the market uses this unfair underwriting guideline demonstrates the necessity to enact this rule to carry out the purposes of Article 21.21. Auto insurance is necessary to operate an automobile. Because the practices prohibited by this rule are unfair, create insurance availability problems for Texas consumers, and harm the beneficially competitive operation of insurance markets, the Department finds it necessary to promulgate this rule to achieve the purposes of Insurance Code, Article 21.21. COMMENT: A commenter argued that the rule adds to the strain already placed on the Department's rulemaking authority by its prior experiments in social policy over the past four years and thereby invites a responsive elected Legislature to question whether the agency should continue to have power to make legislative rules at all. DEPARTMENT'S RESPONSE: The Department disagrees. First, there is no "strain" on the Department's authority to promulgate rules prohibiting the use of unfair underwriting guidelines. The court of appeals in the NAII case, as well as the district court, held that the Department has clear authority to prohibit unfair underwriting practices. The Department has set out, at length, its statutory authority to promulgate this rule and will not repeat those statements here. Second, the Department does not consider this rule to be an "experiment in social policy. "The basis of this rule, that all persons should be treated fairly in the purchase of insurance mandated by statute is sound public policy. Finally, the Legislature has made the determination that the Department should have the authority to identify and prohibit unfair practices through rules. While the commenter may disagree with this authority, the Legislature has determined otherwise. COMMENT: A commenter argued that Insurance Code, Article 5.09 does not provide statutory authority to promulgate this rule. DEPARTMENT'S RESPONSE: The Department agrees that Article 5.09 does not include a grant of rulemaking authority. The Department's citation to Article 5.09 was in reference to Article 5.98.Article 5.98 authorizes the Department to adopt reasonable rules that are appropriate to accomplish the purposes of Insurance Code, Chapter 5, including Article 5.09.Article 5.09 prohibits any distinction or discrimination in favor of an insured having a like hazard, which occurs when an underwriting guideline unrelated to risk or expense is used to place a consumer in a different company within a company group. For instance, if an insurer group has three companies, a preferred company, a standard company and a substandard company, Article 5.09 is violated if insureds having a like hazard are placed in different companies within the group and charged different rates. The rule is necessary, in part, to accomplish the purposes of Article 5.09 because some insurers have attempted to interpret Article 5.09 to not apply to discrimination against consumers of like hazard when the insurer group places those consumers in different companies within the group. COMMENT: A commenter argued that Insurance Code, Article 5.98 does not apply to life, accident and health insurance and does not provide statutory authority for the rule. DEPARTMENT'S RESPONSE: The Department agrees that Article 5.98 does not apply to life, accident and health insurance. However, the rule does not apply to life, accident and health insurance;it applies only to private passenger auto insurance. 5.7 Comments Regarding The Private Cause Of Action. COMMENT: Commenters argued that only the Department should enforce violations of the rule and that there should not be a private cause of action for violations of the rule. Commenters argued that the proposed rule would give rise to frivolous lawsuits. Commenters argued that private lawsuits will not create a deterrent to illegal discrimination but will only encourage members of the protected class to bring a lawsuit whenever they are denied coverage, regardless of the merit of their position. A commenter argued that reliance on private lawsuits to regulate insurers is bad public policy, is an inconsistent and unpredictable way to achieve a regulatory goal, and subverts state administrative regulation of insurance. DEPARTMENT'S RESPONSE: The Department disagrees with these comments. The Legislature, not the Department, has determined that unfair practices in the business of insurance should be policed through both Department enforcement actions and though private actions. Section 16 of Article 21.21 provides for a private cause of action for the violation of any rule promulgated under the authority of Article 21.21 and determined by the Department to be an unfair or deceptive practice in the business of insurance. The commenters are incorrect in assuming that the Department has the authority to deny a private cause of action granted by statute for a practice determined pursuant to Article 21.21 to be an unfair practice. Nevertheless, the Department agrees with the Legislature that public policy mandates that there be a private cause of action for violations of this rule. To the extent a consumer is damaged by the denial of a product mandated by law, the wrongdoer should compensate the consumer for those damages. Moreover, as the NAII court recognized, the private treble damage lawsuit serves two important enforcement purposes. First, it provides individuals not only with the means to discourage deceptive and unfair practices, but also with the incentive to do so. NAII at 9.Second, the threat of treble damage lawsuits provides insurers and agents with a strong disincentive to rely on this type of unfair discrimination in making their decisions to insure. Id. Third, individual instances of unfair practices are usually proved on a case by case basis. The Department does not have the resources to take enforcement actions for all individual instances of unfair discrimination. Rather, the Department's enforcement actions, due to limited resources, must be focused on large patterns of unfair discrimination. Thus, the private cause of action granted by the Legislature is necessary to ensure that individual consumers who are victims of unfair discrimination have the opportunity to seek redress for their damages. As for the filing of frivolous suits, the Department disagrees that the rule permits the filing of frivolous suits. The Department also disagrees that the threat or possibility of frivolous suits should be a basis for permitting the unfair discrimination prohibited by this rule or the denial of redress for those consumers with legitimate claims. The NAII court expressly held that the availability of treble damage lawsuits is an insufficient reason to find that a rule declaring an underwriting practice to be unfair is unnecessary or arbitrary and capricious because the statute, not the Department, authorizes this type of suit. NAII at 9.Undoubtedly the legislature weighed the cost of potentially frivolous suits against the benefits of providing a private cause of action for unfair practices and determined that the benefits outweighed the possible costs of frivolous lawsuits. The Department disagrees that consumers who seek only the minimum coverage required by law will bring a lawsuit whenever they are denied coverage, regardless of the merit of their position. Conversely, the failure to adopt the rule would mean that those consumers who seek only the minimum coverage required by law who do have a legitimate claim would be denied the right to take any action against the wrongdoer to be compensated for any damages caused by the unfair discrimination. The threat of frivolous lawsuits already exists. A person who unjustifiably claims unfair discrimination based on the underwriting guideline prohibited by this rule may sue for damages without the passage of this rule. The rule does not permit these frivolous suits. What the rule does do is permit those with legitimate claims who do not have the right to sue without the rule to sue for their damages. The Department agrees with the Legislature that the threat or cost of frivolous lawsuits is far outweighed by the benefits resulting from the right of legitimate claimants to seek redress for their grievances. Moreover, if a consumer were to file a frivolous lawsuit under Article 21. 21, sec.16, alleging a violation of this rule, the defendants in the suit have a remedy. Article 21.21, sec.16(c) provides that if the court finds that an action was groundless and brought in bad faith or brought for the purpose of harassment, the court shall award to the defendants reasonable and necessary attorney's fees. Finally, as noted previously, past rules promulgated under Article 21.21, for which there is also a private cause of action, have not resulted in any private litigation, to the Department's knowledge. Thus, the existence of a private cause of action is not calculated to cause excessive litigation costs for insurers or agents. COMMENT: Commenters argued that the proposed rule constitutes an attempt to usurp the authority of the legislature to determine when a private cause of action is appropriate. DEPARTMENT'S RESPONSE: The Department disagrees. The Legislature, not the Department, has determined that unfair practices in the business of insurance should be policed through both Department enforcement actions and though private actions. In fact, if the Department determines by rule that these practices are unfair, the Department does not even have the authority to deny a cause of action because that right is determined by statute. The Department is not usurping any powers of the Legislature. On the contrary, the Department is exercising the powers and duties to prohibit unfair trade practices in the business of insurance that have been delegated to it by the Legislature. 5.8 Miscellaneous Comments. COMMENT: A commenter argued that the rule is punitive (although it did not state how the rule is punitive or to whom the rule is punitive) and unnecessary. DEPARTMENT'S RESPONSE: The Department disagrees. The Department has set out the necessity of the rule in the "reasoned justification" section and in response to other comments and will not repeat those statements here. The rule is punitive only against those who engage in these types of unfair discrimination. By definition, any rule that prohibits an unfair practice and provides enforcement mechanisms could be considered punitive against those that engage in the unfair conduct. The Legislature has determined that remedial measures for victims of unfair and deceptive practices are appropriate. Although the rule is clearly remedial as it relates to unfair discrimination, the rule is not punitive as to any other person or entity that is not engaging in unfair discrimination. COMMENT: A commenter argued that "it is disingenuous, if not plain cynical, for the Department of Insurance to propose these pointless new burdens. " DEPARTMENT'S RESPONSE: The Department disagrees. The rules are intended solely to prohibit unfair practices in the business of insurance. There is nothing disingenuous or cynical about the Department's policy, based on statutory authority, to seek the elimination of unfair practices like the practices which are prohibited by this rule. Nor does the Department believe the prohibitions set out in this rule are pointless. On the contrary, as shown previously, the prohibitions are necessary. Although the Department has the authority to promulgate this rule even in the absence of consumer harm, the evidence identified previously demonstrates the necessity to enact this rule to carry out the purposes of Article 21.21.The evidence shows that over one third of the market requires the purchase of coverages in addition to the coverage required by law, that insurance availability problems exist, and that the consumers who are subject to these practices are either denied insurance or are charged higher rates for that insurance. Because the practices prohibited by this rule are unfair, create insurance availability problems for Texas consumers, and harm the competitive nature of insurance markets, the Department finds that the rule is appropriate. COMMENT: A commenter argued that, to the extent the rule prohibits classification or underwriting judgment, the availability and affordability of insurance would likely be jeopardized. The commenter argued that the ability of insurers to develop and market their products in niche markets may be adversely affected, insureds in those niche markets will likely be forced to pay more for insurance, and that in many cases these niche markets would disappear. DEPARTMENT'S RESPONSE: The Department disagrees. As stated previously, the Department believes that insurance availability and affordability will improve as a result of this rule. Those consumers who are unfairly denied coverage or charged higher rates because they seek only to purchase the minimum coverage required by law will encounter improved insurance availability as a result of this rule. The Department rejects the notion that insurance availability is only possible at the expense of unfair underwriting guidelines. Further, the elimination of an unfair underwriting guideline represents a loosening, not a restricting, of insurance markets. A niche market, by definition, is a subset of the population defined by certain characteristics of the consumers to be insured. While niche markets are most often thought of as small subsets of the population, the fact is that virtually every insurer defines its target market in terms of the characteristics of the consumers to be insured. Thus, the smallest insurer is no different than the largest insurer in defining its target market based upon a set of consumer characteristics. The rule therefore will not disproportionately affect any one type of insurer, no matter what size market the insurer targets. The marketing efforts affected by this rule are those which target more affluent consumers desiring coverage beyond the minimum coverage required by law. The Department has seen no evidence to suggest that those consumers purchasing only the minimum coverage required by law pose higher expected costs of the transfer of risk, all other factors constant. As a result, an insurer who targets affluent consumers does not take on a higher-risk consumer by selling a policy to a customer who meets all the insurer's underwriting guidelines but only seeks to purchase the minimum coverage required by law. The insurer is not harmed by issuing a policy to a consumer of similar risk to other consumers the insurer is willing to insure. Consumers of similar expected costs of the transfer of risk will be treated in a similar manner. This is fair to consumers and insurers. COMMENT: Commenters argued that the Department is moving too quickly on the proposed rule, is acting "at the eleventh hour," and should spend more time studying the proposed rule. Commenters argued that the Department should not act on this rule until the Commissioner appointed by Governor-elect Bush is confirmed by the Senate and has a chance to study the rule. DEPARTMENT'S RESPONSE: The Department disagrees for two reasons. First, the Department has thoroughly investigated the underwriting practices of insurers and availability problems discussed herein over a period of three years. Moreover, the Department has carefully analyzed the proposed rule and the comments provided both in writing and at the hearing. After careful consideration and deliberation, the Department has made some non-substantive changes to ensure that the rule is clear and unambiguous. However, the Department has concluded that the rule is necessary and appropriate. The Department does not believe there is a need for further analysis. Second, the consumers who are the victims of the unfair practices that are prohibited by this rule have suffered long enough. Moreover, the financial responsibility act is currently in force and provides the need for the Department to act to protect Texas consumers. There is no justification for permitting these practices to continue. The chronology of Department activities on the issues of insurance availability and unfair discrimination set out in the Reasoned Justification shows a long- term involvement and commitment by the Department. Department staff have worked on this rule for many months prior to its publication. However, in response to these concerns, the Department has amended the rule to apply only to actions taken after June 1, 1995.If the new commissioner believes amendments to the rule or repeal of the rule are necessary, then that commissioner will have the opportunity to do so. This delay will also give those persons subject to the rule sufficient time to make any changes in their practices that are necessary to comply with the rule. COMMENT: A commenter argued that the rule does not address the root causes of losses and costs in insurance. DEPARTMENT'S RESPONSE: The proposed rule is not aimed at reducing the root causes of losses and costs in insurance. Rather, the rule is intended to eliminate unfair practices. While the Department has taken steps to address the problems of losses and costs in insurance, such as through the creation of its safety unit, those efforts are not the subject of this rule. The Department disagrees that this concern should be a basis for rejecting this rule. COMMENT: A commenter argued that the rule prohibits a company from giving discounts because of volume. The commenter implies that placing a consumer who purchases a greater amount of insurance in a preferred company because that business is more profitable amounts to a discount to those consumers in the lower-rated company. The commenter argues that the rule runs counter to the policies set by the Department in approving a discount for homeowners insurance when the consumer purchases other types of insurance. The commenter also argued that the rule is inconsistent with the multiple car volume discount set out in the Automobile Rules and Rating Manual Rule 74. DEPARTMENT'S RESPONSE: The Department disagrees with the commenter's definition of "discount. "When a preferred insurance company refuses to issue a policy and the consumer is then placed in an affiliated standard or substandard company, this is not a "discount;"it is a denial of insurance in the preferred company. The preferred company has rejected the consumer. It has not "provided a discount" to the consumers it is willing to insure. Discounts for automobile insurance are regulated by the Texas Automobile Rules And Rating Manual, Rule 74.No "discount" has been approved for drivers who purchase additional amounts or types of coverage. Therefore, the Department disagrees that the practice of placing consumers who purchase additional coverages in a lower priced company and those consumers who purchase only minimum liability limits in a higher priced company constitutes a "discount" for those consumers in the lower priced company. Nor does the rule run counter to Department policies. The Department does not have a policy that allows unfair rejection of insurance coverage mandated by statute. This rule is limited to automobile insurance because the specific evil to be addressed by the rule is the unfair denial of a product that is required by statute. Contrary to the commenter's assertions, the rule is consistent with the Department's policy regarding discounts. In Rulesec.21.1003, the Department prohibited the use of a multiple car requirement as an underwriting guideline. The Department rejected the argument that a preferred insurer could reject single car applicants and put them in a standard or substandard company. Such treatment is not a discount, it is an unfair denial of coverage by the preferred company. Similarly, this rule prohibits a company from denying coverage based on the coverages purchased. The rule simply does not address, nor does it contradict any Department policy concerning, volume discounts. COMMENT:A commenter noted that the rule does not call the failure by insurers to sell more than minimum liability coverage an unfair trade practice. DEPARTMENT'S RESPONSE: The Department agrees that the rule does not prohibit an insurer or agent from selling solely the minimum liability limits required by law. However, the Department disagrees that this makes the rule inconsistent, ambiguous or arbitrary. When the state requires consumers to purchase a product, it is unfair for sellers to require those consumers to buy additional products beyond the state-mandated purchase. In the situation identified in the comment, the seller is not requiring the consumer to purchase products in excess of those required by statute. Such an insurer is simply providing the product required by statute and only that product. There is nothing inherently unfair in such a practice. COMMENT: A commenter argued that the proposed rule demonstrates no consistency in the Department's concept of unfair trade practices enacted under Article 21.21 or in the Department's articulation of how the rules advance the purpose of Article 21.21.The commenter claimed that the rule conflicts with sec.21.1002 if insurers can show a relationship to risk or expense based on the purchase of additional amounts or types of coverages. DEPARTMENT'S RESPONSE: The Department disagrees. First, Rule 21.1002 is a rule of prohibition, not a rule of authorization. That is, the rule provides that certain unfair underwriting guidelines may not be used. Nowhere in that rule does the Department provide permission to use underwriting guidelines that are risk related even if such guidelines are prohibited by statute or rule. In fact, the last section of that rule specifically provides: Other Laws Not Excepted. Compliance with subsection (a) of this section does not constitute an exemption from other rules or regulations of the department or statutory requirements. As described previously, the Department has prohibited unfair underwriting guidelines for one or both of the following reasons: (1) the guideline is inherently unfair or (2) the guideline is not based upon differences in the expected costs associated with the transfer of risk. The Department adopts this rule because it is inherently unfair for insurers and agents to condition the sale of insurance on the purchase of coverages in excess of that required by law. COMMENT: A commenter argued that insurance companies are free to determine the types and kinds of risk they will accept. The commenter argued that the legislature has expressed its policy that insurance companies are free to reject applicants for any reason whatsoever, other than reasons prohibited by other provisions of the Insurance Code or the federal laws such as those regarding discrimination. DEPARTMENT'S RESPONSE: The Department disagrees with this comment. The Legislature has determined that insurers should be limited to making fair business decisions. The Legislature passed Article 21.21 for the express purpose of prohibiting insurer management and agents from engaging in unfair and deceptive practices, even if management believes such unfair or deceptive practices are appropriate. Moreover, the NAII court upheld another rule which limited the right of management of insurance companies to reject applicants: Rule 1003 does not prevent insurers from accepting and rejecting risks; it merely prohibits the use of inaccurate substitutes ... for real risk factors. ...Rule 1003 prohibits the use of proxies for real risk factors. Similarly, the prohibition against rejection based on the underwriting guideline that is the subject of this rule is appropriate and within the Department's statutory authority. The new rule is adopted under Insurance Code, Articles 1.03A, 5.98, and 21. 21 sec.13.Article 1.03A authorizes the Commissioner to adopt rules and regulations for the conduct and execution of the duties and functions of the department as authorized by statute. Article 21.21 sec.13 authorizes the Department to promulgate rules and regulations to accomplish the purposes of Insurance Code, Articles 21.20 and 21.21.Article 5.98 authorizes the Department to adopt reasonable rules that are appropriate to accomplish the purposes of Insurance Code, Chapter 5, including Article 5.09 (prohibiting any distinction or discrimination in favor of an insured having a like hazard, which occurs when this underwriting guideline unrelated to risk or expense is used to place a consumer in a different company within a company group). Additional discussion of the Department's statutory authority to promulgate this rule is contained in the Reasoned Justification section entitled "The Department has authority to promulgate this rule. " The following Articles of the Insurance Code are affected by this rule: Articles 5.09 and 21.21. sec.21.1005. Prohibition Of Underwriting Guidelines Based On The Purchase Of Types OrAmounts of Coverage In Excess Of Minimum Limits Liability Coverage. (a) Prohibition. After June 1, 1995, an insurer or agent shall not use an underwriting guideline for private passenger automobile insurance based, in whole or in part, on whether an insured or applicant purchases types or amounts of coverage in excess of the minimum automobile liability coverage required to show proof of financial responsibility under the Texas Safety Responsibility Law, Texas Civil Statutes Article 6701h. The failure to comply with this section constitutes an unfair trade practice in the business of insurance in violation of the Insurance Code, Article 21.21, and shall be subject to the provisions thereof. (b) Definition Of "Underwriting Guideline. "For the purposes of this rule, an "underwriting guideline" is a rule, standard, marketing decision, guideline, or practice, whether written, oral or electronic, used by an insurer or its agent to examine, bind, accept, reject, renew, nonrenew, cancel or limit coverages made available to classes of consumers. (c) Definition of "Private Passenger Automobile Insurance. "For the purposes of this rule, "private passenger automobile insurance" is the insurance for which a personal auto policy is issued. This agency hereby certifies that the rule as adopted has been reviewed by legal counsel and found to be a valid exercise of the agency's legal authority. Issued in Austin, Texas, on January 19, 1995. TRD-9500815 D. J. Powers Chief Clerk and General Counsel Texas Department of Insurance Effective date: February 9, 1995 Proposal publication date: November 15, 1994 For further information, please call: (512) 463-6327 TITLE 30. ENVIRONMENTAL QUALITY Part I. Texas Natural Resource Conservation Commission Chapter 330. Municipal Solid Waste Subchapter F. Operational Standards for Solid Waste Land Disposal Sites 30 TAC sec.330.136 The Texas Natural Resource Conservation Commission (TNRCC) adopts an amendment to sec.330.136, concerning Special Waste Receipts Monthly Report, without changes to the proposed text as published in the September 23, 1994, issue of the Texas Register (19 TexReg 7501). The purpose of the amendment is to delete the reporting requirements which duplicated those requirements found in sec.330.603 and to achieve consolidation of all reporting requirements concerning special waste into sec.330.603. Under current municipal solid waste rules, sec.330.136(a)(6) requires municipal solid waste landfills which accept special waste to submit a monthly summary of special wastes received. The report must be submitted no later than the 25th day of the month following the month in which the wastes were received. This provision duplicates most of the requirements found in sec.330. 603, with the exception that reporting under sec.330.136(a)(6) is more frequent. Comments on the proposed rule were submitted by Browning Ferris Industries, Environmental Energy Group, and various individuals. One commenter favored modification of the reporting requirement in sec.330. 136(a)(6) to a quarterly basis and modification of form TNRCC-0297. One commenter was in total support of the rule amendment repealing the special waste monthly receipt reporting requirement. One commenter stated that discrepancies between the Annual Report Form used by the Waste Policy Division (form 0297) and the monthly Special Wastes Receipts Form (form 0140) will cause a loss of specificity concerning the reporting and receipt of certain categories of waste. Another commenter made the general statement that there is inadequate reporting on special waste. The executive director disagrees that a loss of some specificity regarding reporting of special wastes receipts will result from the proposed amendment or will pose any threat to the environment. In accordance with sec.330.601(b)(2) , municipal solid waste disposal facilities and processors are already required to report to the commission, information covering the types and amounts of waste disposed or processed at each facility, and other pertinent information necessary to track the amount of waste generated and disposed of, recovered, or recycled as well as the amount of processing and disposal capacity of each facility. Additionally, sec.330.603 specifies such requirements as report frequency, form, units (amount of waste received), and submittal date. For these reasons, the commission also disagrees with the comment regarding inadequate reporting of special waste. The commission recognizes the fact that special waste receipts reporting requirement are relatively amenable to simple spreadsheet submission. However, there are numerous fringe costs associated with reporting. As stated in the fiscal note attached to the proposed rule, the public benefit anticipated as a result of compliance with this section will be the more effective use of state revenues and resources, improved compliance with state solid waste regulations, and improvements in the accuracy and public access to agency records of solid waste management activities. Another commenter believed that this revision would affect sec.330.137(a) and (c) (which is included in sec.330.603 by reference), claiming such a revision was not consistent with legislative intent to examine and report nonhazardous waste management and state capacity conditions with greater specificity. The executive director disagrees with this commenter's statement since reporting of Class 1 wastes, the type of wastes addressed in sec.330.137(a) and (c), is already required in sec.335.15 (relating to Record Keeping and Reporting Requirements Applicable to Owners or Operators of Storage, Processing, or Disposal Facilities). The amendment is adopted under the Texas Water Code, sec. sec.5.103, 5.105, and 26.011, which provides the TNRCC the authority to adopt rules necessary to carry out its powers, duties, and policies and to protect water quality in the state; and sec.361.024 of the Texas Solid Waste Disposal Act, Texas Health and Safety Code (Vernon 1992), which provides the TNRCC with the authority to adopt rules to regulate the operation, management and control of solid waste under its jurisdiction. This agency hereby certifies that the rule as adopted has been reviewed by legal counsel and found to be a valid exercise of the agency's legal authority. This agency hereby certifies that the rule as adopted has been reviewed by legal counsel and found to be a valid exercise of the agency's legal authority. Issued in Austin, Texas, on January 18, 1995. TRD-9500811 Kevin McCalla Acting Director, Legal Division Texas Natural Resource Conservation Commission Effective date: February 9, 1995 Proposal publication date: September 23, 1994 For further information, please call: (512) 239-6087 TITLE 31. NATURAL RESOURCES AND CONSERVATION Part X. Texas Water Development Board Chapter 363. Financial Assistance Programs The Texas Water Development Board (board) adopts the repeal of sec.363.14 and new sec.363.14, concerning Environmental Assessment; and new sec.363.509, concerning Applicability, without changes to the proposed text as published in the December 16, 1994, issue of the Texas Register (19 TexReg 9958). The board withdraws the proposed amendment to sec.363.224, concerning Hardship Applications. The proposed sec.363.14 will apply to projects financed by the board with only state funds. The purpose of the section is to provide the board with a reasonable level of certainty that a proposed project will comply with the environmental regulations identified in the section. The existing sec.363.14 proposed for repeal also provided for an environmental assessment, but did not provide for less than the full review. The proposed sec.363.14 will require all applicants to submit preliminary project information to the executive administrator of the board and based on that information, the project will undergo a categorical exclusion, mid-level, or full environmental review. Under the proposed sec.363.14, based on the submitted information, the executive administrator will not require applicants to provide further information on the environmental regulations for those projects found eligible for the categorical exclusion review, will not require applicants to provide further information on unaffected environmental regulations but will require further information on the affected environmental regulations for those projects eligible for the mid-level review, and will only require a full environmental assessment document on those projects not eligible for the categorical exclusion or the mid-level reviews. Under the proposed sec.363.14, even when an environmental assessment document is prepared, coordination will not be required with the regulatory agencies which administer unaffected environmental regulations and the applicant will have the choice of requesting board assistance in coordinating the environmental assessment document or may coordinate with the appropriate regulatory agencies without board assistance. The proposed sec.363.14 will require that once the executive administrator has received the applicable responses from regulatory agencies, the executive administrator will prepare a memorandum which will include all relevant environmental data and any regulatory agency comments and public comments received regarding the proposed project and a finding regarding the proposed project's compliance with the environmental regulations and may include a recommendation on any avoidance, minimization, or mitigation measures recommended by an regulatory agency through this review process. The memorandum shall be submitted to and considered by the board with the application for financial assistance. Any assessment prepared by the applicant for any other governmental agency for the proposed project will be sufficient to comply with this section. Section 363.509 requires an environmental review for federally-funded projects consistent with 31 TAC sec.375.35. Comments were received from the Fort Worth Water Department. Comments commended the modifications to make rules easier and less costly for applicants to obtain loans. Subchapter A. General Provisions General Application Procedures 31 TAC sec.363.14 The repeal is adopted under Texas Water Code, sec.6.101, which requires the board to adopt rules to carry out the powers and duties of the board, under the Texas Water Code, and other laws of this state. This agency hereby certifies that the rule as adopted has been reviewed by legal counsel and found to be a valid exercise of the agency's legal authority. Issued in Austin, Texas, on January 20, 1995. TRD-9500879 Craig D. Pedersen Executive Administrator Texas Water Development Board Effective date: February 10, 1995 Proposal publication date: December 16, 1994 For further information, please call: (512) 463-7981 The new section is adopted under Texas Water Code, sec.6.101, which requires the board to adopt rules to carry out the powers and duties of the board, under the Texas Water Code, and other laws of this state. This agency hereby certifies that the rule as adopted has been reviewed by legal counsel and found to be a valid exercise of the agency's legal authority. Issued in Austin, Texas, on January 20, 1995. TRD-9500880 Craig D. Pedersen Executive Administrator Texas Water Development Board Effective date: February 10, 1995 Proposal publication date: December 16, 1994 For further information, please call: (512) 463-7981 Subchapter E. Economically Distressed Areas Program 31 TAC sec.363.509 The new section is adopted under Texas Water Code, sec.6.101, which requires the board to adopt rules to carry out the powers and duties of the board, under the Texas Water Code, and other laws of this state. This agency hereby certifies that the rule as adopted has been reviewed by legal counsel and found to be a valid exercise of the agency's legal authority. Issued in Austin, Texas, on January 20, 1995. TRD-9500881 Craig D. Pedersen Executive Administrator Texas Water Development Board Effective date: February 10, 1995 Proposal publication date: December 16, 1994 For further information, please call: (512) 463-7981 Chapter 375. State Revolving Loan Fund The Texas Water Development Board (board) adopts the repeal of sec.sec.375. 18-375.20, 375.39, 375.72-375.74, and 375.111, amendments to sec.sec.375.2, 375.4, 375.15, 375.35, 375.38, 375.51, 375.62, and 375.81, and new sec.sec.375.18-375.20, 375.40, 375.72, 375.74, and 375.75, concerning the State Water Pollution Control Revolving Fund, without changes to the proposed text as published in the December 16, 1994, issue of the Texas Register (19 TexReg 9961). The amendments will add an alternative method for receiving financial assistance (pre-design funding option) for first-tier SRF projects. These amendments are being made to respond to customer needs for early access to loan proceeds to pay for planning and design costs. Existing rule language will also be simplified and clarified. The amendments to sec.375.2, Definition of Terms, add definitions and clarify other definitions for consistency in meaning and use of the terms. The amendments to sec.375.4 and sec.375.62 and the repeal of sec.375.39 are to eliminate the use of hardship applications under the SRF program which are no longer used by the board. A new sec.375.40, Pre-Design Funding Option, is being added to provide an alternative method of receiving financial assistance from the board. Assistance under this section will provide the applicant with an option to close a loan with simplified technical requirements to receive earlier funding for project planning and design costs, with money for later phases of construction being escrowed until all environmental and technical requirements have been met. Amendments to sec.sec.375.15, 375.35, 375.38, and 375.81, and the repeal of sec.sec.375.18-375.20, 375.72-375.74, and 375.111, and new sec.sec.375. 18- 375.20, 375.72, and 375.74 will make changes necessary to be consistent with closing a loan under the new Pre-Design Funding Option being added under sec.375.40, clarify the procedures for escrowing funds, make changes to be consistent with definition changes under sec.375.2, and clarify requirements for loan applications. Section 375.51 is amended to remove an initial 270-day limitation on the term of commitment by the board. A new sec.375.75, Movement of Funds Between Approved Projects, is being added to allow a borrower to transfer excess funds remaining from one or more board approved projects to the borrower's other board-approved projects. Comments were received from Fort Worth Water Department and Environmental Protection Agency. The comments supported amendments to streamline the loan making process and provide flexibility in the areas of pre-design funding and excess fund transfers. Introductory Provisions 31 TAC sec.375.2, sec.375.4 The amendments are adopted under the authority of Texas Water Code, sec.6. 101 and sec.15.605, which requires the board to adopt rules necessary to carry out the powers and duties of the board provided by Texas Water Code, and adopt rules for the State Water Pollution Control Revolving Fund. This agency hereby certifies that the rule as adopted has been reviewed by legal counsel and found to be a valid exercise of the agency's legal authority. Issued in Austin, Texas, on January 20, 1995. TRD-9500872 Craig D. Pedersen Executive Administrator Texas Water Development Board Effective date: February 10, 1995 Proposal publication date: December 16, 1994 For further information, please call: (512) 463-7981 Program Requirements 31 TAC sec.sec.375.15, 375.18-375.20 The amendments and new sections are adopted under the authority of Texas Water Code, sec.6.101 and sec.15.605, which requires the board to adopt rules necessary to carry out the powers and duties of the board provided by Texas Water Code, and adopt rules for the State Water Pollution Control Revolving Fund. This agency hereby certifies that the rule as adopted has been reviewed by legal counsel and found to be a valid exercise of the agency's legal authority. Issued in Austin, Texas, on January 20, 1995. TRD-9500873 Craig D. Pedersen Executive Administrator Texas Water Development Board Effective date: February 10, 1995 Proposal publication date: December 16, 1994 For further information, please call: (512) 463-7981 31 TAC sec.sec.375.18-375.20 The repeals are adopted under the authority of Texas Water Code, sec.6.101 and sec.15.605, which requires the board to adopt rules necessary to carry out the powers and duties of the board provided by Texas Water Code, and adopt rules for the State Water Pollution Control Revolving Fund. This agency hereby certifies that the rule as adopted has been reviewed by legal counsel and found to be a valid exercise of the agency's legal authority. Issued in Austin, Texas, on January 20, 1995. TRD-9500868 Craig D. Pedersen Executive Administrator Texas Water Development Board Effective date: February 10, 1995 Proposal publication date: December 16, 1994 For further information, please call: (512) 463-7981 Applications for Assistance 31 TAC sec.sec.375.35, 375.38, 375.40 The amendments and new section are adopted under the authority of Texas Water Code, sec.6.101 and sec.15.605, which requires the board to adopt rules necessary to carry out the powers and duties of the board provided by Texas Water Code, and adopt rules for the State Water Pollution Control Revolving Fund. This agency hereby certifies that the rule as adopted has been reviewed by legal counsel and found to be a valid exercise of the agency's legal authority. Issued in Austin, Texas, on January 20, 1995. TRD-9500874 Craig D. Pedersen Executive Administrator Texas Water Development Board Effective date: February 10, 1995 Proposal publication date: December 16, 1994 For further information, please call: (512) 463-7981 31 TAC sec.375.39 The repeal is adopted under the authority of Texas Water Code, sec.6.101 and sec.15.605, which requires the board to adopt rules necessary to carry out the powers and duties of the board provided by Texas Water Code, and adopt rules for the State Water Pollution Control Revolving Fund. This agency hereby certifies that the rule as adopted has been reviewed by legal counsel and found to be a valid exercise of the agency's legal authority. Issued in Austin, Texas, on January 20, 1995. TRD-9500869 Craig D. Pedersen Executive Administrator Texas Water Development Board Effective date: February 10, 1995 Proposal publication date: December 16, 1994 For further information, please call: (512) 463-7981 Board Action on Application 31 TAC sec.375.51 The amendment is adopted under the authority of Texas Water Code, sec.6. 101 and sec.15.605, which requires the board to adopt rules necessary to carry out the powers and duties of the board provided by Texas Water Code, and adopt rules for the State Water Pollution Control Revolving Fund. This agency hereby certifies that the rule as adopted has been reviewed by legal counsel and found to be a valid exercise of the agency's legal authority. Issued in Austin, Texas, on January 20, 1995. TRD-9500875 Craig D. Pedersen Executive Administrator Texas Water Development Board Effective date: February 10, 1995 Proposal publication date: December 16, 1994 For further information, please call: (512) 463-7981 Engineering Design 31 TAC sec.375.62 The amendment is adopted under the authority of Texas Water Code sec.6.101 and sec.15.605 which require the board to adopt rules necessary to carry out the powers and duties of the board provided by Texas Water Code, and adopt rules for the State Water Pollution Control Revolving Fund. This agency hereby certifies that the rule as adopted has been reviewed by legal counsel and found to be a valid exercise of the agency's legal authority. Issued in Austin, Texas, on January 20, 1995. TRD-9500876 Craig D. Pedersen Executive Administrator Texas Water Development Board Effective date: February 10, 1995 Proposal publication date: December 16, 1994 For further information, please call: (512) 463-7981 Prerequisites to Release of Funds 31 TAC sec.sec.375.72-375.74 The repeals are adopted under the authority of Texas Water Code, sec.6.101 and sec.15.605, which requires the board to adopt rules necessary to carry out the powers and duties of the board provided by Texas Water Code, and adopt rules for the State Water Pollution Control Revolving Fund. This agency hereby certifies that the rule as adopted has been reviewed by legal counsel and found to be a valid exercise of the agency's legal authority. Issued in Austin, Texas, on January 20, 1995. TRD-9500870 Craig D. Pedersen Executive Administrator Texas Water Development Board Effective date: February 10, 1995 Proposal publication date: December 16, 1994 For further information, please call: (512) 463-7981 31 TAC sec.sec.375.72, 375.74, 375.75 The new sections are adopted under the authority of Texas Water Code, sec.6.101 and sec.15.605, which requires the board to adopt rules necessary to carry out the powers and duties of the board provided by Texas Water Code, and adopt rules for the State Water Pollution Control Revolving Fund. This agency hereby certifies that the rule as adopted has been reviewed by legal counsel and found to be a valid exercise of the agency's legal authority. Issued in Austin, Texas, on January 20, 1995. TRD-9500877 Craig D. Pedersen Executive Administrator Texas Water Development Board Effective date: February 10, 1995 Proposal publication date: December 16, 1994 For further information, please call: (512) 463-7981 Building Phase 31 TAC sec.375.81 The amendment is adopted under the authority of Texas Water Code, sec.6. 101 and sec.15.605, which requires the board to adopt rules necessary to carry out the powers and duties of the board provided by Texas Water Code, and adopt rules for the State Water Pollution Control Revolving Fund. This agency hereby certifies that the rule as adopted has been reviewed by legal counsel and found to be a valid exercise of the agency's legal authority. Issued in Austin, Texas, on January 20, 1995. TRD-9500878 Craig D. Pedersen Executive Administrator Texas Water Development Board Effective date: February 10, 1995 Proposal publication date: December 16, 1994 For further information, please call: (512) 463-7981 Rating Information 31 TAC sec.375.111 The repeal is adopted under the authority of Texas Water Code, sec.6.101 and sec.15.605, which requires the board to adopt rules necessary to carry out the powers and duties of the board provided by Texas Water Code, and adopt rules for the State Water Pollution Control Revolving Fund. This agency hereby certifies that the rule as adopted has been reviewed by legal counsel and found to be a valid exercise of the agency's legal authority. Issued in Austin, Texas, on January 20, 1995. TRD-9500871 Craig D. Pedersen Executive Administrator Texas Water Development Board Effective date: February 10, 1995 Proposal publication date: December 16, 1994 For further information, please call: (512) 463-7981