1
 1   
 2               BEFORE THE INSURANCE COMMISSIONER
 3                  OF THE STATE OF CALIFORNIA
 4                            --o0o--
 5   
 6   PUBLIC HEARING RE:                )
                                       )
 7   TITLE INSURANCE RATE REGULATIONS  )
     AND STATISTICAL PLAN,             )
 8                                     )
     File No. RH05049799               )
 9   __________________________________)
10   
11             REPORTER'S TRANSCRIPT OF PROCEEDINGS
12                  ___________________________
13                  Wednesday, August 30, 2006
14                          10:00 a.m.
15                     (Pages 1 through 200)
16   
17              California Department of Insurance
18                 Administrative Hearing Bureau
19                         Hearing Room
20                 45 Fremont Street, 22nd Floor
21                   San Francisco, California
22   
23   
24   REPORTED BY:  JOHNNA PIPER CSR 11268      JOB 384975
25   

2
 1                           I N D E X
 2   
 3   APPEARING FOR THE CALIFORNIA DEPARTMENT OF INSURANCE:
 4            GARY COHEN, General Counsel
 5            DOUG BARKER, Chief of Rate Filing Bureau
 6            BRYANT W. HENLEY, Staff Counsel
 7   
 8                  STATEMENTS BEFORE THE PANEL
 9   Mr. Woods............................4
10   Mr. Clark............................8
11   Mr. Miller...........................17
12   Dr. Appel............................41
13   Dr. Vistnes..........................61
14   Mr. Marcial..........................81
15   Mr. Anderson.........................85
16   Mr. Belote...........................89
17   Ms. Butler...........................93
18   Ms. Howard...........................95
19   Ms. Garcia...........................99
20   Mr. Egan.............................106
21   Mr. Hogeboom.........................111
22   Ms. Ackerman.........................114
23   Dr. Hazleton.........................120
24   Ms. Laffin...........................146
25   Mr. Carlston.........................159

3
 1                 STATEMENTS BEFORE THE PANEL
 2   
 3   Dr. Lipshutz.........................160
 4   Mr. Page.............................176
 5   Ms. Garcia...........................178
 6   Ms. Woodkey..........................186
 7   Ms. Koch.............................190
 8   Ms. Monroe...........................191
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10   
11   
12   
13   
14   
15                            --o0o--
16   
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18   
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20   
21   
22   
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25   

4
 1                     P R O C E E D I N G S
 2            MR. COHEN:  Good morning.  This is the public
 3   hearing on the Department's Title Insurance Statistical
 4   Plan and Related Rules Governing Rates and charges CDI
 5   file number RH05049799.  So if your plans for the day,
 6   unfortunately for you, call for you to be doing
 7   something else, now would be a good time for you to
 8   leave.
 9            I'm Gary Cohen.  I'm general counsel of the
10   Department.  I will be presiding over the hearing.  To
11   my right is Bryant Henley, an attorney with the legal
12   division.  And to my left is Doug Barker, who is the
13   Chief of Rate Filing Bureau who will be participating
14   with me.
15            And I believe that the first speaker today is
16   James Woods.
17            MR. WOODS:  Thank you, Mr. Cohen.  My name is
18   James Woods.  I'm a partner with the law firm of
19   LeBoeuf, Lamb, Greene & MacRae and I represent Fidelity
20   National Title Insurance Group.
21            MR. HENLEY:  Mr. Woods, I think your microphone
22   is not on, unfortunately.
23            MR. WOODS:  So you couldn't hear me?
24            MR. HENLEY:  I can still hear you just fine,
25   but if you would for the audio, pull the lever on the

5
 1   very top of the microphone forward.  It is up closer to
 2   the --
 3            MR. WOODS:  Got it.  Okay.
 4            MR. HENLEY:  And also, if you would, Mr. Woods,
 5   and we're going to ask all the folks who want to comment
 6   this morning, state your name and also spell it for the
 7   record and because these proceedings are being reported,
 8   we appreciate it if you would do your best to speak
 9   slowly.  Thank you.
10            MR. WOODS:  Yes, I gave the court reporter my
11   business card.
12            James Woods, W-O-O-D-S, on behalf of Fidelity
13   National Title Insurance Group.
14            We are pleased to present today four witnesses.
15   They are -- to testify.  They are Norris Clark, former
16   Chief Deputy Commissioner for the Financial Surveillance
17   Division of the California Department of Insurance who
18   was responsible for all aspects of insurer financial
19   regulation and monitoring while he occupied that
20   position with the California Department of Insurance for
21   13 years.  Mr. Clark was the Chief Financial Regulator
22   for the California Department of Insurance.  He will
23   testify to the unprecedented length and complexity of
24   the proposed regulations, the implications that require
25   GAAP versus SAP reporting, and the regulation's

6
 1   incongruity with statutory intent.
 2            Next, we wish to present Michael Miller, a
 3   nationally known and recognized consulting actuary.  Mr.
 4   Miller will testify to the unorthodox nature of
 5   rate-making standards proposed by the regulations and
 6   the implications thereof.
 7            Thereafter, Dr. David Appel, an economist who
 8   is with Milliman, will testify.  Dr. Appel will testify
 9   to the confiscatory nature of the maximum rate of return
10   proposed by the regulations.
11            And he will be followed by Dr. Gregory Vistnes,
12   a competition economist with CRA.  Dr. Vistnes had been
13   with the Department of Justice and the FDC.  Dr. Vistnes
14   will testify that California's title insurance industry
15   is competitive.
16            In addition to the presentation of these
17   witnesses, Mr. Henley and Mr. Cohen and Mr. Barker, this
18   morning we've filed with you written testimony of two --
19   not only their written testimony but written testimony
20   of two additional witnesses who will not appear today.
21   They are John Crowley, the chief information officer of
22   Fidelity National Title Group.  Mr. Crowley's written
23   testimony assesses the financial impact of attempting to
24   implement the proposed regulations.  He concludes that
25   it would cause Fidelity National Title Group many

7
 1   millions of dollars in excess -- well in excess of $100
 2   million to implement.
 3            Mr. Crowley could not be here today because of
 4   tropical storm or Hurricane Ernesto.
 5            Additionally, we've submitted the written
 6   testimony of Mark Folk, a CPA.  Mr. Folk examines
 7   accounting and clarity deficiencies of the proposed
 8   regulations.
 9            Equally important, we have submitted this
10   morning in our written testimony for the commissioners'
11   consideration in the record a letter which details many
12   legal deficiencies of the proposed regulations,
13   including the total absence of authority for the
14   Commissioner to promulgate the regulations, the failure
15   to create a predicate for a finding that there does not
16   exist competition for title insurance in California, the
17   deprivation of due process and other procedural rights
18   of the title industry.
19            Thirdly, the deprivation of due process and
20   other procedural rights of the title industry by the
21   proposed regulations, the taking of property
22   contemplated by the proposed regulations in violation of
23   the 5th and 14th Amendments to the United States
24   Constitution, and the failure of the proposed
25   regulations to meet any of the six mandatory standards

8
 1   established by Government Code Section 11349.1.
 2            And with respect to that last point, I draw the
 3   panel's attention to the appendix of the written
 4   material we submitted to you.  Appendix 1 lists the
 5   inconsistencies in use of defined terms within the
 6   proposed regulation; Appendix 2, undefined terms within
 7   the proposed regulation which are key for understanding
 8   them; and finally, Appendix 3, over 150 incorrect
 9   references in the proposed regulations are listed.
10            With that, Mr. Henley, I call our first witness
11   who will summarize briefly his written testimony and
12   that is Mr. Norris Clark.
13            Mr. Clark, if you would state your name and
14   professional affiliation and any other career
15   affiliations you had that might be relevant to this
16   proceeding and briefly summarize for the panel your
17   observation about the proposed regulations.
18            MR. CLARK:  Thank you and good morning.  My
19   name is Norris Clark, N-O-R-R-I-S, C-L-A-R-K.  I'm a
20   consultant with the law firm of Lord, Bissell & Brook.
21            Prior to working for Lord, Bissell & Brook, I
22   worked for the Department of Insurance for 31 years,
23   primarily all in the financial regulation side of the
24   Department.  I was Deputy Commissioner in charge of
25   financial surveillance in the last 13 years that I was

9
 1   with the Department.
 2            I also was involved in development of NEIC
 3   accounting standards as the chair of the Statutory
 4   Accounting Principles Working Group.  That group
 5   developed all of the current statutory accounting
 6   principles, including those that cover title insurance.
 7   And let's just say this is my first time speaking from
 8   this side of the table and I will keep my comments short
 9   because --
10            MR. COHEN:  You'll get used to it.
11            MR. CLARK:  -- I know Gary and Doug have heard
12   my talk enough during my time with the Department.
13            When I was first approached by Jim Woods on
14   behalf of Fidelity National to review these regulations,
15   I was -- and was given a copy of them, I was obviously
16   surprised by the volume and length of the regulation.
17   And I was also -- I also went to the insurance codes,
18   because in my long career with the Department, I was
19   always under the impression that in the area of title
20   insurance, that we had lacked the regulatory --
21   statutory authority to set -- set title insurance rates
22   or to do any sort of prior approval of title insurance
23   rates.  Looking at the -- looking at the code, I was
24   surprised to find out that the law that was being used
25   as the basis for these regulations had been in place

10
 1   since 1973, which actually was the first year I joined
 2   the Department.
 3            I will not reiterate my written testimony, but
 4   just quickly focus -- summarize and focus on the areas
 5   that my testimony covered.  And that is that the
 6   regulations, in my experience, are the longest, most
 7   complex and least understandable that I'm aware of, both
 8   in the time that I wrote -- that I assisted in reviewing
 9   and sometimes writing statutes as well as regulations.
10   Also, the amount of data that's required to be submitted
11   on the basis of consolidating generally accepted
12   accounting principles as opposed to the statutory
13   accounting principles seems not reasonable for a number
14   of reasons.  And finally, the regulation focuses only on
15   the part of the statute that covers excessive rates
16   while the statute talks about the Department's ability
17   to regulate in some form excessive inadequate or
18   unfairly discriminatory rates.
19            MR. COHEN:  Mr. Clark, when you were working at
20   the Department, what sort of financial information, by
21   which I mean cost information and other sorts of
22   financial information, were title companies required to
23   provide to the Department in connection -- what sort of
24   financial information were title companies required to
25   provide to the Department in connection with their rate

11
 1   filings?
 2            MR. CLARK:  The information that they filed in
 3   connection with the rate filing was -- I believe that
 4   related to their rating plans and was filed on the basis
 5   of statutory accounting.  It was not -- not voluminous.
 6            MR. COHEN:  Well, but isn't it true that the
 7   title companies have been required to provide no
 8   financial information relating to their costs to justify
 9   what their rates have been and that was true during the
10   entire time you worked for the Department?
11            MR. CLARK:  Well, the title companies filed
12   significant information about their expenses within
13   their existing filed annual statements and quarterly
14   statements.
15            MR. COHEN:  Right, I'm asking about the rate
16   filings.
17            MR. CLARK:  I said I think that's correct.
18            MR. COHEN:  And the code does provide that the
19   Commissioner may prescribe, by reasonable rules and
20   regulations, for annual reporting of financial data with
21   respect to title companies, right?  And that's Section
22   12401.5.
23            MR. CLARK:  Correct.
24            MR. COHEN:  Okay.  So is your objection today
25   that the Department is asking for financial information

12
 1   from title companies or you just think we're asking for
 2   too much?
 3            MR. CLARK:  My point is that you are asking for
 4   too much in a form that is difficult for -- to be
 5   verified as it being comparable to that information that
 6   is filed with the regular financial filings that title
 7   insurers make.
 8            MR. COHEN:  Difficult for who to verify?
 9            MR. CLARK:  Anybody.
10            MR. COHEN:  Well, but --
11            MR. CLARK:  Again, the regulation requires
12   expense information to be filed for many categories.  I
13   counted 50.  It requires them to be filed -- it is
14   unclear -- but on somewhat on a consolidated basis.  It
15   is unclear if it is to be of the data for the title
16   insurers through the controlled escrow companies or not,
17   as I say, in one -- my count, 50 expense items.  There's
18   -- the annual -- the regular statutory reports are not
19   devoid of some specificity.  There are 30 expense
20   classifications that are in the expense exhibit in the
21   annual statement.  So my view is that if I'm going to
22   have rating information filed on a consolidated GAAP
23   basis in different categories than it is filed in the
24   annual statement and on a different accounting basis,
25   that reconciling those numbers is going to be difficult,

13
 1   if not impossible.
 2            MR. BARKER:  Mr. Clark, during your tenure as
 3   chief at -- of the financial surveillance branch, are
 4   you aware that -- are you aware of any person at the
 5   Department ever defining excessive rates within the
 6   meaning of the insurance code that disallows excessive
 7   rates?  Any regulations, any bulletins, or any memoranda
 8   or any attempt to define excessive rates within the
 9   meaning of the code?
10            MR. CLARK:  By regulation, I don't believe so.
11            Okay.  I'll continue just very briefly.  Again,
12   I think we've discussed now the issue of the
13   reasonableness of requiring the expense data be supplied
14   on a GAAP versus a SAP basis.
15            The final point that I would make is that,
16   again, this regulation, for all of its length,
17   complexity and difficult -- difficult -- varying
18   difficulty in being comprehended, essentially comes up
19   with a maximum allowable rate.  And that, as near as I
20   can tell, is an accumulation of the multiple expenses
21   that are -- that are filed in the statistical plan go
22   through a lot of calculations related to what the
23   expected future business of the company is going to be
24   and come up with a maximum rate, which essentially end
25   up being the average for the industry.  I certainly have

14
 1   a little bit of difficulty with the idea that the
 2   average is, by definition -- or one cent over the
 3   average is, by definition, excessive.  And I also think
 4   that the rate regulation, the statute contemplates that
 5   the determination of whether a rate is excessive,
 6   inadequate or unfairly discriminatory is done on a --
 7   should be done on a company-by-company basis based on
 8   their own facts and circumstances.
 9            MR. HENLEY:  Mr. Clark, with respect to the
10   average rates that you are talking about in the areas
11   within the rate regulations that deal with averages,
12   based upon your responses to Mr. Barker, I assume that
13   you agree that those averages are averages in a market
14   where there has never been a finding of excessiveness so
15   no rate has ever been limited under those averages to
16   date, at least during your tenure with the Department;
17   is that fair to say?
18            MR. CLARK:  That's fair.
19            MR. HENLEY:  Okay.  Thank you.
20            MR. CLARK:  Again, my testimony is that, you
21   know, in my opinion, establishing an industry average as
22   a sort of a cap on the rate that can be charged is not
23   in compliance with the intent of the statute because I
24   believe the statute contemplates that you will evaluate
25   excessiveness or inadequacy in relation to each

15
 1   insurance company and not -- and not as a whole.
 2            So, again, I would conclude that in the
 3   rates -- the regulation is extremely complicated to the
 4   point of being, in many instances, incomprehensible,
 5   very unclear as in a number of parts -- a number of
 6   instructions, has ambiguities.  The burden placed on the
 7   industry of developing a whole new set of accounting --
 8   accounting reporting requirements based on information
 9   that they've not -- their accounting systems, in many
10   instances, probably don't capture is not warranted since
11   statutory accounting again is the basis for all of the
12   rest of the reporting before the Department of
13   Insurance.  And that, while the Department certainly has
14   the -- I think statute would imply that certainly the
15   Department has the ability to regulate the rates of
16   insurance companies on an entity-by-entity basis based
17   on the standards of the excessiveness and inadequacy, it
18   doesn't provide that the Department can establish an
19   industry-wide cap as being the level of excessiveness.
20            MR. COHEN:  Do you know whether any of the
21   title insurers report on a GAAP basis, if not to the
22   Department then for other purposes?
23            MR. CLARK:  Well, certainly a number of the
24   title companies are publicly traded SEC registrants, so
25   they do GAAP statements, but -- they report on a GAAP

16
 1   basis, but again, the level of the accounting that is
 2   done sort of on a ledger basis is not as comprehensive
 3   as would be required by these -- the statistical rating
 4   plan and regulations.  The fact that they file GAAP
 5   numbers does not mean that all of the levels of
 6   expense -- expenses, for example, in the regulation are
 7   accounted for in the books at that level on a GAAP
 8   basis.
 9            MR. COHEN:  So I take it that if you had been
10   instructed by the Insurance Commissioner while you
11   worked at the Department to come up with a financial
12   reporting plan, a statistical plan for the title
13   industry, you would have come up with one that was
14   simpler in terms of the number of categories and
15   information that it asked for?
16            MR. CLARK:  Yes, I would have come up with --
17   yeah, obviously simpler based on statutory accounting
18   and so that it was more readily easily verifiable, both
19   by the statistical advisory organization and by the
20   Department.
21            MR. COHEN:  You said there were 50 categories
22   of expenses.  Can you identify for us which categories
23   of expenses you think aren't necessary or should be
24   eliminated from the regulation, assuming we're going to
25   go ahead and adopt one?

17
 1            MR. CLARK:  Again, I would start with the
 2   basic -- I would start with the basic expense categories
 3   that are included in the statutory filings.  One example
 4   is I think like messenger services.  Some of those
 5   things, there's one line that includes about four
 6   expense items, messenger services, et cetera, in the
 7   rate regulation are broken down, like you have to
 8   categorize them as four different types, and I don't see
 9   why that level of precision is necessary in a
10   statistical plan.
11            MR. COHEN:  Thank you, Mr. Clark.
12            MR. CLARK:  Thank you.
13            MR. WOODS:  Mr. Cohen and the Panel, our next
14   witness is Michael Miller.
15            Mr. Miller, would you please state for the
16   record your name, your affiliation, and any relevant
17   background to this proceeding and give a brief synopsis
18   of your written comments.
19            MR. MILLER:  Yes.  Good morning.  My name is
20   Michael Jay Miller.  Miller is M-I-L-L-E-R.  I'm a
21   fellow of the Casual Actuarial Society and a member of
22   the American Academy.  I've been in the actuarial
23   profession for over 30 years, over 20 of which as a
24   consulting actuary.
25            Actuaries are -- one of the tests that we're

18
 1   tested on to become members of the profession deals with
 2   the history and application of rate regulatory laws and
 3   those of us that practice in the area of rate-making
 4   apply rate regulatory laws as part of our work on an
 5   almost daily basis.  So I'm speaking this morning from
 6   over 30 years of experience with rate filings and
 7   rate-making issues and virtually daily application of
 8   rate regulatory laws in one state or the other.
 9            This morning I would like to summarize
10   four points that are addressed in my written testimony.
11   There are other issues that I address, but I would like
12   to just focus on four this morning.  The first deals
13   with what I understand to be a fundamental change in the
14   definition of rate standards, specifically the
15   definition of an excessive rate.  The second issue deals
16   with the harm that I see to the competitive marketplace.
17   The third issue deals with the statistical plan and the
18   required data reporting, the level of detail in that
19   reporting requirement.  And the fourth issue has to do
20   with the mechanical rate-making formula that is included
21   in the regulation I think will lead to almost a total
22   sacrifice of rate stability in favor of responsiveness
23   and it will be responsive in tracking the cyclical
24   changes and the premium volume which is a function for
25   title insurance of real estate market activity and

19
 1   unfortunately, the cyclical nature of the rates are
 2   going to be about two years out of sync with the cycle.
 3            The first of the issues, the fundamental change
 4   of the definition of rate standards -- rate standards
 5   with respect to excessive rates, my understanding of the
 6   current definition of excessive rates for title
 7   insurance in California is that it is a two-prong test:
 8   First there needs to be a finding that a reasonable
 9   degree of competition doesn't exist in the marketplace
10   and then on an insurer-by-insurer basis, there would be
11   a finding that a specific insurer was charging rates
12   unreasonably high.  As I understand it, it would be an
13   insurer-by-insurer determination that a specific
14   insurer's rates were unreasonably high in relation to
15   the insurer's expected costs.
16            After implementation of this regulation, I
17   understand it to mean that there would be no further
18   testing of whether competition exists in the market or
19   not, nor would there be a situation where you ever
20   evaluate an insurer's expected costs in relation to the
21   rates they are being charged.  It is just a simple test.
22   If they are charging a rate that is in excess of the
23   maximum rate that comes out of the rate-making formula,
24   then by definition, that is an excessive rate.  It leads
25   to some unusual -- there are going to be unusual

20
 1   situations.  You are going to have situations where an
 2   insurer that has lower than average costs, lower than
 3   the industry average costs, are going to be permitted to
 4   charge higher rates than their own expected costs would
 5   justify.  I read the regulation to say that an insurer
 6   could charge up to the maximum rate without ever being
 7   tested.
 8            MR. COHEN:  Isn't that true now?
 9            MR. MILLER:  I don't think so.
10            MR. COHEN:  So you are saying that a company
11   that has lower than average costs can't today charge
12   rates that are higher than some other company?
13            MR. MILLER:  No, I didn't say that.
14            MR. COHEN:  That's my question.  Isn't that
15   true today that it doesn't matter what the insurer's
16   costs are, they can charge whatever they want?
17            MR. MILLER:  I don't think so.  I don't think
18   so.
19            MR. COHEN:  What prevents them from doing that?
20            MR. MILLER:  I read the rate standards to say
21   now that an insurer's rates have to be cost based.  They
22   can't be inadequate, unfairly discriminatory or
23   excessive.  Those are cost-based standards.  And so I
24   would -- I would contend, I would understand it to mean
25   that each insurer should be -- rates should be based on

21
 1   their expected costs with one -- with one proviso here,
 2   and that is the rates can't be determined to be
 3   excessive if there's a reasonable degree of competition
 4   in the market.  But under this regulation, insurers with
 5   below-average costs could charge up to the maximum rate
 6   and those rates would not be tested or disapproved or
 7   questioned, as I understand the regulation.  So in a
 8   situation where the market was not competitive, insurers
 9   would be able to charge above their expected costs and
10   those rates would be accepted.  I think that is the
11   difference.
12            MR. COHEN:  But isn't that a function of -- I
13   mean, it sounds like that is a complaint for the
14   Legislature.  In other words, the Legislature has not
15   provided for a system of prior approval of title rates
16   the way it has in some other lines of insurance.  So we
17   don't have the ability to tell an insurer how high a
18   rate they can charge other than we have the ability to
19   say that they may not charge a rate that is unreasonably
20   high or excessive assuming we also make the finding of
21   lack of sufficient competition.  If the Legislature
22   passed a law that said that we had the same kind of rate
23   regulation authority in title as we do in auto or
24   homeowners, your problem would go away, right?
25            MR. MILLER:  Well, certainly if they changed

22
 1   the law, then it would change the rules of the game, but
 2   they haven't changed the law.  They have passed a law
 3   and the way I read this regulation, this regulation
 4   would change the law as to what constituted an excessive
 5   rate.
 6            There will also be situations when rates
 7   charged by an insurer are inadequate to cover their
 8   expected costs and would be considered inadequate under
 9   the current law, but they will be capped as being
10   excessive under the proposed regulation because this
11   specific insurer happens to have average costs, expected
12   costs, just even slightly above the average.
13            There's going to be a catch-22.  I think that's
14   the right way to describe it.  This regulation --
15   obviously the Commissioner says in the regulation,
16   there's a finding that the Commissioner has made that a
17   reasonable degree of competition does not currently
18   exist and in some of the introductory material, it says
19   that if this regulation is adopted, it would tend to
20   reinvigorate the competition in the marketplace.  Well,
21   if it does reinvigorate the competition in the
22   marketplace, then it seems to me that there ought to be
23   some kind of self destruction of the regulation.  There
24   ought to be some kind of sunset provision, but that's
25   not there.  Even if competition continues or is

23
 1   re-instituted in the Commissioner's determination, this
 2   regulation stays in place and supplants the current
 3   definition of excessive rates.
 4            MR. COHEN:  So just let me summarize.  You are
 5   assuming, it sounds like for purposes of your testimony,
 6   that number one, an insurer that had inadequate rates
 7   under -- because the maximum rate permitted by the
 8   regulation was inadequate to give it a reasonable rate
 9   of return based on its costs, expenses, expected losses
10   and return on capital, you are assuming that insurer
11   would have no remedy with respect to that situation; is
12   that right?
13            MR. MILLER:  That's the way I read the
14   regulation.
15            MR. COHEN:  Okay.
16            MR. MILLER:  The rates are just excessive.
17            MR. COHEN:  So if you are wrong about that
18   assumption, then what you have to say really isn't
19   particularly meaningful today on this subject.  If an
20   insurer would, in fact, have a remedy, you just
21   haven't --
22            MR. MILLER:  That would certainly put some
23   ease.  I mean, you know, I would feel better about it
24   if --
25            MR. COHEN:  And you are assuming that if there

24
 1   is no -- if the situation were to change and there were
 2   to be a reasonable rate of competition, you are assuming
 3   that nothing about the regulations is going to change.
 4   You are assuming that even though the law says that the
 5   Commissioner may only find rates excessive if he makes a
 6   finding that there is not a reasonable rate of
 7   competition, you are assuming that the future
 8   commissioners will flout the law and notwithstanding the
 9   fact that a reasonable degree of competition might
10   exist, they will continue to set a maximum rate, number
11   one.  And number two, you are further assuming that
12   insurers will have no remedy in that situation.
13            MR. MILLER:  No.  No, I'm not assuming any of
14   that.  What I'm -- and I'm not contending the future
15   commissioners will flout the law.
16            MR. COHEN:  It sounds like it.
17            MR. MILLER:  No.  Then you misunderstood what
18   I've said.
19            MR. COHEN:  Well, you are saying even if
20   competition comes into this market, commissioners made a
21   finding there is not a reasonable amount of competition,
22   you are assuming that if the efforts of this regulation
23   and other things that we're doing are successful and
24   there is a degree of competition, you are assuming that
25   even though the law says in that situation, the

25
 1   Commissioner doesn't have authority to regulate rates,
 2   he is going to go ahead and do it anyway.  That is what
 3   you are saying.
 4            MR. MILLER:  No, I think I'm assuming -- I am
 5   assuming that this regulation will stay in place if
 6   competition returns to the marketplace and excessive
 7   rates will continue to be defined by this regulation.  I
 8   am assuming that.  That's the way I read the regulation.
 9   If I'm wrong about that, then I'm wrong about that.  But
10   I don't find where this regulation self-destructs or
11   sunsets if competition returns to the marketplace.
12            MR. HENLEY:  Mr. Miller, are you familiar with
13   the government code and the procedures for petitioning
14   for a rule making action in the State of California?
15            MR. MILLER:  Not the kind of detail that an
16   attorney would have, no.
17            MR. HENLEY:  Okay.
18            MR. BARKER:  Mr. Miller, putting aside the
19   issue of future findings of competition, is it your
20   position that insurers should be able to recover any and
21   all costs they incur in their rate-making?
22            MR. MILLER:  I wouldn't describe it as
23   recovering all costs.  I think rate-making, all
24   rate-making, is respective in nature.  Costs that are
25   incurred, whether they be losses or expenses in the past

26
 1   or behind us, that is water under the bridge.  The rates
 2   are always set on a prospective basis based on what is
 3   expected in the future, so it is not a question of
 4   recovery in my mind.
 5            MR. BARKER:  Do you agree that there is a place
 6   for a regulation to define reasonable costs?
 7            MR. MILLER:  If the Commissioner has authority
 8   under the law to do that, I don't.  But I don't know
 9   that the Commissioner does in California.
10            MR. BARKER:  Well, that is why I prefaced the
11   question that we're going to put aside the issue of
12   competition.  Let's assume that we're talking about a
13   situation where there is a current finding of lack of
14   competition.  The issue then is what is an excessive
15   rate and what costs should be included in defining an
16   excessive rate.  And I'm trying to pin you down as to
17   what the boundaries of an excessive rate are in that
18   scenario.
19            MR. MILLER:  Well, the current definition of
20   excessive rate in a noncompetitive market is
21   unreasonably high in relation to the services.  I
22   interpret that, as an actuary, to mean unreasonably high
23   in relation to the expected costs.  And the expected
24   costs include expected losses, expected expenses and
25   expected costs of capital.

27
 1            Now, how much higher than the expected costs
 2   does it have to be before it becomes unreasonably high?
 3   I don't know the answer to that.  That -- that's not
 4   defined.  I suppose at the extreme, it could be one cent
 5   above, but there's some -- there is some degree above
 6   those excessive -- expected costs where a rate does
 7   become excessive and this regulation sets that level
 8   equal to the industry average.  If you are --
 9            MR. BARKER:  Let me ask you this:  To build on
10   that point, is it not reasonable to use industry data in
11   defining costs and prospective costs for an industry and
12   applying them to an individual insurer?
13            MR. MILLER:  The way I read your rate
14   regulation and your rate law in California and the way
15   it is applied and these laws are applied in most other
16   states, it is on an insurer-by-insurer basis.  I don't
17   think you can determine an individual insurer's rates,
18   whether they are inadequate or excessive, without taking
19   a look at the insurer's expected -- own expected costs.
20            MR. BARKER:  What if that insurer's data is not
21   credible or that insurer's not collecting uniformly
22   relevant data?
23            MR. MILLER:  Data credibility problems are a
24   problem in all -- most all rate-making scenarios for
25   almost all insurers and that data credibility problem

28
 1   doesn't have to be solved through some kind of industry
 2   average.  It could also -- it depends on the data
 3   element in the rate formula.  When you are testing a
 4   particular insurer's rates and one of the data elements
 5   is not fully credible from an actuarial standpoint, you
 6   may fill in the lack of credibility with that insurer's
 7   data from other states.  There are a lot of ways to go
 8   before you get to some kind of industry average.  And
 9   this -- it seems to me like this regulation tosses out
10   all consideration of individual insurer's expected
11   losses and expenses and substitutes industry totals for
12   everything.
13            MR. COHEN:  What if the costs that are to be
14   recovered in a rate include illegal kickbacks, rebates
15   and bribes that are forbidden by law?
16            MR. MILLER:  No.  What goes in the rate
17   calculation from the actuarial standpoint are expected
18   future recurring expenses and you can't -- you can't put
19   in illegal expenses.  First of all, they are against the
20   law.  And second of all, you don't expect them to recur.
21            MR. COHEN:  You are looking at the wrong
22   industry, Mr. Miller.  In this industry, they've been
23   recurring for a long time.
24            MR. MILLER:  They don't go in if they are
25   illegal, period.  For whatever basis you want to exclude

29
 1   them, they are excluded by law, then they are excluded
 2   from the rate calculation.
 3            MR. COHEN:  So would you agree that the
 4   Insurance Commissioner has authority to forbid the
 5   recovery in rates of illegal payments?
 6            MR. MILLER:  Sure.
 7            Can I move to the next point?
 8            MR. COHEN:  Yes.
 9            MR. MILLER:  Okay.  The second point has to do
10   with establishing a maximum rate based on industry
11   average costs.  Whenever you cap rates for some insurers
12   below their expected costs, there are going to be some
13   market availability problems created.  How severe the
14   market availability problems are are dependent upon how
15   severe the caps are.  When you use an industry average
16   as the maximum rate, that's a fairly severe cap because
17   around any average, there are going to be insurers that
18   are below average and insurers that are above average.
19   That's the nature of an average.  The first time the
20   maximum rates are calculated, there will be some
21   insurers that have expected costs above the industry
22   average and need to be able to charge, in order to have
23   adequate rates, higher than the mandated maximums and so
24   for those insurers, the rates will be inadequate and
25   they will have a couple of choices.  They can drop out

30
 1   of the market.  I mean, no insurer is going to continue
 2   in any line of insurance to operate where they think
 3   they are going to have inadequate rates for a long
 4   period of time or they can move to change their
 5   operation in some way to reduce the expenses to get down
 6   to that industry average level.  It sounds pretty
 7   appealing, but whatever they do, those that drop out,
 8   those that change their expenses of operation, that will
 9   change the industry average costs that come out of the
10   statistical plan the next time the calculation is made
11   and now your industry average maximum rate will change
12   and you'll have a new set of insurers that are above
13   average having their rates capped.  Insurers that the
14   first time around were below-average cost insurers, some
15   of those will now be above average.  It will lead to
16   uniform rates and ultimately, unless somebody steps in
17   and changes the regulation, it would lead to a single
18   insurer or just a couple of insurers that happen to have
19   pretty much exactly the same cost structures.
20            MR. BARKER:  On that point, Mr. Miller, do you
21   feel it is appropriate to allow a variance for those
22   insurers that are operating at above-average rates so
23   that they can qualify and stay in the marketplace?
24            MR. MILLER:  It makes the -- it makes a maximum
25   rate more acceptable and do less harm to the marketplace

31
 1   if there's a margin above the industry average before
 2   rates are determined to be excessive.  And I can give
 3   you some examples where something like that has been
 4   done in other lines of insurance still creates problems.
 5   But right now, I'm thinking about the old procedures in
 6   Texas for auto and homeowners where there was a
 7   benchmark rate established based on industry average
 8   costs, industry average losses and expenses and then
 9   insurers were allowed to charge rates 30 percent below,
10   30 percent above, and those rates were deemed to be
11   acceptable under their rates standards of not
12   inadequate, unfairly discriminatory or excessive.  If
13   they wanted to go more than 30 percent above the
14   benchmark rates, then the individual insurer had to come
15   in and justify those higher rates in a prior approval
16   filing and provide the data.  So there was an escape
17   valve for insurers to justify their higher rates if they
18   had higher costs.  I don't see that kind of escape valve
19   in this -- in this regulation.
20            The third point I would like to speak to
21   briefly has to do with the data, the level of detail
22   that is required in the proposed statistical plan.
23   Effective rate regulation goes on in other lines of
24   insurance here in California and other states on a daily
25   basis without statistical plan with a comparable level

32
 1   of detail in place.  I think this is unprecedented.  I
 2   don't -- I can't -- I can't come up with another example
 3   of a statistical plan with this much detail and I've got
 4   a little bit of experience with stat plans.  About
 5   ten years or so ago, I worked with what was then The
 6   National Association of Independent Insurers Company,
 7   hopefully to improve their data editing process.  They
 8   have a fairly large database.  Gathering data and
 9   editing and getting a reasonably accurate usable
10   database is a tough challenge for any large database.
11            I'm thinking of another example.  More recently
12   in North Carolina, the North Carolina Rate Bureau is
13   charged with gathering a limited amount of premium and
14   loss and expense data from all auto insurers in North
15   Carolina and I helped them set up some data editing
16   tests for that database.
17            And I would -- I would advise you that as the
18   level of detail increases in a statistical plan like
19   this one, the problems of ending up with a usable
20   database with reasonable accuracy increases
21   exponentially and I think this one will fall of its own
22   weight.  Too much, too much detail.
23            The insurers -- I mean, there's going to be
24   some other testimony.  I know there's been some already
25   submitted in this hearing, but it is going to cost them

33
 1   tens of millions of dollars to set up internally the
 2   coding system and the computer systems they need to
 3   gather this data.
 4            I'm not aware that there is a statistical agent
 5   out there prepared to receive this data.  So you are
 6   going to have to -- someone is going to have to create
 7   an all-new statistical agent to receive it, aggregate
 8   it, edit it and produce a -- produce a usable aggregated
 9   database.  And I don't know who is going to do that.
10   I'm not sure it makes a lot of business sense to invest
11   a lot of money in creating a stat agency to serve such a
12   specialized need, but that is certainly a problem that
13   is not addressed I think in this regulation.  The --
14            MR. COHEN:  Do you think it would be possible
15   to come up with a statistical plan that would make it --
16   that would enable the Commissioner to determine whether
17   rates are excessive that was -- that was manageable,
18   simpler, et cetera?
19            MR. MILLER:  There's a two-part answer.  First
20   answer is yes.  I would say yes, you can come up with a
21   statistical plan that gathers a reasonable degree of
22   detail that's needed to test rates.  The second part of
23   the answer, though, is I'm not sure you need a
24   statistical plan at all to test the rates.
25            Rates are judged in all lines of insurance all

34
 1   across this country based on an insurer's submission
 2   with their rate filing, not at all based on data being
 3   reported through a statistical reporting database.  So
 4   there's an alternate to having a statistical plan, but
 5   if you were going to go with a statistical plan, the
 6   answer is yes, you could come up with something that is
 7   reasonable and workable and doable.
 8            And something that you also need to keep in
 9   mind, you are not creating a statistical plan here where
10   you are going to gather data once and then you are done.
11   You have to be able to maintain the accuracy of this
12   data to a reasonable degree of accuracy year after year
13   after year and the more you -- the more you are asking
14   for, the closer it gets to being impossible to do that.
15            The last point I would like to emphasize, and
16   very briefly, the way I read this rate-making formula
17   for the mandated rates and I'll say, I'm having trouble
18   reading the formula.  There are a lot of editorial
19   problems with the definitions in the regulation and so
20   in some cases, I've had -- in a lot of cases, I guess,
21   I've had to guess kind of what the definitions were and
22   that's made it difficult for me to follow through and
23   figure out what the rate-making formula is doing.  A lot
24   of my interpretation has to do not with what the
25   regulation says the formula is, but what I guess the

35
 1   intent was because the regulation itself is not very
 2   clear in a lot of places.
 3            But the way I read the rate-making formula, I
 4   think it is going to give you undesirable results.  And
 5   you are relying on one year of data for expenses and
 6   five-year average calendar year data for the losses.
 7   Especially the one year of expense data is going to
 8   cause these rates to be more cyclical than they probably
 9   should be.  There ought to be a little more balance with
10   rate stability and because -- there will be a two-year
11   lag.  You've got -- let's say you gather 2008 data and
12   that gets reported by the end of April in 2009.  It is
13   going to take until October or so for this statistical
14   agent to get it and aggregate the data and get the
15   projection factors and get those published, so it will
16   be late fall before any results of -- late fall in 2009
17   to get any results for the 2008 data, which means that
18   the company -- then the companies have got 60 days to
19   get their filings in, so there's really going to be a
20   two-year lag between the database and the next year's
21   rates.  And this cyclical nature of the rates, when you
22   are only using one year of data up and down, you are
23   going to find situations where you are -- in my case,
24   where I was using the 2008 data and the rates for 2010,
25   you are going to find cases where you are implementing

36
 1   rates for 2010 that are maybe going up when they ought
 2   to be going down because there's been a change in the
 3   real estate market in the two years or you are going to
 4   find situations where the rates are going down when they
 5   really ought to be going up.  That two-year time lag,
 6   coupled with the reliance on just one year of data, is
 7   not only going to cause the rates to be more cyclical,
 8   but it is going to cause the rates to be out of sync
 9   with -- so that really concludes my comments this
10   morning.
11            MR. COHEN:  Do you know how cyclical the title
12   insurance rates have been in California in, say, the
13   past ten years, how -- to what extent the rates have
14   changed to reflect the real estate market?
15            MR. MILLER:  I've looked at maybe 40 or 50
16   filings over the last three or four years in California
17   and I can't tell how cyclical they've been.  I don't
18   think they've been cyclical.  I mean, I -- I don't
19   think.  They are changing the rates sometimes up,
20   sometimes down, but I can't tell that in the past, the
21   rates have been cyclical, but I'm not certain about
22   that.  I want you to understand that, you know, I can't
23   tell with certainty.
24            MR. BARKER:  Mr. Miller, would it surprise you
25   to know that with very few exceptions, the base rates

37
 1   are generally static and have remained flat for the last
 2   five to ten years?
 3            MR. MILLER:  No, that wouldn't surprise -- I'm
 4   not easily surprised, but no, I wouldn't be surprised.
 5   I did -- I did find in reviewing those rate filings more
 6   often than not that the changes were being made for, you
 7   know, specific classes sometimes up, sometimes down as
 8   opposed to just an across-the-board rate change.  I
 9   didn't find much of that.  I did find a lot of what I
10   would call fine tuning of the rate schedule, but that's
11   -- you know, that's not unusual either for -- compared
12   to other lines of insurance.  Most filings are not
13   uniform across-the-board filings, but they are in
14   readjusting rates for various classes and discounts.
15            MR. HENLEY:  Mr. Miller, you wouldn't -- I
16   assume you wouldn't characterize title insurance as the
17   typical line either?  Wouldn't it be fair to say there
18   are some unique differences between title insurance and,
19   say, property/casualty insurance?  For instance, the
20   cyclical nature of the marketplace?
21            MR. MILLER:  That's -- there are cycles in a
22   lot of -- that affect a lot of different lines of
23   insurance.  This particular different cycle is different
24   than the other.  And yes, there are things that are
25   unique about title insurance as compared to some other

38
 1   property and casualty lines, but, in my view, there's a
 2   uniqueness about all the property/casualty lines and
 3   there's as much difference between personal auto
 4   insurance and medical malpractice insurance and surety
 5   and fidelity as there is between auto insurance and
 6   title insurance.  I mean, they are all unique, but
 7   unique in different ways.
 8            MR. HENLEY:  Well, I guess to state my question
 9   differently, Mr. Miller, I just want to make sure I
10   understand that you are not surprised despite the
11   cyclical nature of the real estate market and the recent
12   relatively profitable times as far as real estate prices
13   and the amount of transactions of real estate, despite
14   the fact these have gone on, you are not surprised to
15   see that title insurers' base rates have generally not
16   changed much over that same period of time; is that
17   correct?
18            MR. MILLER:  Yes, that is correct.  And there's
19   -- because there has not been a lot of across-the-board
20   base rate changes doesn't mean that there haven't been
21   significant rate changes.  I tried to make that point.
22   You just don't look at what happened to the base rates.
23   You have to look at all -- what has happened to all the
24   rates for all of the classes.
25            MR. HENLEY:  Right, rate changes for particular

39
 1   segments of the population, but certainly not for the
 2   rate overall generally.
 3            MR. MILLER:  Well, when you add them all up, if
 4   you take -- I mean, one filing maybe didn't do every
 5   segment of the marketplace, but there were changes for
 6   particular segments and then there is another filing
 7   that affects other segments, so I'm not so certain that
 8   if you looked at these over the four or five years,
 9   which I -- which I did, but I didn't try to add up what
10   proportion of the market was affected, I suspect that
11   most of the market was affected at one time or the
12   other.
13            MR. HENLEY:  Well, that's the important
14   inquiry, isn't it?  What portion of the market was
15   affected?  Is that fair to say that that is an important
16   inquiry?
17            MR. MILLER:  Well, it depends on what kind of
18   questions you are asking.  It could be important.
19            MR. HENLEY:  Can you tell me, based upon your
20   review of the filings, where you describe the different
21   segments of the population were affected in different
22   filings?  Can you name one title insurance company that
23   has made changes in its filings such that it did show a
24   reduction in rates overall over a number of filings?
25            MR. MILLER:  I couldn't tell that from the

40
 1   filings.  I had -- I could see there were rate decreases
 2   and there were rate increases, but to be able to
 3   summarize that into a number that represented the
 4   overall change, I couldn't do that.
 5            MR. HENLEY:  Can you tell me more about the
 6   segments of the market?
 7            MR. MILLER:  The reason I couldn't do that is I
 8   didn't find the information in the filings to be able to
 9   do that.
10            MR. HENLEY:  Okay.  Thank you, Mr. Miller.
11            MR. BARKER:  Mr. Miller, putting the filings
12   aside, let's talk about pricing.  It is pretty well
13   documented by DataQuick that the number of transactions
14   has plummeted in recent months, approximately
15   20 percent.  One would think that the title industry,
16   which is well aware of these fluctuations in transaction
17   volume, would be changing their pricing practices if
18   indeed pricing is responsive to market conditions in the
19   title industry.  What pricing changes are you aware of
20   that the title industry or particular insurers have
21   taken in response to the recent dropoff in transactions?
22            MR. MILLER:  I'm not aware of any rate filings
23   recently.  I haven't looked -- I haven't looked at rate
24   filings that have been made this year, for instance, so
25   I can't answer the question.

41
 1            MR. COHEN:  Thank you very much.
 2            MR. MILLER:  Thank you.
 3            MR. WOODS:  Our next witness is Dr. David
 4   Appel.
 5            Dr. Appel, please state your name for the
 6   record and give us a brief description of your
 7   background that's relevant hereto, as well as a brief
 8   synopsis of your written testimony that has been filed
 9   herewith.
10            DR. APPEL:  Thank you.  Pleasure to be here
11   this morning.  I appreciate you taking the time.  My
12   name is David Appel, A-P-P-E-L, and I'm a principal and
13   director of economics consulting with Milliman,
14   Incorporated.  Milliman is one of the world's largest
15   independently owned consulting firms specializing in
16   actuarial science and matters relating to the evaluation
17   and management of risk.  And I'm in charge of the
18   economics consulting practice of the firm.  Personally
19   I've been with Milliman for 17 years when I joined the
20   firm to establish an economics consulting practice and
21   prior to that, I was with the nation's largest Workers'
22   Compensation statistical research and rate-making
23   organization, The National Council on Compensation
24   Insurance.  I've been actively involved in insurance
25   regulatory matters for more than 25 years now since the

42
 1   very early 1980s when rate of return regulation in
 2   insurance was really in its infancy.
 3            I've testified on well more than 100 occasions
 4   in regulatory proceedings in many different
 5   jurisdictions and in the last decade or so, probably in
 6   a half dozen title insurance rate proceedings.
 7            As far as regulation in California is
 8   concerned, I've been actively involved in most
 9   regulatory issues in the state since the early days of
10   rate of return regulation in California at the dawn of
11   Prop 103.  In fact, I believe I testified in the first
12   Prop 103 rollback case which dates back to October or
13   November 1989.  And not less than a couple of years ago,
14   I filed a declaration in what I think is the last extant
15   Prop 103 rollback case which has been going on now for
16   15 years.  In fact, I see in the room here many of my
17   old friends from the Prop 103 days.  I guess this has
18   been a cottage industry for all of us for some period of
19   time now.
20            I would also note that I've been actively
21   involved in workshops relating to the proposed prior
22   approval regulations for other property/casualty lines.
23   And I mention that specifically because part of the
24   critique I have in connection with the title insurance
25   proposed regulations relate to inconsistencies between

43
 1   those proposals and the proposals for other P&C lines.
 2   So I hope my bona fides as respects expertise in the
 3   area of insurance regulation are well established.
 4            In any event, I'm here today to talk about
 5   issues related to the maximum allowable rate of return
 6   as that term is defined in the regulations.  And it is,
 7   I believe, specifically Section 2357 of the proposed
 8   regs which refers to the promulgation of rates.
 9            I also will discuss briefly issues related to
10   the underwriting profit factor in the rates because the
11   underwriting profit factor is the value that gets
12   incorporated in the rate-making formula that essentially
13   expresses the maximum allowable rate of return in
14   rate-making.  And since rate of return falls within the
15   ambit of my discipline, economics, Fidelity has asked me
16   to review those sections of the proposed regs that
17   relate to rate of return and to provide my opinion, my
18   professional opinion, as to the reasonableness of those
19   proposals.
20            As you know, I've submitted a written statement
21   which contains more detailed comments, so this morning,
22   I just want to summarize briefly, if it is possible for
23   me to be brief, the principal conclusions of -- that
24   I've reached on these matters.  And I can see I don't
25   need to invite you to interrupt me with questions.  If

44
 1   you have any, I would be most delighted to answer them
 2   as they come.
 3            I have four major points I want to emphasize.
 4   They are as follows:  I think the regulations are
 5   confiscatory in general.  I think they will be
 6   confiscatory as applied to individual companies.  I
 7   think they are inconsistent with regulations applied to
 8   property/casualty insurers in California and they are
 9   inconsistent with the proposed regulations that are
10   going to be the subject of a hearing in another couple
11   of weeks here.  And I think they are also inconsistent
12   with basic principles of economics and actuarial science
13   as they relate to rate-making.
14            Now, that was a big mouthful.  Let me just go
15   back and reiterate those points with a little bit more
16   emendation and then I will turn to each one and spend
17   hopefully no more than a minute or two describing what
18   is in my written testimony in connection with those
19   issues.
20            So the first point was that the regulations are
21   confiscatory.  In general, the regulations promulgate a
22   formulaic approach to the determination of the maximum
23   allowable rate of return.  That formula involves adding
24   a risk premium to an average of U.S. Treasury Security
25   yield rates.  And if that formula were applied today, it

45
 1   would result in a maximum allowable rate of return of
 2   8 3/4 percent.  In my opinion, that does not meet
 3   constitutional standards of fairness or reasonableness
 4   as those standards are articulated in the seminal cases
 5   relating to regulated industries in the U.S.  For
 6   example, natural gas, if I can paraphrase, the return to
 7   the equity owners should be commensurate with the risk
 8   of the enterprise and sufficient to attract capital.
 9            These regulations occurring in 8 3/4 percent
10   maximum allowable return, in my opinion, will not be
11   sufficient for title insurers to attract capital in
12   current U.S. capital markets.
13            Secondly, the regulations --
14            MR. COHEN:  What would be?
15            DR. APPEL:  What would be?
16            MR. COHEN:  Yeah.
17            DR. APPEL:  I've attached a cost of capital
18   analysis to my written comments.  It contains a recent
19   cost of capital for title insurers, which was
20   13.2 percent, and a cost of capital for
21   property/casualty insurers, which was 11 percent.  It
22   would not be atypical to average those values.  I would
23   also consider financial service firms in addition to
24   title insurers and property/casualty insurers to broaden
25   the sample of comparable industries, if you will, but I

46
 1   think in today's markets, returns in the range of 12 or
 2   13 percent would probably be reasonable, but I would
 3   withhold any formal opinion on that pending further
 4   study.
 5            As to the regulations being confiscatory as
 6   applied, I think even if you could justify 8 3/4 percent
 7   return on average as fair and reasonable for the
 8   industry, and as I said, I don't think you can, but even
 9   if you could, consider that the regulations promulgate
10   an average price based on average costs and that is
11   applied to each and every insurer in the state.  If --
12   and insurers clearly operate in different markets and
13   have different costs structures.  If an insurer
14   operating in a market as a -- because of the markets --
15   because the markets it is operating in have a higher
16   cost structure, that insurer, when being forced to rely
17   upon an average rate, will earn a return below the 8 3/4
18   percent that is included in the rate.  As a consequence,
19   I think as the rates are applied, they will be
20   confiscatory.
21            MR. COHEN:  Well, have you looked to see the
22   extent to which the five major title insurers in fact do
23   operate in different markets that have different costs?
24            DR. APPEL:  I have not studied that matter in
25   California, but I know that these regulations apply not

47
 1   only to the five major title insurers, but to all
 2   participants in the title industry.  And I have no doubt
 3   that some of those participants operate in markets which
 4   are more robust, have more transactions, have higher
 5   average real estate values than others and those things
 6   will affect the costs faced by those insurers.  So
 7   relying on average rates, as I said, I think will force
 8   certain insurers to sell at prices below what is fair
 9   and reasonable.
10            MR. COHEN:  Do you know what market share the
11   top five companies have in California?
12            DR. APPEL:  I have seen some reference to some
13   of those numbers in some of the other testimony.  I
14   couldn't quote it for you.  And, again, I guess there's
15   a difference between the shares of the markets for
16   various different activities within the domain of title
17   insurance, within the broad domain of title insurance,
18   so I don't know that there is a common market share for
19   those five large title insurers when you look at the
20   broad cross-section of services in the market.
21            MR. COHEN:  Well, sure, but you could look at
22   the market share that they have for first-time purchase
23   and sale of a home.  You could look at the market share
24   they have for refinance.  I mean, you could look at each
25   different aspect and presumably have an understanding of

48
 1   what their market share was.  And my question to you was
 2   do you know -- I'm trying to understand what -- how
 3   significant it might be that -- what you are telling me.
 4   Does it really matter to me?  If the top five are, you
 5   know -- I understand that we may have to do something
 6   about the other than the top five, but if the top five,
 7   in fact, you say you don't know whether they are
 8   operating in different markets or whether they have
 9   different costs or not, so your criticism is wholly
10   theoretical that you just made.
11            DR. APPEL:  Well, my criticism is that that
12   would have been a subject that should have been studied
13   before proposing that average rates be applied to each
14   and every insurer and participant in the title insurance
15   industry in California.  I haven't studied that.  I
16   would be delighted to do so, but I think it is a subject
17   which is appropriately precedent to the promulgation of
18   regulations that require all insurers to rely on average
19   costs.
20            In any event, I also -- the third point I was
21   going to make is that the regulations are inconsistent
22   with regulations applied to property/casualty insurers
23   in California.  I'm referring here specifically to the
24   fact that it is my understanding that currently,
25   property/casualty insurers are allowed a 10.7 percent

49
 1   return, maximum allowable rate of return, in review of
 2   rate applications by the Insurance Department and I'm
 3   aware that the proposed regulations, about which I spoke
 4   a moment ago, the proposed prior approval regulations,
 5   propose an 11 percent allowable return.  I've seen no
 6   evidence in the files I've looked at in connection with
 7   this matter, the title insurance matter, that there has
 8   been any study or analysis of the relative risk of title
 9   insurance compared to property/casualty insurers.  It is
10   my view that from an investor perspective, there are not
11   significant differences in those risks, so I see no
12   reason to believe that title insurers should be accorded
13   a significantly lower return than property/casualty
14   insurers.
15            Finally, I also said the regulations were
16   inconsistent with basic principles of economics and
17   actuarial science as applied to rate-making.  What I'm
18   referring to there are several components of the
19   rate-making formula, in particular the investment yield
20   rate and the task rate that are computed and then
21   incorporated in the rate-making formula itself are based
22   on historical data.  They should be based on prospective
23   estimates of the taxes and yields that will apply when
24   the rates are in effect being based on historical data,
25   they are inconsistent with basic economic and actuarial

50
 1   principles.
 2            MR. COHEN:  I just want to go back one second
 3   to the point you made before the last point.  So it is
 4   your view that there is no significantly different risk
 5   to an investor to invest in a title insurer as compared
 6   to, for example, a Workers' Comp carrier in California?
 7            DR. APPEL:  I think the risks are very
 8   different, but the risk to the investor is the risk of
 9   holding an asset within an investment portfolio, a
10   diversified portfolio, and the evidence that I've seen
11   from capital markets is that, if anything, title
12   insurers should be accorded a higher rate of return than
13   property/casualty insurers, but certainly not a lower
14   rate of return.
15            I think if you look at the criteria by which
16   investment analysts evaluate the risks associated with
17   financial placements in various types of securities, you
18   will see that both title insurers and property/casualty
19   insurers tend to fall in the general range of roughly of
20   average risk across all industries in the U.S. economy.
21   And because I think that it is reasonable to believe
22   that they are of roughly average risk, both title and
23   P&C insurers, I don't see any reason to accord title
24   insurers a substantially lower return, in this case, a
25   return that is lower by more than two percentage points.

51
 1            Now, I will agree with you that the nature of
 2   the risks are quite different.  In property/casualty
 3   insurance, we normally think about the risk of losses as
 4   being the major factor that drives uncertainty or risk
 5   and the demand conditions facing property/casualty
 6   insurers have a tendency to be quite stable.
 7            Title insurance is quite a different matter.
 8   The losses are not the big issue.  The losses are a
 9   small piece of the rate, but the demand conditions
10   facing title insurers are very volatile.  They depend on
11   the real estate market, which depends in part on the
12   general economy and on other factors and there is a
13   great deal of volatility from year to year in the
14   revenue that title insurers will achieve.  And because
15   of the very high fixed cost component of the cost
16   structure in title insurance, the risk emanates from a
17   volatile revenue stream combined with high fixed costs,
18   not a stable revenue stream combined with volatile costs
19   as in property/casualty insurance.  But because those
20   risks are different does not mean that one is greater
21   than the other.  In fact, the evidence suggests that, if
22   anything, title insurance is perceived as riskier.
23            In any event, I did want to circle back and try
24   to summarize very briefly some of the testimony that
25   I've provided on each of these points.  So as to the

52
 1   issue that, in my opinion, the rates are confiscatory in
 2   general, as I mentioned, the regulations, if applied
 3   today, would generate a cost of capital or maximum
 4   allowable rate of return for title insurers of 8 3/4
 5   percent.  The question about the reasonableness or
 6   adequacy of that rate of return is intrinsically one of
 7   the costs of capital, that is, what returns are demanded
 8   by investors in capital markets.
 9            So one way to think about whether 8 3/4 percent
10   is reasonable is to think about returns that are
11   available in capital markets.  For example, on debt
12   securities today, you could buy risk-free treasury
13   securities to yield 5 percent roughly.  You could get 7,
14   7 1/4 percent on A-rated utility bonds.  You could get
15   8 1/4 percent.  That is the prime lending rate for major
16   commercial banks to their most creditworthy customers.
17   I think in light of those yields, 8 3/4 percent seems
18   unreasonably low for an equity investment title
19   insurance.
20            Now, consider what other regulated industries
21   receive in terms of allowable rates of return.  As I
22   mentioned in my testimony, a search on the California
23   PUC website finds that water and electric utilities are
24   being allowed returns today in the 10 to 11 percent
25   range.  It is universally agreed that regulated

53
 1   utilities are lower risk than, for example, an
 2   investment in an insurance sector, so if regulated
 3   utilities are being accorded returns in the 10 percent
 4   to 11 or 11 and a half percent range, 8 3/4 percent for
 5   title makes no sense.
 6            Finally, as I mentioned, the property/casualty
 7   insurers in California are allowed returns at least two
 8   percentage points higher than title insurers would be
 9   allowed under these proposals.  And as I said, I see no
10   reason for that difference.  In my opinion, it is absurd
11   to think that investors would risk equity capital in a
12   placement in the title insurance industry for a return
13   of 8 3/4 percent.
14            Add to the regulations being confiscatory as
15   applied, even if you could prove that 8 3/4 percent was
16   fair, the way the regulations work is to force all
17   insurers to price to an average rate or to be subjected
18   to an average rate based on average costs.  As I said a
19   moment ago, because such a high proportion of the costs
20   are fixed and because insurers may operate in different
21   market environments -- and when I say insurers, I'm
22   talking about not strictly the title insurers, the big
23   five companies, but all the participants in the title
24   insurance industry whose rates and prices are going to
25   be covered by these regulations -- since they operate in

54
 1   different market segments, they may offer different
 2   levels of service.  There are a wide variety of reasons
 3   why the cost structures of insurers may differ.
 4   Applying a single rate to all of those insurers is, in
 5   my view, unreasonable.  That's made more so unreasonable
 6   by the fact that the regulations contain no mechanism
 7   for variances and no mechanism, as best as I can see,
 8   for individualized relief.  And so if there is no such
 9   mechanism, and I've heard the questions that you've
10   asked of Mr. Miller about that, if there is no such
11   mechanism for relief, then a company that is faced with
12   a price that is inadequate has only two choices, that
13   is, to simply withdraw from the market or to suffer a
14   confiscatorily low rate of return.
15            That problem is further exacerbated by the fact
16   that the --
17            MR. COHEN:  Or so sue the Department, which
18   they never hesitate to do.
19            DR. APPEL:  Well, I hope they retain me in
20   pursuit of those actions.
21            I would also note that the problem is
22   substantially exacerbated by the fact that the
23   regulations contain these interim rollback rates.  And
24   as I read it, rates, depending on the products, will be
25   rolled back 16 percent or 23 percent or 27 percent for

55
 1   each and every insurer, rolled back from the rates that
 2   were in effect in November 2000.  I saw no consideration
 3   in the regulations for the degree of adequacy of those
 4   rates in November 2000, nor more pertinently, how
 5   adequate are the November 2000 rates relative to the
 6   costs that are being faced by insurers today.  The
 7   proper determination of the reasonableness of rates is
 8   to compare the rate to expected future costs.  If there
 9   was no such comparison, I don't see how you can
10   promulgate fixed and mandatory and identical reductions
11   across each and every insurer in the state.
12            MR. COHEN:  Well, you understand that the rates
13   that were in effect in 2000 were rates that were filed
14   by the insurers and they could, under the law as it was
15   then and still is now, can file whatever rate they want,
16   so don't you think it is a reasonable assumption that
17   those rates were adequate in 2000?
18            DR. APPEL:  What if -- two things:  What if an
19   insurer in December of 2000 filed a substantial rate
20   increase because upon review, the rates that were
21   existing in November of 2000 were wholly inadequate?
22            MR. COHEN:  Do you know that to be true?
23            DR. APPEL:  I don't.
24            MR. COHEN:  So your complaint is wholly
25   hypothetical.  Your complaint is not based on any facts.

56
 1            DR. APPEL:  No.  No.
 2            MR. COHEN:  Your complaint is just it could be
 3   that this happened.  If it did, that would be a bad
 4   thing, but you don't know that to be true.
 5            DR. APPEL:  My complaint is I see no evidence
 6   that anybody has studied that issue and as a
 7   consequence, it makes no sense to promulgate mandatory
 8   rate decreases particularly when there is no method --
 9            MR. COHEN:  You give us very little credit.
10            DR. APPEL:  Well, it would have been most
11   illuminating to me if someone had provided that evidence
12   so that then an analyst could evaluate not only whether
13   the rates were adequate --
14            MR. COHEN:  Your clients know what their rates
15   were and they know whether they made a big rate increase
16   in December of 2000.  They know what rates they filed.
17   They could file whatever rates they wanted.  And they
18   filed -- I assure you, they filed rates that they
19   thought were adequate.  And they were adequate in 2000
20   before housing prices went up an average of 25 to
21   30 percent over the intervening time period and they
22   never reduced their rates.
23            DR. APPEL:  Will they be adequate in light of
24   the expected cost conditions in 2007 or 2008 or 2009
25   when those rates are to be in effect?  That is the

57
 1   relevant question for rate-making, not whether they were
 2   adequate in November 2000.
 3            MR. COHEN:  And once they filed their cost data
 4   with us, then we'll have a basis for knowing, but right
 5   now, they don't even do that.
 6            DR. APPEL:  Well, I think my point remains that
 7   there is then no basis for you to determine that a
 8   23 percent rate decrease is appropriate for each and
 9   every insurer.
10            Now, as to whether the -- or the inconsistency
11   of the proposed regulations with the existing prior
12   approval regulations and with the proposed prior
13   approval regulations for other property/casualty lines,
14   as I said, the rate of return for property/casualty
15   insurers is going to be -- is proposed to be 11 percent.
16   For title insurers, it would be 8 3/4.  I should also
17   note that the 10.7 percent rate of return that I
18   understand to be utilized currently in reviewing rate
19   applications was a return that was established during a
20   rate case in July of -- or June or July of 2003, the
21   Skippy rate case.  And in fact, it was my testimony on
22   cost of capital that was adopted by the administrative
23   law judge that proposed that 10.7 percent cost of
24   capital at that time.
25            At that time, treasury interest rates were two

58
 1   and a half percentage points lower than they are today.
 2   Instead of an average of 5 percent for the three short
 3   intermediate and long-term treasuries, the average yield
 4   at that time was 2 1/2 percent.  If you had applied the
 5   title insurance regulations at that time when the
 6   average yield was 2 1/2 percent, the maximum allowable
 7   return would have been 6 1/4 percent, the 2 1/2 percent,
 8   plus the 3 3/4 percent risk premium that the regulations
 9   say the Commissioner has found to be reasonable.  Now, I
10   can tell you that at a time when property/casualty
11   insurers were found by an ALJ in California to require a
12   return of 10.7 percent, it would've made no sense for
13   title insurers to be allowed a return of only 6 1/4
14   percent.
15            The best evidence of a required return is
16   current capital markets and what investors require and
17   as I've mentioned, I've submitted cost of capital
18   analyses for title and property/casualty insurers
19   attached to my testimony.  It shows that title insurer
20   costs of capital are in excess of 13 percent.
21            MR. COHEN:  Do you know what the return on
22   equity for title insurers has been for the past five
23   years?
24            DR. APPEL:  The book returns on equity, meaning
25   the accounting returns?  Is that the question you are

59
 1   asking?
 2            MR. COHEN:  (Nods head.)
 3            DR. APPEL:  That's not the relevant question
 4   for cost of the capital.
 5            MR. COHEN:  What's the relevant question?
 6            DR. APPEL:  The relevant question is the market
 7   returns that have been earned by title insurers and that
 8   is not even the relevant question as much as the returns
 9   that investors require in the market going forward.
10   Because if investors earned a return of X in the market
11   two or three years ago and capital market yields were
12   two or three percentage points lower than they are
13   today, X is not going to be sufficient today.  So the
14   question is what is the required return prospectively.
15            MR. COHEN:  So from your standpoint, it is
16   completely irrelevant what the rate of return has -- in
17   terms of setting the future rate of return, if we're
18   going to do that, it is completely irrelevant what rate
19   of return the title industry has earned in the past five
20   years.  Doesn't matter if they've been earning monopsony
21   profit, for example.
22            DR. APPEL:  Or a monopoly profit.
23            I noticed in the notice, in the initial
24   statement, the reasons, I believe, to these regulations,
25   that someone contends that the returns that are earned

60
 1   -- that have been earned by title insurers are, in fact,
 2   irrelevant for use in promulgating future returns
 3   because the market is not competitive and therefore
 4   those returns have been excessive.
 5            MR. COHEN:  I'm just asking the question.  I'm
 6   asking for your view.  Is it your view that the rate of
 7   return that has been earned in the title industry for
 8   the past five years is irrelevant to whatever decision
 9   we make now, assuming we make one, as to what an
10   appropriate rate of return is going forward?
11            DR. APPEL:  Yes, I think the rate of return
12   going forward should be the prospective rate of return
13   that is required in capital markets using standard costs
14   of capital techniques, which I have testified to on many
15   occasions over 20-plus years.
16            MR. COHEN:  Understood.
17            DR. APPEL:  Finally, I said that the
18   regulations were inconsistent with basic principles of
19   economics and actuarial science.  And as I mentioned,
20   that has to do with the use of historical data to
21   determine the tax rate and the investment yield rate.  I
22   would note that this is another inconsistency with the
23   proposed prior approval regulations for
24   property/casualty lines.  The regulations that are
25   currently in place in fact did use historical data to

61
 1   determine tax rates and investment yield rates.  And
 2   through the course of the various workshops on the
 3   proposed prior approval regulations, the Department has
 4   seen, in its wisdom, to change that to the proper
 5   prospective values for those variables.  And I don't see
 6   any reason why we should be promulgating title rates
 7   that are inconsistent with those basic economic and
 8   actuarial principles.
 9            With that, I would go back and summarize, but
10   you've heard it all twice now.  So I thank you for your
11   attention and of course, any questions, I would be more
12   than happy to answer.
13            MR. COHEN:  Thank you very much.
14            MR. WOODS:  Our final witness is Dr. Greg
15   Vistnes.
16            Dr. Vistnes, please state your name and briefly
17   describe your background as relevant to these
18   proceedings and also briefly summarize your written
19   testimony which has been submitted.
20            DR. VISTNES:  Thank you very much for the
21   opportunity to speak today.  My name is Gregory Vistnes.
22   Last name is spelled V, as in Victor, I-S-T-N-E-S.  I'm
23   a vice president with the economics consulting firm of
24   CRA International and my office is in Washington, D.C.
25            I've been retained by the law firm of LeBoeuf,

62
 1   Lamb, Greene & MacRae on behalf of Fidelity National
 2   Title Group to analyze the competitiveness of
 3   California's title insurance markets and to analyze
 4   whether the proposed regulations are likely to improve
 5   competition.  This analysis bears directly on what I
 6   understand to be the necessary legal requirement the
 7   Commissioner must satisfy before imposing rate
 8   regulation, thus showing that the market is not
 9   reasonably competitive.
10            My conclusions and the details of my economic
11   analysis are provided in the report I've submitted.
12   That report also provides details regarding my
13   qualifications and experience to speak about competitive
14   issues.  This includes a Ph.D. in economics from
15   Stanford University and ten years of experience at the
16   Federal Antitrust Agencies, the US Department of Justice
17   and the U.S. Federal Trade Commission or FDC.  My
18   experience also includes several years where I held the
19   position of deputy director for antitrust at the FDC's
20   Bureau of Economics, a position where I oversaw the
21   economic analysis of all antitrust and competition
22   matters for the FDC and where I supervised a staff of
23   approximately 40 to 45 Ph.D. economists.  During that
24   time, I also oversaw the economic analysis of several
25   title insurance matters.

63
 1            Let me take this opportunity to briefly
 2   summarize my findings.  Rate regulation is recognized by
 3   economists and policymakers in the United States as the
 4   second-best solution that should generally only be
 5   adopted when the prospects for competition are severely
 6   limited.  Thus, rate regulation is typically only
 7   imposed in industries where there can realistically only
 8   be one provider, industries only referred to by
 9   economists as natural monopolies.
10            California's title insurance markets, however,
11   very clearly cannot be characterized as natural
12   monopolies in which there can only be one competitor or
13   as markets in which there is no realistic prospect for
14   competition among rivals.
15            MR. COHEN:  Well, we have rate regulation for
16   auto and homeowners in this state and we're not unique
17   in the country.  Certainly we have more than one
18   provider for automobile insurance and homeowners
19   insurance, right?  So I don't understand your point, I
20   guess.
21            DR. VISTNES:  Well, I think the point is as
22   policymakers, do you want to be going with the flow of
23   policy and economics as seen in the last 20 or 30 years
24   or do you want to be fighting upstream?  Certainly the
25   stream of economics has clearly learned that the move

64
 1   should and to the benefit of consumers, is away from
 2   regulation when possible, away from rate regulation.
 3            MR. COHEN:  Well, you are familiar with
 4   Proposition 103?
 5            DR. VISTNES:  Yes, I am.
 6            MR. COHEN:  That was passed by the voters in
 7   this state, all right, and that imposed rate regulation,
 8   prior approval rate regulation.
 9            DR. VISTNES:  On title insurance?
10            MR. COHEN:  No.  No.  No, but I don't
11   understand your point.  You say, well, we only put it in
12   where there is only one provider and that is just not
13   true.  At least in California, sir, it is just not true.
14   Voters --
15            DR. VISTNES:  My point is that what consumers
16   benefit from is competition.  When policymakers have the
17   option before them to consider or to propose increasing
18   competition or replacing competition -- and make no
19   bones about it.  What we have before us is not a
20   proposal to reinvigorate competition.  The proposal
21   before us is to replace competition with rate
22   regulation.  Consumers invariably benefit from the move
23   to competition away from rate regulation.  This has
24   clearly been espoused.  For example, the 1996 Telecom
25   Act of the U.S. where we implemented a system to move

65
 1   away from Ma Bell who previously was the natural
 2   monopoly, the regulated monopolist, to a market in which
 3   competition could, in fact, flourish, where consumers
 4   could benefit from having not just the black telephone
 5   in whatever color.
 6            MR. COHEN:  You think California benefited from
 7   deregulation in the energy markets?
 8            DR. VISTNES:  I think that California had some
 9   problems with it.  I think nationwide, the deregulation
10   in power, in telephones, in airlines, in so many
11   industries, has offered tremendous benefits --
12                  (Simultaneous colloquy.)
13            MR. COHEN:  Do you think California benefited
14   from deregulation in the Workers' Compensation market?
15            DR. VISTNES:  I'm not familiar with that.
16            MR. COHEN:  Okay.  I mean, you are here to
17   espouse an ideology, right?
18            DR. VISTNES:  No, I'm not.
19            MR. COHEN:  You are here to espouse a promarket
20   ideology that is antiregulation of any kind whatsoever.
21   It is pro free market.  We've been hearing it for years,
22   and years, and years.  It's had, in this state,
23   devastating impacts costing Californians hundreds and
24   hundreds of millions of dollars.  Okay.  And I'm
25   familiar with it because --

66
 1            DR. VISTNES:  You are mischaracterizing my
 2   testimony.
 3            MR. COHEN:  I was at the Public Utilities
 4   Commission during the energy crisis, so I have some
 5   personal knowledge of what the devastation that
 6   deregulation caused in this state, so, you know --
 7            DR. VISTNES:  I would be happy to discuss other
 8   industries.  Again, I'll go back to telephones where I
 9   doubt many individuals in this room would prefer to go
10   back to a single telephone provider, that they've
11   benefited from deregulation of all the long-distance and
12   local telephones, deregulation of the airlines which
13   have --
14                   (Simultaneous colloquy.)
15            MR. COHEN:  Most of the people in the state of
16   California only have one provider for local telephone
17   service today, sir.
18            DR. VISTNES:  For local service.  That is
19   moving for long-distance.  I believe most individuals
20   here have access to many long-distance carriers at much,
21   much cheaper costs than previously existed.  I would be
22   astounded to find that this Commission would claim that
23   long-distance services are more expensive now than they
24   were 20, 30 years ago.
25            MR. COHEN:  And technological changes have

67
 1   nothing to do with that.  It is all because we
 2   deregulated.
 3            DR. VISTNES:  It has a tremendous amount to do
 4   with deregulation.
 5            MR. COHEN:  Why don't you go on and tell us
 6   about the title industry.
 7            DR. VISTNES:  I would be happy to.
 8            And simply to amend the characterization of my
 9   testimony previously, I'm not here to talk purely about
10   theory.  I'm not here to talk purely about an ideology
11   of precompetition versus regulation.  What I'm here is
12   to put a context behind how economists and how
13   policymakers tend to view the tradeoffs between
14   competition and regulation and then to move into the
15   question of do we have sufficient competition in this
16   industry.  Is it reasonably competitive, as I believe
17   the legal standards before this Commissioner are, to
18   warrant a replacement, a substitution, of the existing
19   competition with rate regulation.
20            Moving right along, what my analysis shows is
21   that despite the presence of limited market
22   imperfections that are endemic in virtually all
23   competitive markets, California's title insurance
24   markets are fundamentally competitive.  Put differently,
25   competition in this title insurance market is alive and

68
 1   well.  In particular, there are several competitively
 2   significant rivals in California's title insurance
 3   markets.  There are no significant impediments to
 4   expansion by those rivals and there are no impediments
 5   to other firms entering the markets.  Consistent with
 6   this structural analysis, there is also evidence of
 7   ongoing price and nonprice competition.  In fact, as
 8   shown in the charts that I've prepared, which is
 9   included in my report, a recent national survey done by
10   Bankrate.com indicates that title costs in California
11   are actually lower than the national average.  Thus,
12   this market is clearly one that satisfies the standards
13   of reasonably competitive and by no stretch of the
14   imagination can it be viewed so noncompetitive and so
15   incapable of supporting competition that consumers would
16   benefit by replacing competition with rate regulation.
17            In contrast to this finding, there's no
18   economic evidence or basis to support a conclusion that
19   there is not a reasonable degree of competition in
20   California's title insurance markets.  In particular,
21   the Birnbaum Report upon which the Commissioner relies
22   in support for the claim that California's markets are
23   not reasonably competitive has been shown by several
24   analysts, including myself, to be fundamentally flawed.
25   These flaws include a failure to consider all forms of

69
 1   competition, a failure to acknowledge ongoing price
 2   competition, embracing inappropriate economic
 3   methodologies for assessing competition, embracing --
 4   excuse me, and failing to assess the competitiveness of
 5   California's insurance markets relative to a relevant
 6   benchmark, that is, the alternative of rate regulation.
 7            MR. COHEN:  Did you look at any of the other
 8   studies that have been done of the title industry?
 9   Leave the Birnbaum Report to one side for a second.  Did
10   you look at any of the other studies that have been done
11   of the title industry that reached essentially the same
12   results that, for example, as long ago as 1977, the
13   Department of Justice did a study which found that the
14   title industry had a long history of anticompetitive
15   practices, including fixed fees, forced tied sales,
16   kickbacks and that it was characterized by reverse
17   competition rather than price competition?  Are you
18   familiar with that?
19            DR. VISTNES:  The 30-year-old study, yes, I am.
20            MR. COHEN:  What's changed in California from
21   1977 to today, in your view?
22            DR. VISTNES:  In my view, what has changed, a
23   lot has been the economic analysis.  As I was saying,
24   1977 and 2006 are very different views of how regulation
25   works.

70
 1            MR. COHEN:  So you have a different ideology,
 2   so you look at the same facts that the Department of
 3   Justice found to be as indicative of a lack of
 4   competition and through your ideological lens, you look
 5   at those same facts and you find competition?  Is
 6   that --
 7            DR. VISTNES:  That's incorrect.  While
 8   farsighted, I don't believe the Department of Justice in
 9   1977 was looking at the facts that I see in 2005, 2006.
10   These facts, these market shares, these ability to enter
11   the comparison of market shares of rivals in California
12   versus in other states, the ability to expand and enter
13   the market, those weren't looked at by the Department of
14   Justice 30 years ago.  Those are factors that were
15   considered in my economic analysis.
16            Other studies that I've looked at have come to
17   similar conclusions that I have that the Birnbaum Report
18   is in fact flawed.  The methodologies are not ones that
19   policymakers should be relying --
20            MR. COHEN:  But you haven't looked at studies
21   retained by the title insurance industry in connection
22   with those proceedings?
23            DR. VISTNES:  That's correct, those are the
24   only other ones that I'm familiar with.  If you can
25   point to other economic studies that have been done

71
 1   recently that have come to conclusions similarly to
 2   Birnbaum, I would be happy to see them.  I don't believe
 3   there is any other study that reaches similar
 4   conclusions.
 5            MR. COHEN:  Are you familiar with a 1980 study
 6   done by Peat Marwick for the Department of Housing and
 7   Urban Development that found that the market for title
 8   insurance and conveyance services are not characterized
 9   by workable competition?
10            DR. VISTNES:  The 26-year-old study?
11            MR. COHEN:  Nor did they perform well in most
12   localities in terms of providing consumers with required
13   settlement services at a price which approximates the
14   cost of efficiently providing those services.
15            DR. VISTNES:  Yes, I did look at that study.
16   Again, I don't believe that study had access to recent
17   data.
18            MR. COHEN:  Well, do you have a quarrel with
19   the study at least as of the time it was done?  Do you
20   think --
21            DR. VISTNES:  I have a quarrel with the
22   economic analysis that was done at that point which I
23   would make an important distinction between ideology.
24   Economics is a science which has moved, I'm glad to say,
25   in the past 25 and 30 years, just as public policy has

72
 1   moved considerably in 25 to 30 years, as I'm sure you
 2   are aware.
 3            MR. HENLEY:  Dr. Vistnes, is it your position
 4   then that despite what was found in these studies in
 5   1977 and 1980 that somehow in 2006, we no longer have
 6   situations where a reversed competitive market exists?
 7            DR. VISTNES:  I take great issue with the
 8   phrase "reversed competitive market" or "reverse
 9   competition."  What those studies generally seem to be
10   characterizing is a situation where an individual gets a
11   referral, gets advice from another individual.  This is
12   pretty similar, for example, to what goes on if I go to
13   my primary care physician and say, "I've been having
14   heart pain."
15            And he says, "Well, go to the cardiologist."
16            There's a referral.  I trust him.  He might not
17   be doing the right thing.  He might be getting a
18   kickback, but we don't see the primary care physician
19   yet being rate regulated.
20            MR. HENLEY:  My question, Dr. Vistnes, is is it
21   your position that there are not illegal kickbacks in
22   2006?
23            DR. VISTNES:  Oh, absolutely not.  And I would
24   actually like to address that possibility because it was
25   earlier discussed what am I advocating, if anything,

73
 1   that this Commission do with respect to the title
 2   insurance industry.  Am I advocating that there be no
 3   regulation?  The answer there is absolutely not.  I
 4   think there are tremendous opportunities for this
 5   Commission to offer benefits to California's consumers,
 6   but those benefits need to be realized in a thoughtful,
 7   careful process and that process is not through rate
 8   regulation.  It is instead through targeted intervention
 9   where you see the problems.
10            Again, wrapping back to my previous
11   testimony --
12            MR. COHEN:  Do you think --
13                   (Simultaneous colloquy.)
14            DR. VISTNES:  Just to finish up very quickly,
15   is where economics has taken us, is to say if there is a
16   problem with a particular market, identify the prolem
17   and do some targeted intervention.  If we believe that
18   there are inappropriate kickbacks, illegal kickbacks,
19   then we have two choices.  We can either, in essence,
20   eliminate the competition that exists in the first case
21   by going for rate regulation and hopefully eliminate the
22   incentives to eliminate those illegal kickbacks or we
23   can do other more targeted approaches, increase the
24   fines for illegal kickbacks, increase enforcement.
25   Those are much more targeted without the harms attendant

74
 1   of rate regulation.
 2            MR. COHEN:  Just quick two questions.  Is it
 3   your testimony there is no rate regulation in the
 4   provision of medical care?
 5            DR. VISTNES:  I'm saying that there is no rate
 6   regulation of physicians.  You may be thinking of
 7   Medicare setting a price, but that is a purchaser
 8   setting a price.  I'm not sure what rate regulation you
 9   are referring to.
10            MR. COHEN:  Okay.  Well.  All right.  Fine.
11            DR. VISTNES:  Well, this is an important
12   distinction.
13            MR. COHEN:  Are you aware -- well, what we're
14   doing is not rate regulation either.  We're setting a
15   proposal to set a maximum allowable rate to assure that
16   rates are not excessive.  We're not -- so --
17            DR. VISTNES:  This is a distinction that is
18   very finely drawn and to most economists --
19            MR. COHEN:  Thank you.
20            DR. VISTNES:  -- would be one that would not be
21   recognized.
22            MR. COHEN:  I'll take that as a compliment.
23            Are you familiar with the efforts that this
24   department has taken in the past three years and
25   eight months with respect to enforcement in the --

75
 1   against illegal rebating and kickbacks in the title
 2   industry?  Do you know what we've done?
 3            DR. VISTNES:  At a general level, not with the
 4   specifics.
 5            Can I ask you, have those efforts been
 6   successful?  Have you had success reducing it?
 7            MR. COHEN:  Well, that is a very difficult to
 8   know, obviously, because we're talking about illegal
 9   conduct that, you know, have we reduced it or not.
10            DR. VISTNES:  Have you levied more fines?
11            MR. COHEN:  We've levied a lot of fines in huge
12   amounts of money and --
13            DR. VISTNES:  And that's exactly the type of
14   regulatory initiative that is really very
15   procompetitive.  It is targeting the problem that I
16   think much of this rate regulation is driven to try to
17   eliminate but in a much more focused way without the
18   attendant.
19            MR. COHEN:  Right.  And if rates had gone down,
20   if everyone had stood up and said you are right, we're
21   not going to make illegal payments anymore and as a
22   result, we're going to be able to save our customers
23   some money and we're going to reduce our rates, we'd be
24   happy people, but that has not happened.
25            DR. VISTNES:  Well, if you are not happy at

76
 1   this point, then I think the question that needs to be
 2   addressed from a policymaker or economics perspective is
 3   what is still wrong with this industry.  It is
 4   fundamentally competitive.  There are a number of
 5   players out there.  It is a market where entry can
 6   happen, where expansion can happen.  Why is not
 7   competition working as well as you would like it to
 8   happen and rather than throwing out competition, can you
 9   make competition better?  Can you use your regulatory
10   initiatives to stimulate competition?
11            Here, I think you have a number of different
12   options that you could pursue and that would provide
13   potentially much higher benefits to California's
14   consumers.  These would include giving more education to
15   the individual consumers, letting them know what title
16   insurance is, knowing that they have an option, knowing
17   that if they shop around, they may save $50, $100 by
18   shopping around.  That may interject more price
19   sensitivity, more price competition than exists today
20   into the market.  You could continue your efforts to
21   make public comparisons and easy comparisons of title
22   prices available to the consumer so that when they do
23   try to shop around price, they can easily find out what
24   happens.  These are the types of things that work within
25   the competitive markets that again is where the policy

77
 1   and economics in the past 20 years has been moving to
 2   make competition work for you, to harness the full
 3   potential of competition to the benefit of consumers.
 4            MR. COHEN:  And I totally agree with you and
 5   those things should happen and I think to some extent,
 6   they are happening and they are all good things, but the
 7   problem I have is that we have a law that says that the
 8   insurance Commissioner may not permit, may not, shall
 9   not permit an insurer to charge an excessive rate if he
10   makes a finding that there is inadequate competition.
11   Now, I understand we have a disagreement about whether
12   there is or isn't, but the fact that we may make efforts
13   going forward to try to increase the amount of
14   competition from our standpoint, while those are good
15   things, they don't -- it doesn't mean that the finding
16   that we've made that there is inadequate competition
17   today isn't correct.  I mean, that's part of the debate,
18   obviously, but once we've made -- if we make that
19   determination, then it is not good enough for us to just
20   say, well, we're going to do all of these other things
21   because the law mandates us to not permit excessive
22   rates to be charged.
23            DR. VISTNES:  And once a finding of reasonable
24   competition has been made and has been supported, then I
25   can't speak to your legal obligations.  What I can say,

78
 1   though, and what I strenuously say to you today is that
 2   I do not believe that this market is one that can, by
 3   any stretch of the imagination, be characterized as not
 4   reasonably competitive because as I believe I said
 5   six months -- eight months ago before this Commission is
 6   the definition of a reasonably competitive market has to
 7   take into consideration what is the alternative.  That
 8   is a baseline that was never considered by the Birnbaum
 9   Report.  And here, as I suspected in January and is now
10   very clearly true, the alternative to competition that
11   is being considered and being advocated by this
12   Commissioner is a move to rate regulation and that
13   defines the context of reasonable competition.  In other
14   words, is competition so ineffective, so poorly working
15   that we are better off by eliminating, by substituting
16   away from competition and moving to a rate regulated
17   environment and in that type of a context, rate
18   regulation has got just as many, likely far more
19   problems with it, than competition ever would.  In that
20   type of a context, this market cannot be considered not
21   to be reasonably competitive.  Consumers will be better
22   off.
23            MR. COHEN:  What's your definition?  I mean, I
24   guess I'm sitting here thinking that the definition of
25   reasonable competitive, it is not reasonably competitive

79
 1   if companies are able to -- well, tell me what your
 2   definition.
 3            DR. VISTNES:  Reasonable competition has to do
 4   with our -- at the heart of the matter, are consumers
 5   better off in today's world or even better, today's
 6   world with further efforts to educate consumers and make
 7   competition work, are they better off with competition
 8   or under rate regulation?  If they are better off under
 9   rate regulation, then you are absolutely correct.  The
10   market should be deemed not reasonably competitive, but
11   that tradeoff has never been considered.  And what I'm
12   very worried has happened here is -- oftentimes happens
13   -- is the notion of rate regulation comes with it a
14   notion that we will do perfectly.  We will do the best
15   possible job.  We will get it right.  That's never
16   happened in the history of any regulated industry.  I
17   suspect that if you look at other title insurance
18   states, you'll find that their experience, those who
19   have rate regulated, they haven't done much better.
20   They haven't done better at all than California has
21   done.  Do you want to get out of -- and I wouldn't even
22   say you are in a frying pan right now -- but do you want
23   to get out of the frying pan of competition into the
24   fire of rate regulation?  I think you'll find yourself
25   much, much worse off.

80
 1            MR. COHEN:  Okay.  So your definition, I take
 2   it, is an economic definition.  It is certainly not a
 3   legal definition of what a reasonable --
 4            DR. VISTNES:  I'm not sure that reasonable
 5   competition has a legal definition and in that sense, it