State Farm Lloyds v. Rathgeber (453 S.W.3d 87, 2014)

OPINION

Bob Pemberton, Justice

State Farm Lloyds appeals a district court judgment affirming a final order of the Commissioner of Insurance determining that it had charged consumers homeowners insurance premiums that were excessive for several years during the 2000s and ordering refunds with interest. We will affirm the Commissioner’s order with respect to the first year at issue, but must reverse as to the remaining years and remand for further proceedings. We also hold that there was reversible error in the Commissioner’s award of interest on refunds he determined to be due.

BACKGROUND

This appeal arises from the proceedings on remand this Court required in Geeslin v. State Farm Lloyds (State Farm Lloyds I), and we will refer the reader to that opinion for a comprehensive explanation of statutory context and procedural prologue. On remand, the Texas Department of Insurance (TDI) noticed a “re-hearing” to determine whether the Commissioner should affirm the reduction TDI had ordered in the “initial rate” State Farm Lloyds had filed under former art. 5.26-1 of the Insurance Code, or require a greater or lesser reduction instead. The Office of Public Insurance Counsel (OPIC) intervened. The hearing was ultimately conducted over several days in 2009, and the record was closed in November of that year.

The State Farm Lloyds “rate” in dispute at the hearing referred to “the cost of insurance per exposure unit ... with an adjustment to account for the treatment of expenses, profit, and individual insurer variation in loss experience, and before any application of individual risk variations.” Former art. 5.26-1 required that the “initial rate” filed by State Farm Lloyds and ultimately'approved by TDI be “just, reasonable, adequate, not excessive, and not unfairly discriminatory for the risks to which it applies.” These requirements, simply put, mean that an insurer charges consumers a price sufficient to recover both its projected expenses of asT suming risks under its policy and a profit yielding a “reasonable” rate of return on its capital, but not a profit “unreasonably” higher than this. The requirements also operate against a constitutional backdrop. This Court has held — most recently in State Farm Lloyds I — that government-set rates are deemed to effect an unconstitutional taking of an insurer’s property if the insurer cannot recover both its projected “operating expenses” and a “reasonable rate of return” on its capital.

In advocating their views of a reasonable rate that would comply with these statutory and constitutional requirements, the parties, generally speaking, followed a common methodology in which they calculated an “indicated” rate comprised of the sum of several specified categories of projected expenses per exposure unit (e.g., estimated payments or losses related to hurricanes), plus an additional “underwriting profit” provision calculated so as to ensure that State Farm Lloyds obtained an overall profit (including net income from both premiums and investments) sufficient to provide a rate of return on its capital equivalent to that which it could obtain in alternative investments of equivalent risk (i.e., a return compensating it for the “opportunity cost” of its capital). The indicated rate would then be compared to the premium State Farm Lloyds was projected to earn per exposure unit under the filed initial rate it had charged its customers. If the indicated rate was less than State Farm Lloyds’s projected premiums, its initial rate would be deemed excessive. Conversely, if the indicated rate equaled or exceeded the projected premiums, a rate reduction would be considered confiscatory. Although generally following the same method for calculating the indicated rate and any required reduction, the parties differed with respect to the cost or expense elements that should be included in the indicated rate and their amount.

The issues were further framed by an unusual procedural posture on remand. As explained in State Farm Lloyds I, former art. 5.26-1 (a component of the 78th Legislature’s watershed S.B. 14) had governed the first of three phases through which the Legislature imposed rate regulation on what had become a largely unregulated Texas homeowners insurance market. Under former art. 5.26-1, effective June 11, 2003 through August 31, 2004, insurers were required to file their initial regulated rates within 20 days of the statute’s effective date and implement them. After this initial filing, former art. 5.142, effective June 11, 2003, through November 30, 2004, provided temporary rate-regulation procedures. Under former art. 5.142, insurers were required to file their rates with TDI and await the Commissioner’s approval before implementing them. Then, beginning on December 1, 2004, a permanent file-and-use regime, governed by former art. 5.13-2 of the Insurance Code (now codified as chapter 2251 of that code) took effect whereby insurers file their rates with TDI and implement them, subject to the Commissioner’s power to disapprove the rates before they go into effect or disapprove further use of the rates after they go into effect. In State Farm Lloyds’s case, TDI had ordered, and the Commissioner had affirmed, a 12% reduction in the insurer’s initial filed rate. This reduction, all other things being equal, would have taken effect on September 7, 2003. However, in former art. 5.26-I, the Legislature had allowed an insurer who sought judicial review of a rate-reduction order, as State Farm Lloyds had, the option of charging its filed rate while litigation was pending, subject to mandatory refunds of “the difference in overcharged premium to each policyholder, plus interest,” if “on final appeal the court upholds the commissioner’s determination that the insurer’s rates are excessive.” State Farm had availed itself of this option and continued charging its initial filed rate (which we will term its “implemented rate”), notwithstanding the Commissioner’s opposition to it, pending litigation over its validity.

As events turned out, the first round of litigation over State Farm Lloyds’s implemented rate had not concluded until 2008, when this Court issued its State Farm Lloyds I decision. In remanding the case to the Commissioner for further proceedings despite former art. 5.26-1’s expiration on September 1, 2004, this Court observed that the Legislature had provided that the expiration ‘“does not affect an action or proceeding against an insurer subject to that law for failure to comply with that law before its expiration, regardless of when the action or proceeding was commenced, and that law is continued in effect for that purpose.’” In the meantime, however, State Farm Lloyds’s implemented rate has remained in effect not only as its operative initial rate under former art. 5.26-1, but also as the insurer’s operative rate under former art. 5.142, which had contained parallel provisions authorizing the insurer to charge its desired rate • pending appeal, subject to refunds with interest if the rate was later found excessive. State Farm Lloyds had similarly continued charging the implemented rate as the file-and-use regime began on December 1, 2004, and would ultimately do so, despite TDI’s attempts to restrict the insurer from continuing to charge the rate and the insurer’s efforts to obtain rate increases, until mid-2008, when the Commissioner finally approved increased rates effective on June 1 for new business and August 1 for renewal business. Consequently, the dispute on remand concerned whether State Farm Lloyds, through its implemented rate, had overcharged its policyholders not only between September 7, 2003, and August 31, 2004, the period in which former art. 5.26-1 had been in effect, but whether it had continued to do so for several years thereafter. The statutory standards governing the “excessiveness” of State Farm’s “rate” after September 1, 2004, were essentially identical to those applicable under former art. 5.26-1.

But while the hearing on remand thus concerned whether State Farm Lloyds had overcharged its customers in the past, the Commissioner emphasized that “ratemak-ing is a prospective endeavor,” alluding to the longstanding principles barring retroactive ratemaking, the making of “a retrospective inquiry to determine whether a prior rate was reasonable and imposing a surcharge when rates were too low or a refund when rates are too high.” He likewise observed that both the relevant Insurance Code provisions and actuarial principles contemplated prospective ratemaking based on estimates of future costs, and he additionally deemed it “unfair to judge the reasonableness of any of the parties’ estimates of future costs based on information that was unknowable” at the time the estimates were made.” (Emphases in original.) Thus, the proper rate-making inquiry on remand, as the Commissioner reasoned, centered not on real-life events that had occurred while the implemented rate was in effect, viewed in hindsight — as he put it, “retrospective evidence ... has no business in a rate hearing” — but on the rate or rates the Commissioner should have set prospectively from the perspective of a time preceding the period or periods in which the rate was used. To that end, the Commissioner focused the inquiry on information known or “knowable” as of early September 2003, the date of the original hearing. However, the Commissioner did conclude that evidence of State Farm Lloyds’s financial condition as of the time of the rehearing would be relevant to assessing the impact of any refunds he might order.

A related question concerned the time intervals for the rate or rates the Commissioner would determine — not only the period in which former art. 5.26-1 had been in effect, and for which the cost estimates underlying State Farm Lloyds’s implemented rate had been made, but almost four years thereafter, far longer than the typical one-year term of a homeowner’s insurance policy. The Commissioner ultimately focused the inquiry primarily on determining the rate that should have applied during an “initial term” between September 7, 2003 and August 31, 2004, corresponding roughly to the period in which former art. 5.26-1 had been in effect and for which the implemented rate had been designed. Then, utilizing his initial-term indicated rate as a starting point, the Commissioner considered the extent to which adjustments or modifications to the indicated rate should be made during the “subsequent period” between September 1, 2004 and July 31, 2008.

A further development impacting the hearing’s procedural posture had been the 2004 discovery of an error in State Farm Lloyds’s original premium projections under the implemented rate that had caused it to significantly overstate the figure. TDI had also relied on the same premium projections, and the error had correspondingly skewed upward the amount of rate reduction it determined necessary to conform State Farm’s Lloyds’s implemented rate with the agency’s view of the proper indicated rate. The Commissioner deemed this error to be “knowable” at the time of the first hearing, and TDI agreed that its calculations should be revised and abandoned its advocacy of the original 12% rate reduction. Accordingly, the Commissioner found that TDI’s original 12% reduction would “produce a confiscatory rate” and, as such, that State Farm Lloyds had met its initial burden under former art. 5.26-1 (as modified by State Farm Lloyds I) to show by clear and convincing evidence that TDI’s rate would not be “just, reasonable, [and] adequate ... for the risks to which it applies.” And with that burden being met, the Commissioner reasoned, the relevant “issue for determination” became simply “the development of rates chargeable by SFL [State Farm Lloyds] which are just and reasonable and neither confiscatory nor excessive for the risks to which they apply.” In the Commissioner’s view, “[n]either [TDI] Staff nor SFL bore the burden of production or persuasion on this issue.”

After correcting for the erroneous premium projections, TDI determined that State Farm Lloyds’s implemented rate had been excessive by over 9% through June 2004. OPIC, on the other hand, did not correct for the error and urged rate reductions in line with TDI’s original position. In contrast, State Farm Lloyds insisted that the Commissioner adopt its implemented rate in lieu of any reduction because its costs had actually justified a 12% rate increase over its implemented rate, had it opted to seek one. Although there were other areas of divergence in the parties’ respective calculations of the indicated rate, this appeal would ultimately center on two.

The first, presenting what the Commissioner would term the most “vexing and difficult” issue in the proceeding, concerned a provision State Farm Lloyds had included in its rate to aid its recovery from large financial losses it had incurred a few years earlier. Between 2000 and 2002, State Farm Lloyds had incurred almost $2 million in underwriting losses from unanticipated mold claims and a multitude of non-hurricane catastrophes (e.g., tornadoes, hailstorms, and ice storms). The aggregate losses had dwarfed the preexisting amount of State Farm Lloyds’s surplus, the cash reserves that insurers are required to maintain beyond the amounts reserved for incurred and expected claims, which serve as a “cushion” against losses not anticipated in the existing rate. By statute, State Farm Lloyds was required to maintain a minimum surplus equaling one-third of its total premiums — 33$ for every $1 of premium, or a 3:1 premium-to-surplus ratio — or else be deemed “statutorily insolvent” and potentially subject to supervision or conservatorship. Amid its losses, there is no dispute that State Farm Lloyds would have been rendered statutorily insolvent absent large cash infusions, and thus it had turned to an affiliate, State Farm Mutual Automobile Insurance Company (State Farm Mutual), and obtained three advances — in November 2001, February 2002, and September 2002 — in amounts totaling over one billion dollars. When State Farm Lloyds filed its initial rate in June 2003, its surplus was just below $467 million, giving it a premium-to-surplus ratio of roughly 2.8:1.

The advances from State Farm Mutual had formed the consideration for a $1.05 billion “consolidated surplus debenture” that State Farm Lloyds had issued to State Farm Mutual. The parties agree that the terms of this instrument distinguish it as a “surplus note,” a type of financial instrument that evidently has been used in the insurance industry for decades and has specifically been addressed by TDI rule. As the term suggests, a “surplus note” is in the nature of a debt instrument, but the interests of the creditor are subordinated in a manner permitting the proceeds to be initially treated for accounting purposes as unencumbered surplus, similar to equity capital. In the case of State Farm Lloyds’s surplus note, it reflects that the insurer owes State Farm Mutual a principal amount of $1.05 billion, plus interest accruing at 7% per annum, compounded and payable semiannually, with a maturity date of December 31, 2016. However, tracking requirements from TDI’s rules, the instrument conditions State Farm Lloyds’s payment obligation on the existence of surplus exceeding specified threshold amounts — principal is to be repaid only out of “excess surplus funds” that exceed $900 million, while semi-annual interest payments are to be made only from surplus, if any, that exceeds $700 million. Similarly, only if and to the extent these payment obligations actually arise is any offsetting liability recognized. Of final note, TDI’s rules require that the Commissioner give prior approval to any surplus notes before issuance, and State Farm Lloyds obtained such approval here.

State Farm Lloyds had included in its rate indication a “surplus note” provision in the amount of 9% of premium. This amount, as explained by the insurer’s witnesses during the hearing, was intended to (1) capture the annual costs of repaying the principal on the surplus note, plus interest, amortized over a 15-year term, plus (2) provide additional funds to increase State Farm Lloyds’s surplus (net of the funds going toward the surplus-note payments) at a rate so as to equal the amount of the company’s projected annual premiums (i.e., 1:1 premium-to-surplus ratio) within nine years. Both TDI and OPIC opposed the inclusion of the surplus-note provision in the rate, urging that State Farm Lloyds was entitled to recover only the opportunity cost of the surplus-note proceeds, not additional sums to recapitalize the company, and that the company’s rate would already ensure it this recovery through the rate of return secured by the underwriting-profit provision. In addition to its surplus-note provision, State Farm Lloyds had included an underwriting-profit provision in its rate, equal to 5% of premiums, determining that this amount would provide it a rate of return on its capital equivalent to alternative investments of similar risk. TDI had agreed that this underwriting-profit figure was appropriate for recovering State Farm Lloyds’s costs of capital — including any recoverable costs related to the surplus note. In contrast, State Farm Lloyds insisted that the costs of amortizing the surplus-note principal and “rebuilding” the company’s surplus, as it sought to recover through the surplus-note provision, were instead in the nature of expenses of providing homeowner’s insurance in the volatile Texas market, akin to projected payments on claims, and were appropriately compensated in the rate separately and apart from its costs of capital recovered through underwriting profit and rate of return.

The second material disputed rate component was a “contingencies” provision, equal to 2% of premium, that State Farm Lloyds had included in its rate. The Commissioner heard evidence, and the parties appear generally to agree, that a “contingencies” provision, like underwriting profit, is an accepted means by which ratemak-ers account for the cost of capital in light of risk. Underwriting profit is said to account for the undifferentiated risk that an insurer’s actual expenses will turn out to vary from the estimates that the rate is designed to recover within any given period. But where deviations between an insurer’s estimated and actual expenses can be shown to persist systematically over time and be incapable of being eliminated by changing other components of the ratemaking process, it is considered appropriate to include in the rate an additional contingencies provision to compensate for the expected range of unanticipated losses. Thus, to summarize the difference between the two types of provisions, a contingency provision seeks to recover an expected range of losses and is thus not expected to be realized as profit, while an underwriting-profit provision yields an expected profit that accounts for variability in results.

In attempting to establish the requisite systematic deviations between estimated and actual expenses, State Farm Lloyds relied in part on evidence of past court decisions that had effectively broadened coverage beyond what was contemplated in its rate structure. Initially, both TDI and OPIC opposed inclusion of a contingencies provision. Although TDI eventually acceded to the provision, OPIC maintained that State Farm Lloyds had failed to demonstrate any pattern of deviations that had not been addressed by intervening regulatory changes. It emphasized, for example, that the Commissioner in 2002 had approved new homeowners-policy forms that unequivocally excluded mold coverage.

The Commissioner determined that neither State Farm Lloyds’s 9% surplus-note provision nor its 2% contingencies provision should be included in the insurer’s rate. Regarding the former, the Commissioner agreed with TDI and OPIC that State Farm Lloyds was entitled to recover only the cost of the surplus-note proceeds that would already be compensated through a reasonable return on capital ensured through the underwriting-profit provision. Consequently, he reasoned that “[a]llowing a separate provision for a write-down or amortization of SFL’s surplus note and related interest would be tantamount to allowing two returns on capital in the ratemaking formula.” The Commissioner similarly concluded that “[i]t is unreasonable to include principal and interest payments oh the surplus note as an expense in SFL’s rates” and that doing so “in addition to rate provisions which already contemplate SFL’s expected future costs, including its cost of capital, will produce excessive rates.” As for the contingencies provision, the Commissioner found that “[t]he evidence does not support a conclusion that there is a systematic variation between expected costs and actual costs.” Accordingly, he concluded that “[i]nelusion of a contingency provision over and above a reasonable underwriting profit provision which reflects the risks of SFL writing homeowners insurance in Texas in 2008 will produce excessive rates.”

But while deciding that these specific rate provisions were unwarranted and inappropriate, the Commissioner determined that the underlying evidence was nonetheless probative of risk that had not yet been sufficiently accounted for in State Farm Lloyds’s calculation of underwriting profit. Although stopping short of finding that a “systematic variation between expected costs and actual costs” actually existed so as to warrant a contingencies provision, the Commissioner found that there “may be ” such a variation (emphasis in original), that this “conclusion ... implies risk,” and that “this risk can be considered and addressed in deriving an appropriate underwriting profit ... provision.” Similarly, with respect to the surplus-note obligation, the Commissioner found that:

While the inclusion of the separate 9.0% surplus note provision in the ratemaking formula would be unreasonable, it is reasonable to consider the existence of the surplus note, and the need for both the principal and related interest to be paid by December 31, 2016, in considering the reasonableness of the underwriting profit provision. Specifically, the Commissioner finds it is reasonable to consider the existence of the surplus note, and SFL’s obligation to timely repay it when determining: (1) the level of risk faced by SFL in writing homeowners insurance in 2008; (2) an appropriate premium to surplus ratio [as explained below, a method of weighing risk] or cost of capital; and (3) an appropriate underwriting profit provision.

The Commissioner additionally found that the analysis should also consider another “indication of risk” that had been “brought forth in the record”: “[t]he fact that SFL is a single-state insurer deriving almost its entire premium from a single line of insurance which includes catastrophe coverage in a catastrophe-prone state.” And while the Commissioner acknowledged evidence that “SFL is making significant provision for catastrophe reinsurance” (i.e., shifting the risk of such losses to the reinsurer)— in fact, the Commissioner ultimately approved including a rate component to fund such coverage — he also found that “some catastrophe exposure” faced by State Farm Lloyds “is not fully covered by reinsurance.”

In light of these indicators of additional risk he had identified, the Commissioner, to summarize his analysis, recalculated underwriting profit using the same basic methodology that State Farm Lloyds had utilized, but with greater weighting of risk in the equation. Based on this analysis, the Commissioner concluded that an appropriate underwriting profit for State Farm Lloyds during the initial period was 8.5% of premium — in other words, an underwriting profit 3.5% higher than the company itself had sought, and 1.5% higher than the combined total of the company’s underwriting-profit and contingencies provisions.

Despite this increase in the underwriting-profit component of the Commissioner’s rate indication, State Farm Lloyds’s implemented rate remained excessive by comparison. In accordance with the difference, the Commissioner concluded that a “rate reduction of -6.2% ... produces rates that are both just and reasonable and neither excessive nor confiscatory for the period September 7, 2003, through August 31, 2004.” He then turned to the “subsequent period” between September 1, 2004 and July 31, 2008.

The Commissioner rejected arguments by OPIC that he should merely extend the initial-period rate indication unchanged through the subsequent period, finding that “[tjhere is no evidence in the record to suggest that SFL’s rates remained at the same level of excessiveness for the entire period” and that, to the contrary, the “evidence ... suggests] the level of excessiveness of SFL’s rates declined over time.” To account for these changes, the Commissioner, relying on the same data set of September 2003 information from which the initial rate had been derived, projected trends of increases in several cost components of the rate (which would tend to justify a higher rate) into the subsequent period to determine a single rate for that entire period. But while determining these cost elements prospectively from the perspective of September 2003, the Commissioner also reduced the underwriting-profit component of the rate based on events that had occurred much later.

In 2006 and 2007, State Farm Lloyds’s non-hurricane catastrophe losses had turned out to be significantly lower than the projections built into its implemented rate, causing the insurer’s surplus to increase to an extent that it had been able to pay both accrued interest on the surplus note and large amounts of principal. Finding that “[djuring the subsequent period SFL [had] repaid approximately $400 million, or more than one-third, of the surplus note principal,” the Commissioner deemed it “reasonable to consider the repayment of $400 million of surplus note principal during the subsequent period when evaluating the risk associated with the repayment of the $1.05 billion surplus note.” On that basis, he determined that a “reasonable underwriting profit provision used to determine the rate in the subsequent period is 8.0%,” a reduction of one-half of one percent from the underwriting profit in the ordered rate for the initial period. Incorporating the lower underwriting profit into the flat rate the Commissioner had calculated for the subsequent period yielded an indicated rate that was 3.4% lower than State Farm Lloyds’s implemented rate throughout the entire subsequent period.

In light of his determinations that State Farm Lloyds’s implemented rate had been excessive during both the initial and subsequent periods, the Commissioner ordered that the insurer refund the difference to its policyholders. He estimated the gross amount of these refunds to be $256.7 million, plus accrued interest of approximately $53.0 million. The Commissioner found, however, that the insurer could provide these refunds in the form of credits to policyholders during the initial or subsequent period who renewed their coverage.

State Farm Lloyds timely sought judicial review of the Commissioner’s final order in the district court below. On evidence consisting solely of the administrative record, the district court affirmed the Commissioner’s order in full. State Farm Lloyds then perfected this appeal.

ANALYSIS

State Farm Lloyds brings six points of error on appeal. Collectively, the points challenge, based on an assortment of evi-dentiary and constitutional grounds, (1) the Commissioner’s refusal to include the surplus-note provision in State Farm Lloyds’s rate; (2) the Commissioner’s refusal to include the 2% contingencies provision in the rate; (3) the Commissioner’s determination of the underwriting-profit component of the rate for the initial period; (4) the rate the Commissioner imposed for the “subsequent period;” (5) the refunds ordered by the Commissioner; and (6) interest awarded by the Commissioner on amounts he held to be due.

Standard of review

The parties agree that judicial review is governed by the familiar standard set forth in section 2001.174 of the Administrative Procedure Act (APA):

[A]court may not substitute its judgment for that of the agency as to the weight of the evidence on questions committed to agency discretion but:

(1) may affirm the decision of the agency in whole or in part; and

(2) shall reverse or remand the case for further proceedings if substantial rights of the appellant have been prejudiced because the administrative findings, inferences, conclusions, or decisions are:

(A) in violation of a constitutional or statutory provision;

(B) in excess of the agency’s statutory authority;

(C) made through unlawful procedure;

(D) affected by other error of law;

(E) not reasonably supported by substantial evidence considering the reliable and probative evidence in the record as a whole; or

(F) arbitrary or capricious or characterized by abuse of discretion or clearly unwarranted exercise of discretion.

Essentially, this is a rational-basis test to determine, as a matter of law, whether an agency’s order finds reasonable support in the record. “The test is not whether the agency made the correct conclusion in our view, but whether some reasonable basis exists in the record for the agency’s action.” We apply this analysis without deference to the district court’s judgment. We presume that the agency’s findings, inferences, conclusions, and decisions are supported by substantial evidence, and the burden is on the contestant to demonstrate otherwise.

Substantial-evidence analysis entails two component inquiries: (1) whether the agency made findings of underlying facts that logically support the ultimate facts and legal conclusions establishing the legal authority for the agency’s decision or action and, in turn, (2) whether the findings of underlying fact are reasonably supported by evidence. The second inquiry, which has been termed the “crux” of substantial-evidence review, is highly deferential to the agency’s determination: “substantial evidence” in this sense “does not mean a large or considerable amount of evidence” — in fact, the evidence may even preponderate against the agency’s finding — but requires only “such relevant evidence as a reasonable mind might accept as adequate to support a [finding] of fact.” Likewise, we “may not substitute [our] judgment for the judgment of the state agency on the weight of the evidence on questions committed to agency discretion.” In contrast, the first inquiry, concerning the extent to which the underlying facts found by the agency logically support its ultimate decision or action, may entail questions of law that we review de novo.

State Farm Lloyds’s points of error implicate both deferential aspects of substantial-evidence review and issues that we must examine de novo. Foremost among the latter are State Farm Lloyds’s arguments grounded in constitutional takings principles, which substantially overlap and interrelate with their non-constitutional grounds. Although these principles derive from both the Texas and federal constitutions, the parties have not suggested any material substantive difference between these provisions as they impact this case, so we will assume there are none. Similarly, in invoking competing views of these principles and their application here, both sides have relied primarily on jurisprudence from the United States Supreme Court applying the Takings Clause of the federal constitution, with much emphasis on its seminal Hope Natural Gas decision.

Under these authorities, the United States Supreme Court has explained, “[t]he guiding principle has been that the Constitution protects [regulated entities] from being limited to a charge for their property serving the public which is so ‘unjust’ as to be confiscatory,” a charge that is “ ‘so unjust as to destroy [the] value of the property for all the purposes for which it was acquired,’ and in so doing ‘practically deprive[s] the owner of property without due process of law.’” But above this constitutional floor, a rate “may reduce the value of the property which is being regulated” or “limit stringently the return recovered on investment.” “All that is protected against, in a constitutional sense, is that the rates fixed by the [government] be higher than a confiscatory level.”

Starting with Hope, the Supreme Court began focusing this inquiry not on the precise methodology through which a rate is formulated, but on a rate order’s “end result”:

It is not theory but the impact of the rate order that counts. If the total effect of the rate order cannot be said to be unjust and unreasonable, judicial inquiry ... is at an end. The fact that the method employed to reach that result may contain infirmities is not then important.

Thus, as far as constitutional takings principles are concerned, a governmental rate-maker “[i]s not bound to the use of any single formula or combination of formulae in determining rates.”

Hope further explained that evaluating the justness and reasonableness of a rate’s “end result” entails “a balancing of the investor and the consumer interests.” In that analysis:

[T]he investor interest has a legitimate concern with the financial integrity of the company whose rates are being regulated. From the investor or company point of view it is important that there be enough revenue not only for operating expenses but also for the capital costs of the business. These include service on the debt and dividends on the stock. By that standard, the return to the equity owner should be commensurate with returns on investments having corresponding risks. That return, moreover, should be sufficient to assure confidence in the financial integrity of the enterprise so as to maintain its credit and to attract capital.

In short, courts consider “whether the order may reasonably be expected to maintain financial integrity, attract necessary capital, and fairly compensate investors for the risks they have assumed, and yet provide appropriate protection for the relevant public interests.” A rate whose end result effects a reasonable balancing of insurer and investor interests relative to ratepayer or broader public interests “cannot properly be attacked as COnfiSCatO-py ”

In reviewing whether the Commissioner’s order effected a reasonable balancing of these interests, we give deference under the substantial-evidence standard to his findings regarding “initial questions of historical fact,” but review de novo his “second-order analysis [of] applying] th[e] historical facts to the legal standards.”

Surplus note

We will begin with the single most pivotal question in this rate appeal, and the one on which State Farm Lloyds places the greatest emphasis — the validity of the Commissioner’s decision not to include the 9% “surplus note” provision in the ordered rate. State Farm Lloyds challenges this determination principally through its first two points of error.

Interest

In its first point of error, State Farm Lloyds insists that without the surplus-note provision, the ordered rate, in both the initial and subsequent periods, is confiscatory and unconstitutional because it fails to account for the interest it owes on the surplus note. This is so, State Farm Lloyds reasons, because interest on the surplus note is properly considered an “operating expense” distinct from the costs of capital compensated through rate of return on capital and underwriting profit, and must be compensated as such in the rate. To support this premise, State Farm Lloyds points to TDI’s rule governing surplus notes, which requires accounting recognition of interest payments as “liabilities” when they come due and accounting principles, generally incorporated into TDI’s rules, requiring that interest “shall be expensed in the statements of operation when approved for payment.” State Farm Lloyds also emphasizes Texas Supreme Court decisions involving utility ratemaking that, in its view, approve or contemplate recovery of interest or other “carrying costs” on debt as specific components of the rate separate from a return on capital. In response, TDI and OPIC continue to maintain that, as the Commissioner found, State Farm Lloyds is seeking to double-recover a cost of capital for which it is already being compensated in the rate.

To address State Farm Lloyds’s assertions, we begin by noting that the Hope court characterized “service on the debt” as a component of the “the capital costs of the business,” as opposed to “operating expenses,” and that interest on debt is commonly accounted for through the rate of return on capital in other ratemaking contexts. The Commissioner heard evidence that the same is true in insurance ratemaking — interest on an insurer’s debt is considered to be a cost of capital that is properly and customarily compensated through the rate of return secured through underwriting profit, not as a type of operating expense. We cannot conclude the Commissioner’s decision to address State Farm Lloyds’s surplus-note interest the same way is without reasonable support in the evidence.

But the more critical feature of Hope, as it relates to State Farm Lloyds’s ultimate constitutional complaint, is the Supreme Court’s emphasis on the “total effect of the rate order,” not the “theory” or “method employed,” in determining a rate’s constitutionality. Under Hope, whether the ordered rate addressed interest on the surplus note as an “operating expense,” a “cost of capital” addressed through underwriting profit and rate of return, or through some other means, is singularly of little constitutional significance. What matters is whether the rate, in its ultimate effect, sufficiently accounted for the cost in some fashion.

To the extent State Farm Lloyds contends that the ordered rate fails altogether to account for interest -on the surplus note, it overlooks that the reasonable cost of capital contemplated by the insurer’s own underwriting-profit model, later utilized by the Commissioner, would include the cost of the surplus-note proceeds. That is, the ordered rate provided State Farm Lloyds a return on its capital, including the surplus-note proceeds, calculated so as to approximate the returns the funds would have garnered in alternative investments of similar risk. TDI’s witnesses testified that these earnings are the cost or value of State Farm Lloyds’s capital in economic effect, and for ratemaking purposes, inasmuch as they represent the rate of return that must be paid to investors to risk their funds in the enterprise.

While the Commissioner did not attempt to distinguish or specifically account for the actual amount of State Farm Lloyds’s interest obligations under the surplus note in determining the rate of return on the proceeds — in effect, he “costed” all of State Farm Lloyds’s capital as if it were equity — TDI presented expert testimony that this was the norm in insurance rate-making. Further support for the Commissioner’s approach is found in the evidence that the surplus note, while a debt instrument, also had attributes of equity — the debt obligations are subordinated so as to ensure that the proceeds can be used to supply minimum levels of surplus first. Yet even if there were any error in failing to differentiate surplus-note interest from its other costs of capital, State Farm Lloyds has not demonstrated any harm from the Commissioner’s approach.

To the contrary, according to projections prepared by one of State Farm Lloyds’s own experts, Dr. David Appel, the 5% underwriting profit originally advocated by the insurer and TDI would generate earnings sufficient to cover the same amortized costs of repaying the surplus note that the insurer had built into its surplus-note provision — including both interest and principal — -plus grow additional surplus at a rate of at least 4% annually through 2008. Ap-pel also prepared a similar set of projections that assumed a 7.8% underwriting profit, which generated surplus growth of at least 9% annually above the amortized costs of repaying the surplus note through the same period. The rate ultimately ordered by the Commissioner, as noted, provided State Farm Lloyds an even higher underwriting profit in both the initial and subsequent periods.

This evidence reasonably supports the Commissioner’s findings that the ordered rate fully accounts for interest on the surplus note (and, indeed, also principal) through the return on capital secured through underwriting profit. It would follow that allowing a separate provision to recover interest would, as the Commissioner found, amount to a double-recovery and render the rate excessive. In light of these findings and their evidentiary support, we cannot conclude that the Commissioner’s refusal to separately provide for recovery of surplus-note interest renders the ordered rate unreasonable or confiscatory. Accordingly, we overrule State Farm Lloyds’s first point of error.

Recapitalization

In its second point of error, State Farm Lloyds asserts that the ordered rate, in both the initial and subsequent periods, “failed to adequately and measurably provide for [its] principal payments on the surplus note.” By this, significantly, State Farm Lloyds does not mean that the ordered rate failed to provide it sufficient earnings to repay principal owed on the surplus note — again, Appel’s projections tended to show that the rate would cover the annualized amortized principal and interest on the note even with a lower underwriting profit than the Commissioner ultimately ordered. Instead, the insurer’s contention is that the rate must also enable it to build additional surplus at a rate that would increase its total surplus (net of amounts reserved for surplus-note payments) to a 1:1 premium-to-surplus ratio within nine years. Unless the rate enables it to do both, State Farm Lloyds insists, it would be forced to operate with “depleted” levels of surplus for an inordinately prolonged period of time, and run the risk in the meantime that further catastrophes would derail its repayment of the surplus note. Such developments, it adds,- would undermine confidence in its financial integrity and prevent it from attracting future investment to an unreasonable and unconstitutional degree.

This was the real point of Appel’s projections, as State Farm Lloyds emphasizes. According to Appel’s calculations, a rate with a 5% underwriting profit and no surplus-note provision would require 21 years (2024) to grow State Farm Lloyds’s surplus, net of surplus-note payments, to reach a 1:1 premium-to-surplus ratio. With a 7.8% underwriting profit, according to Appel, such “recapitalization” would take 17 years (2020).

The Commissioner was unpersuaded that State Farm Lloyds was entitled to recover any costs related to the surplus note beyond the aforementioned return on its capital secured through underwriting profit. Assuming the rate provided State Farm Lloyds returns on its capital commensurate with those to be earned in alternative investments of similar risk, as the Commissioner observed in his order, there would be incentives for investors to provide capital to State Farm Lloyds going forward. The Commissioner was similarly skeptical that there was any immediate financial compulsion to provide State Farm Lloyds anything more. Although aeknowl-edging that having a 1:1 premium-to-surplus ratio would be “ideal,” the Commissioner cited Appel’s projections indicating that the ordered rate (and even a rate providing a lower underwriting profit) would enable the insurer to gradually rebuild its surplus to that 1:1 level while amortizing the surplus note, albeit at a slower pace than would be possible with the surplus-note provision. In light of this evidence, the upshot of State Farm Lloyds’s arguments, as the Commissioner saw it, was that he should “establish a rate so [the] insurer can expect to grow its surplus to a pre-determined level over a specified period of time over and above its cost of capital.” He rejected that notion, emphasizing the Supreme Court’s holdings that “[a]ll that is protected against, in a constitutional sense, is that the rates ... be higher than a confiscatory level.” He similarly viewed the surplus-note provision as an unjustified attempt by State Farm Lloyds not only to recoup its legitimate costs of providing insurance to its then-current policyholders, but also to effectively shift its past losses to them as well.

On the other hand, the Commissioner was given some pause by evidence that State Farm Lloyds’s premium-to-surplus ratio in 2003 was relatively low, noting a concession by TDI’s expert that the insurer’s premium-to-surplus ratio was only 2.35:1 around the time of the original hearing. Until State Farm Lloyds regained more solid financial footing, the Commissioner acknowledged, further unanticipated catastrophes would have had potentially “severe” repercussions for the insurer’s ability to fund repayment of the surplus note, obtain additional capital, and ultimately maintain financial viability. But the Commissioner remained unconvinced that he should approve the surplus-note provision for these reasons, a provision that, in his view, purported to provide State Farm Lloyds extraordinary returns above its cost of capital. Rather, the Commissioner viewed these considerations as going to the cost of capital itself, more specifically risk — the potential that State Farm Lloyds’s actual costs would vary from the expected costs anticipated in its rate — that is factored into determination of the reasonable return on its capital and underwriting profit. Additionally, the Commissioner determined that the parties themselves had not sufficiently accounted for these and other considerations bearing on risk when determining cost of capital and underwriting profit. To determine the appropriate rate, then, the Commissioner recalculated underwriting profit with greater weighting of risk and determined that State Farm Lloyds should receive a substantially higher underwriting profit of 8.5% of premium during the initial period and 8.0% in the subsequent period. Thus, the net effect of these rulings was to provide State Farm Lloyds an additional 3.0% to 3.5% of premium on top of the 5% it had sought as underwriting profit during the initial period, but not the full 9% of premium it had sought in the form of the surplus-note provision..

As State Farm Lloyds recognizes, our ultimate consideration in addressing its constitutional challenge to the ordered rate is whether the “end result” represents a reasonable balancing between the interests of the insurer and its investors (chiefly State Farm Mutual) on one hand, and those of its policyholders and the broader public interest on the other. With respect to State Farm Lloyds’s second issue, that inquiry focuses on whether the Commissioner’s refusal to permit State Farm Lloyds recovery of the full 9% of premium it sought through the surplus-note provision caused the ordered rate to unreasonably disfavor its financial and investor interests relative to those of ratepayers and the public. On the company and investor side of the equation, a rate that provided State Farm Lloyds returns reflecting the opportunity cost of its capital would, as the Commissioner observed, tend to attract funds from economically rational investors, at least in theory. Moreover, as TDI and OPIC emphasize on appeal, the Commissioner heard evidence that if the expense and earnings estimates anticipated in the rate held true, State Farm Lloyds would be able to cover the annualized amortized costs of the surplus note and gradually grow its surplus. And while the Commissioner acknowledged the potentially troubling consequences if actual events did not turn out that way, especially during the initial term, he took account of this risk through a substantial increase in the underwriting profit provided in the rate.

On the other side of the equation, furthermore, were concerns that a higher rate would effectively force State Farm Lloyds’s then-current policyholders to bear the costs of the company’s past losses. The Supreme Court has long held that a “company may not insist as a matter of constitutional right that past losses may be made up by rates to be applied in the present and future.” On the other hand, State Farm Lloyds insists that the surplus-note provision would actually benefit, not harm, its ratepayers, and should accordingly be weighed favorably in the constitutional balance. Because accelerated rebuilding of its surplus would tend to reduce the risk of future financial perils, State Farm Lloyds urges, its current ratepayers should appropriately bear these along with other costs of providing them insurance. More broadly, State Farm Lloyds insists that if its rate fails to include the surplus-note provision, it and other insurers will be discouraged from seeking this sort of extraordinary financing to survive future perilous times, opting instead to simply withdraw from the market, and that future investment to aid financially strapped insurers in such circumstances will likewise be chilled. These outcomes, State Farm Lloyds argues, would in turn not only harm Texas consumers (especially if a large homeowners insurer like itself were to leave the market), but thwart the regulated private-market approach to homeowners insurance that the Legislature has heretofore generally preferred over more government-intensive policy alternatives.

We echo the Commissioner’s assessment that these are “vexing” and “difficult” questions of insurance regulation, economic theory, and public policy. But resolution of such issues within our governmental framework is vested first in the Commissioner or the Legislature, and it is only at the margins of the other Branches’ lawful powers that the Judiciary properly has a say. We are unpersuaded that the Commissioner, in refusing to afford State Farm Lloyds recovery of the full 9% of premium it sought through the surplus-note provision, has effected such an unreasonable balancing among the interests of State Farm Lloyds, its investors, ratepayers, and the public as to violate the constitutional norms. Consequently, we cannot conclude this decision renders the rate confiscatory. Accordingly, we overrule State Farm Lloyd’s second point of error.

Contingencies

In its third point of error, State Farm Lloyds challenges the Commissioner’s refusal to include the 2% contingencies provision in the rates for the initial and subsequent periods. Alternatively, it urges that to the extent the Commissioner effectively included a contingencies provision in the increased underwriting profit he awarded, he deprived it of a reasonable rate of return on its capital because contingencies are in the nature of anticipated expenses rather than anticipated profit. The predicate for both arguments is that the Commissioner’s failure to find the required systematic variation between State Farm Lloyds’s projected and actual expenses was arbitrary and not supported by substantial evidence. This is so, according to the insurer, because it presented “un-contradicted” and “unimpeached” evidence establishing the required systematic shortfalls.

Even accepting State Farm Lloyds’s view of the record, the Commissioner was not obligated to accept or credit the insurer’s evidence regarding the contingencies provision as long as he provided an explanation or findings that would establish a reasonable basis for his doing so. And, although State Farm Lloyds asserts otherwise, the Commissioner made underlying findings demonstrating a reasonable basis for his rejection of the carrier’s evidence of systemic variations. Among other facts, the Commissioner pointed to a significant intervening change in the ratemaking process — in 2002, he had approved the use of policy forms that unequivocally excluded most mold losses from basic coverage, thereby addressing a key driver of the adverse court decisions that State Farm Lloyds had cited as proof of a systemic pattern of unforeseen losses. In the face of such facts, State Farm Lloyds’s argument goes ultimately to the weight the Commissioner ascribed to its evidence, and we cannot conclude he acted unreasonably or exceeded his discretion in that regard. We overrule State Farm Lloyds’s third point of error.

Underwriting profit

We next consider State Farm Lloyds’s challenge to the Commissioner’s determination of underwriting profit in the initial period, a component of its fifth point of error. In addition to being an independent ground for reversal, our preceding analysis of State Farm Lloyds’s arguments regarding the surplus note rested, in part, on the assumption that the underwriting-profit provision in the ordered rate had sufficiently secured it a rate of return consistent with its cost of capital.

State Farm Lloyds argues that the Commissioner’s determination of underwriting profit is not supported by substantial evidence because “he used a method that no witness proposed and no record evidence supports as an acceptable method for determining the profit provision.” It thus invokes the principle that substantial-evidence review, however deferential its factual aspects may be, still requires that an agency decision find ultimate support in evidence or facts officially noticed, and mere “agency expertise cannot be a substitute for proof.” It follows from this principle, as State Farm Lloyds emphasizes, that an agency’s methodology for calculating a rate or a rate component must find ultimate support in the evidence, facts judicially noticed, or an agency rule. But this does not necessarily mean that there must be explicit testimony or evidence of a particular methodology or calculation — in a given case, for example, the evidence might well enable the agency to reasonably infer an appropriate method that combines elements presented by different witnesses but no single witness. Similarly, even where no single witness testifies that the calculation should yield a specific figure, competing testimony may present a range of reasonable options from which the agency has discretion to choose.

The primary focus of State Farm Lloyds’s argument is that the Commissioner took account of the surplus-note obligation and the possibility of contingencies as factors probative of risk that should bear upon underwriting profit rather than viewing them as justifications for the specific rate provisions it had advocated. In State Farm Lloyds’s view, the evidence afforded the Commissioner only one alternative for addressing these issues — adopt the solution advocated by its experts and include the 9% surplus-note provision and 2% contingencies provision in the rate. State Farm Lloyds overlooks that TDI and OPIC’s experts advocated an alternative method for addressing the surplus-note obligation and the possibility of contingencies, albeit not the one the insurer preferred — regard any such costs as costs of capital and relegate State Farm Lloyds to recovering these costs through the underwriting-profit provision of the rate. As previously indicated, there was ample evidence to support the Commissioner’s rejection of State Farm Lloyds’s proposed alternative. In this respect, State Farm Lloyds’s complaint about underwriting profit is merely a corollary to its other arguments challenging the Commissioner’s refusal to include the surplus-note and contingencies provisions in the rate.

State Farm Lloyds is correct, however, that no witness explicitly advocated taking account of the surplus-note obligation and the possibility of contingency as additional elements of risk to be factored into underwriting profit above the risk that would already be reflected in the 5% underwriting profit State Farm Lloyds had advocated. But to the extent State Farm Lloyds is arguing that the Commissioner should have refrained from making his upward adjustments to underwriting profit after having rejected the two rate provisions, any error would only have been to the insurer’s benefit. Regardless, the evidence reasonably supported the Commissioner’s decision to make an upward adjustment to underwriting profit. A key underpinning of TDI and OPIC’s opposition to the surplus-note provision (and, ultimately, of the Commissioner’s rationale in rejecting it) was that the rate’s underwriting-profit provision already compensated State Farm Lloyds for its cost of capital. This reasoning logically presumes a reasonably accurate calculation of State Farm Lloyds’s cost of capital and underwriting profit. A key determinant of the cost of capital (and, in turn, underwriting profit), everyone agrees, is the level of risk the insurer faces (i.e., the potential for future random deviations between the estimated costs accounted for in the insurer’s rate and what its actual costs turn out to be). Hence, if the Commissioner found the existence of additional risk that had not been factored into the determination of underwriting profit and was material to it, it would follow that an adjustment to that provision would be necessary to ensure that the insurer was reasonably compensated for its cost of capital. The Commissioner found such an adjustment to be warranted here, and this finding is reasonably supported by at least two evidentiary bases. First, and most obviously, State Farm Lloyds itself had viewed the surplus-note obligation and contingencies issue as justifying separate rate provisions and presumably would not have factored them into the risk bearing on its underwriting-profit calculation. Second, the Commissioner heard evidence to the effect that the 5% underwriting-profit figure advocated by State Farm Lloyds was to some extent a standard or industry figure commonly used when fashioning property-insurance rates. This case was different, the Commissioner reasoned, finding that “[t]he element of risk associated with repaying a surplus note, plus interest, would not be present in a typical insurer, which has no surplus notes, and would not be prominent in an aggregation of all insurers, as most insurers do not have surplus notes.” State Farm Lloyds has not challenged that finding. In sum, while not advocated specifically by any one witness, the Commissioner’s decision to consider the surplus-note obligation and possibility of contingencies as indicia of additional risk and accordingly revisit underwriting profit is nonetheless grounded in reasonable inferences from the evidence the parties did present.

State Farm Lloyds further contends that the specific methodology through which the Commissioner adjusted underwriting profit lacks support by substantial evidence. To the extent State Farm Lloyds is urging that the Commissioner should have adjusted underwriting profit to some amount higher than it did, we will' proceed to address its contention. To determine the necessary adjustments to underwriting profit, the Commissioner utilized the same basic formula that State Farm Lloyds had itself employed to calculate underwriting profit, a method that the evidence further indicates is widely accepted among actuaries. Under this method, simply described, State Farm Lloyds solved for the amount of underwriting profit the carrier would have to obtain to yield, when combined with estimated investment income and other income, and after taxes, what would be a reasonable average rate of return on a hypothetical risk-adjusted level of capital. According to State Farm Lloyds’s witnesses, the hypothetical level of capital — customarily expressed in terms of a premium-to-surplus ratio, with a lower ratio signifying higher risk and vice versa — represents a level at which the risk associated with the amount of capital allocated to each exposure unit is of a targeted average intensity. In determin