(Released on 5/04/08)
The Intermediate Court of Appeals handed down a decision that confirms what we have known all along, that a user fee set at a rate greater than what is needed to provide the requisite service is nothing more than a tax, especially when the proceeds are used to fund programs and services totally unrelated to the fee payer.
The suit had been brought by the trade association representing local insurance companies who pay fees to the department of commerce and consumer affairs, which regulates the insurance industry in Hawaii. These user fees are supposed to cover the cost of the service, or in this case the cost of regulating the industry, that will then benefit the insurance companies who pay the fees.
As the Circuit Court found and the Intermediate Court of Appeals affirmed, that was not the case in the situation involving the insurance companies. While there were many legal orders involved, the long and short of it was that the insurance commissioner substantially increased the assessments of the insurance companies in order to build up a reserve. What the court found was that the fee ended up covering not only the overhead costs of the insurance division, but also the overhead costs of the department of commerce and consumer affairs as well as those overhead costs of the department of budget and finance.
During the same year that the insurance company assessments were increased, creating a reserve margin, the legislature determined that there was an excess of $4 million in the insurance reserve fund and authorized the director of finance to transfer this excess from the insurance fund to the state general fund. Although then Governor Cayetano vetoed half of the transfer, the other half of the authorization was allowed to be transferred.
During the same session the legislature basically collapsed the insurance reserve fund, along with many other funds administered for a variety of professions, into a much larger special fund managed by the department of commerce and consumer affairs called the Compliance Resolution Fund. Although sub-accounts were created within the Compliance Resolution Fund, it was difficult for the average taxpayer to figure out how much was in each sub-account. But the consolidation into the Compliance Resolution Fund created a temptingly large potential source for additional money to support the state general fund.
In fact, in the following year, the legislature authorized the transfer of up to $15 million from the Compliance Resolution fund to the state general fund. Of this amount, about $1.5 million was taken from the insurance regulation sub-account within the larger fund.
It was this taking of the special funds paid by the insurance industry for the regulatory services of the insurance division that the court found to be a violation of both the state constitution as well as the United States Constitution as the fees or assessments constituted illegal and unconstitutional taxes. In other words, because the fees assessed the insurance companies were for the purpose of regulating the actions of the insurance companies, those funds could not be used for any other purpose. By setting the fees at a level that produced more than what was needed to provide the regulatory services, the fees created excesses that were then channeled over to the state general fund to pay for costs unrelated to insurance regulation.
This is an issue that legislators had been cautioned about beginning in the late 1980’s when lawmakers took surplus general funds and allocated them into special funds. Then when the state general fund started to go south, those funds were used to shore up the general fund. When those special funds were depleted, they turned their attention to funds which had been established specifically to account for user fees paid by those who wanted a benefit or service as a result of paying the fee.
It is interesting that a corroborating opinion written by the presiding judge cites the on-going reports done by the State Auditor that established criteria to determine whether or not a special fund was appropriate and valid. Among the criteria presented was that a special fund should serve the purpose for which it was originally established, reflect a clear relationship between the benefits sought and the charges made, provide an appropriate means of financing for the program and have the capacity to be financially self-sustaining.
Given that the proceeds of the insurance regulatory fees produced excesses which then were use for other purposes, it did not meet the criteria established by the State Auditor. This decision will now bring into question many of the other special funds cited by the Auditor and the state will have to pay more attention to the use of special funds.