The Hawai'i Supreme Court has ruled the Legislature was wrong when it ordered the transfer of $3.5 million from regulatory fees paid by insurers to the state's general fund.

The court upheld part of lower court decisions about the transfer but also had some good news for the state in ruling that regulatory fee assessments imposed by the state Insurance Commissioner were not an unconstitutional tax.

The case has been watched by members of the Legislature as well as those in Gov. Linda Lingle's administration because of the money involved and the potential effect on other state programs where assessments and fees are levied. The Supreme Court ruling appears to invalidate any legislative efforts to use fee money from regulatory funds for general budget purposes.

"The $3.5 million that was moved into the general fund pursuant to the transfer bills must be returned to the compliance resolution fund so that they may be used for the regulation or benefit of the parties upon whom the assessments were imposed," the state Supreme Court concluded.

The case grew out of a 1999 change that made the state Insurance Division and its parent, the Department of Commerce and Consumer Affairs, financially self-sufficient. As such, the Insurance Division started charging fees to insurers to help cover operations.

The Hawaii Insurers Council sued the state in 2002 as the Legislature ordered the transfer of some of the collected fees from the insurance division into the state's general fund, which provides money for state needs.

The insurers argued the fees amounted to an unconstitutional tax for several reasons, including the state deeming the regulatory fund had excess money and directing that some of it be used for general purposes.

The insurers won in Circuit Court and then at the Intermediate Court of Appeals.

On Thursday, the Supreme Court issued an opinion that the regulatory assessments were not an unconstitutional tax in that they were originally imposed to cover the Insurance Division's expenses. But it did rule against the transfer of the $3.5 million because the Legislature unlawfully sought to divert legitimate regulatory fees into the general tax revenue stream.