CHAPTER 4 LIMITATION ON STATE'S ENFORCEMENT OF REGULATIONS

• Jurisdiction: United States
• Publication year: 2018

Although the California Department of Insurance (CDI) has attempted to expand its ability to regulate insurers, a 2012 decision by an administrative law judge shows that the state's power is subject to limitations.

A. Administrative Law Judge Ruling Changed CDI's Ability to Impose Penalties Against Insurers

California Administrative Law Judge Stephen J. Smith recently issued a 51-page ruling finding the CDI's Fair Claims Practices Regulations (FCPR) might not be brought as unfair claims acts.

The ruling affects how the CDI has imposed, and will impose in the future, penalties against insurers for claims since the inception of the FCPR in 1992. [O]nly two cases have gone to adjudication challenging the procedure and fines as most insurance companies have chosen to settle. In both cases, the insurance companies—an auto insurer and a life and health insurer—retained . . . Barger & Wolen to represent them.

In the most recent decision, Judge Smith's ruling was based on the CDI's Order to Show Cause action, alleging 697 violations against the five Torchmark groups of life and health insurers. ¹

The first case, according to [counsel] involved an examination performed by the department two years ago on an auto insurer. The CDI found 450 violations of the Regulations. In both exams, the violations were considered to be more technical than substantive.

The technical violations were cases like a 30-day letter that was sent out a day or two late. A nontechnical violation might relate to an insurer underpaying the settlement amount on a claim.

According to the insurance regulatory attorney, while every insurer is required to undergo a claims examination once every three years, the fines demanded by the department in these two cases were much higher than normal. ²

The motion [to strike the FCPR allegations] relied on California Government Code § 11506 to challenge the FCPR as improper to seek monetary penalties and a cease and desist order. A four-hour legal argument on the motion occurred on May 25, 2012, before Judge Smith. In the court's extensive ruling, which contained 150 separate findings, the court ruled that:

1. None of the standards prescribed in the FCPR appear anywhere in California Insurance Code § 790.03 (pursuant to which statute the CDI adopted the FCPR); these are additional standards added exclusively by regulatory action of the CDI.

2. The FCPR as applied are unenforceable pursuant to California Government Code §§ 11152 and 11342.2, which establish the test for determining the validity of regulations. Specifically, the court held that § 2695.1 of the FCPR improperly creates new unfair standards and duties within the meaning of Insurance Code § 790.03(h), which subjects insurers to the penalty provisions of Insurance Code § 790.035 for failure to meet those standards.

3. The FCPR through CCR § 2695.1(a) dramatically and impermissibly expands the scope, nature and reach of the 16 unfair claims settlement practices set forth in Insurance Code § 790.03(h)(1)-(16). The court held that new unfair acts may only be promulgated by the legislature or through the process set forth in Insurance Code § 790.06.

4. The CDI's language in CCR § 2695.1 impermissibly amends Insurance Code § 790.03(h) such that a violation can be proved by means of a single knowing act or by proof of a general business practice, which amendment lowers the burden of proof and quality of evidence necessary for the CDI to prove a violation of § 790.03(h). In order to assert a violation of § 790.03(h), proof must be shown that the violation was both knowingly committed and performed with such frequency as to reflect a general business practice.

5. An OSC drawn from the conclusions or statements in a Market Conduct Examination is improper to support a valid pleading. Such examinations lack specificity about each act. OSC pleadings must assert violations under Insurance Code § 790.03(h)(1)-(16) and pleadings must set forth the charges and allegations in ordinary and concise language, such that the acts or omissions of which the respondent is charged may be reasonably ascertained. ³

During a hearing, an administrative law judge (ALJ) determines whether a violation occurred and then decides the amount of any penalty, ranging from zero to $5,000 for each act. If the act is determined to have been willful, the fine can increase to $10,000.

The attorney for the insurers found the ruling to be an "extraordinary indictment of the FCPR because for the past 20 years the CDI has required insurers to follow the FCPR under threat of an order to show cause proceeding and large fines."

He said this may also result in changes to market conduct examinations if they are to serve as the basis for an OSC proceeding.

The decision will affect all lines of insurance regulated by the DOI. ⁴

Counsel for the insurers, Robert W. Hogeboom, described the court's ruling as follows:

The ruling concluded that the CDI incorrectly alleged the companies violated the regulation, instead of correctly alleging a violation of the statute. The CDI incorrectly used the regulations to create new acts. As a result, he said the regulations are invalid. ⁵

Hogeboom further said:

The court said, "What these regulations mean is that they are a best practice, in effect, guidelines insurers can follow, such that they create a safe harbor for insurers and any type of action that would be brought by the department or in any potential litigation." Insurers can feel more comfortable about their claims operations, and they need to be focusing more on the 16 statutes than the regs [regulations], because the regs are so very specific on how companies must do their claims, which is not what the intent of the 16 statutory acts are[.]" ⁶

Hogeboom was quoted as follows:

According to [an] article, the five Torchmark companies stood accused of nearly 700 unfair or deceptive acts but Judge Stephen

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