Administrative Law Judge Invalidates Fair Claims Settlement Practices Regulations by California Department of Insurance

By Robert Hogeboom

Insurance companies could soon be off the hook for stiff penalties and fines imposed by the California Department of Insurance’s (“CDI”) for violations of the Fair Claims Settlement Practices Regulations (“FCPR”).  This is according to California Administrative Law Judge Stephen J. Smith, who recently issued a 51-page ruling finding the CDI’s Fair Claims Settlement Practices Regulations might not be brought as unfair claims acts.  

This ruling affects how the CDI has imposed penalties against insurers for claims since the inception of the FCPR in 1992. Since that time, only 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 Robert Hogeboom, senior insurance regulatory attorney with Barger & Wolen, to represent them.

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

According to Hogeboom,

This ruling is 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 OSC proceeding and large fines."  

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 impact all lines of insurance regulated by the DOI.

Full Analysis of the Decision

On August 25, 2012, California Administrative Law Judge Stephen J. Smith, issued a 51-page ruling that found the California Department of Insurance’s (“CDI”) Fair Claims Settlement Practices Regulations (“FCPR”) may not be asserted as unfair claims acts. The ruling affects how the CDI has asserted penalties since the inception of the FCPR in 1992 in Order to Show Cause proceedings based on Market Conduct Examinations. Robert Hogeboom of Barger & Wolen represented the successful insurer, the Torchmark group of five life and health insurers, in the proceeding.

Judge Smith’s ruling was issued in the form of an Order pursuant to the CDI’s Order to Show Cause (“OSC”) action alleging 697 violations against the five Torchmark group of life and health insurers. The violations were based primarily on violations of the FCPR contained in § 2695.1 et seq. of Title X, California Administrative Code. The OSC was issued following the CDI’s Market Conduct Claims Examination which examined Torchmark’s life and health claims settlement practices principally through application of the FCPR.

On behalf of Torchmark, Barger & Wolen filed a denial of the allegations in the OSC followed by a Motion to Strike the FCPR allegations. The motion 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. 

Hogeboom’s observations on the ruling are the following:

  1. The ruling is an extraordinary indictment of the FCPR and how for the last 20 years the CDI has required insurers to follow the FCPR under threat of an OSC proceeding and large fines.
  2. The ruling will require the CDI to plead OSCs using pertinent facts relating to each specific transaction.
  3. The ruling may result in changes made to Market Conduct Examinations if they are to serve as the basis for an OSC proceeding.
  4. The ruling requires the CDI to show a general business practice as a condition for a violation of claims settlement practices specified in § 790.03(h)(1-16).
  5. The ruling also covers all Insurance Code § 790.03 unfair practices. Accordingly, this brings into question the validity of the § 790.03 penalty provisions in the recent regulation containing the standards for homeowners’ estimates of replacement value contained in CCR § 2695.183 and the long-standing broker fee regulations in CCR § 2189.5.

Because of the impact of this decision on the claims regulations and market conduct examinations, Mr. Hogeboom will hold a seminar on the background of the FCPR, the court’s decision and Market Conduct Examinations in the near future. Mr. Hogeboom is also available to meet with specific insurers at their home offices upon request.

For more information or for a copy of the ruling, please contact Robert Hogeboom at (213) 614-7304 or via e-mail; or Mr. Hogeboom’s assistant, Veronica Montero-Kossak, at (213) 680-2800 ext. 7204 or via e-mail.

Originally posted on Barger & Wolen's Insurance Litigation & Regulatory Law blog.

Draft Guidance 2470, Concerning Review of Complaints Concerning Health Insurance Policy Rescission or Cancellation, Released by California Department of Insurance

On May 26, 2011, the California Department of Insurance (“CDI”) released a second draft of its Guidance 2470, which is designed to implement various provisions of AB 2470. AB 2470, enacted in 2010, legislated certain aspects of rescission, non-renewal, and cancellation of health insurance policies and health care service plans in California. 

The CDI’s draft Guidance 2470 purports to set forth requirements concerning the CDI’s review of complaints related to the cancellation, rescission, or non-renewal of a health insurance policy. T

he draft Guidance includes, among other items, provisions concerning the notice health insurers are required to provide to policyholders about the CDI’s review process and information concerning the mechanisms for the review process. 

The draft Guidance also purports to enumerate the factual showing required of health insurers in order to demonstrate that a cancellation or rescission is lawful.

Finally, the draft Guidance requires health insurers to continue to provide coverage to the policyholder until such time as the CDI makes a decision on the lawfulness of a cancellation, rescission, or non-renewal following the CDI’s receipt of a valid complaint from the policyholder.

As the public comment period on draft Guidance 2470 closed on June 6, 2011, it is anticipated that the CDI will issue its final version of Guidance 2470 in the near future.

Rate Regulation Bill Applicable to Health Care Service Plans and Health Insurers Passed by California Assembly

On June 1, 2011, the California State Assembly passed AB 52, which was initially introduced in December 2010.

Beginning January 1, 2012, the bill would require health care service plans and health insurers in California to obtain prior approval from the Department of Managed Health Care or the Department of Insurance for all proposed rate increases.

Under the proposed legislation, the Department of Managed Health Care and the Department of Insurance would be prohibited from approving any rate or rate change that is excessive, inadequate, or unfairly discriminatory. 

In addition, the bill calls for an examination by the Department of Managed Health Care and the Department of Insurance of all rate increases that become effective between January 1, 2011 and December 31, 2011, to ensure that those rates are not excessive, inadequate, or unfairly discriminatory, and to order the refund of any payments made pursuant to any such rate.

The bill must still be approved by the California Senate and signed into law by the Governor in order to become legally operative.

California Department of Managed Health Care Releases Draft Guidance Concerning SB 1163

On April 22, 2011, the California Department of Managed Health Care (“DMHC”) released draft Letter No. 8-K, which is designed to provide health care service plans with guidance concerning SB 1163. This follows the California Department of Insurance’s (“CDI”) release on April 5, 2011, of Guidance 1163:2 concerning SB 1163.

SB 1163, effective January 1, 2011, amended the California Health and Safety Code and the California Insurance Code to provide for review of rate increases by health care service plans and health insurers for purposes of determining whether the rate increase is unreasonable. 

SB 1163 was adopted in response to a provision in the federal Patient Protection and Affordable Care Act (“PPACA”) that requires health care service plans and health insurers’ rate increases to be reviewed by the federal government to determine whether the rate increase is unreasonable, unless a state has established its own rate review process. The key implementing provisions of SB 1163 are located at California Health and Safety Code Sections 1385.01 to 1385.13 and California Insurance Code Sections 10181 to 10181.13

California Health and Safety Code Section 1385.08(a) states that the DMHC, “may issue guidance to health care service plans regarding compliance with this article.” This tracks the language found in California Insurance Code Section 10181.9(a), which states that the CDI, “may issue guidance to health insurers regarding compliance with this article.” 

Both Health and Safety Code Section 1385.08(a) and Insurance Code Section 10181.9(a) exempt the DMHC and the CDI from following the formal procedures employed for the adoption of regulations in California when issuing guidance concerning compliance with Health and Safety Code Sections 1385.01 to 1385.13 and Insurance Code Sections 10181 to 10181.13. 

Guidance 1163:2 issued by the CDI purports to define the factors the CDI will consider in determining whether a rate increase is “unreasonable” in the individual and small group markets, in addition to attempting to implement certain procedural aspects of SB 1163 for these markets. 

A comparison of the DMHC’s draft Letter No. 8-K with the CDI’s Guidance 1163:2 reveals that the DMHC has preliminarily adopted many of the provisions contained in the CDI’s Guidance, without modification, and may consider some of the other factors contained in the CDI's Guidance when making reasonableness determinations for these markets.

Emergency Regulations to Enforce PPACA Medical Loss Ratio Guidelines Granted to California Department of Insurance

On Monday January 24, 2011, newly elected California Insurance Commissioner Dave Jones announced in a press release that he had obtained approval from the California Office of Administrative Law to issue an emergency regulation allowing the Department of Insurance (the “Department”) to enforce the medical loss ratio guidelines in the Patient Protection and Affordable Care Act of 2009 (“PPACA”). 

As of January 1, 2011, the PPACA requires all health insurers in the individual market to maintain an 80% medical loss ratio. The Department obtained approval to amend 10 California Code of Regulations § 2222.12 to mirror this requirement. A copy of the amended text can be viewed here

The emergency regulation went into effect on January 24, 2011, and expires on July 26, 2011. It requires California health insurers to demonstrate compliance with the 80% medical loss ratio at the time of the Department’s rate review.

Court Invalidates New Regulations Issued by Department of Insurance Concerning Underwriting and Rescission of Health Insurance Policies

On December 30, 2010, Sacramento County Superior Court Judge Michael Kenny invalidated several recently issued regulations by the California Department of Insurance (“CDI”) in response to a challenge filed by the Association of California Life & Health Insurance Companies (“ACLHIC”). 

ACLHIC was represented by Gregory Pimstone of Manatt, Phelps and Phillips and by Barger & Wolen partner John M. LeBlanc

The regulations were issued by the CDI on August 5, 2010, and attempted to impose a series of underwriting requirements on health insurers and restrict health insurers’ ability to rescind health insurance policies in California. A copy of the Court’s ruling can be found here.

ACLHIC challenged the regulations on several grounds, claiming that the CDI abused its discretion in adopting the regulations.

 

In particular, ACLHIC argued that the CDI lacked the authority to promulgate the regulations. The Court agreed with the ACLHIC with respect to the key regulations at issue. It held that the CDI lacked authority to issue either 10 California Code of Regulations § 2274.74 or 10 California Code of Regulations § 2274.77. The CDI argued, unsuccessfully, that its authority to issue these sections was found in Insurance Code §§ 790.10 and 12921

Proposed Section 2274.74, entitled “Standard for Avoiding Prohibited Postclaims Underwriting,” would have prohibited a health insurer from rescinding or canceling a policy if it did not comply with certain underwriting requirements set forth in the regulation, including requiring insurers to obtain health history information from a source other than the applicant. 

The regulation also purported to define medical underwriting by seven enumerated activities required of health insurers, without limiting medical underwriting to those seven activities. 

Further, the regulation attempted to establish the six activities that a health insurer had to conduct in order to resolve all questions arising from application materials.

If a health insurer failed with respect to either of these two items (i.e., any failure to complete the seven enumerated medical underwriting activities or the six activities required to resolve application questions), the regulation barred any rescission or cancellation. 

Finally, if a health insurer made any error in applying its own underwriting procedures – no matter how minor – the regulation likewise prohibited any rescission or cancellation.    

The Court concluded that the CDI lacked the authority to promulgate Section 2274.74.  

It determined that Insurance Code§ 790.10 only applied to those activities governed by Article 6.5 of Chapter 1 of Part 2 of Division 1 of the Insurance Code (within which section 790.10 falls) and that postclaims underwriting is governed by a separate article outside the reach of Insurance Code § 790.10. 

It reinforced this conclusion with the fact that the items prohibited by Insurance Code§§ 790.03, which Insurance Code § 790.10 governs, included an exhaustive list of prohibited business practices, none of which included postclaims underwriting and rescission based thereon. 

Finally, the Court concluded that Insurance Code§ 12921 only permitted the CDI to enforce existing laws regulating the insurance industry and that it did not provide authority for the CDI to promulgate new regulations.

The Court also invalided Section 2274.77 for these same reasons, as the CDI again relied on Insurance Code§§ 790.10 and 12921 to support its position that it was empowered to promulgate this regulation. 

Section 2274.77 purported to require an insurer, at the time of issuance and delivery of a policy, to return a complete copy of the application to the insured for review by including it in the same mailing, or other delivery mechanism, as the policy. If the insurer failed to comply with this requirement, it was precluded from using the information in the application as the basis for rescinding or canceling the policy.