On August 15, 2012, California Administrative Law Judge Stephen J. Smith issued a 51-page ruling and Order holding that the long-standing California Fair Claims Practices Regulations ("FCPR") may not be asserted as claims violations for purposes of assessing penalties under the California Unfair Practices Act (the "Act"). Since 1992 when the FCPR were adopted, the California Department of Insurance ("CDI") has used the FCPR to examine insurers in market conduct claims examinations and, based on those examinations, assess penalties for violations of the FCPR.
The Ruling followed the CDI's 2005-2006 market conduct examination of five Torchmark insurers. In 2011, an Order to Show Cause was issued against the insurers alleging 522 violations of the FCPR, 59 violations of the California Insurance Code ("CIC") § 790.03(h) (relating to unfair or deceptive claims settlement practices), and 116 violations of statutes outside of § 790.03.
On behalf of Torchmark, Barger & Wolen LLP filed a Motion to Strike all of the FCPR-based violations relying on Government Code § 11506. The Motion challenged the FCPR as inappropriately creating new unfair claims settlement practices, which the Commissioner has no authority to do under the statutory scheme. The court dismissed with prejudice all 522 FCPR violations and dismissed with leave to amend the remaining allegations. The CDI did not appeal the Ruling or amend the OSC which ultimately dismissed the entire action.
This article discusses the history of the FCPR, explains the 51-page Ruling of the Court and the effect of the Ruling.
History of the FCPR
A. 1959 California Unfair Practices Act
The Act, which created CIC § 790-790.09 was adopted in 1959. It followed the NAIC model law of 1947 also adopted by other states. The Act regulates trade practices in the business of insurance by defining and providing for the determination of unfair practices. The Act did not incorporate claims settlements practices within the Act until 1972. The key provisions of the 1959 Act are:
a) Section § 790.03 defines the prohibited unfair acts.1
b) Section § 790.04 gave the Commissioner the power to examine insurers and others in the business of insurance.
c) Section § 790.05 provides the hearing process on alleged violations of the § 790.03 defined acts and gives the Commissioner the power to issue cease and desist orders.
d) Section § 790.06 sets forth the process to prosecute practices not defined in Section § 790.03.2
e) Section § 790.07 sets forth the penalty provision which established the penalty for violating a previously imposed § 790.05 cease and desist or § 790.06 injunction. The penalty was established at $50 for non-willful acts and $500 for willful acts.
B. 1971-72 Statutory Additions to the Unfair Practices Act
In 1971, Section § 790.10 was added to give the Commissioner "as conditions warrant" the power to "promulgate reasonable rules and regulations as are necessary to administer this article."
In 1972, subsection (h) was added to § 790.03 to bring claims settlement practices within the Act. California adopted the NAIC model which defined 13 unfair claims settlement practices. Unlike all other unfair acts in § 790.03, claims settlement practice violations are limited to violations that occur as a general business practice - i.e. the acts must be "knowingly committed or performed with such frequency as to indicate a general business practice."
C. Penalty Provision Amendments
In 1988, the penalty provision of § 790.07 was amended to increase the penalty for a violation of a cease and desist issued pursuant to § 790.05 or a violation of an injunction under § 790.06, to up to $5,000 or $55,000 if the violation is found to be willful.
In 1989, § 790.035 was added to expand the penalty provision to allow the imposition of penalties directly for violations of § 790.03 at an amount not exceeding $5,000 for each act or $10,000 for each willful act. It also gave the Commissioner the flexibility to determine what constitutes an "act." Section § 790.035 was a controversial addition to § 790.03 as it departed from the NAIC model by giving the Commissioner added enforcement power through very high ($5,000-$10,000 per act) penalties. The rationale for the legislation pushed by the CDI was based on the 1988 Moradi Shalal appellate decision which eliminated an individual's ability to bring a first party unlawful settlement practices action based on private enforcement of § 790.03.3 The CDI in advocating for the § 790.035 legislation argued that because these private actions were eliminated, the CDI needed harsher penalties to protect consumers.4
The higher penalties in newly adopted § 790.035 set the stage for the 1992 adoption of the FCPR by the CDI which were contested by the industry. The FCPR (contained in Sections § 2695.1-.14 of Title X of the California Administrative Code) sets forth a comprehensive set of "unfair standards or acts" in settling claims. The FCPR consists of general categories, including: definitions; file/documentation maintenance; representation of policy provisions and benefits including disclosure and timing requirements; duties upon receipt of communications from CDI and claimants; training and certification; standards for prompt, fair and equitable settlements and standards for determination of penalties. The FCPR also includes settlement practices by specific classes of insureds including auto, homeowners, surety and life and disability.5
The Order to Show Cause
In Torchmark, the CDI issued an Order to Show Cause ("OSC") under § 790.05 based upon findings in the CDI's claims examination and alleging 697 unfair acts of which 522 violations of the FCPR.6 The principal FCPR allegations included: 100 instances alleging failure to disclose all benefits, coverages, time limits and other provisions of the policy that may apply to the claim - § 2695.4(a); 130 instances alleging failure to provide an explanation of benefits with a clear explanation of the computation of benefits - § 2695.11(b); 87 instances for alleged failure to include in a claim denial that the claimant may have the matter reviewed by the CDI - § 2695.7(b)(3); 85 instances for alleged failure to disclose which claims were denied and/or to provide the factual legal basis for each denial; 27 instances for allegedly settling a claim by making an unreasonably low settlement offer - § 2695.7(g); 15 instances for alleged failure to maintain all documents and notes, correspondence and work papers - § 2695.3(a); and 75 instances for alleged failure to produce a certification for annual training of claims agents.
Ruling on the Invalidity of the FCPR
A Motion to Strike the FCPR and other allegations was filed and briefed. In May 2012, a four-hour argument took place before Administrative Law Judge Stephen J. Smith, who three months later on August 15, 2012 issued the 51-page Order dismissing the FCPR allegations with prejudice. The court's Order is summarized as follows:
a) The court noted that the CDI relied on § 2695.1 of the FCPR as the basis to assert 515 violations under the FCPR. Section 2695.1 provides that the FCPR "promotes the good faith, prompt, efficient and equitable settlement of claims which, when violated knowingly on a single occasion or performed with such frequency as to indicate a general business practice, shall constitute an unfair settlement practice within the meaning of Insurance Code Section §790.03(h). Other acts or practices not specifically delineated in this set of regulations may also be unfair claims settlement practices subject to Insurance Code Section § 790.03. All licensees are required to have thorough knowledge of such regulations."
b) The court noted that § 2695.1 "bridged" the FCPR to CIC § 790.03(h)'s unfair acts and violations. The court concluded that § 2695.1 created new unfair practices (enforceable through § 790.03(h) and subject to penalties under § 790.035) and that the regulation was inappropriate procedurally and unfounded legally. 7
c) The court held that neither Govt. Code § 11152 nor § 11342.2 supports the legal effectiveness of § 2695.1.8 The court explained as follows:
i) The allegations in paragraphs 50-68 of the OSC, with a few exceptions, rely on the bridging language in § 2695.1(a)(1) for authority to impose penalties.9 In that regard, under the statutory scheme, the CDI can only impose penalties for acts defined as unfair or deception under § 790.03. Therefore, in order to seek penalties for violations of the FCPR, each of the specific regulations in § 2695 et seq. rely on § 2695.1(a)(1) as the bridge between the "newly engrafted duties, requirements and responsibilities of insurers," and the authority to impose penalties pursuant to § 790.03(h) and § 790.035.10
ii) The use of the regulations in the OSC seeks to use this "bridge" to "rewrite the language" of § 790.03(h) and dilute its proof requirements.11 By proceeding in this fashion, the DOI seeks to use the "standards" set forth in the FCPR to create new § 790.03(h) unfair practices without going through the mandatory process established in § 790.06 for creating new § 790.03(h) unfair acts. Due to the fact that the trigger regulation in § 2695.1(a) is an impermissible extension of the DOI's authority as applied in this OSC, each of the allegations fail as a matter of law. This is fatal to each OSC violation based on the FCPR.12
iii) In rejecting the CDI's argument that § 2695.1(a)(1) is a lawful and permissible extension of the CDI's authority to interpret § 790.03(h), the court held that regulation § 2695.1(a) does not interpret the language of § 790.03(h). It rewrites, adds words and punctuation that does not appear in the statute. It seeks to redefine statutory language of § 790.03(h) to dramatically and impermissibly expand the scope, nature and reach of unfair practices the legislature wrote into § 790.03 and in particular § 790.03(h) and circumvents the exclusive § 790.06 process to add new unfair and deceptive claims.13
iv) None of the duties, requirements or standards required, or practices and procedures prescribed in the FCPR appear anywhere in § 790.03. These are additional standards and guidelines and prohibited practices which are added exclusively by regulatory action of the DOI.14
v) Finding persuasive a previous Barger & Wolen LLP case in which the Superior Court rejected the CDI's argument that post claims underwriting and rescission practices were included in § 790.03 list of practices, the order held that "nothing in the language or structure of § 790.03 indicates that the list of actions is anything but exclusive. The legislature reserved for itself the right to categorically define unfair practices."15
vi) The procedure set forth in § 790.06 is a mandatory condition precedent to adding new unfair acts not established by the legislature in § 790.03(h).16
vii) The legislature expressly intended to make exclusive the list of unfair practices in § 790.03. Thus, additional unlawful practices are prohibited. The legislature both fully occupies this field, thus preempting the DOI from using the process of adopting "interpretive" regulations as an alternative to the § 790.06 process.17
viii) Citing to a previous Superior Court case, the ruling reflected that there are only 2 ways to add new unfair acts: 1) the legislature adds a new practice; or 2) the DOI may proceed through a § 790.06 action.18
d) The court held that the FCPR were "best practice guidelines" which are inappropriately added to the 16 sub-classes of § 790.03(h) as additional unfair acts. The court indicated that such an interpretation by the DOI hugely expands the 16 specific practices that the legislature saw fit to adopt and authorize in subdivision (h)'s subparts. This massive augmentation of the specific enumerated prohibited and deceptive practices set forth in § 790.03(h) is ipso facto a violation of the statutory and case authorities.19
e) The legislature expressed no intention of authorizing the DOI to add new unlawful practices via a regulatory fiat instead of going through the § 790.06 process. None of the authorities cited, found or reviewed provide the DOI the authority to unilaterally to do so as it seeks to here through the consolidated OSC.20
f) The DOI is not lacking in remedies. The door is open for the DOI to plead and prove that the FCPR allegations constitute unfair practices through a § 790.06 proceeding. This process is both mandatory and exclusive per the legislature and may not be circumvented by regulatory drafting or interpretation. As a result, the allegations based on the FCPR fail as a matter of law.21
Ruling on General Business Practice/Deference Argument
The court also rules on the CDI's interpretation of the general business practice language of § 790.03(h), as rewritten by the CDI in § 2695.1(a) of the FCPR. The statutory language requires that the unfair acts are "knowingly committing or performing with such frequency as to indicate a general business practice...." Section 2695.1(a)(1), on the other hand, restates the test to provide that a violation occurs "when either knowingly committed on a single occasion, or performed with such frequency as to indicate a general business practice...." The court rejected the CDI's language.
a) The court noted that the standard of proof that the legislature enacted for a violation of § 790.03(h) is conjunctive. Proof of violations requires both proof of a knowing violation and proof that the violation is a general business practice. Moradi Shalal held that the Commissioner is authorized to impose administrative sanctions if the investigation reveals a "pattern" of unfair settlement practices as opposed to a single wrongful act.22
b) The court held that "the CDI's defacto amendment of § 790.03(h) through the use of regulation § 2596.1(a)(1) is the quintessence of what statutory and case authority specifically prohibit; a regulation 'expanding the scope and reach' of the statute through the vehicle of purported regulatory interpretation."23
c) The legislature's choice of language and punctuation, choosing to enact a two prong, conjunctive standard of proof (knowingly committed and performed with frequency) creates a legislatively imposed limitation that the CDI may not alter, rewrite or relax under the guise of "interpretation" via regulations.24
d) The DOI's construction under § 2695.2(k)(1) defines "knowingly" as performed with actual, implied or constructive knowledge including but not limited to that which is implied by operation of law. Here, the court noted that § 2696.2(k)(1) has the effect of defining that a single knowingly committed and actionable violation of § 790.03(h) can occur through a single act of inadvertence due to the exceedingly broad definition of "knowingly committed." The CDI's construction of the statute renders the second prong of the statute (requiring violations to be performed as a general business practice) superfluous, ineffectual and thus violates well-settled rules of statutory construction.25
The court held that the FCPR provisions were used as additional unfair practices not authorized by statute. Thus, the court dismissed the allegations based on the FCPR with prejudice. In so holding, the court noted that there is no conceivable method by which the specific allegations (of the FCPR) may be rephrased in a fashion that would not run a foul of these standards.26
The FCPR have been in existence since 1992. There have been only three known actions filed to contest the FCPR following the issuance of an OSC as the harsh penalties in CIC § 790.035 disincentivizes insurers from seeking a judicial challenge and instead encourage settlements favoring the CDI. There also have been no known actions by the CDI to hold separate hearings under CIC § 790.06 to allege new unfair acts since the CDI has been able to regulate claims practices through the acts asserted in the FCPR under which it can assert monetary penalties.
Per the court's ruling, § 2695.1 of the FCPR is unlawful as they create new unfair acts, eliminate the general business practice test from the statute, and avoids the mandatory § 790.06 hearings for declaring new unfair acts.
Since the Torchmark case is the second case under which two different Administrative Law Judges have ruled against the use of the FCPR to define unfair acts, the CDI will have a more difficult time in asserting violations and penalties following market conduct examinations.