• California Court of Appeal Strikes Down Regulations Restricting the Use of Losses and Loss Exposure in residential Property Insurance Rating and Underwriting: Commissioner Sponsors Legislation in Response to Court's Ruling
  • June 21, 2005 | Authors: Kathrin A. Wanner; Thomas R. McMorrow
  • Law Firms: Manatt, Phelps & Phillips, LLP - Los Angeles Office; Manatt, Phelps & Phillips, LLP - Sacramento Office
  • The California Court of Appeal recently struck down a regulation promulgated by California Insurance Commissioner John Garamendi seeking to regulate the use of losses and loss exposure in residential property insurance rating and underwriting. American Insurance Association et al. v. John Garamendi et al., 127 Cal. App. 4th 228 (2005). The regulation was promulgated by Commissioner Garamendi on an emergency basis. The Court of Appeal for the Third Appellate District held that because the Insurance Code did not give the Commissioner the authority to regulate underwriting for homeowners' insurance, and because such expansive authority cannot be implied, the regulation was invalid.

    The regulation at issue was adopted in response to a perceived crisis in the availability of homeowners' insurance due to the alleged use by insurers of underwriting guidelines that resulted in insurance coverage being lost due to filing a claim or making an inquiry about coverage for a claim. The Department of Insurance experienced an increase in consumer complaints about the cancellation, nonrenewal and availability of homeowners' insurance, and the Commissioner viewed many of these problems as resulting from the use in underwriting of the Comprehensive Loss Underwriting Exchange ("CLUE"), a national database to which all insurance claims or inquiries are reported. The Commissioner believed that the CLUE database often contained inaccurate information, that insurers were violating California law by basing decisions solely on the contents of these databases, and that insurance was being denied due to prior claims without any evaluation of whether those claims had a substantial relationship to an increased risk of loss, also in violation of California law.

    After the Commissioner first sought to address this perceived crisis through an advisory notice, the American Insurance Association, Association of California Insurance Companies, and Personal Insurance Federation of California ("Petitioners") sought to invalidate the notice, arguing that it was an illegal "underground" regulation and conflicted with existing law because loss history data is an objective factor related to the risk of future loss. The trial court found the advisory notice was likely a regulation and stayed its enforcement. In response, in July of 2003, the Commissioner responded by adopting, on an emergency basis, Section 2361 of Title 10 of California Code of Regulations ("Regulation 2361") which addressed the same issues as the advisory notice.

    Regulation 2361 provided, among other things, that 1) an insurer shall not base, in whole or in part, an adverse underwriting decision on losses or loss exposures that have been fully remedied or otherwise resolved; 2) an insurer shall not base an adverse underwriting decision, in whole or in part, on an inquiry regarding coverage, unless a hazard or condition is identified which both bears a substantial relationship to loss exposure and presents an increased risk of loss; and 3) an insurer shall gather adequate information to determine that an increased risk of loss exists before a loss, loss exposure, or an inquiry regarding coverage can be used as a ground for an adverse underwriting decision, and an insurer cannot rely solely on information obtained from an insurance-support organization (such as the CLUE database).

    Petitioners challenged the regulation and sought to set it aside, arguing that there was no emergency, and that the regulation exceeded the scope of the Commissioner's authority and was inconsistent with existing statutory provisions. The trial court agreed, finding that the Commissioner exceeded his authority in promulgating the regulation because it is inconsistent with Section 791.12 of the Insurance Code, which the court found does not prohibit the use of loss history information in making adverse underwriting decisions.

    On appeal, the Commissioner's principal argument was that Section 1861.05 of the Insurance Code, which states that the Commissioner shall not approve any excessive or unfair discriminatory insurance rates, provides authority for Regulation 2361. The Commissioner argued that using loss history that is not substantially related to future risk may result in discriminatory rates in violation of Section 1861.05, and therefore, because the Commissioner has authority to regulate rates, he may also regulate this practice of underwriting.

    The Court of Appeal rejected the Commissioner's argument, finding that the Insurance Code does not restrict the use of prior claims in making underwriting determinations, and the fact "that the Commissioner has the authority to enforce laws designed to counter unfair or discriminatory business practices does not give him authority, without legislative approval, to determine whether certain business practices, in the form of underwriting rules, are unfair or discriminatory and to prohibit them."

    In reaching its decision, the court determined that homeowners' insurance is subject to only a few restrictions, all set forth in the Insurance Code, and refused to interpret the Insurance Code to give the Commissioner authority to regulate underwriting beyond these specific provisions. The decision potentially also has more far-reaching implications for the regulation of insurance in the state of California, as the court refused to extend the Commissioner's enforcement powers to permit him to prohibit a business practice that is not specifically restricted by law.

    Two bills have been introduced in the California State Legislature in response to this decision. In the Senate, the Commissioner has sponsored SB150. This proposed legislation would require that an insurer explain to an applicant, policyholder, or individual proposed for coverage under a policy of auto, homeowners', or other insurance sold to individuals the reason(s) the person was not approved for coverage and would prohibit the use of information about past claims history in underwriting unless it includes specified information. SB150 would also require insurers and agents to provide this information to insurance industry-supported organizations whose primary sources of information are insurers and agents.

    The other bill has been introduced in the State Assembly. Under this proposed legislation, AB1640, an insurer would be required to disclose that claim information under a homeowners' insurance policy is reported to a claims information database.