Administrative Law Judge Invalidates Fair Claims Practices Regulations by CDI

Insurers familiar with California’s strict claims handling guidelines may be surprised to learn companies could be off the hook for penalties and fines imposed by the California Department of Insurance (CDI) for violations.

This is according to California Administrative Law Judge Stephen J. Smith, who recently issued a 51-page ruling finding the CDI’s Fair Claims Practices Regulations (FCPR) 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, according to Robert Hogeboom, senior insurance regulatory attorney with Los Angeles-based Barger & Wolen.

Only two cases have gone to adjudication challenging the procedure and fines because most insurance companies have chosen to settle. In both cases, the insurance companies — an auto insurer and a life and health insurer – retained Hogeboom, 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.

The first case, according to Hogeboom, 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. An example of a technical violation might be 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.

“The theory is that penalties would be much higher for those that dealt with substantive violations than just technical things,” Hogeboom said.

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.

“We’re talking seven figures here, for the auto and even higher in 2011 for the life and health,” said Hogeboom. “Because those penalties were so extraordinarily high, each of those companies said, ‘We’ll take our chances and go to hearing.'”

During a hearing, an administrative law judge 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.

Hogeboom said the 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 [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.

According to Hogeboom, 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.

“The court said, ‘What these regulations mean is that they are a best practices, 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,” said Hogeboom.

Companies will likely continue doing what they’ve been doing, but they will feel more comfortable that they’re not going to be penalized when they have a disagreement with the department, the insurance regulatory attorney said.

“Meanwhile, the department will probably have to determine if they want to go to the legislature to create more acts that would give them more power,” Hogeboom said.