Dave Jones, in his capacity as Insurance Commissioner of the State of California (the Commissioner) appealed an order enjoining him from enforcing three regulations, adopted in 1992, to implement the unfair claims settlement practices provisions of the Unfair Insurance Practices Act (UIPA). Following nearly a decade of uncertainty as to their enforceability, the California Court of Appeal upheld key components of the California Fair Claims Settlement Practices Regulations on September 20, 2018 and affirmed that the California Insurance Commissioner has the authority to penalize insurers for engaging in improper claim settlement practices based upon even a single act of misconduct.
In 1959, the California Legislature enacted the Unfair Insurance Practices Act (“UIPA”), Cal. Ins. Code § 790, et seq., in order to regulate trade practices in the business of insurance by defining and prohibiting unfair or deceptive acts or practices. In 1971, the Legislature enacted § 790.10 authorizing the Commissioner to promulgate regulations necessary to administer the UIPA.
The following year, in 1972, the Legislature enacted § 790.03(h), which prohibits 16 enumerated “unfair claims settlement practices” by insurers, “if knowingly committed or performed with such frequency as to indicate a general business practice.”
Over the years, various cases have held, and been reversed in their holdings, that these code sections create a private right of action against an insurer. In Moradi-Shalal v. Fireman’s Fund Ins. Cos. (1988) 46 Cal.3d 287, the California Supreme held that there was no private right of action. In the wake of Moradi-Shalal, only the Commissioner could sue an insurer for violating the UIPA, and the available relief was limited to a cease and desist order. The following year, in 1989, the Legislature enacted Cal. Ins. Code § 790.035, which (i) authorizes the imposition of additional financial penalties for violations of § 790.03, and (ii) grants the Commissioner “the discretion to establish what constitutes an act” for purposes of imposing these new penalties.
In 1992, the Commissioner promulgated the Fair Claims Settlement Practice Regulations (the “Regulations”), 10 Cal. Code. Regs. §§ 2695.1-2695.14, which became effective in January 1993. These apply to all insurance companies except workers compensation and liability insurance for professional malpractice of health care providers.
Jones v. Pacificare
The dispute underlying PacifiCare began in 2007, when the CDI initiated a market conduct examination of PacifiCare’s claims-handling practices. The Commissioner initiated the examination based upon his belief that there were “failures at every level of claims handling.” Following the completion of the examination, the CDI commenced an enforcement proceeding in order to impose penalties on PacifiCare for its allegedly unlawful claims-handling practices.
In 2013, following 230 days of evidentiary hearings taking place over three years, the ALJ issued a proposed decision finding that PacifiCare had committed 92 violations of § 790.03 and imposing a penalty of approximately $11.5 million.
On June 9, 2014, however, the Commissioner rejected the ALJ’s proposed decision and instead issued his own decision finding that PacifiCare had committed 908,547 violations of § 790.03 (spanning some 20 categories, ranging from the failure to timely pay claims to the failure to provide notice of the right to seek an independent medical review), and imposing an aggregate penalty of $173.6 million. This was the first enforcement action brought under the UIPA since its enactment in 1959 that had been litigated to a decision.
On July 10, 2014, PacifiCare filed a petition for writ of mandate and complaint for declaratory and injunctive relief, seeking review of the Commissioner’s Decision by the Orange County Superior Court. PacifiCare characterized 98% of the claims handling violations found by the Commissioner to be “routine claims-processing mistakes” that did not rise to the level of unfair insurance practices. Accordingly, PacifiCare asserted that the Commissioner’s Decision was based on arbitrary and fundamentally flawed interpretations of §§ 790.03(h) and 790.035.
PacifiCare sought a determination that three of the Regulations underlying the Commissioner’s Decision, on their face, were inconsistent with the statutory language of UIPA and thereby facially invalid – namely, (i) § 2695.1(a), which states that, for purposes of defining an unfair claims settlement practice, a violation occurs when the practice is either “knowingly committed on a single occasion,” or “performed with such frequency as to indicate a general business practice[;]” (ii) § 2695.2(l), which defines the word “knowingly” to include implied and constructive knowledge; and (iii) § 2695.2(y), which defines the word “willful” for the purpose of a penalty enhancement without requiring specific intent to cause harm or violate the law.
The Superior Court bifurcated the case. In the first phase, the Superior Court addressed the validity of the challenged regulations. At the conclusion, the Superior Court sustained PacifiCare’s facial challenge to the legality of the challenged regulations and enjoined the Commissioner from continuing to enforce them.
In the second phase, the Superior Court determined that its first phase invalidation of the challenged regulations negated $91 million of the penalties, and that the remaining $82 million in penalties were invalid on other grounds. The second phase ruling is the subject of a second appeal which is not yet complete.
On appeal, the Court of Appeal was faced with having to determine whether the Legislature intended to authorize the Commissioner to: (a) regulate only established patterns of unfair claims settlement practices; or (b) authorize enforcement activities based on single acts of misconduct.
Specifically, the Court held that the first challenged regulation (§ 2695.1) was not inconsistent with § 790.03(h), because the California Supreme Court had previously held in Royal Globe that § 790.03(h) applies to “a single violation knowingly committed” and that ruling remains good law today. Accordingly, the Court of Appeal “reject[ed] PacifiCare’s contention that an ‘unfair claims settlement practice’ must refer to an insurer’s pattern of conduct, rather than to any individual act.”
The Court of Appeal held that the second challenged regulation (§ 2695.2(l)), which defines the word “knowingly” to include implied and constructive knowledge, was not inconsistent with § 790.03(h), because the Commissioner’s definition was entitled to deference, comports with traditional principles establishing corporate knowledge, tracks the Labor Commissioner’s similar definition for the purpose of implementing regulatory penalties under the workers’ compensation law, and appropriately creates incentives for insurers to make all proper inquiries and to exercise diligence in the claims settlement process. Accordingly, the Court rejected PacifiCare’s contention that inclusion of implied or constructive knowledge within the meaning of “knowingly committed” writes out any scienter element from the statute and allows an insurer to be penalized for inadvertent acts.
Finally, the Court of Appeal held that the third challenged regulation (§ 2695.2(y)), which defines the word “willful” for the purpose of a fine enhancement without requiring specific intent to cause harm or violate the law, does not blur the distinction between willful and non-willful violations and thereby create an inconsistency between the two-tier penalty scheme in § 790.035.
The California Supreme Court declined to review the appellate court’s decision on January 4, 2019. The penalties in the second phase will likely be affirmed.
In addition to monetary penalties, insurance companies can also have their licenses revoked or placement of business halted. These are severe penalties for non-compliance. It is because the insurance company is in a position of control and superiority to claimants that the regulations and consequential penalties exist. Pursuant to California Code of Regulations Section 2695.6, all insurance agents/adjuster are to be trained in these regulations once per year. Along with lawful policies and requirements that insurance company employees be in compliance, it is another tool to prevent potential liability and penalties.
For a copy of the complete decision, see: PacifiCare Life & Health Insurance Co. v. Jones (California Court of Appeals)