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Prop 103 Enforcement Project Comments on Enforcing Regulations

Letter to:

Mr. Joel Laucher
Chief, Market Conduct Division
California Department of Insurance
45 Fremont St., 22nd Floor
San Francisco, CA 94105

Re: The Proposition 103 Enforcement Project's Comments on the Department's Prenotice Public Discussion on Contemplated Regulations for Enforcement Actions and Penalties (RH 02023676)

Dear Mr. Laucher,

The Proposition 103 Enforcement Project (The Project) submits the following comments in response to the California Department of Insurance's September 9, 2002 memorandum seeking public comments on its Contemplated Regulations for Enforcement Actions and Penalties.

The Project strongly opposes the draft regulations in their present form. The enforcement scheme proposed -- which would result in far too few enforcement actions and would impose penalties far smaller than the maximum penalties permitted by the Insurance Code -- has several fatal flaws.

A key problem with the proposed schedule of reduced penalties is that it would dramatically reduce the potential deterrent effect of the law. The proposal would enable any bad actor to determine maximum financial exposure by multiplying the number of discoverable violations by the reduced penalty amounts specified in the regulations. The proposed scheme would thus greatly diminish the possible financial exposure of lawbreakers, and some unlawful claims denials and refusals of coverage by insurers that were once too risky would now pass a cost-benefit analysis.

Moreover, these regulations would announce that the commissioner has, in effect, absolute discretion regarding when and whether to enforce the Insurance Code, including absolute discretion not to bring any formal enforcement actions against violators at all. This is a dangerous and legally incorrect position, given the commissioner's statutory mandate to punish wrongdoers and otherwise enforce the Insurance Code.

At a time when the vast majority of known violations of the Insurance Code go unprosecuted and unpunished by the CDI, the last thing the CDI should be doing is creating a set of guidelines that would weaken its negotiating power with insurers or in any other way constrain the agency's future attempts to impose the full sanctions authorized by law. What is needed from the CDI instead is a new commitment to stringently enforce the Insurance Code to protect consumers, a substantial increase in the initiation of formal enforcement actions, and a decreased reliance on warning letters, verbal warnings, and other informal resolutions of violations. The Project urges the Department to completely revise this weak proposal, and to come back with a proposal that does not establish any "maximum" fines below the maximums set out in the Insurance Code, and that is centered instead around a schedule of floor amounts below which it will not settle.


There is no question that one of the key areas where the CDI's regulation of the insurance industry needs to improve is in the enforcement of the Insurance Code and the punishment of wrongdoers:

According to its website, from 1991 to 2001, the CDI averaged only 15.9 completed enforcement actions against insurers per year. In 2001, the CDI completed a mere seven enforcement actions against insurers. In contrast, the Texas Department of Insurance, which is responsible for a smaller population of consumers, completed over eighty enforcement actions against insurers in 2001.

- Under the previous administration, CDI staff identified thousands of violations by insurers and, in the case of State Farm recommended $115 million in restitution for policyholders and over $2 billion in claims against the company. The Quackenbush administration, steeped in the corruption that led to Mr. Quackenbush's resignation, ignored CDI's findings and did not enforce the law. Now, however, more than two years since Quackenbush left in disgrace, there have been virtually no major enforcement actions against these or other insurers.

- On June 25, 2001, the CDI initiated administrative proceedings against the State Farm group of insurance companies by issuing three Orders to Show Cause, alleging 60 separate instances where the companies "knowingly committed or perform[ed] with such frequency as to indicate a general business practice" violations of the Unfair Insurance Practices Act (Ins. Code 790 et seq.) and the Fair Claims Settlement Practices regulations (10 CCR 2695.1 et seq.). The CDI initially requested $10,000 in penalties for each "willful" violation, and $5,000 for every other violation, as authorized by the Unfair Insurance Practices Act. However, on May 22, 2002, the CDI finalized a settlement agreement with State Farm that resolved all 60 allegedly unfair or deceptive acts or practices for a mere $7,000 and an agreement from State Farm to stop breaking the law!

Complying with the insurance laws should be a condition for doing business in California, and should be required if a company is to retain its certificate to operate in California. Agreeing to comply should not be considered a negotiating point. State Farm's willingness to change its ways should not have exempted it from paying substantial penalties for its past wrongdoing.

- On October 30, 2001, the CDI released its market conduct examination report for the 21st Century group of insurers. The review of 2,288 closed claims files uncovered 435 violations, including failure to tender payment within the time specified by the CDI's regulations and attempting to settle claims with unreasonably low offers. However, according to information posted on the CDI's website, no formal enforcement action has been taken against 21st Century for these violations.

- On December 21, 2001, the CDI released its market conduct examination report for the United Services Automobile Association (USAA) group of insurers. The CDI's review of 139 of closed claims files for "USAA Casualty Insurance Company" uncovered 38 violations; the review of 121 closed claim files for "USAA" uncovered 35 violations, including failure to tender payment within the time specified by the CDI's regulations, and attempting to settle claims with unreasonably low offers. Again, according to information posted on the CDI's website, no formal enforcement action has been taken against USAA for these violations.

As the above examples show, the CDI initiates enforcement actions too infrequently and settles for too little, in many cases failing to enforce the expressly mandated penalties in the Insurance Code. There should be a presumption at the agency that any violation of the Insurance Code for which the Insurance Code provides penalties should result in a fine or other enforcement action. Strictly applying the penalties specified in the Insurance Code for violations should be the general rule -- not the exception.

As part of the CDI's efforts to improve enforcement, The Project strongly encourages the agency to investigate complaints more promptly, and to play a more active role in resolving so-called "question of fact" complaints -- complaints that would be considered justified by the CDI if the allegations made by the consumer were proven true. Because it is often impractical (or, in the case of certain third-party claimants, impossible) for the wronged consumer to seek relief in court, it is important that the CDI investigate and attempt to resolve more "question of fact" complaints.


The Project is very concerned that these regulations would ostensibly provide the commissioner with absolute discretion to enforce or not enforce the Insurance Code -- even in circumstances where enforcement and penalties are mandated by law. Although the regulations state that they apply "only to those provisions of the insurance code that grant the commissioner discretion in pursuing a penalty against an insurer and in setting the penalty amount for each illegal act," several sections of the Insurance Code that these regulations explicitly would implement actually contain mandatory, directive language incompatible with the discretionary scheme these regulations would create. For example, section 11756 of the Insurance Code provides in part:

Failure to comply with commissioner's final order. Any person, insurer, or organization, who fails to comply with a final order of the commissioner under this article shall be liable to the state in an amount not exceeding fifty dollars ($50), but if the failure is willful, he, she, or it shall be liable to the state in an amount not exceeding five thousand dollars ($5,000) for the failure. The commissioner shall collect the amount so payable and may bring an action in the name of the people of the state of California to enforce collection. These penalties may be in addition to any other penalties provided by law. (emphasis added)

And section 1859.1 provides in part:

Any person, insurer, organization, group, or association who fails to comply with a final order of the commissioner under this chapter shall be liable to the state in an amount not exceeding fifty thousand dollars ($50,000) but if the failure is willful he or she or it shall be liable to the state in an amount not exceeding two hundred fifty thousand dollars ($250,000) for the failure. That penalty shall be in addition to any penalty arising under Section 1858.07. The commissioner shall collect the amount so payable and may bring an action in the name of the people of the State of California to enforce collection. (emphasis added)

However, despite this mandatory, directive language, the proposed regulations would ostensibly make formal CDI enforcement discretionary in all cases. Section XXXX would direct the commissioner to first apply the enumerated criteria before determining whether a particular violation warrants enforcement action, while section XXXX.3 would permit the commissioner to give each criterion whatever weight he/she sees fit, and to consider any unnamed additional criteria as well. Taken together, sections XXXX and XXXX.3 provide the commissioner with enormous discretion not to initiate formal enforcement action -- even for violations for which formal enforcement action is always required under the Insurance Code!

In addition, the regulations would ostensibly give the commissioner discretion to settle with violators for any percentage of the maximum allowable fine, or for no fine at all. These regulations would therefore conflict with the provisions of the Insurance Code that set minimum fines for certain violations. For example, subsection 10199.7(b) sets a minimum fine of $1,000 for certain violations, which is 40% of the maximum fine allowable fine of $2,500. Moreover, the proposed provision ostensibly allowing the commissioner to collect no fine at all would obviously conflict with Insurance Code provisions described above that require the commissioner to seek penalties in certain circumstances.

As a general rule, the CDI should initiate formal enforcement action whenever the Insurance Code does not expressly give it discretion. Where the Insurance Code does give the CDI discretion, at a minimum, there should be a very strong presumption that formal enforcement action should be taken for more serious violations, such as violations that directly harm consumers and repeat violations -- and, at a minimum, the regulations should require the commissioner to justify in writing any failure to take formal enforcement action for one of these more serious violations.

To ensure that available fines will provide sufficient deterrence, the CDI should not issue any regulations that attempt to authorize it to regularly negotiate fines below the minimum specified in the Insurance Code. Moreover, any new enforcement regulations should specify that a settlement for a percentage of the maximum fine must also require the violator to provide restitution and/or refunds to consumers injured by the violation. Such a consumer protection provision is especially important with regard to third party claimants, who have limited legal rights to recover from insurers that improperly deny claims.


Draft subsections XXXX.2(c) and XXXX.2(e)(5) provide that the commissioner may reduce penalties when violations are not knowing or willful, and when a previous related action has not been taken against the insurer. However, in many cases the maximum available penalty will already reflect whether or not the violation was willful or knowing, and whether or not the violation was a first offense. Thus, applying the criteria specified in subsections XXXX.2(c) and XXXX.2(e)(5) to determine the amount of penalties would often result in an unwarranted "double discount" for wrongdoers.

For example, section 1858.07 of the Insurance Code provides for a fine of $10,000 for certain "willful" violations of the rate laws. However, the maximum fine for similar violations that are not willful is set at $5,000, or fifty-percent less than the maximum available fine for willful violations. Thus, non-willful violators are already liable for reduced penalties as a result of their less culpable mental state.

Similarly, Insurance Code subsection 10140.5(b) provides penalties for certain unlawful discriminatory practices of up to $2,500 for first-time violations by insurers, but up to $5,000 for subsequent violations. Thus, again, one of the key criteria that would be used under these proposed regulations to reduce penalties has already been factored into the maximum available penalty.

The regulations as written would go much too far to reduce penalties that often already reflect whether the violation is willful, or knowing, or a repeat offense. Worse, the Appendix's examples of how these regulations would be applied to various sets of facts made it very clear that these very factors would be some of the most important in determining penalties.

Moreover, draft subsection XXXX.2(c) does not distinguish between acts that are "knowing" and acts that are "willful," although as applied elsewhere in the Insurance Code the terms are not synonymous. If subsection XXXX.2(c) is retained, the CDI should clarify whether "knowing" and "willful" are intended to have the same meaning as in other areas of the Insurance Code.


Draft subsection XXXX.2(c) provides in part:

In the case of an employee or agent or contract entity conducting business on the insurer's behalf, willfulness shall be attributed to the insurer unless the employee, agent or contract entity has acted outside of the scope of employment or otherwise not in the interest of the insurer.

In this subsection, the phrase "or otherwise not in the interest of the insurer" should be stricken, because only without this phrase will the provision hold insurers accountable. Assuming that penalties are appropriately high, any action by an employee that is discovered by the CDI and determined to be a violation of the Insurance Code will be an action "not in the interest of the insurer." The final phrase would be used by insurers to escape liability, and is unnecessary in any case, as the phrase providing immunity for acts committed by employees acting "outside the scope of employment" provides sufficient protection to insurers.


Draft subsection XXXX.2(b) provides:

The frequency of the occurrence of the violation. In determining the frequency, consideration shall be given to the number of violations specifically identified and the number of persons reasonably determined to have been impacted by such violations within the insurer's population of applicants, insureds, claimants or potential applicants and to the number of files in which the violation takes place compared to the number of files with a similar transaction but no violation.

This section should only apply to violations discovered as a result of market conduct examinations and other circumstances where the CDI would have knowledge of the content of other, similar files. When violations are discovered through consumer complaints, the CDI will often not have a statistically significant set of similar files on hand. This fact should not prevent the CDI from applying maximum penalties.


Draft subsection XXXX.2(f) provides:

The duration of the non-compliant activity. When the commissioner determines that this criterion is relevant, consideration will be given as to whether the violation was a single event or continued repeatedly over a given period of time.

This language is both confusing and legally incorrect. Violations repeated "over a period of time" constitute a series of separate violations, each punishable by a separate penalty. It is important to note that while violations that are repeated or are part of a general business practice may be punishable by enhanced penalties, these enhanced penalties apply to each unlawful act. This subsection as written could easily mislead a CDI employee into treating a series of violations as a single infraction.


In a few provisions, such as subsections 10509.9(a) and (c), the Insurance Code provides a minimum penalty but no maximum. How will settlement amounts be calculated in those cases?


Any new regulations regarding the CDI's enforcement activities should include provisions to improve the quality and amount of information available to the public regarding the agency's enforcement activities. The CDI should provide detailed information to enable the public to monitor the CDI's enforcement of the Insurance Code and identify trends in the CDI's enforcement over time. Ideally, this information should be broken down by insurer to ensure consistent enforcement and to help the public easily identify compliant and noncompliant insurers.

Pursuant to the information dissemination requirements of Insurance Code section 12921.1, the CDI's website currently provides some useful information regarding enforcement actions and consumer complaints. However, the CDI apparently does not provide consumers with the number of violations found per year for each insurer as required by subsection 12921.1(a)(5)(C). It is possible to find on the website the number of violations identified during insurer market conduct examinations, and the CDI does publish the number of "justified" consumer complaints per company per year. If the combined total of market conduct examination citations and justified consumer complaints represent all insurer violations of the Insurance Code known by the CDI to have occurred, then this fact should be made clear, and a single number of violations for each insurer should be published on the website pursuant to 12921.1(a)(5)(c). Moreover, the type of violations found through consumer complaint investigations should also be published on the website pursuant to 12921.1(a)(5)(c)

At a minimum, to enable the public to monitor the CDI's enforcement activities and monitor individual insurers, and to meet the information dissemination requirements of section 12921.1(a), the CDI should provide the public with the following information for each admitted insurer and for each surplus lines insurer on the CDI's List of Eligible Surplus Lines Insurers:

1. the number and type of complaints filed with or referred to the CDI,
2. the number of these complaints investigated,
3. the number and type of violations identified through complaints investigations,
4. the number and type of violations identified through market conduct investigations,
5. the number and type of violations resolved informally through letters and verbal warnings (This information is currently unavailable on the CDI's website, but is absolutely critical to enable those outside the agency to monitor and track the agency's enforcement activities over time.),
6. The number of violations settled and the key provisions of those settlements (The full text of the settlement documents are already available on the CDI's website),
7. the number of violations adjudicated in ALJ hearings (This information is already available on the website, but it should be made easier for the reader to distinguish settlement agreements from adjudicated disputes),
8. The number of ALJ hearings regarding Insurance Code violations that resulted in a fine or other enforcement action against an insurer, and the amount of the fine and/or the nature of the other enforcement action taken.
9. the number of ALJ hearings regarding Insurance Code violations that resulted in a fine or other enforcement action against an insurer and that were appealed by the insurer, and
10. the result of each appeal (i.e., which parts, if any, of the ALJ's order were invalidated by the reviewing court).

This information should be disseminated on the CDI's website and through monthly press releases to major California media outlets and interested members of the public who so request.


For the reasons stated above, the Project strongly opposes the CDI's Contemplated Regulations for Enforcement Actions and Penalties as drafted. While we applaud any movement to improve the CDI's enforcement of the Insurance Code, particularly with regard to insurers that violate the law at the expense of consumers, we strongly encourage the agency not to create any regulations that would weaken its negotiating power with lawbreakers or otherwise constrain the agency's future attempts to impose the full sanctions authorized by law.

Instead, the CDI should prepare a plan that would place greater emphasis on insurer accountability by creating a schedule of floor amounts below which it will not settle. Moreover, any new enforcement regulations should provide for stringent application of the mandatory enforcement provisions in the Insurance Code and should disfavor the use of informal enforcement measures, such as verbal and written warnings.

We appreciate this opportunity to comment on the Department's contemplated regulations, and would be happy to answer any questions about our comments.


Pam Pressley

On behalf of The Proposition 103 Enforcement Project, a project of The Foundation for Taxpayer and Consumer Rights

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