Association of California Insurance Companies v. Jones

In Association of California Insurance Companies v. Jones, 2 Cal. 5th 376 (January 23, 2017), the California Supreme Court reversed the Court of Appeal’s judgment invalidating the Insurance Commissioner’s 2011 regulation covering replacement cost estimates for homeowners insurance (“Regulation”). The Court determined the Unfair Insurance Practices Act (Section 790.10 of the Insurance Code) (“UIPA” or “Act”) supports the Commissioner’s authority to promulgate the challenged regulation.

Legislators discovered that California residents, whose homes had been damaged in the 1991 Oakland Hills fire and 2003 Southern California wildfires, had insufficient insurance coverage to rebuild their homes. Following these fires, the Legislature attempted to address the discrepancy between the homeowners’ expectations of coverage and the actual coverage provided under their policies, but – as a result of the large wildfires in Southern California in 2007 and 2008 – realized the “underinsurance problem” persisted. Responding to complaints of underinsurance, the Department of Insurance’s market conduct division conducted an investigation of the four largest insurers (who accounted for approximately half the market covering these losses), which revealed that, for a majority of the policies examined, the “coverage limits matched what was indicated by the insurer’s own coverage calculator,” but “the recommended coverage nonetheless understated what was actually needed to rebuild the insured’s home over 80 percent of the time.” Even 57 percent of policies that included extended replacement cost coverage were still underinsured. Further:

A United Policyholders survey of victims who lost their homes in the 2007 wildfires similarly showed that only 26 percent had sufficient coverage to repair, replace, or rebuild their homes. These victims were underinsured by an average of $ 240,000. Once again, in a significant number of cases, the policyholder had relied on the estimate provided by the insurer's replacement cost estimate tool in purchasing such coverage.

As guaranteed replacement coverage is no longer “the norm” and only a limited number of homeowners now qualify for such coverage, the Commissioner focused on improving the accuracy of the replacement cost estimates:

Although estimates for labor, building supply costs, and other costs of rebuilding a home may or may not turn out to be accurate, the Commissioner found that even the most careful estimate would be deficient and misleading if the estimate failed to consider the complete range of tasks necessary to repair or rebuild the home, such as the costs of replacing the foundation, debris removal and demolition expenses, and overhead and profit, as well as engineering reports and architectural plans. The Commissioner also concluded that estimates would be more complete and accurate—and purchasers would be better informed about replacement cost coverage—if such estimates reflected the home's size, materials, square footage, wall heights, slope, and location; the type of frame, roof, and siding; the number of stories; and its age.

To address these concerns, the Commissioner proposed new regulations and amendments to existing regulations consistent with the procedures specified in the Administrative Procedure Act (Gov. Code, § 11340 et seq.). According to the Commissioner's initial statement of reasons, the proposed regulation standardized the components of a replacement cost estimate “to create a more consistent, comprehensive and accurate replacement cost calculation” and clarified that estimates “not comporting with the applicable provision of the regulation will constitute making a statement with respect to the business of insurance which is misleading and which by the exercise of reasonable care should be known to be misleading, pursuant to Insurance Code section 790.03.” (Dept. of Insurance, Initial Statement of Reasons, Standards and Training for Estimating Replacement Value on Homeowners' Insurance (Apr. 2, 2010) pp. 1, 20.) The Commissioner's initial statement of reasons also described the specific purpose and need for the regulations, the alternatives considered by the Commissioner, and the prenotice discussions held at the Department of Insurance's office. (See Gov. Code, §§ 11346.2, subd. (b), 11346.3, 11346.45, subd. (a).) The Commissioner's notice of proposed action solicited public comment, announced the time and date for a public hearing, and analyzed the potential economic impact of the regulations. (Gov. Code, §§ 11346.3, 11346.4, 11346.5.)

In response to public comments submitted in writing and at the public hearing, the Commissioner modified the proposed regulations and issued a “final statement of reasons” on November 17, 2010. (Gov. Code, § 11346.9.) The Commissioner also identified the specific statutes authorizing adoption of the regulations and listed the statutory provisions “being implemented, interpreted, or made specific” by each section of the regulations. (Gov. Code, § 11346.2, subd. (a)(2).) On December 29, 2010, the Office of Administrative Law approved the regulations. The regulations became effective on June 27, 2011.

The regulation “does not require an insurer to set or recommend a policy limit or to provide an estimate of the cost to rebuild or replace a home,” “ut if the insurer does choose to opine on replacement costs, the Regulation specifies how that estimate is to be calculated and communicated,” by barring an insurer from communicating an estimate unless the estimate complies with subdivisions (a) through (e) of the Regulation (requiring that the cost to rebuild or repair must be based on the single property being evaluated – not the cost to build multiple or tract dwellings; the estimate shall not include the resale value of the land, any outstanding loan balance, or a deduction for physical depreciation; and the insurer must “take reasonable steps” to verify the estimate methods are updated at least annually).

The Legislature enacted the Unfair Insurance Practices Act (Insurance Code section 790, et seq.) in 1959 to regulate insurance trade practices by defining, or providing for the determination of, all practices in the State “which constitute unfair methods of competition or unfair or deceptive acts or practices and by prohibiting the trade practices so defined or determined.” The Act defined “various unfair methods of competition and unfair or deceptive acts or practices” to include “making or disseminating or causing to be made or disseminated [ . . . ] any statement containing any assertion, representation, or statement [ . . . ] which is untrue, deceptive, or misleading, and which is known, or which by the exercise of reasonable care should be known, to be untrue, deceptive, or misleading.” The Act also empowers the Commissioner (1) to investigate insurance companies to determine if the company is or has committed any such unfair acts and “to bring an administrative action against, recover damages from, and enjoin any person” who is or has been engaging in any such unfair competition; and (2) to “issue an order to show cause and initiate an administrative proceeding to determine whether the challenged conduct [which is not expressly defined in the Act] is unfair or deceptive” and, if so, to “serve a written report so declaring on the insurer.” Finally, the Act grants the Commissioner rulemaking power: “The commissioner shall, from time to time as conditions warrant, after notice and public hearing, promulgate reasonable rules and regulations, and amendments and additions thereto, as are necessary to administer this article.”

A few weeks before the Regulation was to become effective, plaintiffs Association of California Insurance Companies and the Personal Insurance Federation of California (collectively, the Association) filed a complaint for declaratory relief. The action challenged the validity of the Regulation on the ground (1) that the Regulation exceeded the Commissioner's authority by defining a new unfair or deceptive insurance practice; (2) that the Regulation improperly restricted the underwriting of insurance, which the Commissioner lacked authority to regulate; and (3) that the Regulation violated insurers' rights to free speech under the state and federal Constitutions. The parties agreed that the case could be tried based on the rulemaking file, written briefs, and oral argument, without the need for oral testimony.

The trial court invalidated the Regulation on the first ground—i.e., “that the Commissioner exceeded his authority by attempting to define additional acts or practices by regulation rather than by the procedure set out in section 790.06.” The trial court reasoned that an estimate of replacement costs is “inherently inaccurate” but could not be deemed misleading, unless one were to claim or imply that the estimate was accurate. Because the Regulation thus expanded the scope of misleading statements beyond that defined in section 790.03, subdivision (b), upholding the Regulation would “obviate the need” to use the mechanism in section 790.06 to determine that conduct not defined by the UIPA was unfair or deceptive. Having invalidated the Regulation, the trial court found it unnecessary to consider the Association's remaining challenges.

The Court of Appeal affirmed. The appellate court found it significant that the Legislature had specifically defined the advertising of insurance that the insurer does not sell as “an unfair and deceptive act or practice” (§ 790.036, subd. (a)) but had failed to so define incomplete replacement cost estimates. Invoking the interpretive canon expressio unius est exclusio alterius, the court inferred that the omission “was a deliberate choice” by the Legislature and that “the Commissioner did not have authority to add content and format requirements for replacement cost estimates in homeowner insurance to the list of practices set forth in section 790.03 under the guise of deeming nonconforming estimates misleading under section 790.03, subdivision (b).”

The Court of Appeal believed also that the Commissioner's interpretation of his rulemaking authority would render it needlessly duplicative of his power to bring an enforcement action under section 790.05, on the one hand, or to institute an administrative proceeding under section 790.06 to determine whether undefined conduct was unfair or deceptive, on the other. As to the first, “there would be no need for the Regulation because, as the Commissioner points out, he would already have had the means in section 790.05 to assess penalties and issue a cease and desist order against a licensee the Commissioner believed had given a lowball or incomplete estimate . . . .” As to the second, the Commissioner “would never have to resort to the procedures in section 790.06 regarding practices not ‘defined’ in section 790.03 because the Commissioner could always argue that conduct not meeting standards in a regulation promulgated under the cover of the Commissioner's power to administer under section 790.10 would be ‘misleading.’”

The Court began its analysis: “The Regulation, like any agency action, comes to the court with a presumption of validity.” While the Court exercises independent judgment on the question of law (whether the Regulation falls outside the Commissioner’s authority), the Court “accord[s] great weight and respect” to the agency’s construction. How “much” weight depends on context, including both “factors relating to the agency’s technical knowledge and expertise” and “factors relating to the care with which the interpretation was promulgated.”

The Commissioner has only so much rulemaking power as is granted by statute; to be valid, a regulation must be within that authority conferred by the Legislature – authority which the Court noted “appears to be quite broad.”

The Court previously considered a similarly expansive grant of authority to the director of the Department of Motor Vehicles in Ford Dealers Association v. Department of Motor Vehicles, 32 Cal. 3d 347 (1982). The Court reversed the trial court’s ruling that had invalidated various regulations, “explain[ing] that the DMV, which was authorized ‘to ‘fill up the details’ of the statutory scheme,’ had the statutory authority to promulgate a regulation ‘barring a specific class of misleading statements.’” Id. at 362-363. While noting that the Commissioner’s grant of authority “is written in terms of what is necessary to administer the authorizing statute” and not in terms of what is necessary to carry it out [as in Ford] or implement it,” the Court determined that “such slight difference in wording [does not] evidence any substantial distinction in the power of the Legislature conveyed.” Concluding, “[t]o administer is to carry out or direct, and in the process to implement.” Similarly, in Moore v. California State Board of Accountancy, 2 Cal. 4th 999, 1013 (1992), “in construing the [State Board of Accountancy’s] authority to administer the general prohibition on misleading titles and designations, [the Court] found it ‘apparent’ that the board had been delegated the power to determine whether a particular title of designation not explicitly identified in the statute was nonetheless likely to confuse or mislead the public.” The Court found: “The Commissioner's authority to administer the UIPA thus includes the power to promulgate a rule applying to a specific kind of statement prohibited under section 790.03, subdivision (b).”

The Court addressed the Association’s argument that “the Legislature reserved to itself the power to define unfair or deceptive acts (as, for example, in § 790.03) and to set forth a procedure by which conduct not statutorily defined as unfair or deceptive could be determined (using the order to show cause procedure in § 790.06) to be so.” According to the Association, the Regulation “is either unnecessary (in that the subject of the Regulation has already been defined as unfair in § 790.03), or it represents an unlawful expansion of the Commissioner's power by purporting to reach conduct not otherwise defined as unfair or deceptive without complying with the order to show cause procedure in section 790.06.”

The dichotomy posited by the Association is incomplete. Yes, the Legislature “defined” untrue, deceptive, or misleading statements with respect to the business of insurance as an unfair method of competition or an unfair and deceptive act or practice in section 790.03, subdivision (b). But it would be wrong to conclude that the Commissioner was thereby deprived of authority to “interpret, or make specific” those defined methods, acts, or practices by rule or regulation. (Gov. Code, § 11342.600.) Where, as here, the Legislature uses open-ended language that implicates policy choices of the sort the agency is empowered to make, a court may find the Legislature delegated the task of interpreting or elaborating on the statutory text to the administrative agency. [Cite]

In this instance, the Commissioner undertook an investigation into the widespread problem of underinsurance and, in particular, the disconnect between a homeowner's expectation and the actual scope of insurance coverage purchased. Based on that investigation, he determined that an incomplete replacement cost estimate—i.e., an estimate that fails to account for all of the costs necessary to rebuild the structure—qualifies as “a specific kind of misleading statement,” and that regulation of any misleading statement “is authorized by the broad statutory prohibition against false and misleading statements” in section 790.03, subdivision (b). [Cite.] The Commissioner's determination complied with relevant procedures in the Insurance Code and the Administrative Procedure Act, which require an initial statement of reasons from the agency, a request for public comment, a public hearing, an assessment of alternatives to and the economic impact of the Regulation, and a final statement of reasons and written responses to public input. Even if the statutory prohibition on misleading statements is (as the Association contends) self-executing, an administrative agency nonetheless has authority to promulgate rules and regulations as reasonably necessary to administer it. [Citations]

A survey of the agency's legal authority and role readily shows why. As the Association concedes, the Commissioner could certainly have brought an enforcement action against an insurer's use of misleading replacement cost estimates under section 790.05, which permits an agency to address unfair practices defined in section 790.03 on a case-by-case basis even in the absence of a specific regulatory rule. What this enforcement power does not imply is that the Commissioner was disabled from addressing the problem posed by such estimates through regulation. A key part of the expertise an agency brings to bear on its administrative function is its assessment of the trade-offs inherent in deciding whether to enforce a statutory mandate by way of an adjudication against a regulated entity or through a generalized rule. [Citations] Adjudication may prove desirable when a problem is unforeseeable, when it is so specialized or idiosyncratic as not to be susceptible to a general rule, or when the agency lacks the experience to justify announcement of a general rule. [Citations] Rulemaking, on the other hand, offers the agency an opportunity to research and develop all relevant arguments from the affected stakeholders and address a problem in a comprehensive way that treats regulated entities in a like manner. [Citations]

Where an agency has been granted both the power to adjudicate and to promulgate rules, we generally defer to the agency's choice of how to proceed. [ . . . ] An agency's choice regarding the use of rulemaking or adjudication implicates the expertise and accountability rationales that cut in favor of deference to the agency, and the Association does not contend that any statute expressly limited the Commissioner's ability to choose between rulemaking and adjudication. We therefore defer to the Commissioner's decision to address the problem of underinsurance by rulemaking.

Finding otherwise would not only cut against the grain of our previous decisions and the importance they ascribe to the agency's expertise in deciding how it makes policy, but would also eviscerate section 790.10. It is the agency's prerogative to promulgate reasonable rules and regulations “as are necessary to administer” the UIPA (§ 790.10)—not merely to do so where it cannot otherwise address offending conduct through enforcement actions.

The Court noted that the Commissioner’s authority “to determine what undefined conduct qualifies as unfair or deceptive is irrelevant to the question whether the Commissioner had the authority to regulate incomplete replacement cost estimates as misleading statements.” The Association “effectively concede[d]” that the Regulation does not pertain to undefined conduct.

Finally, the Court rejected the Association’s argument that the Commissioner’s regulatory authority must be narrowly construed, which relied on “a snippet of an enrolled bill report prepared by the Department of Finance” which estimated the fiscal impact of Section 790.10 as a one-time hearing cost of $1,500. The Court was unpersuaded by this estimate, prepared by a Department “that has no role in administering or enforcing the UIPA” and found the report to be “flatly inconsistent with the statutory text,” which does not contain a “‘one time’ limitation.” Further, the Court found that a committee analysis of a bill is more persuasive that an enrolled bill report, and the analyses undermined the Association’s reading. “In light of the statutory text and other indicia of section 790.10's purpose, however, the enrolled bill report does not appear to shed light on the number, scope, or timing of regulations that could be promulgated by the Commissioner.”

After finding the Regulation was within the authority delegated by the Legislature, the Court then turned to “whether the Regulation is ‘consistent and not in conflict with’ the statute and whether it is ‘reasonably necessary to effectuate the purpose of the statute.’” Whereas quasi-legislative rules “have the dignity of statutes” and, therefore, the review thereof is narrow, a Court reviewing an interpretive rule must determine (1) “whether the rule is within the scope of the authority conferred” and (2) “whether the rule is reasonably necessary to effectuate the statute’s purpose.” As to the second question, the judiciary “accords great weight and respect to the administrative construction.”

In this instance, we need not decide whether the Regulation's interpretation of a “misleading” statement under section 790.03, subdivision (b) is best characterized as quasi-legislative or merely an interpretive rule devoid of any quasi-legislative authority. [Cite] Even if the Regulation were considered purely interpretive, we would conclude that the Commissioner has reasonably and properly interpreted the statutory mandate.

It is the Commissioner who is charged with implementing the UIPA. In doing so here, the Commissioner set forth his interpretation in a regulation adopted pursuant to the Administrative Procedure Act. [Cite] Moreover, the Regulation does no more than identify a specific class of offending statements within the general statutory prohibition on any untrue, deceptive, or misleading statements in connection with the business of insurance. [Citations] In the Commissioner's view, “calling something a replacement cost estimate when what is being estimated is necessarily something less than what it could take to replace the structure is a misleading statement.”

The Court rejected the Association’s invocation of expressio unius est exclusio alterius, finding that the Legislator, instead of “choos[ing] to specify the types of statements that must be deemed misleading,” “entrusted that determination instead to the Commissioner's expertise.” “That the Legislature entrusted to the Commissioner the application of these and other statutory provisions to specific problems—problems the Legislature did not, and in some cases could not, anticipate—is precisely why enactment of section 790.10 makes sense in the broader statutory scheme.” The Court rejected a similar argument in Ralphs Grocery v. Reimel, 69 Cal. 2d 172 (1968), finding that the existence of “separately enacted laws governing quantity discounts on milk and wine” does not deny the Department of Alcoholic Beverage Control the authority to regulate quantity discounts for beer under Business and Professions Code section 25006.

The Court also “reject[ed] the suggestion by amicus curiae Pacific Association of Domestic Insurance Companies that the disclosure form mandated by Section 10102 impliedly restricted the Commissioner's authority to specify the content of a replacement cost estimate,” instead finding that “the Regulation works in a complementary fashion with” the disclosure form.

The Court addressed the trial court’s finding that an estimate “is inherently inaccurate and therefore cannot be deemed ‘misleading’”:

But the defect sought to be remedied by the Regulation is not the possibility that actual costs, for unforeseeable reasons, may not align with estimated costs. Rather, the Regulation seeks to reduce the possibility that an estimate would be misleading by ensuring that the estimate include all that is reasonably knowable about actual costs at the time the insurance contract is executed.

* * *

The individual components the Regulation requires were also subject to a brief challenge from the Association. The Association asserts, for example, that a dwelling's age (Cal. Code Regs., § 2695.183, subd. (a)(5)(J)) may have no bearing on the cost to replace the structure, and that the annual requirement to verify and update sources and methods of estimating replacement costs (id., subd. (e)) may be unnecessary if costs have not changed or have decreased in the interim. As the Commissioner pointed out in his initial statement of reasons, however, a structure's age may help identify the costs of complying with current building code requirements and assess the availability of certain materials. And the happenstance that a replacement cost estimate might in unusual circumstances remain current even without taking reasonable steps to update the sources and methods of estimating replacement costs on an annual basis is hardly a basis for invalidating the Regulation. If (as the Association supposes) the estimate thereby provided “a dollar amount higher than required to cover reconstruction,” the estimate would have resulted in the unnecessary expense of overinsurance and would, once again, be misleading.

Finally, we reject the Association's challenge to the parts of the Regulation detailing the format of the replacement cost estimate, the means by which such estimates are to be communicated to the applicant or insured, and how records shall be maintained. [Cite] The Regulation deems misleading only those estimates that fail to comply with the content requirements of subdivisions (a) through (e). [Cite] Whether an estimate that fails to comply with the other parts of the Regulation is misleading would depend on the circumstances of the particular case. Because the Association has advanced only a facial challenge to the Regulation, its burden was to show, at the least, that a noncompliant estimate would not be misleading in the generality or vast majority of cases. [Cites] The Association has not carried its burden. Moreover, the recordkeeping components of the Regulation appear designed to facilitate the Commissioner's ability to examine and investigate an insurer's compliance with the substantive components of the Regulation. [Cite] We therefore reject the Association's facial challenge to the Regulation.

The Court concluded:

The Commissioner enacted the replacement cost regulation by exercising valid authority conferred under section 790.10 of the UIPA. That the Commissioner also possesses authority to enforce the statute through case-by-case adjudication merely underscores that sometimes agencies must make considered judgments about how they will implement a statute. But such authority does not preclude the Commissioner's use of a regulation to address the type of concern that motivated the present measure. Neither the UIPA nor any other statute categorically limits the Commissioner's authority to issue the Regulation. On the contrary: section 790.10 explicitly vests in the Commissioner authority to issue “reasonable rules and regulations” to administer the UIPA, which is what the Commissioner sought to do here.

Because the Regulation was invalidated below solely under the Administrative Procedure Act, neither the trial court nor the Court of Appeal has yet considered the Association's remaining challenges to the Regulation. We therefore reverse the judgment of the Court of Appeal and remand the matter for further proceedings consistent with our opinion.

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