On February 8, 2013, the US Department of Housing and Urban Development sent its final rule ("Rule") to the Federal Register for publication that codifies the use of a "discriminatory effect" or "disparate impact" burden-shifting analysis to prove allegations of unlawful discrimination under the Fair Housing Act ("FHA"). The Rule will take effect thirty days after its publication in the Federal Register. Disparate impact claims, which can impose liability based on a practice's discriminatory effect without proof of an intent to discriminate, have long been recognized under the FHA, but HUD now contends that it has developed a uniform criteria for applying this theory of liability. While disparate impact claims are traditionally asserted against mortgage lenders, realtors and other entities directly involved in the sale and financing of homes, HUD asserts that its disparate impact criteria may also be applied to insurers issuing homeowners policies.
Disparate impact claims have previously been brought under the FHA against homeowners insurers in challenging certain underwriting and rate-making practices. However, HUD's explicit announcement that these claims are applicable to insurers may invigorate private litigation and spur HUD agency action in the insurance sector. This is a troubling development in the first instance because, pursuant to the McCarran-Ferguson Act, 15 U.S.C. §§ 1011-1015 ("McCarran-Ferguson"), the regulation of insurance is the province of the states. As a result, the states have developed well-established decades old systems to regulate insurance underwriting and rate-making. States uniformly prohibit insurers from refusing to underwrite policies or charge rates based on protected classifications such as race, color, national origin, religion, sex, familial status and disability. However, risk classification tools neutral as to race and other protected classifications are regulated based on generally accepted actuarial principles. For example, nearly all states prohibit insurers from charging "unfairly discriminatory rates", which means different rates to actuarially similar insurance risks. Therefore, the application of a disparate impact theory of liability to insurers can create an entirely different and perhaps contradictory test for determining the legality of an insurer's system of risk classification. Simply put, an actuarially sound rate might result in a disparate impact on certain protected classes of insurance customers.
As articulated in the Rule, the disparate impact test would apply as follows:
- The party challenging a practice by an insurer must first prove a prima facie case that the practice results in, or would predictably result in, a discriminatory effect on the basis of a protected characteristic, which under the FHA includes race, color, national origin, religion, sex, familial status and disability.
- If the challenging party meets that burden, the burden shifts to the respondent/defendant to prove that the challenged practice is necessary to achieve one or more of its substantial, legitimate, nondiscriminatory interests. A legally sufficient justification must be supported by evidence and not be hypothetical or speculative. A substantial interest is a core interest of the organization that has a direct relationship to the function of that organization. A substantial, legitimate, nondiscriminatory interest is equivalent to the concept of "business necessity" applied in connection with other types of discrimination claims.
- If the respondent/defendant meets its burden, the challenging party may still establish liability by proving that the substantial, legitimate, nondiscriminatory interest could be served by a practice that has less discriminatory effect.
Therefore, an actuarially sound risk classification that is neutral as to protected classifications and that is not "unfairly discriminatory" under state law could still run afoul of the FHA if the risk classification results in a disparate impact and is either
- Not deemed a "business necessity;" or
- Deemed a business necessity, but there is an alternative risk classification that could accomplish the same legitimate business interest with less discriminatory effect.
This clash between federal and state law raises important and complex questions as to whether disparate impact claims under the FHA should be "reverse preempted" under McCarran-Ferguson. While intuition suggests the answer is yes, certain courts that have reviewed this question have declined to reverse preempt except where the state is specifically regulating the particular rate classification at issue. For example, a general state unfair discrimination law might not reverse preempt a disparate impact claim under McCarran-Ferguson, but a state law specifically regulating risk classification based on credit scoring has been found to reverse preempt a disparate impact claim based on credit scoring.
Ultimately, if disparate impact claims are allowed to proceed, insurers will be defending risk classifications that were built to comply with state regulatory schemes based on generally accepted actuarial principles. Insurance, of course, is based on discriminating between different types of risk, and there are a host of risk classifications that, while neutral on their face as to protected classes, actuarially sound and compliant with state law, could well have a disparate impact on certain protected classes. After a claimant makes a disparate impact showing, the legality of an insurer's risk classification system would quickly transform into a battle over business necessity and less discriminatory alternatives regardless of whether the risk classification system complies with state law and is actuarially sound.
Disparate impact claims present unique challenges to the insurance industry at multiple levels. Important public policy, regulatory and litigated debates will likely ensue over the threshold question of whether the HUD Rule should be applied to homeowners insurance. If it is applied, as HUD claims it should be and courts have recognized, insurers will have to grapple with a relative lack of jurisprudence elucidating how the three prongs of the disparate impact test should be applied to insurance risk classification systems. Accordingly, it is imperative for insurers to evaluate aggressively the implications of this new HUD Rule.
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