United States: Blueprint for Judicial Review of Regulations

How broad is an agency’s discretion to adopt regulations to promote the public welfare?

That question was answered by the Court of Appeal, Third District, in American Insurance Ass’n, et al. v. John Garamendi, et al., on February 28, 2005. The Court’s decision is a blueprint for judicial review of agency rulemaking.

The issue involved an emergency regulation adopted by the Insurance Commissioner, restricting insurance companies’ use of loss history data, that is, information about an insured’s past claims, in determining whether to issue or renew a policy for homeowners insurance and whether to charge a higher premium for that policy. These determinations are referred to as underwriting decisions; a company that declines to issue or renew a policy or adds a surcharge to the premium makes an "adverse underwriting decision."

The emergency regulation prohibited a company from making an adverse underwriting decision based on previous claims data unless the previous claim created a condition that presents a greater likelihood of future loss. The regulation also provided that a loss that was fully remedied presented no greater likelihood of future loss. The regulation prohibited the use of claims data from any source, including a company’s records, despite actuarial data demonstrating that past claims are a valid predictor of future claims. The Commissioner was particularly critical of loss history data compiled by independent sources known as insurance support organizations. He asserted that their data often contains errors.

The question addressed by the Court is whether the Commissioner had statutory authority to regulate underwriting of homeowners insurance. He argued that Proposition 103 gave him broad discretion. Specifically, it gave him authority over insurance rates, and the power to disapprove rates that are excessive, inadequate, or unfairly discriminatory.

Since the Commissioner can regulate rates, and since underwriting decisions affect rates, he reasoned that he must have authority to regulate underwriting. He contended that a rate may be unfairly discriminatory if underwriting is not actuarially sound.

The Court, citing State Farm v. Garamendi (2004) 32 Cal.4^th 1029, pointed out that Proposition 103 confers more authority on the Commissioner than simply to regulate rates. "It also addresses the underlying factors that may impermissibly affect rates charged by insurers and lead to insurance that is unfair, unavailable, and unaffordable."

Relying on State Farm v. Garamendi, the Commissioner asserted that the use of loss history data that has no substantial relationship to future risk "may impermissibly affect rates charged by insurers and lead to insurance that is unfair, unavailable, and unaffordable." However, the issue in the State Farm case involved the authority of the Commissioner to gather information about factors affecting the fairness, availability, and affordability of insurance. The authority to gather information does not include the authority to regulate underwriting.

The Court noted that the Legislature has not dictated what risk in homeowners insurance a company must insure where prior claims are present. The Court reviewed the sections of the Insurance Code limiting a company’s right to non-renew a policy, concluding that none of these provisions restrict a company from basing a decision to refuse to insure or renew a policy on loss history data.

Similarly, the Court reviewed the sections prohibiting discriminatory practices, noting that "[p]rior claims experience is not cited as a prohibited basis for discrimination." The Court summarized its review of these provisions as follows: "None of them indicate any legislative concern with the use of claims or loss history, nor can they be read as providing implied authority for the Commissioner to regulate the use of loss history in homeowners insurance underwriting."

The Commissioner also argued that he has authority to enforce the Unruh Civil Rights Act and the state’s anti-trust and unfair business practices law. The Court responded that his argument is boot-strapping. The "authority to enforce laws designed to counter unfair or discriminatory business practices does not give him authority, without legislative approval, to determine whether certain business practices, in the form of underwriting rules, are unfair or discriminatory and to prohibit them."

Returning to Proposition 103, the Court pointed out that provisions added to the Insurance Code imposed restrictions on the issuance and renewal of automobile insurance. For example, a company must issue a policy to a "good driver," and non-renewals are strictly limited. But the Court emphasized, "no similar restrictions were placed on homeowners insurance by Proposition 103."

Finally, the Court cited the Legislature’s rejection of SB 64 as support for its conclusion that the Insurance Code does not give the Commissioner authority to regulate underwriting for homeowners insurance. When it was rejected, SB 64 would have given the Commissioner authority to approve or disapprove underwriting guidelines. Also, it would have prohibited a company from basing an underwriting decision on the use of loss history information provided by an insurance support organization.

Petitioners argued that the rejection of SB 64 belied the Commissioner’s claim that he has authority to regulate underwriting. The Court agreed, relying on Court Reporter Ass’n v. Judicial Council (1995) 39 Cal.App.4^th 15. Generally, the Legislature’s failure to amend a statute provides little guidance on legislative intent. This is because of the conflicting inferences. However, when determining whether a regulation is consistent with existing statutes, a legislative rejection of an authorizing statute is more persuasive. An attempt to obtain an amendment is "an implicit admission that legislative authorization was needed." The rejection of SB 64 is consistent with and supports the Court’s interpretation of the existing statutes.

The existing statues contain no indication that the Legislature conferred authority on the Commissioner to regulate underwriting despite the broad discretion of Proposition 103.

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