Law and Insurance

Perfect Storm Brewing Over Climate Change Disclosures Sought By Regulators From Insurance Industry

Just before hurricane season heats up, the winds are starting to blow from the insurance industry over questions posed by a committee of the National Association of Insurance Commissioners (NAIC) in a white paper outlining the "Potential Impact of Climate Change on Insurance Regulation."  (See Adopted White Paper).  Unless or until insurance regulation is federalized, the NAIC remains the most powerful body overseeing the U.S. Insurance industry, and for the last year or so has fixed its sights on preparing for climate change.  The Climate Change Task Force of the NAIC has promulgated nine questions to insurers (paraphrased as follows):

1. Do you have a plan to mitigate your own emissions?
2. Do you have a policy for handling climate change risk and investment management?
3. Have you considered the impact of global warming on your own investment portfolio?
4. What steps have you taken to encourage policyholders to reduce losses from climate change?
5. Describe your use of computer modeling to assess global warming impact.
6. Do you know of any trends or effects of global warming that may have a material impact on your operations or financial condition?
7. Are there geographic locations (read Gulf coast) where you are reducing business or line of insurance you are reducing or eliminating due to global warming?
8. What analysis have you conducted on the impact of global warming on your business?
9. Describe steps you have taken to engage key constituencies on the topic of climate change.

The industry's response has been, well, mixed.  Immediate comment by spokespersons for the American Council of Life Insurers and the Property Casualty Insurers Association of America was concern over the potential public release of proprietary and competitively sensitive information.  (See NAIC Climate Change Blueprint for Insurers).

Interestingly, recent comment has focused on the political aspects of the NAIC requests.  Robert Detlefesen, vice president of the National Association of Mutual Insurance Companies, stated that the disclosures are "essentially a call-to-action that seeks to enlist insurers in a campaign to promote an agenda informed not by science or evidence, but by the policy predilections of a handful of interests groups."  (See story posted on ClimateWire).  Mr. Detlefesen may have been reacting to the involvement in the NAIC process of such public and consumer interest groups as Center for Economic Justice and Ceres. 

Other industry voices suggest more openness to some kind of disclosure process and dialog with state regulators.  After all, the insurance industry was probably the first from the private business sector to take global warming seriously and begin planning.  What happens in 2009 from the NAIC disclosure-requests may depend on the 2008 hurricane season.  Another Katrina or Rita and the NAIC may issue subpoenas and promulgate interrogatories; or maybe it won't have to.

Broad Federal Insurance Regulation To Follow?

Recently introduced, H.R. 5840, the Insurance Information Act of 2008 (see H.R. 5840 Text) will create a new Office of Insurance Information to collect and analyze data on insurance, advise the Secretary of the Treasury on foreign and domestic insurance issues, report to Congress every two years, establish federal policy on international insurance matters, and ensure consistency between state and federal insurance laws as well as coordinate international trade agreements.  The bill will also create an advisory group to inform and advise the head of the Office, which will include state regulators, consumer groups, and others in the insurance industry. 

Over all, the insurance industry appears to welcome the creation of the OII as a rational and necessary precursor to any federal action (or inaction) on future federal regulation.  For example, a senior officer of the Council of Insurance Agents & Brokers (quoted in Business Insurance Magazine, April 21, 2008) said, "There are few creative and bold acts of leadership that transform the dynamics of any insurance regulatory issue and that is precisely what has been done."  Leigh Ann Pusey, COO of the American Insurance Ass'n, observed, "We have a need to have someone at the federal level to develop some insurance knowledge and expertise and to help develop policy." 

However, not all industry voices are supportive.  Some see this measure as a first step to unwanted federal control over insurance business.  Justin Roth, senior federal affairs director for the National Ass'n of Mutual Insurance Companies, noted that the OII is the kind of agency advocated in the March 31 blueprint for financial services regulatory reform proposed by the Treasury Department.  "If you go by the Treasury Blueprint, this is step No. 1 toward an [optional national charter].  It is obvious to us that this is step No. 1, and we strongly oppose federal regulation and we have concerns that this will lead to federal regulation."

The bill does seem to point to inevitable federal regulation of some kind.  But which is worse?  Federal insurance regulation or uninformed federal regulation?

Insurers May Use In-House Staff Lawyers To Defend Insureds in Texas

Unauthorized Practice of Law Committee v. American Home Assur. Co., #04-0138 (Tex. March 28, 2008) See Law Committee Decision.

The Texas Supreme Court ruled that, despite genuine concerns for potential conflicts of interest, insurers' use of salaried employee-staff lawyers to defend insureds did not constitute an unauthorized practice of law by an insurance company.  However, staff lawyers may be used only where the interests of the insurer and the insured are aligned in defeating the claim against the insured.  Also, the insurer must fully disclose the defense attorney's affiliation with the insurer.

In Texas, the Supreme Court regulates the practice of law and established the Unauthorized Practice of Law Committee to carry out this function.  In this case the Committee ruled that American Home and other insurers violated a statute prohibiting corporations from practicing law when they used in-house staff lawyers to defend insureds.  Corporations may use in-house counsel to represent the corporation's own interests (hence corporate counsel departments in most corporations), but they may not use employee-lawyers to represent unrelated persons.  The Court ruled that insurers with a duty to defend insureds are protecting their own interests when they hire defense counsel because the insurers pay the judgment.

The Committee had condemned the use of staff lawyers in part because of concerns that insurers have greater power over employees than over outside law firms and have been known to limit the attorney's ability to conduct depositions, obtain paper discovery, and hire expert witnesses.  Some insurers have prohibited staff lawyers from informing insureds of the insurer's Stowers obligation to accept reasonable settlements within policy limits.  However, the High Court held that, even if this was true, there is no reason to believe that insurers have any less control over outside counsel, which they can hire and fire at will just like employees.  Also, the Court found no evidence of actual harm ever resulting from the use of in-house attorneys.

Two Justices dissented on the narrow basis that the practice violates the State Bar Act (Sec. 81.101 of the Texas Government Code).  Because the "practice of law" definition in the statute contains no provision for profit or loss considerations, the dissent argued that for-profit corporations, whose board and shareholders are not (necessarily) attorneys limited by professional, ethical and disciplinary rules, cannot legally provide legal services to the public.

Thus employee-attorneys may defend insureds except where the insurer raises substantive coverage defenses.  Does this mean that the policyholder may sue the insurer if the lawyer commits legal malpractice?  In State Farm Mut. Auto. Ins. Co. v. Traver, 980 S.W.2d 625 (Tex. 1998), the Supreme Court held that the insured may not hold the insurer liable for the mistakes of defense counsel because the counsel owes an unqualified duty of loyalty to the insured even when the insurance company hired the attorney.  The American Home opinion says that the insurer's control over outside counsel is substantively the same as over its own employees.  Presumably, the Court would say that the attorney's duties to the insured are the same whether outside or employed, and Traver still controls.  But employers are vicariously liable for the torts of their employees, and nothing in American Home suggests any change in that law.

That question remains for another day.

Normal Legal Principles May Not Apply With Government Backed Insurance Programs

Reynolds v. Southern Farm Bureau Cas. Ins. Co., #SA-06-CV-0700 RF (W.D. Tex. March 13, 2008)

This flood insurance case stands in bold contrast to the last case I described illustrating courts' aversion to the often harsh effects of absolute legal forfeitures.  See Conditions Precedent Continue Under Attack in Insurance Policies.  But the law can be a tricky thing, as the Reynolds case shows.  "Estoppel," not condition precedent, is the legal principle at stake in Reynolds.  Estoppel, as my contracts law professor explained, means nothing more than "shut up!" and bars a party from asserting an otherwise valid legal right under a contract based on that party's earlier conduct inconsistent with that right and the other party's reliance on that conduct.  Example:  The policy requires submission of of proof of loss within 60 days after loss.  Insured asks for a week extension, and the insurer agrees.  The insurer will normally be estopped from enforcing the 60 day deadline based on its earlier indication that it would grant the request for an extension.  In other words, the court will tell the insurer, "shut up" if the insurer tries to assert its legal right to enforce the deadline.

The facts in Reynold are a little more complicated.  in fact, it's hard to see that the insured was treated unfairly, but, as the court observed, it would come to the same result even if the equities tilted dramatically in the insured's favor.  The Reynolds purchased flood insurance under the National Flood Insurance Program (NFIP) for their vacation home.  The floods came -- twice.  After the first flood in 2002, the insureds submitted their proof of loss for the flood damage a couple of months after the 60 day deadline.  However, FEMA granted a waiver, and the Reynolds' claim of $16,000 was paid.

The same home was damaged again after a 2004 flood, a claim for which was again paid under the policy.  However, the Reynolds also submitted an additional proof of loss for more than $40,000 for unreported repairs resulting form the 2002 flood.  FEMA refused to waive the 60 day deadline for these damages, and the Reynolds cried foul: Insurer should be estopped based on its earlier waiver of the deadline.

Under these facts, a court might not have applied estoppel in any case, particularly since the reason given for the refusal was not the 2-year delay but that the repairs were done before any investigation could be made.  But that is not the point.  Let's assume the fact pattern that I stated above.  60 day deadline--insurer agrees in writing to a week's extension--insured relies on the extension and files a week late--insurer denies.  A court would reach the same result under those facts as in the Reynolds case in the absence of FEMA's written acceptance of the extension.

Why FEMA?  The NFIP is a government-backed program under which private insurance companies issue flood policies that are underwritten by the federal government and administered by FEMA.  That makes all the difference.  The normal principles of law and equity that allow courts to bend conditions precedent to favor coverage or shut up insurers that try to assert policy defenses unfairly have no effect before the federal government because of Constitutional reservation and separation of powers.  As the Reynolds court observed (quoting Growland v. Aetna, 143 F.3d 951 (5th Cir. 1998):

When federal funds are involved, the judiciary is powerless to uphold a claim of estoppel because such a holding would encroach upon the appropriation power granted exclusively to Congress by the Constitution.  "Any exercise of power granted by the Constitution to one of the other branches of Government is limited by a valid reservation of congressional control over funds in the Treasury." (citation omitted)

Pretty scary stuff for a homeowner without a law degree (or even with a law degree).  In this case FEMA probably acted fairly.  But even if it acted unfairly, the courts would not interfere.  The lesson is this:  when dealing with a contract with, or backed by, the federal government, authorized approval is crucial.  The adjuster or the insurance company may not, and probably does not, have authority to bind the government.  Any deviation from the terms of the flood policy should be pre-approved by the authorized federal agent.  Who is that?  I don't know.  You might get approval from a FEMA representative, only to learn later that her boss now says she didn't have the authority to grant the approval.  I can only say that right now Michael Chertoff has the requisite authority.

Supreme Court Finds No Broad Prohibition of Insurance Covering Punitive Damages -- But . . .

Fairfield Ins. Co. v. Stephens Martin Paving, LP, # 04-0728 (Tex. Feb. 15, 2008), see Fairfield Decision

In this long-awaited decision, the Texas Supreme Court answers the Federal Fifth Circuit's certified question: "Does Texas public policy prohibit a liability insurance provider from indemnifying an award for punitive damages imposed on its insured because of gross negligence?"  The short answer:

[W]e answer that the public policy of Texas does not prohibit [such coverage].  However, without clear legislative intent to generally prohibit or allow the insurance of exemplary damages arising from gross negligence, we decline to make a broad proclamation of public policy here but offer some considerations applicable to the analysis in other cases.

So, this decision probably ends all challenges in Texas by workers' compensation (WC) insurers to Employer's-Liability coverage of punitive damages for gross negligence.  Also, the Court appears to firmly shut the door on uninsured-underinsured motorist coverage for a tortfeasor's punitive damages. But otherwise, unless a statute prohibits or allows specific punitive-damage coverage, just about every other type of liability insurance coverage is left open for future case-by-case development.

The Court agreed unanimously only on the result and those portions of the opinion concerning the WC policy and Texas law on exemplary damages.  Justice Hecht, joined by three other justices, wrote a separate discussion of the all-important "Public Policy Considerations."  However, it appeared to me that all nine justices were in general agreement that insurance coverage of punitive damages would offend Texas public policy in some circumstances. 

At the risk of oversimplifying, the Court agreed that the sole purpose of punitive damages is to punish a wrongdoer.  Other purposes evident in days gone by, such as making an example to others or to compensate a plaintiff, have been dropped from the statutory scheme defining gross negligence and punitive damages.  Thus, where punitive damages may have some purpose other than to punish, such as compensation, coverage is less likely to offend public policy.  The clearest example of this is the WC scheme itself, created by the Texas Constitution, that appears to allow a decedent's survivors to seek punitive damages for an employer's gross negligence as a form of compensation.  It may be for this reason that the Court appears to bless this coverage without any balancing of factors like the culpability of the employer, or whether the employer is an individual or a corporation.

The Court recognized a public-policy interest against shifting responsibility for paying punitive damages to an insurer where doing so would undermine or eliminate the punitive purpose of the remedy.  Two examples: 

1. Uninsured/underinsured motorist insurance is meant to compensate an insured drivers for their own injuries when the tortfeasor fails to have adequate liability insurance.  However, punitive damages fail to punish the tortfeasor if payment is shifted from the tortfeasor to an insurer, even if the tortfeasor is judgment-proof. 
2. By contrast, a corporation whose employees are grossly negligent in their work or production may cause severe injury resulting in punitive damages against the corporation.  In this case, it may make little difference whether payment is shifted to an insurer or to the corporation (actually to the customers of the corporation).  Accordingly, it probably would not offend public policy to allow the insurer to cover the corporation.  The answer might be different, however, for a sole proprietor, or where the CEO was deeply involved in the offensive conduct.

The Court weighs other considerations, all of which will be grist for the mill of future coverage litigation.  Rather than lay the issue to rest, this decision provides ammunition to both insurers and policyholders for non-WC challenges over public-policy challenges to coverage for punitive damages.

Texas Supreme Court Decides That Workers’ Compensation Claimant May Appeal Agency Ruling In Her Local District

What’s wrong with Austin, Texas? Nothing, unless you are a widow in El Paso seeking to reverse a determination by the Texas Workers’ Compensation Commission that your late husband was killed while working as an independent contractor, not an employee. Thus, the issue in this case is appellate jurisdiction under the Texas Workers’ Compensation Act. Claimants must challenge a denial of benefits before the TWCC. After exhausting agency appeals, a claimant may file a judicial appeal either in the claimant’s local state district court (if the dispute is over compensability or eligibility for benefits) or in district court in Austin, the state capital, for any other type of claim.

Margarita Morales’ husband died after falling from a ladder while repairing a motel roof in El Paso. She contended that he was an employee of one of three entities: two were insured by the defendants, one was a non-subscriber that did not purchase workers’ compensation insurance. The TWCC affirmed the denial of workers’ compensation benefits, finding that Morales was an independent contractor, and thus had not suffered a “compensable injury.” Morales filed suit in El Paso County to appeal that finding, but the case was dismissed for lack of jurisdiction, and the El Paso Court of Appeals affirmed based on the insurers’ argument that the case did not concern compensability.

The insurers acknowledged that employment-course-and-scope inquiries generally concern compensability. But they argued that when one or more potential employers is a non-subscriber, the worker’s actual employer must be determined as a threshold issue before the compensability issue arises. Therefore, the insurers believed that Austin was a mandatory venue under the Act. The Supreme Court reversed and held that coverage and compensability are not necessarily mutually exclusive concepts in a subscriber/non-subscriber situation as presumed by the insurers. Thus, the general rule still applied, and Morales’ employment status remained merely one relevant factor in the compensability determination.

So now, the El Paso district court will decide whether the TWCC got it right, and Mr. Morales was working as an independent contractor.

Court Lays Out Blueprint for ERISA Preemption of State Court Remedies

Martinez v. Unum Life Insurance Company of America, No. H-07-1988 (S. D. Tex. November 9, 2007)

I do not usually comment on cases featuring health and disability claimants trying to bust through the ERISA-preemption barrier (because it almost never works), but this case so clearly lays out the legal hurtles (in the 5th Circuit at least) that it is worth a look.  As a rule, Judge Atlas's opinions are well reasoned and supported with relevant case authority.

The court notes that Mark Martinez appears to be a sympathetic plaintiff.  He is insured under a Group Long Term Disability Insurance Policy purchased by his employer from Unum Life.  He alleges that he suffers from advanced heart failure and uncontrolled diabetes.  He received benefits for these ailments until they were "arbitrarily terminated" in 2002.  His doctors provided written opinions that he needed intensive medical therapy and could not engage in any productive work.  The insurer refused to reinstate his benefits.  Mr. Martinez sued in state court for negligence and gross negligence, breach of contract, breach of the common law duty of good faith and fair dealing, fraud and misrepresentation, as well as deceptive trade practices under Texas consumer protection provisions in the Insurance Code.

Unum Life removed the case to federal court and asserted that all state law claims be dismissed because the plaintiff's sole remedies are those provided under the Employee Retirement Income Security Act of 1974, 29 U.S.C. Sec. 1101("ERISA").  Basically, any health and disability insurance benefits provided under an employment benefit plan are governed by ERISA.  The plaintiff argued that ERISA contains a "savings clause": "Except as provided [elsewhere in the ERISA statute], nothing in this title shall be construed to exempt or relieve any person from any law of any state which regulates insurance . . ."  However, the court says, "Despite the sympathetic facts Plaintiff presents about his condition, Plaintiff's arguments are unavailing."  The court then marshals the following legal precedents that doom the Plaintiff's arguments:

• Section 502 [of ERISA], by providing a civil enforcement cause of action, completely preempts any state cause of action seeking the same relief, regardless of how artfully pleaded as a state action.  McGowin v. ManPower Int'l, Inc., 363 F.3d 556, 559 (5th Cir. 2002);
• ERISA preempts any state laws insofar as they relate to any employee benefit plan, and a claim "relates to a plan" when the claim itself is premised on the existence of an employee benefit plan.  Christopher v. Mobil Oil Corp., 950 F.2d 1209, 1220 (5th Cir. 1992);
• Negligence and gross negligence claims based on a plan administrator's handling of claims are completely preempted by ERISA.  Haynes v. Prudential Health Care, 313 F.3d 330, 336-37 (5th Cir. 2002);
• ERISA preempts claims related to denial of benefits brought under the Texas Deceptive Trade Practices Act and the Texas Insurance Code.  Hogan v. Kraft Foods, 969 F.2d 142, 144-45 (5th Cir. 1992);
• Good faith and fair dealing and fraud/misrepresentation claims are also preempted.  McGowin, 363 F. 3d at 559; Hogan, 969 F.2d at 144-45;
• State law extracontractual claims for punitive damages are preempted by ERISA.  Rogers v. Hartford Life & Accident Ins. Co., 167 F.3d 933, 944 (5th Cir. 1999)

Why do claimants want to break out of ERISA?  Because they must prove that the plan administrator's denial of benefits was arbitrary and capricious (which is tougher to prove than negligence), and if they win, they get the benefits they should have had, plus (maybe) attorneys' fees. 

House Bill Would Create Federal Guarantees for Disaster Insurance Program

Yesterday, the U.S. House of Representatives passed on a vote of 258 to 155 a bill designed to backstop private property insurance in the event of huge natural catastrophes like Hurricane Katrina or the San Diego fires.  Opponents of HR 335 (known as Homeowners' Defense Act of 2007), including the White House, say the legislation would shift business from the private market to the federal government and would unfairly benefit disaster-prone states like Florida and Louisiana at the expense of other states.

Under the program, individual states would enter pooling arrangements to provide reinsurance for private insurers (reinsurance covers part of the insurers' risk in issuing private insurance).  If a catastrophic event results in damages above a certain threshold (measured by disaster costs that exceed 1.5 times the amount of premiums collected from homeowners and businesses in the previous year), the affected state could apply for loans from the federal government.

The bill's sponsor's, Reps. Ron Klein (D-Fla.) and Tim Mahoney (D.Fla), assert that the measure is necessary to reassure private insurers that affordable reinsurance is available and to absorb the costs of the largest natural disasters without the need for post-hoc government bailouts.  The insurance industry is divided over the legislation.  The Big "I" (Independent Insurance Agents and Brokers of America) support the bill; The AIA (American Insurance Association) believes the Act will not create incentives as advertised for private insurance markets.

Sens. Hillary Clinton (D-NY) and Bill Nelson (D-Fla.) have introduced similar legislation in the Senate.  President Bush has indicated he will veto the measure.

For more information on this bill, see NY Times House Approves Creation of a Federal Disaster Insurance Program.

White House Threatens To Veto Extension of Terorrism Insurance

According to a story by the Associated Press on Monday, Bush advisers threaten to veto the 15 year extension of the  2001 Terrorism Risk Insurance Act that is working its way through Congress.  See Veto Threat.  The current proposal to extend the government-backed insurance program with added protection for domestic as well as foreign terrorist acts, faces perhaps it strongest opposition so far.  The administration indicates that government should get out of the insurance business.  Proponents argue that without the back-stop insurance program, it will be impossible to obtain insurance, particularly for nuclear, biological, chemical and radiological attacks.

Insurance Adjusters Face Personal Liability For Statutory Bad Faith In Texas

Insurance adjusters may find themselves as defendants in more insurance bad faith litigation after the Fifth Circuit Court of Appeals decision in Gasch v. Hartford Acc. & Indem. Co., 491 F.3d 278 (5th Cir. 2007), which held that federal courts had no diversity jurisdiction over an insurance bad faith action against an out-of-state insurer and an in-state adjuster because the adjuster was "a person in the business of insurance" and so could be liable under Texas Insurance Code art. 21.21 (now Sec. 541).  Federal diversity jurisdiction is destroyed when one defendant is a citizen of the same state as the plaintiff.  Therefore, although the lower court had dismissed the bad faith claims against both defendants as groundless, which the Fifth Circuit doesn't contest, the case was remanded to the lower court so it could dismiss the action, after which it would continue in state court.  This is not good news for adjusters.

In 1994, the Texas Supreme Court appeared to exonerate adjusters from bad-faith liability in Natividad v. Alexsis, Inc., 875 S.W.2d 695 (Tex. 1994), holding that adjusters under contract with insurers could not be held liable for common law bad faith because they were not parties to the contract between he insured and insurer.  However, since that time policyholders have gained more success pursuing both insurers and adjusters for mishandling claims under Texas' consumer protection statute in Art. 21.21 of the Insurance Code.  Under the statute, a party need not be in contractual privity with the insured to be liable.  It is enough if the party is engaged in "the business of insurance," which the Insurance Code explicitly defines to include investigating or adjusting claims (Sec. 101.501).

The Gasch court refused to apply the reasoning the the Natividad case and found that an adjuster can be liable for unfair claims settlement practices under Art. 21.21.  Because plaintiffs usually prefer to bring insurance lawsuits in state court, we can expect more lawsuits joining in-state defendants, especially local adjusters, to prevent insurers from removing state court actions to federal court.

Premises Owners May Obtain Exclusive-Remedy Defense Under Texas Labor Code

Entergy Gulf States, Inc. v. Summers, No. 05-0272 (Tex. August 31, 2007)

This recent case clarifies the distinction under Texas law between a premises-owner and a "General Contractor" and holds that an owner acting as its own general contractor may obtain the protection under the Texas Labor of restricting an injured employee's remedies to workers' compensation benefits.  John Summers worked as the employee of International Maintenance Corp. (IMC) which contracted to perform construction and maintenance at Entergy Gulf States's plant.  The parties' contract provided that Entergy was a statutory employer that would procure workers' compensation coverage for IMC's employees.

Section 406 of the Texas Labor Code provides that a "general contractor" may enter a written contract to provide worker's compensation coverage for a subcontractor's employees, which makes the general contractor the employer of the subcontractor's employees for purposes of the workers' compensation laws.  A "general contractor" is defined as "a person who undertakes to procure the performance of work or a service, either separately or through the use of subcontractors." (Tex. Labor Code Sec. 406.123 (e)).

The lower appeals court had followed earlier cases and held that a general contractor had to enter a prime contract with another [an owner] and then agree to subcontract all or part of that work to a subcontractor.  This interpretation was based on language in the Labor Code that was changed in 1993 revisions when the Code was recodified, ostensibly "without substantive change."  Nevertheless, the Texas Supreme Court held that a court must give effect effect to a statute's clear and specific wording despite a generic statement disclaiming substantive changes.  The current statute contains no limitation on the definition and permits an owner to qualify as a general contractor on its own behalf.

Accordingly, it is now clear that premises owners may contract with contractors and obtain the benefits of the exclusive remedy of the the workers' compensation laws.

Judge Dismisses Antitrust Claims Against Insurers and Brokers Over Alleged Contingent Fee/Bid Rigging Practices

A federal district court judge in New Jersey ended a huge antitrust lawsuit against dozens of the nation's largest insurance companies and brokers alleging conspiracy to allocate customers and fix prices.  Policyholders, both corporate and individual and interested public agencies brought the lawsuit concerning practices first scrutinized by the New York Attorney General in 2004 in which certain insurance brokers allegedly received undisclosed or inadequately disclosed commissions, so-called "contingent commissions," from insurers for preferential placement of business and solicited phony bids from some insurers in bid-rigging schemes.  Since 2004, many brokers have promised to cease taking contingent commissions, and RIMS, a national association of risk managers, has condemned the practice.  See RIMS.  Moreover, many of the participants have paid regulators millions in settlements.  See, e.g., Marsh settlement.

The Judge Garrett E. Brown Jr threw out the lawsuit writing that the "hub and spoke" conspiracy "is devoid of a factual basis for this court to infer that an agreement existed among the competitors - in this case, the insurer defendants."  The plaintiffs failed to show a horizontal agreement among the insurer defendants to divide the brokers' business and refrain from competition.  Judge Brown also concluded that the plaintiffs failed to demonstrate a global conspiracy among the broker defendants to hide the existence of "contingent," or bonus, commissions from their own clients, or the clients of another broker in an effort to steal that broker's clients.  For a fuller discussion of this dismissal, see Judge Again Dismisses Lawsuit.

Report Details Fraudulent Claims-Adjustment Practices in Homeowner Insurance Industry

In response to widespread insurance abuses reported in the 1960's and 1970's, many states, including Texas, instituted consumer protection laws to curb sharp practices and punish insurers that delay or refuse to pay meritorious claims.  According to a recent article by David Dietz and Darrell Preston published on Bloomberg.com (Home Insurers' Secret Tactics Cheat Fire Victims, Hike Profits), homeowners are facing a current wave of abuses designed to underpay property losses.  The authors provide numerous details of how such large insurers as Allstate and State Farm train adjusters to make low ball offers for damaged or destroyed homes and fight vigorously if the policyholder holds out for full replacement cost.

Perhaps most disturbing is evidence developed through discovery in several lawsuits across the country that insurers have relied on advice of consultants, particularly a New York-based consulting firm called McKinsey & Co., advising insurers on methods to raise profits by paying out less in claims.  For example, one powerpoint slide shown in a Kentucky court room entitled "Good Hands or Boxing Gloves" advises Allstate adjusters to make an initial low offer.  If the policyholder accepts the low offer, McKinsey's slide tells the adjuster to treat the person with good hands.  "If the customer protests or hires a lawyer, Allstate should fight back."

Another reported practice is the use of computer programs, including "Colossus" and "Xactimate," that allegedly calculate insured losses and systematically underpay policyholders without regard to the validity of each individual claim.  This article also reports on insurer practices of rewarding adjusters who underpay claims.

At a time when insurance company profits have increases year to year, despite Katrina-related losses (the article reports property-casualty profits up 49% in 2006), reports like these may well spur another cycle of consumer protection legislation.

Texas Governor Signs Joint Resolution Opposing Federalization of Insurance Regulation

Governor Rick Perry today signed a joint Senate and House resolution of the 80th Legislature affirming support of continued state regulation of the insurance industry and opposing pending congressional legislation that would allow federal chartering of insurance companies.  See Federal Regulation of Insurance Industry.  The Independent Insurance Agents of Texas (IIAT) drafted the resolution sponsored by Texas State Sen. Kip Averitt and State Rep. Craig Eiland.  The resolution emphasizes the advantages of state regulation because it provides stronger consumer-protection laws and more streamlined and  prompt attention to problems.

IIAT President-Elect Frank Swingle announced his support for the resolution saying that, "Independent agents understand the need for efficient and effective regulation of our business, but we don't believe that that can be achieved in Washington, and neither do Texas lawmakers."  The resolution is being distributed to President George Bush, U. S. representatives and senators, as well as selected senior officials.  For a fuller discussion of this resolution see Insurance Journal: "Gov. Signs Texas Agents' Resolution Opposing Federal Regulation"

New York Regulators Allow Marsh to Amend Settlement

As reported in a story by Lavonne Kuykendall in today's Wall Street Journal, Marsh & McLennan Cos. announced an amendment to the 2005 settlement of contingent-fee and bid-rigging litigation brought by then New York Attorney General Eliot Spitzer.  The settlement required Marsh to give up more than $800 million a year in revenue from contingent fee commissions, often ill-disclosed payments by insurers to brokers for volume business.  Contingent commissions have been renounced by many in the risk industry, including the Risk and Insurance Management Society, an association of risk managers.  See Blog on RIMS Call to End Contingent Fees. 

The amendment will allow Marsh to charge insurers for services it provides to customers, if those charges are fixed at the time the policy is written or renewed.  This is the second amendment to the settlement.  In August 2006, New York regulators permitted an amendment to allow Marsh to accept commissions from insurers where Marsh worked for the insurer in the capacity as a managing general agent or underwriting manager.  Marsh competitors, Aon Corp. and Willis Group Holdings executed similar amendments in 2006 and expect to obtain a similar amendment to the one announced today.

House Committee Takes a Step Closer to Renewing Terrorism Reinsurance Bill

A week after the House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises voted to extend the federal terrorism reinsurance law (see my post at Subcommittee Action), the House Financial Services Committee voted 49 to 20 to extend the 2002 legislation for an additional 15 years against the desires of the Bush administration.  If passed, H.R.2761 will expand federal participation in backstop insurance coverage losses caused by domestic as well as foreign acts of terrorism and will include coverage against nuclear, biological, chemical and radiological attacks, a provision not welcome by all insurers. 

The Bush Administration has opposed attempts to continue and expand the government program, while the insurance industry has been largely supportive, and argues that the federal backstop is necessary for the private market to be able to insure properties in locations at high risk of a terrorist attack.  The administration has urged that the government should not continue to be involved in the private market.  For a fuller discussion of this matter, see Insurance Journal.

Subcommittee Sends Terrorism Insurance Extension To Full Committee For Vote

This week, the House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises moved the federal Terrorism Risk Insurance Revision and Extension Act on to the full House Financial Services Committee for a vote.  First passed in 2002, the Terrorism Risk Insurance Act (TRIA) provides government participation above a certain cap in the event of property and casualty loss caused by an act of foreign terrorism.  First extended in 2005, H.R. 2761 proposes to extend the program for an additional 10 years with significant modifications.

The bill, approved by the subcommittee by a vote of 26 to 17, eliminates the distinction between foreign and domestic terrorism; lowers the program's event triggers for the federal government backstop from $100 million to as little as $5 million; adds group life insurance; creates a blue-ribbon commission to develop long-term recommendations; and improves coverage for nuclear, biological, chemical, and radiological terrorism events.

The insurance industry generally supports this legislation but is cautious about covering nuclear, biological, chemical, and radiological events, which could cause more catastrophic losses than conventional terrorist attacks.  For a fuller discussion of this legislation, see Insurance Journal.

House Passes Bill to Streamline Surplus Lines Insurance Regulation

This week the U.S. House of Representatives passed H.R. 1065, the "Nonadmitted and Reinsurance Reform Act of 2007" intended to establish national standards for the regulation of surplus lines and reinsurance, create a uniform system of surplus lines premium tax allocation and remittance, one-state compliance on multi-state surplus lines risks, and direct access to the surplus lines market for sophisticated commercial purchasers.  The bill was welcomed by many insurers, agents and brokers, as well as by some consumer advocates because it makes clear that the state in charge of regulation is the state where the policyholder resides.  For a more detailed description of the legislation and reactions to it, see HR 1065 article in the National News section of the Insurance Journal.

Federal Court Orders Production of Reinsurance and Loss Reserve Information

A federal magistrate in Kansas recently granted an insured's motion to compel 15 insurers to produce documents relating to reinsurance, loss reserves, claims handling manuals, and document retention policies.  In U.S. Fire Insurance Co. v. Bunge North America, Inc., et al., two insurers filed a declaratory judgment action against the insured, Bunge, and several other insurers seeking a declaration that they were not liable for environmental contamination at three of Bunge’s grain elevator facilities.  Bunge had entered a remediation agreement settling groundwater contamination claims at one of the sites for $4,755,000.

 

Bunge filed counterclaims against the Plaintiff Insurers, cross-claims against the Co-Defendant Insurers, and Third-Party claims against several other issuers, alleging that they acted in bad faith by failing to investigate Bunge's coverage claims in a timely manner, and by failing to accept or reject coverage in a reasonable time.  Bunge also alleged that three of the insurers failed to produce and refused to acknowledge evidence of their policies.

 

The insurers claimed that reinsurance was irrelevant to the interpretation of the policies underlying the declaratory judgment suit, was confidential and proprietary, and that production of reinsurance information was against public interest.  Recognizing a split in federal authority, the court agreed with Bunge's argument that reinsurance materials—and communications between the insurers and their reinsurers—were relevant and discoverable for purposes of: (1) rebutting the insurers’ defense of late notice; (2) Bunge's allegations of bad faith and improper handling of its claims; (3) the insurers' assessment of their potential liability or exposure; (4) the insurers’ admissions regarding coverage; and (5) to reconstruct the terms of policies which were allegedly lost.

 

Because Bunge's counterclaims, cross-claims, and third-party claims directly sought a monetary award, the court distinguished decisions finding that reinsurance agreements are not per se discoverable in declaratory judgment litigation between a policy holder and its insurer that does not involve a damages claim.  Instead, the court approved of cases finding that reinsurance is discoverable under the broad language of Federal Rule 26(a), regardless of the reinsurer’s indirect liability.

 

Regarding Bunge's request for the insurers’ loss-reserve information, the court ruled that such a request was facially relevant to: (1)  the insurers' position that they had no liability for the contaminated sites; (2) Bunge's claims of the insurers' bad faith in investigating and accepting or rejecting coverage within a reasonable time; and (3) Bunge's allegations that certain insurers failed to produce and acknowledge certain relevant policies.  In so ruling, the court expressly rejected as conclusory and without foundation the insurers' arguments that reserve information was merely an estimate of presumed, potential liability made in the ordinary course of business, rather than an actual evaluation of the likelihood of liability or coverage.  The insurers failed to cite any applicable state law or produce evidentiary support establishing their reserve preparation policies.

 

In concluding that reserve information was discoverable, the court approved of federal cases finding that loss-reserve information was relevant not as an admission of liability, but because it was pertinent to other issues, such as the plaintiff’s attempt to rebut a defense, notice, or the defendant’s bad faith.  The court observed that in those cases holding that loss-reserve information was not relevant, that the courts did not examine the specific facts presented, and instead accepted the general proposition that setting reserves is perfunctory, and does not involve an insurer’s evaluation of coverage.  The court believed that it was necessary to determine the relevancy of reserve information on a case-by-case basis by looking to the specific facts presented.  Here, the court found that the timing and establishment of reserve information was relevant to Bunge’s claims of mishandling, bad faith, and breach of the insurers’ duties. 

 

The court also ordered production of certain insurers’ claims handling manuals, based upon Bunge’s assertion that its claims were improperly handled.  The insurers’ argument that these documents’ relevance were outweighed by the harm of disclosure, specifically from the business advantage that their competitors might gain, was rejected.  Finally, the court found that Bunge’s request for the insurers’ document retention policies was facially relevant to Bunge’s claims regarding the allegedly lost policies, but that other requests for documents mentioning or discussing document retention policies were overbroad.  Notably, the court ordered that the parties’ use of reinsurance and claims handling materials was to be limited to the pending litigation, and the parties were prohibited from disclosing reinsurance and reserve information to outside parties.

U.S. Supreme Court Holds Insurers' To a Lenient Standard Under the Fair Credit Reporting Act

It is rare for the U.S. Supreme Court to weigh in on insurance matters, but interpretation of the Federal Fair Credit Reporting Act (FCRA) that requires companies to notify consumers in "adverse action notices" about rate increases that are based on information in their consumer credit reports is a matter for the federal courts.  In a victory for insurers Geico Corp. and Safeco Corp., the high court reversed a Ninth Circuit Court of Appeals decision and held insurers do not have to send adverse action letters to consumers that would have received a lower premium had their credit scores been higher.  The safe harbor for insurers is that no notice is required if the premium offered is no higher than would have been offered if the credit score had been ignored.  In other words, a consumer may not be punished with a higher rate for a bad score without notification, but the insurer is not required to reward consumers by notifying them that they would receive a lower rate with a better score.  Insurers are relieved by this decision.  See Insurance Journal Report for more.

Risk Managers Call for an End to Contingent Commissions in Insurance Industry

Today, the world's largest organization of risk managers, The Risk and Insurance Management Society (RIMS), strongly denounced the practice of insurers' paying "contingent commissions" to insurance brokers in return for policy placements.  The widespread use of contingent commissions first came to national attention in 2004 when then New York Attorney General Eliot Spitzer brought an action against broker Marsh & McLennan Cos. for abuses surrounding the use of these commissions.  Many RIMS members denounced the practice at the time because the commissions potentially interfere with the broker's duty to represent the interests of the policyholder.  Several large brokers pledged to stop the practice, but others equivocated.

RIMS's decision to come out now with a strongly worded official position appears to be in response to statements made at RIMS national convention in April by a number of representatives of insurers and brokers that they might continue the practice or even reconsider earlier pledges to refuse to accept such commissions.  RIMS has now put the fence-sitters on notice.  "RIMS is troubled that the insurance industry continues to promote this compensation model despite its many associated issues."  RIMS members are urged to look closely at their purchases to make sure all fees and commissions are transparent.  For RIMS's complete statement, see RIMS.

Senators Sununu and Johnson Urge Federal Insurance Regulatory Reform

In a press release yesterday, United States Senators John Sununu (R-NH) and Tim Johnson (D-SD) announced the reintroduction of legislation to permit life and property casualty insurance companies operating under multiple state jurisdictions to choose to be regulated at the national level under a new "Optional Federal Charter."  See Press Release.  Currently, companies in the business of insurance are state-chartered only, which some have argued leads to unwieldy and inconsistent regulation of the insurance industry.  Senator Johnson said, "there is no reason why this country's insurance industry, its agents, brokers and consumers they serve should be hamstrung by a system of regulation that is redundant, inefficient, burdensome, complicated, and costly."

The proposed National Insurance Act of 2007, similar to legislation introduced last year, is intended to provide both strong Federal regulatory oversight of insurers operating in multiple states as well as quicker and more efficient delivery of insurance products to consumers.  "America's $5 trillion insurance industry operates in a global marketplace, highlighting the importance of a clear, consistent regulatory framework. The fragmented system currently in effect has no place in a modern economy. Given the needs of insurers, it inevitably must be modernized," said Sununu. "This legislation provides a choice for insurers if they wish to become chartered at the national level, enabling them to work under a uniform set of regulations and an effective federal regulator. Some institutions may choose not to do so, and this bill does not weaken or undermine the current state system for these firms."

Reaction to the proposed legislation is mixed.  As reported in the Insurance Journal, many industry trade associations favor the bill (SB 40) as reasonable and timely.  See Insurance Journal.  The optional federal charter "simply makes sense," said Ken A. Crerar, President of the Council of Insurance Agents & Brokers.  Also supporting the bill, the American Insurance Association’s president, Marc Racicot said the legislation is rooted in free-market principles, and would allow competition to flourish. "Consumers would be empowered by market-based regulation that would allow insurers to customize products and meet consumer needs more quickly, while retaining strong federal regulatory oversight of market behavior and financial condition."

Other groups expressing support for SB 40 include the Agents for Change, the American Bankers Association, the American Bankers Insurance Association, the American Council of Life Insurers, the Financial Services Forum, the Financial Services Roundtable, the Life Insurers Council, the National Association of Independent Life Brokerage Agencies, the Reinsurance Association of America, and the Risk and Insurance Management Society.

Other trade associations, however, strongly oppose the National Insurance Act including the National Association of Mutual Insurance Companies (“NAMIC”) and the Independent Insurance Agents & Brokers of America (“Big ‘I’”).  NAMIC's senior federal affairs director, Justin Roth, said, "in addition to being completely unnecessary, this bill would likely lead to additional bureaucracy for insurers and, ultimately, higher prices for consumers. . . . It makes little sense to introduce legislation that would create a system that the vast majority of companies and agents in the property/casualty world strongly oppose.”

Big "I" Senior Vice President for Government Affairs and Federal Relations, Charles E. Symington Jr., "there is no question in the insurance market that the existing regulatory system needs to be reformed.  . . . Change is overdue, and virtually every industry stakeholder agrees the existing system can be slow, inefficient, and duplicative. The Big "I" agrees with the need to update the regulatory system, but a one-size-fits-all scheme that creates a new federal bureaucracy is not the answer."  The Big “I” also expressed concerns that a federal regulator in Washington might unnecessarily impede agents and brokers from representing their customers, and that a bifurcated regulatory scheme might have disastrous implications for solvency regulation.