When a U.S. insurance regulator investigates market conduct or financial solvency, its work is governed by a state law based on the NAIC Model Law on Examinations. Like the Model Law, all state laws strictly protect the confidentiality of documents and information that are “created, produced or obtained by[,] or disclosed to” the regulator or its agents. Recently, in City of Sterling Heights Gen. Employees’ Retirement Syst. v. Prudential Financial, Inc., No. 12-5275 (D.N.J. April 30, 2015), a court in New Jersey poked a hole in that firewall: it ruled thatneither state examination laws nor any evidentiary privilege will “categorically” protect regulators’ communications with an independent auditor from disclosure in a federal lawsuit against the insurer. If the decision stands, insurers can expect to engage routinely in discovery battles over regulatory records.
Opening The Death Master File
In early 2009, several state treasurers and controllers, led by California, initiated an unclaimed property audit of Prudential’s life insurance business. Several months later, a group of state insurance departments, led by Pennsylvania, began a related market conduct examination of Prudential’s settlement practices and policies. In connection with both investigations, the regulators retained Verus Financial LLC, a privately-owned firm that specializes in auditing insurers to identify unclaimed property—such as life insurance policies that are eligible for payment or escheatment.
Verus identified a significant number of such policies—in some cases, because the policyholders’ deaths had been reported in the Social Security Death Master File. In late 2011, Prudential resolved both investigations by agreeing to pay out the unclaimed property. At about the same time, the insurer took a significant charge against earnings, based on its previous failure to recognize that property.
When the charge was announced, the plaintiff in Sterling Heights filed a putative class action, alleging violations of the federal securities laws. Among other things, the complaint charged the insurer with misrepresenting its financial condition, because it allegedly knew or should have known that the policies identified by Verus were eligible for payment.
The Discovery Requests
The plaintiff in the lawsuit served Verus with a subpoena that requested a large number of documents, including:
- all documents and communications relating to the unclaimed property audit and/or the market conduct examination;
- all documents and communications relating to Prudential’s unclaimed property and escheatment practices;
- all records of Verus’s communications with, or relating to, Prudential; and
- all records of communications between Verus and “any governmental or regulatory entity.
Verus objected, on the ground that certain of the requested documents were protected by “statutory and/or common law privileges belonging to Verus'[s] client states and state agencies.” The objection applied only to documents in Verus’s possession; no dispute was raised about the plaintiff’s ability to acquire documents and information from Prudential, even if Prudential had also produced them during the examination.
The plaintiff moved to compel, and, on December 3, 2014, a U.S. Magistrate Judge ruled as follows:
Verus'[s] relevance and privilege objections are OVERRULED and do not shield the information sought from production.
Check Your Privilege
Verus appealed the Magistrate Judge’s Order to the district court, and its motion was supported by briefs from two groups of amici curiae—(i) the National Association of Insurance Commissioners and (ii) a group of seven state insurance departments that had participated in the market conduct examination. Separately, one of Verus’s clients in the unclaimed property audit, the Controller of the State of California, sought leave to intervene in the class action to preserve his right to assert privilege claims over documents in Verus’s possession.
Verus and its supporters offered two principal arguments, the first of which was that the court should recognize an “insurance examination privilege.” In cases arising under federal statutes, Federal Rule of Evidence 501 provides that privilege issues are governed by federal common law. When federal courts are asked to recognize a new privilege, they consider such factors as “policy decisions of the States,” whether the privilege will “serv[e] public ends” and the “likely evidentiary benefit that would result from denial of the privilege.” Jaffee v. Redmond, 518 U.S. 1 (1996).
In this case, all 50 states have made a “policy decision” to preserve the confidentiality of documents produced in the course of insurance examinations—a decision they manifested by adopting examination statutes with confidentiality provisions based on the NAIC’s Model Law. Both Verus and the amici placed heavy emphasis on this fact; the NAIC called confidentiality “a foundational principle related to conducting insurer examinations,” explaining that the assurance of nondisclosure permits regulators to
regulate effectively for the public good and obtain needed information without the regulatory examination process becoming the target of private actions such as the present matter.
Without assurance of confidentiality, the NAIC warned,
there is a risk of negative consequences for the consumers, regulators and industry. … [I]insurance companies … would likely become less forthcoming with their regulators …; … insurance department resources may be further strained by the inability to utilize outside experts …; other … regulators would likely refuse to share confidential information in their possession … ; and consumers may have to bear the consequences of an ineffective regulator being unable to participate fully in a wider, mutually-cooperative system.
Verus’s second argument was based on the McCarran-Ferguson Act, 15 U.S.C. § 1012, under which a state law that “regulat[es] the business of insurance” will “reverse preempt” any federal statute. Under McCarran-Ferguson, Verus and the amici contended, the confidentiality provisions of the relevant state examination statutes trump Rule 45 of the Federal Rules of Civil Procedure (which governs third-party subpoenas), as well as FRE 501.
We Have All Been Here Before
Shortly before the motion to compel was granted on December 3, 2014, the Magistrate Judge who issued the ruling was elevated to the position of District Judge. The Sterling Heights case was then transferred to her in her new capacity on December 22. Thus, the Judge was asked to hear the appeal from her own order—under a standard calling for de novo review. Looking at the matter afresh, the court nevertheless came to the same conclusions.
Revisiting the question of the “insurance examination privilege,” the court acknowledged that the state examination statutes count in favor of recognizing such a privilege. But the court found two factors running the other way. First, this privilege was not one of the possible new privileges that are discussed in the Advisory Committee Note to FRE 501. (The Note was published in 1972; the NAIC’s Model Law was not adopted until 1990.) Second, the court was not convinced that the privilege would further public policy:
Verus argues that without such a privilege, insurance companies would be less willing to share information … . This argument, however, ignores the fact that state laws require insurers to share information freely and openly with their regulators. … [T]he Court finds unpersuasive Verus’s claim that insurers would be less willing to do what the law requires them to do without the adoption of a federal insurance examination privilege.
On the McCarran-Ferguson issue, the court ruled that the statute simply does not apply in these circumstances:
[T]he Court is not convinced that the anti-disclosure statutes were enacted for the purpose of regulating the business of insurance—i.e., with the goal ‘of adjusting, managing or controlling the business of insurance.’ Instead, these statutes provide direction … as to how and when documents and communications related to an insurance examination may or may not be disseminated. In other words, the statutes merely control the flow of information during an insurance examination.
In addition to these rulings, the court granted the motion of the California Controller for leave to intervene. Thus, to the extent the Controller intends to assert some privilege other than the insurance examination privilege (for example, the attorney-client privilege) with respect to some or all of the documents in Verus’s possession, he will not be foreclosed from doing so.
Tomorrow Is the Question
Verus has sought leave to file an interlocutory appeal from the district court’s latest order; if it is successful, the appeal will be heard by at least two judges who are new to the case. Those judges will have a lot to consider:
For one thing, the district court’s public policy analysis was exceptionally narrow. It is true that state examination statutes require insures to transmit information, but that requirement comes coupled with a guaranty of confidentiality. No state has adopted a policy of requiring insurers to produce information about their reserving practices (for example) under circumstances that would later expose that information to policyholders engaged in coverage litigation. And while the examination statutes make some disclosures mandatory, the statutes cover a wide variety of examinations; in some contexts, insurers still have a degree of choice about precisely what information to share and how it should be presented. If the disclosures are subject to discovery by adverse litigation parties, insurers would have to take that risk into account.
The district court’s McCarran-Ferguson analysis was also constricted. In effect, it treated the confidentiality provisions of state examination statutes as stand-alone laws, only incidentally connected to the insurance examinations to which they apply. A financial solvency or market conduct examination almost certainly involves “the goal ‘of adjusting, managing or controlling the business of insurance.'” It is hard to see, therefore, how a law that “control[s] the flow of information during an insurance examination” could fail to involve the same goal—especially when that law is just one section of a statute that establishes examinations in the first place.
If the appeal in Sterling Heights does not succeed, therefore, the battle that played out in that case is likely to be re-enacted often. While the court addressed the parties’ arguments about disclosure by insurers, the real dispute in Sterling Heights was about communications between regulators and their independent consultants. The primary issue, in other words, was not whether plaintiffs should have access to information in an insurer’s possession, but whether they should get to see what regulatory staff had to say about that information—not in their final rulings, but during the course of the examination.
Regulators’ comments might suggest new legal strategies or theories to plaintiffs’ counsel; they might also be misleading or inflammatory when presented to a jury. In either case, there is no evidence that any state has adopted a public policy in favor of their disclosure. But there is no doubt that plaintiffs’ counsel want to see them.