In 2011, the California Insurance Commissioner promulgated a regulation governing replacement cost estimates for homeowners insurance (Cal. Code Regs., tit. 10, §2695.183 [the Regulation]). After the trial court and intermediate court of appeal invalidated the Regulation, this week the California Supreme Court reversed those decisions in a published decision, Association of California Insurance Companies v. Jones (Cal. Jan. 23, 2017) Case No. S226529.
The Regulation was originally enacted in response to complaints from numerous homeowners who found that they were underinsured only after disaster completely destroyed their homes. In investigating these complaints, the Department of Insurance had found that the replacement cost coverage limit recommended by a number of insurers for their policyholders had understated what was actually necessary to rebuild the insured’s home over 80 percent of the time, and that many of the replacement cost estimates by insurers failed to consider costs of replacing the foundation, debris/demolition expenses, overhead and profit, and engineering reports and architectural plans.
The Regulation does not require an insurer to recommend a particular policy limit or provide a replacement cost estimate when it was issuing or renewing a policy, but if the insurer does choose to opine on replacement costs, the Regulation specifies how that estimate is to be calculated and what factors it must include. Under the Regulation, the estimate must account for “the expenses that would reasonably be incurred to rebuild the insured structure(s) in its entirety,” including the cost of labor, building materials and supplies, overhead and profit, demolition and debris removal, and the cost of permits and architect’s plans. The estimate also must take into account “components and features of the insured structure,” including enumerated items such as the type of foundation and framing. Further, at least annually, the Regulation requires the insurer to “take reasonable steps” to verify that estimate methods are updated to reflect relevant changes.
The Association of California Insurance Companies (ACIC) and other trade groups challenged the Regulation, arguing that the Insurance Commissioner exceeded his rulemaking authority under the Unfair Insurance Practices Act (UIPA) (Insurance Code §790 et seq.). The trial court agreed, and invalidated the regulation by finding that the Insurance Commissioner had exceeded his authority by defining additional “unfair and deceptive” acts or practices by regulation rather than the procedure set out in the UIPA. The Court of Appeal affirmed.
In a decision this week, however, the California Supreme Court, reversed the lower courts’ decisions. In doing so, the Supreme Court afforded significant deference to the Insurance Commissioner, and found that the Commissioner’s authority to administer the UIPA “includes the power to promulgate a rule applying to a specific kind of statement prohibited under section 790.03, subdivision (b),” and that includes the authority to regulate any kind of “misleading statement” – which the Commissioner found the incomplete replacement cost estimates to be.
ACIC argued that because the Commissioner could have brought an enforcement action, it did not have the power to promulgate a regulation on the issue. The Court rejected this argument as well, noting that “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.”
The Supreme Court then addressed whether the Regulation was “consistent and not in conflict” with the UIPA and whether it was “reasonably necessary to effectuate the purpose of the statute” – both required for a regulation to be valid under the Administrative Procedures Act. On both counts, the Court answered in the affirmative. Notably, the Supreme Court criticized the trial’s court’s interpretation of the term “misleading”:
The trial court reasoned that a replacement cost estimate –– as an estimate — is inherently inaccurate and therefore cannot be deemed ―misleading within the meaning of section 790.03, subdivision (b). 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. It may be theoretically possible for a replacement cost estimate that omits consideration of labor costs or the materials used in constructing the home nonetheless to come close to the actual replacement cost if (say) the expected rate of inflation or some other cost component was badly or unreasonably overstated. But the estimate would still have been misleading in purporting to represent each of the essential components for rebuilding the dwelling. In addition, it would have been misleading to the extent that the incomplete estimate could not meaningfully have been compared with a competitor‘s estimate that did faithfully account for each component necessary to rebuild the dwelling.
Nonetheless, the challenge to the Regulation does not end here. ACIC had originally challenged the Regulation on several other grounds (including improper restrictions on underwriting and free speech), but because the trial court and intermediate appellate court had invalidated the Regulation on the grounds discussed above related to the Administrative Procedures Act, they did not consider the other challenged grounds. Accordingly, the Supreme Court reversed the lower courts’ determinations, but remanded the case to the trial court to decide the remaining issues. It remains to be seen what, if any, further challenges there will be.