California Supreme Court Upholds Insurance Commissioner’s Authority to Regulate Replacement Cost Estimates

In Assn. of Cal. Insurance Companies v. Jones ( No. S226529, filed 1/23/17), the California Supreme Court reversed trial and appellate court decisions to hold that California’s Insurance Commissioner Dave Jones had the authority to promulgate California Code of Regulations, title 10, section 2695.183, which sets out specific requirements for estimating replacement cost as part of any application for or renewal of homeowners insurance.

The regulation was promulgated in 2010 in response to complaints from homeowners who lost their homes in the Southern California wildfires of 2003, 2007, and 2008, and who discovered that they did not have enough insurance to cover the full cost of repairing or rebuilding their homes because the insurers’ estimates of replacement value were too low when they purchased the insurance. The regulation specifies that:

“No licensee shall communicate an estimate of replacement cost to an applicant or insured in connection with an application for or renewal of a homeowners’ insurance policy that provides coverage on a replacement cost basis, unless…. (a) The estimate of replacement cost shall include the expenses that would reasonably be incurred to rebuild the insured structure(s) in its entirety, including at least the following: (1) Cost of labor, building materials and supplies; (2) Overhead and profit; (3) Cost of demolition and debris removal; (4) Cost of permits and architect’s plans; and (5) Consideration of components and features of the insured structure…. (b) The estimate of replacement cost shall be based on an estimate of the cost to rebuild or replace the structure taking into account the cost to reconstruct the single property being evaluated, as compared to the cost to build multiple, or tract, dwellings. (c) The estimate of replacement cost shall not be based upon the resale value of the land, or upon the amount or outstanding balance of any loan. (d) The estimate of replacement cost shall not include a deduction for physical depreciation. (e) The licensee shall no less frequently than annually take reasonable steps to verify that the sources and methods used to generate the estimate of replacement cost are kept current to reflect changes in the costs of reconstruction and rebuilding, including changes in labor, building materials, and supplies, based upon the geographic location of the insured structure. The estimate of replacement cost shall be created using such reasonably current sources and methods.”

The regulation also included requirements for additional training for insurance agents on estimating replacement cost and insurer record-keeping about homeowners’ insurance sales. Further, under the regulation:

“[C]ommunicat[ing] an estimate of replacement value not comporting with divisions (a) through (e)” to an applicant for homeowner insurance “provid[ing] coverage on a replacement cost basis,” or any renewal thereof, “constitutes making a statement with respect to the business of insurance which is misleading and which by the exercise of reasonable care should be known to be misleading, pursuant to Insurance Code section 790.03.”

Insurer-backed industry trade organizations objected to the mandated formula and particular words that insurers are required to use, as well as the regulation’s authorization of punishment for deviating from the state-required formula. In particular, they objected to the possibility that under the regulation, any change to the formula could automatically be treated by the Commissioner as a “deceptive” sales practice, subjecting the insurer to discipline.

The trade groups filed suit on the ground that the Insurance Commissioner lacked the statutory authority to impose a single mandatory underwriting criteria for calculating replacement cost, and the trial and appellate courts agreed. In particular, the appeals court said that the Commissioner could bring individual enforcement actions on a case-by-case basis, but that setting general rules applicable to all insurers was for the Legislature.

The Supreme Court reversed. The Court first engaged in a discussion of the general law regarding the regulatory authority of executive agencies in California, citing examples involving the Department of Motor Vehicles, the State Board of Accountancy and the Agricultural Labor Relations Board, to conclude that the Legislature’s grant of authority to “administer” the Unfair Insurance Practices Act (“UIPA”) (Ins. Code, §§ 790. et seq.), includes both enforcement actions and rulemaking. And, “[w]here an agency has been granted both the power to adjudicate and to promulgate rules, we generally defer to the agency’s choice of how to proceed…. We therefore defer to the Commissioner’s decision to address the problem of underinsurance by rulemaking.”

Having found that the Insurance Commissioner has rulemaking authority, the Supreme Court then considered whether the regulation is consistent and not in conflict with the UIPA. Specifically focusing on the statutory prohibition on “misleading statements,” the Court rejected the idea that a replacement cost estimate is inherently inaccurate, and therefore not “misleading”: “The prohibition on untrue or misleading statements in [Insurance Code] section 790.03, subdivision (b) … extends to statements that are ‘likely’ ” to deceive the public. [] The Commissioner could reasonably conclude that replacement cost estimates are likely to mislead the public about the actual cost of repair or replacement when they willfully omit cost components essential to repairing or rebuilding a dwelling.”

Thus, the Court reversed the lower courts by concluding: “The Commissioner enacted the replacement cost regulation by exercising valid authority conferred under section 790.10 of the UIPA…. section 790.10 explicitly vests in the Commissioner authority to issue ‘reasonable rules and regulations’ to administer the UIPA. Which is what the Commissioner sought to do here.”

That was not the end, however, because the Supreme Court expressly left the door open for further challenges, stating: “Because the Regulation was invalidated below solely under the Administrative Procedure Act, neither the trial court nor the Court of Appeal has yet considered the Association’s remaining challenges to the Regulation. We therefore reverse the judgment of the Court of Appeal and remand the matter for further proceedings consistent with our opinion.”

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January 24, 2017