Caution: The ruling in this case was reversed by the California Supreme Court on January 23, 2017.
In Assn. of Cal. Insurance Companies v. Jones ( No. B248622, filed 4/8/15), a California appeals court held that California’s Insurance Commissioner Dave Jones lacked the authority to promulgate California Code of Regulations, title 10, section 2695.183, which set out specific requirements for estimating replacement cost as part of any application or renewal for homeowners insurance.
The regulation was promulgated in 2010 in response to complaints from homeowners who lost their homes in the wildfires in Southern California in 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 specified 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. 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 were 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 courts agreed. According to the appeals court, when read as a whole, the State’s Unfair Insurance Practices Act, Insurance Code sections 790, et seq., did not authorize the Commissioner to promulgate the regulation, since Insurance Code section 790.03 lists the specific insurance industry conduct that the Legislature has deemed unfair and deceptive, and replacement cost estimates are not included in that list. Examining the historical development of the Act, the court said that the Legislature could have gone on to define the content and format of replacement cost estimates, but did not do so. The appeals court summed up, stating:
“By our opinion today, we are not suggesting that the Legislature could not regulate the form and content of replacement cost estimates if it chooses to do so. We are also not suggesting that the Commissioner could not use the administrative and court processes in [Insurance Code] section 790.06 to seek a determination that replacement cost estimates not including certain information are unfair and deceptive. Nor are we limiting the Commissioner’s authority under section 790.05 to bring an enforcement action against a licensee who has lowballed or otherwise given an incomplete replacement cost estimate. Our ruling today is limited to one conclusion—that the [Unfair Insurance Practices Act] has not as of yet given the Commissioner authority to regulate the content and format of replacement cost estimates.
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