UNFAIR PROPERTY/CASUALTY CLAIMS SETTLEMENT PRACTICES
An unfair claims settlement is the improper handling of an insurance claim by an insurance company violating a state law of unfair claims practices. Such laws are typically a variation of the National Association of Insurance Commissioners’ (NAIC) Unfair Claims Settlement Practices Act (UCSPA). In 1990, the NAIC drafted a set of model laws known as the UCSPA which set forth standards for the investigation and settlement of claims under all types of insurance policies except Workers Compensation, Boiler and Machinery; Equipment Breakdown, and Fidelity, and Surety insurance respectively. Although a majority of states have adopted the model laws in some form, each has incorporated its own modifications. Thus, unfair claims settlement regulations vary from state to state and are enforced by individual state insurance departments.
The Model Act, which has been adopted in most states, identifies fourteen (14) prohibited “unfair” claims practices. The Act delineates five (5) prohibited practices involving communications with insured and claimants: (1) knowingly misrepresenting to claimants and insureds relevant facts or policy provisions relating to coverages at issue; (2) failing to acknowledge with reasonable promptness pertinent communications with respect to claims arising under its policies; (3) failing to affirm or deny coverage of claims within a reasonable time after having completed its investigation relating to such claim or claims failing: (4) in the case of claims denials or offers of compromise settlement to promptly provide a reasonable and accurate explanation of the basis for such action: (5) failing to provide forms necessary to present claims within fifteen (15) calendar days of a request with reasonable explanations regarding their use.
The Model Act delineates seven (7) specific claim activities/practices which are prohibited:
- not attempting in good faith to effectuate prompt, fair and equitable settlement of claims submitted in which liability has become reasonably clear
- compelling insured or beneficiaries to institute suits to recover amounts due under its policies by offering substantially less than the amounts ultimately recovered in suits brought by them
- refusing to pay claims without conducting a reasonable investigation
- attempting to settle or settling claims for less than the amount that a reasonable person would believe the insured or beneficiary was entitled by reference to written or printed advertising material accompanying or made part of an application
- attempting to settle or settling claims on the basis of an application that was materially altered without notice to, or knowledge or consent of, the insured
- making claims payments to an insured or beneficiary without indicating the coverage under which each payment is being made
- unreasonably delaying the investigation or payment of claims by requiring both a formal proof of loss form and subsequent verification that would result in duplication of information and verification appearing in the formal proof of loss form.
The model act and the state laws define certain minimum standards which, if violated with such frequency as to indicate a general business practice, will be deemed to constitute unfair claims settlement practices. These regulations apply to all persons and to all insurance policies and insurance contracts except policies of Workers’ Compensation insurance.
The purpose of the regulation is to;-
- Set forth minimum standards for the investigation and disposition of property and casualty claims arising under contracts or certificates issued to residents of the States. It is not intended to cover claims involving Workers’ Compensation, Fidelity, Surety ship or Boiler and Machinery insurance.
- The various provisions of the regulation are intended to define procedures and practices which constitute unfair claims practices. Nothing therein should be construed to neither create nor imply a private cause of action for violation of this regulation. The provisions are merely a clarification of the NAIC’s original intent and does not indicate any change of any prior position held by the NAIC.
Most of the definitions used in Section 3of the original model were adopted and incorporated in the new model act.
- FILE AND RECORD DOCUMENTATION.
Under the act and the various state laws an insurance company’s claim files are subject to examination by the state’s Commissioner of Insurance or by the state’s Commissioner’s duly appointed designees. As specified by UCSPA and incorporated by the various states the purpose for records maintenance is to:
A. Require an insurer to maintain claim’s data that is accessible and retrievable for examination. An insurer as such, shall be required to provide the claim number, line of coverage, date of loss, date of payment of a claim, date of denial, and/or date of closed claims without payment. The provision and the laws basically require this data be available for all open and closed files for the current year and the two preceding years (basically up to three years).
B. Require an insurer to maintain detailed documentation in each claim file in order to permit reconstruction of the insurer’s activities relative to each claim.
C. Require an insurer to maintain relevant document within a claim file which shall be noted as to the date received, the date processed, or the date mailed.
D. Welcome to the digital age; for those insurers that do not maintain hard copy files, claim files must be accessible from Cathode Ray Tube (CRT) or micrographics and be capable of duplication to hard copy.
Unfair Claims Settlement Practices Act further urges the states to recognize and utilize electronic or other types of “paperless” file systems that are efficient and accommodate all reasonable application of such systems.
- MISREPRESENTATION OF POLICY PROVISIONS.
Misrepresentation of policy provisions may lead to a range of unjust practices, which may differ from one state to another, the UCSPA and the various state laws prohibit acts by insurers that:
A. MISREPRESENT RELEVANT FACTS
Insurance companies are required to fully disclose to first party claimants all pertinent benefits, coverages or other provisions of a policy or contract under which a claim is presented. For example, a claimant’s commercial property policy states that building-ordinance coverage is included, but your insurer says the coverage is excluded.
B. CONCEAL OF RELEVANT INFORMATION
No agent shall conceal from first party claimants benefits, coverages or other provisions of any insurance policy or insurance contract when such benefits, coverages or other provisions are pertinent to a claim.
C.REQUIRE UNREASONABLE CONDITIONS
A claim shall not be denied on the basis of failure to exhibit property unless there is documentation of breach of the policy provisions in the claim file.
D. No insurer shall deny a claim based upon the failure of a first party claimant to give written notice of loss within a specified time limit unless the written notice is a written policy condition, or claimant’s failure to give written notice after being requested to do so is so unreasonable as to constitute a breach of the claimant’s duty to cooperate with the insurer.
E. No insurer shall indicate to a first party claimant on a payment draft, check or in any accompanying letter that said payment is “final” or “a release” of any claim unless the policy limit has been paid or there has been a compromise settlement agreed to by the first party claimant and the insurer as to coverage and amount payable under the contract.
F. No insurer shall issue checks or drafts in partial settlement of a loss or claim under a specific coverage that contains language purporting to release the insurer or it’s insured from total liability.
- FAILURE TO ACKNOWLEDGE PERTINENT COMMUNICATION
- RECEIPT OF NOTIFICATION OF CLAIM
Upon receiving a notification of a claim, an insurer shall acknowledge receipt within fifteen (15) days. The acknowledgement may be made by writing or an appropriate notation of the acknowledgement shall be made in the claim file of the insurer and dated. A notification given to an agent of an insurer shall be notification to the insurer.
During the drafting of this regulation, the chair of the NAIC advisory committee objected to the previous time frame for responding to claimants. Originally claimants had ten days for response, but the advisory committee felt that ten days was insufficient time for a claimant to respond. Since the proposed regulation was to fit all lines of insurance and all kinds of companies with varying methods of operations, they proposed 15 day response time frame would be more realistic starting point.
- RECEIPT OF ANY INQUIRY
Receipt of any inquiry by an insurer from the insurance department in regard to a claim shall, furnish the department with an adequate response to the inquiry in duplicate within 21 days of receipt of such inquiry.
- REPLY TO PERTINENT COMMUNICATION
An appropriate reply shall be made within fifteen (15) days on all other pertinent communications from a claimant which reasonably suggest that a response is expected.
- PROVISION OF CLAIM FORMS
Every insurer, upon receiving notification of claim, shall promptly provide necessary claim forms, instructions and reasonable assistance so that first party claimants can comply with the policy conditions and the insurer’s reasonable requirements. Compliance with this paragraph within fifteen (15) days of notification of a claim shall constitute compliance with Subsection A of this section.
ADMINISTRATIVE REGULATION OF CLAIM PRACTICES
The presence of market failures means that market forces alone cannot ensure that insurance companies deliver satisfactory claim practices. The system of insurance regulation recognizes this fact and regulates claim practices in a number of ways. First, some regulation aims to improve the operation of the market for claim practices. This type of regulation is directed at information problems that disadvantage potential insureds; some of it corrects policy terms that are particularly likely to cause problematic claim practices. Second, some regulation is more direct, setting standards for claim practices and enforcing those standards through administrative means, they include:-
- PROMPT, FAIR AND EQUITBALE SETTLEMENTS – (APPLICABLE TO ALL INSURERS)
Section 7 and 8 of the model provides for the standards to be used by insurers to obtain prompt, fair and equitable settlements.
Foremost, no insurer shall discriminate in its claims settlement practices based upon the claimant’s age, race, gender, income, religion, language, sexual orientation, ancestry, national origin, or physical disability, or upon the territory of the property or person insured.
- The following subsections outline the procedure of conducting a fair and acceptable settlement;-
- Within twenty-one (21) days after the insurer has accepted properly executed proofs of loss,
- The first party claimant shall be advised on the acceptance or denial of the claim by the insurer.
- No insurer shall deny a claim on the grounds of a specific policy provision, condition or exclusion unless reference to such provision, condition, or exclusion is included in the denial. The denial must be given to the claimant in writing and the claim file of the insurer shall contain documentation of the denial as stipulated in the model.
- Where there is a reasonable basis supported by specific information available for review by the insurance regulatory authority that the first party claimant has fraudulently caused or contributed to the loss;-
- The insurer shall be relieved from the requirements of this subsection; provided, however, that the claimant shall be advised of the acceptance or denial of the claim within a reasonable time for full investigation after receipt by the insurer of a properly executed proof of loss.
- If an insurer needs more time to determine whether a first party claim should be accepted or denied, it shall so notify the first party claimant within twenty-one (21) days after receipt of the proofs of loss, giving the reasons more time is needed.
If the investigation remains incomplete, the insurer shall send to the claimant a letter setting forth the reasons for additional time. The additional is meant for investigation forty-five (45) days from the initial notification and every forty-five (45) days thereafter.
In the event there is a reasonable basis supported by specific information, suspecting that the first party claimant has fraudulently caused or contributed to the loss, the insurer is relieved from the requirements of this subsection. It is imperative that the claimant be advised of the acceptance or denial of the claim by an insurer within a reasonable time for full investigation after receipt by the insurer of a properly executed proof of loss.
The specific information must be reviewed by the Insurance Regulatory Authority.
C. Insurers should not fail to settle first party claims on the basis that responsibility for payment should be assumed by others except when provided by policy provisions.
D. Insurers shall not continue negotiations for settlement of a claim directly with a claimant who is neither an attorney nor represented by an attorney until the claimant’s rights may be affected by a statute of limitations or a policy or contract time limit, without giving the claimant written notice that the time limit may be expiring and may affect the claimant’s rights. Such notice shall be given to first party claimants thirty days and to third party claimants sixty days before the date on which such time limit may expire.
E. No insurer should make statements indicating that the rights of a third party claimant may be impaired if a form or release is not completed within a given period of time unless the statement is given for the purpose of notifying the third party claimant of the provision of a statute of limitations.
F. The insurer shall affirm or deny liability on claims within a reasonable time and shall tender payment within thirty (30) days of affirmation of liability, if the amount of the claim is determined and not in dispute. In claims where multiple coverages are involved, payments which are not in dispute and where the payee is known should be tendered within thirty (30) days if such payment would terminate the insurer’s known liability under that individual coverage.
G. Every insurer should request any insured to submit to a polygraph examination unless authorized under the applicable insurance contracts and state law.
H. If, after an insurer rejects a claim, the claimant objects to such rejection, the insurer should notify the claimant in writing that he or she may have the matter.
PROMPT, FAIR AND EQUITBALE SETTLEMENTS – APPLICABLE TO AUTO MOBILE INSURANCE
Section 8 enumerates standards which apply to adjustment and settlement of automobile insurance claims.
A. When the insurance policy provides for the adjustment and settlement of first party automobile total losses on the basis of actual cash value or replacement with another of like kind and quality, one of the following methods must apply:
(1) The insurer may elect to offer a replacement automobile which is a specific comparable automobile available to the insured, with all applicable taxes, license fees and other fees incident to transfer of evidence of ownership of the automobile paid, at no cost other than any deductible provided in the policy. The insurer shall pay all applicable taxes, license fees and other fees incident to transfer of evidence of ownership of the automobile paid, at no cost other than any deductible provided in the policy. The offer and any rejection thereof must be documented in the claim file. The offer and any rejection thereof must be documented in the claim file.
(2) The insurer may elect a cash settlement based upon the actual cost, less any deductible provided in the policy, to purchase a comparable automobile including all applicable taxes, license fees and other fees incident to transfer of evidence of ownership of a comparable automobile. Such cost may be determined by
(a) The cost of a comparable automobile in the local market area when a comparable automobile is available in the local market area.
(b) One of two or more quotations obtained by the insurer from two or more licensed dealers located within the local market area when a comparable automobile is not available in the local market area.
The insurer may elect a cash settlement based upon the actual cost, less any deductible provided in the policy, to purchase a comparable automobile including all applicable taxes, license fees and other fees incident to transfer of evidence of ownership of a comparable automobile. Such cost may be derived from:
(a) The cost of two or more comparable automobiles in the local market area when comparable automobiles are available or were available within the last ninety (90) days to consumers in the local market area; or
(b) The cost of two (2) or more comparable automobiles in areas proximate to the local market area, including the closest major metropolitan areas within or without the state, that are available or were available within the last ninety (90) days to consumers when comparable automobiles are not available in the local market area pursuant to Subparagraph (a); or
(c) One of two or more quotations obtained by the insurer from two or more licensed dealers located within the local market area when the cost of comparable automobiles are not available pursuant to (a) and (b) above; or
(d) Any source for determining statistically valid fair market values that meet all of the following criteria:
(i) The source shall give primary consideration to the values of vehicles in the local market area and may consider data on vehicles outside the area;
(ii) The source’s database shall produce values for at least eighty-five percent (85%) of all makes and models for the last fifteen (15) model years taking into account the values of all major options for such vehicles; and
(iii) The source shall produce fair market values based on current data available from the area surrounding the location where the insured vehicle was principally garaged or a necessary expansion of parameters (such as time and area) to assure statistical validity.
(e) Right of Recourse—If the insurer is notified within thirty-five (35) days of the receipt of the claim draft that the insured cannot purchase a comparable vehicle for the market value, the company shall reopen its claim file and the following procedures shall apply:
(i) The company may locate a comparable vehicle by the same manufacturer, same year, similar body style and similar options and price range for the insured for the market value determined by the company at the time of settlement. Any such vehicle must be available through licensed dealers;
(ii) The company shall either pay the insured the difference between the market value before applicable deductions and the cost of the comparable vehicle of like kind and quality which the insured has located, or negotiate and effect the purchase of this vehicle for the insured;
(iii) The company may elect to offer a replacement in accordance with the provisions set forth in Section 8A (1); or
(iv) The company may conclude the loss settlement as provided for under the appraisal section of the insurance contract in force at the time of loss. This appraisal shall be considered as binding against both parties, but shall not preclude and waive any other rights either party has under the insurance contract or a common law. The company is not required to take action under this subsection if its documentation to the insured at the time of settlement included written notification of the availability and location of a specified and comparable vehicle of the same manufacturer, same year, similar body style and similar options in as good or better condition as the total loss vehicle which could have been purchased for the market value determined by the company before applicable deductions. The documentation shall include the vehicle identification number.
(3) When a first party automobile total loss is settled on a basis which deviates from the methods described in Subsection A(1) and A(2) of this section, the deviation must be supported by documentation giving particulars of the automobile condition. Any deductions from the cost, including deduction for salvage, must be measurable, discernible, itemized and specified as to dollar amount and shall be appropriate in amount. The basis for the settlement shall be fully explained to the first party claimant.
B. Where liability and damages are reasonably clear, insurers shall not recommend that third party claimants make claim under their own policies solely to avoid paying claims under such insurer’s policy.
C. Insurers shall not require a claimant to travel an unreasonable distance either to inspect a replacement automobile, to obtain a repair estimate or to have the automobile repaired at a specific repair shop.
D. Insurers shall, upon the claimant’s request, include the first party claimant’s deductible, if any, in subrogation demands. Subrogation recoveries shall be shared on a proportionate basis with the first party claimant, unless the deductible amount has been otherwise recovered. No deduction for expenses can be made from the deductible recovery unless an outside attorney is retained to collect such recovery. The deduction may then be for only a pro rata share of the allocated loss adjustment expense.
E. Vehicle Repairs. If partial losses are settled on the basis of a written estimate prepared by or for the insurer, the insurer shall supply the insured a copy of the estimate upon which the settlement is based. The estimate prepared by or for the insurer shall be reasonable, in accordance with applicable policy provisions, and of an amount which will allow for repairs to be made in a workmanlike manner. If the insured subsequently claims, based upon a written estimate which he obtains, that necessary repairs will exceed the written estimate prepared by or for the insurer, the insurer shall
(1) Pay the difference between the written estimate and a higher estimate obtained by the insured, or
(2) Promptly provide the insured with the name of at least one repair shop that will make the repairs for the amount of the written estimate. If the insurer designates only one or two such repairers, the insurer shall assure that the repairs are performed in a workmanlike manner. The insurer shall maintain documentation of all such communications.
F. When the amount claimed is reduced because of betterment or depreciation all information for such reduction shall be contained in the claim file. The deductions shall be itemized and specified as to dollar amount and shall be appropriate for the amount of deductions.
G. When the insurer elects to repair and designates a specific repair shop for automobile repairs, the insurer shall cause the damaged automobile to be restored to its condition prior to the loss at no additional cost to the claimant other than as stated in the policy and within a reasonable period of time.
H. Storage and Towing. The insurer shall provide reasonable notice to an insured prior to termination of payment for automobile storage charges and documentation of the denial as required by Section 4. Such insurer shall provide reasonable time for the insured to remove the vehicle from storage prior to the termination of payment. Unless the insurer has provided an insured with the name of a specific towing company prior to the insured’s use of another towing company, the insurer shall pay any and all reasonable towing charges irrespective of the towing company used by the insured.
I. Betterment deductions are allowable only if the deductions:
(1) (a) Reflect a measurable decrease in market value attributable to the poorer condition of, or prior damage to, the vehicle;
(b) Reflect the general overall condition of the vehicle, considering its age, for either or both:
(i) The wear and tear or rust, limited to no more than a deduction of $1,000;
(ii) Missing parts, limited to no more of a deduction than the replacement costs of the part or parts.
(2) Any deductions set forth in (1)(a) or (b) above must be measurable, itemized, specified as to dollar amount and documented in the claim file.
(3) No insurer shall require the insured or claimant to supply parts for replacement.
J. REPLACEMENT CRASH PARTS
(1) Purpose The purpose of this subsection is to set forth standards for the prompt, fair and equitable settlements applicable to automobile insurance with regard to the use of replacement crash parts. It is intended to regulate the use of replacement crash parts in automobile damage repairs which insurers pay for on their insured’s vehicle. It also requires that all replacement crash parts, as defined in this section, be identified and be of the same quality as the original part.
(2) “Replacement crash part,” for purposes of this regulation, means sheet metal or plastic parts which generally constitute the exterior of a motor vehicle, including inner and outer panels.
(3) Identification All replacement crash parts, which are subject to this section and manufactured after the effective date of this section, shall carry sufficient permanent non-removable identification so as to identify its manufacturer. Such identification shall be accessible to the extent possible after installation.
(4) Like Kind and Quality No insurer shall require the use of replacement crash parts in the repair of an automobile unless the replacement crash part is at least equal in kind and quality to the original part in terms of fit, quality and performance. Insurers specifying the use of replacement crash parts shall consider the cost of any modifications which may become necessary when making the repair.
STANDARDS FOR PROMPT, FAIR AND EQUITABLE SETTLEMENTS APPLICABLE TO FIRE AND EXTENDED COVERAGE
Type Policies with Replacement Cost Coverage
A. When the policy provides for the adjustment and settlement of first party losses based on replacement cost, the following shall apply:
(1) When a loss requires repair or replacement of an item or part, any consequential physical damage incurred in making such repair or replacement not otherwise excluded by the policy, shall be included in the loss. The insured shall not have to pay for betterment nor any other cost except for the applicable deductible.
(2) When a loss requires replacement of items and the replaced items do not match in quality, color or size, the insurer shall replace all items in the area so as to conform to a reasonably uniform appearance. This applies to interior and exterior losses. The insured shall not bear any cost over the applicable deductible, if any.
B. Actual Cash Value:
(1) When the insurance policy provides for the adjustment and settlement of losses on an actual cash value basis on residential fire and extended coverage, the insurer shall determine actual cash value as follows: replacement cost of property at time of loss less depreciation, if any. Upon the insured’s request, the insurer shall provide a copy of the claim file worksheets detailing any and all deductions for depreciation.
(2) In cases in which the insured’s interest is limited because the property has nominal or no economic value, or a value disproportionate to replacement cost less depreciation, the determination of actual cash value as set forth above is not required. In such cases, the insurer shall provide, upon the insured’s request, a written explanation of the basis for limiting the amount of recovery along with the amount payable under the policy.
To conclude, standard business day for claims professionals is populated by interruptions, time crunches, large case loads, inundation of correspondence and an incessantly ringing telephone. The effective claims professional must be a professional juggler in this circus who performs in the arena with many eyes watching. It is impossible to guarantee that every communication from an attorney or insured is going to be timely and appropriately responded to. Nevertheless, the diligent claims adjuster diaries his claim log and manages the onslaught of daily activities which represent the claim environment. It has been this author’s experience that most claims professionals manage to accurately represent relevant facts and policy provisions, timely affirm or deny coverage of claims once the claim investigation has been completed, and provide necessary forms in first party cases to present claims. The problematic areas remain timely acknowledgement of pertinent communications with insured and attorneys and the providing of inadequate explanations for claim denials and offers of compromised settlements.
In conclusion, the current system of administrative regulation of claim practices standards is sound in concept. However, what is sound in concept is not realized in practice. Administrative regulation currently does not achieve enough regulatory intervention in the market to ensure that insurers engage in an optimal level of observance of claim practices standards. Indeed, as constituted at present, it cannot.
THE FAILURE OF ADMINISTRATIVE ENFORCEMENT OF CLAIM PRACTICES STANDARDS
The administrative regulation of insurance takes many procedures.
The procedures include;-
- Licensing of insurers and providers,
- Control over policy forms and premium rates, and
- Setting financial requirements, among others.
The regulation of claim practices involves setting claim practices standards and enforcing the standards.
Currently there are numerous claim practices standards, some mandated by statute or administrative rule and others from common law.
The NAIC’s Model Unfair Claims Settlement Practices Act, some parts of the Act, has been adopted in nearly every state. The states have adopted many standards, some general, some specific, and some in between.
Other statutes set out standards emphasis many states to enact statutes that will require payment of claims within specified time periods. Other states have enacted statutes that generally prohibit a company to “unreasonably delay or deny payment of a claim,” in such circumstances unreasonableness is defined when “the insurer delayed or denied authorizing payment of a covered benefit without a reasonable basis for that action.”
Some statutory standards are focused on potentially problematic elements of the claim process: For a state like California, it requires that the policyholder be furnished on request a copy of all claim-related documents and prohibits insurance companies from paying adjusters any part of their compensation based on the amount for which they settle claims.
Setting standards for claim practices by itself may contribute to adherence to those standards by insurers. Setting the standards illuminates expectations about behavior, and insurers’ institutional cultures may adopt the standards as internal norms.
More is required to be done when it comes to the basic principle of government regulation. The burden is mostly on outside entities, either regulators or private litigants or both, must have the incentive and mechanisms to enforce the standards, and the sanctions, and remedies available to them must be sufficient to induce compliance by insurers.
The NAIC’s Market Regulation Handbook identifies a “continuum of regulatory responses” for the analysis and regulation of market conduct. The elements of the continuum are
(1) Contact with the regulated entity,
(2) Market conduct examinations (MCEs),
(3) Enforcement actions, and
Each of these elements may take several forms.
- Contact with the regulated entity includes interrogatories, interviews with the company, contact with other stakeholders, targeted information gathering, policy and procedure reviews, reviews of self-audit and self-review documents, and review of voluntary compliance programs.
- MCEs may take the form of “desk examinations” of a company’s documents or on-site reviews.
- Enforcement actions range from an agreement for a voluntary compliance plan through ongoing monitoring and self-audit to fines or even revocation of the insurer’s license.
- Closure may include determining that no further action is needed; communicating the insurance department’s position; providing education, communication, or notices to insurers; ongoing, and requesting legislative or regulatory rule changes. Along this continuum of claim-practice regulation, three elements are most important: the handling of consumer complaints, market conduct examinations, and enforcement actions.
- Handling Consumer Complaints.
Every state insurance regulator receives and processes questions and complaints from policyholders about their insurers. This mechanism has the potential to enforce claim practices standards, although the effect is at best indirect and the potential is seldom realized. When a policyholder files a complaint with an insurance department, typically the department separates complaints from simple inquiries and, if the former, determines if it has jurisdiction. Then the complaint is sent to the insurer for its response.
Upon receiving the response, a department employee may discuss the response with the insurer and consumer in an effort to reach a common understanding or voluntary resolution of the complaint. In all but a few jurisdictions, the department lacks the authority to authoritatively resolve the complaint and may in any event refrain from doing so to avoid taking a formal regulatory action.
The processing of consumer inquiries and complaints serves three functions for insurance regulators.
- The resolution of disputes between insurers and their policyholders, particularly small value disputes.
- Disputes provide regulators with information about failures to adhere to claim practices standards, either by individual companies or in types of situations, and that information may spur other regulatory action.
- The process has an affective function for the department itself by generating goodwill, as it appears to be helpful, and for insurers by legitimizing claim denials or potentially contentious claim practices.
The existence of the complaint process may itself contribute to the dispute resolution function and to an extent the affective function.
- Market-Conduct Examinations (MCE)
Market-conduct examinations can be focused at a number of areas, including marketing and sales, underwriting and rating, and producer licensing as well as claim practices. The guiding philosophy of market-conduct examinations was stated in the NAIC’s first Market Conduct Surveillance Handbook:
“Since it is inevitable that all companies will, on occasion, make errors that result in unfair treatment of policyholders, market conduct surveillance must be selective. It can only be effective if it focuses on general business practices as opposed to instances of treatment of policyholders or claimants, which may be infrequent or unintentional.
A company engages in a general business practice when;
1. The underlying cause of the problem, regardless of its frequency, can be traced to a company policy or regularly followed procedure as distinguished from an unintentional error.
2. The frequency of the problem—e.g. the percentage of auto policies incorrectly rated is significantly greater for the company than the standard determined acceptable.
While solvency regulation and rate regulation historically have been the areas of greatest focus for insurance regulators, efforts have been made in recent decades to improve market-conduct regulation, including but not limited to the regulation of claim practices.
In the early 1970s the NAIC engaged McKinsey & Co. to investigate and make recommendations on systems for analyzing and improving financial surveillance of insurers and market conduct.
Its recommendations contributed to the development of a coordinated but voluntary system for the collection of consumer-complaint data and the drafting of the NAIC’s first Market Conduct Surveillance Handbook in 1974.
Despite the NAIC’s efforts at reform, progress was seen to be slow. In 2003, the federal General Accounting Office found that market analysis and onsite examinations were used inconsistently, resulting in gaps in regulation in some instances and duplication in others. Since then, two trends in MCEs have been reported.
First, the NAIC continued its efforts at reform, particularly by inaugurating new systems for the collection of market conduct data.
Second, regulators have relied less on MCEs in recent years. Between 2003 and 2005, for example, the total number of all examinations dropped by eighteen percent; onsite, single-state, targeted examinations fell by thirty percent, and lengthy examinations fell by a third and high-cost examinations by two-thirds. Despite these efforts, the state-based system with national but nonbinding coordination has produced substantial complaints by insurers that market conduct examinations are expensive, duplicative, and wasteful.
MCEs disserve the public as well as insurers. Currently, the states subject insurers to extensive, duplicative and costly examinations that focus too much on minor errors and too little on major patterns of abuse. Individual states’ experiences of MCEs are highly variable. Without a broad study of market conduct examinations in all states and across states, generalizations like those above are hard to document.
That study has not been done, and to the extent that the NAIC collects and collates data, it is not available to the public. As a possibly representative example of what one might describe as the ordinary use of MCEs, let us consider a snapshot of the New Jersey situation.
The New Jersey Department of Banking and Insurance reports having conducted fifty-four market conduct examinations over the past nine years, with a high of nine concluded in one year and a low of three. A probably typical example is an MCE of Esurance Insurance Company of New Jersey. The examination was an on-site examination conducted under the standards prescribed in the NAIC handbook.
The examiners checked for compliance with all applicable statutes and regulations that govern timeliness requirements in settling first and third party claims. The examiners conducted specific reviews placing emphasis on” the state’s adoption of the Unfair Claims Settlement Practices Act and other relevant statutes. They detected error ratios of twenty-three percent in paid claims and nine percent in denied claims. The errors found principally were failing to pay within the legal time limits without obtaining an extension; also noted were failure to pay interest or sales tax due and failure to give required notices. These errors fairly can be described as systemic—delaying or underpaying claims in one out of four paid claims and one out of eleven denied. Nevertheless, no enforcement action was taken. Instead, the department gave an order to the company, and the company agreed that it would take corrective measures while the department would reexamine the company within two years.
Timeliness and the required notices are important. But the MCE’s modest focus on “timeliness” (modest because the systemic errors were not regarded as serious enough to penalize Esurance) ignores many other statutory requirements—for example, those that prohibit:
c. Failing to adopt and implement reasonable standards for the prompt investigation of claims arising under insurance policies;
d. Refusing to pay claims without conducting a reasonable investigation based upon all available information;
f. Not attempting in good faith to effectuate prompt, fair and equitable settlements of claims in which liability has become reasonably clear; [and]
g. Compelling insureds to institute litigation to recover amounts due under an insurance policy by offering substantially less than the amounts ultimately recovered in actions brought by such insureds.
Market conduct examinations can be and in some cases are effective administrative tools for regulating claim practices. But experience suggests that their use has been intermittently and not always effectively focused on claim practices because of resources and a limited focus, as well as because of the broader issues
- Enforcement Actions
In every jurisdiction, insurance regulators have the authority to directly enforce claim practices standards through penalties for violations of the standards and through cease and desist orders. The NAIC’s Model Act provides that when a commissioner has reasonable cause to believe that an insurer is engaging in any unfair claims practice as defined by the statute, the commissioner should issue a notice and conduct a hearing.
Upon a finding of a violation, the commissioner issues a cease and desist order and “may, at the commissioner’s discretion” impose monetary penalties or even, in the extreme, revoke the insurer’s license.
Under the Model Act and many statutes, penalties are tiered.
First, higher penalties are imposed for violations committed “flagrantly and in conscious disregard” of the statute. Under the Model Act, for example, the specified penalty is not more than $1,000 per violation, or $25,000 per flagrant and conscious violation.
Second, penalties are subject to an aggregate limit of $100,000 for ordinary violations or $250,000 for flagrant violations. Jurisdictions have adopted different versions of these penalties. Connecticut, for example, has modest penalties of $5,000 per violation and $50,000 in the aggregate per six month period for ordinary violations and $25,000 per/$250,000 aggregate for violations of which the offender knew or should have known. Others are more dramatic; Illinois, for instance, has a penalty up to $250,000 for a single violation with no aggregate cap. A few states provide guidance on determining the scale of penalties to be imposed. For example: In determining the penalty imposed the director shall consider the amount of loss or harm caused by the violation and the amount of benefit derived by the person by reason of the violation and may consider other factors, including the seriousness of the violation, the promptness and completeness of remedial action, whether the violation was a single act or a trade practice, and deterrence of the violator or others.
Or: The Division of Insurance shall consider all pertinent facts and circumstances to determine the severity and appropriateness of action to be taken including but not limited to, the following: 1. The magnitude of the harm to the claimant or insured;
2. Any actions by the insured, claimant, or insurer that mitigate or exacerbate the impact of the violation;
3. Actions of the claimant or insured which impeded the insurer in processing or settling the claim;
4. Actions of the insurer which increase the detriment to the claimant or insured. The director need not show a general business practice in taking administrative action for these violations.
There is an important qualification to even the largest penalties. The Model Act specifies a variety of unfair practices, but those practices constitute statutory violations only if they are committed “flagrantly and in conscious disregard” of the Act or “with such frequency to indicate a general business practice to engage in that type of conduct. The great majority of statutes include the requirement that prohibited acts constitute a violation only if committed “with such frequency as to indicate a general business practice” or similar language. Therefore, single violations, occasional violations, or even repeated violations that do not rise to the level of “a general business practice” are not really violations at all. Thus the enforcement mechanisms are limited in two significant ways. First, an insurer may violate the statute but the violation may not subject it to an enforcement proceeding unless the violation is a regular and repeated practice or is flagrant and intentional; the regulators lack the authority to sanction serious violations that are merely reckless or occasional. Under a more robust regulatory enforcement system, factors such as regularity and intent would go to the extent of the penalty, not the presence of a violation. Second, the statutory penalties available in many jurisdictions are exceedingly small. Individual penalties in the thousands of dollars and aggregate limits in the hundreds of thousands of dollars are unlikely to provide a substantial deterrent to insurers with premium income in the tens or hundreds of millions of dollars.
Even in those jurisdictions with significant penalties available, their use in claim practices cases is arguably insufficient. As with market-conduct examinations, a national survey of enforcement actions is needed to demonstrate the full scope of administrative enforcement of claim practices standards.
WHY ADMINISTRATIVE REGULATION HAS FAILED
The failure of administrative regulation to substantially improve the market for claim practices or to improve claim practices through direct enforcement presents a paradox: insurance may be the most highly regulated industry in the United States, but regulators have not performed very well in this area. In fact, insurance regulators do very well in ensuring the solvency of companies, reasonably well in controlling the rates companies charge, and not at all well in regulating insurers’ market conduct, including their claim practices.
Many factors produce these results, but a plausible hypothesis is that insurance regulation is most effective where the public interest and industry interests align and least effective where those interests conflict. In solvency regulation, regulators protect the public against financially insecure insurers while solving a collective action problem for insurers. Insolvency often results from collecting premiums that are too low or taking risks that are too great, and if one insurer does that, others must race to the bottom in order to compete. Even insurers that are able to resist are disadvantaged because the failure of one company diminishes the public’s faith in all insurance companies and reduces the demand for all insurers’ products. Where there is the strongest conflict between the public interest and industry interests, regulation is weaker and less effective, and surely the conflict is strongest in the regulation of claim practices.
The revolving door between regulators and industry swings frequently. The industry is a major campaign donor at the state and federal level. Influence also comes from organizations, and the insurance industry teems with organizations that generate research and public-relations materials that shape the thinking of regulators and govern governance.
Industry influence is magnified by the unusual structure of insurance regulation in which an industry dominated by huge, national and multinational corporations is regulated in fifty state capitals with coordination done by the public-private NAIC, which has its own issues with industry influence.
Insurance issues tend to be complex and of low public visibility, except when sparked by major events such as Hurricane Katrina or Superstorm Sandy. Insurance-industry capture of regulation provides a good example of the nuances of contemporary approaches to the understanding of capture. First, the early literature on regulatory capture focused on attempts by a regulated industry to obtain favorable regulations from an administrative agency that had primary responsibility for regulating the industry, such as the Interstate Commerce Commission and the railroad industry. But capture more accurately includes both statutory and regulatory capture influencing legislation and also rulemaking and enforcement under that legislation.
The limits of the effective regulation of claim practices are both statutory and administrative. In most states, for example, regulators are barred by statute from making public data from the MCAS on an individual company basis, data that could be used to improve the market for claim practices. And where regulators have the statutory authority to publish claims data, they fail to do so.
Second, capture scholarship commonly has focused on industry efforts to obtain favorable regulation. But capture may also be corrosive in which the industry pushes the regulatory process in a weaker direction with the aim of reducing costly rules and enforcement actions that reduce firm profits.
Claim-practices regulation inherently favors insurance consumers over insurers, but capture guarantees that the tilt is not too great. The modest enforcement penalties available in most states and the even more modest efforts at actual enforcement in claim practices cases demonstrate that nominally pro consumer regulation can be corroded.
INTRODUCING LITIGATION AS A REGULATION.
Where the actions of insurers are less rigorously policed initially, leading to regulatory under enforcement, however, there is a greater need for litigation as a supplement to administrative regulation. Unlike litigation about insolvency, can contribute substantially to regulation.
Litigation about ordinary insurance coverage disputes revolves around the interpretation and application of the terms of the insurance policy. But there is a sense in which this ordinary litigation is regulatory as well. In a typical coverage case, the court begins with the relevant policy language. If the court does not find an unambiguous application of the language to the facts of the case, the court resorts to a variety of interpretive doctrines to resolve the issue. Policy language is interpreted against the company as its drafter. Grants of coverage are interpreted broadly and exclusions narrowly. The reasonable expectations of the policyholder are given weight.
Regulation requires standards to which a regulated entity must adhere, a mechanism for applying those standards, and a means of enforcing adherence to the standards or of making violations of them sufficiently costly to deter such violations. In order for claim practices litigation to best serve a regulatory function, therefore, what is required is a liability rule that reflects proper claim practices standards and that is capable of being operationalized effectively and efficiently, a correlative damage rule that provides adequate incentives for plaintiffs and achieves an appropriate level of deterrence for insurers, sufficient visibility of the rule, and a remedy for potential plaintiffs.
The lack of effective remedies for violations of claim practices standards renders the standards ineffective; the insured would not be compensated for the injury incurred and the company would not have a financial incentive to observe the standards if damages are limited to the amount owed under the policy. The damages rule should be the correlative of the liability rule. If the policyholder litigates to enforce the company’s obligations under the policy, its initial remedy is to receive the benefits to which it was expressly entitled: payment of the claim. That remedy is insufficient to fully protect the policyholder’s interest. The policyholder may suffer consequential economic loss from the failure to receive, whether in a timely manner or at all, the benefits owed under the policy.
The market for insurance works well in some respects. In all lines of insurance, prospective policyholders have an abundance of information to compare prices. Because the market does not always work so well, the insurance industry is highly regulated, and much of the regulation is highly successful. During the financial crisis that began in 2008, only a handful of insurers became insolvent, a success attributable to effective solvency regulation. But the success of the market and of the regulation of market failures has not been uniform. There is no effective market for quality in claim practices, and regulators have not provided adequate controls. The market could be improved and administrative regulation could be strengthened.
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