IIABCal Joins Lawsuit Against CDI on "Replacement Cost" Regulations

IBA West has filed an amicus letter brief in Los Angeles County Superior Court litigation challenging the legality of regulations the California Department of Insurance has promulgated regarding calculation of "replacement cost" construction estimates in homeowners insurance policies.

In "Association of California Insurance Companies and Personal Insurance Federation of California v. Dave Jones," the insurance company trade groups brought suit earlier this year and have filed a motion for judgment on the pleadings, claiming that the regulations lack essential statutory authority, constitute an impermissable intrusion into insurance company underwriting, and violate companies' First Amendment rights by prohibiting truthful statements about replacement cost estimates that may depart from mandatory criteria outlined in the regulations. A hearing on that motion has been set for Jan. 6, 2012.

IBA West on Dec. 21 filed an amicus letter in support of the plaintiffs' motion, joining the companies' argument that the regulation is illegal for want of statutory authority.

The regulations, among other things, set forth over 20 mandatory factors that must be incorporated into any estimate of construction "replacement cost" in homeowners' insurance policies, prohibit insurers from providing or communicating any replacement cost estimate that does not incorporate all of the mandatory components, require broker-agents to provide detailed documentation to homeowners' insurance clients on how such estimates were created and costed out, and to retain those records for at least five years.

In promulgating the regulations, CDI said it hoped to bring greater uniformity and standardization into replacement cost estimates, although CDI admits the regulations are not designed necessarily to produce "accurate" cost estimates.

In the absence of any express California Insurance Code provision authorizing the Insurance Commissioner to develop these rules, lawyers at CDI have asserted that they are justified by provisions in Insurance Code Section 790.03(b), which prohibits "misleading" statements in the business of insurance; and Section 1749.85, which requires broker-agents to complete a one-time-only continuing education class on estimating replacement costs, and permits the Commissioner to impose--solely upon real estate appraisers--future regulations regarding replacement cost calculation methodology.

In a letter brief prepared Steve Hirsch, a partner at Keker & VanNest, a nationally respected litigation firm in San Francisco, IBA West told the court that neither one of those statutes applies to this regulation.

"By attempting to standardize the meaning of 'replacement-cost estimate,' the Commissioner effectively concedes that no one is really sure what the phrase means--in which he case he cannot prove that using other definitions is 'Misleading,'" Hirsch argued.  "The Commissioner responds that using any definition other than the one in his Regulation is misleading because it is not the one in his Regulation--but that is not logic, it is bootstrapping."

Moreover, Hirsch pointed out, Insurance Code Section 1749.85 does not apply because of the express limitation it contains on the Commissioner's authority.  "Being limited to appraisers, [the law] does not grant the Department any authority to dictate the methodology that insurance producers must use when providing a replacement-cost estimate to a customer," Hirsch wrote.

During the Department's deliberations of these proposed regulations in 2010, IBA West expressed support for the concept CDI proposed--of standardizing a methodology for insurers to then weight and price as they saw fit, and of providing more information to consumers before deciding how much insurance they wanted to buy--but expressed concerns, both publicly and privately to the Department, regarding CDI's attempt to use 790.03 as the legal foundation for the proposed regulations.

"There is nothing inherently misleading about other methodologies for calculating replacement cost," IBA West General Counsel Steve Young said.  "Other approaches may be non-conforming with the model the CDI selected, but being non-conforming is not the same thing as being misleading--and there is nothing that makes non-conformity in this instance illegal.  If CDI could justify this set of regulations on nothing more than this very flimsy statutory basis, then future Commissioners could essentially create an unlimited number of Draconian new rules without ever going to the Legislature or seeking approval of the Governor.

"It was the clear and present danger of this potential precedent that compelled us to intervene in this case," he said.

Click here to read a copy of the IBA West amicus letter brief.