Drawing One Useful Lesson from Two Recent Court Decisions on Insurance Regulations

Recently one New York State court approved a fiduciary standard for sales of life insurance and annuities imposed on New York-licensed agents, while another court in New York invalidated title insurance marketing restrictions as unconstitutional. Together, these rulings provide insight into what litigation strategy may be more likely to succeed if a challenge to insurance regulations ever becomes necessary.

A New York Supreme Court ruling in late July sided with the state’s Department of Financial Services (DFS), upholding Regulation 187 which requires that agents use a “best interest” of the consumer standard in making any recommendation about purchasing, exchanging or keeping a life insurance policy or annuity contract. The DFS regulation imposing that standard took effect on August 1 for annuity contracts and will take effect on February 1, 2020 for life insurance policies. The regulation not only heightens the standard of care owed by the sellers of life insurance products, but also expands the breadth of products to which the standard applies from annuities to all life insurance products, including term-life insurance.^[1]

The ruling addresses two distinct applications for a declaratory judgment from producer trade organizations. In denying each plaintiff a declaratory judgment, the court found that the “[a]mendment is a proper exercise of the powers granted to the DFS Superintendent, that it is not an attempt by DFS to improperly legislate, and that it is neither arbitrary or capricious.” The court found also that DFS complied with the State Administrative Procedure Act (SAPA) in promulgating the regulation, and that petitioner’s argument that the SAPA was violated due to the lack of a valid cost analysis was without merit.

The Court held that the new rule is “a rational and reasonable movement towards consumer protection.” It found the insurers’ arguments about the increased costs they will face as a result of the new rule unconvincing, reasoning, “costs that consumers incur when they are sold products that do not fit their needs – wasted premiums, loss of needed benefits – far outweigh any costs to the insurer” and stated, “revenues lost from recommending products which are not in the consumer’s best interests is not a viable insurer ‘cost’ for the purposes of a reasonable SAPA analysis.”  The court held, “[t]he Amendment, which is directed at providing guidelines for trustworthy and competent producer practices, and preventing self-dealing by producers at the consumer’s expenses, falls squarely within the provisions of Financial Services Law and the Insurance Law . . . Against a backdrop of legitimate concerns for consumers, the burgeoning market of increasingly complex insurance and annuity products, and the rather remarkable lapse rate the market is experiencing, the Amendment is . . . consistent with underlying statutory purposes.”

The ruling is in accord with other decisions affording deference to the judgment of the agency that promulgated the regulation in question in response to claimants’ arguments that a regulation is arbitrary and capricious. In New York, as long ago as 1988, the New York Court of Appeals rejected a challenge to an order of the Superintendent of Insurance setting medical malpractice insurance rates far below the level sought by insurers.^[2]

Similarly, in California, challenges brought to California Department of Insurance regulations routinely fail on the grounds that the regulation at issue was not arbitrary and capricious, and was within the agency’s discretion. For example, 20th Century Ins. Co. v. Garamendi, a 1994 California Supreme Court case challenging the validity of rate regulations adopted by the Insurance Commissioner and the Commissioner’s order determining an insurer’s rate rollback liability, rejected the insurer’s claims, and held that the rate regulations were not invalid on their face, the Commissioner’s rate-making formula was not confiscatory, and the rate rollback order was not arbitrary, discriminatory, or demonstrably irrelevant to the legitimate policy of protection of consumer welfare.^[3] Likewise, in a 2009 California Court of Appeal case, the Association of California Insurance Companies petitioned for peremptory writ of mandate and a complaint for declaratory and injunctive relief, seeking to invalidate Department of Insurance regulations on authorization of compensation awards for participation in the insurance rate-setting process. The Court of Appeal rejected the insurers’ petition and complaint, holding that the regulations were consistent with the authorizing statute.^[4] 

By contrast, title agents succeeded in attacking a different DFS regulation on First Amendment and Due Process Clause grounds. Last year the New York State Land Title Association attacked DFS's Regulation 208, which would have barred the entire title insurance industry in New York State from engaging in traditional industry marketing and advertising practices ranging from a title insurance agent taking a real estate attorney to lunch to hosting an office party.  Although losing on its claim that the regulation was arbitrary and beyond statutory authority^[5], on August 2 the Association persuaded the New York Supreme Court that the Regulation's restrictions on title insurance marketing—and in particular, the ban on political donations, charitable contributions, and advertising that are not "reasonable and customary" or are "lavish and excessive"—were unconstitutionally vague under the Due Process Clause and violative of the agents’ right to free speech under the First Amendment. As Justice Rakower explained, the statute "does not define what would constitute 'reasonable and customary' yet not 'lavish and excessive' political donations, charitable donations, or advertising activity" and does not sufficiently put businesses on notice of prohibited conduct to ensure that they "can conform their conduct to the dictates of the law." Moreover, the court ruled: "The statute imprecisely prohibits constitutionally protected speech without narrowly tailoring the regulation to fit the state's needs, which invites arbitrary enforcement and chills corporations from engaging in these forms of constitutionally protected speech under the First Amendment."

The decision invalidating Regulation 208 on constitutional grounds is subject to an appeal by DFS, but its teaching is clear: constitutional arguments may hold more promise for a litigant challenging insurance regulations than the often unsuccessful claim that the regulator acted arbitrarily or outside statutory boundaries. For more information, please contact the professional(s) listed below, or your regular Crowell & Moring contact.