The California Department of Insurance (CDI) has been handed a procedural setback in its effort to crack down on agents charging broker fees. This week, the California Office of Administrative Law (OAL) determined that former Insurance Commissioner John Garamendi acted illegally last year when he deemed a settlement with an insurer accused of allowing its agents to improperly charge broker fees to insureds a precedential decision, giving the settlement the force of law.
CDI has been examining the practice of agents charging broker fees for several years, adopting regulations in 2000 that limit their use only to brokers who are not appointed agents of the insurer with which coverage is placed and who disclose the fee to prospective insureds when coverage is quoted.
In a settlement accepted by American Reliable Insurance Co. last June, Garamendi ruled that Superior Access Insurance Services acted as American Reliable’s agent and thus improperly collected broker fees from American Reliable policyholders. Garamendi also deemed the broker fees excessive premium in violation of Proposition 103.
“Because Superior Access charged fees while other American Reliable agents did not, for policies subject to the same rate, rating plan or rating system, American Reliable insureds were subjected to unfair rate discrimination, in violation of section 1861.05(a). American Reliable willfully or negligently permitted the rate discrimination to occur,” CDI charged in the settlement.
The settlement with American Reliable delineated 11 situations in which a producer is deemed to be acting as an agent of an insurer under Insurance Code section 1731 and thus barred from charging insureds broker fees, including when “the relationship between the producer and the insurer is functionally indistinguishable from the relationship between the insurer and its appointed agents.”
The settlement also incorporated common law, stating producers deemed to be acting as agents rather than brokers pursuant to judicial rulings are not permitted to charge broker fees. In 2002, a San Francisco Superior Court ruled in Krumme v. Mercury Insurance Co. that brokers for Mercury Insurance Co. acted as de facto agents of Mercury and thus could not charge broker fees. The court rejected Mercury’s contention that the Legislature had consolidated the broker-agent license and eliminated the distinction between brokers and agents. The California Court of Appeal upheld the ruling.
The Insurance Brokers and Agents of the West challenged the adoption of the American Reliable settlement as a precedential decision in a petition to OAL, alleging Garamendi was attempting to adopt an “underground” regulation, circumventing the requirements of the Administrative Procedures Act (APA). The APA requires formal protocols for the adoption of a regulation, including a notice period and public hearings. Another producer group, the Alliance of Insurance Agents and Brokers filed a letter in support of the petition.
IBA West argued that while litigated decisions by the insurance commissioner may be adopted as a precedential decision, mere settlements cannot. IBA West warned that allowing CDI to adopt precedential decisions arising out of settlements is prone to agency abuse, because a regulated entity is not on an equal negotiating footing with regulators who possess the power to put regulated entities out of business.
“He [Garamendi] was effectively holding a gun to a licensee’s head behind closed doors, forcing it to agree to a lengthy ‘manifesto’ written by his lawyers, and then attempted to use a relatively obscure and limited provision in the Government Code to give these opinions the force of law,” said IBA West General Counsel Steve Young.
Young warned if CDI’s use of the procedure was not overruled, it could be used against licensees “on any subject in which the Department of Insurance desired to make new law — without having to persuade the Legislature and governor of the merit of its proposals, or having to comply with the minimum due process requirements of the California Administrative Procedures Act in promulgating regulations.”
The OAL agreed, citing a 1999 report by the California Law Revision Commission. “As the Law Revision Commission comments make clear, there are two ways for agencies to make new law or policy: 1) APA rulemaking or 2) administrative adjudication which has been designed a precedential decision. The Department did not employ either method.”
OAL concluded that if it sanctioned CDI’s view that a non-adjudicated settlement reached by compromise with a licensee could be transformed into a precedential decision, “the result would not only create a third rulemaking method not sanctioned by the Legislature, but would also effectively eviscerate the rulemaking portion of the APA.”
Young said if CDI’s action had been upheld by OAL, “the APA would in practical effect have been completely nullified — and the commissioner could have exercised near dictatorial powers to create and enforce new regulatory requirements.”
Bryon Tucker, CDI deputy commissioner for communications, said CDI is reviewing OAL’s determination to determine whether to appeal it to the courts or pursue formal rulemaking.
The Alliance of Insurance Agents and Brokers’ Executive Director David Nielson called OAL’s ruling, “a major victory for all California insurance producers,” but predicted “that the battle to protect the broker-carrier relationship is not over.”