Replacement cost estimates in California

Insurance companies in California won’t have to abide by a 2010 state regulation that dictates the content of replacement cost estimates for homeowner insurance. The California Court of Appeal has upheld a lower court’s decision in Association of California Insurance Companies et al., v. Dave Jones that invalidated the rule.

The regulation established specific requirements for replacement cost estimates and said any non-conforming estimates would be deemed to be a misleading communication in violation of the Unfair Insurance Practices Act. The rule also required mandatory training for agents and brokers who sell homeowner insurance; created standards for real estate appraisers who estimate replacement cost for insurance purposes; specified a mandatory process and formula for estimating replacement and construction costs; and established five-year recordkeeping requirements for agents.

These regs got started because of complaints from homeowners whose homes were destroyed in California fires during 2003, 2007 and 2008. They learned after the fact their insurance wouldn’t pay the full cost to rebuild because insurance companies had set replacement value estimates that were too low.

At the time, Dave Jones, California’s state insurance commissioner, said the new rule would enhance the standards and training for estimating the replacement value on homeowner insurance in the event of a disaster. He saw it as part of a concerted social policy effort to significantly curb the all-too-common problem of homeowners finding out too late that they’re underinsured for a loss after a disaster. So the rule was adopted in 2010 and went into effect a year later.

But the Association of Californian Insurance Companies and the Personal Insurance Federation of California sued, saying Jones and the insurance department didn’t have the authority to issue the rule. They said they feared that any change to the formula, however beneficial or clarifying it might be, would automatically be seen as a deceptive sales practice subject to discipline. In May 2013, a district court agreed and invalidated the regulation. Jones appealed.

But the Court of Appeal agreed with insurers, saying in its ruling that it’s up to California’s legislature, not the insurance commissioner, to define what is or isn’t a unfair or deceptive practice, and the insurance commissioner can’t do that for himself unless that’s delegated by lawmakers.

“The legislature was deliberate in choosing what conduct to brand … as ‘unfair and deceptive,’” the court said. “We can infer that the absence of a provision regarding replacement cost estimates was a deliberate choice.”

In essence, said the Court of Appeal, the commissioner’s power to write regulations in this case was limited to acts expressly forbidden by the Unfair Insurance Practices Act. “The legislature did not give the commissioner power to define by regulation acts or conduct not otherwise deemed unfair or deceptive in the statute.”

In fact, the court said Jones already had a remedy available to him. If the nonconforming estimates were as deceptive as he claimed, Jones didn’t have to write new regulations—he could just issue cease-and-desist orders against insurers who low-balled their policyholders.

For the most part, property & casualty insurers in the Golden State and their two trade groups have supported most of the new regulation, including additional training for estimating replacement costs for homes, maintaining information about homeowner insurance sales in case of a claims dispute, and legislation that improved homeowner insurance disclosures.

But the industry balked at requiring insurers to use a formula and particular words when talking with a customer and at the penalties that would be assessed against any insurer that deviated from the state-required formula. Now the entire rule has been thrown out.

“Insurers work to help policyholders understand their homeowner’s insurance coverage and coverage limitations, and consumer complaints on replacement cost estimates are very few and far between,” said ACIC president Mark Sektnan. “This regulation created unnecessary compliance costs and could have created greater confusion.”

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Copyright 2015 Rogers Publishing Ltd. This article first appeared in the May 2015 edition of Canadian Insurance Top Broker magazine

This story was originally published by Canadian Insurance Top Broker.