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Regulators Rebuffed: CA Court Rejects $27 Million “Broker Fees” Fine

For decades, the California Department of Insurance (CDI) has interpreted the California Insurance Code in a manner that recognizes broker-charged fees as part of a “premium” that may be imputed to the insurer for purposes of rate-setting and rate-filing regulations. This position has long been a roadblock for brokers in the non-standard automobile insurance industry. However, in a considerable setback for the CDI, an Orange County Superior Court has invalidated this interpretation in its review of a CDI enforcement action against an insurer. On August 12, 2016, in Mercury Insurance Company v. Jones, the court ruled that broker fees charged for services other than the procurement of insurance should not be considered a component of “premium” for purposes of rate regulations. On these grounds, the court reversed the CDI’s imposition of a record-breaking $27 million civil penalty against Mercury Insurance Company.

A Legacy of Proposition 103

The underlying CDI enforcement action against Mercury was the product of longstanding ambiguity in the California Insurance Code related to the eroding distinctions between insurance “agents” and “brokers.” (In 1988, California Proposition 103 contributed to this erosion by setting rate and eligibility regardless of whether the policy is placed through an agent or a broker.) Recognizing this changing landscape, Mercury shifted its approach—where it once exclusively utilized independent agents, in 1989 it began to convert its independent agents into brokers. A small percentage of these brokers began to charge broker fees for additional services such as comparative shopping and risk assessment—unlike independent agents, brokers have long been permitted to charge broker fees for broker services. These fees were not shared with Mercury, and indeed customers who received comparative shopping services did not always choose a Mercury policy. In 1998, the CDI investigated Mercury’s shift from independent agents to brokers, voicing the concern that the brokers were acting as “de facto agents.” However, for a number of reasons, CDI did not initiate an enforcement action at that time, and indeed continued to approve Mercury rate filings with the knowledge that the filings did not reflect broker fees.

The landscape changed when Robert Krumme successfully sued Mercury in 2000 under unfair competition law, alleging that Mercury’s brokers were in fact acting as de facto agents because their services were indistinguishable from those provided by agents. Therefore, Krumme argued that Mercury misled consumers by failing to file Action Notices with CDI designating the brokers as agents. This theory was upheld by the California Court of Appeal on October 29, 2004. Although Mercury was enjoined from continuing to use brokers without filing Action Notices, no damages were awarded.

CDI Targets Unreported “Premium” Fees

The plaintiff’s success in Krumme apparently encouraged the CDI to restart its own enforcement process for violation of rate regulations, which was first heard before the Administrative Hearing Bureau. There, the administrative law judge (“ALJ”) sided with the CDI, holding that because the brokers were de facto agents—who therefore cannot charge broker fees—their fees constituted “premium” that must be imputed to Mercury, who did not report said fees when submitting rates for approval. As a result, the ALJ imposed a penalty of $27.6 million.

However, Mercury sought judicial review of the administrative ruling, arguing that because the broker fees were charged for comparative shopping and risk assessment services (rather than for the insurance coverage itself), they should not be considered a part of “premium.” The trial court agreed, emphasizing that “[i]t is commonly understood that a premium is the amount paid for certain insurance for a certain period of coverage.” Mercury Insurance Company v. Jones at 7 (Super. Ct. Orange County, 2016, No. 30-2015-00770552-CU-JR-CXC). Although the CDI cited case law defining “premium” as including both direct and indirect costs to consumers, the court explained that broker fees are entirely separate and distinct from the costs of insurance: “the fee was not part of the cost of obtaining a policy from Mercury—it was part of the cost of using [the broker] to obtain insurance from any number of potential insurers.” Id. The court further found significant the fact that consumers appeared to benefit from these services, and were not obligated to use the services in order to purchase coverage. Because the CDI’s case relied entirely upon its erroneous interpretation of “premium,” the trial court remanded the case to CDI with instructions to vacate its ruling, overturning the penalty.

Potential Sea Change For Brokers and Carriers

The trial court’s rejection of the CDI’s interpretation may signal good news for insurance brokers and carriers in California. However, this optimism should be tempered—the CDI is likely to appeal the ruling, and, given the stakes involved, the case may ultimately be heard by the Supreme Court of California (and likely result in considerable amicus briefing). Until the appellate courts weigh in, California insurance brokers would do well to proceed cautiously with respect to fees charged for services other than procurement of insurance, such as comparative shopping and risk assessment. To the extent broker fees are charged, brokers should carefully document the nature of the additional services rendered and the benefits accruing to the consumer. Further, brokers should make clear that the consumer retains the option to procure insurance without purchasing additional services. The CDI has remained relatively quiet in the wake of the Mercury decision, but rest assured that the noise from this decision will continue to reverberate within the insurance industry for some time.

This blog post is not offered as, and should not be relied on as, legal advice. You should consult an attorney for advice in specific situations.