BEFORE THE INSURANCE COMMISSIONER OF THE STATE OF CALIFORNIA. YOU ARE HEREBY NOTIFIED that the Insurance Commissioner of the State of

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1 CALIFORNIA DEPARTMENT OF INSURANCE LEGAL DIVISION Rate Enforcement Bureau Bryant Henley, Bar No. 00 Donald P. Hilla, Bar No. 1 Fremont Street, st Floor San Francisco, CA Telephone: --1 Facsimile: -0-0 Attorneys for The California Department of Insurance BEFORE THE INSURANCE COMMISSIONER OF THE STATE OF CALIFORNIA In the Matter of the Rates, Rating Plans, or Rating Systems of Farmers Insurance Exchange; Fire Insurance Exchange; Mid-Century Insurance Company, Respondents. File No. NC00 FIRST AMENDED NOTICE OF NONCOMPLIANCE PURSUANT TO CALIFORNIA INSURANCE CODE SECTION YOU ARE HEREBY NOTIFIED that the Insurance Commissioner of the State of California (hereafter Commissioner ) has good cause to believe that the rating plans, rating systems and rates of Respondents, FARMERS INSURANCE EXCHANGE, FIRE INSURANCE EXCHANGE AND MID-CENTURY INSURANCE COMPANY (hereafter Respondents ) have violated California Insurance Code (hereafter CIC ) sections, 1.01 and 1.0, and Title, California Code of Regulations (hereafter CCR ) sections 0., 0., 0. and 0.. The manner and extent of the noncompliance is set forth below. -1-

2 1 1 I. GENERAL ALLEGATIONS / APPLICABLE LAW 1.1 Respondents are, and were at all relevant times, an insurer group licensed to transact the business of insurance in the State of California. 1. Respondents transact the business of insurance in California on risks or lines subject to the provisions of CIC sections, 1.01 and 1.0, and also subject to the provisions of CCR, sections 0., 0., 0., and 0.. THE PROPERTY EXPERIENCE RATING PLAN 1. On or after April, 0, Respondents began implementing a new rating scheme, known as the Property Experience Rating Plan (hereafter PERP ). PERP represents a change in Respondents rating and underwriting procedures. 1. PERP is a rating plan affecting Homeowners policies in California. According to Respondents rating rules, PERP provides that a discount or surcharge will be applied to an insured s Homeowners policy premium based upon each insured s claims experience for the last three years. (See Exhibit 1, attached.) 1. If an insured has not had a chargeable loss in the last three years, PERP provides that the insured is entitled to a discount. The discount may be stated in terms of the following formula: (base rate x. = discounted rate). 1. If an insured has had one chargeable loss in the past three years, PERP will neither reduce nor increase the insured s base rate. Stated as a formula, an insured with one qualifying claim in the last three years will have his or her premium affected as follows: (base rate x 1 = base rate). 1. If an insured has had two chargeable losses in the past three years, PERP will surcharge the insured s premium. Stated as a formula, an insured with two chargeable losses in the past three years will have his or her premium surcharged as follows: (base rate x 1. = surcharged rate). Similarly, if an insured has had three chargeable losses in the past three years, PERP will surcharge the premium as follows: (base rate x.00 --

3 1 1 = surcharged rate). An insured with four chargeable losses in the past three years will be surcharged as follows: (base rate x. = surcharged rate). 1. Respondents non-renew those insureds with five or more chargeable losses in the last three years. 1. In order for a claim to be considered a chargeable loss for purposes of PERP, the claim must have resulted in at least one dollar of payment; or alternatively, Respondents must have set money aside in reserve to pay for the claim. One of Respondents memoranda concerning PERP states that: any chargeable loss with a zero paid amount and no reserve set won t be used for rating 1. The rating rules of PERP also provide that if a claim constituting a chargeable loss is withdrawn, denied or ultimately falls under the policy deductible amount, any existing pending reserve will be eliminated and the loss will not be subject to surcharge. 1. Respondents rating rules dictate that claims for damage arising from fire catastrophe, wind, hail, lightning or earthquake will never be considered chargeable losses for purposes of PERP surcharges. 1. According to Respondents rating rules, in calculating an insured s premium, Respondents will cease to surcharge and/or consider a particular chargeable loss, as of the renewal date following the three-year anniversary of the date of the chargeable loss. 1. The Department of Insurance (hereafter Department ) has received numerous complaints and continues to receive complaints regarding the manner in which Respondents apply PERP in practice. PUBLIC PROTECTION CLASS UPRATES 1. On or after October 1, 01 for new business and June, 0 for renewal business, Respondents made changes to their rating methodology for rating homeowners insurance fire risks. --

4 Respondents assign each residential homeowners property address with a class code multiplier that affects the homeowners premium charged for a particular residence. 1. The class codes are derived from Public Protection Class data that the Insurance Services Office makes available to the insurance industry. The purpose of the Public Protection Class codes (hereafter PPC ) is to quantify the strength of the local fire department s fire suppression capabilities, as those capabilities relate to a particular residential address. 1.1 Respondents ultimate choice of PPC code assignment for a particular residential address largely depends upon the property s proximity to a fire hydrant. 1. The PPC codes range from a smallest risk of fire rating of 1 to a greatest risk of fire rating of. 1.1 On or after October 1, 01 for new business and June, 0 for renewal business, Respondents initiated a new, web-based Geographic Underwriting System (hereafter GUS ). The GUS is an automated database, designed to help Respondents assign more accurate PPC codes for assessing the fire risk of particular addresses within the State of California. 1. Respondents have informed the Department that the GUS program can identify the general distance between a fire hydrant and a particular residence for most residential properties in the State of California. 1. Respondents acknowledge, however, that for to percent of the residential properties in urban areas, the GUS program will fail to identify whether the property is within 1,000 feet of a fire hydrant. Respondents note, further, that the use of its GUS program will result in an even higher percentage of failure for those policyholders located in rural areas. 1. The GUS program s failure to identify the proximity of a particular residential address to a fire hydrant is an event Respondents characterize as a split class event. 1. Respondents apply a counteractive procedure to protect Respondents loss reserves against this split class defect in the GUS program. Specifically, Respondents send --

5 1 1 an automated agent referral system warning message to the agent assigned to the particular homeowners policyholder whenever a split class event appears on an upcoming renewal. 1. Approximately 0 days prior to the renewal date for the split class policyholder, Respondents agents are given days to follow up with Respondents split class policyholder, and determine the distance between the home and the nearest fire hydrant for that residence. 1. In the event that Respondents agent does not make this determination within the allotted days, Respondents automatically assign a PPC code of, in calculating the split class policyholder s premium at renewal. 1. An assigned PPC code of to a particular property means that Respondents believe the property presents a very high risk of fire danger. The assignment of a PPC code of, therefore, will typically result in a significant increase in the renewal premium for those policyholders that are located in split class regions. 1. Respondents acknowledge that these split class policyholders may be entitled to a lower PPC code than the PPC of. 1. With respect to approximately 1, split class policyholders, Respondents have also acknowledged that the policyholders fire hydrant information was available through Respondents old rating system, but was never transferred to the GUS for appropriate rating. 1. The Department has received numerous consumer complaints and continues to receive complaints regarding the manner in which Respondents apply this rating methodology in practice. 1.0 Respondents advised the Department in December of 0, that Respondents would investigate the split class error for its remaining homeowners policies; however, the Department continues to receive complaints related to this PPC coding methodology. 1.1 CIC section requires every insurer to maintain records reasonably adapted to the insurer s method of operation and experience, including, but not limited to any --

6 1 1 information used by the insurer in connection with the insurer s rates and underwriting rules. CIC section also requires that insurers maintain records used in connection with the rating plans used by the insurer. 1. CIC section 1.0, subdivision (a) provides that no rate can remain in effect if it is excessive, inadequate, unfairly discriminatory or otherwise in violation of Division 1, Part, Chapter of the Insurance Code. CIC section 1.0, subdivision (b) requires that every rate change must be filed with the Commissioner via a complete rate change application. Pursuant to CIC section 1.01, subdivision (c), an insurer cannot implement a rate change until after the Commissioner has approved of the insurer s proposed change. 1. CCR section 0. requires insurers to maintain eligibility guidelines for all lines of insurance in sufficient detail so that the appropriate rating plan can be determined for each insured. That section also provides that any insured that meets the guidelines must qualify to buy the insurance. 1. CCR section 0. specifically provides: An insurer shall charge each insured the lowest Premium for which the insured qualifies. At each policy renewal the insurer shall adjust the Premium charged to the insured, as necessary, to reflect the lowest Premium for which the insured qualifies at that time. 1. CCR section 0. provides that it is the insurer s responsibility to determine and charge the lowest Premium for which an insured qualifies. If an insurer delegates this responsibility to an agent, the insurer remains responsible for its agent s determination. 1. CCR section 0. states that an insurer must keep documentation in the underwriting files of each policy issued that identifies all information considered by the insurer in determining the premium charged. 1. Based upon the Department s review of Respondents rating and underwriting practices and applicable law, the Department has good cause to believe that Respondents practices are in violation of various provisions of the CIC and CCR. --

7 1 1 II. SPECIFIC ALLEGATIONS.1 RESPONDENTS UNDERWRITING GUIDELINES VIOLATE CCR SECTION 0. BECAUSE THEY LACK SUFFICIENT DETAIL TO ENSURE THAT QUALIFYING POLICYHOLDERS CONSISTENTLY RECEIVE AN APPROPRIATE PERP RATE..1.1 The Department incorporates, by reference, paragraphs 1. through 1., above..1. CCR section 0. requires that eligibility guidelines be sufficiently detailed to determine the appropriate rating plan for each insured. CCR section 0.0 defines eligibility guidelines as specific, objective factors, or categories of specific, objective factors, which are selected and/or defined by an insurer, and which have a substantial relationship to an insured s loss exposure..1. The Department is informed and believes that Respondents PERP rating rules expressly provide that losses withdrawn, denied or that ultimately fall under a policy s deductible, shall not adversely impact a policyholder s eligibility for a PERP discount..1. The Department is informed and believes that Respondents commonly surcharge policyholders for damage claims arising from fire catastrophe, wind, hail, lightning or earthquake, despite Respondents PERP rating rules, which prohibit such surcharges..1. The Department is informed and believes that Respondents commonly surcharge policyholders for claims losses, despite the fact that those losses are ultimately withdrawn, denied or fall within a policy s deductible..1. Because Respondents commonly surcharge policyholders for losses in contravention of Respondents PERP rating rules, and because Respondents eligibility guidelines do not contain sufficient detail to prevent this common occurrence, Respondents guidelines are of insufficient detail to determine the appropriate rating plan for each insured, and Respondents are in violation of CCR section Respondents routine erroneous application of PERP surcharges to policyholders, in contravention of Respondents rating rules is also an unfairly discriminatory practice, in violation of CIC section 1.0, subdivision (a). --

8 1 1. RESPONDENTS ROUTINELY SURCHARGE AND NEGLECT TO RERATE PREMIUM FOR POLICYHOLDERS WITH CLAIMS THAT ULTIMATELY RESULT IN NO PAYMENT, IN VIOLATION OF CCR SECTIONS 0., 0. AND CIC SECTION The Department incorporates, by reference, paragraphs 1. through 1., above... CCR section 0. and 0. provide that it is Respondents duty to ensure that each policyholder is charged the lowest premium for which the insured qualifies... CIC section 1.0, subdivision (a) prohibits rates or rating plans that are applied in an unfairly discriminatory manner... The Department is informed and believes that Respondents PERP rating rules expressly provide that losses withdrawn, denied or that ultimately fall under a policy s deductible, will not adversely impact a policyholder s eligibility for a PERP discount... The Department is informed and believes that Respondents commonly surcharge policyholders for claims losses, despite the fact that those losses ultimately result in no payment because they are withdrawn, denied or fall within a policy s deductible... Additionally, the Department is informed and believes that Respondents have attempted to apply a PERP surcharge to some policyholders, despite the fact that the policyholders have never filed a claim of any sort within the last three years... Respondents failure to determine the lowest premium for which each of its policyholders qualifies is a violation of CCR sections 0. and Respondents routine erroneous application of PERP surcharges to policyholders with no claims history is also an unfairly discriminatory practice, in violation of CIC section 1.0, subdivision (a).. RESPONDENTS LACK DISCERNIBLE GUIDELINES TO DEAL WITH COMMON SITUATIONS WHERE A CLAIM SHOULD RESULT IN NO PAYMENT, DUE TO SUBROGATION, IN VIOLATION OF CCR SECTION The Department incorporates, by reference, paragraphs 1. through 1., above. --

9 1 1.. CCR section 0. requires that eligibility guidelines be sufficiently detailed to determine the appropriate rating plan for each insured. CCR section 0.0 defines eligibility guidelines as specific, objective factors, or categories of specific, objective factors, which are selected and/or defined by an insurer, and which have a substantial relationship to an insured s loss exposure... The Department is informed and believes that Respondents PERP rating rules expressly provide that losses withdrawn, denied or that ultimately fall under a policy s deductible, will not adversely impact a policyholder s eligibility for a PERP discount... The Department is informed and believes that Respondents commonly surcharge policyholders for claims losses, despite the fact that those losses are ultimately subject to subrogation, or fall within a policy s deductible... The Department is informed and believes that Respondents underwriting guidelines do not contain sufficiently detailed instructions for its underwriters, so that claims appropriately subject to subrogation will not result in a PERP surcharge... Respondents failure to maintain underwriting guidelines sufficiently detailed to determine the appropriate rating plan for those insureds with claims subject to subrogation is in violation of CCR section 0... RESPONDENTS ONLY REIMBURSE POLICYHOLDERS THAT FORMALLY OBJECT TO SURCHARGES FOR SUBROGATED CLAIMS, AND DO NOT MAKE EFFORTS TO REVIEW OTHER CLAIMS SUBJECT TO SUBROGATION TO SEE IF A PERP DISCOUNT SHOULD APPLY; AN UNFAIRLY DISCRIMINATORY PRACTICE IN VIOLATION OF CIC SECTION The Department incorporates, by reference, paragraphs 1. through 1., above... CIC section 1.0, subdivision (a) prohibits rates or rating plans that are applied in an unfairly discriminatory manner... The Department is informed and believes that Respondents commonly refuse to pursue subrogation of claims made by a policyholder, despite the fact that an insurer other --

10 than Respondents has offered to pay for some or all of the policyholder s damages resulting from a particular claim... The Department is informed and believes that, rather than pursue the possible subrogation of claims referenced in paragraph.., Respondents often elect to impose a PERP surcharge on the policyholder s Premium... The Department is informed and believes that, on other occasions, when a similarlysituated policyholder protests a PERP surcharge on the grounds that the underlying basis for the surcharge is a subrogated claim, Respondents often remove the surcharge... Respondents varied application of its PERP rating rules to policyholders with similarly-situated claims subject to subrogation results in an unfairly discriminatory application of Respondents rates, in violation of CIC section 1.0, subdivision (a) RESPONDENTS LACK SUFFICIENT GUIDELINES TO CONSISTENTLY DETERMINE WHEN TO NONRENEW A POLICYHOLDER FOR HAVING TOO MANY CLAIMS, A VIOLATION OF CCR SECTION 0. AND CIC SECTION The Department incorporates, by reference, paragraphs 1. through 1., above... CCR section 0. requires that eligibility guidelines be sufficiently detailed to determine the appropriate rating plan for each insured. CCR section 0.0 defines eligibility guidelines as specific, objective factors, or categories of specific, objective factors, which are selected and/or defined by an insurer, and which have a substantial relationship to an insured s loss exposure... CIC section 1.0, subdivision (a) prohibits rates or rating plans that are applied in an unfairly discriminatory manner... The Department is informed and believes that Respondents internal underwriting bulletin concerning the application of PERP states that policyholders with five or more chargeable losses in the last three years are ineligible for coverage and will be referred to underwriting for nonrenewal. --

11 1 1.. The Department is informed and believes that Respondents commonly nonrenew policyholders with less-than five claims on the grounds that those policyholders have too many claims, despite the fact that such policyholders should, instead, only receive a Premium surcharge in accordance with PERP... The Department is informed and believes that Respondents lack sufficiently detailed underwriting guidelines to determine when a policyholder is ineligible for coverage due to excessive claims... Respondents failure to maintain eligibility guidelines that are sufficiently detailed to determine the appropriate rating plan for each insured is a violation of CCR section Because some policyholders with less-than five claims in a three-year period are renewed, while other similarly situated policyholders with less-than five claims in a three-year period are nonrenewed, Respondents rating plan operates in an unfairly discriminatory manner. Respondents rating plan, therefore, operates in violation of CIC section 1.0, subdivision (a).. RESPONDENTS AUTOMATICALLY UPRATE ANY HOMEOWNERS POLICYHOLDER FALLING WITHIN A COMPUTER-ASSIGNED SPLIT CLASS, THEREBY, FAILING TO CHARGE THE LOWEST PREMIUM FOR WHICH THE HOMEOWNERS INSURED QUALIFIES, IN VIOLATION OF CCR SECTIONS 0. AND 0. AND CIC SECTION The Department incorporates, by reference, paragraphs 1. through 1.0, above... CCR section 0. specifically provides: An insurer shall charge each insured the lowest Premium for which the insured qualifies. At each policy renewal the insurer shall adjust the Premium charged to the insured, as necessary, to reflect the lowest Premium for which the insured qualifies at that time... CCR section 0. states that it is the insurer s responsibility to determine the lowest premium for which an insured qualifies. In the event that an insurer delegates this --

12 1 1 responsibility to one of its agents, CCR section 0. states that the insurer remains responsible for its agent s conduct in determining the lowest premium... The Department is informed and believes that Respondents neglect their responsibility to determine the lowest premium for those insureds that fall within a split class, as determined by Respondents computerized GUS program... The Department is informed and believes that Respondents automatically assign split class insureds with a PPC code of, resulting in an increase in the premium charge for most, if not all, of Respondents split class insureds... The Department is informed and believes that Respondents allow their agents days to determine whether the PPC code of is an appropriate code for a given split class insured... In the event that Respondents agent does not provide Respondents with more accurate PPC code information for a split class insured within the days, the Department is informed and believes that Respondents elect to impose the second-highest risk PPC code to such insureds, despite Respondents knowledge that most of these insureds should be eligible for a lower PPC code and a concomitantly lower premium charge... Respondents failure to determine the lowest premium for which its split class insureds qualify violates CCR sections 0. and Because Respondents GUS program assigns those policyholders in split class zones a PPC code of, while Respondents GUS program assigns other similarly situated policyholders with lower PPC codes, similarly situated policyholders are charged dissimilar rates. Respondents rating methodology, therefore, operates in an unfairly discriminatory manner, in violation of CIC section 1.0, subdivision (a). III. RELIEF REQUESTED.1 RESPONDENTS ARE HEREBY NOTIFIED that, to the extent Respondents unlawful practices are ongoing at the time of delivery of this notice, the --

13 1 1 noncompliance referred to herein must be corrected within twenty () days of receipt of this notice. For each allegation listed above, proof of system-wide correction, or other response permitted by California Insurance Code section.1, must also be provided within twenty () days of receipt of this notice.. RESPONDENTS ARE FURTHER NOTIFIED that if Respondents fail to make an adequate or timely response, a public hearing will be set pursuant to California Insurance Code sections. and.. If, at the conclusion of the hearing, the Commissioner finds that the facts as alleged above have occurred and that these facts constitute violations of the applicable sections of the Insurance Code and/or Code of Regulations, as set forth, he may issue an order for payment of money penalties and any other corrective action as he may deem appropriate.. RESPONDENTS ARE FURTHER NOTIFIED that if the noncompliance referred to above constitutes willful acts involving the use of rates, rating plans, and/or rating systems in violation of Chapter, Part, Division 1 of the California Insurance Code, pursuant to section.0 of the California Insurance Code, the imposition of civil penalties will be sought in the amount of $, for each act. This Notice may be amended to set forth additional willful acts in violation of Chapter, Part, Division 1, of the California Insurance Code and to seek additional penalties therefor in the amount of $, for each act.. RESPONDENTS ARE FURTHER NOTIFIED that, alternatively, in the event that those acts involving the use of rates, rating plans, and/or rating systems in violation of Chapter, Part, Division 1 of the California Insurance Code are not found to be willful violations of that chapter, then pursuant to California Insurance Code section.0, the imposition of civil penalties will be sought in the amount of $, for each act. The Commissioner further reserves the right to seek any other penalties provided for under California Insurance Code section.0 in the event that the acts set forth above, or such acts as may be alleged upon amendment hereof, were inadvertent. --

14 . The California Department of Insurance reserves the right to amend this Notice of Noncompliance, as new facts become available. 1 1 Dated: July, 0. CALIFORNIA DEPARTMENT OF INSURANCE By /s/ Bryant Henley Staff Counsel --