TWENTY FIRST ANNUAL NORTHEAST SURETY AND FIDELITY CLAIMS CONFERENCE

TWENTY FIRST ANNUAL NORTHEAST SURETY AND FIDELITY CLAIMS CONFERENCE rd th SEPTEMBER 23-24, 2010 REGULATING ETHICS - ATTEMPTS TO REGULATE SURETY CLAIMS PRACTICES PRESENTED BY: CYNTHIA E. RODGERS-WAIRE Wright, Constable & Skeen, LLP 100 North Charles Street Baltimore, MD 21201 OMAR J. HARB Alber Crafton, PSC 2301 West Big Beaver Road - Suite 300 Troy, MI 48084-3326

REGULATING ETHICS ATTEMPTS TO REGULATE SURETY CLAIMS PRACTICES By: Cynthia E. Rodgers-Waire and Omar J. Harb INTRODUCTION While generally, a determination of whether a surety has conducted itself in an ethical manner would be a case-by-case determination, there have been various attempts over the years to remove the guesswork from this analysis. These exercises began with model acts, which have been adopted (with various modifications) by most states. This paper will briefly examine the history of the model acts and some common issues addressed by the various states in their versions of the model acts. I. BASIS FOR STATE LEGISLATION/REGULATION/MODEL ACTS A. Unfair Trade Practices Act Although insurance regulation has largely been left to the purview of the individual states, the National Association of Insurance Commissioners (NAIC), an organization comprised of the elected or appointed regulators of the individual states, was formed in 1871 to, in part, coordinate regulation of multi-state insurers. 1 The Unfair Trade Practices Act, first promulgated in 1947, proposed wide-ranging model regulations for nearly all facets of insurance regulation, including claims handling practices. 2 Significantly, the UTPA did not exclude suretyship from its provisions or definitions, and was widely, but not uniformly, adopted by the states. B. Unfair Claims Settlement Practices Act In 1991, NAIC sought to further clarify and amplify the broad claims handling provisions and promulgated the Unfair Claims Settlement Practices Act (UCSPA). The USPCA sought to delve into more specific detail in more uniformly identifying the specific acts, or failures to act, which would constitute an unfair claims settlement practice, including: - knowingly misrepresenting to claimants and insureds relevant facts or policy provisions relating to coverages at issue - failing to acknowledge with reasonable promptness pertinent communications with respect to claims arising under its policies - failing to adopt and implement reasonable standards for prompt investigation and settlement of claims arising under its policies - not attempting in good faith to effectuate prompt, fair and equitable settlement of claims submitted in which liability has become reasonably clear 1 See www.naic.org. 2 NAIC, Unfair Trade Practices Act (1947).

- compelling insureds or beneficiaries to institute suits to recover amounts due under its policies by offering substantially less than the amounts ultimately recovered in suits brought by them - refusing to pay claims without conducting a reasonable investigation - failing to affirm or deny coverage of claims within a reasonable time after having completed its investigation related to such claim or claims - attempting to settle or settling claims for less than the amount that a reasonable person would believe the insured or beneficiary was entitled by reference to written or printed advertising material accompanying or made part of an application - attempting to settle or settling claims on the basis of an application that was materially altered without notice to, or knowledge or consent of, the insured - making claims payments to an insured or beneficiary without indicating the coverage under which each payment is being made - unreasonably delaying the investigation or payment of claims by requiring both a formal proof of loss form and subsequent verification that would result in duplication of information and verification appearing in the formal proof of loss form - failing in the case of claims denials or offers of compromise settlement to promptly provide a reasonable and accurate explanation of the basis of such actions - failing to provide forms necessary to present claims within fifteen (15) calendar days of a request with reasonable explanations regarding their use - failing to adopt and implement reasonable standards to assure that the repairs of a repairer owned by or required to be used by the insurer are performed in a workmanlike manner. 3 Interestingly, the USPCA 1 also provides that: [t]he purpose of this Act is to set forth standards for the investigation and disposition of claims arising under policies or certificates of insurance issued to residents of [state]. It is not intended to cover claims involving workers compensation, fidelity, suretyship or boiler and machinery insurance. 4 Like its predecessor, the UCSPA was adopted by many of the states in the years following its original promulgation. However, due in part to the vagaries of the individual states own existing regulations and practices, their adaptation of modified versions of the UTPA and/or the UCSPA, and the UCSPA s intentional exclusion of suretyship from its scope, neither the UTPA nor the UCSPA delivered uniformity or clarity to the states definitions and regulation of unfair claims settlement practices for sureties. 3 Uniform Claims Settlement Practices Act (1991). 4 Id. 2

II. SOME ISSUES AND PRACTICES COVERED BY STATE LEGISLATION AND REGULATION A. Are Sureties Covered by Insurance Legislation/Regulation? Every state has some form of insurance claim handling legislation. Nearly every state has adopted some version of the UCSPA or its predecessor, the UTPA. 5 Because insurance law is purely a creature of state law, each state legislature is free to create its own unique modifications. Although many states have adopted the UCSPA in full, verbatim, some states have made minor variations to conform to their own interests. Thus, it is necessary in each instance to examine the applicable jurisdiction s statute and regulations to determine what alterations, if any, have been made. 6 One good example of such state-by-state variation is whether the unfair insurance claims practices legislation applies to sureties. As noted above, UCSPA Section 1 expressly excludes suretyship from coverage under the UCSPA. 7 The majority of states have elected not to adopt UCSPA s Section 1 exclusion of sureties. A few states, by their own legislation, explicitly exclude sureties from coverage. For example, in Maryland, the applicable statute states that it does not apply to reinsurance, worker s compensation insurance or surety insurance but does apply to fidelity policies. 8 In contrast, the Colorado insurance statute defines insurance policy or insurance contract in a manner that includes all contracts of suretyship. 9 The statute also contains specific examples of unfair or deceptive acts or practices in the business of insurance. 10 The California insurance code does not state whether a surety is subject to the statutory unfair claim provisions; however, related regulations provide that the term insurance policy does not include a surety bond. 11 Instead, California provides a separate section in its regulations containing standards applicable to surety bonds. 12 In some states where the statutory language is inconclusive, courts have stepped in to express their 5 Mississippi has not adopted any version of the USCPA or UTPA; rather, Mississippi s insurance statute merely provides that insurance companies cannot act or engage in practices considered unfair or deceptive. Miss. Code Ann. 83-5-45(1). In Alabama, an insurance company cannot refuse to pay or settle claims without just cause and with such frequency as to indicate a general business practice. Ala. Code 27-12- 24. 6 See James P. Diwik, A State by State Survey of Unfair Insurance Practices Regulations, in The Fidelity and Surety Desk Reference Book (DeWitte Thompson ed., 2006), for a then current list of applicable statutes. 7 8 In contrast, there is no similar provision under the UTPA excluding sureties. See Md. Code Ann. Ins. 27-302(b). 9 Colo. Rev. Stat. 10-3-1102(2). See also Brighton Sch. Dist. 27 J v. Transamerica Premier Ins. Co., 923 P.2d 328 (Colo. App. 1996) aff d. 940 P.2d 348 (Colo. 1997). 10 11 12 Colo. Rev. Stat. 10-3-1104(1)(h). Cal. Code of Reg., tit. 10, Chapter 5, Subchapter 7.5, 2695.2(j). Cal. Code of Reg., tit. 10, Chapter 5, Subchapter 7.5, 2695.10. 3

opinions. For example, in Great American Ins. Co. v. North Austin Municipal Utility District No. 1 13, the Supreme Court of Texas, recognizing the fundamental differences between suretyship and insurance, held that a surety is not in the business of insurance and was not subject to Texas version of the UCSPA. Subsequently, Texas enacted its Unfair Claims Settlement Practices Act, which supported the appellate court s interpretation and excludes sureties from the definition of the types of insurers to which the Act is applicable. 14 B. Degree of Intentional Conduct Necessary for Liability to be Found The statutes are not consistent with regard to what conduct is necessary to trigger liability as an unfair claim practice. In some states, a single act in violation of one of the prohibited unfair claims settlement practices, if knowingly committed, can form the basis for liability. Colorado s statute references a willful violation of the statute. 15 Alternatively, an insurer can also be found liable under the Colorado statute by engaging in a prohibited practice with such frequency that it is found to be a general business practice. California s statute scheme is similar. 16 In order to find liability under New York s statute, the insurer must commit the proscribed act without just cause and with such frequency as to indicate a general business practice. 17 Finally, in yet another variation, Connecticut s Unfair Claim Settlement Practices Statute omits any reference to a willful component and establishes liability only when the improper conduct is engaged in as a general business practice. 18 Apart from certain egregious actions of deception described in the statute, Florida s law likewise requires the insurer to engage in the prohibited acts as part of a general business practice in order to establish liability. 19 C. Conducting a Reasonable Investigation Most states have adopted some version of the following unfair settlement practice found in the UCSPA: Failing to adopt and implement reasonable standards for prompt investigation and settlement of claims arising under its policies. 13 14 15 16 17 18 19 908 S.W.2d 415, 424 (Tex. 1995). Tex. Ins. Code Ann. 542.002; see also Tex. Admin. Code tit. 28 21.202(6) and 21.203. Colo. Rev. Stat. 10-3-1104(1)(h). Cal. Ins. Code 790.03(h). N.Y. ISC. LAW 2601. Conn. Gen. Stat. 38A-816(6). Fla. Stat. 626.9541(1)(i)(3). 4

Other statutes simply direct an insurer to conduct a reasonable investigation before denying any claim. What is determined to be reasonable is a fact-specific inquiry addressed on a case-by-case basis. D. Promptness of Investigation/Response to Claim Many states statutes or regulations require an insurer or surety to respond to a claimant within a particular time period or within a reasonable time. For obvious reasons, a claimant has an interest in having its claim resolved at the soonest possible opportunity. States have determined that it is an improper practice to act in a dilatory manner in investigating or responding to a claim. In New York, for example, the Rules provide the following among the Standards for prompt, fair and equitable settlements : Within 15 business days after receipt by the insurer of a properly executed proof of loss and/or receipt of all items, statements and forms which the insurer requested from the claimant, the claimant, or the claimant's authorized representative, shall be advised in writing of the acceptance or rejection of the claim by the insurer. 20 Such a rule contemplates that the 15-day period does not begin to run until after the insurer/surety receives all items requested from the claimant. This leaves the issue of whether the claimant has appropriately complied with all requests for information or documentation open for discussion, potentially. However, to the extent the claimant has at least arguably provided all requested items, a surety has only 15 days to provide a response. Note that the provision gives the insurer/surety an opportunity to obtain additional time to determine whether a claim should be accepted or rejected, as long as it sends a notice to the claimant to that effect and provides the reasons why additional time is required. Id. In Pennsylvania, on the other hand, the insurer/surety is not given an express period of time within which to respond, but rather must do so within a reasonable time. Specifically, the Pennsylvania statute provides that one of the acts that would constitute an unfair claim settlement practice (if committed with sufficient frequency to be considered a business practice) is [f]ailing to affirm or deny coverage of claims within a reasonable time after proof of loss statements have been completed and communicated to the company or its representative. 21 It is left to interpretation what is considered reasonable, and presumably this would be a case-by-case determination. E. Promptness of Payment Commonly, states require insurers/sureties to promptly pay claims when coverage is not contested. For example, in Connecticut, it is an unfair claim settlement practice to fail to promptly settle claims, where liability has become reasonably clear, under one portion of 20 21 11 NYCRR 216.6(c). 40 Pa. Cons. Stat. Ann. 1171.5(a)(10)(v). 5

the insurance policy coverage in order to influence settlements under other portions... 22 Very similar language is contained under California s Insurance Code. 23 These provisions appear to be intended to prevent an insurer/surety from using a payment on an undisputed portion of a claim as leverage to obtain a favorable settlement on another claim. Michigan s statute is more specific, expressly requiring an insurer/surety to pay the undisputed portion of a claim within 60 days after receiving the proof of loss. 24 That statute further provides that the amount of the claim that is payable accrues interest at the rate of 12 percent per year, commencing 60 days after the proof of loss is received. 25 F. Statements or Representations Regarding the Statute of Limitations Less common is a requirement that the insurer/surety notify claimants of the imminent expiration of the applicable statute of limitations. A Minnesota statute provides that the following constitutes an unfair settlement practice : failing to advise in writing an insured or claimant who has filed a notification of claim known to be unresolved, and who has not retained an attorney, of the expiration of a statute of limitations at least 60 days prior to that expiration. 26 The provision only pertains to unrepresented claimants, and is aimed at protecting such claimants from being surprised by the running of the statute of limitations. Note, however, that the statute creates an exception with respect to claimants who have not communicated with the insurer/surety for two years prior to the running of the statute of limitations, creating the assumption that the claimant is no longer pursuing the claim. 27 It is unclear whether this statute would apply to contractual periods of limitations, in addition to statutory limitations periods. G. Is There a Private Right of Action Under Unfair Claims Practices Acts? Both the UTPA and the UCSPA expressly provide that they are not intended to provide for a private right of action; however, because states have not all uniformly adopted all of the provisions of either the UTPA or the UCSPA, it is not clear in every state whether a private cause of action exists under the applicable unfair claims practices statute. In those states where the statute does not expressly prohibit a private right of action and where no case authority is established, the law remains uncertain. In 1979, the California Supreme Court ruled that third parties had standing to sue insurers for violations of California s unfair claims 22 23 24 25 26 27 Conn. Gen. Stat. 38a-816(6)(m). Cal. Ins. Code Sec. 790.03(h)(12). MCL 500.2006(3). MCL 500.2006(4). Minn. Stat. 72A.201 (Subsection 4) (8). Id. 6

settlement practices statute. 28 Nine years later, the California Supreme Court reserved itself and stated that California s statute did not create a private right of action for any party, whether first-party insured or third-party claimant, and was intended to be used as an enforcement device by the State s insurance commissioner. 29 Most courts that have addressed this issue have ruled that no statutory private cause of action exists, though common-law claims of bad faith are recognized in many jurisdictions. A handful of states continue to recognize a private right of action under unfair claim practice statutes. III. INDUSTRY SELF-REGULATION In addition to claims-handling rules imposed by states, insurance companies themselves can elect to implement a set of guidelines for ethical standards to be followed. The Chartered Property Casualty Underwriters ( CPCU ) Society published a Guide to Organizational Ethics Policy, which provides assistance to an insurer that wishes to develop and maintain an ethics policy. The CPCU s Guide sets forth various steps involved in the process of developing an organizational ethics policy, including: Creating an ethical mission Selecting the appropriate major topics and sub topics to be addressed, each containing a short statement of the expected behavior for each topic or sub topic Identification of how and to whom any violations of the Policy should be reported (including whether the reporting individual may choose to remain anonymous) Identification of the sanctions for violations (ranging from discussions with management to warnings to suspension or termination of the individual) Identification of an appeals process for persons sanctioned, if any Obtaining approval of the Policy from senior management and the organization s counsel Introduction of the Policy to members of the organization (it is recommended that this be done by top management, and that all members be required to sign a statement that he or she has read, understands and will abide by the Ethics Policy) Periodically updating the Policy as appropriate 28 29 Royal Globe Ins. Co. v. Superior Court, 592 P.2d 329 (Cal. 1979). Moradi-Shalal v. Fireman s Fund Ins. Cos., 758 P.2d 58 (Cal. 1988). 7

While an internal ethics policy may not be binding as it relates to a particular claimant, it could be persuasive if the insurer/surety s good faith is at issue. In other words, evidence that the claims handler followed the company s ethics policy could be important evidence in determining whether the claim was handled in good faith. Conversely, evidence that the claims handler did not follow the company s own internal procedures could be a significant hurdle in the company s attempt to defend a claim of bad faith against it. In any event, companies that determine to develop and implement an internal ethics policy should do so with great care and only after consultation with counsel. IV. CONCLUSION The various statutes and regulations enacted by the states provide important ethical guidelines for the surety and insurance industry. As shown by the differing language and provisions enacted by some of the states, it is important for claims handlers to review and become familiar with the particular guidelines in effect in the states in which they are working. To the extent the insurance or surety company has its own policies, those must be taken into account as well in making claims handling decisions. 237665v3 8