An Orange County, California court has given the state’s Department of Insurance a stunning smack down in a long-running case about the “broker fees” charged by some insurance agents. The complicated case offers insight into the bureaucratic world of insurance regulation and sheds light on the heavy-handed way state regulators often treat the companies they regulate.

In January 2015, Insurance Commissioner Dave Jones issued a statement touting the department’s record-setting fine against Mercury Insurance Group:

Mercury auto insurance consumers paid $27.5 million in unapproved fees. While the $27.5 million fine against Mercury is significant, it is commensurate with the amount of money that was unlawfully collected from Mercury policyholders.

The massive fine stemmed from a dispute over fees charged by Mercury agents between 1999 and 2004. Years ago, the Los Angeles-based company had sold auto insurance through its own appointed agent force. But in 1988, California’s voters dramatically changed the nature of the insurance industry by giving an elected insurance commissioner the power to approve or reject property-casualty rates via Proposition 103. After the measure’s passage, Mercury in 1999 shifted to marketing their policies primarily through independent brokers.

Independent insurance producers sell insurance from a variety of companies, and when they act as brokers on behalf of an insurance buyer, they are allowed to charge that customer a brokerage fee. By contrast, agents acting on behalf of the company are not allowed to charge such fees. Mercury did not get any portion of the fees.

One particular broker, Aon subsidiary Auto Insurance Specialists (AIS), sold Mercury policies about 75 percent to 80 percent of the time, according to the Orange County Superior Court ruling. Because of that high percentage of sales from Mercury, the California Department of Insurance ruled that “Mercury’s direction and control over brokers meant they were ‘operating as de facto agents,’” which thus violated an insurance code, the court explained.

In essence, the department was flexing its newfound power – accusing a company of charging improper fees based on an interpretation that clearly was in a gray area. It was such an area of uncertainty that Mercury and the department “agreed that Mercury would pursue legislation to clarify the broker/agent issue,” according to the court’s explanation. Mercury backed a bill that ultimately was opposed by the department. Mercury argued that this measure fixed the matter, but the Department of Insurance reportedly ignored the company’s efforts to resolve things.

The dispute over these fees – typically in the range of $150 per-policy – continued for 16 years through administrative and court proceedings. That massive fine nearly $30 million fine was imposed by CDI based on an estimate of nearly 184,000 sales transactions. Mercury challenged the decision in the California court system and claimed it was denied due process during the department’s proceedings.

“Mercury is correct that there were due process violations,” ruled Judge Gail Andler. She found improper communications within the department and efforts to persuade the department’s administrative law judge to change his ruling. CDI “commingled its prosecutorial and adjudicatory functions in seeking and securing a rule change, through ex parte communications inside (the Department of Insurance), which would have substantive effects on the case while the case was pending,” the judge ruled. “At a minimum, the result is a lack of appearance of fairness.”

The court denied the company’s petition on that issue. It agreed there were serious due-process problems, but found that insufficient to dismiss the case. But the judge granted the company its petitions on the other crucial matters.

For instance, the court explained Mercury “does not dispute for purposes of this petition that AIS brokers were ‘de facto’ agents of Mercury.” But the company argued that imposing such fees without the department’s approval did not violate the insurance code because the fees did not meet the definition of “premium.”

The judge agreed with the company:

The ‘broker fees’ charged by AIS were not ‘premium,’ as the evidence establishes that those fees were charged for a separate service provided by AIS, in giving customers comparative pricing, for multiple potential insurers. AIS charged those fees to place policies with any insurer, not just Mercury — and Mercury was not always chosen. Mercury did not collect those fees, require them, or control them. AIS’ ‘broker’ fees thus were not part of ‘the amount paid for certain insurance for a certain period of coverage.’

The judge also agreed “the penalty imposed violates due process” because the company “was not given fair notice that it could be subjected to penalties.” The judge also found the agency engaged in unreasonable delays in its proceedings. The end result is that the court remanded the matter back to the department “to vacate” its order and to enter a new order consistent with the court’s decision. In the insurance world, this is a big deal.

The department is quick to issue statements championing the fines it imposes on companies. Perhaps not surprisingly, the California Department of Insurance has yet to issue a statement referring to this stunning smack down.

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