Report 2000-123 Summary - October 2000

Department of Insurance:

Recent Settlement and Enforcement Practices Raise Serious Concerns About Its Regulation of Insurance Companies


The recent settlement practices of the Department of Insurance (department) and its management of enforcement activities, unless changed, raise concerns about its ability to carry out its mission: to regulate insurance companies and protect consumers. The insurance commissioner has the discretion to settle enforcement actions against insurance companies when he or she believes that a settlement will satisfactorily address violations of the Insurance Code and avoid protracted legal proceedings. However, the former commissioner abused this discretion by requiring companies to make "off-the-book" payments, known as outreach payments, directly to nonprofit organizations and vendors. During the former commissioner's tenure, the department levied outreach payments totaling $28.8 million without posting them to the department's accounting records. Ultimately, many of these outreach payments were used for purposes completely unrelated to the regulatory responsibility of the department.

According to a recent opinion of the attorney general, settlement payments directed to third parties are legal only when used for activities related to the regulatory issues that prompted them. For example, the department might require an insurer accused of discrimination against minority neighborhoods to direct settlement payments to community groups in those neighborhoods to fund programs that enhance safety and quality of life, thus helping to reduce insurable risks in those neighborhoods. Using the attorney general's opinion as criteria, we concluded the former commissioner overstepped his authority when he ordered insurers to make outreach payments to nonprofit organizations and vendors totaling $12.3 million. The terms in each of these settlements were for vague and ambiguous purposes that failed to establish the relationship between the regulatory issues that culminated in the settlements and the outreach payments ordered.

Although the terms in the settlements for the remaining $16.5 million in outreach payments directed to third parties appear to have met the attorney general's threshold for legality, we believe such payments are imprudent because they are not subject to state purchasing and expenditure controls. This practice limits the department's ability to ensure that outreach payments were made in accordance with the terms of the agreements and used in ways that relate to the regulatory issues involved in the settlement. Moreover, it usurps the authority of the Legislature to oversee and direct expenditure of the funds through the budget process. Absent these fiscal controls, outreach payments were spent for questionable purposes. For example, one nonprofit organization that received outreach payments donated more than $500,000 to the Sacramento Urban League to construct a new building and made an additional $263,000 donation to an athletic foundation that operates youth football camps. Neither of these purposes even remotely relates to the department's regulatory activities.

Furthermore, many settlements failed to include any monetary penalties against insurance companies found to have violated certain provisions of the Insurance Code and the Unfair Practices Act such as handling claims in bad faith or receiving illegal monetary benefits on amounts deposited in escrow accounts. The department also omitted critical enforcement provisions from settlement agreements, thereby further eroding the department's ability to effectively regulate insurers. For instance, in some settlement agreements, the department did not include specific provisions requiring the insurers to cease activities that were in violation of the law and failed to impose fines, making it appear that it had absolved them of misconduct. Additionally, the department sometimes concealed the specifics of outreach payments by including the amount or nature of the payments in separate letters. The department then kept these letters confidential, rather than including such information in the public settlement agreements. When the settlements did not include monetary penalties or orders to cease illegal activities, the insurers' violations were not reported to the National Association of Insurance Commissioners. Therefore, by reaching settlement agreements that require outreach payments rather than imposing penalties, the department limited the amount of information available to other states' insurance regulators and increased the risk of continued violations. The department also deprived consumers of important information on how insurance companies conduct themselves because the public settlement agreements involving outreach payments frequently omitted details of the insurers' illegal activities and the original examinations that identified the insurers' violations of the law are deemed confidential according to current statutes.

Finally, because the department has not managed its enforcement activities effectively, insurers that break the law may go unpunished. The department's legal division does not promptly resolve cases that other bureaus refer to it, even though some are designated as high priority. The department's bureaus also cannot effectively track the status of a referred case because they lack an integrated monitoring system that includes such standard information as the case number, identification of violations, and the outcome of the legal division's review. Further, the department currently tracks enforcement activities using five systems that do not share data. As a result, it cannot readily determine the number and status of open and closed cases, thereby depriving management of information needed to assess the department's ability to effectively regulate the industry. The department's poor controls over payments for fines, cost reimbursements, and outreach activities also inhibit its ability to ensure that it receives and deposits these payments promptly and that the funds are used to further its regulatory purposes.


To ensure that all activities and expenditures funded by settlement payments are what the department intended and that they adhere to state fiscal controls, it should require insurers to direct all payments to the department. If necessary, it can then contract for activities that clearly relate to the regulatory issues that originally prompted the payments. This practice would allow the department to maintain direct control over expenditures made for outreach and education and ensure that they clearly enhance its regulatory role and are legal.

Additionally, the Legislature should consider a change to the Insurance Code that would forbid the insurance commissioner from specifying that payments go directly to nonprofit organizations, foundations, or vendors as part of a settlement agreement.

In those instances in which egregious violations have been identified, the department should require the insurer to pay an appropriate penalty. Further, the department should clearly state the amount of the penalty, the date each type of payment is due, and all other settlement terms in the public settlement agreement, along with a listing of the violations and an order to cease and desist the activities.

Finally, to improve the effectiveness of its enforcement activities, the department should take the following actions:

  • Develop an integrated system for tracking enforcement activities.

  • Periodically review open enforcement cases.

  • Promptly assign and resolve the backlog of open cases in the legal division.

  • Instruct insurers to remit settlement payments directly to the accounting division or establish cashiering units within the enforcement bureaus and the legal division. Once a settlement agreement is reached, the legal division should also immediately communicate the terms to the accounting division.

  • Strengthen accounting controls to ensure settlement payments are collected promptly and deposited in the appropriate state funds.

The new insurance commissioner believes our findings present a convincing case for organizational improvement and change and he is committed to implementing our recommendations during his tenure.