On July 17, 2018, the California Superior Court in San Francisco ordered declaratory and injunctive relief against the Office of the California State Controller (California Controller) in connection with the controller’s regulation of life’s insurers’ compliance with California’s Unclaimed Property Law, Cal. Code Civ. Proc. §§ 1500 et seq. (UPL). Specifically, the court held that the California Controller had improperly promulgated two regulations imposing requirements on life insurers under the UPL. The court invalidated the following “underground” regulations, which the controller adopted without complying with the procedural requirements of the California Administrative Procedure Act (California APA):
A Dormancy Trigger Regulation under which the California Controller required life insurers report unpaid life insurance proceeds as unclaimed property three years after the death of the insured, even where “less than three years had elapsed since the insurer’s own records disclosed that the insured had died”; and
An External Database Regulation under which the California Controller required that “in some or all circumstances a life insurer must perform a comparison of its insureds’ life insurance policies and/or other documents maintained by the insurer with the Social Security Administration’s Death Master File or similar database to determine whether any of its insureds are deceased for purposed of complying with” the UPL.
The court issued its order (the July 17 Order) in connection with granting summary judgment in favor of Cozen O’Connor’s client, Thrivent Financial for Lutherans (Thrivent), in the case titled Thrivent Financial for Lutherans v. Betty T. Yee, et al., Case No. CGC-15-548384. The July 17 Order enjoins the California Controller from imposing the two regulations on any life insurance companies. While it remains to be seen how the court’s injunction will impact any unclaimed property audits of life insurers still being conducted by the California Controller, the order expressly enjoins the controller from “under any circumstances knowingly impos[ing] any financial consequences of any kind on any life insurance company for failing to comply with” the underground regulations. (July 17 Order at 1.)
Thrivent’s lawsuit stemmed from the California Controller’s efforts, beginning in around 2008, to impose the above-described regulations against life insurers operating in California. In the course of auditing life insurers to identify unclaimed life insurance policy proceeds that should have been escheated under the UPL, in 2008 the controller articulated new standards to measure life insurers’ compliance with the UPL. Those standards, which the controller adopted without following any regulatory process and without previously announcing them publicly, deviated significantly from the statute as written, under which California’s three-year dormancy period begins when life insurance proceeds are due and payable according to the records of the insurer — i.e., when the insurer receives proof of death and a claim for benefits. The controller’s new standard of compliance asserted that the dormancy period was triggered by the insured’s death, such that life insurers must escheat unpaid life insurance proceeds three years after the insured’s death, regardless of what the insurer’s records reflected and regardless of whether the insurer was even aware that its insured had died.
Not only did the California Controller implement a new standard for measuring the start of the dormancy period in the course of auditing life insurers, but the controller purported to apply this standard retroactively and threatened life insurers with penalties for non-compliance and 12 percent annual interest assessments against all proceeds not escheated according to the controller’s newly promulgated standards. The controller pursued audits of numerous life insurers on this basis, ultimately reaching settlements with more than 25 of them. According to the California Controller’s public statements, it has collected more than $300 million from life insurers under these settlement agreements.
Thrivent’s lawsuit against the controller marks Thrivent’s second round of litigation with the California State Controller’s Office. Previously, the California Controller commenced an audit of Thrivent in 2013. Thrivent disagreed with the controller’s interpretations of law that would have enabled the controller to obtain unwarranted, sensitive member information in the course of the audit and to inaccurately assert Thrivent’s non-compliance with unclaimed property reporting requirements. Thrivent filed suit to protect its members’ information and assets by seeking clarification of California law and a determination of Thrivent’s audit rights, but before that case could proceed to trial the controller closed its audit of Thrivent, acknowledging that Thrivent held no unclaimed property payable to California, and the case was dismissed.
Subsequently, on October 9, 2015, Thrivent filed a lawsuit against the California Controller that sought to clarify Thrivent’s prospective compliance obligations under the UPL. Thrivent’s complaint requested a declaratory judgment that the California Controller had improperly adopted two regulations without following the procedures required by the California APA, making them invalid “underground” regulations. Thrivent further sought an injunction against the controller enforcing the underground regulations.
In granting Thrivent’s motion for summary judgment, the court concluded that the controller’s two regulations imposed obligations on life insurers that “are nowhere mentioned in” the UPL. (July 17 Order at 3.) Nor was the court persuaded by the California State Controller’s argument that the Dormancy Trigger Regulation was “the only legally tenable construction of section 1515” (id.); rather, the court found that section 1515 was “reasonably susceptible” to an “interpretation that the triggering event for the reporting of a policy is the disclosure by an insurer’s own records that its insured is deceased,” not what the “insurer had reason to know” under the California State Controller’s interpretation. (Id.)
Because the controller’s regulations were not promulgated in accordance with the California APA, the court declared that they are “invalid” and ordered that “unless and until the External Database Regulation and/or the Dormancy Trigger Regulation are validly promulgated per the [California] APA or section 1515 is amended to enact either or both of those regulations, [the California State Controller] may not under any circumstances knowingly impose any financial consequences of any kind on any life insurance company for failing to comply with those regulations.” (July 17 Order at 1, emphasis added). Furthermore, and addressing the fact that the invalid regulations were reflected in the controller’s Unclaimed Property Holder Handbook, the court ordered that the controller “must remove all references to those regulations in the materials they disseminate to life insurance companies unless accompanied by a conspicuous disclaimer that the purported requirements of these two regulations are merely [the California State Controller’s] views and do not have any legal effect.” (Id.)
The ramifications of this ruling are substantial. The California Controller can no longer credibly threaten life insurers with interest or penalties in order to compel compliance with its unsupported position that an insured’s date of death alone triggers the three-year dormancy period prior to reporting and escheatment of unclaimed life insurance proceeds. Nor can the California Controller require insurers to use the Death Master File, or use comparison with the Death Master File as the basis for triggering the statutory dormancy period. And the California Controller can no longer threaten financial penalties pursuant to these invalid regulations in order to secure settlements from life insurance companies.
The underground regulations adopted by the controller are reflective of broader, multi-state efforts by unclaimed property regulators across the country to audit life insurers’ compliance with state unclaimed property laws according to standards that are not consistent with existing state law. Beyond asserting an entitlement to the unpaid life insurance policy proceeds themselves, in the course of audits unclaimed property regulators have threatened life insurers with massive penalties and interest assessments for “non-compliance”; these sums are sought to be paid directly to the state, and not for the benefit of the true owner of the insurance policy proceeds, on whose behalf the state holds unclaimed property.
To this end, the California trial court’s decision is consistent with a prior judicial ruling obtained by Thrivent, in which the Florida Court of Appeal rejected the Florida Department of Financial Services’ similar efforts to impose unclaimed property law compliance obligations against life insurers in a manner that was contrary to existing law as written. In Thrivent Financial for Lutherans v. State of Florida, Department of Financial Services, 145 So. 3d 178 (Fla. Dist. Ct. App. 2014), the court of appeal rejected the agency’s position that life insurance policy death benefits were due and payable upon the insured’s death, as the Florida DFS had asserted in the context of numerous audits and in an administrative ruling that it issued to Thrivent. Instead, the court of appeal held that death benefits are payable upon the insurer’s receipt of a claim for benefits and proof of death.
Similarly, at the agency level, Thrivent obtained a declaratory ruling from the North Carolina Department of State Treasurer affirming that the standards that unclaimed property regulators have attempted to impose through ongoing nationwide audits are inconsistent with North Carolina unclaimed property law. The North Carolina Department of State Treasurer determined instead that a life insurer’s receipt of proof of death was necessary to trigger the three-year dormancy period before life insurance death benefits would be presumed abandoned and escheatable to the state under North Carolina’s law.
Thrivent’s litigation team in these matters has been led by Cozen O’Connor member Andrew B. Kay in Washington, D.C. Andrew was joined in the California lawsuit by Cozen O’Connor member P. Randolph Seybold, also in Washington, D.C., with assistance from associates Haryle Kaldis, Michael Melusky, and Armeen F. Mistry.