The New York State Court of Appeals ruled last week that amendments to Regulation 187, which created a suitability and best interest standard for the sale of life insurance and annuity products, were constitutional. This decision ends a legal battle that started in 2018.
How did we get here?
This case stemmed from the introduction of amendments to existing Regulation 187 titled “Suitability and Best Interests in Life Insurance and Annuity Transactions.” These amendments created an increased standard on insurance producers when selling life insurance products and required all recommendations be made in the best interests of the consumer without regard for producer compensation. The amendments went into effect Feb. 1, 2020, for life insurance transactions.
Prior to the effective date of the regulation, PIANY, Independent Insurance Agents and Brokers of New York Inc., and Testa Brothers Ltd., filed a lawsuit against the New York State Department of Financial Services alleging, in part, that the regulation was unconstitutionally vague. The Supreme Court ruled that the regulation was not unconstitutionally vague. Subsequently, the IIABNY and Testa Brothers appealed the decision to the Appellate Division Third Judicial Department of the New York Supreme Court. That court ruled last year that amendments to Regulation 187 were unconstitutionally vague. Then, the department appealed the case to the New York State Court of Appeals—the highest court in state.
What did the court say?
The Court of Appeals first examined whether the regulation was unconstitutionally vague, as the Appellate Division had held. To determine the answer to this question, the court applied a two-part test: 1. was the regulation detailed enough to allow a reasonable person to understand what conduct is and is not permitted?; and 2. was the regulation detailed enough to allow for clear standards of enforcement to avoid an ad hoc application of the regulation by regulators?
Before getting to this test, the court made a detour. It pointed out a key distinction about this case, which hinted to how this opinion was going to go for the petitioners. (Spoiler alert: not well.)
The court noted that this case involved a “facial challenge” of the regulation. That means the petitioners brought the case without first being subject to an enforcement action. This is important because when there is an actual conflict, the court has a specific set of facts to examine to determine the unconstitutional vagueness. For example, if an insurance producer had been confused by what the regulation required—and was punished by the DFS for it—the court could examine facts to determine if there was unconstitutional vagueness.
However, when a challenge is brought absent a conflict the court is forced to answer the question without the benefit of real-world examples to support one side or the other. For that reason, facial challenges are disfavored by courts and the petitioners must prove that the regulation is vague in all its application, not just in convoluted hypotheticals.
Having set the stage, the court directed its attention to the actual argument that the regulation was vague. Specifically, the petitioners argued that three terms, “recommendation,” “suitability information,” and “best interest” were so vague they fail to provide notice of what conduct is or is not permitted.
The court was not convinced by this argument, stating, “Petitioners have fallen woefully short of their burden to sustain a facial due process challenge on vagueness grounds …”. The court considered each of the three terms referenced by the petitioner and found that each had a clear definition that used standard legal terminology that any reasonable person would understand.
But, wait there’s more
Then, the court addressed three alternative arguments the petitioner made for invalidating the amendment. These arguments, which were not addressed by the Appellate Division were: 1. that DFS exceeded its authority in promulgating the amended regulation; 2. that the DFS violated the State Administrative Procedure Act; and 3. that the amended regulation is arbitrary and capricious. This should come as no surprise, but the court was not convinced by these arguments either.
In discussing whether there was regulatory overreach, the court considered whether the DFS engaged in impermissible legislative policymaking, as opposed to permissible administrative rule making. By that determination, the court looked at a series of factors including whether the agency made decisions based on value judgments as opposed to preexisting guidelines; whether the agency had created the set of rules out of whole cloth or they were merely filling in the details of a board policy set out by the Legislature; whether the Legislature had unsuccessfully tried to legislate on this issue, and whether the agency used any special expertise in the field to develop the regulation.
The court found that the DFS did not cross the line into legislative policymaking. The Legislature granted the DFS the authority to supervise insurance producers and carriers. That grant of authority was in part to establish high standards of honesty and transparency. The court found that the goals of the regulation were well-aligned with that grant of authority.
Then, the court considered the argument that the DFS violated the State Administrative Procedure Act. SAPA lays out rules that agencies must follow when promulgating regulations and creating agency guidance. The petitioners argued that the DFS violated SAPA by not including a best estimate of the regulations expected costs, the impact on small business, or providing a statement on whether the rule exceeds federal standards. The court found the lack of a cost estimate a feature of the regulation, not a defect. The DFS designed the regulation in a way to allow producers flexibility in determining the best way to comply. This flexibility would minimize expected costs as DFS anticipated that many insurers already were providing many of the compliance tools to their producers. The court noted that the DFS did in fact extensively analyze the amendment’s impact on small business and altered the regulation to minimize the impact. On the argument regarding federal standards, the court found that the DFS did include an analysis and explanation of why the rule exceeds federal standards.
Finally, the court addressed the petitioner’s argument that the amendments were arbitrary or irritational. Here the court delivers its shortest and most frank analysis. The court said: “The goal of the amendment is straightforward and supported by the administrative record, and the amendment is plainly tailored to achieve those objectives. Ultimately, [the] petitioners’ quarrel is with the policy and objectives of the regulation, not with its rationality.”
With that, the court rejected the petitioner’s arguments and reversed the decision of the Appellate Division.
What comes next?
Nothing. Well, at least in the courts. Having rendered its opinion, the New York Court of Appeals is the final word on this matter. The regulation has been determined to be constitutional and will stay in effect as it is. This does not preclude separate legal challenges of the regulation in the future, but this decision will make any such challenge difficult.
What is the impact on insurance agents?
Not much. The amendments to Regulation 187 have been in effect for more than two years. Insurance carriers and producers already are complying with the amendments. So, while this a big win for the regulators, it will have minimal impact on producers or their clients.