California’s State Farm action noted in yesterday’s post, “What Would a Good Neighbor Do Next? California Calls Out State Farm’s Claims Handling,” is both a validation of market conduct exams and an indictment of their limitations. The best way to understand market conduct exams is to remember why they emerged. Historically, insurance regulation focused on solvency and whether insurers were financially able to pay. Market conduct surveillance developed later, especially after the NAIC’s early-1970s work with McKinsey, to focus on how insurers behave in the marketplace. I noted this in “What is the History of Market Conduct Studies?” The purpose was to protect policyholders and claimants from unfair market practices, especially patterns rather than isolated mistakes.
That original purpose is still sound. The weakness is execution. Market conduct exams are strongest when they identify repeat patterns, test claim files against legal duties, force corrective action, and publish findings so the public can see what regulators found. California did a number of those things well in the State Farm matter. The Department reviewed 220 wildfire claim files, found alleged violations in 114 of them, and cited 398 violations from the market conduct exam, as well as additional violations from consumer complaints. That is not a decorative audit. That is a significant enforcement record.
In my opinion, after reading many of these exams, the recent California exam’s strength is its specificity. It identifies repeated failures by State Farm to send 30-day status letters, delayed payments after accepted claims, failures to respond within 15 days, unreasonably low settlement offers, improper depreciation, multiple adjuster reassignments, denials of smoke-damage testing, and misrepresentations about policy provisions. It also breaks down violation counts by category, which makes it much harder for State Farm to dismiss everything as anecdotal grumbling.
California also did something many regulators fail to do. It looked at smoke and ash claims as a distinct problem. The report flags State Farm’s treatment of hygienist and environmental testing, including charging some testing costs against indemnity limits rather than treating them as loss adjustment expenses, and using a “Right to Inspect” provision as a basis to deny testing reimbursement. Those are not mere timing mistakes. They go to scope, causation, claim valuation, and the structure of how smoke claims are adjusted.
The problem with this recent examination and most market claims examinations is that the exam largely proves results but does not fully expose the causes for the wrongful claims conduct. This is the elephant in the room with many market conduct studies. I have no idea why regulators and those conducting these examinations fail to undertake a study to find out what is causing the wrongful claims conduct. They are often excellent at finding that something went wrong. They are much less effective at proving why it went wrong. They examine claim files, letters, timelines, and payments. Those are important. But the real architecture of wrongful claims conduct is often upstream, in staffing decisions, catastrophe directives, severity goals, vendor instructions, reinspection protocols, reserve pressure, performance evaluations, claim workflow directives, claim scorecards, and management communications about priorities and other special instructions that lead to lower payments.
This is not a new concern. Few market conduct exams have meaningfully analyzed the insurer’s internal claims operation and instead become claim-file reviews looking for technical deficiencies. The North Dakota Farmers “Bring Back a Billion” example remains instructive because it examined incentive culture and cost-cutting programs, not just individual claim files, as noted in “Are Market Conduct Examiners Listening to Common Property Insurance Claims Complaints?”
California’s report gestures toward the deeper issue but does not fully chase it. It notes repeated problems with Servpro, smoke damage scope, hygienist testing, adjuster churn, and inconsistent ALE handling. It even states that State Farm’s use of preferred vendors may present a conflict because those vendors serve the insurer’s interests in cost control and efficiency. That is a major observation, but the report stops short of fully unpacking the vendor architecture, management directives, or economic incentives behind it.
This matters because State Farm’s predictable defense is already visible in the report. State Farm will probably cite file-specific errors, unintentional oversights, refresher training, and no general business practice. The Department’s challenge is to prove that 398 violations in a sample of 220 claims are not just random errors arising from catastrophe chaos. The best way to do that is not merely more claim-file counting. It is to obtain and analyze the internal and otherwise secret State Farm documents that produced those files. This is what the Oklahoma Attorney General is trying to do, as noted in “Why Is State Farm Asking the Oklahoma Supreme Court to Protect Its Secret Claims Playbook?”
The Insurance Regulatory Examiners Society (IRES) describes its mission in terms of professional standards, ethical standards, training, expertise, and public confidence in insurance regulators. That is exactly right as an aspiration. IRES says it is dedicated to consumer protection and promotes fair, cost-effective, and efficient insurance regulation through professionalism and integrity among regulators. Its stated objectives include establishing high professional standards, promoting uniform ethical standards, enforcing minimum conduct and training requirements, and developing continuing education for insurance regulation.
The issue I put to this organization is whether the market conduct system actually equips examiners to uncover claims misconduct architecture rather than just claim-file symptoms. For property insurance claims, reform should begin with mandatory cause-of-failure analysis. Every significant catastrophe market conduct exam should ask what internal decisions produced these outcomes. Regulators should demand catastrophe claims playbooks, claims handling bulletins, vendor instructions, estimating guidelines, reserve communications, authority-level rules, reinspection criteria, litigation avoidance directives, AI tools, claims process directives, dashboards, severity metrics, quality assurance reviews, supervisor communications, and compensation or evaluation systems tied to claim severity payments and outcomes.
Market conduct examinations should include a request for policyholder-side intelligence before sampling and investigation begins. Public comment from public adjusters, contractors, hygienists, restoration professionals, policyholder lawyers, consumer groups, and catastrophe survivors should be sought so that the recurring problems are investigated. Regulators and examiners should not let the insurer’s data architecture define the exam’s blind spots.
California deserves credit for bringing a strong action. It found a high violation rate, identified serious claim handling failures, elevated smoke damage issues, and moved to an Accusation and Order to Show Cause seeking penalties, cease-and-desist relief, and even possible suspension authority.
What is missing is the deeper story about who designed the claims process, what incentives shaped it, what vendors were told, what management knew, whether AI or estimating tools influenced outcomes, whether reassignments were caused by understaffing or strategy, and whether unreviewed policyholders will get relief.
The market conduct study system was allegedly made to protect policyholders from unfair insurance claims practices. California’s action shows the system can still bite. But if regulators and examiners only identify bad outcomes without exposing the machinery that produced them, the same machinery will keep running after the fine is paid.
Thought For The Day
“All truths are easy to understand once they are discovered; the point is to discover them.”
— Galileo Galilei