0674: FIRST ANALYSIS - SELF-EVALUATIVE INS. AUDIT PRIVILEGE

SELF-EVALUATIVE INS. AUDIT PRIVILEGE - S.B. 674 (S-1): FIRST ANALYSIS

Senate Bill 674 (Substitute S-1 as reported)

Date Completed: 10-9-01

RATIONALE

Although insurers are subject to examination by State regulators, some companies also are interested in undergoing an independent audit to determine whether they are in compliance with State and Federal regulations. Insurers apparently are reluctant to do so, however, due to fear that an audit report will become a public document. For example, an audit might reveal that an insurer was not complying with a statute that had been amended, because the insurer was not aware of the amendment. Although the insurer would need to correct its practice in order to meet governmental standards, it would not want information about the noncompliance to be publicized. To encourage insurers to engage in self-evaluations and ensure their compliance with current laws, it has been suggested that these audits and audit reports be granted a statutory privilege that would keep them confidential.

CONTENT

The bill would amend the Insurance Code to create an "insurance compliance self-evaluative audit document" privilege, which would mean that the document could not be admitted as evidence in a civil, criminal, or administrative proceeding and a person who prepared the audit could not be compelled to testify about it. The bill also would do the following:

-- Provide for the confidentiality and privilege of a document submitted to the Commissioner of the Office of Financial and Insurance Services (OFIS).

-- Specify that the privilege would not apply if a court required disclosure after a private hearing.

-- Establish the burden of proof for asserting a privilege or grounds for disclosure.

-- Exempt specific information from the privilege.

"Insurance compliance self-evaluative audit document" would mean a document prepared as a result of or in connection with an insurance compliance audit, and could include a written response to the findings of such an audit. (This term is described more fully below.) "Insurance compliance audit" would mean a voluntary, internal evaluation, review, assessment, audit, or investigation for the purpose of identifying or preventing noncompliance with or promoting compliance with laws, regulations, orders, or industry or professional standards, conducted by or on behalf of an insurer licensed or regulated under the Code or involving an activity regulated under the Code.

Creation of Privilege

Except as otherwise provided in the bill, an insurance compliance self-evaluative audit document would be privileged information and would not be discoverable or admissible as evidence in any civil, criminal, or administrative proceeding. Also, except as otherwise provided in the bill, a person involved in preparing such an audit or audit document would not be subject to examination concerning the audit or audit document in any civil, criminal, or administrative proceeding. If the audit or audit document or any portion of it were not privileged, however, the individual involved in its preparation could be examined concerning the portion that was not privileged.

If the document were disclosed to a governmental agency, whether voluntarily or as compelled by law, the disclosure would not constitute a waiver of the privileges with respect to any other person or governmental agency.

Neither of the proposed privileges would apply to the extent that it was expressly waived by the insurer that prepared the document or caused it to be prepared.

The bill states that it would not limit, waive, or abrogate the scope or nature of any other statutory or common law privilege.

Submission to Commissioner

If an insurance compliance self-evaluative audit document were furnished to the Commissioner voluntarily or as a result of a request of the Commissioner under a claim of authority to compel disclosure under the bill, the Commissioner could not provide the document to any other person, and it would have to be given the same confidentiality and protections as provided in Section 222(7) of the Code, without waiver of the privileges described above. Any use of the document would be limited to determining whether any disclosed defects in an insurer's policies and procedures or inappropriate treatment of customers had been remedied or that an appropriate plan for remedy was in place. (Section 222(7) requires an examination report to be withheld from public inspection until it is finalized and filed with the Commissioner; allows the Commissioner to withhold any examination report from the public as long as he or she considers proper; and provides that all information furnished to the OFIS and related to an examination report or investigation is confidential.)

An insurance compliance self-evaluative audit document submitted to the Commissioner would remain subject to all applicable statutory or common law privileges, including the work product doctrine, the attorney-client privilege, and the subsequent remedial measures exclusion. A document submitted to the Commissioner would remain the property of the insurer and would not be subject to disclosure under the Freedom of Information Act.

Court-Required Disclosure

The privileges proposed by the bill would not apply if a court, after an in camera (private) review, required disclosure in a civil, administrative, or criminal proceeding after determining that the privilege was asserted for a fraudulent purpose and/or that the material was not subject to the privilege as provided in the bill.

The privileges also would not apply in a criminal proceeding if the court determined, after an in camera review, that the material contained evidence relevant to the commission of a criminal offense under the Code, the Commissioner or the Attorney General had a compelling need for the information, the information was not otherwise available, and the Commissioner or Attorney General was unable to obtain the substantial equivalent of the information by any means without incurring unreasonable cost and delay.

Within 30 days after the Commissioner or the Attorney General made a written request by certified mail for disclosure of an insurance compliance self-evaluative audit document, the insurer that prepared the document or had it prepared could file with the Ingham County Circuit Court a petition requesting an in camera hearing on whether the document or portions of it were subject to disclosure. An insurer's failure to file a petition would waive the privilege for that request. An insurer asserting the privilege in response to a request for disclosure would have to include all of the following information:

-- The date of the document.

-- The identity of the entity or individual conducting the audit.

-- The general nature of the activities covered by the audit.

-- An identification of the portions of the document for which the privilege was being asserted.

Within 45 days after the petition was filed, the court would have to issue an order scheduling an in camera hearing.

If a court required disclosure as described above, it could compel the disclosure of only those portions of a document relevant to issues in dispute in the underlying proceeding. Information required to be disclosed would not be considered a public document or a waiver of the privilege for any other civil, criminal, or administrative proceeding.

Assertion of Privilege

An insurer asserting the proposed privilege in response to a request for disclosure by the Commissioner or the Attorney General, would have to give the Commissioner or the Attorney General, at the time of filing any objection to the disclosure, the same the information that would have to be included if an insurer filed a petition for an in camera hearing.

The insurer would have the burden of demonstrating that the privilege applied. Once the insurer had met that burden, a party seeking disclosure in a civil or administrative proceeding on the ground that the privilege was asserted for a fraudulent purpose, would have the burden of proving that. If the Commissioner or Attorney General were seeking disclosure in a criminal proceeding on the ground that the material contained relevant evidence that was not otherwise available, the Commissioner or Attorney General would have the burden of proving the elements of that ground for disclosure.

In proceedings under the bill, the parties could stipulate at any time to entry of an order directing that specific information contained in an insurance compliance self-evaluative audit document was or was not subject to the proposed privilege. Any such stipulation could be limited to that particular proceeding and, absent specific language to the contrary, would not apply to any other proceeding.

Exceptions

The privileges proposed by the bill would not extend to any of the following:

-- Documents, communications, data, reports, or other information expressly required to be collected, developed, maintained, or reported to a regulatory agency under the Code or other Federal or State law.

-- Information obtained by observation or monitoring by any regulatory agency.

-- Information obtained from a source independent of the insurance compliance audit.

Definition

An insurance compliance self-evaluative audit document could include field notes and records of observations, findings, opinions, suggestions, conclusions, drafts, memoranda, drawings, photographs, exhibits, computer-generated or electronically recorded information, phone records, maps, charts, graphs, and surveys, if this supporting information were collected or developed for the primary purpose and in the course of an insurance compliance audit. An insurance compliance self-evaluative audit document also would include any of the following:

-- An insurance compliance audit report prepared by an auditor, who could be an employee of the insurer or an independent contractor. The report could include the scope of the audit, the information gained in it, and conclusions and recommendations, with exhibits and appendices.

-- Memoranda and documents analyzing portions or all of the insurance compliance audit report and discussing potential implementation issues.

-- An implementation plan that addressed correcting past noncompliance, improving current compliance, and preventing future noncompliance.

-- Analytic data generated in the course of conducting the insurance compliance audit.

Proposed MCL 500.221

ARGUMENTS

(Please note: The arguments contained in this analysis originate from sources outside the Senate Fiscal Agency. The Senate Fiscal Agency neither supports nor opposes legislation.)

Supporting Argument

The bill would encourage insurance companies to undergo self-evaluations to identify noncompliance with the law and promote compliance. Since insurance regulations are complex and constantly changing, it is entirely possible that an insurer might inadvertently fail to comply with current law. For example, a statute governing the computation of interest on an annuity might be amended to require a different actuarial standard. If an insurer is not aware that the law was changed, it will continue to calculate interest based on the original standard. Then, if an independent audit uncovers this practice, the insurer will have a chance to correct it and, if necessary, repay policy holders. If the audit became public, however, the insurer could be exposed to litigation and sanctions. To avoid these consequences, therefore, the insurer might simply not undergo the audit, which means that its noncompliance would remain undiscovered and uncorrected. Insurers should not be penalized for taking steps to improve their performance and ultimately benefit their policy holders.

According to a representative of the Life Insurance Association of Michigan, Illinois enacted similar legislation that has worked well for five years, and New Jersey, North Dakota, and Oregon have enacted other versions of the confidentiality protections for insurers.

Supporting Argument

Michigan law already allows other industries to perform self-evaluations that are confidential. In particular, the Banking Code of 1999 permits banks to appoint compliance review committees to evaluate their compliance with Federal and State requirements. The Code specifies that material gathered or prepared for a compliance review committee is confidential and not discoverable or admissible in evidence in any civil action, unless otherwise required by law (MCL 487.13902). Also, the Natural Resources and Environmental Protection Act provides for the confidentiality of environmental audits, which are voluntary, internal evaluations of facilities subject to State, Federal, or local controls (MCL 324.14801 et seq.). Under the Act, environmental audit reports are not subject to discovery or admissible as evidence in any civil, criminal, or administrative proceeding. Like financial institutions and businesses subject to environmental laws, insurance companies see the value of self-initiated audits but fear that the audit information could be used by regulatory agencies to identify areas of violation for enforcement action.

In addition, statutes and common law provide for a number of privileges, such as the attorney-client privilege and the physician-patient privilege, which permit the parties to communicate without fear of disclosure. The bill would create a similar protection for the communication between an insurer and an auditor.

Response: As noted above, the confidentiality allowed for banks applies only to civil proceedings. The documents subject to this privilege also are more narrowly defined than the material under the bill. Perhaps the proposed privilege for insurers should be similarly limited.

Supporting Argument

The Insurance Marketing Standards Association (IMSA) was created several years ago to function as an independent certification body for insurers that sell individual life insurance and annuity policies and long-term care insurance. To become an IMSA member, an insurer must undergo both a self-assessment and an assessment by an outside, independent examiner; to remain a member, the insurer must repeat this process every three years. An insurer also is required to have a monitoring system (which may include internal auditing) to ensure its compliance with the Association's code of conduct and with applicable laws and regulations. If an insurer meets the Association's high ethical standards, IMSA will award its "seal of approval". Although the insurance industry appears to be enthusiastic about the Association and the concept of third-party certification, insurers are reluctant to participate because they do not want the audit report to become public. By creating a privilege for self-evaluation audits, the bill would encourage insurers to join an organization that promotes honesty, integrity, and sound marketing practices.

Opposing Argument

The process required for obtain an audit document would be unduly time-consuming and cumbersome, and would severely impede the Commissioner's access to information involving insurance carriers in Michigan. First, the Commissioner or the Attorney General would have to make a request for disclosure by certified mail. The insurer then would have 30 days to file a petition. After the petition was filed, the court would have up to 45 days to schedule a hearing, which would not have to be held by any specific deadline. Although time could be of the essence, the parties could spend months simply preparing to argue the privilege before the issue of compliance was even addressed.

Response: The bill is based on a model act developed by the National Conference of Insurance Regulators. Perhaps the time frames could be adjusted to accommodate these concerns.

Opposing Argument

The bill would make it unreasonably difficult for the Commissioner or the Attorney General to obtain information relevant to a criminal offense. The Commissioner or Attorney General would have to prove a "compelling need", that the information was not "otherwise available", and that a "substantial equivalent" could not be obtained without "unreasonable cost and delay". The use of these terms could cause lengthy litigation as both sides argued their meaning. Also, the bill would create a "Catch-22" by requiring the Commissioner or Attorney General to prove that he or she needed information before gaining access to it. Without a way to retrieve the information, it could be virtually impossible to prove the need for it. Furthermore, according to the OFIS, there is some question as to whether a court could withhold evidence of criminal activity in any case.

Opposing Argument

There is concern that the bill could preempt the Commissioner's examination authority found in Section 222 of the Insurance Code. This section authorizes the Commissioner or his or her representatives to examine any or all of the books, records, and documents of an insurer at any time after it has been incorporated or authorized to do business in this State. Section 222 also requires the Commissioner or his or her representatives to examine the books, records, and documents of each authorized insurer at least once every five years. In addition, the business affairs, assets, and contingent liabilities of insurers are subject to examination by the Commissioner at any time.

According to supporters of the bill, the proposed privilege would apply only to a self-audit "document", and would not interfere with the Commissioner's existing access to information. Under the bill's definition, however, the document could include virtually any item collected or developed for the purpose of the audit. This could leave the Commissioner in the position of having to prove that the information sought was not subject to the definition or produced specifically for the audit. Although the privilege would not apply to documents or information "expressly required to be collected, developed, maintained, or reported to a regulatory agency", the Commissioner still would have to go though the hearing process and wait for a court to determine that the exception applied. In practical terms, the Commissioner's access to information would be seriously compromised.

- Legislative Analyst: S. Lowe

FISCAL IMPACT

The bill would have no fiscal impact on State or local government.

- Fiscal Analyst: M. TyszkiewiczA0102\s674a

This analysis was prepared by nonpartisan Senate staff for use by the Senate in its deliberations and does not constitute an official statement of legislative intent.