Texas Department of Housing and Community Affairs and Its Potential Impact on Underwriting Policies and Procedures

Insurance & Reinsurance Newsletter
May 2016

In Texas Department of Housing and Community Affairs v. Inclusive Communities Project, Inc., 135 S. Ct. 2507 (2015), one of the most watched cases of 2015, the Supreme Court held that plaintiffs may rely on a disparate impact theory to establish a violation of the Fair Housing Act (“FHA”). Unlike direct discrimination claims, disparate impact liability does not require any evidence of intentional discrimination by a defendant. Historically plaintiffs have often established liability or at least compelled defendants to entertain plaintiff-friendly settlements by relying almost exclusively on statistical evidence to show that a facially neutral policy was discriminatory because of the particularly negative impact it had on a protected class. In recent years, the plaintiffs’ bar, as well as the Department of Housing and Urban Development (“HUD”), have increased their efforts to utilize disparate impact analysis to challenge insurance underwriting practices that many in the industry long thought were beyond the scope of the FHA. As a result of the Texas Department of Housing decision, that trend is likely to continue and a different landscape will emerge as the government and plaintiffs’ attorneys attempt to employ disparate impact allegations within the broad framework outlined by the Court, while insurers and state regulators adjust and adapt to the business implications of the Court’s decision.

Although the Court’s 5 to 4 opinion, written by Justice Kennedy, was most notable for the holding that disparate impact claims are cognizable under the FHA, the Court also noted that disparate impact claims were not without limits. For example, the Court made clear that disparate impact liability based solely on a showing of statistical disparities would not be sufficient to establish liability under the FHA and could present serious constitutional questions. The Court also emphasized that disparate impact liability is not intended to overturn legitimate governmental or business decisions. Accordingly, the Court instructed trial courts to “… examine with care whether a plaintiff has made out a prima facie case of disparate impact.” Id. at 2523. The Court also broadly outlined an approach to resolving disparate impact claims that begins with the requirement that the plaintiff plead facts sufficient to demonstrate that the defendant has a concrete policy or practice that caused a disparate impact on a protected class, but also permits the defendant to establish a “valid interest” in the subject policy or practice that, at least in some circumstances, will outweigh the negative impact on the protected class.

At first glance, the Court’s outline looks distressingly similar to the test proposed by HUD in its earlier rule making exercise. That facial similarity may well embolden plaintiffs’ attorneys to continue the pursuit of what they perceive to be hidden discrimination resulting from otherwise facially neutral policies and practices. If so, the insurance industry needs to gird itself for another wave of litigation.

Given the inherently subjective nature of the risk analysis that lies at the heart of the underwriting process, underwriting guidelines and procedures are particularly susceptible to attack under a disparate impact theory. For example, a decision by an insurer not to underwrite certain risks in a particular region based solely on loss history and actuarial analysis may be challenged if the decision disproportionately impacts members of a protected class. Similarly, utilizing an underwriting guideline that considers an insured’s or the insured’s tenants’ sources of income, tenant make-up, age of the premises or even the type or style of construction may present similar problems.

In an effort to comply with the first step in the Supreme Court’s analysis, resourceful plaintiff’s counsel will develop data purporting to link such facially neutral underwriting criteria to an alleged lack of availability of property and casualty or specialty lines insurance in minority neighborhoods and communities or to an alleged increase in the cost of the insurance that is available. If a credible statistical argument can be developed demonstrating a link between a particular underwriting guideline and a specific negative impact on a minority group, the burden will then fall to the defendant company to show a “valid interest” in the form of a necessary connection between the underwriting policy or practice at issue and the reasoned analysis of the degree of risk associated with the hypothetical loss that a particular insurance product is designed to cover. While this may sound simple enough, producing admissible evidence of a business interest in a specific underwriting practice can be challenging. Relevant material would include: industry or company studies linking the challenged underwriting practice to a risk of loss, the date of any such studies, the manner in which any such studies were conducted, countervailing data if any, and the defendant’s internal records relating to the specific policy or practice. In order to establish a “valid interest” the available memoranda and data will need to demonstrate that the defendant’s focus was on the business interest of accurately assessing the risk of loss. But even if a company succeeds in establishing a “valid interest” in maintaining its existing underwriting policies and procedures, the plaintiff could still prevail by showing that other reasonable and less discriminatory alternatives could gauge the risk of loss with equal or greater accuracy.

Largely because of the evidentiary challenges it will present for defendant companies, the Court’s discussion of the ability to defend disparate impact claims by establishing a “valid interest” in maintaining existing policies and procedures will likely have less impact on the development of FHA law, than will Justice Kennedy’s emphasis on the importance of establishing a causal link between the challenged practice and the alleged discriminating impact. It is one thing to present statistical evidence demonstrating that a particular demographic is underserviced by the insurance industry or that certain groups tend to pay more than others for similar coverage. However, it is another thing altogether to establish that a particular underwriting policy or procedure caused a minority community to be underserviced or overcharged. Focusing on the need for such a causal connection, will likely prove to be the most effective line of defense to whatever suits follow in the wake of the Texas Department of Housing decision. Nevertheless, prudence suggests that companies review their underwriting policies and procedures to identify potentially problematic practices and consider whether alternative approaches might be equally effective at gauging the risk of loss without creating the appearance of discrimination by disproportionately impacting protected groups.