Insurance Law

Inclusive Communities: Supreme Court Recognizes Disparate-Impact Claims Under FHA – Implications for Property Insurers

By Kathleen A. Birrane, David D. Luce, and Peter S. Rice

By a five-to-four margin, the Supreme Court of the United States has held that “disparate-impact claims are cognizable under the Fair Housing Act.” Texas Dep’t of Hous. & Cmty. Affairs v. Inclusive Cmtys. Project, Inc., 576 U.S. ___ (2015), [subscribers can access an enhanced version of this opinion: lexis.com | Lexis Advance].

While the majority opinion, authored by Justice Anthony M. Kennedy, relies on both the language and the history of the Act in reaching that conclusion, it is clear (as the dissent notes) that the majority was concerned primarily with preserving what it perceives to be a critical tool in “moving the Nation toward a more integrated society.” The Court recognized, however, that disparate-impact claims are particularly susceptible to abuse and, thus, imposed significant and specific conditions on the elements of such claims.

The Court’s ruling, issued on June 25, is important to property insurers that write homeowner’s insurance.  The Department of Housing and Urban Development  applies the Fair Housing Act, 42 U.S.C. §§ 3601-3631, [subscribers can access an enhanced version of this statute: lexis.com | Lexis Advance], (the FHA) to the issuance of homeowner’s insurance. 24 C.F.R. 100.70(d)(4), [subscribers can access an enhanced version of this regulation: lexis.com | Lexis Advance].  More significantly, as it confirmed in the preamble to its 2013 disparate-impact rule, HUD takes the position that insurers may be held liable on a disparate-impact theory with respect to underwriting and rating decisions made in the issuance of housing related insurance products.  See, Implementation of the Fair Housing Act’s Discriminatory Effects Standard, 78 Fed. Reg. 11.460 (Feb. 15, 2013) (the HUD Rule), [subscribers can access an enhanced version of this regulation: lexis.com | Lexis Advance].  In affirming that position, HUD dismissed the argument of the insurance industry that the application of disparate-impact liability to insurers under the FHA would violate the reverse preempt provisions of the McCarron-Ferguson Act, as well as arguments that the HUD Rule expanded disparate-impact liability beyond the scope previously recognized by the Supreme Court and was unconstitutional.

In light of HUD’s position, property insurers have been sued for housing discrimination under the FHA on disparate impact theory with respect to underwriting and rating guidelines that prohibit or surcharge coverage for dwellings that have flat roofs or that are certified as Section 8 housing.  Plaintiffs argue that, regardless of their facial neutrality and even enforcement, such guidelines/rating rules violate the FHA because they allegedly have a disparate impact on protected classes in certain geographic areas.  For example, in Viens v. American Empire Surplus Lines Insurance Co.; Fair Housing Continuum v. International Catastrophe Insurance Managers, LLC; and Jones v. Travelers and Brevard Neighborhood Development Coalition v. International Catastrophe Insurance Managers, LLC, the plaintiffs rely on the demographic profile of Section 8 voucher-holders as their prima facia evidence of discrimination.

Disparate-impact claims, by their nature, are not premised on intentional discrimination, otherwise referred to as disparate treatment.  Disparate impact “challenges practices that have a ‘disproportionately adverse effect on minorities’ and are otherwise unjustified by a legitimate rationale.” Inclusive Cmtys., 576 U.S., at ___ (slip op., at 1). (quoting Ricci v. DeStefano, 557 U.S. 557, 577 (2009)), [subscribers can access an enhanced version of this opinion: lexis.com | Lexis Advance].   Recognizing the amorphous nature of such cases, the Court devoted a significant portion of its opinion to describing the safeguards that must be employed by lower courts in order “to protect potential defendants against abusive disparate-impact claims.” The Court noted that “disparate-impact liability has always been properly limited in key respects” in order to avoid the “serious constitutional questions” that would arise if, in order to avoid such claims, the protected characteristic (such as race) is “used and considered in a pervasive way.”  576 U.S.  at ___ (slip op. at 18, 20).

The Court emphasized that lower courts must “examine with care” disparate-impact claims “at the pleading stage” and cautioned that “‘[r]acial imbalance … does not, without more, establish a prima facie case of disparate impact …’  Rather, a plaintiff must plead and prove a “robust” causal connection between the defendant’s policies and the disparity shown.  Such proof is necessary to “protect[ ] defendants from being held liable for racial disparities they did not create.”  Id. at ___ (slip op., at 20).

Even where a prima facie case is established, a defendant’s policies “are not contrary to the disparate-impact requirement unless they are ‘artificial, arbitrary, and unnecessary barriers.’”  Id. at ___ (slip op., at 21).  Disparate-impact liability is not intended to “displace valid governmental and private priorities.” In that regard, both the majority opinion and the dissent drew particular attention to Gallagher v. Magner, 619 F.3d 823 (2010), [subscribers can access an enhanced version of this opinion: lexis.com | Lexis Advance], in which the Eighth Circuit held that the City of St. Paul’s “aggressive enforcement” of its Housing Code was actionable as discrimination under the FHA, solely because minorities were disproportionately impacted by rent increases that followed the City’s enforcement actions.  Id. at 830, 834 – 35.   The Court made it clear that cases like Manger do not meet the “cautionary standards” required to assure that putative defendants are not “prevented from achieving legitimate objectives,” such as complying with other laws, such as health and safety codes.  Inclusive Cmtys., 576 U.S., at ___ (slip op., at 21, 22).

Furthermore, where courts do find disparate-impact liability, “remedial orders” must “concentrate on the elimination of the offending practice.” Courts must strive to design measures to “eliminate racial disparities through race-neutral means.”  Id. at ___ (slip op., at 22).

Inclusive Communities was not decided on the basis of, and does not directly address, the HUD Rule.  However, the enforceability of disparate-impact liability as set forth in the HUD Rule is questionable, given the restrictions clearly placed on the application of that theory by the Court.  It is unclear at this juncture whether HUD will revise the Rule or otherwise act to  bring the Rule into clear alignment with the Court’s directives or will leave that task to the courts.

Inclusive Communities also does not resolve whether disparate-impact liability may be applied to insurers or whether McCarran-Ferguson preempts the FHA insofar as the application of disparate-impact analysis and theories of liability conflict with, and would violate or force insurers to violate, state laws that regulate their underwriting and rating practices.  Those issues were addressed in two federal cases decided in 2014, one of which vacated the HUD Rule and the other of which remanded it to HUD for further consideration of McCarran-Ferguson.  In Prop. Cas. Ins. Ass’n. v. Donovan, [subscribers can access an enhanced version of this opinion: lexis.com | Lexis Advance], the United States District Court for the Northern District of Illinois concluded that HUD had failed to consider the inconsistency between the HUD Rule and the nature of insurance rating, as well as the significance of the McCarran-Ferguson Act and remanded the HUD Rule to HUD for further consideration.  No. 13-8564, 66 F. Supp. 3d 1018 (N.D. Ill. Sept. 3, 2014).  In Am. Ins. Assn. v. Dep’t of Hous. and Urban Dev., 74 F. Supp. 3d 30 (D.D.C. Nov. 7, 2014), [subscribers can access an enhanced version of this opinion: lexis.com | Lexis Advance], the United States District Court for the District of Columbia vacated the HUD Rule outright on the ground that the FHA only prohibits disparate treatment and, thus, HUD had no authority to issue the Rule and adopt a disparate impact standard in the first instance.   Id. at *7-*13.  The DC District Court also found that the application of the disparate impact standard to insurers would run afoul of McCarran-Ferguson, noting that consideration of disparate impact would require insurers to “mak[e] corrective underwriting, rating and pricing adjustments to recalibrate away from risk and towards parity of ‘impact.’”  Id.  at *11 n. 30.  Thus, the Court concluded, differences in underwriting and rating would no longer be premised on neutral characteristics determined statistically to be predictive of loss, but, rather, would force carriers to base decisions on those very characteristics which they are prohibited by state law from considering.  Id.  at *11.  Donovan was not appealed by HUD.   AIA is currently on appeal.  The status and impact of these cases is unclear following Inclusive Communities, but it is unlikely that the questions which are of concern to homeowner’s insurers that are left open by the case will be resolved any time soon.

As these issues await clarification, insurers should continue to anticipate and be prepared to defend claims attacking their underwriting and rating practices under disparate-impact theory.  The defense of such cases begins with the analysis of McCarran-Ferguson and the line that it draws with respect to the application of the FHA in general and disparate-impact theory in specific to insurers.  For cases that move beyond that hurdle, insurers must argue against the applicability of the HUD Rule, relying on the limitations and safeguards set forth in Inclusive CommunitiesIt will be incumbent on insurers to distinguish between the language of the HUD Rule and the clear directives regarding limitations on disparate-impact liability articulated in Inclusive Communities.

In addressing the specific allegations of a disparate-impact claim focused on rates, property insurers have the benefit of their loss cost analysis and rate making/rate approval processes in defending rates as race neutral and justified by business needs.  Insurers must likewise be prepared to identify and to justify the basis of their underwriting guidelines from a loss cost basis and to demonstrate that their underwriting standards are not artificial and  represent valid and neutral business decisions. This exercise can be time consuming for large insurers with multiple writing companies and products, particularly where entities have been acquired and underwriting standards have converged over time.  The challenge that some insurers have had in producing such information in litigation has emboldened plaintiffs’ counsel and, in some cases, has been touted as evidence that the offending guidelines are a substitute for red-lining.

While not the boon that plaintiffs’ counsel and certain advocates would have liked, the Supreme Court’s decision in Inclusive Communities did not, as the industry had hoped, offer property insurers protection from disparate-impact claims in connection with the underwriting and pricing of policies issued to housing property owners.  The extent to which McCarron-Ferguson will be held to preempt the application of such claims, as well as the final interpretation of the HUD Rule, will play out in the district and appellate courts over time and are unlikely to be finally resolved for years.

In the meantime, property insurers should  take the instruction of Inclusive Communities and begin to lay the foundation of solid legal and factual defenses to the suits that may well follow.

Find out more about the implications of this important decision by contacting the authors.

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