Over the past several years, a number of courts have considered the scope of insurer discretion to set cost of insurance (COI) rates for life insurance policies and have reached different results. Although some of the differences can be explained by variations in policy language, this article focuses on several cases that have reached opposite conclusions in interpreting the same language, specifically the phrase “based on.”
Plaintiffs in these cases have typically alleged that COI rates must be based solely on what plaintiffs identify as mortality factors (e.g., age, sex, underwriting class) and cannot include other considerations unless those factors are expressly listed in the contract. The insurance policies at issue often contain a provision stating that COI rates will be “based on” particular factors, and the cases have turned in part on the meaning of that phrase. If COI rates are to be “based on” certain enumerated factors under the policy, must the rates be “solely based on” those factors, or does the insurer have discretion to consider other factors in determining COI rates? Some courts have held that insurers have broad discretion to consider a wide range of factors in setting rates, while other courts have held that an insurer may only consider factors expressly enumerated in the policy. With analogies to cake recipes and package shipping rates, courts continue to disagree on the proper interpretation of these policies.
Judicial reasoning. The only federal appellate court to have considered the issue is the Seventh Circuit Court of Appeals, in a 2013 decision in Norem v. Lincoln Benefit Life Co., 737 F.3d 1145 (7th Cir. 2013). The Seventh Circuit held that the insurer had broad discretion to set COI rates. The court considered the “plain and ordinary meaning” of the phrase “based on,” noting that the dictionary definition is the “main ingredient” or “the fundamental part,” but that the term does not imply exclusivity. By analogy, the court stated, “[N]o one would suppose that a cake recipe ‘based on’ flour, sugar, and eggs must be limited only to those ingredients” (Id. at 1150).
In another illustration of the way courts are approaching this issue, a Wisconsin district court ruled in 2013 in Thao v. Midland National Life Insurance Co., No. 2:09-cv-01158-AEG, 2013 WL 119871 (E.D. Wis. Jan. 9, 2013), aff’d, 549 F. App’x 534 (7th Cir. 2013), that an insurer has broad discretion to set rates, comparing the COI issue to the setting of rates on package shipping. The court reasoned that the insurer was like a shipping company that informed a customer that rates are “based on” the size, weight, and destination of a package. On that basis, the court stated that the insurer had broad discretion to set COI rates, as long as the rates were within the range of the contractual guaranteed maximum rates.
A different interpretation. Two more recent decisions, however, have declined to follow the Seventh Circuit’s reasoning. In April 2014, in a class action challenging a COI rate increase, a New York federal district court stated in Fleisher v. Phoenix Life Insurance Co., 18 F. Supp. 3d 456 (S.D.N.Y. 2014), that an insurer may only consider factors specifically enumerated in the policy when raising COI rates on a life insurance policy. The Fleisher action was the lead case in a series of cases against an insurer challenging a COI rate increase on a block of universal life policies. The plaintiffs alleged, among other theories, that a COI rate increase was a breach of contract because the insurer considered purportedly impermissible factors when deciding to raise rates. Specifically, the plaintiffs contended that the insurer breached the contract by impermissibly considering “funding level”—a factor they say was not permitted by the policy—when it raised COI rates for groups of policyholders who maintained a low cash value.
The Fleisher court devoted much of its opinion to an analysis of what factors could be considered in raising COI rates under the policy at issue and ultimately stated that only enumerated factors could be considered. The policy specifically enumerated six factors, stating: “The Cost of Insurance Charge for a specific Policy Month . . . will be based on our expectations of future mortality, persistency, investment earnings, expense experience, capital and reserve requirements, and tax assumptions” (Fleisher, 18 F. Supp. 3d at 463–64). The court rejected the insurer’s argument that it was implicitly entitled to consider other factors. Because the court believed that the plaintiffs’ interpretation was reasonable, it believed that the contract was at least ambiguous, and “[a]pplying New York’s doctrine of contra proferentem in the insurance context, if there are two or more reasonable interpretations of a phrase in an insurance contract, the Court must prefer the one advanced by the insured to the one advanced by the insurer” (Id. at 471). The New York district court considered and expressly rejected the reasoning from Norem. In declining to follow Norem, the Fleisher court took issue with the Seventh Circuit’s cake analogy. Instead, the court said it found more persuasive the opinions in two other lower court cases, which held that “based on” should be interpreted as “solely based on.” The Fleisher court also noted that Norem was decided under Illinois law and suggested that New York law was different. Notwithstanding its narrow interpretation of the policy at issue, however, the district court in Fleisher found that the insurer could properly consider policy values because they affected the insurer’s expectations of future investment income, one of the factors enumerated in the policy’s COI provision. Accordingly, the court granted the insurer’s motion for summary judgment on the plaintiffs’ breach of contract theory based on alleged consideration of impermissible factors. The case has since been settled.
Most recently, the Indiana Court of Appeals, affirming class certification in Lincoln National Life Insurance Co. v. Bezich, 33 N.E.3d 1160, 1168 (Ind. Ct. App.), transfer granted, 37 N.E.3d 493 (Ind. 2015), reviewed the divergent case law on the issue and agreed with the plaintiff that the insurer’s discretion to set rates was limited to the factors specifically enumerated in the policy. The court stated that “[a]n ordinary policyholder of average intelligence would read the COI rate provision to say that the COI rate is calculated using the factors enumerated and only those factors,” and “[n]o reasonable policyholder” would read the COI rate provision as permitting the insurer to charge “undisclosed fees or costs” (Id.). The court disagreed with Norem and instead found Fleisher persuasive, and on that basis held that “the plain language of the COI rate provision unambiguously precludes [the insurer] from considering factors other than mortality factors when determining COI rates” (Id.). At the time of this writing, the parties in the Indiana litigation have announced that they have reached a settlement.
Conclusion. How courts decide future COI cases will likely depend on a variety of factors, including the policy language, applicable law, and the facts peculiar to each case. The core issue of the meaning of “based on,” however, is one on which the courts that have spoken to date disagree. The Seventh Circuit’s decision in Norem was the first federal appellate case to consider these issues and found that this language did not restrict an insurer’s ability to consider factors not enumerated in the policy’s COI provision. By contrast, the decisions in New York and Indiana held that this phrase limited insurers to considering the enumerated factors.
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This article is an abridged and edited version of one that originally appeared on page 18 of The Brief, Winter 2016 (45:2).
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