“Based on” What? Courts Split over Cost of Insurance Rates

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. While 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 (i.e., 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.¹ 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. Thus, neither the dictionary definitions nor the common understanding of the phrase “based on” suggest that [the insurer] is prohibited from considering factors beyond [the enumerated factors of] sex, issue age, policy year, and payment class when calculating its COI rates.²

The Norem court also found it significant that the policy terms at issue in the case included a maximum guaranteed COI rate, which the insurer had never exceeded. The court noted that the guaranteed maximum rates were “based on” standard mortality tables. The court said that “[i]t is thus difficult to characterize [the plaintiff’s] COI rate, which is less than the guaranteed rate in the 1980 [Commissioners Standard Ordinary Mortality] table, as an inflated figure over and above what he identifies as ‘mortality experience.’”³ Instead, the court found that the COI provision “is more reasonably read as containing two parts: first, an explanatory clause listing key components of the COI rate; and second, a guaranteed rate that allows a policyholder to see the maximum COI charge that could be deducted from his policy value.”⁴ The plaintiff could not prevail, said the court, because he wanted mortality factors to be the exclusive elements in the COI charge, but this argument was not consistent with the policy language.

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. that an insurer has broad discretion to set rates, comparing the COI issue to the setting of rates on package shipping.⁵ 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. According to the court:

[T]he customer [sending a package] would understand that what the company meant is that it has a pricing schedule that is organized by size, weight, and destination—not that the company considered only size, weight and destination when setting the rates that appear on the schedule. The customer would understand that the shipper had to consider a wide range of factors when setting its rates, such as the cost of fuel, employee salaries, competitor’s prices, and the need to earn a profit.⁶

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. that an insurer may only consider factors specifically enumerated in the policy when raising COI rates on a life insurance policy.⁷ 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.”⁸ The court rejected the insurer’s argument that it was implicitly entitled to consider other factors. According to the court:

[I]t would be perfectly plausible—and certainly not unreasonable—for an average insured to conclude . . . that when [the insurer] says it will calculate the COI rate for a particular Policy Month “based on” six specifically enumerated factors, those are the only six factors it will take into account when adjusting the rate.⁹

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.”¹⁰

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.

In the cookbooks I read, recipes are exhaustive lists of all the ingredients needed to bake a cake. . . . There is nothing in either policy to suggest that the listed factors are merely a starting point for the rate calculation, and that the insurance company is free to add a dollop of Undisclosed Factor A and a dash of Undisclosed Factor B in order to “season” the COI rate to its liking.¹¹

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.”¹² 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, 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.¹³ 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.”¹⁴ 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.”¹⁵ 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, and 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. n

Notes

1. 737 F.3d 1145 (7th Cir. 2013).

2. Id. at 1150.

3. Id.

4. Id. at 1152.

5. 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).

6. Id. at *2.

7. 18 F. Supp. 3d 456 (S.D.N.Y. 2014). The court reiterated this holding in a subsequent decision in U.S. Bank Nat’l Ass’n v. PHL Variable Ins. Co., Nos. 12-cv-6811, 13-cv-1580, 2014 WL 2199428 (S.D.N.Y. May 23, 2014).

8. Fleisher, 18 F. Supp. 3d at 463–64.

9. Id. at 471.

10. Id.

11. Id. at 473.

12. Id. at 470–74 (citing Yue v. Conseco Life Ins. Co., No. CV 08-1506, 2011 WL 210943 (C.D. Cal. Jan. 19, 2011); Jeanes v. Allied Life Ins. Co., 168 F. Supp. 2d 958 (S.D. Iowa 2001)).

13. 33 N.E.3d 1160, 1168 (Ind. Ct. App.), transfer granted, 37 N.E.3d 493 (Ind. 2015).

14. Id.

15. Id.