In recent months, life insurers across the country have faced a new onslaught of putative cost of insurance class actions. These cases bring novel theories but may also revive a decades-old jurisprudential debate over whether a seemingly simple phrase—“based on”—indicates an exhaustive list of factors meant to provide the sole basis for calculating cost of insurance rates.
Background: The proper interpretation of “based on”?
Universal life insurance policies include various periodic charges, including a cost of insurance (COI) charge. COI is typically not defined in the policy. Instead, the policy prescribes guaranteed maximum COI rates and the insurer reserves discretion to set COI rates below these maximums. The rates themselves are set by actuaries in a complex process that considers a number of factors. The policy often also includes a paragraph discussing the determination of COI rates. A typical policy provides as follows:
The cost of insurance rate is based on the insured’s sex, issue age, policy year, and payment class. The rates will be determined by us, but they will never be more than the guaranteed rates shown on Page 5.
See, e.g., Norem v. Lincoln Benefit Life, 737 F.3d 1145, 1147 (7th Cir. 2013).
Over the last two decades, courts have split on whether paragraphs such as the one above should be construed as limiting the insurer's discretion in setting COI rates. The central dispute is whether the enumerated factor or factors which follow the “based on” phrase are intended to be an exhaustive list of factors that can be considered in calculating the COI rate.
The Seventh Circuit has concluded the phrase is not exhaustive: instead, the phrase “based on” connotes a descriptive list, reasoning by analogy that “no one would suppose that a cake recipe ‘based on’ flour, sugar, and eggs must be limited only to those ingredients.” Norem, 737 F.3d at 1149–1150.The court also rejected plaintiff’s argument that the insurer’s interpretation violated the rule against writing terms into a contract that could easily have been included but were not. Instead, it was plaintiff's proffered interpretation that required the insertion of an additional term—"solely" or "exclusively"— into the COI paragraph. In support of its reasoning, the court considered the policy language in the context of the standard insurance industry practice of considering numerous factors (beyond those enumerated) to set COI rate scales, noting that it would be impossible to calculate the COI rate based solely on the enumerated factors without some sort of mathematical formula or underlying data assumptions. Id. at 1152. In that context, the enumerated factors only serve to give the policyholder “a sense of which factors unique to him will affect his ultimate COI rate.” Id. at 1150.
The Seventh Circuit resolved a similar dispute involvinga COI provision in Thao v. Midland National Life Ins. Co., 549 Fed. Appx. 534 (7th Cir. 2013) (non-precedential opinion). The COI provision at issue in Thao stated: “[The insurer] may declare Cost of Insurance Rates [. . .] that differ from those stated in the Schedule of Policy Benefits. Changes in the Cost of Insurance Rates are based on the Issue age, completed Policy Years, Sex, Specified Amount, and Premium Class of the Insured.” Id. at 536–37 (emphasis added). Relying on its holding in Norem, supra, the Seventh Circuit held that "… when the policy says that the monthly cost of insurance rate will be 'based on' specified factors, it does not mean that the rate will be based exclusively on those factors. Rather, it signifies that the named factors will have a significant, foundational role in determining the rate.” Id. at 537 (internal citations omitted).
The Seventh Circuit’s more nuanced reasoning has not been adopted by all courts, however. Several district courts have reached a contrary result by strictly construing the plain terms of the policy to conclude that “based on” connotes an exhaustive list of factors an insurer may consider in calculating COI rates. See Dean v. Omaha Life Ins. Co., 2007 WL 7079558 (C.D. Cal. 2005); In re Conseco Life Ins. Co., 2012 WL 2917227 (N.D. Cal. 2012); Rosenbaum v. Philadelphia Life Ins. Co.,Case No. 93-0834, B52 (C.D. Cal. Mar. 1, 1994) (“There is nothing in the [policy] language which suggests that the cost of insurance is based on, among other factors, [the Company’s] expectations as to future mortality experience”) (emphasis added).
Adding to the confusion, some courts have held that the disagreement as to the meaning of the term “based on” in the COI context creates an ambiguity to be construed against the insurer. Dean v. Omaha Life Ins. Co., 2007 WL 7079558, at *3–6 (C.D. Cal. 2005) (finding that “based on” language created an ambiguity); see also Fleisher v. Phoenix Life Ins. Co., 18 F. Supp. 3d 456, 473–74 (S.D.N.Y. 2014) (holding that the existence of competing jurisprudence renders the phrase “based on” ambiguous as a threshold matter but also holding that a COI increase was properly based on an enumerated factor).
Recent putative COI class actions
In recent months, a wave of putative class actions challenging COI rates has brought heightened attention to this COI debate. Like previous COI cases, plaintiffs in these recent lawsuits contend the insurer may only calculate COI rates based solely and exclusively on the enumerated list of factors. These new COI lawsuits also raise some new theories of liability.
For example, some insurers face claims from policyholders arguing they improperly failed to lower their COI rates, despite recent improved mortality experience. Additionally, some policyholders are pursuing fraud theories, alleging their insurers claim to be increasing COI rates based upon one or more of the enumerated factors while allegedly being motivated instead by allegedly improper ulterior motives, such as a desire to increase profits or to recoup past losses. It remains to be seen how the courts will address these (and other) new theories.
These cases underscore the importance of careful policy drafting. Those insurers who have recently announced, or are considering, COI increases should carefully monitor the latest wave of COI litigation as Plaintiffs are pursuing both old and new theories of liability.
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