In Phillips v. Prudential Insurance Co. of America, No. 11-3870 (7th Cir. May 6, 2013), the Seventh Circuit recently affirmed dismissal of a putative class action that challenged a life insurer’s use of “retained asset accounts” to make payment of the policy’s benefits. On behalf of a putative class, Zena Phillips sued Prudential, alleging that by not paying her policy benefits in a lump sum, it breached an insurance policy, its statutory duty of good faith, and its fiduciary duties. The policy gave Michael Strang (the insured) and Ms. Phillips (his beneficiary) the choice of the way in which Prudential would pay the policy’s death benefit. Upon Mr. Strang’s passing, Prudential sent Ms. Phillips a claim form listing various options for it to pay her. While the policy entitled Ms. Phillips to elect a lump-sum payment, the claim form did not mention that option. Instead, the form permitted Ms. Phillips to write on the form any other “payment option allowed in the policy.” Ms. Phillips, however, did not express any preference, so Prudential used the death benefit to fund a retained asset account held within Prudential’s general investment account. Ms. Phillips could draw on this account as she pleased at any time. Prudential guaranteed that Ms. Phillips’s account would accrue interest at 3%, while Prudential kept any investment returns exceeding 3%.

The Seventh Circuit upheld dismissal of Ms. Phillips’s complaint, finding that Prudential did not breach the insurance policy because, by returning the claim form without selecting a payment option, Ms. Phillips selected the retained asset account by default. The policy explicitly contemplated this result. Moreover, the Court held that Prudential did not commit statutory bad faith because tendering the retained asset account to her did not delay payment of the death benefit. Finally, Prudential did not owe Ms. Phillips any fiduciary duties that it could breach: by holding the funds in its investment account, Prudential was a mere debtor, not a fiduciary.

Such use of retained asset accounts has been controversial, and regulators have acted to curb this practice. For example, the Illinois Insurance Code’s Section 5/244(l) requires an insurer to pay a beneficiary benefits plus interest at a rate of 10% per year if it does not pay the policy benefits quickly enough. Payment in the form of a retained asset account could permit the insurer to keep – and continue to invest – those benefits without paying 10% interest. The funds are taken from the insurer only as the beneficiary withdraws them from the account. Notably, in a Company Bulletin issued after Prudential set up Ms. Phillips’s account, the Illinois Department of Insurance determined that retained asset accounts – when the funds are, to use the Bulletin’s words, “held by the insurer” – do not spare an insurer from accruing interest under Section 5/244(l). It is not clear what effect this Bulletin would have in a beneficiary’s lawsuit against an insurance company, given that the Bulletin is merely the Department’s interpretation of Section 5/244(l). Certainly, the Illinois regulator’s statutory interpretation must be considered carefully, but it is not equivalent to an interpretation of an Illinois court. It is also not clear whether an insurer can comply with this Bulletin by having an affiliate hold the funds.

A copy of the Seventh Circuit’s decision can be found here.