Legal Alert: Cost of Insurance Litigation – Insurers Retain Discretion to Set COI Rates in Two Key Victories

by Eversheds Sutherland (US) LLP

In the first federal appellate decisions addressing cost of insurance (COI) charges in life insurance policies, the Seventh Circuit Court of Appeals handed two victories to insurers in opinions issued December 13, 2013. In both decisions (one published and one unpublished), the court held that the policy language at issue did not limit the insurer’s discretion to consider a wide range of factors in setting COI rates.

Litigation has been percolating in a number of cases across the country challenging COI rates. The complaints in the COI cases generally allege that COI rates must be based solely on mortality factors, as defined by plaintiffs (e.g., age, sex, underwriting class), and cannot be increased or set based on other factors. The Seventh Circuit rejected this theory in two cases based on the policy language at issue, and these decisions are a significant victory for the industry in this line of cases. In another recent decision, a federal district court in Florida dismissed a putative class action as barred by a prior class action settlement. This Legal Alert reports on these recent developments in litigation challenging COI charges.

Seventh Circuit Decisions Give Insurers Broad Discretion to Set COI Rates

The recent Seventh Circuit decision in Norem v. Lincoln Benefit Life Company immediately becomes the leading federal appellate case on COI issues. No. 12-1816 (7th Cir. Dec. 13, 2013) In a published opinion, the court held that absent a promise to use a specific formula when calculating a COI rate, an insurer is not bound to consider only those factors listed in a COI provision. Interpreting the policy language at issue, the court affirmed summary judgment for the insurer.

The case arose when the plaintiff brought claims for breach of contract, alleging that COI charges should be based solely on mortality factors expressly identified in the policy. In granting summary judgment, the lower court applied dictionary definitions of “based on” and held that the language in the contract setting the COI rates—“based on the insured’s sex, issue age, policy year, and payment class”—meant that those factors are the foundation, principal components, or fundamental ingredients of the COI rates, but not the exclusive factors to be considered in setting those rates. The lower court held that “[s]o long as the rates remained below the guaranteed rates, defendant had discretion in setting those rates under the policy.” Norem v. Lincoln Benefit Life Company, 2012 WL 1034495, No. 1:10-cv-2233 (N.D. Ill. Mar. 20, 2012).

The Seventh Circuit agreed and affirmed the district court ruling. Like the district court, the Seventh Circuit considered the “plain and ordinary meaning” of the phrase “based on.” The court noted that the dictionary definition of “based on” is the “main ingredient” or “the fundamental part,” but that the term “based on” did 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 sex, issue age, policy year, and payment class when calculating its COI rates.”

The court also found it significant that the policy terms 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. Therefore, the court said that “it is thus difficult to characterize [plaintiff’s] COI rate, which is less than the guaranteed rate in the 1980 CSO table, as an inflated figure over and above what he identifies as ‘mortality experience.’” 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.” 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.

The Seventh Circuit also rejected or distinguished the reasoning of several lower court decisions that reached opposite conclusions. In particular, the court rejected the reasoning of Jeanes v. Allied Life Ins. Co., 168 F. Supp. 2d 958 (S.D. Iowa 2001) and Yue v.Conseco Life Ins. Co., No. CV 08-1506, 2011 WL 210943 (C.D. Cal. Jan. 19, 2011) (Yue I), in which courts held that “based on” should be interpreted as “solely based on.” Sutherland previously reported on this in a Legal Alert entitled "Cost of Insurance Litigation - Recent Ruling on Meaning of "Mortality Experience" and Other Developments." The Seventh Circuit also distinguished Yue v. Conseco Life Ins. Co., 282 F.R.D. 469, 481 (C.D. Cal. 2012) (Yue II) as involving different circumstances and policy language.

On the same day it decided Norem, the Seventh Circuit also issued an unpublished decision in Thao v. Midland National Life Insurance Company, Nos. 13-1272 and 13-2366 (7th Cir. Dec. 13, 2013). Similar to Norem, the insured was appealing a federal district court decision granting summary judgment in favor of an insurer and holding that the COI provision in a universal life policy “does not impose any contraints on the process [the insurer] uses to set its cost-of-insurance rates.” Thao v. Midland National Life Insurance Company, No. 2:09-cv-01158-AEG (E.D. Wisc. Jan. 9, 2013). In this case, the plaintiff brought a putative class action challenging the setting of COI rates on the basis that the insurer allegedly considered factors unrelated to mortality expectations. The plaintiff argued that the insurer was required to set COI rates “based on” five listed factors commonly associated with mortality—issue age, policy years, sex, amount, and premium class—and was not permitted to consider other factors.

The Seventh Circuit affirmed summary judgment in favor of the insurer, finding that the issue was resolved by Norem. Where the policy language stated that the “cost of insurance rates are based on the issue age, completed policy years, sex, specified amount, and premium class,” the contract did not limit the insurer’s calculation of the COI rate to the factors expressly identified. The insurer was contractually permitted to consider additional factors in setting the rates.

A Florida Federal Court Dismisses Putative Class Action as Barred by Prior Class Settlement

On December 10, 2013, a federal district court in Florida granted a motion to dismiss in a putative class action alleging that an insurer breached a flexible premium life insurance policy by including amounts for expenses and profits in the COI charge. Lucas v. Metropolitan Tower Life Insurance Company, 2:11-cv-467 (M.D. Fla.). In its decision, the court agreed with the insurer that the claims were barred by a 1999 settlement regarding insurance sales practices. The plaintiff was a member of the settlement class, and the settlement included a release with broadly worded language that expressly mentioned cost of insurance as part of the released claims. On that basis, the court found that the new COI claims were encompassed within the scope of the prior release, and the plaintiff was therefore precluded from bringing the COI claims. The court dismissed the case with prejudice.


Sutherland has previously reported on other decisions where lower courts reached different conclusions on COI issues in a Legal Alert entitled “Recent Rulings Diverge on the Scope of Insurer Discretion to Set Rates.” With the Seventh Circuit adding its voice, the leading appellate cases have now been decided in favor of insurers. Nevertheless, a number of cases are still pending in various courts, and further developments are expected in 2014. 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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