State Farm Ruling Opens Door for Conversion Claims Against Insurers Who Impose Unlawful Cost of Insurance Rate Increases

Life Settlements Alert | September.13.2019

On August 19, 2019 a federal judge in the Northern District of California denied State Farm Life Insurance Company’s (State Farm) motion for summary judgment on Plaintiff Elizabeth A. Bally’s claims for conversion and breach of contract in a putative class action alleging State Farm made improper cost of insurance (COI) deductions on certain of its universal life insurance policies. See Bally v. State Farm Life Ins. Co., No. 18-cv-04954-CRB, 2019 WL 3891149 (N.D. Cal. Aug. 19, 2019). The court’s ruling opens another door for policyholders to potentially recover tort remedies in cases alleging unlawful COI rate increases by insurers.

In 1994 Elizabeth Bally purchased a universal life policy from State Farm. The policy has an Account Value component, which Bally alleges is her property held in trust by State Farm. Under the policy, State Farm deducts monthly charges from the Account Value, including a COI charge. The policy states that the monthly COI rates “for each Policy year are based on the Insured’s age on the Policy anniversary, sex, and applicable rate class.”

In 2018 Bally, on behalf of herself and a putative class of similarly situated policyholders, filed a class action against State Farm alleging State Farm had breached the policy by calculating the COI charges based on factors not listed in the policy, including expenses, persistency, taxes, profit and investment earnings. Bally also asserted a claim for conversion, alleging that by taking unlawful COI deductions from her Account Value, State Farm converted her property.

On May 21, 2019 State Farm moved for summary judgment on Bally’s conversion and breach of contract claims, and on August 19, 2019 the court denied the motion in its entirety.

In its motion, State Farm argued that a conversion claim based on excessive COI deductions is “impossible under California law” because a conversion claim cannot be based on an alleged “overcharge.” State Farm argued that the policy authorized it to take monthly deductions from the Account Value, and Bally’s only objection was to the amount of the deductions – not to the taking of the deductions itself. In State Farm’s view, Bally’s conversion claim amounted to an “overcharge” claim, which cannot be the basis for a conversion claim under California law.

Bally responded that her conversion claim was not a mere “overcharge” claim. Rather, the conversion claim was based on allegations that State Farm transferred funds out of her Account Value that it had no right to transfer, and these unauthorized transfers constituted conversion.

The court agreed with Bally, observing that her conversion claim – based on allegations that State Farm deducted COI charges “in [allegedly] unauthorized amounts from the Account Value” – was different from a claim based on allegations that State Farm was “overcharging for [its] services.” Bally, 2019 WL 3891149, at *4.

The court’s ruling would appear to apply equally to situations where insurers take excessive COI deductions based on unlawful COI rate increases, and represents a positive development for policyholders asserting claims against such insurers, including AXA, Transamerica, Lincoln and John Hancock. The decision now arms those policyholders with another potential claim that would permit the recovery of punitive damages.

In addition, the court denied State Farm’s motion for summary judgment on the breach of contract claim. In its motion, State Farm argued that Bally’s policy permitted it to consider factors other than the insured’s age, sex and applicable rate class when determining COI rates because the policy states that COI rates would be “based on” those factors, and “based on” does not mean that those are the only factors State Farm can consider. Bally, on the other hand, argued that “based on” means State Farm can consider the enumerated factors only. The crux of the dispute was therefore “whether the phrase ‘based on the Insured’s age on the Policy anniversary, sex, and applicable rate class’ permits State Farm to consider factors other than those three listed.”

In deciding this issue, the court followed the multi-step approach to contract interpretation under California law. It first looked “to the language of the contract in order to ascertain its plain meaning or the meaning a layperson would ordinarily attach to it.” Bally, 2019 WL 3891149, at *5. Analyzing dictionary definitions and common usage, the court concluded that the plain meaning of “based on” is ambiguous. Id.

The court next analyzed whether the context of the life insurance policy provided clarity. It noted that many other courts have found that “insurance policies that calculate COI ‘based on’ listed factors do not unambiguously permit insurance companies to consider other, unlisted, factors.” Id., at *5.

The court also rejected State Farm’s argument that Bally’s restrictive interpretation of “based on” would be unreasonable because it would “prohibit State Farm from considering actuarially necessary variables” in determining COI rates and would have the effect of preventing State Farm from making a profit. Id., at *7. Observing that an insurance contract should be read as a layman would read it, and not as it might be analyzed by a lawyer or an insurance expert, the court found that a layperson would not understand that State Farm expected to derive profit solely from the COI charges. Id. The court noted other ways State Farm could derive profits, including profits from the 5% premium expense charge on every premium paid, the monthly expense charge and the monthly charges for any applicable riders. Id.

Based upon its determination, the court concluded that “[u]nder California law, the contract must therefore be construed in favor of the insured.” Id., at *8. Because the policy was, at best, ambiguous, the court could not “conclude that, as a matter of law, State Farm complied with the terms of the Policy when it calculated the COI” based on unenumerated factors. Id. The court therefore denied State Farm’s motion for summary judgment on the breach of contract claim.

The court’s ruling represents another win for policyholders, as it reinforces prior decisions finding that where policies state that COI rates will be “based on” certain enumerated factors, courts are likely to hold the insurer to the factors it listed in the policy.