OCTOBER 2017 BAD FAITH CASES: APPLYING CALIFORNIA LAW, MOTION TO DISMISS DENIED WHERE ALLEGATIONS SUPPORT BREACH OF CONTRACT, BREACH OF IMPLIED COVENANT OF GOOD FAITH AND FAIR DEALING, AND TORTIOUS BREACH OF THE IMPLIED COVENANT CLAIMS (Philadelphia Federal)

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This action is similar to other life insurance litigation recently before Judge Pappert.  This case was determined under California law.

The insureds had flexible premium universal life insurance policies, and alleged breach of contract, breach of the implied covenant of good faith and fair dealing, and tortious breach of the implied covenant of good faith and fair dealing. Under these policies, policyholders may adjust both the amount and frequency of their premium payments, so long as they maintain sufficient funds in the account to cover a monthly deduction. The monthly deduction is comprised of a cost of insurance (“COI”) charge and other related expenses.

According to the insureds, the COI is the “largest and most significant charge” of the monthly deduction. A policyholder may elect to pay a premium in excess of the monthly deduction, and the policy provides that those excess funds will accrue interest at a rate of at least 4%. However, if the monthly deduction exceeds the value of the premium paid, the policy value is reduced.

The insureds allege that the insurer breached the policies by increasing the COI, because the COI rate increase was not based on a list of enumerated factors in the policies. The insureds further argued that the increase was not applied on a uniform basis for insureds of the same rate classes. The insurer moved to dismiss.

Specifically, the parties disagreed as to the proper interpretation of the insurer’s COI Notice Letter, which states, “the amount of the COI rate change depends upon the product, underwriting class and duration.” While the parties provided different explanations for their understanding of the terms in the Notice Letter, the Court stated that the insureds’ allegations are sufficient to state a claim for breach of contract.

The Notice Letter also contained language stating the COI increase was necessary because the insurer “was ‘operating in a challenging and changing environment as we continue to face nearly a decade of persistently low interest rates, including recent history lows, and volatile financial markets.’” Based upon this language, and other statements made to brokers and agents, the Court held that the insureds stated plausible allegations to support their breach of contract claim.

After conducting a choice of law analysis, the Court then addressed the insureds’ breach of the implied covenant of good faith and fair dealing claim. The insureds argued that the insurer deliberately attempted to force the insureds to either pay exorbitant premiums that the insurer knew would not justify the ultimate benefits of the policy, or force the insureds to surrender the policies upon lapse. The Court held again that the insureds’ allegations were adequate to allege that the insurer breached the implied covenant with its actions that were “unreasonable and unfair . . . with the bad faith intent of inducing lapses, frustrating policyholders’ expectations and depriving them of the benefit of the agreement.”

While Pennsylvania law does not recognize a cause of action for tortious breach of the implied covenant, California law does recognize such a claim where the plaintiff shows “(1) [that] benefits due under the policy were withheld; and (2) the reason for withholding the benefits must have been unreasonable or without proper cause.” To support this claim, the insureds alleged that the insurer’s COI increase was unlawful, excessive, and denied the insureds the benefit of their policies. Citing its previous reasoning, the Court held the insureds’ allegations were sufficient to state a claim for tortious breach of the implied covenant. The Court also declined to dismiss the insureds’ punitive damages claim at this stage of the litigation.

In sum, the Court denied the insurer’s motion to dismiss the breach of contract and both breach of the implied covenant claims.

Date of Decision: September 22, 2017

EFG Bank AG v. Lincoln National Life Ins. Co., No. 17-02592, 2017 U.S. Dist. LEXIS 154985 (E.D. Pa. Sept. 22, 2017) (Pappert, J.)

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