MARCH 2011 BAD FAITH CASES BAD FAITH AND BREACH OF CONTRACT CLAIMS SURVIVE DISMISSAL AS INSURED SUFFICIENTLY PLEADS INSURER UNREASONABLY FAILED TO PAY OR DELAYED PAYMENT OF LIFE INSURANCE BENEFITS (Philadelphia Federal)
The dispute concerned an insurer’s obligation to pay out benefits on a life insurance policy. The decedent was issued a $500,000 life insurance policy in December 2000, and he transferred all rights and interest in the policy to the defendant insured in May 2001. The insurer did not object to the transfer or raise any concerns upon receiving notice of the transfer.
The insured paid premiums on the policy totaling over $100,000 until the decedent policyholder’s death in January 2009. It submitted a claim for death benefits a month later, and it provided the necessary documentation. However, the insurer allegedly “refused to pay the death benefits” and “failed to timely make a decision on its claims” despite receiving at least three demands from the insured for payment after it filed the initial claim.
In this case the insurer commenced the proceedings by filing a suit for declaratory judgment action to determine whether the decedent purchased the policy with the intent of selling his interest to the insured as part of a stranger-oriented life insurance (“STOLI”) scheme, which it claimed would void the policy under Pennsylvania law. The insured answered the initial Complaint and filed counterclaims, asserting both breach of contract and bad faith by the insurer for failing to pay benefits under the policy. The insurer then filed a motion to dismiss the counterclaims for failure to state a cause of action under Fed. R. Civ. Pro. 12(b)(6).
The court first addressed the breach of contract counterclaim. It noted that the policy included a contestability clause, which provided a two-year period, starting on the issuing date, where it could contest the validity of the policy. The two-year period expired in 2002, and under Pennsylvania law, insurers generally cannot contest the validity of life insurance policies after the contestability period is over unless there is an explicit exception (for example, the failure to pay premiums). Courts had not addressed whether an insurer could dispute the validity of a policy for being part of a STOLI scheme, so it still was an open question as to whether the delay and refusal of paying benefits constituted a breach. The court therefore determined that the issue could not be resolved on a motion do dismiss, and it concluded that the insured sufficiently pleaded its breach of contract claim.
With respect to the bad faith claim, the court noted that Pennsylvania’s bad faith statute, 42 Pa. Cons. Stat. § 8371, includes “causes of actions arising out of the bad faith handling or non-payment of claims” in addition to the literal act of denying a claim. Therefore, even though the insurer never expressly denied the claim, the bad faith statute would be triggered if the insurer had no basis for refusing to pay or extending the delay of payment and knew or recklessly disregarded that fact.
The court held that the insured sufficiently pleaded that such refusal or delay was without reasonable basis, as it alleged that the insurer had notice of the transfer of interest from the decedent to the insured and raised no objections, and it conveniently waited until the decedent passed away before questioning his intentions. Finally, the lack of responses by the insurer to the insured’s multiple demands could constitute bad faith if proven to be true and unreasonable.
The court determined that the insured also sufficiently pleaded a bad faith claim, and it therefore denied the insured’s motion to dismiss both the breach of contract and bad faith claims.