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Can An Employee's Obligation to Provide Evidence of Insurability to Secure Life Insurance Be Excused by the Doctrine of Incontestability or by An ERISA Claim for Breach of Fiduciary Duty?

A recent life insurance case involving the issue of incontestability caught our attention.

Patterson v. Reliance Standard Life Ins.Co., 2013 U.S.Dist.LEXIS 171873 (C.D.Cal. December 4, 2013)(Issue: Incontestability). This case involved life insurance - the plaintiff's sister was an employee of Redlands Community Hospital who was offered the opportunity to purchase $260,000 in voluntary group life insurance benefits under a policy insured by Reliance Standard. The employee paid the premiums for four years through payroll deductions, but when she died, the insurer refused to pay asserting that it was never given proof of good health at the time of application. After a pre-litigation appeal failed, the plaintiff filed suit seeking to recover benefits. The court found in the plaintiff's favor and awarded the benefits due. The court relied primarily on an incontestability clause contained in the policy, which states in relevant part:

Any statement made in your application will be deemed a representation, not a warranty. We cannot contest this Policy after it has been in force for two (2) years from the date of issue, except for non-payment of premium.

Before addressing the applicability of that provision, the court recited the underlying facts. The plaintiff's sister began her employment at Redlands in June 2006. In October 2006, she completed a group enrollment form in order to enroll in the voluntary insurance program. However, she did not submit an evidence of insurability form or proof of good health at the time she enrolled even though the plan specified that such proof be submitted if the application for benefits was made more than 31 days after the employee first became eligible to enroll. In March 2010, the plaintiff's decedent died of acute lymphoblastic leukemia, and the plaintiff submitted a claim for benefits. However, the claim was denied by the insurer, which maintained that it never received proof of good health at the time of enrollment. Thus, Reliance Standard asserted the coverage never went into effect and requested that Redlands refund the premiums it had collected.

Although the benefit plan granted Reliance discretion, the court found the insurer acted arbitrarily. While the plaintiff primarily asserted that the incontestability provision barred Reliance from denying coverage, the insurer maintained that the provision was inapplicable because the coverage never became effective since a condition precedent to coverage; i.e., the proof of good health. Was never submitted. Under California law, "Good health provisions are enforceable conditions precedent." Willard v. Valley Forge Life Ins. Co., 218 F. Supp. 2d 1197, 1201 (C.D. Cal. 2002) (finding that a good health provision in a life insurance policy, which required a prospective insured's health condition remain the same between application and policy delivery dates, to be an enforceable condition precedent to coverage under California law). And the court found that here, too, "the required proof of good health qualifies as a condition precedent." The proof of good health requirement in the policy applied to anyone who applied more than 31 days after becoming eligible for coverage - the employee started working for the hospital on June 12 2006; she became eligible for coverage 90 days later, or September 10, 2006. However, the application was submitted on October 30, 2006. Thus, proof of good health was required; and the court found the insured failed to fulfill a condition precedent to coverage.

However, the court examined Amex Life Assurance Co. v. Super. Ct., 14 Cal. 4th 1231 (1997), which involved an applicant for life insurance who was HIV positive, and who lied on his application and sent an imposter to take his insurance examination. However, because the insured died after the incontestability period ended, the court found the insured was covered because he paid all of the premiums up to the date of death. Here, too, Reliance Standard collected premiums for more than three years, a fact it could not deny. Hence, the court held:

Based on the standard set forth in Amex, Reliance Standard's claim that Ms. Dietrich failed to provide proof of good health qualifies as a defense of a breach of a condition precedent that falls within the scope of the incontestability clause. Since the contestability period expired and Ms. Dietrich fulfilled her obligation to pay the required premium payments, the incontestability clause applies in this case and bars Reliance Standard from contesting the Policy. As the court in Amex stated, "[t]o hold otherwise would be to permit such a clause in its unqualified form to remain in a policy as a deceptive inducement to the insured." Amex, 14 Cal. 4th at 1246.

The court added that its decision comported with the public policy considerations behind the incontestability clause which provide insureds "a guaranty against possible expensive litigation to defeat his claim after the lapse of many years, and at the same time gives the company time and opportunity for investigation, to ascertain whether the contract should be in force." (citing Amex, 14 Cal. 4th at 1238 (internal citations and quotations omitted). Thus, because Reliance had more than three years to investigate whether the policy was properly in force, the incontestability clause barred the insurer from contesting coverage. The court explained, "the need for the protection afforded by the incontestability clause is highest here, where Ms. Dietrich fulfilled her obligation to pay the insurance premiums for more than three years, the beneficiary's most potent witness is deceased, and Reliance Standard had ample opportunity to conduct an investigation."

Discussion: The court could also have made an alternative finding. Based on the Fourth Circuit's ruling in McCravy v. Metro.Life Ins.Co., 690 F.3d 176 (4th Cir. 2012), even if the court had held that a claim to recover benefits under 29 U.S.C. § 1132(a)(1)(B) was precluded, a claim for a surcharge remedy under 29 U.S.C. § 1132(a)(3) would have been viable. In McCravy, the plaintiff was paying life insurance premiums to insurer her daughter; and those payments continued well past the date when the daughter remained eligible to continue receiving coverage. However, MetLife accepted the premiums. But when McCravy's daughter was murdered and she sought to collect benefits under the life insurance policy, MetLife denied the claim and attempted to refund the premiums. The court held that MetLife's acceptance of the premiums created potential liability for breach of fiduciary duty; and observed:

In sum, with Amara, the Supreme Court clarified that remedies beyond mere premium refunds-including the surcharge and equitable estoppel remedies at issue here-are indeed available to ERISA plaintiffs suing fiduciaries under Section 1132(a)(3). This makes sense-otherwise, the stifled state of the law interpreting Section 1132(a)(3) would encourage abuse by fiduciaries. Indeed, fiduciaries would have every incentive to wrongfully accept premiums, even if they had no idea as to whether coverage existed-or even if they affirmatively knew that it did not. The biggest risk fiduciaries would face would be the return of their ill-gotten gains, and even this risk would only materialize in the (likely small) subset of circumstances where plan participants actually needed the benefits for which they had paid. Meanwhile, fiduciaries would enjoy essentially risk-free windfall profits from employees who paid premiums on non-existent benefits but who never filed a claim for those benefits. With Amara, the Supreme Court has put these perverse incentives to rest and paved the way for McCravy to seek a remedy beyond a mere premium refund. 690 F.3d at 182-83.

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DeBofsky, Sherman & Casciari, PC