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Mutual insurance companies owe fiduciary duty


“The policyholders are dependent upon Northwestern’s investment decisions and are thus in an inferior position to Northwestern. Consequently, Northwestern owes the policyholders a fiduciary duty.”

Hon. Gregory A. Peterson
Wisconsin Court of Appeals

Both a mutual insurance company, and its officers and directors, owe a fiduciary duty to the purchasers of deferred annuity contracts, the Wiscon-sin Court of Appeals held on June 22.

In 1976, Daniel A. and Catherine D. Noonan purchased deferred annuity contracts issued by Northwestern Mutual Life Insurance Company. The annuities are “participating” and the contracts originally stated: “This policy shall share in the divisible surplus, if any, of the Company. This policy’s share shall be determined annually and credited as a dividend. Payment of the first dividend is contingent upon payment of the premium or premiums for the second policy year and shall be credited proportionately as each premium is paid. Thereafter, each dividend shall be payable on the policy anniversary.”

In 1983, the contracts were amended to provide: “This policy will share in the divisible surplus of the Company. This surplus is determined each year. The policy’s share will be credited as a dividend on the policy anniversary. This dividend will reflect the mortality, expense and investment experience of the Company and will be affected by any policy indebtedness during the policy year.”

Until 1985, dividends were paid based on Northwestern’s overall financial performance, measured by the return on a general account portfolio of investments. These included securities, real estate, business enterprises and other investments.

In 1985, Northwestern changed the way it distributed dividends to annuity policyholders. Northwestern created a segmented account invested in short-term bonds.

Owners of annuities then received a share of interest earned on the short-term bonds only.

The Noonans learned of the change in 2000, and brought suit against Northwestern and its officers and directors, alleging breach of contract, and breach of fiduciary duty.

Northwestern moved to dismiss the complaint, and Reserve Judge William Eich granted the motion. The Noonans appealed, and the court of appeals reversed in a decision by Judge Gregory A. Peterson.

Breach of Contract

The court held that the Noonans stated a claim for breach of contract, citing the terms of the contract, and sec. 632.62.

Section 632.62(1)(b) provides that mutual insurance companies may issue only “participating policies.”

Section 632.62(2) provides, “Every participating policy shall by its terms give its holder full right to participate annually in the part of the surplus accumulations from the participating business of the insurer that are to be distributed.”

The surplus accumulation to be distributed is determined according to sec. 632.62(4)(b): “Every insurer doing a participating business shall annually ascertain the surplus over required reserves and other liabilities. After setting aside such contingency reserves as may be considered necessary and be lawful, such reasonable nondistributable surplus as is needed to permit orderly growth, making provision for the payment of reasonable dividends upon capital stock and such sums as are required by prior contracts to be held on account of deferred dividend policies, the remaining surplus shall be equitably apportioned and returned as a dividend to the participating policyholders or certificate holders entitled to share therein.”

The policy provides: “This policy will share in the divisible surplus of the Company” and the “share shall be determined annually and credited as a dividend.”

What the court held

Case: Catherine D. & Daniel A. Noonan v. Northwestern Mutual Life Ins. Co., No. 03-1432..

Issue: Did a mutual insurance company breach its contract with annuity policyholders, when it distributed surplus in a manner other than that prescribed by sec. 632.32?

Do mutual insurance companies, and their officers and directors, owe a fiduciary duty to such policyholders?

Holding: Yes. The statute sets forth the only manner is which a mutual insurance company can calculate its dividends.

Yes. The insurer occupies a position of trust, and enjoy a superior position to its policyholders, that warrants imposition of a fiduciary duty.

Counsel: E. Campion Kersten, Milwaukee; Georgen P. Kersten, Milwaukee; Kenan J. Kersten, Milwaukee; Mark B. Pollack, Milwaukee; K. Scott, Wagner, Milwaukee; Maria S. Lazar, Milwaukee, for appellant; Eric J. Van Vugt, Milwaukee; Daniel E. Conley, Milwaukee; Cristina D. Hernandez-Malaby, Milwaukee, for respondent.

The court held that the Noonans stated sufficient facts to support a breach of contract claim, reasoning, “Wisconsin Stat. sec. 632.62(4)(b) mandates how the divisible surplus is to be determined. Every year Northwestern must (1) ascertain the surplus over required reserves and liabilities and (2) subtract necessary contingency reserves, funds for orderly growth, dividends for capital stock and sums required by prior contracts. Id. After the surplus is determined, then and o
nly then must Northwestern decide how to equitably apportion the surplus. Id. Here, North-western made the allocation to annuity policyholders before it determined the surplus.

This is contrary to the terms of the annuity contracts and the statute. Thus, the Noonans have alleged sufficient facts to state a claim that Northwestern breached the annuity contracts.”

Fiduciary Duty

The court also concluded that Northwestern owes a fiduciary duty to its policyholders.

The court acknowledged significant authority that no such duty exists. In In re Metro. Life Derivative Litig., 935 F. Supp. 286, 293 (S.D.N.Y. 1996), the court held, “the relationship between a mutual insurer and a policyholder is not of a fiduciary nature but is instead that of a debtor and creditor.”

Likewise, in Fidelity & Cas. Co. v. Metropolitan Life Ins. Co., 248 N.Y.S.2d 559, 623 (N.Y.S. 1963), the court held, “As an incident of membership in [a mutual insurance company], the policyholder acquires certain specified proprietary interests therein, but, apart from these, the relationship is not of a fiduciary nature … and the relationship between the company and its policyholder is essentially that of debtor and creditor.”

Also, in Andrews v. Equitable Life Assur. Soc. 124 F.2d 788, 789 (7th Cir. 1941), the court concluded, “Whatever rights a member of a mutual company has are delineated by the terms of the contract, and come from it alone.”

Finally, annuities do not usually involve a fiduciary relationship. 3B C.J.S. Annuities 34 (2003), states that “[t]he relationship of an insurer and an annuitant is not a fiduciary one.”

However, the court also found conflicting authority that would suggest a fiduciary duty does exist, noting 44 C.J.S. Insurance § 114(c) (1993), which states: “The officers and directors of a mutual insurance company stand in a fiduciary relation to the company and its members, and occupy a position of trust. Officers and agents owe reasonable protection to the rights of the members, and they may render themselves liable to the company or its members for gross neglect of duty or for willful wrong in the management of the company and its business.”

In addition, Couch on Insurance, sec. 39:37, states, “Although there is no formal trust relationship, there is a duty imposed upon the company to act in good faith and to observe the rights of the members. This duty is often figuratively described as a duty of trust. Thus, it is said that the funds of a benefit society are trust funds for the members which have been created by their contributions.”

The court concluded that the latter line of authority should control, inasmuch as the annuities at issue were not traditional annuities — in which a person pays a certain sum for the annuity, and in return, the issuer of the annuity agrees to pay the annuitant periodic payments.

The Noonans’ annuities, in contrast, involve more. In addition to the periodic payments of a typical annuity, the Noonans’ policies provide that they will share in Northwestern’s divisible surplus. In addition, sec. 632.62(4)(b) defines how a mutual insurance companies are to determine its annual surplus.

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Case Analysis

Noting that the statute requires the surplus be “equitably apportioned and re-turned as a dividend to the participating policyholders,” the court concluded, “Northwestern occupies a position of trust not just to determine the surplus, but to equitably apportion the surplus among all participating policyholders.”

The court found that the inequality in the relationship also justifies imposing a fiduciary duty, stating, “The policyholders are dependent upon Northwestern’s investment decisions and are thus in an inferior position to Northwestern. Consequently, Northwestern owes the policyholders a fiduciary duty.”

Accordingly, the court reversed on this issue, as well. The court also concluded that the complaint stated a claim against the officers and directors, again citing 44 C.J.S. Insurance 114(c).

The court further found that the suit was not barred by the statute of limitations. Although the initial change in determining dividends occurred in 1985, the court found that claim subject to the continuing violation rule. Thus, the court held that the Noonans can sue for breach of contract over the six years prior to filing the action.

Finally, the court rejected Northwest-ern’s argument that the economic loss doctrine bars the breach of fiduciary duty claim, limiting the doctrine to damages resulting from the sale of products that do not perform as intended.

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David Ziemer can be reached by email.

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