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MARTZ v. UNION LABOR LIFE INS. CO.

United States District Court, Northern District of Illinois, W.D


October 25, 1983

HERBERT E. MARTZ, PLAINTIFF,
v.
THE UNION LABOR LIFE INSURANCE COMPANY, DEFENDANT.

The opinion of the court was delivered by: Roszkowski, District Judge.

ORDER

Before the court are cross-motions for summary judgment filed by the plaintiff, Herbert E. Martz, and the defendant, The Union Labor Life Insurance Company. For the reasons stated herein, the plaintiff's motion for summary judgment is granted and the defendant's motion for summary judgment is denied.

Jurisdiction is invoked pursuant to 28 U.S.C. § 1332. Plaintiff is a resident of Illinois, and the defendant is a Maryland corporation authorized to do business in Illinois. The matter in controversy, exclusive of interest and costs, exceeds the sum of Ten Thousand Dollars ($10,000).

The undisputed facts are as follows.

The plaintiff, Herbert E. Martz, was a member of the Central Laborers Union. As a union member, plaintiff was insured by the Union Labor Life Insurance Company under a group policy. The policy covered medical and hospital bills up to a maximum of $100,000 per calendar year.

Termination or modification of the policy was provided for under the policy terms, which stated:

TERMINATION AND CHANGE OF POLICY . . .

    On any premium due date the Policyholder may
  terminate this Policy or, subject to the Company's
  approval, may modify, amend or change the provisions,
  terms and conditions of this Policy. The Company's
  written consent shall be required to make any such
  modification, amendment or change, but the consent of
  any insured Person or any other Person referred to in
  this Policy shall not be required to effect such
  termination or any modification, amendment or change
  of this Policy.

In early August 1980, Donald Dippold, Executive Administrator of the union's welfare fund, began to look for ways to reduce the costs of the insurance plan. He contacted Richard Falcone, Union Labor Insurance Company's Midwest Regional Manager of Claims and Service. Falcone suggested a subrogation provision for containing the cost of premiums, and Dippold requested that Falcone outline, in writing, his suggestions regarding the subrogation provision. Falcone then wrote a letter to Dippold recommending the adoption of the subrogation provision. Falcone attached an executed copy of Union Labor's standard subrogation provision rider. The rider provided:

  SUBROGATION. The Company shall be subrogated to the
  extent of any benefits paid under this Contract, to
  the proceeds of any settlement or judgment effected
  against a third party and resulting from the exercise
  of any rights of recovery which the Person may have
  against any person or organization. The Person
  claiming benefits under this Policy shall execute and
  deliver such instruments and take such other action
  as the Company may require to implement this
  provision. The Person shall do nothing to prejudice
  the rights given the Company by this provision
  without its consent.

The Trustees of the Central Laborers Union Welfare Fund met on October 28, 1980 to consider the subrogation provision. At this meeting the trustees reviewed and unanimously voted to amend the policy to include the subrogation provision. The Rider adopted stated that the subrogation provision was to be effective on and after October 28, 1980.

A little less than a month later, a freight train struck the plaintiff as he was driving his pick-up truck near Lena, Illinois. He suffered severe injuries, was hospitalized, and was treated by various doctors.

After the plaintiff was injured, two actions were taken regarding the insurance policy. First, on December 9, 1980, the trustees of the union's fund formally signed the subrogation rider which was approved in the October 28, 1980 meeting. Second, in mid-December, union members were given notice that the insurance policy had been modified through the addition of the subrogation provision. It is undisputed that the plaintiff received his notice on December 18, 1980.

After incurring medical and hospital costs, the plaintiff filed claims with the insurer. The insurer paid claims amounting to approximately $44,750.00. The insurer then requested the plaintiff to sign a subrogation agreement, authorizing them to proceed against the railroad involved in the accident. Plaintiff refused, contending that the insurer had no right to subrogation. Upon plaintiff's refusal, the insurer immediately ceased paying plaintiff's medical and hospital bills.

Plaintiff then commenced this action seeking a declaratory judgment that the subrogation provision has no binding legal effect upon him. Plaintiff raises four contentions: 1) that the subrogation provision was not adopted in accordance with the Master Plan's procedures for amending the policy; 2) the modification, if valid, did not take effect until December 9, 1980, the day the rider was signed; 3) prior notice of any change to the insured is required by law and plaintiff did not receive notice of the modification until December 18, 1980; and 4) The Rider's subrogation language had not been approved by the Illinois Department of Insurance and is therefore invalid.

Plaintiff seeks a declaration that the subrogation provision has no binding effect upon him and a ruling that the defendant must pay plaintiff's hospital and medical bills.

The plaintiff also seeks attorney's fees, costs and statutory penalties under Ill.Rev.Stat. ch. 73 § 767 (1981). Section 767 permits recovery of fees, costs, and penalties when an insurer has vexatiously refused to pay benefits under an insurance policy. Plaintiff contends that defendant's decision to cease payment of his hospital bills after he had refused to sign the subrogation authorization constitutes willful and vexatious conduct.

Both parties, alleging that there are no material issues of fact, have moved for summary judgment on the liability issue. The plaintiff claims he is entitled to judgment for the four reasons set forth in his complaint; the defendant, in turn, contends that the amendment to the policy was lawfully adopted and is therefore binding on the plaintiff.

Federal Rule of Civil Procedure 56 provides that a summary judgment shall be rendered if "no genuine issue as to any material fact" exists. The Court in Rigsby v. Mutual of New York, 331 F.2d 353, 354 (10th Cir. 1964), held that when the "only issue was the application of the provisions of the [insurance] contract" use of summary judgment is proper. Here, where the court can resolve the legal questions raised by reference to the contract and established principles of law, summary judgment is appropriate.

Because consideration of the notice issue resolves the liability question, the Court will address the notice issue first.

A. Notice

The majority of jurisdictions in this country require notice*fn1 to the insured employee before the employer or the group insurer can cancel or modify benefits under a group policy. The Kansas Supreme Court, in adopting this majority rule, observed that:

  It is clear that in other jurisdictions the weight of
  authority holds that without reasonable notice to the
  contributing employee, neither the employer nor the
  insurance company may cancel or modify the benefits
  under a group insurance before liability has attached
  so as to deprive the employee or his beneficiary of
  rights under the policy.

Ogden v. Continental Casualty Company, 208 Kan. 806, 494 P.2d 1169 (1972) (emphasis supplied). Legal commentators have also noted the prevalence of the majority rule. See 68 A.L.R.2d 249, Cancellation or Modification of Master Policy As Termination of Coverage Under Group Policy, § 12 (1959).*fn2

The majority position is grounded upon two policy considerations. First, there is a recognition that the insured employee, if not a party to the insurance contract, at the very least has significant rights under the policy which should be protected. In Fagan v. John Hancock Mutual Life Insurance Company, 200 F. Supp. 142 (D.Kan. 1961), the court applied the majority rule, in part, because:

  although deceased was not a party to the insurance
  contract, he did have rights under it. For example,
  he could designate beneficiaries. He could also
  convert to an individual policy within thirty-one
  days after termination of coverage under the group
  policy. The weight of the authority is that notice
  must be given the employee of any modification of the
  contract which affects his rights.

Id. at 144. (emphasis supplied). And where the employee contributes to the cost of the group policy, the courts have been especially diligent in requiring notice of any change affecting rights under the policy. In Ogden, supra, the Kansas Supreme Court reasoned that:

  where the employee pays a portion of the premiums he
  has valuable rights in the policy and therefore
  notice should be given him of any modification of the
  contract which might effect those rights.

Ogden, 494 F.2d at 1172.

Second, the notice requirement allows the insured to exercise conversion rights or to obtain alternative coverage so that no gap in protection arises. The Pennsylvania and Alabama Supreme Courts have required notice to the insured:

  So that he may timely exercise any conversion
  privilege which may be available to him under the
  terms of the policy or,

  where such privilege is not given, in order that he
  may reasonably obtain similar insurance protection on
  his own account elsewhere.

Harrison Insurance Co. of North America, 294 Ala. 387, 318 So.2d 253, 258 (Ala. 1975) quoting Poch v. Equitable Life Assurance Society, 343 Pa. 119, 22 A.2d 590 (1941).

A minority of jurisdictions, in contrast, hold that an employer may validly cancel or modify a master group policy without notice to the insured employee. E.g. Kimbal v. Travelers Ins. Co., 151 Fla. 786, 10 So.2d 728 (1942); Johnson v. Metropolitan Life Insurance Co., 52 Ga. App. 759, 184 S.E. 392 (1936). Where the employee has not contributed to the policy, these courts have reasoned that the group insurance coverage was a voluntary and gratuitous gift to the employee which the employer could cancel at will. E.g. Meyerson v. New Idea Hosiery Co., 217 Ala. 153, 115 So. 94 (1927). Where the employee has contributed to the plan, these courts have reasoned that the group policy is nevertheless a contract between the employer and insurer, and therefore notice serves no purpose because the insured could never step into the employer's shoes and continue the policy in effect. E.g. Johnson v. Metropolitan Life Insurance Co., 52 Ga. App. 759, 184 S.E. 392 (1936).

In a diversity action, this court is bound to follow the state law in which the court sits. Erie v. Tompkins, 304 U.S. 64, 58 S.Ct. 817, 82 L.Ed. 1188 (1938). The question therefore becomes whether Illinois follows the majority or minority position. While Illinois law is not entirely clear on the notice issue, it does appear that Illinois precedents adopt the majority position.

Both cases construing Illinois' notice requirements under group insurance plans involved the failure to notify the insured of the termination of coverage. The first decision applying Illinois law arose in the U.S. District Court for the District of Kansas. In Fagan v. John Hancock Mutual Life Insurance Co., 200 F. Supp. 142 (D.Kan. 1961), the original master policy provided insurance coverage, including life insurance, for all employees. The employer and the insured then amended the master policy to terminate the life insurance coverage upon an employee's retirement from full-time work. Illinois law governed the dispute. The Court held:

  notice must be given the employee of any modification
  of the contract which affects his rights. (citations
  omitted). This is a sound rule. Unless an employee is
  notified of coverage termination, he cannot take
  advantage of his conversion rights.

Id. at 144. (emphasis supplied). Unfortunately, there existed no Illinois authority to guide the Fagan court; the court essentially decided that it was likely Illinois would follow the majority rule.

After Fagan, the Illinois Appellate Court for the Second District confronted the notice issue in Lindgren v. Metropolitan Life Insur. Co., 57 Ill. App.2d 315, 206 N.E.2d 734 (2d Dist. 1975). In Lindgren, the employer cancelled a group policy insurance which had provided life insurance to the contributing employees. No notice of the cancellation was given to the employee, who subsequently died. Despite the cancellation, the employee's estate was able to recover the policy proceeds because no notice of cancellation was given. The court began its analysis by observing that "there appears to be no Illinois cases on this exact point." The court therefore chose to rely on Fagan and the ALR's statement of the majority position. The court stated:

The Annotator states, on page 269:

      "In a majority of cases directly dealing with
    this question the view has been taken that, without
    reasonable notice to the employee, the employer may
    not cancel or modify a master group policy, before
    liability has attached, so as to deprive the
    employee or his beneficiary of rights under the
    policy."

    We agree with the reasoning in the Annotation and
  in the cases cited above. Where an employee applies
  for

  coverage under a group policy, is accepted, and pays
  the premiums required by the insurer, he has a vested
  interest in that policy at least to the extent that
  he cannot be divested without notice.

    The certificate issued by Metropolitan indicates
  that the employee, Lindgren, had conversion
  privileges under the policy. He was entitled to a
  determination of whether any of the conversion
  privileges were available to him or to the right of
  seeking adequate protection elsewhere.

206 N.E.2d at 736.

Relying principally upon Lindgren, this court finds that Illinois law requires notice prior to the cancellation or modification of a group insurance policy. While Lindgren admittedly is not an Illinois Supreme Court decision, an appellate level decision is a fair indicator of what a state's supreme court is likely to do. The Lindgren holding combined with the fact that the rule announced in Lindgren is clearly the majority rule, convinces this court that the Illinois Supreme Court would adopt the Lindgren holding.*fn3

The defendant attempts to distinguish Lindgren and Fagan from the present case because they involved termination of coverage; whereas the present case involves a less significant subrogation right. Defendants argue that while requiring notice is a sensible prerequisite to cancellation because it allows for exercise of conversion rights and/or for time to replace the eliminated coverage, notice makes little sense for subrogation rights.

It is true that a stronger argument for notice exists where the policy is cancelled than where a less significant modification is involved. And admittedly it is unlikely that the addition of a subrogation provision would involve any conversion rights. Still, the distinction defendant draws misses two points.

First, the notice requirement is premised on two grounds. One is the need to preserve the opportunity to exercise conversion rights; but the other recognizes that the insured should not be deprived of a benefit without notice. It is this second policy concern that applies with equal force to both cancellations and modifications. The plaintiff in this case possessed a valuable right to institute suit against the party responsible for his injuries. The right could be worth up to $100,000. The majority rule simply recognizes that before a valuable policy right is eliminated, notice must be given.

Second, the majority cases and the ALR upon which the Lindgren court relied explicitly state that the notice rule applies to cancellations or modifications. The ALR states, "without reasonable notice to the employee, the employer may not cancel or modify a master group policy". Consequently, the language in Lindgren itself establishes that the notice requirement applies with equal force to modifications and cancellations.

For these reasons, the court holds as a matter of law that the subrogation rider has no binding legal effect upon the plaintiff. Because the notice issue is dispositive, the court need not consider plaintiff's alternative theories of relief.

B. Costs, Attorney's Fees and Penalties

Illinois law allows the award of costs, fees and statutory penalties where the court finds that an insurer's delay in paying an insured's claim is vexatious and unreasonable. See Ill.Rev.Stat. ch. 73 ¶ 767 (1981).*fn4

Whether an insurer's delay has been vexatious or unreasonable is usually a matter vesting in the judgment and discretion of the trial court. Songer v. State Farm Fire and Casualty Co., 91 Ill. App.3d 248, 414 N.E.2d 768, 46 Ill.Dec. 715 (5th Dist. 1980). It has been generally recognized, however, that where the insurer defends in good faith, e.g., Jenkins v. State Sec. Ins. Co., 56 Ill. App.3d 737, 371 N.E.2d 1203, 14 Ill.Dec. 150 (1st Dist. 1978), or on the basis of a reasonable legal defense which raises an issue of first impression in the jurisdiction, e.g., Goetze v. Franklin Life Ins. Co., 26 Ill. App.3d 104, 324 N.E.2d 437 (2nd Dist. 1975), the insurer does not act unreasonably or vexatiously.

In the present case, the insurer defended on the basis of a reasonable legal position on an unsettled issue which only one Illinois appellate decision had ever addressed. Even the single precedent was arguably distinguishable from the case at hand. If the insurer had prevailed in establishing its position that it could implement a subrogation provision without notice to the insured, the plaintiff would have been deemed to have breached his obligations and the insurer was justified in withholding benefits until plaintiff signed the subrogation authorization. Under these circumstances, the court finds that the insurer's decision to contest the plaintiff's claim was neither vexatious or unreasonable. Consequently, the request for costs, attorney's fees and penalties based upon § 767 is hereby denied.

For the reasons stated herein, the court enters judgment on behalf of the plaintiff and against the defendant. The plaintiff is entitled to the medical and hospitalization benefits provided under the policy without relinquishing his right to maintain, and retain the proceeds from, a third party action.

It is so ordered.


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