American College of Surgeons v. Lumbermens Mut. Cas. Co.

• Court: Appellate Court of Illinois
• Writing for the Court: BILANDIC
• Citation: American College of Surgeons v. Lumbermens Mut. Cas. Co., 491 N.E.2d 1179, 142 Ill.App.3d 680, 96 Ill.Dec. 719 (Ill. App. 1986)
• Decision Date: 25 March 1986
• Docket Number: No. 83-3080,83-3080
• Parties: , 96 Ill.Dec. 719 AMERICAN COLLEGE OF SURGEONS, Plaintiff-Appellant, Cross-Appellee, v. LUMBERMENS MUTUAL CASUALTY COMPANY, Defendant-Appellee, Cross-Appellant.

Page 1179

491 N.E.2d 1179

142 Ill.App.3d 680, 96 Ill.Dec. 719

AMERICAN COLLEGE OF SURGEONS, Plaintiff-Appellant, Cross-Appellee, v. LUMBERMENS MUTUAL CASUALTY COMPANY, Defendant-Appellee Cross-Appellant.

No. 83-3080.

Appellate Court of Illinois First District, Second Division.

March 25, 1986.

Vedder, Price, Kaufman & Kammholz, Roy S. Kullby, Allan E. Lapidus and Gifford R. Zimmerman, Chicago, for plaintiff-appellant, cross-appellee.

Clausen, Miller, Gorman, Caffrey & Witous, P.C., James T. Ferrini, Frank L Schneider and Katherine S. Dedrick, Chicago, defendant-appellee, cross-appellant.

Presiding Justice BILANDIC delivered the opinion of the court:

Plaintiff, American College of Surgeons (hereinafter ACS), filed a breach of contract action against defendant Lumbermens Mutual Casualty Company (hereinafter LMC) alleging that defendant agreed to return to plaintiff "retention reserves" in the form of dividends for a period of ten years after the policies terminated. ACS cancelled its policies in 1974 and, shortly thereafter, defendant informed ACS that its obligation to return reserves was only for a 20-month period after termination.

The trial court submitted to the jury the questions whether there was a contract, whether it met the requirements of the Statute of Frauds, and whether there was a breach by the defendant. The jury returned a verdict for plaintiff and awarded it $1,732,669 in damages. The trial court, which earlier had reserved ruling on defendant's motion for a directed verdict, entered judgment notwithstanding the verdict (n.o.v.) for the defendant and, in the alternative, granted defendant's motion for a new trial on the issue of damages. Defendant's alternative motion for a new trial on all issues was denied.

ACS appealed from the order setting aside the jury's verdict and entering judgment n.o.v. in favor of LMC and the alternative order granting LMC a new trial on the issue of damages. LMC filed a cross-appeal from the order denying its alternative motion for new trial on all issues.

The issues presented are: (1) whether it was error for the trial court to set aside the jury's verdict for the plaintiff and to enter judgment n.o.v. for defendant; (2) whether it was error for the trial court to conditionally grant a new trial on the issue of damages; and (3) whether it was error for the trial court to deny defendant's motion for a new trial on all issues.

This case presents a historical review of the inception, under-writing, and administration of the mass marketing of insurance policies. In the 1950's, the insurance industry was emerging from what now appears to be a rather primitive method of having an insurance company agent or salesman sell a policy to a customer on an individual basis. A new breed of entrepreneur emerged that became known as the "Administrator." He sought out large groups of potential insurance purchasers through their professional, trade, or craft associations, determined their insurance needs, and tailored a program to fit their requirements. Armed with this potential group sale, the Administrator shopped various insurance companies for the best deal in terms of benefits and cost. Ideally, everyone would benefit. The group members purchased insurance at lower prices than they could individually. Insurance companies that underwrote the group program benefited because they could put a block of business on the books at a lower acquisition cost per policy. Associations benefited by providing an additional service for their members, and the Administrator earned a fee or commission.

The Administrator sells the association on the idea of offering such a program and, if successful, "markets" the program among the members to induce them to place their insurance through the program. The Administrator receives the applications and the premiums, sends them on to the insurance company-underwriter, and ultimately returns certificates of insurance to the participating members. For these functions, the Administrator receives a commission on the premiums collected.

The insurance company-underwriter negotiates with the Administrator and the association with respect to the benefits and premium rates, and issues a "Master Benefits Policy" to the association. Upon receipt of applications for insurance from the Administrator, the insurance company determines whether to accept the applicant within the range of premiums and benefits defined in the Master Policy and issues a "Certificate of Insurance" for return to the association member. Out of the gross premium, the insurance company pays the Administrator's commission, pays its own out-of-pocket expenses, and invests the remainder, called "reserves," in income-producing securities. From the reserves and the investment income derived therefrom, the insurance company pays all claims under the policies, and, absent any agreement to the contrary, keeps any remainder as profit for itself.

Although the benefits of group insurance were obvious, the main concern of the insurance company-underwriter was fixing a premium that would be attractive to the group and profitable to the company. On the other hand, the association group was concerned with protecting its members against unreasonably high premiums and excessive profits by the Administrator and the insurance company-underwriter.

In the 1950's, when the association group business first started, the practice of association policyholders' seeking to limit the Administrator's commissions or insurance company's profits did not exist because no one realized that such programs would become so profitable; however, large association policyholders, such as ACS, began to make demands to limit profits so that the cost of the insurance would be reduced. During the 1960's and 1970's, agreements limiting commissions and insurance company profits and providing for refunds of any surplus or excess reserves to policyholders began to appear. Such arrangements became commonly known in the insurance industry as "retention basis underwriting" or "retention and dividend agreements."

"Excess reserves" or "surplus" in a program are distinguished from "claim reserves." The "claim reserves" are the portion of premium income which, according to the insurance company's actuarial department, must be set aside to pay presently pending and future claims. The claim reserves are counted as being already among the "losses" under the program, even though the money has not yet been actually paid out. "Excess reserves," "surplus," or "contingency reserves" are the amounts remaining that are not considered necessary to pay present or expected claims.

"Retention" is the percentage of premium that by agreement is set aside to cover insurance company out-of-pocket expenses, including commissions paid, plus a certain percentage called the "insurance charge," in order to provide an agreed-upon profit margin for the insurance company. The insurance company's investment of the reserves remained an important source of its income in addition to the insurance charge.

Such retention and dividend agreements were negotiated and entered into through correspondence, memoranda, and accounting reports, and have never been written into the master policies themselves. Even when such a "retention and dividend" agreement existed, the master policies have continued to cover only insurance matters such as premium rates and the definitions of the benefits and exclusions under the policy.

ACS is a not-for-profit corporation headquartered in Chicago, whose members are 46,000 physicians who practice surgery throughout the world. LMC is an Illinois insurance corporation organized under the Illinois Insurance Code. It is headquartered in the Chicago area and is part of what is known as "The Kemper Group" of companies.

In the early 1950's, insurance administrator Charles O. Finley sold the ACS on the concept of offering its members a group insurance program. This initial program was underwritten by another carrier. The program was switched to LMC in 1956. Three types of coverage were available to ACS members: (1) disability income protection; (2) major hospital expenses; and (3) accidental death and dismemberment (AD & D). Under the program, ACS was the master policyholder for the benefit of its participating members. The premiums generated in the ACS/LMC program rose to over $5 million per year and totaled over $68 million from its inception with LMC in 1956 until termination in 1974.

By 1961, ACS became concerned about its insurance costs. It requested LMC to provide a special report on commissions, expenses, and profits for the year ending September 30, 1961. To analyze the reports and to negotiate a reduction in costs with Finley and LMC, ACS hired Harold W. Torgerson, Professor of Finance at Northwestern University, as its agent and consultant. Professor Torgerson had previously represented other medical associations in negotiations with insurance companies, including LMC.

During 1962, Professor Torgerson had a series of meetings with representatives of LMC. In May 1962, Torgerson met with Finley and four officers of LMC. They discussed increasing the major hospital premium, reducing Finley's and LMC's charges, and Finley's and Torgerson's suggestion that any "surplus" or "excess reserves" should be recognized as the property of ACS and paid to ACS at some future date or in the event of cancellation.

The parties reached an agreement that all calculations concerning reserves would be made as of the date of the program's inception, and the parties agreed on profit margins. On January 2, 1963, LMC made a written presentation of how the calculations of dividends would be made and entitled the document, "Illustrative Dividend Projections for years ending Dec. 31, 1962 through 1965." Ultimately, all the elements of the retention and dividend agreement were incorporated into the so-called "Experience for Dividend" report...