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PrintUnearned Insurance Premium Rebates Class Action ShowsDanger of Ambiguous Writing In The Passive Voice
by Randy Henrick
It is generally understood that when a consumer pays off vehicle financing prior to the end of the scheduled term, the consumer has overpaid for credit insurance because the initial charge assumed insurance coverage for the full term. In these circumstances, a consumer is entitled to a "rebate" of the "unearned premiums" that were paid in full up front.Certain auto finance contracts (precomputed interest contracts that are not simple interest contracts) work the same way when you compute a payoff balance. Under a precomputed interest contract, payments are applied against the total of payments due for the entire term regardless of when they are made although late charges and other fees can be added on if payments are made outside of the contract grace period. If a consumer pays off early, he or she is entitled to a rebate of the "unearned finance charges" that along with the principal made up the total of payments to compute the payoff balance. Essentially, you don't have to pay for what you didn't get and if you pay the contract off early, unearned finance charge must be deducted from the remaining total of payments and, in that sense, must be rebated to the consumer in calculating the payoff amount.
Much litigation in the past has focused on how premiums or finance charges are "earned" under these agreements. Most insurance contracts use the arcane "Rule of 78s" that front loads the premiums (the Rule of 78s gets its name from the sum of the numbers 1 through 12 and it heavily front-loads premiums and finance charges). In 1993, the U.S. Congress outlawed the Rule of 78s for computing unearned interest and payoff balances in precomputed interest contracts having terms longer than 61 months and provided that the customer must get a payoff at least as favorable as the actuarial method of calculating earned interest. Many state laws also restrict use of the Rule of 78s. Today, this is all done by computer.
But in a recent Ohio case, a more troubling issue on rebating unearned insurance premiums was presented in a class action. The plaintiff argued that a credit life insurance company had failed to rebate any unearned premiums to its customers and was liable for millions of dollars it had wrongfully retained. The insurance contract clearly provided for a rebate to the consumer as is required by most state laws, including Ohio's. But the insurance company countered by pointing to language in the policy that stated "We will refund any unearned premium within 30 days of the date we are notified that a premium refund is due to the insured debtor." Ah, the beauty of writing in the passive voice.
The insurance company argued that they never received notice from the plaintiffs which was a condition precedent to its obligation to pay the unearned premium. It argued that it had no way of knowing when any given consumer would pay off so it was incumbent on the consumer to notify the insurance company which typically never happened. So the insurance company just kept all the money. It asked the court to dismiss the class action.
Not so fast, argued the consumer. The consumer cited an Ohio law that requires an insurance company to rebate unearned premiums on credit insurance and to communicate with creditors as well. Because the rebate law was unconditional, the consumer argued no so-called condition precedent of notice could be added by contract. The insurance company in turn argued that it did not have equivalent sources of information to determine when a loan was paid off and that it could only determine an early pay-off through extremely costly, laborious, and time-consuming processes thus making reasonable the contractual requirement for notice to be implicitly provided by the consumer as a condition precedent to payment. Curiously, the Court did not discuss any obligation of the bank to notify the insurance company of payoffs and no bank was a party to the case
The Court ruled that the credit insurance contract was silent as to who is required to provide the notice and by what means and therefore the contract was ambiguous. On that basis, the Court stated that the plaintiff could prevail at trial and denied the insurance company's motion to dismiss. Presumably this portends a huge settlement payment from the insurance company so this issue doesn't get before a jury.
The morale of the story is to write in the active voice ("I will give notice and you will pay") not the passive voice ("I will pay when notice is given"). Ambiguous contracts are almost always construed against the party that wrote them, in this case the insurance company. Lawyers call this "the rule of construction against the draftsman." If you have an affiliated insurance company, take a look at their contracts. Almost every state requires payment of unearned premiums when the customer pays off early and you don't want to be arguing "it must mean this or that" if it comes down to a dispute. Again, make sure it is clear who has to perform every obligation and condition. This is a good rule for your contracts and writings in general as well. I've never seen a study but I would bet that when ambiguous contracts go to a jury, the party that wrote the contract loses the vast majority of the time especially when that party is an unsympathetic entity like an insurance company, bank, or auto dealer. Don't let this happen to you.
Hardy v. Minnesota Life Insurance Co., 2009 U.S. Dist. LEXIS 53641 (N.D. Ohio June 25, 2009).
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Randy Henrick is Associate General Counsel and lead Compliance Counsel for DealerTrack, Inc. This article is intended for information purposes only and does not constitute the giving of legal or compliance advice to any person or entity. Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on your particular situations.