Edstrom Industries, Inc. v. COMPANION LIFE INS.

Citations: 516 F.3d 546; 43 Employee Benefits Cas. (BNA) 2097; 2008 U.S. App. LEXIS 2940; 2008 WL 351450Docket: 07-2165

Court: Court of Appeals for the Seventh Circuit; February 10, 2008; Federal Appellate Court

SummaryOriginalCytator Case TreatmentBackward CitatorAnalysis

EnglishEspañolSimplified EnglishEspañol Fácil

Edstrom Industries, Inc. sponsors a group health insurance plan and pays claims up to $65,000, above which Companion Life Insurance Company provides "stop loss" insurance. This insurance limits Edstrom's liability for aggregate and specific medical claims. Companion required Edstrom to disclose participants likely to incur over $32,500 in medical expenses before issuing the policy on January 1, 2004. Edstrom reported no such participants, despite one participant’s child developing a serious condition shortly after birth, which Edstrom may or may not have known about at that time. Upon discovering the child's condition, Companion increased the child's deductible from $65,000 to $450,000, citing reliance on Edstrom's earlier representation. Consequently, Companion denied reimbursement for $890,000 in medical expenses incurred by Edstrom. After losing in arbitration, Edstrom attempted to challenge the arbitrator's decision in district court and is now appealing. The arbitration clause specified adherence to the policy terms and Wisconsin law, leading the parties to conclude that Wisconsin's arbitration statute governs the case, rather than the Federal Arbitration Act.

The contract containing the arbitration clause impacts interstate commerce, making the federal Arbitration Act applicable. Parties can opt out of this federal framework if the state arbitration statute does not undermine the Act's intent regarding the arbitration of disputes in maritime or interstate commerce. In this case, both Wisconsin and federal statutes align, satisfying the requirement for opting out. 

The courts are divided on whether parties can modify the standard of judicial review of arbitral awards without contravening the Federal Arbitration Act. Most rulings favor allowing such modifications. This issue is pending before the Supreme Court in Hall Street Associates, L.L.C. v. Mattel, Inc. 

The current case centers on whether an arbitrator can be mandated to apply specific substantive norms. The Supreme Court's decision in Volt Information Sciences established that a contract's arbitration clause can include a choice of law provision that adheres to state arbitration law without conflicting with federal law. This implies that parties can specify governing substantive norms within their arbitration agreement.

The arbitrator determined that the insurance policy granted Companion the right to increase the deductible upon discovering previously undisclosed medical conditions. Regardless of whether the omission was a mistake or negligence, the contract explicitly allowed Companion to adjust the deductibles based on such disclosures.

Edstrom contends that a Wisconsin statute, Wis. Stat. 631.11(1)(b), stipulates that an insurer's obligations cannot be influenced by misrepresentations unless the insured was aware or should have been aware of their falsity. Edstrom asserts that it did not know, nor had any reason to know, that its representation to Companion regarding medical expenses exceeding $32,500 in 2004 was false, suggesting it should not be held accountable. The arbitrator did not reference this statute, but the magistrate judge determined it was inapplicable because it does not pertain to reinsurance contracts, classifying the stop-loss policy as such. Under this classification, Edstrom's knowledge of a participant's potential medical expenses becomes irrelevant unless the statute supersedes the policy provision, affecting Companion's ability to adjust the deductible based on undisclosed conditions.

The magistrate judge's interpretation that stop-loss insurance functions as reinsurance is highlighted by a comparison to traditional group health insurance, as stop-loss does not provide direct coverage to plan members. However, the document emphasizes that merely labeling a contract as “insurance” does not align with statutory definitions governing insurance. Various examples illustrate that agreements which provide risk coverage, such as indemnities or warranties, do not constitute insurance under regulatory statutes. The text clarifies that stop-loss insurance operates as a policy covering losses that the insured self-insures up to a deductible limit, distinguishing it from reinsurance contracts, which involve regulated transactions between insurance companies. Ultimately, Edstrom is classified as an insured rather than an insurer, reinforcing its position under the regulatory framework.

Terry Humo's "Employer's Guide to Self-Insuring Health Benefits" references the prohibition under ERISA against classifying employee welfare benefit plans as insurance companies. Companion, identified as an insurance company and not a reinsurance entity, would not benefit from the protections afforded by Wisconsin statutes if classified otherwise. The magistrate judge's interpretation could undermine protections for purchasers of stop-loss insurance, which could include small companies, and disrupt the Wisconsin Health Insurance Risk Sharing Plan that relies on fees from health insurers. If Companion were to be treated as a reinsurance company, it would be exempt from certain taxes, which raises concerns about the implications of such classification. Companion argues that the correctness of the arbitrator's interpretation is less important than the existence of a plausible "interpretive path" linking the statute to the conclusion that stop-loss insurers are excluded. Courts generally do not set aside arbitration awards based on legal errors unless the arbitrators exceed their authority or violate the agreed-upon arbitration process. The arbitration clause specifically requires adherence to Wisconsin law, emphasizing that the arbitrator cannot apply laws from other jurisdictions. When parties agree to arbitration, they relinquish the right to appeal based on mere mistakes in judgment, focusing instead on breaches of the arbitration agreement itself.

An arbitration clause's directive language limits the arbitrator's discretion in interpreting Wisconsin insurance law. The arbitrator failed to address the misrepresentation statute, Wis. Stat. 631.11(1)(b), which was central to Edstrom's argument. This omission indicates a disregard for the required application of Wisconsin law, undermining the integrity of the arbitration process. While it could be argued that the arbitrator's lack of written opinion might allow for presumed adherence to the law, the case does not support such an interpretive path. Additionally, Companion's argument that the arbitrator's decision could still be upheld based on possible interpretations of the statute was unconvincing. The arbitrator's statement regarding the irrelevance of Edstrom's sincerity implied a refusal to engage with the statute's applicability. Consequently, the court directed that the arbitration award be vacated, requiring the arbitrator to reassess whether Edstrom knew or should have known its representation was false. The decision was reversed and remanded for further proceedings.