Edstrom Indus Inc v. Companion Life Insur ( 2008 )

In the
United States Court of Appeals
For the Seventh Circuit
____________
No. 07-2165
EDSTROM INDUSTRIES, INC.,
Plaintiff-Appellant,
v.
COMPANION LIFE INSURANCE COMPANY,
Defendant-Appellee.
____________
Appeal from the United States District Court
for the Eastern District of Wisconsin.
No. 06 C 964—Aaron E. Goodstein, Magistrate Judge.
____________
ARGUED JANUARY 11, 2008—DECIDED FEBRUARY 11, 2008
____________
Before BAUER, POSNER, and EVANS, Circuit Judges.
POSNER, Circuit Judge. Edstrom, a manufacturing com-
pany that is the plaintiff in this diversity suit, which is
governed by Wisconsin law, sponsors a group health
insurance plan for its employees and their dependents.
It pays claims under the plan out of its own pocket—up
to $65,000. Above that, an insurance company, the defen-
dant, Companion, which has sold Edstrom what is called
a “stop loss” insurance policy, pays. As explained in Jerry
S. Rosenbloom, The Handbook of Employee Benefits: Design,
Funding and Administration, 98 (2005), “If an organization
2 No. 07-2165
utilizes a cost-plus or self-insured method of financing,
it may choose to limit its potential aggregate medical
claims exposure by purchasing insurance that would make
payment if claims exceeded a certain predetermined
amount for the entire group. This insurance coverage for
capping the total claims experience of the group is known
as aggregate stop loss. A firm might also limit its liability
using specific stop loss. Specific stop loss sets a limit on the
amount that a plan sponsor will pay for an individual
case. If a catastrophic medical case occurs, the employer
will only be responsible for paying covered medical costs
on that individual case up to the stop-loss amount.”
Companion’s policy specifies an aggregate as well as a
specific stop-loss amount, but the former is not involved
in this case and we can therefore ignore it.
As a condition of issuing the policy, Companion re-
quired Edstrom to identify any participant in its group
insurance health plan who could reasonably be expected
to incur more than $32,500 in medical expenses in 2004.
In December 2003, Edstrom told Companion there was
no such participant, and the policy was issued to Edstrom
on January 1, 2004. Four months before Edstrom had made
the required representation, however, one of the plan
participants had had a child who shortly after birth had
developed a grave medical condition. It has not been
determined whether Edstrom learned this before or after
it made the representation. When Companion dis-
covered the child’s condition, it altered the policy to raise
the child’s deductible from $65,000 to $450,000, pursuant
to a provision of the policy that after noting Companion’s
reliance on information provided by the insured states
that “should subsequent information become known
which, if known prior to the issuance of this [policy],
No. 07-2165 3
would affect the rates, deductibles, terms or conditions
hereunder, [Companion] will have the right to revise
[them] as of the effective date of issuance, by providing
written notice to the [insured].” By the end of 2004, in
reliance on this provision, Companion had refused to
reimburse Edstrom for $890,000 in medical expenses
that Edstrom had incurred for treatment of the child.
Edstrom invoked arbitration pursuant to the insurance
policy, lost, sought unsuccessfully in the district court to
overturn the arbitrator’s decision, and now appeals to us.
The arbitration clause included an “express stipulation
that the arbitrator shall strictly abide by the terms of this
[policy] and shall strictly apply rules of law applicable
thereto,” namely the rules of Wisconsin law. This stipula-
tion persuaded the parties and the district judge that the
arbitration is governed by Wisconsin’s arbitration statute
rather than by the Federal Arbitration Act (title 9 of the
U.S. Code). It is true that the contract in which the clause
is embedded affects interstate commerce, and so the fed-
eral act is applicable. 9 U.S.C. § 2; Allied-Bruce Terminix
Cos. v. Dobson, 513 U.S. 265 (1995). But the Supreme Court
has held that parties can opt out of the federal act, pro-
vided the state arbitration statute does not contain provi-
sions that would undermine the federal act’s aim of
facilitating the resolution of disputes involving maritime or
interstate commerce by arbitration. Compare Volt Informa-
tion Sciences, Inc. v. Board of Trustees of Leland Stanford Junior
University, 489 U.S. 468, 476-79 (1989), with Doctor’s
Associates, Inc. v. Casarotto, 517 U.S. 681, 686-87 (1996); see
also Flexible Mfg. Systems Pty. Limited v. Super Products
Corp., 86 F.3d 96 (7th Cir. 1996); Securities Industry Ass’n v.
Connolly, 883 F.2d 1114, 1120 (1st Cir. 1989). The proviso is
satisfied here; the Wisconsin and federal statutes do not
4 No. 07-2165
differ in any particular that bears on this appeal. Cf. Flexible
Mfg. Systems Pty. Limited v. Super Products Corp., supra,86 F.3d at 98-99.
The courts of appeals are divided over a question related
to opting out of the Federal Arbitration Act—whether
parties can alter the standard of judicial review of arbitral
awards, and specifically can make it more searching,
without running afoul of the Act. Most of the cases
answer yes. Compare Puerto Rico Telephone Co. v. U.S.
Phone Mfg. Corp., 427 F.3d 21, 31 (1st Cir. 2005); Jacada
(Europe) Ltd. v. International Marketing Strategies, 401 F.3d
701, 710-12 (6th Cir. 2005); Roadway Package System, Inc. v.
Kayser, 257 F.3d 287, 292-93 (3d Cir. 2001), and Gateway
Technologies, Inc. v. MCI Telecommunications Corp., 64 F.3d
993, 997 (5th Cir. 1995), with Kyocera Corp. v. Prudential-
Bache Trade Services, Inc., 341 F.3d 987, 1000 (9th Cir. 2003)
(en banc), and Bowen v. Amoco Pipeline Co., 254 F.3d 925,
936-37 (10th Cir. 2001). The question is before the Supreme
Court. Hall Street Associates, L.L.C. v. Mattel, Inc., 196
F. Appx. 476 (9th Cir. 2006), cert. granted, 127 S. Ct. 2875(May 29, 2007).
The question in our case is different. It is whether the
arbitrator can be directed to apply specific substantive
norms and held to the application. The Supreme Court
held in the Volt case that parties to a contract may in-
clude in the contract’s arbitration clause a choice of law
provision defining, by reference to a state’s arbitration law
(provided it does not undermine the federal arbitration
law), “the rules under which that arbitration will be
conducted.” 489 U.S. at 479; see also Dr. Kenneth Ford v.
NYLCare Health Plans of Gulf Coast, Inc., 141 F.3d 243, 246-49
(5th Cir. 1998). We cannot think of any reason why the
choice of law provision could not designate the governing
No. 07-2165 5
substantive norms. Cf. 1 Jay E. Grenig, Alternative Dispute
Resolution, § 7.2, p. 149-51 (3d ed. 2005). The alternative
would be to leave every arbitrator free to make up his
own law of contracts.
It shouldn’t matter that the arbitrator was directed to
“strictly” apply, rather than just apply, Wisconsin law. If
parties add, in the provision designating what body of
law shall apply to disputes referred to arbitration, “and
we mean it!”—which is in essence what they did here—no
federal policy requires the arbitrator to ignore that direc-
tive. Nowhere in the Federal Arbitration Act is it written
that arbitrators are always to apply loosely whatever body
of law the parties have specified to guide the arbitrators
in resolving disputes.
The arbitrator ruled that the insurance policy gave
Companion “the complete and unfettered right at its sole
election” to raise the deductible “when it became aware
of [the child’s] medical condition…. It is of no moment
whether omission of [the child] was, in the word[s] of
Edstrom’s counsel, ‘an honest mistake,’ or the product of
Edstrom’s failure to exercise due care or worse. This is
because, first and foremost, the contract gave [Companion]
the unqualified right to revise deductibles upon disclosure
of previously undisclosed conditions.” Edstrom argues
that the ruling violates a Wisconsin statute which pro-
vides that a misrepresentation cannot affect an insurer’s
obligations unless the insured “knew or should have
known that the representation was false.” Wis. Stat.
§ 631.11(1)(b). So if Edstrom neither knew nor had reason
to know, when it represented to Companion that no plan
participant or dependent was likely to incur medical
expenses in excess of $32,500 in 2004, that the representa-
tion was false, it should be home free. The arbitrator did
6 No. 07-2165
not mention the statute, but the magistrate judge ruled
that it did not apply in this case because it does not apply
to contracts of reinsurance, Wis. Stat. § 631.01(2), and he
held that the stop-loss policy was a contract of reinsur-
ance—that Edstrom was the insurer of claims under its
group health plan and Companion was the reinsurer. If
this is right, it is irrelevant whether Edstrom knew or
should have known that a participant in its plan was likely
to incur medical expenses in excess of the deductible. As
the arbitrator said, the policy makes that irrelevant, so that
only if the statute is applicable, preempting the policy
provision, is Companion’s right to raise the deductible
on the basis of an innocently undisclosed preexisting
condition constrained.
The magistrate judge’s ruling that stop-loss insurance is
reinsurance under Wisconsin law is perhaps understand-
able, because “unlike traditional group-health insurance,
stop-loss insurance is akin to reinsurance in that it does
not provide coverage directly to plan members or benefi-
ciaries.” Travelers Ins. Co. v. Cuomo, 14 F.3d 708, 723 (2d
Cir. 1993), reversed on other grounds, 514 U.S. 645 (1995).
But kinship is not enough. It is a mistake to think that
anything someone does to “insure” someone else against
a risk is “insurance” within the meaning of statutes
that regulate insurance. If you sign an accommodation
note, you guarantee another’s debt; in effect, you “insure”
the creditor. If a contract contains a warranty, the promisor
is “insuring” the promisee against the consequences of
a defect in the product covered by the warranty. Strict
products liability is likewise a system of insurance against
product defects (though that is not all it is). A debtor’s
promise to indemnify his creditor for the costs of collec-
tion if the debtor defaults is still another example of
No. 07-2165 7
“insurance” in the broad sense. And if a company promises
a “golden parachute” to one of its executives, it is “insur-
ing” the executive against not being able to find as good
a job should he lose his present one. But as in the other
examples, the golden parachute is not an “insurance”
policy within the meaning of the insurance statutes.
Finally, a person who has a $5,000 deductible in his
automobile collision policy is “self-insured” for damage
up to the amount, but that does not make him an insur-
ance company and his auto insurance policy a reinsur-
ance policy. Stop-loss insurance is an insurance policy
for losses that the insured self-insures up to the limit of
the deductible.
Reinsurance contracts are (largely) unregulated be-
cause they are contracts between insurance companies,
Ott v. All-Star Ins. Corp., 299 N.W.2d 839, 843 (Wis. 1981);
Franklin Mutual Ins. Co. v. Meeme Town Mutual Fire Ins. Co.,
228 N.W.2d 165, 166 (Wis. 1975) (“reinsurance, to an
insurance lawyer, means one thing only—the ceding by
one insurance company to another of all or a portion of
its risks for a stipulated portion of the premium” (internal
quotation marks, and citation, omitted)), and insurance
companies are heavily regulated. The insurance policies
they issue are regulated in order to protect insureds from
insurers (and to an extent the reverse as well), rather
than to protect insurance companies from each other.
Edstrom is not an insurance company, but an insured. See
Wis. Stat. § 600.03(27), and with specific reference to stop-
loss insurance, Wisconsin Office of Commissioner of
Insurance, “Opinion Letter Regarding ‘Single Employer
Self-Insured Group Medical Plan’ ” 2 (July 22, 2002), and
“Regulatory Alert to Stop Loss Carriers and Third
Party Administrators” 2 (June 4, 2003), www.oci.wi.gov/
8 No. 07-2165
bulletin/0603mewa.htm (visited Jan. 18, 2008); Terry
Humo, Employer’s Guide to Self-Insuring Health Benefits
¶ 600, p. 2 (2007); cf. 29 U.S.C. § 1144(b)(2)(B) (employee
welfare benefit plans governed by ERISA may not be
deemed to be insurance companies). Companion is not a
reinsurance company, but an insurance company. True,
Edstrom is a company rather than a hapless individual,
but chapter 31 of the Wisconsin statutes, the chapter
that contains the protective provision at issue in this
case, does not exempt from its protections insureds that
happen not to be natural persons.
The magistrate judge’s interpretation would not only
strip the purchasers of stop-loss insurance, even when they
are small companies, of the extensive protections
that Wisconsin law provides to insureds, see, e.g., Wis.
Stat. §§ 631.20, 645.68(3), (5), but it would disrupt the
Wisconsin Health Insurance Risk Sharing Plan. The plan
provides health insurance to persons who cannot obtain
private coverage, and finances the program by imposing
fees on health-insurance companies—including com-
panies that sell stop-loss insurance to employers who
sponsor self-funded employee welfare benefit plans. See
Safeco Life Ins. Co. v. Musser, 65 F.3d 647 (7th Cir. 1995); Wis.
Stat. §§ 149.10(b)(5), 149.13. Were Companion classified as
a reinsurance company rather than a seller of health
insurance, it would be exempt from the tax.
Companion argues that it doesn’t matter whether the
arbitrator interpreted the statute correctly, or, as we
believe, incorrectly—a conclusion consonant with how
other courts have interpreted similar statutes in other
states. Kitchell v. Public Service Co. of New Mexico, 972 P.2d
344, 348 (N.M. 1998); South Carolina Property & Casualty
Ins. Guaranty Ass’n v. Carolinas Roofing & Sheet Metal
No. 07-2165 9
Contractors Self-Insurance Fund, 446 S.E.2d 422, 424-25 (S.C.
1994); Stamp v. Department of Labor & Industries, 859 P.2d
597, 540-44 (Wash. 1993); Iowa Contractors Workers’ Compen-
sation Group v. Iowa Ins. Guaranty Ass’n, 437 N.W.2d 909,
914-16 (Iowa 1989); Zinke-Smith, Inc. v. Florida Ins. Guaranty
Ass’n, Inc., 304 So.2d 507 (Fla. App. 1974); Tennessee
Department of Commerce and Insurance, “Regulation of
Excess Stop-Loss Coverage,” Tenn. Ins. Bulletin 7-1-94
(1994). All that matters, according to Companion, is that
we be able to imagine an “interpretive path” connecting
the statute to the arbitrator’s conclusion that the statute
does not apply to a stop-loss insurer. Chicago Typographical
Union No. 16 v. Chicago Sun-Times, Inc., 935 F.2d 1501, 1504-
06 (7th Cir. 1991). And it is true that errors of law com-
mitted by arbitrators are not grounds for setting aside
an arbitral award. That would transform the judicial role
in arbitration into appellate review of the award. George
Watts & Son, Inc. v. Tiffany & Co., 248 F.3d 577, 579 (7th Cir.
2001). The parties’ effort to shift the resolution of their
dispute from the court system, by agreeing to arbitration,
would be thwarted.
But precisely because arbitration is a creature of con-
tract, the arbitrator cannot disregard the lawful directions
the parties have given them. If they tell him to apply
Wisconsin law, he cannot apply New York law. Id.; Mil-
waukee Board of School Directors v. Milwaukee Teachers’
Education Ass’n, 287 N.W.2d 131, 135-36 (Wis. 1980).
“When parties agree to arbitrate their disputes they opt
out of the court system, and when one of them challenges
the resulting arbitration award he perforce does so not on
the ground that the arbitrators made a mistake but that
they violated the agreement to arbitrate, as by corruption,
evident partiality, exceeding their powers, etc.—conduct
10 No. 07-2165
to which the parties did not consent when they included
an arbitration clause in their contract.” Wise v. Wachovia
Securities, LLC, 450 F.3d 265, 269 (7th Cir. 2006).
The arbitration clause in this case told the arbitrator to
apply Wisconsin law “strictly.” This unusual stipulation,
like other exact directive language in arbitration clauses,
see, e.g., Poland Spring Corp. v. United Food & Commercial
Workers Int’l Union, AFL-CIO-CLC, Local 1445, 314 F.3d
29 (1st Cir. 2002); Roadway Package System, Inc. v. Kayser,
257 F.3d 287 (3d Cir. 2001); Milwaukee Board of School
Directors v. Milwaukee Teachers’ Education Ass’n, supra,
287 N.W.2d at 135-36, limited the extent to which the
arbitrator could indulge his fancy, here in interpreting
Wisconsin insurance law. It is unrealistic to think that the
arbitrator was even trying to interpret Wisconsin law.
For though the misrepresentation statute, Wis. Stat.
§ 631.11(1)(b), on which Edstrom relies was argued to
the arbitrator, he did not mention it in his opinion, let
alone try to show that it is inapplicable because stop-
loss insurance is really reinsurance. He seems not to
have interpreted it at all but merely to have ignored it,
which was inconsistent with the directive that he
strictly apply Wisconsin law—and would have been
inconsistent even if “strictly” had been omitted.
It might be replied that had the arbitrator not written
an opinion (and he was not required to do so), we
would attribute to him whatever interpretive path might
lead to a conclusion that the statute was indeed inap-
plicable; and so if we pick apart arbitrators’ opinions as
we are doing here the result will be to deter arbitrators
from writing opinions and “this would be undesirable for
a well-reasoned opinion tends to engender confidence
in the integrity of the process and aids in clarifying the
No. 07-2165 11
underlying agreement.” United Steelworkers of America v.
Enterprise Wheel & Car Corp., 363 U.S. 593, 598 (1960). We
doubt that there is an interpretive path in this case. Chicago
Typographical Union No. 16 v. Chicago Sun-Times, Inc., supra,
935 F.2d at 1504-06. Companion has tried to persuade us
that there is, but has failed. And we can no more ignore
what an arbitrator says than what a jury says when it
returns a special verdict rather than a general verdict or
what a judge says who explains the basis for a ruling
excluding evidence rather than just saying “objection
sustained.” Had the arbitrator in this case said to hell
with Wisconsin law, we could not enforce his award on
the ground that had he said nothing we would imagine
what he might have said to make it seem that he was
applying that law. Westerbeke Corp. v. Daihatsu Motor
Co., 304 F.3d 200, 212 (2d Cir. 2002); Ottley v. Sheepshead
Nursing Home, 688 F.2d 883, 891-92 and n. 2 (2d Cir. 1982)
(concurring opinion).
Companion further argues that we must uphold the
arbitrator’s ruling if he could have found that the
statute, even if strictly applied, would not forbid raising
the deductible. There was evidence that Edstrom knew
or should have known that its representation was false,
and if that is right the statute would not protect it. But by
saying only that the sincerity of Edstrom’s representa-
tion was irrelevant (which it would be, if the Wisconsin
statute were inapplicable), the arbitrator implied that he
had not decided, and would not decide, the issue.
The district court is directed to vacate the arbitration
award and return the matter to the arbitrator to determine
whether Edstrom knew or should have known that its
representation to Companion was false.
REVERSED AND REMANDED, WITH DIRECTIONS.
12 No. 07-2165
A true Copy:
Teste:
_____________________________
Clerk of the United States Court of
Appeals for the Seventh Circuit
USCA-02-C-0072—2-11-08