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Insurer's Calculation of Pre-Disability Earnings Upheld, Based on Amounts Reported on Federal Tax Returns

ERISA and Life Insurance News
(August 21, 2012)

After Dr. Fortier became disabled in 2005, he submitted claims for disability benefits under ERISA-governed group insurance policies issued by Principal Life Insurance Company and under individual insurance policies issued by Unum Life Insurance Company of America.

Principal immediately began to provide Dr. Fortier with short-term disability benefits. Two months later, however, when Dr. Fortier began receiving $15,470 in monthly benefits from Unum, Principal ceased making payments under its group policies because Dr. Fortier’s predisability income “was not sufficiently large to exceed the limits stated in the policies.”

The Principal policies provided that an insured who was disabled was entitled to receive 60% of his predisability earnings, capped at $1,500 per week for short-term disability benefits and $6,000 per month for long-term disability benefits. Benefits under the Principal policies, however, were reduced to the extent that all disability benefits – from both individual and group policies – exceeded predisability earnings.

Predisability earnings under the Principal policies were determined by subtracting business expenses from gross earnings. Business expenses were defined in pertinent part as (1) “the usual and customary unreimbursed business expenses,” (2) “which are incurred on a regular basis,” (3) that “are essential to the established operation of the Policyholder,” and (4) that “are deductible for Federal Income Tax purposes.”

In calculating Dr. Fortier’s predisability earnings, Principal used the predisability business expenses that Dr. Fortier deducted on his 2003 and 2004 federal income tax returns, making his monthly predisability earnings $9,916 – less than he was receiving under the individual policies.

Dr. Fortier contended, however, that Principal “erroneously deducted from his gross predisability earnings extraordinary and one-time business expenses incurred by him in 2003-04 in starting up his practice and in pursuing litigation with partners in his former medical practice.” Dr. Fortier claimed that if such “extraordinary” expenses were excluded, his predisability earnings would have been $48,913 – entitling him to 100% of the benefits under both the group and individual policies.

Principal upheld its interpretation on administrative review, and Dr. Fortier brought suit in federal court. The district court, applying the deferential abuse of discretion standard, ruled that Principal’s interpretation was reasonable. The court reasoned that because Dr. Fortier claimed his “extraordinary” expenses as deductions on his federal tax returns, he had represented that such expenses were “ordinary and necessary” business expenses under the Internal Revenue Code.

The Fourth Circuit Court of Appeals affirmed the district court’s ruling, concluding that Principal’s “interpretation was a reasonable one.”

The Fourth Circuit recognized, however, “that the policy language, defining those expenses that may be subtracted from gross income to arrive at predisability earnings, is somewhat confusing and, to be sure, needlessly verbose ....” Specifically, the court noted that the first three criteria for business expenses under the policies – “usual and customary,” “incurred on a regular basis,” and “essential to the established business operation” – were seemingly superfluous, because the phrase “deductible for Federal Income Tax purposes” was arguably “the only one needed to accomplish the policies’ purposes under [Principal’s] interpretation.”

Click here to view the full August 2012 Edition of the ERISA and Life Insurance News.

H. Sanders Carter
T (404) 962-1015
F (404) 962-1220
Kenton J. Coppage
T (404) 962-1065
F (404) 962-1256
Dorothy H. Cornwell
T (404) 962-1096
F (404) 962-1246

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