Indiana Lumbermans Mutual Insurance Company v. Reinsurance Results, Inc.

The defendant in this diversity
suit for breach of contract governed by Indiana law
appeals from the grant of summary judgment in favor of
the plaintiff. The case turns on the interpretation of a
contract between an insurance company, Lumbermens
Mutual, the plaintiff, and Reinsurance Results, the defendant,
which reviews an insurance company's claims
against its reinsurers to make sure the insurance company
receives the benefits to which its reinsurance contracts
entitle it. We'll sometimes call Lumbermens the
"insurance company" and we'll call Reinsurance Results
the "service company."

The contract is very short and its key language shorter
still. The service company undertakes to review the
insurance company's claims and to report any "premium
and/or claims identified during the course of the review
that have not been processed in accordance with the
reinsurance contract terms and conditions." The fee for
this service is 33 percent of the " 'Net Funds' collected
from [the insurance company's] reinsurers as a result of
this review." The service company claims that it obtained
net funds of $2.2 million for its client and thus is owed
33 percent of that amount. The insurance company,
disagreeing, brought this declaratory judgment action,
contending that it owes the service company nothing,
and won.

Reinsurance is a dauntingly complex, esoteric field of
business and the briefs in this case are correspondingly
complex and esoteric. But the facts relevant to the appeal
are actually rather simple, and the forbidding jargon of
reinsurance ("ceded unearned premium," "aggregate
excess of loss," "under-ceded reinsurance loss," "reinsurance
treaty," and the rest) can be dispensed with. An
insurance company - which is to the reinsurer as an
insured is to the insurance company - pays premiums
for reinsurance. Until 2000, Lumbermens expensed the
entire premium cost of its reinsurance policies in the
calendar year in which it bought them. That year, with
the approval of its auditor, PricewaterhouseCoopers
(PwC), it changed its accounting method as follows. It
divided the premium by the number of years of coverage
that it had brought, and treated each year's share of
the premium as an expense in that year. It then reclassiNo.
fied the premium - which it had already paid, for coverage
over the life of the policy - as a prepayment of future
expenses and thus as a capital asset (like a reserve for a
tenant who pays a year's worth of rent in advance) to
be amortized over its useful life (the period of coverage).

By thus increasing the assets reflected on its books of
account, Lumbermens increased the amount of surplus
shown on the books.

The accounting change affected the amount that
Lumbermens could bill its reinsurers for losses covered
by its reinsurance policies. This will take some explaining.
There are tiers of reinsurance coverage, just as there
are tiers of insurance coverage. Assume, to keep things
simple, that there are only two reinsurance tiers, with
the first covering losses up to some specified amount
and the second losses above that limit. (That is the equivalent
of primary and secondary coverage in an ordinary
insurance contract.) If a loss above the first reinsurer's
limit occurs, the insured (that is, the insurance company,
Lumbermens in our case) bills it for the loss. But the net
recovery by the insurance company is the reimbursement
for the loss minus the premium it paid for the
coverage. The loss above the first reinsurer's loss limit is
reimbursed by the second reinsurer, but - and this is the
key to understanding this case - the premium that the
second reinsurer charges is based on the net reimbursement
to the insurance company by the first reinsurer and
thus on the loss up to the first reinsurer's loss limit
minus the premium paid to that reinsurer. So if, for example,
the loss to be reinsured against is $20 million, the
loss limit of the first reinsurer $10 million, and the premium
paid to the first reinsurer $1 million (10 percent
of the policy limit), the second reinsurer, which makes
good the difference between the $20 million loss and the
$10 million paid by the first reinsurer, will base its premium
(which let's suppose is also 10 percent) on the
difference between the first reinsurer's loss limit and that
reinsurer's premium. That difference in our example is
$9 million ($10 million – $1 million), and so the second
reinsurer's premium is $900,000 rather than $1 million;
if instead the second reinsurer charged the insurance
company $1 million, the company would therefore be
entitled to a refund of $100,000.

But when in 2000 Lumbermens changed its accounting
method, no longer, when it submitted a claim to the second
reinsurer, would it deduct the premium to the first
insurer, though it had paid it, because on its books it had
deferred that premium expense, and its contracts with
the reinsurers based premiums on book values rather
than cash flow. The amounts deferred must have exceeded
the higher premiums paid the second-tier reinsurers,
so that the accounting change increased the company's
surplus; otherwise the company would not have
made the change. But why would an insurance company
trade higher book value (another term for surplus) for
a lower cash flow? The answer appears to be that the
number of policies an insurer is permitted by its regulators
to write, and therefore the amount of premiums that
it can collect, is proportional to its surplus. So Lumbermens
may have traded higher premium revenue for
lower reimbursements from its reinsurers without abandoning
its business common sense. And the fact that an
insurance company's ability to write policies is tethered
to the surplus shown on its books may explain why
reinsurers base their premiums on the company's accounting
classifications. The more policies an insurer
writes, the more likely it is that one of its policy holders
will incur a loss that triggers the reinsurer's liability to
the insurance company. To compensate for this elevated
risk, the prudent reinsurer demands a higher premium,
which takes the form of a delayed reimbursement to the
insurer. The insurer gets to write additional policies, and
during the interval when the insurer's surplus is inflated
by its method of accounting, the reinsurer enjoys the
time value of money reimbursed at a later date.

Lumbermens' contract with the service company
went into effect in November of 2004. A few days later
the company sent Lumbermens a memo noting the
2000 accounting change and suggesting that it was improper.
The insurance company checked with PwC,
which advised the insurance company, on the basis of a
change that had been made in the National Association
of Insurance Commissioners' Statement of Statutory Accounting
Procedure 62, to revert to its pre-2000 accounting
practice. It did so, and this required it to reduce the net
surplus carried on its books by $829,000. It billed the
second- (and higher-) tier reinsurance companies for the
premium overpayments that it had incurred by virtue
of not deducting the lower-tier reinsurers' premiums
when it had paid them. The reinsurance companies paid
what the insurance company said they owed it and that
is the $2.2 million of which the service company claims
to be owed a third.

The insurance company argues that the receipt of the
$2.2 million from the reinsurers was not a benefit to the
company. It wanted to defer the receipt of that money
from its reinsurers in order to augment its surplus because
it thought the profits derived from the additional
policies that it would be able to write as a result of having
a higher surplus would exceed the premium over6
payments. If this is right, the service company did
Lumbermens no favor by causing it to return to the
old method.

The argument is not necessarily wrong, though it is
speculative. The insurance company's accounting method
was questionable (or so at least PwC advised it), and
continued adherence to it might have gotten it into
trouble with the insurance regulators. They do not like
insurance companies to use questionable accounting
methods to jack up their surpluses, since overstating
the company's assets and thus the amount of insurance that
it may write increases the risk of default. Sooner or later,
then, the company would probably have had to go back to
its old method of accounting for reinsurance premiums.

And by then, the service company argues, it might have
been too late for the insurance company to be able to collect
the money (the excess premiums) owed it by the upper-tier
reinsurers. This, however, is unlikely. The insurance
company would not have wanted to defer receipt of the
money owed it by its reinsurers to a point at which the
money might become uncollectible. And it did not; rather
than deferring receipt indefinitely, as the service company's
argument implies, it deferred it just till the reinsurance
policy expired, at which point its prepayment asset
would have been fully depreciated.

The service company's better argument is that by causing
the insurance company to check with PwC and as
a result revert to its old accounting practice, it saved
the insurance company from a possible tiff with its
regulators - though the service company's lawyer acknowledged
at argument that the regulators might not
have noticed the accounting irregularity, or if it did
notice them, care.

We defer for the moment further discussion of the
benefit, if any, conferred on the insurance company by
the service company to consider whether, if a benefit
was conferred, the conferral was pursuant to the contract.

It was not. The contract, drafted by the service
company's chief executive officer, is specific and clear;
and were it unclear, any ambiguity would have to be
resolved against the service company because it drafted
the contract. Indiana applies this rule of contract interpretation,
rightly or, as might be argued, wrongly, Farmers
Automobile Ins. Ass'n v. St. Paul Mercury Ins. Co., 482 F.3d
976, 977 (7th Cir. 2007) - but that is none of our business
in a case governed by Indiana law - even when the other
party to the contract is, as in this case, commercially
sophisticated. E.g., Cinergy Corp. v. Associated Electric &
Gas Ins. Services, Ltd., 865 N.E.2d 571, 574-77 (Ind. 2007);
Trustcorp Mortgage Co. v. Metro Mortgage Co., 867 N.E.2d
203, 213-16 (Ind. App. 2007); Liberty Ins. Corp. v. Ferguson
Steel Co., 812 N.E.2d 228, 230 (Ind. App. 2004).

The contract states that the service company is to report
any loss or premium-overpayment claims, discovered
during the course of its review of the insurance
company's reinsurance contracts, "that have not been
processed in accordance with the reinsurance contract terms
and conditions" (emphasis added). The claims that the
insurance company submitted to its reinsurers were
correctly processed. Nothing in the terms of its reinsurance
contracts requires it to use one method of accounting
rather than another. The decision first to defer reporting
to the upper-tier reinsurers the premiums paid
to the lower-tier reinsurers and then, four years later, to
bill them for the premiums it had overpaid, because
PwC told it that deferring the reporting of the premiums

was a violation of accounting standards, was a decision
internal to the insurance company; it had nothing to
do with the terms of the reinsurance contracts. Had the
service company discovered that a term of one of those
contracts entitled the insurance company to coverage for
a loss that it had experienced but for which it had not
submitted a claim, then the service company would be
entitled to 33 percent of the amount of the claim when
the insurance company billed and received it. But that is
not what happened. The service company's discovery of
the 2000 accounting maneuver and its recommendation
that the insurance company abandon it may have benefited
the company. But it was not a benefit for which the
insurance company was contractually obligated to compensate
the service company.

One who voluntarily confers a benefit on another,
which is to say in the absence of a contractual obligation
to do so, ordinarily has no legal claim to be compensated.
E.g., In re Grabill Corp., 983 F.2d 773, 776 (7th Cir. 1993);
American Law Institute, Restatement (First) of Restitution
§ 2 (1937). If while you are sitting on your porch sipping
Margaritas a trio of itinerant musicians serenades you
with mandolin, lute, and hautboy, you have no obligation,
in the absence of a contract, to pay them for their
performance no matter how much you enjoyed it; and
likewise if they were gardeners whom you had hired
and on a break from their gardening they took up their
musical instruments to serenade you. When voluntary
transactions are feasible (in economic parlance, when
transaction costs are low), it is better and cheaper to require
the parties to make their own terms than for a
court to try to fix them - better and cheaper that the
musicians should negotiate a price with you in advance
than for them to go running to court for a judicial determination
of the just price for their performance. In contrast,
"when a businessman renders a valuable service
in circumstances in which compensation would normally
be expected, and though he is acting without the knowledge
or consent of the recipient of the service there is
no alternative because transacting with the owner would
be infeasible (maybe the owner can't be located), an
award of compensation is appropriate to encourage a
valuable activity." Nadalin v. Automobile Recovery Bureau,
Inc., 169 F.3d 1084, 1086 (7th Cir. 1999). That is the case
of prohibitively high transaction costs. This is not such a
case.

Another inapplicable exception to the law's hands-off
approach comes into play when the party rendering
the service reasonably expects to be paid for it though
he has no contractual entitlement. E.g., Olsson v. Moore,
590 N.E.2d 160, 163 (Ind. App. 1992). There might be a
contract but it might be unenforceable because it violated
the statute of frauds, yet thinking it enforceable the performing
party had performed his (reasonably, but incorrectly,
supposed) obligations under the contract and now
seeks compensation. He would not be entitled to the
contract price, because the contract was unenforceable,
but he would be entitled to the market value of his performance.
Wallace v. Long, 5 N.E. 666, 668-69 (Ind. 1886);
Mueller v. Karns, 873 N.E.2d 652, 658-59 (Ind. App. 2007);
Scheiber v. Dolby Laboratories, Inc., 293 F.3d 1014, 1022-23
(7th Cir. 2002) (Indiana Law); ConFold Pacific, Inc. v. Polaris
Industries, Inc., 433 F.3d 952, 957-58 (7th Cir. 2006).

The doctrine that allows this is quantum meruit, a
branch of the law of restitution, having roots in equitable
notions; and the service company advanced a claim for
compensation under it in the district court. The court

rejected the quantum meruit claim, and the company has
abandoned the claim on appeal - wisely. The service
company did not render a service pursuant to an unenforceable
contract; it rendered a service outside the contract,
as we have seen. When parties have a valid contract,
there is no bargaining failure that would justify a
court's awarding a party more than he had contracted for.

As we noted in Industrial Dredging & Engineering Corp. v.
Southern Indiana Gas & Electric Co., 840 F.2d 523, 525 (7th
Cir. 1988) (citations omitted), "Indiana appellate courts
have uniformly held that ‘the existence of a valid express
contract for services . . . precludes implication of a contract
covering the same subject matter. The rights of the
parties are controlled by the contract and under such
circumstances recovery cannot be had on the theory
of quantum meruit.' " See, e.g., Milwaukee Guardian Ins., Inc.
v. Reichhart, 479 N.E.2d 1340, 1343-44 (Ind. App. 1985);
see also Goldstick v. ICM Realty, 788 F.2d 456, 466-67 (7th
Cir. 1986).

The result may seem harsh, but we will be able to see
the sense behind it by resuming our discussion of whether
the service company actually conferred a benefit on
the insurance company. We said that it may have done
so, but we said nothing about the size of the benefit. It is
most unlikely that the $2.2 million that the insurance
company received from its reinsurers as a result of the
service company's tip was a net benefit to the insurance
company. The company wanted to defer receipt of the
money, and would probably have gone on doing just
that, for a time anyway, had it not been induced by the
service company to seek the advice of its auditor, from
whom it learned the bad news. By continuing, the insurance
company might have gotten into hot water with its
regulators, but perhaps not - so could a court compute
the benefit that the tip had conferred?

Nor is benefit conferred the usual measure of market
value, which is the value that courts use to calculate the
relief due a plaintiff whose claim of quantum meruit
succeeds. In re Carroll's Estate, 436 N.E.2d 864, 866 (Ind.
App. 1982); ConFold Pacific, Inc. v. Polaris Industries, Inc.,
supra, 433 F.3d at 958. In a competitive market, price
tends to be driven down to or at least near cost; it is under
monopoly conditions that sellers are able to appropriate
what economists call "consumer surplus" - the difference
between the value of a good or service to a consumer
(in the sense of the highest price he could be made to pay
for it - his "reservation price") and the market price. If
an airline ticket costs $100, but you would be willing,
if pushed, to pay up to $300 for it, you derive $200 in
consumer surplus from the transaction. Obviously this
does not mean that if your travel agent obtains the ticket
for you, he will charge you $300. Travel agents nowadays
do often charge ticketing fees, but they are modest, reflecting
competitive pressures. It is no surprise that when
courts award quantum meruit they base the award on the
market price of the good or service in question. There
is no market price for the extracontractual "service" that
the service company rendered the insurance company.

The service company might have drafted the contract
that it submitted to the insurance company more
broadly - might have inserted a provision entitling the
service company to be compensated for any advice it
gave the insurance company that the latter took. But the
insurance company might well have balked at such a
demand, as vistas of contention over benefits conferred
opened up before it. So the service company really is
seeking more than it bargained to receive.

A note, finally, on advocacy in this court. The lawyers'
oral arguments were excellent. But their briefs, although
well written and professionally competent, were difficult
for us judges to understand because of the density of the
reinsurance jargon in them. There is nothing wrong with
a specialized vocabulary - for use by specialists. Federal
district and circuit judges, however, with the partial
exception of the judges of the court of appeals for the
Federal Circuit (which is semi-specialized), are generalists.

We hear very few cases involving reinsurance, and
cannot possibly achieve expertise in reinsurance practices
except by the happenstance of having practiced in
that area before becoming a judge, as none of us has.

Lawyers should understand the judges' limited knowledge
of specialized fields and choose their vocabulary
accordingly. Every esoteric term used by the reinsurance
industry has a counterpart in ordinary English, as we
hope this opinion has demonstrated. The able lawyers
who briefed and argued this case could have saved us
some work and presented their positions more effectively
had they done the translations from reinsurancese
into everyday English themselves.