Spence v. Medical Mutual Liability Insurance Society

⁴¹³ ROSALYN B. BELL, Judge. In this case we decide that former policy holders of a mutual company providing medical malpractice insurance are not entitled to participate in the distribution of a dividend from earned surplus stemming from a year in which they had policies in effect. Medical Mutual Liability Insurance Society of Maryland was created by the Legislature in 1975, and issued its first policies effective July 1, 1975 to individual physicians and their partnerships, corporations and professional associations. During its first year of operation, Medical Mutual collected $5,057,000 in net premiums.

The company also derived its funding from two additional sources: (1) a one-time tax of $300 on physicians licensed in Maryland 1 and (2) an assessment on each policyholder equal to 10% of the insurance premium as a Stabilization Reserve Fund charge. 2 Eight years after Medical Mutual issued its first policies, the company ascertained its underwriting losses and expenses and determined its investment income for 1975, the first year of operation. Medical Mutual showed an underwriting loss of over $2,000,000 for that year; however, as a result of investment income earned on 1975 premiums and income earned from the Reserve Fund, it projected a surplus of $1,357,000. Medical Mutual’s Board of Directors considered these operating results, and on December 6, 1983 declared that “policyholders of record on [that date] who were also insured by the Society in 1975, are eligible for the first dividend to be awarded by the physician-owned company” ⁴¹⁴ and that the dividend of $500,000 would be shared by the eligible policyholders in May of the next year. James W. Spence, M.D., other individual physicians and their professional corporations brought suit in the Circuit Court for Baltimore County against Medical Mutual seeking an adjudication of their right to share in the distribution of the dividend declared in December 1983.

They claimed that even though they were not insured under policies issued in 1983, they were entitled to participate in the distribution of the dividend because they were 1975 policyholders. Spence and the others moved to certify the case as a class action. After a hearing, the court granted the motion and certified the class as being “[a]ll of those persons, partnerships and professional corporations who were insured by Medical Mutual Liability Insurance Society of Maryland under policies in force in 1975 but who were not insured by Medical Mutual Liability Insurance Society of Maryland under policies in force on December 6, 1983 and therefore were not designated to share in the $500,000 dividend declared by the Board of Directors of Medical Mutual Liability Insurance Society of Maryland on December 6, 1983.” Both sides moved for summary judgment. The court granted Medical Mutual’s motion, and entered judgment in its favor.

Spence and the others then noted this appeal. They present these questions: “1. Did Medical Mutual’s refund of 1975 premiums as a dividend from surplus to only a segment of the policyholders holding a single class of participating mutual insurance discriminate against those policyholders excluded where the policy of insurance neither provides for any distinction nor makes any reference to a bylaw provision asserted as the basis of the distinction? “2. Are appellants, as members of the same policyholder class, entitled to a refund on their 1975 premiums pro rata to that already paid by Medical Mutual to the other policyholders of the class? ⁴¹⁵ “3.

Are partnerships and professional corporations who paid premiums and who are named insured in the policies of insurance entitled to participate ratably with individual policyholders in the distribution of surplus where the policy itself makes no distinction?” Before exploring these issues, a brief description of the origin of Medical Mutual will prove helpful. Origin of Medical Mutual During the mid-1970’s there was increasing public awareness of what came to be known as the “medical malpractice crisis.” Between 1975 and 1977 almost every State Legislature enacted one or more measures addressing medical malpractice. Abraham, Medical Malpractice Reform: A Preliminary Analysis, 36 Md.L.Rev. 489 (1977). One aspect of this crisis became particularly acute in Maryland, when in 1975, the major insurer ceased writing medical malpractice insurance here because it had been refused an additional rate increase.

Attorney General v. Johnson, 282 Md. 274, 280 , 385 A.2d 57 (1978). One of the ways the Maryland Legislature responded to this exigency was by creating Medical Mutual Liability Insurance Society of Maryland. See Md.Code Ann., Art. 48A, § 550 (1957, 1979 Repl.Vol., 1985 Cum.Supp.) 3 . The purpose of Medical Mutual, as provided in the enabling legislation, is to “provide for the payment of indemnities to persons suffering injury arising out of the rendering of or the failure to render professional services by physicians and to provide means whereby physicians may obtain insurance against liability for injury due to the rendering of or ⁴¹⁶ failure to render any professional service, subject to the limitations and immunities provided in this subtitle.” Act of April 29, 1975, ch. 544, § 1, 1975 Md.Laws 2605. 4 In 1975, 2400 physicians purchased medical malpractice insurance through Medical Mutual.

Three years later, the Society was providing insurance to ninety percent of the State’s doctors. Attorney General v. Johnson, 282 Md. at 281 , 385 A.2d 57 . When this controversy arose in 1983, other insurance companies had once again begun to write malpractice insurance in Maryland; hence, about 1300 of the 2400 initial subscribers no longer had current policies in force with Medical Mutual. It is against this background that we address the questions raised by appellants.

Within the first question they include a spate of arguments: 1. Distribution of divisible surplus by Medical Mutual is of a totally different character than payment of a dividend by a stock company; 2. Distribution of divisible surplus declared by Medical Mutual’s Board of Directors is governed by the contribution method; 3. The dividend declared by Medical Mutual’s Board of Directors: (a) is not governed by the company’s by-laws since they were not referred to in the contract of insurance or disseminated to the policyholders; and (b) is not in accordance with the terms of the 1975 policy and the applicable statutes; and 4.

By excluding appellants from the distribution of the dividend, Medical Mutual has impermissibly rewritten the 1975 policy and has, in effect, required appellants to pay ⁴¹⁷ more for identical malpractice coverage than other policyholders in the same class. We will examine each of these in turn. DOES THE PROPOSED DISTRIBUTION UNFAIRLY DISCRIMINATE Divisible Surplus of a Mutual Insurer It is appellants’ contention that “[distributions of divisible surplus by a mutual insurer are of a totally different character than the payment of dividends by a stock company.” In support of this proposition they explain that “while a dividend from a stock corporation represents profit, a dividend from a mutual insurer represents not a profit but a reduction in the amount of the premium to reflect the difference between the estimated cost and the actual cost of providing insurance.” Additionally, they state that “[w]hile the initial premium paid by the policyholder usually represents a somewhat inflated estimate of the cost of the policy, it is contemplated that, when such cost is actually ascertained, the company will refund to its policyholders the excess premium, that is, the amount in excess of the company’s actual cost.” While we agree that the distribution of divisible surplus by a mutual insurer differs from the payment of a dividend by a stock company, that is not the issue before us. The issue we must decide is whether the distribution of the contested dividend was in accordance with the issued policy, and the by-laws and statutes governing Medical Mutual.

In any event, the divisible surplus in this case did not represent “excess premium.” The company experienced a statutory underwriting loss for the 1975 policy year. Medical Mutual earned high investment income on premium investments during that year and in all subsequent years. As a result, the company showed a profit in 1975, and was able to declare the dividend in question. ⁴¹⁸ The Contribution Method Appellants next assert that the distribution of divisible surplus by Medical Mutual is governed by the contribution method. They claim that “[a]mong mutual insurance companies, the recognized industry standard for allocating divisible surplus among policyholders holding participating policies is by the ‘contribution’ method, whereby each policyholder is entitled to such portion of the divisible surplus as has been contributed thereto by his premiums.” Appellants misconstrue the purpose of the contribution method.

It is not utilized to ascertain who is entitled to participate in the distribution of divisible surplus; instead, it is a method of calculating the pro rata shares of those already deemed entitled to participate in the company’s surplus. Miller v. New York Life Insurance Co., 179 Ky. 246 , 200 S.W. 482, 486 (1918); Rhine v. New York Life Insurance Co., 248 A.D. 120 , 289 N.Y.S. 117 , aff'd. 273 N.Y. 1 , 6 N.E.2d 74 (1936). Furthermore, the contribution method is based upon an “intricate mathematical formula” that relates solely to the life insurance industry, Rhine v. New York Life Insurance Co., 289 N.Y.S. at 124-25 , and hence is not applicable here. Appellants further maintain that under the principles inherent in the concept of contribution “policyholders must be included in any distribution arising from a year in which their premiums contributed to the surplus, whether or not they hold current policies in the year the distribution is declared.” In support of this proposition, we are referred to life insurance cases from other jurisdictions.

In view of the law in this jurisdiction which we will discuss, infra, these cases are inapposite. 5 ⁴¹⁹ The Policy, By-laws and Applicable Statutes To determine whether appellants are entitled to participate in the distribution of the contested dividend, we must construe the insurance policy in accordance with Medical Mutual’s charter, its by-laws and the applicable statutes. 13A Appleman, Insurance Law and Practice § 7582 (1976). —The Policy— It is undisputed that appellants were policyholders and insureds in 1975. A policyholder is “[t]he person who owns the policy of insurance whether he is the insured or not.” Black’s Law Dictionary 1041 (rev. 5th ed. 1979). An insured is “[t]he person who obtains or is otherwise covered by insurance____” Id. at 726. Appellants contend that since they were policyholders in 1975, they are entitled to participate in the contested dividend.

They argue that their entitlement stems from the following language in their 1975 policies: “This Policy is issued upon a Participating basis and the INSURED shall participate, to the extent and upon the Conditions fixed and determined by the Company’s BOARD OF DIRECTORS in accordance with the Provisions of Law, in any distribution of dividends so fixed and determined.” They further assert that since Medical Mutual’s by-laws neither were referred to in the 1975 policy nor disseminated to the policyholders, the contract of insurance cannot be construed with reference to them. A mutual insurance company’s charter and by-laws form part of the contract of insurance, regardless of whether they are referred to in the policy. Condon v. Mutual Reserve Fund Life Association, 89 Md. 99 , 42 A. 944 (1899); ⁴²⁰ see also The Maccabees v. Lipps, 182 Md. 190 , 34 A.2d 424 (1943); Supreme Council of the Royal Arcanum v. Brashears, 89 Md. 624 , 43 A. 866 (1899). Furthermore, even though the by-laws may not have been distributed to appellants, they are presumed to have knowledge of them.

See Condon v. Mutual Reserve Fund Life Association, supra. We might well agree that appellants are entitled to the dividend were we to interpret the 1975 policy in a vacuum. This we cannot do. As we previously stated, the contract of insurance must be construed in accordance with appellee’s charter and by-laws. 13A Appleman, Insurance Law and Practice, supra.

We turn, then, to an examination of these corporate documents to test whether appellants are entitled to the contested dividend. —The Charter and By-laws— Medical Mutual’s charter does not address who is entitled to participate in the distribution of dividends. The by-laws, however, are more instructive. Article VII, Section 3 of the 1975 by-laws provides, in pertinent part, that the Board “shall determine and declare the amount, if any, of premium contributions to be returned to the members as dividends to policyholders.” Similarly, appellee’s amended bylaws which were adopted prior to the declaration of the disputed dividend, provide “[t]he Board of Directors shall determine the amount, if any, of the premium contributions to be returned to the members as dividends.” According to the 1975 by-laws, one who has a current policy in effect is a member of Medical Mutual. Article II, Section 1 provides that “[mjembership shall continue in effect until the expiration or cancellation date of the policy (or renewal thereof) whichever occurs first.” In 1983, this definition was amended to provide that “[m]embers whose policies terminate shall automatically be dropped from membership in the Society.” Thus, under appellee’s by-laws, it is only members — that is, current policyholders, — who are entitled to participate in the distribution of dividends. ⁴²¹ Appellants maintain that these by-law provisions conflict with the express language of the 1975 policy, and that where such inconsistency exists the policy governs.

We disagree. When the language of the 1975 policy is construed with reference to the by-laws, it is apparent that they do not conflict with one another. In fact, the by-laws further clarify the nature of