Judge: Class action against State Farm over PHL life policies can proceed

A federal judge has put off ruling on State Farm’s bid to dismiss a proposed class-action lawsuit alleging the insurer and its agents misrepresented and withheld information about PHL Variable Life Insurance Co. policies.

The U.S. District Court for the Northern District of Illinois recently denied State Farm’s motion to dismiss without prejudice, allowing the insurer to renew its arguments after the court addresses whether the case can proceed as a class action.

Fourteen plaintiffs from nine states allege State Farm, through its agents, breached fiduciary and professional duties and engaged in consumer fraud by misrepresenting or omitting information about their PHL policies while continuing to collect premiums.

Connecticut regulators placed PHL Variable into rehabilitation in May 2024 due to hazardous financial conditions, attaching a moratorium on benefits and premiums. PHL is expected to be placed into liquidation next year.

At the time State Farm sold its policies, the insurer was known as Phoenix Life Variable Insurance Co.

The plaintiffs assert claims for breach of fiduciary duty, professional negligence and unjust enrichment. They also brought consumer-fraud claims under the laws of Illinois, California and New Jersey, although plaintiffs withdrew the New Jersey claim.

After Judge Virginia Kendall denied State Farm’s motion to dismiss, the insurer filed a response to the lawsuit. “State Farm denies each and every allegation of the Amended Complaint,” it reads.

Kendall said she ordered additional briefing on choice-of-law issues for the state law claims and noted those issues preclude her from resolving the dismissal request.

“Judicial economy favors addressing class certification before reaching the merits of the claims,” Kendall wrote in the ruling. “The 14 named plaintiffs are from nine different states and are bringing state law claims on behalf of themselves and a purported nationwide class.”

Implications for agents

State Farm agents sold PHL Variable policies from March 2001 until PHL’s ratings downgrade in 2009. The relationship yielded $290 million in cumulative new total life premiums and $1.2 billion in annuity deposits for State Farm, the lawsuit states.

State Farm is named as the defendant in the lawsuit, along with “unnamed affiliates and associates.”

The idea that agents could be held liable for not knowing the financial health of the insurer behind the policies it sells would be a major precedent for the industry, experts say.

“I believe that this case could have far-reaching implications,” said Sheryl Moore, founder of Moore Market Intelligence and Wink, Inc. “While there aren’t a ton of examples of life insurance companies with joint ventures like this, there have been a few.”

According to the complaint, State Farm continued servicing roughly 90,000 in-force PHL policies 15 years after the 2009 ratings downgrade. Agents continued collecting trailing commissions and, plaintiffs allege, never told existing policyholders that PHL had been downgraded or even that State Farm had stopped selling its products.

Plaintiffs describe being surprised and shortchanged by PHL’s financial situation. Plaintiff Jennifer Nappo only received 15% of what she was owed under her term life insurance policy after her husband James Nappo died in April 2024.

Jennifer Nappo collected just $300,001.76 of a $2 million life insurance policy, the complaint says.

State Farm “had the ability and obligation to prevent such enormous financial injury,” the lawsuit states.

Larry Rybka, CEO of the Valmark Financial Group, agreed that Nappo would have fared a lot better with a 1035 exchange.

“The core of the case is not only the poor recommendation of Phoenix, but the complete absence of any follow-up or update as the company was acquired by [private equity] and the ratings dropped,” he added.

State law differences

Rather than decide the merits of State Farm’s dismissal motion, Kendall said the case presents significant differences in state law that should be addressed as part of the class-certification process.

Federal law generally calls for class certification to be addressed at an early stage of litigation. The Seventh Circuit has instructed district courts to consider certification before deciding the merits in most circumstances, the court noted.

That approach is particularly important in this case because the named plaintiffs come from nine states and seek to apply various state laws to a proposed nationwide class, the judge explained.

A federal court exercising diversity jurisdiction generally applies the choice-of-law rules of the state where it sits. That means Illinois choice-of-law rules apply in the State Farm lawsuit.

The parties argued that the court did not need to conduct a detailed choice-of-law analysis because there were no outcome-determinative differences among the states’ laws. Kendall disagreed.

“Even a cursory review of the relevant states’ laws reveals material differences across jurisdictions,” the judge wrote.

The court specifically pointed to the parties’ treatment of insurance companies, insurance agents and insurance brokers as interchangeable, saying their briefing had conflated the distinct legal roles.

Under Illinois law, for example, insurance brokers can owe fiduciary duties to insureds, while insurance agents and insurers generally do not. Illinois law also limits fiduciary-duty liability under the Insurance Placement Liability Act.

The court cited Seventh Circuit precedent holding that a class action is improper unless the litigants are governed by the same legal rules. Because the plaintiffs seek nationwide treatment of state-law claims, the court said it will have to examine those differences in determining whether a single class is appropriate.

The parties are expected to tell the court at their next status hearing how they want to proceed with the case, including the path toward class certification.

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