ERISA preemption and state bans on discretionary clauses

This article was published in the Chicago Daily Law Bulletin on September 17, 2015.

By Mark D. DeBofsky
Mark D. DeBofsky is a name partner of DeBofsky, Sherman & Casciari, PC. He handles civil and appellate litigation involving employee benefits, disability insurance and other insurance claims and coverage . He can be reached at mdebofsky@debofsky.com.

The Employee Retirement Income Security Act is so pervasive in its scope that it broadly pre-empts all state laws that relate to employee benefit plans. However, ERISA pre-emption is extremely complex, and it has provoked more than a dozen Supreme Court cases that have examined the breadth of ERISA pre-emption in a number of ways.

One such case is Rush Prudential HMO Inc. v. Moran, 536 U.S. 355, 122 S.Ct. 2151, 153 L.Ed.2d 375 (2002), which held that an Illinois law mandating independent review of claims denied by health maintenance organizations was not preempted. The reason the Illinois law escaped pre-emption is that the ERISA statute, 29 U.S.C. Section 1001 et seq., explicitly states that notwithstanding the broad preemption provisions of the law, state laws regulating banking, securities and insurance are "saved" from pre-emption. 29 U.S.C. Section 1144(b)(2)(A).

Because the HMO provision under Illinois law was considered a law that regulates insurance, it fell within ERISA's savings provision.

However, notwithstanding the protection of laws that regulate insurance, not every law is saved. Insurance laws (which include court decisions, regulations or even rulings or directives by the insurance director) would not be pre-empted if they supplant or supplement ERISA's remedial provisions. Moreover, to be saved from pre-emption, the law must be directed at the relationship between insurers and policyholders and the circumstances under which benefits are payable.

Hence, laws mandating particular coverage schemes under group health plans are saved from pre-emption. But laws such as 215 ILCS 5/155, which impose penalties in addition to the benefits payable under policies in situations involving unreasonable and vexatious conduct, would be preempted.

Following the promulgation of a model law by the National Association of Insurance Commissioners that bans the inclusion of so-called discretionary clauses in health and disability insurance policies, several states have issued laws or regulations adopting the NAIC's model law.

In Illinois, 50 Ill. Admin. Code Section 2001.3 bars health and disability insurers from incorporating discretionary clauses in policies sold or delivered in Illinois. Approximately half the states have adopted some version of a similar rule.

The reason discretionary clauses have been singled out for attention is because of a 1989 Supreme Court ruling, Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101 (1989). The Supreme Court held in Firestone that the typical judicial review standard applied in adjudicating ERISA cases is the de novo standard, which requires the court to independently adjudicate whether the benefit claimant is entitled to the benefits sought.

However, the Supreme Court noted that if the benefit plan contains a clause granting discretion to the plan administrator to interpret the terms of the plan or decide questions of benefit eligibility, courts are to defer to the determination and overturn benefit decisions only if they are the product of an abuse of discretion or arbitrary and capricious.

The abuse of discretion standard of review is highly favorable to the administrators of private benefit plans and insurers that provide coverage for employer-sponsored group benefit plans such as group health and disability insurance. Claimants, on the other hand, prefer the de novo standard because it allows for more extensive court review without a thumb on the scale in favor of the insurance company.

In a recent ruling from a federal court in California, Williby v. Aetna Life Insurance Co., 2015 WL 5145499 (C.D. Calif., Aug. 31, 2015), the court addressed whether section 10110.6 of the California Insurance Code, banning discretionary clauses, applies to a self-funded plan sponsored by the Boeing Corp. but administered by an insurance company, Aetna.

The court found that plan provisions conferring discretionary authority to Aetna were void and unenforceable because the law is specifically applicable to employer-sponsored plans. Thus, the court applied the de novo standard of judicial review. However, the court indicated in a footnote that it would have ruled the same way under an abuse of discretion standard.

Although Section 10110.6 is even more broadly drafted than 50 Ill. Admin. Code Section 2001.3, it appears the court may have erred in finding the law applicable to a self-funded plan.

While the ERISA savings clause has been held by various district courts to apply to the California ban on discretionary clauses, the court did not discuss yet another provision of the ERISA statute known as the deemer clause. The deemer clause provides that self-funded plans are not to be deemed to be "engaged in the business of insurance or banking for purposes of any law of any state purporting to regulate insurance companies, insurance contracts, banks, trust companies or investment companies." 29 U.S.C. Section 1144(b)(2)(B).

Thus, since the Boeing disability plan is self-funded, California's Section 10110.6 would not apply to Boeing's self-funded disability plan even though Boeing retained an insurance company to administer the benefit program. However, had Boeing's disability program been insured by Aetna, Section 10110.6 would undoubtedly survive pre-emption.

The 9th U.S. Circuit Court of Appeals ruled in Standard Insurance Co. v. Morrison, 584 F.3d 837 (9th Cir. 2009) that Montana's discretionary clause ban fell within the ERISA savings clause and was not pre-empted, as did the 6th Circuit in American Council of Life Insurers v. Ross, 558 F.3d 600 (6th Cir. 2009), which addressed Michigan's ban on discretionary clauses.

And earlier this month, the 7th Circuit joined the 6th and 9th Circuits when it upheld the Illinois regulation banning discretionary clauses.

In Fontaine v. Metropolitan Life Insurance Co., 2015 WL 5173039 (7th Cir. Sept. 4, 2015), the court followed the same course as the two circuits that preceded it and also rejected several other arguments MetLife raised, finding that the ban on discretionary clauses survived pre-emption and applied not only to the insurance policy and certificate of coverage, but also encompassed any benefit plan document that related to the coverage at issue. The court determined that a different outcome would render the ERISA savings clause meaningless.

Note: The author represented the plaintiff in the Fontaine case.