Editor’s note: This is the first of two parts. The second will run on Tuesday.

Rud v. Liberty Life Assur.Co.,438 F.3d 772 (7th Cir. 2006).

After injuring his back in a fall, the plaintiff filed a disability claim under his employer-sponsored group disability insurance plan. Although benefits were paid under an initial 24 month ”own occupation” period (and several months thereafter while an ”any occupation” investigation was ongoing), the insurer determined that Rud did not meet a disability definition requiring that he be unable to perform the duties of any job. Rud then brought suit in state court that was removed to federal court based on ERISA preemption. After that suit was unsuccessful, he appealed.

The appellate court affirmed the lower court’s determination, finding there was ”no doubt that Liberty Life’s determination that Rud was capable of performing light or sedentary work despite his back problem was reasonable.” *2. Hence, under the arbitrary and capricious standard of review, the insurer would be entitled to prevail. However, Rud’s principal attack was his contention that Liberty’s conflicted role as plan administrator and benefit payor created a ”profound” conflict of interest requiring plenary review. The court rejected that argument.

First, the court held that even though the plan’s administrator was Andersen Windows, plaintiff’s employer, Liberty Life was still an ERISA fiduciary. Otherwise, if Liberty were not a fiduciary, Rud would have had a ”simple state-law breach of contract suit.” The court found Liberty was a fiduciary because it fit within the statutory definition as being ”an entity that has discretionary authority over assets of an ERISA plan.” 29 U.S.C. §1022(21)(A). The court added that a combination of factors made Liberty an ERISA fiduciary: 1) that the policy issued to Andersen stated the insurer had the authority to construe the plan terms and determine benefit eligibility; 2) plan assets were used to purchase the policy; and 3) the policy administration and choices regarding disbursement of plan assets was ”confided to the discretion of the insurance company.” *5.

The court noted that it might seem odd that the employer was listed as plan administrator when, in fact, it was Liberty that administered the benefits. However, the court explained that ”administration is divided. Andersen decides who is eligible to participate in the plan and explains the plan to its employees, but the determination of eligibility to receive benefits under the plan is confided to Liberty Life. This division gives the insurance company discretionary authority over claim applications, making it an ERISA fiduciary.” *5. Nonetheless, the court acknowledged that other courts are divided on the question of whether there can be a ”de facto” administrator. In the 7t U.S. Circuit Court of Appeals, the issue has been resolved with a suggestion that equitable estoppel might justify giving a party plan administrator status. The court then observed: ”But maybe it’s wrong to get hung up on who is (are) the plan administrator(s). Maybe the right question to ask is whether the particular defendant made a discretionary determination concerning the plaintiff’s entitlement to plan benefits.” *6-*7.

The court next seemed confounded by the fact that the plan was not in the record – only fragments of a plan summary and the insurance policy. The court suggested that the omission was due to the fact that the employer was not sued, and remarked that there must be a copy somewhere. Then, the court made a remarkable assumption:

”The plan’s absence, however, is of no consequence to the appeal. No one is questioning that there is a plan and that the plan confides the making of benefits determinations to Liberty Life. The policy is the plan, Bidlack v. Wheelabrator Corp., 993 F.2d 603, 615 (7th Cir. 1993), so far as disability benefits are concerned, and the recital in the policy that we quoted thus determines the scope of judicial review – unless Rud is correct that the insurance company has a conflict of interest sufficient to defeat the recital.” *7.

Thus, the court turned to the conflict of interest that the plaintiff argued resulted from a situation where any money used to pay benefits reduces the insurer’s profits. The court questioned whether that situation even created a conflict, though:

”The ubiquity of such a situation makes us hesitate to describe it as a conflict of interest. There is no contract the parties to which do not have a conflict of interest in the same severely attenuated sense, because each party wants to get as much out of the contract as possible. How serious the conflict is depends on circumstances. See, e.g., Leahy v. Raytheon Co., 315 F.3d 11, 15-16 (1st Cir. 2002). If Liberty Life refuses to honor meritorious claims, it will obtain windfall profits in the short run, assuming that the premium that Andersen paid it was calculated on the expectation of a normal claims experience. But Andersen will be dismayed – it has no interest in conferring such profits on Liberty Life, thereby incurring its employees’ ill will with no offsetting financial benefit to itself – and so may refuse to renew the policy when it expires, or demand a much lower premium. The latter option suggests a theoretical basis for suspecting a long-run conflict of interest: the chintzier the insurance company is in responding to benefits claims, the lower (given a competitive insurance market) the premium that Andersen will have to pay, whether to Liberty Life or to a competitor of Liberty Life, to obtain insurance.” *7-*8.

Acknowledging that every other court outside of the 7th Circuit has been troubled by a conflict of interest ”whenever an insurer is being asked to dip into its own pocket to pay a claim for benefits” (Pinto v. Reliance Standard Life Ins. Co., 214 F.3d 377, 387-89 (3d Cir. 2000); Armstrong v. Aetna Life Ins. Co., 128 F.3d 1263, 1265 (8th Cir. 1997); Brown v. Blue Cross & Blue Shield of Alabama Inc., 898 F.2d 1556, 1561-62 (11th Cir. 1990)), the 7th Circuit has consistently rejected that argument (Shyman v. Unum Life Ins. Co., 427 F.3d 452, 455 (2005); Leipzig v. AIG Life Ins. Co., 362 F.3d 406, 408-09 (2004); Perlman v. Swiss Bank Corp. Comprehensive Disability Protection Plan, 195 F.3d 975, 980-81 (1999); Mers v. Marriott International Group Accidental Death & Dismemberment Plan, supra, 144 F.3d at 1020-21; Chalmers v. Quaker Oats Co., 61 F.3d 1340, 1344 (1995)). The 7th Circuit’s reasoning is based on a proposition ”that given reasonably well-informed employees, an employer cannot reap a long-run benefit from reducing welfare benefits, whether directly or by delegating administration to a hard-nosed insurance company.” *10.

The court recognized, though, that its analysis perhaps reflects ”too sunny a view of the operation of labor markets.” *10. As Pinto points out, ”While in a perfect world, employees might pressure their companies to switch from self-dealing insurers, there are likely to be problems of imperfect information and information flow. Employees typically do not have access to information about claim-denying by insurance companies, and the relationship between employees and insurance companies is quite attenuated; so long as obviously meritorious claims are well-handled, it is unlikely that an insurance company’s business will suffer because of its client’s employees’ dissatisfaction.” *10-*11 (quoting Pinto v. Reliance Standard Life Ins. Co., supra, 214 F.3d at 388).

Although the court admitted ”there is doubtless some truth in these critiques,” it then noted ”their acceptance would destabilize large reaches of contract law, of which ERISA is, after all, a part, since it neither requires employers to establish welfare and pension plans nor prescribes the terms of such plans.” *11. Further, despite the paternalistic nature of the ERISA statute, the court pointed out, ”it is hard to see why, if the plan unequivocally authorizes the insurance company to make the conclusive determination of eligibility, the courts should rewrite the provision.” Moreover, the 7th Circuit criticized other courts that have raised conflict of interest as a factor diminishing discretion because those courts have abrogated freedom of contract and because such ” ‘conflict of interest’ is found in every contract.” *12.

Although the court suggested situations where a conflict could occur, it pointed out that Rud presented no evidence to show an actual conflict of interest. The court noted, ”The critical question in the application of the sliding-scale approach is whether evidence shall be required or conflicts of interest presumed. If no evidence is required, the sliding-scale approach can allow a conflict of interest to be attributed on the basis of the fundamental tug-of-war character of every contract. Our cases, such as Shyman and Leipzig, by rejecting the automatic assumption that an insurer has a conflict of interest that justifies departing from the ‘arbitrary and capricious’ standard, implicitly reject a sliding-scale approach conceived in such abstract terms. But our cases permit the plaintiff to show that the particular circumstances of his case demonstrate the existence of a real and not merely notional conflict of interest, the sort of thing the parties would not have foreseen when they agreed that the plan administrator’s determinations would be conclusive. Mers v. Marriott International Group Accidental Death & Dismemberment Plan, supra, 144 F.3d at 1020-21. We find this approach in cases from other circuits as well. See Atwood v. Newmont Gold Co., 45 F.3d 1317, 1322-23 (9th Cir. 1995), and cases cited in Pinto v. Reliance Standard Life Ins. Co., supra, 214 F.3d at 385. It strikes the right balance, consistent with Firestone, between freedom of contract and a realistic sense of its limits.” *14-*15.

Therefore, the district court was affirmed.

The analysis of the court’s ruling will continue in the second installment

This article was initially published in the Chicago Daily Law Bulletin. 

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