In 1989, the Supreme Court issued Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101 (1989), which permitted the inclusion of language in employee benefit plans (including insurance policies) that would trigger a deferential standard of court review in ERISA cases.

Since then, there have been hundreds of appellate decisions and thousands of district court decisions that have struggled with interpreting when plan language affords discretion and when it does not. This ruling was one court’s effort to try to close the debate once and for all.

Alanna Schwartz was a legal secretary in Chicago who had to stop working due to disabling pain. She applied for disability benefits under a long-term disability insurance policy issued by Prudential for the benefit of the employees of Sachnoff & Weaver Ltd., the firm where Schwartz worked. However, Prudential denied her claim, and when pre-suit appeals failed, she brought suit in federal court. The district court found in Prudential’s favor after determining the policy granted it discretionary authority. The Court of Appeals soundly reversed.

Schwartz v. Prudential Insur. Co. of America, 2006 U.S.App.LEXIS 14387 (7th Cir. June 13, 2006).

The court focused on the standard of review issue, discerning from two prior precedents, Herzberger v. Standard Insur. Co., 205 F.3d 327 (7th Cir. 2000) and Diaz v. Prudential Insur. Co. of America, 424 F.3d 635 (7th Cir. 2005), that language mandating the insured provide ”satisfactory proof” was too ambiguous to confer discretionary authority. In fact, the 7th Circuit proposed language in Herzberger that it held would constitute a ”safe harbor” against challenge: ”Benefits under this plan will be paid only if the plan administrator decides in his discretion that the applicant is entitled to them.” 205 F.3d at 331. The court reiterated that Prudential’s policy fell well short of that standard.

Because the language in the policy at issue in this case was identical to the Diaz policy language, the court asked:

”At the risk of being flippant, we might ask what part of ‘no’ doesn’t Prudential understand? We acknowledge, though, that perhaps a fairer question, given our cases on this point, is what part of ‘probably not’ doesn’t it understand. We take this opportunity to reaffirm that the language in this plan is not sufficient to confer discretion on Prudential.”

The decision then turned to Prudential’s secondary argument that the summary plan description grants discretionary authority. Although the SPD contained discretionary language, the court pointed out that the plan did not, placing the two documents in conflict with one another. Only where the plan participant relies on the summary plan description to his detriment would the SPD control; otherwise, the court explained, it is the plan itself that it more complete. The court then cited Shaw v. Connecticut General Life Insur. Co., 353 F.3d 1276 (11th Cir. 2003) and Grosz-Salomon v. Paul Revere Life Insur. Co., 237 F.3d 1154 (9th Cir. 2001), which presented the same issue. Both cases found the SPD could not change the terms of the insurance contract; therefore a de novo standard of review applied. In the present situation, the court elaborated:

”The SPD is a document that the administrator must provide to participants pursuant to 29 U.S.C. §§ 1022 and 1024. It is not the subject of negotiation. Information in the SPD must be provided in a manner ‘calculated to be understood by the average participant.’ § 1022. Without casting aspersions on Prudential, we note that the implication of ‘§ 1022 is that the SPD will be an accurate summary, not an unnegotiated enlargement of the administrator’s authority. Were we to say the SPD controlled in this situation, we would be – to use an apropos cliche – allowing the tail to wag the dog.”

Consequently, the case was reversed and remanded for consideration under a de novo standard of review.

The judicial frustration over having to repeatedly decide standard of review questions in ERISA cases has to be overwhelming. As the Supreme Court has pointed out, the deferential standard of review is ”highly prized” by benefit plans. Rush Prudential HMO, Inc. v. Moran, 122 S.Ct. 2151, 2169 (2002). This is because claimants have to prove the benefit determination was not just wrong, but was arbitrary and capricious. As a result, insurers have repeatedly argued that policy language requiring the submission of ”satisfactory proof” or ”proof satisfactory to the [insurer]” triggers an arbitrary and capricious standard of review. One court expressed its fatigue over having to wade into the ”semantic swamp” of trying to discern whether language created discretion (Kinstler v. First Reliance Standard Life Insurance Company, 181 F.3d 243 (2d Cir. 1999)), while Herzberger held that insurers should not be allowed to ”pull a discretionary rabbit out of their hat” when it isn’t clear that employees have been informed as to what they are getting into. The difference between de novo and arbitrary and capricious is more than mere semantics; Herzberger noted, ”The very existence of ‘rights’ under [employee benefit] plans depends on the degree of discretion lodged in the administrator. The broader that discretion, the less solid an entitlement the employee has.” 205 F.3d at 331.

Certainly, the 7th Circuit is hoping that the debate is now over; and the court should be uplifted by other developments that point in that direction. The National Association of Insurance Commissioners promulgated a model law in 2004 that prohibits the inclusion of discretionary clauses in insurance policies. Several states have now adopted versions of that law. New York, California and Illinois, are among the major states that have done so. The prohibition in Illinois was effective July 1, 2005, and published in the Illinois Register at 29 Ill.Reg. 10172 (July 15, 2005), amending 50 Ill.Admin.Code Sec. 2001. The California prohibition has just survived its first court test. In Hartford Life Insur.Co. v. State of California, No. CPF 05-505218 (Super.Ct.Cal. San Francisco, June 8, 2006), the court upheld the California Insurance Commissioner’s authority to prohibit discretionary clauses and also ruled that such prohibition is not preempted by ERISA, which specifically excludes from its preemptive force state laws regulating insurance. It therefore appears that the arbitrary and capricious standard of review in insurance cases will soon be a historical footnote.

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

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