Last year, I wrote about a pair of district court rulings upholding the authority of states to prohibit the inclusion of clauses in insurance policies governed by ERISA, which have the effect of triggering a deferential standard of court review (”Rulings uphold State power over review clauses,” Chicago Daily Law Bulletin March 3, 2008). The 6th U.S. Circuit Court of Appeals recently affirmed one of those decisions in American Council of Life Insurers v. Ross, 2009 U.S.App.LEXIS 5748 (6th Cir. March 18, 2009). Ross makes it abundantly clear that states have the authority to ban discretionary clauses despite the broad sweep of ERISA preemption. In 2007, the Commissioner of Michigan’s Office of Financial and Insurance Services issued rules prohibiting insurers from ”issuing, delivering, or advertising insurance contracts or policies that contain ‘discretionary clauses.”’ Such clauses, when included in policies governed by ERISA, mandate that courts give deference to insurers’ decisions denying benefits or interpreting plan terms. Objecting to those rules, two insurance industry trade groups filed suit to bar enforcement of the discretionary clause prohibition, but the district court found the commissioner possessed the authority to issue the rules, and that the rules are ”saved” from ERISA preemption pursuant to ERISA § 514(b)(2)(A), 29 U.S.C. § 1144(b)(2)(A), which provides that state laws regulating insurance are not preempted by ERISA. The 6th Circuit both affirmed and expanded on the district court’s ruling.

Following the Supreme Court’s most recent guidance on express ERISA preemption set forth in Kentucky Association of Health Plans v. Miller, 538 U.S. 329 (2003), the court noted there are two requirements that must be met before a law alleged to fall within the ERISA savings clause is saved: First, ”the state law must be specifically directed toward entities engaged in insurance,” and, second, ”the state law must substantially affect the risk-pooling arrangement between the insurer and the insured[s].” The 6th Circuit ruled that both tests were met.

The court easily disposed of the first requirement, finding that the rules prohibiting discretionary clauses regulate only entities engaged in the business of insurance. The court further pointed out that the rules relate specifically to permissible contract terms in insurance policies. The insurance industry disagreed, contending that ”the effect of the rules is felt primarily by the fiduciary who administers the plan, rather than by the insurer.” However, the court overruled that objection based on Miller and another Supreme Court ruling, Rush Prudential HMO Inc. v. Moran, 536 U.S. 355, 372 (2002) (holding that the possibility that a state law could affect non-insurers is not enough ”to remove a state law entirely from the category of insurance regulation saved from preemption”).

The court then addressed whether the rules substantially affect the risk-pooling arrangement. The insurance industry plaintiff argued that the risk was impacted only after the risk had been transferred. However, the court could find no precedent that inquired into the timing of when the effect on risk-pooling occurs. Thus, the court found that by changing the permissible terms of insurance contracts, the rules alter the scope of permissible bargains between insurers and insureds. Also, by eliminating unfettered discretionary authority, the rules ”dictate to the insurance company the conditions under which it must pay for the risk it has assumed” (citing Miller, 538 U.S. at 339 n.3). Thus, there was a substantial effect on risk-pooling.

The court next addressed an aspect of ERISA preemption known as ”conflict preemption,” which would nonetheless still preempt a law falling within the savings clause if it directly conflicted with ERISA’s civil enforcement provisions, such as a law adding remedies beyond those provided in 29 U.S.C. section 1132(a). Disagreeing with the insurance industry, the court found, the rules do not authorize relief or ”create, duplicate, supplant, or supplement any of the causes of action that may be alleged under ERISA.” The court likewise turned aside an objection that the rules conflict with ERISA’s purpose. The court pointed out that nothing in the ERISA statute sets forth a standard for reviewing benefit claims decisions; and indeed, the Supreme Court ruled the de novo standard is the default. Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101, 115 (1989). The court also found the insurance industry’s argument was foreclosed by Rush Prudential, which upheld the authority of states to mandate independent reviews of medical necessity determinations in health insurance plans. Rush Prudential noted: ”Nor is there any conflict in the removal of fiduciary ‘discretion’; … ERISA does not require that such decisions be discretionary, and insurance regulation is not preempted merely because it conflicts with substantive plan terms.” 536 U.S. at 384 n.16.

Finally, the court cited the Supreme Court’s more recent decision in Metropolitan Life Insurance Co. v. Glenn, 128 S. Ct. 2343 (2008), which reaffirmed Firestone. The 6th Circuit also deemed Glenn significant in its recognition of the conflict of interest faced by insurers that both administer and pay benefits. Based on that ruling, the 6th Circuit found:

”If, as Glenn reaffirms, there is a conflict of interest when the same plan administrator decides the merits of a benefits plan and pays that claim, and if, as Glenn also holds, it is consistent with ERISA to account for that conflict of interest in reviewing a plan administrator’s decision, it is difficult to understand why a State should not be allowed to eliminate the potential for such a conflict of interest by prohibiting discretionary clauses in the first place.”

The 9th Circuit will soon decide the identical issue on appeal from Standard Ins.Co. v. Morrison, 537 F.Supp.2d 1142 (D.Mont. 2008). Given the recognition of at least one insurer’s gross misuse of discretionary authority (See, e.g., McCauley v. First Unum Life Ins. Co., 551 F.3d 126 (2d Cir. 2008)(citing Unum’s biased history of claims administration)), discretionary clauses are under harsh fire. And they should be given the following candid acknowledgment by courts: ”The broader that discretion, the less solid an entitlement the employee has….’ Herzberger v. Standard Insur. Co., 205 F.3d 327, 331 (7th Cir. 2000). The only possible policy justification for even giving deference to insurance companies that administer employer sponsored health and disability insurance programs is that it allegedly holds down premium costs. However, even that argument is questionable in view of the industry’s own assessment of the modest impact on premium charges that would result from removal of discretionary clauses. See, American Council of Life Insurers, (”Impact of Disability Insurance Policy Mandates Proposed by the California Department of Insurance,” at 8, available at default.aspx?docid=13557. Moreover, to suggest an analogy, it is doubtful a consumer needing open heart surgery would choose a facility with a higher mortality rate just to save less than 5 percent of the cost. Choosing an insurance policy offering less protection merely to achieve modest savings is just as absurd. The Supreme Court’s Glenn ruling has reaffirmed that insurers will continue to receive deferential claim reviews so long as they incorporate discretionary clauses in their policies, albeit with recognition of conflict of interest as a factor to be considered. Consequently, the effort of the states to abolish discretionary clauses, as has been done in Michigan, as well as in Illinois (See, 50 Ill.Admin.Code ‘§ 2001.3) and several other states, is welcome and long overdue.

Note: I represented the plaintiff in the Herzberger case.

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

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