Disability and life insurers frequently include clauses in their insurance policies affording them complete discretion to decide whether a claim has merit. The clauses usually state the insurer has total discretion to decide whether the claimant is eligible for the policy’s benefits, to decide the amount, if any, of benefits to which they are entitled, to interpret the policy’s terms how they see fit, or something similar. Employers regularly include these same types of “discretionary clauses” in their employee welfare benefit plan documents, and if a group insurance policy is the funding source of the plan’s benefits, they then delegate that discretion to decide the merits of claims to the insurer.
Employee benefit plans and the corresponding group insurance policies that fund them are governed by a federal law, the Employee Retirement Income Security Act of 1974 (“ERISA”), codified at 29 U.S.C. section 1001, et seq. The result of these discretionary provisions in ERISA cases, until recently, has been that a federal court reviewing the insurance company’s claim decision had to give deference to whatever the insurer decided, even if the court disagreed with the insurer’s decision, unless the insurer abused its discretion by acting arbitrarily and capriciously. The district court was required to apply an “abuse of discretion” or “arbitrary and capricious” standard of review rather than a de novo standard (where no such deference to the insurer’s decision is given). The former standard, obviously, is much more difficult than the latter for an insured to meet. While a district court applying an abuse of discretion standard to the insurer’s claim decision is not required to “rubber stamp” it with no oversight, its ability to overturn the decision is far more limited than when reviewing the insurer’s decision de novo.
In most types of insurance policies, insurers have not been so brazen to include these draconian insurer discretionary provisions. It is astonishing that the California legislature let disability and life insurers get away with this practice for so long. The clauses directly contravene many “black-letter” pro-policyholder California insurance laws (such as the doctrine that ambiguous policy provisions must be strictly construed against the insurer as the drafter). Think about it. Under these provisions, the company legally responsible to pay an employee’s or beneficiary’s benefit claim also has nearly unchecked power to decide whether the claim has merit and to interpret the plan’s provisions. From the standpoint of a California policyholder and their counsel, that is shocking, truly shocking. It demonstrates the power of the insurance company lobby.
Not surprisingly, these discretionary provisions lead to a higher rate of claim denials by disability and life insurers than in other types of policies and, in our opinion, industry wide abuse, particularly for disability insurers. The U.S. Department of Labor estimates that a whopping 75 percent of long-term disability claims are denied. The statistics seems to provide empirical support for Lord Acton’s famous phrase uttered in the 1800’s, “power tends to corrupt and absolute power corrupts absolutely.”
On January 1, 2012, no doubt aware of this potential for abuse by insurers, the California legislature decided to put an end to discretionary provisions in disability and life insurance contracts. It enacted California Insurance Code section 10110.6, which made void and unenforceable any grant of discretionary authority to an insurer or agent of the insurer in “a policy, contract, certificate, or agreement” that provides or funds disability or life insurance coverage for California residents. More than a dozen states have similar laws, as noted in Standard Ins. Co. v. Morrison, 584 F.3d 837, 841 (9th Cir. 2009) (upholding Montana Insurance Commissioner’s practice of disapproving disability insurance policy forms with clauses vesting discretion in insurers). These states include California, Connecticut, Hawaii, Idaho, Illinois, Indiana, Kentucky, Maine, Maryland, Montana, New Jersey, New York, South Dakota, Texas, Utah, Vermont, Washington, Wyoming and perhaps others (some bar discretionary clauses in health insurance or other types of policies, not just in disability and life insurance policies). Several of these states banned or limited discretionary clauses in response to a notorious example of one insurer who, to boost its profits, had intentionally used discretionary clauses to repeatedly deny claims it knew were valid. See Saffon v. Wells Fargo & Co. Long Term Disability Plan, 522 F.3d 863, 867 (9th Cir. 2008).
Despite California’s statutory ban on insurer discretionary clauses, group disability and life insurers have steadfastly challenged the statute’s application to ERISA-governed policies and related employee welfare benefit plan documents. They routinely argue that ERISA preempts the State law, the statutory ban applies just to insurance policies but not plan documents, and other creative arguments, all to sustain the status quo of their mostly unfettered power to decide claims with little scrutiny by courts. Their arguments have been repeatedly rejected by most California federal district courts. A few rogue courts in the minority have agreed with the insurer’s creative arguments. This left, until now, some uncertainty about what the law in the 9th Circuit is for California employees.
On May 11, 2017, the 9th Circuit put the final nail in the coffin for grants of discretionary authority to insurers in ERISA-governed insurance policies and employer plan documents. Orzechowski v. Boeing Co. Non-Union Long-Term Disability Plan, No. 14-55919, 2017 DJDAR 4376 (9th Cir. May 11, 2017). In that case, The Boeing Company (“Boeing”) offered its employees long-term disability coverage through an ERISA-governed plan. Boeing purchased a group disability insurance policy from Aetna Life Insurance Company (“Aetna”) to fund the plan’s disability benefits and vested Aetna with discretion to decide the merits of benefit claims. Aetna’s policy granted it discretionary authority to “review all denied claims,” “determine whether and to what extent employees and beneficiaries are entitled to benefits,” and “construe any disputed or doubtful terms of the policy.” The policy further specified that, “Aetna shall be deemed to have properly exercised such authority unless Aetna abuses its discretion by acting arbitrarily and capriciously.” Boeing’s principal plan document, The Boeing Company’s Master Welfare Plan (“Master Plan”), similarly contained a broad grant of discretionary authority delegated to Aetna which included the power to “determine all questions that may arise including all questions relating to the eligibility of Employees and Dependents to participate in the Plan and amount of benefits to which any Participant or Dependent may become entitled.” In short, the group policy and employer’s plan document each gave Aetna fairly unchecked power to decide the merits of claims, the claims Aetna was responsible to pay.
A Boeing employee, Talana Orzechowski, submitted a claim for disability benefits under the plan because she suffered from physical illnesses, chronic fatigue syndrome and fibromyalgia, and could no longer perform her job duties as a result. After paying the claim for two years, Aetna decided to terminate her benefits based upon the plan’s 24-month limit for disabilities primarily caused by mental illness. Aetna determined Ms. Orzechowski’s condition was not physical but only mental based upon the opinions of medical consultants it hired to review her medical records. Aetna disagreed with Ms. Orzechowski’s treating physicians. They concluded after examining her in-person that she had a physical disability and that her mental illness, depression and anxiety, was secondary to her physical problems, chronic fatigue syndrome and fibromyalgia.
Ms. Orzechowski filed suit in federal district court under ERISA to recover her disability benefits. Following a bench trial, the trial court upheld Aetna’s benefit decision. It reviewed Aetna’s decision for an abuse of discretion (because Boeing’s Master Plan gave Aetna discretionary authority), rather than de novo, the default standard in an ERISA case.
The 9th Circuit held the district court should have applied a de novo standard of review to Aetna’s claim decision. It ruled that California Insurance Code section 10110.6 voided the discretionary provisions in both Aetna’s insurance policy and Boeing’s plan documents, including in the Master Plan. It reversed the district court’s decision and remanded the case for it to review the insurer’s claim denial de novo, with instructions to focus on Ms. Orzechowski’s physical illnesses that Aetna had ignored when terminating her benefits.
ERISA Preemption and Savings
The 9th Circuit rejected Boeing’s argument that ERISA preempts the California statute. The Court reasoned that while the California law comes within ERISA’s broad preemption clause, which preempts “any and all State laws insofar as they may now or hereafter relate to any employee benefit plan,” 29 U.S.C. § 1144(a), ERISA’s savings clause saved the California law from preemption. The savings clause saves from preemption “any law of any State which regulates insurance, banking, or securities.” 29 U.S.C. § 1144(b)(2)(A). For the savings clause to apply, the State law must satisfy a two-part test set forth in Kentucky Association of Health Plans v. Miller, 538 U.S. 329, 342 (2003). First, the State law must be specifically directed toward entities engaged in insurance, and second, the law must substantially affect the risk pooling arrangement between the insurer and insured. After some very technical arguments, the Orzechowski Court held the California statute meets both prongs of the Miller test, “regulates insurance,” and, therefore, is saved from ERISA preemption.
Statute Interpretation Arguments
The Court rejected Boeing’s other arguments that section 10110.6 did not void the discretionary clause in the Master Plan because it (1) only voids discretionary clauses in insurance policies but not in employer plan documents, and (2) is not retroactive and became effective on January 1, 2012 after the January 1, 2011 Master Plan. The Court reasoned the California statute, by its terms, covers not only “policies” that provide or fund disability insurance coverage but also “contracts, certificates, or agreements” that do so. It cited to 9th Circuit precedent holding that an ERISA plan is a “contract” and concluded Boeing’s Master Plan falls under section 10110.6, not just Aetna’s policy.
The Court rejected Boeing’s second argument because the California statute, while not retroactive, voids discretionary provisions in any policy “or contract” that renews after the statute’s effective date of January 1, 2012. The statute defines “renewed” as “continued in force on or after the policy’s anniversary date.” The policy’s anniversary date was January 1, 2012 and the Master Plan continued in force thereafter. The Master Plan, a contract, thus “renewed” after the statute’s effective date.
While Orzechowski marks the end of an era – that had allowed discretionary clauses in insurer-funded employee benefit plans providing disability and life coverage to California residents – there is still an open question whether California’s statutory ban will be extended to self-funded plans. Orzechowski did not reach that issue. Many large employers fund their benefit plans with their own money rather than through an insurance policy. Thus, even after Orzechowski, employers and their self-funded plans will continue to argue California’s ban does not apply to them. The debate remains alive and well in California (for self-funded plans) and, for both insurer- and self-funded plans, in most states because they have not enacted similar laws to California’s statute.
One thing we know for certain based on the 9th Circuit’s Orzechowski decision: discretionary clauses are void and unenforceable in insurer-funded ERISA employee benefit plans providing disability or life coverage for California residents, whether the clause appears in the insurer’s group policy, the employer’s separate plan document or both. Federal judges will thus have to start applying a standard of review more favorable to claimants, de novo, in insurer-funded ERISA plans. This will probably lead to better results for claimants in litigated cases and, potentially, less claim denials from group disability and life insurers in the first instance.