ERISA Disability Policies In California And Beyond

Employer BenefitsClaims for benefits under most employee benefit plans are governed by federal law, i.e., the Employee Retirement Income Security Act of 1974 (ERISA), 29 U.S.C. 1001 et seq. Employee benefit plans provide health, life, and disability coverage, often through the purchase of insurance.

These policies typically contain language granting to the insurer the discretionary authority to determine eligibility for benefits and to interpret the terms of the policy and the plan. In Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101, 110 (1989), the Supreme Court held that when a plan contains a discretionary clause, the denial of benefits is reviewed by a court under the deferential arbitrary and capricious standard.

There has been an effort in the past few years to prohibit the use of discretionary clauses in insurance policies and the deferential standard of review that flows from them. In 2002, the National Association of Insurance Commissioners (NAIC) adopted Model Act 42, which prohibits the use of discretionary language in health insurance plans.

The NAIC expanded the Model Act two years later to include disability policies. Several states have enacted the Model Act or similar language, including Illinois, Maine, Montana, Utah and Nevada. Therefore, it is ironic that California is at the forefront of the debate over states' attempts to regulate discretionary clauses, since it failed to enact the Model Act.

California's Regulatory Effort

With the support of the California Insurance Commissioner, the California legislature considered Model Act 42, but the proposed legislation failed to gather enough support. Undeterred by the failure to pass the Model Act, the California Insurance Commissioner issued an Opinion Letter on February 26, 2004, stating that discretionary clauses in disability insurance policies violate California law. See http://www.insurance.ca.gov/0250-insurers/0300-insurers/0200-bulletins/bulletin-notices-commiss-opinion/upload/Opinion-February-26-2004.pdf.

The Commissioner based the opinion on the belief that discretionary clauses render the obligations under the contract "unintelligible, uncertain [and] ambiguous," and that they "are likely to mislead the insured." Of note, the Opinion Letter was drafted at the request of counsel representing a claimant in an ERISA action.

At the same time the Opinion Letter was sent, the California Department of Insurance (DOI) issued a Notice of its Intention to Withdraw Approval of all disability policy forms that contain discretionary language clauses. See http://www.insurance.ca.gov/0250-insurers/0500-legal-info/0600-decision-ruling/0200-non-precedential/upload/UL-Order-and-Decision.pdf. Although the Notice was addressed to "All Disability Insurers Doing Business in California," the Notice applied only to Unum Life Insurance Company of America, Provident Life and Accident Insurance Company, Metropolitan Life Insurance Company, and Hartford Life Insurance Company.

The DOI Notice was not challenged by Metropolitan Life Insurance Company. The remaining insurers filed briefs challenging the DOI action. Following an administrative hearing, the California DOI issued an order on March 22, 2005, adopting the hearing officer's decision that discretionary clauses are invalid and should be deleted from disability policy forms. See http:// www.insurance.ca.gov/0200-industry/0500-legalinfo/ 0600-decision-ruling/0200-non-precedential/ upload/UL-Order-and-Decision.pdf.

In reaching this conclusion, the Commissioner agreed with the insurers that the language in discretionary clauses is not ambiguous. However, the Commissioner concluded that the effect of the clauses caused an ambiguity by misleading insureds as to their rights under the policies. According to the Department, an insured would not know that, when a policy contains discretionary language, a reviewing court will look to whether the denial of benefits was "grounded on any reasonable basis," a reference to the standard applied when a court's review is for abuse of discretion.

Hartford Life Insurance Company continues to fight the California DOI action. A Petition for Writ of Mandate/Prohibition was filed by Hartford Life Insurance Company in the Superior Court of California, and that action is still pending. The two other insurers, Unum Life Insurance Company of America and Provident Life and Accident Insurance Company, dismissed their collective challenge when they entered into a global settlement with the California DOI following a Market Conduct Examination. As part of this settlement, the companies agreed to change several provisions in the policies they offer in California, including the discontinuation of discretionary clauses. On October 3, 2005, the California DOI expanded the scope of its assault on discretionary clauses to include all disability insurers writing...