The presence or absence of discretionary clauses in employee benefit plans has been the key factor in determining the applicable standard of review in ERISA benefit claims litigation since the U.S. Supreme Court’s 1989 decision in Firestone Tire and Rubber Co. v. Bruch. Since February 2004, the California Department of Insurance (“DOI”) has prohibited insurance companies from including in their insurance policies “discretionary clauses” reserving discretionary authority to the insurer as the benefits claims decision-maker. See our previous article, published in the September 2004 issue of Benefits Report. This article provides an update on the effect of the DOI’s prohibition of discretionary clauses on the standard of review for ERISA benefit claims litigation.

Background

A discretionary clause in an insurance policy is a contract provision or language that confers discretionary authority on the insurer, when making a benefit claim determination, to interpret the terms and conditions of the policy and to determine the eligibility of an insured for benefits under the policy. The main purpose of including such a provision is to limit judicial review of the insurer’s benefit claims determinations, as the claims review fiduciary, to a more favorable standard of review in accordance with Firestone Tire and Rubber Co. v. Bruch.

In Firestone, the U.S. Supreme Court held that only when a plan confers discretionary authority on the claims fiduciary or administrator to determine eligibility for benefits or to construe the terms of the plan, will the determination of the fiduciary or administrator be subject to the “abuse of discretion” standard of review. The abuse of discretion standard gives deference to the administrator’s decisions on granting or denying benefit claims, in contrast to the “de novo” standard of review, which provides no deference to the administrator’s decision. In June 2008, in Metropolitan Life Ins. Co. v. Glenn, the Supreme Court reaffirmed Firestone and stated that the abuse of discretion standard of review should apply when the claims administrator has discretionary authority and its claim determination is challenged in court, but that conflicts of interest are a factor in the abuse of discretion analysis. Thus, unless an insurance policy expressly includes a discretionary clause, thereby limiting judicial review to an abuse of discretion standard, the baseline assumption is that a de novo standard of review applies.

Since the Firestone case was decided, the National Association of Insurance Commissioners (“NAIC”) has adopted a model act stating that no health or disability insurance policy may contain a provision purporting to reserve discretion (see Model Act 42 “Prohibition on the Use of Discretionary Clauses Model Act,” NAIC 42–1(2006)). More than a dozen states, California among them, have passed regulations or adopted policies prohibiting the use of discretionary clauses altogether.

The California Department of Insurance

Pursuant to Cal. Ins. Code § 10290, insurers operating in California must submit their policy forms for approval with the California Insurance Commissioner (“Commissioner”) before they can begin issuing their disability insurance policy to employers. Under § 10291.5(b), the Commissioner has the authority to approve or disapprove the policy forms when originally submitted, or at renewal. In addition, under § 10291.5(f), the Commissioner has the authority to withdraw approval of a disability income policy previously approved by him or her.

In our September 2004 article, we noted that:

• on February 26, 2004, the California Department of Insurance had issued an opinion letter stating that discretionary clauses in disability insurance policies violate California law because these clauses deprive insureds of protection to which they are entitled under the California Insurance Code; and
• on February 27, 2004, the DOI had issued a Notice of Withdrawal of Approval of certain disability income insurance policies containing a discretionary clause.

Since February 2004 the DOI has consistently held that the use of discretionary clauses in disability income insurance policies, including those issued to plans governed by ERISA, violates California law.

Several insurance companies listed in the Notice filed a request for an administrative hearing before the DOI, pursuant to Cal. Ins. Code. § 10291.5(f), to determine whether the withdrawal of approval should be annulled, modified or confirmed. On March 18, 2005, the administrative hearing was held and the Hearing Officer issued a proposed decision affirming and approving the Commissioner’s Notice. On March 22, 2005, the DOI issued an order adopting the proposed decision affirming the withdrawal of approval of the policy forms listed in the Notice. Following publication of this order, some of the affected insurance companies entered into a settlement agreement with the DOI to remove the discretionary clauses from their insurance policy forms. On March 13, 2006, the Commissioner issued an order designating the March 22, 2005 decision as precedential pursuant to Cal. Gov. Code § 11425.60: i.e. all persons may rely upon the decision as precedent.

On April 21, 2005, Hartford Life Insurance Co., one of the insurance companies affected by the Notice, filed suit in the California Superior Court to challenge the Commissioner’s March 22, 2005 order. On January 8, 2007, the Superior Court issued a judgment in favor of the DOI. Hartford subsequently appealed to the Court of Appeal. On June 27, 2007, Hartford and the DOI entered into a settlement agreement under which Hartford replaced the discretionary clause in its policy forms with language the Commissioner believed did not violate Cal. Ins. Code § 10291.5. In addition, the DOI agreed to void its March 13, 2006 order designating its March 22, 2005 order as precedential. In exchange, Hartford agreed to dismiss its appeal with the Court of Appeal.

The Impact of State Regulation on the Standard of Review in ERISA Claims

In light of the California DOI’s position that discretionary clauses violate state law, the immediate question raised was whether such clauses in thenexisting policies were valid and, if not, how it would affect the standard of review of an ERISA benefit claim. To date, the state prohibition on discretionary clauses has had little impact on the standard of review in ERISA cases litigated in federal courts in California because courts have for the most part enforced those insurance provisions. While recognizing the DOI’s authority to withdraw approval, the courts have put forth various rationales for applying the abuse of discretion standard, such as:

• the DOI’s February 26, 2004 opinion letter operates only on a prospective basis;
• the discretionary clause cannot be severed from the rest of the insurance policy, so that either the plan is valid and contains the clause or the plan is voidable as a whole; or
• the California Code of Insurance does not provide the claimant a private right of action to revise the terms of the insurance policy that was bargained for.

However, there have been a small number of instances where a federal district court has expressed skepticism that the DOI has the authority to regulate discretionary clauses in disability income insurance policies. Some courts have agreed with plaintiffs who have argued that the DOI’s prohibition against discretionary clauses is not preempted by ERISA because state laws regulating insurance are saved from ERISA preemption under the Savings Clause (29 U.S.C. § 1144(b)(2)(A)) and therefore, if an ERISA disability plan is insured, the DOI may regulate it indirectly through regulation of the insurer and the insurance contract. But, as discussed further below, other courts have disagreed. The following is a survey of some of the notable cases on this issue.

Post-Notice Disability Benefit Claims Cases Reviewed Under the Abuse of Discretion Standard

• In Toth v. Automobile Club of Cal. Long Term Disability Plan, 2005 WL 1877150 (C.D. Cal. 2005), the court applied the abuse of discretion standard, stating that the Commissioner’s Notice did not purport to invalidate disability policies containing discretionary clauses retroactively. Similarly, in Mitchell v. Aetna Life Ins. Co., 359 F.Supp.2d 880 (C.D. Cal. 2005), the court found the DOI’s February 26, 2004 opinion letter did not subject Aetna’s decision to terminate the claimant’s benefits to de novo review because:
  • Cal. Ins. Code § 10291.5 does not provide a private right of action against the insurer to rewrite the terms of the policy; and
  • any revocation of approval by the Commissioner would apply only prospectively rather than retroactively.
• In Palmer v. Unum Life Ins. Co. of America, 2005 WL 1562800 (N.D. Cal. 2005), the claimant filed a motion to review the denial of his claim for disability benefits under a de novo standard because the DOI had not approved the plan’s discretionary clause. The court denied the motion, stating that the discretionary clause existed in the policy form that was approved by the DOI in 1995 and 2000. The court declined to address the issue of DOI approval of the discretionary clause but stated that the discretionary clause was not severable from the plan — either the plan was valid and contained the clause, or the plan was voidable as a whole.
• In Firestone v. Acuson Corporation Long Term Disability Plan, 326 F.Supp.2d 1040 (N.D. Cal. 2004), the plaintiff argued the DOI opinion letter constituted persuasive authority and requested de novo review. The court rejected the argument, stating that once the DOI has approved a policy that is otherwise validly issued, it is a binding contract and governs the obligation of the parties until the DOI revokes its approval (the insurer was not one of the companies listed in the DOI’s Notice of Withdrawal of Approval). The court stated that it had no power to invalidate a portion of an insurance policy or to unilaterally reform the terms of the policy so that the beneficiary may obtain benefits for which he never bargained. The plaintiff’s only potential remedy was to file a writ of mandamus to compel the DOI to withdraw its approval of the policy, otherwise the court must apply the abuse of discretion standard.

Post-Notice Disability Benefit Claims Cases Reviewed Under the de novo Standard

Thus far, very few federal district court decisions have applied the heightened de novo standard of review pursuant to the DOI opinion letter and have withstood appellate review.

• In Fenberg v. Cowden Automotive Long Term Disability Plan, 2004 WL 2496174 (N.D. Cal. 2004), the court, relying on the DOI’s opinion letter, invalidated the discretionary clause in the insurance policy (which was filed with and approved by the Rhode Island Insurance Commissioner) and granted plaintiff’s motion for summary adjudication on standard of review and reviewed the denial of benefits de novo. In an unpublished decision in 2007, the Ninth Circuit Court of Appeals reversed the district court’s decision, holding that Rhode Island law rather than California law applied because the respondent had failed to show that the bargained-for Rhode Island choice of law provision in the insurance policy was unreasonable or fundamentally unfair. Thus, the discretionary clause was valid under Rhode Island law, and the Ninth Circuit remanded the case to the district court for review of the benefit denial under the abuse of discretion standard.
• As noted in our September 2004 article, the district court in Rosten v. Sutter Health Long-Term Disability Plan, CV 03–4597 JSW (N.D. Cal. June 18, 2004), found the opinion of the DOI to be persuasive in its interpretation of the California Insurance Code and ruled that the discretionary clause in the policy violated California law and that the standard of review in the case would be de novo even though the disability insurance policy had been issued to the employer prior to the DOI’s opinion letter and the Notice to Withdraw Approval in February 2004. However, rulings applying the DOI opinion letter retroactively lie in the minority of cases addressing this issue and have yet to be reviewed at the appellate level.

The majority of courts addressing the presence of discretionary clauses in insurance policies continue to review an insurer’s claims decisions under an abuse of discretion standard based on the reasoning that state regulation applies only prospectively.

Cases Expressing Skepticism Regarding the DOI’s Authority to Regulate Discretionary Clauses in Disability Insurance Plans

• In Lundquist v. Continental Casualty Co., 394 F.Supp.2d 1230 (C.D. Cal 2005), the district court rejected the plaintiff’s argument for a de novo standard of review based upon the DOI’s withdrawal of approval of discretionary clauses on the basis that withdrawal of approval operated only prospectively. In addition to its ruling on the Notice’s prospective effect the court, referencing Firestone, stated that “the United States Supreme Court has expressly approved of the use of discretionary clauses in insurance disability policies” and so deemed the inclusion of such clauses was not a breach of fiduciary duty under ERISA that would entitle a plaintiff to a de novo standard of review.
• Similarly, in McCurdy v. Metropolitan Life Ins. Co., 2007 WL 915177 (E.D. Cal. 2007), the court rejected the plaintiff’s argument that a discretionary clause was void as against public policy. The court stated, “[r]egardless of any underlying state policy disfavoring discretionary clauses, the United States Supreme Court has approved of such clauses and held that [the] administrator’s decisions made pursuant to such clauses should be reviewed for abuse of discretion.” Furthermore, the court cited to its holding in Hansen v. Unum Life Ins. Co., 2004 U.S. Dist. LEXIS 22995 (E.D.Cal. Oct. 21, 2004), that “Cal. Ins. Code § 10291.5 falls within ERISA’s preemptive scope as it clearly relates to an employee benefit plan.” The court then stated in footnote 1, “this court agrees with the holding in Hansen that these state law provisions are not controlling given ERISA’s preemptive effect on employee benefit plans.” However, the court ordered MetLife to provide the plaintiff with written, verified responses on the issue of whether the plan’s discretionary clause was actually approved by the DOI.
• In Mixon v. Metropolitan Life Ins. Co., 442 F.Supp.2d 903 (C.D. Cal. 2006), the plaintiff asserted that the language in the SPD granting an ERISA plan administrator discretion to deny benefits violated Cal. Ins. Code § 10291.5 in accordance with the DOI’s opinion letter. The court rejected this argument, stating the DOI’s opinion letter is not binding on the court in this instance because:
  • the DOI only has jurisdiction over insurance policy forms, not SPDs;
  • the SPD is governed by federal rather than state law; and
  • the opinion letter merely states the Commissioner’s opinion and does not have “the force of law.”

Ninth Circuit Court of Appeals

In an unpublished opinion in Baida v. First Unum Life Ins. Co., 2007 WL 4467637 (9th Cir. 2007), the Ninth Circuit Court of Appeals affirmed the district court’s application of the abuse of discretion standard for review of the denial of plaintiff’s claim because the disability plan contained an unambiguous grant of discretion to the plan administrator to determine eligibility for benefits. The Ninth Circuit stated the DOI’s opinion letter and Notice to Withdraw Approval “do not render the discretionary clause in the Plan unenforceable.” Id. at 30. Citing Mixon, the Court stated, “an opinion letter ‘merely states the opinion of the insurance commissioner, and does not have the force of law.'” Id. Furthermore, the Court cited Acuson for the notion that Cal. Ins. Code § 10291.5(b) only sets forth the parameters within which the Commissioner may approve or disapprove insurance policies but does not afford a private action by an insured against the insurer to rewrite the terms of his policy, and does not empower a court to declare a certain portion of plaintiff’s policy invalid or to unilaterally reform the terms and conditions of that policy. The Ninth Circuit also stated that the DOI’s withdrawal of its approval of Unum’s policy did not apply retroactively.

Up until the decision in Baida, the Ninth Circuit, except for a brief mention in Judge Kleinfeld’s concurring opinion in Abatie v. ALTA Health & Life Ins. Co., 458 F.3d 955, 976 (9th Cir. 2006), had declined to weigh in specifically on the impact of the prohibition against discretionary clauses upon the standard of review.

Conclusion

Since the Firestone case was decided in 1989, there has been a national movement by the NAIC and various states towards adopting regulations prohibiting discretionary clauses in insurance policies. In 2002, the NAIC issued Model Act 42, “Prohibition on the Use of Discretionary Clauses Model Act,” which urged states to adopt legislation that prohibits discretionary clauses in health insurance contracts. The 2002 Model Act shows that the NAIC disfavors the inclusion of discretionary clauses because they strip away the rights and protections afforded to insureds under state insurance laws. In December 2004, the NAIC passed another model act that expanded the prohibition of discretionary clauses to both health and disability insurance policies (see Model Act 42 “Prohibition on the Use of Discretionary Clauses Model Act,” NAIC 42–1(2006)).

Various states have either adopted the provision in the Model Act or have used similar language from the Model Act in passing state legislation against discretionary clauses in insurance policies. To date, 13 states have statutes or policies against the use of discretionary clauses in insurance policies: California, Hawaii, Idaho, Indiana, Illinois, Maine, Michigan, Minnesota, Montana, New Jersey, New York, Oregon and Utah.

California did not adopt the Model Act, and the state’s policy against discretionary clauses is currently limited to disability insurance policies. Since 2004, most insurance carriers operating in California have agreed to either withdraw or modify the discretionary clauses in their policy forms. The DOI continues to maintain the position that, although policies that are already in force are not affected, discretionary clauses must be removed by the time the insurers file for renewal of their policies.

The impact of the California DOI’s prohibition against discretionary clauses in disability insurance policies upon the standard of review analysis remains uncertain for the most part. Notably, there are no new cases on this issue filed in federal courts in California within the last couple of years. This is likely a result of insurance companies’ elimination of discretionary clauses from their California-issued policies in light of the DOI’s position on the matter. It remains to be seen whether similar changes in other states will be made as a result of California’s position and the NAIC Model Act.