Life, Health, Disability, and ERISA Hot Topics of 2010:

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1 Life, Health, Disability, and ERISA Hot Topics of 2010: Recovering Attorneys Fees under ERISA in the Aftermath of Hardt and the Trend toward State Prohibition of Discretionary Clauses in ERISA-Governed Benefit Plans Scott M. Trager Semmes, Bowen & Semmes 25 South Charles St., Ste 1400 Baltimore, Maryland (410) (410) [fax] Return to course materials table of contents

2 Scott M. Trager is a principal at Semmes, Bowen & Semmes in its Baltimore, Maryland, office. He is a graduate of the University of Tennessee, Knoxville, and the University of Baltimore School of Law. His practice covers a broad spectrum of litigation matters in the state and federal courts of Maryland and the District of Columbia, as well as the Maryland Insurance Administration and Maryland Office of Administrative Hearings, focusing on insurance coverage and general liability defense, life, health, ERISA, and non-erisa claims. He has substantial experience in interpreting insurance policies and in rendering opinions on coverage, duty to defend, duty to indemnify, and other insurance contract-related issues. He is a member of several state and national professional associations and is an active member of DRI s Life, Health and Disability Committee and its marketing subcommittee.

3 Life, Health, Disability, and ERISA Hot Topics of 2010: Recovering Attorneys Fees under ERISA in the Aftermath of Hardt and the Trend toward State Prohibition of Discretionary Clauses in ERISA-Governed Benefit Plans Table of Contents I. Recovering Attorneys Fees under ERISA in the Aftermath of Hardt A. Attorneys Fees and ERISA B. Hardt v. Reliance Standard Life Insurance Co Factual background The district court decision The remand to Reliance The district court s award of attorneys fees and costs to Hardt The Fourth Circuit decision The Supreme Court decision II. The Trend toward State Prohibition of Discretionary Clauses in ERISA- Governed Benefit Plans A. The Evolution of Discretionary Clauses B. The Difference between de Novo and Deferential Judicial Review C. The Benefits of Discretionary Clauses D. State Insurance Regulators Response to Discretionary Clauses E. Plan Fiduciaries Defense to State Insurance Regulators Attack ERISA Preemption Statutory preemption Preemption by virtue of ERISA s civil enforcement scheme F. Key Cases American Council of Life Insurers v. Ross, 558 F.3d 600 (6th Cir. 2009) McClenahan v. Metropolitan Life Insurance Co., 621 F. Supp. 2d 1135 (D. Colo. 2009) Standard Insurance Co. v. Morrison, 584 F.3d 837 (9th Cir. 2009) Hancock v. Metropolitan Life Insurance Co., 590 F.3d 1141 (10th Cir. 2009) G. The Future of Discretionary Clauses Life, Health, Disability, and ERISA Hot Topics of 2010: Recovering Attorneys... v Trager v 479

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5 Life, Health, Disability, and ERISA Hot Topics of 2010: Recovering Attorneys Fees under ERISA in the Aftermath of Hardt and the Trend toward State Prohibition of Discretionary Clauses in ERISA-Governed Benefit Plans I. Recovering Attorneys Fees under ERISA in the Aftermath of Hardt A. Attorneys Fees and ERISA In the United States, the prevailing litigant is ordinarily unentitled to collect attorneys fees from the loser of the litigation. See Alyeska Pipeline Serv. Co. v. Wilderness Soc y, 421 U.S. 240 (1975). Rather, litigants must pay their own attorneys fees and costs of litigation unless provided for by contractual agreement, common law, or by a fee-shifting statute or provision. Id. Since its enactment in 1974, ERISA has contained a fee-shifting provision, providing for the recovery of attorneys fees and costs by either party to the action: In any action under this subchapter by a participant, beneficiary, or fiduciary, the court in its discretion may allow a reasonable attorney s fee and costs of action to either party. 29 U.S.C. 1132(g)(1). The purpose of ERISA s attorneys fee award provision is purely compensatory and not punitive. As stated by the Seventh Circuit, the provision for attorneys fees under ERISA is not in the nature of a punitive damage award, but rather is analogous to an assessment of costs. Rivera v. Benefit Trust Life Ins. Co., 921 F.2d 692, 697 (7th Cir. 1991). A court may award fees to either a plaintiff or a defendant, and it is generally true that its determination may be reversed only upon an abuse of discretion. Even though the provision contains no specific requirement that a party must prevail in order to recover fees, a party seeking benefits under ERISA may not recover his fees and costs where the decision to deny or terminate the claim was upheld. While courts are not required to adhere to a prevailing party standard, the application of various factors aiding in the courts determination will likely render an outcome in favor of the party that most substantially prevails. Appellate courts are fairly consistent in requiring trial courts to apply the Five- Factor Test in deciding whether to award fees to a plaintiff: 1) the degree of the defendant s culpability or bad faith; 2) the ability of the defendant to satisfy an award of fees and costs; 3) whether an award of fees and costs against the defendant would deter others from acting under similar circumstances; 4) whether the party requesting fees sought to benefit all participants and beneficiaries of an ERISA plan or to resolve a significant legal question regarding ERISA; and 5) the relative merits of the parties positions. See, e.g., Reinking v. Philadelphia Life Ins. Co., 910 F.2d 1210, (4th Cir. 1990); Iron Workers Local No. 272 v. Bowen, 624 F.2d 1255, 1266 (5th Cir. 1980); Eaves v. Penn, 587 F.2d 453, 465 (10th Cir. 1978). Life, Health, Disability, and ERISA Hot Topics of 2010: Recovering Attorneys... v Trager v 481

6 B. Hardt v. Reliance Standard Life Insurance Co. 1. Factual background Bridget Hardt (the plaintiff or Hardt ) was employed as an executive assistant to the president of Dan River Inc. ( Dan River ), a textile manufacturer. In 2000, she began experiencing pain in her neck and shoulders and was diagnosed with carpal tunnel syndrome ( CTS ) and underwent surgery on both of her wrists. She continued to experience pain and stopped working on January 23, In August 2003, Hardt requested that Reliance Standard Life Insurance Company ( Reliance ) pay her long term disability ( LTD ) benefits pursuant to Dan River s Group Long-Term Disability Insurance Program Plan (the Plan ), administered by Dan River and underwritten by Reliance, which decided whether a particular individual is entitled to benefits. In response to Hardt s request, Reliance notified her that she was required to submit to a functional capacities evaluation ( FCE ) and granted her a provisional approval. In October 2003, Hardt underwent an FCE and the evaluator concluded that Hardt suffered from the following: neck and upper extremity pain, decreased right-hand dexterity and strength, restricted overhead reach, a restricted ability to squat and kneel, the inability to crawl or to climb ladders, and decreased lift, carrying, and push-and-pull capabilities. In December 2003, Reliance denied Hardt s LTD claim, concluding that she did not meet the Plan s definition of total disability. Hardt appealed this decision, and Reliance reversed its original decision so that Hardt ultimately received LTD benefits for 24 months. In the meantime, Hardt was also diagnosed with hereditary small-fiber neuropathy and her pain became worse over the following months. In addition to other symptoms, Hardt experienced burning sensations in her feet and pain in her calves, which made walking difficult. Hardt applied to the Social Security Administration ( SSA ) for disability insurance benefits and submitted two questionnaires completed by her treating physicians that concluded that she could not return to her prior position or other sedentary positions because of her neuropathy and other maladies. The SSA found that Hardt was disabled under the Social Security Act because she was unable to return to her former employment or make an adjustment to perform other work. A few months later, Reliance notified Hardt that her benefits would expire at the end of the 24-month period. The Plan provided benefits after 24 months only to individuals totally disabled from any occupation. Reliance concluded that Hardt was not totally disabled under the Plan as it determined that there were several employment opportunities available to her. Hardt again appealed this denial of her claim to Reliance, submitting medical records, the SSA questionnaires completed by her treating physicians, and an updated questionnaire from one of those physicians that opined that Hardt would be unable to maintain a job. Reliance requested that Hardt complete an updated FCE before making a final decision on her appeal but did not request that the testing company review her for neuropathic pain. Hardt underwent two updated FCEs on December 29, 2005, and January 26, 2006; however, the results of both examinations were considered invalid by the examiners because her effort was submaximal for fear of nausea and pain. Reliance then hired Dr. Michael Leibowitz, who reviewed only some of Hardt s medical records. In his report, Dr. Leibowitz failed to mention any of the pain medications Hardt was taking or the treating physicians questionnaires. He ultimately concluded that Hardt s health was expected to improve. 482 v DRI Annual Meeting v October 2010

7 Reliance also hired a vocational rehabilitation counselor to determine if any jobs existed that Hardt was capable of performing. The labor market study identified eight employment opportunities suitable for Hardt; however, that study was based on Hardt s health in On March 27, 2006, Reliance, relying on the FCEs, Dr. Leibowitz s report and the labor market study, advised Hardt that she was still ineligible to receive LTD benefits. As her administrative remedies had been exhausted, Hardt filed a complaint in the United States District Court for the Eastern District of Virginia, alleging that Reliance violated ERISA by wrongfully denying her LTD benefits. 2. The district court decision The parties filed cross-motions for summary judgment, and the district court reviewed Reliance s denial of LTD benefits under a modified abuse-of-discretion standard of review. See Hardt v. Reliance Standard Life Ins. Co., 540 F. Supp. 2d 656 (E.D. Va. 2008). The district court denied Reliance s motion for summary judgment and concluded that Reliance s decision was not based on substantial evidence. See id. at 663. Specifically, the district court found that the FCEs did not assess the impact of Hardt s neuropathy or neuropathic pain on her ability to perform a sedentary job. Dr. Leibowitz s report was found to be incomplete and inadequate and the vocational report was based on outdated information. Reliance also failed to consider medical records submitted by Hardt that demonstrated that she was suffering from neuropathy. See id. The district court determined that Hardt was totally disabled due to her neuropathy; however, it did not find that the evidence was so overwhelming to conclude that she was entitled to judgment as a matter of law. See id. at 664. Accordingly, Hardt s motion for summary judgment was also denied. The district court provided Reliance with the opportunity to address the deficiencies in its decision and remanded the matter back to Reliance to fully and adequately assess Hardt s claim. See id. 3. The remand to Reliance On remand, Hardt provided additional medical records to Reliance for its consideration, and Reliance reversed its earlier decision and awarded Hardt full LTD benefits until her 66th birthday, as well as retroactive benefits for the time already elapsed. 4. The district court s award of attorneys fees and costs to Hardt Hardt then filed a motion for attorneys fees and costs in the district court based upon her status as the prevailing party. The district court granted her motion on August 7, 2008, concluding that the court sanctioned a material change in the legal relationship of the parties by ordering [Reliance] to conduct the type of review to which [Hardt] was entitled, and that because, on remand, [Hardt] received precisely the benefits she had sought, she meets the definition of a prevailing party and is eligible for an award of attorneys fees. The district court awarded her $39, in fees. Reliance thereafter appealed to the Fourth Circuit. 5. The Fourth Circuit decision The Fourth Circuit reviewed de novo the district court s determination that Hardt was a prevailing party for purposes of awarding attorneys fees. See Hardt v. Reliance Standard Life Ins. Co., 336 Fed. Appx. 332, 2009 WL (4th Cir. July 14, 2009). The Fourth Circuit, relying on Buckhannon Life, Health, Disability, and ERISA Hot Topics of 2010: Recovering Attorneys... v Trager v 483

8 Bd. & Care Home, Inc. v. West Virginia Dep t of Health & Human Resources, 532 U.S. 598, 603 (2001), stated that to be a prevailing party, a plaintiff must receive at least some relief on the merits of his claim. See id. at *335, 2009 WL , *3. The Buckhannon court, in explaining what constitutes relief on the merits, stated that enforceable judgments on the merits and court-ordered consent decrees create the material alteration of the legal relationship of the parties necessary to permit an award of attorney s fees. Id., 532 U.S. at 604. The Fourth Circuit agreed with Reliance s argument that there was no enforceable judgment on the merits or judicially sanctioned relief and held that remand was insufficient to overcome the statutory requirement that a party applying for an award of fees and costs must first have been accorded some relief in the district court. See 336 Fed. Appx. at *336, 2009 WL , *4. Because the district court did not require Reliance to award benefits to Hardt, the Fourth Circuit held that the remand did not constitute an enforceable judgment on the merits as required by Buckhannon. See id. Moreover, Hardt s only request for relief was for an award of benefits; she did not request remand as an alternative remedy. Had she done so, she would have been entitled to an award of attorneys fees as the district court would have provided the very relief requested in the complaint. See id.; Clark v. Metropolitan Life Ins. Co., 384 F. Supp. 2d 894 (E.D. Va. 2005) (awarding attorneys fees after a remand to a plan administrator); Christian v. DuPont-Waynesboro Health Care Coverage Plan, 12 F. Supp. 2d 535 (W.D. Va. 1998) (same). The Fourth Circuit thus vacated the award of attorneys fees to Hardt. 6. The Supreme Court decision On May 24, 2010, the Supreme Court issued its decision in Hardt v. Reliance Standard Life Insurance Co., --- S. Ct. ---, 2010 WL (May 24, 2010), unanimously reversing the decision of the Fourth Circuit and finding that the district court properly exercised its discretion in awarding attorneys fees to Hardt. See id. at *9. The issues before the Supreme Court were: (1) whether ERISA s fee-shifting statute, 29 U.S.C. 1132(g)(1), includes a prevailing party requirement for an award of attorneys fees; and (2) whether a fee claimant is entitled to attorneys fees under 29 U.S.C. 1132(g)(1) where the district court remands the previously denied claim for benefits to a claim administrator for further review and benefits are ultimately awarded during remand. See id. at *6. The Supreme Court began by analyzing the statutory language of 1132(g)(1) and noted that it did not limit the availability of attorneys fees to a prevailing party. See id. at *7. Rather, the statute expressly grants district courts discretion to award attorneys fees to either party. The Court distinguished 1132(g)(1) from 1132(g)(2), which governs the availability of attorneys fees in ERISA actions under 1145 (actions to recover delinquent employer contributions to a multiemployer plan). See id. Unlike 1132(g)(1), 1132(g)(2) entitles plaintiffs to seek attorneys fees only where they obtain a judgment in favor of the plan. Id. The Court criticized the decision of the Fourth Circuit, stating that it more closely resembled inventing a statute rather than interpreting one. Id. Under the plain language of the statute, the Court held that a fee claimant need not be a prevailing party to be eligible for an award of attorneys fees under 1132(g)(1). See id. The Court next considered the circumstances under which a court may award attorneys fees pursuant to 1132(g)(1), interpreting it in light of precedents addressing statutory deviations from the American rule that do not limit attorneys fees awards to the prevailing party. See id. at *8. Although not foreclosing its potential applicability, the Court found that the Five-Factor Test was not required for channeling a court s discretion when awarding fees. Id. at *9. The Court looked principally to 484 v DRI Annual Meeting v October 2010

9 Ruckelshaus v. Sierra Club, 463 U.S. 680 (1983), in laying down the proper markers to guide a court in exercising the discretion granted by 1132(g)(1). See id. Specifically, a fees claimant must show some degree of success on the merits before a court may award attorneys fees under 1132(g)(1). See id. A claimant must achieve more than trivial success on the merits or a purely procedural victory, but the court need not conduct a lengthy inquir[y] into the question where a particular party s success was substantial or occurred on a central issue. Id. The Supreme Court found that although Hardt failed to win summary judgment on her benefits claim, the district court did find compelling evidence that Ms. Hardt is totally disabled due to her neuropathy, and stated that it was inclined to rule in Ms. Hardt s favor on her benefits claim but declined to do so before first giving Reliance the chance to address the deficiencies in its review of that claim. Id. Accordingly, Hardt obtained a judicial order instructing Reliance to act, which led it to reverse its decision and award her the benefits she sought. See id. The Court found that these facts established that Hardt achieved far more than trivial success on the merits or a purely procedural victory and held that the district court properly exercised its discretion to award Ms. Hardt attorneys fees. See id. The Court, however, declined to decide whether a remand order, without more, constitutes some success on the merits sufficient to make a party eligible for attorneys fees under 1132(g)(1). See id. at *9. II. The Trend toward State Prohibition of Discretionary Clauses in ERISA- Governed Benefit Plans ERISA plan administrators and insurers rely on discretionary clauses to gain deferential court review should a plan participant file a lawsuit challenging the denial of a claim for benefits. When states ban or prohibit insurers from including discretionary clauses in their products, ERISA plan administrators lose their ability to obtain deferential review of these decisions. Such an outcome weighs in favor of plan participants who will typically ask a court to give a de novo look at the administrator s decision. With increasing frequency, states are moving to implement measures in an effort to ban discretionary clauses in insurance products, including ERISA plans. This effort to ban discretionary clauses has inevitably led to legal challenges that, to date, have weighed in favor of the states. A. The Evolution of Discretionary Clauses Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101 (1989), represents the watershed case in the formulation of the standard of review with discretionary clauses. In Bruch, the Supreme Court established the standard of review for cases involving benefit denials by ERISA-covered plans. Although ERISA grants a plan participant the right to bring a civil action to recover benefits due to him under the terms of his plan, ERISA does not specify the standard of review that a court should use in such an action. The Bruch case addressed this issue and formulated the standard under which benefit denials are to be judicially reviewed. The Court stated that the reviewing court should be guided by principals of trust law, as an ERISA plan administrator is in a position analogous to that of a trustee of a common-law trust. See id. at 110. The Court concluded that, as with a trustee, a claim administrator s decisions should be reviewed de novo, unless the plan explicitly grants to the administrator the discretionary authority to determined plan benefits or to construe the terms of the plan. When a plan contains such a grant, the principles of trust law make a deferential standard of judicial review appropriate. See id. at That Life, Health, Disability, and ERISA Hot Topics of 2010: Recovering Attorneys... v Trager v 485

10 standard is known as the arbitrary-and-capricious or the abuse-of-discretion standard. As a result of the Bruch decision, many insurers that issue group policies funding employee benefit plans included discretionary clauses in the plan documents and/or insurance policies. Thus, the default standard was de novo (no deference), but it further provided that the arbitrary-and-capricious standard of review would apply where the plan contained discretionary language. The Supreme Court s opinion in Bruch provided a blueprint for preserving deferential review through discretionary clauses. Since Bruch, federal courts have looked to the plan documents to determine whether they contain language granting the claim administrator the discretion to interpret the terms of the plan and determine eligibility for benefits, in order to determine whether the court s review of the decision should be de novo or deferential. In 2008, in Metropolitan Life Insurance Co. v. Glenn, 128 S. Ct (2008), the Supreme Court, reaffirming Bruch, again stated that the abuse-of-discretion standard of review should apply when the claim administrator has discretionary authority and its claim determination is judicially challenged. See id. at The Court in Glenn specifically stated that it would not overturn Bruch by adopting a rule that in practice could bring about near universal review by judges de novo i.e., without deference of the lion s share of ERISA plan claims denials. Id. The Supreme Court, in Conkright v. Frommert, 130 S. Ct (2010), most recently again reaffirmed Bruch by stating that its deferential standard promotes efficiency, predictability, and uniformity. See id. at The Court further found that the deferential standard of review does not, ipso facto, lead to a victory by the plan administrator on the merits; rather, it means that the plan administrator s interpretation of the plan will not be disturbed if reasonable. Id. at 1651 (quoting Bruch, 489 U.S. at 111). Thus, under Bruch, Glenn, and Conkright, the deferential standard of review is alive and well. B. The Difference between de Novo and Deferential Judicial Review Over time, nearly all ERISA plan sponsors have written discretionary language into the plan so as to guarantee that if a plan participant or beneficiary files an ERISA lawsuit, the court will be required to give deference to the administrator s decision. While the inclusion of such discretionary language does not guarantee that an administrator will prevail, it does make it more difficult for plan participants to persuade a court to overturn the administrator s decision. When a court applies the deferential abuse-of-discretion standard of review, its task is to determine whether the decision of the administrator was arbitrary or capricious. As Bruch directs, a decision is not arbitrary or capricious if it is reasonable. A decision may be demonstrated to be reasonable if it is supported by substantial evidence, which has been described as being more than a scintilla, but less than a preponderance. If the court determines that, based on all the evidence that was before the administrator, a reasonable person could have reached a similar decision, it should uphold the decision even if a different decision could also have been made. However, in conducting a de novo review, a court must itself review the evidence that was before the administrator to determine whether it agrees with the administrator s conclusion. The court may also consider facts that were unknown to the administrator when it made its decision. If, after its review, the court determines it would have come to a conclusion different from that of the administrator, even if the decision of the administrator was reasonable, the court will substitute its judgment for that of the administrator. 486 v DRI Annual Meeting v October 2010

11 Statistically, claimants have far greater protection under the de novo standard of review compared with the discretionary standard of review. Specifically, in Standard Insurance Co. v. Morrison, 537 F. Supp. 2d 1142 (D. Mont. 2008), regulators presented evidence that when the claim denial results in a lawsuit, claimants recover benefits in 68 percent of lawsuits when a discretionary clause is absent, compared to a 28 percent rate of recovery when the plan gives the insurer discretion. The plaintiffs bar generally views the presence of discretionary clauses in plans as being the difference between winning and losing. C. The Benefits of Discretionary Clauses Opponents of the ban on discretionary clauses argue that adequate protections already exist for participants and beneficiaries, since ERISA itself imposes stringent legal duties and procedural requirements on plan fiduciaries, including insurers wielding discretionary authority over benefits. Employers and plan sponsors also contend that the elimination of fiduciary discretion undermines their ability to control the scope of benefits to be provided. They also observe that resources for paying plan benefits will be diminished or exhausted by the litigation costs incurred in defending lawsuits by frustrated claimants. Discretionary clauses keep costs manageable, and the failure to control litigation costs will discourage employers from offering employee benefit programs. Moreover, deferential review deters claimants from filing suit--attorneys are reluctant to take benefit denial cases when plan terms contain a discretionary clause because the probability of success is low. Discretionary clauses further decrease the cost of obtaining insurance to fund disability income benefit plans, both to employers and to employees who contribute to that cost. They also decrease the cost of administering and paying claims under self-funded plans. Discretionary clauses enable plan administrators to operate the plans consistently in an efficient and effective manner. This consistency could be harmed when the determinations of individual judges can be substituted for the determinations of a claim administrator. A judge reviewing a disability income benefits denial de novo may not have experience in administering disability benefits generally. When a number of different judges review claim determinations de novo, there are likely to be inconsistent determinations plans would be subject to varying interpretations depending on the particular judge and the particular federal circuit in which the case is heard. Inconsistent decisions are significantly reduced if the benefit determination rests on the judgment of the claim administrator with knowledge of the particular plan for all claims that are filed under it. The existence of inconsistent fact finding and plan interpretations may prevent claimants and their advisors from being guided by precedent when making the determination whether to contest a claim determination in court, further driving up the incidence of litigation. D. State Insurance Regulators Response to Discretionary Clauses Discretionary clauses have, for years, been challenged by ERISA plaintiffs and consumer groups. State insurance regulators entered the arena in 2002 and appear to be succeeding in setting aside these clauses for insured plans. In 2002, the National Association of Insurance Commissioners ( NAIC ), consisting of the principal insurance regulatory officials of the states, the District of Columbia, and the U.S. territories adopted the Prohibition on the Use of Discretionary Clauses Model Act (the Act ) to prohibit the use of discretionary clauses in health insurance contracts. The Act was adopted because members of the NAIC believed that discretionary clauses in insurance contracts were inequitable, deceptive, and misleading to consumers. The Act broadly disapproved of any proposed insurance form containing a discretionary clause, typically defined as any clause that (1) provides an insurer with sole discretionary Life, Health, Disability, and ERISA Hot Topics of 2010: Recovering Attorneys... v Trager v 487

12 authority to determine eligibility for benefits under, or interpret the terms and provisions of, an insurance policy and (2) purports to give the insurer s determination or interpretation binding effect as to the policy holder. In 2004, NAIC unanimously extended the Act to apply to disability income insurance policies. It appears that the Act was also intended to reach insured ERISA plans. NAIC, seeking to level the playing field between plan insurers and participants, took the position that discretionary clauses are unfair and inequitable because they insulate plan insurers from judicial review. State insurance regulators argue that discretionary clauses are problematic. The arguments for banning discretionary clauses are as follows: (1) the inclusion of a discretionary clause is unfair because it is inequitable, deceptive, and misleading to consumers and it deprives a claimant of de novo judicial review of a denial of ERISA plan benefits; (2) such clauses reverse the burden on the insured to show that the insurers decision was arbitrary and capricious; (3) discretionary clauses render the benefits illusory because it permits the insurer to ignore the terms of the policy; (4) banning such clauses serves to avoid the inherent conflict of interest of an insurer that pays and decides benefits; (5) discretionary clauses leave questions of judgment to the insurer or their administrator resulting in a lower rate of success compared with the de novo standard; (6) ERISA does not provide that review under the discretionary standard (limited to the administrative record) is to be analyzed pursuant to administrative law; (7) eliminating discretionary clauses helps assure the reasonable expectations of insureds that they would be protected under an objective, contract-based standard for claims adjudication; (8) prohibition of discretionary clauses enables state regulators to protect consumers by promoting the payment of legitimate claims; and (9) discretionary clauses clash with the doctrine of contra proferentem when faced with differing policy interpretations, coverage is to be extended to protect policyholders from ambiguities. The Act broadly disapproves of any proposed insurance form containing a discretionary clause. Specifically, the Act provides: The purpose of this act is to assure that health insurance benefits and disability income protection coverage are contractually guaranteed, and to avoid the conflict of interest that occurs when the carrier responsible for providing benefits has discretionary authority to decide what benefits are due. * * * No policy, contract, certificate or agreement offered or issued in this state providing for disability income protection coverage may contain a provision purporting to reserve discretion to the insurer to interpret the terms of the contract, or to provide standards of interpretation or review that are inconsistent with the laws of this state. In an effort to curb the use of such clauses, many states have implemented the Act s provisions in one form or another by banning, limiting, or looking unfavorably on discretionary clauses either through statutory prohibition, prohibition by regulation, or prohibition by refusing to approve policies. These states include: Alaska, California, Colorado, Hawaii, Idaho, Illinois, Indiana, Maine, Michigan, Minnesota, Montana, New Hampshire, New Jersey, New York, Oregon, South Dakota, Utah, Washington, and Wyoming. Other states, such as Maryland, Nevada, and Texas have previously considered and/ or are considering banning discretionary clauses. 488 v DRI Annual Meeting v October 2010

13 E. Plan Fiduciaries Defense to State Insurance Regulators Attack ERISA Preemption One of the biggest obstacles facing states as they implement discretionary clause bans is the force of ERISA preemption. Specifically, insurers and administrators of ERISA plans have argued that states cannot regulate the language that is placed in ERISA plans. Accordingly, plan sponsors and fiduciaries have challenged several state laws on the grounds that they are broadly preempted by ERISA either statutorily or by virtue of its civil enforcement scheme. 1. Statutory preemption Under statutory preemption, state laws that relate to an ERISA plan are superseded except state laws that regulate insurance, see 29 U.S.C This exception exempts any law of any State which regulates insurance, banking, and securities. 29 U.S.C. 1144(b)(2)(A). This insurance savings clause removes insurance regulation from ERISA s otherwise broad preemption. This exception is limited by the deemer clause, which provides: Neither an employee benefit plan nor any trust established under such a plan[] shall be deemed to be an insurance company for purposes of any law of any State purporting to regulate insurance companies. The deemer clause places self-funded plans in the preempted category; therefore, a state cannot prohibit a discretionary clause in a self-funded plan, even if the plan provides health or disability coverage through an insurer. The key savings clause cases include Kentucky Association of Health Plans v. Miller, 538 U.S. 329 (2003) (holding that the Any Willing Provider provisions of the Kentucky Health Care Reform Act, which prohibited health benefit plans from discriminating against providers willing to meet terms and conditions for plan participation, were laws regulating insurance and were saved from ERISA preemption), Rush Prudential HMO, Inc. v. Moran, 536 U.S. 355 (2002) (holding that an Illinois statute did not conflict with ERISA by supplementing or supplanting its civil enforcement scheme and did not conflict with ERISA by impermissibly depriving HMOs of deferential standard of review of benefits determinations), Pilot Life Insurance Co. v. Dedeaux, 481 U.S. 41 (1987) (holding that a state lawsuit asserting improper processing of claim for benefits under ERISA-regulated plan was preempted by federal law where state common-law cause of action did not regulate insurance, within the meaning of the savings clause in an ERISA preemption provision, and there was a clear expression of congressional intent that ERISA s civil enforcement scheme be exclusive), and Metropolitan Life Insurance Co. v. Massachusetts, 471 U.S. 724 (1985) (holding that a Massachusetts statute setting forth mandatory minimum health care benefits for inclusion in general insurance policies was not preempted by ERISA). 2. Preemption by virtue of ERISA s civil enforcement scheme The second type of ERISA preemption is by virtue of ERISA s civil enforcement scheme: state laws that purport or supplant the civil enforcement provisions of ERISA are preempted, regardless of whether they regulate insurance. See 29 U.S.C. 1132(a). In a 2002 case that foreshadowed NAIC s efforts to undermine a deferential standard of review, the Supreme Court, in Rush Prudential HMO, Inc. v. Moran, 536 U.S. 355 (2002), addressed ERISA s savings clause. In that 5-4 decision, the Supreme Court held that ERISA did not preempt an Illinois statute requiring independent review of disputes between a primary care physician and an HMO. In so holding, the Court rejected arguments that the independent review mechanism conflicted with ERISA s enforcement scheme by depriving the HMO of deferential review arising out of its interpretive discretion. The Court wrote: Life, Health, Disability, and ERISA Hot Topics of 2010: Recovering Attorneys... v Trager v 489

14 Not only is there no ERISA provision directly providing a lenient standard of review of benefit denials, but there is no requirement necessarily entailing such an effect even indirectly. Nothing in ERISA requires that these kinds of decisions be so discretionary in the first place. [The statute] prohibits designing an insurance contract so as to accord unfettered discretion to the insurer to interpret the contract s terms. As such, it does not implicate ERISA s enforcement scheme at all, and is no different from the types of substantive state regulation of insurance contracts we have in the past permitted to survive preemption. Id. at Rush Prudential triggered the run on banning discretionary clauses: if the court has a sense that the law regulates insurance and that it does not supplant ERISA, it will fall within ERISA s savings clause. The issue before the courts has been whether state laws banning discretionary clauses regulate insurance within the meaning of 514(b)(2)(A), which is determined by reference to the test set forth in Kentucky Association of Health Plans, Inc. v. Miller, 538 U.S. 329 (2003). In Miller, the Supreme Court broke with earlier precedent and established a new, more liberal framework for determining whether a given law was saved from ERISA preemption. The Court held that a state law regulated insurance and was thus saved from preemption where: (1) the law was specifically directed to the insurance industry; and (2) the law substantially affects the risk-pooling arrangement between the insurer and the insured. See id. at Against this backdrop, insurers have argued that state laws banning discretionary clauses are not state laws that regulate insurance as discretionary clauses have no impact in the risk-pooling arrangement between the insurer and the insured and that state prohibitions conflict with ERISA s civil enforcement scheme. Those who advocate banning discretionary clauses, however, have argued that ERISA does not preempt these state laws because ERISA specifically carves out an exception that allows states to regulate insurance. F. Key Cases The usual ERISA preemption defense appears to be giving way to a wave of state insurance regulation preventing insured ERISA plans from giving Bruch discretion to fiduciaries of insured plans. To date, three federal appeals courts have examined state insurance laws that ban discretionary clauses. Two circuits ruled that ERISA did not preempt state laws that used a blanket ban on all discretionary clauses. One circuit found that ERISA preempted a state law that required ERISA plans to use certain language explaining the ramifications of discretionary clauses. 1. American Council of Life Insurers v. Ross, 558 F.3d 600 (6th Cir. 2009) The Sixth Circuit, in American Council of Life Insurers v. Ross, 558 F.3d 600 (6th Cir. 2009), was the first circuit to address the preemption issue as it relates to state attempts to ban discretionary clauses. In Ross, several national trade associations representing health plans, health insurers, and life insurers that conduct business in Michigan sought a declaratory judgment that Michigan s ban on discretionary clauses did not apply to the administration and enforcement of ERISA plans. See id. at 603. The ban came in 2007 when the Michigan Office of Financial and Insurance Services put in place a set of administrative rules that prohibited insurers and nonprofit health care corporations from issuing, advertising, or delivering to any person in Michigan a policy, contract, rider, endorsement, certificate, or similar contract document that contained a discretionary clause. See id. The United States District 490 v DRI Annual Meeting v October 2010

15 Court for the Western District of Michigan ruled against the industry groups, finding that ERISA did not preempt the discretionary clause rules because the rules were saved from ERISA preemption as laws that regulate insurance. See American Council of Life Insurers v. Watters, 536 F. Supp. 2d 811 (W.D. Mich. 2008). The Sixth Circuit affirmed and concluded that this ban on discretionary clauses was saved from preemption because the rules were aimed at the insurance industry and substantially affected the riskpooling arrangement between insurers and insureds. See 558 F.3d at In so holding, the court rejected the argument that the Michigan ban was not directed at regulating insurance because the regulation s effects were felt primarily by plan fiduciaries, not insurers. The court focused on ERISA s savings clause and the two-part test enunciated in Kentucky Association of Health Plans v. Miller, 538 U.S. 329 (2003). See 558 F.3d at 606. The Ross court first found no serious dispute that the Michigan ban was directed at regulating insurance (the first Miller factor), rejecting the industry s argument that the regulation s effects were felt primarily by plan fiduciaries, not insurers. See id. at 605. The court also held that the Michigan ban substantially affected the risk-pooling arrangement between insureds and insurers (the second Miller factor) because the ban: (1) directly dictated which policy terms were prohibited and (2) eliminated plan administrators unfettered discretion in making benefits determinations. See id. at 607. On this point, the court rejected the industry argument that the ban was implicated only after the transfer of risk had occurred, noting that prior Supreme Court decisions did not turn on the timing of risk transfer. See id. at 606. The industry also asserted an implied preemption defense, arguing that the Michigan ban conflicted with ERISA s goal of establishing uniform standards for adjudicating benefits claims. See id. at 607. The court found this argument unpersuasive, observing that the Michigan ban did not create any alternative remedies to ERISA and that ERISA does not bar de novo review of benefit claims. See id. at Thus, the Michigan ban was saved from ERISA preemption as a permissible regulation of the insurance industry. 2. McClenahan v. Metropolitan Life Insurance Co., 621 F. Supp. 2d 1135 (D. Colo. 2009) A few months after Ross, the United States District Court for the District of Colorado, in McClenahan v. Metropolitan Life Insurance Co., 621 F. Supp. 2d 1135 (D. Colo. 2009), ruled that a Colorado statute that prohibited discretionary clauses was saved from preemption. Like the Ross court, the McClenahan court relied on Miller and concluded that enforcement of the Colorado statute would dictate to the insurance company the conditions under which it must pay for the risk it has assumed. Id. at Thus, the court rejected MetLife s argument that the statute conflicted with ERISA insofar as it would preclude application of the arbitrary and capricious standard of review in all Colorado ERISA cases. See id. Relying on the Supreme Court s decision in Rush Prudential, the court concluded that ERISA itself provides nothing about the standard of review, and thus the statute did not conflict with ERISA. See id. at Standard Insurance Co. v. Morrison, 584 F.3d 837 (9th Cir. 2009) The Ninth Circuit, in Standard Insurance Co. v. Morrison, 584 F.3d 837 (9th Cir. 2009), followed the same reasoning of Ross and concluded that a Montana state law prohibiting any insurance contract from containing a discretionary clause was saved from preemption. At issue in Morrison was a practice implemented by Montana Insurance Commissioner John Morrison to disapprove of any insurance contract that contained a discretionary clause. See id. at 840. Morrison argued that he had the power to disapprove of these discretionary clauses by virtue of Montana Code Ann , which provides Life, Health, Disability, and ERISA Hot Topics of 2010: Recovering Attorneys... v Trager v 491

16 that the state insurance commissioner shall disapprove any [insurance] form [that] contains or incorporates by reference, any inconsistent, ambiguous, or misleading clauses or exceptions and conditions. Id. Standard challenged Morrison s ability to implement this practice of prohibiting discretionary clauses, arguing that ERISA permits these clauses and that Morrison s actions were preempted by ERISA. See id. at 841. The United States District Court for the District of Montana ruled in favor of Morrison and found that ERISA did not prevent him from implementing the discretionary clause ban because Morrison s practice was aimed at the insurance industry, and as such, the practice was saved from ERISA preemption. See Standard Ins. Co. v. Morrison, 537 F. Supp. 2d 1142 (D. Mont. 2008). The Ninth Circuit affirmed the lower court and rejected Standard s argument that the ban was not specifically directed at insurers because it was nothing more than an attempt to apply the commonlaw rule that ambiguous contract terms are interpreted against their drafters (contra proferentem). See 584 F.3d at 843. Because Montana insureds may no longer agree to a discretionary clause in exchange for a more affordable premium, the court concluded that the scope of permissible bargains between insurers and insureds had been narrowed. See id. at In other words, the ban on discretionary clauses dictates to the insurance company the conditions under which it must pay for the risk it has assumed. Id. at 845. In addition, the court said that Morrison s practice met ERISA s savings clause test because the practice affected the risk-pooling arrangement between insurers and their insureds. See id. at 845. On January 25, 2010, Standard Insurance Company filed a petition for writ of certiorari to the United States Supreme Court challenging the Ninth Circuit s ruling in Morrison. The case was captioned Standard Insurance Co. v. Lindeen, No , because Lindeen succeeded Morrison as Utah s insurance commissioner. Standard s petition presented two questions for review: (1) whether a state rule banning discretionary clauses is preempted by ERISA; and (2) whether the Supreme Court s decision in Rush Prudential authorizes states to eliminate the option of deferential review. However, on May 17, 2010, the Supreme Court denied Standard s petition for writ of certiorari, leaving the Ninth Circuit judgment unchanged. 4. Hancock v. Metropolitan Life Insurance Co., 590 F.3d 1141 (10th Cir. 2009) On different facts, the Tenth Circuit reached a different conclusion in Hancock v. Metropolitan Life Insurance Co., 590 F.3d 1141 (10th Cir. 2009). At issue in Hancock was Utah Administrative Code Rule This rule imposed a ban on discretionary clauses in insurance policy forms, but it authorized such clauses for ERISA-governed plans if they contain certain safe harbor language. The rule required that ERISA plans highlight discretionary clauses by using a particular font. An individual who was insured under an accidental death benefit plan insured by MetLife argued that it could not rely on its plan s discretionary clause because MetLife had not complied with Rule The United States District Court for the District of Utah rejected this argument, finding that ERISA preempted Rule , and thus the rule could not be enforced on MetLife. See Hancock v. Metropolitan Life Ins. Co., 2008 WL (D. Utah, Aug. 1, 2008). The Tenth Circuit agreed with the lower court and concluded that Utah s rule, which authorized discretion-granting clauses as long as they disclose certain matters and conform to the rule s font requirement, was preempted by ERISA. See 590 F.3d at Specifically, because the rule related to the form and not the substance of ERISA plans and thus did not remove the option of insurer discretion from the scope of permissible insurance bargains in ERISA plans, it had no impact on risk-pooling 492 v DRI Annual Meeting v October 2010

17 and was therefore not within ERISA s savings clause. See id. at On that basis, the Tenth Circuit found Utah s rule distinguishable from the state bans on discretionary clauses in Ross and Morrison. See id. However, the Hancock court suggested, in dicta, that while the preempted regulation did not prohibit discretionary clauses altogether, it would likely sustain such a ban of discretionary clauses if it were presented with that issue. G. The Future of Discretionary Clauses The trend in banning discretionary clauses is clearly unfavorable for insurance carriers administering group health, life, and other insured ERISA plans. Thus far, the cases represent the growing trend toward greater state regulation of decision-making by ERISA plan fiduciaries of insured plans. In the wake of the decisions by the Sixth and Ninth Circuits, and the Supreme Court s denial of certiorari in Lindeen, there is a strong likelihood that more states will come on board in enacting laws, rules, or regulations that prohibit or substantially limit discretionary clauses. Plan insurers are likely to continue their opposition to the laws and argue that states run afoul of ERISA when they attempt to regulate the language in ERISA plans. The continued attempts by the states to prohibit discretionary clauses will likely increase the incentive to go to self-funded plans for employers large enough to undertake this risk. Since ERISA exempts self-insured plans from insurance regulation, see 29 U.S.C. 1144(b)(B)(2), a self-funded format will permit larger plan sponsors to continue using fiduciary discretion as a means to control the scope of the benefits to be provided. In contrast, smaller employers may be forced into an unappetizing choice of paying higher premiums or terminating employee-benefit programs they can no longer afford. Life, Health, Disability, and ERISA Hot Topics of 2010: Recovering Attorneys... v Trager v 493