In the May 25, 2017 edition of the Los Angeles Daily Journal, Robert McKennon and Joseph McMillen of the McKennon Law Group PC published an article entitled “Decision Marks the End of an Era for Employee Benefit Plans,” about a new Ninth Circuit case. In the article, Mr. McKennon and Mr. McMillen explain that the case makes void and unenforceable “discretionary clauses” in insurer-funded employee benefit plans providing disability and life coverage to California residents. The decision will lead to a de novo standard of review in most ERISA actions, which is quite favorable for claimants. Orzechowski v. Boeing Co. Non-Union Long-Term Disability Plan, 2017 DJDAR 4376 (May 17, 2017).
The article is posted below with the permission of the Los Angeles Daily Journal.
By Robert J. McKennon and Joseph S. McMillen
Long-term disability insurers and life insurers frequently include clauses in their insurance policies affording them complete 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, and to interpret the policy’s terms how they see fit. Employers and their claims fiduciaries (i.e., the insurers) regularly include these same types of “discretionary clauses” in their employee welfare benefit plan documents, and if the insurer is the funding source of the plan’s benefits, the inherent conflict of interest becomes readily obvious.
Employee benefit plans and the corresponding group insurance policies that fund them are governed by 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 is 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.
On Jan. 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. Several of these states banned or limited discretionary clauses in response to notorious examples of insurers who, to boost their profits, intentionally used discretionary clauses to repeatedly deny claims they knew were valid. See, e.g., 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 statutory bans on insurer discretionary clauses and that the statutory ban applies just to insurance policies but not plan documents. Their arguments have been repeatedly rejected by most California federal district courts.
On May 11, the 9th U.S. Circuit Court of Appeals, in Orzechowski v. Boeing Co. Non-Union Long-Term Disability Plan, 2017 DJDAR 4376, put the final nail in the coffin for grants of discretionary authority to insurers in ERISA-governed insurance policies and employer plan documents. In that case, The Boeing Company offered its employees long-term disability coverage through an ERISA-governed plan. Boeing arranged a group disability insurance coverage through Aetna Life Insurance Company to fund the plan’s disability benefits and vested Aetna with discretion to decide the merits of benefit claims. The plan documents 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 plan 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, 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.”
A Boeing employee, Talana Orzechowski, submitted a claim for long-term 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 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 Orzechowski’s treating physicians. They concluded that she had a physical disability and that her mental illness, depression and anxiety, were secondary to her physical problems, chronic fatigue syndrome and fibromyalgia.
Orzechowski filed suit in federal district court under ERISA to recover her disability benefits. 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 reversed, holding that 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 remanded the case to the district court for it to review the insurer’s claim denial de novo, with instructions to focus on Orzechowski’s physical illnesses that Aetna had ignored when terminating her benefits.
The 9th Circuit first rejected Boeing’s argument that ERISA preempts the California statute. The court reasoned that while the California statute came 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. Section 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. Section 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. The Orzechowski court held the California statute meets both prongs of the Miller test, “regulates insurance,” and, therefore, is saved from ERISA preemption.
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 Jan. 1, 2012 after the Jan. 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 fell 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 Jan. 1, 2012. The statute defines “renewed” as “continued in force on or after the policy’s anniversary date.” The policy’s anniversary date was Jan. 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. Thus, even after Orzechowski, employers and their self-funded plans will continue to argue California’s ban does not apply to them. 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 apply a de novo standard of review more favorable to claimants in insurer-funded ERISA plans. This will lead to better results for claimants in litigated cases and, potentially, less claim denials from group disability and life insurers in the first instance.