CHAPTER 17 PREEMPTION AND THE POWER TO CONTROL INSURANCE

• Jurisdiction: United States

Since the enactment of the McCarran-Ferguson Act in 1945 the business of insurance is regulated solely by the states. The provisions of the act specify that:

"[T]his business of insurance" shall be recognized as a subject of state regulation, 15 U.S.C. § 1012(a), which will be good against preemption by federal legislation unless that legislation "specifically relates to the business of insurance . . ." ¹

The policy behind § 1012 is that "continued regulation and taxation by the several States of the business of insurance is in the public interest" and "silence on the part of the Congress shall not be construed to impose any barrier to the regulation or taxation of such business by the several States."

In Unum Life Ins. Co. v. Ward, 526 U.S. 358 (1999), McCarran-Ferguson came into play and the enactment of ERISA by the U.S. Congress. The U.S. Supreme Court was asked to resolve a dispute whether the California notice-prejudice rule was subject to preemption or could be applied as part of the state's need to regulate insurance and is exempted from preemption.

UNUM Life Insurance Company of America (UNUM) issued a long-term group disability policy to Management Analysis Company (MAC) as an insured welfare benefit plan governed by the Employee Retirement Income Security Act of 1974 (ERISA). The policy provides that proofs of claim must be furnished to UNUM, at the latest, one year and 180 days after the onset of disability. Under the admitted facts of this case, plaintiff-respondent Ward, a MAC employee, became permanently disabled on May 5, 1992. In late February or early March 1993, he qualified for state disability benefits in California, where he worked, and thereupon informed MAC of his disability. In April 1994, Ward asked MAC whether its long-term disability plan covered his condition. When MAC told him it did, Ward completed a benefits application and sent it to MAC, which processed the application and forwarded it to UNUM. UNUM received proof of Ward's claim on April 11, 1994. Because this notice was late under the policy terms, UNUM advised Ward that his claim was denied as untimely.

Ward sued under ERISA's civil enforcement provision, 29 U. S. C. 1132(a), to recover the disability benefits provided by the plan. He argued that, because a California employer administering an insured group health plan should be deemed to act as the insurance company's agent under Elfstrom v. New York Life Ins. Co., 67 Cal. 2d 503, 512, 432 P.2d 731, 737, his notice of permanent disability to MAC, in February or March 1993, sufficed to supply timely notice to UNUM. The District Court rejected this argument, concluding that California's Elfstrom rule is subject to ERISA's preemption clause, 1144(a), which states that ERISA provisions "shall supersede . . . State laws" to the extent that those laws "relate to any employee benefit plan."

California's notice-prejudice rule is a "law . . . which regulates insurance," and is therefore saved from preemption by ERISA. Because the parties agree that the notice-prejudice rule falls under ERISA's preemption clause as a state law that "relate[s] to" employee benefit plans, their dispute hinges on whether the rule "regulates insurance" and thus escapes preemption under the saving clause.

The Ninth Circuit correctly concluded that the notice-prejudice rule "regulates insurance" as a matter of common sense. Because it controls the terms of the insurance relationship by requiring the insurer to prove prejudice before enforcing proof-of-claim requirements, the California rule, by its very terms, is directed specifically at the insurance industry and is applicable only to insurance contracts. The rule thus appears to satisfy the common-sense view as a regulation that homes in on the insurance industry and does not just have an impact on that industry. The Court reject[ed] UNUM's argument that the rule cannot be held to "regulate insurance" because it is merely an industry-specific application of the general principle that disproportionate forfeiture should be avoided in the enforcement of contracts.

Insurance policies like UNUM's frame timely notice provisions as conditions precedent to be satisfied by the insured before an insurer's contractual obligation arises.

It is no doubt true that diverse California decisions bear out the maxim that "law abhors a forfeiture" and that the notice-prejudice rule is an application of that maxim. But it is an application of a special order, a rule mandatory for insurance contracts, not a principle a court may pliably employ when the circumstances so warrant. California's insistence that insurers show prejudice before they may deny coverage because of late notice is grounded in policy concerns specific to the insurance industry.

As the Ninth Circuit correctly recognized, the McCarran-Ferguson factors are checking points or "guideposts, not separate essential elements . . . that must each be satisfied" to save the State's law.

[The] McCarran-Ferguson factors, verifying the common-sense view, are securely satisfied [by the facts of the case.]

Meeting the second factor, the notice-prejudice rule serves as "an integral part of the policy relationship between the insurer and the insured." [I]t "effectively creates a mandatory contract term" that requires the insurer to prove prejudice before enforcing a timeliness-of-claim provision. As the Ninth Circuit stated: "The [notice-prejudice] rule dictates the terms of the relationship between the insurer and the insured, and consequently, is integral to that relationship."

The third McCarran-Ferguson factor—which asks whether the rule is limited to entities within the insurance industry—is also well met. The rule "does not merely have an impact on the insurance industry; it is aimed at it." FMC Corp. v. Holliday, 498 U.S. 52, 61 (1990).

Ward successfully maintained in the Ninth Circuit that MAC had timely notice of his disability and that his notice to MAC could be found to have served as notice to UNUM on the theory that MAC, as administrator of the group policy, acted as UNUM's agent. The policy itself provides otherwise:

For all purposes of this policy, the policyholder [MAC] acts on its own behalf or as agent of the employee. Under no circumstances will the policyholder be deemed the agent of the Company [UNUM] without a written authorization.

California law rendered that policy provision ineffective, the Ninth Circuit appeared to conclude, because under the rule stated in Elfstrom v. New York Life Ins. Co., 67 Cal. 2d, 512, 432 P.2d, at 737, "the employer is the agent of the insurer in performing the duties of administering group insurance policies." Thus, the Ninth Circuit instructed that, on remand, if UNUM was found to have suffered actual prejudice on account of Ward's late notice of claim, the District Court should then determine whether the claim was timely under Elfstrom.

Ward does not argue in this Court that the Elfstrom rule, as comprehended by the Ninth Circuit, is a law that "regulates insurance." Whatever the contours of Elfstrom may be, the Ninth Circuit held that the state law emerging from that case does not

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