Exorcising discretion: the death of caprice in ERISA claims handling.

• Author: Morrison, John

1. INTRODUCTION

   The Employee Retirement Income Security Act of 1974 (ERISA) (1) was enacted to rectify mismanagement of union-sponsored pension plans. (2) To that end, the Act sought to "protect ... participants in employee benefit plans and their beneficiaries ..." by imposing fiduciary duties on persons responsible for management of benefit plans. (3) More than 130 million Americans receive health coverage and other employee benefits under plans governed by ERISA. About 64 million of them are covered under insurance policies purchased by their employers. (4)

   ERISA permits a person who is denied benefits under a plan to contest the denial in federal court, subject to various limitations. (5) Nearly all ERISA plans contain "discretionary clauses," which bestow discretion on the "plan administrator" to interpret language in the policy and otherwise determine eligibility for benefits. These clauses proliferated in the early 1990s when they were construed by the federal courts to confer such authority upon insurers and employers that benefit denials can only be reversed when they are found to be "arbitrary and capricious." After more than a decade of litigation among private parties in every federal circuit, state insurance regulators stepped in, banning the clauses and restoring the rights of tens of millions of Americans to go to court to enforce their insurance contracts. (6) Challenged by the insurance industry, states have prevailed in two key legal battles. In Standard Insurance Co. v. Morrison and American Council of Life Insurers v. Ross, the federal courts ruled that ERISA does not preempt the power of state insurance regulators to prohibit discretionary clauses from insured group health and disability insurance policies. (7)

   The cumulative effect of state regulatory action in this area, now judicially affirmed, can hardly be overestimated. Standard Insurance declared in its unsuccessful petition for Writ of Certiorari to the United States Supreme Court, "[t]his issue ... affects a massive number of cases, as there are nearly two million ERISA benefits denials annually that are potentially subject to challenge in federal court...." (8) In a broader sense, the elimination of discretionary clauses in ERISA plans makes health and disability coverage more meaningful by restoring a level of fairness to claims handling. Under the "arbitrary and capricious" standard of review, a federal court could not overturn a denial of benefits even if the court would have reached a different conclusion based on the evidence. Without that standard of review, insureds are entitled to their health or disability benefits when the evidence shows they are so entitled. This article reviews the history and effect of the discretionary clause, traces the movement among state insurance commissioners that led to its successful ban, and examines the judicial decisions that affirmed this historic exercise of state administrative power.

2. EVOLUTION AND PERVASIVENESS

   A discretionary clause is a plan provision that grants authority to the plan administrator "to interpret the plan and to resolve all questions arising under it." (9) Such a clause might read: "Insurer has full discretion and authority to determine the benefits and amounts payable [as well as] to construe and interpret all terms and provisions of the plan." (10) Nearly all ERISA plan sponsors have written discretionary language into their plans to ensure that if a plan participant or beneficiary files an ERISA lawsuit, the court will be required to give deference to the administrator's decision. (11) This deferential standard is "a feature of judicial review highly prized by benefit plans[.]" (12)

   ERISA does not mention discretionary clauses or the standard of review expected of courts examining denials of claims, or in ERISA parlance, plan benefits. (13) The notion that language in a plan or policy giving discretion to the plan administrator, often an insurer, leads to a deferential standard of review stems from the Supreme Court's 1989 opinion in Firestone v. Bruch. (14)

   Firestone's landscape-changing opinion held that the default and "regular" standard of adjudicating ERISA claims is the de novo standard, which is consistent with the judicial interpretation of employee benefit plans prior to the enactment of ERISA. (15) However, the Court further held that, if the benefit plan expressly gives the plan administrator or fiduciary discretionary authority to determine eligibility for benefits or to construe the plan's terms, a deferential standard of review is appropriate. (16) The Court based its application of deferential review on the principles of trust law, which, it said, are summoned by ERISA's legislative history and the Court's prior decisions interpreting the statute. (17)

3. EFFECT OF THE CLAUSE

   The ERISA claimant finds his litigation rights restricted in a host of ways. In claims arising under ERISA from benefit denials, there is no right to a jury trial. (18) Available remedies are limited to those set forth in ERISA. (19) They do not include consequential, non-economic, or punitive damages. (20) When a discretionary clause is present, discovery and the right to introduce evidence are limited and the federal court review is confined to consideration of the claim file, which serves as the administrative record. (21)

   One ERISA scholar has called the discretionary clause an "enormous advantage" for the insurer and "a substantial, often insurmountable hurdle" for the claimant. (22) This is particularly true for the unwary claimant who does not have the benefit of counsel during the internal appeal process. He may be left with an incomplete administrative record to which the reviewing courts are confined. The advantage and the hurdle are magnified when the plan administrator is the insurance company that is at risk for the claim and is operating under a manifest conflict of interest. (23)

   The hallmark of the discretionary clause is the arbitrary and capricious standard of review that it triggers. A glaring example of the resulting inequity appears in the First Circuit's opinion in Brigham v. Sun Life of Canada. (24) Upholding the denial of disability benefits to a paraplegic, the court seemed to lament the result and called it "counterintuitive." (25) "The question we face in this appeal," the court said, is "'not which side we believe is right, but whether [the insurer] had substantial evidentiary grounds for a reasonable decision in its favor.'" (26) The court continued:

   Beyond this, it seems counterintuitive that a paraplegic suffering serious muscle strain and pain, severely limited in his bodily functions, would not be deemed totally disabled. Moreover, it seems clear that Sun Life has taken a minimalist view of the record. But it is equally true that the hurdle plaintiff had to surmount, establishing his inability to perform any occupation for which he could be trained, was a high one. As to that issue, we have to agree with the district court that the undisputed facts of record do not permit us to find that Sun Life acted in an arbitrary or capricious manner in terminating appellant Brigham's benefits. (27) Prior to Firestone, Richard Posner, renowned judge of the Seventh Circuit and legal philosopher, decried the deferential standard of review in Van Boxel v. The Journal Co. Employees' Pension Trust. (28) He wrote that employee benefits "are too important these days for most employees to want to place them at the mercy of a biased tribunal subject only to a narrow form of 'arbitrary and capricious' review, relying on the company's interest in its reputation to prevent it from acting on its bias." (29)

   Another noted ERISA expert, Mark D. Debofsky, explained in comments before the National Association of Insurance Commissioners that:

   ... the effect of discretionary clauses has been to transform the judicial paradigm of decisionmaking. It is not enough for a claimant to show an insurer's decision was wrong or contrary to the terms of the insurance contract. Instead, the claimant must prove the decision is unreasonable, and not merely incorrect. (30) Finally, Yale law professor John Langbein described discretionary clauses as "self-serving terms that severely restrict the ability of a reviewing court to correct a wrongful benefit denial." (31) Professor Langbein attributed the spate of bad faith claim denials that led to a multi-state investigation of Unum to the clauses and "an ill-considered passage in" Firestone Tire. (32)

4. THE MOVEMENT TO BAN THE CLAUSES

   1. THE NAIC

      Unlike the other financial service industries, insurance is regulated by the states, a principal that was enshrined by the Supreme Court in 1868 (33) and, after a change of course by the Court, reaffirmed by Congress in the McCarran-Ferguson Act. (34)

      The National Association of Insurance Commissioners (NAIC) is the organization of elected and appointed state government officials who, along with their departments and staff, regulate insurance in the states. (35) It is the avowed mission of the NAIC to "protect the public interest" and to "facilitate the fair and equitable treatment of insurance consumers." (36) The NAIC adopts model laws and generally serves as a national regulatory body for the insurance industry. (37)

   2. THE MODELS

      In March of 2001, the NAIC ERISA Working Group discussed the creation of a model law to assure that all insurer and HMO claims would be subject to de novo review and directed the NAIC legal staff to research the authority of the states to prohibit discretionary clauses in light of ERISA. In June 2001, the working group voted to develop a model law proposal. (38) After hearings and comments, the Health Insurance and Managed Care (B) Committee of the NAIC voted to adopt the "Prohibition on Use of Discretionary Clauses Model Act." (39) At the June 2002 NAIC meeting, despite "a flurry of notes to commissioners" and an industry attempt to derail the model act...