Discretionary Language, Conflicts of Interest, and Standard of Review for Erisa Disability Plans

• Publication year: 2005

SEATTLE UNIVERSITY LAW REVIEWVolume 28, No. 3SPRING 2005

Discretionary Language, Conflicts of Interest, and Standard of Review for ERISA Disability Plans

Peter A. Meyers(fn*)

[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.(fn1) -Richard Posner, U.S. District Court Judge

I. Introduction

In November 2004, the UnumProvident Corporation ("Unum"), the largest disability insurer in the United States,(fn2) signed a landmark agreement with the insurance directors of Massachusetts, Maine, and Tennessee, and the United States Department of Labor.(fn3) The Attorney General of the State of New York, Elliot Spitzer, endorsed the agreement.(fn4) The agreement, made after Unum had lost several high-profile cases,(fn5) calls for sweeping changes in the way Unum and the companies it owns(fn6) handle disability insurance claims. In part, the agreement consisted of a $140 million settlement and a $15 million penalty against Unum.(fn7) Most importantly, Unum agreed to reexamine more than 200,000 claims(fn8) it denied since January 1, 1997, to institute new claims handling procedures and benefit determination practices, to improve accountability and oversight, and to enhance its own corporate governance.(fn9) Forty other states have signed on to the agreement.(fn10) If Unum fails to improve its practices in accord with the agreements, an additional $145 million fine will be imposed.(fn11)

Many of the disability policies that Unum sells find their way into employer-sponsored benefit packages covered by the Employee Retirement Income Security Act of 1974 (ERISA).(fn12) Under ERISA, Unum is a fiduciary with a conflict of interest because it both determines the fact of a claimant's disability and pays out of its own purse to resolve claims.(fn13) Additionally, Unum probably has language in each of its disability policies that gives it discretion to construe the terms of its policies and decide which claimants get paid. Because Unum is a fiduciary exercising discretion, under current ERISA jurisprudence, its reasons for denying a disability claim are reviewed at the district court level only for an abuse of that discretion.(fn14)

The Unum settlement exposed Unum's claim denial practices that, because of generally limited discovery, ordinarily would not come to light in a disability claim in federal court under ERISA.(fn15) The settlement showed the lengths to which a conflicted fiduciary would go in order to benefit its own bottom line over the needs of disabled employee-beneficiaries. If the Unum settlement had been an ERISA case that had been reviewed de novo, additional discovery could take place that would take a plaintiff beyond the record to search for evidence of such denial practices.(fn16)

In most circuits, however, evidence of abusive practices will not come to light; so long as the plan document explicitly gives the fiduciary discretion to make benefit determinations, courts ordinarily must defer to the fiduciary's decisions.(fn17) Because discretionary clauses can hide the kind of abuse seen in the Unum settlement, in order to remedy the plight of employees who have obtained bargained-for benefits under ERISA, all ERISA fiduciaries that are also insurance companies should be deemed to have an inherent conflict of interest. Federal courts reviewing these conflicted decisions should then apply a "presumptively void" rule to the conflicted decision, necessitating de novo review.(fn18) Broad discovery then should be granted under de novo review in order to search for a fiduciary's actual conflict of interest. This approach would help employee-beneficiaries recover benefits due them under the plan free of the conflict of interest.

Part II of this article will introduce the reader to disability insurance. Part III will examine how ERISA is a mixture of different law and how that mixture led to discretionary clauses being inserted and the re- suiting severe conflicts of interest. Part IV will look at Firestone Tire and Rubber Co. v. Bruch, the seminal ERISA case on conflicts of interest. Part V will examine the contributions that the Ninth Circuit has made to ERISA conflict of interest law. Part VI will treat scope of review and discovery and Part VII will conclude that insurers should be strictly regulated in ERISA plans.

II. ERISA Disability Basics

Disability insurance is designed to be replacement income for an employee when illness or injury makes it difficult or impossible to work, and is one type of insurance that is frequently part of an employee's compensation package. The administration of such a plan is regulated by ERISA if the plan "was established or maintained for the purpose of providing for its participants or their beneficiaries, through the purchase of insurance or otherwise ... disability ... benefits ...."(fn19) If the employee then gets disabled such that he or she cannot work, the payments from the insurance company can often constitute a major portion of the employee's income. Disability insurance is an eminently compassionate way for an employer to treat its employees. If an employee is totally disabled and cannot work at any occupation, he is useless to an employer.

When determining the fact of an employee's disability, the plan administrator(fn20) examines the so-called administrative record that the administrator itself has compiled. The employee submits an initial disability claim to the administrator, who has the discretion to request doctors' reports, opinions, and other medical evidence to show whether the employee can perform certain tasks essential to his job. Often, the employee will do job-performance studies and work studies with a specialist, reports of which, when combined with reports from the employee's treating physician, form the basis of the administrative record. In addition to the employee's treating physician, the administrator also has the option of independently examining the claimant with its own medical personnel. If the plan document has granted discretion to the administrator, the administrator holds ultimate power to make decisions, based on the record, on whether the employee is disabled. The employee can ask for further review if at first denied, but once the internal review process is exhausted,(fn21) the employee must make out a complaint against the insurer or the plan itself in federal court under ERISA.

Although ERISA sets out causes of action and remedies for participants and beneficiaries of benefit plans,(fn22) the statute is silent on the judicial standard of review to be applied to fiduciaries' decisions;(fn23) this has lead to wide discrepancies in courts' treatment of challenged disability plans. Before the landmark Firestone Tire and Rubber Co. v. Bruch decision, courts typically borrowed the "arbitrary and capricious" standard from labor law(fn24) or used contract law's de novo review.(fn25) Trust law was also a natural choice because of the fiduciary duties involved. Since the funding vehicles in ERISA disability plans are often insurance contracts, state insurance law was relevant as well. In other words, no single body of law could be called upon to adjudicate ERISA cases.(fn26)

In 1989, the United States Supreme Court decided Firestone Tire and Rubber Co. v. Bruch, which set a de novo standard of review for ERISA fiduciaries' decisions to deny benefits.(fn27) Unless the terms of the plan document give the fiduciary discretion to make eligibility decisions or to construe the terms of the plan, the standard of review is de novo.(fn28) If an employee can obtain de novo review, discovery can take place outside the administrative record and that evidence can be admitted. If a fiduciary has drafted discretionary authority into the plan document, however, a court will review the fiduciary's decision only for an abuse of that discretion and will not inquire beyond the record.(fn29)

As important as discretionary authority is to an abuse of discretion analysis, any fiduciary that operates under a conflict of interest(fn30) will find that conflict also weighed by the reviewing court.(fn31) The federal circuits have weighed conflicts into their standard of review analyses in at least seven different ways.(fn32) The problem, however, is that conflicts are not properly weighed because, in an abuse of discretion analysis that looks at the record alone, conflicts that are not evident in the record cannot be properly examined.(fn33) Agreements such as the Unum settlement should make the rest of the circuits more willing to adopt the Ninth Circuit's "presumptively void" standard in order to apply de novo review when the insurer of an ERISA disability plan is also its fiduciary.

During the multi-state market conduct investigation that led to the Unum settlement, it became clear that what Unum had been doing only scratches the surface of what is wrong with the state of disability insurance, and highlights why courts should apply a de novo review standard more often. Unum relied excessively on the opinions of in-house medical professionals rather than using an independent medical examiner ("IME");(fn34) when it did use the report of an IME or an employee's attending physician, its own medical...