Illinois Court Validates Illinois’ Ban On Discretionary

Clauses in Insured ERISA Benefit Plans

On Feb. 23, 2011 Magistrate Judge Arlander Keys of the U.S. District Court for the Northern District of Illinois issued an opinion that validated Illinois’ statutory ban on discretionary clauses in all accident, health and disability insurance policies. This article examines the decision and discusses the impact that these sorts of bans may have on plan sponsors and on the recipients of benefits under similar policies.

The United States Supreme Court held over twenty years ago, in Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101, 115 (1989), that reviewing courts are required to apply a de novo standard of review when considering a plan administrator’s decision to deny benefits, meaning the plan administrator’s decision is entitled no deference whatsoever, unless the benefit plan grants the administrator discretionary authority to determine eligibility or to construe the plan’s terms. If the plan provides for such discretionary authority, said the Supreme Court, then the reviewing court is required to consider the administrator’s decision for abuse of discretion, meaning the plan administrator’s decision is entitled to a great deal of deference. As one might imagine, discretionary clauses tend to make it difficult for litigants to overturn a plan administrator’s decision to deny a benefits claim, which explains why, since Firestone, discretionary clauses have become the norm in Employee Retirement Income Security Act (ERISA) plans.

In response to this development, the National Association of Insurance Commissioners adopted a Model Act that bans discretionary clauses in ERISA plans. In doing so, the Association urged each member state to adopt legislation tracking the Model Act, thus prohibiting clauses that reserved “discretion to the health carrier to interpret the terms of the contract, or to provide standards of interpretation or review that are inconsistent with the laws of the state.” NAIC, Model Act 42. In 2004 the Association issued a revised Model Act that extended the suggested ban on discretionary clauses to disability plans. Several states, including California, Hawaii, Maine, Michigan, Minnesota, Montana, New Jersey, New York, Oregon, and Utah, have implemented some version of the Model Act. Illinois joined the list in 2005.

The Illinois ban on discretionary clauses provides that “[n]o policy, contract, certificate, endorsement, rider application or agreement offered or issued in this State, by a health carrier, to provide, deliver, arrange for, pay for or reimburse any of the costs of health care services or of a disability may contain a provision purporting to reserve discretion to the health carrier to interpret the terms of the contract, or to provide standards of interpretation or review that are inconsistent with the laws of the State.” Ill. Admin. Code tit. 50, § 2001.3 (2005). A short time after this provision went into effect, health insurance issuers sought to overturn the ban on discretionary clauses in court, arguing that federal law, namely, ERISA, required reviewing courts to disregard the state ban and apply the arbitrary and capricious standard instead.

Judge Keys’ opinion in Ball v. Standard Insurance Co. is the most recent decision on this issue. There the plaintiff sought review of a plan administrator’s decision denying her claim for long-term disability benefits. She argued that the state ban governed her employer’s disability policy, and because the regulation prohibited discretionary clauses, the court was required to review the plan administrator’s decision de novo, and not under the arbitrary and capricious standard specified in the governing plan. The primary issue thus became whether ERISA effectively banned the ban on discretionary clauses. If it did, then the arbitrary and capricious standard still would apply.

To answer this question, the court turned to ERISA’s savings clause, which saves from federal preemption state laws that regulate insurance, banking, or securities. 29 U.S.C. § 1144(b)(2)(A). Under this provision, if a state seeks to promulgate a statute that controls what insurers can and cannot include in their insurance policies, ERISA’s savings clause kicks in and saves that statute from preemption. But unfortunately for insured plans, the savings clause is not as broad as it might be. The United States Supreme Court in Kentucky Association of Health Plans, Inc. v. Miller, 538 U.S. 329, 341-42 (2003), clarified the test used to determine whether a state law regulates insurance. First, the law must be directed toward entities engaged in insurance, and second, the law must substantially affect the risk-pooling arrangement between the insurer and the insured.

Applying this test, the court in Ball decided that the Illinois regulation was saved from preemption because it required any entity wishing to provide insurance in Illinois to refrain from including discretionary clauses in their policies. Through this directive, Illinois not only regulates insurance, but § 2001.3 also substantially affects the risk-pooling arrangement between insurers and insureds because the directive regulates the practice of issuing insurance itself; it does not just regulate insurance companies. Accordingly, the plaintiff was entitled to the more favorable (for her) de novo standard of review.

Although the Seventh Circuit Court of Appeals, which hears cases from Illinois federal courts, has yet to rule on whether ERISA preempts the Illinois regulation, Judge Keys’ decision is consistent with the rulings of other district courts in Illinois, as well as various circuit and district courts throughout the country. In 2009 the Sixth Circuit and the Ninth Circuit Courts of Appeals each held that ERISA did not preempt regulations that were similar to the one in Illinois. Standard Insurance Co. v. Morrison, 584 F.3d 837, 842 (9th Cir. 2009); American Council of Life Insurers v. Ross, 558 F.3d 600, 606 (6th Cir. 2009). That same year a Colorado district court followed suit. McClenahan v. Metropolitan Life Insurance Co., 621 F. Supp. 2d 1135, 1140 (D. Colo. 2009). Until the Supreme Court decides this issue, bans on discretionary clauses are likely to be the source of an ongoing debate.

Meanwhile, the willingness of courts to enforce state bans may have an impact on plan issuers that goes beyond imposing an unfavorable standard of review on benefits determinations. For example, it may provide a greater incentive for employers to offer self-funded benefit plans. A self-funded plan is exempt from insurance regulation, ERISA § 514(b)(2)(B), and thus permits plan sponsors to continue to include discretionary clauses in their policies. The problem with a self-funded format, however, is the significant potential financial risk of self-insuring claims, and thus it should be reserved for employers that are large enough to absorb the risk. For smaller companies, they should prepare for higher premiums and might consider passing a portion of that cost on to their employees.

Finally, for Illinois companies planning to keep their insured benefits plans unchanged, they should note that for any insurance policy issued since July 1, 2005, the discretionary clauses in those policies are nullified. Although the Illinois regulation is not retroactive, policies offering accident, health, and disability benefits are often revised and renewed frequently. That means, according to a recent bulletin from the Illinois Department of Insurance, that it is unlikely that there are any insurance policies in existence that have not been either renewed or issued subsequent to the effective date of the regulation. The Illinois Department of Insurance warns that insurers that do not comply with Illinois’ absolute prohibition on discretionary clauses will be held accountable and subject to regulatory action.

If you would like further guidance on this issue, please contact Brian J. Paul, Isaac Colunga or Craig Burke.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice.  The reader must consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.

March 17, 2011