Earlier this year, I wrote about a significant ruling issued by the 6th U.S. Circuit Court of Appeals, American Council of Life Insurers v. Ross, 558 F.3d 600 (March 18) ("Discretionary clauses under heavy fire, Chicago Daily Law Bulletin April 6). Ross upheld the authority of states to ban clauses in insurance policies that give insurers discretion to decide health and disability claims and thus trigger a deferential standard of court review over such claims. That article noted that a similar issue was pending in the 9th Circuit, and on Oct. 27 that court issued its ruling in Standard Ins.Co. v. Morrison, 2009 U.S.App.LEXIS 23598, which concurred in all respects with Ross. Morrison involved Montana's insurance commissioner issuing an order disapproving policies containing discretionary clauses pursuant to a state statute requiring the commissioner's disapproval of insurance contracts containing "any inconsistent, ambiguous, or misleading clauses or exceptions and conditions which deceptively affect the risk purported to be assumed in the general coverage of the contract …" Mont. Code Ann. § 33-1-502. One of the insurers affected, Standard Insurance Company, challenged the rule; however, the 9th Circuit rejected Standard's challenge.

The issue behind the dispute was succinctly explained by the court: "If an insurance contract has a discretionary clause, the decisions of the insurance company are reviewed under an abuse of discretion standard. Absent a discretionary clause, review is de novo" (citing Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101, 111, 109 S. Ct. 948, 103 L. Ed. 2d 80 (1989)). The court acknowledged that discretionary clauses are controversial and that the National Association of Insurance Commissioners has opposed their use because such clauses, according to the NAIC, "may result in insurers engaging in inappropriate claim practices and relying on the discretionary clause as a shield." The insurers' argument in favor of such clauses was that "they keep insurance costs manageable." But for such clauses, the insurers argued that more litigation will be filed and de novo consideration of such cases would result in increased costs.

The court's decision focused on 29 U.S.C. section 1144, which preempts "any and all State laws insofar as they may now or hereafter relate to any [covered] employee benefit plan." The scope of preemption is limited, though, by the "savings" clause, which saves from preemption "any law of any State which regulates insurance, banking, or securities" (§ 1144(b)(2)(A)). The question presented was whether the Montana insurance commissioner's actions fell under the savings clause since there was no question that the ban on discretionary clauses related to employee benefit plans. The court answered that question in the affirmative. The court relied primarily on two key Supreme Court decisions, Rush Prudential HMO Inc. v. Moran, 536 U.S. 355, 364, 122 S. Ct. 2151, 153 L. Ed. 2d 375 (2002), and Kentucky Ass'n of Health Plans Inc. v. Miller, 538 U.S. 329, 342, 123 S. Ct. 1471, 155 L. Ed. 2d 468 (2003). Moran "saved" from preemption a provision of Illinois law relating to health maintenance organizations that allows claimants to obtain an independent medical review of a denied claim for medical benefits. Miller rejected an ERISA preemption challenge to a state law requiring managed care insurers to allow any willing provider to treat any patient at the same rate as a provider within the managed care network. Miller also clarified when the savings clause is applicable: "First, the state law must be specifically directed toward entities engaged in insurance." Also, it "must substantially affect the risk pooling arrangement between the insurer and the insured."

The court found the first part of the Miller test satisfied because the prohibition of discretionary clauses was specifically directed at insurance companies. The Supreme Court has made it clear that the states are free to regulate the terms insurance companies can place in their policies; hence, the court agreed with Ross in concluding that "[g]iven that the rules impose conditions only on an insurer's right to engage in the business of insurance in [the state] … the rules are directed toward entities engaged in the business of insurance."

The court found the second Miller prong satisfied as well since the disapproval of policy forms containing discretionary clauses would substantially affect risk pooling. The court noted that risk pooling involves spreading losses "over all the risks so as to enable the insurer to accept each risk." Union Labor Life Ins. Co. v. Pireno, 458 U.S. 119, 127-28, 102 S. Ct. 3002, 73 L. Ed. 2d 647 & n.7 (1982). The ban on discretionary clauses falls within that definition because it narrows the scope of permissible bargains between insurers and insureds. The court also pointed out that risk pooling is affected because it "dictates to the insurance company the conditions under which it must pay for the risk it has assumed" (citing Std. Ins. Co. v. Morrison, 537 F. Supp. 2d 1142, 1151 (D. Mont. 2008)).

The court added: "One could go even further: consumers can be reasonably sure of claim acceptance only when an improperly balking insurer can be called to answer for its decision in court. By removing the benefit of a deferential standard of review from insurers, it is likely that the Commissioner's practice will lead to a greater number of claims being paid. More losses will thus be covered, increasing the benefit of risk pooling for consumers."

The court further rejected Standard's challenge asserting that Montana's ban on discretionary clauses conflicts with ERISA's remedial scheme, finding the discretionary clause ban provided no additional remedies that duplicate, supplement or supplant any existing ERISA remedies. Finally, the court addressed Standard's assertion that forbidding discretionary clauses is inconsistent with ERISA. The court found that argument was rejected in Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101 (1989), where the court held the default standard of reviewing ERISA claims is the de novo standard, and that the abuse of discretion standard is only triggered by the inclusion of language giving discretion to the plan administrator.

The court concluded by discussing the overall rationale behind ERISA, and pointing out that Congress intended the U.S. district court to be the "ultimate decisionmaking entity." The court added, "The familiar processes of the federal courts — the Federal Rules of Civil Procedure and the like — still control the proceeding." Finding that the Supreme Court explicitly accepted a "neutral standard of review" of ERISA claims in Firestone, the court found no basis for Standard's assertion that ERISA's purposes would be undermined.

Summing up, the court wrote: "The Commissioner's practice is directed at the elimination of insurer advantage, a goal which the Supreme Court has identified as central to any reasonable understanding of the savings clause. It creates no new substantive right, offers no additional remedy not contemplated by ERISA's remedial scheme, and institutes no decisionmakers or procedures foreign to ERISA."

Hence, the court upheld Montana's ban on discretionary clauses.

Because two circuits have now concurred that states have the authority to outlaw discretionary clauses in insurance policies, and any further challenge will likely be ineffective, the strategy may turn toward trying to incorporate discretionary clauses in other "plan documents." That line of attack may already have been foreclosed, though, in yet another Supreme Court ruling on the savings clause, Unum Life Ins.Co. v. Ward, 526 U.S. 358 (1999).

There, the Court explained: "Under UNUM's interpretation of [ERISA statutory provisions requiring that fiduciaries act in accordance with employee plan documents], however, States would be powerless to alter the terms of the insurance relationship in ERISA plans; insurers could displace any state regulation simply by inserting a contrary term in plan documents. This interpretation would virtually 'read the saving clause out of ERISA.' Metropolitan Life [Ins. Co. v. Massachusetts, 471 U.S. 724 (1985)], 471 U.S. at 741."

Metropolitan Life was a seminal case involving the savings clause, which held that states could mandate coverage for treatment of mental illness in group insurance policies. That ruling set the stage for the Supreme Court to also remark in Ward that even though the states' varying insurance regulations would create disuniformities in plans that operate across multiple states, "such disuniformities … are the inevitable result of the congressional decision to 'save' local insurance regulation." Thus, since the court has already signaled that it will not undermine state regulation of insurance by permitting the inclusion in other plan documents that which is prohibited from inclusion in the insurance contract, it is unlikely that insurers will be successful in evading state regulation prohibiting discretionary clauses by incorporating such terms in other plan documents. However, until Congress finally acts to specify a standard of review for unfunded ERISA benefits; i.e., those benefits that are funded by insurance or by means other than a trust, this battle will undoubtedly continue given the tenacity shown by the insurance industry in its efforts to maintain a deferential standard of review over benefit determinations.

Note: I was a participant in the Morrison case.