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The Standard Insurance Company loses their battle to enforce discretionary clauses in long-term disability policies

Once again the Ninth Circuit U.S. Court of Appeals has upheld a state’s rights to protect employees that have long-term disability insurance policies issued by their employers. In an opinion filed on October 27, 2009, three circuit judges on the ninth circuit reached a unanimous decision that a state’s practice of disapproving insurance policies that contain clauses that vest insurers with discretion in how they process long-term disability claims and who they issue these claims to is legal and does not conflict with Federal law. The court agreed that a discretionary clause in a long-term disability plans is not valid. This is a major victory for disability claimants; however this ruling is only binding in the following states: Washington, Oregon, Montana, California, Arizona, Idaho and Nevada.

The use of discretionary clauses in long-term insurance policies has been a long-standing issue between the National Association of Insurance Commissioners (“NAIC”) and insurance companies. The NAIC claims that the practice leads to insurance companies engaging in inappropriate practices and using these clauses as a shield when questioned about a decision to deny a long-term disability claim. Insurance companies argue that discretionary clauses save both insurance companies and the taxpayer money by reducing the number of cases that are filed, as well as reducing the cost of reviewing cases that go to court.

This specific case revolved around the right of Montana’s state auditor, John Morrison who acts as commissioner of insurance within that capacity, to refuse to approve disability insurance forms submitted to him by Standard Insurance Company (“Standard”). The forms submitted to Morrison included discretionary clauses.

Standard took Morrison to court, arguing that his right to disapprove the forms was preempted by the Employee Retirement Income Security Act of 1974 (“ERISA”). This is what the judges had to determine. Had Montana law run afoul of ERISA? Or was Morrison lawfully operating under the so-called savings clause that retains a state’s rights to regulate insurance, banking and securities within its jurisdiction?

Standard claimed that Morrison’s practice of denying approval of insurance forms with discretionary clauses was preempted by ERISA. In order to support their claim, they had to prove two things:

  1. the state law they were contesting was not specifically directed at entities engaged in insurance; and
  2. the law did not substantially affect the risk pooling arrangement between Standard and the people they insured.

While Morrison’s practice of denying approval to “any form” that contained “inconsistent, ambiguous, or misleading clauses or exceptions and conditions which deceptively affects the risk purported to be assumed in the general coverage of the contract…” (Mont. Code Ann. §33-1-502) clearly covered more than insurance and was being applied to employee benefit plans, was Standard right in claiming that Morrison’s practice was directed toward ERISA plans and procedures not insurance companies? The court said no on the following grounds. First, the judges ruled that ERISA plans are a form of insurance, and “any practice” that “regulates insurance companies by limiting what they can and cannot include in their insurance policies” is deemed to regulate insurance. The judges found that Commissioner Morrison’s refusal to approve discretionary clauses was part of his power to regulate allegedly unfair and misleading practices in the insurance industry as a whole within the state.

Standard claimed that Montana’s law only applied the common-law rule that contracts are interpreted against their drafter. The court disagreed. They found that the state did not require approval of most contracts but did require approval of insurance contracts. Morrison’s practice of disapproving insurance forms containing discretionary clauses was specific to the insurance industry. The court also found that Morrison’s practice applied to all insurers and was grounded in policy concerns that are specific to the insurance industry.

Standard lost the argument that Montana’s law did not directly regulate insurance. Standard needed to prove that Montana’s law did not substantially affect the risk pooling arrangement between insurer and insured to win their case.

In a nutshell, risk pooling involves accepting premiums from a number of policy holders after evaluating the level of risk that one of these policy holders will have a claim, and then dividing the cost of that risk between all of the policy holders. Standard wanted the court to accept their definition of risk pooling, “risk is pooled at the time the insurance contract is made, not at the time a claim is made.” The insurance company did not want other factors such as claim investigation costs or the appeals process to be included.

The court rejected this limited definition based on a Supreme Court ruling that extends the definition of risk pool to include state statutes that forbid insurance companies from discriminating against any doctor who is willing to meet the terms and conditions laid out in the health plan. The court ruled that because Montana insured’s cannot agree to a discretionary clause that lowers their premium, Montana’s law effectively impacts the risk pooling arrangement between the insurer and the insured. Also, Morrison’s disapproval of discretionary clauses “dictates to the insurance company the conditions under which it must pay for the risk it has assumed.” The court stated that in its opinion Morrison’s practices were more likely to lead to more claims being paid.

The application of Montana law clearly affected risk pooling. Montana’s law was clearly saved under both points and was not preempted by ERISA.

Standard went on to argue that Montana law conflicted with ERISA’s exclusive remedial scheme for insured’s who have been denied benefits. The court did not find this conflict. Instead if found that Morrison’s actions were in harmony with ERISA process.

Standard’s final argument was that “a state’s forbidding discretionary clauses is inconsistent with the purpose and policy of the ERISA remedial system, which emphasizes a balance between protecting employees’ right to benefits and incentivizing employers to offer benefit plans.” Standard relied on a United States Supreme Court decision from Metropolitan Life Insurance Co. v. Glenn where the Court noted that a conflict of interest exists when the entity determining eligibility for benefit also bears the financial burden for paying for them. While the court recognized this fact, it refused to repudiate the abuse-of-discretion standard, even if it was willing to temper its decision by the abuse-of-conflict standard.

The Court’s final opinion, based on case law, states that the state has a perfectly appropriate right to eliminate anything that minimizes scrutiny of an insurance plan’s denial of benefits. The Court equated Commissioner Morrison’s actions as similar, because they prevent insurers from inserting terms into their policies that tip the balance in their favor. The Court has found that there was no need to create an exception to the savings clause, because Morrison’s practice is directed at eliminating insurer advantage and does not fall within the scope of exceptions to the savings clause.

This ruling is one of several battles that have been won at the state level in recent years. It reflects the Court’s interpretation of the stance ERISA takes toward discretionary clauses – an automatic in-depth review of any claims of improper denial of benefits. We see this ruling as very good news for all employees that have a long-term disability insurance policy issued by their employer. Not only does the ruling support state rights to protect consumers, it also reflects a pro consumer attitude on the part of the court system that makes it easier for consumers to avail themselves of the benefits they have paid into the system to receive in the event they are disabled.



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