Exorcising Discretion: The Death of Caprice in ERISA Claims Handling

By Morrison, John; McDonald, Jonathan | South Dakota Law Review, Fall 2011 | Go to article overview

Exorcising Discretion: The Death of Caprice in ERISA Claims Handling


Morrison, John, McDonald, Jonathan, South Dakota Law Review


I. 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.

II. 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. …

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