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Northwest OH Legal Blog

Tuesday, August 1, 2017

Federal Appellate Court Rules ERISA Does Not Preempt California Law Voiding Discretionary Clauses in Disability Plans

In a federal appellate court ruling on the limits of federal-law preemption under the Employee Retirement Income Security Act of 1974 (“ERISA”), the United States Court of Appeals for the Ninth Circuit has upheld a California law that takes away the right of insurers to have the final say on benefit determinations in disability plans.

Background.  Under the facts in Talana Orzechowski v. Boeing Co. Non-Union LTD Plan, et al., Case No. 14-55919 (9th Circuit May 11, 2017), the Boeing Company (“Boeing”) sponsored a non-union, ERISA-governed disability plan for its eligible employees.  To insure those benefits, Boeing purchased a disability insurance policy from Aetna Life Insurance Company (“Aetna”). The policy gave discretion to Aetna to “determine all questions that may arise including all questions relating to the eligibility of Employees and Dependents to participate in the Plan and amount of benefits to which any Participant or Dependent may become entitled.”  Exercising its discretion under the policy, Aetna terminated long-term disability payments to Talana Orzechowski, a Boeing worker who was suffering from chronic pain and fatigue disorders.

ERISA Preemption.  In general, ERISA preempts any state laws that “relate to” an employee benefit plan.  However, ERISA’s so-called “saving clause” saves from preemption “any law of any State which regulates insurance, banking, or securities.”  For ERISA’s saving clause to apply, a state statute must satisfy a two-part test.  First, the law must be “specifically directed toward entities engaged in insurance.”  Second, the law must substantially affect the risk-pooling arrangement between the insurer and the insured.

California Statute.  The California statute in question provided that if an insurance company issued or renewed a disability insurance policy containing a provision that reserved discretionary authority to the insurer (or an agent of the insurer) to—

  • determine eligibility for benefits or coverage,
  • interpret the terms of the policy, or
  • provide standards of interpretation or review that are inconsistent with the laws of the State of California,

that provision would be deemed void and unenforceable.  The statute defined the word “renewed” to apply when a policy continued in force on or after the policy’s anniversary date.

Federal Court Ruling.  The federal district court reviewed Aetna’s benefits decision based on an abuse-of-discretion standard of review because Boeing’s ERISA-governed disability plan gave Aetna discretionary authority to determine all plan-related questions, including eligibility for benefits.  Under that standard, the federal district court was required to give Aetna’s benefits decision deference for its correctness and could reverse Aetna’s decision only if the court found the decision to be arbitrary and capricious.  On appeal, however, the Ninth Circuit rejected the application of the abuse-of-discretion standard, holding that the California statute in question, which voided the plan’s discretionary review clause, required that the federal district court review Aetna’s benefits decision based on a de novo standard of review.  Under that standard, a reviewing court could review Aetna’s benefits decision anew without any deference for the correctness of Aetna’s original decision.  The federal appellate court’s ruling was premised on its determination that the California statute was, first, directed toward entities engaged in insurance and, second, substantially affected the risk-pooling arrangement between the insurer and the insured.  Thus, the state statute fell within the purview of ERISA’s saving clause.

The appellate court also addressed Boeing’s contention that because the California statute did not become effective until January 1, 2012, Boeing’s disability plan, which became effective on January 1, 2011, was grandfathered.  The court determined that because the Aetna insurance policy purchased by Boeing to insure disability benefits under the plan had an anniversary date of January 1, 2012, the plan was not grandfathered and thus subject to the statute’s requirement that any clause in the plan giving Aetna discretionary authority to determine benefits be deemed void and unenforceable.

Takeaway.  The appellate court’s ruling in Orzechowski indicates that if an insurance policy or an ERISA-governed plan delegates discretionary authority to an insurer (or agent of an insurer) to determine eligibility for benefits, a state law that takes away the insurer’s (or the insurer’s agent’s) right to have the final say on benefit determinations can, at least in the Ninth Circuit Court of Appeals, survive an ERISA preemption challenge.  In such cases, the insurer will need to defend an adverse benefit determination under a de novo standard of review (versus the arbitrary and capricious standard of review).  There is still an open question as to whether the court’s ruling in Orzechowski would extend to self-insured, ERISA-governed plans.


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