However, as will be explained below, discretionary clauses are contrary to ERISA’s purpose and intent. Legislation that would prohibit discretionary clauses in benefit plans other than multi-employer plans, and that also would prohibit mandatory arbitration of ERISA benefit cases[1] was recently passed by the U.S. House of Representatives,[2] and it must be passed by the U.S. Senate as well, and signed into law by President Joe Biden.
Here’s why.
ERISA was enacted in 1974 by Congress to
protect … participants in employee benefit plans and their beneficiaries, by requiring the disclosure and reporting to participants and beneficiaries of financial and other information with respect thereto, by establishing standards of conduct, responsibility, and obligation for fiduciaries of employee benefit plans, and by providing for appropriate remedies, sanctions, and ready access to the Federal Courts.[3]
Contrary to that statement of legislative purpose, discretionary clauses in employee benefit plans have been used to thwart meritorious claims by requiring claimants to not only prove that their claims were wrongfully denied, but in addition, that the denial was an abuse of discretion or arbitrary and capricious.[4]
For years, courts questioned whether a deferential standard of review over denied employee benefit claims was appropriate.
For example, in 1987 in Van Boxel v. Journal Company Employees’ Pension Trust,[5] the U.S Court of Appeals for the Seventh Circuit wrote:
[Benefits] are too important these days for most employees to want to place them at the mercy of a biased tribunal subject only to a narrow form of “arbitrary and capricious” review, relying on the company’s interest in its reputation to prevent it from acting on its bias.
In 1991, the U.S. Court of Appeals for the Third Circuit, in Luby v. Teamsters Health, Welfare and Pension Trust Funds,[6] also weighed in by observing that plan administrators “may be laypersons … without any experience in or understanding of the complex problems arising under ERISA.”[7]
And, of course, the U.S. Supreme Court, in its seminal 1989 ERISA ruling in Firestone Tire & Rubber Co. v. Bruch,[8] deemed the de novo standard the default standard of review of ERISA cases, although the court’s ruling permitted plans to incorporate discretionary provisions in their plan documents.
In concluding that the de novo standard should generally apply, though, the Supreme Court cited the statutory language quoted above and further pointed out that a contrary position “would afford less protection to employees and their beneficiaries than they enjoyed before ERISA was enacted.”[9]
The court also rejected Firestone’s argument that prior legislative efforts to ban discretionary clauses showed Congress’ intent to permit the widespread use of the arbitrary and capricious standard, finding the prior failure to pass legislation “is not conclusive of Congress’ views on the appropriate standard of review.”[10]
The court also rejected another key argument often made in favor of the use of discretionary clauses — that litigation costs would increase and therefore discourage employers from offering benefits to their employees.[11]
The ruing maintained “the threat of increased litigation is not sufficient to outweigh the reasons for a de novo standard that we have already explained.”[12]
A subsequent ruling from the Seventh Circuit in Herzberger v. Standard Insurance Co. expanded upon the Supreme Court’s rationale, pointing out in its 2000 opinion:
The very existence of “rights” under [employee benefit] plans depends on the degree of discretion lodged in the administrator. The broader that discretion, the less solid an entitlement the employee has.[13]
An illustration of how pernicious the impact of discretionary clauses can be may be found in Graham v. L&B Realty Advisors Inc.,[14] where the U.S. District Court for the Northern District of Texas in 2003 upheld a disability benefit denial notwithstanding “clear evidence to the contrary” of the insurer’s determination because the court believed its hands were tied by the deferential review standard.
Yet another shocking expression of the application of a deferential standard of review is the U.S. Court of Appeals for the First Circuit’s 2003 opinion in Brigham v. Sun Life of Canada,[15] where the court upheld an insurer’s decision to deny disability benefits to a paraplegic, explaining:
The question we face in this appeal is “not which side we believe is right, but whether [the insurer] had substantial evidentiary grounds for a reasonable decision in its favor.” … Beyond this, it seems counterintuitive that a paraplegic suffering serious muscle strain and pain, severely limited in his bodily functions, would not be deemed totally disabled. Moreover, it seems clear that Sun Life has taken a minimalist view of the record. But it is equally true that the hurdle plaintiff had to surmount, establishing his inability to perform any occupation for which he could be trained, was a high one.
Another issue that has made discretionary clauses even more of a challenge for claimants is the 2003 ruling by the Supreme Court in Black & Decker Disability Plan v. Nord,[16] which found that disability insurers were not obligated to defer to treating doctors’ opinions, thus giving insurers even more power to deny claims.
As a result of that ruling, insurers are able to establish the “reasonableness” of their decision by obtaining an opinion from a doctor who has merely reviewed medical records but has never examined the claimant.
The presence of discretionary clauses also markedly affects the adjudication of ERISA benefit cases. Under the de novo standard, although the majority of courts still conduct a review of the so-called administrative record, additional evidence may be considered,[17] and the Seventh Circuit even permits trials.[18] If the judicial standard of review is arbitrary and capricious, though, courts do not permit the introduction of any new evidence.[19]
Discretionary clauses also permit plan administrators to impose self-serving interpretations of ambiguous policy terms. That power is inconsistent with a well-accepted principle of insurance law known as contra proferentem, which mandates that ambiguities be interpreted in favor of the insured and against the insurer.[20]
Contra proferentem is even abrogated where the plan administrator is conflicted even though the Supreme Court ruled that courts should consider affording less deference to plan administrators who operate under a structural conflict of interest whenever they serve in the dual role of being both the source of benefit payments and also have the responsibility to decide disputed claims.[21]
Although the most successful initiative to date to limit discretionary clauses has been the National Association of Insurance Commissioners’ model law prohibiting discretionary clauses,[22] that provision has only been adopted in approximately 20 states.[23] While several court rulings have protected state law bans on discretionary clauses against ERISA preemption challenges,[24] state laws have no effect on self-funded plans.[25]
Accordingly, the only way to effectively moot discretionary clauses is congressional action, such as the legislation that recently passed the House and is now pending before the Senate. If discretionary clauses are banned, claimants will finally be able to receive court review that gives equal consideration to the evidence presented by both sides.
Therefore, in order for the language in the preamble of ERISA to mean what it says regarding the law’s focus on protecting employees, discretionary clauses must be prohibited.
Mark D. DeBofsky is a shareholder at DeBofsky Law.
This article was first published by Law 360 on October 12, 2022
[1] H.R. 7780 – Sections 702 and 703.
[2] Mental Health Matters Act, H.R. 7780 (Full text available at https://www.congress.gov/bill/117th-congress/house-bill/7780/text).
[3] 29 U.S.C. §1001(b)(2003).
[4] See, Pokratz v. Jones Dairy Farm, 771 F.2d 206, 209 (7th Cir. 1985), which noted:
“Although it is an overstatement to say that a decision is not arbitrary or capricious whenever a court can review the reasons stated for the decision without a loud guffaw, it is not much of an overstatement. The arbitrary or capricious standard is the least demanding form of judicial review of administrative action. Any questions of judgment are left to the agency, or here to the administrator of the Plan.[citations omitted]Before condemning a decision as arbitrary or capricious a court must be very confident that the decisionmaker overlooked something important or seriously erred in appreciating the significance of the evidence.”
[5] Van Boxel v. Journal Company Employees’ Pension Trust, 836 F.2d 1048 (7th Cir. 1987).
[6] Luby v. Teamsters Health, Welfare and Pension Trust Funds, 944 F.2d 1176 (3d Cir. 1991).
[7] 944 F.2d at 1183.
[8] Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101 (1989).
[9] 489 U.S. at 114.
[10] Id.
[11] 489 U.S. at 114-115.
[12] 489 U.S. at 115.
[13] Herzberger v. Standard Ins. Co., 205 F.3d 327, 331 (7th Cir. 2000).
[14] Graham v. L&B Realty Advisors Inc., 2003 U.S.Dist.LEXIS 17272 (N.D.Tex. September 30, 2003).
[15] Brigham v. Sun Life of Canada, 317 F.3d 72 (1st Cir. 2003).
[16] Black & Decker Disability Plan v. Nord, 123 S.Ct. 1965; 155 L. Ed. 2d 1034 (2003).
[17] See, See, Quesinberry v. Life Ins. Co. of N. Am., 987 F.2d 1017, 1027 (4th Cir. 1993) (identifying factors that would permit discovery – “claims that require consideration of complex medical questions or issues regarding the credibility of medical experts; the availability of very limited administrative review procedures with little or no evidentiary record; the necessity of evidence regarding interpretation of the terms of the plan rather than specific historical facts; instances where the payor and the administrator are the same entity and the court is concerned about impartiality; claims which would have been insurance contract claims prior to ERISA; and circumstances in which there is additional evidence that the claimant could not have presented in the administrative process.”).
[18] Krolnik v. Prudential Ins. Co., 570 F.3d 841 (7th Cir. 2009).
[19] Perlman v. Swiss Bank Corp., 195 F.3d 975 (7th Cir. 1999).
[20] See, Kimber v. Thiokol Corp., 196 F.3d 1092 (10th Cir. 1999).
[21] See, Clemons v. Norton Healthcare Inc., 890 F.3d 254, 264-66 (6th Cir. 2018).
[22] See, NAIC Model Laws, Prohibition on the Use of Discretionary Clauses Model Act.
[23] NAIC Model Laws, Regulations and Guidelines 42-1, State Adoption.
[24] See, e.g., Orzechowski v. Boeing Company Non-Union Long Term Disability Plan, 856 F.3d 686 (9th Cir. 2017).
[25] See, Williby v. Aetna Life Ins. Co., 867 F.3d 1129 (9th Cir. 2017).
