Monday, July 16, 2012

What is NY Waiting For?

In 2002, as amended in 2004, the National Association of Insurance Commissioners issued a model act entitled “Prohibition on the Use of Discretionary Clauses” (the “Model Act”). When an insurance company issues a group disability policy, a discretionary clause grants the insurer or administrator the authority to determine eligibility for benefits and to interpret terms and provisions of the policy. The purpose of the Model Act is to prohibit clauses that purport to reserve discretion to the insurer to interpret the terms of a disability insurance policy.

On March 27, 2006, New York State Insurance Department issued Circular Letter no. 8 that adopted the Model Act. However, the insurance industry pressured the Insurance Department into withdrawing the Model Act just three months later in Circular Letter No. 14 on June 29, 2006. In Letter No. 14, the Insurance Department stated that because it believed that the use of discretionary clauses are contrary to the State insurance laws, it was “drafting regulations that would prohibit the use of discretionary clauses in all new and existing accident and health insurance policies, life insurance policies, annuity contracts and subscriber contracts upon renewal, modification, alteration or amendment on or after the effective date of the regulation.” To date, no such regulations exist.

Discretionary clauses place the insured at a disadvantage when litigation ensues over the meaning of the insurance contract because they commandeer much of the judge’s authority in deciding the case, and foster the insurer’s inherent conflict of interests in being both the entity that pays and the entity that decides what does or does not need to be paid. Where an insurer both determines whether an employee is eligible for benefits and pays those benefits out of its own pocket, there is a conflict of interest. A discretionary clause requires the court to defer to the insurer’s interpretation of the contract and will only overturn the insurer’s position if the court finds it was arbitrary and capricious. As the New York Insurance Department said when it originally banned discretionary clauses in 2006, where the clauses are present, “policies, contracts and certificates may be rendered illusory by nullifying the insurer’s responsibility to pay.”

Discretionary clauses unreasonably skew the balance of power further in favor of the insurer. The insurer knows it can win a lawsuit even if it made the wrong decision under a deferential standard. If discretionary clauses are prohibited, the court applies a de novo standard of review and is free to substitute its own judgment for that of the insurer, which levels the playing field.

Illinois is one of the States that has adopted the Model Act. Barrett v. Life Insurance Company of North America, a CIGNA company, was issued on June 14, 2012. Based on the Illinois law that adopted the Model Act, the court ruled that, “review will be de novo rather than measured against an arbitrary-and-capricious yardstick.” How long must New Yorkers wait for similar protection?

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