Thursday, March 30, 2017

Discretionary Clauses

Englert v. Prudential Insurance Company of America, 2017 WL 1133380 (N.D.Cal. Mar. 27, 2017), is the latest federal district court from outside New York to rule that discretionary clauses are not enforceable. Disability insurance companies misuse discretionary clauses to deny benefits to claimants. 

Discretionary clauses are contract provisions that grant an insurance company or administrator the unrestricted authority to determine eligibility for benefits and to interpret terms and provisions of the policy, contract or certificate. An example is: “the company has full, exclusive, and discretionary authority to determine all questions arising in connection with the policy, including its interpretation.” 

Why Discretionary Clauses Need To Be Banned In New York 

Over 20 States prohibit discretionary clauses in insurance policies because they have been found to be unjust, unfair and inequitable. New York once banned discretionary clauses, but the insurance lobby succeeded in having the insurance regulations banning those clauses withdrawn. 

Discretionary clauses place the insured at a great disadvantage in any disagreement over the meaning of the insurance contract, usurp the role of the courts in deciding a matter of law, that is, the meaning of the contract, and exacerbate the insurer’s inherent conflict of interest in being both the entity that pays and decides what does or does not need to be paid. In other words, the insurance company profits increase when it denies and terminates claims. As noted by the Supreme Court in Metlife v. Glenn, 554 U.S. 105, 128 S.Ct. 2343 (2008), 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. This conflict would be mitigated by prohibiting discretionary clauses and lessening the insurer’s discretion to decide what the contract means. 

Discretionary clauses are also unjust and contrary to the laws of this State because the deferential standard of review is opposed to the common law doctrine that ambiguities in insurance contracts should be construed in favor of the insured. Moreover, discretionary clauses in insurance contracts are misleading because policyholders probably do not understand when reading these clauses that they are giving up the right to a neutral, merits-based review of the insurer’s decisions and the meaning of the policy, and that the insurer as a practical matter could proceed with essentially absolute discretion as to what the policy means. Disability insurers always argue that they have the discretion to deny or terminate benefits by relying exclusively on the opinions of their doctors, who reject the opinions of the treating doctors, regardless of what the evidence reveals. 

A disability or health insurance policy is a contract. The interpretation of a contract is a matter of law and ordinarily questions of law are for the judiciary to decide. In a lawsuit on a contract, such as when an insured sues an insurer, a court looks at the question of law de novo, i.e., without regard for how the contract might have been initially interpreted by the insurer. However, when a discretionary clause is present, it usurps the role of the courts because they are required to give deference to the insurer’s interpretation of the contract, and will only overturn the insurer’s view if the court finds the insurer’s decision was arbitrary and capricious. This leads insurers to deny and terminate claims that they know should be approved. 

A client that I am currently representing illustrates a concrete example of what is at stake. She is covered by two disability policies that were issued by First Unum. One policy grants discretionary authority, while the other does not. First Unum found that my client can perform her own occupation, and has denied benefits, under the policy that it mistakenly thinks grants it discretionary authority. At the same time, based upon the same, and actually less, evidence, First Unum found my client was disabled from any occupation under the policy that does not grant discretionary authority. 

Insurance companies’ widespread abuse due to discretionary clauses prompted some regulatory authorities to take action. In 2002, the National Association of Insurance Commissioners (the “NAIC”) 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. 

The abuse of discretionary authority by the insurance companies became so widespread that the media covered the issue. On October 13, 2002, NBC Dateline did an expose called “Benefit of the Doubt”. The story described how Unum, the largest disability insurance provider, had systematically manipulated and created evidence in order to create excuses to deny and terminate disability claims. On November 20, 2002, CBS 60 Minutes also did an expose on Unum called “Did Insurer Cheat Disabled Clients?” The 60 Minutes piece detailed how Unum forced doctors to manufacture evidence as a means to deny and terminate disability claims. 

The abuses by Unum resulted in the U.S. Department of Labor and 49 State Insurance Departments bringing an action against Unum that resulted in a regulatory settlement agreement. Among other things, Unum was forced to reassess hundreds of thousands of disability claims that it had denied or terminated. Although Unum continues to engage in the same tactics that led to the agreement, no further action has been taken, and other disability insurers are now following Unum’s lead. Perhaps no further regulatory action has been taken because many states have now banned discretionary authority. 

On March 27, 2006, New York State Insurance Department issued Circular Letter No. 8 that adopted the NAIC Model Act. The letter stated that “discretionary clause provisions in accident and health insurance policies and in subscriber contracts will no longer be approved by the Department” because “The Department has determined that the use of discretionary clauses violates Sections 3201(c) and 4308(a) of the Insurance Law in that the provisions ‘encourage misrepresentation or are unjust, unfair, inequitable, misleading, deceptive, or contrary to law or to the public policy of this state.’ Additionally, the Department believes that the use of discretionary clauses is an unfair or deceptive act or practice, within the meaning of Article 24 of the Insurance Law.” 

In what is already a contract of adhesion, i.e., one that a consumer has no choice but to accept, discretionary clauses skew the balance of power even further in favor of the insurer. In other words, when a disability policy in New York grants the insurer discretionary authority, New Yorkers are at a severe disadvantage in any contest over questions of coverage, eligibility and interpretations and applications of the provisions of the contract for the simple reason that the insurer included a discretionary clause in the contract. If discretionary clauses are prohibited, then the courts apply the de novo standard of review, and are free to substitute their own judgment for that of the insurer. If a matter comes to court, the consumer faces a level playing field, and is better protected. 

What is perhaps most affected by the differing standards of review is the mindset of the insurer – its confidence that whatever it decides is sacrosanct under the “arbitrary and capricious” standard, as opposed to the more cautious approach it would take knowing that its decisions would be reviewed de novo. My experience has shown that whenever a court rules that a de novo standard of review applies, the insurer immediately seeks to settle the case, which is a tacit admission that the insurer knew its decision was wrong. 

Recognizing that a level playing field would require insurers to stop denying and terminating claims, the insurance lobby prevailed upon the Insurance Department to withdraw the Model Act just three months after it was adopted. On June 29, 2006, the Insurance Department issued Circular Letter No. 14, which withdrew the ban. The Letter stated that discretionary clauses that require courts to review disability and medical insurance claims under an arbitrary and capricious standard of review rather than de novo review negate essential features of the policies, as well as statutorily required appeal rights, which nullifies the insurer’s responsibility to pay. The Insurance Department found that discretionary clauses were likely to mislead the policyholder, contract holder or certificate holder; were “unjust, unfair or inequitable; and were an “unfair or deceptive act or trade practice.” While no longer banning discretionary clauses, the Insurance Department stated that it was “drafting regulations that would prohibit the use of discretionary clauses” in insurance policies. 

To date, seven years later, no such regulations exist, although in April 2010, the Insurance Department asked for comments about proposed regulations to ban discretionary clauses, but no regulations were enacted. Last year, I spoke with Insurance Department-Department of Financial Services representatives, and they said that it was highly unlikely that anyone would be drafting any such regulations now. 

Over twenty States have enacted legislation to ban discretionary clauses, and the list includes “Red” States such as Texas and “Blue States” such as Vermont. Adopting the Model Act levels the playing field when the disabled are forced to sue insurance companies to receive their benefits. For example, in Barrett v. Life Insurance Company of North America, 868 F.Supp.2d 779 (N.D.Ill. 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? 

[1] Circular Letter No. 14 can be found at:
[1] Subchapter M, §§3.1201- 3.1203

[1] 8 V.S.A. § 4062f


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