State Law May Prohibit Discretionary Clauses in ERISA-covered Plans

Despite ERISA's preemption clause, a federal district court has upheld, in Thomas vs. Aetna Life insurance Co., a California law prohibiting discretionary clauses in ERISA-covered plans.

Background. An employee in California was injured in an automobile accident and applied for benefits under her employer's self-funded short term disability plan. The plan administrator denied the benefit and the employee sued.

At trial, the two sides clashed over what the appropriate standard of review for the case should be. Generally, the default standard of review for benefit denials in an ERISA-covered plan is a "de novo" standard of review, which means that a court will independently review a claim and not defer to the plan administrator's, or insurer's, decision. However, if the plan document (or insurance contract) grants discretionary authority to determine benefit entitlement, the court applies a less-demanding "arbitrary and capricious" standard of review, which means that the plan's or insurer's decision will be upheld unless it is determined to be arbitrary and capricious.

The disability plan at issue contained a discretionary clause that provided the plan administrator with "the discretion and authority to interpret and construe the provisions of the STD plan.. [and] decide any dispute which may arise with regard to the rights of Participants entitled to benefits." However, a California law says "[I]f a policy, contract, [or] certificate... that provides or funds life insurance or disability insurance coverage for any California resident contains a provision that reserves discretionary authority... to determine eligibility for benefits or coverage.... that provision is void and unenforceable."

District Court Decision. At trial, the plan administrator agued that this law was preempted by ERISA because, with certain exceptions such as insurance laws, ERISA is meant to "supersede any and all State laws insofar as they relate to any employee benefit plan." Because this plan was self-insured the administrator said that the California law could not be applied.

The district court first said that the law could apply to a self-funded plan because the California law purported to cover "contracts" and not just insurance policies. It stated that "[A]n ERISA plan is a contract."

In the Supreme Court decision in Gobeille (see the Alert of 3/9/14), the Court had said that ERISA preempts two categories of state laws: "(1) where a state's law acts immediately and exclusively upon ERISA plans and (2) where a state law has an 'impermissible connection' with ERISA plans." The district court determined that neither of these categories applied to the instant case. It explained that the first category did not apply because the California law did not act exclusively on ERISA plans. Regarding the second category, the court said that "the initial decision made by a plan administrator to deny or grant disability benefits is a technical medical decision based on the evidence before the administrator. Whether that decision will be subject to de novo or discretionary review should not impact the administrator's decision..."

Ultimately, the court ruled that state laws such as the California law, whether applied to self-funded plans or not, do not govern a central matter of plan administration or interfere with nationally uniform plan administration.; therefore, they do not have an "impermissible connection" to ERISA plans. Accordingly, the court concluded that the California law was not preempted and that it will review the plan administrator's claims decision under the stricter de novo standard.