ERISA Preemption of State Insurance Laws Applicable to Disability Claims:

A Brief Glimpse at the Possible Light at the End of the Tunnel

            Individuals seeking disability benefits from insurance companies under plans issued by their employers have traditionally been precluded from taking advantage of state laws aimed at curing improprieties by insurance companies in claims processing.  Courts have regularly determined that such state laws are preempted by a federal law, the Employee Retirement Income Security Act (ERISA), a law which does not punish insurers for bad faith processing of disability claims.  Generally, ERISA applies to disability plans issued by employers.  Under ERISA, no matter how egregiously an insurance company denies a disability claim, the employee will not receive more than the benefits owed and attorneys’ fees.

            The current view on preemption, however, is open for reconsideration in light of the Supreme Court’s 2003 decision in Kentucky Association of Health Plans, Inc. v. Miller.  A federal court applying that decision has concluded that Pennsylvania’s bad faith insurance law is not preempted by ERISA, thus exposing an insurance company that allegedly processed a disability claim in bad faith to penalties not available under ERISA.  Together, these cases open the door for reconsideration of the existing case law that allows insurers to hide behind a law enacted to benefit employees.

            Passed in 1974, ERISA was designed to stop abuses occurring in private employee pension plans.  At the time, there was widespread misuse of private pension funds, chronic under-funding of pension benefits, and rising instances of employees losing their pensions.  Enacted in the spirit of an employees’ Bill of Rights, ERISA aimed to remedy the pension problem by, among other things, mandating specific pension vesting periods, and guaranteeing payment of vested pensions.  ERISA does not require an employer to adopt a pension plan, but its drafters hoped to encourage voluntary pension plan development by providing that ERISA would not be compromised by potentially contradictory state laws.  To this end, Congress adopted a broad preemption provision dictating that ERISA supersedes state laws “that relate to any employee benefit plan.” 

            This broad preemption provision would not affect disability claimants if ERISA only governed pensions.  But while ERISA’s primary objective was to provide protection to employees from pension abuses, it generally covers employee benefit plans, including both pension plans, and the welfare plans under which many employers provide their employees disability benefits.  A welfare plan is defined in ERISA to include any “plan fund, or program” maintained for the purpose of providing medical or other health benefits for employees or their beneficiaries “through the purchase of insurance or otherwise.”  This broad construct means, in essence, any benefit provided by an employer that is not a pension plan. 

            In comparison to its pension provisions, ERISA is relatively silent regarding regulation of “welfare” benefits.  The law consists almost exclusively of non-content regulation, such as reporting and disclosure requirements and administration requirements.  In 1974, abuses of welfare benefit plans were not apparent, and the vast majority of American workers were commercially insured by companies subject to state regulation.  Accordingly, Congress provided an important exception, called the “savings clause” to ERISA’s broad preemption provision.  Congress expressly provided that insurance provided to ERISA protected employees should continue to be regulated by the states by exempting from ERISA’s preemptive powers “any law of any state which regulates insurance.”

            Despite the historical background and the resulting savings clause regarding insurance, disability claimants have been surprisingly unsuccessful in using bad faith insurance laws to punish, and thereby deter, the growing number of insurers who process claims in bad faith.  In the mid 1980’s, the Supreme Court developed a three factor test, developed under cases interpreting the phrase “business of insurance” in the McCarran-Ferguson Act, to delineate which state laws “regulate insurance” under the savings clause.  Under these decisions, a state law “regulates the business of insurance” when it has the effect of spreading policy holder risk, affects an integral part of the insurer/insured policy relationship, and specifically targets the insurance industry.  This test has been applied rather stringently with courts almost unanimously finding that state bad faith insurance laws do not met these requirements.

            On April 2, 2003, however, the Supreme Court decided the case of Kentucky Association of Health Plans, Inc. v. Miller, a case which revamps the analysis to be used when examining whether the savings clause applies to a state law.  Under the Court’s decision, for a state law to be deemed a law “which regulates insurance” for the purposes of the savings clause, it must satisfy two requirements.  First, it must be specifically directed towards entities engaged in insurance.  Second, it must substantially affect the risk pooling arrangement between the insurer and the insured.  With respect to the second factor, the Court explained that it is not required that the law alter or control the actual terms of insurance policies to qualify for the savings clause.  On its face, the new test appears to lessen the requirements for application of the savings clause.

            The law at issue in the Kentucky decision sought to prevent Kentucky insurers from setting up closed networks of health care providers.  According to the Court, because the law prevents those insured in Kentucky from seeking “insurance from a closed network of health-care providers in exchange for a lower premium,” the law substantially affects the type of risk pooling arrangements insurers may offer.  The Court further clarified this point, and differentiated the new analysis, by explaining that “our test requires only that the state law substantially affect the risk pooling arrangement between the insurer and the insured; it does not require that the state law actually spread risk.”

            In the case of Rosenbaum v. UNUM, a federal district court in Pennsylvania applying the Kentucky decision determined that Pennsylvania’s bad faith statute for insurance claims is saved from preemption under ERISA.  Applying the first part of the new Kentucky test, the court easily found that the law, which applies when “the insurer has acted in bad faith toward the insured,” is clearly directed towards entities engaged in insurance.  To be clear of the impact of this action, once a law is “saved” from pre-emption, it means the Defendant insurance company has to deal with issues such as punitive damage awards and other deterrents to bad faith claims processing.

            Applying the second part, the court explained two ways in which the existence of a bad faith cause of action against an insurer substantially affects the risk pooling arrangement.  First, the existence of the bad faith statute dissuades insurers from denying claims in bad faith, effectively altering the risk that the insurer will deny a claim in bad faith.  Second, and most significantly, the existence of the statute and possible cause of action has the effect of altering policy provisions.  Risk deflection provisions an insurer might use (and often do use) to create limitations on claims and damages are overridden by the bad faith statute.  For example, the Pennsylvania bad faith statute at issue would override language in a policy providing a specific statute of limitations, prohibiting claims for bad faith, or excluding punitive damages.  The court concluded that “there can be little dispute” that the bad faith statute thus “substantially affects the risk pooling arrangement between the insurer and the insured.”

            The insurance company in Rosenbaum argued that even if the Pennsylvania law fell with the savings clause, that allowing the claim to go forward would undermine Congress’ intent in drafting ERISA, and should be preempted under a theory called “conflict preemption.”  The insurer argued that any remedies not available under the remedy section of ERISA (Section 502) are, by implication, specifically excluded in ERISA related cases.  The idea behind this argument is that the policy choices Congress implemented in ERISA by including certain remedies, and excluding others, would be undermined if ERISA plan participants and beneficiaries were able to obtain remedies under state law not available under ERISA.  This argument rests upon an implied intent attributed to Congress not expressly found in the statute.  The insurer pointed to the following statement from the Supreme Court on the matter:

Although we have yet to encounter a forced choice between the congressional policies of exclusively federal remedies and the ‘reservation of the business of insurance to the States’ we have anticipated such a conflict, with the state insurance regulation losing out if it allows plan participants to obtain remedies that Congress rejected in ERISA.

The Rosenbaum court rejected this argument, explaining that this reasoning is flawed in three respects.  First, when the words of a statute are unambiguous, the first and last cannon of statutory construction is that courts should assume that Congress says what it means and means what it says.  By not applying the clear language of the savings clause excepting state insurance laws from preemption, a court goes beyond what should be that first and last cannon, by instead adopting the cannon that the inclusion of one remedy implies the exclusion of another. 

            Second, the application of this implied intent directly contradicts the express intent found in the plain language of ERISA.  The savings clause places no requisites or restrictions for a state law to be saved from preemption, other than that it must regulate insurance.   Thus, Congress expressed a clear intent that it wanted all state laws that regulate insurance to be saved from ERISA preemption.  A questionably derived implied intent should not overrule Congress’ express intent.

            Third, the insurance company’s argument disregards the fundamental presumption against implied preemption.  Powers that have historically resided with the states should not be superseded by a federal law unless that is Congress’ clear and manifest   purpose.  Insurance regulation has historically been dominated by the states.  Under ERISA, Congress’ clear and manifest purpose is memorialized in the savings clause, and to find contrary would supplant Congress’s express intent. 

            The Rosenbaum court pointed out three strong factors against the implied intent theory of conflict preemption of state bad faith insurance laws; but there are even more reasons against it.  To begin with, such a view is directly inconsistent with the Supreme Court’s 1983 decision in Franchise Tax Board v. Construction Laborer’s Vacation Trust, the first case to discuss implied conflict preemption of state law claims under ERISA.   In that case, the Court ruled that section 502 of ERISA, the portion of the statue that provides remedies for violations of ERISA, does not provide the sole remedy for all claims arising in connection with an ERISA plan.  The Court explained that state laws protected by the savings clause are not preempted under the idea of implied preemption, because the savings clause expressly limits whatever inference of implied preemption arises from section 502.

            The ERISA statute itself also clearly mandates against implied conflict preemption.  Section 514, which contains the savings clause, specifically states that “nothing in this subchapter shall be construed” to preempt state insurance regulation.  Section 502, the section used to argue for implied conflict preemption, is part of the same subsection as section 514.   Therefore, under the express terms of ERISA, section 502 should not be construed to preempt state insurance regulation.

            Additionally, ERISA should also not be interpreted to supersede the clear language of another federal law, the McCarran-Ferguson Act.  Enacted in 1945 to permit the states to continue regulating the insurance business, the law states that “no act of Congress shall be construed to invalidate . . . any law enacted by any state for the purpose of regulating the business of insurance . . . .”  ERISA section 514 states that ERISA shall not be construed to supersede any other federal law.  Taken together then, ERISA does not supersede the McCarran-Ferguson Act, and state laws regulating insurers, including those who deny disability claims in bad faith, should not be preempted.

            Finally, the historical prologue to ERISA’s enactment, and ERISA’s legislative history (as confirmed by its preamble), indicate that ERISA’s primary goal is to protect employees.  When courts interpret the statute to preempt state laws designed to discourage wrongful processing of disability claims by insurers, this fundamental goal of ERISA is thwarted.  A vacuum is created in which insurers administering ERISA disability plans are able to blatantly deny claims without fear of repercussions, because ERISA only remedies lost benefits and attorneys fees.  This, of course, fails to deter insurance companies from processing disability claims unfairly.  The sad irony is that while ERISA was designed to ensure fair treatment for employee benefit plan participants, the insurance companies use ERISA as a shield against such fair treatment.

            It is uncertain how widely accepted Rosenbaum’s reasoning will be.  If nothing else, it demonstrates that the Supreme Court’s Kentucky decision has breathed new life into the savings clause.   There is no doubt that the savings clause has become more applicable than before, and that new challenges to the traditional mantra of total preemption of bad faith claims will be mounted in Pennsylvania and states with similar statutes.  One might even hope that as similar bad faith claims survive preemption, and the outcry over unfair disability claim denials continues, that states that currently do not have such laws will adopt similar bad faith laws to arm their citizenry against corrupt insurers.   In the absence of a change in the ERISA statute itself, there is still a long road ahead before insurers are held accountable for bad faith denials nationwide.  Now, more than any time in recent memory, however, it appears there may be a light at the end of the tunnel.

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