Case Updates Archives - Page 2 of 21

Court Rules Insurers Cannot Hide Behind Biased Expert Consultants to Dispose of Bad Faith Claims

Insurance companies owe a duty of good faith and fair dealing to the persons they insure. This duty is often referred to as the “implied covenant of good faith and fair dealing” which automatically exists by law in every insurance contract. They often defend “bad faith” litigation by invoking a what is known as the “genuine dispute” doctrine. In a recent California Court of Appeal decision, Fadeeff v. State Farm General Ins. Co., 50 Cal.App.5th 94 (2020), the Court ruled that an insurer relying on this doctrine should not automatically be considered to have acted in good faith just because the insurer relied on independent expert opinions when making claim determinations.

In Fadeeff, plaintiffs filed a property insurance claim with State Farm General Insurance Company (“State Farm”) for smoke and soot damage to their home due to a valley fire. After some initial payments, State Farm denied an additional claim for further smoke damage. After its denial, State Farm retained Forensic Analytical Consulting Services (“Forensic Analytical”) to perform an inspection and opine whether the additional repairs were necessary. Predictably, Forensic Analytical determined no further repairs were warranted. Plaintiffs filed a lawsuit against State Farm alleging breach of the implied covenant of good faith and fair dealing, or bad faith.

Subsequently, State Farm filed a motion for summary judgment asking the court to find that it did not deny plaintiffs’ claim in bad faith. State Farm argued that the genuine dispute doctrine automatically defeats a claim for bad faith where an insurer reasonably relies upon expert opinions when making its claim determinations. The trial court granted State Farm’s motion. Plaintiffs appealed.
State Farm argued that it could not have denied plaintiff’s claim in bad faith, since State Farm’s expert, Forensic Analytical, determined that no additional repairs were warranted. State Farm argued there could be no bad faith since its denial of the plaintiff’s claim was based on Forensic Analytical’s opinion and not its own opinion. The appellate court disagreed. The court held that an insurer’s reliance on an outside expert does not automatically insulate the insurer from a bad faith claim under the genuine dispute doctrine. Instead, when an insurer relies on the advice and opinions of independent experts, it is only a single factor in determining whether the insurer handled a claim in good faith. The court stated that there are several circumstances where a biased investigation claim should be decided by a jury.

In this case, the court held that all of State Farm’s conduct must be examined, not just the opinion of an independent expert when determining a claim for bad faith. For example, other factors to be considered include the following: (1) State Farm initially found that all claimed damage was caused by the fire, but the new adjuster for the additional claim concluded that some of the earlier claimed damage was caused by wear and tear; (2) Some of the additional damage was caused by the power washing that was recommended by State Farm; (3) It was apparent that Forensic Analytical did not perform a thorough investigation; and (4) State Farm’s coverage positions were inconsistent. Therefore, the court reversed the trial court dismissal of the plaintiff’s bad faith claim.
Importantly, the summary judgment motion was also reversed as to the issue of punitive damages. State Farm had previously argued that plaintiffs could not describe the factual basis for their punitive damages request and testified at deposition that they did not get the impression that anyone from State Farm was trying to harm them. However, with regard to punitive damages, the initial burden is on State Farm to show that plaintiffs could not prove that State Farm acted without malice, oppression or fraud. Only after State Farm had met its burden, did the burden shift to plaintiffs to establish evidence supporting punitive damages. The court held that State Farm had not met its burden, as plaintiffs’ “beliefs” do not conclusively answer the question of whether State Farm intentionally misrepresented or concealed a material fact because there can be other evidence to support these allegations.
Fadeeff is a very good opinion for California insureds who have all types of insurance claims, especially life and disability insurance claims as it significantly limits the genuine dispute doctrine, and thus the ability of insurers to utilize the doctrine as a complete defense to bad faith claims. This court did not allow insurers to hide behind its hired experts, no matter how biased they are, to avoid bad faith claims.

If your insurance company or plan administrator has mishandled or improperly denied your long-term disability, life insurance, health insurance, or accidental death claims, please contact our firm for a free consultation.

When Can a Disability Claimant Obtain Discovery in an ERISA Suit When the De Novo Review Standard Applies?

When it Goes to the Bias of an Insurer’s Consultants, that’s When a claimant who challenges a denial of disability or life insurance benefits by filing a court action under ERISA is generally not able to present evidence to the court that is not in the administrative record. The administrative record consists of all the medical records, documents and other information obtained by and submitted to the plan administrator during the initial stages of the claim and through the appeal process. Because courts are generally unwilling to consider any evidence which is not in the administrative record, plaintiffs are normally not entitled to legal discovery from the insurance company.

However, courts in the Ninth Circuit have carved out exceptions to the above discovery rule in de novo review cases. “[T]he district court should exercise its discretion to consider evidence outside of the administrative record ‘only when the circumstances clearly establish that additional evidence is necessary to conduct an adequate de novo review of the benefit decision.’” Opeta v. Nw. Airlines Pension Plan for Contract Emp., 484 F.3d 1211, 1217 (9^th Cir 2007) (emphasis added.).

In a recent decision by the U.S. District Court of Arizona, Coffou v. Life Insurance Company of North America, 2020 WL 1502104 (D. Arizona 2020), the court allowed discovery in an ERISA case relating to the plan administrator’s alleged use of biased experts when it denied a claim for waiver of premium benefits under a life insurance policy. In Coffou, the Plaintiff, Mary Coffou, filed a lawsuit against Life Insurance Company of North America (“LINA”) after it determined Ms. Coffou did not meet its definition of “disabled” and as a result, denied her a waiver of life insurance policy premiums. Ms. Coffou alleged that LINA intentionally denied her claim by hiring third-party vendors to supply a biased vocational expert and biased medical experts who had a history of providing findings to support LINA’s denial of claims.

While the court stated that compensating experts for work done is not in itself proof of bias, evidence such as a long-standing relationship or substantial compensation may be important to access an expert’s bias and credibility. In Coffou, the Court held as follows:

For several reasons, this case meets the exceptional circumstances test set out by Opeta. This is a case in which the carrier has an admitted structural conflict and a history of self-dealing, resulting in its claims practices being subject to an extensive national “market conduct study,” a 2013 Regulatory Settlement Agreement (“RSA”), and continued monitoring. In addition, Plaintiff’s claims would have been insurance contract claims prior to ERISA. Further, Plaintiff has pointed out that some of LINA’s experts, Drs. Grattan and Mobo, rendered opinions outside their area of expertise. And, Plaintiff has indicated that LINA provided its vocational consultant, Glenna Taylor, with the reports and limitations by its own experts, Drs. Mobo and Grattan, but did not provide all the medical records and report that Plaintiff used to support her claim. Also, LINA did not provide the SSA ALJ’s decision, the SSA claims file, or Plaintiff’s medical, vocational, and lay witness evidence.

LINA’s conduct puts this case outside the garden-variety “structural conflict of interest” scenario. Rather, LINA’s history and the unchallenged representations of Plaintiff that LINA provided its experts with its other experts’ reports, but not the entire record, raises concerns whether LINA’s structural incentive to minimize benefit payments distorts its obligation to fairly handle benefits claims. This warrants discovery into LINA’s relationships with its vendors and experts and into whether it was employing vendors and experts who would reliably do LINA’s bidding.

The Court concluded that discovery beyond the administrative record would be helpful to determine the credibility of LINA’s experts. LINA was ordered to respond to interrogatories relating to its relationship history with the subject third-party vendors and experts used to determine Ms. Coffou’s claim. Specially, LINA was required to respond to discovery that delved into the number of times it retained the subject third-party vendors and experts and what amount of money was paid to them, as well as the number of times its internal vocational expert has conducted assessments and concluded the claimant could perform work.

As Coffou demonstrates, while discovery in ERISA de novo review cases is limited, under the right circumstances the courts will allow discovery that will expose insurance company bias in the denial of ERISA life and disability insurance claims to protect insureds from having their claims improperly denied.

Court Rejects Third Party Administrator’s Demurrer to Insurance Bad Faith Claim Based on Plaintiffs’ Theory of Joint Venture Liability

Implied in every insurance contract is a promise of “good faith and fair dealing,” which means that the insurer must not take unreasonable steps to prevent an insured’s right to receive benefits under the policy. To comply with its promise to act in good faith, the insurer must adhere to certain duties, such as the duty to adequately investigate a claim made by an insured. An insurer acts in bad faith when it fails to meet those duties unreasonably and without proper cause. Determining whether there has been bad faith conduct is important, in part, because it directly affects the insured’s potential recovery. If the insurer is found to have acted in bad faith, the insured may have access to a substantial additional recovery, including attorneys’ fees, emotional distress, consequential and punitive damages. An insured’s ability to sue for insurance bad faith is his or her most potent and effective legal weapon to wield against rogue insurance companies. It is common knowledge that a policyholder can assert a bad faith claim against an insurer. But what about an insured’s ability to sue a Third Party Administrator (“TPA”)?

TPAs are not insurers, although they typically perform some of the insurer’s functions: billing, recordkeeping and processing of life insurance, disability insurance and medical insurance claims. Many insurers “outsource” such claims processing tasks to TPAs and grant TPAs broad discretion to interpret policy provisions, investigate claims and deny or approve claims as they see fit. But, although TPAs often spend the most “face-time” with individual policyholders, their primary relationship is with the insurance company and not the insured. Even though TPAs may commit bad faith by making unreasonable claims decisions, most traditional legal theories immunize TPAs from liability for claims handling misconduct. Rather, the insurer is typically liable for any bad faith conduct by the TPAs. Consequently, TPAs may lack incentives, financial or otherwise, to properly handle and process an insured’s life, health or disability insurance claim.

However, new legal theories adopted by McKennon Law Group PC appear to be shifting the course on TPA accountability. One theory our firm has successfully utilized in several recent cases is joint venture liability. Under joint venture liability theory, the policyholder alleges that, unlike agents or employees of the insurer, the TPA entered into the business of insurance as a joint venture with the insurer. As such, both the TPA and the insurer may be held legally accountable for their bad faith conduct. In this article, we discuss TPAs, joint venture liability theory and the Firm’s recent success in alleging the joint venture liability of a TPA.

Third Party Administrators
In the insurance industry, it is commonplace for a TPA to provide claims handling services for an insurer. Typically, the insurer funds the insurance policy and pays the benefits, whereas the TPA interprets the policy provisions, handles the claims, and ultimately decides whether a claim should be paid. Customarily, the insurer’s agents and employees are exempt from liability for breach of contract and bad faith. In other words, if the insurer’s long-term disability claims specialist improperly denies your claim, he would be immunized from a lawsuit because he is not a party to the contract for insurance and he acted as an agent of the insurer. This agent-principal theory also shields TPAs from liability for breach of contract and bad faith, despite the fact that TPAs are distinct, sophisticated entities often independently exercising broad discretionary authority in the administration of claims under the policy.

TPAs and Joint Venture Liability Theory
Despite the more traditional law that immunizes TPAs from bad faith liability, non-insurer defendants may be held liable under insurance contracts if they jointly ventured with the insurer. In this instance they are not considered agents or employees of the insurer, but instead a partner of sorts, known as a joint venturer, engaged in a particular business venture with an insurer. Where there is a joint venture, all are liable for agreements entered into by the joint venturers in furtherance of the joint venture. To establish a joint venture requires (1) an intent to become partners; (2) a community of interest in the undertaking; (3) an understanding to share profits and losses; and (4) authority and right to direct and control the conduct of all co-venturers with respect to the joint venture.

In Forest v. Equitable Life Assurance Society of U.S., No. C99-5173 SI, 2001 WL 1338809, at *5 (N.D. Cal. June 12, 2001), the court allowed plaintiff’s theory for TPA liability based on a joint venture theory. Plaintiff alleged that the companies, including two acting TPAs, Paul Revere and Provident Life, and one acting insurer, Equitable, were joint-venturers who were all subject to bad faith under California law. The “joint venture” encompassed a series of agreements between Equitable, Paul Revere and Provident Life, with the latter two offering claims management services similar to what many other TPAs also provide. The agreements supported inferences that Paul Revere, Provident and Equitable shared a community of interest in the business of claims administration and shared profits and losses through an incentive fee scheme. In response to a legal challenge to this joint venture liability, the court found that the TPA “Paul Revere exercised broad discretion and control while Equitable retained final authority in most matters.” The court also noted that the parties shared a variety of resources, including information, bank accounts, human resources and joint marketing development. Based on these agreements, the court found that “it cannot be said as a matter of law that Paul Revere, Provident Life and Equitable were not in a joint venture for the business of offering and providing disability insurance policies such as plaintiff’s policy.” Thus, the court upheld the bad faith claims against the TPAs, Paul Revere and Provident Life.

Sharkh v. Continentale Krankenversicherung A.G.
In a recent ruling in Sharkh v. Continentale Krankenversicherung A.G., No. SC127208 (L.A. Super. Ct. Jan. 17, 2018), the court found in favor of Plaintiffs, rejecting a legal challenge to Plaintiffs’ causes of action for breach of contract and bad faith as to Defendant and TPA Global Medical Management, Inc., (“GMMI”). In this lawsuit, Plaintiffs, represented by Robert McKennon and Scott Calvert of the McKennon Law Group PC, filed an amended complaint against Defendants Continentale Krankenversicherung A.G. (“Continentale”) and GMMI. The amended complaint alleged liability on multiple theories, including joint venture liability against GMMI based on the Defendants’ denial of numerous health insurance claims without good cause relative to two sick young children, one of whom who is gravely ill. On December 11, 2017, GMMI demurred to Plaintiffs’ amended complaint on the grounds that the breach of contract and bad faith causes of action alleged were improper. Specifically, GMMI asserted that it could not be subject to causes of action for breach of contract and breach of the implied covenant of good faith and fair dealing (bad faith) because it was not a party to the underlying insurance contract, acting only as a TPA.

On January 3, 2018, Plaintiffs, via counsel, responded, opposing GMMI’s demurrer. As the opposition explained, GMMI and Continentale co-ventured into the business of health insurance. Both parties shared a community interest in profits and losses, as well as the ability to independently exercise broad discretionary authority. The policy also reflected an intent to become partners, identifying GMMI as the claims administrator. Following briefing, the court issued an order in favor of Plaintiffs, finding that the amended complaint sufficiently alleged a theory of joint venture liability in the administration of the health insurance policy at issue by both the TPA, GMMI, and the insurer Continentale.

Ultimately, an insured’s ability to hold TPAs accountable is a good thing for insureds. Without some accountability, TPAs will exercise unbridled discretionary authority over the claims handling process without any liability whatsoever.

High Court Changes Cumis Landscape

We all know the maxim that “bad facts make bad law.” Two years after J.R. Marketing, LLC prevailed in the Court of Appeal concerning its dispute with its commercial general liability insurer, Hartford, it ran out of luck before the California Supreme Court in its fight over important Cumis counsel issues. Hartford Cas. Ins. Co. v. J.R. Marketing, LLC, 190 Cal. Rptr. 3d 599, 2015 DJDAR 9111 (Cal. Aug. 10, 2015). This is a must read for every lawyer in California that acts as Cumis counsel.

The High Court held an insurance company can sue independent counsel (i.e., Cumis counsel) directly for reimbursement of unreasonable or unnecessary legal charges counsel billed it to defend its insured. This decision may dramatically change the entire Cumis counsel landscape. Previously, an insurer could only sue its insured for reimbursement of defense fees. The High Court’s decision, no doubt, will have a chilling effect on how Cumis lawyers represent their clients. They will fear subsequent fee litigation from the insurer. One has to wonder if “independent counsel” will truly be independent anymore. Quite possibly, this case will practically (though not legally) relegate Cumis counsel to a similar role as an insurance company’s panel counsel, who has to pander to the “hand that feeds them” even though, under the law, Cumis counsel has two clients, the insured and the insurer.

The facts of this case were unique because Cumis counsel racked-up a whopping $15 million in legal bills under a court order it drafted that allowed it to bill the insurer without any fear whether or not the bills would be immediately paid in full. Hartford had issued J.R. Marketing a commercial general liability policy that covered business-related defamation and disparagement. J.R. Marketing was sued in Marin County (and other liability actions) for interference with business relationships, defamation, unfair competition and other business-related torts. It tendered the defamation lawsuit to Hartford under the policy. Hartford denied any duty to defend or indemnify.

J.R. Marketing sued Hartford for breaching the insurance policy. Hartford, only after the coverage action was filed, agreed to defend under a reservation of rights but only prospectively. It refused to pay J.R. Marketing’s legal bills back to the date of tender, and it also refused to provide Cumis counsel in place of its own panel defense counsel. The trial court in the coverage action found Hartford breached it duty to defend by failing to provide and pay for Cumis counsel from the date of tender.

A few months later, because Hartford still had not paid Cumis counsel’s bills violating the trial court’s summary adjudication order, the trial court entered an enforcement order in the coverage action. The order, drafted by J.R. Marketing’s Cumis counsel, Squire Sanders, required Hartford to promptly pay all of Squire Sanders’s past defense invoices within 15 days and to pay “all future defense costs” in the defamation action “within 30 days of receipt.” The order stated Hartford breached its duty to defend by failing to honor it until ordered to do so by the court and by thereafter failing to pay counsel’s submitted bills in a timely fashion. The order further stated that Squire Sanders’s bills had to be reasonable and necessary and that, to “the extent Hartford seeks to challenge fees and costs as unreasonable or unnecessary, it may do so by way of reimbursement after resolution of the” underlying defamation action. The trial court’s order did not specify from whom Hartford could seek reimbursement, i.e. from its insured, J.R. Marketing or from Squire Sanders.

After the defamation suit ended, Hartford filed a cross-complaint in the coverage action for “reimbursement pursuant to the enforcement order,” unjust enrichment and other claims. It directly sued Cumis counsel, Squire Sanders, as well as its insured J.R. Marketing. “The cross-complaint asserted that Hartford was entitled to recoup from the cross-defendants a significant portion of some $15 million in defense fees and expenses, including some $13.5 million Hartford paid to Squire Sanders pursuant to the enforcement order.”

Squire Sanders, representing itself and J.R. Marketing, demurred to Hartford’s cross-complaint. It argued, among other things, that an insurer has no direct claim against an insured’s independent counsel for reimbursement. The trial court agreed and “concluded that Hartford’s right to reimbursement, if any, was from its insureds, not directly from Cumis counsel.” The appellate court affirmed the decision. It rejected Hartford’s argument that an insurer has a right to recover directly from Cumis counsel unreasonable and excessive fees it pays counsel because counsel (and not just the insured) is unjustly enriched in that scenario.

The California Supreme Court reversed. The Court was very careful to narrowly frame the issue before it because it did not want its holding to apply to all Cumis counsel cases, just ones where the insurer had a reimbursement right rooted in a trial court order. It therefore stated the issue in great detail as:

From whom may a CGL insurer seek reimbursement when: (1) the insurer initially refused to defend its insured against a third-party lawsuit; (2) compelled by a court order, the insurer subsequently provided independent counsel under a reservation of rights . . . to defend its insured in the third party suit; (3) the court order required the insurer to pay all “reasonable and necessary defense costs,” but expressly preserved the insurer’s right to later challenge and recover payments for “unreasonable and unnecessary” charges by counsel; and (4) the insurer now alleges that independent counsel “padded” their bills by charging fees that were, in part, excessive, unreasonable, and unnecessary?

The Court emphasized again, “We granted Hartford’s petition for review, which raised a narrow question: May an insurer seek reimbursement directly from counsel when, in satisfaction of its duty to fund its insureds’ defense in a third party action against them, the insurer paid bills submitted by the insureds’ independent counsel for the fees and costs of mounting this defense, and has done so in compliance with a court order expressly preserving the insurer’s post-litigation right to recover ‘unreasonable and unnecessary’ amounts billed by counsel?” [Emphasis added].

To that very narrow issue the High Court responded:

We conclude that under the circumstances of this case, the insurer may seek reimbursement directly from Cumis counsel. If Cumis counsel, operating under a court order that expressly provided that the insurer would be able to recover payments of excessive fees, sought and received from the insurer payment for time and costs that were fraudulent, or were otherwise manifestly and objectively useless and wasteful when incurred, Cumis counsel have been unjustly enriched at the insurer’s expense. [Emphasis added].

As alluded to earlier, bad facts make bad law. The Court could not ignore the fact that the law firm acting as independent counsel, Squire Sanders, had racked up $15 million in legal bills defending the insured! Moreover, the Squire firm had written its own meal-ticket. It drafted the proposed order adopted by the trial court finding the defendant insurance company owed a duty to defend its insured through independent counsel. But Squire Sanders did not stop there. It included language in the order requiring Hartford to pay all of its legal bills in the case within thirty days, no questions asked, and that Hartford could not challenge any of the bills until after the underlying liability action had ended. The Squire firm’s aggressive and expensive litigation tactics completely unchecked by anyone, and the fact that the firm had drafted the very order permitting that highly advantageous scenario to them, lead the High Court to decide it had to allow a direct reimbursement action by Hartford against Squire Sanders. It could not allow $15 million in legal bills to stand without affording Hartford an opportunity to contest their reasonableness.

Unfortunately, the extreme facts of J.R. Marketing may forever change the Cumis counsel landscape, and not in a good way. While the Supreme Court was careful to clarify its holding was limited to the unusual facts of the case before it, its opinion unrealistically downplays the chilling effect it will have on Cumis counsel’s ability to zealously represent their client’s interests independent from the influence of its insurer.

We emphasize that our conclusion hinges on the particular facts and procedural history of this litigation. . . . We . . . express no view as to what rights an insurer that breaches its defense obligations might have to seek reimbursement directly from Cumis counsel in situations other than the rather unusual one before us in this case.

While firms acting as independent counsel will try to zealously defend their clients and look out solely for their interests (as the law requires), the threat of fee litigation looming over their heads by insurance companies will shape Cumis counsel’s strategy. Cumis lawyers will consider whether the insurance company is likely to challenge their defense strategies as unnecessary in a subsequent reimbursement action for fear of having to re-pay large legal bills. They are likely to decide how to defend the case based not just on their client’s best interests but, on their own and the insurer’s too.

If insurance companies had a record of integrity and looking out for their insured’s interests (and the lawyers that defend them), the Court’s opinion might work. But they don’t. They have a well-earned reputation of unreasonably nitpicking lawyer’s bills, refusing to pay for necessary legal work, demanding to pay antiquated hourly rates rather than market rates, employing auditing firms paid on a commission by how much of a lawyer’s bills they cut, and by trying to impose unreasonable billing guidelines on law firms. Cumis firms therefore will make legal strategy decisions against that backdrop. They will decide strategy based not only on whether they think legal work is necessary to their client’s defense, but, the possibility that the insurer paying their bills will file an expensive reimbursement action against them that unreasonably challenges their fees.

In the proceedings below, the trial court and the appellate court held a breaching insurer has no right to seek reimbursement directly from Cumis counsel. The lower court’s opinion enhanced the ability of independent counsel retained by insureds to vigorously prosecute their clients’ cases without fear of a possible action for reimbursement by insurers. It sent a strong message: insurers who reserve their rights and refuse to fund the defense of Cumis counsel take a big chance that they will be stuck paying those fees without any real ability to challenge them.

The California Supreme Court obliterated that vitally important message and sent its own. Cumis lawyers better carefully scrutinize their bills and only perform legal work that is absolutely reasonable and necessary to defending their clients because, if they cross the line, they will end up with a huge legal bill of their own. This decision, no doubt, will have a chilling effect on how Cumis lawyers represent their clients.

This decision would appear to undermine the purpose of the Cumis doctrine codified in Civil Code section 2860: when the insurer has a conflict with its insured on how to defend the underlying liability case because the outcome of a reserved coverage issue can be controlled by how it is defended, the insurer must pay for an independent defense lawyer chosen by and with allegiance solely to its insured to defend the case. How can a lawyer be truly independent from the client’s insurer and solely dedicated to protecting the insured’s interests when the insurer has the power to question every defense decision the lawyer makes and recoup legal fees that were arguably not wisely spent? Even the most ethical, skilled lawyer will measure each strategy decision he makes not just by whether it will benefit his client’s defense but by whether an insurer may have room to argue against the strategy. What is the silver lining? Perhaps the courts will indeed limit this holding to its very unique facts and confine its application. We can only hope.

9th Circuit puts final nail in coffin for discretionary clauses in insurer-funded ERISA plans

Disability and life insurers frequently include clauses in their insurance policies affording them complete discretion to decide whether a claim has merit. The clauses usually state the insurer has total discretion to decide whether the claimant is eligible for the policy’s benefits, to decide the amount, if any, of benefits to which they are entitled, to interpret the policy’s terms how they see fit, or something similar. Employers regularly include these same types of “discretionary clauses” in their employee welfare benefit plan documents, and if a group insurance policy is the funding source of the plan’s benefits, they then delegate that discretion to decide the merits of claims to the insurer.

Employee benefit plans and the corresponding group insurance policies that fund them are governed by a federal law, the Employee Retirement Income Security Act of 1974 (“ERISA”), codified at 29 U.S.C. section 1001, et seq. The result of these discretionary provisions in ERISA cases, until recently, has been that a federal court reviewing the insurance company’s claim decision had to give deference to whatever the insurer decided, even if the court disagreed with the insurer’s decision, unless the insurer abused its discretion by acting arbitrarily and capriciously. The district court was required to apply an “abuse of discretion” or “arbitrary and capricious” standard of review rather than a de novo standard (where no such deference to the insurer’s decision is given). The former standard, obviously, is much more difficult than the latter for an insured to meet. While a district court applying an abuse of discretion standard to the insurer’s claim decision is not required to “rubber stamp” it with no oversight, its ability to overturn the decision is far more limited than when reviewing the insurer’s decision de novo.

In most types of insurance policies, insurers have not been so brazen to include these draconian insurer discretionary provisions. It is astonishing that the California legislature let disability and life insurers get away with this practice for so long. The clauses directly contravene many “black-letter” pro-policyholder California insurance laws (such as the doctrine that ambiguous policy provisions must be strictly construed against the insurer as the drafter). Think about it. Under these provisions, the company legally responsible to pay an employee’s or beneficiary’s benefit claim also has nearly unchecked power to decide whether the claim has merit and to interpret the plan’s provisions. From the standpoint of a California policyholder and their counsel, that is shocking, truly shocking. It demonstrates the power of the insurance company lobby.

Not surprisingly, these discretionary provisions lead to a higher rate of claim denials by disability and life insurers than in other types of policies and, in our opinion, industry wide abuse, particularly for disability insurers. The U.S. Department of Labor estimates that a whopping 75 percent of long-term disability claims are denied. The statistics seems to provide empirical support for Lord Acton’s famous phrase uttered in the 1800’s, “power tends to corrupt and absolute power corrupts absolutely.”

On January 1, 2012, no doubt aware of this potential for abuse by insurers, the California legislature decided to put an end to discretionary provisions in disability and life insurance contracts. It enacted California Insurance Code section 10110.6, which made void and unenforceable any grant of discretionary authority to an insurer or agent of the insurer in “a policy, contract, certificate, or agreement” that provides or funds disability or life insurance coverage for California residents. More than a dozen states have similar laws, as noted in Standard Ins. Co. v. Morrison, 584 F.3d 837, 841 (9th Cir. 2009) (upholding Montana Insurance Commissioner’s practice of disapproving disability insurance policy forms with clauses vesting discretion in insurers). These states include California, Connecticut, Hawaii, Idaho, Illinois, Indiana, Kentucky, Maine, Maryland, Montana, New Jersey, New York, South Dakota, Texas, Utah, Vermont, Washington, Wyoming and perhaps others (some bar discretionary clauses in health insurance or other types of policies, not just in disability and life insurance policies). Several of these states banned or limited discretionary clauses in response to a notorious example of one insurer who, to boost its profits, had intentionally used discretionary clauses to repeatedly deny claims it knew were valid. See Saffon v. Wells Fargo & Co. Long Term Disability Plan, 522 F.3d 863, 867 (9th Cir. 2008).

Despite California’s statutory ban on insurer discretionary clauses, group disability and life insurers have steadfastly challenged the statute’s application to ERISA-governed policies and related employee welfare benefit plan documents. They routinely argue that ERISA preempts the State law, the statutory ban applies just to insurance policies but not plan documents, and other creative arguments, all to sustain the status quo of their mostly unfettered power to decide claims with little scrutiny by courts. Their arguments have been repeatedly rejected by most California federal district courts. A few rogue courts in the minority have agreed with the insurer’s creative arguments. This left, until now, some uncertainty about what the law in the 9th Circuit is for California employees.

On May 11, 2017, the 9th Circuit put the final nail in the coffin for grants of discretionary authority to insurers in ERISA-governed insurance policies and employer plan documents. Orzechowski v. Boeing Co. Non-Union Long-Term Disability Plan, No. 14-55919, 2017 DJDAR 4376 (9th Cir. May 11, 2017). In that case, The Boeing Company (“Boeing”) offered its employees long-term disability coverage through an ERISA-governed plan. Boeing purchased a group disability insurance policy from Aetna Life Insurance Company (“Aetna”) to fund the plan’s disability benefits and vested Aetna with discretion to decide the merits of benefit claims. Aetna’s policy granted it discretionary authority to “review all denied claims,” “determine whether and to what extent employees and beneficiaries are entitled to benefits,” and “construe any disputed or doubtful terms of the policy.” The policy further specified that, “Aetna shall be deemed to have properly exercised such authority unless Aetna abuses its discretion by acting arbitrarily and capriciously.” Boeing’s principal plan document, The Boeing Company’s Master Welfare Plan (“Master Plan”), similarly contained a broad grant of discretionary authority delegated to Aetna which included the power to “determine all questions that may arise including all questions relating to the eligibility of Employees and Dependents to participate in the Plan and amount of benefits to which any Participant or Dependent may become entitled.” In short, the group policy and employer’s plan document each gave Aetna fairly unchecked power to decide the merits of claims, the claims Aetna was responsible to pay.

A Boeing employee, Talana Orzechowski, submitted a claim for disability benefits under the plan because she suffered from physical illnesses, chronic fatigue syndrome and fibromyalgia, and could no longer perform her job duties as a result. After paying the claim for two years, Aetna decided to terminate her benefits based upon the plan’s 24-month limit for disabilities primarily caused by mental illness. Aetna determined Ms. Orzechowski’s condition was not physical but only mental based upon the opinions of medical consultants it hired to review her medical records. Aetna disagreed with Ms. Orzechowski’s treating physicians. They concluded after examining her in-person that she had a physical disability and that her mental illness, depression and anxiety, was secondary to her physical problems, chronic fatigue syndrome and fibromyalgia.

Ms. Orzechowski filed suit in federal district court under ERISA to recover her disability benefits. Following a bench trial, the trial court upheld Aetna’s benefit decision. It reviewed Aetna’s decision for an abuse of discretion (because Boeing’s Master Plan gave Aetna discretionary authority), rather than de novo, the default standard in an ERISA case.

The 9th Circuit held the district court should have applied a de novo standard of review to Aetna’s claim decision. It ruled that California Insurance Code section 10110.6 voided the discretionary provisions in both Aetna’s insurance policy and Boeing’s plan documents, including in the Master Plan. It reversed the district court’s decision and remanded the case for it to review the insurer’s claim denial de novo, with instructions to focus on Ms. Orzechowski’s physical illnesses that Aetna had ignored when terminating her benefits.

ERISA Preemption and Savings

The 9th Circuit rejected Boeing’s argument that ERISA preempts the California statute. The Court reasoned that while the California law comes within ERISA’s broad preemption clause, which preempts “any and all State laws insofar as they may now or hereafter relate to any employee benefit plan,” 29 U.S.C. § 1144(a), ERISA’s savings clause saved the California law from preemption. The savings clause saves from preemption “any law of any State which regulates insurance, banking, or securities.” 29 U.S.C. § 1144(b)(2)(A). For the savings clause to apply, the State law must satisfy a two-part test set forth in Kentucky Association of Health Plans v. Miller, 538 U.S. 329, 342 (2003). First, the State law must be specifically directed toward entities engaged in insurance, and second, the law must substantially affect the risk pooling arrangement between the insurer and insured. After some very technical arguments, the Orzechowski Court held the California statute meets both prongs of the Miller test, “regulates insurance,” and, therefore, is saved from ERISA preemption.

Statute Interpretation Arguments

The Court rejected Boeing’s other arguments that section 10110.6 did not void the discretionary clause in the Master Plan because it (1) only voids discretionary clauses in insurance policies but not in employer plan documents, and (2) is not retroactive and became effective on January 1, 2012 after the January 1, 2011 Master Plan. The Court reasoned the California statute, by its terms, covers not only “policies” that provide or fund disability insurance coverage but also “contracts, certificates, or agreements” that do so. It cited to 9th Circuit precedent holding that an ERISA plan is a “contract” and concluded Boeing’s Master Plan falls under section 10110.6, not just Aetna’s policy.

The Court rejected Boeing’s second argument because the California statute, while not retroactive, voids discretionary provisions in any policy “or contract” that renews after the statute’s effective date of January 1, 2012. The statute defines “renewed” as “continued in force on or after the policy’s anniversary date.” The policy’s anniversary date was January 1, 2012 and the Master Plan continued in force thereafter. The Master Plan, a contract, thus “renewed” after the statute’s effective date.

Conclusion

While Orzechowski marks the end of an era – that had allowed discretionary clauses in insurer-funded employee benefit plans providing disability and life coverage to California residents – there is still an open question whether California’s statutory ban will be extended to self-funded plans. Orzechowski did not reach that issue. Many large employers fund their benefit plans with their own money rather than through an insurance policy. Thus, even after Orzechowski, employers and their self-funded plans will continue to argue California’s ban does not apply to them. The debate remains alive and well in California (for self-funded plans) and, for both insurer- and self-funded plans, in most states because they have not enacted similar laws to California’s statute.

One thing we know for certain based on the 9th Circuit’s Orzechowski decision: discretionary clauses are void and unenforceable in insurer-funded ERISA employee benefit plans providing disability or life coverage for California residents, whether the clause appears in the insurer’s group policy, the employer’s separate plan document or both. Federal judges will thus have to start applying a standard of review more favorable to claimants, de novo, in insurer-funded ERISA plans. This will probably lead to better results for claimants in litigated cases and, potentially, less claim denials from group disability and life insurers in the first instance.

Life Insurer on the Hook for Breaching Terminated Contract

Life, health and disability insurers, whether governed by ERISA or state insurance bad faith laws, often do not have your best interests in mind, despite what the law requires of them. Insurers, like other businesses, are motivated by profits. Sometimes that drive leads to crossing legal, ethical or moral lines to improve the bottom-line. That is what occurred in a recent pro-policyholder Ninth Circuit Court of Appeal case, Burnett v. Conseco Life Insurance Company, 2017 WL 1828145 (9th Cir. May 4, 2017) (reversing the district court decision found at 87 F. Supp. 3d 1238 (N.D. Cal. Apr. 9, 2015)). In that case, applying California state insurance bad faith laws, the Ninth Circuit held a life insurer cannot completely absolve itself from further liability under a whole life insurance policy by terminating it. If it breaches the policy before termination, the life insurer is liable for damages caused by that breach, even if the policy is later surrendered. While that is the legal principle gleaned from the case, and it is an important one, what is far more interesting is the look into the life insurer’s boardroom and corporate decision-making the case facts provide.

Jeffrey Burnett, Joe Camp and many other class action plaintiffs had purchased whole life insurance policies from a life insurer in the 1980s and 1990s, which policies were later assumed by the defendant, Conseco Life Insurance Company. The policies provided a death benefit, investment income to the insured during his lifetime (including a guaranteed rate of interest on the policy’s account value), and a cash value payable upon the policy’s surrender. The policies had explicit provisions governing the amount of premiums that could be charged, and even included a “vanishing premium” after five years if certain policy formulas were met.

By the early 2000s, Conseco was losing money on the policies. In 2008, it substantially raised the premiums on the product to all policyholders in breach of the policy’s premium provisions and formulas. Conseco expected and intended thousands of policyholders would respond to the shock of massive premium increases by surrendering their policies or letting them lapse because they were no longer economically worth keeping, thus saving Conseco tens of millions of dollars on a money-losing product line. The strategy worked. Mr. Burnett, Mr. Camp and several other class members surrendered their policies in 2009 and 2010 because they were too expensive. In short, Conseco forced its policyholders to surrender their whole life insurance policies by improperly raising the premiums in violation of the terms of the contract. The company was driven by greed and profit, not its policyholders’ interests, contractual rights and benefits as the law requires.

The policyholders entered surrender agreements with Conseco whereby their policies were terminated in exchange for it paying the cash surrender value of the policies. That was far less than the death benefit. For example, one of the class action members, Mr. Camp, received a little over $89,000 when he surrendered his policy, but the death benefit, which was no longer available because the policy terminated upon surrender, would have been $500,000.

Burnett, Camp and other class members, now former policyholders of their terminated policies, sued Conseco for breach of contract, alleging it had forced them to surrender their policies by raising premiums in breach of the policy’s terms. The former insureds sought consequential damages caused by Conseco’s breach, such as the difference between the premiums they had been paying to Conseco and the premiums they would have to pay to another insurer in the marketplace for a like amount of whole life insurance, i.e. the replacement cost of the life insurance policies they had surrendered.

Conseco filed a motion to dismiss the Complaint for failure to state a claim, arguing that a former policyholder cannot sue on a terminated life insurance contract. The plaintiffs argued that they were entitled to consequential damages for Conseco’s breaches of contract because the breaches occurred while their policies were still in effect (even though the policies were later surrendered). The district court agreed with the insurer and dismissed the case, reasoning that because the plaintiffs received cash value upon the termination of their life insurance policies which were now surrendered, their claims were no longer “legally cognizable.”

The Ninth Circuit reversed the district court, siding with the former policyholders. The Ninth Circuit cited California law that “generally permits pre-termination breach of contract claims, including claims involving insurance contracts.” And, where “a contract is terminable at will, liability attaches for breaches occurring prior to the termination of the contract.” In other words, because Conseco breached the terms of the policies before the policies terminated (by illegally raising premiums), the now former policyholders could sue for those pre-termination breaches even post-termination of the contracts. They were entitled to recover the consequential damages caused by the pre-termination breaches – the replacement cost of the surrendered policies – but not the death benefit. The Ninth Circuit also pointed out that in the surrender agreements between the plaintiffs and Conseco, the plaintiffs did not expressly waive their right to sue for breach of contract.

Our take: The life insurer did not fare too badly. It lost the legal battle but won the profitability war. While it was found liable for breach of contract, it is economically better off for breaching. It forced numerous insureds to surrender their policies by drastically raising premiums (when it did not have that right under the contract), which allowed it to get out from under having to pay the death benefit and ongoing investment income on thousands of policies. It was able to dump an unprofitable product for a fraction of what it would have cost had the policies remained in force. It only had to pay for the plaintiffs’ cost to replace their terminated policies in the marketplace instead of much higher policy benefits.

The Burnett case is just one example of how some life insurers use deceitful business practices to avoid paying policy benefits. The insurer was willing to breach the contract to get the profit it wanted. We have seen far worse in the way of insurers denying legitimate claims, especially when the insured has not hired an experienced ERISA or bad faith lawyer. Life, health and disability insurers love to take your premiums but they resist paying claims. Do not let your insurer do that. If you have a legitimate life, health or long-term disability insurance claim, you need an experienced attorney to fight hard for you. At McKennon Law Group PC, our lawyers have decades of experience litigating these types of claims, both under ERISA and state insurance bad faith laws. Let us try to win your case for you.

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