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The 9th Circuit Upholds California’s Prohibition of Insurance Policy Discretionary Clauses

In Orzechowski v. The Boeing Company Non-Union Long-Term Disability Plan, et al., Case No. 14-55919 (9th Cir. May 11, 2017), the Ninth Circuit reversed a district court’s decision based on the district court’s failure to apply the correct standard of review.  At issue was the applicability of California’s ban on discretionary clauses.  Under California’s Insurance Code §10110.6, discretionary clauses are prohibited and rendered void and unenforceable if they are contained in an insurance policy or plan.  Specifically, §1011.6 states:

If a policy, contract, certificate, or agreement offered, issued, delivered, or [continued in force on or after the policy’s anniversary date] … contains a provision that reserves discretionary authority to the insurer… that provision is void and unenforceable.

The defendant attempted to avoid this section of California’s insurance code by arguing that this ban on discretionary clauses only applied to insurance policies and not other plan documents.  The Ninth Circuit rejected this argument and held “10110.6 covers not only ‘policies’ that provide or fund disability insurance coverage but also ‘contracts, certificates, or agreements’ that ‘fund’ disability insurance coverage… thus the Master Plan falls under § 10110.6.”

Why do discretionary clauses matter?

In ERISA cases, a federal judge is going to look at your case under one of two perspectives – collectively called the standard of review.  The first standard of review – and the default standard – is the de novo standard. Under this standard, the judge will decide whether the decision to deny your claim was right or wrong.  This is the standard you want for your claim.

The second standard of review is referred to as the arbitrary and capricious (A&C) standard (the deferential standard.  Under this standard, the judge does not consider whether the decision was right or wrong.  Instead, the judge looks solely to see whether the insurance company’s decision was reasonable.  Even if the judge disagrees with the decision, under the A&C standard the claim denial will not be reversed.  Insurance companies love the A&C standard and fight aggressively to get it.  

The A&C standard creates a very high burden for ERISA plaintiffs to overcome.  If the insurance policy contains a “discretionary clause” – a grant of discretion — the judge will likely apply the A&C standard.  

Because of the significant impact “discretionary clauses” have on ERISA insurance claims – favoring the insurance company over the insured plaintiff – a number of states have enacted insurance statutes and regulations to prohibit insurance companies from inserting “discretionary clauses” in their policies.  By way of example, as discussed in the Orzechowski case above, California’s Insurance Code expressly bans discretionary clauses and renders them void and unenforceable.  However, as Orzechowski shows, even when there is a clear state insurance statute or regulation banning discretionary clauses, insurance companies will continue to argue for the A&C standard – in many cases, not making the judge aware of the statutory prohibition despite a fiduciary and ethical obligation to do so.  

The standard of review can be a game changer.  This is why it is crucial to retain qualified ERISA counsel when filing a lawsuit to challenge an insurance company’s denial of short-term disability, long-term disability, or life and accident benefits.  

Grabhorn Law has years of ERISA experience litigating insurance claims, including working with state insurance regulators to prohibit the use of discretionary clauses.  If you are dealing with a potential lawsuit, you likely have many questions.  Grabhorn Law is available to provide you with an initial free consultation to answer your questions and, if needed, assist you with your lawsuit.