Insurance bad faith claims are not preempted.

Given the Supreme Court's Unum v. Ward decision, plaintiffs can fight insurance industry abuses fostered by ERISA preemption.

In 1987, the U.S. Supreme Court issued its decision in Pilot Life Insurance Co. v. Dedeaux.(1) The case held that Mississippi's cause of action for tortious breach of contract was preempted by the Employee and Retirement Income Security Act (ERISA). The Court probably did not realize what devastation it would bring.

Many courts have interpreted Pilot Life to hold that all insurance bad faith claims are preempted by ERISA, and most attorneys assume this is true. However, the Supreme Court's more recent decision in Unum Life Insurance Co. v. Ward helps counter that assumption.(2)

The courts that have held that ERISA preempts bad faith claims have done so entirely on the basis of the Pilot Life decision. Because of the Unum decision, it is now clear that these courts have long misconstrued Pilot Life. The U.S. Supreme Court has never held that ERISA preempts insurance bad faith claims. In Unum, the Court made it clear that the lower courts improperly applied the Pilot Life decision. Now, the federal district courts are beginning to recognize the significance of Unum and are departing from appellate courts that have ruled that ERISA does preempt such claims.

When the courts apply ERISA to life, health, and disability insurers, the companies are immunized against liability for even the most outrageous bad faith conduct. For insureds who are covered by these policies as part of an employee benefit plan, remedies are limited to the narrow ones permitted under ERISA.

In an action by an insured, consequential damages--such as those for emotional distress--punitive damages, and jury trials are not available under ERISA. An insurer may not even have to prove that it was correct to deny a claim, only that it did not act arbitrarily or capriciously. To prove that, the insurer may be able to rely solely on the claim file it built in secret and without the insured's knowledge.

The application of preemption principles in bad faith litigation has led to the unparalleled and deliberate abuse of insureds by insurers, who believe themselves to be immunized against liability. After Unum, they are no longer entitled to the benefits of this assumption.

This article summarizes the development of ERISA preemption and explains the Pilot Life case and the potential impact of Unum. The contentions are based primarily on principles that are clearly set forth in California law. The conclusion should be the same in other states with bad faith principles similar to those in California. We believe that Unum is the beginning of the end for ERISA preemption.

The purpose of ERISA was to protect employees' pension and benefit plans, which were not being protected adequately by employers.(3) Congress expressly and specifically declared that the legislation was intended to protect "the continued well-being and security of millions of employees and their dependents."(4) ERISA applies to benefits that accrue to an employee under a plan established or maintained by an employer to provide benefits to its employees.(5)

ERISA contains two pertinent provisions, the preemption clause and the savings clause. The preemption clause states, "except as provided in [the savings clause] the provisions of this title ... shall supersede any and all state laws insofar as they ... relate to any employee benefit plan...."(6)

The savings clause says "nothing in this title shall be construed to exempt or relieve any person from any law of any state which regulates insurance."(7)

The Pilot Life case

This clear congressional intent--that "any law of any state which regulates insurance" is not preempted--was clouded by the first major Supreme Court ruling on the issue. In Pilot Life, Everate Dedeaux sued Pilot Life Insurance Co. for its alleged wrongful termination of his disability benefits. Dedeaux admitted that his insurance policy was part of an employee benefit plan covered by ERISA.

Dedeaux claimed, however, that the Mississippi law of bad faith, "tortious breach of contract," was a law regulating insurance that fell within ERISA's savings clause. Therefore, he argued, his claim was not preempted. The Supreme Court rejected his argument, ruling that the claim was preempted.(8)

In its analysis, the Court applied a "commonsense approach." It analyzed the law using the three factors specified in the McCarran-Ferguson Act,(9) which precludes undue federal influence over state statutes that regulate the "business of insurance."(10) These factors were whether the law (1) effected the transfer or spreading of the policyholder's risk, (2) was integral to the relationship between the insurer and the insured, and (3) was limited to the insurance industry.

The Court held that the Mississippi law did not satisfy these three criteria. It did not effect the transfer or spreading of the insurance risk, was no more integral to the relationship between the insurer and the insured than any other law of general application, and was not limited to the insurance industry.(11)

The Court also held that the law was preempted because it conflicted with ERISA's specified remedies, which the Court found were intended to be exclusive.(12) The justices relied heavily on the arguments made by the U.S. solicitor general, who contended that the exclusive enforcement vehicle for an improper denial of an ERISA claim was the civil enforcement remedy under the act. Allowing various state causes of action, the solicitor general claimed, would obstruct ERISA's purposes and objectives.(13)

The Court noted that ERISA's remedies did not include emotional distress damages or punitive damages. ERISA's remedies, it held, are limited to the rights to sue to recover benefits due, to enforce the participant's rights under the plan, and to clarify the insured's rights to future benefits. Given this enforcement program, the Court said, the federal scheme would be completely undermined "if ERISA-plan participants ... were free to obtain remedies under state law that Congress rejected in ERISA."(14)

This discussion, however, was limited to the context of a law that did not fall within the savings clause.

Preemption spreads

The Pilot Life decision led to a widespread denial of bad faith claims across the states. State courts immediately, and often without any independent analysis, threw out claims in these cases even though, unlike Mississippi's law, many states' bad faith laws are limited exclusively to insurance claims.(15) These courts based their conclusions on the second part of Pilot Life, which they understood to hold that any remedy inconsistent with ERISA's remedies was preempted--even if the law invoked by the plaintiff fell within the savings clause and, thus, would seem on its face to be "saved" from preemption.

A good example is the Kanne v. Connecticut General Life Insurance Co. case,(16) in which the Ninth Circuit Court of Appeals was asked to determine whether ERISA preempted a claim under the California Insurance Unfair Practices Act.(17) The court assumed that the statute "regulated insurance" and therefore fell within the savings clause.

Nonetheless, it held:

   Kanne's argument asks us to limit Pilot Life's preemption holding to only
   those state laws which do not fall within the savings clause. To accept
   this argument, however, we would have to ignore the second half of Pilot
   Life ... in which the Court made abundantly clear that its preemption
   holding was equally based on its acceptance of the solicitor general's view
   that "Congress clearly expressed an intent that the civil enforcement
   provision of ERISA [sections] 502(a) be the exclusive vehicle for [actions]
   asserting improper processing of a claim for benefits."(18)

Decisions like Kanne have effectively precluded insureds from pursuing state bad faith claims when the insurance plan falls under ERISA.

On April 20, 1999, however, the Supreme Court issued its unanimous decision in Unum, which dramatically altered the ERISA landscape.

The Unum case

Plaintiff John Ward was insured under a group long-term disability insurance policy issued by Unum to his employer, Management Analysis Company (MAC). This policy was issued as part of MAC's employee benefit plan and, therefore, was covered by ERISA. The policy required that a proof of claim be submitted to Unum within 18 months from the onset of the claimant's disability.

Ward became disabled on May 5, 1992, but because he was unaware that Unum provided coverage, he did not submit his disability claim until April 1994, nearly two years later. Unum denied the claim on the grounds that it was untimely, and Ward filed an ERISA action against the company, but only in federal court. The state law at issue--California's notice-prejudice rule--arose not as a separate claim but as a controlling rule of law governing when insurers may deny claims based on untimely notice.

Ward claimed that Unum's denial violated California's notice-prejudice rule, a judicially created doctrine prohibiting an insurer from denying an untimely insurance claim unless the insurer can prove it suffered actual prejudice. Unum argued that ERISA preempted California's rule.

First, Unum claimed that ERISA's savings clause did not apply, because the rule was not a law regulating insurance. Second, it argued that even if the notice-prejudice rule fell within the clause, it provided a remedy in conflict with ERISA's civil enforcement scheme. Therefore, Unum claimed, the California rule was preempted even if it fell within the savings clause.

The Supreme Court rejected Unum's arguments in an opinion by Justice Ruth Bader Ginsburg. In analyzing whether the notice-prejudice rule fell within the savings clause, the Court applied the framework it established in Pilot Life. "First, we must ask whether, from a `commonsense view of the matter' the contested prescription regulates insurance. Second, we consider three factors employed to determine whether the regulation fits within the `business of insurance' as that phrase is used in the McCarran-Ferguson Act."(19)

The Court found that the notice-prejudice rule is grounded in policy concerns specific to the insurance industry, and that it easily satisfies the commonsense requirement of the analytical framework.

In addressing the McCarran-Ferguson factors, the Court clarified that all three factors heed not apply. These factors, the justices said, are only "considerations [to be] weighed."(20) Without addressing the transferring-or-spreading-of-risk factor, the Court easily found that the notice-prejudice rule plays an integral part in the relationship between the insurer and the insured and that the rule is limited to the insurance industry. Following these findings, the Court held that the rule falls within ERISA's savings clause.

Unum argued, however, that even if the notice-prejudice rule falls within the savings clause, the holdings in cases such as Kanne still require that the plaintiff's claim be preempted because ERISA's remedies are exclusive. Unum claimed that application of the notice-prejudice rule provides a remedy not authorized by ERISA and that, under the authority of Pilot Life and cases such as Kanne, the rule is preempted.

The Court said it did not have to address the preemption issue because the notice-prejudice rule does not provide an additional remedy:

   Unum next contends that ERISA's civil enforcement provision, [sections]
   502(a).... preempts any action for plan benefits brought under state rules
   such as notice-prejudice. Whatever the merits of Unum's view of [sections]
   502(a)'s preemptive force, the issue is not implicated here. Ward sued
   under [sections] 502(a)(1)(B) `to recover benefits due ... under the terms
   of his plan.' The notice-prejudice rule supplied the relevant rule of
   decision for this [sections] 502(a) suit. The case therefore does not raise
   the question whether [sections] 502(a) provides the sole launching ground
   for an ERISA enforcement action.(21)

Through that statement, the Court rejected the conclusion in Kanne and other decisions that Pilot Life eliminates the possibility of additional remedies. The Court made it clear that the question of whether non-ERISA remedies are available remains open. Accordingly, the Court seemingly invited a case for review where, unlike the situation presented in Unum, the insured pursued a state-law bad faith claim separate and independent of ERISA.

In a footnote, the Supreme Court explained that it discussed the issue of whether outside relief could coexist with ERISA's remedy provisions in Pilot Life. In its note, the Court clarified that the solicitor general's position on the issue announced in Pilot Life was made in the context of a law not specifically directed to the insurance industry and thus not saved from preemption.

The Supreme Court then explained in note 7:

   The solicitor general now maintains that the discussion of [sections]
   502(a) in Pilot Life "does not in itself require that a state law that
   `regulates insurance,' and so comes within the terms of the savings clause,
   is nevertheless preempted if it provides a state law cause of action or
   remedy."

      We need not address the solicitor general's current argument, for Ward
   has sued under [sections] 502(a)(1)(B) for benefits due, and seeks only the
   application of saved state insurance law as a relevant rule of decision in
   his [sections] 502(a) action.(22)

The Court stated definitively that when a law that, unlike the Mississippi law, does fall within the savings clause provides a remedy outside those set forth in ERISA, the decision in Pilot Life does not foreclose the additional remedy. Indeed, this is precisely what the solicitor general stated.

Plaintiff lawyers should argue there is no reason for a state court to conclude automatically that a state law concerning bad faith conflicts with or otherwise frustrates ERISA. The purpose of both is to protect the insured.

The fact that these two laws can exist in harmony is confirmed by another unanimous Court decision written by Ginsburg only three months before the Unum opinion was issued. Humana, Inc. v. Forsyth shows there is nothing that would prevent a state law remedy from coexisting with ERISA's remedy.(23)

In Humana, a plaintiff, alleging a pattern of racketeering activity, sought to assert a federal RICO claim against an insurance company. The insurer moved to dismiss the RICO claim, citing the McCarran-Ferguson Act, which bars the application of any federal statute that would "invalidate, impair, or supersede" any state law regulating the business of insurance. The insurer claimed that RICO impaired the state's insurance laws and could not be asserted against the company.

The Court ruled that the McCarran-Ferguson Act does not prohibit RICO claims. The justices held that "a federal law which proscribes the same conduct as state law but provides materially different remedies [does not] `impair' state law under ... McCarran-Ferguson"(24) and that the remedies could coexist.(25)

Using Humana, plaintiff lawyers should argue that state law remedies for bad faith and ERISA's remedies can coexist without impairing ERISA's scheme. This is particularly true considering that the act specified that state insurance laws would remain in force after ERISA's enactment and that "nothing" in ERISA would affect "any" of those laws.

There are many published and unpublished opinions from courts around the country agreeing that, after Unum, ERISA no longer preempts bad faith claims.(26) Some of these decisions were issued even after previous appellate court rulings, in accordance with Pilot Life, held that ERISA preempted such claims.(27)

Perhaps the most persuasive case is the decision in Hill v. Blue Cross Blue Shield of Alabama, in which the court found that previous rulings no longer applied after Ward. The court ruled:

   There is no way to read [Unum] except as an acknowledgment by the highest
   court that if Mississippi's cause of action for bad faith breach of an
   obligation to pay had been allowable only as to insurance policies, the
   action addressed in Pilot Life would have been saved from ERISA preemption
   by [sections] 1144(b)(2)(A). Although there are some district courts which
   disagree with this court's reading of Unum, this court finds nothing fuzzy
   or ambiguous about what the Unum Court was saying. Surely, at least one
   justice out of nine would have balked if he or she had detected any need to
   back off from what Justice Ginsburg clearly wrote for the whole court.(28)

Some courts, of course, have not accepted the significance of Unum.(29)

Judicial criticism

Respected members of the bench have voiced strong criticism of the preemption

argument in their rulings, particularly in cases involving managed care. They have decried the enormous abuses that have arisen in the insurance industry since the Supreme Court issued its opinion in Pilot Life. One particularly powerful statement was written by U.S. District Court Judge William Young in Andrews-Clarke v. Travelers Insurance Co.(30)

In that decision, Young explained in detail how the "tragic events set forth in [this] complaint cry out for relief."(31) Describing the result under a ruling of ERISA preemption as "absurd" and a "perverse outcome," he wrote:

   This case, thus, becomes yet another illustration of the glaring need for
   Congress to amend ERISA to account for the changing realities of the modern
   health care system. Enacted to safeguard the interests of employees and
   their beneficiaries, ERISA has evolved into a shield of immunity that
   protects health insurers, utilization review providers, and other managed
   care entities from potential liability for the consequences of their
   wrongful denial of health benefits.

      Thus, the practical impact of ERISA in this case is to immunize
   [insurers] from any potential liability for the consequences of their
   denial of benefits....

      ERISA is a "comprehensive statute designed to promote the interests of
   employees and their beneficiaries in employee benefit plans." It is
   therefore deeply troubling that, in the health insurance context, ERISA has
   evolved into a shield of immunity which thwarts the legitimate claims of
   the very people it was designed to protect. What went wrong?(32)

In Patrick v. Unum Life Insurance Co., a California state court judge expressed similar criticism, finding that the insurer's conduct in terminating disability benefits that were clearly owed to the insured was "a deliberate corporate policy" of disturbing behavior.(33) Noting that "for reasons best known to Congress, ERISA insulates the insurance carriers from financial punishment for even the most egregious conduct," the court awarded an insured substantial attorney fees.

The court told the parties at a hearing, "This case shocks my conscience. This case is a poster child for the need for exemplary damages in these cases.(34)

In Dishman v. Unum Life Insurance Co. of America, U.S. District Court Judge J. Spencer Letts wrote, regarding Unum's conduct in denying disability benefits to an insured:

   [T]he facts of this case are so disturbing that they call into question the
   merit of the expansive scope of ERISA preemption. [The insurer's]
   unscrupulous conduct in this action may be closer to the norm of insurance
   company practice than the court has previously suspected. This case reveals
   that for benefit plans funded and administered by insurance companies,
   there is no practical or legal deterrent to unscrupulous claims practices.
   Absent such deterrence, the bad faith denial of large claims, as a strategy
   for settling them for substantially less than the amount owed, may well
   become a common practice of insurance companies.(35)

Hope for the future

The Unum v. Ward decision offers plaintiffs real hope that ERISA preemption may be a thing of the past. Without any doubt, the 12 years between Pilot Life and Unum showed the Supreme Court that its earlier decision defeated ERISA's intended purpose by granting immunity to insurance companies.

ERISA provides that "any law of any state which regulates insurance" is not preempted. This seems clear on its face. The Court has taken note and sent word in Unum that contrary interpretations of its Pilot Life opinion are wrong.

With perseverance, plaintiff lawyers can show the trial and appellate courts that ERISA does not preempt insurance bad faith cases. They should press this issue at every opportunity.

Notes

(1.) 481 U.S. 41 (1987).

(2.) 526 U.S. 358 (1999).

(3.) 29 U.S.C. [sections] 1001(b)(2001); see Shaw v. Delta Air Lines, Inc., 463 U.S. 85, 105-06 (1983); Marshall v. Bankers Life & Cas. Co., 832 P.2d 573, 577-78 (Cal. 1992).

(4.) 29 U.S.C. [sections] 1001(a).

(5.) 29 U.S.C. [sections] 1002(1); see Marshall, 832 P. 2d 573, 577.

(6.) 29 U.S.C. [sections] 1144 (a).

(7.) 29 U.S.C. [sections] 1144(b)(2)(A).

(8.) Pilot Life, 481 U.S. 41, 48.

(9.) 15 U.S.C. [sections] 1012(a).

(10.) Pilot Life, 481 U.S. 41, 48.

(11.) Id. at 50-51.

(12.) Id. at 54.

(13.) Id. at 52.

(14.) Id. at 54.

(15.) See, e.g., Kanne v. Conn. Gen. Life Ins. Co., 867 F.2d 489 (9th Cir. 1989); Tri-State Mach., Inc. v. Nationwide Life Ins. Co., 33 F.3d 309, 311 (4th Cir. 1994); In re Life Ins. Co. of N. Am., 857 F. 2d 1190, 1194-95 (8th Cir. 1988); Commercial Life Ins. Co. v. Superior Court, 764 P.2d 1059, 1062 (Cal. 1988). See also Franklin H. Williams Ins. Trust v. Travelers Ins. Co., 50 F.3d 144, 151 (2d Cir. 1995); but see Rizzi v. Blue Cross, 253 Cal. Rptr. 541, 549 (Ct. App. 1988).

(16.) Kanne, 867 F.2d 489.

(17.) CAL. INS. CODE [sections] 790.03(h) (Deering 2001).

(18.) Kanne, 867 F. 2d 489, 494.

(19.) Unum, 526 U.S. 358, 367 (citations omitted).

(20.) Id. at 374.

(21.) Id. at 377 (emphasis added).

(22.) Id. at 377 n.7.

(23.) 525 U.S. 299 (1999).

(24.) Id. at 305.

(25.) Id. at 311-12.

(26.) Gilbert v. Alta Health & Life Ins. Co., 122 F. Supp. 2d 1267, 1268-69, 1271-73 (N.D. Ala. 2000); Hill v. Blue Cross Blue Shield, 117 F. Supp. 2d 1209, 1211-12 (N.D. Ala. 2000); Lewis v. Aetna U.S. Healthcare, 78 F. Supp. 2d 1202, 1205 (N.D. Okla. 1999). See also Selby v. Principal Mut. Life Ins. Co., No. 98 CIV. 5283 (RLC), 2000 WL 178191 (S.D.N.Y. Feb. 16, 2000) (finding New York insurance claims law is within savings clause and is not preempted).

(27.) Hill, 117 F. Supp. 2d 1209, 1211;Lewis, 78 F. Supp. 2d 1202, 1213-14.

(28.) Hill, 117 F. Supp. 2d 1209, 1211-12.

(29.) See, e.g., Corporate Health Ins., Inc. v. Texas, 215 F.3d 526, 538-39 (5th Cir. 2000); Bridges v. Provident Life & Accident Ins. Co., 121 F. Supp. 2d 1369, 1371-73 (M.D. Fla. 2000); Chilton v. Prudential Ins. Co. of Am., 124 F. Supp. 2d 673, 681-83 (M.D. Fla. 2000); Clancy v. Employers Health Ins. Co., 101 F. Supp. 2d 463, 465, 467 (E.D. La. 2000) (acknowledging that the issue is a close one).

(30.) 984 F. Supp. 49 (D. Mass. 1997).

(31.) Id. at 52.

(32.) Id. at 53-56.

(33.) No. 388506 (Cal., San Mateo County Super. Ct. 1999).

(34.) Reporter's Transcript of Proceedings at 23, Patrick No. 388506 (on file with authors).

(35.) No. 96-0015 JSL, 1997 WL 906146, at *11-12 (C.D. Cal. May 9, 1997).

Arnold R. Levinson and Terrence J. Coleman are partners in the firm of Pillsbury and Levinson in San Francisco.