Guest Article

(From the March 15, 2010 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

Conflict Forming in the Circuits: ERISA Preemption of State Laws that Prohibit Discretionary Clauses

The Tenth Circuit recently held that ERISA preempts a Utah state insurance statute which prohibits insured employee benefit plans from including "discretionary clauses" other than those prescribed by the statute. Discretionary clauses, which reserve to the plan administrator the discretion to interpret the plan document and determine the benefits payable, have long been staple language in ERISA plans. The decision conflicts with decisions in the Ninth and Sixth Circuits, which held such state laws enforceable.

Overview of Legal Framework

ERISA preempts any and all state laws insofar as they may now or hereafter relate to any employee benefit plan. However, ERISA carves-out or "saves" from preemption state laws that regulate insurance. The Supreme Court has ruled that the test for whether a state law "regulates insurance" is two-fold: first, the law must be directed at entities engaged in insurance; and second, the law must substantially affect the risk pooling arrangement between the insurer and the insured. See ERISA § 514.

Both the Ninth and the Sixth Circuits have held that state laws that prohibit insurance contracts from including discretionary clauses are laws that "regulate insurance" and, therefore, are not preempted by ERISA. As a result, such laws would apply to insured ERISA plans by virtue of their applicability to the plan's insurance policies or contracts.

Tenth Circuit Analysis

In contrast, only two months after the October 2009 decision by the Ninth Circuit, the Tenth Circuit came to a different conclusion. It addressed a Utah statute that allowed discretionary clauses in an insurance contract related to an employee benefit plan only if the language was substantially similar to safe-harbor language prescribed by the statute. In applying the two-fold test established by the Supreme Court to determine whether the Utah statute "regulated insurance," the Tenth Circuit easily concluded that it did not. Although aimed at entities engaged in insurance, the Utah statute did not affect the risk-pooling between the insurer and the insured:

As a result, the statue was preempted by ERISA and it did not apply to the insured welfare benefit plan in the case. The plan's discretionary clause was held valid.

The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations. If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067, Stephen LaGarde 202.879-5608, Bart Massey 202.220.2104, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Deborah Walker 202.879.4955. Copyright 2010, Deloitte.