BILL ANALYSIS Ó
SENATE INSURANCE COMMITTEE
Senator Ronald Calderon, Chair
SB 621 (Calderon) Hearing Date: March 23, 2011
As Introduced: February 18, 2011
Fiscal: Yes
Urgency: No
SUMMARY To invalidate any discretionary clause contained in a
life and disability insurance policy and to prohibit the
Insurance Commissioner from approving disability insurance
policies that contain such a discretionary clause.
DIGEST
Existing law
1.Contains broad standards regarding disability benefits
designed to prevent fraud, unfair trade practices, insurance
that is not economically sound for the insured and to ensure
that the language of disability policies is easily understood
and interpreted.
2.Includes minimum benefit standards, generally applicable to
individual disability policies, on the basis that group
policyholders are assumed to be in a better position to
bargain for desired benefits whereas individual policies are
more commonly sold without negotiation as to terms or
coverage.
3.Makes it illegal for any insurer to issue a disability policy
if the Insurance Commissioner notifies that insurer, in
writing, that the filed form of that policy does not comply
with the requirements of law;
4.Prohibits the Insurance Commissioner from approving any
disability policy which possesses any one of very numerous
specified characteristics, including, among others:
a) The Commissioner finds that it contains it
contains material that is unintelligible, uncertain,
ambiguous, or abstruse, or likely to mislead a person
SB 621 (Calderon) Page 2
who receives it.
b) If it contains payment rates that violate
specified standards.
c) If it does not provide for a grace period of at
least 7 days for policies providing for a weekly
payment of premium, at least 10 days for policies
providing for monthly payment of premium, and at least
31 days for all other policies.
This bill
1.Would make void and unenforceable a provision in a life
insurance or disability insurance policy, contract,
certificate, or agreement that is issued, delivered or
renewed, as defined, for a California resident, if the
provision reserves discretionary authority to the insurer, or
its agent, to:
a. determine eligibility for benefits or coverage;
b. interpret the terms of the policy, contract,
certificate, or agreement; or
c. provide standards of interpretation or review that
are inconsistent with the laws of this state;
2.Would define "Renewed" as continued in force on or after the
policy's anniversary date;
3.Would provide nothing in the bill prohibits an insurer from
including contract language informing their insured that as
part of its routine operations the insurer applies the terms
of its contracts for making decisions, including making
determinations regarding eligibility, receipt of benefits and
claims, or explaining policies, procedures, and processes, so
long as the provision could not give rise to a deferential
standard of review by any reviewing court;
4.Would prohibit the Insurance Commissioner from approving a
disability policy that reserves discretionary authority to the
insurer or its agent to
a. determine the eligibility for benefits or coverage
b. interpret the terms of the policy; or
c. provide standards of interpretation or review that
are inconsistent with the laws of this state.
SB 621 (Calderon) Page 3
COMMENTS
1. Purpose of the bill This Department of Insurance sponsored
bill would prohibit life and disability insurance policies
from containing a discretionary clause, and to prohibit the
Insurance Commissioner from approving disability insurance
policies that contain a discretionary clause;
The Department of Insurance explains that a discretionary
clause is a provision that reserves discretionary authority to
the insurer to determine eligibility for benefits or coverage,
to interpret the terms of the policy, or to provide standards
of interpretation or review that are inconsistent with the
laws of this state.
5.Background Under existing law, the Insurance Commissioner must
not approve disability insurance policies containing any
clause or provision that is "unintelligible, uncertain,
ambiguous, abstruse, or likely to mislead a person to whom the
policy is offered, delivered, or issued."
6.In 2002, The National Association of Insurance Commissioners
(NAIC), in recognition of the issues this bill seeks to
address, adopted a Model law (Model 42) which it describes as
follows:
"(MDL-42) This models helps ensure that health
insurance benefits and disability-income protection
coverage are contractually guaranteed, and helps avoid
the conflict of interest that occurs when the carrier
responsible for providing benefits has discretionary
authority to decide what benefits are due."
7.Subsequent to the adoption by the NAIC of Model Law 42,
Insurance Commissioner Garamendi's General Counsel issued a
letter opinion in 2004 on the question of whether
discretionary clauses were legal under California Law. The
opinion concluded they were not.
8.The main body of that 2004 Garamendi office opinion appears
below:
"It is this Department's position that all such
discretionary clauses in disability insurance contracts
violate California law and deprive insureds of
SB 621 (Calderon) Page 4
protections to which they are entitled. Moreover,
concurrently with the issuance of this letter, the
Department will withdraw any approval of any disability
forms known to contain such discretionary clauses. Such
withdrawal of approval is authorized under CIC
§10291.5(f) and §12957. We define "discretionary clauses"
as any contract provisions or language that purport to
confer on the insurer discretionary authority to
determine eligibility for benefits or to interpret the
terms or provisions of the contract. We note that
"disability" insurance includes coverage types classified
under CIC §106 such as disability income insurance and
health insurance.
Discretionary Clauses render the contract "fraudulent or
unsound insurance" within the meaning of CIC §10291.5.
Although the contract contains the insurer's promise to
pay benefits under the stated conditions, the
discretionary clause makes those payments contingent on
the unfettered discretion of the insurer, thereby
nullifying the promise to pay and rendering the contract
potentially illusory.
Because the discretionary clause effectively negates
operative terms of the contract, the contract becomes
unintelligible, uncertain, ambiguous, abstruse and likely
to mislead the insured, in violation of CIC §
10291.5(b)(1). The commissioner is prohibited from
approving such contracts or provisions. CIC § 10291.5
(b). The discretionary clause may cause California
insureds to believe the insurer's decision to be final
and to accept an unjustified denial of benefits.
Under CIC § 10291.5(b)(13), a disability insurance
contract may not be approved "if it fails to conform in
any respect with any law of this state." Therefore,
insureds may not be deprived of the protections of
California insurance law, including the covenant of good
faith and fair dealing, the principles of contract
interpretation such as the rule of reasonable
interpretation or the law of adhesion contracts under
which ambiguities are resolved in favor of the insured.
In the case of group, employer-sponsored disability
contracts that are governed by ERISA, the presence of a
discretionary clause has the legal effect of limiting
SB 621 (Calderon) Page 5
judicial review of a denial of benefits to a review for
abuse of discretion. An insurer's denial of benefits will
not be overruled by the court unless the insurer's
decision is found to be "arbitrary and capricious". This
standard of review deprives California insureds of the
benefits for which they bargained, access to the
protections in the Insurance Code and other protections
in California law.
It has sometimes been argued that ERISA requires all
benefit determinations under ERISA-governed insurance
contracts to be discretionary. There is, however, no such
requirement in the statute. Under ERISA, states are free
to determine the contents of insurance contracts.
Specifically, the states' authority to address the issue
of discretionary clauses in insurance contracts is
unencumbered by ERISA. Through ERISA's savings clause,
§514(b)(2)(A), states are entrusted with the regulation
of insurance. The Supreme Court "has repeatedly held that
state laws mandating insurance contract terms are saved
from preemption." Unum v. Ward, 526 U.S. 358, 375-376
(1999), citing Metropolitan Life Ins. Co. v.
Massachusetts 471 U.S. 724, 758 (1985). The Supreme Court
has acknowledged that states indirectly regulate ERISA
plans through the regulation of the plan's insurer and
the plan's insurer's insurance contracts. FMC Corp. v.
Holliday, 498 U.S. 52, 64 (1990). In Rush Prudential HMO,
Inc. v. Moran, 122 S. Ct. 2151 (2002), the Supreme Court
stated, "Nothing in ERISA, however, requires that these
kinds of decisions be so 'discretionary' in the first
place; whether they are is simply a matter of plan design
or the drafting of an Ýinsurance] contract." The Moran
court went on to say that a state law may prohibit
"designing an insurance contract so as to accord
unfettered discretion to the insurer to interpret the
contract's terms. As such, it does not implicate ERISA's
enforcement scheme at all, and is no different from the
types of substantive state regulation of insurance
contracts we have in the past permitted to survive
preemption?" Moran, at 2170. For these reasons, ERISA
does not preclude California's authority to prohibit the
use of discretionary clauses in insurance contracts.
In 2002, the National Association of Insurance
Commissioners (NAIC), adopted Model Act 42 titled
"Prohibition on the Use of Discretionary Clauses Model
SB 621 (Calderon) Page 6
Act" which recommends that each member state initiate
legislation prohibiting insurance contract clauses which
purport "to reserve discretion to the health carrier to
interpret the terms of the contract, or to provide
standards of interpretation or review that are
inconsistent with the laws of the state." The stated
purpose of the Model Act is "to assure that health
insurance benefits are contractually guaranteed, and to
avoid the conflict of interest that occurs when the
health carrier has unfettered authority to decide what
benefits are due."
Although the insurance industry has argued that the NAIC
Model Act is intentionally limited to health insurance
(implying that discretionary clauses should be
permissible in other insurance contracts, such as
disability income insurance), we are satisfied it was not
the intention of the NAIC to exclude disability income
and other coverages from the prohibition. The committee
drafting the model had a limited charge in the area of
health insurance and the NAIC is currently considering
expanding the scope of the Model Act to include other
non-health coverages, specifically disability income
insurance. Moreover, it is our opinion that the reasoning
supporting the NAIC's prohibition against discretionary
clauses is equally applicable to any insurance contract.
It is this Department's position that discretionary
clauses have great legal significance because they act to
nullify the bargained contract provisions and create an
illusory contract. In the ERISA context, they place a
severe burden on insureds and effectively shield insurers
who deny meritorious claims. Under ERISA law, state
insurance regulation is exempt from federal preemption
thereby permitting states to prohibit discretionary
clauses if they violate state law. Under California law,
discretionary clauses violate the rights of the insured
and render the insurance contract "fraudulent or unsound
insurance."
9.Arguments in Support The Department of Insurance states that
an inherent conflict of interest exists when an insurance
company both determines eligibility for benefits and bears the
financial burden of paying for them. The abuse of discretion
SB 621 (Calderon) Page 7
standard of review flies in the face of California's
long-standing principle of interpreting a contract against the
drafter, rather than against an unsophisticated policyholder,
and needs to be corrected. This bill would give insured
people who are denied benefits a fair hearing in court.
Instead of limited judicial review dictated by an insurance
company's inclusion of a discretionary clause in a policy, a
court would engage in a more balanced review of denial of
benefits decisions.
10. The Consumer Attorneys of California (CAOC) who support SB
621, state :
"Under current law, when an ERISA disability carrier in
California decides a claim, the consumer has the right to an
administrative appeal (before a different reviewer, employed
by the same insurance company). Most ERISA disability
policies reserve broad discretion to interpret the language
and terms of the contract. Thus, if the consumer chooses to
appeal his or her claim, it must be done in Federal Court.
But, the claimant's hands are tied and he or she must show
that the insurance company abused its discretion in reaching
its decision without the ability to bring in new information
or facts. This makes it near impossible for the consumer to
have a fair and impartial hearing."
11. Other Communications Received: The Association of
California Life and Health Insurance Companies (ACLHIC) has
advised the author that:
"the bill in its current form reflects important
clarifying changes that were agreed to in this committee
last year as part of AB 1868 - although the bill was
ultimately vetoed. These changes address the primary
policy concerns expressed by our collective members."
While ACLHIC has restated their view that the SB 621 as
introduced reflects the agreement which resolved their
opposition to AB 1868 (Jones) of the 2009-2010 session,
ACLHIC also notes they are continuing to examine this bill
out of a concern for its possible extraterritorial
application in ways that could be unforeseen. On this issue,
ACLHIC intends to continue its study of the bill; the result
of that ongoing inquiry will be addressed with the author and
sponsor.
SB 621 (Calderon) Page 8
12.Suggested Amendments SB 621 as introduced requires
technical amendments as follows:
a. On page 2, line 33 strike "Assure" and insert
"Ensure".
b. On page 6, line 22, after "contains", insert "a".
c. On page 7, line 22, after "contain", insert "a"
d. On page 8, line 31, strike "any such" and insert
"the".
13.Prior Legislation This is identical to AB 1868 (Jones) of the
2009-2010 Session which was vetoed in 2010. In the veto
message of SB 1868, the Governor stated:
"I am returning Assembly Bill 1868 without my signature.
This bill would prohibit the Insurance Commissioner from
approving
any disability or life insurance policy if it includes a
provision that would reserve discretionary authority to the
insurer to determine eligibility for benefits, and voids
certain provisions of a policy or agreement if it provides
or funds life insurance or
disability insurance coverage.
This bill is unnecessary, as the Insurance Commissioner
already has the authority to prohibit the use of
discretionary clauses.
For this reason I cannot sign this bill."
POSITIONS
Support
California Department of Insurance (Sponsor)
Consumer Attorneys of California
Opposition
None
Consultant: Kenneth Cooley (916) 651-4110
SB 621 (Calderon) Page 9