BILL ANALYSIS
SENATE COMMITTEE ON BANKING, FINANCE,
AND INSURANCE
Senator Ronald Calderon, Chair
AB 1868 (Jones) Hearing Date: June 30, 2010
As Amended:April 13, 2010
Fiscal: Yes
Urgency: No
VOTES: Asm. Floor(06/01/10)48-28/Pass
Asm. Appr. (05/28/10)12-05/Pass
Asm. Ins. (04/07/10)08-04/Pass
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
AB 1868 (Jones), Page 2
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
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. "Renewed"
is defined as continued in force on or after the policy's
anniversary date.
2.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;
COMMENTS
1. Purpose of the bill To prohibit life and disability insurance
AB 1868 (Jones), Page 3
policies from containing a discretionary clause, and to
prohibit the Insurance Commissioner from approving disability
insurance policies that contain a discretionary clause;
The author 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.
2. 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."
3.In 2004, Insurance Commissioner Garamendi's General Counsel
issued a letter opinion in response to a question as to
whether discretionary clauses were legal under California Law.
The opinion concluded they were not.
4.The main body of the opinion issued during the tenure of
Insurance Commissioner Garamendi, including its reasoning and
conclusion, appear below:
"It is this Department's position that all such
discretionary clauses in disability insurance contracts
violate California law and deprive insureds of
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
AB 1868 (Jones), Page 4
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
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,
AB 1868 (Jones), Page 5
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 [insurance] 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
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
AB 1868 (Jones), Page 6
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."
5. The National Association of Insurance Commissioners (NAIC),
as cited by the Garamendi opinion, has an adopted 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."
6. Arguments in Support The author 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 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
AB 1868 (Jones), Page 7
would engage in a more balanced review of denial of benefits
decisions.
7. Mr. Gary Cohen, former General Counsel of the Department of
Insurance and the author of the opinion letter cited above is
in support of AB 1868 and states in relevant part:
"On March 22, 2005, then-Commissioner Garamendi adopted a
Proposed Decision ?. On March 13, 2006, that decision was
designated as precedential pursuant to Government Code
Section 11425.60 ?.
The Decision adopted by the Commissioner states that the
uncertainty about outcome caused by the Discretionary
Clause "makes the policy as a whole ambiguous and
misleading, in violation of [Insurance Code] section
102951.5 (b)(13)
?
Since April 2005 it has been the Department's policy that
policies containing the Discretionary Clause violate the
Insurance Code. During Commissioner Garamendi's term of
office, and during the portion of Commissioner Poizner's
term while I remained General Counsel, the Department made
efforts, within then-existing staffing levels, to ensure
that all disability income insurance carriers removed the
Discretionary Clause from their policies.
I cannot speak directly to the question of what the
Department has been doing to enforce the Commissioner's
March 22, 2005 Order since I left in July 2007. It is my
understanding that a number of companies continue to sell
disability policies in the State which contain the
unlawful Discretionary Clause."
8. The California Labor Federation states that discretionary
clauses give such discretion to insurance companies that they
can easily justify their denials in court, even when the
medical evidence overwhelmingly supports the case of the
disabled policyholder. According to the Labor Federation,
this practice leaves many disability insurance policyholders,
who have dutifully paid their premiums, without benefits at a
time when they are disabled and most in need.
9. Arguments in Opposition. The Association of California Life
AB 1868 (Jones), Page 8
and Health Insurance Companies (ACLHIC) and the American
Council of Life Insurers (ACLI) state that this bill would
outlaw the use of discretionary clauses in disability
insurance products and likely expand the ban to many other
types of insurance including life, annuity, and health
products. ACLHIC and ACLI also state concerns that banning
discretionary clause language may prohibit lawful contract
language that the Department of Insurance currently approves.
10.The California Association of Health Underwriters (CAHU)
states that this bill will remove insurers' ability to
contract and to adjudicate claims. CAHU states that as part
of the insurance process it is necessary to make a decision
on the validity of the claim. Insurers need to have
stability and uniformity in the claims paying process in
order to execute a contract that assumes a claims risk.
11. Questions The bill appears to present the question of
whether California law should codify the conclusion of the
2004 Garamendi letter opinion, given the clear policy of
current law, seen in subdivision (a) of Section 10291.5 on
page 2, lines 17-22 .
12. Suggested Amendments None
13. Prior and Related Legislation None
POSITIONS
Support
California Labor Federation, AFL-CIO
Consumer Attorneys of California
Glenn R. Kantor, Kantor & Kantor, LLP
Professor Kenneth Klein, California Western School of Law
Gary M. Cohen, Esq.
Institute of Health law Studies
United Policyholders
Arnold Levinson, Pillsbury & Levinson, LLP
California Conference Board of the Amalgamated Transit Union
United Food and Commercial Workers Union, Western states
Council.
Engineers and Scientists of California
UNITE HERE!
California Conference of Machinists
AB 1868 (Jones), Page 9
Professional & Technical Engineers, Local 21
Int'l Longshore & Warehouse Union
California Teamsters Public Affairs Council
AFSCME
Disability Rights Legal Center
Opposition
American Council of Life Insurers
Association of California Life and Health Insurance Companies
California Association of Health Underwriters
National Association of Insurance and Financial Advisors of
California (NAIFA-California)
Consultant: Kenneth Cooley (916) 651-4102