BILL ANALYSIS
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|SENATE RULES COMMITTEE | AB 1868|
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THIRD READING
Bill No: AB 1868
Author: Jones (D), et al
Amended: 8/10/10 in Senate
Vote: 21
SENATE BANKING, FINANCE, AND INS. COMMITTEE : 10-0, 6/30/10
AYES: Calderon, Cogdill, Correa, Florez, Kehoe, Liu,
Lowenthal, Padilla, Price, Runner
NO VOTE RECORDED: Cox
SENATE APPROPRIATIONS COMMITTEE : 6-3, 8/2/10
AYES: Kehoe, Alquist, Corbett, Leno, Wolk, Yee
NOES: Ashburn, Emmerson, Wyland
NO VOTE RECORDED: Price, Walters
ASSEMBLY FLOOR : 48-28, 6/1/10 - See last page for vote
SUBJECT : Insurance: discretionary clauses
SOURCE : Author
DIGEST : This bill invalidates any discretionary clause
contained in a life and disability insurance policy and
prohibits the Insurance Commissioner from approving
disability insurance policies that contain such a
discretionary clause.
ANALYSIS :
Existing law:
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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 Insurance 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 seven 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. Makes 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
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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.
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. Defines the term "discretionary authority" as a policy
provision that has the effect of conferring discretion
on an insurer or other claim administrator to determine
entitlement to benefits or interpret policy language
that, in turn, could lead to a deferential standard of
review by any reviewing court.
3. Specifies that nothing prohibits an insurer from
including a provision in a contract that informs an
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. Prohibits the Insurance Commissioner, commencing January
1, 2011, 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.
C. Provide standards of interpretation or review that
are inconsistent with the laws of this state.
Background
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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."
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.
The main body of the opinion issued during the tenure of
Insurance Commissioner Garamendi, including its reasoning
and conclusion, state:
"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
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
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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 [Employee Retirement
Income Security Act], 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,
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
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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
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
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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.'"
FISCAL EFFECT : Appropriation: No Fiscal Com.: Yes
Local: No
According to the Senate Appropriations Committee:
Fiscal Impact (in thousands)
Major Provisions 2010-11 2011-12 2012-13 Fund
Department of Insurance likely minor
Special*
review of insurer policy
filings to ensure compliance
* Insurance Fund
SUPPORT : (Verified 8/3/10)
American Federation of State, County and Municipal
Employees
California Conference Board of the Amalgamated Transit
Union
California Conference of Machinists
California Labor Federation, AFL-CIO
California Teamsters Public Affairs Council
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Consumer Attorneys of California
Disability Rights Legal Center
Engineers and Scientists of California
Glenn R. Kantor, Kantor & Kantor, LLP
Institute of Health Law Studies
International Longshore and Warehouse Union
Professional and Technical Engineers, Local 21
Professor Kenneth Klein, California Western School of Law
UNITE HERE!
United Food and Commercial Workers Union, Western States
Council
United Policyholders
ARGUMENTS IN SUPPORT : The author's office 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 gives 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.
ASSEMBLY FLOOR :
AYES: Ammiano, Arambula, Bass, Beall, Block, Blumenfield,
Bradford, Brownley, Buchanan, Caballero, Charles
Calderon, Carter, Chesbro, Coto, Davis, De La Torre, De
Leon, Eng, Evans, Feuer, Fong, Fuentes, Furutani, Hall,
Hayashi, Hernandez, Hill, Huffman, Jones, Lieu, Bonnie
Lowenthal, Ma, Mendoza, Monning, Nava, V. Manuel Perez,
Portantino, Ruskin, Salas, Saldana, Skinner, Solorio,
Swanson, Torlakson, Torres, Torrico, Yamada, John A.
Perez
NOES: Adams, Anderson, Bill Berryhill, Blakeslee, Conway,
Cook, DeVore, Emmerson, Fletcher, Fuller, Gaines,
Garrick, Gilmore, Hagman, Harkey, Huber, Jeffries,
Knight, Logue, Miller, Nestande, Niello, Nielsen, Norby,
Silva, Smyth, Tran, Villines
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NO VOTE RECORDED: Tom Berryhill, Galgiani, Audra
Strickland, Vacancy
JJA:mw 8/10/10 Senate Floor Analyses
SUPPORT/OPPOSITION: SEE ABOVE
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