Do you know if you can bring a Bad Faith claim against an insurer with an ERISA governed disability insurance policy? As of September 2004, the answer to this question is: No. Chief Judge Anthony Scirica, writing for the United States Court of Appeals for the Third Circuit last fall, in Barber v. UNUM, ended years of judicial debate about whether ERISA preempted Pennsylvania’s Bad Faith Statute under it’s broadly interpreted preemption clause. The Court held that Bad Faith is preempted under ERISA, under both the doctrine of conflict preemption and under express preemption. This decision effectively put to rest the debate and, some say has once again limited the remedies that a plan participant covered under an LTD policy can seek in a claim against his insurer.
1. PA Bad Faith Statute
Enacted in 1990, Pennsylvania’s Bad Faith Statute, 42 Pa. C.S. § 8371, provides that:
[i]n an action arising under an insurance policy, if the court finds that the insurer has acted in bad faith toward the insured, the court may take all of the following actions:
- Award interest on the amount of the claim from the date the claim was made by the insured in an amount equal to the prime rate of interest plus 3%.
- Award punitive damages against the insurer.
- Assess court costs and attorney fees against the insurer.
The purpose of Pennsylvania’s Bad Faith statute was to prevent unfair and unreasonable conduct by insurers by empowering and protecting the insured. The Statute allows insureds to seek punitive damages, court costs, and attorney’s fees from insurance companies who do not handle their claims in good faith. Pennsylvania’s Bad Faith Statute is similar in content and scope to other Bad Faith Statutes across the country.
There is no question that the debate over whether The Employee Retirement Income Security Act of 1974 (ERISA) better serves plans’ insurers or plan participants is a hotly debated issue. The decision in the Barber Case and those of other federal courts during the last 20 years has done little to cool the dispute. ERISA was enacted in 1974 in order to provide safegaurds for voluntary, employer sponsored health and pension plans. On the Disability Insurance front, ERISA only governs policies which are part of employee benefit plans which are usually Long Term Disability policies and not Individual Disability policies. It was believed that by providing ready access to the federal courts, and appropriate remedies to those covered under policies, plan participation and protection would increase. According to Congress ERISA would “assure American workers that they may look forward with anticipation to a retirement with financial security and dignity, and without fear that this period of life will be lacking in the necessities to sustain them as human beings with our society.”
ERISA is governed by the U.S. Department of Labor, which is responsible for administering and enforcing ERISA law and setting policy for the conduct of employee benefit plans. ERISA is an immense and complicated piece of legislation that includes broadly interpreted preemption language as well as complex exception provisions. ERISA requires plan providers to provide participants with important plan information about features and funding. It also creates fiduciary responsibilities for individuals who manage and control plan assets and requires plans to maintain a claims and appeals process in order for participants to obtain benefits. Most importantly, ERISA gives plan participants the right to sue in the event of an adverse decision. Notably, there are no provisions for bad faith.
ERISA’s preemption language makes void all state laws to the extent that they “relate to” employer sponsored health plans. Specifically, Section 514 states that “the provisions of [ERISA] shall supersede any and all State laws insofar as they may now or hereafter relate to any employee benefit plan.” Courts have spent considerable effort in interpreting the meaning of “relate[s] to an employee benefit plan” and the issue was critical in the Court’s determination in Barber. Also in Section 514, is ERISA’s “Savings Clause,” § 514(b)(2)(A), which creates an exception to preemption for a state statute when that statute “proposes to regulate insurance.” The application of these provisions to the debate about Bad Faith preemption has been as varied as the federal court decisions on the subject during the last two decades.
3. CASE HISTORY
- Pilot Life Ins. v. Dedeaux, 481 U.S. 41 (1987)
The case history for any explanation of the federal court’s treatment of ERISA’s preemption language in relation to state law statutes begins with the U.S. Supreme Court’s pivotal 1987 decision in Pilot Life Ins. v. Dedeaux. The case involved an ERISA plan participant who brought a common-law claim for bad faith against an insurance company that issued his LTD policy. In issuing the Court’s opinion, Justice O’Connor wrote that ERISA’s has created a “comprehensive civil enforcement scheme…[whose] remedies were intended to be exclusive.” The Court applied a conflict preemption standard to the issue and essentially opined that if a specific claim for damages is not included in ERISA, than it was meant to be excluded.
In the Pilot Life case, the Mississippi common-law bad faith claim was conflict pre-empted by ERISA because it “related to” an ERISA plan and was not “saved” by the savings clause. The Court wrote that, “the policy choices reflected in the inclusion of certain remedies and the exclusion of others under the federal scheme would be completely undermined if ERISA-plan participants and beneficiaries were free to obtain remedies under state law that Congress rejected in ERISA.” The Court gave great weight to Congress’ development of the ERISA legislation and stated that, “[t] he deliberate care with which ERISA’s civil enforcement remedies were drafted and the balancing of policies embodied in its choice of remedies argues strongly for the conclusion that ERISA’s civil enforcement remedies were intended to be exclusive.”
- UNUM Life Ins. v. Ward, 526 U.S. 358 (1999) 367
Twelve years after the Supreme Court’s decision in Pilot Life, it was presented with the issue of whether ERISA preempted California’s ‘notice-prejudice” rule, under which “an insurer cannot avoid liability although the proof of claim is untimely, unless the insurer shows it suffered actual prejudice from the delay.” In UNUM v. Ward, Justice Ginsburg wrote for a unanimous Court, which held that “California’s notice-prejudice rule is a ‘law…which regulates insurance,’ and is therefore saved from preemption.”
The Court determined that in deciding whether ERISA preempts a state law, the issue should be analyzed using a two-part test: the “common sense view” and the “McCarran-Ferguson Act” three factor test. Under the “common sense view,” the law must “be specifically directed towards” the insurance industry. The second part of the test required greater analysis.
The McCarran-Ferguson Act was enacted in 1945 and states that that, “[n]o Act of Congress shall be construed to invalidate, impair, or supercede any law enacted by any State for the purpose of regulating the business of insurance.” In determining whether a law regulates insurance, the Act lays out three standards, which became the second part of the test established in Ward.
The McCarran-Ferguson Act test states that a certain practice constitutes “the business of insurance” if it:
- has the effect of transferring or spreading a policyholder’s risk;
- is an integral part of the policy relationship between the insurer and the insured; and
- is limited to entities within the insurance industry.
This decision laid the framework under which all future ERISA preemption cases were to be analyzed by the Courts.
- Rosenbaum I, No. 01-6758, E.D.Pa. (2002)
It was based on this test that Senior Judge Clarence C. Newcomer of the U.S. District Court for the Eastern District of Pennsylvania held in 2002 that Pennsylvania’s bad faith statute was not preempted by ERISA since it was a state law regulating insurance that was “saved” from preemption. Judge Newcomer’s decision in Rosenbaum v. UNUM Life Ins. (Rosenbaum I), caused immediate dispute within the Third circuit and became one of the most hotly contested decisions in recent Third Circuit history. The decision was a departure from existing case law and from the onslaught of cases decided in favor of preemption.
In applying the McCarran-Ferguson test, Judge Newcomer stated that despite previous interpretation, Pennsylvania’s Bad Faith Statute did in fact “play an integral part in the policy relationship between the insurer and the insured,” because it “affords the parties rights or remedies other than those originally bargained for.” Finally, Newcomer opined that Pilot Life was not applicable because it only “dealt with common law bad faith” and not a statutory claim specific to the insurance industry. The majority of district court judges did not follow Newcomer’s decision and instead followed the Sprecher v. Aetna U.S. Healthcare case which came out of the Eastern District of Pennsylvania two months later and held that Pennsylvania’s Bad Faith Statute did not meet the second prong of the McCarran-Ferguson test because there is a duty of good faith implied in every contract.
- Kentucky Ass’n of Health Plans v. Miller, 538 U.S. 329 (2003)
After Judge Newcomer’s decision in Rosenbaum I, the U.S Supreme Court handed down its decision in Kentucky Association of Health Plans v. Miller, which effectively changed the test for determining whether a state law “regulated” the insurance industry and is therefore “saved” from ERISA preemption. In the case, a Kentucky HMO brought suit against Kentucky’s Commissioner for the Department of Insurance, seeking to declare certain provisions of the Kentucky Health Care Reform Act preempted under ERISA. In writing the opinion for the Court, Justice Scalia wrote that the Supreme Court’s “use of the McCarran-Ferguson case law in the ERISA context has misdirected attentions, [and] failed to provide clear guidance to lower federal courts.” The Court then created a new two-prong test, which states that:
In order for a state law to be saved from pre-emption:
- the law must be “specifically directed” towards entities engaged in insurance, and
- the law must “substantially affect” the risk pooling arrangement between the insured and the insurer.
The Court entirely rejected the use of the McCarran-Ferguson test, stating that the Court’s previous approach to preemption analysis was repetitive and confusing.
- Rosenbaum II, No. 01-6758, E.D.Pa. (2003)
Upon reconsideration, Judge Newcomer of the District Court for the Eastern District of Pennsylvania ruled again in the Rosenbaum case, this time considering the effect of Kentucky v. Miller. In his decision in Rosenbaum II, Judge Newcomer found that under the new Miller Test, the Pennsylvania Bad Faith Statute was still “saved” from pre-emption under ERISA’s savings clause. Judge Newcomer found that the Statute met all the requirements of the new test, writing that the “[r]isk deflection provisions used by an insurer to create limitations on claims and damages are effectively nullified,” by the Bad Faith Statute and therefore, “[t]here can be little dispute that…[the Statute] substantially effects the risk pooling arrangement between the insurer and the insured.” This decision was as hotly debated and criticized in the legal community as the earlier decision had been and in the following three years, twelve federal judges in Pennsylvania’s three federal districts ruled contrary to Newcomer’s decision in Rosenbaum.
- Aetna Health v. Davila, 124 S.Ct. 2488 (2004)
In June 2004, just months before the U.S. Supreme Court’s decision in Barber v. UNUM, the Court handed down its decision in Aetna v. Davila in which held that a plaintiff in Texas did not have a right to sue his HMO in state court under the Texas Health Care Liability Act (THCLA) but can only bring the claim in federal court as an ERISA action. In the case, two Texas claimants brought suit in Texas state court under the THCLA seeking damages allegedly caused by their insurer’s decision not to provide coverage for certain treatment. The case was removed to federal court and the plaintiff’s refused to amend their complaints. The District Court dismissed the complaints but the Fifth Circuit reversed the District Court and restored the state-law cause of action.
In reversing and remanding the case, Justice Thomas wrote that Congress enacted ERISA to “protect…the interests of participants in employee benefit plans and their beneficiaries’ by setting out substantive regulatory requirements for employee benefit plans and to ‘provid[e] for appropriate remedies, sanction, and ready access to the Federal Courts.'” Justice Thomas noted that “the purpose of ERISA is to provide a uniform regulatory regime over employee benefit plans. To this end, ERISA included expansive preemption provisions…which are intended to insure that employee benefit plans regulation would be ‘exclusively a federal concern.'”
- Barber v. UNUM Life Ins., 383 F.3d 134 (2004)
Finally in September 2004, the United States Court of Appeals for the Third Circuit put an end to the debate about Pennsylvania Bad Faith claims under ERISA when it handed down its decision in Barber v. UNUM Life Ins. The case stemmed from a decision by UNUM to terminate the LTD benefits of an employee whom it determined was no longer disabled. The employee brought suit for breach of contract and for bad faith, for which he demanded punitive damages per the Pennsylvania Bad Faith Statute. In the lower court, Judge Newcomer had ruled against the insurer in its bid to dismiss the bad faith claim based on his analysis in the Rosenbaum II case but certified the case for immediate appeal to the Third Circuit.
Judge Scirica wrote that under Davila, “conflict preemption applies to any ‘state cause of action that provides an alternative remedy to those provided by the ERISA civil enforcement mechanism’ because such a cause of action ‘conflicts with Congress’ clear intent to make the ERISA mechanism exclusive.'” Further, a state statute is pre-empted if it provides “a form of ultimate relief in a judicial forum that added to the judicial remedies provided by ERISA,” or if it “duplicates, supplements or supplants the ERISA civil enforcement remedy.” In reaching its decision, the Court opined that Pennsylvania’s Bad Faith Statute did not meet the second prong of the Miller Test which requires a cause of action to “substantially affect” the risk pooling arrangement between the insured and the insurer. Judge Scirica wrote that, “claims for bad faith insurance breaches bear no relation…to the risk of loss the insurer agrees to bear on behalf of the insured.”
4. WHAT NOW?
In her 1989 Supreme Court opinion in Firestone Tire & Rubber Co. v. Bruch, Justice O’Connor wrote that the Court should not rule in such a way as to “afford less protection to employees and their beneficiaries than they enjoyed before ERISA was enacted.” There is little argument, however, that Barber apparently ended any chances that remedies under Pennsylvania’s Bad Faith Statute can survive under an ERISA claim; effectively affording less protection to claimants than they would have received if ERISA did not exist. Lawyers on both sides of the table recognize that the Barber decision has definitively removed Bad Faith damages from the ERISA platform. What remains to be seen is if the decision bars only the recovery of damages for Bad Faith or is the claim itself, although rendered toothless by Barber, still available to plan participants?