THE NEW STANDARD: FOUGHT V. UNUM LIFE INSURANCE CO. OF AMERICA
In the landmark 1989 case Firestone Tire & Rubber Co. v. Bruch, the Supreme Court instructed federal courts to apply their most deferential standard of review (the arbitrary and capricious standard) to benefit decisions made by ERISA plan administrators under plans that grant them discretionary authority to determine eligibility for benefits or construe plan terms. For the administrator to prevail over a participant’s challenge under this deferential standard, the reviewing court need only find that the administrator’s interpretation of the plan was reasonable and in good faith. After Firestone, however, each of the Circuit Courts of Appeals has been forced to adjust the arbitrary and capricious standard in cases where plan administrators deny benefits under a conflict of interest.
Since 1996, the Tenth Circuit (which covers Kansas and several other states) has applied a sliding scale approach to court review of benefit denials under group health plans where the administrator operates under a conflict of interest. Under this approach, the reviewing court is instructed to decrease the degree of deference it affords to the administrator’s decision in proportion to the seriousness of the conflict. But, as the court recently noted in Fought v. UNUM Life Insurance Co. of America, to say that there is a sliding scale of deference merely begs the question, How much less deference does the court owe a conflicted decision? Admitting that the vagueness of its previous rule has confused the lower courts and encouraged litigation, the entire Tenth Circuit reconsidered the question in Fought. Its new decision revises the opinion published earlier by a three-judge panel and explains, in detail, how the sliding scale will apply in future cases.
Fought establishes a two-tiered approach, under which the reviewing court’s first step will be to place the case into one of two categories, based on the seriousness of the administrator’s conflict. The first tier consists of so-called standard conflicts, in which there is some reason to suspect the plan administrators’ impartiality. The participant bears the burden of proving that such a conflict of interest exists; and, unless the participant can demonstrate that the conflict is serious, the reviewing court will merely consider that conflict as one factor in determining whether a benefit denial was arbitrary and capricious.
If, however, the participant can prove a serious conflict of interest, or if such a conflict is inherent in the plan’s administrative structure (e.g., where a single entity serves as both insurer and administrator), or if a serious procedural irregularity exists, then the case belongs in the second tier, and the court must, accordingly, slide along the scale considerably, further reducing its deference to the decision.
Once a decision falls within this second tier, the court will take a hard look to determine (1) whether the administrator’s interpretation of the plan terms was reasonable, and (2) whether the administrator has established by substantial evidence that the plan did not cover the participant’s claim. This formulation of the standard of review actually shifts the burden of proof from the participant, who no longer needs to attack the decision to prevail, to the plan fiduciary, which must now prove by a preponderance of the evidence that its denial was reasonable. In Fought, the court applied this second-tier approach to reverse the district court’s grant of summary judgment to UNUM.
THE FOUGHT DECISION
The suit arose when a participant challenged a decision by UNUM’s claims manager to deny her long-term disability benefits under her employer’s group disability plan. After undergoing open-heart surgery, the participant, who had been diagnosed and treated for coronary artery disease before enrolling in the plan, developed an infection and was hospitalized for several months. In denying disability coverage, UNUM’s plan administrator relied on the plan’s preexisting condition exclusion, under which any disabilities “caused by, contributed to by, or resulting from” a preexisting condition were excluded from coverage.
UNUM argued that the participant’s preexisting heart condition caused the infection: had she not suffered from the condition, the argument went, she would not have needed surgery; and had she not needed the surgery, she never would have contracted the infection. Applying its more searching and less deferential second-tier standard of review to this argument, the court first determined that UNUM’s interpretation of cause was unreasonably broad. Under UNUM’s reading of the exclusion, the court reasoned, any disability even remotely connected to a preexisting condition would be excluded from coverage.
The court then turned to the administrative record to determine whether substantial evidence supported UNUM’s denial of benefits. In holding that UNUM had failed to justify its decision with such evidence, the court found especially significant the fact that UNUM was aware of its own conflict of interest, yet undertook no independent evaluation or investigation of the participant’s case.
In what appears to be advice to future defendants, the court opined that where, as here, a conflict of interest may impede the plan administrator’s impartiality, the administrator best promotes the purposes of ERISA by obtaining an independent evaluation.
WHAT THE DECISION MEANS FOR PLAN SPONSORS
The Fought decision arguably does more than clarify the court’s existing arbitrary and capricious standard. Under the newly-formulated second-tier analysis, the plan fiduciary, rather than the participant, bears the burden of proof and must show, by a preponderance of the evidence, that its decision was reasonable. Once this burden has shifted, it is difficult to discern what deference remains in the once-very-deferential (if not quite rubber-stamp) arbitrary and capricious standard.
The decision will have a broad application. The new second-tier standard will apply virtually automatically to both self-funded plans with in-house claims administrators (as opposed to third-party administrators) and to insured plans (because the insurance company is both payor and claims administrator): both groups come with a ready-made, inherent conflict of interest. As a result, employers sponsoring plans of the former type will experience direct financial pressure because they pay claims directly out of their own pockets; sponsors of insured plans will experience indirect pressure, through a nearly inevitable rate hike.
WHAT CAN CONFLICTED ADMINISTRATORS DO?: DEVELOP THE ADMINISTRATIVE RECORD
Judicial review of benefit denials is generally limited to the administrative record. The Tenth Circuit’s unmistakable message in Fought is that a scant administrative record is likely to wilt under the hard look Fought requires whenever an administrator denies benefits under a second-tier conflict of interest. Borrowing stern language from the Seventh Circuit, the court offered some idea of what it expects of an administrator operating under a serious conflict of interest: When it is possible to question the fiduciaries’ loyalty, they are obligated at a minimum to engage in an intensive and scrupulous independent investigation of their options to insure that they act in the best interests of the plan beneficiaries (emphasis added).