Rescission of Coverage under ERISA Plans

Transcription

1 Does Federal or State Law Control? By Erna A.P. Womble and George K. Evans, Jr. Rescission of Coverage under ERISA Plans If state law interferes with declaratory relief, the consequence may be rewarding a claimant for obtaining coverage through fraud. Every state allows insureds to rescind insurance coverage obtained by misrepresentation, subject to time limits and conditions imposed by state law. What law controls when the coverage is governed by ERISA? Questions about preemption of state insurance law by the Employee Retirement Income Security Act of 1974, 29 U.S.C et seq., continue to vex claimants and insurers alike, as courts work to determine what state law is protected from preemption by ERISA s saving clause. Generally, ERISA supersede[s] any and all State laws that relate to any employee benefit plan. 29 U.S.C. 1144(a). However the saving clause, 29 U.S.C. 1144(b)(2)(A), excludes from preemption state law that regulates insurance. State law includes statutes, regulations and decisional law. 29 U.S.C. 1144(c). It has now been 22 years since Pilot Life Ins. Co. v. Dedeaux, 481 U.S. 41 (1987), a landmark case that made clear that ERISA preempts most state law relating to selfadministered and insured life, health and disability plans sponsored by employers. Despite the passage of time, and numerous appellate decisions regarding preemption, some basic questions remain unresolved. One such question, commonly faced, is whether state or federal law governs the right of an insurer to seek rescission of coverage for misrepresentation in an application. While life, health and disability group coverage is often issued without medical underwriting, the problem of coverage obtained through misrepresentation remains substantial. Supplemental life coverage is normally underwritten, as is coverage for late entrants. Pricing for group health insurance may be based on data obtained from individual employees, which is then used collectively to underwrite the group. Policies issued to individuals, based upon health questions, may be subject to ERISA when they are part of an employersponsored arrangement. (Self- funded plans, administered by insurers, do not face this question. The deemer clause, 29 U.S.C. 1144(b)(2)(B), provides that a plan shall not be deemed to be an insurance company or other insurer for pur- n Erna A.P. Womble is a member and George K. Evans, Jr., is of counsel in the Winston-Salem, North Carolina, office of Womble Carlyle Sandridge & Rice, PLLC. Ms. Womble s practice is focused on life, disability and ERISA matters and product liability claims in federal and state courts. Mr. Evans practice is also directed toward ERISA, life and disability insurance defense. Ms. Womble and Mr. Evans are active members of DRI, and Ms. Womble is an active member of the Product Liability Advisory Council DRI. All rights reserved. For The Defense n September 2009 n 39

2 poses of any law of any State purporting to regulate insurance companies, [or] insurance contracts. ). Generally, the right to rescind ERISA coverage obtained by misrepresentation is well established. But is that right subject to limitations imposed by state law because of the saving clause? The answers from various federal district courts and courts of appeal Each state s law is a blend of statutes and decisional law, which results in sometimes significant differences from state to state. are surprisingly mixed, as are sometimes the consequences of that determination. Johnson v. Connecticut General Life Ins. Co., 2009 WL (6th Cir. Apr. 7, 2009), is the most recent appellate case to address this issue. Rejecting a 1997 Sixth Circuit ruling, Johnson held that a state statute governing misrepresentation is law that regulates insurance, so that the law of the plaintiff s home state of Ohio, not federal law, governed the right to rescind. It concluded that the Supreme Court rulings in Ward v. Unum Life Ins. Co. of Am., 526 U.S. 358 (1999), and Kentucky Association of Health Plans, Inc. v. Miller, 538 U.S. 329 (2003), fundamentally altered the manner in which the saving clause should be analyzed, and thus called into question earlier rulings on this issue. The Johnson analysis may not only be important in future consideration of misrepresentation issues, but other preemption questions that involve state insurance law. In Davies v. Centennial Life Ins. Co., 128 F.3d 934 (6th Cir. 1997), the court had ruled that state law governing rescission did not regulate insurance, and was thus preempted. Pilot Life had held that Mississippi punitive damage law relating to the denial of insurance claims was based upon the state s general contract law, and thus was not saved 40 n For The Defense n September 2009 from preemption because it was not primarily directed toward insurance. 481 U.S. at 49 (It was also preempted because it afforded a remedy to plan claimants that was not provided by ERISA. Id. at ) Led by this analysis in Pilot Life, and a more specific test enunciated in Metropolitan Life Ins. Co. v. Massachusetts, 471 U.S. 724, (1985), Davies had concluded that the Ohio statute governing rescission has its roots firmly planted in the general principles of Ohio contract law, and thus was not specifically directed at the insurance industry. 128 F.3d at 941. In Johnson, both the district court and Sixth Circuit Court of Appeals concluded that the earlier Davies decision was no longer binding precedent, in light of Ward and Miller. Thus state law, not federal common law, governed the right to rescind. What Are the Consequences? The facts may enable the court to conclude, with little debate, that the result would be the same under state or federal law. See, e.g., Dignity Viatical Settlement Partners v. Cedalion Systems, Inc., 4 F. Supp. 2d 466 (W.D.N.C. 1998). However, some states, such as Kansas, require that the misrepresented information relate to the cause of loss in order to rescind. Kan. Stat. Ann (c). Others require specific intent to deceive the insurer. The Ohio statute discussed in Johnson requires a showing that the applicant willfully gave a false answer that was made fraudulently. However, judicial decisions construe the statute to require only a showing that the applicant knowingly provided a false answer WL , at *7. Most states require judicial assertion of the rescission claim within the time limits for contesting coverage, but some allow insurers to satisfy the time limit by declaring the policy void and tendering a premium refund. In view of Johnson, there is a significant likelihood that courts will apply state law in most circuits, even if there are earlier decisions to the contrary. Thus the unique requirements of state law must be addressed during the claim, unless it is clear that federal common law applies. What Changed after Davies? Davies, which has often been cited, was decided in In Ward (1999), a unanimous Supreme Court concluded that the California notice- prejudice rule was a law that regulates insurance, and was thus immune from preemption under the saving clause. That judicially created rule bars insurers from denying claims that have not been submitted within policy deadlines, unless the insurer can show that it was prejudiced by the late submission. Following the test enunciated in Metropolitan Life Ins. Co. v. Massachusetts, 471 U.S. 724 (1985), the Supreme Court first considered whether this judicial rule regulated insurance in a common- sense view of the matter. It then considered three factors utilized to determine whether a law falls within the business of insurance, as that term is used in the McCarran- Ferguson Act, 15 U.S.C. 1011, et seq.: first, whether the practice has the effect of transferring or spreading a policyholder s risk; second, whether the practice is an integral part of the policy relationship between the insurer and the insured; and third, whether the practice is limited to entities within the insurance industry. 526 U.S. at In Ward, the insurer argued that the judicial notice- prejudice rule is an application of the general contract principle that inappropriate forfeitures should normally be avoided. Thus, like the state bad faith law that was preempted in Pilot Life, this rule is not specifically directed toward insurance. The Court disagreed, observing that the notice- prejudice rule is not consistent with general contract law, but is in derogation of the contract principle that conditions precedent should be enforced. The notice- prejudice rule grew from California public policy that favored insureds. It applies only in insurance matters, and is not a general principle guiding a court s discretion in a range of matters. Id. at 371. The Court went on to clarify that the McCarran- Ferguson factors were merely relevant, not required. Id. at Thus it was unnecessary to determine whether the riskspreading factor was satisfied because the notice- prejudice rule clearly met the other two McCarran factors. In Miller (2003), the Supreme Court announced a new test for determining whether a state law regulates insurance. Plaintiffs were health maintenance organizations that challenged enforcement of several Kentucky Any Willing Provider

3 statutes. Those statutes require such organizations to contract with all health care providers who agree to follow contracts made with other providers, thus preventing the creation of exclusive provider networks. The unanimous Court found the statutes to be within the saving clause as laws that regulate insurance, even though not specifically directed toward insurers. The first question was restated to ask whether the law is specifically directed toward entities engaged in insurance. 538 U.S. at 342. The statutes at issue were so directed, even though they affected noninsurers as well. 538 U.S. at The three-part McCarran- Ferguson inquiry was replaced with a single question, whether the law substantially affect[s] the risk pooling arrangement between the insurer and the insured. Id. The risk pooling arrangement was substantially affected because these statutes increased the number of providers from whom an insured may receive health services, thus alter[ing] the scope of permissible bargains between insurers and insureds. Id. at 338. Johnson found the new Miller test to be at odds with its previous analysis in Davies. Davies had concluded that the Ohio misrepresentation statute did not spread insurance risks. Even though it forces the insurer to bear the legal risks associated with innocent misrepresentations in an insurance application, it does not alter the risks for which the insurer and insured originally contracted. 128 F.3d at 942. Miller made clear that the change in language was more than grammatical tweaking. The new substantially affect the risk pooling arrangement test does not require that the state law actually spread risk. 538 U.S. at 339 n.3. The holding in Ward was consistent with this new test because the notice- prejudice rule altered the conditions under which [the insurer] must pay for the risk that it had assumed. Id. Johnson thus concluded that the state statute was not preempted because it alters the scope of permissible bargains by dictating the conditions under which the insurer may deny recovery for misrepresentations in the application for life insurance WL , at *5. Those decisions that predate Ward and Miller, and find state misrepresentation law to be preempted, such as Security Life Ins. Co. of Am. v. Meyling, 146 F.3d 1184 (9th Cir. 1998), must be reevaluated. But does the Miller test call for a different result, as Johnson has concluded? Equitable Relief under ERISA When coverage is obtained by alleged misrepresentation, the issue before the court is not the effect of state law on the ongoing relationship between the insurer and the insured. Rather it is whether the insurer has the right to the equitable remedy of rescission, ending the coverage retroactively, because of misrepresentative statements upon which it relied. Rescission is not simply a defense to a claim, but a remedy that voids the contract from its inception. Premiums are to be refunded to the insured and previously paid benefits may be recovered. The potential right to recover erroneously paid benefits is well illustrated in Provident Life & Accident Ins. Co v. Sharpless, 364 F.3d 634 (5th Cir. 2004), in which the insurer not only obtained a declaration that the defendant s policy was void, but also a judgment to recover over $900,000 in benefits paid before discovery of the misrepresentation, less the premium refund. Nothing in ERISA specifically addresses fraud or misrepresentation. Is there an inherent right to rescind ERISA plan coverage if insurance is not involved? This right was confirmed in Nash v. Trustees of Boston Univ., 946 F.2d 960 (1st Cir. 1991). The plaintiff had entered into an early retirement agreement with his employer, the terms of which were based in part upon his false representation that he was retiring. The defendant refused to make the payments provided in the agreement after learning that the plaintiff had made false statements, concealing that he had another job. The plaintiff sued to enforce the agreement, and the defendant sought rescission. The court assumed in its analysis that the agreement was governed by ERISA. Following the directive in Pilot Life to develop federal common law to fill the gaps in ERISA, the court utilized Massachusetts contract principles as a guide in ruling that the plaintiff could not enforce this agreement obtained by fraud. ERISA specifically authorizes fiduciaries to obtain equitable relief to redress plan violations or enforce plan terms. 29 U.S.C. 1132(a)(3)(B). This section enables an insurer, as an ERISA fiduciary, to bring an action to rescind coverage issued as a result of fraud. Provident Life & Accident Ins. Co. v. Cohen, 423 F.3d 413, 422 (4th Cir. 2005). While in Ward, state law was found to override an express plan provision regarding the timely submission of claims, there Rescission is not simply a defense to a claim, but a remedy that voids the contract from its inception. was no claim for equitable relief involved. Rescission of a contract for misrepresentation is something more. Rescission is relief from misconduct, an equitable remedy that cancels plan participation altogether, retroactive to its inception. In one sense, this certainly substantially affect[s] the risk pooling arrangement between insurer and insured, by ending it altogether. But is this how Miller should be applied in this context? Must State Law Be Applied? In Provident Life & Accident Ins. Co. v. Sharpless, 364 F.3d 634 (5th Cir. 2004), the Fifth Circuit found that state law was preempted, despite Miller. Sharpless reconsidered and affirmed the court s earlier analysis in Tingle v. Pacific Mut. Ins. Co., 996 F.2d 105 (5th Cir. 1993), which had found state misrepresentation law to be preempted. With little comment, Sharpless concluded that the Louisiana misrepresentation statute at issue did not substantially affect the risk pooling arrangement. Citing Tingle, the court observed that the statute does not even address the risk for which the insurance company contracted. 364 F.3d at In other words, the risk in the Miller test is the hazard insured by the contract, not the legal risk of whether coverage is valid. The Eighth Circuit is the only other federal appellate court that has addressed this question after Miller. In Shipley v. Arkansas For The Defense n September 2009 n 41

4 Blue Cross & Blue Shield, 333 F.3d 898 (8th Cir. 2003), that court applied federal common law, without discussion of Ward or Miller. The court of appeals expressly disagreed with the district court s assumption that the Arkansas misrepresentation statute was applicable, but noted that Arkansas law was consistent with what it considered to be applicable federal common law. Most policies do not fully describe the principles governing the consequences of misrepresentation. In Werdehausen v. Benicorp Ins. Co., 487 F.3d 660 (8th Cir. 2007), the court reaffirmed the Shipley ruling, although it found another state statute regarding the consequence of pre- certification not to be preempted, based upon Miller. The First, Second, Third, Seventh and Tenth Circuit Courts of Appeals have not expressly ruled on this question. District courts within those circuits have generally tended to apply federal law. See, e.g., Espinosa v. Guardian Life Ins. Co., 856 F. Supp. 711 (D. Mass. 1994); Corn v. Protective Life Ins. Co., 1998 WL (D. Conn. Feb. 4, 1998). Post- Miller district court decisions are limited. In McBride v. Hartford Life and Accident Ins. Co., 2007 WL (E.D. Pa. Jan. 29, 2007), the court applied federal common law, consistent with earlier district court decisions within the Third Circuit. The Second Circuit did apply state law in Jackson v. Travelers Ins. Co., 113 F.3d 367 (2d 1997), but in that action the plaintiffappellant did not challenge the ruling below which utilized New York law without deciding which law governed. In Sofo v. Pan- American Life Ins. Co., 13 F.3d 239 (7th Cir. 1994), and Spencer v. Arkansas Blue Cross and Blue Shield, 205 Fed. Appx. 652 (10th Cir. 2006), the Seventh and Tenth Circuits affirmed the right to rescind ERISA coverage for material misrepresentation without addressing the choice-of-law question. The District of Columbia Circuit has not ruled on this question. 42 n For The Defense n September 2009 In Beard v. TMG Life Ins. Co., 1992 WL (4th Cir. Jul. 22, 1992), the court applied Virginia law, referring to the saving clause without further discussion. The most recent ruling from the Ninth Circuit, Security Life Ins. Co. of Am. v. Meyling, 146 F.3d 1184 (9th Cir. 1998), found state law to be preempted in an action in which the insurer sought to apply state law. However, in considering a different issue in Standard Ins. Co. v. Morrison, 537 F. Supp. 2d 1142, 1152 n.3 (D. Mont. 2008), a district court questioned the continuing validity of Meyling. In Hauser v. Life General Security Ins. Co., 56 F.3d 1330 (11th Cir. 1995), the court found state law to be preempted, but utilized Florida law to craft an appropriate federal common law. However, in a case decided only days earlier, Fioretti v. Massachusetts General Life Ins. Co., 53 F.3d 1228 (11th Cir. 1995), the court, in dicta, commented that state law governing misrepresentation would probably be protected from preemption. Id. at 1230 n.2. What Is the Federal Common Law of Misrepresentation? If state law is preempted, what are the rules governing the insurer s right to rescind? In some cases, such as Hauser, courts have looked to the specific law of the claimant s home state to describe applicable federal common law. Other courts have drawn on law from various jurisdictions. In Shipley, the court discussed at some length general contract principles from a number of states, and endorsed the following language from the Restatement (Second) of Contracts, 164(1) (1981): If a party s manifestation of assent is induced by either a fraudulent or a material misrepresentation by the other party upon which the recipient is justified in relying, the contract is voidable by the recipient. 333 F.3d at 903. In Sharpless, the court stated that under federal common law, a party claiming fraudulent misstatement must prove: 1) that the defendant made a false statement; 2) that the statement was material; 3) that the defendant knew the statement was false at the time it was made, or that it was made recklessly without any knowledge of its truth; and 4) that the false statement was made with the intent to deceive. 364 F.3d at 641. What about Policy Language? Even if state law is found to limit the right to rescind, ERISA provides a remedy for equitable relief. The right to equitable relief, including rescission, under ERISA is statutory, so it should not matter if the policy does not fully spell out the consequences of misrepresentation. Policies will inevitably incorporate some state law by including provisions required by statute, such as time limit provisions. But most policies do not fully describe the principles governing the consequences of misrepresentation. If the policy does address misrepresentation, it may alter the consequences of misrepresentative health information. In Meyling, the claimant provided false information to the insurer in a questionnaire utilized to underwrite health coverage for the group. The policy provided for automatic retroactive premium adjustments if new health information would have altered premium rates for the group. The insurer argued that state law was not preempted and that applicable statutes allowed it to rescind coverage. The court found that the California statutes governing misrepresentation were not within the saving clause, but that insurers nevertheless have the right under federal common law to rescind coverage obtained by material misrepresentation. Here, however, the misrepresentation was not material to the insurer s decision to insure this group, because of the automatic premium adjustment provision, so that rescission was not appropriate. 146 F.3d at Comparable facts led to a similar result in Werdehausen. There the policy provided for a premium adjustment when facts were misstated, while reserving the insurer s right to terminate coverage for material misstatement in the group enrollment form. As in Meyling, the enrollment form was not for the purpose of underwriting individual coverage, but rather to underwrite the group as a whole. The record established that the insurer always rescinded coverage when there was a misrepresentation, rather than applying the alternative premium adjustment. The court found the record to be unclear as to whether the premium adjustment option was available for this particular misrepresentation, and remanded for further findings. As

5 these cases illustrate, specific policy language may limit the right to rescind. Practice Tips Except perhaps in the Fifth and Eighth Circuits, insurers investigating possible misrepresentation in the application must take into account both potentially applicable state law, and general contract rules, in evaluating a claim. When a claim is governed by ERISA, the claim file is the administrative record of evidence that will be reviewed by the court. That record should not only contain medical or other records establishing the misrepresentation, but a full explanation of its materiality. An underwriter s statement should be included, with appropriate reference to underwriting guidelines, to show that the undisclosed health information would have led to rejection, to a different premium, or different policy provisions. If specific policy language addresses the consequence of misrepresentation, that language should be discussed in the denial letter. Credibility questions, when raised, should be addressed in the record. If intent is potentially an issue, the claim file should document the insured s explanation for the false information, and if necessary, an explanation of why this explanation was rejected. For example, courts from some jurisdictions have found that an application containing language that the responses are true to the best of my knowledge and belief requires the insurer to show that the applicant subjectively believed the responses to be false in order to rescind. State decisional law from such states may provide, however, that some statements may be deemed false as a matter of law, no matter how sincerely it may be believed. To conclude otherwise would be to place insurance companies at the mercy of those capable of the most invincible self- deception. Skinner v. Aetna Life and Casualty Co., 804 F.2d 148, 153 (D.C. Cir. 1986). If an ERISA policy grants discretionary authority, the insurer should exercise that authority to determine whether the claimant s explanation is to be believed, taking into account potentially applicable nuances of state law, and document the reasons for its conclusions. Equally important for insurers and their counsel is the need to address preemption issues within a given circuit in a consistent manner. Usually, for the insurer, the benefits of federal common law outweigh the burden of applying insurance law from 50 states. Claimants are free to make ad hoc arguments regarding choice of law on a case-by-case basis, but counsel for insurers should be cautious about making expedient arguments without careful consideration of positions taken on the same or related issues in other cases. Practitioners defending claims for insured coverage obtained by misrepresentation should be prepared to respond to the argument that state law governs as a result of Miller. One approach may be to focus the preemption analysis on the source and nature of the remedy sought by the insurer. Rescission is equitable relief available through ERISA, derived from common law principles of contract law. Rescission claims often involve questions of waiver or estoppel, which are also general principles of contract law, not law uniquely directed toward insurance. Does Johnson mandate the adoption of state waiver and estoppel principles as well? In Sun Life Assurance Co. v. Tinsley, 2007 WL (W.D. Va. Apr. 4, 2007), aff d, 266 Fed. Appx. 278 (4th Cir. 2008), the court considered whether ERISA preempted state law concerning undue influence, in deciding which life insurance beneficiary designation controlled. After considering Miller, it held that state law was preempted because such questions were not unique to insurance law, so that federal common law should be applied. The remedy at issue is declaratory relief, to return the parties to the status quo. If state law interferes with that remedy, the consequence not only alters the relationship between the insurer and the insured, but deprives the insurer of such relief and rewards the claimant for obtaining coverage through fraud. The Supreme Court s adoption of new terminology in Miller was in a very different context from that of an insurer seeking to protect itself from fraud. While the statute considered in Miller fundamentally altered the way an insured health plan may work, it did not deprive an ERISA fiduciary of an equitable remedy, provided by federal law. Pilot Life held that state law may not provide an ERISA claimant with a remedy not authorized by ERISA. May state laws limit equitable relief otherwise available to insurers? By consistent analysis and advocacy, insurers may be able to direct the focus of courts to the remedy involved, so that preemption of state misrepresentation statutes and decisional law can be distinguished from preemption of other state law directed at insurance. For The Defense n September 2009 n 43