Utah Bar Journal

The Employee Retirement Income Security Act (ERISA), enacted by Congress in 1974, governs the provision by employers of most benefits to employees, whether pension benefits, medical benefits, or any other kind of employee benefit. So long as the benefits are provided by a private employer pursuant to an 'employee benefit plan,' it is governed by ERISA. ERISA also provides the mechanism for challenging the plan administrator's denial of medical or other employee benefits. An employee who is a 'participant' in an employee benefit plan, or a dependent who is a 'beneficiary' of such a plan, has the right to file suit in state or federal court against the employee benefit plan or its administrator for the purpose of obtaining judicial review of the administrator's decision to deny a claim. Such claims may be filed in either state or federal court, but are almost without exception filed in federal court or removed to federal court if filed in state court.

In such cases, the district court judge sits as a quasi-appellate court. The judge determines whether the administrator of the employee benefit plan properly denied the benefit at issue. However, ERISA does not specify the standard of review the district court should apply in reviewing such denials. Accordingly, until 1989, the federal Circuit Courts of Appeals usually relied on pre-ERISA labor cases involving the review of decisions of boards of trustees of joint union-management employee benefit plans. In those cases, such trustee decisions were overturned only where the plaintiff showed that the decisions were arbitrary and capricious. See generally Kathryn J. Kennedy, Judicial Standard of Review in ERISA Benefit Claim Cases, 50 Am. U.L. Rev. 1083, 1102-04 (June 2001).

In 1989, the Supreme Court decided the seminal case of Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101 (1989), which held that benefit denial claims should be evaluated according to principles of trust law, and that under applicable trust law, the decision of a plan administrator to deny a claim is subject to de novo review, unless the plan documents provide that the plan administrator is given 'discretionary authority to determine eligibility for benefits or to construe the terms of the plan.' 489 U.S. at 115. If the plan documents provide such discretion, then the decision should be upheld unless it was arbitrary and capricious.1 The Court added, however, that 'if a benefit plan gives discretion to an administrator or fiduciary who is operating under a conflict of interest, that conflict must be weighed as a factor in determining whether there is an abuse of discretion.'' Id. (quoting Restatement (Second) of Trusts ¤ 187, Comment d (1959)) (internal quotes and brackets omitted).

Following the issuance of the Court's decision in Firestone, the Circuit Courts of Appeals dealt with several issues not resolved in Firestone. For example, Firestone did not indicate what language in the documents establishing and describing the plan would be sufficient to trigger deferential review, and the Circuits have since decided many cases evaluating the sufficiency of various formulations. More importantly for purposes of this article, Firestone did not shed any light on the issue of conflict of interest in cases applying the deferential standard of review Ð how it is established and what effect it should have on the review process, other than constituting a 'factor' in the analysis. Conflict of interest is a common issue because the administrator of an employee benefit plan is often a company employee, such as the company's director of human resources or benefits administrator, and has a potential conflict of interest in deciding claims that would be paid from the company's assets. Additionally, medical benefits or disability benefits are usually insured, and the plan administrator in such cases is usually an employee of the insurance company, which also has an obvious financial interest in denying claims that would be paid from its assets.

The Tenth Circuit initially held with regard to conflicts of interest that it would apply a 'sliding scale' approach. Chambers v. Family Health Plan Corp., 100 F.3d 818, 825 (10th Cir. 1996). The court stated in Chambers that '[u]nder this approach, the reviewing court will always apply an arbitrary and capricious standard, but the court must decrease the level of deference given to the conflicted administrator's decision in proportion to the seriousness of the conflict.' Id. Although the sliding scale approach had the virtue of flexibility, it provided little guidance to lower courts in determining the extent to which the level of deference should be decreased when a conflict has been identified.

The Tenth Circuit therefore addressed the issue again in the recent case of Fought v. UNUM Life Insurance Company, 379 F.3d 997 (10th Cir. 2004). In Fought, the plaintiff had been denied long term disability benefits by UNUM on the ground that her health problems were caused by a pre-existing condition, and that benefits were therefore barred by an exclusion in the long-term disability policy. After UNUM's final denial of benefits, the plaintiff filed suit in the U.S. District Court for the District of New Mexico, alleging that the denial was in violation of 29 U.S.C. ¤ 1132, the ERISA enforcement statute. At the district court level, UNUM admitted that it had a conflict of interest because it administered and paid the claims under the long-term disability plan. However, the magistrate judge denied the plaintiff's request to conduct discovery regarding the extent of the conflict of interest. UNUM then moved for summary judgment, which the district court granted on grounds that UNUM's denial was not arbitrary and capricious.

In reviewing the lower court judgment, the Tenth Circuit first upheld the district court's determination, which neither party contested, that the plan documents vested UNUM with discretion, and that the proper standard of review was therefore arbitrary and capricious. The court then clarified that when the standard of review was arbitrary and capricious, the district court should uphold it if it was arrived at:

(a) as a result of [a] reasoned and principled process (b) consistent with any prior interpretations by the plan administrator (c) reasonable in light of any external standards and (d) consistent with the purposes of the plan.

Fought, 379 F.3d at 1003 (quoting Kennedy, Judicial Standard of Review in ERISA Benefit Claim Cases, supra, 50 Am. U.L. Rev. 1083, 1135, 1172 (2001)). The Tenth Circuit also noted that in cases applying the arbitrary and capricious standard of review, the district court was limited to the 'administrative record,' i.e., 'the materials compiled by the administrator in the course of making his decision.' Id.

The Tenth Circuit then addressed the effect of a conflict of interest. The court first noted that there are two types of conflict of interest: (a) a 'standard' conflict of interest and (b) an 'inherent' conflict of interest. The court stated specifically that an inherent conflict of interest exists when an insurance company both decides claims and pays them from its own assets. That situation usually arises when the plan is fully insured, as is often the case in employee health plans, and almost always the case in employee long-term disability plans.

The same reasoning might suggest that the Tenth Circuit would find an inherent conflict of interest in the context of a self-funded plan where the final denial decision is made by the 'company' acting through its board of directors or executive officers. See Chambers v. Family Health Plan Corp., 100 F.3d 818. 825 (10th Cir. 1996) (court found conflict of interest where final decision was made by defendant's board of directors). However, it is more likely that the Tenth Circuit would classify such a conflict as 'standard' based on the distinction it has drawn between insurance companies and companies administering self-funded plans:

More importantly, unlike the self-funded company in Kimber [v. Thiokol Corp., 196 F.3d 1092 (10th Cir. 1999)] where the company's profit is not derived solely from its administration of the health benefits plan, Blue Cross is in the business of insurance. Thus, it can only remain economically viable through its insurance transactions. By contrast, self-funded companies typically have other means of generating profit and income. Thus, in Blue Cross' situation, there is an inherent conflict of interest between its discretion in paying claims and its need to stay financially sound.

Pitman v. Blue Cross and Blue Shield, 217 F.3d 1291, 1296 n.4 (10th Cir. 2000) (finding inherent conflict of interest in context of fully-insured plan). In essence, a standard conflict of interest is every conflict that is not an inherent conflict of interest.

The court went on to state in Fought that where there is a standard conflict of interest, 'the plaintiff is required to prove the existence of the conflict.' Fought, 379 F.3d at 1005. Although the existence of the conflict seems to be a given whenever the decision-maker is affiliated with the payer, the court later clarified that the plaintiff must prove that this standard conflict of interest is 'serious.' Id. In doing so, the plaintiff must prove 'that the plan administrator's dual role jeopardized his impartiality.' Id. (internal quotes omitted). The court explained this inquiry as follows:

The mere fact that the plan administrator was a [company] employee is not enough per se to demonstrate a conflict. Rather, a court should consider various factors including whether: (1) the plan is self-funded; (2) the company funding the plan appointed and compensated the plan administrator; (3) the plan administrator's performance reviews or level of compensation were linked to the denial of benefits; and (4) the provision of benefits had a significant economic impact on the company administering the plan.

Fought, 379 F.3d at 1005 (quoting Cirulis v. UNUM Corp., 321 F.3d 1010, 1017 n.6 (10th Cir. 2003) (internal quotes omitted). The court then explained that where this inquiry does not show that there is a serious conflict of interest, the standard conflict of interest will be considered as a factor in determining whether there has been an abuse of discretion. Id.

However, the Tenth Circuit made clear that 'an additional reduction in deference is appropriate' where (1) the conflict of interest is inherent, (2) the standard conflict of interest has been shown to be serious, or (3) there has been a serious procedural irregularity. 379 F.3d at 1006. The court described this additional reduction in deference as follows:

Under this less deferential standard, the plan administrator bears the burden of proving the reasonableness of its decision pursuant to this court's traditional arbitrary and capricious standard. In such instances, the plan administrator must demonstrate that its interpretation of the terms of the plan is reasonable and that its application of those terms to the claimant is supported by substantial evidence. The district court must take a hard look at the evidence and arguments presented to the plan administrator to ensure that the decision was a reasoned application of the terms of the plan to the particular case, untainted by the conflict of interest.

Id. (citation omitted). The court did not define 'serious procedural irregularity,' but found that one existed in Fought because UNUM had not sought review from an independent medical source in a 'complicated' medical situation and, although UNUM admitted its conflict of interest, it resisted discovery into the extent of that conflict.

Having concluded that UNUM had an inherent conflict of interest, the court held that the district court should have 'considerably' reduced the deference accorded under the arbitrary and capricious standard of review. This modified arbitrary and capricious standard of review, which the court described as 'searching,' required the court to 'take a hard look and determine whether UNUM established by substantial evidence that Ms. Fought's claim was not covered by the plan.' Applying this standard of review, the court first found that UNUM's interpretation of the pre-existing condition exclusion was overbroad. It then determined that UNUM's denial of benefits was not supported by substantial evidence. While the specifics of the court's reasoning are not important for purposes of this article, the fact that the court engaged in an extended analysis and ultimately overturned the denial of benefits demonstrates that by 'hard look' the court means that it will grant relatively little deference to the plan administrator decision where the conflict is inherent or serious, or in cases involving a 'serious procedural irregularity.'

The Tenth Circuit opinion in Fought clarifies the standard of review to be applied in ERISA cases by district courts where the plan language provides the administrator with discretion but the administrator operates under a conflict of interest. In a standard conflict of interest case, the district court should consider the conflict as a factor in determining whether the denial of benefits was arbitrary and capricious. However, when the conflict is inherent, when the plaintiff demonstrates that the conflict is 'serious,' or when there is a 'serious procedural irregularity,' the burden shifts to the plan administrator to demonstrate that its decision was reasonable. In such cases, the district court is to take a 'hard look' at the administrator's evidence and rationale. This new statement of the standard to be applied in the Tenth Circuit makes it clear that the arbitrary and capricious standard, at least in cases where the administrator has a conflict of interest, will not automatically result in affirming the plan administrator's decision.

1. The Court also used the term 'abuse of discretion' to refer to the same standard of review. The Tenth Circuit has determined that the standards of abuse of discretion and arbitrary and capricious are equivalent when used in the context of ERISA claims. Chambers v. Family Health Plan Corp., 100 F.3d 818, 825 n.1 (10th Cir. 1996).