ERISA Does not Preempt Michigan's Restriction

April 15, 2008

The ERISA preemption doctrine can perhaps be best understood as a triangle. The first side is the premise that federal law trumps state law in the area of benefits. The second side provides an exception for insurance, where states are free to regulate. The third side provides a clarification that self-insured benefits are not insurance.

Most ERISA preemption litigation occurs at the intersection of the first two sides of the triangle. Case in point: a recent Michigan case that tested the legality of some administrative rules that took effect in June 2007.

In American Council of Life Insurers v. Watters, a federal district court reviewed whether Michigan's insurance authority, known as the Office of Financial and Insurance Services (OFIS), could prohibit discretionary clauses in insurance policies. Discretionary clauses have been popular since the landmark 1989 Supreme Court decision in Firestone Tire & Rubber Co. v. Brunch. The Brunch case recognized that a discretionary clause gives plan administrators the right to exercise discretion in making plan decisions. If a policy has such a clause, courts will overrule plan decisions only when they are arbitrary or capricious. If there is no clause, courts review all of the facts de novo, without deference to the earlier decision.

OFIS issued Administrative Rules 500.2201-500.2202 and 550.111-550.112, which barred discretionary clauses from insurance policies issued in Michigan. This affected all sorts of insurance policies, like health, life, long-term disability and long-term care.

The parties taking this case to court were a collection of insurance and benefits associations. They had two primary arguments. First, the Michigan Administrative Rules (Rules) interfered with Congressional intent in passing ERISA, the concept that there should be one general set of rules for all states. The court quickly dismissed that argument as lacking merit.

The second argument took a little more discussion. The plaintiffs asserted that the Rules interfered with the way ERISA cases are decided because the Rules eliminated an otherwise available evidentiary standard. The court disagreed. The Rules did not create any new type of damages or cause of action under state law. The effect of the Rules was limited to entities in the insurance industry.

Thus, the court held that the Rules were saved from ERISA preemption and continue to be in effect. Other states have passed similar laws or regulations in an effort to limit the discretion of plan administrators and carriers.