In 2011, the California legislature passed Insurance Code Section 10110.6 which bans the use of discretionary clauses in any policy, contract, certificate, or agreement offered, issued, delivered, or renewed, whether or not in California, that provides or funds life insurance or disability insurance coverage. The district courts in California have enthusiastically enforced this ban, holding that discretionary clauses are unenforceable in group insurance policies and self-funded employee welfare benefit plans that provide disability benefits.

Finally, there is good news on the discretionary clause front. In Bain v. United Healthcare Inc., 15-cv-03305-EMC (August 30, 2016), Judge Edward M. Chen of the United States District Court for the Northern District of California applied choice of law principles to find that New York law applied and also found that even if California law were to apply, Section 10110.6 does not apply to health insurance plans.

The Facts

David Bain, Dayna Bain, and Alaina Bain sued United Healthcare, Inc. and the Sagent Advisors Inc. Group Health Plan (the Plan) under the Employee Retirement Income Security Act of 1974 (ERISA). They claimed that United and the Plan wrongfully refused to reimburse medical costs incurred by Alaina Bain under a group health insurance policy sponsored by the Plan. They argued that California law applied and that the court was required to conduct a de novo review because Section 10110.6 prohibited the application of the discretionary clause contained in the group policy and certificate of coverage.

The group policy was administered by United through Oxford Health Insurance (Oxford). It stated that it was “governed by the laws of New York and that it shall be interpreted according to the laws of the State of New York.” The certificate stated that Oxford would only provide coverage for services that were medically necessary, and that “determinations as to Medical Necessity are made by [Oxford], and … are solely within [Oxford’s] discretion.”

Choice of Law

United argued that New York law applied to the matter, including the application of the discretionary language. Rather than simply relying on the language in the group policy concerning the application of New York law, United also pointed to the fact that Oxford was incorporated under the laws of New York and the employer, Sagent, had its principal place of business in New York. In addition, Oxford and Sagent were New York residents and had offices in New York. Judge Chen, in concluding that New York law applied, held that New York had a substantial relationship to the parties and there was a reasonable basis for New York’s law to be chosen. The parties’ choice of New York law was not unreasonable or unfair.

Section 10110.6 Does Not Apply to Health Plans

After finding that New York law applied, Judge Chen addressed the application of Section 10110.6, concluding that even if California law applied, Section 10110.6 does not apply because “section 10110.6 is limited to life and disability insurance.”

Judge Chen began his analysis by looking at the language of the statute. He concluded that the discretionary ban is limited to “polic[ies], contract[s], certificate[s], or agreement[s] … that provide[] or fund[] life insurance or disability insurance coverage for any California resident..” § 10110.6(a). He noted that a federal court must apply the California state law principle of statutory construction that a court must look first to the words of the statute themselves, giving to the language its usual, ordinary import and according significance, if possible, to every word, phrase and sentence in pursuance of the legislative purpose. According to Judge Chen, section 10110.6 was not ambiguous, as the language of the statute limited Section 10110.6’s application to “life insurance or disability insurance.”

Citing a number of definitions and descriptions of “disability insurance,” Judge Chen next explained that there is a difference between disability insurance, which is subject to Section 10110.6, and health insurance, which is not expressly identified in Section 10110.6. He determined that “disability insurance is keyed to the beneficiaries’ inability to work, and benefits are designed to provide substitute income.” The group policy paid medical expenses and the benefit claim at issue had no connection to a disability.

Judge Chen also pointed to the distinction between health and disability insurance as established by the fact that California regulates insurance plans and healthcare service plans differently. He relied on Williams v. Cal. Physicians’ Serv., 72 Cal. App. 4th 722, 729 (1999), in which the court held that the health plan at issue was not “an insurance policy subject to approval by the Insurance Commissioner, but a ‘health care service plan’ subject to approval by the Commissioner of Corporations.”

The Bains argued that there is a latent ambiguity in Section 10110.6 because in California “health insurance is considered a type of disability insurance.” The Bains relied on California Insurance Code Section 106(b) which directs that: “In statutes that become effective on or after January 1, 2002, the term ‘health insurance’ for purposes of this code shall mean an individual or group disability insurance policy that provides coverage for hospital, medical, or surgical benefits.” Judge Chen rejected this argument, concluding that even where this code section refers to “health insurance,” it says that such insurance “shall not include … disability insurance, including hospital indemnity, accident only, and specified disease insurance … credit disability … [and] disability income.” See, § 106 (b)(2), (3), (5). Judge Chen’s analysis is well-taken as policies that provide only disability income insurance are not considered health insurance under California Insurance Code Section 106.

Ultimately, Judge Chen held that Section 106 does not negate the difference between the fundamental characteristics of health versus disability insurance. The Bains did not seek insurance benefits due to a loss of income caused by Alaina Bain’s inability to work. Rather, the Bains sought reimbursement for the cost of healthcare services. Because the Bains did not claim benefits under a disability or life insurance policy, Section 10110.6 did not void the discretionary clause in the group policy.

Key Takeaways

Judge Chen’s opinion in Bain v. United Healthcare Inc. is important in two respects. First, it is a reminder of the importance of presenting facts that support a choice of law argument and not relying just on the language in the plan or policy.

Second, Judge Chen correctly determined the proper application of Section 10110.6. The language of the statute clearly states that it applies to contracts that provide disability and life insurance benefits. The district courts in California have concluded that Section 10110.6 is not preempted by ERISA and that it applies to group insurance policies and self-funded plans that provide life and disability insurance. It is a welcomed development that, at least for now, health insurers still have discretion in making complex decisions regarding the application of plan terms and the medical necessity of treatment.