In defending or prosecuting claims involving insurance policies, an issue that often arises is whether or not a cause of action founded upon a state law that is ostensibly related to the business of insurance is pre-empted by the Employee Retirement Income Security Act of 1974 (ERISA), 29 U.S.C.S. § 1001 et seq. Until recently, courts and practitioners were guided by the U.S. Supreme Court's holdings in Metropolitan Life Ins. Co. v. Mass., 471 U.S. 725 (1985) and Pilot Life Ins. Co. v. Dedeaux, 481 U.S. 41 (1987). However, on April 2, 2003, Justice Scalia, speaking for a unanimous court, authored the decision in Kentucky Assoc. of Health Plans, Inc., et. al., v. Janie A. Miller, Commissioner, Kentucky Dept. of Ins., 123 S.Ct. 1471 (2003), which partially overturned the Metropolitan and Pilot holdings, and clarified the analysis to be used when examining a claim asserting a cause of action for insurance bad faith under ERISA's savings clause. Effectively, the Court simplified the analysis to be used when determining whether or not a state law relating to the business of insurance is preempted by ERISA. Additionally, the Court reduced the scope of ERISA's preemptive powers by lowering the bar for claims to be classified as "related to the business of insurance".
1. The Law Under Metropolitan and Pilot
In Metropolitan Life Ins. Co. v. Mass., 471 U.S. 725 (1985), the U.S. Supreme Court applied both the "common sense" test and the McCarran-Ferguson Act's definition of "business of insurance" to the issue of ERISA's savings clause. The same Court in Pilot Life Ins. Co. v. Dedeaux, 481 U.S. 41 (1987) applied the holding of Metropolitan to the area of bad faith litigation and addressed the issue of whether Mississippi's common law of bad faith fell under ERISA's savings clause. The Court held that Mississippi's bad faith law 1 did not fall under the savings clause because it passed neither the "common sense" test, nor the factors enumerated in the McCarran-Ferguson Act, 15 U.S.C. § 1011 et. seq. Id. As to the "common sense" test the Court stated:
- Certainly a common-sense understanding of the phrase "regulates insurance" does not support the argument that the Mississippi law of bad faith falls under the savings clause. A common-sense view of the word "regulates" would lead to the conclusion that in order to regulate insurance, a law must not just have an impact on the insurance industry, but must be specifically directed toward that industry.
Pilot, 481 U.S. at 50. The Court then examined the Mississippi Bad Faith law under the case law interpreting the phrase "business of insurance" as it is used in the McCarran-Ferguson Act. That body of law has produced several "factors" which the court stated as:
- First, whether the practice has the effect of transferring or spreading a policy holder'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.
Id. at 49-50. The Pilot Court applied those factors to Mississippi's bad faith law and held that the law did not meet at least two of the factors. Id. at 51. Specifically, the Court held that Mississippi's law did not "define the terms of the relationship between the insurer and the insured". Id. Accordingly, the Court concluded that Mississippi's law of bad faith was not saved from preemption.
2. The Kentucky Holding
In April of this year, the U.S. Supreme Court handed down a decision in Kentucky, 123 S.Ct. 1471 (2003), which departed from Metropolitan and Pilot, and changed the factors Courts must consider when determining whether a state law "regulates insurance," specifically making "a clean break from the McCarran-Ferguson factors." Kentucky, 123 S.Ct. at 1479. The new factors are only two: 1) the state law must be specifically directed toward entities engaged in insurance; and 2) the state law must substantially affect the risk pooling arrangement between the insurer and the insured. Id. at 1479. With respect to the second factor, Justice Scalia stated that it is not required that "state laws must alter or control the actual terms of insurance policies to be deemed 'laws . . . which regulate insurance' under §1144(b)(2)(A); it suffices that they substantially affect the risk pooling arrangement between insurer and insured." Id. At 1477. Justice Scalia cited as an example a law that forces insurance companies to pay their janitors twice the minimum wage, which he said is not a law that regulates insurance. However, the law addressed in Kentucky did satisfy the second requirement.
The law examined in the Kentucky decision sought to prevent Kentucky insurers from setting up closed networks of health-care providers. Id. The Court said that because this law prevented Kentucky insureds from seeking "insurance from a closed network of health-care providers in exchange for a lower premium," the law substantially affects the type of risk pooling arrangements that insurers may offer. Id. at 1478. The Court further emphasized this point by stating in a footnote that "our test requires only that the state law substantially affect the risk pooling arrangement between the insurer and the insured; it does not require that the state law actually spread risk." Id. at 1478, n3. The Court gave another example of a law that would affect the risk pooling arrangement by stating "[t]he notice-prejudice rule governs whether or not an insurance company must cover claims submitted late, which dictates to the insurance company the conditions under which it must pay for the risk that it has assumed. This certainly qualifies as a substantial effect on the risk pooling arrangement between the insurer and insured." Id.
3. ERISA Preemption of the Pennsylvania Bad Faith Statute
Under the Metropolitan and Pilot decisions, the District Courts in Pennsylvania have almost unanimously held that bad faith claims fall under the ERISA preemption provisions. See Tutolo v. Independ. Blue Cross, 1999 WL 274975 (E.D. Pa. 1999); Kuestner v. Health & Welfare Fund, 972 F. Supp. 905 (E.D. Pa. 1997), Sopak v. Highmark, Inc., 2002 WL 1271366 (W.D. Pa. 2002). For example, in Tutolo, the court held that bad faith claims were preempted by ERISA because the Pennsylvania bad faith statute did not serve to transfer or spread the policy holder's risk and because the bad faith law is not an integral part of the insurer-insured relationship. Tutolo, 1999 WL 274975.
Holdings such as Tutolo are now less precedential, as the Supreme Court has changed the analysis upon which such holdings are based. Under the new analysis, Pennsylvania's bad faith statute may no longer be subject to preemption under ERISA. In applying the two Kentucky factors to the bad faith statute, it is clear by the language of the statute that the Pennsylvania law is directed towards insurance carriers, as the bad faith statute only regulates entities engaged in insurance. As to the second factor, counsel for insureds could argue that the Pennsylvania bad faith statute affects the risk pooling arrangement between the insurer and insured. For example, it can be argued that because insurance companies are faced with the prospect of bad faith claims (which increase their exposure on every policy they write), they must raise their premiums to compensate, which thereby transfers a portion of the risk to the policy holder. Accordingly, the risk-pooling arrangement has been affected.
While it is not certain that Pennsylvania courts will now save bad faith claims from preemption, the groundwork for a trend in that direction exists. Specifically, Senior Judge Newcomer recently held in Rosenbaum v. UNUM Life Ins. Co. of America, 2002 WL 1769899 (E.D. Pa. 2002), that Pennsylvania's bad faith statute was not preempted by ERISA. Judge Newcomer concluded that the Pennsylvania statue regulates insurance under both the common sense view of ERISA's savings clause and the factors set forth by the McCarran-Ferguson Act. Id. This decision was handed down prior to the Kentucky decision but was not followed in subsequent opinions. See Sprecher v. Aetna U.S. Healthcare, Inc., 2002 WL 1917711 (E.D. Pa. 2002) (court disagreed with Rosenbaum decision, finding Pennsylvania statue still preempted by ERISA). Nevertheless, given the changes set forth in the Kentucky decision, and the obvious disagreement amongst District Court Judges, it is not inconceivable that Pennsylvania District Courts may soon revisit their prior holdings and decide that ERISA does not preempt bad faith claims.
4. Conclusion
The recent U.S. Supreme Court holding in Kentucky, 123 S.Ct. 1471, could well change the legal landscape as it relates to ERISA preemption of bad faith claims. What we know is that the legal analysis has been simplified to a two factor test. The most likely effect of this may be to lower the bar with respect to what laws will be saved from ERISA preemption. Accordingly, it can be expected that the Pennsylvania District Court's stance on the preemption of bad faith claims will be challenged anew, perhaps with a different result.
1 It is important to note that Mississippi's bad faith law is distinguishable from Pennsylvania's bad faith statute. Mississippi's bad faith law developed from the common law and applies across the legal spectrum to any breach of contract action. Pennsylvania's bad faith statute applies only to insurance companies.