The Evolving Standard for ERISA Preemption of State Law Under Recent United States Supreme Court Precedent

The Employee Retirement Income Security Act ("ERISA") was passed in 1974. The purpose of ERISA was to "promote the interests of employees and their beneficiaries in employment benefit plans." ERISA regulates employee benefit plans of private employers. The comprehensive statutory regulation prescribed by ERISA affects over eighty-five percent of non-elderly American workers who have private health insurance through employee benefit plans.

Congress, in passing ERISA, was motivated by a desire to protect against private sector mismanagement of employee benefit plans which placed individual participants' potential benefits at risk. For example, the closing of the Studebaker Automotive plant in 1963 left over ten thousand employees unable to receive pension plan benefits because the pension plan had not been adequately funded. In order to protect citizens from unexpected loss of promised benefits, Congress enacted ERISA, a uniform set of federal regulations governing employee benefit plans.

To achieve uniformity by supplanting an assortment of federal labor laws and state regulations, Congress included an express preemption provision in ERISA. Section 514(a) of ERISA provides for the provisions of Title I and IV to "supersede any and all State laws" so far as "[the State laws] relate to any employee benefit plan." Determining the meaning of the inherently vague phrase "relate to" is frequently a key issue in ERISA litigation. Recently, the United States Supreme Court had the opportunity to further delineate the boundaries encompassed by the phrase "relate to." This opportunity arose in the context of resolving a conflict between the United States Court of Appeals for the Third Circuit and the United States Court of Appeals for the Second Circuit.

The result of resolving the conflict between the circuits was enunciated in the 1995 United States Supreme Court Decision New York Blue Cross Plans v. Travelers Insurance Co. Before its decision in Travelers the Supreme Court had defined "relates to" as a "connection with or reference to ERISA plans." This definition meant that whenever a state law was determined to have a "connection with or reference to" ERISA or an ERISA plan, the State law would be preempted by the federal regulatory scheme. Courts had a fairly easy time applying this standard in two contexts.

First, if the state law or regulation specifically referred to ERISA plans the state law would be preempted by ERISA. Second, if the state law directly regulated the administration of ERISA plans or the benefits available under such plans, the state law would be preempted. However, a more difficult issue arose when the state law had an indirect effect on the employee benefit plan. The lower courts were left with little guidance as to what a "connection with" an ERISA plan would entail. In fact, the United States Supreme Court had not done a much better job of providing a definition of the scope of ERISA preemption than the statutory language of 514(a) had accomplished. In Travelers, the Court further defined when a state law would be deemed to have a "connection with" an employee benefit plan which would be significant enough to overcome the presumption against federal preemption of state law.

The litigation in Travelers arose in 1993 when the Travelers Insurance Company challenged the validity of three surcharges imposed on the company by the New York Public Health Law. The company alleged ERISA preemption as a defense to the imposition of the surcharges. The effect of the surcharges was to raise the cost of heath care to persons using commercial insurers such as Travelers or to persons using self-insured plans. As a result of the increased costs in commercial insurance and self-insured plans, people had an incentive to enroll in the lower cost plans offered by Blue Cross. Also, health maintenance organizations ("HMO's") were encouraged to enroll additional Medicaid patients due to the broad class of surcharges authorized by the New York Public Health Law.

The purely federal defense of complete preemption is jurisdictional in nature. As a result, the federal defense of ERISA preemption alleged by Travelers served as the basis for federal question jurisdiction under 28 U.S.C. section 1331. This jurisdictional aspect of a complete preemption defense is an exception to the well-pleaded complaint rule which usually bars a defendant from supplanting a plaintiff's choice of a state court as a forum by invoking federal court jurisdiction simply by pleading a purely federal defense.

Therefore, a federal court with proper venue would have jurisdiction to hear Travelers claim. The United States District Court for the Southern District of New York held that ERISA preempted the New York law. On appeal, the United States Court of Appeals for the Second Circuit upheld the District Court's decision. The basis of the Second Circuit's holding was that the surcharges imposed by the New York Law shared a sufficient "connection with" ERISA plans to meet the "relate to" standard for preemption under section 514(a) because the surcharges were designed to make the Blue Cross coverage more appealing for ERISA plans.

In an opinion by Justice Souter, a unanimous Supreme Court reversed the Second Circuit. As a preliminary matter, the Court reviewed the congressional intent in drafting section 514 to determine the intended scope of federal preemption. Justice Souter reaffirmed the Court's sentiment that in order for a federal law to preempt state law in an area traditionally subject to state regulation the Court assumes that "the historic police powers of the States were not to be [preempted] by [ERISA] unless that was the clear and manifest purpose of Congress." Finding Congressional intent to preempt state law apparent from the language of section 514, the Court went on to acknowledge that the definition of "relate to" has been less than clear.

The Court noted that if the phrase "relate to" were applied in the broadest possible manner the words of limitation "insofar as" wold not have been necessary. To apply the phrase "relate to" in a sweeping sense would also "read the . . . presumption against preemption out of the law whenever Congress speaks to a matter with generality." Following the District Court and the Second Circuit, the Court followed its holding in Shaw v. Delta Airlines that a law "relates to" an employee benefit plan, "in the normal sense of the phrase, if [the state law] has a connection with or reference to such a plan." The Court did not need to discuss the "makes reference to" prong of the test because the surcharges were imposed on patients and HMO's even if the coverage was not secured by an ERISA plan and the New York Public Health Law did not mention employee benefit plans in its statutory language.

As a result the primary focus of the decision centered around answering the question of when a state law has a sufficient "connection with" an employment benefit plan to render the state law ineffective because the state law is preempted by ERISA. In Travelers, the question was whether the three surcharges imposed under the New York law had a "connection with" ERISA plans. A literal application of the phrase "connection with" would be equally unhelpful as a literal application of the phrase "relate to." As a result, the Court looked to the objectives of ERISA and to the legislative history of ERISA to define "the scope of the state law" that Congress did not intend to preempt.

The Court found that Congress intended ERISA to "avoid a multiplicity of regulation" and "permit the nationally uniform administration of employee benefit plans." This finding of Congressional intent was also consistent with the purpose of ERISA, to safeguard employees' expectations in receiving employee benefit plans through comprehensive Congressional regulation of these plans by the passage of ERISA in 1974. Justice Souter found support for the principle that Congress intended national uniformity in the administration of employee benefit plans in Shaw v. Delta Airlines, FMC Corp. v. Holliday, and Alessi v. Raybestos-Manhattan Inc. In all three cases federal law (ERISA) preempted state laws that mandated administration of employee benefit plans.

In Shaw, the Court held that a state law which prevented plans from being structured to discriminate on the basis of pregnancy, and require an employer to pay specific employee benefits "relate to" benefit plans and are therefore preempted by ERISA. The rationale of Shaw was that varying benefits could become available, distinct from the national scheme, if the challenged statute was not struck down as preempted be ERISA. This rationale was consistent with the policy goal and objective of Congress in maintaining uniform national regulation of employee benefit plans through ERISA.

In FMC Corp., the Court held that a state law which proscribed a plan from being set up to recover in any way from a third party was preempted by ERISA. The rationale was that employers whose employees had recovered from a tortfeasor should not reap benefits in excess of what employers in other states enjoyed. The policy is the same. One state should not be able to offer more benefits to its citizens when the authorization of such benefits will disrupt the national regulatory scheme (ERISA).

Again, the goal is uniformity of national regulation.

In Alessi, the Court struck down a state law which usurped federal law standards for calculating benefits. The state law at issue in Alessi allowed calculation of benefits to include workers' compensation plans in the calculation of employee benefit plans, thereby reducing the total amount of benefits awarded. The rationale was that preemption was appropriate because federal law had enunciated a standard for calculating benefits. The policy of uniformity was again upheld because to allow the states to set their own biased methods of calculation would be tantamount to letting the states ignore the Supremacy Clause whenever the state did not agree with the terms of, and regulations enacted pursuant to, a federal statute.

In Travelers, the Court determined that the surcharges imposed by New York law should not be preempted because the charge differentials at issue in Travelers were distinguishable from those at issue in Shaw, FMC Corp., and Alessi. Specifically, the charge differentials (surcharges) between commercial insurers and Blue Cross could be justified on the grounds that the Blue Cross provides coverage to individuals who are less likely to secure coverage from an HMO or Travelers. By adopting this reasoning the Court has created a new sub-category where ERISA will not preempt state law. This sub-category is best described by stating the standard upon which the Court relied.

The Court reasoned that when the "effects flow from . . . [the] purpose . . . [of the statute], the statute does not necessarily have a "connection with" and therefore "relate to" an ERISA plan. In other words, the surcharges did not "function as a regulation of an ERISA plan itself" because the surcharges did not restrict the decisions of the plan administrators. The surcharges did not affect the uniform national administration of ERISA plans due to the fact that the surcharges only affected the plan's cost, not the benefits the plan would provide.

As a result, the surcharges were no more than an "indirect economic influence" which might or might not induce a purchaser of insurance, including the administrator of an ERISA plan to purchase Blue Cross insurance. The Court expressly recognized that the commercial insurers can still come back and offer more attractive rates than Blue Cross, as may the HMO's. However, the absent binding regulation of an ERISA plan by New York law, the mere existence of an indirect economic influence would not suffice to warrant preemption.

In light of Shaw, FMC Corp., and Alessi the Court's decision was well grounded in the Court's prior decisions. Recall that in Shaw, the Court held that a state law which prevented plans from being structured to discriminate on the basis of pregnancy, and require an employer to pay specific employee benefits "relate to" benefit plans and are therefore preempted by ERISA. The rationale of Shaw was that varying benefits could become available, distinct from the national scheme, if the challenged statute was not struck down as preempted be ERISA. In Travelers, there was no danger of varying benefits. In fact, there was no disparity of benefits offered by either the commercial plans or the Blue Cross plans. The only indirect economic effect of the New York law was to create a difference in the costs of the Travelers commercial plan versus the Blue Cross plan.

In FMC Corp., the Court held that a state law which proscribed a plan from being set up to recover in any way from a third party was preempted by ERISA. The rationale was that employers who recovered from a tortfeasor should not reap benefits in excess of what employers in other states enjoyed. The policy is the same. One state should not be able to offer more benefits to its citizens when the authorization of such benefits will disrupt the national regulatory scheme (ERISA).

Travelers is distinguishable from FMC Corp. because there is no difference in the benefits offered under the insurance sold by Travelers and that sold by the Blue Cross. Again, a mere indirect economic effect does exist. Specifically, that the plan administrator will have to choose which plan to purchase. However, the New York law did not bind the plan administrators decision nor cause any increase or decrease in the benefits offered under either plan. In fact, even the cost differential could be corrected by Travelers if the corporation chose to respond to the lower cost of the Blue Cross plan by lowering the cost of their commercial plans.

Recall that in Alessi, the Court struck down a state law which usurped federal law standards for calculating benefits. The state law at issue in Alessi allowed calculation of benefits to include workers' compensation plans in the calculation of employee benefit plans, thereby reducing the total amount of benefits awarded. Unlike Alessi, the New York law in Travelers did not operate to reduce the benefits enjoyed by beneficiaries of employee benefit plans. Again, the only monetary difference evident in Travelers was the lower cost of the Blue Cross plans as opposed to the commercial and self-insured plans. The only effect was "an indirect economic effect."

While the Court could have just as easily gone the other way and said that an "indirect economic effect" has a sufficient "connection with" and therefore "relates to" an ERISA plan, the Court's reasoning seems sound in light of its prior decisions explored above. These decisions tell us that the general presumption that state law will not be preempted by federal law may be overcome when a state law operates to create disparate benefits under the same plan. In defining disparate, it is enough to find preemption appropriate that one class of beneficiaries in a particular state does not receive the same benefits as another class of beneficiaries in that state. It is also enough to warrant preemption when a state adopts a method of computing benefits which deviates from a national standard and therefore subjects all beneficiaries in that state to disparate benefits from citizens of other states. Finally, we know preemption is appropriate when a state law allows the beneficiaries in one state to enjoy greater financial gain than those in another state.

It would not be enough to label an "indirect economic effect" such as the surcharges at issue in Travelers a form of disparate treatment because the New York law at issue does not allow any disparity of benefits between one intrastate class and another. In addition, the New York law does not create any disparity in interstate distribution of benefits. The unanimous Court would have been hard pressed to escape the rationales of its prior decisions had the Court decided to broaden the definition of "connection with" to include tangential economic effects because the Court's prior decisions had rested upon the notion that the only state laws which Congress had intended ERISA preempt were those which, by operation or on their face, created disparate standards of benefits from those authorized by federal law.

Consistent with the above principal is the general rule that the presumption against federal preemption is not rebutted by the existence of a general state law which has an indirect effect on ERISA plans. The Court had recognized the basis for this principle in 1988 in Mackey v Lanier Collection Agency. In Mackey, the Court distinguished direct economic effects on ERISA plans from indirect economic effects. The Court held that section 514 did not warrant preemption of a general state statute which allowed participants' benefits to be garnished while in their ERISA plan. The rationale of Mackey, that "Congress did not intend [to prohibit] the use of state-law mechanisms [for] executing judgments" even when those judgments would be executed against ERISA welfare benefit plans and could "prevent plan participants from receiving their benefits."

The Court found the force of the above rationale applied just as strongly to the surcharges authorized by the New York Public Health Law. The Court in Travelers reasoned that "if a law authorizing an indirect source of economic cost is not [subject to] preemp[tion], it should follow that a law operating as an indirect source of . . . economic influence on administrative decisions . . . should not [be enough] to trigger preemption either."

The general rule of Mackey, reinforced by Travelers, will allow a state law to impact employee benefit plans regulated by ERISA without being preempted so long as the law has an "indirect economic effect" on the plan. As evidenced by Shaw, FMC Corp., and Alessi, the effect will be deemed direct if one of two scenarios are present. First, the law will be deemed direct of the effect of the law is to bind the decision of the plan administrator. Second, the law will be deemed direct if the law provides for variation in the benefits provided by the plan which are inconsistent with federal law.

However, the Court carved out an express exception to this general rule to save the need to modify or overrule Travelers in a future decision. This express caveat to the general rule leaves open the question of just how far state legislatures can go when the indirect effects of their laws impact employee benefit plans regulated by ERISA.

We acknowledge that a state law might produce such acute, albeit indirect, economic effects, by intent or otherwise, as to force an ERISA plan to adopt a certain scheme of substantive coverage or effectively restrict its choice of insurers, and that such a state law might indeed be preempted under section 514.

Therefore, as long as legislatures realize that they run the risk of enacting a state law which will be preempted if the effect of the law is so acute as to coerce a plan administrator into adopting a certain scheme of coverage or restrict the plan administrator's choice of insurers, even a state law which has an "indirect economic effect," on an employee benefit plan regulated by ERISA will not be preempted by federal law.


Table of Authorities

Cases

Alessi v. Raybestos-Manhattan, 451 U.S. 504 (1981)

FMC Corp. v. Holliday, 498 U.S. 52 (1990)

Mackey v. Lanier Collection Agency, 486 U.S. 825 (1988)

New York Blue Cross Plans v. Travelers Ins. Co., 115 S.Ct. 1671 (1995)

Shaw v. Delta Airlines, 463 U.S. 85 (1983)

Travelers Ins. Co. v. Cuomo, 813 F. Supp. 996 (S.D.N.Y. 1993)

Travelers Ins. Co. v. Cuomo, 14 F.3d 708 (2d Cir. 1993)


Statutes

Pub. l. no. 93-406, 88 Stat. 829 (1974)

(codified at 29 U.S.C. ss 1001-1461 (1994)

29 U.S.C. s 1001(a)

29 U.S.C. s 1002(1)-(2)

29 U.S.C. s 1003

29 U.S.C. s 1144(a)-(d)