Premium Discounts for Individual LTD Policy Did Not Create an ERISA Plan

Practical Law Legal Update w-036-1774 (Approx. 5 pages)

Premium Discounts for Individual LTD Policy Did Not Create an ERISA Plan

by Practical Law Employee Benefits & Executive Compensation

Insurers Argued That Employee's State-Law Claims Were ERISA-Preempted

The employee in this case was covered under an individual LTD insurance policy purchased while he was employed as a physician with a health care system. After suffering an embolism that affected his ability to continue working, the employee sought benefits under the LTD policy. Following a coverage dispute under the policy, the employee sued the policy's insurers alleging state-law claims that included bad faith breach of contract and (alternatively) claims under ERISA (see ERISA Litigation Toolkit). The insurers argued that ERISA preempted the employee's state-law claims (see Practice Note, ERISA Litigation: Preemption of State Laws). In determining whether the policy was governed by ERISA, the district court analyzed the DOL's safe harbor exemption from ERISA for insurance arrangements that satisfy a four-part test (see Practice Note, Voluntary Benefits: Four Conditions for Satisfying DOL's Safe Harbor).

Safe Harbor Analysis Focused on Employer Contributions and Involvement

Focusing on two disputed conditions of the DOL's voluntary benefits safe harbor, the district court concluded that the LTD policy was exempt from ERISA (29 C.F.R. § 2510.3-1(j)).

Under the voluntary benefits safe harbor, an arrangement is excluded from ERISA if all of the following conditions are met:

No contributions are made by an employer or employee organization.
Participation in the program is completely voluntary for employees.
The employer or employee organization is limited to specific functions (for example, publicizing the program, collecting premiums through payroll deductions, and remitting premiums) and does not endorse the program.
The employer or employee organization receives no consideration (cash or otherwise) regarding the program, subject to limited exceptions.

(29 C.F.R. § 2510.3-1(j).)

Here, the parties disagreed regarding whether the first and third conditions of the safe harbor (that is, no employer contributions and limited employer involvement) were met.

Employer Did Not Contribute to LTD Policy

Regarding the first condition, the district court concluded that the employer did not contribute directly to the employee's policy. Among other reasons, the court noted that the employee's earnings statements showed monthly withholdings for the policy's premiums—suggesting that the employee had actually paid the premiums for the policy.

The court also rejected the insurers' arguments that the employer contributed indirectly to the employee's policy by obtaining policy features that were unavailable outside of an employer-sponsored plan. These features included:

Discounted premiums.
A guaranteed standard issue feature (referring to the monthly benefit an employee could receive without medical underwriting).
Guaranteed coverage increases.
Preferential underwriting.
An annual premium increase.

Regarding the first feature, for example, the insurers asserted that the employee only received a premium discount because of the employer's involvement in negotiating coverage. Rejecting this argument, the court concluded that:

The discount was a standard feature used by the insurers to market their policies to employees.
The insurers failed to show that the employer negotiated the discount specifically for the employee-plaintiff's benefit.

As a result, the court concluded that the premium discount (standing alone) was not an employer contribution.

As another example, the court rejected the insurer's argument that the guaranteed standard issue feature was only available to the employee through an employer-sponsored plan (and was therefore an indirect employer contribution for safe harbor purposes). According to the court, the evidence showed not that the feature was only available to employees in an employer-sponsored plan, but that it was only available to an employer group of employees. The court reasoned that the employee's purchasing of the LTD policy alongside other employees (that is, part of an employer group) is expressly permitted under the DOL's safe harbor. Moreover, the insurers failed to show that the employer negotiated this policy feature for the employee. (A similar analysis and conclusion applied regarding the other policy features.)

Accordingly, the court concluded that the employer did not contribute to the employee's policy for safe harbor purposes.

Employer Did Not Exceed Limited Functions Permitted Under DOL's Safe Harbor

The district court next analyzed whether the employer's actions exceeded the limited employer functions permitted under the DOL's safe harbor (see Practice Note, Voluntary Benefits: Limited Employer Functions). The insurers argued that the employer exceeded these functions by discussing initial plan features, updates, and renewals.

Regarding initial policy features, the insurers focused on a "reverse combo" feature involving coordination of individual and group disability coverage. The court concluded, however, that the evidence did not show that the employee's policy was part of a combination arrangement.

The court also rejected the insurers' arguments that the employer exceeded the safe harbor's limited functions by modifying and updating the policies. For example, the insurers cited numerous email chains and documents in which the employer:

Considered reducing the elimination period.
Sought clarification on the disability compensation formula.
Discussed increasing the guaranteed standard issue amount.
Informed the employee of the policy.

However, the court concluded that:

These actions were ministerial in nature.
In several instances, there was no evidence that the changes applied to the employee's policy (or had ever gone into effect).

Having determined that the first and third conditions of the DOL's safe harbor were satisfied, the court concluded that:

The safe harbor applied to the employee's policy and it was exempt from ERISA.
The employee's state-law claims survived (though the employee's alternative ERISA claims must be dismissed).

Practical Impact

This case underscores the often fact-specific nature of disputes involving the DOL's voluntary benefits safe harbor. It also reflects a common litigation strategy (here, unsuccessful) in which insurers attempt to use ERISA preemption as a shield to protect against having to litigate state-law claims (see Practice Note, Voluntary Benefits: Why It Matters Whether ERISA Applies). By limiting their involvement with voluntary benefits to the functions permitted under the DOL's safe harbor, employers will be better positioned to avoid such litigation.

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