Discretionary Clause

What is a discretionary clause?


A discretionary clause is any provision in an insurance policy..."that purports to confer on the carrier sole discretionary  authority to determine eligibility for benefits or to interpret the terms or provisions of the policy or contract." ("Prohibition of Discretionary Clauses" by New Jersey Division of Insurance, authorized by Steven M. Goldman, Commissioner, Department of Banking and Insurance, 2006)


What are the effects of discretionary clauses?


The health insurance contract may list the benefits payable, but the discretionary clause "makes those payments contingent on the unfettered discretion of the insurer, thereby nullifying the promise to pay and rendering the contract potentially illusory." ("Letter opinion per CIC - 12912.9: Discretionary Clauses" by Gary M. Cohen, General Counsel, State of California, Department of Insurance, 26 Feb. 2004)


When a discretionary clause is in place and the insurance company's decision is challenged in court, that decision can be overturned only if it can be proven to be "arbitrary and capricious," a difficult standard to meet since the court does not have the opportunity to fully review a claim. If a discretionary clause is in place, an insured person can lose the case, "even if the overwhelming weight of evidence favors the insured." (Best's Review, June 2007)


What discretionary clause laws and regulations are in effect?


In 2002, the National Association of Insurance Commissioners adopted Model Act 42, "Prohibition on the Use of Discretionary Clauses." The purpose was "to assure that health insurance benefits are guaranteed, and to avoid the conflict of interest that occurs when the carrier has unfettered authority to decide what benefits are due." The act recommends that each member state initiate legislation prohibiting insurance contract clauses which seek "to reserve discretion to the health carrier to interpret the terms of the contract, or to provide standards of interpretation or review that are inconsistent with the laws of the state." ("Letter opinion per CIC - 12921.9: Discretionary Clauses" by Gary M. Cohen, General Counsel, Department of Insurance, State of California, 26 Feb. 2004)


In 2004, the NAIC again issued a model act to ban discretionary clauses, this time covering both the health insurance and disability income protection coverage.


States with statutes or policies against discretionary clauses include California, Hawaii, Indiana, Illinois, Maine, Michigan, Minnesota, Montana, New Jersey, New York, Oregon, and Utah. In some of these states, the policy was changed through the Insurance Commissioner's office; in the rest, the legislature enacted a law.


Why is it important to ban discretionary clauses?


A conflict of interest may result when the insurance company responsible for providing benefits has a monetary interest in spending as little money as possible. The motive to make money conflicts with the promise to pay benefits. When discretionary clauses are in place, insureds can be denied the benefits described in the policy for which they are paying premiums. Patients who sue the insurance company for benefits must meet a higher standard of review in court when a discretionary clause is in place. As a matter of fact, the court will generally not overturn a carrier's decision except to preven an abuse of discretion EVEN IF THE COURT ITSELF WOULD HAVE REACHED A DIFFERENT CONCLUSION. If no discretionary clause is in place, the court must do a 'de novo' review and consider all facts, making its own determination about whether the decision to deny benefits was appropriate. ("Discretionary Clauses in Disability and Health Insurance Policies" by Elliott Andalman, 31 Aug. 2006)


What are important impacts of a discretionary clause law?


Social impact: The law would have a favorable impact on consumers. In a court case, the 'de novo' standard of review would ensure that cases could be completely reviewed and patients would have a better chance of receiving the benefits promised in their policies. Carriers would no longer have free rein to interpret the policies as they wish. ("Prohibition of Discretionary Clauses" by Actuarial Services, New Jersey Department of Banking and Insurance, Division of Insurance, 2006)


Economic Impact: Consumers will likely receive benefits for claims which would have been denied before. This means that carriers may be paying out more in claims than they did before. Having a uniform policy of banning discretionary clauses will economically benefit carriers since if will improve the efficiency of form presentation and of the filing process. (New Jersey Department of Banking and Insurance) Also, with the 'de novo' standard of review in place, insurance carriers are more apt to approve claims and avoid possible court cases which they are more likely to lose. (Andalman, 31 Aug. 2006)


Impact on small businesses: Some claims will be paid that would not have been paid had a discretionary clause been in place, so self-funded goups may pay a little more in claims. However, a study by the Maryland Insurance Administration determined that a ban on discretionary clauses would have little impact on small business. ("Fiscal and Policy Note" by Alexandra M. Rzasa, Insurance Administration, Maryland, 26 Feb. 2008) A 2005 study by Milliman, Inc. suggested that, for disability policies, premiums would rise 3 to 4 percent. Milliman points out that increases "appear modest and seem a small price to pay for fairness in claim adjudication and protection promised by the ERISA statute." ("Discretionary Clauses and Insurance" by Mark D. DeBofsky, Adjunct Professor of Law, John Marshall Law School, 2006) Besides, the insurer already reserves for claims and avoids the costs of litigation by paying according to the contract. (Andalman, 31 Aug. 2006)


What was the final version of the bill that was signed into law?


Here is the link to the PDF file of Senate File 62 (Senate Enacted Act 34) that Governor Fruedenthal signed into law on March 02, 2009:



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Text Box: Successfully passed on March 02, 2009