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Just Because Your Employee Disability Policy Says It’s Governed By ERISA Doesn’t Mean It Is

Nearly all employee benefit plans are governed by the Employee Retirement Income Security Act of 1974, or ERISA.  ERISA is a federal law.  As a result, claimants who sue their plans for a denial of disability benefits usually will have to try their cases in federal courts.

More importantly, in an ERISA case, a claimant must show the court that a denial of disability benefits was not merely incorrect, but “arbitrary and capricious.”  That’s a difficult standard.  In an ERISA case, it’s not enough for claimants to show that the plan’s decision to deny them benefits was incorrect; they must also show that the decision had no factual basis.

Despite the broad scope of ERISA, it expressly exempts from its provisions any “governmental plan.” What that means for a government employee, or anyone else covered under the exception, is that he or she can bring a lawsuit challenging a denial of disability benefits without having to contend with ERISA’s strict standards and procedural requirements. Usually, that will be an advantage to the claimant bringing the disability lawsuit.

Further, in Tennessee, a claimant exempted from ERISA by the governmental exception can raise state law claims against the disability insurer or plan administrator including a bad faith failure to pay claim. Under Tennessee’s bad faith failure to pay law, a claimant could be awarded up to 25 percent of his or her claim as a bad faith penalty.  In contrast, claimants cannot avail themselves of state law remedies in a standard ERISA action.

As you might expect, under ERISA, a governmental plan includes any plan established by the federal government or by any state government.  However, the definition of a governmental plan does not stop there. ERISA also extends the definition of a governmental plan to include any plan established by a political subdivision or any agency or instrumentality of the government, state or federal.

In most cases, it’s fairly easy to determine if you have a governmental plan.  However, because ERISA does not provide any definition of the terms “political subdivision” or “instrumentality of government,” there are some gray areas as to when an employer’s disability plan meets the governmental exception. What’s important to remember, for claimants and practitioners alike, is that private entities may still be considered an “instrumentality of government,” particularly if they contract with a municipal organization or body.

For example, in Smith v. Reg’l Transit Auth. (5th Cir. 2016), the plaintiffs had a plan through the two defendants, the Regional Transit Authority (“RTA”) and Transit Management of Southeast Louisiana (“TMSEL”). Although the RTA was created by statute and was clearly a political subdivision under ERISA, TMSEL was owned by a series of private entities. Because the plaintiffs were employees of TMSEL, a case could be made that their plan was not a governmental plan and was, instead, governed under ERISA.  In fact, TMSEL itself held out its own plan as an ERISA plan.

As noted above, it is usually to a plaintiff’s benefit that the plan at issue is a governmental plan and not subject to ERISA’s rules. In this particular case, however, the plaintiffs were trying to argue that their plan was not a governmental plan, for reasons the opinion did not make clear. Specifically, they stated that their plan was a private plan under a test set out in Alley v. Resolution Trust Corp. (D.C. Cir. 1993.)

Under the Alley test, the court examines the “nature of an entity’s relationship to and governance of its employees.” The plaintiffs argued that, since TMSEL treated them as private employees, the plan was not a governmental plan under Alley.

The 5th Circuit, however, did not adopt the Alley test.  Instead, it looked to a more intricate six-factor test that the 2nd Circuit used to determine if an employee benefit plan was a governmental plan.  Originally set out in an IRS Revenue Ruling, the six-factors used to determine if an entity is a public agency or instrumentality of the government are as follows:

(1) Whether it is used for a governmental purpose and performs a governmental function; (2) whether performance of its function is on behalf of one or more states or political subdivisions; (3) whether there are any private interests involved, or whether the states or political subdivisions involved have the powers and interests of an owner; (4) whether control and supervision of the organization is vested in public authority or authorities; (5) if express or implied statutory or other authority is necessary for the creation and/or use of such an instrumentality, and whether such authority exists; and (6) the degree of financial autonomy and the source of its operating expenses.

The district court determined—and the Fifth Circuit agreed—that the defendants’ plan was a governmental plan under the six-factor test. In essence, the IRS’s test examines whether the entity at issue (in this case TMSEL) was set up to serve a government body, and whether it does so in a subservient role.  That was the case in Smith v. RTA.    As the court noted, although TMSEL was a private entity, it administered the day-to-day operations of the RTA’s public transit system.  In addition, while TMSEL provided bus drivers, mechanics and other support personnel to the RTA, the RTA had the authority to remove TMSEL’s managerial employees for cause.  Perhaps most importantly, TMSEL was funded exclusively by the RTA.

In sum, TMSEL was not an independent private entity. It existed solely to serve a public agency. As a result, the Fifth Circuit determined that TMSEL’s employee welfare benefit plan was a governmental plan, even if TMSEL itself was a private body.

One other important lesson from the Smith v. RTA case:  The 5th Circuit was not swayed by the fact that TMSEL had previously informed its employees that the plan at issue was an ERISA plan. As the court noted, whether an entity intended ERISA to govern is not relevant.  In fact, it is not uncommon for a disability policy to state that it is an ERISA plan, even though it is subject to the governmental exception.

Whether an employee welfare benefit plan is a government or private plan can make a difference in a dispute over disability benefits.  If you have questions regarding whether ERISA governs your disability coverage, you should consult with an experienced disability insurance law firm.