Insurers Acting as ERISA Fiduciaries May Be Required to Disclose Certain Attorney-Client Communications

The Ninth Circuit Court of Appeals recently analyzed the parameters of the fiduciary exception to the attorney-client privilege for communications between an insurer acting as an ERISA fiduciary and its counsel regarding a claims decision contested by the beneficiary. Stephan v. Unum Life Ins. Co., No. 10-16840 (9th Cir. Sept. 12, 2012) (Stephan v. Unum). The opinion purports to "reject the Third Circuit's conclusion" in Wachtel v. Health Net, Inc., 482 F.3d 225 (3d Cir., 2007), which had held in broad terms that the fiduciary exception did not apply to an insurer and thus preserved the application of the attorney-client privilege to shield documents from an adverse beneficiary. 

Instead, Stephan v. Unum concludes there is no principled basis for excluding insurers from the fiduciary exception, initially raising the possibility that ERISA insurers could have to produce all otherwise attorney-client communications when litigating against plan beneficiaries. However, close consideration of the Stephan v. Unum and Wachtel v. Health Net, Inc. cases reveals that despite seemingly polar opposite conclusions they actually share certain underlying policies which should (or at least could) operate as a partial privilege shelter for ERISA insurers even in a post-Stephan v. Unum world, provided that insurers take certain precautions.

Plaintiff, Mark Stephan (Stephan), then in his late 40s, signed a contract for a new job as Institutional Sales Managing Director for a private wealth management company, with an annual salary of $200,000 and a first year "guaranteed" $300,000 bonus. Id. at 11083. Four months later, Stephan almost died in a bicycling accident and was rendered a quadriplegic. Id. He applied for disability benefits under his employer's insurance plan, underwritten and administered by Unum Life Insurance Company (Unum). Id. Unum determined Stephan's disability benefits based on a $200,000 annual salary. Id. at 11083-85. Stephan argued that his benefits should have been based on a $500,000 annual salary, determined by adding his salary and bonus, the bonus being a critical but largely expected compensation component for someone in Stephan's position in a financial services firm. Id. at 11083-11085, 11111. The difference between the parties' positions was $10,000 per month, potentially adding up to millions of dollars over the remaining life of the policy should Stephan live to be sixty-five years old.

During judicial review of the claims decision, the District court first upheld "abuse of discretion" as the proper standard to apply to Unum's claims decision process in light of plan language granting discretionary authority to Unum. Against that background, the District court then analyzed whether Stephan was entitled to discover otherwise privileged documents between Unum's in-house counsel and claims administrators under the fiduciary exception to the attorney-client privilege. Id. at 11085-86, 11100-111001. Stephan intended to use these documents to show a conflict of interest between Unum's duty to determine benefits and its obligation to pay for them, undermining Unum's argument that it did not abuse its discretion in denying Stephan greater benefits based on his bonus. Id. at 11085.

Of course, the attorney-client privilege generally protects from disclosure confidential communications between a client and attorney that pertain to legal assistance. But the privilege is not absolute: there are requirements and there are exceptions, such as the "fiduciary exception." The fiduciary exception to the privilege prohibits certain fiduciaries who obtain legal advice in the execution of their fiduciary obligations from asserting the privilege against their beneficiaries. Id. at 11100. Courts have applied this exception against ERISA fiduciaries based on two rationales: (1) the fiduciary has a duty to furnish beneficiaries with information regarding administration of the plan, and (2) when the fiduciary seeks advice regarding administration, the "real client" is the beneficiary anyway, so it makes no sense to keep counsel's advice from the real client.  Id. at 11100-01. 

However, as noted in the introduction, in 2007 in Wachtel v. Health Net, Inc. the Third Circuit held that the fiduciary exception did not apply to an insurer acting as an ERISA fiduciary because the reasoning behind the exception did not apply as well to insurers. The court reasoned that, where the ERISA claims administrator is an insurer, the lawyer's "real client" is the insurer, not the plan beneficiary. Id. at 234. It based its conclusion on four factors: (1) the insurer owned and managed its own assets; (2) the insurer had conflicting interests regarding its profit motive because the fund from which benefits were paid was the same used to determine profits; (3) the insurer had conflicting fiduciary obligations to the multiple ERISA plans it managed; and (4) the insurer paid for legal advice with its own funds instead of those used for beneficiaries. Id. at 233-36. The court further held that Congress did not intend an insurer's duty to disclose information to plan beneficiaries to mirror the duty of other fiduciaries.  Id. at 236.

Stephan v. Unum gave short shrift to the Wachtel analysis, looking simply to the ERISA statute and regulations and finding no reason "why the disclosure of information is any less important where an insurer, rather than a trustee or other ERISA fiduciary, is the decisionmaker." Id. at 11101. The Ninth Circuit holds that the fiduciary exception does apply to an insurer acting as an ERISA fiduciary, thus permitting the discovery of communications between the insurer and its counsel regarding a claims decision. Stephan v. Unum at 11101. The Ninth Circuit reiterated and emphasized the two traditional rationales for applying the fiduciary exception to ERISA fiduciaries generally: (a) beneficiaries have the right to all information regarding plan administration; and, (b) the fiduciary is simply a representative for the beneficiary, who stands as the real target of the attorney's advice anyway. Ultimately, the Ninth Circuit concluded that "[t]he justifications for excepting ERISA fiduciaries from attorney-client privilege apply equally to insurance companies" because there is "no principled basis [under these theories] for excluding insurers from the fiduciary exception." Id. at 11100-01. Although the Ninth Circuit's opinion does not analyze the issue as thoroughly as the Third Circuit, it noted that "[e]very district court that has considered the question since [the 2007 Wachtel decision] has rejected Wachtel's approach and held that the fiduciary exemption does apply to insurance companies."  Id. at 11000 n.6 (citing three intervening District court opinions). As of the writing of this alert Appellee Unum had filed for and received an extension to file a petition for panel rehearing or rehearing en banc.

Despite the contrasting conclusions in Stephan v. Unum and Wachtel, insurers and their counsel (in-house and external) should take note that the two courts agree on some key points, suggesting  that the Stephan v. Unum decision may not be as bad for ERISA insurers as some initial reports hypothesized.  

• As a baseline, the courts agree that the fiduciary exception applies to communications between counsel and a fiduciary who acts essentially as a representative of the beneficiary and administers the plan for the beneficiaries' benefit. See Stephan v. Unum at 11102-04; Wachtel at 233-34. There, the beneficiary is the "real client" and target of the attorney's advice. See Wachtel at 233-34. Applying the attorney-client privilege to these communications would conceal information from the "real client" and frustrate the objectives of the privilege itself. Id. (Note for what it is worth that the swing majority vote in Stephan was cast by a judge sitting by designation: the Senior Circuit Judge for the Third Circuit, the very Circuit that penned Wachtel). Viewing this swing vote in light of the Stephan v. Unum case and the three intervening District court opinions rejecting Wachtel, one wonders how solid Wachtel remains even in the Third Circuit.

• Both courts also agree that, as the interests between a fiduciary and the beneficiary diverge or the relationship becomes more adversarial, the justifications for disclosing information to the beneficiary decline while the justification for protecting the fiduciary's privilege over the communications strengthens. See Watchel at 234; Stephan v. Unum at 11102-03. The courts disagree about the point at which the parties become adverse enough to uphold the attorney-client privilege. The Third Circuit found that an insurer's inherent conflicts of interest were sufficient to apply the privilege's protection. The Ninth Circuit suggests that parties would never be sufficiently adverse until after the final internal administrative appeal of a claims decision. See Wachtel at 234; Stephan v. Unum at 11103.

• Finally, both courts noted that where the fiduciary seeks legal advice regarding its own civil and criminal liabilities, the privilege will likely be upheld. See Wachtel at 234-35; Stephan v. Unum at 11102. Further, these two opinions may be limited to attorney-client communications regarding the interpretation of a benefit plan; communications on other matters may also remain privileged. See Wachtel at 233 (noting that courts have held the fiduciary exception does not apply to a fiduciary's action of adopting, modifying, or terminating an employee benefit plan); Stephan v. Unum at 11101-04.

In terms of go-forward takeaways for ERISA insurers and their counsel, they should keep in mind that even though Stephan v. Unum applies the fiduciary exception to ERISA insurers and enables plan beneficiaries to discover some information that would have remained privileged under the Wachtel framework, there are still limits on the scope of the fiduciary exception. The attorney-client privilege will likely continue to be enforced where the insurer has clearly adverse interests to the beneficiary, which even under Stephan v. Unum includes any time after a final administrative appeal. See Wachtel at 234; Stephan v. Unum at 11102-03. Insurers should be cautious about their communications with counsel prior to that time, knowing that they may be discoverable. Training businesspeople and lawyers alike on neutral, sensitive ways to seek and impart legal guidance may also help avoid the generation of bad documents produced in discovery.

Insurers wanting or needing to obtain legal advice prior to final administrative appeal can also take certain measures to increase the likelihood of retaining the privilege. For example, the insurer can pay counsel with funds separate from those used for beneficiaries or seek legal advice from new outside counsel. See Wachtel at 235-36. This could help an insurer demonstrate that the legal advice was sought for a purpose adverse to the beneficiary, not a purpose focused on plan administration, and would weaken a beneficiary's right to the information because plan funds did not secure the legal assistance.

In the meantime, navigating the fiduciary exception will send ERISA insurers and their counsel through potentially perilous and poorly charted waters until more Circuits or the Supreme Court can weigh in on this issue and provide additional insight for insurers serving as ERISA fiduciaries about the scope of the fiduciary exception and measures that may protect the confidentiality of attorney communications.

ERISA fiduciary insurers should therefore make every effort to document a fair and unbiased decision making process underlying their claims administration to preserve later arguments for the application of privilege. Insurers should also anticipate that the courts will permit exceptionally broad discovery, not only into the history of similar claims handling but also into any communications with attorneys. The Ninth Circuit also emphasized the importance of an insurer being able to demonstrate policies and procedures that would mitigate any possible conflict of interest. The Stephan opinion serves as a reminder to revisit all of these risk management measures.

Finally, it is interesting to note Stephan's astonishing recovery from quadriplegia. Just five months after doctors told him he would never walk again in light of his August, 2007 bicycle accident, Stephan apparently regained the ability to walk and even went on in December 2009 to complete a stair climb to the top of the Chicago Willis (Sears) Tower. This past summer he rode a recumbent bicycle across the country to raise funds for charity. (Click here for more information on Stephan's remarkable recovery).