State Level “Bad Faith” Laws Don’t Apply to ERISA Disability Insurance Claimants… Yet

by Kolin C. Tang and Jenna Leslie

For many Americans, disability insurance is meant to safeguard against a sudden loss of their ability to earn a living. But when disability benefits are denied, claimants often discover the patchwork of legal protections available to them are limited and layered in confusing ways. For those who receive employer-sponsored benefits, the Employee Retirement Income Security Act (ERISA) governs most plans.

According to a recent census, a majority of people in the United States rely on their employer for insurance. In 2025, about 55% of all workers were covered by employer health insurance plans. However, access to employer-provided disability insurance varies, ranging from 31% to 68% of workers depending on the employer’s size.

Understanding how disability insurance claims are handled is crucial to evaluating whether the current legal framework is functioning properly. When workers’ ability to earn a living is suddenly threatened, they often become dependent on employer-provided disability insurance. While ERISA may provide a consistent path for litigation around benefit plans, it is unclear if the current process can adequately protect workers who become disabled.

“Bad Faith” State Laws

Individual state laws have attempted to offer more protection for people who face insurance claim denials. States like California, Pennsylvania, and Florida have “bad faith” laws, which allow policyholders to sue disability insurance companies for denying or delaying claims without any reasonable basis. Some states include additional punitive damages to deter insurers from acting in bad faith.

However, these state policies face great limitations in practice. Since disability insurance is often received through an employee benefit plan, ERISA’s standards “preempt,” or override, the expanded protections for bad faith cases. As a result, individuals whose claims for long-term or short-term disability benefits are denied may find themselves confined to ERISA’s narrower remedies, even in states that would otherwise provide stronger protections against unfair practices.

ERISA’s Preemption Clause

ERISA’s preemption clause, Section 514, allows plan sponsors to operate across states which may have conflicting statutes around the process of maintaining, reporting, and administering benefits. The preemption framework was intended to give the federal regulators sole jurisdiction over ERISA’s enforcement. There is a developed body of legal opinions identifying areas where the preemption clause can and cannot operate.

ERISA’s preemption structure has three parts: the “relate to” clause, the savings clause, and the deemer clause, as described below. They work together to distinguish which types of benefit plans are regulated by ERISA alone and which plans may be subject to state regulators. In general, state laws which regulate insurance without overreaching and regulating benefits plans themselves may not be subject to ERISA preemption. For those plans that are not solely governed by ERISA, disability benefits recipients have the potential to receive stronger protections against unreasonable claim denials.

The “Relate To” Clause

In general, all state laws are void if they “relate to” employer-sponsored health plans. The United States Supreme Court has interpreted this clause to include any state laws that have an explicit reference to ERISA plans or would create a substantial financial or administrative impact on them. It has instructed the preemption clause to apply broadly to state laws that purport to regulate employer-sponsored benefits plans.

Lower courts have followed this guidance and held that ERISA prohibits state laws that directly and indirectly affect plans. For example, state laws that would require employers to offer health insurance or regulate the provider networks that a plan may use would likely be void under the “relate to” clause. In the case of disability insurance, many short-term and long-term disability insurance plans will be governed by ERISA if provided by an employer.

The Savings Clause And The Deemer Clause

While the “relate to” clause covers a broad group of state policies, the two other clauses allow for exceptions to the rule. The savings clause allows states to regulate insurance, banking, and securities, while the deemer clause prevents self-funded ERISA plans from being treated as, or “deemed as,” insurers to evade federal preemption.

The savings clause limits the “relate to” clause, in part. While ERISA generally supersedes state laws that aim to regulate employee benefit plans, some aspects are still subject to state authority. Insurance, banking, and securities can still be regulated at the state level, even when they are used to provide benefits through ERISA-governed plans.

The deemer clause limits the savings clause and retains the broad application of the “relate to” clause. If a state regulates the insurer that provides coverage to ERISA plan participants, it generally cannot directly regulate the self-funded plans themselves. This distinction limits the extent to which state-level insurance protections apply to ERISA-governed plans.

Voluntary Plans And The Safe Harbor Provision

Traditionally, health insurance is paid for, in part, by the employer providing the coverage. However, most disability insurance plans are voluntary – meaning the program is optional and the employee is responsible for the entire cost of the premiums. Voluntary disability insurance programs are typically either “short-term” or “long-term,” but packages often vary depending on the employer.

Employers who provide voluntary benefits packages may think that those plans are exempt from ERISA, but the plans must meet specific criteria. When voluntary plans qualify for an ERISA “safe harbor,” it means they can avoid ERISA compliance requirements. When plans reach “safe harbor,” then plan participants may have more options in seeking protection from insurers making unreasonable claim denials at the state level.

For a voluntary benefit plan to qualify for ERISA’s “safe harbor” provision, and therefore avoid being treated as an ERISA-governed plan, it generally must meet all four conditions: (1) the employer makes no contribution; (2) employee participation is entirely voluntary; (3) the employer’s role is limited to allowing an insurer to promote the plan and facilitating payroll deductions without endorsing the program; and (4) the employer receives no compensation from the insurer beyond reasonable payment for administrative tasks like processing payroll deductions.

When State Laws Do Apply

Some disability policies may not be governed by ERISA even when they are organized through the workplace. In cases where the employer makes no contribution and participation is voluntary, courts often find such disability plans not subject to ERISA’s jurisdiction. Disability plans provided to public sector employees or plans provided by a church may also be exempt from ERISA’s preemption clause.

In such cases, state laws addressing bad faith insurance claim denials may apply, potentially allowing claimants to pursue additional remedies that are otherwise unavailable to them under ERISA. These remedies include consequential damages and/or punitive damages when an insurer wrongfully denies benefits. As a result, individuals covered by non-ERISA disability policies may have access to broader legal protections and enjoy stronger incentives for their insurers to process claims fairly.

Future Trends of State Regulation

In 2025, states were actively codifying protections around many aspects of healthcare plans. From prescription drug pricing to cost transparency issues, state-level bills are regulating compliance measures for health insurance at an accelerating pace.

This broader trend of greater state oversight for health insurance might also boost momentum for stronger state regulation of claim handling practices, including “bad faith” laws. As state legislators become more interested in imposing standards on insurers’ accountability, they may increasingly create new or expand existing statutes that penalize unreasonable claim denials. In turn, these developments might strengthen the remedies available to those with disability insurance benefits that are not governed under the federal ERISA framework.