We have a client who increased the life insurance benefit for its employees. An employee was on a leave of absence when this happened and pursuant to the plan administrator's interpretation was not entitled to the enhanced benefit because he was not actively employed. When (if) the employee resumes employment, the enhanced benefit will apply. The employee elected the cash-out option while on leave and is now claiming entitlement to the enhanced benefit. Our position is that he is not eligible for the enhanced benefit because he was not actively employed when he elected to receive his cash out of the life insurance proceeds. Unfortunately, payroll imputed income to him as though he was entitled to the enhanced benefit. Are there any cases out there and/or guidance that would bolster the argument that notwithstanding the administrative oversight - which has since been corrected - our interpretation is nonetheless not arbitrary and capricious?

Any insight will be greatly appreciated!

Just tell him the carrier isn't going to allow it and show him the summary plan description supporting your stance.

Ran into similar situation a couple of years ago, and had to deal with several death claims. Our old plan had an actively at work provision. Our (enhanced) replacement plan has an actively at work provision. We actually charged higher premium on a couple of people.

We reversed the payroll errors and provided the inquiring beneficiaries with copies of both life contracts with the applicable provisions highlighted. They weren't very happy about it. I know there were lawyers involved, but no suits were forthcoming following denial/explanation letters.

What is "cash-out option"? Our plan is term with no cash value, with a 50% "living benefit" upon substantiated terminal (6 months or less) diagnosis. Would this be the same?

Stand your ground (with advice of your counsel).

Yes, the "cash-out" option has to do with terminal individuals as well as individuals who are permanently and totally disabled.