CHAPTER TWO. AMERICAN HEALTH CARE FINANCING: PRIVATE THIRD PARTY HEALTH FINANCING ARRANGEMENTS

A. AN INTRODUCTION TO THIS CHAPTER

If you live in the United States in the first decade of the 21st century, it is very likely that some time in the next year you will seek some form of health care and that it will be a costly experience. It is just as likely that some time in your life, perhaps next year, perhaps a decade from now, you or a family member will incur major, perhaps even "catastrophic," health care expenses. Almost everyone, at some point, incurs health care expenses in excess of tens of thousands of dollars. In fact, the risk of incurring bills in excess of several hundred thousand dollars is small but extant for each of us. And for a growing number of Americans, there is an increased likelihood that at some point in their lives they may need to purchase nursing home or some other form of long term care for themselves, their spouse or parent, or even their child -- again a prospect of extraordinary expense.

These potential costs bear heavily on three sets of important decisions by American consumers: choices concerning the purchase of some form of third party payment, choices between various providers at the time of perceived need, and choices among options for treatment at the time of an encounter with a provider. All these decisions are determined in large part by the unique array of insurance and other arrangements through which Americans finance their health care.

The purpose of this chapter is to describe the private health care financing arrangements currently available to Americans and to identify important, related, political and legal problems. The next chapter will review the various public third party financing arrangements, principally Medicaid and Medicare. The emphasis in both these chapters is on the demand or consumer side of the health care financing equation. That is to say, particular attention is paid in these chapters to issues regarding eligibility, scope of coverage, limits and exclusions, and other important elements of American health care financing arrangements that are important to the individual consumer. Chapters 4 and 5 will again focus on these health care financing arrangements, but from the perspective of providers and with a particular emphasis on issues involving provider reimbursement and other supply-side issues.

Subsections B.1-2 describe the types of private health financing arrangements currently available to Americans, their key characteristics, and some of the important differences between traditional insurance-type schemes and those which integrate to some degree the delivery and financing of health care. These subsections focus particular attention on those elements of private health

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financing arrangements likely to be involved in current and future political and legal controversies, such as the reliance on employer-purchased health benefits, the tax treatment of private health benefits, various cost-containing efforts such as cost-sharing limits on coverage, and the trend towards "managed care" arrangements that characterized American health care financing in the 1990s.

Subsection B.3 describes the various state and federal efforts to regulate private health financing arrangements, and analyzes important legal disputes concerning these regulatory efforts, and, in particular, the scope and implications of the federal ERISA legislation.

Subsections B.4 and B.5 review the statutory and common law principles that govern disputes over coverage and eligibility in private financing arrangements.

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B. PRIVATE THIRD-PARTY PAYERS

1. An Overview of Private Third Party Financing Arrangements

How many Americans have private health insurance?

Nearly 200 million Americans held some form of private health insurance in 2004, representing roughly 70 percent of the population under the age of 65. These figures are somewhat misleading and exaggerate both the number of people covered and the extent of their coverage. Not all of these people have coverage throughout the year. Further, while virtually all forms of private financing include some form of coverage for hospitalization, coverage for physician services and, particularly, other services is not so extensive. Even when a plan covers these categories of services, coverage is often limited by a fixed dollar ceiling, durational limits, specific exclusions, or by various cost-sharing requirements. In addition, a number of these policies are supplemental, as in the case of Medi-Gap policies for Medicare beneficiaries (see explanation in Chapter 3), and many people buy more than one policy, in some cases providing duplicative and unnecessary coverage. For updates and more detailed analysis of these figures, see Employee Benefit Research Institute, Sources of Health Insurance and Characteristics of the Uninsured (this EBRI report is annually updated).

How much health care is purchased through these private health financing arrangements?

Private third party payers paid for roughly one-third of total personal health expenditures in 2004. By comparison, public third party payers, primarily the Medicare and Medicaid programs, paid for 45 percent of personal health expenditures (while covering about one-fourth of the population). The remaining less than 20 percent of spending represented individual consumer out-of-pocket payments: cost-sharing and payments for services not covered by the insurer or direct out-of-pocket payments by the uninsured. Because of more extensive coverage, private health insurers pay for a much larger share of hospital and physician services than they do for other services. For example, almost 80 percent of privately purchased, inpatient hospital services and nearly 75 percent of privately purchased physician services were paid by private health insurers. In contrast, private health insurers paid for less than 15 percent of privately financed nursing home care.

Where do Americans "buy" their health financing arrangements?

Some people buy their health coverage individually, but many, though clearly not all, Americans receive their health coverage through their employment, benefits that are not subject to federal income or Social Security taxes. (See discussion in the next subsection.) In 2004, nearly 100 million workers, roughly 60 percent of all workers, received their health insurance through their employment. Not all employers, however, provide benefits for their employees' families or dependents. There is also a great deal of variation between types of employment, across income categories, and between geographic regions. For more details, see The Kaiser Family Foundation & Health Research and Education Trust, 2005 Employer Health Benefits Survey (annually updated).

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See also discussion of out-of-pocket payers and the "underinsured" in Section 2D.

Understandably, those employers who pay all or a large portion of their employees' health insurance costs are the most sensitive to the increasing costs of purchasing those benefits. Throughout the 1980s and into the 1990s, the costs of employer-purchased health benefits rose rapidly, often exceeding the rate of growth of overall health costs. (See Section B in Chapter 8 for discussion of rising health care costs and their underlying causes.) In the mid-1990s, however, there was a marked moderation in the rate of growth of employers' contributions to employees' health benefits. There were, of course, wide variations from employer to employer. Most experts attributed this slow growth rate in the mid-1990s to employers’ increased reliance on health maintenance organizations and other plans that rely on managed care practices. On the other hand, since that time, the costs of employment-based health benefits have started to rise again and, in fact, are predicted to jump substantially in the next few years.

Many health policy analysts believe that one driving force behind these swings in the rates of cost increases is the insurance "underwriting cycle." The underwriting cycle is a historic pattern of pricing where insurers and other plans under-price their products during times of profitability in order to increase their market share -- and then raise their prices rapidly when they later experience financial losses. For the most recent data, see the Kaiser Family Foundation & Employee Benefits Research Institute report cited supra.

As the costs of benefits go up, some employers rely more heavily on part-time or contract employees, or simply reduce their commitment to provide health benefits. On the other hand, those who continue to provide broadly defined health insurance benefits to their employees may consider self-insuring, or restructuring their benefits to increase employee cost-sharing liability, as discussed infra. Still other employers may turn to “defined-contribution” (as opposed to “defined benefit”) plans, offering a fixed dollar commitment to their employees who then may choose to spend those dollars on one of a series of health benefit plans or even on other benefits.

What kinds of health financing arrangements are available to Americans?

There is a wide -- some would say endless -- variety of group and individual health financing arrangements available to Americans. For the most part, however, all are variations on three basic prototypes: traditional indemnity policies, service-benefit plans such as traditional Blue Cross and Blue Shield, and HMOs, PPOs, and other schemes that provide some degree of integration between the delivery and financing of services. See Figures I, II, and III. But within these prototypes fall many variations.

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SIDEBAR: WHAT EVER HAPPENED TO THE BLUES?

The "Blues," the national network of Blue Cross and Blue Shield plans, have played a critical role in the evolution of private health financing in the United States. As described in the introduction, they originally forged a unique nonprofit persona designed to meet the needs of both consumers and providers. Throughout the 1950s and 1960s the service-benefit-type plans offered by the Blues dominated the market for private health insurance. With only slight exaggeration, the Blues claimed the role of America's private alternative to government-run health insurance. After all, the Blues were willing to offer insurance in communities where other insurers would not and to people who would otherwise be uninsured. When Medicare was enacted, the Blues took a large role in administering that program as carriers and fiscal intermediaries.

As health care costs soared in the decades that followed, however, the Blues found it difficult to maintain both their traditional persona and compete effectively with commercial insurers, HMOs, and others plans that were both more willing to experiment with alternative financing arrangements and that could be more selective in their enrollment practices. By the mid-1980s, many of the Blues were reporting huge losses, especially following the revocation of their federal tax exemption in 1986. Both within and without the industry there were claims that many Blues were poorly managed and that the Blues had lost both their financial stability and their sense of mission. In 1990, the West Virginia plan was seized by the state's insurance commissioner and forced to declare bankruptcy. A 1994 study by the GAO reported that as many as 25 percent of Blue Cross and Blue Shield subscribers belong to plans that were described as financially "weak." In 1995, the U.S. Senate issued a report on the activities of the Blues in West Virginia, Maryland, New York, and the District of Columbia. It claimed to find a disturbing pattern of both internal mismanagement and ineffective state oversight.

In response, some states attempted to more closely monitor the operations of the Blues -- with some surprising results. In March of 1996, the New York Insurance Department fined Empire Blue Cross and Blue Shield $1.1 million for inconsistency in denying coverage claims. There also were more than a few accusations of malfeasance. In 1998, Blue Cross Blue Shield of Illinois pleaded guilty to eight felony counts of Medicare fraud and paid the Department of Justice a fine of $144 million. In August of 2000, Blue Cross and Blue Shield of Kansas agreed to pay $75 million to a foundation for charitable care to settle a dispute with the state over their nonprofit status. (In 2002, an effort by an out-of-state for-profit company to buy Blue Cross and Blue Shield of Kansas was was rejected by the of the Kansas insurance commissioner. See Blue Cross & Blue Shield of Kansas v. Prager, 276 Kan. 232, 75 P.3d 226 ((2003)).)

In other areas of the country, the Blues have been able to respond more successfully to changing conditions, for the most part by abandoning their traditional consumer-oriented practices and adopting those of their more proprietary competitors.

Many Blues, while continuing to claim that community service is still a primary part of their mission, now offer a variety of HMO, PPO, and other "managed care" options. Others have abandoned their traditional persona altogether, either by creating for-profit subsidiaries or by giving up their

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nonprofit status and restructuring as for-profit entities. Indeed, today the plans offered by the Blues and their spin-off enterprises are indistinguishable from those offered by other payers in many areas of the country.

There is, nonetheless, some legal distinction between the Blues and other payers. All states closely regulate the Blues and their practices, some under separate statutory authorization, some under general insurance laws. In many states, the Blues are still allowed their nonprofit status and, in some cases, receive mandated discounts and other statutorily imposed advantages unavailable to some of their rivals. But both their special status and their efforts to restructure have led to some interesting and unique legal controversies. Some states have fought to limit the discretion of the Blues to restructure as for-profit organizations, either as an exercise of the states' general power over the dissolution of nonprofit entities or under specially enacted legislation. Of particular concern has been the Blues' ability to use the assets accrued from their nonprofit activities in their new, for-profit endeavors. Some public officials and consumer groups have argued that the assets should be segregated into a nonprofit trust or foundation or, at least, dedicated to “charitable” activities.

But whether they have adopted an entirely new identity or continued to maintain some special status with their jurisdiction, one thing is clear: The Blues, as they exist in the first decade of the 21st century, bear little resemblance to the Blue Cross and Blue Shield plans that once claimed to be America's private alternative to government-run health insurance.

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As noted, employers may offer their employees a single option or a choice of several. While the majority of employers that offer health benefits offer traditional indemnity insurance as an option, only a very few employers, less than 5 percent, offer only a traditional indemnity-type insurance plan. Virtually all offer some HMO or other "managed care" option. Similarly, very few employers offer health benefits without some monthly contribution by the employee.

From the point of view of the purchaser, the most significant structural

differences between these options are in the nature of the relationship between the insurer and the provider of services. Under a traditional indemnity arrangement, there is virtually no relationship between the insurer and the provider. The insurer simply agrees to pay for services that are covered by the insurance contract. Sometimes, the insurer pays directly to the insured, who then must pay the provider’s bill in a separate transaction. Under a traditional service-benefit plan, the insurer negotiates contracts with many physicians, hospitals, and other providers concerning the level of reimbursement and the amounts of cost-sharing by the plan's subscribers. Most Blue Cross and Blue Shield plans also secure an agreement that contracting hospitals (but less often physicians) will agree to accept all their subscribers. Beyond that, service-benefit type plans exercise little control over the provision of care.

HMOs integrate the delivery and financing of services. Fully integrated health maintenance organizations such as Kaiser Permanente own their own hospitals, contract with medical groups or directly employ their own physicians, and contract to provide other covered services. Other HMO-type plans deliver services by contracting with a few hospitals or selected -- or "preferred" -- physicians to provide services to the plans' members. There are at least four different types of HMOs: staff models, group models, network models, and independent practice associations (IPAs), all of which vary in terms of the type of relationship and degree of control between the plan and its individual providers.

There are usually differences between the costs of these plans, differences in both the cost of monthly premiums and the cost-sharing paid when services are received. There also are important differences in terms of the economic incentive for consumers to consume and providers to provide services, as discussed more fully infra. The key to understanding the structural differences between these types of arrangements lies in the implications of these arrangements for the consumer’s (a) access to providers and (b) freedom-of-choice between providers. Under traditional indemnity insurance the insurer only contracts to reimburse for incurred expenses; the insurer neither assures the consumer that a provider will be available nor that any provider will accept them. On the other hand, there is no restriction on the consumer's "freedom of choice." Traditional Blue Cross and Blue Shield subscribers sacrifice a little "freedom of choice," but in most communities, most hospitals and many if not most physicians enter into contracts with the Blues and subscribers are assured that those providers will accept them or, at least, that those that accept them will accept Blue Cross or Blue Shield reimbursement.

In contrast, HMOs and other integrated arrangements require the subscriber to concede more "freedom of choice" in return for a more direct assurance that services will be available and provided -- if the subscriber goes to the plan's providers -- and usually a minimal amount of cost-sharing. PPOs represent a variation on this theme. Although the PPO usually will provide some reimbursement for services received outside of the PPO network, the PPO pays full reimbursement with little or no cost-sharing only if the subscriber uses

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PPO-approved physicians (or goes to providers that have been approved by the plan's "gatekeeper" provider).

Recently, some plans have been offering "point-of-service" options, incorporating some of the advantages of PPO-type plans but retaining greater "freedom of choice." Under an HMO with a "point-of-service" option, for example, the subscriber can choose to go to a provider outside of the HMO's plan, but will pay higher cost-sharing if they do so and the HMO will pay only a share of the remainder of the provider's charges to the patient.

As discussed in detail in the sidebar infra, one of the most predominant trends in the 1990s was the movement towards "managed care" arrangements. The obvious attraction of managing care and, for that matter, the apparent result, is that “managed” arrangements can control the costs of covered benefits while still offering the same type of coverage. But do "managed care" arrangements provide care of an adequate quality and, at the same time, reduce costs, or do they reduce costs by providing less care or, most critically, care of lower quality? The answer would appear obvious: "Managed care" must work. Why else would so many third party payers be adopting the mantel of "managed care"? Surprisingly, the relative cost and quality of care available through these arrangements have been matters of some controversy. Most experts agree that at least fully integrated HMOs -- one of the prototypes for “managed care” -- can provide high quality services at somewhat lower costs than plans that are less integrated and, especially, than plans that reimburse providers of a fee-for-service basis. See, e.g., Peter Kemper, James D. Reschovsky, & Ha T. Tu, Do HMOs Make a Difference? Summary and Implications, 36 Inquiry 419 (2000). For a comprehensive review of the literature, see Marsha Gold, Contemporary Managed Care: Readings in Structure, Operations, and Public Policy (1998); Robert H. Miller & Harold S. Luft, HMO Plan Performance Update: An Analysis of the Literature, 1997-2001, 21 Health Affairs 63 (2002). See similar discussion of cost-savings under "managed care" arrangements in public programs in Chapter 3.

Part of the difficulty of generalizing from any of these studies is that some studies compare only fully integrated HMOs -- which represents roughly 15 percent to 20 percent of private financing arrangements -- with other forms of integrated financing; but other studies compare all forms of "managed care" which, as noted in the sidebar, could describe as much as two-thirds of private financing arrangements. There also are vast differences between various parts of the country. In the Northwest, for example, about one third of the population is enrolled in various HMOs and virtually all group health plans could be described as “managed care.” In some areas of the South, fewer than 10 percent of the population are enrolled in HMOs and more traditional indemnity arrangements are still prevalent.

What is a "self-funded" employer health benefits plan?

In the last several decades many large employers have turned to one or more self-funded options to provide health benefits to their employees. One survey of employers with more than 10 employees found that 25 percent of employers who offered an indemnity plan self-funded that plan; in contrast, 22 percent of employers that sponsored a PPO, and 10 percent of employers who sponsored an HMO were self-funded. See Ken McDonnell & Paul Fronstein, EBRI Health Benefits Databook 92 (1st ed. 1999).

On the other hand, it is clear that “self-funded” is also a term that can be misleading. Some large employers actually pay for their employees’ health

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benefits on a pay-as-you-go basis, with no separate funding. Others self-fund some benefits but arrange for some sort of back-up or stop-loss policy. Virtually all hire some outside agent to administer their benefits. The only unifying element is quite practical: Employers who self-insure try to structure their plans in order to be exempt from state insurance laws as provided under the ERISA legislation. See discussion in subsection 2B.3.

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SIDEBAR: JUST WHAT IS "MANAGED CARE"?

The term “managed care” will be used frequently throughout this textbook, just as it appears frequently in public and private discussions, governmental deliberations, and in almost everything written about American health care in the last few years. The late 1990s ushered in, we are told, the "managed care era." Through managed care the costs of programs like Medicaid and Medicare can be contained while services and coverage are continued, if not expanded. Managed care has fundamentally altered the relationships between patients, their providers, and those who pay for their services. But while everyone is talking about managed care, it is not clear that all of these references are to the same phenomenon. Just what managed care is and why people are so concerned with it are obvious but not easily answered questions.

The simplest way to describe managed care is to refer to the structural prototypes in which many of the elements of managed care are found: HMOs, IPAs, PPOs, and other plans that directly or through contractual agreements integrate -- and therefore are able to manage -- financing and service delivery. In fact, in some contexts, the terms "HMOs" and "managed care arrangements” are used almost interchangeably. But clearly "managed care" is the broader and more general term and can be used to include virtually any financing arrangement where there is third-party management or supervision that attempts in some structured way to oversee the quality and, particularly, the costs of the services delivered to the plan's beneficiaries.

Perhaps the better question is this: What kinds of practices typify managed care plans? In HMO and other arrangements in which the delivery and financing are integrated, the managing is provided by the economic incentives of providers, usually through some form of capitation or other financial incentive to control utilization and, therefore, costs. Most integrated arrangements also manage care by limiting access of their beneficiaries to certain providers -- generally those who have been chosen because of their demonstrated ability to limit utilization or the costs of the services they provide. Other managed care practices include pre-certification or second opinions for certain kinds of services; various forms of ongoing or post-service utilization review; and standards and guidelines to encourage or, in some cases, require limits on services rendered.

All of these practices have been around for some time in one form or another. For that matter, some of these practices can be undertaken by virtually any third-party financing scheme. Even traditional indemnity insurers retain the authority to make “medical necessity” decisions or to exclude coverage for experimental services. The key to understanding managed care practices lies not so much in the specific structure of managed care plans or the practices that they adopt, but in the rigor with which manage care plans exercise their potential authority. To borrow from the popular lexicon, managed care is an attitude. Health care has always been managed, but until recently, it has been managed in a manner that has ceded much decision-making authority to providers, especially physicians. Until the late 1980s, most physicians, even those who worked in a group or institutional setting, could provide care, order diagnostic tests, and prescribe additional services with little third-party control from the organizations within which they practiced, or from the insurers or other entities that ultimately paid for those decisions. Few decisions were supervised

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or managed on an individual or systemic basis. As the costs of health care have continued to rise, however, more and more attention has been focused on the need to control utilization, reduce unnecessary services, and avoid excessive costs -- all issues that ultimately call for some serious limits on the decision-making autonomy that providers have traditionally exercised. One of the most important ways in which that call has been answered has been by managing care through the various arrangements and practices outlined above.

In this regard, projections that nearly all Americans with privately purchased health financing will be enrolled in managed care plans by the year 2010 are misleading in that they suggest that certain financing arrangements are identifiable as managed care plans and can be easily distinguished from others. What is meaningful about that projection and what makes managed care so important, whether it is a reference to a structural prototype or the rigor with which third-party payers exercise control over utilization, is the underlying fact that 21st century consumers can expect to have the decisions of their providers managed -- in a whole variety of ways, regardless of the source of their coverage or the setting in which they receive care -- and in ways that earlier generations of consumers may never have experienced.

American consumers are not all that happy about this. Indeed, “anti-managed care” legislation maintains a high priority on the agendas of our federal and state legislatures. See Chapter 8. On the other hand, those same legislators have frequently relied on managed care plans and practices in their efforts to control the costs of publicly funded programs. Managed care, whether called "managed care" or not, seems likely to be around for quite a while. For further discussion of the implications of managed care for provider behavior, see Chapters 4 and 5.

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What part do "HIPCs" play in these arrangements?

In many discussions of ways in which to reform private health financing, there are references to various forms of purchasing alliances, employer or other group-pooling arrangements through which individual consumers (or employers) can purchase health benefits with the advantages of group purchasing power. One prototype for doing so is described as a HIPC: a health insurance purchasing cooperative. The term was first authored by Alain Enthoven as part of his proposal for reforming American health care financing under a national program of "managed competition." The term also was incorporated into the ill-fated Clinton national health care reform proposal, although Clinton's HIPC differed from Enthoven's in a number of important ways. See discussion of both Enthoven's and Clinton's proposals in Section C of Chapter 8. But HIPCs or, at least, group purchasing alliances have a history that predates these proposals. In fact, the basic notion of pooling the purchasing power of many individual or small group consumers into a larger purchasing arrangement is an idea that finds its origins in the success of large union or employer groups, the Federal Employee Benefits Plan, and some state employee plans in controlling the costs of their health benefits over the last several decades. Compared to the costs of individually purchased health insurance and even to the costs of the benefits purchased by most smaller groups, these groups have been able to slow the growth of their costs while maintaining levels of benefits, in some cases remarkably so. The primary reason is obvious: Large groups of consumers have more bargaining power with insurers and other private financing arrangements and may obtain better prices or more benefits or both. Purchasing alliances -- structured as HIPCs or otherwise -- simply allow individuals and small groups to obtain comparable bargaining power.

The details of the structure of an alliance can be important, as will be discussed in Chapter 8. Two primary variations, however, are important to understand for present purposes. First, there is a critical difference between "purchaser" alliances and "sponsor" alliances. Under the former, the alliance bargains with insurers and selects a few or even just one plan which is then offered to the enrolled consumers. The alliance then monitors performance and helps implement cost management programs. Under "sponsor" alliances -- of which Enthoven's HIPCs would be one example -- the alliance selects a number of plans offering standard benefits but with some variation in cost-sharing and other terms; the alliance then assist consumers in making choices among the plans, usually with the consumer bearing the full cost of the premium above some minimum amount. But once the consumer chooses the plan, the sponsor plays little or no role until the next selection period arises.

Are employers required to provide health benefits to their employees?

While employers are not generally required by law to offer health benefits to their employees, the Consolidated Omnibus Budget Reconciliation Act of 1986 (COBRA), 26 U.S.C. § 2980B(f), requires that employers with 20 or more employees that offer health benefits to their employees or their employee's spouse or dependents, must continue to offer those benefits following the termination of employment -- but at the former beneficiary's expense. If the employee is discharged other than for gross misconduct, the employer must continue to offer benefits for 18 months. If health benefits are terminated because of a divorce or the death of any employee, the employer's obligation continues for 36 months. Benefits terminated because of the disability of the employee must continue to be offered for 29 months (at which time the former employee may qualify for Medicare). COBRA allows the employer to charge the beneficiary 102 percent of

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the full cost of such benefits. According to a recent estimate, at any one time, nearly 4.7 million former employees rely on COBRA benefits. The Kaiser Commission on Medicaid and the Uninsured, COBRA Coverage for Low-Income Umemployed Workers (October 2001). For a discussion of the discretion of an employee to choose to buy COBRA benefits from a prior employer, see Geissal v. Medical Corp., 524 U.S. 74 (1998).

Employers also are required to continue to provide health benefits for employees who qualify for unpaid leave under the Family and Medical Leave Act, 29 U.S.C. § 2614(c). Those benefits -- and the employer's contribution -- must be maintained at the same level as if the employee had continued employment.

Some employers not only provide their employees with health benefits during their years of active employment, but also following their retirement. In some cases, these retirement health benefits provide coverage for the years after retirement but before Medicare coverage is available at age 65. For those 65 or over, the coverage is often akin to a "Medi-Gap" policy, acting as a supplement to Medicare and financing services that are not covered by Medicare but that may have been included in the benefits available to the employee during active employment years. In fact, retirement health benefits are often viewed -- by both employer and employee -- as simply a continuation of the health benefits plan that the employee received during their working years.

A survey in 1999 found that 41 percent of large (200 or more workers) firms offered health benefits to their retired employees while only 8 percent of small (3-199 workers) offered retirees health benefits. High income, unionized, and public employees were more likely to receive benefits than individuals in low income jobs. In some cases, the benefits were merely the opportunity to remain in the employer's plan and the employee was required to bear the full cost of the benefits. In others, the employer pays part or, in some few cases, all of the cost. For more recent estimates of existing retiree plans, see Kaiser Family Foundation & Hewitt Associates, Retiree Health Benefits in 2003: Employer Survey (2004).

Obviously these are expensive commitments, whether or not retired employees are asked to share in their costs, especially since retiree health benefits, unlike retiree cash benefits, are not pre-funded but paid out of annual revenues by most employers. Increasingly in recent years, many employers have undertaken efforts to control the costs of these benefits by requiring more beneficiary participation in premium costs, imposing cost-sharing, requiring participation in managed care plans, and adopting other measures that continue their commitment but limit their potential liability. Some employers, however, have simply tried to limit, or in some cases, to withdraw their prior commitments altogether.

Does an employer have the discretion to limit or terminate retirement health benefits? Are retirement health benefits "vested" like pensions and some other retirement benefits? For that matter, what are those benefits: Are they the same benefits that the employee received while working or are they comparable to what the employer gives to current employees? Oddly, until very recently, these matters received very little attention and many employees assumed that their retirement benefits would include health benefits as well.

As will be discussed more fully in subsection B.3, a private employer's obligations are governed almost exclusively by the federal Employee Retirement Income Security Act (ERISA) which essentially requires an employer to do no more -- and no less -- than comply with whatever the employer has contracted to do.

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ERISA imposes "vesting" requirements on some pension benefits, but there are no vesting requirements imposed by the statute for health benefits (for retired or current workers.) The results can be rather harsh. In John Morrell & Co. v. United Food & Commercial Workers International Union, 37 F.3d 1302 (8th Cir. 1994), the court held that an employer that had a 30-year history of providing health benefits to its retired employees and their dependents could terminate those benefits at any time. Since the union contract governing benefits did not explicitly describe those benefits as "vested," neither the past practices nor written statements affirming the employer's intent to continue those benefits were sufficient to legally obligate the employer. See also Schoonejongen v. Curtis-Wright Corp., 143 F.3d 120 (9th Cir. 1998) (employer can terminate retirement health benefits only if the ERISA-mandated procedures for notification are followed, but notification found to satisfy ERISA); Marx v. Loral Corp., 87 F.3d 1049 (9th Cir. 1996) (employer not required by ERISA to continue benefits to retirees despite assurances from employer to the contrary where unambiguous terms of the health benefits plan provide for unilateral termination).

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2. The Tax Treatment of Employer-Purchased Health Benefits and Its Impact on Private Health Financing

If an employer makes a contribution toward the purchase of health benefits for an employee or that employee's dependents, either directly or through a "cafeteria" arrangement, or establishes a self-insurance scheme that directly pays the employee's medical bills, the employer's contribution, unlike wages and most other forms of employee compensation, is not subject to either federal income or payroll tax on the employee. 26 U.S.C. §§ 105(b), 106(a), 3101, 3102, 3121. The amount contributed by the employer is also excluded from computation of the employer’s payroll, corporate, and other federal tax liability. 26 U.S.C. § 162(a); Treas. Reg. § 1.162-10. Most states follow the federal law and exempt employer-purchased health benefits from state income tax as well.

Under legislation adopted in 1998, self-employed individuals are allowed to deduct the costs of their health benefits from their federal income tax liability as well. In addition, all federal taxpayers can deduct medical expenses, including insurance premiums, in excess of 7.5 percent of adjusted gross income from their gross income.

As described in the introduction, the exclusion of employer-purchased health benefits from the computation of federal income and payroll taxes was adopted administratively during World War II and codified in the Internal Revenue Code in 1954. While it is not clear whether it was intended to be so at that time, this indirect federal subsidy of the costs of most (but not all) private health financing has become one of the foundational elements of federal health policy.

It also has become a major fiscal effort. In 2004, the tax "expenditure," the amount of revenue lost by this exclusion each year, was estimated to be over $150 billion for the federal government and an additional $25 billion for the states. This obviously has long-term implications for federal fiscal policy generally as well for any future efforts to reform health care financing. See discussion in Chapter 8.

The more immediate implications -- those for the employee-consumer -- can be illustrated best by an (over-simplified) example:

Suppose an employee's adjusted gross income is $36,000. She will pay roughly 28 percent of this amount in income and payroll taxes. Assuming no other deductions, her actual net income will be $28,825. If her employer also contributes an additional $4000 in health benefits, the employee will receive the full value of those benefits. If, on the other hand, the employer gives her $4000 in additional wages, she will receive only $2880 in cash ($4000 minus 28 percent in taxes.) If the employee attempts to purchase the same benefits with her own cash income, she must earn over $5555 ($5555 minus 28 percent roughly equals $4000) in adjusted income to receive the "after tax dollars" to purchase the same benefits. Obviously, both the employer and the employee gain by converting cash income into health benefits.

Note, however, that the effect of the subsidy -- at least as it is currently configured -- is skewed by any gradations in tax brackets: People paying higher tax rates are effectively given a greater subsidy than those paying lower tax rates, and, of course, those paying little or no tax do not benefit at all. For example, our taxpayer/employee above receives a $1,120 subsidy (28 percent of $4,000) in the form of taxes not paid. If our taxpayer

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made over $250,000 (putting her in the highest tax bracket), and received the same health benefits from her employer, she would receive a $1,584 subsidy (39.6 percent of $4,000). And if she were in the lowest tax bracket (if her income were $15,000, she would pay a tax rate of 15 percent), she would receive only a $600 subsidy in the form of unpaid taxes. (The exact calculation of the subsidy is actually more complicated because neither the employer nor the employee pays payroll or “Social Security” taxes on employer-purchased health benefits, and the payroll tax does not have income adjusted brackets.)

Critics, even those who would continue some sort of favorable tax treatment of employer-financed health benefits, have often advocated changes that would make the effects of the exclusion more equitable. See further discussion in Section C of Chapter 8.

But the current tax treatment of employer-purchased health insurance has been heavily criticized for a more basic reason. Traditional economists have argued that this indirect subsidy immunizes the consumer from the real costs of decisions relating to the purchase of benefits, choices of providers, and treatment options. Because consumers are spending subsidized "pre-tax dollars" that can only be spent on health benefits, consumers generally buy more health benefits than they would if they were using "after tax dollars" and dollars that would be available to buy other things; in addition, critics claim, consumers have less incentive to "shop" for cheaper or more efficient arrangements for the health benefits they purchase. At the same time, having purchased more health benefits with "pre-tax dollars" than they would have with "after tax dollars," consumers then seek out and demand more services than they would have with more limited coverage or if they had to pay out-of-pocket for those services.

Intuitively, each of these claims would appear to be true, although it should be noted that the data concerning utilization of services by people with varied levels of third party coverage reveal a somewhat more complicated picture. See, e.g., Kathleen N. Lohr, et al., Use of Medical Care in the Rand Health Insurance Experiment: Diagnosis- and Service-Specific Analyses in a Randomized Controlled Trial, Medical Care, Sept. 1986, at S72-78; U.S. Congress, Office of Technology Assessment, Benefit Design: Patient Cost Sharing (1993) at 15; Joe V. Shelby, Effect of a Co-payment on Use of the Emergency Department in a Health Maintenance Organization, 334 New England Journal of Medicine 635 (1996). But at least in the broadest sense, if they are subsidized, people will buy more third party coverage and seek out and utilize more health services. Indeed, that is the underlying purpose of the policy to exclude health benefits from taxation: to encourage people to buy more third party coverage and, therefore, to use it to buy more health care.

But encouraging people to buy more health benefits is exactly the problem from the point of view of traditional economic theory. According to that view, any health benefits plan, whether in the form of indemnity insurance, a service-benefit plan, or a more integrated arrangement, is basically an attempt by the individual consumer to spread the future costs of health care evenly over time and to minimize the uncertain risk of high medical bills by pooling that individual's risk with those of other purchasers. From this perspective, the market for health benefits is appropriately structured when each consumer is paying no more and no less than the expected cost of his or her own future health care needs. Furthermore, under these conditions, each consumer will shop for the least-cost alternative among plans and, in response, insurers and other plans will compete for the consumer's dollar. Among other expected results, consumers will be more concerned with "last dollar" coverage, coverage for the unpredictable risk of high or catastrophic medical bills that consumers cannot

19

afford to pay out-of-pocket. Many consumers also might eschew "first dollar" coverage (or accept cost-sharing limits) or coverage for services that they could afford to buy on an individual, out-of-pocket basis or pay for through individual savings, e.g., physician office visits or dental care. In fact, less "first dollar" coverage and more cost-sharing are exactly what economists predict would be the result of a properly functioning market for health benefits. And in a proper functioning market, economists claim, consumers would find the things that they value and both buyers and sellers would have the incentives to make wise, cost-conscious decisions.

Obviously a government policy of excluding employer-purchased health benefits from taxation is antithetical to these notions and values. It diminishes consumer cost-consciousness in choices among plans and at the time of treatment. As will be discussed more extensively in Chapter 8, most economists are concerned any time that collective or governmental decisions are substituted for individual, market decisions; but they are particularly concerned when government decisions insulate consumers from the economic costs of their decisions -- for both philosophical and practical reasons.

If this indirect subsidy offends these underlying tenets of economic theory, are there any reasons to continue to subsidize the purchase of health benefits, either as currently done by federal law or through some alternative means that might adjust for some of the criticisms of the current manner of doing so? One obvious notion is that the tax subsidy allows people who cannot afford to buy what they need -- or what policymakers believe they need -- with their own resources. All but the most doctrinaire market theorists concede that government policy can and should assist those with lower incomes either through some government-sponsored "safety net," or, preferably, through vouchers or subsidies that allow those who need assistance to compete on equal terms with other consumers. See discussion in Chapter 8. But as noted earlier, the current tax treatment of employer-purchased health insurance is at best a clumsy way to do so and, ironically, it provides more of a subsidy to people with higher incomes than to those with lower incomes.

Why not have each of us -- at least those who can arguably afford it -- pay the full costs of health insurance? For that matter, why encourage people to buy health insurance at all? Why not encourage at least some people to pay out-of-pocket for at least some things? Is there any inherent advantage in shifting some of the costs to taxpayers and away from consumers -- which is what the current tax treatment of employer-purchased health benefits does? Who benefits? Who loses? What are the likely effects on health and health care? What are the political and philosophical implications of doing so?

One part of the rationale for the tax subsidy must lie in the implicit notion that we want to encourage people to buy more health benefits than they would if left to their own choices with their own dollars; that more coverage is better for consumers collectively and better than what economists would claim is good for consumers acting individually; that we as a society value a distribution of health benefits that is different than that which would result from a non-subsidized market. All of these controversial notions will be taken up in more detail in Chapter 8 which considers options for health care reform. Modifying or eliminating the current tax treatment of employment-based health benefits is one important strategy for doing so.

But in anticipation of this later, more detailed discussion of the tax incentives to purchase health insurance, consider the issue in its broadest form: Why should the government encourage people to buy health insurance --

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however it is done? What is wrong with allowing people to buy only what they want: pooling some of their resources with others when they choose to do so and accepting the risks of paying out-of-pocket for those things for which they forego insurance coverage?

The articles that follow articulate somewhat different perspectives on the need for and advantages of health insurance generally, the types of health insurance available to most Americans, and the manner in which government policy makers use the tax system to encourage people to buy health insurance.

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Rashi Fein, Social and Economic Attitudes Shaping American Health Policy, 58 Milbank Memorial Fund Quarterly 349, 376-82 (1980)

* * *

Existing financing and reimbursement arrangements provide incentives for the public to seek and providers to deliver more [health care]. . . . The free-marketer suggests that this is the inevitable outcome of a set of policies that have interfered with the market by introducing government funding for health care and resource development and by encouraging the expansion of health insurance coverage. He attaches special blame to health insurance that eliminates, or significantly reduces, the patient's monetary payment at the time that the particular service is sought. . . .

. . . .

True, each of us is aware that our own behavior contributes to the escalation of premiums. But each of us is also aware that our individual contribution is negligible and that premiums would not be different if we "behaved" ourselves while others did not -- and why should we assume they would? Indeed, we assume that others would take advantage of the system, we feel encouraged to do so ourselves. . . .

The argument sounds powerful; yet there is more. How is it that, knowing the outcome, we purchase the insurance nonetheless, and purchase it though it covers events many of us could finance out-of-pocket? Why should we form voluntary association with those who will abuse the system? Ignoring the psychological security provided by insurance and our willingness to pay for risk aversion, the explanation for our behavior is sought in government tax policy, which . . . encourages the purchase of insurance by reducing its true price. . . .

This argument, though captivating, is incomplete or, perhaps because it is incomplete, it appears simple and captivating. It ignores the externalities, the social benefits of insurance, the welfare gains associated with security, the unequal distribution of income and of purchasing power. . . . It ignores the fact that our attitudes and behavior toward medical care are not the same as, say, towards ice cream cones. The argument defines the free-market allocation of resources as optimal and assumes that except for insurance we would, in fact, have a free market. It says that voting with dollars is somehow more appropriate than voting with ballots and that being "free to choose" in the market will yield better outcomes than being "free to choose" in the political sphere, as if, for example, each of us should buy clean air and not collectively legislate about it.

[Fein then reviews some of the proposals by traditional economists and other "free-marketeers" to repeal or modify the existing tax treatment of employer-purchased health benefits and to encourage the purchase of health insurance with more limited coverage and substantial cost-sharing.]

. . . First, I should like to mention some matters that, I believe, call into question the idea that the answer to the economic problems of the United States health sector, to resource misallocation, and to rising expenditures lies in increasing cost-sharing or charges and in reducing government support for, and provision of, insurance. I question the notion that these devices would maximize "efficiency." But I shall not leave it at that. . . .

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1. Does a proposal that erects a substantial economic barrier to the receipt of non-catastrophic medical care respond to the area of prevention and early treatment . . . ? Does such an approach represent good medicine? . . .

2. Does the emphasis on cost-sharing meet the clear desire expressed by individuals in their voting and personal behavior and in union-management collective-bargaining agreements for a budgeting device that reduces the impact of the non-foreseeable illness? Everything we observe suggests that individuals who can afford it rush to buy insurance to fill in the uncovered bits and pieces . . . at rates that . . . are actuarially unsound. . . . If we do believe in individual choice, why rule out these choices, why rule out individual choices collectively expressed?

3. Can economic deterrents work with equal impact on families and individuals with unequal economic resources? Will not the poor face barriers that will impede access to early treatment? Can we really expect that the only care that will be affected is that which really was "unnecessary"?

4. If we conceive of a program that is income-related or means-tested, we will need to know income and to pay the costs of ascertaining and monitoring the requisite data. We will also have to pay the costs of keeping track of the deductibles and other elements of cost-sharing. . . .

5. The assumption of competitive behavior on the part of providers and price shopping on the part of consumers in seeking care is questionable at best and foolish at worst. Can we really expect the benefits of price competition?

. . . [C]onsumers, confronted by illness, are hardly in a position to shop, are not privy to the information required, and might (as all of us do so often) assume that higher price means higher quality. If so, they are hardly likely to feel comfortable about seeking low-cost care for themselves or their dependents.

. . . .

It seems to me we solve little in the American health care problem by adopting a solution that assumes unreal conditions: that consumers have, or could acquire, perfect knowledge; that providers could compete; and that cost-sharing and income data would spew out of the computer at little cost. If one is searching for a frame of reference, some understanding of how the system would behave, that frame of reference is not to be found in textbook descriptions of pure competition, which are useful for didactic purposes only because they abstract from reality. Instead, look to an examination of the behavior of real markets populated by real people, people with fears, emotions, and passions. . . .

. . . .

None of us lives in an economy. We live in a society. That society is something bigger than the economy, prices, balance of payments, and exchange rates. A society's goals and aspirations, the way it works, what it calls forth from us, the way we see ourselves and others, how we behave, all these are more than economics. Surely economic arrangements influence those matters, and that is just the point. Since economic arrangements do have an impact on the fabric of the society, we dare not evaluate those economic arrangements solely on the basis of their presumed economic benefits, on what they might do to investment

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or to production. We must consider what impact they might have on the social fabric. . . .

. . . The impersonal market, the interplay of prices and unequal incomes, will distribute resources as it distributes cars, phonograph records, books, and fine wine. Researchers may suggest that medical care is not as helpful as the public thinks, that it does not offer value for money, but both patients and physicians are unlikely to accept that argument. Those with low incomes and inadequate care, observing the behavior of those with money, will be more impressed by the behavior of the rich in seeking care than by the words of those who say the rich are wasting their money in doing so. They will conclude, and rightly so, that budget cuts and new constraints will not affect the provision of care and cure for the individual who can pay the price, but will affect their opportunities. They will conclude that the social benefit-cost criteria will apply to them but not to others. They will wonder why, if efficiency is really so desirable, it should not be sought everywhere. . . .

* * *

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Deborah A. Stone, The Struggle For the Soul of Health Insurance, 18 Journal of Health Politics, Policy, & Law 28 (1993)

* * *

Both social and commercial health insurance are mechanisms for pooling savings and redistributing funds from healthy premium payers to sick ones. They operate from two fundamentally different logics, however. Social insurance operates by the logic of solidarity. Its purpose is to guarantee that certain agreed-upon individual needs will be paid for by a community or group. This is the logic of mutual aid societies and fraternal associations, as well as the logic of government social insurance programs. Having decided in advance that some need is deserving of social aid, a society undertakes to guarantee that the need is met for all its members. In the health area, the argument for financing medical care via social insurance rests on the prior assumption that medical care should be distributed according to medical need or the ability of the individual to benefit from medical care.

If medical care were financed like most market goods, by charging people for exactly the goods and services they consume, the ultimate distribution of medical care would be only partially according to need. Those who are sick and need care would come forward to purchase it, but among the sick, only those who could afford it would actually receive care. In addition, some who are not sick but who have the resources might try to purchase care as well. People who could not afford to buy care would not receive any, regardless of their need for it or ability to benefit from it.

Social insurance unties the two essential connections of the market: the linkage between the amount one pays for care and the amount one consumes and the linkage between the amount of care one buys and one’s ability to pay. Under a social insurance scheme, individuals are entitled to receive whatever they need, and the amounts they pay to finance the scheme are totally unrelated to the amount or cost of the care they actually use. . . .

. . . .

Commercial insurers, that is, private firms selling insurance as a profit-making venture, operate on a deep contradiction. They provide for pooling of risks and mutual aid among policyholders, much as social insurance does, yet they select their policyholders, group them, and price their policies according to market logic. When they speak of equity or distributive justice, commercial insurers espouse the principle of actuarial fairness. It holds that premium rates should be differentiated so that “each insured [person] will pay in accordance with the quality of his risk.” By quality of risk, insurers mean the likelihood a person will incur whatever loss he or she is insured against. In life insurance, they are principally interested in factors that might affect life expectancy, while in health insurance, they are interested in factors that affect or predict a person’s use of medical care. These include one’s occupation, hobbies (since some are very dangerous), family medical history, personal medical history, and any medical information that is prognostic of disease, even if the disease hasn’t yet occurred.

Insurers assert that actuarial fairness requires them to seek the most complete risk information on applicants. . . . People who have diseases or serious risks to their health are in a sense getting a more valuable insurance policy than those with lesser risks, so they ought to pay more for the extra

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value. Or, to see the matter another way, if insurers did not identify people with higher risks, separate them from the general pool of policyholders, and charge them more, insurers would be causing a “forced subsidy from the healthy to the less healthy.” (citation omitted) . . .

Here is the crux of the conflict: the very redistribution from the healthy to the sick that is the essential purpose of health insurance under the solidarity principle is anathema to commercial insurers. Tellingly, insurers virtually never use the word subsidy without a pejorative modifier such as coerced, forced, or unfair. Although all insurance entails a subsidy from the lucky to the unlucky (whether for car accidents, diseases, or fires), commercial insurers eschew subsidy from one “class” of policyholders to another. . . . To commercial insurers, subsidy is not what they pursue but the unwanted result of their failure or inability to segregate people into homogeneous risk classes.

If the actuarial fairness principle could be perfectly implemented, if we had perfect predictive information and precise rating, each person would pay for her- or himself. This, of course, would be the antithesis of insurance. . . .

* * *

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Richard A. Epstein, Mortal Peril: Our Inalienable Right to Health Care 121-132 (1997)

* * *

Risk Classifications

It is an odd commentary on our times that the most common criticism of unregulated private insurance markets is their tendency to match the premium charged the customer with the risk assumed by the carrier. That outcome is achieved by separating insureds into categories that roughly mirror their anticipated costs to the carrier. The insurance company that lumps disparate individuals into a single risk classification invites its own economic ruination. The high-risk individuals within the group will stay because they enjoy a deal better than they can find elsewhere. The low-risk individuals will quickly migrate to rival carriers who charge them lower premiums commensurate with their lower expected losses. Left with high-risk insureds and a blended premium rate, the original insurer is destined for insolvency unless it learns to classify risks as well as its rivals. Yet when risks are accurately priced, both high- and low-risk customers tend to stay put unless a more efficient insurer can service the line at some lower cost. Correct risk classification allows the insurance market to reach a stable equilibrium.

Perfection in classification, however, is neither required nor advisable to maintain this state of affairs. Because no insurance company has, or can gather at reasonable cost, all the information relevant to determining the risk to given individuals, rough classifications are enough to preserve the market equilibrium. No wise insurer will strive to form tiny subclasses populated by virtually identical individuals because it is unwise to spend a fortune on medical examinations and background tests in the vain hope of eliminating all wobble -- that is, implicit cross-subsidies -- from the system. Any workable risk classification system allows some individuals to use private knowledge to squeeze into a too favorable risk category. But the size of these potential gains is likely to be contained by simple but robust tests -- by age, sex, or prior medical history -- that block these abuses. The successful insurer therefore fights a two-front war. First, it works to deter its rivals from cherry picking its best risks by keeping their prices low. Second, it works to prevent too many insureds from insinuating their way into a too favorable rate class. Over the long haul, a competitive insurance system rewards the firms that make correct risk assessments and the individuals who present good risk profiles. As with all competitive industries, market pressures bleed out cross-subsidies between customers.

The constant attacks on market insurance all stem from its success in preventing this redistribution of wealth from healthy to sick customers. Thus, in context, no one can trot out the usual suspects for market regulation, namely, that insurance carriers and their insureds systematically misperceive or miss-price their risk. The familiar villains of asymmetrical or imperfect information and widespread insurer or customer irrationality, when present, lead to capricious outcomes, which unregulated markets assiduously try to avoid. It is a sign of their success that the chorus of complaints here is directed to the converse result: the limited information that insurance companies collect in open markets is too accurate and therefore prevents those with the greatest need from getting someone else in the insurance pool to pay for their health insurance. The social argument reduces to the single proposition that it is

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appropriate for healthier people to pay the health insurance premiums for sicker ones as though that program of redistribution had no attendant costs. But making the insurance industry leaner and more efficient pushes hard in the opposite direction. Efficiency means more accurate risk classification at lower administrative cost. Efficient markets bleed out redistribution; they do not foster it. Only regulation can do that.

One way that regulation can bring about redistribution is to prevent the insurer from collecting the information necessary for setting rates. Once again the argument misses its mark. Notwithstanding the familiar charges of the exploitive position of insurance companies in competitive markets, the real business risks run in the opposite direction. The insurer has no market power to dictate price, but individual customers possess something more valuable than any insurer's fleeting claim of market power: private knowledge over personal medical risks. If allowed to keep that information private, they will happily purchase insurance at bargain rates. The risk of asymmetrical information is rife in insurance markets, and it is a risk that falls to the firms.

Not surprisingly, the common law of insurance has long sought to counter that risk by requiring insureds to make full disclosure of all material information. . . .

The traditional legal view thus rightly regarded the mischief maker as the potential insured, not the insurer. Redistribution through insurance amounts therefore -– no more and no less –- to a turnaround in world view, complete with a new cast of potential villains. This clash between efficiency and redistribution in insurance markets comes to a head over two issues. One is grand and abstract, and the other has a narrower focus but is of such enormous practical importance that it has been made a centerpiece of the health care debate in the aftermath of the Clintoncare debacle. The larger issue is that of community rating, and the smaller one is that of pre-existing medical conditions, that is, known disabilities of an individual who has sought health insurance, either individually or as part of some group plan. It is useful to take up these issues in sequence.

Community Rating

A system of "community rating" limits the permissible grounds for risk classification by an insurer. Restrictions of this sort are already in place in other lines of insurance. State insurance codes commonly limit the classification schemes for automobile insurance. California bars classification by territory, by sex, and by age, while allowing experience rating based on individual accident history. With health insurance, the same pressure for uniform policy coverage has taken hold as well: age and sex are more frequently regarded as irrelevant characteristics, notwithstanding their predictive value. Territory may be taken into account in setting community rates, but although the claims experience is tolerated for bad drivers, it is firmly out of bounds with health. To hold otherwise is to concede the relevance of prior medical history and thus to defeat the desired level of coverage.

Whatever their difference on particulars, community rating systems for both automobile and health insurance are basically meant to block the risk classifications that private insurers use to constrain wealth redistribution. An extreme proposal of this form was contained in Clinton's Health Security Act, which championed a community rating system tied only to family size and geographical area. The present New York law, although narrower in scope,

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requires community rating, but only for the sale of policies to individuals or to groups of between 3 and 50 individuals. For those regulated transactions, it is illegal for the insurer to take into account age, sex, health status, or occupation. Open enrollment is a staple of the basic program: any individual, group member, or dependent "must be accepted at all times throughout the year for any hospital and/or medical coverage offered by the insurer to individuals or small groups." Other statutes of equally recent vintage follow the same line. Still others have adopted modified versions of community rating plans that allow some, but not all, factors on the list to set premiums. Thus the New Jersey statute disregards age, sex, occupation, and geographical location, but it takes into account health status. Florida's modified community rating system takes into account the "eligible employee's and eligible dependents' gender, age, family composition, tobacco use, or geographical location."

The pure forms of community rating interfere far more powerfully with the ordinary underwriting practices than do the modified forms. Any comprehensive assessment of these statutes would require a detailed examination of how each variation works out in practice. For these purposes, however, it is most instructive to look to a standard form of community rating in order to assess its effects. The New York statute was passed in 1993, and the early evidence confirms that its mandate creates the predicted cross-subsidies. The American Academy of Actuaries reports that "the young would subsidize the old, males would subsidize females at most ages, the healthy would subsidize the sick and the poor may subsidize the wealthy, since young people generally earn less income than older people." Before the passage of the statute, going rates varied four- to six-fold for persons from age 20 to 64. Under the statute, premium compression reduced top premiums by about 20 percent for 9 percent of the insured groups and 18 percent of the insured individuals. At the other end, 21 percent of the groups and 30 percent of the individuals received rate increases of up to 20 percent, with 5 percent over 100 percent. Many insureds dropped out of the pool altogether. Within a year of the program's operation, for example, the median age of policy holders under one insurer (Mutual of Omaha) rose by 3.5 years from 41.5 to 45 years old. Nonetheless New York State Commission of Insurance Salvatore R. Curiale pronounced the program a success because of the protection it gave to individuals with bad claims histories seeking renewal. Those forced to pick up the tab had a different view.

Standing alone, testimonials either way count for little because they are endemic to all subsidy situations. The ultimate test must look at the overall effects of the program. It is an undeniable good to help individuals in need. But, as the general theory indicates, coercive regimes that create positive rights contain substantial hidden costs that impair their effectiveness. First, the New York subsidy plan undercuts any rate distinction between employed and unemployed workers. Because firms can no longer capture the gains from keeping their workers in trim by taking aggressive health measures, they are less likely to insist on exercise, diet, or smoking restrictions. To be sure, some incentives remain because the firms can still benefit from the improved productivity that good health brings to its work force, but even so, at the margin, the statute dulls this desirable effect. The sheer magnitude of the cross-subsidy –- estimated at 44 billion dollars per year nationwide –- not only reduces the profitability of the regulated firms, but also increases the rate of unemployment. As the cost of keeping workers rises, some of them will be let go.

Community rating also alters the dominant patterns of individual behavior for the worse. Cross-subsidies necessarily allow everyone to pass off some part of the costs of their own risky behavior onto other persons. Accordingly everyone is more likely to engage in riskier activities, whether driving faster

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or eating richer foods. The countless facets of life in which care is reduced make it very costly for a firm to monitor individual behavior. Overall the deterioration in care levels across the pool of insureds is a classic illustration of the prisoner's dilemma. Everyone takes less care than is ideal. Everyone undertakes riskier activities. The redistributive impulse brings in its wake higher overall system costs.

The long-term implications of community rating are also unnerving. A system of community rating cannot survive if all insurers must cover their insured risks solely from the premiums they collect. Yet the community rating system denies the insurer the right to refuse to write demanded coverage in an individual case simply because the premium does not cover the risk. Whether by design or by chance, some plans will be more heavily subscribed by individuals, perhaps because of the greater expertise in handling specific disabilities or diseases. Yet now an insurer develops expertise at its peril. Faced with the influx of high-risk patients, these specialized firms will go bankrupt if denied transfer payments from rival firms with superior books of business, or from the public treasury. . . .

Nor do we have any reason to believe that community rating can operate within the previous system-wide budget constraints, such as they were. Compliance costs are not trivial and must be covered either from premiums or general revenues. The general fitness of members of the insurable pool is likely to deteriorate somewhat with cross-subsidies because of the reduced incentives for good health. In addition, calibrating any needed transfer payments between insurers will tax the political system when low-risk individuals are clamoring to get in. The long term prognosis is for system-wide instability. The short-term protection for high-risk individuals comes at an undisclosed system-wide price, part of which is paid by the intended beneficiaries of the program.

By what right are they kept in the program? One reason might be to counter the risk that some fraction of these low-risk individuals may choose to opt out in the belief that they will receive care in the event of extreme illness whether or not they purchased insurance. Thus one defense of universal coverage takes this form: "These free-riding individuals impose an external cost on others when they become ill and sift the costs of their care to others. They should be required to finance their care by obtaining the minimally required health insurance." Yet the other, unspoken alternative is not to supply that care in time of necessity at public expense. If so, the alleged external cost disappears, even if some people die or are injured. Yet if that bad outcome happens more than once or twice, the inability to obtain the care in time of need will lead many young adults to think twice before going without health insurance -- which they could purchase at low rates in a market not permeated by paternalism, coercion, and cross-subsidy. Social Darwinism is a bit too unfashionable in modern circles of thought. The constant collective unwillingness to bear the consequences of one's own decision only postpones the day when the well runs dry.

Coercion, then, is too often taken for granted. Yet, ironically, it is unclear whether the coercive strategy will work. Once low-risk persons are not allowed to switch, they will fight any expansions in insurance coverage. Or they might leave nonetheless, not by withdrawing from the plan while remaining within the state, but by leaving the state. Once coverage is mandatory, exit is the preferred option if the implicit tax from community rating overrides the benefits from staying put. For states with small boundaries, this exit option is serious both for the individual and the firm. A plant in the Boston area

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relocates to New Hampshire. An Illinois factory opens a branch in Indiana. Individual workers migrate across state boundaries. Worse still, in-migration of new firms and workers is deterred by the implicit tax. The size of these effects is hard to estimate, but don't think that they are necessarily small. State after state -- California, Illinois, and New York to name three -- worry about the impact on job creation of high payroll taxes for workers' compensation. The exit option effectively controls the level of state income taxation and has worked to knock out the estate tax. Don't think that it cannot happen here.

Pre-existing Conditions

ON THE FRONT BURNER

The question of pre-existing conditions closely relates to the issue of community rating. The two were linked together, for example, in the 1993 Clinton Health Security Act, which sought to ban both the exclusion of pre-existing conditions and the imposition of waiting periods before coverage took effect.

Indeed, the recent passage of the Health Insurance Portability and Accountability Act (HIPAA) of 1996 deals with just this topic. . . .

The attractiveness of the new scheme depends implicitly on the distinction between direct government administration and indirect government regulation of health care markets. But that distinction is not, and should not be, regarded as categorical in either theory or practice. All forms of regulation limit the power of individuals to choose their associates and thus trench upon the right to exclude, one of the key incidents of ownership. Regulation over prices and association is both in theory and in fact an assertion of partial government ownership over private firms. The distinction between the operation and regulation approaches is of degree, not of kind. . . .

THE MARKET RESPONSE

Suppose a ship sank at sea on January 1, 1997. On February 1, 1997, would its owner be allowed to purchase insurance against that known loss at rates that presupposed that the boat was still in productive use? Not unless the coverage equals the value of the loss, which is no insurance at all. A similar issue arises with pre-existing conditions. Here it may well be that they have not given rise to actual loss, but in some cases it is only a matter of time before they do so. In others, the future loss may not be certain, but the risk is surely heightened. In an unregulated market, insurers strive mightily to avoid making wagers that they have already lost or are sure to lose. The only question that they face is how best to prevent these risks from filling their book of business.

In an unregulated market, one standard response is for insurers to insist on full disclosure of all conditions that materially affect risk. In that setting, moreover, the firm does not have to rely solely on disclosure to protect its vital interests. To better protect itself (and its low-risk customers), the insurer could run its own tests to identify these conditions and to exclude from coverage individuals with serious conditions such as AIDS and Huntington's disease. In addition, it could protect itself by contract against having to pay for risks that had materialized before the purchase of the ostensible insurance coverage. This provision guards against the obvious risk

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that a person will enroll in a heath plan on day one and then schedule major surgery for day two. But the standard clause also covers all situations in which a dangerous condition has been identified in any way within a 12-month interval prior to the effective coverage date. In the absence of legislation, clauses of this sort are generally held to deny coverage when symptoms are evident before the policy period, even though the precise diagnosis is only made afterwards. Yet even here, some courts have allowed the principle to fray at the edges by applying the principle of contra proferentem -- construe any ambiguous term in an insurance policy against the insured -- to permit juries to award coverage on the shaky ground that treatment cannot be "for" a condition unless and until the correct diagnosis has already been made. Similarly, most courts will enforce a waiver of the pre-existing conditions clause against an insurer, which can happen if the employee had full coverage from a prior employer. No matter how these close cases are decided, it is critical to note that the standard clause is intended to expand the scope of coverage. Even for persons with pre-existing conditions, coverage under the standard clause is never denied for conditions that were asymptomatic and otherwise unknown when the contract took effect. In those cases, the moral hazard of insured misbehavior is not nearly so acute, so the insurer can profit by extending the coverage on fair rates. The purpose of the pre-existing condition clause is to insure the minimum conditions for contractual stability: namely, that all those parties to the contract are left better off ex ante than they were before.

This contractual exclusion of pre-existing conditions has been attacked on a number of grounds. One ground is that this rule makes insurance unavailable to certain key insureds, namely, those with the highest risk profile. But this objection misunderstands what is meant by availability of insurance. That charge has a certain cogency if insurers ban together to restrict the competitive sale of the insurance product. And it certainly applies when the government decrees that certain forms of insurance should not be sold at all. But it is quite another thing to say that insurance is not available when there is no risk to insure in the first place, for now the fault, if such there be, lies not with the insurance market, but with the underlying social problem.

Suppose that it is known for certain that I will incur an obligation of $100,000 five years from now. That loss is important to me, but it is uninsurable no matter how many insurance companies operate in the market. No insurance policy will be written unless it promises gains to both the insurer and the insured. So long as the loss is certain to happen, there is no risk to insure. Any nominal "insurance" sold at market rates will simply be a prepayment plan, discounted down to present value, say, $70,000, in order to cover the anticipated loss. . . .

Now suppose that this five-year obligation will with certainty lie in the range of $100,000 to $200,000. This is an insurable risk, but the premium rate includes a fixed premium of $70,000 for the guaranteed payment, plus some figure for the variable loss, a premium that would hover around $35,000 if the expected total payment on the appointed day was $150,000. Stated otherwise, insurance is possible only over the variance in expected outcomes. The example just given therefore is a combination of a loan to the insurance company plus an insurance contract. The individual who only wants insurance will only pay, as a first approximation, a $35,000 premium for a policy that contains a $100,000 deductible and a $100,000 limit. He will be unable to procure any insurance coverage for that first element of loss, even in a competitive market.

Many health expenditures have this characteristic. The effort to buy long-term nursing care has components of prepayment and genuine insurance. Thus the

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combined payment must be very high, and many individuals will simply prefer to save for the future on their own or through some form of tax-free annuity. The absence of a vibrant market for future nursing care is not a market failure. It is in part a recognition of the limited variation in future outcomes, coupled with a material risk that the early coverage will be purchased by the individuals more likely to use it.

Pre-existing conditions raise similar issues. Insurance is not available to cover these conditions because of the lack of variation in the underlying risk. No matter how competitive the market, the transaction is part prepayment and part insurance and should be priced accordingly. It is, however, wholly incorrect to suppose that some market failure justifies government intervention. Rightly understood, insurance availability is not an issue in this context, as it would be if a number of distinct sellers conspired to restrain sales in violation of the antitrust law. To the contrary, the key problem is the known shortage of wealth of the parties who face these certain losses or high levels of risk. If they do not have the wealth to cover the losses, they will not have the wealth to cover the risks.

CHERRY PICKING

[Some critics have] attacked the restrictive coverage of pre-existing conditions as an unjustified "cherry pick" of the best risks. In fact, the contractual logic operates the other way. No company ever makes a dime from the insurance policies it does not write. It only makes money from sales whose costs are lower than the premium received. The insurer loses an opportunity for profit if it excludes a person from coverage because of one condition. At some risk, it can make a profit by writing coverage on other risks to the person. Under the standard agreements, any person with the AIDS virus or Huntington's disease can still receive health insurance for an automobile accident or appendicitis. Providing partial coverage of persons with pre-existing conditions does not constrict the reach of the market; it extends that reach by offering limited protection to persons who otherwise would be wholly uninsurable.

Paradoxically, cherry picking will occur precisely because insurers are forced to cover pre-existing conditions at a standard premium. Because the insurer can no longer vary price, it has two choices. First, it could exit the market altogether, which it will do if the losing contracts are too onerous. Alternatively, it could remain in the market and seek to cut its losses by excluding by hook or by crook high-risk persons from coverage. Yet once the insurance carrier is allowed to adjust its premium levels, that incentive disappears. Now its self-interest could aggressively try to cover as many market segments as possible, provided that it knows that its contractual limitations will be fully enforced. But if the contractual protections are compromised, as by the intermittent application of a contra proferentem rule(under which ambiguous language is construed against an insurer), the insurer will once again find reasons for abandoning the market altogether, to the great detriment of its shareholders, employees, and low-risk customers.

* * *

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PROBLEMS FOR DISCUSSION: CHOOSING A PLAN; STRUCTURING A PLAN

In one sense, the individual American consumer faces a bewildering array of options: various types of HMOs, "point-of-service" options, preferred provider arrangements, and a variety of other plans -- many of which are "managing care." The choice among them carries with it important and, in some cases, life-and-death consequences. But for most middle class working Americans, the initial and most primary decision is much more discrete: choosing among the two or three options made available through their employment, usually a choice made as part of the initial employment process and then renewed annually thereafter. Indeed, much of the choosing is done for them by their employers who structure their benefit options. And, because the tax incentives to buy health benefits are only available if they purchase them through their employment, most working Americans have little practical option but to choose from what their employers offer them.

There are two sets of issues worth considering in depth: First, and most basic, how should an employee go about picking among the available options? Second, given that employers have some discretion to change the benefits that they offer (even under existing tax laws), how should an employer structure the choices available to employees?

Choosing a Plan

A good illustrative exercise is to select a range of representative employers in your community, for example a small law firm, a university or other large employer, and a local manufacturer with 50-100 employees. Obtain the forms, brochures, or other descriptive material that those employers give to their new employees to help them make the choices available in that employment setting. Then assume you are a new employee (and assume your own or someone else's particular living and family circumstances.) In each of these work settings, what are your actual options, what information do you need, and how do you make your decision?

If you are like most people, particularly in the initial flurry of decisions relating to acceptance of a job, you will consider first and foremost the dollar contribution by your employer, your share of the monthly premium, and the amount and type of cost-sharing that comes with each plan. If you have a choice among plans with obvious differences in the levels of coverage, you may attempt to trade-off differences in out-of-pocket liability for your perceived future need for various services. But what else will you -- or can you -- do?Consider the following as a partial outline of the difficulties in "consuming" health benefits:

1. Suppose one of these employers offers a choice between an HMO-type plan, a "point-of-service" plan, and a more traditional insurance scheme with the first two options offering a slightly lower monthly premium. How do you choose? What are the real differences, not just between prototype HMOs and prototype "point-of-service" plans and indemnity insurance -- but between the particular plans available in your community?

2. Most people value "freedom of choice" and high quality of services. How do you really assess such things as the availability of providers and the quality of services available under one plan or the next -- again in terms that reflect what services are actually available to you in your community, e.g.,

34

travel time, convenience of hours, cultural sensitivity? Are the offerings of the Web really useful? Are they understandable -- by you or the types of people who are asked to use them?

3. How do you assess your future needs for health care? Can you predict your future health problems and those of your covered dependents in some way that will help you assess the need for available services and for financial third party payment to secure them? Where do you get this type of information? On the Web? From television and other mass media? Providers?

4. Even if you define your future needs solely in terms of potential financial liability for incurred services, what are the financial risks you are trying to avoid? Are you concerned with "last dollar" or "first dollar" coverage? Are you buying financial security in the actuarial sense, or in some "I-don't-want-to-be-bothered" sense? Can you give your answers in dollar figures or in sufficient specificity to choose among plans with different price tags?

5. Can you -- and do you -- view "cost-sharing" as anything other than something to be avoided?

6. Beyond such matters as the out-of-pocket costs and the scope of coverage of each option, what other contractual terms should be given some weight in your choice? As the next two sections will demonstrate, there are other aspects of the employer's commitment to the employee, and other terms of the plan that can be as important as cost and coverage, but that are frequently overlooked in decisions regarding choice of plans. (See discussion infra concerning exclusions or cancellation of coverage and medical necessity and other denials of reimbursement.)

7. Other crucial terms of the agreement that are frequently overlooked involve the arrangements between the plan and the various types of providers who will be reimbursed, at least in part, by the plan. Does the plan negotiate a discounted rate of reimbursement? If so, is the provider allowed to recover any amount above that negotiated rate from the plan beneficiary -- a practice known as “balanced billing”? For that matter, do all or any of the providers of covered services agree to accept the plan’s beneficiaries, or are they reimbursed only if they choose to accept the patient? These issues will be analyzed in more detail in Chapters 4 and 5. But in many, many ways, the terms of reimbursement written into a financing scheme are as important to the beneficiary as the terms that define the categories of services that are coverage and such matters as deductibles and coinsurance.

There are some sources that have developed objective criteria for evaluating health plans and, in some cases, to rate their performance. See the evaluation of “accountable health plans” by the National Committee for Quality Assurance at http://www.ncqa.org/ (last visited September 2005); see also the similar efforts of the Leapfrog Group (a private purchaser-sponsored organization at http://www.leapfroggroup.org/ (last visited September 2006).Many individual states and even intra-state regions have their own health plan evaluation schemes. See, e.g., http://www.premera.com/ (“quality score cards” for large medical groups in the State of Washington developed by the state’s Blue Cross affiliate; last visited October 2005).

Structuring a Benefits Plan

To look at this problem from a different perspective, assume again that you work for one of the employers described by this exercise. Suppose that it is

35

one year later, and you have been chosen by your fellow employees to bargain with your employer for improvements in compensation, including health benefits. Your employer offers a total "budget figure" of increased compensation for the coming year. But she makes the obvious point that any increase in the employer's contribution to health benefits will be offset against wage increases. Given what is currently offered by that employer (again this is only a problem that can really be examined with a real-world illustration in hand), what are the options you might present to your co-workers? Are there other “deals” beyond those currently offered that you might want your employer to consider? Do you want to give each employee more discretion to make trade-offs between wages and health benefits or, for that matter, other benefits such as retirement or disability income?

On the other hand, are there additional services or other health-related benefits that you think should be available to all employees regardless of what they might individually choose, as Fein implicitly advocates?

Your hypothetical work setting is likely to have large and small families, childless, dual income couples, and a range of ages. Cash benefits, unlike health benefits, will be distributed at a range of levels. You may even have people with identifiable needs: disabilities, substance abuse problems, stress-related jobs, and so on. Some workers may well benefit from some changes in the plan, but only at the expense of others. There are, as Stone points out, inherent subsidies in all insurance schemes. To what extent do you want to subsidize the health benefits of your co-workers with high medical bills because of their medical condition? What about those who have high medical bills because they have large families? Or those who want to enroll in expensive fertility programs in order to have any children? What about those who want to try an expensive, experimental treatment as a last resort? What should you do about those co-workers who could purchase their health benefits through their spouse’s employment or that strange person in the back room who objects to participating in any health insurance plan on philosophical grounds?

There are several more focused exercises which may illustrate some of these same issues. Many employers offer coverage for dental care as an option, typically allowing the employee to purchase coverage with pre-tax dollars, but with no additional contribution from the employer. Under what circumstances do you buy dental coverage with your own pre-tax dollars? If your employer does not offer this option, should you negotiate for such benefits? The same questions can be asked but not easily answered about coverage for eye glasses, mental health services, prescription drugs that enhance sexual potency, or the many other things that are often excluded from health benefits plans or available only as options. Again there are two separate issues to think about: Would you buy insurance coverage for that service if it were available through your employer? Should your employer add it to the mix of health and other benefits that are available and, if so, how should that benefit be structured?

With regard to that latter issue, you may find that you are trying to distinguish between categories of services that you consider “necessary” and those that you consider “optional” or, at least, of lesser importance. In your efforts to do so, try to identify some general definition or principle that may help answer these questions on something other than an ad hoc basis. Is dental care “necessary”? If not, is substance abuse counseling or fertility services? How about an organ transplant that is the only way to treat a life-threatening condition? Alternatively, what about an unproven experimental treatment for an otherwise incurable disease? What do your answers to these questions tell you about your willingness to pay for someone else’s care or your need to pool

36

resources with other people to insure your own care. Your answers to these and the other questions in this exercise will be useful to you in reviewing many of the problems throughout these materials.

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GLOSSARY: A NAME DROPPER’S GUIDE TO PRIVATE HEALTH CARE FINANCING

Obviously things are changing fast; in little over a decade the term "health insurance" has been virtually antiquated. People now buy into PPOs and IPAs and other contractual arrangements that are only in part insurance in the traditional sense of the term. The following list of terms is likely to be out-of-date before the ink dries, but it may be helpful in sorting out who is who and what is what:

Co-payment:A type of cost-sharing where the insured individual is responsible for

paying a fixed dollar amount per service.

COBRA:Consolidated Omnibus Budget Reconciliation Act of 1986. Federal mandate

that employers with 20 or more employees that offer those workers health benefits must give any employee they cover the opportunity to purchase "continuation" coverage after their employment-based coverage ends for up to 18 months.

Community rating:A technique for determining health plan premiums on the basis of average

claims experience for a population instead of on an individual basis.

Consumer driven health plan (CDHP)

Any of a number of arrangements under which the consumer has some form on health insurance but most first-dollar coverage is spent out-of-pocket and generally payment is made directly to the provider, even if the consumer is later reimbursed for some portion of that payment.

Deductible:A specified amount of covered medical expenses that a beneficiary must pay

before receiving benefits.

Defined Contribution Plan:A plan where an employer makes a fixed dollar contribution to the employee

and allows the employee full discretion as to the type and nature of the health benefits to purchase

Employee Retirement Income Security Act (ERISA):A federal law that preempts state laws that relate to employment-based

health benefits except for state insurance laws.

Experience-rated:A plan with premiums rates based on the past experience of its enrollees.

Flexible benefit plan:Also known as a cafeteria plan, this benefit plan allows participants to

select from various taxable and tax-preferred forms of compensation such as health benefits, enrollment in a 401(k) savings plan, or additional cash remuneration.

Freedom-of-choice:

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Limitation placed on beneficiary's ability to choose which provider will provide care.

Group (vs. individual) policies:Group policies are purchased by an organization on behalf of all members

of some pre-existing group.

HIPC:Health insurance purchasing cooperative. An arrangement which pools the

purchasing power of small businesses or other buyers. HIPCs negotiate with health plans for the entire pool of covered beneficiaries thus obtaining comprehensive coverage at better rates than available to small purchasers.

HMO:Health maintenance organization. A prepaid health plan in which services

are provided through a system of affiliated providers. Comprehensive benefits are financed by prepaid premiums generally with limited co-payments.

Indemnity insurance:An insurance plan where the insurer reimburses the insured for liability

incurred.

IPA:Independent practice association. An HMO that contracts with individual

physicians to provide services to HMO members at a negotiated per capita fee-for-service rate. Physicians maintain their own offices and can contract with other HMOs and see other fee-for-service patients.

Major medical:Insurance with a high or no maximum limit to cover the costs of major

illness, usually with substantial cost-sharing for initial liability.

Medical savings account:An account to which an employee is allowed to contribute pre-tax dollars

and from which health benefits can be purchased. At the end of the year, unused funds can be rolled over for use in subsequent years (instead of forfeited as is the case with flexible benefit plan accounts under current tax law.)

MET:Multiple employer-trust. A group of employers who together purchase group

health insurance, often through a self-funded approach to avoid state mandates and insurance regulations.

MEWA:Multiple-employer welfare arrangement. A specific type of purchasing

group, defined in the Employee Retirement Income Security Act of 1974, that offers health benefits to employees of two or more employers.

MSO:Management service organization. One of a variety of arrangements where an

organization affiliated with a hospital or group of physicians buys, leases, or otherwise contracts with one or more physicians to provide financial, administrative or other services for the physicians' practices. PHO:

Physician-hospital organization. An arrangement between physicians and hospitals where the PHO will serve multiple purposes such as contracting,

39

operating managed care plans, or providing administrative services to members. The physicians maintain much of their autonomy, and risk-sharing is limited.

Point-of-service plan:A hybrid model that combines features of both prepaid and indemnity

insurance. Enrollees decide whether to use network or non-network providers at the time care is needed and are usually charged sizable co-payments for selecting the latter.

Portability:The ability of a covered individual to change from one plan to another

(for example, when the individual changes employment) without being subject to a new waiting period or exclusions for pre-existing conditions.

PPO:Preferred provider organization. A financing arrangement in which networks

or panels of providers agree to furnish services and receive payment on a discounted basis. Enrollees are offered a financial incentive to use providers on the preferred list.

Premium:An amount paid periodically to purchase health benefits.

Risk adjustment:An adjustment to a capitated or other rate based on the results of a risk

assessment.

Risk assessment:The process by which plans estimate the anticipated costs of extending

coverage to identified subscribers.

Risk selection:The process by which plans seek to enroll health, low-cost subscribers.

Self-insured:A health or other benefit plan where all or part of the risk is assumed by

the employer.

Service-benefit plan:An insurance plan where the insurer contracts with providers to ensure

that they will accept the plan's beneficiaries and providers agree to various limits on billing those beneficiaries.

Stop-loss:Self-insured, employer-purchased insurance, where employer pays directly

for all medical claims, except those which, either in the aggregate or individually, exceed a predetermined threshold.

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3. Public Regulation of Private Health Insurance and Other Financing Arrangements

METROPOLITAN LIFE INSURANCE CO. v. MASSACHUSETTS, 471 U.S. 724 (1985)

Blackmun, Justice.

* * *

. . . [I]nsurance presently is subject to extensive state regulation, including regulation of the carrier, regulation of the sale and advertising of the insurance, and regulation of the content of the contracts. Mandated-benefit laws that require an insurer to provide a certain kind of benefit to cover a specified illness or procedure whenever someone purchases a certain kind of insurance are a subclass of such content regulation.

While mandated-benefit statutes are a relatively recent phenomenon, statutes regulating the substantive terms of insurance contracts have become commonplace in all 50 States over the last 30 years. Perhaps the most familiar are those regulating the content of automobile insurance policies.

The substantive terms of group-health insurance contracts, in particular, also have been extensively regulated by the States. For example, the majority of States currently require that coverage for dependents continue beyond any contractually imposed age limitation when the dependent is incapable of self-sustaining employment because of mental or physical handicap; such statutes date back to the early 1960's. And over the last 15 years all 50 States have required that coverage of infants begin at birth, rather than at some time shortly after birth, as had been the prior practice in the unregulated market. Many state statutes require that insurers offer on an optional basis particular kinds of coverage to purchasers. Others require insurers either to offer or mandate that insurance policies include coverage for services rendered by a particular type of health-care provider.

Mandated-benefit statutes, then, are only one variety of a matrix of state laws that regulate the substantive content of health-insurance policies to further state health policy. Massachusetts Gen. Laws Ann., ch. 175, § 47B (West Supp. 1985), is typical of mandated-benefit laws currently in place in the majority of States. With respect to a Massachusetts resident, it requires any general health-insurance policy that provides hospital and surgical coverage, or any benefit plan that has such coverage . . . provide 60 days of coverage for confinement in a mental hospital, coverage for confinement in a general hospital equal to that provided by the policy for non-mental illness, and certain minimum outpatient benefits.

Section 47B was designed to address problems encountered in treating mental illness in Massachusetts. The Commonwealth determined that its working people needed to be protected against the high cost of treatment for such illness. It also believed that, without insurance, mentally ill workers were often institutionalized in large state mental hospitals, and that mandatory insurance would lead to a higher incidence of more effective treatment in private community mental-health centers.

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In addition, the Commonwealth concluded that the voluntary insurance market was not adequately providing mental-health coverage, because of "adverse selection" in mental-health insurance: Good insurance risks were not purchasing coverage and this drove up the price of coverage for those who otherwise might purchase mental-health insurance. The legislature believed that the public interest required that it correct the insurance market in the Commonwealth by mandating minimum-coverage levels, effectively forcing the good-risk individuals to become part of the risk pool, and enabling insurers to price the insurance at an average market rather than a market retracted due to adverse selection. . . .

. . . .

B.

The federal Employee Retirement Income Security Act of 1974, 88 Stat. 829, as amended, 29 U.S.C. § 1001 et seq. (ERISA), comprehensively regulates employee pension and welfare plans. An employee welfare-benefit plan or welfare plan is defined as one which provides to employees "medical, surgical, or hospital care or benefits, or benefits in the event of sickness, accident, disability [or] death," whether these benefits are provided "through the purchase of insurance or otherwise." Plans may self-insure or they may purchase insurance for their participants. . . .

ERISA imposes upon pension plans a variety of substantive requirements relating to participation, funding, and vesting. It also establishes various uniform procedural standards concerning reporting, disclosure, and fiduciary responsibility for both pension and welfare plans. It does not regulate the substantive content of welfare-benefit plans.

ERISA thus contains almost no federal regulation of the terms of benefit plans. It does, however, contain a broad preemption provision declaring that the statute shall "supersede any and all State laws insofar as they may now or hereafter relate to any employee benefit plan." Appellant Metropolitan . . . argues that ERISA preempts Massachusetts' mandated-benefit law insofar as § 47B restricts the kinds of insurance policies that benefit plans may purchase.

While § 514(a) of ERISA broadly preempts state laws that relate to an employee-benefit plan, that preemption is substantially qualified by an "insurance saving clause," § 514(b)(2)(A), 29 U.S.C. § 1144(b)(2)(A), which broadly states that, with one exception, nothing in ERISA "shall be construed to exempt or relieve any person from any law of any State which regulates insurance, banking, or securities." The specified exception to the saving clause is found in § 514(b)(2)(B), . . . the so-called "deemer clause," which states that no employee-benefit plan, with certain exceptions not relevant here, "shall be deemed to be an insurance company or other insurer, bank, trust company, or investment company or to be engaged in the business of insurance or banking for purposes of any law of any State purporting to regulate insurance companies, insurance contracts, banks, trust companies, or investment companies." Massachusetts argues that its mandated-benefit law, as applied to insurance companies that sell insurance to benefit plans, is a "law which regulates insurance," and therefore is saved from the effect of the general preemption clause of ERISA.

. . . .

II

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Appellants are Metropolitan Life Insurance Company and Travelers Insurance Company (insurers) who are located in New York and Connecticut respectively and who issue group-health policies providing hospital and surgical coverage to plans, or to employers or unions that employ or represent employees residing in Massachusetts. Under the terms of § 47B, both appellants are required to provide minimal mental-health benefits in policies issued to cover Commonwealth residents.

. . . .

III

"In deciding whether a federal law preempts a state statute, our task is to ascertain Congress' intent in enacting the federal statute at issue. 'Pre-emption may be either express or implied, and is compelled whether Congress' command is explicitly stated in the statute's language or implicitly contained in its structure and purpose.'" . . .

A.

Section 47B clearly "relate[s] to" welfare plans governed by ERISA so as to fall within the reach of ERISA's pre-emption provision . . . .

Though § 47B is not denominated a benefit-plan law, it bears indirectly but substantially on all insured benefit plans, for it requires them to purchase the mental-health benefits specified in the statute when they purchase a certain kind of common insurance policy. The Commonwealth does not argue that § 47B as applied to policies purchased by benefit plans does not relate to those plans, and we agree with the Supreme Judicial Court that the mandated-benefit law as applied relates to ERISA plans and thus is covered by ERISA's broad preemption provision set forth in § 514(a).

B.

Nonetheless, the sphere in which § 514(a) operates was explicitly limited by § 514(b)(2). The insurance saving clause preserves any state law "which regulates insurance, banking, or securities." The two preemption sections, while clear enough on their faces, perhaps are not a model of legislative drafting, for while the general preemption clause broadly preempts state law, the saving clause appears broadly to preserve the States' lawmaking power over much of the same regulation. While Congress occasionally decides to return to the States what it has previously taken away, it does not normally do both at the same time.

. . . .

To state the obvious, § 47B regulates the terms of certain insurance contracts, and so seems to be saved from preemption by the saving clause as a law "which regulates insurance." This common-sense view of the matter, moreover, is reinforced by the language of the subsequent subsection of ERISA, the "deemer clause," which states that an employee-benefit plan shall not be deemed to be an insurance company "for purposes of any law of any State purporting to regulate insurance companies, insurance contracts, banks, trust companies, or investment companies." § 514(b)(2)(B). . . . By exempting from the saving clause laws regulating insurance contracts that apply directly to benefit plans, the deemer clause makes explicit Congress' intention to include laws that regulate

43

insurance contracts within the scope of the insurance laws preserved by the saving clause. . . .

. . . .

Section 47B obviously regulates the spreading of risk: As we have indicated, it was intended to effectuate the legislative judgment that the risk of mental-health care should be shared. It is also evident that mandated-benefit laws directly regulate an integral part of the relationship between the insurer and the policyholder by limiting the type of insurance that an insurer may sell to the policyholder. Finally . . . mandated-benefit statutes impose requirements only on insurers, with the intent of affecting the relationship between the insurer and the policyholder. . . . .

. . . .

We are aware that our decision results in a distinction between insured and uninsured plans, leaving the former open to indirect regulation while the latter are not. By so doing we merely give life to a distinction created by Congress in the "deemer clause," a distinction Congress is aware of and one it has chosen not to alter. . . .

* * *

44

NEW YORK STATE CONFERENCE OF BLUE CROSS & BLUE SHIELD PLANS v. TRAVELERS INSURANCE CO., 514 U.S. 645 (1995)

Souter, Justice.

* * *

New York's Prospective Hospital Reimbursement Methodology (NYPHRM) regulates hospital rates for all in-patient care, except for services provided to Medicare beneficiaries. The scheme calls for patients to be charged not for the cost of their individual treatment, but for the average cost of treating the patient's medical problem, as classified under one or another of 794 Diagnostic Related Groups (DRGs). The charges allowable in accordance with DRG classifications are adjusted for a specific hospital to reflect its particular operating costs, capital investments, bad debts, costs of charity care and the like.

Patients with Blue Cross/Blue Shield coverage, Medicaid patients, and HMO participants are billed at a hospital's DRG rate. Others, however, are not. Patients served by commercial insurers providing in-patient hospital coverage on an expense-incurred basis, by self-insured funds directly reimbursing hospitals, and by certain workers' compensation, volunteer firefighters' benefit, ambulance workers' benefit, and no-fault motor vehicle insurance funds, must be billed at the DRG rate plus a 13% surcharge to be retained by the hospital. N.Y. Pub. Health Law § 2807-c(1)(b). For the year ending March 31, 1993, moreover, hospitals were required to bill commercially insured patients for a further 11% surcharge to be turned over to the State, with the result that these patients were charged 24% more than the DRG rate. § 2807-c(11)(i).

New York law also imposes a surcharge on HMOs, which varies depending on the number of eligible Medicaid recipients an HMO has enrolled, but which may run as high as 9% of the aggregate monthly charges paid by an HMO for its members' in-patient hospital care. § 2807-c(2-a)(a)-(2-a)(e). This assessment is not an increase in the rates to be paid by an HMO to hospitals, but a direct payment by the HMO to the State's general fund.

B.

ERISA's comprehensive regulation of employee welfare and pension benefit plans extends to those that provide "medical, surgical, or hospital care or benefits" for plan participants or their beneficiaries "through the purchase of insurance or otherwise." The federal statute does not go about protecting plan participants and their beneficiaries by requiring employers to provide any given set of minimum benefits, but instead controls the administration of benefit plans as by imposing reporting and disclosure mandates, §§ 101-111, 29 U.S.C. §§ 1021-1031, participation and vesting requirements, §§ 201-211, 29 U.S.C. 1051-1061, funding standards, §§ 301-308, 29 U.S.C. §§ 1081-1086, and fiduciary responsibilities for plan administrators, §§ 401-414, 29 U.S.C. §§ 1101-1114. It envisions administrative oversight, imposes criminal sanctions, and establishes a comprehensive civil enforcement scheme. §§ 501-515, 29 U.S.C. §§ 1131-1145. It also preempts some state law.

Section 514(a) provides that ERISA "shall supersede any and all State laws insofar as they . . . relate to any employee benefit plan" covered by the statute, 29 U.S.C. § 1144(a), although preemption stops short of "any law of any

45

State which regulates insurance." § 514(b)(2)(A), 29 U.S.C. § 1144(b)(2)(A). (This exception for insurance regulation is itself limited, however, by the provision that an employee welfare benefit plan may not "be deemed to be an insurance company or other insurer . . . or to be engaged in the business of insurance. . . ." § 514(b)(2)(B), 29 U.S.C. § 1144(b)(2)(B). . . .

C.

On the claimed authority of ERISA's general preemption provision, several commercial insurers, acting as fiduciaries of ERISA plans they administer, joined with their trade associations to bring actions against state officials in United States District Court seeking to invalidate the 13%, 11%, and 9% surcharge statutes. The New York State Conference of Blue Cross and Blue Shield plans, Empire Blue Cross and Blue Shield (collectively the Blues), and the Hospital Association of New York State intervened as defendants, and the New York State Health Maintenance Organization Conference and several HMOs intervened as plaintiffs. The District Court consolidated the actions and granted summary judgment to the plaintiffs. The court found that although the surcharges "do not directly increase a plan's costs or [a]ffect the level of benefits to be offered" there could be "little doubt that the [s]urcharges at issue will have a significant effect on the commercial insurers and HMOs which do or could provide coverage for ERISA plans and thus lead, at least indirectly, to an increase in plan costs." It found that the "entire justification for the [s]urcharges is premised on that exact result -- that the [s]urcharges will increase the cost of obtaining medical insurance through any source other than the Blues to a sufficient extent that customers will switch their coverage to and ensure the economic viability of the Blues." The District Court concluded that this effect on choices by ERISA plans was enough to trigger preemption under § 514(a) and that the surcharges were not saved by § 514(b) as regulating insurance. . . .

The Court of Appeals for the Second Circuit affirmed . . . .

. . . .

II

. . . [W]e have never assumed lightly that Congress has derogated state regulation, but instead have addressed claims of preemption with the starting presumption that Congress does not intend to supplant state law. Indeed, in cases like this one, where federal law is said to bar state action in fields of traditional state regulation . . . we have worked on the "assumption that the historic police powers of the States were not to be superseded by the Federal Act unless that was the clear and manifest purpose of Congress."

. . . .

In Shaw [v. Delta Airlines], we explained that "[a] law 'relates to' an employee benefit plan, in the normal sense of the phrase, if it has a connection with or reference to such a plan." The latter alternative, at least, can be ruled out. The surcharges are imposed upon patients and HMOs, regardless of whether the commercial coverage or membership, respectively, is ultimately secured by an ERISA plan, private purchase, or otherwise, with the consequence that the surcharge statutes cannot be said to make "reference to" ERISA plans in any manner. But this still leaves us to question whether the surcharge laws have a "connection with" the ERISA plans, and here an uncritical literalism is no more help than in trying to construe "relate to." . . . We simply must go beyond

46

the unhelpful text and the frustrating difficulty of defining its key term, and look instead to the objectives of the ERISA statute as a guide to the scope of the state law that Congress understood would survive.

A.

As we have said before, § 514 indicates Congress's intent to establish the regulation of employee welfare benefit plans "as exclusively a federal concern." We have found that in passing § 514(a), Congress intended "to ensure that plans and plan sponsors would be subject to a uniform body of benefits law; the goal was to minimize the administrative and financial burden of complying with conflicting directives among States or between States and the Federal Government . . . [and to prevent] the potential for conflict in substantive law . . . requiring the tailoring of plans and employer conduct to the peculiarities of the law of each jurisdiction."

. . . The basic thrust of the preemption clause, then, was to avoid a multiplicity of regulation in order to permit the nationally uniform administration of employee benefit plans.

Accordingly in Shaw, for example, we had no trouble finding that New York's "Human Rights Law, which prohibit[ed] employers from structuring their employee benefit plans in a manner that discriminate[d] on the basis of pregnancy, and [New York's] Disability Benefits Law, which require[d] employers to pay employees specific benefits, clearly 'relate[d] to' benefit plans." These mandates affecting coverage could have been honored only by varying the subjects of a plan's benefits whenever New York law might have applied, or by requiring every plan to provide all beneficiaries with a benefit demanded by New York law if New York law could have been said to require it for any one beneficiary. Similarly, Pennsylvania's law that prohibited "plans from . . . requiring reimbursement [from the beneficiary] in the event of recovery from a third party" related to employee benefit plans within the meaning of § 514(a). . . . In each of these cases, ERISA preempted state laws that mandated employee benefit structures or their administration. . . . [W]e have held that state laws providing alternate enforcement mechanisms also relate to ERISA plans . . . .

B.

Both the purpose and the effects of the New York surcharge statutes distinguish them from the examples just given. The charge differentials have been justified on the ground that the Blues pay the hospitals promptly and efficiently and, more importantly, provide coverage for many subscribers whom the commercial insurers would reject as unacceptable risks. The Blues' practice, called open enrollment, has consistently been cited as the principal reason for charge differentials, whether the differentials resulted from voluntary negotiation between hospitals and payers as was the case prior to the NYPHRM system, or were created by the surcharges as is the case now. Since the surcharges are presumably passed on at least in part to those who purchase commercial insurance or HMO membership, their effects follow from their purpose. Although there is no evidence that the surcharges will drive every health insurance consumer to the Blues, they do make the Blues more attractive (or less unattractive) as insurance alternatives and thus have an indirect economic effect on choices made by insurance buyers, including ERISA plans.

An indirect economic influence, however, does not bind plan administrators to any particular choice and thus function as a regulation of an ERISA plan itself; commercial insurers and HMOs may still offer more attractive packages

47

than the Blues. Nor does the indirect influence of the surcharges preclude uniform administrative practice or the provision of a uniform interstate benefit package if a plan wishes to provide one. It simply bears on the costs of benefits and the relative costs of competing insurance to provide them. It is an influence that can affect a plan's shopping decisions, but it does not affect the fact that any plan will shop for the best deal it can get, surcharges or no surcharges.

. . . .

. . . [O]ther common state action with indirect economic effects on a plan's costs leaves the intent to preempt even less likely. Quality standards, for example, set by the State in one subject area of hospital services but not another would affect the relative cost of providing those services over others and, so, of providing different packages of health insurance benefits. Even basic regulation of employment conditions will invariably affect the cost and price of services.

. . . [I]n the absence of a more exact guide to intended preemption than § 514, it is fair to conclude that mandates for rate differentials would not be preempted unless other regulation with indirect effects on plan costs would be superseded as well. The bigger the package of regulation with indirect effects that would fall on the respondent's reading of § 514, the less likely it is that federal regulation of benefit plans was intended to eliminate state regulation of health care costs.

Indeed, to read the preemption provision as displacing all state laws affecting costs and charges on the theory that they indirectly relate to ERISA plans that purchase insurance policies or HMO memberships that would cover such services, would effectively read the limiting language in § 514(a) out of the statute, a conclusion that would violate basic principles of statutory interpretation and could not be squared with our prior pronouncement that "[p]reemption does not occur . . . if the state law has only a tenuous, remote, or peripheral connection with covered plans, as is the case with many laws of general applicability." . . .

In sum, cost-uniformity was almost certainly not an object of preemption, just as laws with only an indirect economic effect on the relative costs of various health insurance packages in a given State are a far cry from those "conflicting directives" from which Congress meant to insulate ERISA plans. Such state laws leave plan administrators right where they would be in any case, with the responsibility to choose the best overall coverage for the money. We therefore conclude that such state laws do not bear the requisite "connection with" ERISA plans to trigger preemption.

C.

. . . .

The commercial challengers counter by invoking the earlier case of Metropolitan Life Insurance Co. v. Massachusetts . . . which considered whether a State could mandate coverage of specified minimum mental-health-care benefits by policies insuring against hospital and surgical expenses. Because the regulated policies included those bought by employee welfare benefit plans, we recognized that the law "directly affected" such plans. Although we went on to hold that the law was ultimately saved from preemption by the insurance savings

48

clause, respondents proffer the first steps in our decision as support for their argument . . . . The challengers take Metropolitan Life too far, however.

The Massachusetts statute applied not only to "'[a]ny blanket or general policy of insurance . . . or any policy of accident and sickness insurance'" but also to "'any employees' health and welfare fund which provide[d] hospital expense and surgical expense benefits." In fact, the State did not even try to defend its law as unrelated to employee benefit plans for the purpose of § 514(a). As a result, there was no reason to distinguish with any precision between the effects on insurers that are sufficiently connected with employee benefit plans to "relate to" the plans and those effects that are not. . . .

In any event, Metropolitan Life can not carry the weight the commercial insurers would place on it. The New York surcharges do not impose the kind of substantive coverage requirement binding plan administrators that was at issue in Metropolitan Life. Although even in the absence of mandated coverage there might be a point at which an exorbitant tax leaving consumers with a Hobson's choice would be treated as imposing a substantive mandate, no showing has been made here that the surcharges are so prohibitive as to force all health insurance consumers to contract with the Blues. As they currently stand, the surcharges do not require plans to deal with only one insurer, or to insure against an entire category of illnesses they might otherwise choose to leave without coverage.

. . . .

III

. . . [W]e do not hold today that ERISA preempts only direct regulation of ERISA plans, nor could we do that with fidelity to the views expressed in our prior opinions on the matter. We acknowledge that a state law might produce such acute, albeit indirect, economic effects, by intent or otherwise, as to force an ERISA plan to adopt a certain scheme of substantive coverage or effectively restrict its choice of insurers, and that such a state law might indeed be pre-empted under § 514. But as we have shown, New York's surcharges do not fall into either category; they affect only indirectly the relative prices of insurance policies, a result no different from myriad state laws in areas traditionally subject to local regulation, which Congress could not possibly have intended to eliminate.

* * *

49

RUSH PRUDENTIAL HMO, INC. V. MORAN, 536 U.S. 355 (2002)

Souter, Justice.

* * *

Petitioner is a health maintenance organization (HMO) that contracts to provide medical services for employee welfare benefit plans covered by ERISA. Respondent Debra Moran is a beneficiary under one such plan, sponsored by her husband's employer. Rush's "Certificate of Group Coverage," issued to employees who participate in employer-sponsored plans, promises that Rush will provide them with "medically necessary" services. The terms of the certificate give Rush the "broadest possible discretion" to determine whether a medical service claimed by a beneficiary is covered under the certificate. . . .

As the certificate explains, Rush contracts with physicians "to arrange for or provide services and supplies for medical care and treatment" of covered persons. Each covered person selects a primary care physician from those under contract to Rush, while Rush will pay for medical services by an unaffiliated physician only if the services have been "authorized" both by the primary care physician and Rush's medical director.

In 1996, when Moran began to have pain and numbness in her right shoulder, Dr. Arthur LaMarre, her primary care physician, unsuccessfully administered "conservative" treatments such as physiotherapy. In October 1997, Dr. LaMarre recommended that Rush approve surgery by an unaffiliated specialist, Dr. Julia Terzis, who had developed an unconventional treatment for Moran's condition. Although Dr. LaMarre said that Moran would be "best served" by that procedure, Rush denied the request and, after Moran's internal appeals, affirmed the denial on the ground that the procedure was not "medically necessary." Rush instead proposed that Moran undergo standard surgery, performed by a physician affiliated with Rush.

In January 1998, Moran made a written demand for an independent medical review of her claim, as guaranteed by § 4-10 of Illinois's HMO Act which provides:

Each Health Maintenance Organization shall provide a mechanism for the timely review by a physician holding the same class of license as the primary care physician, who is unaffiliated with the Health Maintenance Organization, jointly selected by the patient . . . , [the] primary care physician, and the Health Maintenance Organization in the event of a dispute between the primary care physician and the Health Maintenance Organization regarding the medical necessity of a covered service proposed by a primary care physician. In the event that the reviewing physician determines the covered service to be medically necessary, the Health Maintenance Organization shall provide the covered service.

The Act defines a "Health Maintenance Organization" as: “any organization formed under the laws of this or another state to provide or arrange for one or more health care plans under a system which causes any part of the risk of health care delivery to be borne by the organization or its providers."

When Rush failed to provide the independent review, Moran sued in an Illinois state court to compel compliance with the state Act. Rush removed the

50

suit to Federal District Court, arguing that the cause of action was "completely preempted" under ERISA. [As discussed in subsection 2.B.4 infra, when a “cause of action is “completely preempted,” it can only be heard by a federal court, not a state court].

While the suit was pending, Moran had surgery by Dr. Terzis at her own expense and submitted a $94,841.27 reimbursement claim to Rush. Rush treated the claim as a renewed request for benefits and began a new inquiry to determine coverage. The three doctors consulted by Rush said the surgery had been medically unnecessary.

Meanwhile, the federal court remanded the case back to state court on Moran's motion, concluding that because Moran's request for independent review under § 4-10 would not require interpretation of the terms of an ERISA plan, the claim was not "completely preempted" so as to permit removal . . . . The state court enforced the state statute and ordered Rush to submit to review by an independent physician. The doctor selected was a reconstructive surgeon at Johns Hopkins Medical Center, Dr. A. Lee Dellon. Dr. Dellon decided that Dr. Terzis's treatment had been medically necessary, based on the definition of medical necessity in Rush's Certificate of Group Coverage, as well as his own medical judgment. Rush's medical director, however, refused to concede that the surgery had been medically necessary, and denied Moran's claim in January 1999.

Moran amended her complaint in state court to seek reimbursement for the surgery as "medically necessary" under Illinois's HMO Act, and Rush again removed to federal court, arguing that Moran's amended complaint stated a claim for ERISA benefits and was thus completely preempted by ERISA's civil enforcement provisions . . . . The District Court treated Moran's claim as a suit under ERISA, and denied the claim on the ground that ERISA preempted Illinois's independent review statute.

The Court of Appeals for the Seventh Circuit reversed. . . .

II. . . .

It is beyond serious dispute that under existing precedent § 4-10 of the Illinois HMO Act "relates to" employee benefit plans within the meaning of § 1144(a). The state law bears "indirectly but substantially on all insured benefit plans," by requiring them to submit to an extra layer of review for certain benefit denials if they purchase medical coverage from any of the common types of health care organizations covered by the state law's definition of HMO. As a law that "relates to" ERISA plans under [it] is saved from preemption only if it also "regulates insurance" under § 1144(b)(2)(a).

A

In Metropolitan Life we said that in deciding whether a law "regulates insurance" under ERISA's saving clause, we start with a "common-sense view of the matter," under which "a law must not just have an impact on the insurance industry, but must be specifically directed toward that industry." We then test the results of the common-sense enquiry by employing the three factors used to point to insurance laws spared from federal preemption under the McCarran-Ferguson Act [which holds that Congress shall not regulate insurance activities that are subject to state regulation]. Although this is not the place to plot the exact perimeter of the saving clause, it is generally fair to think of the combined "common-sense" and McCarran-Ferguson factors as parsing the "who" and

51

the "what": when insurers are regulated with respect to their insurance practices, the state law survives ERISA.

The common-sense enquiry focuses on "primary elements of an insurance contract [which] are the spreading and underwriting of a policyholder's risk." The Illinois statute addresses these elements by defining "health maintenance organization" by reference to the risk that it bears. . . .

Rush contends that seeing an HMO as an insurer distorts the nature of an HMO, which is, after all, a health care provider, too. This, Rush argues, should determine its characterization, with the consequence that regulation of an HMO is not insurance regulation within the meaning of ERISA.

The answer to Rush is, of course, that an HMO is both: It provides health care, and it does so as an insurer. Nothing in the saving clause requires an either-or choice between health care and insurance in deciding a preemption question, and as long as providing insurance fairly accounts for the application of state law, the saving clause may apply. There is no serious question about that here, for it would ignore the whole purpose of the HMO-style of organization to conceive of HMOs without their insurance element.

. . . .

2

On a second tack, Rush and its amici dispute that § 4-10 is aimed specifically at the insurance industry. They say the law sweeps too broadly with definitions capturing organizations that provide no insurance, and by regulating non-insurance activities of HMOs that do. Rush points out that Illinois law defines HMOs to include organizations that cause the risk of health care delivery to be borne by the organization itself, or by "its providers." In Rush's view, the reference to "its providers" suggests that an organization may be an HMO under state law (and subject to § 4-10) even if it does not bear risk itself, either because it has "devolve[d]" the risk of health care delivery onto others, or because it has contracted only to provide "administrative" or other services for self-funded plans.

These arguments, however, are built on unsound assumptions. Rush's first contention assumes that an HMO is no longer an insurer when it arranges to limit its exposure, as when an HMO arranges for capitated contracts to compensate its affiliated physicians with a set fee for each HMO patient regardless of the treatment provided. . . .

The problem with Rush's argument is simply that a reinsurance contract does not take the primary insurer out of the insurance business . . . . The HMO is still bound to provide medical care to its members, and this is so regardless of the ability of physicians or third-party insurers to honor their contracts with the HMO.

Nor do we see anything standing in the way of applying the saving clause if we assume that the general state definition of HMO would include a contractor that provides only administrative services for a self-funded plan. . . . [T]he requirement that the HMO "provide" the covered service if the independent reviewer finds it medically necessary seems to assume that the HMO in question is a provider, not the mere arranger mentioned in the general definition of an HMO. . . .

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B

The McCarran-Ferguson factors confirm our conclusion. A law regulating insurance for McCarran-Ferguson purposes targets practices or provisions that "ha[ve] the effect of transferring or spreading a policyholder's risk; [that are] an integral part of the policy relationship between the insurer and the insured; and [are] limited to entities within the insurance industry." Because the factors are guideposts, a state law is not required to satisfy all three McCarran-Ferguson criteria to survive preemption, and so we follow our precedent and leave open whether the review mandated here may be described as going to a practice that "spread[s] a policyholder's risk." For in any event, the second and third factors are clearly satisfied by § 4-10.

It is obvious enough that the independent review requirement regulates "an integral part of the policy relationship between the insurer and the insured." Illinois adds an extra layer of review when there is internal disagreement about an HMO's denial of coverage. . . . The review affects the "policy relationship" between HMO and covered persons by translating the relationship under the HMO agreement into concrete terms of specific obligation or freedom from duty. Hence our repeated statements that the interpretation of insurance contracts is at the "core" of the business of insurance.

The final factor, that the law be aimed at a "practice . . . limited to entities within the insurance industry," is satisfied for many of the same reasons . . .

III

. . . Rush, however, does not give up. It argues for preemption anyway, emphasizing that the question is ultimately one of congressional intent, which sometimes is so clear that it overrides a statutory provision designed to save state law from being preempted. . . .

[The Court then discusses whether this type of state insurance law is so intertwined with the enforcement provisions of ERISA that it must be preempted despite the apparent dictates of the “insurance savings” clause and concludes that it is not. See discussion in Davila in Section 2B.5 of these materials.]

. . . .

In deciding what to make of these facts and conclusions, it helps to go back to where we started and recall the ways States regulate insurance in looking out for the welfare of their citizens. Illinois has chosen to regulate insurance as one way to regulate the practice of medicine, which we have previously held to be permissible under ERISA. While the statute designed to do this undeniably eliminates whatever may have remained of a plan sponsor's option to minimize scrutiny of benefit denials, this effect of eliminating an insurer's autonomy to guarantee terms congenial to its own interests is the stuff of garden variety insurance regulation through the imposition of standard policy terms. It is therefore hard to imagine a reservation of state power to regulate insurance that would not be meant to cover restrictions of the insurer's advantage in this kind of way. And any lingering doubt about the reasonableness of § 4-10 in affecting the application of § 1132(a) may be put to rest by recalling that regulating insurance tied to what is medically necessary is probably inseparable from enforcing the quintessentially state-law standards of reasonable medical care. . . . The saving clause is entitled to prevail here, and we affirm the judgment.

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[A dissent written by Justice Thomas and joined by Justices Rehnquist, Scalia, and Kennedy is omitted.]

* * *

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Notes and Questions on the Public Regulation of Private Financing Arrangements

1. The health care insuring and financing arrangements discussed in the previous section are primarily private transactions. As a result, disputes over their scope and nature are governed in large part by principles of contract, as will be discussed in more detail the next subsection. There is, however, a significant network of state and federal control over the sale of insurance and other financing plans, the coverage of the resulting arrangements, and the resolution of disputes over eligibility, reimbursement, and other related matters.

As summarized in both Metropolitan Life and Travelers, both insurance generally and health insuring and financing arrangements in particular are governed by a wide range of state laws. Most states license both insurers and insurance brokers and regulate their practices in a variety of ways. Many states also require certain benefits to be included in all health insuring arrangements, prohibit discrimination against certain categories of providers, or put limits on the exclusion of particular services of beneficiaries. Virtually all states provide some administrative review of the rates and premiums charged for insurance or other health financing plans, although in many cases this provides for little more than public disclosure of the rates and how they were calculated, and it does not result in rigorously enforced or mandatory limits on rates or reimbursement levels. In this regard, the mandatory surcharges in Travelers are somewhat unusual, but they are certainly not unprecedented. See discussion of related rate setting programs in Chapter 4.

From their inception, the Blues have been extensively regulated by the states. The states created the Blues through special enabling legislation, which allowed for their nonprofit structure, exempted them from some insurance law requirements, and generally provided them with a publicly approved monopoly over "service-benefit" type arrangements. At the same time, the enabling legislation also imposed additional requirements on the Blues, requirements relating to the benefits offered by these plans, the kind and nature of their relationship with providers, and the rates charged to subscribers. See discussion in Chapter 1.

Many states also have enacted special enabling legislation for HMOs, PPOs, and other alternative arrangements, not only exempting them from some of the controls imposed over more traditional insurance entities but also imposing additional requirements or conditions on the plans that they offer. More recently, a number of states have moved in a somewhat different direction, enacting "any willing provider," “anti-managed care,” and “patients rights” legislation. The Arkansas legislation at issue in Prudential is a good example. For other examples and a discussion of their political origins, see Section D in Chapter 8.

The courts have had little trouble upholding the constitutionality of any of these state laws either in terms of the states' general regulatory authority or their ability to treat some types of payers preferentially or differently than others. See, e.g., Golden Rule Insurance Co. v. Stephens, 912 F. Supp. 261 (E.D. Ky. 1995); Attorney General v. Travelers, Insurance Co., 391 Mass. 730, 463 N.E.2d 548 (1984), aff'd, 471 U.S. 724 (1985). For an exceptional case, see Idaho Ass’n of Chiropractic Physicians, Inc. v. Alcorn, 132 Idaho 486, 975 P.2d 219 (1999)(holding that state cap on insurance reimbursement to chiropractors violated the equal protection clause of the state and federal constitutions).

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The federal role in regulating private health insurance and other health financing arrangements is somewhat harder to characterize. In 1945, Congress enacted the McCarran-Ferguson Act affirming the states' primary responsibility for regulating insurance, in response to a prior Supreme Court opinion that had found the sale of insurance as a "transaction in commerce" for purposes of federal antitrust jurisdiction. On the other hand, the beneficial tax treatment of employer-purchased health benefits was enacted during that same time, which obviously has had a profound impact on the scope and nature of private health financing, as has the ERISA legislation adopted in 1974. Other examples reflect the "off-again/on-again" nature of federal regulation of health financing. In 1986, for example, Congress required all employers with 20 or more employees to continue to offer health care coverage (at the employee's expense) for up to 18 months for former employees and up to 36 months for widows, divorced spouses, and dependents of formerly covered workers. 29 U.S.C. § 1161-1168 (COBRA). In 1986, Congress also passed the Tax Reform Act of 1986, which imposed limits on the ability of the employer to discriminate between categories of employees in offering health benefits. 26 U.S.C. § 105(h).

In 1990 federal legislation was enacted regulating the sale of "Medi-Gap" policies. 42 U.S.C. §§ 1395b-2 & 1395ss. Both employers and insurers are also subject to various federal laws of general applicability prohibiting discrimination on the basis of race, sex, disability, and other factors. See discussion in McGann infra.

In 1996 Congress enacted the Newborns’ and Mothers’ Protection Act, a kind of federally mandated benefit law requiring insurers to cover inpatient hospital care following child birth for at least 48 hours and other prenatal and child birth-related services. 42 U.S.C. § 300gg-4. Congress also enacted the Health Insurance Portability and Accountability Act of 1996, which requires private insurers to offer group and, in some cases, individual coverage to people who have been previously covered, prohibits the use of pre-existing conditions or exclusions, and imposes other standards on private financing arrangements. It also authorized the limited use of medical savings accounts (as tax deductible employment-based benefits) and mandated standards for the protection and security of electronically stored data.

As with state effort to regulate insurance and other financing arrangements, the courts have had little trouble upholding the constitutionality of federal authority to regulate either health financing specifically or insurance generally under the interstate commerce authority. For an overview, see Kenneth R. Wing & Benjamin Gilbert, The Law and the Public’s Health 139-58 (7th ed. 2006).

2. The major legal controversies concerning the scope and nature of government control over health care financing and related matters have not been based on constitutional principles. These controversies have derived from the impact of the ERISA legislation which preempts some, but not all, forms of state regulation and yet imposes few substantive requirements on health insuring and financing arrangements subject to ERISA's reach.

ERISA regulates employee benefits plans including those that provide "through the purchase of insurance or otherwise . . . medical, surgical, or hospital care or benefits." 29 U.S.C. §§ 1002(1) & 1002(l)(A). It does not impose substantive requirements on those plans, but imposes requirements on their administration, disclosure, and funding. It gives the Department of Labor oversight authority and provides for criminal and civil sanctions for ERISA

56

violations. See discussion in the next subsection. Most importantly, ERISA also preempts some state laws that relate to employee benefits. See 29 U.S.C. § 1144.

While ERISA's preemption language is cumbersome (and what the Court calls "not a model of clarity"), Metropolitan Life set out a fairly clear outline of principles: ERISA generally preempts any state law that may "relate to" an ERISA-covered employee benefit plan; the preemption does not apply to any state law that regulates insurance; for this purpose, a self-insured employee benefits plan cannot be deemed an insurance plan or engaged in the business of insurance. According to Metropolitan Life, the Massachusetts' mandated benefits legislation "related to" ERISA-covered plans but was exempted from the preemption as a law that regulates insurance, as would, presumably, any similar legislation.

In District of Columbia v. Greater Washington Board of Trade, 506 U.S. 125 (1992), the Supreme Court provided some further guidance for the lower courts when it overturned a District of Columbia statute that required employers who offer health insurance to provide a scope of benefits that is equivalent to that provided to their employees under the state’s workers' compensation program. Even though ERISA allows states to regulate compliance with their workers' compensation laws, the Court held that the state could not impose the same requirements of their employee’s plans; such requirement "relate to" a covered employee benefit plan and is, therefore, preempted by ERISA.

The Travelers decision claimed to be consistent with the principles set out in Metropolitan Life, but, in fact, it provided a somewhat modified definition of the all-important "relates to" language that triggers ERISA preemption. According to Travelers, a state law "relates to" an employee benefits plan if the law has a "connection with" that plan or the state law makes a specific reference to such a plan. Obviously New York's surcharge does have an indirect economic effect on employee benefit plans if the plans choose to purchase services subject to the surcharge; but, according to the Travelers decision, because the plans are not required to purchase those services, this effect is an insufficient "connection" to trigger ERISA preemption. In contrast, the Travelers Court claimed, the benefit law mandated by the state involved in Metropolitan Life required all insurers and all health plans that purchase insurance to provide the mandated benefits. This was the reason that Metropolitan Life concluded that the state law "related to" ERISA plans (and upheld the law only because it was an insurance regulation exempt from preemption).

While this is a rather strained reading of Metropolitan Life, it implies, at least, that a surcharge or other general requirement that has only an economic impact on ERISA-governed plans still might be preempted if affected plans have little or no choice whether to incur that impact. On the other hand, the Court in Travelers noted that any regulatory control imposed on hospitals or other providers might have some economic impact on health benefit plans that buy services from them. Presumably, not all such laws fall within the ERISA preemption. In addition, the last section of the Travelers decision appears to be a defense of hospital rate setting and other similar state laws of general applicability -- laws that also would have unavoidable economic effects on all employee benefit plans in the state.

Since Travelers, the Supreme Court has issued several decisions that tend to confirm the principles set out in Metropolitan Life and Travelers. In De Buono v. NYSA-ILA Medical & Clinical Services Fund, 520 U.S. 806 (1997), the Court reaffirmed its decision in Travelers by holding that a state health care facility tax could not be applied directly to an multi-employer health benefits

57

trust fund. See also California Div. Of Labor Standards Enforcement v. Dillingham, 519 U.S. 316 (1997). Nonetheless, the circuits have had some trouble applying the Metropolitan Life/Travelers principles to the wide variety of state efforts to regulate private health financing.

3. The Rush decision attempted to clarify further the scope of the savings clause. In the same year, the Supreme Court also decided Kentucky Association of Health Plans, Inc. v. Miller 538 U.S. 329 (2003). In Kentucky Association, the Court held that the state’s "any willing provider" law was an insurance law and, therefore, exempt from the ERISA preemption. As they did in Rush, the Court argued that Kentucky’s law was not beyond in the “insurance savings” clause because it applied to entities that were not insurance companies:

It is of course true that as a consequence of Kentucky's AWP laws, entities outside the insurance industry (such as health-care providers) will be unable to enter into certain agreements with Kentucky insurers. But the same could be said about the state laws we held saved from preemption in Rush . . . . Illinois' requirement that HMOs provide independent review of whether services are “medically necessary,” likewise excluded insureds from joining an HMO that would have withheld the right to independent review in exchange for a lower premium. . . . Regulations “directed toward” certain entities will almost always disable other entities from doing, with the regulated entities, what the regulations forbid; this does not suffice to place such regulation outside the scope of ERISA's saving clause.

Both of Kentucky's AWP laws apply to all HMOs, including HMOs that do not act as insurers but instead provide only administrative services to self-insured plans. Petitioners maintain that the application to non-insuring HMOs forfeits the laws' status as “law[s] . . . which regulat[e] insurance.” We disagree. To begin with, these non-insuring HMOs would be administering self-insured plans, which we think suffices to bring them within the activity of insurance . . . . [W]e think petitioners' argument is foreclosed by Rush where we noted that Illinois' independent-review laws contained “some overbreadth” . . . yet held that “there is no reason to think Congress would have meant such minimal application to non-insurers to remove a state law entirely from the category of insurance regulation saved from preemption.”

538 U.S. at 335.

The Court in Kentucky Association was also unconcerned that the “any willing provider” law did not directly regulate the relationship between the insured and the insurer:

Petitioners claim that the AWP laws do not regulate insurers with respect to an insurance practice because, unlike the state laws we held saved from preemption in Metropolitan Life and Rush they do not control the actual terms of insurance policies. Rather, they focus upon the relationship between an insurer and third-party providers -- which in petitioners' view does not constitute an “insurance practice.”

. . . Those who wish to provide health insurance in Kentucky (any “health insurer”) may not discriminate against any willing provider. This “regulates” insurance by imposing conditions on the right to engage in the business of insurance . . . .

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We emphasize that conditions on the right to engage in the business of insurance must also substantially affect the risk pooling arrangement between the insurer and the insured to be covered by ERISA's saving clause. Otherwise, any state law aimed at insurance companies could be deemed a law that “regulates insurance” . . . . A state law requiring all insurance companies to pay their janitors twice the minimum wage would not “regulate insurance,” even though it would be a prerequisite to engaging in the business of insurance, because it does not substantially affect the risk pooling arrangement undertaken by insurer and insured. Petitioners contend that Kentucky's AWP statutes fail this test as well, since they do not alter or affect the terms of insurance policies, but concern only the relationship between insureds and third-party providers . . . . We have never held that state laws must alter or control the actual terms of insurance policies to be deemed “laws . . . which regulat[e] insurance” . . . . {I]t suffices that they substantially affect the risk pooling arrangement between insurer and insured. By expanding the number of providers from whom an insured may receive health services, AWP laws alter the scope of permissible bargains between insurers and insureds in a manner similar to the mandated-benefit laws we upheld in Metropolitan Life. No longer may Kentucky insureds seek insurance from a closed network of health-care providers in exchange for a lower premium. The AWP prohibition substantially affects the type of risk pooling arrangements that insurers may offer.

Id. at 336.

Note the relevance of Rush and Kentucky Association to the decisions discussed in the next subsection, particularly Davila.

4. Whether or not the limits on ERISA preemption are clear, the issue of ERISA preemption has enormous implications for a wide variety of state efforts to regulate providers (as discussed further in Chapters 4 and 5), to govern disputes over coverage and eligibility under private insuring and financing arrangements (as discussed in the next subsection), and even to determine of tort liability under state law. The extent to which ERISA preempts state law has, in fact, become a predominant legal constraint on many state efforts to expand access to health care, to contain the costs of health care, or to otherwise reform health care delivery and financing in the broadest sense of the term. As will be discussed in more depth in Chapter 8, almost any major state reform necessarily raises ERISA problems, if it directly requires employers to provide for or finance benefits, or, in some cases, if it affects the choices that are available to employee benefit plans. The former is clearly preempted; the latter turns on a reading of Metropolitan Life, Travelers, and their progeny. State laws that “relate to” employee benefits plans are preempted. States, just as surely, have wide discretion to regulate insurance and other financing arrangements, but employers can always avoid any state insurance law by self-insuring, an increasingly popular trend.

Some states have considered imposing “pay or play” requirements on employers, laws that require employers who do not provide health benefits to pay a tax. Others have considered achieving the same thing by simply taxing employers and using the funds to finance some sort of program for the uninsured. A few states have toyed with the so-called "single payer" proposals, under which a state-authorized entity would become the sole insurer in the jurisdiction. Which of these “relate to” ERISA-governed plans? Which are insurance laws? Which

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could be applied to self-insured employers? The implications are important but, unfortunately wrapped in the cumbersome and almost byzantine analysis that ERISA necessarily entails.

5. The underlying politics of ERISA are fascinating. Even in an era when less federal control and more state discretion have become popular political dogma, most observers assume Congress will be reluctant to modify or repeal the ERISA preemption. This is true even if they are requested to do so by those states that are willing to do what Congress has been unable to do: grapple with rising health care costs and other critical problems. Even when Congress agreed in 1982 to exempt Hawaii's health insurance program (that relied heavily on an employer-mandate) it only "grandfathered" the Hawaiian scheme as it existed prior to the 1974 enactment of ERISA (29 U.S.C. § 1144(b)(5)). See discussion in Chapter 8. Thus, Hawaii may not expand the scope or coverage of its employer-mandate without further congressional approval. Congress has denied exemption from ERISA for all other states that have requested it. More recently, proposals to allow for an administrative waiver by DHHS for states that want to experiment with various reforms, or to enact minimum federal standards within which states could experiment, also have been rejected.

Why is Congress so insistent that the states not reform health care or, at least, not undertake any program that "relates to" most employment-purchased health benefits and, therefore, most private health insuring or financing arrangements? Preemption is more often invoked to prevent states from interfering with a federal regulatory effort or initiative. At least with regard to employee health benefits, ERISA only preempts state efforts; it substitutes virtually no federal regulatory alternatives or standards. Stated differently, who benefits from ERISA preemption and why have they been so successful in defending ERISA?

ERISA can be defended as a labor law that protects the primacy of those benefits for which employers and their employees have bargained. See cases discussed infra. More generally, most employers see ERISA as their defense against state regulatory controls or costly mandates; even some labor unions side with employers in their opposition to the curtailment of ERISA preemption, fearing that state reform efforts will necessarily reduce their flexibility at the bargaining table. Large multi-state employers also support ERISA, arguing that without preemption they would have to comply with several different, possibly conflicting state schemes. And even though insurers are technically not protected from state regulation by ERISA, the limits of the preemption provision and the "escape hatch" of self-insurance effectively frustrate so many state reform efforts that insurers are effectively protected by the ERISA preemption as well. That’s a formidable cast of political supporters and one that cuts across party and ideological lines -- and has done so persistently for nearly three decades.

Whatever its political pedigree, one thing is clear: ERISA preemption is an important part of the legal framework of American health care. As a result, throughout the materials that follow, it will be frequently necessary to sort out the "ERISA issue" as part of virtually every problem that touches on privately financed health care. And it will continue to be necessary so long as American health care financing is tied so closely to employment.

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4. Disputes Involving the Scope and Coverage of Private Health Financing Schemes

Under any scheme of health financing, some services and people are covered and some are not. Even in wholly socialized schemes, where the centralized government both finances and provides care to the whole population, there are both implied and explicit limits on the scope of services covered. (In Great Britain, for instance, kidney dialysis is not available to people in higher age groups.) In the United States, all public and private financing arrangements explicitly limit their scope and coverage in a variety of ways, from cost-sharing requirements, to limits on coverage of certain categories of services, to exclusions of certain categories of people. Nonetheless, these limits and exclusions can be controversial, especially in their application to particular cases. Indeed, as virtually all health financing arrangements are incorporating utilization review, prior authorization, and other "managed care" strategies into their schemes, these sorts of disputes are likely to become more and more frequent -- and even more controversial.

When these controversies involve the type of private financing arrangements discussed in this section, their resolution is governed, in large part, by traditional principles of contract and, in some cases, tort law; but as should be clear from the last section, both the states and the federal government have imposed some public controls over these arrangements. These controls can, in some instances, modify, replace or, in the case of ERISA, preempt the application of those contract and tort principles. Thus, as the cases to follow will demonstrate, the outcome of each dispute will turn, in large part, on the specific terms of the contractual agreement and related documents involved in that case. But those terms may be modified by state legislation, and both, in turn, may be modified by federal legislation, in particular, ERISA.

As you consider the particular legal issues that arise in each case, try first to sort out which laws -- federal or state, common law or statutory -- govern which kinds of individual disputes. But also be aware that this legal framework can very quickly change: Employers and insurers can draft more specific exclusionary language into their agreements; states can dramatically expand the regulation of contractually determined financing arrangements; and the federal government can expand -- or withdraw -- the scope of ERISA coverage or create more extensive federal controls. For that reason, it is also important to consider the "big picture" issues that underlie these cases. Is the net result equitable -- to any of the parties? Do these types of disputes primarily arise because of disagreements over what is or is not actually included in a health financing contract? Or, alternatively, do these disputes arise because neither the contract nor the public controls over these types of arrangements have clarified who will make critical decisions or how disputes will be resolved? If either the pattern of winners and losers or the manner in which we determine these decisions is unfair, how should these disputes be resolved under current or future arrangements?

As an organizational matter, note that the cases that follow primarily concern actions by payers to either deny or delay reimbursement. Nonetheless, they are related to decisions concerning allegations that health plans have some causal role in the delivery of poor quality care. The line between these two types of cases -- sometimes described as that between the “quantity of care” and the “quality of care" cases or, as the Supreme Court recently fashioned, between ”eligibility” cases and “treatment” cases -- is questionable at best;

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nonetheless, it is a line with important doctrinal consequences, especially in determining which cases will be governed by ERISA and which by state law.

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DAVIS V. GHS HEALTH MAINTENANCE ORGANIZATION, 22 P.3d 1204 (Okla. 2001)

Kauger, Justice.

* * *

We retained this cause to determine whether pursuant to [Oklahoma state law] an insured, who has not received full payment for disputed medical expenses, must exhaust administrative remedies before filing a bad faith suit in district court. [The Oklahoma statute] requires HMOs denying claims to advise insureds of the right of appeal and the name of the entity from whom review may be requested. Because the HMO did not inform the insured of review or appeal rights in its denial letter, we hold that, under the unique facts of this cause, an insured, who has not pursued administrative remedies, may file a bad faith action in district court.

The appellee . . . contracted with the State of Oklahoma to provide insurance coverage to state employees and their dependents. In 1996, while working for the Oklahoma Department of Transportation . . . [Davis] chose to enroll himself and his wife as members of the HMO . . . .

As a result of a severe diabetes condition, Davis suffers from organic impotence. The insured asserts that he chose coverage with the HMO based on assurances that an inflatable penile implant procedure fell within his plan. Davis underwent surgery on August 19, 1997, believing that he had been approved for the surgery.

Although it appears that the HMO paid the surgeon and the anesthesiologist who performed the procedure, Davis received a collection letter in November, 1998, indicating that the hospital bill had not been satisfied. Initially, Davis states that BlueLincs informed him that coverage had been denied because of an invalid pre-certification number and the failure to obtain the HMO's doctor's or director's signature on the referral authorization. On January 12, 1999, Davis wrote BlueLincs demanding that they forward $9,072.87 to the collection agency in payment of the hospitalization charges. BlueLincs responded with a form letter on January 16, 1999, stating that "[t]he services rendered are not a benefit of your health plan. This is your responsibility." Although the letter contains telephone numbers where further questions may be directed, it does not give any information on the possibility of review or appeal of the denial.

On February 1, 1999, in his first amended petition, Davis filed suit in district court for fraud, constructive fraud and breach of the implied covenant of good faith and fair dealing. Alleging that Davis had not exhausted the administrative procedures imposed by the HMO's internal grievance procedure and the Benefits Act, the HMO moved for dismissal on March 15, 1999. [T]he matter was dismissed on "jurisdictional grounds." . . .

I.

The insured contends that the grievance procedures contained in the Benefits Act are not exclusive and that they do not require exhaustion before instituting an action for bad faith breach of an insurance contract. Additionally, Davis maintains that the HMO has adopted grievance procedures which clearly do not require exhaustion before proceeding in district court. The HMO maintains that the Benefits Act contains comprehensive, mandatory and

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binding administrative procedures broad enough to encompass tort actions. Because Davis did not pursue administrative remedies, the insurer argues that the district court "lacked jurisdiction."

Recognizing the individual needs of state employees, the Legislature enacted the Benefits Act creating the Oklahoma State Employees Benefits Council (Benefits Council) to establish and administer the flexible benefits plan. The Benefits Act was passed with the purpose of providing state employees and their dependents with optional employee benefits including enhanced health insurance coverage, health maintenance organization services, life insurance, dental insurance and enhanced long-term disability insurance.

The HMO relies primarily on the language of . . . the statute which provides:

The Council shall interpret the plan and decide any matters arising

thereunder and may adopt such rules and procedures as it deems necessary, desirable or appropriate in the administration of the plan subject to the Administrative Procedures Act. All rules and decisions of the Council shall be uniformly and consistently applied to all participants in similar circumstances and shall be conclusive and binding on all persons having an interest in the plan. . . .

The insurer contends that the Legislature's use of the term "any matters"

is sufficiently broad to cover bad faith claims and that the statute mandates not only that the Council determine all issues relating to claims but that the Council's decisions "shall be conclusive."

. . . .

Clearly, both the statute and the administrative rule, place claims for insurance benefits squarely within the province of the Benefits Council. However, neither the statute nor the rule authorize the Benefits Council to address bad faith claims or to award damages appropriate to tort actions. . . .

Our determination that the Benefits Council has no authority to determine actions in bad faith does not end the inquiry into the necessity of exhaustion of administrative remedies. The insured argues that because the Benefits Council cannot determine issues of bad faith or award damages associated with the tort, the general requirement of exhaustion of administrative remedies should be excused as futile. The HMO contends that without the Benefit Council's determination that the claim falls within its coverage, it cannot be held liable for bad faith. Because the issue of liability has not been established and because the claim remains unpaid, the insurer argues that Davis is precluded from proceeding in district court.

We agree with the HMO that a determination of liability under the contract is a prerequisite to a recovery for bad faith breach of an insurance contract. We also agree that, generally, when coverage has not been determined through the administrative process, an action in district court for bad faith breach of the insurance contract would be precluded. Nevertheless, the unique facts of this cause militate against requiring the insured to exhaust either the HMO's internal grievance process or to proceed before the Benefits Council.

[The Oklahoma statutes] contemplate that HMOs may adopt their own grievance procedures providing that the Benefits Council shall be responsible for determining rights under the plan "except to the extent that a benefit plan

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provides to the contrary." Pursuant to the authority of the statute and the administrative rule, the HMO adopted a grievance process which is outlined in the Member Handbook (Handbook).

Insureds whose HMOs have adopted internal procedures similar to the one at issue here have two opportunities for review -- first with the HMOs appeals body and second before the Benefits Council. In both instances, the insured is entitled to written notice from the HMO advising of the right of review and the party from whom relief should be sought.

Review of claims denied in whole or in part are handled differently when an HMO has instituted grievance procedures and when it has not. . . .

Nevertheless, all HMOs must notify their insureds of the denial of a claim within forty-five (45) days of the claim's filing. . . . An HMO with an internal review process may be required to give notice to its insured twice -- if the claim is denied initially, it must advise its insured of the right to appeal and the party with whom the request must be filed; if the claim is denied during the internal review, the HMO must give the insured written notice delineating the rights of appeal before the Benefits Council.

. . . .

The statute and the rule direct the HMO to provide the insured written information of the right of appeal. The rule goes further, specifically providing that the HMO shall advise the insured with whom the appeal must be lodged. The notice given Davis wholly fails the mandates of the statute and the rule. The insured was provided a form letter indicating that his claim had been denied. Although it contained telephone numbers to which further questions might be directed, it provided no information on the appeals process available either through the HMO or the Benefits Council. By engaging an attorney and proceeding in district court, the insured has incurred legal expenses. A finding that the HMO was under no duty to provide the mandated notice would not only contradict the [statutory] language and it would prejudice the insured's right to proceed with his bad faith claim and ignore the fact that the lack of notice may have resulted in Davis' incurring unnecessary legal expenses.

Although the notice issue was not artfully argued, the question was raised in the trial court and on appeal. . . . [W]hen public law issues are presented, the Court may, on review, resolve them by application of legal theories not tendered below. We take judicial notice of public policy established through statutory enactments, and we are constrained to take into consideration rules promulgated pursuant to the Administrative Procedures Act. Here, both [statutes] mandate that the insured be given written notice of the right of appeal and of the entity who must be contacted to guarantee review. Failure to give the statutorily mandated and rule provided notice excuses the generally mandated exhaustion requirements.

* * *

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KUHL v. LINCOLN NATIONAL HEALTH PLAN OF KANSAS CITY, INC., 999 F.2d 298 (8th Cir. 1993), cert. denied, 510 U.S. 1045 (1994)

Beam, Judge.

* * *

Lincoln National is an "independent physician" HMO, which means that it pays independent physicians, hospitals, and other health care providers to render medical services for its members. Pursuant to a contract between Lincoln National and Belger Cartage Services, Inc. (Belger), Lincoln National pays for medical services provided to Belger employees under Belger's Group Health Plan. Belger's Group Health Plan is an "employee welfare benefit plan" regulated under ERISA. 29 U.S.C. § 1002(1). Under the Belger Plan, Lincoln National is not contractually obligated to pay for medical services rendered outside the "Service Area" of the Lincoln National network or for medical services rendered by personnel not participating in the Lincoln National network. All decisions concerning the payment of claims under the Belger Plan are the responsibility of Lincoln National. Lincoln National makes advance decisions regarding payment for medical services rendered outside of its service area through "pre-certification review," a process by which it determines whether a particular procedure or hospitalization is covered by the Belger Plan.

Buddy Kuhl was an employee of Belger, and had opted to receive medical benefits under the Belger Plan administered by Lincoln National as of March 1, 1989. On April 29, 1989, Buddy Kuhl suffered a heart attack. Dr. Grimes, Buddy Kuhl's designated primary care physician, placed Buddy Kuhl in the care of Dr. Levi, a heart specialist at Menorah Medical Center. Dr. Levi concluded that heart surgery was necessary, including open heart LV aneurysmectomy and a coronary by-pass. Lincoln National arranged for a second opinion by Dr. Ahuja. In a letter dated May 23, 1989, Dr. Ahuja confirmed that surgery was necessary, stating that Buddy Kuhl was "at high risk of sudden death" and needed the recommended surgery "in the next few weeks."

Buddy Kuhl underwent extensive tests at Menorah between June 13, 1989, and June 16, 1989, to determine the extent of his heart damage and the proper course of treatment. On June 20, 1989, Dr. Levi determined that Buddy Kuhl had inducible ventricular tachycardia and would need formal electrophysiologically guided left ventricular aneurysm resection and subendocardial resection, as well as his bypass surgery. Because the Kansas City area hospitals did not have the equipment to perform the necessary surgery, Dr. Levi concluded that Buddy Kuhl would have the best chance of survival if the surgery were performed at Barnes Hospital in St. Louis, Missouri. Dr. Levi also noted that the surgeons at Barnes Hospital had more experience and success with this type of surgery than any doctor in Kansas City. Dr. Hannah, a cardiac surgeon at Menorah and a participating provider under the Belger Plan, concurred in Dr. Levi's conclusions. Therefore, arrangements were made for Dr. Cox, a heart surgeon specializing in computerized cardiac mapping and bypass surgery, to perform the surgery at Barnes Hospital on July 6, 1989.

On June 20, 1989, Dianne Long, a utilization review coordinator for Lincoln National, received a call from Barnes Hospital requesting pre-certification for the surgery. On June 23, 1989, Lincoln National refused to pre-certify payment for the surgery because Barnes Hospital is outside the Lincoln National service area. The surgery scheduled for July 6, 1989, was

66

canceled. Lincoln National then scheduled an appointment for Buddy Kuhl to see Dr. Brodine at Research Medical Center in Kansas City on July 6, 1989, to determine whether the surgery could be performed in Kansas City rather than in St. Louis. After examining Buddy Kuhl, Dr. Brodine immediately informed Lincoln National that he agreed with the recommendations of Dr. Levi and Dr. Hannah that the surgery should be performed at Barnes Hospital.

Two weeks later, on July 20, 1989, Lincoln National informed Buddy Kuhl that it would authorize the surgery at Barnes Hospital. Buddy Kuhl immediately attempted to schedule the surgery, but was informed that the surgery team was unavailable until September 1989. On September 2, 1989, Dr. Cox examined Buddy Kuhl in anticipation of surgery and found that his heart had deteriorated to such an extent that the proposed surgery was no longer a viable option. Dr. Cox recommended that Buddy Kuhl be evaluated for cardiac transplantation and asked that he be placed on a heart transplant waiting list at Barnes Hospital. Lincoln National refused to pre-certify payment of these medical costs. However, Buddy Kuhl was placed on a heart transplant waiting list at Kansas University Medical Center.

Buddy Kuhl died as a result of ventricular tachycardia on December 28, 1989, while waiting for a heart transplant.

[The Kuhls asserted four claims against Lincoln National: medical malpractice, emotional distress, tortious interference with Buddy Kuhl's right to contract for medical care, and breach of a contract through Buddy Kuhl as a third-party beneficiary. The district court determined that the Kuhls' state law claims arose from the administration of the Belger Plan and therefore were preempted as claims that "relate to" an ERISA plan. The court also examined the possible remedies under ERISA, and concluded that the Kuhls could not state a claim under ERISA. The Kuhls then moved to amend the judgment, moved to amend their complaint to include a cause of action under ERISA, and filed a second suit in the district court alleging that Lincoln National breached its fiduciary duty under ERISA. The district court denied the Kuhls' motion to amend the original complaint and held that the Kuhls' claims could not be re-characterized as ERISA claims and thus, reaffirmed its grant of summary judgment in favor of Lincoln National.]

II. DISCUSSION

A. ERISA Preemption

. . . .

1. Tortious Interference, Medical Malpractice, and Breach of Contract

We have no difficulty in concluding that the Kuhls' three state law claims that rely on Buddy Kuhl's status as a beneficiary of the Belger Plan are preempted by ERISA. The Kuhls' claims are all based on Lincoln National's alleged misconduct in delaying Buddy Kuhl's heart surgery in St. Louis. The Kuhls contend that Lincoln National tortiously interfered with the contractual relationship between Buddy Kuhl and his doctors, that Lincoln National committed medical malpractice because it assumed the role of Buddy Kuhl's physician by making decisions about proper medical treatment and made decisions that constitute medical malpractice, and that Lincoln National breached its contract with Belger, to which Buddy Kuhl was a third-party beneficiary, by delaying the surgery in St. Louis. . . .

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In Pilot Life, the Supreme Court held that ERISA preempts state common law causes of action arising from the alleged improper processing of a claim for benefits under an ERISA-regulated plan. [citation to Pilot Life Ins. Co. v. Dedeaux, 481 U.S. 41 (1987)]. In that case, the beneficiary of an ERISA-regulated plan brought state common law tort and contract claims against the insurer for failure to pay benefits under the insurance policy. The Court held that these state law claims "relate to" the employee benefit plan and thus, the comprehensive civil enforcement scheme detailed in the provisions of [ERISA] provides the exclusive remedies for claims involving the administration of plan benefits. . . .

The Kuhls attempt to avoid ERISA preemption by suggesting that Lincoln National's actions with respect to Buddy Kuhl went beyond the mere administration of benefits. They assert that Lincoln National not only refused to pre-certify payment for Buddy Kuhl's operation, but "cancelled" the operation and undertook treatment of Buddy Kuhl according to its own medical opinions. The Kuhls rely heavily on Lincoln National's admission for the purpose of its motion for summary judgment that it "cancelled" the surgery scheduled for July 6, 1989, in St. Louis. The district court rejected the Kuhls' arguments, concluding that the Kuhls' "claims are based on the manner in which Lincoln National responded to the request for 'pre-certification' of Buddy Kuhl's heart surgery. Artful pleading by characterizing Lincoln National's actions in refusing to pay for the surgery as 'cancellation' or by characterizing the same administrative decisions as 'malpractice' does not change the fact that plaintiffs' claims are based on the contention that Lincoln National improperly processed Kuhl's claim for medical benefits."

Taking the facts in the light most favorable to the Kuhls, as we must for purposes of Lincoln National's motion for summary judgment, we are compelled to agree with the district court. Lincoln National became involved in the cancellation of the St. Louis surgery only after the Barnes Hospital staff requested a pre-certification review. Lincoln National's admission that it "cancelled" the surgery cannot be stretched to imply that Lincoln National went beyond the administration of benefits and undertook to provide Buddy Kuhl with medical advice. Although the surgery in St. Louis was unquestionably cancelled as a result of Lincoln National's decision not to pre-certify payment, the decision not to pre-certify payment relates directly to Lincoln National's administration of benefits.

We do not imply that how the surgery was cancelled would be immaterial in every case. In a different case, the cancellation of a beneficiary's surgery by an ERISA benefits provider may lay the basis for non-preempted state law claims. Here, however, the Kuhls have failed to allege that there was a practical difference between Lincoln National "cancelling" the surgery and simply denying pre-certification. The Kuhls make no allegations that Buddy Kuhl would have had the surgery even if Lincoln National refused to pay for it; that Buddy Kuhl was thwarted in his efforts to arrange other financing for the surgery upon Lincoln National's "cancellation;" or that the timing of the "cancellation" made it impossible for Buddy Kuhl to have the surgery on July 6, 1989, if payment could be otherwise arranged. . . .

. . . .

We recognize the obvious salutary effect that imposing state law liability on Lincoln National might have on deterring poor pre-certification decisions. However, this is precisely the type of state regulation of plan administration that ERISA was designed to replace. "Section 514(a) [§ 1144] was intended to

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ensure that plans and plan sponsors would be subject to a uniform body of benefits law; the goal was to minimize the administrative and financial burden of complying with conflicting directives among States or between States and the Federal Government." Other courts have speculated that Congress could not have foreseen the pre-certification review process when it enacted a preemption clause so broad that it relieves ERISA-regulated plans of most tort liability. Although this may well be true, modification of ERISA in light of questionable modern insurance practices must be the job of Congress, not the courts.

B. ERISA Claims

[The court then held that ERISA did not allow for claims for monetary damages; see discussion infra.]

* * *

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BOOTH v. WAL-MART STORES, INC. ASSOCIATES HEALTH AND WELFARE PLAN, 201 F.3d 335 (4th Cir. 2000)

Niehmeyer, Judge.

* * *

Barbara A. Booth, a full-time employee of Wal-Mart Stores, Inc., enrolled in Wal-Mart's self-funded employee benefit plan (the "Plan") on July 29, 1994, when she became eligible to do so. The parties agree that the Plan is governed by ERISA . . . . Wal-Mart is the sponsor of the Plan but does not act as the Plan trustee. The "administrator" of the Plan, as that term is defined in 29 U.S.C. § 1002(16)(A), is the Plan's Administrative Committee.

In late November 1994, roughly four months after subscribing to the Plan, Booth experienced chest pain, which recurred over the course of five days. Her general physician sent her to be examined by Dr. Boshra G. Zakhary, a cardiologist, who recorded that Booth suffered from hypertension, hypertensive cardiovascular disease, and hyperlipidemia (excess fat in the blood). Because of Booth's chest pain, which was consistent with angina, her multiple risk factors for coronary artery disease, and her abnormal EKG, Zakhary performed a left cardiac catheterization with coronary angiography and left ventriculography on December 2, 1994. Through the procedure (during which a small catheter is inserted into the femoral artery in the groin and threaded up into the arteries in the heart, allowing the cardiologist to shoot dye into the coronary arteries and thereby spot blockages), Zakhary learned that the middle segment of Booth's right coronary artery had a 75% stenosis (blockage), prompting him to recommend that Booth receive a coronary angioplasty (in which a small balloon is inflated within the blockage in order to open the artery). Dr. Victor S. Behar performed a coronary angioplasty to Booth's right coronary artery on December 5, 1994. Upon her discharge, Booth was diagnosed with coronary artery disease with unstable angina, hyperlipidemia, hypertension, and anxiety.

Booth sought reimbursement from the Plan to cover the $30,887.18 in medical expenses that she incurred in relation to the coronary angioplasty procedures. The Plan denied her claim after determining that her condition existed before she enrolled in the Plan or was a secondary condition or complication of a pre-existing condition and that her expenses were therefore excluded by the Plan's preexisting condition provision. That provision reads:

Benefits shall not be payable for the following:

Pre - existing conditions

Any charges with respect to any participant for any illness, injury, or symptom (including secondary conditions and complications) which was medically documented as existing, or for which medical treatment, medical service, prescriptions or other medical expense was incurred within 12 months preceding the effective date of these benefits as to that participant, shall be considered pre-existing and shall not be eligible for benefits under this Medical Coverage, until the participant has been continuously covered under the Medical Coverage 12 consecutive months. (Pre-existing conditions include any diagnosed or undiagnosed condition.)

Booth appealed the denial of her claim, asserting that she had been treated previously for high blood pressure and cholesterol but not for any heart

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condition. Also, Dr. Julian A. Koplen, Booth's general physician, who provided most of her medical care during the 12-month exclusionary period before her enrollment in the Plan, sent a letter to the Plan stating that he had reviewed Booth's records and found no evidence of preexisting coronary artery disease. He explained that the abbreviation "PVI," which appeared in his treatment records of Booth, denoted "peripheral venous insufficiency" (incompetent veins in legs, resulting in pooling of blood), not "peripheral vascular insufficiency" (insufficient arterial blood supply, resulting in difficulty supplying oxygenated blood to the limbs).

The Plan reviewed its denial of Booth's claims and, as part of its normal appeal process, sought a medical review of its previous determination. The Plan sent Booth's medical records to Dr. William M. Allen, a cardiologist, who was directed to "document any illness, injury or symptom, including secondary conditions and complications" that were related to Booth's diagnoses in November and December 1994 and that had been documented as existing during the 12-month exclusionary period. In summarizing his findings, Dr. Allen related that "[t]he diagnoses of hypertensive heart disease and hyperlipidemia were clearly present" during the exclusionary period. He also stated his belief that Booth had also been treated for coronary artery disease during that period. He noted that, although none of the relevant medical records diagnosed coronary artery disease, Dr. Behar, who performed Booth's coronary angioplasty, had indicated that Booth's coronary artery disease dated back to 1986 when she was evaluated for chest pain. Allen noted that during the exclusionary period Booth was taking Cardizem, a medicine "effective not only for hypertension but also coronary artery disease and angina."

The Plan's Administrative Committee met on August 9, 1995, to consider Booth's appeal and decided to postpone a decision until its next meeting in order to obtain another medical review of the file by a general practitioner, Dr. James H. Arkins. It made this decision because Dr. Koplen was a general practitioner and had disputed the conclusion of Dr. Allen, a cardiologist, that Koplen's records contained evidence of preexisting coronary heart disease or symptoms to suggest the condition.

After reviewing Booth's records, Dr. Arkins reported that he found "numerous pages of documentation of treatment for heart disease and hyperlipidemia" in Booth's medical records from the exclusionary period. He specifically pointed to Dr. Koplen's documentation of Booth's treatment for "HCVD," which Arkins defined as "hypertensive coronary vascular disease," and to Booth's prescription for Cardizem. Dr. Arkins advised the Plan's Administrative Committee, however, that he found no evidence of preexisting hypopotassemia, lung disease, or abnormal blood chemistry.

The Plan's Administrative Committee met again to review Booth's appeal and determined that hypopotassemia, lung disease, and abnormal blood chemistry were not pre-existing conditions and that expenses incurred by Booth for their treatment would therefore be reconsidered for payment. But the Plan's Administrative Committee again denied Booth's remaining claims relating to the coronary angioplasty, finding that they were related to pre-existing conditions and thus not eligible for coverage.

Booth continued to contest the decision of the Administrative Committee. Dr. Koplen sent a second letter on her behalf to the Committee on October 12, 1995, and reiterated that Booth never had any evidence of coronary disease while she was his patient. He also stated that he believed confusion may have stemmed from a misunderstanding of his abbreviation "HCVD." He stated that, while the

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Plan's reviewers interpreted HCVD to signify "hypertensive coronary vascular disease," he used the abbreviation to denote "hypertensive cardiovascular disease," a term he asserted physicians use loosely to describe high blood pressure. Also, on March 13, 1996, Booth's attorney sent the Plan a request for another appeal. Thereafter, he forwarded a letter written by Dr. Stephen V. Davis, which stated that Booth was neither treated for nor diagnosed as having coronary artery disease or angina prior to November 1994. Davis' letter also explained that HCVD is a term used by physicians to denote either hypertensive cardiovascular disease or hypertensive coronary vascular disease.

. . . On July 8, 1996, the Plan's Administrative Committee met, reviewed the entire appeal file, and again denied Booth's heart-disease- related claims because of the existence of a pre-existing condition. The Administrative Committee based this determination on three factors: (1) a Plan policy that hypertension is a symptom of heart disease; (2) documentation in Booth's file indicating she had been treated for heart disease; and (3) Booth's treatment with Cardizem, which is prescribed for heart conditions.

Booth then filed this action . . . .

II

Because the standard of judicial review is dispositive in this case, we turn first to the proper standard for judicial review of a plan administrator's decision to grant or deny benefits under an employee welfare benefit plan regulated by ERISA.

Because ERISA does not specify the appropriate standard of judicial review of a fiduciary decision, courts are instructed to develop a federal common law, guided by principles of trust law. See Firestone Tire & Rubber Co. . . . . Thus, as a general proposition, ERISA plans, as contractual documents . . . are interpreted de novo by the courts, which conduct their review "without deferring to either party's interpretation." . . . Thus, we have held that in deciding whether a plan provision for benefits is prescriptive or discretionary, we review the Plan's language de novo. . . . Similarly, in determining the scope of contractually conferred discretion and whether a fiduciary has acted within that scope, we act de novo.

When, however, a plan by its terms confers discretion on a fiduciary and the fiduciary acts within the scope of conferred discretion, we defer to the fiduciary in accordance with well-settled principles of trust law: "Where discretion is conferred upon the trustee with respect to the exercise of a power, its exercise is not subject to control by the court except to prevent an abuse by the trustee of his discretion." . . . Thus, a trustee's discretionary decision will not be disturbed if reasonable, even if the court itself would have reached a different conclusion.

A survey of our cases decided after Firestone reveals a certain ambiguity about the appropriate standard of review of a fiduciary's discretionary decision -- whether it is "abuse of discretion" or "arbitrary and capricious" and whether the two standards are equivalent. . . .

We now put to rest any doubt about the appropriate standard of judicial review of a discretionary decision by a plan administrator or fiduciary and the elements of that standard.

First, we continue to recognize that an "arbitrary and capricious"

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standard is more deferential to the fiduciary than is an "abuse of discretion" standard. And second, we affirm that the abuse of discretion standard, not the arbitrary and capricious standard, is the appropriate one for judicial review of a fiduciary's discretionary decision under ERISA. . . . [W]e will not disturb such a decision if it is reasonable.

In determining whether a fiduciary's exercise of discretion is reasonable, numerous factors have been identified as relevant, both in the cases applying ERISA and in principles of trust law. . . .

Combining these various criteria for determining the reasonableness of a fiduciary's discretionary decision, we conclude that a court may consider, but is not limited to, such factors as: (1) the language of the plan; (2) the purposes and goals of the plan; (3) the adequacy of the materials considered to make the decision and the degree to which they support it; (4) whether the fiduciary's interpretation was consistent with other provisions in the plan and with earlier interpretations of the plan; (5) whether the decision-making process was reasoned and principled; (6) whether the decision was consistent with the procedural and substantive requirements of ERISA; (7) any external standard relevant to the exercise of discretion; and (8) the fiduciary's motives and any conflict of interest it may have. A fiduciary's conflict of interest, in addition to serving as a factor in the reasonableness inquiry, may operate to reduce the deference given to a discretionary decision of that fiduciary. We have held that a court, presented with a fiduciary's conflict of interest, may lessen the deference given to the fiduciary's discretionary decision to the extent necessary to "neutralize any untoward influence resulting from that conflict."

. . . .

III

As with any interpretation of a contractual trust document, we begin by examining the language of the Plan to determine whether the provision of benefits is prescriptive or discretionary and, if discretionary, whether the plan administrator acted within its discretion. This review is conducted de novo.

The express terms of the Wal-Mart employee benefit plan give the Plan's Administrative Committee "complete discretion to interpret the provisions of the Plan, make findings of fact, correct errors, and supply omissions." And the scope of this discretion is unusually broad. The Plan provides, "All decisions and interpretations of the Plan Administrator made in good faith pursuant to the Plan shall be final, conclusive and binding on all persons, subject only to the claims procedure, and may not be overturned unless found by a court to be arbitrary and capricious."

From this contractual language, it might be argued that the Plan is attempting to limit courts in their review to the narrowest of circumstances, i.e., whether the administrator acted in bad faith. Moreover, the Plan purports to return judicial review to the pre-Firestone/de Nobel standard of "arbitrary and capricious." But to interpret the Plan in this manner would impinge on the proper role of courts in enforcing contracts and establishing principles of judicial review. Both Firestone and de Nobel articulate standards of judicial review of discretionary decisions by fiduciaries in the context of ERISA and its purposes. While the ERISA jurisprudence recognizes that parties have broad authority through contractual language to agree on the scope of benefits and the

73

procedures to follow in applying for them, we do not understand ERISA to allow a plan to alter the established standard of judicial review of discretionary decisions for reasonableness.

Taking into account the entire Plan before us, however, we do not interpret the Plan's language to authorize discretionary decisions that would violate established principles of reasonableness. The Plan thoroughly delineates benefits to which its beneficiaries are entitled, and it carefully details benefit eligibility requirements. It would be incongruous to interpret the Plan documents before us as additionally conferring such broad discretion on its administrator as to sanction determinations that would not withstand analysis using the reasonableness factors that have been recognized by Firestone and its progeny in the Fourth Circuit. The Plan does not authorize its administrator to make determinations that are contrary to the plain language of the Plan; that frustrate the purposes and goals of the Plan; that are inconsistent with other provisions or earlier interpretations of the Plan; that are rendered pursuant to arbitrary or uninformed decision-making processes; that are inconsistent with the procedural and substantive requirements of ERISA; or that are made in furtherance of an interest that conflicts with that of the Plan beneficiaries.

Accordingly, we conclude that the Plan in this case provides its administrator with discretion to interpret Plan language and to grant or deny benefits in accordance with these interpretations, but we will enforce the administrator's decisions only if they are reasonable, applying the factors that we have previously identified. In addition, we conclude that the Administrative Committee in interpreting the Plan's preexisting-condition provision and in denying in part Booth's claim for benefits acted within the scope of discretion conferred by the Plan documents.

Because the administrator was given discretion to make the decisions under review in this case and acted within the scope of this discretion, we will not disturb the administrator's decision if it is reasonable, even if we independently would have come to a different conclusion. . . .

* * *

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HEASLEY v. BELDEN & BLAKE CORPORATION, 2 F.3d 1249 (3d Cir. 1993)

Scirica, Judge.

* * *

This case presents several questions concerning the interpretation and application of an employee health insurance plan, an area litigated with increasing frequency under the Employee Retirement Income Security of Act of 1974 (ERISA). Belden & Blake Corporation appeals the district court's final judgment directing it to pay for employee Richard Heasley's liver/pancreas transplant as a treatment for pancreatic cancer which spread to both lobes of his liver. [The term’s of Belden & Blake’s self-insured plan specifically exclude “experimental procedures.”]

[In sections I and II of the opinion, the court reviewed the factual background leading up to this litigation and defined the appropriate standard of review for the trial court and on this appeal. The appellate court held that the trial court properly applied a de novo standard to the review of the decision to deny coverage since the insurance agreement did not clearly and unequivocally delegate that decision to the plan's administrator. For a further discussion of the standard of review, see note 5 infra.]

. . . .

In order to determine whether liver transplants for neuroendocrine tumors are covered under the Belden & Blake Plan, we now consider the meaning of the term "experimental." Courts construing the term in similar health insurance plans have found it resistant to precise definition. . . .

The concept can be captured by a verbal formula, but only at a high level of generality. The definitions offered by the experts in this case are illustrative. For example, the University of Pittsburgh transplant surgeon Dr. Martin defined as experimental "a procedure that has not been tested before, so that the outcome is unknown." Similarly, AultCare [the plan's administrator] physician Dr. Rovner testified a procedure remains experimental "until you can show that it will . . . cure patients and prolong their lives in a predictable fashion." These definitions, although easy to state, are hard to apply. This problem is exacerbated because, as experts for both parties agreed, it is difficult to identify precisely when a procedure ceases to be experimental and becomes accepted.

Insurers and plan administrators have employed several approaches to cure the inherent ambiguity of the term "experimental." Some plans enumerate particular conditions for which a given procedure is experimental or simply write into the plan specific exclusions for these conditions without reference to their experimental nature. . . .

Other insurers and employers resolve the definitional problem by specifying who will decide the meaning of the term "experimental." Often, such plans incorporate by reference classifications adopted by one or more independent authoritative medical bodies. . . .

75

As a corollary, courts have refused to rely exclusively on particular third-party classifications where the plan has not explicitly referenced them in defining its experimental procedure exclusion. . . .

The Belden & Blake Plan neither enumerates experimental procedures nor defines that term by incorporating the classification schemes employed by other medical bodies. Important consequences flow from these omissions. {For example] we cannot uphold Belden & Blake's initial justification for its denial of benefits -- that liver transplants for neuroendocrine tumors are not yet approved by the federal Medicare guidelines -- because the plan neither incorporates nor otherwise references the guidelines. Therefore we must turn to other sources to define the term "experimental" in the Belden & Blake Plan. As have other courts faced with this problem, . . . we look to the testimony and the medical literature submitted by the expert witnesses.

Employing this approach, the district court found Heasley's proposed transplant was not experimental for several reasons. Noting neither liver transplants generally nor surgical removal of neuroendocrine tumors are considered experimental, the court reasoned that a liver transplant was the next logical step in the treatment of these tumors. That relatively few patients (50 in its estimation) have received transplants for neuroendocrine tumors did not, in the court's view, establish the procedure was experimental in light of the rarity of the condition, the recent availability of the surgery, and its demonstrated success. The court also relied on data showing only 5 percent of liver transplant patients at the University of Pittsburgh died of complications associated with the surgery. Finally, it credited the views of Heasley's experts, who testified the procedure was not experimental, and bolstered its conclusion by referring to medical journal articles introduced by these experts.

Several aspects of this analysis are problematic. First, we are uncertain whether the court should have relied on data showing the post-operative mortality rate for the procedure at the University of Pittsburgh was only 5 percent. The undisputed testimony reveals this was the mortality rate for all liver transplants at the University of Pittsburgh, whereas the post-operative mortality rate for patients receiving transplants for neuroendocrine tumors was much higher. The data supplied by Heasley's doctors to AultCare revealed that four of the eight University of Pittsburgh patients with neuroendocrine tumors receiving transplants died of post-operative complications. The article offered by Heasley's experts . . . indicated that 4 of 14 patients studied, or 29 percent, died of post-operative complications. We note that neuroendocrine tumors are exceptionally rare, comprising only 14 of the 5,000 liver transplants performed at the University of Pittsburgh. On remand, the district court should consider whether the higher post-operative mortality rate for neuroendocrine tumor patients receiving transplants has a medical explanation or whether it simply reflects a statistical anomaly resulting from the small number of such patients who have been transplanted.

Second, we are not certain the record supports the district court's conclusion that over 50 liver transplants have been performed for neuroendocrine tumors worldwide. The record provides solid support for about half that number. . . .

Finally, the district court offered no rationale for accepting the testimony of Heasley's experts rather than that of Belden & Blake's experts. The parties dispute which of these groups of experts were better informed. Only Heasley's experts were transplant surgeons with personal experience with performing the contested procedure. Yet Belden & Blake maintains these witnesses

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were biased in favor of surgery and contends the district court should also have relied on the testimony of the oncologists for each side. Furthermore, only Belden & Blake offered an expert in the field of health insurance. Although resolution of conflicting testimony is within the province of the district court, where, as here, apparently credible and informed experts testified for both sides, we believe some explanation of its apparent choice to rely entirely on Heasley's experts was warranted.

For these reasons, we are unable to determine whether the district court's conclusion that the transplant was not an experimental procedure was clearly erroneous. Accordingly, we believe the best course is to vacate the district court's order and remand for further proceedings.

As did the district court and the experts who appeared before it, we believe the term "experimental" basically hinges on the safety and effectiveness of the procedure in question, as demonstrated by its use on an appreciable number of patients. Yet given the increasing amount of litigation over what constitutes an "experimental procedure" and the fact-intensive nature of this determination, we believe a more systematic approach is warranted than simply applying a general definition. Absent any analytic framework for construing the term "experimental," a court is forced to choose between the testimony of two sets of experts who often seek "a floating standard which can rise or fall in any fact situation [and which is], not reviewable against identifiable criteria." Yet bright-line rules risk over- or under-inclusiveness in such a fact-bound area. For these reasons, we believe it is better to set forth a non-exclusive list of factors to determine whether a procedure is experimental.

The first factor is the judgment of other insurers and medical bodies. Heasley's doctors offered undisputed evidence that several commercial and government insurers have covered the transplant. Because Belden & Blake conceded these insurers' policies contain an experimental procedure exclusion, their approval of coverage provides support for a finding that the procedure is not experimental. Similarly, to the extent other authoritative medical bodies have considered the procedure, this evidence is probative.

A second factor is the amount of experience with the procedure. Often this is simply a function of the number of times the procedure has been performed, but it may be more complicated. Belden & Blake contends only transplants in the United States should be considered in arriving at a total figure. We disagree. First, had Belden & Blake wished to limit the analysis this way, it could have so defined "experimental" in the plan. . . . Consideration of European cases was especially appropriate in this case. Two of the three largest liver transplant centers are in London, England and Hannover, Germany, and the surgeons there were trained by Dr. Starzl of the University of Pittsburgh, the surgeon who pioneered the liver transplant.

The number of transplants performed may not always indicate a procedure is experimental. For example, AultCare physician Dr. Rovner refused to say how many transplants it would take before the procedure ceased to be experimental. This has proven a familiar pattern with defense experts, and courts faced with such testimony have appropriately discounted the significance of this factor. . . .

A third factor is the demonstrated effectiveness of the procedure. Several indicia bear on this inquiry, including the long-term survival rate associated with the procedure, the likelihood of recurrence of the cancer, and the post-operative mortality rate. Because effectiveness is a relative inquiry, data on

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these rates must be compared to data associated with no treatment or with alternative treatments. . . .

Measures of effectiveness should be compared not only to other treatments but also over time. As the Court of Appeals for the Fifth Circuit stated, "it is the nature of medical research that what may one day be experimental may the next be state of the art treatment." . . .

In certain cases, there will be differences in the quality of the evidence regarding a procedure's effectiveness. Belden & Blake emphasizes no randomized double-blind studies have been done with respect to liver transplants for neuroendocrine tumors. Such studies track two groups of patients with the same condition, with only one group being given the disputed treatment and the other serving as the "control" group. Belden & Blake contrasts these studies with the medical journal articles offered by Heasley in the district court, which contain only anecdotal information regarding transplants for neuroendocrine tumors.

In evaluating this critique, we note initially, as at least one other court has observed, that "nothing in the plan requires that a treatment be the subject of completed [double-blind] studies to escape the experimental treatment exclusion." More importantly, such studies represent only one, albeit a generally reliable, means for comparing two treatments. The significance of their absence therefore depends on the availability and quality of other comparative data, some of which is contained in the record. Often, peer-reviewed medical journal articles, or, in certain cases, expert testimony, will provide helpful sources of this data as well.

Part of the comparative analysis involves the attractiveness of the various treatment alternatives for the particular patient. Thus, in concluding an autologous bone marrow transplant with high-dose chemotherapy was not experimental for a patient with multiple myeloma, one court noted "it was simply the only appropriate treatment available to treat plaintiff's condition" in light of expert testimony that the plaintiff would receive no more benefit from standard chemotherapy. Indeed, one reason Heasley's doctors recommended a transplant was their belief he was no longer responding to chemotherapy. Also, there was testimony that the patients with neuroendocrine tumors who were transplanted at the University of Pittsburgh had no realistic survival options other than the transplant given the extent of their metastasization. Additionally, Heasley's experts testified that transplants are recommended only for the patients with the worst tumors, and many patients with the most advanced tumors come to the University of Pittsburgh, a leading liver transplant center. If true, these facts would tend to make statistics regarding effectiveness less favorable, and, to the extent they suggest no other treatment option is viable, would help place in perspective data regarding the effectiveness of the transplant.

. . . .

On remand, both parties may submit testimony concerning application of the term "experimental procedure" to Heasley's transplant in light of the factors and concerns we have identified. But neither party may supplement the record with data generated since the district court's initial ruling. . . .

* * *

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PEGRAM v. HERDRICH, 530 U.S. 211 (2000)

SOUTER, Justice.

* * *

Petitioners, Carle Clinic Association, P. C., Health Alliance Medical Plans, Inc., and Carle Health Insurance Management Co., Inc. (collectively Carle) function as a health maintenance organization (HMO) organized for profit. Its owners are physicians providing prepaid medical services to participants whose employers contract with Carle to provide such coverage. Respondent, Cynthia Herdrich, was covered by Carle through her husband's employer, State Farm Insurance Company.

The events in question began when a Carle physician, petitioner Lori Pegram, examined Herdrich, who was experiencing pain in the midline area of her groin. Six days later, Dr. Pegram discovered a six by eight centimeter inflamed mass in Herdrich's abdomen. Despite the noticeable inflammation, Dr. Pegram did not order an ultrasound diagnostic procedure at a local hospital, but decided that Herdrich would have to wait eight more days for an ultrasound, to be performed at a facility staffed by Carle more than 50 miles away. Before the eight days were over, Herdrich's appendix ruptured, causing peritonitis.

Herdrich sued Pegram and Carle in state court for medical malpractice, and she later added two counts charging state-law fraud. Carle and Pegram responded that ERISA preempted the new counts, and removed the case to federal court, where they then sought summary judgment on the state-law fraud counts. The District Court granted their motion as to the second fraud count but granted Herdrich leave to amend the one remaining. This she did by alleging that provision of medical services under the terms of the Carle HMO organization, rewarding its physician owners for limiting medical care, entailed an inherent or anticipatory breach of an ERISA fiduciary duty, since these terms created an incentive to make decisions in the physicians' self-interest, rather than the exclusive interests of plan participants.

Herdrich sought relief under 29 U.S.C. § 1109(a), which provides that

[a]ny person who is a fiduciary with respect to a plan who breaches any of the responsibilities, obligations, or duties imposed upon fiduciaries by this subchapter shall be personally liable to make good to such plan any losses to the plan resulting from each such breach, and to restore to such plan any profits of such fiduciary which have been made through use of assets of the plan by the fiduciary, and shall be subject to such other equitable or remedial relief as the court may deem appropriate, including removal of such fiduciary.

When Carle moved to dismiss the ERISA count for failure to state a claim upon which relief could be granted, the District Court granted the motion, accepting the Magistrate Judge's determination that Carle was not "involved [in these events] as" an ERISA fiduciary. The original malpractice counts were then tried to a jury, and Herdrich prevailed on both, receiving $35,000 in compensation for her injury. She then appealed the dismissal of the ERISA claim to the Court of Appeals for the Seventh Circuit, which reversed. The court held that Carle was acting as a fiduciary when its physicians made the challenged

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decisions and that Herdrich's allegations were sufficient to state a claim. . . .

. . . .

II

Whether Carle is a fiduciary when it acts through its physician owners as pleaded in the ERISA count depends on some background of fact and law about HMO organizations, medical benefit plans, fiduciary obligation, and the meaning of Herdrich's allegations.

. . . .

Like other risk-bearing organizations, HMOs take steps to control costs. At the least, HMOs, like traditional insurers, will in some fashion make coverage determinations, scrutinizing requested services against the contractual provisions to make sure that a request for care falls within the scope of covered circumstances (pregnancy, for example), or that a given treatment falls within the scope of the care promised (surgery, for instance). They customarily issue general guidelines for their physicians about appropriate levels of care. And they commonly require utilization review (in which specific treatment decisions are reviewed by a decision maker other than the treating physician) and approval in advance (pre-certification) for many types of care, keyed to standards of medical necessity or the reasonableness of the proposed treatment. These cost-controlling measures are commonly complemented by specific financial incentives to physicians, rewarding them for decreasing utilization of health-care services, and penalizing them for what may be found to be excessive treatment. Hence, in an HMO system, a physician's financial interest lies in providing less care, not more. The check on this influence (like that on the converse, fee-for-service incentive) is the professional obligation to provide covered services with a reasonable degree of skill and judgment in the patient's interest.

. . . HMOs became popular because fee-for-service physicians were thought to be providing unnecessary or useless services; today, many doctors and other observers argue that HMOs often ignore the individual needs of a patient in order to improve the HMOs' bottom lines. . . . In this case, for instance, one could argue that Pegram's decision to wait before getting an ultrasound for Herdrich, and her insistence that the ultrasound be done at a distant facility owned by Carle, reflected an interest in limiting the HMO's expenses, which blinded her to the need for immediate diagnosis and treatment.

Herdrich focuses on the Carle scheme's provision for a "year-end distribution” to the HMO's physician owners. She argues that this particular incentive device of annually paying physician owners the profit resulting from their own decisions rationing care can distinguish Carle's organization from HMOs generally, so that reviewing Carle's decisions under a fiduciary standard as pleaded in Herdrich's complaint would not open the door to like claims about other HMO structures.

Although it is true that the relationship between sparing medical treatment and physician reward is not a subtle one under the Carle scheme, no HMO organization could survive without some incentive connecting physician reward with treatment rationing. The essence of an HMO is that salaries and profits are limited by the HMO's fixed membership fees. This is not to suggest that the Carle provisions are as socially desirable as some other HMO

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organizational schemes; they may not be. But whatever the HMO, there must be rationing and inducement to ration.

Since inducement to ration care goes to the very point of any HMO scheme, and rationing necessarily raises some risks while reducing others (ruptured appendixes are more likely; unnecessary appendectomies are less so), any legal principle purporting to draw a line between good and bad HMOs would embody, in effect, a judgment about socially acceptable medical risk. A valid conclusion of this sort would, however, necessarily turn on facts to which courts would probably not have ready access: correlations between malpractice rates and various HMO models, similar correlations involving fee-for-service models, and so on. And, of course, assuming such material could be obtained by courts in litigation like this, any standard defining the unacceptably risky HMO structure (and consequent vulnerability to claims like Herdrich's) would depend on a judgment about the appropriate level of expenditure for health care in light of the associated malpractice risk. But such complicated fact finding and such a debatable social judgment are not wisely required of courts unless for some reason resort cannot be had to the legislative process, with its preferable forum for comprehensive investigations and judgments of social value, such as optimum treatment levels and health care expenditure.

We think, then, that courts are not in a position to derive a sound legal principle to differentiate an HMO like Carle from other HMOs. For that reason, we proceed on the assumption that the decisions listed in Herdrich's complaint cannot be subject to a claim that they violate fiduciary standards unless all such decisions by all HMOs acting through their owner or employee physicians are to be judged by the same standards and subject to the same claims.

. . . .

In general terms, fiduciary responsibility under ERISA is simply stated. The statute provides that fiduciaries shall discharge their duties with respect to a plan "solely in the interest of the participants and beneficiaries," § 1104(a)(1), that is, "for the exclusive purpose of (i) providing benefits to participants and their beneficiaries; and (ii) defraying reasonable expenses of administering the plan," § 1104(a)(1)(A). These responsibilities imposed by ERISA have the familiar ring of their source in the common law of trusts. Thus, the common law (understood as including what were once the distinct rules of equity) charges fiduciaries with a duty of loyalty to guarantee beneficiaries' interests: "The most fundamental duty owed by the trustee to the beneficiaries of the trust is the duty of loyalty . . . . It is the duty of a trustee to administer the trust solely in the interest of the beneficiaries."

Beyond the threshold statement of responsibility, however, the analogy between ERISA fiduciary and common law trustee becomes problematic. This is so because the trustee at common law characteristically wears only his fiduciary hat when he takes action to affect a beneficiary, whereas the trustee under ERISA may wear different hats.

. . . Under ERISA . . . a fiduciary may have financial interests adverse to beneficiaries. Employers, for example, can be ERISA fiduciaries and still take actions to the disadvantage of employee beneficiaries, when they act as employers (e.g., firing a beneficiary for reasons unrelated to the ERISA plan), or even as plan sponsors (e.g., modifying the terms of a plan as allowed by ERISA to provide less generous benefits). Nor is there any apparent reason in the ERISA provisions to conclude, as Herdrich argues, that this tension is

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permissible only for the employer or plan sponsor, to the exclusion of persons who provide services to an ERISA plan.

ERISA does require, however, that the fiduciary with two hats wear only one at a time, and wear the fiduciary hat when making fiduciary decisions [citation to Varity Corporation]. Thus, the statute does not describe fiduciaries simply as administrators of the plan, or managers or advisers. Instead it defines an administrator, for example, as a fiduciary only "to the extent" that he acts in such a capacity in relation to a plan. In every case charging breach of ERISA fiduciary duty, then, the threshold question is not whether the actions of some person employed to provide services under a plan adversely affected a plan beneficiary's interest, but whether that person was acting as a fiduciary (that is, was performing a fiduciary function) when taking the action subject to complaint.

The allegations of Herdrich's ERISA count that identify the claimed fiduciary breach are difficult to understand. In this count, Herdrich does not point to a particular act by any Carle physician owner as a breach. She does not complain about Pegram's actions, and at oral argument her counsel confirmed that the ERISA count could have been brought, and would have been no different, if Herdrich had never had a sick day in her life.

What she does claim is that Carle, acting through its physician owners, breached its duty to act solely in the interest of beneficiaries by making decisions affecting medical treatment while influenced by the terms of the Carle HMO scheme, under which the physician owners ultimately profit from their own choices to minimize the medical services provided. She emphasizes the threat to fiduciary responsibility in the Carle scheme's feature of a year-end distribution to the physicians of profit derived from the spread between subscription income and expenses of care and administration.

The specific payout detail of the plan was, of course, a feature that the employer as plan sponsor was free to adopt without breach of any fiduciary duty under ERISA, since an employer's decisions about the content of a plan are not themselves fiduciary acts. Likewise it is clear that there was no violation of ERISA when the incorporators of the Carle HMO provided for the year-end payout. The HMO is not the ERISA plan . . . .

The nub of the claim, then, is that when State Farm contracted with Carle, Carle became a fiduciary under the plan, acting through its physicians. At once, Carle as fiduciary administrator was subject to such influence from the year-end payout provision that its fiduciary capacity was necessarily compromised, and its readiness to act amounted to anticipatory breach of fiduciary obligation.

The pleadings must also be parsed very carefully to understand what acts by physician owners acting on Carle's behalf are alleged to be fiduciary in nature. It will help to keep two sorts of arguably administrative acts in mind. . . . What we will call pure "eligibility decisions" turn on the plan's coverage of a particular condition or medical procedure for its treatment. "Treatment decisions," by contrast, are choices about how to go about diagnosing and treating a patient's condition: given a patient's constellation of symptoms, what is the appropriate medical response?

These decisions are often practically inextricable from one another . . . . This is so not merely because, under a scheme like Carle's, treatment and eligibility decisions are made by the same person, the treating physician. It is so because a great many and possibly most coverage questions

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are not simple yes-or-no questions, like whether appendicitis is a covered condition (when there is no dispute that a patient has appendicitis) . . . . The more common coverage question is a when-and-how question. Although coverage for many conditions will be clear and various treatment options will be indisputably compensable, physicians still must decide what to do in particular cases. The issue may be, say, whether one treatment option is so superior to another under the circumstances, and needed so promptly, that a decision to proceed with it would meet the medical necessity requirement that conditions the HMO's obligation to provide or pay for that particular procedure at that time in that case. The Government in its brief alludes to a similar example when it discusses an HMO's refusal to pay for emergency care on the ground that the situation giving rise to the need for care was not an emergency . . . . In practical terms, these eligibility decisions cannot be untangled from physicians' judgments about reasonable medical treatment, and in the case before us, Dr. Pegram's decision was one of that sort. She decided (wrongly, as it turned out) that Herdrich's condition did not warrant immediate action; the consequence of that medical determination was that Carle would not cover immediate care, whereas it would have done so if Dr. Pegram had made the proper diagnosis and judgment to treat. The eligibility decision and the treatment decision were inextricably mixed, as they are in countless medical administrative decisions every day.

The kinds of decisions mentioned in Herdrich's ERISA count and claimed to be fiduciary in character are just such mixed eligibility and treatment decisions: physicians' conclusions about when to use diagnostic tests; about seeking consultations and making referrals to physicians and facilities other than Carle's; about proper standards of care, the experimental character of a proposed course of treatment, the reasonableness of a certain treatment, and the emergency character of a medical condition.

We do not read the ERISA count, however, as alleging fiduciary breach with reference to a different variety of administrative decisions, those we have called pure eligibility determinations, such as whether a plan covers an undisputed case of appendicitis. Nor do we read it as claiming breach by reference to discrete administrative decisions separate from medical judgments; say, rejecting a claim for no other reason than the HMO's financial condition. . . .

III

Based on our understanding of the matters just discussed, we think Congress did not intend Carle or any other HMO to be treated as a fiduciary to the extent that it makes mixed eligibility decisions acting through its physicians. We begin with doubt that Congress would ever have thought of a mixed eligibility decision as fiduciary in nature. At common law, fiduciary duties characteristically attach to decisions about managing assets and distributing property to beneficiaries. Trustees buy, sell, and lease investment property, lend and borrow, and do other things to conserve and nurture assets. . . .

Mixed eligibility decisions by an HMO acting through its physicians have, however, only a limited resemblance to the usual business of traditional trustees. . . . Private trustees do not make treatment judgments, whereas treatment judgments are what physicians reaching mixed decisions do make, by definition. Indeed, the physicians through whom HMOs act make just the sorts of decisions made by licensed medical practitioners millions of times every day, in every possible medical setting: HMOs, fee-for-service proprietorships, public and private hospitals, military field hospitals, and so on. . . . Thus, it is at least questionable whether Congress would have had mixed eligibility decisions

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in mind when it provided that decisions administering a plan were fiduciary in nature. Indeed, when Congress took up the subject of fiduciary responsibility under ERISA, it concentrated on fiduciaries' financial decisions, focusing on pension plans, the difficulty many retirees faced in getting the payments they expected, and the financial mismanagement that had too often deprived employees of their benefits. . . .

Our doubt that Congress intended the category of fiduciary administrative functions to encompass the mixed determinations at issue here hardens into conviction when we consider the consequences that would follow from Herdrich's contrary view.

. . . Although Herdrich is vague about the mechanics of relief, the one point that seems clear is that she seeks the return of profit from the pockets of the Carle HMO's owners, with the money to be given to the plan for the benefit of the participants. Since the provision for profit is what makes the HMO a proprietary organization, her remedy in effect would be nothing less than elimination of the for-profit HMO. . . . [T]he Judiciary has no warrant to precipitate the upheaval that would follow a refusal to dismiss Herdrich's ERISA claim. . . .

. . . [T]he second possible consequence of applying the fiduciary standard that requires our attention would flow from the difficulty of extending it to particular mixed decisions that on Herdrich's theory are fiduciary in nature.The fiduciary is, of course, obliged to act exclusively in the interest of the beneficiary, but this translates into no rule readily applicable to HMO decisions or those of any other variety of medical practice. While the incentive of the HMO physician is to give treatment sparingly, imposing a fiduciary obligation upon him would not lead to a simple default rule, say, that whenever it is reasonably possible to disagree about treatment options, the physician should treat aggressively. . . . It would be so easy to allege, and to find, an economic influence when sparing care did not lead to a well patient, that any such standard in practice would allow a fact finder to convert an HMO into a guarantor of recovery.

These difficulties may have led the Court of Appeals to try to confine the fiduciary breach to cases where "the sole purpose" of delaying or withholding treatment was to increase the physician's financial reward. But this attempt to confine mixed decision claims to their most egregious examples entails erroneous corruption of fiduciary obligation and would simply lead to further difficulties that we think fatal. While a mixed decision made solely to benefit the HMO or its physician would violate a fiduciary duty, the fiduciary standard condemns far more than that, in its requirement of "an eye single" toward beneficiaries' interests. . . . [T]he defense of any HMO would be that its physician did not act out of financial interest but for good medical reasons, the plausibility of which would require reference to standards of reasonable and customary medical practice in like circumstances. That, of course, is the traditional standard of the common law. Thus, for all practical purposes, every claim of fiduciary breach by an HMO physician making a mixed decision would boil down to a malpractice claim, and the fiduciary standard would be nothing but the malpractice standard traditionally applied in actions against physicians. . . . It would simply apply the law already available in state courts and federal diversity actions today, and the formulaic addition of an allegation of financial incentive would do nothing but bring the same claim into a federal court under federal-question jurisdiction. It is true that in States that do not allow malpractice actions against HMOs the fiduciary claim would offer a plaintiff a further defendant to be sued for direct liability, and in some cases

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the HMO might have a deeper pocket than the physician. But we have seen enough to know that ERISA was not enacted out of concern that physicians were too poor to be sued, or in order to federalize malpractice litigation in the name of fiduciary duty for any other reason. . . .

. . . .

We hold that mixed eligibility decisions by HMO physicians are not fiduciary decisions under ERISA. Herdrich's ERISA count fails to state an ERISA claim, and the judgment of the Court of Appeals is reversed.

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AETNA HEALTH INC. V. DAVILA, 542 U.S. 200 (2004)

Thomas, Justice.

* * *

Respondent Juan Davila is a participant, and respondent Ruby Calad is a beneficiary, in ERISA-regulated employee benefit plans. Their respective plan sponsors had entered into agreements with petitioners, Aetna Health Inc. and CIGNA Healthcare of Texas, Inc., to administer the plans. Under Davila's plan, for instance, Aetna reviews requests for coverage and pays providers, such as doctors, hospitals, and nursing homes, which perform covered services for members; under Calad's plan sponsor's agreement, CIGNA is responsible for plan benefits and coverage decisions.

Respondents both suffered injuries allegedly arising from Aetna's and CIGNA's decisions not to provide coverage for certain treatment and services recommended by respondents' treating physicians. Davila's treating physician prescribed Vioxx to remedy Davila's arthritis pain, but Aetna refused to pay for it. Davila did not appeal or contest this decision, nor did he purchase Vioxx with his own resources and seek reimbursement. Instead, Davila began taking Naprosyn, from which he allegedly suffered a severe reaction that required extensive treatment and hospitalization. Calad underwent surgery, and although her treating physician recommended an extended hospital stay, a CIGNA discharge nurse determined that Calad did not meet the plan's criteria for a continued hospital stay. CIGNA consequently denied coverage for the extended hospital stay. Calad experienced post-surgery complications forcing her to return to the hospital. She alleges that these complications would not have occurred had CIGNA approved coverage for a longer hospital stay.

Respondents brought separate suits in Texas state court against petitioners. Invoking THCLA [§ 88.002(a)][Texas Health Care Liability Act] respondents argued that petitioners' refusal to cover the requested services violated their "duty to exercise ordinary care when making health care treatment decisions," and that these refusals "proximately caused" their injuries. Petitioners removed the cases to federal district courts, arguing that respondents' causes of action fit within the scope of, and were therefore completely preempted by, ERISA. The respective district courts agreed, and declined to remand the cases to state court. Because respondents refused to amend their complaints to bring explicit ERISA claims, the district courts dismissed the complaints with prejudice.

. . . After examining the causes of action available under [ERISA], the Court of Appeals determined that respondents' claims could possibly fall under only two: a cause of action for the recovery of wrongfully denied benefits, [or] suit against a plan fiduciary for breaches of fiduciary duty to the plan.

. . . [T]he Court of Appeals concluded that, under Pegram, the decisions for which petitioners were being sued were "mixed eligibility and treatment decisions" and hence were not fiduciary in nature. The Court of Appeals next determined that . . . respondents "assert tort claims," while [ERISA only] "creates a cause of action for breach of contract," and also that respondents "are not seeking reimbursement for benefits denied them," but rather request "tort damages" arising from "an external, statutorily imposed duty of 'ordinary care.' " . . .

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II

. . . .

Congress enacted ERISA to "protect . . . the interests of participants in employee benefit plans and their beneficiaries" by setting out substantive regulatory requirements for employee benefit plans and to "provid[e] for appropriate remedies, sanctions, and ready access to the federal courts." The purpose of ERISA is to provide a uniform regulatory regime over employee benefit plans. To this end, ERISA includes expansive preemption provisions . . . which are intended to ensure that employee benefit plan regulation would be "exclusively a federal concern." . . . Therefore, any state-law cause of action that duplicates, supplements, or supplants the ERISA civil enforcement remedy conflicts with the clear congressional intent to make the ERISA remedy exclusive and is therefore preempted. . . . The preemptive force of ERISA’s civil enforcement provision is still stronger. . . . The ERISA civil enforcement mechanism is one of those provisions with such "extraordinary preemptive power" that it "converts an ordinary state common law complaint into one stating a federal claim for purposes of the well-pleaded complaint rule." Hence, "causes of action within the scope of the civil enforcement provisions [are] removable to federal court."

III

. . . ERISA’s civil enforcement provision is relatively straightforward. If a participant or beneficiary believes that benefits promised to him under the terms of the plan are not provided, he can bring suit seeking provision of those benefits. A participant or beneficiary can also bring suit generically to "enforce his rights" under the plan, or to clarify any of his rights to future benefits. Any dispute over the precise terms of the plan is resolved by a court under a de novo review standard, unless the terms of the plan "giv[e] the administrator or fiduciary discretionary authority to determine eligibility for benefits or to construe the terms of the plan."

It follows that if an individual brings suit complaining of a denial of coverage for medical care, where the individual is entitled to such coverage only because of the terms of an ERISA-regulated employee benefit plan, and where no legal duty (state or federal) independent of ERISA or the plan terms is violated, then the suit falls "within the scope of" ERISA. In other words . . . the individual's cause of action is completely preempted by ERISA.

To determine whether respondents' causes of action fall "within the scope" of ERISA’s civil enforcement provision, we must examine respondents' complaints, the statute on which their claims are based (the THCLA), and the various plan documents. Davila alleges that Aetna provides health coverage under his employer's health benefits plan. Davila also alleges that after his primary care physician prescribed Vioxx, Aetna refused to pay for it. The only action complained of was Aetna's refusal to approve payment for Davila's Vioxx prescription. Further, the only relationship Aetna had with Davila was its partial administration of Davila's employer's benefit plan.

[Calad’s claims are similar.]

It is clear, then, that respondents complain only about denials of

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coverage promised under the terms of ERISA-regulated employee benefit plans. Upon the denial of benefits, respondents could have paid for the treatment themselves and then sought reimbursement . . . or sought a preliminary injunction . . . .

Respondents contend, however, that the complained-of actions violate legal duties that arise independently of ERISA or the terms of the employee benefit plans at issue in these cases. Both respondents brought suit specifically under the THCLA, alleging that petitioners "controlled, influenced, participated in, and made decisions which affected the quality of the diagnosis, care, and treatment provided" in a manner that violated "the duty of ordinary care set forth [in the THCLA]. Respondents contend that this duty of ordinary care is an independent legal duty. . . . Because this duty of ordinary care arises independently of any duty imposed by ERISA or the plan terms, the argument goes, any civil action to enforce this duty is not within the scope of the ERISA civil enforcement mechanism.

The duties imposed by the THCLA in the context of these cases, however, do not arise independently of ERISA or the plan terms. The THCLA does impose a duty on managed care entities to "exercise ordinary care when making health care treatment decisions," and makes them liable for damages proximately caused by failures to abide by that duty. However, if a managed care entity correctly concluded that, under the terms of the relevant plan, a particular treatment was not covered, the managed care entity's denial of coverage would not be a proximate cause of any injuries arising from the denial. Rather, the failure of the plan itself to cover the requested treatment would be the proximate cause. More significantly, the THCLA clearly states that "[t]he standards in Subsections (a) and (b) create no obligation on the part of the health insurance carrier, health maintenance organization, or other managed care entity to provide to an insured or enrollee treatment which is not covered by the health care plan of the entity." Hence, a managed care entity could not be subject to liability under the THCLA if it denied coverage for any treatment not covered by the health care plan that it was administering.

Thus, interpretation of the terms of respondents' benefit plans forms an essential part of their THCLA claim, and THCLA liability would exist here only because of petitioners' administration of ERISA-regulated benefit plans. Petitioners' potential liability under the THCLA in these cases, then, derives entirely from the particular rights and obligations established by the benefit plans. So . . . respondents' THCLA causes of action are not entirely independent of the federally regulated contract itself. . . .

[R]espondents bring suit only to rectify a wrongful denial of benefits promised under ERISA-regulated plans, and do not attempt to remedy any violation of a legal duty independent of ERISA. We hold that respondents' state causes of action fall "within the scope of" ERISA [and are] completely pre-empted by ERISA . . . .

The Court of Appeals came to a contrary conclusion for several reasons, all of them erroneous. First, the Court of Appeals found it significant that respondents "assert a tort claim for tort damages" rather than "a contract claim for contract damages," and that respondents "are not seeking reimbursement for benefits denied them." But, distinguishing between preempted and non-preempted claims based on the particular label affixed to them would "elevate form over substance and allow parties to evade" the preemptive scope of ERISA simply "by re-labeling their contract claims as claims for tortious breach of contract." . . . Nor can the mere fact that the state cause of action attempts to authorize

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remedies beyond those authorized by ERISA put the cause of action outside the scope of the ERISA civil enforcement mechanism. . . . The limited remedies available under ERISA are an inherent part of the "careful balancing" between ensuring fair and prompt enforcement of rights under a plan and the encouragement of the creation of such plans.

. . . .

Respondents also argue . . . that the THCLA is a law that regulates insurance, and hence that ERISA § 514(b)(2)(A) saves their causes of action from preemption . . . . This argument is unavailing. The existence of a comprehensive remedial scheme can demonstrate an "overpowering federal policy" that determines the interpretation of a statutory provision designed to save state law from being preempted. ERISA's civil enforcement provision is one such example.

As this Court stated in Pilot Life "our understanding of [§ 514(b)(2)(A)] must be informed by the legislative intent concerning the civil enforcement provisions provided by ERISA § 502(a) . . . . “[T]he policy choices reflected in the inclusion of certain remedies and the exclusion of others under the federal scheme would be completely undermined if ERISA plan participants and beneficiaries were free to obtain remedies under state law that Congress rejected in ERISA." The Court then held, based on "the common-sense understanding of the saving clause, the McCarran-Ferguson Act factors defining the business of insurance, and, most importantly, the clear expression of congressional intent that ERISA's civil enforcement scheme be exclusive, . . . that [the plaintiff's] state law suit asserting improper processing of a claim for benefits under an ERISA-regulated plan is not saved by § 514(b)(2)(A)."

. . . Allowing respondents to proceed with their state law suits would "pose an obstacle to the purposes and objectives of Congress." . . . ERISA § 514(b)(2)(A) must be interpreted in light of the congressional intent to create an exclusive federal remedy in ERISA. Under ordinary principles of conflict preemption, then, even a state law that can arguably be characterized as "regulating insurance" will be preempted if it provides a separate vehicle to assert a claim for benefits outside of, or in addition to, ERISA's remedial scheme.

* * *

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SIDE BAR: THE LANGUAGE OF ERISA

THE PREEMPTION, THE “SAVINGS”, AND THE “DEEMER” CLAUSES

29 U.S.C. § 1144(a) [§ 514(a)]:

"Except as provided in subsection (b) of this section, the provisions of this title . . . shall supercede any and all State laws insofar as they may now or hereafter relate to any employee benefit plan . . . ."

29 U.S.C. § 1144(b)(2)(a) [§ 514(b)(2)(a)]:

". . . [N]othing in this title shall be construed to exempt or relieve any person from any law of any State which regulates insurance, banking, or securities."

29 U.S.C. § 1144(b)(2)(b) [§ 514(b)(2)(b)]:

"Neither an employee benefit plan described in section 4(a), which is not exempt under section 4(b) . . . nor any trust established under such a plan, shall be deemed to be an insurance company or other insurer . . . or engaged in the business of insurance . . . for purposes of any law of any State . . . ."

THE CIVIL ENFORCEMENT CLAUSE

29 U.S.C. § 1132(a) [§ 514(a)]:

"A civil action may be brought--(1) by a participant or beneficiary --(A) for the relief provided for in subsection (c) of this section, or(B) to recover benefits due to him under the terms of his plan, to enforce

his rights under the terms of the plan, or to clarify his rights to future benefits under the terms of the plan;

(2) by the Secretary [of Labor] or by a participant, beneficiary, or fiduciary for appropriate relief under section 409 [liability for breach of fiduciary duty];

(3) by a participant, beneficiary, or fiduciary (A) to enjoin any act or practice which violates the provision of this title or the terms of the plan, or (B) to obtain other appropriate equitable relief (i) to redress such violations or (ii) to enforce any provisions of this title or the terms of the plan."

LIABILITY FOR BREACH OF FIDUCIARY DUTY

29 U.S.C. § 1109(a) [§ 409(a)]:

"Any person who is a fiduciary with respect to a plan who breaches any of the responsibilities, obligations, or duties imposed upon fiduciaries by this title shall be personally liable to make good to such plan any losses to the plan

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resulting from each such breach, and to restore to such plan any profits of such fiduciary which have been made through use of assets of the plan by the fiduciary, and shall be subject to such equitable or remedial relief as the court may deem appropriate . . . ."

NONDISCRIMINATION IN ERISA GOVERNED PLANS

29 U.S.C. § 1140 [§ 510]

"It shall be unlawful for any person to discharge, fine, suspend, expel, discipline, or discriminate against a participant or beneficiary for exercising any right to which he is entitled under the provisions of an employee benefit plan . . . or for the purpose of interfering with the attainment of any right to which such participant may become entitled under the plan. . . ."

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Notes and Questions on Coverage and Eligibility Disputes

1. Cases such as Davis generally apply an important traditional insurance-law doctrine: Ambiguous provisions in an insurance agreement will be construed in favor of the beneficiary. In the strictest sense, the courts that apply this doctrine merely interpret the language of the contract; and, indirectly, in doing so, they affirm the more basic contract principle that unambiguous language, e.g., a clearly worded exclusion or delegation, will be strictly enforced regardless of the equity of the result. But where a court finds the terms of an insurance contract ambiguous -- or at least claims that it does -- it can reach a result that is based more on notions of equity than on an actual "reading" of the contractual terms. For a similar case, see Sarchett v. Blue Shield of California, 43 Cal. 3d 1, 729 P.2d 267, 233 Cal Rptr. 776 (1987). Note the similarity to the rule in ERISA-governed cases concerning ambiguous exclusions or delegations of decision-making authority, as summarized in note 4 infra.

Insurers and other third party payers, of course, can avoid the implications of this doctrine by making exclusionary language that is exacting and specific, clearly reserving or delegating control over these decisions, or requiring arbitration of these disputes as part of the insuring contract. Note, however, that even when they attempt to do so, they are not always fully successful. Note also that some states have attempted, by statute or administrative regulation under their general insurance laws, to limit the discretion of insurers and other payers to enforce exclusions, or to retain full control over their application. See, e.g., Tex. Ins. Code Ann. §§ 3.51-6, 3.70-3, & 21.21 (prohibiting denial of benefits without properly investigating circumstances); see also Wash. Admin. Code §§ 284.10.050, 284.44.043, & 284.46.507. Such state laws presumably are "insurance laws" and thus not preempted by ERISA (although they cannot be enforced against self-insured employers). For that matter, ERISA somewhat limits the ability of plan’s to define the limits on their own decision-making discretion, as illustrated in the Booth decision.

2. As discussed in Davis and Kuhl, beneficiaries of insurance contracts can, under some circumstances, pursue the tort-based claims such as bad faith breach of contract, in addition to any contractual claims when an insurer denies a claim. See, e.g., Long v. Great-West Life & Annuity Insurance Co., 957 P.2d 823 (Wyo. 1998) (public employee sued administrator of employer's plan for delays in processing prior authorization request). The obvious significance of these alternative theories of recovery is that under a tort theory the plaintiff can seek compensatory and, possibly, punitive damages as well as restitution for unpaid claims. If restitution is the only recovery, as it generally is under contract-based claims, many claimants may be discouraged from pursuing all but the largest claims -- a lesson that is surely not lost on insurers and other payers.

3. The more basic policy question that is raised but not answered in many of these cases is as much policy as law: How are disputes over "medical necessity" and similar exclusions properly settled? For the most part, the courts tend to treat the question in the manner that courts traditionally have treated such issues, that is, by attempting to identify who gets to decide the question rather than addressing what is -- or is not -- "medically necessary." See, e.g., Blue Cross & Blue Shield of Virginia v. Keller, 248 Va. 618, 450 S.E.2d 136

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(1994)(no issue of fact where contract clearly allows administrator of plan sole discretion to make "medical necessity" determinations); Katskee v. Blue Cross/Blue Shield of Nebraska, 245 Neb. 808, 515 N.W.2d 645 (1994)(whether prophylactic hysterectomy for woman with a genetic predisposition to ovarian cancer was "preventive" or "medically necessary" is issue of fact for trial court).

Other than enforcing contractual agreements and clarifying the locus of decision making, how should courts decide what types and kinds of services are "medically necessary"? Suppose, for example, that a beneficiary wants a very expensive treatment that had a very small chance of success. What factors other than cost and the likelihood of benefit should be considered -- and by whom? Should it make a difference whether or not the payer and the provider are "integrated"? The problem goes beyond current financing arrangements; it is one that will plague any health care financing scheme. And at the heart of the matter lies a very basic conflict. Obviously the potential recipient's perspective of the value of the arguably unnecessary care and that of the third parties who are asked to participate in its cost may be at odds. No one wants to pay for or receive "unnecessary" care, but necessity is very much in the eye of the beholder.

But there is another basic issue here, one that relates to these problems as well as to many others throughout these materials. Is this a question for professional judgment? Should this be, as questions of medical malpractice generally are, a decision made almost entirely by physicians and based largely on their opinion and experience? Or is it an empirical question, i.e., a number crunching exercise, one for which physicians may not be the only or even the best sources of information regarding such matters as efficacy and likelihood of result, and one for which they are not the final decision maker? Perhaps the final decision maker should be an independent arbitrator or other body or even a computer. Unfortunately, the case law gives us very little guidance as to how any of these questions will be addressed under current financing arrangements, and virtually no guidance as to how these questions could better be addressed in the future. For a description of efforts to address these questions through legislation see the article by Dallek & Pollitz infra. See also the sidebar on “evidence-based decisionmaking” infra.

4. The most basic problem for the state law claimant in the vast majority of cases will not be either finding a theory of recovery that allows for more than contractual damages or sorting out the knotty problems of defining what exactly is “medical necessity.” As the Kuhl case demonstrates, in the vast majority of these types of cases, the first and most important issue is whether ERISA preempts state law claims altogether. ERISA clearly preempts state law-based claims for denial of benefits so long as the benefits are employment-based and requires the claimant to pursue only those remedies allowed under the federal statute. At least according to Kuhl, this means that the plaintiff only can seek "equitable remedies" and contractual damages, but not compensatory damages. See 29 U.S.C. § 1132(a). ERISA claimants also are required to pursue their remedies in federal, not state courts. The underlying reasoning is a little obscure but demonstrative of the scope of ERISA. Since ERISA preempts all state law claims relating to employee health benefits, even state-based claims for contractual recovery are preempted. Only federal law-based claims can be pursued -- hence the need for a federal common law of contracts.

The implications can be harsh, as Kuhl demonstrates, but the same approach has been followed in a number of other jurisdictions. See, e.g., Garcia v.

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Kaiser Foundation Hospitals, 90 Haw. 425, 978 P.2d 863 (1999)(HMO refused to pay for back and hip surgery; state law actions against ERISA-governed plan preempted). Hull v. Fallon, 188 F.3d 939 (8th Cir. 1999), cert. denied, 528 U.S. 1189 (2000) (holding Kuhl applies even where the decision to deny coverage was made by patient’s treating physician).

State law still controls in some cases, e.g., public employees and people who purchase policies individually are not subject to the ERISA preemption. For example, in one case that received a great deal of national attention, Aetna U.S. Healthcare lost a trial court verdict and was ordered to pay $116 million in punitive damages to the family of a public school teacher who claimed that Aetna had denied treatment for his stomach cancer. (For subsequent history of that litigation, see Goodrich v. Aetna U.S. Healthcare of California, Inc, 1999 WL 181418.) See also Kelly v. Blue Cross & Blue Shield of Rhode Island, 814 F. Supp. 220 (D.R.I. 1993) (ERISA applies only to employees under an ERISA plan, not the employer even if she is covered under the same plan as the employees.) Moreover, even in ERISA-governed cases, state contract (but not tort) law has some relevance. The federal courts have relied on many state common law principles in fashioning their federal common law principles and in interpreting ERISA-governed insurance and other health financing contracts.

It is not clear whether ERISA also preempts actions based in state law that grow out of denials of health benefits to beneficiaries under the federal Employees Health Benefits Program. See Rocky Mountain Hospital & Medical Service v. Phillips, 835 F. Supp. 575 (D. Colo. 1993), cert. denied, 514 U.S. 1048 (1995). There also are questions as to whether Medicare beneficiaries are prevented (by the federal Medicare statute, not ERISA) from pursuing state law claims against private health plans providing services to Medicare beneficiaries. See Ardary v. Aetna Health Plans of California, 98 F.3d 496 (9th Cir. 1996).

5. As discussed in Booth, decisions relating to denials of coverage under an ERISA-controlled plan that are clearly and "unequivocally" delegated to the plan administrator or other agent of the plan are still subject to a very limited level of judicial review. For another example, see Jones v. Kodak Medical Assistance Plan, 169 F.3d 1287, (10th Cir. 1999)(decision of plan administrator that alcoholism treatment was neither medically necessary or geographically appropriate upheld). Conversely, if there is no delegation of discretion, the courts apply a de novo review to any denial of benefits under the plan, as the court did in Heasley. As Booth notes, this generally is described as a "reading" of ERISA, although, in fact, there is no explicit ERISA provision which defines the standard of review. Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101 (1989); Loyola University of Chicago v. Humana Insurance Co., 996 F.2d 895 (7th Cir. 1993). The Booth approach, using the law of trusts to distinguish between an arbitrary and capricious standard and an abuse of discretion standard has not been followed in all ERISA cases, but, nonetheless, it does reflect the broad discretion granted to plan administrators so long as that discretion is clearly set out in the plan agreement -- another lesson surely not lost on plans and their lawyers.

As Booth indicates, the courts will consider whether a plan administrator has a conflict of interest as one factor in determining whether the administrator abused its discretion, but economic self-interest alone is not enough to either show a violation or to change the applicable standard. Note, however, as illustrated in Booth, the insurer cannot limit the scope of the

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court’s review beyond the abuse of discretion standard, even if the terms of the contract attempt to do so.

6. As Heasley demonstrates, most insurers and third party payers exclude coverage for "investigational" or "experimental" procedures, sometimes as a separate exclusion, sometimes as a subset of the exclusion of "medically unnecessary" services. Heasley is particularly interesting because both the trial and the appellate court attempt to define more specifically what is "experimental" or "investigational" and what evidence can be considered in making those determinations. In doing so, the Heasley decision obviously provides some guidance for determining "medical necessity" questions as well (although, ironically, it is still not clear by the end of the appellate decision whether Heasley will be successful on retrial.)

7. The Pegram decisions follows in the wake of several lower court decisions that raised the possibility that some claimants might be able to pursue additional remedies, including those allowing for non-contractual damages, in ERISA-governed cases by arguing that their health plans had violated their ERISA-recognized fiduiciary duty to the plaintiff.

In Varity Corp. v. Howe, 516 U.S. 489 (1996), the defendant made representations to its employees claiming that a new subsidiary of the defendant had "a bright future." It urged the employees to voluntarily dis-enroll from their existing health plan and join that of the subsidiary. When the subsidiary proved to be insolvent, individual employees sued claiming that the defendant had fraudulently breached its fiduciary duty as imposed by ERISA. The lower courts agreed and awarded the plaintiffs reinstatement in the defendant's original plan and restitution for benefits that would have been received while they were members of the insolvent plan. The Supreme Court affirmed, holding that the employer was acting in its capacity as plan administrator and had violated its ERISA-imposed obligation to operate the plan solely for the interests of the beneficiaries. Under such circumstances, "appropriate equitable relief" included both reinstatement and restitution (which the lower court had characterized as a form of equitable relief and distinguished from other compensatory, monetary damages). In doing so, the Court explicitly pointed out that it was not expanding the bases for liability of employers under ERISA or raising the standard of review that it had set out in Firestone. The Court, however, did not elaborate on the circumstances under which non-contractual damages could be awarded in ERISA fiduciary duty actions other than to affirm the decision of the lower court to order the type of damages allowed in this case.

Some courts, prior to Pegram read this as an implied invitation to interpret the fiduciary duty expansively. In Shea v. Esensten, 107 F.3d 625 (8th Cir.), cert. denied, 522 U.S. 914 (1997), the circuit court, relying on Varity, held that a health plan may have violated its ERISA-imposed fiduciary duty by failing to disclose financial incentives to physicians to minimize referrals. Cf. Ehlmann v. Kaiser Foundation Health Plan of Texas, 198 F.3d 552 (8th Cir. 2000).

Pegram appears to narrow the circumstances under which such claims can be made, but not preclude them altogether. According to Pegram, HMOs and their physicians may have a fiduciary duty in carrying out certain administrative or “eligibility” decisions, but that duty does not extend to “treatment decisions” or, apparently, to “mixed” treatment and eligibility decisions. Note, however,

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that the Pegram decision declined to address the viability of an ERISA-based claim involving the kind of allegations that were involved in the original Shea decision -- which had alleged that the defendant-physician had not disclosed the financial incentives to discourage further treatment.

Pegram does not clarify what kinds of damages would be available -- even if there is a viable ERISA-based cause of action against a fiduciary. One possibility that is consistent with other decisions denying non-contractual damages in ERISA cases is an award of restitution for any profits or economic gain by the defendant-violator. In such a case, however, the recipient of the award might be the plan and not the plaintiff-beneficiary.

For a related decision considering a state law based claim of a breach of fiduciary duty by the physician in the Shea case, see Shea v. Esensten, 208 F.3d 712 (8th Cir.), cert. denied, 531 U.S. 871 (2000).

8. In justifying its decision in Pegram, the Court made some observations concerning the importance of health maintenance organizations, the legitimacy of their inherent economic incentives to limit utilization, and the need to control health care costs. While these observations were drawn in the context of interpreting the language and intent of the ERISA statute, they were based as much on the Court’s perception of good public policy as on legal principle (including some rather esoteric principles from the law of trusts). As such, these observations are sure to be quoted repeatedly in future legal and political debates.

9. While Pegram surely forecloses one line of liability for health plans, it reinforced the viability of others. At several points, the opinion distinguishes between what it calls “eligibility” decisions and “treatment” decisions. The same distinction has been referred to by other courts distinguishing between “quantity” and “quality” cases. See Dukes v. U.S. Healthcare, Inc., 57 F.3d 350 (3d Cir. 1995) (which the Pegram decision appears to endorse). Most importantly, Pegram argues that the need for an ERISA-based claim of liability is unnecessary in cases where HMO-based physicians make decisions which effectively deny or delay care because plaintiffs still can bring traditional malpractice claims against those physicians (which, in fact, the plaintiff did successfully in this case). In doing so, Pegram recognizes that ERISA does not preempt state common law and statutory claims against providers for poor quality care, at least against individual providers, even if it does preempt other claims against some of the same potential defendants for activities relating to their administration of benefits.

That in itself is important. Read literally, the ERISA preemption “relates to” language could be applied to some types of traditional malpractice claims, for example, where the plan itself is the employer of a provider who renders poor quality care. Indeed, the extension of vicarious liability and “corporate negligence” principles to HMOs and other integrated plans is a development in the law that is of growing importance as more and more care is provided through various arrangements that rely on “managed care.” See, e.g., Jones v. Chicago HMO Ltd. of Illinois, 191 Ill. 2d 278, 730 N.E.2d 1119 (2000). But while some courts have been extending the liability of integrated plans in what are generally regarded as malpractice cases, others have been enforcing the preemption provisions of ERISA to limit their liability -- in cases that are not all that dissimilar. Where is the line between these two types of cases? Pegram

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may be at least offer a partial clarification, if not an answer, to that question.

Note that while the Court’s explanation in Pegram of the difference between “treatment” and “eligibility” decisions -- and apparently between preempted and not preempted malpractice cases -- is a good indication of the Court’s views, it is still regarded as dictum and not wholly binding on future courts. Moreover, even if there is a line between ERISA-governed “eligibility” cases and “treatment” or “quality” decisions, it is not, as even the Court admits, a clear cut line. Future courts will surely struggle with making many case-by-case determinations of which cases fall on what side of this all-determinative line.

One thing is clear: Thus far no court has even suggested that the ERISA preemption extends to classic malpractice claims. That is to say, to date, no court has suggested that a physician, hospital, or other provider who is delivering services that are financed through an employment-purchased health benefit plan is also protected by the ERISA preemption from state, common law negligence principles with regard to the quality of the services they provide. What courts have done is recognize that some cases that would otherwise be actionable under traditional malpractice claims, cases that involve ERISA would call “eligibility” or “mixed” decisions, are preempted because they involve “eligibility” decisions made by ERISA-governed plans. See, e.g., Hull and Garcia supra note 4. Cf. Long v. Great West Life & Annuity Ins. Co., 957 P.2d 823 (Wy. 1998)(suit by public employee alleging tort and contract violations in denial of preauthorization for surgery).

10. Davila appears to be a confused and confusing case, but in fact, it may be merely a narrow application of some traditional principles. The State of Texas had attempted to by-pass the ERISA preemption of most state-law based claims against health plans by imposing a duty of care on plans -- ostensibly as a law regulating insurance. As such it is arguable that the law was saved from preemption by the ERISA “insurance regulation clause.” But what Justice Thomas appears to be saying is that some state laws, even those saved from the ERISA “relates to” preemption, also can be preempted implicitly because they conflict with the underlying policy of ERISA to provide the exclusive remedy for health plan decisions concerning eligibility and coverage in ERISA-governed plans. That is a separate and distinct basis for preempting a state law from the more familiar ERISA preemption under the “relates to” language. The latter is, of course, subject to the “savings clause” exception. The former is not, or so it would seem from Davila.

Whether this is a correct reading of congressional intent is another matter. What it surely does is add to the complicated, web-like reach of ERISA, especially as it affects the ability of plan beneficiaries to seek redress for various grievances against their HMOs and other health plans.

11. The net result of all these cases has caused considerable political fallout. The technical reasons why some lawsuits cannot be brought against health plans for some types of decisions may be beyond the general public’s understanding, but most Americans have gotten the not-quite-accurate, bottom line message: “Patients cannot sue their HMOs.” The message might be more accurately stated as “ERISA preempts many lawsuits against HMOs and other health plans if their benefits are employer-purchased.” But technical accuracy has never been important in this type of political debate. A number of state legislatures have

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attempted to enact legislation responding to this concern. As discussed in Davila, many if not most of these efforts are unable to overcome the ERISA preemption. Indeed, as Davila demonstrates, the Court intends to enforce the policy underlying the ERISA preemption even beyond the specific statutory language of ERISA.

12. As described in the previous subsection, while ERISA preempts many state common law and statutory claims, ERISA does except “insurance laws” from the ERISA preemption (although such laws cannot be applied to self-insured employers under ERISA’s “deemer clause.”) Thus states may prohibit insurers and other payers (but not self-insured ERISA plans) from excluding beneficiaries with pre-existing conditions or, as described in the prior subsection, require that they cover certain services or conditions or offer access to “any willing provider.”Davila appears to qualify this state discretion, but it does allow that at least some “insurance laws” are anticipated by the ERISA scheme.

For example, some states have tried to require that medical necessity and other decision-making by insurers and other third party payers be reviewed by some independent or external agency, as illustrated in Rush. For other examples, see the Dallek & Pollitz article and the Washington State IRO scheme cited in the problem infra. See also discussion of the appeals and grievance procedures available to Medicare and Medicaid beneficiaries enrolled in managed care plans infra. ERISA also has minimum requirements pertaining to claims under employee benefit plans, including health benefit plans. See 29 C.F.R. § 2560.503-1. The Rush decision appears to allow these state laws as "insurance laws" and, therefore, "saved" from the ERISA preemption, although subject to the limits of the “deemer clause.”

As illustrated by Davila, some states tried to take the “insurance regulation” exception one step further and to authorize tort-type liability claims against insurers and other third party payers. Prior to Davila, it could have been argued that such legislation should be regarded as “insurance regulation” and "saved" from ERISA preemption (except, again, as applied to self-insured employer plans). Davila rejects this argument; as explained by Justice Thomas, the intent of the ERISA legislation was to provide the exclusive remedy for disputes that can be related to any interpretation of the scope of the benefits plan. The Court, according to Thomas, must consider that intent, even in interpreting the scope of the “insurance regulation" clause.

13. Note that there have been many attempts in Congress to either amend ERISA or otherwise authorize liability actions against managed care plans and other insurers, generally under the label of “patients’ rights” or “anti-managed care” legislation. For a discussion, see Section D in Chapter 8. So far, however, those attempts have been unsuccessful. For better or worse, clarified or not, ERISA has become an important determinate of outcomes in disputes concerning eligibility and coverage of many, though not all, health benefits plans.

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Geraldine Dallek & Karen Pollitz, External Review of Health Plan Decisions (Kaiser Family Foundation May 2000)

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INTRODUCTION

External review programs provide an independent review of a health plan’s decision to deny, reduce or terminate care. Devised initially by insurance regulators in a handful of states, by Medicare, and by some managed care plans to help resolve disputes over difficult cases, external review programs are proliferating across states and in the private sector. They are meant to address concerns about managed care incentives that might lead to the inappropriate denial of care, and to help restore public confidence in managed care. External review is widely cited as a fair, impartial, and usually expeditious and cost effective way to resolve disputes.

Even as the concept catches hold, however, it is evolving. As more states create external review programs, as more private health plans adopt the practice voluntarily, and as federal legislation is considered to establish the protection nationwide, there are more variations on the theme. . . .

EXTERNAL REVIEW ENTITIES AND THE REVIEW PROCESS

Independent Review Organizations (IROs) -- IROs are used by most, though not all, of the original state programs studied to perform external review. Examples of state external review programs not based on the IRO model include Vermont’s mental health appeals program, which relies on a state-appointed panel of mental health practitioners, and New Mexico, where the insurance commissioner appoints a panel of two physicians and one attorney to review each appeal. With a few exceptions, more recent state external review laws use the IRO model. No study has been conducted to compare the quality of IRO reviews and those conducted by other state dispute resolution programs.

“IRO” is not a term of art. Rather, it is used here to describe private organizations that contract with states (and, increasingly, with private health plans) to conduct external reviews. These organizations in turn contract with practicing physicians from many specialties who agree to be available to review cases. IROs vary in their structure and activities. Some IROs are for-profit and some are non-profit. Some IROs were established to conduct internal and external reviews for health plans or to review and evaluate other aspects of health plans or health care institutions. Others were established for different purposes. Some IROs focus primarily or exclusively on providing independent external medical reviews. For others, external review is only one of many activities they perform for health plans and states and the federal government. . . . In other states, academic medical centers can be IROs. Some specialize in certain types of reviews -- for example, an IRO might review only mental and substance abuse cases, or concentrate primarily on high technology cases -- while others handle a broad range of cases.

IRO procedures vary by IRO, by state requirements, and, sometimes, by the type of case. However, IROs generally share a number of common features. Most have medical directors and formal protocols to evaluate the quality of the review process. IROs collect and organize external review case files to send to clinician reviewers (who are not on staff) based on the characteristics of the case and the reviewer’s qualifications. Many, but not all, IROs include a list

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of questions with the case file for the reviewer(s) to answer. Some IROs will also conduct a medical literature review for cases requiring supporting documentation (see the following discussion on types of reviews). However, most IROs depend on their reviewers to provide appropriate cites to the medical literature.

. . . .

External Reviewers -- Because many state external review laws require IROs to handle the full range of appealable issues, most IROs have agreements with a broad spectrum of practicing physicians and other clinicians to conduct reviews in their field of expertise. Many have expanded their contracting network to include non-physicians (e.g., acupuncturists, physical therapists, psychologists, etc.). Some IROs also employ or contract with health benefits experts who have experience reading and interpreting coverage language in health insurance contracts.

At a minimum, IROs require that medical (as opposed to benefit) reviewers meet the following requirements:

Board certification;

Active practice (full or part-time) for a minimum number of years;

Practice in a different medical market than the case under review; and

Free of other conflicts of interest (see following discussion).

IROs require reviewers to be of the same or similar specialty as appropriate for the case under review, as well as have extensive experience in the type of case under review.

. . . .

Depending on the type of case and state requirements, IROs will assign one or more reviewers to a case. In cases involving experimental or investigational procedures/therapies/drugs, three reviewers are often used. More than one reviewer may be assigned to high technology cases and cases involving co-existing illnesses or with both a medical and psychiatric component. Multiple reviewers may be assigned to “contentious cases.” In highly complex cases, reviewers with academic medical appointments are used. Cost is an important consideration in assessing the number of reviewers needed for a particular case.

Conflict of Interest Requirements -- For reviews to be independent, IROs and their contracting reviewers must be free of any conflict of interest with the managed care plan and the case under review. State laws generally prohibit IROs and reviewers from having material professional, familial, or financial affiliation with the plan, the treating physician or physician’s medical group, the appellant, the institution at which the therapy would be provided, or the development or manufacture of the drug, device, procedure or other therapy proposed for the appellant.

Two issues may give rise to questions about conflicts of interest under new external review programs, especially those programs adopted voluntarily by health plans.

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The first has to do with who chooses the IRO. Under most state programs created prior to 1999, regulators select and contract with one or more IROs to handle all external reviews for that state. Some states, such as Connecticut, New Jersey, Texas, and Vermont, contract with multiple IROs and assign cases on a rotational basis. If a conflict of interest arises, that IRO is skipped over in the rotation. However, under several recently passed state external review laws (and under pending congressional bills), health plans are permitted to select and hire the IRO -- usually from an approved list. When health plans voluntarily provide external review, their choice of IROs is not governed by any rules . . . . However, the independence of the IRO may be diminished somewhat when it is selected by and contracts directly with the health plan.

A second issue has to do with the performance of multiple tasks by the IRO for health plans. Several IROs we interviewed regularly contract with health plans to conduct such tasks as pre-determination reviews (to assist health plans to make coverage decisions), internal appeals, quality of care studies, development of clinical protocols, data validation, and medical technology assessments. These IROs also contract with the same health plans to conduct external review.

. . . .

The mere presence of a contract between the health plan and the IRO may raise questions about independence. This is not to say that external reviews performed under such circumstances are necessarily biased; but they are inherently less independent because the IRO formally works for one of the disputing parties. Some IROs argue that if they are prohibited from contracting with managed care organizations for other work, they will forego external review contracts because of the small number of reviews. Companies would be unable to stay in business providing only external reviews. . . .

Types of Reviews -- As discussed above, the number and expertise of reviewers depends on the type of review in question. Only a minority of reviews are “evidence based,” requiring specific medical/scientific evidence to support the reviewer’s decision. Many reviews are simply a second (albeit, in many cases, binding) opinion by an independent expert based on prevailing standards of good medical practice.

. . . .

The type of evidence required and number of reviewers depends on the type of case in question and state law. For example, evidence-based medical necessity and/or investigational/experimental exclusion reviews for terminally or seriously ill patients often require a three-physician panel and citations from peer reviewed literature. Criteria-based medical necessity reviews use a single reviewer and rely on medical consensus as reflected by clinical practice guidelines, practice standards, and consensus statements of professional associations. Opinion reviews simply depend on the opinion of a knowledgeable physician/clinician where there is neither evidence nor criteria upon which to base a review decision.

New York categorizes reviews as:

Clinical trial;

Experimental/investigational treatment; or

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Medical necessity

In clinical trial reviews, the decision is based on whether the trial is scientifically adequate, the patient is eligible to participate, and participation is the patient’s best option. For experimental/investigational treatment denials, the decision is based on whether or not the patient can reasonably expect to receive more health benefit from the proposed treatment than any other (standard) therapy. For medical necessity cases, reviewers are asked to make a decision based on whether the proposed treatment could be expected to benefit the health of the patient. Decisions for experimental/investigational reviews are evidence based, while medical necessity reviews are based on the judgment of a qualified expert practitioner.

For cases involving clinical trials or experimental/investigational treatment, New York requires a minimum of three reviewers. In very complex cases with unique circumstances, up to five reviewers may be used. For medical necessity reviews, New York requires one reviewer unless the treatment of the patient’s condition involves multiple specialties or the treatment involves a potential controversy over the provider’s qualifications.

. . . .

Basis for External Review Decisions: Defining Medical Necessity -- An emerging controversy is over whether state law, the reviewers/IROs, or managed care organizations should dictate the basis upon which medical review decisions are made. Who defines “medical necessity” and how that definition is interpreted by reviewers can determine the outcome of any appeal. Plans and purchasers argue that if non-plan definitions of medical necessity are used, they will lose their ability to determine what is and is not a covered benefit. Consumer advocates counter that external review is designed to resolve disputes over what is medically necessary, and so this definition ought not to be controlled by one of the disputing parties.

A recent study by Stanford University’s Center for Health Policy found a number of problems with the current use of medical necessity definitions. Definitions may be circular (medical necessity is what the plan says it is); vary by plan (what may be considered medically necessary by one plan is not by another); rest on outdated clinical guidelines; or fail to take the individual circumstances of a patient into account. Medical necessity definitions are also not interpreted uniformly by health plan medical directors. For example, when three medical directors were asked hypothetically whether they would approve or deny a treatment, all three had different answers and two responses contradicted their own plan’s coverage guidelines.

On the uses and misuses of “medical necessity” definitions, Stanford researchers concluded that:

Conflicting opinions and ambiguous evidence cause a standard of care based on medical necessity to break down. The idiosyncratic way that coverage decisions are made in health care organizations has led to variations that create inequity for consumers, greater cause for appeal of denials, and more litigation.

In state programs, “medical necessity” can be defined by the state, the reviewers, or the plan.

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Medical necessity defined by the state. At least six states define in law or regulation a standard for medical necessity that external reviewers should follow in evaluating cases. California is an example of a state that imposes its own definition of medical necessity. For experimental and investigational reviews in that state, IROs may not base their determination on the health plan’s definition of experimental/investigational, regardless of how the health plan may define this. In fact, IROs are prohibited from sending a plan’s definition to reviewers. As long as the treatment is otherwise covered under the plan, reviewers are expected to answer only two questions: (1) Is the requested therapy likely to be more beneficial for the patient than any standard therapy?(2) Should the requested therapy by provided by the health plan?

New York’s statute requires reviewers to determine “Whether the health care plan acted reasonably and with sound medical judgment, and in the best interest of the patient.” For medical necessity cases, one IRO under New York contract defines medical necessity as “health care beneficial to the patient.”Vermont defines “medically necessary care” as: “health care services including diagnostic testing, preventive services and aftercare appropriate, in terms of type, amount, frequency, level, setting, and duration to the member’s diagnosis or condition. Medically necessary care must be consistent with generally accepted practice parameters as recognized by health care providers in the same or similar general specialty to typically treat or manage the diagnosis or conditions and to: 1) help restore or maintain the member’s health; or 2) prevent deterioration of or palliate the member’s condition; or 3) prevent the reasonably likely onset of a health problem or detect an incipient problem.”

Medical necessity defined by the reviewer/IRO. The reviewer’s or IRO’s definition of medical necessity is substituted for that of the plan in at least 14 states and the District of Columbia. For example, New Jersey regulations require that an IRO, in determining whether the “member was deprived of medically necessary covered services,” consider:

. . . all pertinent medical records, consulting physician reports and other documents submitted by the parties, any applicable, generally accepted practice guidelines developed by the federal government, national or professional medical societies, boards and associations, and any applicable clinical protocols and/or practice guidelines developed by the HMO. . . .

Medical necessity defined by the plan. Currently, under at least eight state laws and many voluntary programs, IROs and their reviewers must make decisions based on the managed care plan’s definition of medical necessity. In these cases, reviewers may be less likely to overturn a plan’s decision. For example, one IRO we interviewed evaluates medical necessity for care against the plan’s definition of what is medically necessary and upholds 90 percent of plan denials under this standard. It is not clear whether other IROs would have the same uphold rate under similar standards.

In other cases, the health plan’s contract may be less specific and allow IROs more discretion. Some IROs require reviewers to find the plan’s definition of medical necessity “reasonable” before making a decision based on it. Although the reviewer may not like the definition, as long as it is “reasonable,” the reviewer must judge the case based on that definition.

COORDINATION AMONG STATE, VOLUNTARY, AND FEDERAL REVIEW PROGRAMS

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. . . [T]he National Commission On Quality Assurance, as part of its accreditation process, will be requiring HMOs to provide enrollees access to external review. The American Accreditation Healthcare Commission/URAC has proposed IRO accreditation standards. Both organizations have said that state law will preempt their voluntary programs. However, issues of coordination will remain.

For example, as noted above, a recent interpretation of Texas IRO law has led to the conclusion that retrospective cases (where services have been provided, but payment subsequently denied) are not eligible for external review. Thus, some cases may be ineligible for state mandated reviews but eligible for NCQA review, requiring two different notices and review processes. Coordination between any federally mandated external review program and state programs will also be important. Notice requirements, timelines, types of cases eligible for review, and the review process itself will likely differ depending on whether the member is eligible for state or federal review.

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PROBLEM FOR DISCUSSION: WHO DECIDES AND HOW DO THEY DO SO?

In 1999, three highly publicized cases illustrated some of the difficulties in resolving disputes concerning the medical necessity of treatment that is expensive or of questionable value or both. James Ellison was a wheelchair-bound father of four with multiple sclerosis. His doctors said the disease was moving so rapidly that none of the standard drug therapies offered him any hope of benefit. His only hope was a regimen of high dose chemotherapy, radiation, and an admittedly experimental stem cell transplant, a procedure that would cost $100,000.

Teri Lafnitzegger’s brain tumor was inoperable. Her physicians told her that her only hope for survival was an experimental therapy that had been developed by a researcher at Duke University using radioactive antibodies.

Zachary Johnson was a 15-year old youth with activate protein C resistance, a rare blood-clotting disorder that his doctors said would kill him; his physicians recommended that he go to Stanford Medical Center for a special procedure in which a stent is implanted in the major veins to prevent them from clotting off.

Each of these three people was told by their health insurer that their policy would not cover the expense of the procedures recommended for them because each was “experimental.”

As it happened, all three people eventually got the therapy that they sought, largely by publicizing the initial denials they received. That in itself is a lesson in how these sorts of disputes can be resolved. Ellison appealed the decision of his Blue Cross-affiliate PPO under the plan’s grievance procedure; but while the appeal was pending, an anonymous donor offered to pay for Ellison’s transplant. Lafnitzegger’s plan, Group Health Cooperative, reversed its original denial, claiming publicly that Group Health employees had mistakenly encouraged Lafnitzegger to contact Duke University and for that reason they would pay -- on a one time basis -- for her treatment (which they still insisted was not technically covered by the plan.) Johnson’s insurer, a Blue Shield spin-off, also relented under the pressures of adverse publicity.

But what about the next Jim Ellison -- or anyone else with a condition for which the only hope is a treatment that is arguably experimental or otherwise not medically necessary in the traditional sense of the term? As the cases in this subsection demonstrate, the legal dispute often focuses on two issues (a) what are the contractual terms of the plan? and (b) who gets to interpret those terms -- the patient’s provider, the plan’s administrator, or the judge who may or may not review the initial decision. As demonstrated by the materials in this subsection, the answers to these questions can be solely a matter of the terms of the contract or be modified by various state and federal laws. Ultimately, however those legal issues are resolved, someone has to decide whether it is “worth it,” whether the costs of the treatment are worth the benefits of the treatment. And that is true whether the question is framed as “what is experimental?” or “what is medically necessary?” and regardless of who is, at the end of the day, left with the final choice.

Consider each of the three people described above. Assume they are enrolled in a health plan that covers medically necessary treatment and excludes

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experimental treatment -- with no further definition of those terms. Assume any of the following roles:

a. The health plan’s contract clearly and unequivocably delegates decisions regarding coverage to the plan’s administrator; you are that administrator.

b. The health plan’s contract delgates the decision to an independent IRO. You are selected to be a member of its decision-making body.

c. The health plan’s contract does not clearly and unequivocably delegate decisionmaking to the plan’s administrator or to an IRO, but the plan refuses to pay. The beneficiary sues claiming the plan should cover the treatment. You are the trial court judge.

d. The plan refuses to pay and the courts do not provide a remedy (and the plan does not “give in” to the adverse publicity that results). You are a state legislator who wants these decisions made “fairly” and “justly.”

What do you decide?

Heasley provides an interesting starting point for analysis. According to Heasley, deciding whether a particular treatment is “experimental” is basically an assessment of the safety and effectiveness of the procedure “as demonstrated by its use on an appreciable number of patients.” And the court sets out a non-exclusive list of factors to consider including (a) the judgment of other insurers and medical bodies; (b) the amount of experience with the procedure; (c)the effectiveness of such experience as compared to no treatment and to alternative treatment; (d) the quality of the information; according to the court, double-blind studies or other controlled clinical trials are the most persuasive, but expert testimony, journal articles, and anecdotal evidence appear to be relevant “second best” information. The court also noted that the rarity of the procedure may be relevant, admitting that it’s harder to gather good data on procedures that have been infrequently performed.

Does this help? What other factors do you want to consider? Suppose you find enough data to make a reasonable prognosis for success. Is a five percent chance that the patient will survive for one year enough? What if the chances were 10 percent? 50 percent? Is the quality of the life that survives a consideration -- or even relevant? How do you factor in considerations of cost? For that matter, do you even consider the patient’s age, family status, social or occupational role? Ultimately, you have to integrate your answers to each of these questions into a final decision.

These are tough, perhaps even imponderable questions, even with good information. But good information is almost never available. The “gold standard” for therapeutic information is the controlled, clinical trial. But there have not been clinical trials to adjudge the effectiveness or even the safety for many medical procedures, including those that are relatively routine, let alone those that derive from recent developments. Clinical trials are expensive and time-consuming. Most medical decisions are based on physicians’ medical judgment, a funny mix of science and art and heavily reliant on “what those physicians usually do.”

One issue that has compounded the problem is that some willing patients can’t participate in clinical trials because their insurers will not pay for the treatment that is being evaluated, as it is almost by definition, experimental. But until enough participants are found, it is difficult to amass enough data to

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complete the clinical trial. For background and one possible solution, see A Proposal for Federal Legislation to Address Health Insurance Coverage for Experimental and Investigational Treatments, 78 Or. L. Rev. 203 (1999).

Even “second best” evidence is not always available or accessible to plans, to those who would review or evaluate their decisions, or, for that matter, patients. The internet has, however, made some inroads into this problem. Most notably, the Agency for Healthcare Research and Quality maintains a clearinghouse for clinical practice guidelines, essentially protocols that have been developed by various professional associations and other entities for the treatment of certain diseases and conditions. See The National Guideline Clearinghouse, http://www.guideline.gov (last visited October 2006); see also National Guideline Clearinghouse Links to Patients Resources, http://www.ahcpr.gov/clinic (last visited October 2006). Information on diseases and conditions and other resources also can be found at http://www.nlm.nih.gov/medlineplus/ (last visited October 2006).

The problems of defining medical necessity also can be considered

prospectively. Consider the options available to a health plan for (a) defining medical necessity and (b) setting out the procedures by which medical necessity decisions are made and appealed. (You may find it useful to use the provisions of the health benefits plan you selected in the problem earlier in this chapter as a starting point.) The Dallek article reviews some attempts to define medical necessity and the range of options for incorporating an IRO-type decision-making body into the process. Which type of IRO would you use? How would you define their authority? What else would you add?

For an illustration of how the State of Washington has attempted to structure these types of decisions, see Wash. Rev. Code §§ 43.70.235; 48.43.500; 48.43.535 (2005) and interpretative regulations at Wash. Ad. Code §§ 182-16-040; 246-305-001 thru 110; 284-43-130 thru 899. To find additional information on the Washington scheme, see the website of the state’s insurance commissioner, http://www.insurance.wa.gov (last visited September 2005).

Consider as one option an explicit (and preferably illustrative) list of conditions/treatments that are per se medically unnecessary -- or, a similar list of conditions/treatments that illustrate what is medically necessary. Alternatively, consider whether individual decisions should be explained (or at least published) as a kind of “common law” to aid future decision makers and to inform consumers of how the plan’s provisions are likely to be interpreted. Another technique would be to define certain dollar amounts (e.g. treatments that will cost less than $50,000) or estimates of benefit (treatments that are estimated to improve a one-year life expectancy by more than 10 percent) as presumptively medically necessary; all others are subject to review by the plan or some other decision maker.

Will any of these efforts help make the “tough choices” less difficult? Are there concerns for the “justness” of the process, even if the likely outcomes of these choices are no better than they are under current arrangements?

For a good review of the types of decisions that are most often contested, see David M. Studdert & Carole Roan Gresenz, Enrollee Appeals of Preservice Coverage Denials at 2 Health Maintenance Organizations, 289 JAMA 864 (2003). For a summary overview of the law governing these issues, see Kaiser Family Foundation & Consumers Union, A Consumer Guide to Handling Disputes With Your Employer or Private Health Plan: 2005 Update (2005).

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SIDE BAR: WHAT IS “EVIDENCE BASED MEDICINE”?

At first glance, any reference to “evidence-based medicine” may sound superfluous: Surely physicians and other practitioners make their medical treatment decisions based on some sort of evidence, even if sometimes it is “second-best” evidence and not the result of a controlled clinical trial.

Or do they? As it turns out, yes, practitioners generally rely on evidence in their decision making, if and when it is available. But that may mean a telephone call with a colleague or a quick review of recent journal articles or something of that ilk. What it does not mean, at least in most cases, is that medical practitioners take the time and effort to review the available literature and various electronic resources and make their treatment decisions based on the analysis of even that data which is available through these sources. Moreover, they also rely frequently on other factors, some conscious, some not: hunches and intuition, patterns of practice that reflect their particular education and training, their personal experience with similar patients, the advice of their colleagues, and so on. Indeed, once a particular course of treatment has been followed successfully once, that “sample-size one” trial may have a heavy influence on the treatment of any subsequent patient who encounters the practitioner who treated the first patient. In this regard, lawyers must see parallels in the practice decisions of legal practitioners who rely almost exclusively on their past experience and intuition, and rarely on anything that could be regarded or described as “evidence-based.”

Starting in the 1990s, various voices within the medical community began a debate over the need to train practitioners to rely more heavily on available evidence and to do so more systematically than they had in the past. “Evidence based medicine” became the catch-all “buzz word” within this debate. “Evidence-based medicine” allows practitioners to provide higher quality care; “evidence-based medicine” allows practitioners to avoid wasting resources on expensive care that, based on the evidence, is not likely to be successful. And so on. In this regard, a call for “evidence-based medicine” can be a call for more care, better care, or less care. Not surprisingly, the term has found its way into the court room on occasion, especially in malpractice litigation.

For a good source of related information, see the website of the Center for Evidence-Based Medicine, http://www.cebm.utoronto.ca (last visited September 2005).For a good, scholarly analysis, see Lars Noah, Medicine’s Epistemology: Mapping the Haphazard Diffusion of Knowledge in the Biomedical Community, 44 Arizona Law Review 373 (2002); for a discussion of the need to focus more closely on evidence-based decisions in promoting patient safety, see Lucien L. Leape, et al., What Practices Will Most Improve Patient Safety: Evidence-Based Medicine Meets Patient Safety, 288 JAMA 501 (2002).

The movement towards “evidence-based medicine” also can be related to the parallel efforts of various professional organizations and governmental agencies to objectively assess the efficacy of various treatment options through the development of clinical guidelines or standards. As discussed in the Problem supra, clinical guidelines can be useful in making medical necessity and other related determinations more objectively. Note, however, that while clinical guidelines often purport to be based on the same “evidence” as “evidence-based medicine,” they often are more in the nature of professional judgments or consensus standards. For examples, see the websites cited in the Problem supra.

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5. Discrimination in Structuring Employer-Sponsored Health Benefits Plans

MCGANN v. H & H MUSIC CO., 946 F.2d 401 (5th Cir. 1991), cert. denied, 506 U.S. 981 (1992)

Garwood, Judge.

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FACTS AND PROCEEDINGS BELOW

McGann, an employee of H & H Music, discovered that he was afflicted with AIDS in December 1987. Soon thereafter, McGann submitted his first claims for reimbursement under H & H Music's group medical plan, provided through Brook Mays, the plan administrator, and issued by General American, the plan insurer, and informed his employer that he had AIDS. McGann met with officials of H & H Music in March 1988, at which time they discussed McGann's illness. Before the change in the terms of the plan, it provided for lifetime medical benefits of up to $1,000,000 to all employees.

In July 1988, H & H Music informed its employees that, effective August 1, 1988, changes would be made in their medical coverage. These changes included, but were not limited to, limitation of benefits payable for AIDS-related claims to a lifetime maximum of $5,000. No limitation was placed on any other catastrophic illness. H & H Music became self-insured under the new plan and General American became the plan's administrator. By January 1990, McGann had exhausted the $5,000 limit on coverage for his illness.

In August 1989, McGann sued H & H Music, Brook Mays and General American under section 510 of ERISA, which provides, in part, as follows:

It shall be unlawful for any person to discharge, fine, suspend, expel, discipline, or discriminate against a participant or beneficiary for exercising any right to which he is entitled under the provisions of an employee benefit plan . . . or for the purpose of interfering with the attainment of any right to which such participant may become entitled under the plan. . . ." 29 U.S.C. § 1140.

McGann claimed that defendants discriminated against him in violation of both prohibitions of section 510. He claimed that the provision limiting coverage for AIDS-related expenses was directed specifically at him in retaliation for exercising his rights under the medical plan and for the purpose of interfering with his attainment of a right to which he may become entitled under the plan.

Defendants, conceding the factual allegations of McGann's complaint, moved for summary judgment. These factual allegations include no assertion that the reduction of AIDS benefits was intended to deny benefits to McGann for any reason which would not be applicable to other beneficiaries who might then or thereafter have AIDS, but rather that the reduction was prompted by the knowledge of McGann's illness, and that McGann was the only beneficiary then known to have AIDS. . . .

. . . .

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Although we assume there was a connection between the benefits reduction and either McGann's filing of claims or his revelations about his illness, there is nothing in the record to suggest that defendants' motivation was other than as they asserted, namely to avoid the expense of paying for AIDS treatment (if not, indeed, also for other treatment), no more for McGann than for any other present or future plan beneficiary who might suffer from AIDS. McGann concedes that the reduction in AIDS benefits will apply equally to all employees filing AIDS-related claims and that the effect of the reduction will not necessarily be felt only by him. He fails to allege that the coverage reduction was otherwise specifically intended to deny him particularly medical coverage except "in effect." He does not challenge defendants' assertion that their purpose in reducing AIDS benefits was to reduce costs.

Furthermore, McGann has failed to adduce evidence of the existence of "any right to which [he] may become entitled under the plan." The right referred to in the second clause of section 510 is not simply any right to which an employee may conceivably become entitled, but rather any right to which an employee may become entitled pursuant to an existing, enforceable obligation assumed by the employer. . . .

McGann's allegations show no promised benefit, for there is nothing to indicate that defendants ever promised that the $1,000,000 coverage limit was permanent. The H & H Music plan expressly provides: "Termination or Amendment of Plan: The Plan Sponsor may terminate or amend the Plan at any time or terminate any benefit under the Plan at any time." There is no allegation or evidence that any oral or written representations were made to McGann that the $1,000,000 coverage limit would never be lowered. Defendants broke no promise to McGann. . . . To adopt McGann's contrary construction of this portion of section 510 would mean that an employer could not effectively reserve the right to amend a medical plan to reduce benefits respecting subsequently incurred medical expenses, as H & H Music did here, because such an amendment would obviously have as a purpose preventing participants from attaining the right to such future benefits as they otherwise might do under the existing plan absent the amendment. But this is plainly not the law, and ERISA does not require such "vesting" of the right to a continued level of the same medical benefits once those are ever included in a welfare plan.

McGann appears to contend that the reduction in AIDS benefits alone supports an inference of specific intent to retaliate against him or to interfere with his future exercise of rights under the plan. McGann characterizes as evidence of an individualized intent to discriminate the fact that AIDS was the only catastrophic illness to which the $5,000 limit was applied and the fact that McGann was the only employee known to have AIDS. He contends that if defendants reduced AIDS coverage because they learned of McGann's illness through his exercising of his rights under the plan by filing claims, the coverage reduction therefore could be "retaliation" for McGann's filing of the claims. Under McGann's theory, any reduction in employee benefits would be impermissibly discriminatory if motivated by a desire to avoid the anticipated costs of continuing to provide coverage for a particular beneficiary. . . .

McGann cites only one case in which a court has ruled that a change in the terms and conditions of an employee-benefits plan could constitute illegal discrimination under section 510. . . . [In that case], however, the plan change at issue resulted in the plaintiff and only the plaintiff being excluded from coverage. . . .

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McGann effectively contends that section 510 was intended to prohibit any discrimination in the alteration of an employee benefits plan that results in an identifiable employee or group of employees being treated differently from other employees. The First Circuit rejected a somewhat similar contention in Aronson v. Servus Rubber, Div. of Chromalloy, 730 F.2d 12 (1st Cir.), cert. denied, 469 U.S. 1017, 105 S. Ct. 431, 83 L. Ed. 2d 357 (1984), . . . stating in part:

[Section 510] relates to discriminatory conduct directed against individuals, not to actions involving the plan in general. The problem is with the word 'discriminate.' An overly literal interpretation of this section would make illegal any partial termination, since such terminations obviously interfere with the attainment of benefits by the terminated group, and, indeed, are expressly intended so to interfere. . . . This is not to say that a plan could not be discriminatorily modified, intentionally benefiting, or injuring, certain identified employees or a certain group of employees, but a partial termination cannot constitute discrimination per se. A termination that cuts along independently established lines -- here separate divisions -- and that has a readily apparent business justification, demonstrates no invidious intent.

. . . .

As persuasively explained by the Second Circuit, the policy of allowing employers freedom to amend or eliminate employee benefits is particularly compelling with respect to medical plans:

With regard to an employer's right to change medical plans, Congress evidenced its recognition of the need for flexibility in rejecting the automatic vesting of welfare plans. Automatic vesting was rejected because the costs of such plans are subject to fluctuating and unpredictable variables. Actuarial decisions concerning fixed annuities are based on fairly stable data, and vesting is appropriate. In contrast, medical insurance must take account of inflation, changes in medical practice and technology, and increases in the costs of treatment independent of inflation. These unstable variables prevent accurate predictions of future needs and costs. (citation omitted)

. . . .

McGann's claim cannot be reconciled with the well-settled principle that Congress did not intend that ERISA circumscribe employers' control over the content of benefits plans they offered to their employees. McGann interprets section 510 to prevent an employer from reducing or eliminating coverage for a particular illness in response to the escalating costs of covering an employee suffering from that illness. Such an interpretation would, in effect, change the terms of H & H Music's plan. Instead of making the $1,000,000 limit available for medical expenses on an as-incurred basis only as long as the limit remained in effect, the policy would make the limit permanently available for all medical expenses as they might thereafter be incurred because of a single event, such as the contracting of AIDS. Under McGann's theory, defendants would be effectively proscribed from reducing coverage for AIDS once McGann had contracted that illness and filed claims for AIDS-related expenses. If a federal court could prevent an employer from reducing an employee's coverage limits for AIDS treatment once that employee contracted AIDS, the boundaries of judicial involvement in the creation, alteration or termination of ERISA plans would be sorely tested.

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As noted, McGann has failed to adduce any evidence of defendants' specific intent to engage in conduct proscribed by section 510. A party against whom summary judgment is ordered cannot raise a fact issue simply by stating a cause of action where defendants' state of mind is a material element.

Proof of defendants' specific intent to discriminate among plan beneficiaries on grounds not proscribed by section 510 does not enable McGann to avoid summary judgment. ERISA does not broadly prevent an employer from "discriminating" in the creation, alteration or termination of employee benefits plans; thus, evidence of such intentional discrimination cannot alone sustain a claim under section 510. That section does not prohibit welfare plan discrimination between or among categories of diseases. Section 510 does not mandate that if some, or most, or virtually all catastrophic illnesses are covered, AIDS (or any other particular catastrophic illness) must be among them. It does not prohibit an employer from electing not to cover or continue to cover AIDS, while covering or continuing to cover other catastrophic illnesses, even though the employer's decision in this respect may stem from some "prejudice" against AIDS or its victims generally. The same, of course, is true of any other disease and its victims. That sort of "discrimination" is simply not addressed by section 510. Under section 510, the asserted discrimination is illegal only if it is motivated by a desire to retaliate against an employee or to deprive an employee of an existing right to which he may become entitled. . . .

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MCNEIL v. TIME INSURANCE CO., 205 F.3d 179 (5th Cir. 2000)

Jolly, Judge.

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In the Spring of 1994, Dr. Michael McNeil, a Texas optometrist, did not know that he would be dead within the year because of AIDS. He thus routinely sought to cover himself and his employee in his optometry practice under a general health insurance plan.

Dr. McNeil's optometry practice was a two-person partnership with Dr. Roy F. Dickey. The partnership had one employee, its secretary, Jana Jay. The partnership was a member of the Texas Optometric Association, which operated as a trust, allowing its members to purchase group insurance. In April, Dr. McNeil received information about a new life and health insurance policy offered by Time Insurance Company through the association. The brochure described the policy's benefits and costs. The policy contained no limitation on pre-existing conditions and provided lifetime maximum benefits of $2 million. There were limitations on coverage for several specific health problems. One of these was for Acquired Immune Deficiency Syndrome ("AIDS"). The policy limited coverage for AIDS and AIDS Related Complex ("ARC") to $10,000 during the first two years of the policy but provided maximum benefits after that.

Dr. McNeil decided that the partnership should purchase this plan. He filled out the employer application, signing a document indicating that he had "authority to bind the employer," and then he and Ms. Jay mailed employee enrollment forms to Time. His form listed him as an "employee." Dr. Dickey was covered by Medicare and did not enroll. The partnership paid the first premium to Time for Dr. McNeil and Ms. Jay from its operating account, though Dr. McNeil later reimbursed the partnership for his portion. The plan became effective on May 1, 1994.

After the plan became effective, Dr. McNeil paid his own premiums, while the partnership paid for Ms. Jay's. During the plan's operation, the partnership's administrative duties consisted of receiving premium notices and paying Ms. Jay's premiums.

In September 1994, Dr. McNeil was diagnosed with AIDS. He was admitted to the hospital and treated for pneumonia. Time paid the first $10,000 of his costs but nothing more. Dr. McNeil subsequently incurred over $400,000 in medical expenses. He died on March 1, 1995.

Before his death, Dr. McNeil brought suit in Texas state court. After Dr. McNeil's death, his father and the executor of his estate took over the suit. Time later removed the case to federal court based on ERISA preemption and diversity. Mr. McNeil then amended the complaint several times. The last version, the Third Amended Complaint, asserted several common law causes of action: breach of contract, breach of the duty of good faith and fair dealing, negligent misrepresentation, common law discrimination, waiver, estoppel, and ratification. This amended complaint also charged that Time had violated a host of state and federal statutes, including the Texas Deceptive Trade Practices Act ("DTPA"), the Texas Insurance Code, the Texas Commission on Human Rights Act ("TCHRA"), the Americans with Disabilities Act ("ADA"), and ERISA.

. . . .

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II

We first address the district court's dismissal of Mr. McNeil's claim under the Texas Insurance Code . . . .

An insurer who delivers or issues for delivery or renews any insurance in this state may not refuse to insure, refuse to continue to insure, limit the amount, extent, or kind of coverage available to an individual, or charge an individual a different rate for the same coverage solely because of handicap or partial handicap, except where the refusal, limitation, or rate differential is based on sound actuarial principles or is related to actual or reasonably anticipated experience.

. . . .

In condensed form and for purposes of the case before us, we read this statute as follows: An insurer who issues a policy may not limit the amount or extent of coverage to an individual solely because of handicap. This reading leaves us with these questions. First, is AIDS a handicap for purposes of this statute, and, second, if AIDS is a handicap, did Time, the insurer, limit the amount or extent of the policy's coverage to the individual, Dr. McNeil, because of handicap?

We touch on the first question only briefly because the lack of clarity in Texas law makes us reluctant to say whether AIDS constitutes a handicap under the law of that state. The statute itself does not define the term "handicap," and there are no Texas administrative regulations we comfortably can rely on. . . . For the sake of this appeal only, however, we will assume that AIDS is a handicap for purposes of Article 21.21-3.

Even so, Time did not violate Article 21.21-3, either at the time that it issued the policy or when it refused to pay more than $10,000 in health care costs.

We begin with the issuance of the policy to Dr. McNeil. It is true that the policy limited its coverage for AIDS to $10,000 during the first two years of the policy. The statute, however, focuses on the conduct of the insurer. The phrase "because of handicap" indicates that the insurer must know that the applicant is handicapped and that the insurer limits coverage to that individual for that reason. Dr. McNeil was not handicapped when Time issued this policy to him, or, at the least, Time did not know that he was. Thus, the limitation by the insurer could not have been "because of handicap."

But even if Time had known this when it sold Dr. McNeil the policy, we do not believe it would change our result. The statute specifies that the insurer may not limit the amount or extent of coverage available "to an individual." In short, the statute prevents an insurer from discriminating against an individual applicant because of handicap. Time offered this general policy without distinguishing between individual applicants based on whether they had AIDS. As long as Time offered Dr. McNeil the same policy it offered everyone else, Time has not violated Article 21.21-3 . . .

. . . Under the policy, $10,000 was all that was available for AIDS; the insurer simply applied the terms of the policy. The insurance policy itself

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controlled and determined the benefits. But under the plain language of the statute, the violation must be committed by the insurer, not by a term of the policy. We thus conclude that Time did not violate Article 21.21-3, that is, limit the amount of coverage solely because of handicap, because it was merely applying a term of the policy.

. . . .

Mr. McNeil also charged Time with violation of Article 21.21, [of the Texas Insurance Code], specifically, § 4(7)(b) [which] prohibits all unfair and deceptive practices and acts by insurers:

Making or permitting any unfair discrimination between individuals of the same class and of essentially the same hazard in the amount of premium, policy fees, or rates charged for any policy or contract of accident or health insurance or in the benefits payable thereunder, or in any of the terms or conditions of such contract, or in any other manner whatever.

Mr. McNeil does not attempt to define the class to which his son belonged at the time the insurer issued the policy. He has not alleged that other individuals of any defined class were charged rates or provided benefits different from those charged and provided to Dr. McNeil. Indeed, he does not even mention other insureds or potential insureds. Thus, Mr. McNeil has failed to state a claim under this section of Article 21.21.

III

We next turn to Mr. McNeil's claim that Time's policy violated Title III of the ADA. The relevant portion of Title III reads:

No individual shall be discriminated against on the basis of disability in the full and equal enjoyment of the goods, services, facilities, privileges, advantages, or accommodations of any place of public accommodation by any person who owns, leases (or leases to), or operates a place of public accommodation.

42 U.S.C. § 12182.

. . . On appeal, Mr. McNeil argues that any limitation on enjoyment of the goods and services of a place of public accommodation violates the statute. He urges us to read the statute expansively in the light of the purpose of the statute and administrative regulations interpreting it. Time, on the other hand, pushes for a narrower reading based on Congress' deference to state insurance law and on the impact of a broad reading on the insurance industry. Specifically, Time proposes that the statute merely regulates access to -- not the content of -- goods and services. Time also argues that its policy is not discriminatory under the statute. Both parties acknowledge, as they must, that AIDS is a "handicap" for Title III purposes.

We read the statute to say: No owner, operator, lessee, or lessor of a place of public accommodation shall discriminate against an individual by denying him or her, because of handicap, the full and equal enjoyment of the goods and services that the place of public accommodation offers. We think, therefore, that the question to answer in determining the scope of Title III in this case is concise: What does it mean to be discriminated against in the full

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and equal enjoyment of the goods and services of a place of public accommodation? We believe that Title III prohibits the owner, operator, lessee, or lessor from denying the disabled access to, or interfering with their enjoyment of, the goods and services of a place of public accommodation. Title III does not, however, regulate the content of goods and services that are offered. We reach this conclusion based on the language in the statute and on a practical application of that language.

To be sure, we think that the plain language of the statute demonstrates that a business is not required to alter or modify the goods or services it offers to satisfy Title III. The prohibition of the statute is directed against owners, etc., of places of public accommodation. It prohibits them from discriminating against the disabled. The discrimination prohibited is that the owner, etc., may not deny the disabled the full and equal enjoyment of the business's goods and services. Practically speaking, how can an owner, etc., deny the full and equal enjoyment of the goods or services that he offers? By denying access to, or otherwise interfering with, the use of the goods or services that the business offers. The goods and services that the business offers exist a priori and independently from any discrimination. Stated differently, the goods and services referred to in the statute are simply those that the business normally offers.

We acknowledge that it is literally possible, though strained, to construe "full and equal enjoyment" to suggest that the disabled must be able to enjoy every good and service offered to the same and identical extent as those who are not disabled. Construed in this manner, the statute would regulate the content and type of goods and services. That would be necessary to ensure that the disabled's enjoyment of goods and services offered by the place of public accommodation would be no less than, or different from, that of the non- disabled. But such a reading is plainly unrealistic, and surely unintended, because it makes an unattainable demand.

. . . The blind may surely enjoy attending a movie or even a tennis match. But it seems indisputable that the blind will not fully and equally enjoy the "good" or "service" of those places of public accommodation when visual elements of that experience are, by circumstance, denied them. Similarly, the deaf sometimes enjoy symphonies because they can sense the vibrations of the music. But their enjoyment cannot be full or equal compared to one with hearing, because they are not privy to the full range of sounds that one with hearing is. . . .

. . . If the blind must be able to enjoy all goods and services to the same extent as the sighted, bookstores would be forced to limit the selection of books they carried because they would need to stock braille versions of every book. Shoe stores would reduce the styles available to their general customers, because they would need to offer special shoes for people with disabling foot deformities in every style sold to the non-disabled.

By citing such examples, we do not mean to make the statute sound ridiculous. We do this to illustrate that the language of the statute can only reasonably be interpreted to have some practical, common sense boundaries. And if we construe Title III to regulate the content of goods and services, there seem to be no statutory boundaries. Based on the language of the statute, we simply see no non-arbitrary way to distinguish regulating the content of some goods from regulating the content of all goods.

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. . . This construction assures that the disabled have access to all goods and services offered by the business and the opportunity to use and enjoy that good or service without interference by the owner, etc. Our opinion merely declines to dictate to every business in the country what types of goods and services must be offered.

. . . .

It follows from our construction of the statute that Time has not violated Title III by offering a policy that limits the amount of coverage for AIDS to $10,000 over the first two years of the policy. The "good" in this case is the insurance policy that Time offered to the members of the Texas Optometric Association. To establish a Title III violation, Mr. McNeil is required to demonstrate that Time denied his son access to that good or interfered with his son's enjoyment of it. Mr. McNeil concedes that Time offered the policy to his son on the same terms as it offered the policy to other members of the association; that is, his son had non-discriminatory access to the good. Mr. McNeil has not alleged that Time interfered with his son's ability to enjoy that policy as it was written and offered to the non-disabled public. Instead, Mr. McNeil's Title III challenge is to a particular provision of the policy -- the AIDS limitation. He is, in effect, challenging the content of the good that Time offered. Because Title III does not reach so far as to regulate the content of goods and services, and because it is undisputed this limitation for AIDS is part of the content of the good that Time offered, Mr. McNeil's Title III claim must fail.

IV

[The court then held that although Dr. McNeil was a partner in the practice that purchased the health benefits and paid his own premiums out-of-pocket, his policy with Time still qualified under ERISA’s definition of an employee health plan (even if Dr. McNeil was an employer-owner) and therefore all of McNeil’s remaining state common law and statutory claims were subject to ERISA preemption.]

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Notes and Questions on Discrimination in Structuring Employer-Sponsored Health Benefits

1. In strictly legal terms, McGann is a straightforward decision. According to the Fifth Circuit, the kind of discrimination involved in this factual setting is not the kind of discrimination prohibited by ERISA. Moreover, since McGann's employer was self-insured, ERISA preempts any alternative cause of action based on state insurance laws (as would be true in the vast majority of cases). Employers, including self-insured employers, are still subject to federal anti-discriminations laws (which ERISA does not preempt), although, as McNeil demonstrates, those federal laws may not provide a remedy for people like McGann either. Employers who are not self-insured may be subject to state insurance laws that prohibit certain forms of discrimination (as in McNeil, although it is not clear whether that state law in McNeil would have provided McGann with a viable claim.) In any event, as the McGann decision points out, ERISA does not require employers to provide any particular benefits in any particular way and there is no general prohibition on discrimination in structuring -- or restructuring or terminating -- an employee health benefits plan. For a similar case, see Hines v. Massachusetts Mutual Life Insurance, Inc., 43 F.3d 207 (5th Cir. 1995) (ERISA does not prevent an employer from switching plans, even if the result is to deny coverage for an employee because of a pre-existing condition in the new plan that was covered under the original plan). Cf. Wheeler v. Dynamic Engineering, 62 F.3d 634 (4th Cir. 1995)(ERISA requires continuation of treatment if initiated prior to termination of benefits).

2. What kinds of discrimination are prohibited by ERISA? As McGann notes, 29 U.S.C. § 1140 prohibits actions intended to prevent a particular employee from exercising a right to which the employee is entitled. Presumably McGann's employer could not have fired him with the purpose of reducing the costs of the employer's health plan or, alternatively, threatened McGann with a loss of employment if he chose to seek treatment under the plan. See Seaman v. Arvida Realty Sales, 985 F.2d 543 (11th Cir.), cert. denied, 510 U.S. 916 (1993). Cf. Stiltner v. Beretta U.S.A. Corp., 74 F.3d 1473 (4th Cir. 1995). Note also that ERISA requires certain notice and other procedural requirements to be followed in amending or reducing an existing plan and that a "Summary Plan Description" be distributed annually. 29 U.S.C. § 1022. See Wise v. El Paso Natural Gas Co., 986 F.2d 929 (5th Cir.), cert. denied, 510 U.S. 870 (1993). Failure to follow these requirements would invalidate an effort to do what McGann's employer did -- at least temporarily. See Curtiss-Wright Corp. v. Schoonejongen, 514 U.S. 73 (1995) (general description in SDP of employer's discretion to terminate retirement benefits satisfies ERISA requirements).

3. Following McGann, some experts believed that the Americans With Disabilities Act of 1990, 42 U.S.C. §§ 12101-12213 (ADA) would impose additional limits on an employer's discretion to discriminate in structuring health benefits plans. Title I of the ADA generally prohibits employers from discriminating against their employees on the basis of disability in making a wide range of employment and compensation decisions, including those relating to health benefits plans. As described in McNeil, “public accomodations, including insurers and other health plans, also are subject to nondiscrimination requirements under Title III of the ADA. For purposes of the ADA, "disability" has been interpreted to include a number of medical conditions, including AIDS and HIV-infection. See Bragdon v. Abbott, 524 U.S. 624 (1998).

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An important limitation on the scope of the ADA prohibitions is incorporated in Title V section 501(c), known as the “safe harbor" provision which reads:

Subchapters I through III of this chapter . . . shall not be construed to prohibit or restrict (1) an insurer, hospital or medical service company, health maintenance organization, or any agent, or entity that administers benefits plans . . . from underwriting risks, classifying risks, or administering such risks that are based on or not inconsistent with State law . . . .

Paragraph (1) shall not be used as a subterfuge to evade the purposes of [Titles] I and III . . . .

As illustrated by McNeil, the courts have taken a rather narrow view of the application of Title III, even without reliance on Title V. According to the circuit court, Title III may prohibit an insurer from refusing to sell its products to someone with an ADA-qualified disability, but it does not prohibit the kinds of limits on coverage included in McNeil’s policy. Presumably this same limit on the scope of Title III would be applied in suits against employers under Title I. That is, employer’s like McGann’s employer, cannot refuse to offer benefits to employees with ADA-qualified disabilities, but it could offer policies with limits such as those in McNeil or, more generally, that offer more coverage for services that are not related to the disability.

The decision in McNeil may reflect a narrow view of the reach of the ADA -- indeed, the court seems to react with disbelief to the plaintiff’s arguments -- but it appears to be the majority rule. See, e.g., Doe v. Mutual of Omaha Insurance Co., 179 F.3d 557 (7th Cir. 1999), cert. denied, 528 U.S. 1106 (2000).

Other decisions have drawn other possible limits on the ADA’s reach. For example, in Leonard F. v. Israel Discount Bank of New York, 199 F.3d 99 (2d Cir. 1999), the court held that the lack of an actuarial basis for a differential treatment of a disabled employee or policyholder does not necessarily prove that the action is a “subterfuge” under Title V. Under this view, presumably the plaintiffs must produce some evidence of an intent to discriminate in order to overcome the protection of the “safe harbor” provision. For that matter, Leonard F. even suggested that Title III does not apply at all to insurance policies sold to employers. On the other hand, some courts have recognized that Title III does impose some limits on insurers. In Pallozzi v. Allstate Life Insurance Co., 198 F.3d 28 (1999), the Second Circuit held that Title III prohibits an insurance company from refusing to sell life insurance to mentally ill applicants. (Note, however that the Pallozzi defendants admitted that the Title V defense was not available to them.) See also Henderson v. Bodine Aluminum, Inc., 70 F.3d 958 (8th Cir. 1995)(health plan may have violated the ADA when it refused to pay for ABMT for the plaintiff's breast cancer under a plan that did cover ABMT for other forms of cancer).

Interestingly, the McNeil court and the courts in many of these other decisions have refused to accept a broader reading of the ADA even though such a reading has been supported by the Department of Justice and the Equal Employment Opportunity Commission. See, e.g., Doe at 179 F.3d at 563; Leonard F., 199 F.3d at 106. As a technical matter, there are circumstances where a court can properly overrule or ignore an agency’s interpretation of a statute that it is charged with enforcing. Nonetheless, the pattern of these cases implies an underlying hostility to a broader reading of the ADA. Cf. E.E.O.C., Interim Policy Guidance on ADA and Health Insurance, 18 Americans with Disabilities Act Manual (BNA) § 70.1051-70.1056; 28 C.F.R. pt. 36, app. B at 640.

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4. Whether ERISA or the ADA allow or prohibit the practices of McGann's employer or McNeil’s insurer, both decisions highlight some important health policy issues. Indeed, the McGann decision sparked considerable public outcry. Here, after all, was an employer refusing to honor a commitment to its employee at the worst possible time and in a way that is popularly, if not legally, regarded as discrimination. Why pay for health insurance that covers important services if the policy can be revoked if you ever try to use it? McNeil received less national attention, but it too can evoke some strong response: McNeil buys health insurance assuming he will be covered for his future costs, only to find that the policy excludes coverage for the condition he develops. Why limit AIDS coverage to $10,000 and allow $1 million in benefits for other conditions? What possible basis could there be for this limit other than some type of animosity towards people with AIDS? Surely "something ought to be done" or, more concretely, ERISA or the ADA or some other legislation should be amended to right what is apparently wrong?

But that latter question can and should be turned around. What is wrong or unfair about what happened to McGann or McNeil and, just as importantly, how could those situations be appropriately remedied? The first question is easier for most people to answer, at least in general terms: People like McGann and McNeil should have continuing coverage for the extraordinary health care costs they undoubtedly face. After all, that is why they -- and the rest of us -- buy health insurance. But consider some of the implications of some types of remedies. The plight of McGann’s employer if forced to cover McGann is the most demonstrative. McGann's employer claimed the costs of maintaining the health plan for his small work force (fewer than 10 employees) would skyrocket if McGann's costs were included in their self-insured plan. The same would be true for any small employer. For that matter, consider the plight of McGann's co-workers who would, in effect, have to participate in financing McGann's cost if he is included in their plan. And unless the "something that is done" does much more than rewrite ERISA or the ADA, McGann's employer is under no obligation to provide health benefits at all. If the employer can't exclude McGann, maybe it will stop providing health benefits altogether.

What about McNeil’s insurer or the participants -- it was a two-person plan -- if forced to cover McNeil? How should their costs be distributed? Is there a way to remedy the "wrong" to people like McNeil that takes into account these -- and many other -- economic considerations? It may be useful to consider your answers to these questions in light of some of the issues raised in Chapter 8 concerning the difficulty of regulating some but not all aspects of privately purchased health financing plans.

The fact that the plight of people like McGann or McNeil or other people who are denied coverage has struck so many Americans as a "wrong" tells us a great deal about the underlying values of Americans. But the problems of attempting to provide them with a remedy or to prevent these situations from recurring also tells us a great deal about current American health financing arrangements and why "doing something" to right even identifiable wrongs can be such a difficult and complex task.

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