Undermining ERISA: Federal Courts Give Double Whammy to Law Preempting State Lawsuits

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Law Feature --August 2000  

By Walt Borges
Associate Editor

Organized medicine, managed care organizations, state regulators, and consumer groups all found something to praise in a pair of recent decisions by the US Supreme Court and the US 5th Circuit Court of Appeals. But the decisions issued in late June were less a victory for any one interest group than a prescription for continued legal and legislative challenges to managed care.

Together, the Supreme Court's unanimous ruling in Pegram v Herdrich and the decision of a three-judge 5th Circuit panel in Corporate Health Insurance Inc v Texas Department of Insurance have moved the federal judiciary closer to overturning long-standing interpretations of the Employment Retirement Income Security Act of 1974 (ERISA) that keep injured patients from suing managed care organizations in state courts.

The decisions also prompted renewed calls from the Texas Medical Association and the American Medical Association for Congress to set national standards for patient protection by passing a Patients' Bill of Rights.

TMA President Jim Rohack, MD, of Temple, said the 5th Circuit ruling "highlights the need for Congress to act quickly to establish national patient protection standards including independent review of health plan decisions to delay or deny medically necessary care."

The high court issued its Pegram decision on June 12 as AMA was holding its annual summer meeting in Chicago. In a statement by the AMA Board of Trustees, Trustee Donald Palmisano, MD, called the Pegram decision "a compelling argument for a strong Patients' Bill of Rights. We urge Congress to pass appropriate legislation and protect America's patients now."

For Texas physicians and patients, the 5th Circuit case (commonly called the Aetna case because the four entities that challenged the Health Care Liability Act of 1997 [HCLA] were subsidiaries of Aetna US Healthcare) has the greater impact. A three-judge panel, with 5th Circuit Judge Patrick Higginbotham, of Dallas, writing, held that ERISA did not preempt the state law that allows patients to sue health maintenance organizations (HMOs) that negligently delay or deny medically necessary treatment. That part of the decision adopted many of the positions advocated by TMA and AMA in a friend-of-the-court brief filed in the case, Dr Rohack said in a statement released June 21.

Jerry Patterson, the former state legislator who is now executive director of the Texas Association of Health Plans, says the two cases are part of a trend in the courts to narrow ERISA preemption of state laws. But he noted that the 5th Circuit panel sent a message to plan members that "coverage decisions should not be confused with decisions regarding medical necessity."

Elizabeth Rogers, JD, a lawyer with the Austin office of Vinson & Elkins who represents both health care plans and physicians, said the Aetna case will force Texas courts handling HMO negligence claims to determine "whether the complaint is about a pure coverage decision by [the] HMO, which would be preempted by federal law, or if it's a health care treatment decision affecting the quality of care. The problem is, as history has shown, there was no black or white, either-or test under the treatment versus coverage decision analysis."

The Texas statute did not escape 5th Circuit review unscathed. The panel knocked out the independent review process that provided patients with a means to challenge HMOs for failure to exercise ordinary care in making adverse treatment decisions. Lawyers in the Texas Attorney General's Office have asked for a rehearing of the case by the full complement of 5th Circuit judges.

While the unanimous panel essentially upheld the 1999 ruling of a federal district judge in Houston, it did reverse her rulings on two key points. The 5th Circuit panel held that ERISA preempted provisions of HCLA that prevented managed care organizations from retaliating against physicians and health plan members who challenged HMO decisions. It also overturned a ruling that prohibited managed care organizations from requiring physicians to indemnify the managed care companies for the costs of legal action.

In upholding the HCLA provisions against retaliation and indemnification, the court stated, "Together, the provisions thus better preserve the physician's independent judgment in the face of the managed care entity's incentives for cost containment."

Rationing care  

The Aetna decision was rife with implications for Texas physicians, but the Supreme Court's decision in Pegram was a narrow one, says TMA General Counsel Donald P. Wilcox, JD.

In Pegram , the high court unanimously rejected a patient's claim that physician owners of an HMO breached a fiduciary duty under ERISA to act solely in her interests by providing incentives to its physicians to ration care.

Financial incentives to ration care are key to the nature of the HMO to reward the rationing of care, wrote Justice David Souter. The justice wrote that the court would not reach a decision that might result in "the elimination of the for-profit HMO."

But in language explaining the court's decision, Justice Souter undermined the scope of managed care's victory, suggesting that Congress needed to address policy questions surrounding HMOs. The court also strongly hinted that state courts were the proper setting for deciding whether HMOs and other managed care organizations had intruded on medical decision-making and the quality of care.

" Pegram is a very limited case that says there is no ERISA relief for breach of a fiduciary duty by a physician who has a financial interest in an HMO," Mr Wilcox explained. "That's because the definition of fiduciary under ERISA does not include physicians making medical decisions."

The Litigation Center, which includes AMA and state societies such as TMA, filed an amicus brief in the case arguing the position that the court ultimately adopted, Mr Wilcox says. He says the rest of the case was extraneous language that supports the need for a Patients' Bill of Rights in Congress.

Defining "fiduciary"  

Cynthia Herdrich, of Bloomington, Ill, sued her HMO in 1992, claiming its incentives caused her physician, Lori Pegram, MD, to forego an ultrasound scan of Ms Herdrich's inflamed abdomen at a local hospital so she could schedule the scan 8 days later at an HMO-owned facility 50 miles away. Ms Herdrich's appendix ruptured before the scan could be performed, causing peritonitis.

Dr Pegram was a physician owner of three entities, collectively known as "Carle," which function as an HMO. Dr Pegram and Carle were sued by Ms Herdrich, who won damages of $35,000 in a state medical malpractice suit.

Ms Herdrich also sued Carle for fraud under state law. Carle and Dr Pegram responded that the fraud counts were preempted by ERISA, which is often interpreted by the courts to exclude any lawsuits filed under state law if the suit involves the delivery of benefits to employees. Carle and Pegram successfully moved the case into federal district court.

A federal district judge then threw out one of the two fraud counts, but allowed Ms Herdrich and her lawyers to reformulate the other. In amending her pleadings, Ms Herdrich alleged that the owners of the Carle HMO breached or anticipated breaching their fiduciary duty under ERISA by structuring the HMO with incentives to ration care. In doing so, Ms Herdrich argued, the HMO physician owners placed their economic self-interest before the exclusive interests of the health plan participants.

A federal district court dismissed Ms Herdrich's remaining count, but the US 7th Circuit Court of Appeals reversed the decision, holding that the Carle HMO was acting as a fiduciary when its physicians made the challenged decisions.

Justice Souter, writing for a unanimous Supreme Court, disagreed. HMO physicians often make "inextricably mixed" decisions regarding necessity of treatment and eligibility of coverage for treatment, Justice Souter argued. These decisions differentiate fiduciary duties under ERISA from traditional fiduciary duties of financial trustees who must always put client interest above personal interest, the court said.

The court also declined to give HMOs fiduciary responsibility for their mixed decisions because of the impact such a decision would have. Ms Herdrich sought to have her for-profit HMO return all of its profits to the plan for the benefit of the covered patients. Such a ruling could eliminate for-profit HMOs, and possibly nonprofit HMOs, Justice Souter explained.

AMA was comfortable with the high court decision. Dr Palmisano said the decision "is consistent with AMA's view that ERISA is not the proper legal avenue for addressing medical decisions that harm or injure patients. ERISA was never intended to apply to medical treatment decisions and, therefore, does not contain appropriate legal remedies."

Under ERISA suits brought in federal court, injured patients who sue HMOs can recover only the value of lost benefits, plus attorneys' fees in some cases. In state court, the injured patients can recover damages for pain and suffering, which often gives them additional leverage in settlement negotiations with HMOs.

While Pegram knocked out one legal avenue of challenging HMO decisions, some plaintiff's lawyers and consumer advocates concede that Ms Herdrich's claim in Pegram was stretching the common interpretation of the law.

Jan Woodward Fox, JD, a former president of the Texas Trial Lawyers Association, is representing two physicians suing Millliman & Robertson, a company that published guidelines widely used by HMOs to limit authorization and payment for health care. The Pegram decision "is understandable in its limited context," she said.

"The issue was a very narrow one involving a creative use of ERISA in the face of limited medical injuries and procedural jockeying around between the state and federal courts," Ms Fox said. "It leaves wide open many avenues to attack the multiple mischiefs within the HMO system, such as the undisclosed use of treatment guidelines to deny care."

A leading Texas advocate for consumer rights concedes that the high court was on target in its legal reasoning, even if it produced a result harmful to consumers of medical services. "In all fairness, the Supreme Court may have gotten the law part right," said Reggie James, JD, director of the Southwest Regional Office of Consumers Union. Mr James says Congress needs to take the court's hint and change ERISA, which offers little protection to the employees it was supposed to benefit.

AMA agrees. "ERISA should not be used as a shield to prevent health plans from being held accountable under applicable state law when they make medical necessity decisions that harm patients," Dr Palmisano noted in the AMA statement.

The court's apparent preference for having state courts handle suits involving HMO liability for medical decisions was reiterated a week later on June 19 when it disposed of two cases involving HMOs, rejecting an attempt to try one case in federal court and ordering the Pennsylvania Supreme Court to handle the other by applying Pegram .

Upholding Texas law  

The Supreme Court decisions gave the 5th Circuit's ruling in the Aetna case the highest level of importance, since Texas' HCLA is the only law currently on the books that allows negligence suits against HMOs in the state courts. Six other states have passed similar laws that have yet to go into effect, and eight other states have such laws under consideration.

In the circuit court opinion handed down on June 20, Judge Higginbotham wrote that the panel agreed with Texas' interpretation that HCLA, enacted in 1997 as Senate Bill 386, is not preempted by ERISA.

"The provisions do not encompass claims based on a managed care entity's denial of coverage for a medical service recommended by the treating physician: that dispute is one over coverage," which is specifically excluded from preemption by HCLA, Judge Higginbotham wrote. "Rather, the [HCLA] would allow suit for claims that a treating physician was negligent in delivering medical services, and it imposes vicarious liability on managed care entities for that negligence."

The court is suggesting that HMOs can be indirectly targeted for negligence under HCLA only when a physician has been sued for negligence, Ms Rogers says. But Mr Wilcox says he thinks the court will allow some direct suits against HMOs.

Mr Wilcox says Texas suits against HMOs for negligence in approving care will fail through preemption if the HMO can get a judge to agree that it simply denied coverage, even if the denial of coverage harmed the patient.

But the door remains open for patients who can get the courts to agree that a physician was acting as an agent of the health plan when he or she provided poor medical care, that the health plan influenced the quality of care through financial incentives or other means, or that the plan improperly screened or supervised physicians admitted to its network.

The 5th Circuit panel also gave the state a bonus by differentiating ERISA preemption of malpractice suits against doctors in managed care organizations for coverage decisions and preemption of state attempts to regulate and police medical care.

ERISA "does not insulate physicians from accountability to their state licensing agency or association charged to enforce professional standards regarding medical decisions," he wrote. "Such accountability is necessary to ensure that plans operate within the broad compass of sound medicine. We are not persuaded that Congress intended ERISA to supplant this state regulation of quality of medical practice."

Mr Wilcox says the decision gives a strong boost to the current effort by the Texas State Board of Medical Examiners to assert jurisdiction over UnitedHealthcare's medical director for North Texas, whom United is challenging in a current suit in federal court.

Killing IRO  

The court also knocked out the process of independent review, which allows patients access to reviewers outside the managed care organization to appeal denials of treatment because the health plan regards the treatment as medically unnecessary.

Judge Higginbotham wrote that it is apparent that HCLA's provisions for independent review included "determination by managed care entities as to coverage, not just negligent decisions by a physician. The provisions allow a patient who has been denied coverage to appeal to an outside organization. Such an attempt to impose a state administrative regime governing coverage determinations is squarely within the ambit of ERISA's preemptive reach."

Mr Patterson says many health plans are already voluntarily complying because they like the independent reviews, but he says the Aetna decision raises new questions about how the process should be used. Ultimately, the independent review process should be designated by contract or by legislation that eliminates conflicts with ERISA, he says.

The elimination of independent review disappointed many backers of outside review, including Texas Atty Gen John Cornyn, LLM, Texas Insurance Commissioner Jos J Montemayor, Consumers Union, and plaintiff's lawyers.  

In the wake of the decision, Attorney General Cornyn encouraged all managed care operations to continue using the independent review process, which the Texas Legislature made voluntary in 1999. The attorney general said he would seek specific commitments from HMOs that are currently being sued by his office.  

Lisa McGiffert, a health issues advocate for Consumers Union, says she is pleased by the panel's decision on preemption, but she deplored the preemption of mandatory independent review.  

"A right guaranteed by Texas law has been taken away and replaced with review that is entirely up to insurers," Ms McGiffert said.  

George Parker Young, JD, a Fort Worth plaintiff's attorney who is involved in several suits against HMOs on the part of doctors, says the 5th Circuit decision is likely to lead managed care organizations to pick and choose which cases they want to send to independent review.  

Currently, Texas Department of Insurance statistics show that HMO decisions are upheld in roughly 50% of the reviewed cases. Mr Young says that Aetna HMOs may choose to submit to independent review only in cases where they feel they have an excellent chance of winning, giving the appearance that their decision-making is valid.  


Court decisions at a glance

Key impacts of the   Aetna decision  

  • The Employment Retirement Income Security Act of 1974 (ERISA) does not preempt state efforts to regulate and police the quality of medical care.  
  • Managed care organizations cannot be compelled to participate in the independent review process used to appeal health maintenance organizations' (HMOs') refusal to pay for care that patients and their physicians believe is appropriate or medically necessary.  
  • HMOs cannot drop physicians for advocating medically necessary treatment.  
  • Physicians cannot be required by contract to indemnify managed care organizations for legal costs of the organizations' wrongful decisions.  

Key impacts of the Pegramdecision  

  • Physician owners of HMOs cannot be sued under ERISA by health plan members for providing and receiving incentives to ration care. State remedies, such as the Texas Insurance Code, and other federal remedies, including the Americans with Disabilities Act and the Racketeer Influenced Corrupt Organization Act, are still available.  
  • Challenges to managed care decisions affecting quality of care are more appropriately tried in state courts.  



Independent review

The future of the independent review process was thrown into doubt by the US 5th Circuit Court of Appeals decision in the Aetna case, which ruled that health maintenance organizations (HMOs) and other managed care entities could not be compelled to participate. But the Texas Association of Health Plans and Texas Atty Gen John Cornyn both are urging managed care organizations to continue voluntary use of the independent review organization (IRO).  

Physicians may feel more comfortable helping their patients initiate the independent review process to challenge HMO decisions because the circuit court ruled that managed care organizations cannot retaliate against physicians who challenge decisions involving medical necessity.  

But here are a few things for physicians to keep in mind:  

  • It doesn't cost anything, and if the IRO rules that the treatment is necessary, the health plan must pay for your patient's care. But IRO appeals can be used only to contest treatment denials relating to care that may be medically necessary or appropriate.  
  • Before seeking an IRO appeal, complete the health plan's appeals process. That may entail a direct appeal through the plan or through the utilization review agent (URA) used by some plans to make payments.  
  • If the plan denies the internal appeal, you or your patient may request information and forms for an IRO review. Keep in mind that the plan does not have to participate in the process.  
  • If the health plan is willing to voluntarily undergo IRO review, return the completed forms, making sure the patient or his or her guardian signs a medical release form.  
  • The health plan or URA is required to immediately inform the Texas Department of Insurance (TDI) of the request, and TDI has 1 business day to assign the appeal to one of three Texas IROs. TDI will inform all parties of the assignment.  
  • From the time the health plan or URA receives a request, it has 3 business days to supply information to the IRO. The IRO may take up to 15 business days to make its decision after receiving the records or up to 20 business days after receiving the TDI review request. In life-threatening situations, the IRO has 8 calendar  days to make a decision.  
  • The decision notice will provide the clinical basis for the decision, a description of criteria used to guide the decisions, the qualifications of IRO staff who did the review, and a certification that there is no conflict of interest between the IRO and health plan.  

For more information on the process, call TDI's IRO Information Line at (888) TDI-2IRO (834-2476). In Austin, the line can be reached at 322-3400. The information is available online at www.tdi.state.tx.us/consumer/iro.html .  

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