Impact of Potential Changes to ERISA: Litigation and Appeals Experience of CalPERS, Other Large Public Employers and a Large California Health Plan – Report
Impact of Potential Changes to ERISA:
Litigation and Appeal Experience of CalPERS, Other Large Public Employers and a Large California Health Plan
By Coopers & Lybrand L.L.P.
Sandra Hunt, M.P.A.
John Saari, M.A.A.A.
Kelly Traw, J.D.
The Employee Retirement Income Security Act (ERISA) currently preempts state law related to the wrongful denial or delay of health benefits to the extent that such laws relate to a health benefit plan sponsored by a private employer. This preemption of state law has protected private employers who sponsor health benefit plans from legal actions based on such laws; courts have found that the scope of preemption extends to lawsuits against insurers and HMOs as well. ERISA provides the exclusive avenue for remedies in such cases, which generally are limited to the value of the denied benefit and, in some cases, reasonable attorneys' fees. ERISA does not allow claims for punitive damages or noneconomic damages.
In addition, ERISA governs the grievance and appeal procedures under private employee health benefit plans. Grievance and appeal processes provide an opportunity for individuals to resolve differences with their health plans before resorting to the court system. The Department of Labor, which administers ERISA, plans to issue regulations to require the grievance and appeal procedures of private sector employee health benefit plans to meet certain standards, including time frames for the resolution of appeals. Current greivance and appeal rules do not distinguish between types of claims for benefits (e.g., emergency vs. non-emergency services) and do not require external appeal procedures.
Legislation before Congress includes proposals to narrow the scope of ERISA preemption, allowing individuals to bring suit under state law principles against employee health benefit plans and other parties involved in the administration of the health plan. Many bills also have been introduced to amend ERISA and mandate the use of specific grievance and appeal processes, such as imposing faster turnaround periods for claims related to emergency services, specifying the manner in which decisions are to be made in an internal grievance and appeal process, and requiring the opportunity for a third-party review of certain appeals.
The implications of requiring the use of specific grievance and appeal processes and of allowing individuals to sue managed care organizations and other parties involved in the administration of a private employee health benefit plan are difficult to quantify. However, the experience of state and local government employers, which are not covered by ERISA, may be illustrative. Because such plans have not been shielded from lawsuits based on state law, their grievance and appeal processes and the incidence of litigation experienced by their health benefit plans may be a source of useful information in estimating the frequency of litigation that might be experienced by employers and health plans in the private sector if the scope of ERISA were narrowed.
To gather information on the experience of state and local governmental employers, we utilized contacts within the industry and from previous projects to identify individuals responsible for administering the plans' grievance and appeal processes and who had familiarity with and/or involvement in the litigation experiences of three large government entities that sponsor group health insurance coverage. The entities we identified are the California Public Employees Retirement System (CalPERS), the Los Angeles Unified School District (LAUSD) and the State of Colorado Employee Benefit Plan.
CalPERS provides health care coverage for approximately one million members. LAUSD covers about 70,000 members, and the State of Colorado Employee Benefit Plan covers about 30,000 members. CalPERS covers both active employees and retirees while LAUSD and the State of Colorado Employee Benefit Plan provide health care coverage for active employees only. Enrollment in managed care plans for each of these employers is 80% or higher, with CalPERS and the State of Colorado Employee Benefit Plan having 80% managed care enrollment and the LAUSD having 100% of its enrollees in HMOs or HMO-based Point of Service plans.
In gathering our information, we conducted multiple telephone interviews with individuals with extensive involvement in administrative appeals and litigation experience of health benefit issues for these government-sponsored health benefit programs. We sought information regarding the frequency, nature and costs associated with the appeals and litigation that these organizations have experienced. The individuals interviewed have had direct involvement in appeals and litigation for their organizations over an extended period of time, ranging from seven to fourteen years. In addition, for CalPERS we reviewed Evidence of Coverage booklets, internal procedures, legislation and regulations to obtain a more complete understanding of existing appeal procedures.
Each program has an internal grievance and appeals system established for individuals who disagree with a claims decision. The program grievance and appeal rules require that each step of the appeals process be exhausted prior to moving on to the next steps to resolve grievances. Under most state laws, including California and Colorado, an individual must exhaust available administrative procedures before bringing suit in state court. Therefore, a plan's grievance and appeals system provides a forum in which many benefit disputes are resolved, avoiding the need to file suit against a health plan, administrator, or employer.
CalPERS Appeal Procedures
CalPERS has a formal multistage appeal structure. The legal and regulatory foundation of this program is Section 22815 of the California Government Code and Section 555.1 of the California Code of Regulations. CalPERS requires that the appeals procedure be included in the Evidence of Coverage booklets for each of the HMOs and PPOs that contract with CalPERS. In addition CalPERS has developed a General Procedures for Administrative Hearings brochure for its members to understand the appeal process. This brochure is particularly useful for those appeal situations where the member is representing himself or herself.
The multistage appeal process involves an internal appeal procedure of the health plan, administrator, or HMO, and a subsequent appeal to CalPERS. Each successive stage is available only after exhausting the preceding stage of the appeal procedure. Time limits are included for each stage of the process ranging from 30 to 60 days, although time limits are not specified for all of the steps in each stage. For example, an individual must file with the plan his or her initial objection within 30 days of the action that is being appealed.
An appeal to the health plan, administrator, or HMO typically involves two to four steps, depending on the plan through which the individual receives coverage. A four-step internal appeal procedure would include:
- initial objection to the action;
- request for reconsideration;
- request for administrative review; and
- final appeal to the health plan's Consumer Appeals Department.
In 1995 California enacted additional requirements for the HMO appeal processes that established 30-day time limits at each stage of an appeal and an expedited appeal procedure in life threatening situations. These regulations became effective in April 1996 and January 1997 and included reporting requirements, penalties for non compliance and HMO-funded toll free access to the Department of Corporations (the HMO regulator in California). The health plan appeal process resulting from these reforms may take up to 60 days provided all information is correctly provided by the member and the member does not use the expedited appeal procedure. Prior to this legislation the appeal process could take up to 90 days.
Upon exhausting the plan's internal appeal process, an individual may be able to appeal to CalPERS, which has a three-step appeal procedure:
- an informal “consult and confer” process;
- a formal hearing process before an Administrative Law Judge; and
- a formal decision by the CalPERS Board of Administration.
If an appeal proceeds to litigation, California law protects CalPERS from punitive damage awards. This protection from punitive damages does not extend to the health plan.
The member is responsible for the legal costs of mounting an appeal, excluding any CalPERS staff costs. Although many California HMOs use binding arbitration, HMOs that contract with CalPERS must accept the CalPERS appeal process. Consequently, all CalPERS members have access to an external appeal process. CalPERS's staff believe that members use CalPERS's appeal process regardless of any binding arbitration requirements by an HMO that might otherwise apply.
The CalPERS appeal process is available for claims relating to the acts of and failure to act by contracting health plans, administrators and HMOs. For example, the process is available for appeals of decisions relating to improper payment for covered services, denial for coverage of services and eligibility determinations. The appeal process specifically excludes issues of medical malpractice, and CalPERS makes clear in its Evidence of Coverage brochure that appeals to CalPERS cannot be made related to medical malpractice.
CalPERS Appeal and Litigation Experience
For the seven-year period from 1991 through 1997, CalPERS indicated that there were approximately 60 appeals resolved at the administrative hearing stage of the appeal process (stage 2 of 3) as described above, for an annual rate of 0.9 appeals per 100,000 enrollees. The issues raised in these appeals generally involved denials of benefits and reimbursement disputes. The underlying medical conditions were generally not life threatening. The average internal cost to CalPERS for the preparation of a case before the administrative law judge was estimated by staff to be $10,000.
Over the same time period, between fifteen and twenty appeals reached the level of civil litigation, for a rate of 0.3 per 100,000 enrollees (i.e., the member was dissatisfied with the decisions resulting from the appeal process and proceeded to court. These civil litigation suits were brought against the health plans). Approximately twelve cases concerned denial of benefits and benefit exclusions. The medical conditions underlying these appeals were more serious and usually life threatening. The majority of these cases involved autologous bone marrow transplants for the treatment of breast cancer when this procedure was excluded based upon its experimental nature. Two or three cases involved eligibility issues. Two cases concerned coverage for twenty-four hour skilled nursing care, and one case involved coverage of rehabilitation services for an autistic child.
The majority of these cases were settled prior to trial; in many cases the complainant received at least partial payment for the requested services in the settlement. It is important to note that a significant number of the cases involved experimental procedures in a fast developing area of cancer treatment. It is very likely that similar incidents involving a cluster of lawsuits will occur in the future whenever advances in medicine result in experimental procedures that show promise of effectively treating a life-threatening disease.
Experience of Other Large Public Employers
We also interviewed administrators of the Los Angeles Unified School District (LAUSD) and the State of Colorado Employee Benefit Plan, both of which operate under rules that are largely similar to those used by CalPERS. Over the last fourteen years the staff of LAUSD could recall only three appeals that resulted in litigation. One of these cases involved autologous bone marrow transplant for breast cancer. The other two cases involved eligibility issues. Over the last seven years the State of Colorado Employee Benefit Plan had three appeals reach the litigation stage. One of these cases involved autologous bone marrow transplants for breast cancer.
All three programs reported very low rates of litigation ranging from 0.3 to 1.4 cases per 100,000 enrollees per year. The litigation rate per 100,000 enrollees decreased as the number of persons covered by the program increased. Grievances that reached the CalPERS administrative hearing stage numbered 0.9 per 100,000 enrollees per year. Assuming an average cost per case for litigation of $100,000 and the $10,000 estimate from CalPERS for the cost of an administrative hearing, the direct monthly cost per enrollee related to litigation ranged between $0.03 and $0.13.
The frequency of administrative appeals and litigation reflect the actual experience of CalPERS, LAUSD and the State of Colorado Employee Benefit Plan. This experience is most useful in estimating the administrative appeal and civil litigation exposure for plan sponsors. The specific features of the proposed modifications to ERISA will need to be compared to the CalPERS appeal process to determine any adjustments that may be needed to use these estimates to forecast the impact of the change. Among the factors that could affect the frequency and cost of any appeal process are the internal time limits, the availability of punitive or other damages, and any differences in appeals and litigation between government and non-government plan sponsors.
Impact on Health Insurers and HMOs
Because health insurers and HMOs are more actively involved in the administration of benefit plans and do not enjoy an employee/employer relationship with their members, they may be subject to greater appeal and litigation risks than plan sponsors. Whether health insurers and HMOs are vulnerable to punitive damages awards depends on the relevant state law. These health plans may be subject to federal rules governing appeal procedures, which would likely be enacted if liability reform is enacted.
We have identified two sources of data on the changes in the frequency of litigation for a large health insurer and HMO in California that provide some indication of the costs associated with a modification in the ERISA protection for health insurers and HMOs. These include:
- the plan's litigation experience prior to the 1987 decision in Pilot Life v. Dedeaux, in which the U.S. Supreme Court held that ERISA preempts a lawsuit based on state law against an insurance company for improper claims processing, including the manner in which decisions are made regarding the payment of claims; and
- the plan's litigation experience in the individual health insurance market.
Carrier's Litigation Experience
It is noteworthy that the California carrier experienced a significant drop in the rate of litigation concerning improper claims processing for benefits and determination of covered benefits under an ERISA-covered plan after the Supreme Court's 1987 decision in Pilot Life. From 1985 to 1988 this carrier reported an average of 3.2 litigation cases per 100,000 members, which largely reflects claims under group health plans, although this figure also reflects some claims related to individual plans. Our interviewee reported that lawyers for consumers typically attempted to bring a claim as a representative of a group rather than of an individual because there was perceived to be a greater probability of success.
Subsequent to the Supreme Court's ruling that ERISA preempts cases concerning improper claims processing, litigation cases dropped to 2.4 per 100,000. (This number also includes both group and individual coverage cases.) This change in total litigation experience represents a decrease of 25%, although it is important to note that it is not possible to split the litigation experience between group and individual claims for these two time periods.
ERISA does not apply to individual health insurance coverage, and health plans active in the individual health insurance market have been subject to lawsuits under state law. Beginning in 1993 the health plan we examined began to track litigation related to individual insurance policies separately from litigation related to group health plans. The plan experienced 9.3 lawsuits per 100,000 members per year related to individual coverage for the period January 1993 through June 1996, compared to an average of 1.3 per 100,000 for members covered by groupinsurance.
This difference in litigation experience between individual and group coverage may be partially attributable to differences in ability to sue, the extent of internal and external appeal processes, and differences in the health care needs and circumstances of individuals with group versus individual plans. Those individuals who purchase insurance on their own may have greater health care needs, or may have a greater sense of ownership of the insurance benefit compared to those who receive coverage as an employee benefit. Additionally, many individual policies contain specific limitations on benefits (known as “riders”) that may lead to additional litigation if members attempt to obtain coverage for services that have been excluded from their benefit plan. Consequently, an exact extrapolation cannot be made of the difference in experience, although the data can be used to gain an understanding of the order of magnitude of potential changes in litigation rates.
General Cost Impact
An important consideration in evaluating the effect of potential changes in liability on health plan costs is the average cost per claim in either damages or settlement and the number of claimants. A litigation rate of 3.2 per 100,000 plan members with an average cost per claim of $100,000 translates to $0.27 per person per month. This amount represents approximately 0.25% of premium. If this rate were to double, health plan premiums related to litigation would increase to $0.54, or approximately 0.5% of premium. Note that the numbers provided here are for illustrative purposes only; we do not believe it would be valid to extrapolate the experience of one health plan to the entire managed care health insurance market.
The effect of a change in liability may be expected to vary for health plans that are currently active in the individual insurance market compared to those who sell health insurance only to groups. Those plans offering individual insurance may have greater experience with litigation related to medical malpractice and other benefit issues. Health plans that offer only group insurance coverage may see greater changes in their litigation experience and associated costs. Whether a health plan uses binding arbitration to settle cases may also affect its litigation experience; binding arbitration is likely to reduce the number of disagreements regarding health plan coverage that would reach the courts. Finally, the size of the health plan may impact these costs on a per member per month basis with per member per month costs decreasing as the enrollment of the health plan increases.
We interviewed three large public employers that are not protected by ERISA regarding their litigation experience. All three reported very low rates of litigation ranging from 0.3 to 1.4 cases per 100,000 enrollees per year. The litigation rate per 100,000 enrollees decreased as the number of persons covered by the program increased. Grievances that reached the CalPERS administrative hearing stage numbered 0.9 per 100,000 enrollees per year. The groups we interviewed have strong internal appeals procedures. In addition, other characteristics of the grievance process may have limited the number of cases reaching the civil litigation stage. These include:
- Limited availability of punitive damages;
- The employers in question were all public employers; it may be that public employees have a different propensity to sue than employees of private firms; and
- The plan sponsors were specifically not responsible for medical necessity determinations.
We believe the information discussed here provides some guidance regarding potential changes in litigation rates that may result from a change in rules regarding ERISA protections. The net effect of this type of rule change is difficult to project, as behavior patterns may change with a change in law. An assessment of the effects of this legislative change should take into account the type of internal and external appeal processes that may be in place concurrent with the change in health plan liability. Changes in health plan behavior, including loosening or clarifying utilization review criteria may also occur. If health plans respond to a change in liability by loosening utilization review standards so as to avoid exposure to some litigation there may be an increase in health care costs resulting from increased utilization. If health plans respond by clarifying their standards and communicating those standards to providers and health plan members there may be little change in health plan costs, or perhaps decreases in costs, associated with changes in utilization.
The experience of one large health plan in California before and after clarification of the application of ERISA protection to health plans and HMOs also provides information on potential changes in litigation rates. For that health plan, litigation rates dropped by 25% when the ERISA protection was clarified. This rate may be expected to return to its pre-1988 level if liability rules were changed. Litigation costs for this health plan prior to theses changes represented approximately 0.25% of premium.
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Impact of Potential Changes to ERISA:
Litigation and Appeal Experience of CalPERS, Other Large Public Employers and a Large California Health Plan