Appeals Court Backs Insureds’ Attack on ‘Postclaims Underwriting’

Thursday, December 27, 2007

Page 1

Appeals Court Backs Insureds’ Attack on ‘Postclaims Underwriting’

Fourth District Panel Places Burden on Health Plans to Investigate Possible Omissions From Applications

By KENNETH OFGANG, Staff Writer

A health service plan cannot rescind a contract with an insured based upon material misrepresentation in an application unless the omission was willful or the plan reasonably investigated before it issued the contract, the Fourth District Court of Appeal has ruled.

The court Monday reinstated an Orange County couple’s bad faith and intentional infliction of emotional distress claims against Blue Shield of California and overturned a judgment requiring the couple to reimburse more than $100,000 that Blue Shield had paid on their behalf before rescinding their coverage.

The plaintiffs, Cindy and Steve Hailey, presented enough evidence to create a triable issue as to whether Blue Shield engaged in unlawful “postclaims underwriting,” Justice Richard Aronson wrote.

Incomplete Application

The Haileys applied for Blue Shield coverage in late 2000. Cindy Hailey, who had temporarily retained coverage from a previous employer under the 1985 legislation known as COBRA, testified that she sought the coverage because, unlike the coverage offered by her new employer, it would cover the services of her family physician.

Cindy Hailey completed the portion of the application relating to her personal health history. She did not provide information regarding the health of her husband or son, and testified that she mistakenly believed at the time that she was not required to do so.

Steve Hailey signed the application, but declared in the court proceedings that he had not read it. Blue Shield extended coverage to the family at its “premier” or best rate beginning in December 2000.

Steve Hailey was subsequently hospitalized twice, once for stomach problems, and once due to a disabling auto accident. His medical bills totaled more than $450,000.

On June 1, 2001, Blue Shield notified the Haileys that their coverage was cancelled, retroactive to the date the policy was issued, because they had not informed the carrier that Steve Hailey had been seen for obesity and stomach problems two months before coverage was extended.

Cindy Hailey then obtained new coverage through her employer. But in suing Blue Shield, the couple contended that the new coverage was limited based on preexisting conditions, preventing Steve Hailey from obtaining needed surgery, and that he suffered permanent damage to his bladder as a result of delays in obtaining care as a result of the cancellation.

Summary Judgment

Orange Superior Court Judge Corey Cramin granted summary judgment, finding that Blue Shield was entitled to rescind based on misrepresentations and omissions.

But Aronson, writing for the Court of Appeal, said the Haileys presented enough evidence to raise triable issues as to whether the omissions were willful, and whether Blue Shield adequately investigated before accepting their application for insurance.

Those issues, the justice explained, are governed by a 1993 law, the Health Insurance Access and Equity Act, and specifically by Health and Safety Code Sec. 1389.3.

The statute provides:

“No health care service plan shall engage in the practice of postclaims underwriting. For purposes of this section, ‘postclaims underwriting’ means the rescinding, canceling, or limiting of a plan contract due to the plan’s failure to complete medical underwriting and resolve all reasonable questions arising from written information submitted on or with an application before issuing the plan contract. This section shall not limit a plan’s remedies upon a showing of willful misrepresentation.”

While “the import of section 1389.3’s last sentence is unmistakable”—if a misrepresentation is willful, the insurer can rescind—the Haileys raised a triable issue as to whether the omission was accidental and the result of a confusing form, Aronson wrote.

“Cindy’s explanation for omission of Steve’s information is not patently unbelievable,” the justice wrote.

In one place, he pointed out, the application form instructs: “List applicant and all family members you wish to cover”—suggesting that family members are not considered coapplicants—yet in another place, Blue Shield asks for medical information for “you or any applying family member.” Nor does the form include separate questions about other family members, Aronson noted.

“The form, although understandable upon close examination and reflection, is no model of clarity, and lends credence to Cindy’s explanation of her omission of Steve’s health information,” the justice wrote.

Aronson rejected Blue Shield’s contention that even if the omissions were merely negligent, it is entitled to rescind because it assessed risk and extended coverage on the basis of the answers given. That is inconsistent with the statute’s ban on postclaims underwriting, the justice concluded.

The purpose of the ban, he explained, is to prevent the “patently unfair” practice of collecting premiums from unsuspecting insureds, then rescinding their coverage when they submit large claims, leaving them unable to obtain alternative coverage. If covering the insured represents an unacceptable risk, the justice said, the insured is entitled to know that before the coverage is extended.

“In the present case, the record demonstrates Blue Shield conducted an extensive investigation into Steve Hailey’s medical history after receiving a claim stemming from Steve’s hospitalization for intestinal ailments,” the justice wrote. “In contrast, Blue Shield apparently did little or no investigation into whether the medical information Cindy provided on the application was accurate. Instead, Blue Shield performed its risk assessment on the assumption the application contained no errors. Upon receiving a hospitalization claim under the plan, however, Blue Shield launched an investigation in which it obtained extensive medical records.”

Blue Shield, the jurist went on to say, could have avoided “the tragic situation” by using the release it obtained from the couple—the same release they later used to obtain Steve Hailey’s medical records—to contact the family’s physicians or its previous insurer. Or it could have simply asked Cindy Hailey whether she included the necessary information about her husband and son, Aronson said.

Rescission, he added, is an equitable remedy that is supposed to restore both parties to the status quo, which is impossible after an insured sustains a major injury or illness and cannot pay their bills or obtain new coverage.

Aronson also concluded that there was sufficient evidence for the Haileys to proceed to trial on their claims of bad faith and intentional infliction of emotional distress.

“The facts presented here raise an inference Blue Shield may have acted in bad faith by delaying its decision to rescind the policy,” citing evidence that the company opened a fraud investigation four months before it rescinded the policy, along with the testimony of the company’s underwriting investigator.

The investigator said she investigated about 1,000 claims per year, but fewer than one percent of them resulted in rescissions, which Aronson said suggested that the company unlawfully takes a “wait and see” attitude and continues “to collect premiums while keeping open its rescission option if the subscriber later experiences a serious accident or illness that generates large medical expenses.”

Aronson acknowledged that the termination of a health care services contract, in and of itself, will not be considered sufficiently outrageous to give rise to a claim for intentional infliction of emotional distress.

“But a plan acts in an outrageous manner if it obtains information entitling it to rescind, yet deliberately foregoes rescission until after the subscriber has suffered a serous illness or injury,” the jurist wrote. “By adopting a ‘wait and see’ attitude, a plan not only risks bad faith liability, but liability for intentional infliction of emotional distress if the plan knows the subscriber ‘is peculiarly susceptible to emotional distress, by reason of some physical or mental condition or peculiarity.’”

The case was argued on appeal by Jeffrey L. Garland for the Haileys; Patricia Sturdevant for the California Department of Managed Health Care as amicus in support of the Haileys; Glenn E. Solomon of Hooper, Lundy & Bookman for the California Medical Association, also as amicus supporting the Haileys, Andrew L. Frey of Mayer, Brown, Row & Maw for Blue Shield; and Gregory N. Pimstone of Manattt, Phelps & Phillips for the Association of California Life and Health Insurance Companies as amicus in support of Blue Shield.

Additional amicus briefs were filed on behalf of the California Department of Insurance, United Policyholders, and attorney William M. Shernoff in behalf of the plaintiffs and the California Association of Health Plans in support of Blue Shield.

The case is Hailey v. California Physicians’ Service, 07 S.O.S. 7569.