Employer sponsored health benefit plans under ERISA after Pegram v. Herdrich: the fiduciary duty argument and mixed eligibility versus treatment decisions.

• Author: Karns, Jack E.
• Position: Employee Retirement Income Security Act of 1974

1. INTRODUCTION AND BACKGROUND

   On June 12, 2000, a unanimous Supreme Court quietly rendered what will almost certainly become a landmark decision in healthcare law relative to the interpretation and application of fiduciary duties in an Employer Sponsored Benefit Plan [hereinafter "ESBP"] as regulated by the Employee Retirement Income Security Act of 1974 [hereinafter "ERISA" or the "Act"]. (2) In Pegram v. Herdrich (3) the Court rejected patient Herdrich's claim that a cost containment plan whereby annual payments were made to physicians rose to the level of imposing a fiduciary duty on an HMO pursuant to ERISA. (4) Such a duty would require the providing company to manage the ESBP funds in accordance with the statute and traditional common law principles. (5) Carle Company, a large Health Maintenance Organization, maintained a policy of making annual kickback payments to physicians who cordoned costs at a pre-determined level. (6) The corporation's rationale was that the payments were an incentive to keep costs down, the very essence of the HMO industry. (7)

   Plaintiff Herdrich had been treated by Doctor Pegram who failed to make a referral to a specialist despite patient complaints of severe abdominal pains. Medication was prescribed and the patient sent home. (8) Eventually, Herdrich suffered a ruptured appendix along with the typical resulting complications. (9) She sued Carle Company under the theory that the kickback payments violated the ESBP clause of the ERISA statute in that the company stood as a fiduciary of the funds over which it presided. (10) Specifically, Section 1109(a) of ERISA provides that:

   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 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. (11) The monies in question had been collected from the employer and the worker, and as such, Herdrich claimed that Carle Company had a higher duty to insure their protection and proper use. (12) She also filed a negligence malpractice claim against the individual physician, Dr. Pegram. That suit eventually resulted in a jury verdict in favor of Herdrich with monetary damages. (13) Carle Company, on the other hand adamantly stood by its position that the ESBP did not impose any fiduciary obligation relative to its handling of employee health care plan premiums. (14) The issue as to whether ERISA preempted the claim against the company was not the focal point of the Circuit level dispute regardless of its growing importance amongst members of the managed care industry to keep states and class litigants from initiating any type of legal action comparable to that seen recently in the tobacco cases. (15)

   Previous to the issuance of the Court's opinion in June 2000, the author prepared an article based on the Seventh Circuit's opinion holding in favor of Herdrich. (16) That article agreed in every respect that the managed care industry is insufficiently controlled in this country, or in the alternative, is controlling health care costs at the expense of one patient at a time. (17) More specifically, arguments were made supporting the Seventh Circuit's decision as to the fiduciary application of ERISA against the Carle Company. (18) Although accepted for publication prior to the Supreme Court's opinion hand-down date, the article was not available for circulation until subsequent to June 2000. (19)

   Accordingly, this Article is a rebuttal to the Supreme Court's opinion in Pegram v. Herdrich on the strength of two primary arguments. First, the Seventh Circuit's rationale was on-point and extremely sound in concluding that HMOs do stand as trustees as envisioned by the ESBP and cannot offer kickback payments to physicians simply to increase shareholder wealth at the expense of patient health and welfare. (20) This was a textbook example of breach of fiduciary duty given the medical trust relationship between physician and patient. (21) Had the HMO offered a hedge fund option using securities from firms other than itself, there is no question that the fiduciary issue would have been much more difficult for Herdrich to establish. (22) But by offering cash incentive payments, Carle Company wedged the interest of shareholder wealth maximization between that of physician performance and patient health needs. (23) This created a natural fiduciary tension that cannot be explained away by Justice Souter's comment that, "[t]he pleadings must also be parsed very carefully to understand why acts by physician owners acting on Carle's behalf are alleged to be fiduciary in nature." (24) All such decisions are fiduciary in nature. (25)

   Secondly, even though the courts did not deal with the preemption issue, Pegram opens the door for the industry to next claim complete preemption from state regulation via ERISA's provisions. (26) The managed care industry cannot have it both ways. If the ESBP does not apply to HMOs then neither does the preemption provision of the retirement Act. (27) This would then allow state attorneys general to provide at least minimal protection to residents by regulating managed care organizations via state consumer protection statutes. (28) These are sometimes referred to as "Little FTC Acts," and could be utilized in conjunction with other specific legislation aimed at curbing abuses in this business. (29) For example, North Carolina's new "Patient Bill of Rights" provides for external review of HMO procedures. (30) It also prescribes prompt payment of claims and utilization review. (31) Predictably, supporters of the Pegram decision see managed care organizations as recipients of everything on their wish lists, and then some, by implying too much from Justice Souter's opinion:

   This ruling may not formally end the many class actions filed against HMOs across the country since October [1999]. But the Supreme Court's recognition that the very nature of an HMO involves cost controls reveals these lawsuits for what they are (but claim not to be) -- broad based assaults on the concept of managed care. The court's decision also shows that the insured are unlikely to benefit if these suits prove successful. Instead, they are likely to encounter higher premiums, less access to health care and health insurance, detailed judicial oversight of health care delivery and massive attorney fees. Yet the HMO class actions attack virtually every incentive and practice managed care entities employ to try to curb medical costs. Accordingly, as Justice Souter implicitly recognized, these suits, if successful, would preclude HMOs. Justice Souter's commonsense approach undercuts the theory of the class actions. `The Federal Judiciary would be acting contrary to the congressional policy of allowing HMO organizations if it were to entertain lawsuits that `portend wholesale attacks on existing HMOs solely because of their structure.' The court thus confirmed what everyone already knew: Managed care necessarily entails financial incentives to control runaway medical inflation. (32) Finally, the clarity of the Court's position relative to the straightforward question of whether an employer sponsored health plan falls under the purview of ERISA's fiduciary provision is no longer in issue. (33) However, the significant question is how the decision will affect state efforts to regulate managed care without running afoul of any federal preemption standards established by Pegram, implied or expressed? This is particularly troublesome since the next obvious step for the managed health care industry would be to argue that this case settles all issues regarding both fiduciary and federal preemption of state regulation. (34) Pegram did not directly address the preemption question, but the industry could easily look to a corollary situation for support.

   In 1992, airline carriers argued that the Texas Attorney General [hereinafter "AG"] did not have the authority to impose advertising regulations given the preemption of any such efforts as set forth in [section] 1305(a)(1) of the Airline Deregulation Act of 1988 [hereinafter "ADA of 1988"]. (35) Specifically, the airlines pointed to language in the section that the federal government had the authority to regulate "any law, rule, regulation, standard, or any other standard having the force and effect of law relating to rates, routes, or services of any air carrier." (36) In Morales v. Trans World Airlines, Inc., (37) the Texas AG sought to impose section 2.5 of Air Travel Industry Enforcement Guidelines [hereinafter "Guidelines"], a document which had been adopted by the National Association of Attorneys General [hereinafter "NAAG"]. (38) The key issue in this case concerned the manner in which airlines advertised the component parts of total air fares, while [section] 2.5 of the aforementioned Guidelines related to the handling of surcharges and stated that "[a]ny fuel, tax, or other surcharge to a fare must be included in the total advertised price of the fare." (39) The airlines had engaged in the process of "unbundling" fares such that surcharges were not included in the large print prices but were, instead, listed in fine print at the bottom of the advertisement. (40) Texas, along with six other signatory states, sent a memorandum and copy of the Guidelines to the major airline carriers indicating that failure to heed [section] 2.5 and that the standing practice of "unbundling" fare prices were violations of the Guidelines. (41) Perhaps more importantly, the signatories added that the actions constituted a clear "violation of our respective...