Coverage in Tatters

By Jeanette Borzo

One night in September 2007, Jeffrey B. Isaacs, the chief assistant city attorney in Los Angeles, was going through his usual stack of newspapers when he came across an article describing an insurance case then before the state court of appeal.

The plaintiff, an Orange County small business owner, had been badly injured in a car accident and incurred bills of more than $450,000 for treatment. While he was still recovering, his insurer, Blue Shield of California, rescinded coverage - alleging that his wife had made misstatements onthe family's application. According to the article, the rescission forced the plaintiff to delay surgery, leading to bladder failure and his permanent dependence on an implanted catheter. The trial court had granted Blue Shield's motion for summary judgment, and the plaintiff appealed.

The article's author, William M. Shernoff, a senior partner in Claremont's Shernoff Bidart Darras + Echeverria, argued that Blue Shield's policy applications were designed to confuse, so that misstatements would provide an excuse for rescission should a policyholder ever require expensive treatment. "At a time when the policyholders are seriously ill, the insurance company walks away, leaving them uninsured, uninsurable and buried in debt," wrote Shernoff, a pioneer in the field of bad faith litigation and an amicus in the plaintiff's appeal (Hailey v. California Physicians' Service).

Shernoff's article stopped Isaacs in his tracks. Fresh off of two years' work on a hospital patient - dumping scandal, Isaacs and the rest of Los Angeles City Attorney Rocky Delgadillo's senior staff had a heightened awareness about the failure of the health care system. Delgadillo had hired Isaacs, a 15-year veteran federal prosecutor, in 2005 to head the city's Criminal and Special Litigation Branch. Part of Isaacs's mandate was to combat consumer fraud using California's Unfair Competition Law (UCL). And if health insurance rescission was part of a pattern and practice as Shernoff contended, Isaacs thought, he could use the UCL to great effect.

In the months after Shernoff's article appeared, Isaacs got the green light from Delgadillo to assemble an investigative team to interview alleged victims of unwarranted health insurance rescissions.

"You don't sue Fortune 500 companies lightly, without making sure your boss knows what he's getting into," Isaacs observes.

Isaacs also had his staff call plaintiffs attorney Shernoff, inviting him to meet to discuss ways the city attorney's office might work cooperatively with his law firm.

"We wanted to better understand the nature of the problem," Isaacs says, "to gauge its seriousness, to discuss remedies, to determine the status of pending litigation, to see what kind of evidence was available, and to determine if it was an area that warranted attention. We wanted to confirm that our action would not undermine their position in the case."

Shernoff admits being puzzled by the call. "I was a little skeptical," he says. "At that time, I had no experiene with public officials coming to my aid."

But Shernoff accepted the invitation. In early December 2007 he met with about a half-dozen assistant city attorneys to discuss a multifaceted, statewide campaign against unjustified policy cancellations. Shernoff told them he had grown frustrated fighting the same battle over rescissions year after year. So in March 2006 he'd filed 10 lawsuits on a single day against Blue Cross of California and Blue Cross Life & Health. He hoped the mass filing would attract attention, and it did: Two days later John Garamendi, then state insurance commissioner, spoke approvingly of the litigation and revealed his office's ongoing investigation of Blue Cross's large profits. The state Department of Managed Health Care (DMHC) also responded, promising to launch a separate investigation of Blue Cross. A month later, Shernoff recounted, he filed 13 more lawsuits - 10 against Blue Cross and 3 against Blue Shield of California. The Los Angeles Times covered the court filings and launched a series of reports on health insurance cancellations.

The lawsuits, Shernoff explained, also attracted some powerful allies in the medical profession: doctors and hospitals that had been stuck with unpaid medical bills after a patient's health coverage was rescinded. By April 2007 the California Medical Association and the California Hospital Association had joined a class action filed in Los Angeles Superior Court against Blue Cross of California. And other plaintiffs attorneys meanwhile were filing their own suits and class actions.

Shernoff told the city attorneys of various enforcement actions by the DMHC, including a $1 million fine levied against Blue Cross of California in March 2007. Two months after that, in settling a class action with Shernoff, Blue Cross promised not to cancel individual health insurance policies unless the company could show deliberate misrepresentation. But that settlement later fell apart. Nearly all the critical public policy issues - including uniform standards for legal rescissions, notification procedures for policyholders, plain-language requirements for health insurance applications, and the possible need for legislation to address the recent outbreak of rescissions in the state - were still unresolved.

Clearly, health insurance rescissions had attracted a dog pile of plaintiffs lawyers. But as Shernoff points out, city attorneys and local DAs can bring several things to bear that the plaintiffs bar cannot: They can launch criminal investigations, use the UCL to assess civil penalties against insurers, and sue on behalf of the People of California without having to certify a class (See Cal. Bus. & Prof. Code §§ 16759, 17200-17210 & 17508).

Isaacs, for his part, was prepared to use each of those tactics - along with conducting thorough investigations and offering policy input - to end illegal policy cancellations. "I've never seen otherwise legitimate companies so misuse the law for their profit and then refuse to accept that they did anything wrong," says Isaacs. "We can't let major health insurance companies get away with unlawful practices."

Shernoff left the meeting impressed. "My skepticism evaporated," he says. "Here was a city attorney really willing to commit resources and staff. Jeff was completely invested in getting meaningful recovery for the plaintiffs. This was a major happening - a public official was going to jump in. I felt we had a good and serious ally."

The threat of health care policy rescission directly affects about 3 million Californians, most of whom don't have employer-provided insurance. These individuals often have middle-class jobs as hairdressers, plumbers, or actors and must buy health insurance on their own as part of the so-called individual/family plan group.

Though insurers say that only a minuscule percentage of such policies are ever rescinded, the numbers appear to be rising. Certainly, complaints about the practice have increased, according to the DMHC. And the Los Angeles city attorney claims in court documents that insurance companies rescinded the policies of more than 8,000 Californians from 2002 to 2007. During that period, Blue Cross rescinded insurance on at least 6,000 policyholders, Health Net on 1,600, and Blue Shield on 850.

Bryan A. Liang, executive director of the Institute of Health Law Studies at California Western School of Law in San Diego, suggests that the rise in rescissions follows a broader trend: As fewer companies offer insurance to their employees, more people have to buy individual policies - and the number of rescissions rises in tandem. "This has been brewing for a while, as people have been losing their group insurance," says Liang, who is both a physician and a lawyer. "For at least the past 15 years, the individual [policy] market has been exploding."

That explosion has been driven by a deep-seated fear of living without health insurance. For example, one attorney on Isaacs's staff asked to be excused from working on the rescission cases, because she feared potential retribution from her health insurer. "There is a visceral reaction to these cases ..., a 'There but for the grace of God go I' feeling," says Isaacs.

Whether they're justified or not, such apprehensions convinced Isaacs that the social damage from health insurance rescission extends far beyond the thousands of Californians who are directly involved. "Consumers may change their behavior because of the way insurers approach their obligations to policyholders," Isaacs says. "Are you not going to the doctor because you're thinking of changing jobs and don't want something harmful on your health record?"

Insurers, on the other hand, view policy rescissions as a legitimate means of controlling consumer fraud. When an individual files a major claim shortly after taking out a policy, companies may suspect that the insured knew about a preexisting condition and either failed to disclose it or misrepresented it on the application. (In the Hailey case, for example, Blue Shield claimed that when policyholder Steven Hailey's wife, Cindy, filled out a family policy application, she misstated her husband's weight by 45 pounds and failed to disclose his history of hypertension and acid reflux disease.) With some 45 million Americans lacking health insurance, it's not hard to imagine that some applicants would lie to obtain it.

At the center of these rescission-related cases is the duty of good faith and fair dealing: When an insurer cancels a policy because of misstatements or omissions on the application, is the company combatting fraud - or using deliberately complicated forms to later avoid paying for treatment? Conversely, when applicants misstate or omit details of their medical histories, are they simply forgetful or confused - or hiding preexisting conditions?

Isaacs concedes that insurers may have initially used rescissions to control fraud. "But now it appears to have evolved into a cost-savings method," he says. "It's a systematic, institutional process to flag and pull anything that looks costly to the company." Some insurers, he notes, even have a list of "rescission diagnostic codes" - a group of medical conditions that, when reported on claims, trigger an investigation into potential falsehoods on a policyholder's application that might justify rescission.

"What a great business strategy," says Liang. "Collect policy dues but never pay on policy claims."

Isaacs and others argue that misinformation found in applications often means the forms are so confusing and ambiguous that almost anyone could be subject to rescission. In December 2007 Court of Appeal Justice Richard M. Aronson stated as much in a unanimous opinion in Hailey that reversed the summary judgment and remanded the case for trial (158 Cal. App. 4th 452). Blue Shield's application form, Judge Aronson wrote, "although understandable upon close examination and reflection, is no model of clarity, and lends credence to [wife] Cindy's explanation of her omission of Steve's health information." Facts in the case, Aronson continued, "raise an inference Blue Shield may have acted in bad faith by delaying its decision to rescind the policy."

In the ruling, Aronson points to a key point of contention in many rescission cases: post-claims underwriting. This practice of evaluating a policyholder's insurability after coverage has been issued violates state law (Cal. Ins. Code §§ 10380-10390; Cal. Health & Safety Code § 1389.3). Aronson noted that to rescind a policy for material misrepresentation or omission, the insurer would first have to show either that it had reasonably investigated the application before it issued coverage, or that the policyholder willfully misrepresented information on the application.

If that weren't complicated enough, two codes regulate health insurers in California, making bad faith law even more complex to litigate. Shared-risk insurers, which issue policies to preferred-provider organizations, are covered under the Insurance Code and regulated by the Department of Insurance. Health maintenance organizations are, in general, covered under the Knox-Keene Health Care Service Plan Act of 1975 (Cal. Health & Safety Code §§ 1340-1345) and regulated by the DMHC. "There is confusion because you have two regulatory schemes," says Isaacs. "These are very complex cases. You get bounced back and forth between the different statutes."

One key difference between the codes involves willful misrepresentations on policy applications: Under the Insurance Code, neither intentional nor unintentional misrepresentations justify rescission if the insurer has not completed its medical underwriting prior to issuing a policy. But under the Health and Safety Code, "willful misrepresentation" appears to be sufficient justification for rescission.

Armed with Delgadillo's support, Shernoff's experience, and the recent Hailey decision, Isaacs set out to assemble a "dream team" of investigators before the year's end. He hired four former FBI agents, led by John Keller and Daniel M. Martino, who had supervised the bureau's Health Care Fraud Program in Los Angeles. The investigators created a secure website where they solicited, collected, and screened complaints from former policyholders about allegedly unjustified rescissions.

The work paid off. In February 2008, Isaacs disclosed his office's criminal investigation of Health Net's alleged practice of basing employees' bonuses, in part, on the number of health care policies they had canceled. That investigation is ongoing and includes the question of whether Health Net employees made false statements to the DMHC regarding the bonus payments. Isaacs also filed a civil case against Health Net and two of its subsidiaries - under both the UCL and the False Advertising Law (Cal. Bus. & Prof. Code §§ 17500-17509) - for unjustified rescissions that led to claim payments being either denied or delayed. How many consumers, he asks in the complaint, can be expected to respond accurately when asked if they have ever had "any signs or symptoms" of phlebitis, pyelonephritis, or Raynaud's disease?

Then, last April, Isaacs filed a similar civil case against Well Point and two of its Blue Cross subsidiaries. In July he filed a third case, against Blue Shield of California and a subsidiary. All three complaints carry maximum potential fines of $1 billion.

Shernoff, too, was making progress in his rescission cases. In a February 2008 arbitration, retired Judge Sam Cianchetti granted Shernoff's motion for summary judgment that Health Net had breached the insurance contract of Patsy Bates, a self-employed hairdresser whose policy was rescinded after she developed breast cancer. Cianchetti also found, as a matter of fact, that the company had a policy of awarding bonuses based, in part, on whether an employee met certain rescission goals. "It's difficult to imagine a policy more reprehensible than tying bonuses to encourage the rescission of health insurance that keeps the public well and alive," Cianchetti wrote. Furthermore, he found that Health Net kept a list of several hundred medical conditions that, if found in claims information, could trigger an investigation that might lead to rescission. He awarded Bates nearly $1 million in compensatory damages and an additional $8.4 million in punitive damages. (A copy of the confidential interim arbitration award was obtained by California Lawyer.)

Robert Gianelli, a name partner in Los Angeles's Gianelli & Morris who has filed several rescission suits against Blue Cross and Blue Shield, says the figures in Bates are "off the charts." And considering that "plaintiffs lawyers are always fighting to stay out of arbitration" because of low awards, Gianelli calls the decision a landmark.

William A. Helvestine, managing shareholder at Epstein Becker & Green in San Francisco and an attorney for Health Net in the case, declined to comment on the Bates award.

Insurance defense attorneys frequently complain that because their clients are bound by privacy provisions of the Health Insurance Portability and Accountability Act of 1996 (HIPAA) (42 U.S.C. §§ 1320d-1 through 1320d-8), media coverage of cases against them can appear biased. Consumers can disclose any information they want, while insurers must remain silent about many particular facts, says John M. LeBlanc, a partner at Barger & Wolen in Los Angeles and Blue Shield's outside counsel. "What you hear in the media is one side of the story," he says. "But when Blue Shield defends itself in the courts, it has been very effective."

Regarding Judge Aronson's remarks in the Hailey case about the complexity of the company's policy applications, LeBlanc says that Blue Shield assumes substantial risk when it insures someone, so it naturally "does not want bad information. [It] could be on the hook for significant medical expenses." Therefore the company, he says, designs thorough questionnaires.

Helvestine, of Epstein Becker, concurs. "Applications are designed to be comprehensive," he says. "They are not designed to result in rescission. The number of claims that are reviewed compared to the number of rescissions is very small."

In fact, according to the finding in Bates, Health Net rescinds fewer than 7 percent of the policies issued from applications it investigates. A spokesperson for Blue Cross claims the company rescinds "less than 1 percent" of all individual policies.

Last summer the combined efforts of attorneys, the press, and regulators to halt unjustified rescissions had begun to have an impact. The DMHC announced the first of a series of agreements with insurers to reinstate thousands of individuals and to pay fines for rescinding their policies. By July three of California's largest insurers - Blue Cross, Blue Shield, and Health Net - had stipulated that they would notify canceled policyholders to advise them of their various options for reinstatement or recovery of past medical expenses. The three companies were fined a total of $18.3 million, including a $10 million fine against Blue Cross of California that replaced the earlier fine of $1 million levied by the DMHC. Insurance Commissioner Steve Poizner then announced similar settlement agreements with Health Net in September and with Blue Shield in January.

The DMHC settlements and fines offered some relief for health care consumers, but they also produced tactical splits among consumer advocates. In particular, there were tensions between the plaintiffs bar and regulators at the DMHC over how hard to push insurers in revising rescission standards. "Somebody in Sacramento made a decision that we're going to stop fighting the insurance plans," Isaacs contends. "They flipped back to appeasement. Talk about an about-face."

The bad feelings were evident at a daylong settlement conference held last September at the Central Civil West Courthouse in Los Angeles. Superior Court Judge Peter D. Lichtman had summoned the opposing sides to see if they could resolve more than 30 rescission cases pending against Blue Cross. Isaacs, Shernoff, Gianelli, and several other plaintiffs lawyers gathered early to map settlement strategy.

In the hall outside Lichtman's office, Isaacs waved a copy of Health Net's notice to rescinded policyholders that he had just received. Calling it "entirely deficient," he noted that it made no mention of the pending class actions. In addition, contrary to the May 2008 settlement agreement, the notice had been mailed to policyholders by the DMHC, rather than to their attorneys by the company.

"Has DMHC stepped into the shoes of the insurance plans?" Isaacs asked. "I've never seen anything like this. DMHC doesn't even share publicly available material with us."

(The DMHC's reasoning about the mailings, according to a spokesperson, was that former policyholders would be more likely to open a letter from a state agency than from the insurer that canceled their coverage.)

Though the DMHC had categorized recent settlement agreements as historic wins for consumers, Gianelli summed up the plaintiffs bar's dissatisfaction with the agency: "DMHC did get the insurance companies to agree to give coverage to those people [with rescinded policies], but beyond that, they didn't do much."

Added Shernoff, "These [settlement] agreements are designed to minimize payouts for the insurance plans," and he noted that a new arbitration mechanism for seeking damages doesn't permit testimony or expert witnesses.

The all-day conference in Lichtman's chambers produced nothing. On a break, Isaacs threw his hands in the air, saying, "We have yet to get a counteroffer from them."

Two weeks later, negotiations between the parties in the Blue Cross cases were officially declared dead. Plaintiffs attorneys say they later realized that when they began settlement hearings with Blue Cross and Judge Lichtman in the spring, the DMHC was already conducting its own negotiations directly with the insurers. "We found out that the DMHC had been secretly negotiating with all of California's major insurers, including Blue Cross," Shernoff says. "But they were not saying a word to the court or to us about those negotiations. You would think it was professional courtesy, if nothing else." (A DMHC spokesperson says the department was under no obligation to disclose the negotiations.)

More bad feelings linger after an effort last year to pass a health insurance reform bill sponsored by Assemblymember Hector De La Torre (D-Los Angeles). The measure, AB 1945, would have established an independent review process for health care policy rescissions, and required an insurer to prove that a policyholder had willfully misrepresented any preexisting conditions before it could rescind coverage.

The L.A. City Attorney's office backed the bill, offering suggestions for changes as the measure gathered support in Sacramento. In his State of the State address last year, Gov. Arnold Schwarzenegger also indicated support. He talked about "Todd," a San Diego resident whose insurance company "went back through all of his records looking for a reason to cut him off" after his diagnosis of lymphoma. "They pointed to a knee problem, unrelated to cancer, and they noted that now he weighed less than he did when he applied for the insurance," Schwarzenegger said. "Well, duh. Of course he did, because now he was sick with cancer. But they cut him off. ... Todd died eight months later.

"We are taking action," Schwarzenegger said, "so that what happened to Todd will not happen to any other Californian."

And yet last September, after AB 1945 passed both houses of the Legislature, Schwarzenegger vetoed the bill, explaining that it had been "written by the attorneys that stand to benefit from its provisions," and that "real consumer protections" were not included. L.A. City Attorney Delgadillo released his own message following the veto, stating that Schwarzenegger "cares more about protecting the profits of the large corporations who've bankrolled his campaigns than he does about the health and welfare of California's working families."

By late fall Isaacs was back working his rescission cases, but he wasn't happy. The DMHC had filed an amicus brief in support of Health Net in one case and Blue Cross in another (in which it also filed a writ petition in an effort to block discovery).

According to the DMHC's amicus brief for Blue Cross, the city attorney's suit "would impermissibly impinge upon the department's exclusive jurisdiction to regulate and enforce the [Knox-Keene] Act against health plans in California." That could lead to the UCL and the False Advertising Law (FAL) being used to "second-guess" regulatory decisions in favor of terms the plaintiff may like.

For the record, Cindy Ehnes, director of the DMHC, says she doesn't dispute the Los Angeles city attorney's authority to file actions against health plans - unless those suits "concern the very laws and regulations the DMHC is charged with regulating."

Still, Isaacs remains confident that his office can use the UCL and FAL with success in rescission cases, and others applaud the approach taken by the city attorney's office. Liang, of California Western, calls the strategy "highly innovative" because it is "much more limited" in its targets than, for example, the UCL campaign against tobacco companies for lying about nicotine levels and marketing to children (brought by then - San Francisco City Attorney Louise Renne). Liang also says the strategy is "much broader" because it addresses the entire spectrum of harms to patients, hospitals, doctors, and other providers that are caused by unwarranted health care policy rescissions.

"It's a new ball game," Liang adds. Though none of the parties opposing coverage cancellations can force changes in policy, the city attorney's office, in combination with its allies, has "created a real force to address the practices of insurers," says Liang.

Shernoff agrees. "What Isaacs's group is doing is a good complement to what the private attorneys are doing," he says. "Ever since that first meeting, they have been hands-on and aggressive. It's a new dynamic."

Jeanette Borzo is a senior editor at California Lawyer.

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