Appeals Court Will Examine Health Care Rescission Policy

LITIGATION • Sep. 25, 2007

By Rebecca Beyer
Daily Journal Staff Writer

Cindy and Steven Hailey admit that they failed to disclose key information about Steven's medical history to Blue Shield when the couple applied for medical coverage.

But the Haileys still feel that Blue Shield's descision to revoke their coverage was unfair.

Now their case is at the center of a great debate over when health plans should be able to rescind coverage.

Failure to disclose pertinent information - intentional or not - is enough for a plan to rescind coverage, health plans argue. But the couple, and the Department of Managed Health Care, which governs health plans, argue that plans must prove someone "willfully misrepresented" his or her health history before revoking coverage.

The Haileys applied for coverage and received it in December 2001. In March of that year, Steven Hailey was in a car accident that left him hospitalized for more than 70 days.

In June 2001, after the first $104,000 of what became $450,000 in medical bills, the Haileys' health plan, Blue Shield, rescinded the couple's coverage because of a pre-accident investigation that revealed that Haileys had omitted some information about Steven's medical history from their insurance application.

Blue Shield had begun investigating Steven's medical history before the accident, after a February hospitalization for stomach problems.

The Haileys sued in January 2003, claiming that Blue Shield had engaged in post-claims underwriting.

But in March 2005, the Haileys lost in an Orange County trial court where a judge granted Blue Shield's motion for summary judgment.

Blue Shield successfully argued that a contract can be rescinded if one party conceals or does not provide material facts that would have affected the issuance of the contract. The judge also ordered the Haileys to repay the $104,000 to Blue Shield.

The Haileys appealed. Today at 1 p.m., their case goes before Division 3 of California's 4th Appellate District in Santa Ana.

The case has far-reaching implications for similar rescission cases. The question at the heart of the matter is whether a health plan must prove that a person "willfully misrepresented" information on an application before rescinding coverage.

"Blue Shield's position is that the law in California is well established," said John M. LeBlanc, an attorney for Blue Shield from Barger & Wolen in Los Angeles. "The standard to rescind is that there must be material misrepresentations or ommissions. There is no willful requirement."

Michael G. Nutter, a Santa Ana attorney who represents the Haileys, declined to comment prior to today's arguments. Jeffrey L. Garland, the Haileys' appellate attorney, could not be reached.

The Haileys' story is tragic. But in reality, Steven's car accident had nothing to do with the rescission of his contract. Blue Shield began investigating Steven's medical history because of his admission to the hospital for illness in February 2001, just two months after he was given coverage.

This practice, called post-claims investigation, Blue Shield contends in its brief, is perfectly legal.

Section 1389.3 of the California Health and Safety Code, which governs health plans, defines post-claims underwriting as "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."

Blue Shield argued there were no reasonable questions arising from the Haileys' application. The application was "clean" even though the Haileys admitted later that Steven had several conditions that were not disclosed. Cindy Hailey contends she thought certain portions of the application's questions were directed only to her.

Other plaintiffs' attorneys and interested parties on both sides are weighing in - the appellate court asked for comment from various groups in help with resolving the issue.

"This case is critically important," said Sharon J. Arkin, an attorney from Pasadena's Arkin & Glovsky who submitted a brief in support of the Haileys for United Policyholders. "Both Blue Cross and Blue Shield have several class actions against them on precisely this issue. This decision will be the first in this line of cases. There's more than one on appeal."

William M. Shernoff, of Shernoff Bidart & Darras in Claremont, also submitted an amicus curiae brief in support of the Haileys.

"The court will have the opportunity to look at the whole process of rescission in the insurance context, as to whether it's a fair process," Shernoff said. "It's generally a one-sided investigation."

The Department of Managed Health Care, which oversees health plans, the California Medical Association and the state Department of Insurance have sided with the Haileys. They maintain that a health plan must prove that the insured engaged in willful misrepresentation on his or her application in all rescissions.

An attorney for the Department of Managed Health Care, who will be arguing at today's session, could not be reached for comment.

The debate over willfullness stems from the last sentence of Section 1389.3 of the Health and Safety Code, which states: "This section shall not limit a plan's remedies upon a showing of willful misrepresentation."

Gregory N. Pimstone, an attorney from Manatt, Phelps & Phillips who has represented Blue Shield in similar cases, will be arguing on behalf of two insurance industry trade associations, the Association of California Life and Health Insurance Companies and the California Association of Health Plans.

"Completing medical underwriting and resolving reasonable questions permits insurers to be able to rely on information that applicants are putting down unless a health plan or insurer has a reason to know that something is untrue," he said.

Pimstone said the Haileys and others are trying to create a new standard for all rescissions based on the statute's last sentence, which Blue Shield contends refers to a plan's exemption from post-claims underwriting penalties if a person intentionally misrepresented him or herself.

But attorneys for plaintiffs in such matters say medical underwriting means finding out whether a person is lying or has unintentionally erred in his or her application.

"That's what underwriting is about - finding out what problems there may be with a policy," said Arkin. "To take it at face value is unreasonable."

Pimstone argues that the cost of investigating every answer on every application would be passed through to consumers. It would also increase the time between an application and the issuance or denial of coverage.

But Arkin said studies have shown that health plans and insurance companies could research patients' medical records at very little cost - and actually save $6 for every $1 spent doing so.

Both sides agree the time is right for an appellate court to offer guidance on the issue.

Shernoff maintains that the entire process is unfair, starting with the applications, which he said are purposefully confusing, requiring people to have a "nearly encyclopedic memory of every ailment."

"They're designed for people to make mistakes," he said. "Then [plans] capitalize on those mistakes and rescind coverage after a claim."