June 2000

Health Care E-lert - U.S. Supreme Court Upholds HMO Physician Financial Incentives, 6/29/00

4 min

In one of the most closely followed cases in the health insurance industry, the U.S. Supreme Court's recent decision in Pegram v. Herdrich jettisoned the theory that HMOs or HMO physicians may be held liable under the Employee Retirement Income Security Act (ERISA) because their treatment decisions are influenced by financial incentives to withhold or limit care.

The plaintiff in the case, Cynthia Herdrich, was enrolled in an HMO through her husband's employee health benefit plan. Ms. Herdrich visited her HMO physician, Lori Pegram, M.D., who identified an inflamed mass in Ms. Herdrich's abdomen. Dr. Pegram did not order an ultrasound diagnostic procedure at a local hospital, choosing instead to delay the procedure for eight days in order to schedule it at an HMO-staffed facility more than 50 miles away. Before the ultrasound was conducted, Ms. Herdrich's appendix ruptured and she developed peritonitis.

Ms. Herdrich sued Dr. Pegram and the HMO. She prevailed on her medical malpractice claims against Dr. Pegram, obtaining a judgment for $35,000 in compensatory damages. However, the federal district court concluded that her state law fraud claims against the HMO were preempted by ERISA. If she were to state a viable claim against the HMO, she would need to do so using the exclusive remedies available to her under ERISA.

Therefore, in her amended complaint, Ms. Herdrich claimed that her physician-owned HMO's use of financial incentives that rewarded physicians for limiting care entailed an inherent breach of the HMO's fiduciary duty under ERISA. ERISA requires that any person who is a fiduciary with respect to an ERISA employee benefit plan make decisions based exclusively upon the interests of the plan participant. Ms. Herdrich alleged that her plan's year-end bonuses to HMO physicians who saved costs by limiting care created an incentive for those physicians to make treatment decisions based upon their own self-interest. The district court dismissed the ERISA claims, concluding that the HMO was not acting in a fiduciary capacity when it made the decisions giving rise to Ms. Herdrich's claim. The Seventh Circuit Court of Appeals reversed the lower court's decision, holding that the HMO, through its physician, was acting as a fiduciary when it made the decision to delay the ultrasound in order to minimize costs.

The Supreme Court disagreed, concluding that Ms. Herdrich had not stated a valid ERISA claim. In reaching this decision, the Court distinguished between "pure eligibility decisions," involving an HMO plan's coverage of a particular condition or medical procedure, and "treatment decisions," concerning choices about the manner in which to diagnose and treat a patient's condition. The Court acknowledged that as a practical matter, these two types of HMO decisions are often "inextricable from one another." The Court determined that Dr. Pegram's decision that Ms. Herdrich's condition did not warrant immediate action, and the HMO's subsequent determination that it would not cover immediate care, constituted a "mixed eligibility and treatment decision." Such HMO decisions, the court found, are not fiduciary decisions under ERISA.

Writing for a unanimous Court, Justice Souter reasoned that when Congress enacted ERISA in 1974, its consideration of fiduciary responsibility was focused upon a fiduciary's financial decisions as they related to pension plans, not upon the types of mixed eligibility and medical treatment decisions that are integral to modern HMO health plans. The Court did not address the obvious rejoinder that Congress did not concentrate upon such "mixed" health plan decisions in 1974 because those types of decisions did not then play such a predominant role of the nation's health care delivery system.

As further support for its decision, the Court looked to the consequences that would ensue if Ms. Herdrich's argument were accepted. According to the Court, declaring physician financial incentives to limit care illegal "would be nothing less than elimination of the for-profit HMO." (Hospital providers may recognize a certain dissonance between the Court's recognition that HMOs must provide physicians with incentives to control costs in order to survive, and the OIG's July 1999 Special Advisory Bulletin reminding hospitals that similar cost-saving incentives on their part to encourage physicians to reduce or limit care to Medicare beneficiaries violates the federal Civil Monetary Penalties statute). Noting that Congress has promoted HMOs for over 27 years, the Court indicated that any restrictions upon permissible forms of HMO health care rationing would be more appropriately addressed by Congress.

Nonetheless, the Pegram v. Herdrich decision does not eliminate all possibility that an aggrieved HMO enrollee may obtain judicial relief under ERISA. In a footnote that has been the subject of much attention, the Court observed that those with ERISA fiduciary status do have a duty to disclose certain information to ERISA plan beneficiaries. The Court suggested, but did not decide the issue of whether an HMO enrollee may bring an ERISA claim against an HMO for failing to make full and truthful disclosure concerning physician financial incentives to limit care.

The Supreme Court's opinion may be accessed through Cornell University's website at http://supct.law.cornell.edu/supct/html/98-1949.ZS.html.

For further information, please contact: Peter Parvis at 410.244.7644 or by e-mail.