I have piled in my office, my basement, and my father's garage over 60,000 pages of documents concerning HMO liability. These documents, which include a collection of each state's HMO licensure laws, journal articles and numerous published court opinions, have served many useful purposes during the more than six years that I have collected them.

For instance, the boxes of documents in my basement were once used by my wife and I as end tables right after we got married and moved into a very small apartment. The boxes of documents in my father's garage are used to prop an old snow mobile off of the ground. And the boxes of documents in my office (which are dangerously high) generally serve as a conversational piece--sort of like the tall tropical plant I once bought that grew thorns instead of flowers, and often collapsed on top of me while I sat at my office desk.

I say this to make several points. One, if you buy a tropical plant for the office, make sure it is a descendent of the flower-producing variety. And, two, the subject of HMO liability can be remarkably dense. The purpose of this article, then, is to review traditional theories of liability brought against HMOs to better understand today's more progressive theories of liability. As a starting point, it's important to first consider the fundamentals of managed care.

An HMO is entity that undertakes to provide or arrange for basic comprehensive health care services through an organized system that combines the delivery and financing of health care on a prepaid basis. N.J.A.C. 8:38-1.2. Unlike traditional indemnity plans, if a member of an HMO requires an unexpectedly large amount of medical care, the HMO does not retain the risk of financial loss. Rather, an HMO shifts risk to providers through various reimbursement arrangements.

One of the most common forms of risk-based reimbursement refers to capitation arrangements between an HMO and a primary care physician ("PCP"). Under this arrangement, a PCP is paid a certain fee "per member per month" for health care services. The fee is the same each month, regardless of the extent or cost of the treatment. To calculate the fee, the HMO may consider a member's age, sex, prior medical utilization, family history and lifestyle.

An HMO capitation arrangement generally requires that a percentage of a physician's capitated fee be "withheld," or set aside, every month. These withholds may be placed in a performance risk pool and used to finance certain hospital inpatient charges, diagnostic services, and specialist referrals.

At the end of the designated period (usually every 12 months), actual costs of the HMO are compared to the budgets in the performance risk pool. The health of the budgets--whether they are in the red or the black--determines whether a PCP gets back all, or part of, the withhold.

Separate from capitation, a PCP may be paid a bonus contingent upon whether certain performance protocols, or cost-containment measures, are met for a designated 12-month period. For example, a plan may pay a PCP a bonus based 40% upon that PCP's utilization of health care services, and based 60% upon quality and member satisfaction.

If a participating PCP in an HMO prescribes a high number of referrals, diagnostic tests, and inpatient hospitalization, the PCP risks losing the portion of his or her withhold that is used to fund such expenditures in the performance risk pool. As a result, many of the more progressive theories of liability are premised upon the assumption that risk-based reimbursement may act as a financial inducement for physicians to withhold, deny or delay medically necessary care. In contrast, earlier lawsuits against HMOs focused upon an HMO's amenability to suit under state insurance laws, and general theories of direct and vicarious liability.

For example, in Robbins v. HIP of New Jersey, 264 N.J.Super. 572 (Law Div. 1993), the New Jersey Law Division denied defendant HIP of New Jersey's motion for summary judgment on grounds that the HMO was statutorily immune from medical malpractice claims pursuant to N.J.S.A. 26:2J-25. That section of the New Jersey HMO Act ("Act") provided that any HMO authorized under the Act would not be deemed to be practicing medicine, and that no person participating in the arrangements of an HMO other than the actual provider of health care services would be liable for negligence. The court held that, where the Act merely exempted the HMO from the licensing provision of insurance laws, the Act did not grant immunity to the HMO, itself, in a medical malpractice action. 264 N.J.Super. at 574-575.

After establishing that HMOs were not immune to liability under state licensure laws, courts next addressed whether an HMO could be held vicariously liable for the alleged negligence of a member physician where the HMO did not directly hire, retain, credential or pay the salary of a member physician. To determine an HMO's amenability to suit, courts considered the HMO's corporate structure, and contractual relationships with member physicians.

In general, if an HMO directly hired and paid the salary of a physician (as was done by a Staff model HMO), an HMO could be vicariously liable under the doctrine of respondeat superior for that physician's alleged negligence. However, if the defendant HMO was either a Group model HMO, or Independent Practice Association ("IPA") model HMO, there was no longer a definitive employer-employee relationship between an HMO and a PCP. Rather, the HMO would either contract with a medical group that, in turn, contracted with individual physicians; or, the HMO would contract with an IPA that, in turn, contracted with medical groups or individual physicians. At times, these HMOs also contracted directly with the physicians (but the provider contracts often identified the physicians as independent contractors). As a result, any claim that these types of HMOs were vicariously liable under respondeat superior were dismissed, as in Raglin v. HMO Illinois, Inc., 595 N.E.2d 153 (1992).

However, courts have consistently ruled that Group model HMOs, and IPA model HMOs, may be held vicariously liable under the doctrine of ostensible agency. See Dunn v. Praiss, 256 N.J.Super. 180, 195 (App.Div. 1992), rev'd on other grounds 271 N.J.Super. 311 (App. Div. 1994), rev'd 139 N.J. 564 (1995), citing Boyd v. Albert Eistein Medical Center, 377 Pa. Super. 609 (1988); see, also, Petrovich v. Share Health Plan of Illinois, Inc., 198 Ill.App. 148 (1998). Under that doctrine, an HMO is vicariously liable if a plaintiff establishes that the HMO held out the PCP to be one of its own employees (e.g., physician listed in HMO's provider directory), and the plaintiff looked to the HMO for health care, and not the individual physician (e.g., HMO may require members to obtain precertification for services from the HMO, itself).

As lawsuits against HMOs evolved, there was a shift to bring direct liability claims against HMOs, in addition to vicarious liability claims. The New Jersey Appellate Court in Dunn, supra, for example, recognized that an HMO could be directly liable for the negligent selection and control of an incompetent physician, in addition to corporate negligence based upon the corporation's independent acts of negligence (e.g., in the management of utilization control systems), and malpractice based upon breach of contract or breach of warranty.

Despite the Dunn court's broad holding, the court did not consider whether such direct liability claims would be subject to preemption under the Employee Retirement Income Security Act ("ERISA"), 29 U.S.C. 1001, et seq. Indeed, nearly every direct liability claim brought against HMOs was initially preempted by ERISA. See, e.g, Lancaster v. Kaiser Foundation Health Plan of Mid-Atlantic States, 958 F.Supp. 1137 (1997); Dalton v. Peninsula Center, 626 N.Y.S.2d 362 (1995) (breach of contract); Kearney v. U.S. Healthcare, Inc., 859 F.Supp. 182 (E.D.Pa. 1994) (fraud). The only historical exception to ERISA preemption was those claims alleging the negligent hiring and retention of an incompetent physician. See Dukes v. U.S. Healthcare, 57 F.3d 350, 353 (3^rd Cir. 1995).

Congress enacted ERISA in 1974 to federally regulate employee welfare benefit plans, including medical plans. Section 514(a) of ERISA provides that it "shall supersede any and all State laws insofar as they may now or hereafter be related to any employee benefit plan." In turn, all state laws that "relate to" an employee welfare benefit plan, including any common law or state statutory rights of employees seeking to recover plan benefits, are preempted by ERISA. Whether a state-law based medical negligence action against an HMO "relates to" an ERISA plan is, for the most part, a question of fact for the court to decide.

In addition to Section 514(a) preemption, Congress established a second, and distinct, preemption clause under Section 502(a) of ERISA known as "complete preemption." Complete preemption under Section 502(a) is premised upon federal removal jurisdiction under 28 U.S.C. 1441. Under removal jurisdiction, a claim may not be removed from state court to federal district court unless there exists either: (1) diversity of citizenship between the parties, or (2) a federal question is presented on the face of plaintiff's well-pleaded complaint. Therefore, even though a plaintiff's complaint may not explicitly plead a federal question, it may implicate a federal matter that would preempt plaintiff's state law claim.

Section 502(a) of ERISA provides that a civil action may be brought by a participant or beneficiary to: (1) recover benefits due to him under the terms of his plan; (2) enforce his rights under the terms of the plan; or, to (3) clarify his rights to future benefits under the terms of the plan.

Therefore, whenever a court determines that plaintiff's cause of action implicates recovery, enforcement or the clarification of rights to benefits within the scope of Section 502(a), that cause of action is subject to complete preemption and removal under ERISA.

Early New Jersey district court opinions broadly held that ERISA preempted vicarious liability claims brought against HMOs. See Ricci v. Gooberman, 840 F.Supp. 316 (D.N.J. 1993); Butler v. Wu, 853 F.Supp. 125 (D.N.J. 1994). However, the ERISA preemption shield was pierced following a string of decisions by the Third, Seventh and Tenth U.S. Circuit Courts of Appeal. Dukes, supra, 57 F.3d 350 (3d Cir. 1995); Rice v. Panchall, 65 F.3d 637 (7^th Cir. 1995); Pacificare of Oklahoma, Inc. v. Burrage, 59 F.3d 151 (10^th Cir. 1995).

In Dukes, for example, the Third Circuit held that if a claim was founded upon traditional state tort notions of medical negligence and vicarious liability, ERISA would not preempt such claims where an action concerns the "quality" of medical care provided by the physician as opposed to claims that focus on "quantity of benefits," or whether the plan erroneously withheld benefits due.

The Dukes opinion was not only significant in that it recognized that ERISA did not preempt vicarious liability claims against an HMO but, also, ERISA did not preempt those direct liability claims in which it is alleged that an HMO was negligent for hiring or credentialing an incompetent physician.

The ERISA preemption defense was significantly eroded by the New Jersey district court in Bauman v. U.S. Healthcare, 1 F.Supp.2d 420 (D.N.J. 1998), and by the Third Circuit during the appeal of Bauman in In re U.S. Healthcare, 193 F.3d 151 (3^rd Cir. 1999).

In Bauman, supra, a suit was filed alleging that U.S. Healthcare, among others, was negligent in failing to diagnose an infant's meningitis, causing her death two days after birth. Plaintiff alleged, in part, that U.S. Healthcare acted negligently in adopting a policy that "encouraged, pressured, and/or indirectly required that its participating physicians discharge newborn infants and their mothers from the hospital within 24 hours of the infant's birth." Plaintiff alleged that U.S. Healthcare was motivated only by the "financial profit" it would realize in paying for only one day of hospitalization.

Defendant U.S. Healthcare removed the matter under Section 502(a)'s complete preemption provision. However, the District Court, in conducting it's own construction of Section 502(a), determined that certain counts in the complaint focused on the "quality" of care provided by the physician and the "impact" of U.S. Healthcare's policies on that quality of care. In turn, Section 502(a) was not implicated where plaintiffs did not set out to recover, enforce, or clarify rights to benefits under the plan.

Following the New Jersey District Court's holding in Bauman, supra, U.S. Healthcare filed both a Petition for a Writ of Mandamus and a Notice of Appeal from the District Court's Order. The Bauman's cross-appealed the District Court's Order dismissing one of the counts and denying their motion to remand all of their claims to New Jersey state court under 28 U.S.C. 1447.

On appeal, the Third Circuit affirmed the District Court's decision in Bauman that certain counts were not completely preempted. More significantly, however, the Third Circuit reversed the District Court's Order dismissing one of the counts. That count alleged that U.S. Healthcare had acted negligently in not providing for an in-home visit by a participating provider despite assurances under its L'il Appleseed Program that such a visit would be provided and despite a telephone call from the plaintiff's requesting the service.

With a renewed focus upon certain direct acts of negligence by an HMO premised, in part, upon financial incentive arrangements, there have been self-imposed reforms within the managed care industry, itself, during the past several years. In addition, there have been legislative initiatives as the state and federal level to expand managed care liability. And, finally, courts have addressed more progressive theories of liability regarding a patient’s right to bring a claim against an HMO for certain alleged direct acts of negligence.

In November 1999, United HealthCare announced it was giving its physicians "final say" on treatment decisions by eliminating "precertification" for certain costly procedures and hospitals stays. United HealthCare was spending about $100 million each year to approve expensive procedures and hospital stays. In turn, the HMO cut its utilization review staff by 20 percent.

In addition, Harris Methodist recently settled a case brought against it by 10 physicians who alleged that the HMO provider contracts they entered into served as an incentive to limit medically necessary care. Under the terms of the settlement agreement, the HMO must now pay the physicians a straight monthly capitation rate, free of any withholds and bonuses.

In October 2000, Aetna U.S. Healthcare ("AUSH") announced a new managed care product, called the "Open Access" product, which gives members direct access to specialists without a referral. Certain state laws already require that insurers offer members open access products. In New Jersey, for example, an insurer is required to offer members a Point of Service ("POS") product. N.J.S.A. 26:2S-10. Under this product, a member is able to receive covered services from out-of-network health care providers without having to obtain a referral or prior authorization from the carrier. Id. The POS product may require that a subscriber pay a higher deductible or copayment and a higher premium. Id.

And, in April 2000, AUSH filed an "Assurance of Voluntary Compliance" document during negotiations with the Texas Attorney General in an effort to resolve a lawsuit pending by the Attorney General's office against AUSH regarding its HMO practices. The document provided, in part, that AUSH would detect and prevent underutilization of medical resources for certain members, and require physicians to provide the same quality of care to patients, irrespective of what financial incentives are involved.

The majority of states have developed a patient bill of rights. In New Jersey, the Health Care Quality Act (N.J.S.A. 26:2S), and HMO rules (N.J.A.C. 8:38) protect a patient's rights in a managed care setting. These rights include, in part, the right to have a physician--not an administrator--make decisions to deny or limit coverage. In addition, a patient has a right to know how his or her managed care plan pays its physicians.

To date, at least 32 states have established independent medical review systems, similar to New Jersey's Independent Utilization Review Organizations ("IURO"). N.J.S.A. 26:2S-12. Under the IURO laws, an HMO must establish a three-tiered appeal process for members to appeal adverse utilization determinations of medically necessary covered services.

In addition, seven states have already enacted legislation to expand health plan liability by permitting patients to sue their HMOs. The "right to sue" laws passed in Texas and Oklahoma have been subject to various injunctions to either stop the laws from being enforced, or the laws have been narrowly interpreted to provide plaintiffs with no more latitude to file actions against HMOs other than those well settled under state law.

New Jersey's "Health Care Carrier Accountability Act," S. 1333, mirrors, in part, the Texas legislation. However, the New Jersey legislation, which is before the Assembly Health Committee, is more broad than the Texas "right to sue" laws in that S. 1333 preserves an individual's rights to bring an action against a health care carrier for matters that concern the regulation of a health care plan, including benefit determinations. It is well settled by the courts that these types of claims are preempted by ERISA. Accordingly, it is uncertain whether S. 1333, in its present form, may be enforced without substantial legal challenges.

In addition to industry reforms in the managed care setting, as well as legislation to broaden patient's rights, courts have addressed more progressive theories of liability against HMOs. These theories of liability generally focus upon risk-based reimbursement and an underlying concern that a physician may be financially induced to delay or deny medically necessary care.

Federal courts have recently addressed claims that HMOs and PCPs have a fiduciary duty under ERISA to patients to disclose financial incentive arrangements entered into between the HMO and member physician. The premise for these types of claims is that, if a financial incentive arrangement is disclosed, a patient may not have relied upon a physician's medical advice so completely, and would have sought out the opinion of a specialist at his or her own expense.

In Shea v. Esensten, 107 F.3d 625 (8^th Cir. 1997), cert. denied 118 S.Ct. 297 (1997) ("Shea I"), for example, plaintiff's husband repeatedly visited his family's PCP complaining of severe chest pains, shortness of breath, dizziness, and muscle tingling. Despite those warning signs, the physician persuaded the husband that his symptoms did not merit an appointment with a cardiologist. Several months after his visits, the husband died of heart failure. Unbeknownst to the decedent, his HMO had instituted a financial incentive policy that rewarded its PCPs for not referring patients to specialists.

The Eighth Circuit, reversing the district court, concluded that a cause of action for breach of fiduciary duty exists under ERISA when an HMO fails to disclose physician incentives that could affect a patient's care. By ruling that ERISA preempted any state law claim for nondisclosure, however, the remedy provided by ERISA for breach of that duty was limited to an action to recover equitable relief, such as benefits due, or to clarify rights under a plan. Compensatory damages are not available under ERISA.

More than three years after Shea I was decided, the United States Supreme Court, in Pegram v. Herdrich, 120 S.Ct. 2143 (2000), held that health plan enrollees may not bring federal claims against an HMO under ERISA for denials of coverage by an HMO that are based, in part, upon medical judgement. In particular, the Supreme Court held that "mixed" medical treatment and health plan eligibility decisions made by HMOs acting through their PCPs are not "fiduciary" decisions pursuant to ERISA. Accordingly, plaintiff may not bring a breach of fiduciary duty claim against an HMO in that context.

The fiduciary duty claim in Shea I, supra, was reviewed by the Eight Circuit during the initial appeal of plaintiff's claim. Even though the U.S. District Court for the District of Minnesota had remanded Shea's other state law claims to state court, the defendant medical clinic (where the defendant PCP worked) removed the suit to federal court again, claiming that Shea's "negligent misrepresentation" claim was preempted by ERISA (hence, "Shea II").

The Eight Circuit, in Esensten v. Shea, 2000 WL 336674 (8^th Cir. 2000), cert. denied , U.S., No. 00-12 (10/2/00) ("Shea II"), held that claims based on a physician's failure to disclose financial incentives flow from the process of rendering medical treatment and do not affect the structure or administration of the ERISA plan. Accordingly, ERISA does not preempt claims challenging the financial incentive arrangement between an HMO and a PCP if the allegation is framed as a state law negligent misrepresentation claim.

During the past several years, at least 10 national class action RICO lawsuits have been filed against the nation's largest HMOs, including AUSH, United Healthcare, Cigna, Humana and Pacificare. These lawsuits claim that the HMOs engaged in a nationwide fraudulent scheme to enroll members by promising quality healthcare and then denying needed services.

Last year, the U.S. District Court for the Eastern District of Pennsylvania, in Maio v. Aetna, Inc., 1999 U.S. Dist. LEXIS 15056 (E.D.Pa. 1999), dismissed plaintiffs' RICO claim. The Maio court held that, even though the plaintiffs claimed that they were fraudulently induced to enroll in the HMO based on Aetna's representations about quality of care, plaintiff's waived any claim of injury due to the denial or reduction of benefits, inferior care, malpractice, negligence, and breach of contract. In turn, plaintiffs did not demonstrate an injury that could potentially decrease the value of the defendants' plans. The Third Circuit affirmed the district court in Maio, rejecting class action allegations that Aetna violated RICO law. Maio v. Aetna, Inc., 2000 WL 1137688 (3^rd Cir. 2000).

In light of the Third Circuit's holding in Maio, it is uncertain whether subsequent RICO class actions will also be dismissed. On October 23, 2000, a large number of proposed class actions filed across the country alleging, in part, RICO violations, were transferred to the U.S. District Court for the Southern District of Florida under the terms of an order of the Judicial Panel on Multidistrict Litigation. See In re Humana, Inc. Managed Care Litigation, J.P.M.L., Nos. 1334, 1364, 1366, 1367 (10/23/00).

As set forth above, emerging theories of HMO liability generally focus upon risk-based reimbursement and an underlying concern that such arrangements may act as a financial inducement for physician's to delay, deny or withhold medically necessary treatment. While courts have generally been cautious to recognize direct claims of liability against HMOs premised, in part, upon such financial incentive arrangements, recent court opinions have substantially eroded the ERISA preemption shield and recognized the merit of such progressive theories of HMO liability.

Brad X. Terry, Esq., is an associate with the Health Care Group at the Princeton office of Reed Smith LLP.