HMO Liability Building Corporate Profits At The Expense of Patient Care

I. Introduction:

In recent years, many health maintenance organizations (HMOs) have moved away from paying physicians a straight salary and have instead implemented a bonus/penalty incentive system which compensates physicians, at least in part, according to how well they keep costs down. “Although some of the bonuses and penalties target quality, most reward limiting care and boosting the HMO’s image and enrollment.”1 Since more than a quarter of a million New Hampshire residents receive their health care through HMOs2, the dangerous effects of such cost containment plans are of particular concern in this state.

Legislative proposals designed to address HMO incentive plans are being developed. However, the powerful managed care industry has already succeeded in derailing a federal regulatory initiative. Effective reform will no doubt be difficult to achieve through the political process.

Because there is no legislative or regulatory solution to protect patients from the effects of financial incentive plans, it is up to the courts to provide a remedy after the inevitable medical injuries occur. The imposition of money damages appears to be the only viable means of placing competing financial incentives on HMOs and their physicians to provide an appropriate level of care.

In court, most often, the HMO is alleged to be vicariously liable for the negligence of a particular physician through respondeat superior or agency principles.3 However, actions alleging direct liability are beginning to appear.

Unfortunately, there are also significant obstacles to effective legal relief. Actions against HMOs historically have been subject to the broad preemption clause found in the federal ERISA statute. Fortunately, a recent United States Supreme Court decision appears to have limited the scope of ERISA preemption, opening the door to more successful HMO litigation.

II. Incentive Plans:

HMOs frequently provide financial incentives to their physicians to limit referrals, tests, and hospitalizations.4 Such incentives may involve the payment of bonuses to doctors who keep their referrals down as well as the imposition of financial penalties for those who do not. The implications of such a policy are twofold: First, primary care physicians are under tremendous pressure to resolve questionable cases in favor of less care.5 Second, physicians are forced to engage in risk selection in which “sick” patients are shunned and “healthy” patients are coveted.

According to an editorial in the New England Journal of Medicine, the head of a university hospital recently admonished the faculty that “[we can] no longer tolerate patients with complex and expensive-to-treat conditions being encouraged to transfer to our group.”6 The physicians who authored this editorial candidly admit the dangerous effects that incentive plans have on the quality of care provided to the patient: “The ways we are paid often distort our clinical and moral judgment and seldom improve it. Extreme financial incentives invite extreme distortions.”7

III. Legislative and Regulatory Response:

Legislative solutions to HMO incentive plans are in their infancy. In New Hampshire, the elimination of HMO incentives was a centerpiece of Jeanne Shaheen’s gubernatorial campaign.8 And in Massachusetts, a bill was recently proposed which would outlaw HMO bonuses.9

If the experience at the federal level is any indication, the likelihood of meaningful legislation is doubtful. Earlier this year, the Clinton administration promulgated administrative rules which sought to limit HMO bonuses and penalties which affect Medicare and Medicaid patients.10 Although the rules were adopted in the spring, the opposition of “the increasingly powerful managed-care industry” led the administration to temporarily suspend the rules while promising that they will be imposed “in a slightly modified form” by the beginning of 1997.11

IV. Legal Action:

Individuals harmed by the negligence of an HMO physician frequently sue the HMO under a vicarious liability theory. More recently, due to the emergence of cost containment plans which pressure doctors to limit care, testing, and referrals, direct claims against HMOs have arisen. However, because HMO membership is usually tied to an employee benefit plan, broad preemption language in the ERISA statute12 presents a serious problem. If a claim is preempted by ERISA, the plaintiff is completely deprived of a money damages remedy.

There are no reported New Hampshire cases addressing HMO liability in the medical injury context. However, the general principles of vicarious liability are well-established in this state and there is no reason why they should not apply to HMOs. The law governing direct liability, on the other hand, stems from a 1986 California Court of Appeals case which held that: “Third party payors of health care services can be held legally accountable when medically inappropriate decisions result from defects in the design or implementation of cost containment mechanisms . . .”13

The court in that case, however, went on to state that the physician has ultimate responsibility for the care of the patient and that he “cannot point to the health care payor as the liability scapegoat when the consequences of his own determinative medical decisions go sour.”14

Four years later the same court retreated from the view that ultimate and exclusive legal responsibility lies with the treating physician. The court emphasized that the language in its earlier case suggesting that civil liability rests solely with the physician in all contexts was merely dicta.15 The proper test, according to the court, is that which is generally applied to joint tortfeasors; i.e., whether the defendant’s conduct was a substantial factor in bringing about the harm.16

Although there is no New Hampshire case law directly on point, the New Hampshire Supreme Court’s recent decision in Harper v. Healthsource New Hampshire, Inc.,17 may have a significant effect on direct liability suits against HMOs.

Harper was a wrongful termination suit brought by a preferred provider physician against an HMO. In sorting out the propriety of such a suit, the Court recognized that “[t]he public has a substantial interest in the relationship between health maintenance organizations and their preferred provider physicians . . .”18 As a result, “preferred provider agreements must be ‘fair and in the public interest.'”19 The strong public policy which governed the Harper decision applies equally to claims involving the use of bonuses and penalties in provider agreements. Such provisions are not “in the public interest.”

V. ERISA Preemption:

The federal ERISA statute contains an express preemption clause which, by its terms, eliminates any state law claims that “relate to” an ERISA qualified plan.20 Although the topic of ERISA preemption is far too complex to be treated comprehensively in this article, several observations are appropriate. First, pure vicarious liability claims against HMOs have enjoyed some success in avoiding ERISA preemption.21 In fact, in New Hampshire at least one Superior Court judge has ruled that a vicarious liability claim against an HMO is not preempted by ERISA.22Second, it has been much more difficult to save direct liability claims from preemption.23 Finally, the tide may be turning. In a recent decision, Justice Souter, writing for a unanimous United States Supreme Court, recognized some limits to the broad ERISA preemption language.24

The Supreme Court’s 1995 decision in New York State Conference of Blue Cross Blue Shield Plans v. Travelers Insurance Company is vitally important to future HMO litigation. Beginning with the assumption that “the historic police powers of the States were not to be superseded by the Federal Act unless that was the clear and manifest purpose of Congress,” Justice Souter found that the broad “relate to” language in the preemption clause should not be read with “an uncritical literalism.” Instead, the courts “must go beyond the unhelpful text and the frustrating difficulty of defining its key term, and look instead to the objectives of the ERISA statute as a guide to the scope of the state law that Congress understood would survive.”25 After a typically detailed study of ERISA and its legislative history, Souter concluded that “nothing in the language of the Act or the context of its passage indicates that Congress chose to displace general health care regulation, which historically has been a matter of local concern.”26 Furthermore, a state law “operating as an indirect source of merely economic influence on administrative decisions,” would not trigger preemption.27

Courts are only beginning to apply Travelers to HMO direct liability claims.28 A Pennsylvania appellate court recently relied upon the Supreme Court’s decision to reverse a trial court’s finding that direct negligence claims against an HMO were preempted.29 The Pennsylvania court emphasized that:

The type of recovery sought is based on negligence attributable to the delay caused by a cost containment protocol set by a for- profit organization, and which is aimed at conserving and increasing its profits, an intention diametrically opposed to ERISA’s general purpose of protecting the rights of a plan’s beneficiaries.30

Then, quoting from Travelers, the court held that this type of tort “is, in fact, ‘an indirect source of merely economic influence on administrative decisions.'”31

To find that such claims are preempted because they may interfere with what is in essence a business decision made in the financial interests of a commercial entity is inconsistent with the intention of ERISA and should not “suffice to trigger preemption.”32

It is too early to tell whether the Pennsylvania court’s interpretation will be adopted by other courts. Nevertheless, the Supreme Court has, at the very least, provided some ammunition for successful anti-preemption arguments.

VI. Conclusion:

Patients and physicians alike recognize the dangers of HMO cost containment incentives. Until effective legislation is adopted, these policies will continue. In fact, there is reason to believe they will be tightened even further. According to a recent article:

Unexpectedly high medical costs are slashing HMO profits, prompting speculation that price increases and new restrictions on treatments and drugs are in the offing. Medical experts said yesterday patients could be hurt if HMOs cut expenses too deeply.33

Attorneys representing patients who have been injured as a result of an HMO’s overzealous cost containment policy still face the considerable obstacle of ERISA preemption. The numerous cases addressing preemption in the context of HMO liability should be read carefully. However, the Supreme Court’s most recent interpretation of the ERISA preemption clause may have altered the inquiry. Simply put, this is an emerging area of law which must be followed closely in the years to come.


  1. Steffie Woolhandler, M.D., M.P.H. and David U. Himmelstein, M.D., Extreme Risk – The New Corporate Proposition for Physicians,” 333 New Eng. J. Med. 1706 (December 21, 1995).
  2. Gov. Signs HMO Bill Banning Exclusive Doctor Contracts, Manchester Union Leader, May 22, 1996(quoting statistics provided by New Hampshire Association of Health Underwriters and New Hampshire Citizen Action).
  3. See, e.g. Hansen v. Faraci, No. 94-C-512 (Hills. Sup. Ct. So. Dist.); Donovan v. Harvard Community Health Plan of New England, No. 94-C-567 (Hills. Sup. Ct. So. Dist.).
  4. “74 percent of independent-practice-association (IPA) HMOs and 50 percent of group-model or staff-model HMOs base physicians’ payment in part on measures of utilization and cost, . . .” Woolhandler, supra note 1, at 1706.
  5. Id.
  6. Id. at 1707.
  7. Id.
  8. See Shaheen Listens to HMO Woes, Manchester Union Leader, July 17, 1996 at A6.
  9. See Pols propose bill to cut HMO “bounties” for docs, Boston Herald, June 5, 1996 at 26.
  10. See 8 Med. Mal. L. & Strategy 8 (April 1996).
  11. HMO Rules, Boston Herald, July 9, 1996 at 26.
  12. 29 U.S.C. §1144(a) (1985).
  13. Wickline v. State, 239 Cal. Rptr. 810, 819 (Cal.App. 1986).
  14. Id.
  15. Wilson v. Blue Cross of Southern California, 271 Cal. Rptr. 876, 880 (Cal.App. 1990).
  16. Id. at 883.
  17. 140 N.H. 770 (1996).
  18. Id. at 776.
  19. Id. at 777(quoting R.S.A. 420-C:1 (1991)).
  20. 29 U.S.C. §1144(a) (1985).
  21. Many federal district courts have ruled on this issue with a substantial split. Circuit court cases include Jass v. Prudential Health Care Plan, Inc., 88 F.3d 1482 (7th Cir. 1996) (claims preempted); Pacificare of Oklahoma v. Burrage, 59 F.3d 151 (10th Cir. 1995)(claims not preempted); Dukes v. U.S. Healthcare, Inc., 57 F.3d 350 (3rd Cir. 1995)(claims not preempted).
  22. See Hansen, supra note 3, Order on Motion to Dismiss (May 31, 1995)(Hollman, J.).
  23. Compare Corcoran v. United Healthcare, Inc., 965 F.2d 1321 (5th Cir. 1992); Chaghervand v. CareFirst, 909 F.Supp. 304, 312 (D.Md. 1995); Kearney v. U.S. Healthcare, Inc., 859 F.Supp. 182, 184-85 (E.D.Pa. 1994) withPacificare, 59 F.3d at 151; Pappas v. Asbel, 675 A.2d 711 (Pa.Super. 1996); Smith v. HMO Great Lakes, 852 F.Supp. 669 (N.D.Ill. 1994).
  24. New York State Conference of Blue Cross Blue Shield Plans v. Travelers Insurance Company, 115 S.Ct. 1671 (1995).
  25. Id. at 1677.
  26. Id. at 1680.
  27. Id.
  28. It is interesting to note that the Seventh Circuit’s July 8, 1996 decision in Jass v. Prudential Health Care, Inc., 88 F.3d 1482 (7th Cir. 1996), finding preemption of the plaintiff’s state law HMO claims, does not even mention the Travelers case.Similarly, the New Hampshire Supreme Court’s recent analysis of ERISA preemption in Higgins v. Colby, 140 N.H. 765 (1996), fails to mention the 1995 United States Supreme Court opinion.
  29. See Pappas v. Asbel, 675 A.2d 711 (Pa.Super. 1996).
  30. Id. at 716.
  31. Id. at 716(quoting Travelers, 115 S.Ct. at 1680).
  32. Id.(quoting Travelers, 115 S.Ct. at 1680).
  33. See HMO Costs, Boston Herald, July 12, 1996.