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Legal Intelligencer: Self-Funded Employer Health Plans: Benefits, Pitfalls and Strategies

This column will focus primarily on self-funded plans, the types of disputes that often arise relating to these plans, and suggestions for avoiding or resolving these disputes.

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In the December 2, 2021 edition of The Legal Intelligencer, Edward T. Kang of Kang Haggerty co-authored “Self-Funded Employer Health Plans: Benefits, Pitfalls and Strategies.

The majority of Americans receive their health coverage through some type of employer-based insurance, and there are two main types of plans: fully insured and self-funded. Fully insured plans offer health insurance in the more conventional sense, where an employer and its employees pay monthly premiums to an insurer, who then covers the cost of medical treatment provided by its network of professionals.

In contrast, employers can also choose to set up a self-funded plan where traditional insurance companies merely provide access to their network of providers and perform the administrative services relating to claims adjudication. With self-funded plans, the employer acts as the insurer for the medical expenses of its employees, paying for these costs directly out of a specific fund. The principal benefit of self-funded plans is avoiding the mark-up insurance companies build into their premiums to generate a profit. In a typical year, this will allow employers operating a self-funded plan to save money by not paying any excess premiums to insurance companies. Because medical expenses do not accrue with the uniformity or consistency of other business expenses, however, self-funded plans exhibit significantly more variability than premium-based coverage plans.

Because of the risks involved, self-funded plans are primarily used by large organizations that can spread this risk across a wider pool of employees. The larger the risk pool, the smaller the year-to-year fluctuations will be, and the more savings that these employers can generate from not having to pay the mark-up on insurance premiums. While the decision by employers whether to opt for a fully insured or self-funded plan is primarily an actuarial one, this decision can be further informed by an adept legal analysis. This column will focus primarily on self-funded plans, the types of disputes that often arise relating to these plans, and suggestions for avoiding or resolving these disputes.

Health care in the United States is governed by well-known federal statutes such as the Employee Retirement Income Security Act (ERISA), the Health Insurance Portability and Accountability Act (HIPAA) and the Consolidated Omnibus Budget Reconciliation Act (COBRA). And while many of these statutes explicitly preempt state law, that is not to say that regulation in this area is exclusively federal either, as states often attempt to legislate in the gaps left by federal law. ERISA, the headliner of the aforementioned statutes, has a particularly complex and often-litigation preemption provision.

One of the first things employers should consider when deciding whether to choose a self-funded or fully insured plan is the regulatory framework. Because self-funded plans make the most sense for large organizations, these employers are almost always covered by the Affordable Care Act’s mandate that businesses with 50 or more full-time employees offer health care to their workforce. This threshold will then automatically subject them to ERISA requirements as well, which does not by itself require employers to provide health care, but regulates such plans if they are offered. While ERISA preemption is unclear in some contexts, state law is unequivocally preempted when it comes to self-funded plans, a valuable perk for employers looking to avoid state regulation.

Once a plan is covered by ERISA, employers must ensure that they operate the plan in conformity with its statutory and common law requirements. This includes maintaining the plan’s assets in a separate fund, typically conceptualized as a trust, that is legally distinct from the organization’s other assets. ERISA also establishes certain minimum requirements for these plans relating to funding, asset management and fiduciary responsibilities. It also provides for an internal grievance and appeal process if there is a dispute relating to coverage, as well as granting employees the right to sue over these grievances or alleged breaches of fiduciary duty.

And while employers opting for self-funded plans operate as direct insurers for their plan members, most of these entities are not otherwise involved in the health care industry. For this reason, most self-funded plans contract with traditional insurance companies to operate as third-party administrators (TPAs), to review and adjudicate claims. These TPAs, as conventional health insurers, also grant self-funded plans access to their existing network of providers as part of the agreement.

As TPAs handle the claims adjudication process, they are tasked with deciding what is and is not covered under a certain plan. Such coverage often turns on the phrase “medically necessary,” as determined by the TPA or someone in their network of providers. Because of this, self-funded plans can sometimes find themselves liable for exorbitant sums if a TPA or one of its providers claim the treatment was medically necessary. Employer could be billed millions of dollars charged by a medical provider for procedures that raise the question whether such procedures were “medically necessary.” This is one of most the critical clauses in any TPA agreement, and employers operating self-funded plans should ensure that they have some means of challenging or auditing such decisions. Otherwise, employers can find themselves in the unenviable position of disputing medical necessity determinations retroactively after the costs have already been incurred and adjudicated. Many TPAs do not share their “secret sauce” for determining what is considered “medically necessary.”

In any dispute between a plan and its TPA, courts will first examine the contract between the two parties. Just as preventative care can help minimize future expenses, employers operating self-funded plans should take the requisite precautions before entering into a TPA agreement. At a minimum, this should include the retention of experienced counsel to review and negotiate these agreements. While most of the organizations that opt for self-funded plans will be large enough that they have their own in-house general counsel, this is an area where it is worthwhile to retain a specialist. An experienced outside counsel will not only protect the interests of the plan, but will also be able to recognize any potential areas of uncertainty in the proposed agreement. Contractual ambiguity is the progenitor of litigation, and the best time to resolve these disputes is before they can even occur.

Self-funded plans can also fall victim to the classic insurance coverage dilemma of who is liable when an insured is covered under multiple policies, as was the case in Northeast Department ILGWU v. Teamsters Local Union No. 229, 764 F.2d 147 (3d. 1985). There, a participant in the appellee fund and beneficiary of the appellant fund submitted claims to both funds which then denied coverage based on so-called “other-insurance” clauses. These clauses come in a range of strengths that attempt to predetermine the allocation of each insurer’s share in the event of overlapping coverage. The strongest form of an other-insurance clauses is an “escape clause,” which outright denies coverage if the insured is covered by another policy.

This was the type of clause at issue in Northeast, and the court noted that such a “clause is enforceable only if it is consonant with the provisions and policies of ERISA” Importantly, ERISA prohibits arbitrary and capricious conduct by fund trustees. And while such plans are governed by the federal common law interpreting ERISA, the U.S. Court of Appeals for the Third Circuit in Northeast engaged in a nationwide review of state court decisions to find that escape clauses were almost uniformly disfavored by courts. Underlying this hostility is the indiscriminate nature by which escape clauses operate, forcing insureds to rely on other policies that may have significantly less favorable terms, when they reasonably expected that they would have the full value of their coverage under their desired plan. As such, the Third Circuit held that it was arbitrary and capricious for appellee trustee to have included such a provision in its plan, and that “escape clauses in ERISA covered employee benefit plans are unenforceable as a matter of law.”

The Third Circuit’s opinion in Northeast has been widely influential, and its per se prohibition against escape clauses in ERISA plans is often cited. A decade later, the court in McGurl v. Teamsters Local 560, 925 F.Supp. 280 (D.N.J. 1996) faced a similar situation, but with a less-forceful “excess clause” in play. While excess or “always-secondary” clauses also attempt to shift coverage to an alternative insurer, the excess insurer still provides coverage after the limits of the primary policy are exhausted. Unlike escape clauses, which can “render unsuspecting beneficiaries victims of the paradox by which more insurance could often mean less coverage,” excess clauses do not leave insureds with less total coverage. For this reason, the McGurl court found that excess clauses, while administratively unwieldy, did not violate the policies underlying ERISA as a matter of law.

While many employers will understandably focus on the fiscal consequences of choosing a self-funded over a fully insured plan, the legal consequences of such a decision should not be neglected. And while the types of employers opting for self-funded plans will typically be large entities with considerable internal resources, navigating the complicated framework of statutes and case law is significantly easier with an experienced guide. Like in health care generally, an ounce of prevention is worth a pound of cure, and an attorney well-versed in these matters can help resolve disputes before they even occur. This can be done primarily through well-drafted plan documents, defining the coverage and benefits of the plan, along with a fair and transparent TPA agreement. Self-funded plans already entail a considerable amount of financial risk, and it is imperative that employers not compound these with unnecessary legal risks as well.

Edward T. Kang is the managing member of Kang Haggerty. He devotes the majority of his practice to business litigation and other litigation involving business entities. Contact him at ekang@kanghaggerty.com.

Kang Haggerty associate Ryan Kirk served as co-author of this article.

Reprinted with permission from the December 2, 2021 edition of “The Legal Intelligencer” © 2021 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or reprints@alm.com.

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