Third-Party ERISA Administrator Abused Discretion by Denying Medical Coverage: A Tale of What Not to Do

Sometimes an administrator so unashamedly abuses its discretion in handling an insurance claim that its actions constitute a textbook example of “what not to do” for other administrators and the ensuing decision provides a clear illustration of how courts apply an abuse of discretion standard of review under the Employee Retirement Income Security Act (“ERISA”).  Indeed, a recent case clarified that plan administrators and third-party claims administrators alike are held to comparable standards when issuing claims decisions.  In Pacific Shores Hospital v. United Behavioral Health, 2014 WL 4086784; 2014 U.S. App. LEXIS 16062 (9th Cir. Cal. Aug. 20, 2014) (“Pacific Shores”) the Ninth Circuit Court of Appeal reversed the district court, finding the third-party administrator acted improperly by denying the insured’s claim based on clear factual errors.  Pacific Shores provides a clear example of how courts review a decision for an abuse of discretion, and shows that even third-party administrators, who purportedly have no conflict of interest with the insured, are still held to have the same duties in handling claims and must follow appropriate procedures.

Pacific Shores involved a Wells Fargo & Company (“Wells Fargo”) employee, dubbed “Jane Jones” by the court, covered under the employer’s health plan (“Plan”), governed by ERISA and administered by United Behavioral Health (“UBH”), a third-party claims administrator.  Jones was admitted to the Pacific Shores Hospital (“PSH”) for inpatient treatment for severe anorexia nervosa and major depression with suicide attempts.  During her inpatient stay, Jones submitted a claim to UBH for the costs of treatment, but UBH refused to pay for more than three weeks of treatment.  PSH continued to treat Jones following UBH’s refusal, and subsequently Jones assigned her rights to payment under the Plan to PSH.  PSH sued UBH and the Plan seeking payment for the additional days of inpatient treatment.  The district court ruled in favor of UBH, finding that Jones’ administrative record provided a reasonable basis for UBH’s denial decision.

On appeal, PSH conceded the Plan granted discretion to the administrator, but advanced three arguments for the court to adopt a less deferential review of UBH’s decision.  First PSH argued UBH’s claims administration contained procedural irregularities such that the denial should be reviewed de novo.  Based on its review of the case, the court agreed, stating it was “painfully apparent” that UBH did not follow appropriate procedures in reaching its denial.  For instance, although UBH maintained Jones’ case required medical evaluation due to its “‘medical and psychiatric complexity,’” UBH’s decision was based almost entirely on telephone conversations and voicemail messages.  Indeed, Jones’ claim file was remarkably devoid of any hospital records or independent examination results.  Moreover, UBH’s physician evaluations contained “obvious factual errors could easily have been corrected” if UHB consulted the PSH records or its own administrative record.

Second, PSH argued the court should consider materials outside Jones’ administrative record to review UBH’s denial decision.  The district court declined to consider documents beyond the administrative record, as is typical in cases where a court is reviewing for abuse of discretion.  However, the Court of Appeal explained when the administrator’s decision contains procedural irregularities, courts may consider extrinsic evidence to review the impacts of the irregularity.  In the instant case, the administrator issued its decision based solely on telephone conversations and conflicting information despite the “medical and psychiatric complexity” involved in Jones’ case.  The court determined that a review of the medical files would be helpful in establishing the accuracy of medical facts and Jones’ condition, and therefore it was appropriate to consider extrinsic evidence.

Next, PSH argued that even though UBH was third-party administrator, it was operating under a conflict of interest based on a desire for a continued relationship with Wells Fargo, and the court should consider these factors deciding whether UBH abused its discretion.  The court declined to rule on this matter, stating that based on the record UBH reviewed before issuing its decision, UBH improperly denied Jones’ benefits.  Indeed, even absent this analysis, the court found that there was sufficient information to conclude UBH acted improperly.

The court then explained the abuse of discretion standard entails a review of all the surrounding circumstances for “‘any reasonable basis’” to support an administrator’s decision.  An administrator abuses its discretion if the administrator rendered its decision without any explanation, construed plan provisions in a way that conflicts with the plain language of the plan, fails to develop necessary facts for its determination or relies on clearly erroneous facts.  In Jones’ case, the Plan documents represented an insured was eligible for coverage if any one of six state criteria was met, including having a “serious medical condition” requiring “24-hour management.”  UBH authorized coverage for three weeks of inpatient treatment for Jones after finding this criteria applied.  The Plan further also explains a plan member is eligible for continued coverage based on ten listed criteria involving a continuing condition and active participation in treatment.  UBH, based on its physician evaluations, determined that Jones failed three of the ten criteria, as she did not meet the required level of care, she was not in danger of deterioration if transitioned into a lower level of care, and she was effectively recovering, as determined by UBH’s physician evaluations.  The court first noted that in cases where residential care was required, the requirement necessarily satisfied the ten criteria regarding level of care and participation in treatment.  The physician evaluations contained critical factual errors which downplayed Jones’ condition.  Ultimately, the court held UBH breached its fiduciary duty to discharge its duties with “‘care, skill, prudence, and diligence” and solely in the interest of the Jones by employing and relying on three physician evaluators who made critical factual errors supporting UBH’s denial decision, and its denial was improper under the plan.

Pacific Shores clearly shows third-party administrators are held to the same fiduciary duties as first party plan administrators to act in the insured’s interests when administering claims.  The case also provides support for allowing extrinsic documents in ERISA cases where the administrative record is inadequate.  Although Pacific Shores leaves open the question of whether a third-party administrator may be acting under a conflict of interest with the insureds, for now, third party-administrators are not spared from federal ERISA laws applicable to plan administrators.

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