Mooney, Green, Baker & Saindon, P.C.

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October 1999

    This is one of a continuing series of updates on recent developments in the law affecting employee benefit plans.

I.    Employee Benefit Cases
    A.    HMOs On the Run
    B.    Other Court Decisions
        1.    Requirement that Plan Specify Actuarial Assumptions Not Enforceable
        2.    Benefit in Non-Qualified Plan Exempt From Bankruptcy
        3.    Non-Fiduciaries Not Liable for Prohibited Transactions
        4.    Tax Lien Attaches to Pension
        5.    Early State Pension Distribution Subject to 10% Excise Tax
II.    IRS Rulings
    A.    Make-Whole Payments to Plan Not Contributions
    B.    Transfer of Liabilities From Insolvent Multiemployer Plan to Overfunded Single Employer Plan Not Taxable Event

 I.    Employee Benefit Cases

    A.    HMOs On the Run

    Managed care organizations, and Health Maintenance Organizations (HMOs) in particular, have become the target of public outrage. Even those of us who have not had a bad experience with an HMO have at least seen a movie or TV show where a fictional character has. Compounding the problem is the confusing relationship between the maze of medical care and insurance regulation at the state level and federal regulation of employee benefit plans (and preemption of state law) under ERISA. This has often resulted in an enforcement gap, where ERISA preempts state law but provides no adequate remedy.

    This "enforcement gap" has begun to close in from all sides. By now, everyone is aware that the Senate and House of Representatives have each passed their own disparate versions of legislation intended to address this problem. (A full report on this legislation will be provided in a subsequent Legal Report-if and when it is enacted into law.) In the meantime, the courts have not remained quiet. As cases arise involving egregious facts, where the miserly conduct of managed care providers has resulted in injury or death, the courts have felt compelled to craft judicial remedies.

    In the only ERISA case accepted by the Supreme Court in its new term, Herdrich v. Pegram, 170 F.3d 683 (7^th Cir.), cert. granted, 68 U.S.L.W. 3177 (1999), the Court has agreed to take on the issue. Pegram involves an employee health plan that provided benefits through an HMO. A plan beneficiary showed up one day with a stomachache, which her HMO physician determined was caused by a "six by eight centimeter mass" in her abdomen. The doctor concluded, however, that there was no emergency, and scheduled an ultrasound eight days later at an HMO-member hospital 50 miles away, eschewing the local non-participating hospital. In the interim, the beneficiary's inflamed appendix ruptured, and she ended up with peritonitis. Despite the obvious emergency of the ruptured appendix, the HMO still insisted that the beneficiary travel 50 miles to the participating hospital. Although the beneficiary recovered, she was forced to endure a life-threatening condition as the result of her HMO physician's unsound judgment.

    The beneficiary sued on several grounds. Her claim for state law malpractice against both the physician and the HMO eventually won her $35,000. She also claimed that her physician and the HMO were liable as fiduciaries under ERISA. This latter count was dismissed, and the beneficiary appealed.

    In a 2 to 1 decision, the Seventh Circuit found that the physician's and HMO's discretionary power to award benefits (i.e., to provide covered treatment) made them fiduciaries. The court went further, and concluded that the physicians (including the treating physician) who owned and operated the HMO had a direct financial interest in minimizing the payment of claims, which was both a fiduciary violation and a prohibited transaction. Sadly for the Plaintiff, however, the court made it clear that she would not be able to recover any additional damages for herself. At best, she could obtain injunctive relief and damages for the plan itself. The HMO appealed to the Supreme Court, which has agreed to hear the case.

    Analytically, the Pegram decision appears to conflict with the recent decision of the Third Circuit in In re U.S. Healthcare, 1999 U.S. App. Lexis 22464 (September 16, 1999). In U.S. Healthcare, an HMO-contracted physician, after consulting with the health plan's precertification group, discharged a newborn baby after 24 hours. The next day, the baby got sick, but the HMO refused to readmit the baby or to provide promised at-home care. As it turned out, the baby had contracted a Group B strep infection, and died from meningitis by the end of the day. The parents sued in state court.

    In rejecting the HMO's contention that the state claims were preempted, the Third Circuit, supported by the Department of Labor, distinguished between the actions of an HMO acting as a plan administrator, in which it makes eligibility determinations, calculates and disburses benefits, monitors funds, and keeps records, and those actions taken in its capacity as a health care provider, in which it arranges and provides medical treatment through its contracts with hospitals, doctors and nurses. Claims arising from an HMO's actions as an administrator of benefits are solely governed by federal law, while those in which it acts as a health care provider are governed by state law. Put a different way, the court distinguished between claims directed toward the quality of care provided, which are governed by state law, and those that allege that a plan "erroneously withheld benefits due" or which seek to "enforce [plaintiffs'] rights under their respective plans or to clarify their rights to future benefits," which are completely preempted and governed solely by federal law. The court rejected the analysis applied in Pegram, concluding that the HMO's program of physician incentives designed to reduce medical costs affected the quality of care provided, and was therefore a matter for state, rather than federal, law scrutiny. In accordance with U.S. Healthcare is the decision of the New York Court of Appeals in Nealy v. U.S. Healthcare, 93 N.Y.2d 209 (1999).

    Falling somewhere in between these two cases, and demonstrating the gap in regulation between the federal and state schemes, is the recent decision by the First Circuit in Danca v. Private Health Care Systems, Inc., 185 F.3d 1 (1^st Cir. 1999). In Danca, an insurance company providing hospital precertification services to an employee benefit plan refused to permit a mentally ill patient to go to the hospital recommended by her treating physician, despite her successful treatment at that facility in the past. Instead, she was required to utilize a series of lesser facilities, which provided little or no treatment. Lacking adequate treatment, the patient attempted suicide through self-immolation, suffering severe burns and permanent disfigurement.

    Through her parents, the patient sued in state court for malpractice and negligence. Although the claims against the various medical facilities were permitted to go forward, the claim against the insurance company was dismissed. The First Circuit concluded that, although the insurance company's precertification decision was medical in nature, it was in fact deciding whether to provide or deny plan benefits. As such, these activities are governed solely by ERISA, and the state law claims are preempted. In accordance with this result is the decision by the Sixth Circuit in Tolton v. American Biodyne, Inc, 48 F.3d 937 (6^th Cir. 1995). There, the court concluded that state malpractice claims against a managed care provider of psychiatric treatment were preempted. This line of cases exemplifies the gap between state and federal remedies, where state law is preempted, but ERISA provides no effective remedy. The result is that, although these participants have been horribly injured by the wrongful actions of their health plan's managed care providers, they have no recourse.

    By agreeing to review the Pegram case, the Supreme Court will attempt to impose some order on this mish-mash of judicial decision-making, assuming Congress doesn't get there first. Whatever happens, we will keep you informed.

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    B.    Other Court Decisions

    1.   Requirement that Plan Specify Actuarial Assumptions Not Enforceable

    Stamper v. Total Petroleum Inc. Retirement Plan, No. 98-3013 (10^th Cir. 1999) involved a pension plan that provided a deferred vested benefit payable in full at age 65, or an actuarially reduced benefit beginning as early as age 55. Until its amendment in 1996, in violation of applicable provisions of the Internal Revenue Code, the plan failed to specify the assumptions it used in determining the amount of the actuarial reduction for early retirement. A group of deferred vested participants sued, alleging that the plan's failure to include reduction factors entitled them to an unreduced pension at age 55, and that the imposition of early retirement reduction factors in 1996 violated the "anti-cutback" rule. The 10^th Circuit disagreed, affirming the dismissal of the participants' claims. The court concluded that the requirement that actuarial assumptions be stated in the Plan was only included in the Internal Revenue Code, and not in the substantive provisions of ERISA. As such, it could not be privately enforced. The court noted, however, that there is a split of authority on this issue, with some courts concluding that the requirement that a plan state its actuarial assumptions had been incorporated into the substantive ERISA requirement that benefits under a plan be "definitely determinable."

    Traina v. Sewell, 180 F.3d 707 (5^th Cir. 1999) involved a pension plan that had engaged in prohibited transactions. A participant in the plan filed for personal bankruptcy, and attempted to hold her interest in the plan exempt from her bankruptcy estate. The bankruptcy trustee disagreed, contending that the plan should be disqualified for the prohibited transactions, and that the debtor's interest in the disqualified plan was therefore not exempt from bankruptcy. The Fifth Circuit agreed with the debtor, concluding that a participant's interest in an ERISA-governed pension plan is excludable from bankruptcy, without regard to whether the plan is qualified under the tax code.

    3.    Non-Fiduciaries Not Liable for Prohibited Transactions

    4.    Tax Lien Attaches to Pension

    5.    Early State Pension Distribution Subject to 10% Excise Tax

    Kute v. United States, No. 99-3195 (3^rd Cir. 1999) involved a pension program established under the Pennsylvania constitution that had been qualified by the IRS under Section 401(a), and that covered a group of state troopers . Negotiations for a new collective bargaining agreement between the Fraternal Order of Police and the state reached impasse and the FOP invoked binding interest arbitration. The arbitration panel changed the pension plan to permit state troopers with 20 years of service to retire at any age. The award also permitted such troopers to retire with a lump sum in lieu of an annuity. Subsequently, the state legislature amended the Pennsylvania constitution to provide that pension rights of state employees shall be determined solely by the constitution and no collective bargaining agreement or arbitration award could affect the pension benefits of state employees. A few years later, a trooper retired at age 51 after nearly 30 years of service. The trooper elected a lump sum, which was permitted under the constitution. Because the trooper was not 59-1/2 and had elected a lump sum instead of an annuity, the benefit was subject to a 10% excise tax under IRC § 72(t). The trooper paid the tax, and sued for a refund, arguing that his lump sum benefit was not a pension payment, but resulted from the arbitration award. The court rejected this argument, concluding that the lump sum was indeed an early pension distribution subject to the 10% excise tax.

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II.    IRS Rulings

    PLR 199935073 involved lawsuits against a former plan sponsor for securities law violations which were alleged to have occurred during the course of a corporate reorganization. As part of a settlement, the former plan sponsor agreed to make cash payments to the plan to partially reimburse the participants for their losses resulting from the alleged violations. These 401(k) proceeds were to be allocated to the participants' accounts in the 401(k) plan, and no one would have more than he or she would have had but for the alleged securities violation. Following a request by the parties, the IRS ruled that these "replacement payments" would not be considered to constitute taxable payments to the employees. In addition, they would not be considered as contributions to the plan, and therefore would not be subject to any of the statutory limitations on employer contributions.

    B.    Transfer of Liabilities From Insolvent Multiemployer Plan to Overfunded Single Employer Plan Not Taxable Event

    PLR 199935076 involved an employer that maintained an overfunded single employer pension plan for its non-bargaining unit employees and that contributed to a significantly underfunded multiemployer pension plan for its union employees. Under a deal worked out with the Pension Benefit Guaranty Corporation, the employer agreed that its overfunded pension plan would assume the liability for providing pensions to its union employees who had participated in the multiemployer plan. In exchange, the employer would be absolved from payment of withdrawal liability to the multiemployer plan. The employer sought a ruling from the IRS that its application of the single employer plans' excess assets to liabilities of the multiemployer plan (which would have the affect of relieving the employer from substantial liability) would not subject it either to income tax or to the excise tax under IRC § 4980 for benefiting from a reversion of excess assets from its single employer plan. The IRS concluded that no tax liability would attach to the transaction, reasoning that the use of surplus funds from the overfunded plan to finance the company's union employees' pensions is consistent with the use that was intended when the company claimed deductions for contributions to its plan.

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This Newsletter provides an update on current legal developments, and is not intended as legal advice.  Copyright © 1999 Mooney, Green, Baker & Saindon, P.C.