Court Limits Rescission in Health Plan Contracts
Healthcare Law Newsletter
A California Court of Appeal has held that a health plan may not rescind a contract with a subscriber based on misrepresentation in the application unless it can demonstrate that the misrepresentation was willful or that it had made a reasonable investigation into the accuracy of the application as part of the precontract underwriting process. The decision also expands a plan’s exposure to bad faith and emotional distress liability for postclaims underwriting.
In Hailey v. California Physicians’ Service (2007) 158 Cal.App.4th 452, plaintiff Cindy Hailey applied for Blue Shield health care coverage for herself, her husband, Steve, and her son. Cindy mistakenly believed that the application asked only for her health history, so she omitted any mention of Steve’s obesity and history of health problems. Based on the information in the application, Blue Shield extended coverage to the Haileys. After receiving several hospital claims for Steve, Blue Shield undertook an investigation into possible fraud in the Haileys’ application for coverage. Several months later, Blue Shield sent the Haileys a letter informing them that their health insurance coverage had been cancelled, retroactively, because of the failure to disclose Steve’s medical history. The letter also demanded that the Haileys reimburse Blue Shield for the difference between the premiums the Haileys had paid and the amount Blue Shield had paid for Steve’s medical care. The Haileys filed suit against Blue Shield, alleging causes of action for breach of contract, breach of the implied covenant of good faith and fair dealing, and intentional infliction of emotional distress (IIED). Blue Shield filed a cross-complaint. The trial court granted summary judgment for Blue Shield. The Court of Appeal, reviewing the issues de novo, reversed the trial court’s decision.
First and most foremost, the court addressed whether Blue Shield was entitled to rescind the contract with the Haileys. Rejecting Blue Shield’s arguments, the court held that a health plan is not entitled to rescind a contract because of a material misrepresentation or omission unless the plan can demonstrate that the misrepresentation or omission was willful, or it had made reasonable efforts to ensure the subscriber’s application was accurate and complete as part of the precontract underwriting process. Under this test, the court found triable issues of fact as to both issues precluded summary judgment.
The appellate court stated that a health plan does not "complete medical underwriting" within the meaning of California Health and Safety Code section 1389.3 simply by "blindly accepting the responses on a subscriber’s application without performing any inquiry into whether the responses were the result of mistake or inadvertence." It also noted, "Given the likelihood of inadvertent error, accurate risk assessment requires a reasonable check on the information the insurer uses to evaluate the risk." The Hailey court declined to explicitly state what constitutes a "reasonable investigation," but explained that it would be a factual inquiry, determined on a case-by-case basis.
The next issue the court addressed was whether Blue Shield engaged in bad faith. Again, it found a question of fact, concluding Blue Shield was not entitled to judgment as a matter of law. It stated that "a health care service plan may not adopt a ‘wait and see’ attitude after learning of facts justifying rescission by continuing to collect premiums while keeping open its rescission option if the subscriber later experiences a serious accident or illness that generates large medical expenses." In other words, a health plan must notify a subscriber immediately if there is a problem, or potentially be subject to bad faith liability. The court also determined that a health plan could be subject to an IIED claim for such a "wait and see" attitude.
The Hailey decision is significant for health plans that operate in California. Blue Shield unsuccessfully petitioned the California Supreme for review. Hence, unless a future decision comes out to the contrary, health plans will now be required to conduct a reasonable investigation during the preclaims underwriting process, or will not later be able to rescind a contract based on unintentional misrepresentations or omissions. Failure to do so could not only result in an inability to rescind the contract, but also in liability for bad faith and intentional infliction of emotional distress. Health plans should take a careful look at their underwriting practices and determine if changes need to be made in order to limit exposure to potential liability.