"Medical Necessity" and Health Plan Contracts

Executive Summary

Is it sound public policy for legislators to shift the responsibility for interpreting "medical necessity"—a key concept in health insurance policies—from insurers to providers? This is the core question addressed by this white paper, which is based on a legal opinion commissioned by the Health Insurance Association of America in January 1999 from William G. Schiffbauer, Esq.

The question is provoked by legislation that has been proposed on Capitol Hill1 and in many states. At first blush, such legislation, which would place determinations of "medical necessity" solely into the hands of treating physicians, seems innocuous, even reasonable: Why shouldn’t treating physicians define what is medically necessary? But, in fact, this proposed change—which would have a detrimental effect on health care in America—reflects the widespread public confusion about "medical necessity" as a boundary of health coverage and "medical necessity" as a clinical determination by a treating physician.

The "medical necessity" provisions in currently proposed federal legislation represent a radical rewriting by public officials of the contract between insurers and health plans and their customers. When the provider, rather than the health plan or insurer, interprets the scope of coverage under the contract, health plans and fiduciaries cannot guarantee to the insured that health care dollars are being spent fairly and equitably on medical treatments that are safe, proven, and effective. Indeed, such legislation could give some providers incentives to overtreat patients to enhance their incomes. Under such a regime, who can doubt that insurers’ denials of payment or determinations of noncoverage would be regularly challenged?

In effect, the proposed "medical necessity" provisions represent an attempt to turn back the clock. Such proposals would do more than simply return the health care system to the unconstrained fee-for-service system of payment that was responsible for the double-digit inflation in health care costs of the 1970s and 1980s. It would undermine efforts by all types of health plan delivery models, from HMOs through PPOs and fee-for-service coverage. Even in the earlier era of fee-for-service medical coverage, insurers reviewed claims to ensure that the services already delivered had in fact been medically necessary.

Far from protecting patients, passage of such legislation would be deeply inimical to the interests of health care consumers, driving up the cost of medical care and possibly even placing patients in harm’s way. The legislation would needlessly raise costs for plans, thereby promoting premium increases and reducing the affordability of health insurance. In the long run, such legislation threatens to diminish the availability of coverage and increase the number of the uninsured.

The basis for these misguided proposals is the perception that insurers routinely make numerous, unfounded adverse coverage determinations. A 1997 study based on a survey of over 2,000 physicians caring for patients covered under plans utilizing managed care techniques found that the final overall coverage denial rate for physician-proposed treatment plans in eight categories of care was less than 3 percent, and that the figure was much less for most of the categories of care2. The majority of physicians reported no coverage denials whatsoever. Under specific types of care, coverage for hospitalization was denied only 1 percent of the time; surgical procedures, 1.2 percent; and specialist referrals, 2.6 percent. The rate of initial denials was higher, but between one-half and two-thirds of these first level denials were reversed by the health plans, resulting in the lower final denial rate.

Health plans use national standards validated by evidence-based scientific studies or prepared by prominent medical experts to understand what treatments and services are appropriate. Using those standards, medical professionals at health plans make decisions about which procedures should be covered. These decisions are coverage determinations for payment purposes. Treating physicians are ultimately responsible for recommending a course of treatment for their patients, regardless of coverage.

To illustrate some of the most egregious problems which could result from this legislation that would give physicians authority over plan coverage determinations, we have analyzed legislation under debate in the 106th Congress: the Patients’ Bill of Rights (S. 6/H.R. 358).3 Section 151 of this bill states that insurers and health plans may not "arbitrarily interfere with or alter the decision" of a treating physician for services that the physician has determined to be "medically necessary."4 This proscription would apply to health plans of all designs, from fee-for-service indemnity to staff model health maintenance organizations and those of other managed care organizations (MCOs).5

If enacted, the proposed law would:

(1) Undermine utilization management and increase costs by:

      1. turning over coverage determinations based on medical necessity solely to the treating physicians who have both economic and non-economic incentives to inflate reimbursement;
      2. eliminating, or sharply curtailing, effective utilization review and other cost-containment mechanisms; and
      3. imposing extra-contractual obligations on insurers and plans, thereby driving up premiums.

(2) Encourage fraud and abuse, especially by providers.

(3) Undermine quality and perhaps even expose patients to danger.

(4) Undermine contract law by:

(a) permitting public officials to change essential terms and conditions of the agreement between contracting parties, to the benefit of an interest group that is not party to the contract;

(b) preventing insurers from making appropriate coverage determinations, thus limiting their ability to meet their contractual obligations to premium payers and patients; and

(c) changing the essence of the fiduciary responsibility of plan administrators.

(5) Create a unique coverage regime for private insurance inconsistent with governmentally funded programs.

This proposal is a solution in search of a problem. Currently, according to two studies,6 in 97 percent of the cases involving utilization review, the physicians’ recommended courses of treatment were approved. Therefore, this proposed change would remake the world threatening utilization management, increasing fraud, increasing cost, increasing the risk of harm to patients, undermining quality, and abrogating fiduciary responsibility under ERISAbecause of adverse determinations in less than 3 percent of the coverage determinations made under current practices.

"Medical Necessity" and Health Plan Contracts:

Complete Provider Deference Means Higher Costs, Lower Quality

I. Introduction

Proposals have been advanced to remove the interpretation of a private health insurance contract’s medical necessity requirement from the private contract process and place it in the hands of providers. For example, federal legislation, such as the Patients’ Bill of Rights, would propose that a health plan may not arbitrarily interfere with or alter the decision of a treating physician regarding services that the physician has determined to be "medically necessary." As discussed below, the direct object of this legislation is the substitution of the provider for the group health plan or issuer of the health insurance coverage as the party who will interpret and determine the scope of coverage and payment under the group health plan or health insurance contract.

This proposal would:

    • convert coverage and payment determinations for health care expenses into medical decisions;
    • disable the private contract structure and process for coverage and payment determinations in every type of plan design ranging from fee-for-service indemnity to staff-model health maintenance organizations;
    • eliminate the utilization review process that is fundamental to the managed care "choice";
    • foster opportunities for fraud and abuse;
    • diminish health care quality; and
    • impose unforeseen, extra-contractual obligations that will require premium increases or threaten health plan and insurer solvency.

The proposed legislation, if enacted, would simply shift control of coverage and payment decisions from insurers and managed care plans to providers, and it would have the effect of raising costs, thereby possibly reducing the availability of coverage and increasing the number of uninsured Americans.

II. Description of Proposal

A. In General

The core change that would be brought about by the Patients’ Bill of Rights is that individual providers would be granted statutory deference to control coverage and payment decisions. Section 151 of S. 6/H.R. 358, the Patients’ Bill of Rights, would prohibit group health plans and issuers of health insurance coverage from "arbitrarily interfering with" or "altering the manner or setting" of covered health care services when that care is determined by the treating physician to be medically necessary or appropriate.7 The treating physician may be the patient’s primary care physician or a specialist to whom the patient has been referred. "Manner or setting" would be defined as the location of treatment (such as inpatient or outpatient) and the duration of a service (such as number of days in a hospital).8 Finally, the section defines "medically necessary or appropriate" as a service or benefit that is "consistent with generally accepted principles of professional medical practice."9 Separately, the legislation provides that consumers may appeal the plan’s or insurer’s adherence to this section to an external review entity.10 Additionally, other legal options, including judicial review, may be pursued.11 Finally of note, the legislation would preempt state laws that would "prevent application" of federal law, including Section 151.12

While the sponsors of this legislation contend that it is aimed at reforming the practices of "managed care" plans, in fact, Section 151 would apply to any group health plan or health insurance coverage regardless of the type of plan.13 The legislation incorporates the definitions of the Health Insurance Portability and Accountability Act of 1996 (HIPAA);14 under this definition, a "group health plan" subject to this provider-determined coverage and reimbursement rule is any employee welfare benefit plan that provides coverage for medical care.15 In addition, this rule would apply to any "health insurance coverage," meaning those benefits consisting of medical care provided directly, through insurance or reimbursement or otherwise, and including items and services paid for as medical care under any hospital or medical service policy or certificate, or insurance or HMO contract or certificate.16 The legislation would amend the Public Health Service Act’s group health plan provisions of Title XXVII, incorporating this rule and other provisions by reference.17 It would also amend the individual health insurance rules of Title XXVII.18 Finally, the proposed legislation would incorporate the rule and other new mandates into the Employee Retirement Income Security Act (ERISA).19

The proposed legislation does include a limited safeguard in that all services determined by a treating physician to be medically necessary must be "otherwise a covered benefit."20 However, whether a benefit is itself "covered" is often the subject of interpretation and litigation21— and Section 151 would clearly lead to even greater litigation in this area. Although the "covered benefit" rule may offer some protection against physicians’ attempts to impose payments for excluded "experimental or investigational" treatments, that interpretation of the proposed bill must be weighed against the potential breadth of the "generally accepted principles of medical practice" standard for treatment—which, if interpreted liberally, may sweep in excluded therapies and procedures.22 In addition, many coverage disputes center on whether certain facilities are included in the word "hospital."23 The legislation would, however, specifically protect a treating physician’s determination of the "manner or setting" of the treatment.24

B. Consequences of Establishing Statutory Deference for Providers

Clearly, the proposed legislation is far reaching and would bring dramatic changes to how health care is financed. Nor would the legislation be easy to understand, interpret, and administer. The terminology alone would provoke nearly endless litigation. For example, since the plain meaning of the word "arbitrary" is "without adequate determining principle, or not according to reason or judgment,"25 the question will arise as to whose standard of reason or judgment is adequate. The words "interference" and "alteration" are equally debatable. Indeed, the very ambiguity of these terms would serve as a deterrent to any challenge of a provider’s treatment decisions. At best, it would take years and years of litigation in jurisdictions across the country to provide some guidance in this area. The CBO cost estimate, prepared in relation to the identical Section 151 in the 1998 version of current S. 6/H.R. 358, stated that:

This provision would increase the volume of internal and external appeals above and beyond the volume expected from other provisions. Not only would the provision provide additional incentives to appeal decisions by plans, but it would probably also lead to a higher rate of reversal on appeal. Although the external appeals bodies and the courts might eventually settle on uniform and easily interpreted standards of medical necessity, the variability of medical practice styles across the country would ensure continuing challenges to decisions by plans over the 10-year estimating period.26

In addition to litigation, the consequences of providing legal deference to provider coverage determinations would be far-reaching and would affect the entire health care system. If enacted, Section 151 and other similar proposals:

    • would—at a minimum—have a chilling effect on health plan utilization management, increasing costs to the plans;
    • would lead to increased fraud and abuse in the private health care sector, diverting enormous resources from patient care;
    • would have both direct and indirect impacts on the cost of providing coverage to patients;
    • would have an adverse effect on quality as providers would have increased incentives to overtreat, which could be contrary to the patient’s best interests and to the delivery of quality care; and
    • would abrogate the well-established fiduciary responsibility of health plans and plan administrators to the people covered under the plan.

Health insurance premiums could again spike as the effects of Section 151 requirements on utilization review are felt, and plan operational and administrative costs increase. These new legal barriers to health plan oversight could even place patients in harm’s way. These requirements would radically rewrite the terms of private contracts through government fiat in a manner that is fundamentally inconsistent with the nearly identical rules followed for over three decades by public programs. Each of these concerns is discussed in greater detail below.

III. Analysis

A. Concerns About Increased Fraud and Abuse

1. Fraud Would Become More Difficult to Challenge

Section 151 raises significant legal barriers to private sector efforts to combat waste, fraud, and abuse in the health care system. Treating providers, who would be required only to observe the "generally accepted principles of professional medical practice" (even if such practices have been shown to be unnecessary or only marginally beneficial), would be able to challenge health plan coverage denials as arbitrary interference in or alteration of their decision making. This provision, therefore, would stand in marked contrast to increased recognition of the pervasiveness of fraud and abuse during the past decade and the commensurate expansion of public and private resources to combat fraud and abuse.27

In a 1992 report to Congress, the General Accounting Office estimated that fraud accounted for 10 percent ($70 billion) of the nation’s health care spending in 1991.28 Today, that 10 percent would be more than $100 billion.29 Testifying before the House Committee on Ways and Means in 1997, Charles L. Owens, Chief of the FBI’s Financial Crimes Section, stated that health care fraud has become the number one white collar crime in America.30 In testimony before the Senate Permanent Subcommittee on Investigations of the Senate Committee on Governmental Affairs earlier in that year, Mr. Owens had stated that "[h]ealth care fraud is causing a serious financial drain on the country, and we must continue our collective efforts to combat it."31 A study by the Health Insurance Association of America found that 78 percent of all reported health care fraud cases were the result of provider actions.32

Taxpayers pay higher taxes because of fraud and abuse in public programs such as Medicare and Medicaid, and employers and individuals pay higher private health insurance premiums because of fraud and abuse in the private health care sector. Moreover, the resources wasted paying fraudulent claims reduce the number of dollars available to be spent on patient care.

As awareness of health care fraud and abuse and their increasing pervasiveness has grown during the past few years, both the government and private sector payers have significantly increased their anti-fraud activities. For example, HIPAA significantly strengthened penalties against health care fraud and established and provided funding for a coordinated fraud and abuse control program.33 Penalties for committing fraud against federal government programs were further enhanced by the Balanced Budget Act of 1997.34

As part of these stepped-up anti-fraud activities, in February 1999, the Office of the Inspector General (OIG) of the Department of Health and Human Services announced that improper Medicare payments to doctors, hospitals, and other health care providers declined 45 percent from fiscal year 1996 to fiscal year 1998. HHS reported that a heightened focus since 1993 by the OIG, the FBI, the Health Care Financing Administration, the Department of Justice, and others in government had yielded "a new, more detailed picture of fraudulent activities aimed at" government health care financing programs.35

Moreover, HHS has launched Operation Restore Trust, a project to coordinate federal, state, local, and private resources to fight fraud. According to HHS, during its two-year demonstration phase, the project identified $23 in overpayments for every $1 in project costs.

The stepped-up efforts resulted from years of abuse of Medicare payment policy. The Medicare program is rife with examples of fraudulent schemes designed to bilk taxpayers by claiming that items and services are "medically necessary" when they are not. For example, the government overpaid more than $1.5 million to a New York durable medical equipment (DME) supplier that gave Medicare beneficiaries angora underwear, power massagers, air conditioners, and microwave ovens as an inducement for beneficiaries’ Medicare billing numbers so that the company could charge for items that never were delivered.36 A Texas DME supplier defrauded Medicare of over $1 million by charging the government for $1,300 orthotic body jackets while instead providing inferior wheelchair pads that cost less than $100 to manufacture—a mark-up of over 2,500 percent.37

Government investigators also have uncovered numerous instances of providers billing for phantom psychotherapy sessions or grossly inflating the number of psychotherapy hours provided to reap overpayments from Medicare and private insurers.38 A New York community center director was indicted for stealing nearly $1 million by fraudulently billing the state for over 25,000 sessions that never occurred.39 The billings were so excessive that staff psychiatrists would have had to work well over 24 hours a day to handle the number of visits claimed. In Pennsylvania, the owner of a rehabilitation service was indicted for defrauding Medicare by falsifying patient medical records so that they would appear to be eligible for "medically necessary" speech therapy.40 And a Pennsylvania physician was convicted on 59 counts of illicit distribution of Valium, Apidex, Darvocet, and Vicodin for writing prescriptions to drug abusers and dealers that he claimed were "medically necessary."41

The private sector has also been active in combating fraud. A recent report by the Health Insurance Association of America indicates that nearly 90 percent of private health insurance companies have established anti-fraud programs, including employee training, claims audits, consumer hotlines, and information-sharing among payers and law enforcement agencies.42 These activities are beginning to bear results. Private-sector anti-fraud operations saved over $7.50 for every dollar spent in 1995, compared to $4.30 just two years earlier.43

2. Marginal or Unnecessary Care Could Be Covered and Become More Pervasive

Saddling private health plans with additional legal barriers to challenging coverage determinations on the basis of "medical necessity" would encourage fraudulent claims, and they would become much more commonplace in the private sector. In fact, several classic court decisions demonstrate how fraud and abuse would increase in the private sector if significant deference were to be conferred upon providers in making "medical necessity" decisions.

There have been many cases where payment has been required for treatments that were of dubious value. In one instance, a court required payment for medical services to an insured at a Bahamian clinic utilizing a cancer treatment that had never been approved by any agency of the U.S. government, because the court deferred to the physician’s determination of medical necessity over that of the health plan.44 Indeed, many patients—or their providers, who were seeking reimbursement—have prevailed even when the treatment (whether preventive, exploratory, or investigative or experimental) was explicitly not covered under the terms of the plan.45 Courts (and juries) often rely on the "good faith judgment" of treating physicians as to the medical necessity of services, especially in the absence of an explicit contractual provision to the contrary.46 Sometimes, however, decisions even fly in the face of contractual provisions.47

In addition, the line between inappropriate care and fraud could again become less distinct, as in the classic Duncan case. There, the court, deferring to a treating physician, required insurance coverage under multiple policies for two three-week periods of hospitalization for a husband and wife who suffered bruises and sprains. The facts of the case strongly indicated a motive on the part of the couple to "reap financial gain."48

B. Concerns About Rising Costs and Inflation

1. Every Service Could Be Deemed Covered and Payment Required

Since the advent of managed care, premium increases, which had risen sky-high under fee-for-service medicine, leveled off dramatically, and are now roughly parallel with the consumer-price index. The application of the concept of "medical necessity" in managed care has been responsible for much of its success to date.

The concept of "medical necessity" was developed in tandem with the fee-for-service system, in an early attempt to prevent the unconstrained flow of reimbursement for health care services that persistently drove up costs. While the cost-increasing characteristics of the fee-for-service system have been exhaustively documented,49 it may bear repeating that when economic incentives to increase both the types and frequency of medical services marry up with noneconomic incentives, bad results obtain. These perverse incentives not only drive up costs but could also be detrimental to patient care or could even harm patients. Providers could overprescribe treatments to ensure their patients every possible advantage, no matter how remote; to decrease a perceived risk of medical malpractice liability; or simply because the money is available. But it simply is not feasible to provide every conceivable treatment for every patient without driving up costs substantially for all customers.

While concerns about cost and quality are not new, and payers of medical expenses have always had to assess claims, pressure mounted in the mid-1960s as the medical economy absorbed an ever-growing and disproportionate share of our nation’s resources. Private insurers used medical necessity standards to examine claims and, as technological developments accelerated in the 1970s, added exclusions for experimental or investigational procedures. The federal government adopted the medically necessary and appropriate language used by private insurers for Medicare, Medicaid, and other government health programs.50

2. Standard of Care Could Become Lowest Common Denominator

Under Section 151, nearly every medical service that a treating physician determines to be necessary, whether appropriate for the patient, could be deemed covered and would trigger payment. Indeed, the bill so broadly defines medical necessity that the term could apply to any service or treatment consistent with "generally accepted principles of medical practice."51 Inevitably, questions would arise as to whether practices are "generally accepted" nationally, regionally, or locally. To make matters worse, the term "generally accepted" could apply to practices that may be inappropriate for a particular patient or are no longer considered effective. This is because once a treatment is considered medically necessary, few—if any—treatments are discredited as such, regardless of whether other treatments for the condition being treated have been developed and are considered to be "best practices." In addition, statutory protection for what is "generally accepted medical practice" in a given locality could provide a legal basis for resisting a more appropriate setting for the treatment.

3. Increased Risk of Health Plan Insolvency Due to Infinite Coverage Obligation

In essence, Section 151 would encourage "extra-contractual" benefits—benefits and coverage that are not part of the original bargain between policyholder and insurer. Moreover, if providers were able to obligate health plans to pay for costs related to medical services that had not been reflected in the actuarial assumptions used to price the policy, they would not simply drive up reimbursement costs, but could also threaten the financial stability of the plans. Thus, the basic principle of health economics—the greater the volume and intensity of medical services delivered, the higher the cost to patients and insurers—has a corollary: that unanticipated costs can lead to health plan insolvency.

In short, the terms and conditions of the contract between the health plan or insurer and the customer regarding medically necessary and appropriate services would be eviscerated and replaced with a system that grants the treating provider a presumption of correctness. That could result in increased plan liability. Other provisions in the Patients’ Bill of Rights legislation would explicitly expand liability.

At present, in policies that provide coverage for providers not affiliated with the plan, those providers are not part of the coverage contract between the insurer and the policyholder and become involved in the claim payment determination process as such only if patients "assign" payment for medical services rendered directly to them. In most managed care plans providing such coverage, the patient would have to meet the prior authorization requirements of the plan, except in emergency treatment cases. Indeed, third-party review of the treating physician’s determination of medical necessity—particularly if done before the delivery of services—provides a useful check on the appropriate use of health care resources. But should providers become the sole decision makers as to whether a service is medically necessary and appropriate, this system of checks and balances that works to provide good medicine at an affordable price would be seriously undermined, if not destroyed.

4. Utilization Review and Other Quality and Cost Controls Rendered Moot

Utilization management and other quality and cost-containment mechanisms would fall before the juggernaut of Section 151. Utilization review is a process, or series of processes, to address quality of care. Within a plan, it is developed and managed by health care professionals to assess whether a treatment plan is medically necessary or appropriate and, therefore, a covered benefit deserving of payment under the coverage plan. A well-functioning utilization review program, under the direction of medical professionals, manages the use of available resources to optimize the effectiveness of the care. Physicians and nurses review requests for prior authorization or precertification determinations to make sure that a planned procedure is a covered benefit and to determine that it is medically appropriate (i.e., the right procedure in the right setting, at the right time). Precertification determinations not only protect plan participants from undergoing unnecessary procedures, they also offer other protections, such as care provided in a contracted facility that has met the health plan’s standards, provided by a physician who is credentialed by the health plan. It’s unclear at this time how extensively this proposal would undermine the emerging health plan programs targeting management of specific diseases such as asthma, diabetes, and heart disease. Under Section 151, however, utilization review and other quality and cost-containment mechanisms could arguably be characterized as "arbitrary interference with" or "alteration of" the physician’s medically necessary treatment plan.

Moreover, Section 151’s deference to the treating physician’s decision with respect to the "manner or setting" of treatment also would weaken utilization review. Indeed, under such strictures, health plans may well be tempted, in the words of the CBO Report, "to reduce the frequency with which they challenge[d] physicians’ decisions," regardless of their medical necessity to avoid the administrative costs of adjudicating challenges. (See endnote 26.)

Resources to pay for health care services are limited for both government and private payers. The proposed legislation would put pressure on health plans to approve requests for utilization review determinations that would be questioned under the current system, and to pay any and all claims regardless of their true medical necessity, simply to avoid the expanded liability for denial of payment. This would have an adverse effect on the quality and cost of the care.

5. Provider Financial Conflicts Could Become More Problematic

Insurers—public and private—have relied on the medical necessity standard to help discourage overuse of medical services. Studies comparing the use of certain medical procedures by geographic region have found large differences in physician practice patterns not clearly justified by patient demographics or outcomes. This raises concerns about the efficacy and basis of many medical practices.52 Indeed, a myriad of studies have shown that many services patients received had no significant medical benefit and were, in some instances, harmful.53 Unfortunately, Section 151, by providing the physician with statutory "leverage" over the coverage and payment determinations, could motivate physicians to overtreat.54 Incentives to overtreat include:

    • the inherent and intractable nature of fee-for-service itself;
    • payment and receipt of inducements or kickbacks for referrals—currently illegal only in Medicare and Medicaid;
    • income earned by a physician referring patients to medical facilities owned or invested in by the physician—limited in only certain instances in Medicare;
    • income earned by a physician for dispensing drugs, products, and other ancillary medical services;
    • payments made by hospitals to doctors to purchase physicians’ medical practices and pressure to increase admissions;
    • hospital joint ventures and income guarantee arrangements and loans to physicians to promote referrals to the sponsoring hospital;
    • hospital provision of management functions such as billings, collections, and accounting to promote referrals to the sponsoring hospital;
    • gifts to doctors from medical suppliers offering products that require a physician’s prescription to be sold; and
    • sale of information from patients’ files by doctors to marketing firms, pharmaceutical firms, and others.

C. Concerns About Diminished Quality of Care

1. Evidence-Based Quality Standards Rendered Moot

Each year, as many as 120,000 Americans die, and about 1 million are injured, because of medical mishaps and errors.55 In some cases, doctors prescribe unorthodox or unnecessary courses of treatment that could be defended as consistent with "generally acceptable principles of professional medical practice" under Section 151, but that place patients at significant risk for injury or death.

Patient injuries resulting from medication occur at the rate of about 2,000 a year in each large teaching hospital; about 28 percent are preventable based on current knowledge.56 The 1984 Harvard Medical Practice Study of New York State Hospitals, published in the New England Journal of Medicine in 1991, estimated that more than 27,000 patient injuries are due to negligent care.57 Section 151 could exacerbate these problems because it would give individual providers the authority to bypass the carrier’s utilization review process and its application of practice guidelines to coverage decisions.

Broad-based criteria used by health plans and insurers are objective, measurable decision-making criteria based on sound clinical evidence, consistent with the plan’s clinical practice guidelines, based on "best practices" that reflect up-to-date scientific research. These guidelines—optimal clinical benchmarks for a given condition with no complications—are reviewed by the health plan’s quality committee whose members include network physicians practicing in the area. The use of guidelines in medical decision making is not new. The medical community has traditionally used guidelines. In making prior authorization determinations, health plan medical professionals apply plan guidelines on a case-by-case basis.

The proposed legislation could "lower the bar" for physicians by permitting merely the "generally accepted" standard to prevail. In effect, it would allow an individual provider to ignore decisions made by professional peers and adopted by a health plan as part of its utilization process.

2. Concerns about the Use of Risky Medical Procedures

Because Section 151 would give providers virtually unlimited autonomy with regard to the "manner" or "setting" in which care was delivered, it could subject patients to harm by leading to unnecessary hospital stays and/or possible over- or under-utilization of services. To the extent that treating physicians rather than health plans and insurers would be decision makers regarding plan coverage determinations, the Patients’ Bill of Rights Act would increase health plans’ exposure to civil lawsuits for punitive and other non-compensatory damages resulting in injury or wrongful death.58

The following are examples of problems related to inappropriate treatment involving both overtreatment and undertreatment typical of those that health plan utilization management currently addresses:

    • A study done by HCIA with William Mercer found that if all hospitals performed at the benchmark levels of the top 100 hospitals, inpatient mortality and complication rates would drop 22 percent, and the average length of stay would be cut by about half a day.59
    • A study published in the Journal of the American Medical Association (JAMA) in 1993 found that 16 percent of hysterectomies performed were inappropriate.60
    • Twenty percent of cardiac pacemakers were found to have been inserted for clearly inappropriate reasons, according to a study published in the New England Journal of Medicine in 1988.61
    • Twenty-three percent of children proposed for tympanostomy tube insertion (the most common surgical procedure in childhood) had been recommended for inappropriate reasons according to a study published in JAMA in 1994 and referred to in 1998.62
    • Two 1992 studies of ambulatory adults and children, published in JAMA in 1997 and 1998, found that 21 percent of all antibiotic prescriptions (a total of 23.8 million prescriptions) were used to treat colds, other upper respiratory tract infections, or bronchitis—conditions for which antibiotics are ineffective and pose the risk of life-threatening adverse drug reactions and an increase in antibiotic resistance.63
    • A study by the University of Maryland Medical School showed that cholesterol-lowering drugs are given to only 35 percent of the women and 54 percent of men diagnosed as at risk of having a heart attack.64
    • Approximately one-third of the heart attack victims who could benefit from the use of beta blockers, the widely accepted drug for secondary prevention after acute myocardial infarction, are not prescribed the drug, resulting in about 18,000 deaths a year.65
    • The use of beta blockers varies significantly across the country, from a low of 30.3 percent of the appropriate subject population to a high of 77.1 percent. Beta blockers are associated with a 14 percent lower risk of mortality one year after hospital discharge.66
    • A study conducted by Yale University found that only about 38 percent of the people who could benefit from taking Warfarin, a drug that prevents up to 80 percent of strokes in people with atrial fibrillation, receive prescriptions for it.67

D. Concerns About Abrogation of Contracts

1. Insurers’ Fundamental Fiduciary Duty Would Be Abolished

Health insurance policies are private contracts that spell out the rights and responsibilities of both consumers and issuers or providers of the coverage. These contracts establish the details of the relations between insurers and the insured, health plans and administrators, and health plans and networks of providers. Moreover, standards for private health insurance contracts also appear in state laws, including general contract law, common law, and insurance laws and regulations.68 Government health care programs, including Medicare and FEHBP, also rely on similar "contractual" terms to delineate eligibility, coverage obligations, and various other matters.69 In the case of publicly financed health care, the statutes and regulations that govern both state and federal programs function as contract terms, and adherence to these terms is enforceable.

By defining medical necessity, and mandating that only the treating physician may determine whether particular services are "medically necessary or appropriate," the proposed law would both undermine the ability of the health plan or insurer to define "medical necessity" and to determine whether, for purposes of coverage and reimbursement, particular services are "medically necessary." Accordingly, the proposed law would remove the cornerstone of the private contract, leaving only eligibility and payment rates as subjects for contractual agreement. While the law would permit a general outline of benefits, the treating physician would decide which particular services are required for treatment, how those services are provided, in what setting, and for how long.

In doing so, the law would abrogate the central tenet of insurance contracts, which are in fact agreements in which the insurer pledges to maximize the pooled resources of the many to the advantage of all beneficiaries. This obligation to make the best use of pooled resources is fundamental to all forms of insurance. With health coverage, insurers fulfill this responsibility to those who have paid premiums by agreeing to pay only for "covered" items and services determined to be medically necessary and appropriate. By contract, then, the employer or the sponsor of a group health insurance plan has obligated the health plan or insurer to reserve coverage and payment for only medically necessary care. Similarly, an individual purchasing individual coverage has entered into the same type of contract with the health plan or insurer. Indeed, the insurer is legally obligated to exclude items and services "not reasonable and necessary" for the diagnosis or treatment of illness or injury. This is true of all health care contracts, be they for a managed care arrangement or for fee-for-service coverage.70

2. Fiduciary Deference Under ERISA Would Be Abolished

In addition, the proposed legislation would also play havoc with claims administration of employer-provided benefit plans. This is because the new law would amend ERISA, which was in part passed to foster uniformity and predictability in the administration and structure of benefits. Subjecting coverage and payment decisions to each provider’s medical necessity determination breaches ERISA’s long-standing principle of uniform claims administration and subjects employers to covering many different procedures. Thus, it would impede employer-sponsored group health plans from granting fiduciaries discretion to interpret established contractual terms and conditions for determining coverage provided by employee plans, and would prevent performance of the duty owed to the plan by that fiduciary.

Under current law, where ERISA plans provide discretionary authority to administrators to interpret the plan’s terms and conditions, judicial review of a denial of a benefit is based on an "arbitrary and capricious" standard. This developed under the trust-law model of ERISA, and deference is provided to the fiduciary who is empowered to exercise discretionary authority over benefit claims.71 The proposed legislation would instead give deference to the treating physician, overturning years of judicial precedent. ERISA common law has developed important safeguards, ensuring that decisions by administrators of ERISA group health plans are properly made solely in the interest of participants and beneficiaries. Courts have established a much more narrow deference to such decisions where the financial interests of a fiduciary come into play. A significant line of case law requires that plan administrators carefully review issues of medical necessity including adherence to the plan’s precise definition, review of all medical evidence, and consultation with treating physicians.72

The proposed law also would change the nature of the fiduciary duty owed by plan administrators. Currently, ERISA imposes strict fiduciary obligations on employer plans, requiring administrators to act solely in the interest of the beneficiary and to pay valid claims. A fiduciary can be held personally liable for a breach of that duty.73 The bill appears to alter one of the principles fundamental to this body of law: changing the concept of fiduciary duty from "prudent management of the plan assets for the use of all beneficiaries" to "ensuring that the treating physician of each single beneficiary is paid for services rendered."74 Accordingly, a fiduciary’s duty is narrowed significantly, with a greater duty of deference owed to the physician treating an individual covered under the group health plan.

E. Concerns About Conflict with Public Programs

1. Separate Standard Continued for Public Programs

"Medical necessity" is common to private health insurance contracts and governmental health insurance programs, a touchstone of "contractual" obligation for determining coverage and payment of medical items and services. Public health insurance programs, including Medicare and FEHBP, premise payment on "medical necessity" in order to maximize resources and to protect health care consumers. Medicare, for example, excludes coverage for items and services "not reasonable and necessary."75 The Health Care Financing Administration (HCFA) has issued regulations and circular letters instructing medical intermediaries to adopt claims payment practices based on determination of medical necessity. Medicare may refuse reimbursement for certain kinds of services and prohibit payment of benefits for experimental, investigational, or unproven treatments.

Federal courts have distinguished this coverage determination from medical decisions and have opined that Medicare’s denial of payment for services "not medically necessary" does not constitute the practice of medicine.76 Indeed, in one key case, a court held that while excluding coverage for services determined "not reasonable or necessary" may certainly influence medical decisions, without such an exclusion the Secretary of Health and Human Services would scarcely be able to regulate the Medicare program at all.77 The court further declared that the provision does not direct or prohibit any kind of treatment, but only determines its subsequent reimbursement.78

The federal Medicaid program uses medical necessity as a standard of coverage and payment.79 As a consequence, states have conditioned benefits upon medical necessity.80 For example, troubled by reports of significant numbers of unnecessary surgeries performed in the United States, in 1974 the State of New York formulated more restrictive guidelines and controls for authorized surgical procedures in hopes of saving up to $65 million in Medicaid costs. The state defined its "medical assistance" to mean payment for medically necessary care. Similarly, Massachusetts restricts the amount, duration, and scope of Medicaid benefits based upon such criteria as "medical necessity."

The Military Health Services System, the Civilian Health and Medical Program of the Uniformed Services ("CHAMPUS"), which provides benefits to active duty dependents, retirees, and retirees’ dependents, employs a medical necessity standard.81 For example, in defining the scope of benefits for the program, the statute specifies that coverage is not provided for any service that is not medically necessary.

2. Public Program Principles Apply to Private Contracts

These same key principles are applicable to private contracts for health care coverage, including managed care arrangements under which coverage and payment determinations may occur before services are rendered.82 Some treatments have been determined not to be medically necessary because they were not reimbursable by Medicare under the terms of the program and occurred in connection with medical research.83 However, the Patients’ Bill of Rights legislation would alter this result because such standards become irrelevant in the face of the treating physician’s determination. Because every service would in fact be deemed covered (unless the insurer can prove otherwise), public and private insurance would be running on two different tracks. The congruence between private and public insurance would be destroyed. Hundreds of private contracts referencing the Medicare standard, for example, would need to be amended, causing many controversies and making any reliance on this standard uncertain at best.


The proposed legislation would fundamentally alter the health care market by relegating plans and insurers to the role of writing "blank checks" to the medical community. Key coverage and reimbursement decisions would in fact be made by physicians, who would have both economic and noneconomic incentives to overtreat, thereby driving up costs and lowering the quality of care.

Eliminating medical necessity determinations by plans and insurers also changes the nature of the health insurance contract. It disables the private contract structure for insurers and policyholders, leaving the provider community in command of interpreting essential terms and conditions of contracts to which they often are not parties. It also radically changes the nature of fiduciary responsibilities, especially for ERISA plans. Additional confusion would arise because the law would not apply to government health insurance programs, which would continue to use this mechanism to assure beneficiaries of appropriate health care and proper expenditure of scarce health care dollars.

In sum, this legislation is not an effort to protect patients but to reintroduce fee-for-service reimbursement to the private marketplace, wrest control of coverage determinations from insurers, and maximize provider incomes. It undermines all health care delivery models, including managed care which has served as a protective mechanism for consumers and for society as a whole. It would return our health care system to an unconstrained fee-for-service environment. By turning medical necessity determinations over to providers, the legislation threatens to undermine the considerable progress made with respect to quality and cost. This result would be contrary to sound public policy.


1See, for example, S. 2529, 105th Cong., 2d Sess. 151 (a) (1998), S. 6/H.R. 358, 106th Cong., 1 Sess. 151 (1999)(hereinafter "PBOR").

2Remler, Dahlia K., Karen Donelan, Robert J. Blendon, Georghe D. Lundberg, M.D., David R. Calkins, M.D., Lucian L. Leape, M.D., Katherine Binns, and Joseph P. Newhouse. "What Do Managed Care Plans Do to Affect Care? Results from a Survey of Physicians," Inquiry 34:196-204 (Fall 1997). See also Anderson, Gerard, Mark A. Hall, Teresa R. Smith. "When Courts Review Medical Appropriateness," 36 Med. Care 1295 (1998).

3HIAA Legislative Summary, S. 6/H.R. 358, The Democrats’ Patients’ Bill of Rights Act of 1999.

4See PBOR 151, (a) (1).

5See PBOR 151, (a) (1).

6Remler et al. (Fall 1997). See also Anderson et al. (1998).

7See the Public Health Service Act (PHSA) 2791 (b) (1).

8See PHSA 2791 (b) (1).

9See PHSA 2791 (b) (1).

10See PHSA 2791 (b) (1).

11See PHSA 2791 (b) (1).

12See PHSA 2791 (b) (1).

13See PBOR 151 (a) (1).

14P.L. 104-191.

15See PHSA 2791 (a) (1).

16See PHSA 2791 (b) (1).

17See PBOR 201.

18See PBOR 202.

19See PBOR 301.

20See PBOR 151 (a) (1).

21See Furrow, Barry R. et al. Health Law 11-2 at 8 (1995).

22See Furrow, Barry R. et al. Health Law 11-2 at 12 (1995).

23See e.g., Dungan v. Travelers Ins. Co., 480 P.2d 418 (1971); Cullop v. Rogue Valley Physicians’ Service, Inc., 503 P.2d 699 (1972); Trine v. Prudential Ins. Co., 645 F.2d 39 (1981 C.A.10 Colo.); Hanson v. Prudential Ins. Co., 783 F.2d 762 (1985 CA9 Cal.); Kravitz v. Equitable Life Assur. SOC., 453 F. Supp. 381 (1978, DC Pa.)

24See PBOR 151 (a) (1) and (3).

25See Blacks Law Dictionary at 104-105 (6th Ed. 1990).

26July 16, 1998, CBO cost estimate for H.R. 3605/S. 1890, the Patients’ Bill of Rights Act of 1998, 15. (Emphasis added.)

27Fraud: The Hidden Cost of Health Care, Health Insurance Association of America, Washington, DC: 1996, 15-48.

28Vulnerable Payers Lose Billions to Fraud and Abuse. Washington, DC: Government Accounting Office, 1992.

29Health Care Financing Administration, Office of the Actuary, 1998 projections.

30Testimony of Charles L. Owens, Chief, Financial Crimes Section, Federal Bureau of Investigation, before the House Ways and Means Health Subcommittee, October 9, 1997, serial 105-33.

31Testimony of Charles L. Owens, Chief, Financial Crimes Section, Federal Bureau of Investigation, before the Permanent Subcommittee on Investigations of the Senate Committee on Government Affairs, June 26, 1997, S. Hrg. 105-154,. 20.

32Health Insurers Anti-Fraud Programs. Washington, DC: Health Insurance Association of America, June 1997.

33P.L. 104-191,. 211-217.

34P.L. 105-33.

35"A Comprehensive Strategy to Fight Health Care Waste, Fraud and Abuse," HHS Fact Sheet, February 10, 1999. See also Pear, Robert, "Improper Medicare Payments Fall but Still Cost $12 Billion," The New York Times, February 10, 1999, A17.

36Fraud: The Hidden Cost of Health Care, Washington, DC: Health Insurance Association of America, 1996, 223.

37Ibid., 223.

38Ibid., 225.

39Ibid., 226.

40Ibid., 227.

41Ibid., 229.

42See Endnote 31.

43See Endnote 31.

44See Dallis v. Aetna Life Ins. Co., 768 F.2d 1303 (1985). But see Trustees of the Northwest Laundry and Dry Cleaners Health and Welfare Fund v. Burzynski, 27 F.3d 153 (5th Cir. 1994) (denying coverage of unorthodox cancer treatments determined "medically necessary" by treating physicians).

45See Marker v. Union Fidelity Life Ins. Co., 907 F.2d 1138 (4th Cir. 1990) (awarding summary judgment to the patient for his appendectomy done for purely preventive, exploratory reasons and asserting that "the determination of what was reasonable and necessary was for the licensed, treating physician").

46See Van Vactor v. Blue Cross Association, 365 N.E.2d 638, 643 (Ill. App. Ct. 1977) (stating that where patient was hospitalized to remove impacted teeth, "there was sufficient evidence . . . that the insured was justified in relying on the good faith judgment of his treating physician as to the medical necessity of services prescribed"); Carrao v. Health Care Serv. Corp., 454 N.E.2d 781, 788 (Ill. App. Ct. 1983) (stating that Van Vactor remains good law in the absence of an explicit contractual provision to the contrary).

47See Taylor v. Prudential Ins. Co., 388 So. 2d 470 (1980).

48See Duncan v. J.C. Penny Life Ins. Co., 388 So. 2d 470 (1980).

49See "Managed Care Savings for Employers and Households: 1990 through 2000," a study conducted by The Lewin Group for the American Association of Health Plans, June 1997. According to the study, "without managed care, average health spending for non-aged families in 1996 would have been higher by an average of $406 under a high-range scenario and an average of $304 under a low-range scenario."

50See Social Security Act 1862 (a) (1), 1901. See also Hall, Mark A., and Gerard F. Anderson, "Health Insurers’ Assessment of Medical Necessity," 140 Penn.L.Rev. 1637, 1647 (1992).

51See PBOR 151 (c).

52See Rosenblatt, Rand E., et al., Law and the American Health Care System (1997) at 212-213.

53See Sharpe, Virginia A, Faden, Alan I., "Appropriateness in Patient Care: A New Conceptual Framework," The Milbank Quarterly, 74:115 (March 22, 1996).

54See Rodwin, Marc A. Medicine, Money, and Morals: Physicians Conflict of Interest, Oxford University Press.

55Beeman, Douglas E., "When Mistakes Are Fatal: A Medical Researcher Says Doctors’ Errors May Cause Up to 120,000 Deaths and 1 Million Injuries Each Year," The Press-Enterprise, Riverside, California, October 14, 1996.

56The Journal of the American Medical Association (JAMA) 9/16/98.

57JAMA, 9/16/98.

58See PBOR, 302.

59Managed Healthcare, 1/98.

60JAMA, 9/16/98.




64USA Today, 6/19/98.

65USA Today, 6/17/98.

66JAMA, 8/19/98.

67USA Today, 6/17/98.

68See Furrow, Barry R., et al., Health Law 11-1 at 4 (1995).

69See Social Security Act 1862 (a) (1) (A); and 5 U.S.C. 8902 (n). See also 42 C.F.R. 411.15 (k) (1997); and 5 C.F.R. 890.105(a), (b) (1998).

70See Havinghurst, Clark C., Health Care Choices: Private Contracts as Instruments of Health Reform at 15 (1995).

71 See Firestone Tire & Rubber Co. v. Bruch 489 U.S. 101 (1989).

72 See Bedrick v. Travelers Ins. Co., 93 F.3d 149 (4th Cir. 1996); McGraw v. Prudential Ins. Co. of Amer. (10th Cir. 1998); Friends Hospital v. MetraHealth Serv. Corp., 9 F. Supp. 2d 528 (E.D. Pa. 1998); Dowden v. Blue Cross & Blue Shield of Tex., Inc., 126 F. 3d 641 (5th Cir. 1997).

73 See ERISA 409 (a)

74 See Brown v. Blue Cross & Blue Shield, 898 F.2d 1556 (11th Cir. 1990).

75 See Social Security Act 1862 (a) (1).

76 See Goodman v. Sullivan, 891, F.2d 449 (2nd Cir. 1989). See also State of New York on Behalf of Bodnar v. Sec. Of Health and Human Services, 903 F.2d 122 (1990); Wilkins v. Sullivan, 889 F.2d 135 (1989); Vorster v. Bowen, 709 F. Supp. 934 (1989); Bedford County General Hosp. v. Heckler, 574 F. Supp. 943 (D.C. Tenn. 1983); Torphy v. Weinberger, 384 F. Supp. 1117 (D.C. Wisc. 1974).

77 See Goodman v. Sullivan, 891 F.2d 449, 451.

78 See Goodman v. Sullivan, 891 F.2d 499, 451.

79 See Social Security Act 1901 (limiting appropriations to cover "necessary" medical services); and Social Security Act 1902 (a) (30) (A) (requiring state plans to provide for procedures "necessary to safeguard against unnecessary utilization of care and services"). See also 42 C.F.R. 440.230 (d) (authorizing states to limit services based upon "medical necessity" or utilization control).

80 See e.g. Calif. Welf. & Inst. Code 14059.5, 14137.8; Ann L. Mass. Chap. 118E 15; Mich. C.L. Ann. 400.111a (3) (b), (7) (e), (8); and N.Y. Social Services Law 365-a (2).

81 See 10 U.S.C. 1079 (a) (13) (excluding coverage for any service or supply which is not "medically necessary"). See also 32 C.F.R. 199.2 (defining "medically necessary"); 199.4 (a) (1) (I) (limiting the scope of benefits paid for to those "medically necessary"); 199.4 (a) (1) (i) (limiting the scope of benefits paid for to those "medically necessary"); 199.17 (h) (authorizing review for "medical necessity" under TRICARE).

82 See, e.g., Trustees of the Northwest Laundry and Dry Cleaners Health & Welfare Trust Fund v. Burzynski, 27 F.3d 153 (5th Cir. 1994), cert. denied, 115 S.Ct. 1110 (1995) (physician's "antineoplastons cancer treatments" were not medically necessary" and physician was not entitled to reimbursement); Farley v. Benefit Trust Life Ins. Co., 979 F.2d 653 (8th Cir. 1992) (insured's high-dose chemotherapy treatment accompanied by autologous bone marrow transplant procedure was not "medically necessary").

83 Compare Grethe v. Trustmark Ins. Co., 881 F. Supp. 1160 (N.D. III 1995) (50-year-old person suffering from inoperable, terminal breast cancer is not entitled to preliminary injunction requiring insurer to pay for HDCT/ABMT or peripheral stem cell rescue, such treatment is not "medically necessary" because it is not reimbursable by Medicare and is administered in connection with medical research).