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June 2012

Health Net, Inc. v. RLI Insurance Company ? Dishonest Acts Impact Liability Insurance Coverage.

Liability Insurance Coverage Does Not Exist Where a Health Insurance Company Failed to Pay Insurance Claims Despite Contractual Obligations

(May 22, 2012) ___Cal.App.4th ___ ; 12 C.D.O.S. 5594

On May 22, 2012, the California Court of Appeal, Second Appellate District, Division Three held that where a health insurer is contractually obligated to pay claims and fails to do so, in part because of its own dishonest act, there is no coverage for unpaid claims through the health insurer's own liability insurance coverage.

In the underlying case, plan participants Zev and Linda Watchel, on behalf of their minor son Tory, filed a class action lawsuit against Health Net, Inc. and various subsidiaries in New Jersey federal court alleging Tory had incurred over $42,000 in medical bills, but was only reimbursed $14,000.  Plaintiffs alleged Health Net failed to use the Ingenix database and instead used outdated databases to calculate the reimbursement.  The Plaintiffs asserted causes of action for failure to pay claims owed, breach of fiduciary duty, breach of contract pursuant to the Employee Retirement Income Security Act of 1974, as well as other causes of action.  A second class action was filed by Renee McCoy alleging the currently used databases were systematically flawed.  These cases were consolidated for trial.  While the lawsuits were pending, the New Jersey Department of Banking and Insurance conducted an investigation and concluded that Health Net used outdated databases and concealed its use of these databases from the investigators.

After the investigation, an integrity hearing was held based upon the federal court's belief that Health Net had been less than candid during discovery.  The New Jersey federal court sanctioned Health Net and deemed the following facts admitted: (1) Health Net's knowing and willful use of outdated data; (2) its officials' actions to hide the full scope of its conduct from the New Jersey Department of Banking and Insurance; and (3) false claims of "recent discovery" of malfeasance to avoid injunctive relief.  Thereafter, the parties reached a settlement for $215 million, including attorney's fees. 

Prior to the settlement, Health Net brought suit in California against four of its insurers seeking declaratory judgment that the insurers had a duty to defend and indemnify it in over twenty underlying actions including the Watchel and McCoy actions.  Relying on a policy exclusion for dishonest acts, the trial court granted summary judgment to the insurers.  Health Net appealed.

On appeal, the Court of Appeal considered and resolved three issues.  First, the Court of Appeal held that the great bulk of the claims asserted in the Watchel and McCoy actions were for policy benefits owed under the health plans, which are not covered.  Health Net was contractually obligated to pay its participants and beneficiaries the full benefits to which they are entitled under their health plans.  The Court of Appeal reasoned that the costs cannot be passed on to Health Net's liability insurers simply because Health Net may have committed a wrongful act in its failure to pay the claims. 

Second, the trial court erred in concluding that a "Claim" as used in the policy, applies to the entire lawsuit, and therefore the trial court erroneously concluded that the dishonest acts exclusion barred recovery of defense or indemnity costs unrelated to the dishonest acts themselves.  The Court of Appeal concluded that if the entire cause of action alleges no covered wrongful act under the policy, coverage cannot be bootstrapped based solely on a claim for attorney's fees.  Likewise, if a complaint alleges some covered wrongful acts and some acts which are not covered, the claim for attorney's fees is covered only to the extent it arises out of the covered wrongful acts. 

Lastly, the insurance policy contained an exclusion that replaced the duty to defend with a duty to reimburse provision.  The Court of Appeal held that if there is a finding of a dishonest act, there is no duty for the insurer to reimburse any defense costs of the claim to the extent the claim arose out of the dishonest act.  The Court of Appeal concluded, however, that not all claims in the Watchel and McCoy actions arose out of dishonest acts.  Therefore, the dishonest acts exclusion does not preclude coverage for the entirety of the potentially covered claims. 

Based upon the analysis of the three foregoing issues the Court of Appeal reversed and remanded the case for further proceedings.

This opinion is not final.  It may be withdrawn from publication, modified on rehearing, or review may be granted by the California Supreme Court.  These events would render the opinion unavailable for use as legal authority in California state courts. 

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Ronald K. Alberts

Life, Health & Disability