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By Patrick A. Calhoon

Like millions of Californians, your client is enrolled in a Health Maintenance Organization (“HMO”) plan for her healthcare. Under these plans, the HMO plan contracts with health care providers, usually through medical groups known as Independent Practice Associations (“IPA”), to provide plan members with medical care. In addition to the provision of medical care, the HMO plan often times delegates to the IPA its utilization review function. Utilization review entails determining whether a particular proposed treatment or service is medically necessary or otherwise covered by the HMO plan. Under the contract between the HMO plan and the IPA, the IPA is paid a flat monthly fee in return for assuming responsibility for all necessary medical care, whether the care was provided by physicians within the IPA (in-network) or upon a referral to an out-of-network provider. This is known as a capitation system. Except under limited circumstances, such as where medically necessary services are not available in-network, your client’s contract with the plan required her to obtain all medical care through the IPA. In most cases, the in-network providers are paid contracted rates, which are normally much less than the rates charged by out-of-network providers. The capitation system, therefore, can result in a financial incentive to keep services in-network in disregard of whether it is in the best interest of the patient. This is the typical HMO model.

Your client received treatment for several months under her HMO plan for a festering and unidentified infection she picked up in the ocean surfing near a run-off pipe the day after a heavy rain. The infection left a golf ball sized hole in her calf, exposed muscle and tendon, and was continuing to destroy her leg. The infection could not be controlled with typical antibiotics and customary treatments.  If the wound was not properly treated, she would likely lose the use of her leg due to continuing infection and tissue loss. Her treating physician referred her to a specialist known to be the preeminent expert in treating ocean related pathogens. Per the terms of the Plan, the treating physician submitted a request for authorization to allow the specialist to treat your client. The treating physician explained the necessity for the out-of-network physician and noted that time is of the essence.

The Plan’s utilization review manager received the request for authorization and determined that it was not medically necessary for your client to go to an out-of-network specialist. The request was denied because, according to the utilization review manager, there is an infectious disease physician available in-network. Your client is therefore approved to treat with the Plan’s in-network infectious disease specialist.

Unhappy yet compliant, your client treats with the in-network infectious disease specialist for several weeks. However, despite his best efforts, the infection raged out of control and began to spread. The in-network physician submits another request to refer your client to the out-of-network specialist. He again explains the need for the out-of-network referral using substantially the same information as was presented in the first request.

This time the utilization manager approves the request. Your client goes to the out-of-network specialist who quickly identifies the pathogen and begins a specialized treatment. Within a matter of days the infection is brought under control. Unfortunately, however, by this time much of the tissue in your client’s lower leg is necrotic and the nerves were so severely damaged that she will never be able to walk without an aid. At a minimum, she will require additional surgeries and extensive rehabilitation.  

You file a lawsuit against the HMO Plan. The complaint alleges several causes of action, including breach of the implied covenant of good faith and fair dealing (bad faith). You allege the HMO Plan breached the implied covenant of good faith and fair dealing by (1) unreasonably denying and delaying care and treatment that was covered under the plan; (2) unreasonably avoiding incurring expenses for out-of-network providers for its own financial gain by ignoring the seriousness of your client’s medical condition and needs; (3) placing its own financial interests ahead of your client’s health care; and (4) unreasonably engaging in a pattern and practice of failing to conduct a thorough, fair and balanced investigation in evaluating requests for benefits and/or services for its members under the plan.

Sounds like a great case, right? This HMO Plan is going D-O-W-N! Not so fast, in this situation, bad faith against the HMO may not even on the table.

The Knox-Keene Act Specifically Precludes HMOs from Being Held Vicariously Liable For the Acts of Others

Under traditional notions of insurance bad faith, vicarious liability principles apply and an insurer can be held liable for the acts of its agent. For example, in Major v. Western Home Ins. Co. (2009) 169 Cal. App. 4th 1197, 1204, Western Home used a company named Cambridge Integrated Services (Cambridge) to administer their claims. There was never even an argument that Cambridge was Western Home’s agent for purposes of respondeat superior tort liability for compensatory damages. Id at *1220. According to the court, Western Home retained Cambridge to handle a significant aspect of Western’s business: its claims handling functions. Therefore, the court had no problem in taking it a step further and concluding that Cambridge’s claims manager was also Western Home’s “managing agent.” Id. at *1221. Western Home was held liable for insurance bad faith and the plaintiffs were awarded punitive damages based on the claims handling performed by Cambridge. Other cases are in accord. See, Textron Financial Corp. v. National Union Fire Ins. Co. of Pittsburgh (2004) 118 Cal.App.4th 1061, 1080–1081, (disapproved on another grounds) (a third party insurance agency was a managing agent of an insurer).

Based on Major and many other cases, it would seem to be a given that a HMO could be held vicariously liable for the acts of the entity which was delegated the task of utilization review. After all, HMOs “are in the business of insurance” and function the same way as traditional health insurers. Smith v. PacifiCare Behavioral Health of California, Inc. (2001) 93 Cal. App. 4th 139, 158 (HMOs function the same way as traditional health insurers… and thus HMOs are in the business of insurance). Unfortunately for HMO enrollees however, the Knox-Keene Act completely shields HMOs from vicarious liability.

Section 1371.25 of the Health and Safety Code states:

A plan, any entity contracting with a plan, and providers are each responsible for their own acts or omissions, and are not liable for the acts or omissions of, or the costs of defending, others. Any provision to the contrary in a contract with providers is void and unenforceable. Nothing in this section shall preclude a finding of liability on the part of a plan, any entity contracting with a plan, or a provider, based on the doctrines of equitable indemnity, comparative negligence,  contribution, or other statutory or common law bases for liability.

Moreover, delegation of utilization review and management is expressly permitted under the Knox-Keene Act. See Health & Saf. Code §1367.01(a), 1374.30(b) and 1363.5(a)-(b); Watanabe v. California Physicians’ Service (2008) 169 Cal. App. 4th 56, 65-66 (noting that plans may delegate utilization review and rejecting the argument that HMOs remain liable for injuries resulting from the failure to provide the contracted-for care).

In Watanabe, an HMO contracted with and delegated utilization review function to the IPA. Id. at *60. The IPA made initial determinations as to whether a service or treatment was medically necessary and therefore a covered benefit. Watanabe (the plaintiff) sued the HMO for breach of contract and breach of the implied covenant of good faith and fair dealing based on allegations that the IPA unreasonably delayed and denied medically necessary care. Based on section 1371.25, the trial court instructed the jury it could find the plan liable only for the plan’s own acts or omissions, but not the acts or omissions of the IPA. The jury returned a verdict in the HMO’s favor and the plaintiff appealed, arguing that despite its delegation of utilization review to the IPA, the health care plan remained liable for the IPA’s failure to authorize the requested procedure. Id. at 63. The Court affirmed that a health plan could only be liable for its own actions and was not vicariously liable for the acts of the IPA:

It cannot be said that section 1371.25 is ambiguous. That a plan and provider are “each responsible for their own acts or omissions” is reinforced in the same first sentence by the phrase that these entities “are not liable for the acts or omissions of, or the costs of defending, others.” In the unlikely case that all this is not clear enough, the second sentence cinches it: “Any provision to the contrary in a contract with providers is void and unenforceable.” It is hard to imagine a clearer statement of legislative purpose and intent than this. Id. at 63.

Martin v. PacifiCare of California (2011) 198 Cal. App. 4th 1390 is also on point. There a health care plan contracted with Bright, a third party medical service provider, and delegated to it utilization review. Plaintiffs alleged that Bright unreasonably delayed necessary medical care to the plaintiff. Id. The trial court found that section 1371.25 of the Health and Safety Code barred the plaintiffs’ claims because the HMO did nothing to delay or deny any medical care sought. Id.

On appeal, the Martins argued that section 1371.25 should not bar their bad faith claims because PacifiCare, the HMO, owed a nondelegable duty to timely provide all benefits due under the plan. Id. at *727. The Martins relied on Hughes v. Blue Cross of Northern California (1989) 215 Cal.App.3d 832 (Hughes ), which held an insurer’s duty of good faith and fair dealing is nondelegable. Id. at *848. The Martins also cite cases holding an independent insurance adjuster is not liable to an insured for malfeasance when the insurer delegates to the adjuster the responsibility to handle the insured’s claim because the adjuster is not in contractual privity with the insured. See Gruenberg v. Aetna Ins. Co. (1973) 9 Cal.3d 566, 576, 108 (Gruenberg ) (insurance adjuster and law firm hired to adjust claim not liable for bad faith); Sanchez v. Lindsey Morden Claims Services, Inc. (1999) 72 Cal.App.4th 249, 253 (independent adjuster hired to adjust claim owed no duty to insured.) From these cases, the Martins attempted to draw the conclusion an insurer must remain liable to the insured even when its delegated agent caused the insured’s injury. The court held the nondelegable duty doctrine, however, did not prevent it from applying section 1371.25 to bar the Martins’ bad faith claims. Id. at *727. Accordingly, the Court of Appeal affirmed, and held that claims such as bad faith were barred against HMOs where all the alleged unreasonable conduct was performed by the IPA.

Despite Section 1371.25, Remedies are Available to HMO Plan Members

While it may seem that the deck is stacked against your client, there are remedies in place to ensure HMOs and IPAs are not improperly influenced by the financial incentives that can be the inherent by-product of the capitation system. First, nothing prevents an HMO from being held liable for its own acts or omissions that result in harm to your client. For example, most HMO plans include provisions whereby the plan retains the power to override the IPA’s utilization review decision through established appeal or grievance procedures. Thus, if your client invoked such a procedure and the HMO upholds the IPA’s wrongful and unreasonable decision, your client can likely proceed with a bad faith case directly against the HMO.

Second, under Civil Code section 3428, HMOs owe “a duty of ordinary care to arrange for the provision of medically necessary health care service to its subscribers” and are “liable for any and all harm … caused by its failure to exercise that ordinary care.” Thus, section 3428 requires that HMOs act with ordinary care when entering into and negotiating a capitation agreement with a provider. For example, an HMO could violate this duty of care by entering into a capitation agreement with a provider it knows to be seriously understaffed, poorly administered, or otherwise likely to deny medically necessary services or deliver below-standard levels of care. This option, while potentially viable, is going to be an uphill battle because the capitation system has been judicially deemed “standard in the industry.”

Section 1348.6 of the Health and Safety Code makes clear that the Legislature has prohibited health plans from using financial incentives that are tied to specific medical decisions or specific enrollees, but it has expressly “approved of capitation contracts.” Desert Healthcare Dist. v. Pacificare FHP (2001) 94 Cal.App.4th 781, 789 (Desert Healthcare ); California Medical Assn. v. Aetna U.S. Healthcare of California, Inc. (2001) 94 Cal.App.4th 151, 162 (“the Legislature has specifically approved of various risk-shifting arrangements including capitation payments”). “Capitation” is generally defined as a risk-sharing arrangement in which a plan pays a provider “a set dollar payment per patient per unit of time (usually per month) … to cover a specified set of services and administrative costs without regard to the actual number of services provided.” (42 C.F.R. § 422.208; see also Yarick v. PacifiCare of California (2009) 179 Cal.App.4th 1158, 1163 (Yarick ) (describing capitation agreements); California Emergency Physicians Medical Group v. PacifiCare of California (2003) 111 Cal.App.4th 1127, 1136 (describing capitation agreements as “risk sharing plan” through which “health care service plans … delegate payment responsibility to contracting medical providers.”) Such agreements are “standard in the industry.” Desert Healthcare, supra, 94 Cal.App.4th at 93.

Another option is available which is far more likely to result in justice for your client. If the IPA denies or delays medically necessary services based on its own economic considerations, or for any other improper reason, your client may pursue an action against it. As the United States Supreme Court has observed, under the “[managed care] system, a physician’s financial interest lies in providing less care, not more. The check on this influence … is the professional obligation to provide covered services with a reasonable degree of skill and judgment in the patient’s interest.” Pegram v. Herdrich (2000) 530 U.S. 211, 219. Accordingly, you should always include appropriate causes of action directly against the entity that performed utilization review.


At first blush, the fact pattern discussed in the beginning of this article sounds like an excellent insurance bad faith case. However, under the typical HMO model, the HMO plan is unlikely to have made any decisions resulting in the delay or denial of your client’s medical care. Rather, it’s a safe bet that the HMO delegated the utilization review function to a third-party IPA. Under section 1371.25 of the Health and Safety Code, the HMO cannot be held vicariously liable for the acts of others. So, explore whether your client appealed any decisions directly to HMO which may result in direct liability theory against the HMO. Most importantly, always include claims against the entity responsible for utilization review. It may not be the big bad faith case you thought you were looking at, but you can still bring your client the justice she deserves.