In an interesting decision that raises a host of important issues, a federal district court applying Arkansas law held that due to renewal application misrepresentations, a hospital’s D&O insurance policy is void ab initio, and therefore that the hospital must refund amounts the insurer previously paid as defense costs. The April 17, 2009 opinion, written by Eastern District of Arkansas Judge Susan Webber Wright can be found here.
The insurance dispute involves three key events: the May 22, 2003 adoption by Baptist Health, a nonprofit corporation that operates hospitals in Arkansas, of an Economic Conflict of Interest policy (ECOI policy), commonly known as "economic credentialing"; Baptist Health’s December 16, 2003 renewal of its D&O insurance; and the February 2004 filing of the first of three lawsuits filed against Baptist Health relating to its adoption of and enforcement of the ECOI policy.
The ECOI policy provided that no physician that directly or indirectly owns or acquires an interest in a competing hospital will be eligible to apply for an initial or renewed appointment or clinical privileges for the professional staff at any Baptist Health hospital. The physicians were required to disclose their financial interests, and physicians failing to meet the eligibility requirements were not entitled to any hearing or appellate review.
Judge Wright’s opinion has a detailed review of the events and deliberates that led up to Baptist Health’s adoption of the ECOI policy, because the events and deliberations preceding the adoption were relevant to the subsequent insurance dispute.
As summarized on pages 31 and 32 of the opinion, Judge Webber found, among other things that Baptist Health knew at the time it adopted the ECOI policy that legal challenges had been raised in connection with at least four other hospitals’ attempts to adopt similar policies ; that questions had been raised whether the ECOI policy violated federal kickback laws; that at an FTC hearing prior to Baptist Health’s adoption of the ECOI policy, and in the presence of Baptist Health’s CEO, the head of one of Baptist Hospital’s competitors had raised questions about the legality of ECOI policies.
In addition, by the time Baptist Hospital adopted the ECOI policy, hospital administrators had compiled a list of physicians whom they anticipated would be affected by the policy (all of whom subsequently were plaintiffs in lawsuits against Baptist Health). When asked at a deposition in the subsequent underlying litigation if Baptist Health had adopted the policy "knowing that it could result in a lawsuit," the CEO answered "Yes, sir." (However in the separate coverage litigation with the D&O insurer, the same CEO submitted an affidavit in which he swore that at no time prior to the filing of the first of the underlying lawsuits did he believe that it was likely that the adoption of the ECOI would result in litigation.)
In December 2003 – that is, after the ECOI policy was adopted but before the first of the three underlying lawsuits had been filed – Baptist Health renewed its D&O policy. Its expiring coverage, in force during the period December 12, 2002 to December 12, 2003, had been with one of the larger, more well-established insurance carriers. However, during the policy period of Baptist Health’s D&O policy, the individual that had underwritten the Baptist Health account for the incumbent carrier left that job to join a new, start-up insurance company. For reasons Judge Wright discusses at greater length in her April 17 opinion, Baptist Health moved its coverage from the incumbent carrier to the new, start-up carrier at the time of its December 12, 2003 renewal.
In connection with the renewal process, Baptist Health completed two applications, first completing one on the incumbent carrier’s renewal application form, and then later on the start-up carrier’s application form. Each of these two application forms asked "prior knowledge" questions (discussed below). Although there were slight differences in the questions each form asked, the difference proved to be unimportant for the outcome of the subsequent coverage dispute.
The prior knowledge question in both forms asked whether any entity or individual proposed for coverage is aware of any fact, circumstance, situation or event that could result in a claim. Both renewal application forms also stated that if any such fact, circumstance, situation or event exists, any claim arising thereform is excluded from coverage. In response to this question in each of the application forms, the hospital responded "None," indicating that it was not aware of any such fact or circumstance.
In February 2004, a group of physicians filed the first of three lawsuits against Baptist Health alleging that the ECOI policy violated anti-kickback and Medicaid statutes. Baptist Health submitted this claim and the two subsequent lawsuits to its new D&O insurer as claims under its D&O policy. After the third lawsuit was filed, the D&O carrier became aware of some of the circumstances that had preceded the hospital’s adoption of the ECOI policy.
The D&O insurer subsequently filed an action seeking a judicial declaration that the hospital was required but failed to disclose in the application forms the information that its adoption of the ECOI policy may lead to claims, and as a result there is no coverage under the policy for the three subsequent lawsuits about the ECOI policy. Baptist Health counterclaimed, seeking a judicial declaration of coverage. The parties filed cross-motions for summary judgment.
The April 17 Opinion
In her April 17 opinion, Judge Wright granted the insurance carrier’s motion for summary judgment and denied the hospital’s summary judgment motion.
The essence of her ruling, on pages 30-32 of the opinion, is her conclusion that Baptist Health was "specifically aware" of a wide variety of circumstances that suggested the possibility of a claim when it answered the prior knowledge questions on the application. She found that, given Baptist Health’s awareness of the likelihood of litigation, the conclusion that Baptist Health’s answers to the prior knowledge questions in the renewal applications "were misrepresentations" seems "inescapable."
Among other things, Judge Wright noted that Baptist Hospital was aware of that other hospitals’ adoption of similar policies had led to litigation. She specifically found that "a reasonable person would foresee that adoption" of the policy "in these circumstances may give rise to or result in a claim." She also noted that Baptist Health’s CEO acknowledged in a deposition in the underlying action that the ECOI policy "was adopted knowing that a claim would result."
Judge Wright reviewed Baptist Health’s responses to other questions in the applications that called for relevant information but that Baptist Health had failed to supply. She found Baptist Health’s attempts to explain its answers to these questions to be "reflective of an apparent tendency on the part of Baptist Health to contort language to its own purposes" and "disingenuous." She said of Baptist Health’s defense of its responses to one application question "reflects a parsing of language that might properly be characterized as a misrepresentation."
Judge Wright held under Arkansas law that because the application misrepresentations were material to the underwriting of D&O insurance policy, the policy "is void ab initio and rescinded as if it were never in effect." She also found that even if some of the hospital’s answers were not misrepresentations, the prior knowledge exclusion in the renewal applications "operates to bar coverage."
Finally, Judge Wright held that Baptist Health’s retention of the defense expenses the insurer had paid would represent "unjust enrichment," and therefore the insurer is entitled to recover those amounts from the hospital. She did hold that the insurer had to return to Baptist Health the amount of the premium the hospital had paid.
I have four different reactions to this decision, each one based on different perspectives I have acquired over the years as a participant in different parts of the insurance underwriting and claims handling process.
The first reaction I have is based on my many years of representing insurance companies in coverage litigation similar in many ways to this case, as well as my years as an insurance company manager. From this insurer-oriented perspective, this decision represents a complete sweep for the carrier of a kind that rarely occurs. Judge Wright’s ruling that Baptist Health had to return the amount of previously paid defense fees put an extra olive in a sweet martini that insurance company lawyers rarely get to enjoy. As one who knows how these things go, I tip my hat to the counsel that successfully represented the insurance carrier in this case.
But these considerations lead to the second of my reactions to this decision, which is more from the perspective of a neutral observer. That it, it seems pretty obvious that by the time Judge Wright ruled on the summary judgment motions, she had developed a less than flattering view of Baptist Health.
For instance, I think the opinion suggests pretty strongly that she didn’t think much of the ECOI policy itself, which her opinion describes in negative tones. I also think Judge Wright was genuinely offended that Baptist Health’s CEO submitted an affidavit in support of the summary judgment motion, claiming that Baptist Health was not aware that its adoption of the ECOI policy would result in litigation, even though the same individual had testified in a deposition in the underlying litigation that Baptist Health had adopted the ECOI policy knowing that litigation would result.
When a federal judge refers to a litigant as "disingenuous" and accuses it of "contorting" and "misrepresenting" insurance policy language, that litigant is going down.
My third reaction to this case is based on the perspective from my current role counseling and advocating for policyholders. Here, I am not as concerned with Baptist Health itself and the merits of its particular case, but rather what these facts suggest. Looked at from this perspective, there are a couple of things that trouble me.
First, the insurance dispute arises out of a policy renewal, not the initial placement of a policy. Why then was Baptist Health being asked to answer the "prior knowledge" question in the first place? Yes, both the incumbent and the new carrier asked the question. But to me, the insertion of a "knowledge" question in a application at the time of renewal is inconsistent with the theoretical justifications insurers routinely provide for claims made coverage.
That is, in exchange for the improved loss exposure determinations offered with respect to claims made policies, insurers undertake to provide coverage for any claims made during the policy period, regardless of when the underlying circumstances may have occurred.
Insurance carriers rightfully should not be expected to cover claims that are known or anticipated when coverage initially incepts. But implicit in the "claims made bargain" is that policyholders should be entitled to expect continuity of coverage as the claims made policy renews, so that the policyholder is not susceptible to losing coverage due to the mere caprice of the date on which a claimant chooses to file a claim. The inclusion of the knowledge question into the application at the time of renewal of a claims made policy represents the insertion of a jagged edge that could – and here, did – result in stripping the policyholder of coverage that would have been available under an expiring policy if the claim had been filed before the prior policy expired.
I do not mean to find fault with anyone who was involved in this policy renewal. The insurance marketplace in late 2003 was different than it is today, and I do not mean to judge former circumstances by today’s standards. But even allowing for all of that, I find the inclusion of the knowledge question in a claims made policy application at the time of renewal surprising, troubling, and arguably inconsistent with the very nature of claims made coverage.
The other thing I find troublesome from the policyholder’s perspective about this decision is that Baptist Health’s answer to the knowledge question (which comes with and supposedly is enforced by its own prior knowledge exclusion) resulted not just in an exclusion of coverage, but in a policy rescission rendering the policy void ab initio. For most of the last decade the D&O insurance industry collectively has struggled to develop insurance policy provisions to narrow the coverage forfeiture consequences of application misrepresentations. As part of this dialog, insurers try to characterize the prior knowledge exclusion in a policy application as a stepped-down threat from the possibility of policy rescission, since the remedy it triggers results only in the exclusion of coverage and not in the entire policy being voided.
Yet here, Baptist Health’s answer to the knowledge question (as well as its answers to other questions, to be sure) resulted not just in noncoverage of a claim, but the rescission of the entire policy (which clearly is yet another reason why the inclusion of the knowledge question in a renewal application is highly objectionable).
The fourth and final set of reaction I have to this decision really represents a combination of all points of view. That is, I can’t help but observe that this case involves a couple of very significant missed opportunities.
The first of the missed opportunities was the chance Baptist Health had to lock in coverage for the subsequently filed claims, under the incumbent carrier’s policy that expired on December 12, 2003. That is, if you accept Judge Wright’s findings of fact as true, Baptist Health knew prior to the time this policy expired that it was probably going to get sued; it knew who was probably going to file the lawsuit(s); and it even knew what legal theories were likely going to be asserted.
In short, Baptist Health had at its disposal, prior to the expiration of the incumbent carrier’s policy, all of the constituent elements required to have provided notice of circumstance that might give rise to a claim. Had this notice been provided to the incumbent carrier, then any subsequently filed claim would have related back to the incumbent carrier’s policy.
Again, I am not trying to find fault with anyone that was involved in insurance issues for Baptist Health, particularly since I know I now have the benefit of hindsight and the convenience of the factual recitations in a carefully groomed judicial record. This perspective and these facts may not have been available to the persons directly involved in the insurance transaction. However, if Baptist Health had provided notice of potential claim under the incumbent carrier’s expiring policy, then it could have avoided the problems that later arose with the new carrier under the subsequent policy. (As an aside, I note that this notice of potential claim opportunity may represent the best response to the concerns I noted above about claims made issues).
The final missed opportunity that may have been involved here is the chance the parties had to negotiate a compromise of the insurance coverage dispute. Footnote 1 to the opinion reports that a settlement conference in the case took place before a Magistrate Judge, but that the conference "proved unsuccessful." There are innumerable reasons why any case might not settle. But parties that are motivated to settle can usually find a way to get it done.
Here, Baptist Health had ample reasons to try to seek a compromise, whether it realized it or not. The hospital CEO’s deposition testimony in the underlying case that when Baptist Health adopted the ECOI policy it anticipated getting sued arguably should have motivated the hospital to seek a compromise of this claim (and that is without even considering the deeply troubling conflict between the CEO’s deposition testimony on this point and the contrary affidavit he supplied in connection with Baptist Health’s summary judgment motion in the coverage case.)
There are even reasons why an insurer in this situation might arguably want to consider a compromise. I know many readers would find this observation surprising, especially given how sweeping the insurer’s litigation victory subsequently proved to be. Long experience has taught me that even very strong cases can turn out far differently than expected, and this uncertainty alone ought to counsel any litigant to remain open to possible compromise, regardless of how strong their case may seem.
In addition, as I have previously discussed at length (here), the thing about rescission as a policy defense is that it is such a powerful weapon, its effects can not always be predicted in advance. I have direct, relevant personal experience from which to say that even a complete victory in a highly meritorious rescission case can produce unanticipated collateral damage for an insurer. Based on what I have seen and know, any carrier involved in a rescission case, no matter how meritorious, would be well advised to consider opportunities to resolve the case without taking it all the way to the end.
One final note about this decision is that it is worth reading for the interesting glimpse it affords into the operations of a fledgling insurance company in its earliest stages. I will not characterize here what the opinion reflects, except to say that most industry participants will find the "inside baseball" description of the start-up operation interesting.
Special thanks to Karen Ventrell of the Troutman Sanders law firm, who together with her colleague Whitney Lindahl represented the insurer in this case, and who provided me with a copy of the decision. I hasten to add that the views expressed in this post are exclusively my own, and nothing I said here about the insurance transaction should in any way reflect on the outstanding job the insurer’s lawyers did in this case.