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Court of Appeal, Second District, Division 1, California.

John SARCHETT, Plaintiff and Respondent, v. BLUE SHIELD OF CALIFORNIA, Defendant and Appellant.

Civ. 68549.

Decided: July 11, 1984

Hassard, Bonnington, Rogers & Huber and Howard Hassard, William B. Sturgeon, Rick C. Zimmerman, B. Thomas French, and Tyler G. Draa, San Francisco, for defendant and appellant. Munger, Tolles & Rickershauser and Daniel P. Garcia, Peter R. Taft, and Lucy P. Eisenberg, Los Angeles, as amicus curiae on behalf of defendant and appellant. Shernoff & Levine, Claremont, Leonard Sacks, Inc., Northridge, and Roni Keller, Beverly Hills, for plaintiff and respondent.

This dispute arose because appellant, Blue Shield of California (Blue Shield), denied respondent's claim for hospitalization expense in the amount of $1,203.05.   Respondent brought this action for the hospital expenses and also for breach of the implied covenant of good faith and fair dealing.

After the trial, the court directed a verdict in favor of respondent, instructing the jury in part as follows:  “In this case the court has made a ruling that BLUE SHIELD OF CALIFORNIA has breached its duty of good faith and fair dealing owed to JOHN SARCHETT in failing to pay the hospital bill.  [¶]  The Court has ruled as a matter of law, that the conduct of BLUE SHIELD OF CALIFORNIA in disagreeing with the judgment of the treating physician to hospitalize his patient solely on the basis of retrospective review of hospital files is a violation of the duty of good faith and fair dealing, where the subscriber is not clearly informed of this procedure in the health plan.  [¶]  The Court has ruled as a matter of law that BLUE SHIELD OF CALIFORNIA violated its duty of good faith and fair dealing in failing to advise JOHN SARCHETT of any peer review or arbitration procedure in its denial letters sent to Mr. Sarchett.  [¶]  BLUE SHIELD OF CALIFORNIA cannot avoid this responsibility at a later date by informing other persons such as physicians or the Hospitalization Utilization Review Committee.”

Appellant has arranged with the County of Los Angeles to provide health care for those employees of the county who choose to become members of the Blue Shield plan.   There exists between appellant and the County of Los Angeles a formal group health service contract that, although available to employees, is not ordinarily read by them.   However, prior to initial enrollment, each employee is provided with a brochure describing the benefits available to subscribers under the terms of the contract.   Thereafter, updated brochures are produced annually and are forwarded to each member.   A portion of the formal contract between the county and Blue Shield provides:  “[T]he contract does not provide benefits with respect to services [¶] ․ c. incident to hospitalization primarily for medical observation or diagnostic examinations, or for rest, convalescent and rehabilitation care ․”  The current brochure in effect at the time of respondent's hospitalization provided in pertinent part as follows:  “Services Not Covered [¶] 1.   Services when hospitalized primarily for diagnostic purposes or medical observation, rest or convalescent care ․”

The respondent testified that, although he read the original brochure upon signing the subscription to the plan in 1966, he did not read the annual brochures that were provided to him thereafter as his membership continued.   He further testified that he understood that his health plan did not provide coverage for all medical services that he might receive.

On January 13, 1976, respondent was hospitalized by his family physician.   Mr. Sarchett testified that he went to the hospital because his physician recommended it and he would have done so regardless of whether the hospitalization would be covered by the health plan.   While in the hospital, respondent underwent three days of diagnostic testing but received no treatment for any specific disorder.   None of the tests performed on respondent required that he be hospitalized as they could have been performed on an outpatient basis.   In addition to the hospital costs, respondent incurred costs for the diagnostic tests as well as costs for subsequent visits in the hospital by his family physician.   Respondent's claims for these latter services were paid by appellant in accordance with the terms of respondent's health plan.

Upon appellant's initial review of respondent's claim for hospital benefits, appellant determined that such expenses might perhaps not be covered because of the above exclusion.   Appellant submitted the file to its medical review administration department, which retained Dr. Robert Wolf to review the claim.   Dr. Wolf concluded that respondent had been admitted to the hospital solely for diagnostic testing and that the services provided were not covered under the plan.

When notified of the denial of his claim, respondent promptly requested a reevaluation.   Respondent was requested by Dr. Wolf to have his physician forward information to Dr. Wolf concerning the medical necessity for respondent's hospitalization.   The physician provided the requested information, and, thereafter, appellant retained three additional physicians to assist Dr. Wolf in conducting the reevaluation.   Dr. Wolf and the three consultants agreed, after the reevaluation, that respondent had been hospitalized solely for diagnostic testing.

The Utilization Review Committee of Foothill Presbyterian Hospital (the facility where respondent was hospitalized) reviewed respondent's case and concluded that the hospitalization had been justified.   The committee then interceded with Blue Shield on behalf of respondent.   Dr. Wolf, on behalf of appellant, wrote to the hospital review committee concluding his letter as follows:  “We accede to your formal request to rereview this case and will do so on receipt of the needed information from you.   If after this rereview we are still not in agreement we will arrange for an impartial Peer Physician Panel Review in your area.   Both Doctor Van Vranken [respondent's personal physician] and the patient will be invited to attend and participate.   We will abide by the Panels [sic] decision.”

The “needed information” was not provided by the committee and nothing further was done until a new chairman of the utilization review committee contacted Dr. Wolf almost six months later and once again requested a rereview of respondent's case.   Dr. Wolf informed the new chairman that the utilization review committee had not provided any new information and further advised him that Blue Shield was offering to submit the patient's claim to a peer review committee.   Dr. Wolf made some observations concerning the medical facts and notified the chairman of the utilization review committee that, if it could be demonstrated that any of the diagnostic tests required hospitalization, Blue Shield would reconsider and pay the claim.   There was no response to that letter.   Thereafter respondent instituted this action.

 At the trial conflicting evidence was received concerning the medical necessity of hospitalizing respondent.   Because that issue of fact should have been submitted to the jury, it was error to direct a verdict in this case.   “A ․ directed verdict may be granted ‘only when, disregarding conflicting evidence and giving to plaintiff's evidence all the value to which it is legally entitled, herein indulging in every legitimate inference which may be drawn from that evidence, the result is a determination that there is no evidence of sufficient substantiality to support a verdict in favor of the plaintiff if such a verdict were given.’  [Citations.]  Unless it can be said as a matter of law, that, when so considered, no other reasonable conclusion is legally deducible from the evidence, and that any other holding would be so lacking in evidentiary support that a reviewing court would be impelled to reverse it upon appeal, or the trial court to set it aside as a matter of law, the trial court is not justified in taking the case from the jury.  [Citation.]  ․  [T]he function of the trial court on a motion for a directed verdict is analogous to ․ that of a reviewing court in determining, on appeal, whether there is evidence in the record of sufficient substance to support a verdict.   Although the trial court may weigh the evidence and judge of the credibility of the witnesses on a motion for a new trial, it may not do so on a motion for a directed verdict.”  (Estate of Lances (1932) 216 Cal. 397, 400–401, 14 P.2d 768.)

 Respondent contends that the appellant had no right to deny respondent's claim for hospitalization because neither appellant's agreement with the County of Los Angeles nor the brochure describing the plan that was in effect at the pertinent time specifically sets forth that right.   Respondent correctly asserts that the interpretation of a written contract is a question of law for the court even though questions of fact are involved.  (Parsons v. Bristol Development Co. (1965) 62 Cal.2d 861, 866, 44 Cal.Rptr. 767, 402 P.2d 839.)   However, the ultimate responsibility for the interpretation of a contract lies, not with the trial court, but with the appellate court.   (Ibid.)

 Respondent concedes that an insurer may make and enforce any exclusion of coverage in its policy that it desires.   Respondent nevertheless contends that the proper interpretation of the contract at issue requires a holding that a determination of the necessity of hospitalization for reasons other than diagnostic testing rests within the sole discretion and judgment of the treating physician.   In support of his position, respondent cites Van Vactor v. Blue Cross Ass'n (1977) 50 Ill.App.3d 709, 8 Ill.Dec. 400, 365 N.E.2d 638.   In Van Vactor the court affirmed the granting of summary judgment in favor of the plaintiffs who had brought a declaratory class action to require the defendant insurer to pay the claims of thousands of policy holders who had been denied benefits for hospitalization expenses incurred for oral surgery.

In that case the brochure and contract provided in substance that hospital bills incident to inpatient removal of compacted teeth would be paid where the hospitalization was medically necessary.   The court, in construing the insurance contract, concluded that the insurer did not have authority to review the judgment of the treating dentist as to the medical necessity of the hospitalization.  (Van Vactor v. Blue Cross Ass'n, supra, 50 Ill.App.3d 709, 8 Ill.Dec. 400, 365 N.E.2d at pp. 643–645.)   The practical assistance of Van Vactor to the case at bench is sorely limited because we are not provided with the terms of the contract and brochure at issue in that decision.   The decision recites that the judgment stated, “ ‘․ pursuant to the terms and provisions of said contract, determination of whether and to what extent hospital services rendered to a subscriber to said contract are medically necessary, is vested solely and exclusively in the judgment and discretion of the treating physician upon whose recommendation the patient was duly admitted to the hospital ․’ ”  (Van Vactor v. Blue Cross Ass'n, supra, 50 Ill.App.3d 709, 8 Ill.Dec. 400, 365 N.E.2d at p. 641.)   Even if the language quoted from the trial court judgment in Van Vactor included a verbatim quotation of the underlying contract, as respondent contends, we nevertheless would be unable to compare the Van Vactor contract and brochure with the documents in issue in this case.   Moreover, the overwhelming weight of authority seems to be contrary to the Van Vactor holding.

Although not decisive, industry practice is relevant in interpreting a contract.   Medical review of the conduct of physicians is and has been for many years a standard practice of the health provider industry.   Retrospective review is a feature of the federal Medicare program (42 U.S.C. § 1395y(a)) and of California's Medicaid program (Welf. & Inst.Code, § 14110, subd. (e)), and it is approved by most of the courts that have considered the question.  (E.g., Blue Cross & Blue Shield of Ky. v. Smither (Ky.App.1978) 573 S.W.2d 363, 365;  Lockshin v. Blue Cross of Northeast Ohio (1980) 70 Ohio App.2d 70, 434 N.E.2d 754, 755;  cf. Schweiker v. McClure (1982) 456 U.S. 188, 102 S.Ct. 1665, 72 L.Ed.2d 1;  Ross v. Richardson (6th Cir.1971) 440 F.2d 690.)

In Lockshin the plaintiff claimed the cost of special nurses who were provided following her caesarean operation.   The claim was denied by the defendant, Blue Cross, on the grounds that the services of special nurses were unnecessary even though the plaintiff's physician had found that such care was required.   The Ohio court stated, “[T]he focus of this appeal is the meaning of the word ‘necessary’ in the hospitalization plan ․  However, the question of who decides what is or is not ‘necessary’ is intrinsic in that answer and of equal importance.   The trial court held that the term ‘necessary’ was ambiguous, vis-a-vis who must ultimately decide what is ‘necessary.’   Consequently, the trial court strictly construed the policy against the drafter and found for the claimant (plaintiff).   We view the result of that holding as creating a per se rule that the attending physician's decision on such matters is binding on the insurer.   We do not believe the facts, or the insurance policy, warrant such a rule.”  (Lockshin v. Blue Cross of Northeast Ohio, supra, 70 Ohio App.2d 70, 434 N.E.2d at p. 755, italics in original.)   The court went on to point out that a function basic to an insurer is the right to review claims that are submitted to it.  (Lockshin v. Blue Cross of Northeast Ohio, supra, 70 Ohio App.2d 70, 434 N.E.2d at p. 756.)   The court noted that, without such right, the orderly establishment, administration, and dispensation of insurance benefits would be virtually impossible.  (Ibid.)  The court held, “While the decision of a physician is both relevant and probative on the issue of necessity, it is not dispositive of the question, when, upon judicial review, the record does not confirm that determination.   [Citations.]”  (Lockshin v. Blue Cross of Northeast Ohio, supra, 70 Ohio App.2d 70, 434 N.E.2d at pp. 756–757.)

Appellant argues, and we agree, that the exclusion here involved would be meaningless unless appellant retains the right to evaluate the claims submitted to it to determine in the first instance whether the exclusion applies.  “[A]n insurer is not required to pay every claim presented to it.   Besides the duty to deal fairly with the insured, the insurer also has a duty to its other policyholders and to the stockholders ․ not to dissipate its reserves through the payment of meritless claims.”  (Austero v. National Cas. Co. (1978) 84 Cal.App.3d 1, 30, 148 Cal.Rptr. 653, disapproved as to another point in Egan v. Mutual of Omaha Ins. Co. (1979) 24 Cal.3d 809, 169 Cal.Rptr. 691, 620 P.2d 141, app. dism. and cert. den. (1980) 445 U.S. 912, 100 S.Ct. 1271, 63 L.Ed.2d 597.)

Upholding the trial court's decision in this case would result in a per se holding that the attending physician's opinion concerning whether hospitalization was necessary would be binding on the insurer.  (Lockshin v. Blue Cross of Northeast Ohio, supra, 70 Ohio App.2d 70, 434 N.E.2d at p. 755.)   A per se rule as contended for by respondent would be contrary to the statutory requirements of the Medicare and Medicaid programs as indicated ante at page 538 and would disrupt what appears to be a long-standing industry practice.   The justification proffered by respondent for such a rule in this case is that neither the contract nor the brochure describing the plan explicitly informed the subscriber that the insurer would exercise its right of review to determine whether a claim was covered by the terms of the policy.   In our view, such explicit warning was unnecessary because the contract and the brochure clearly set forth the existence of the various exclusions to coverage.   Further, it is difficult to conceive just how the various physicians within the community would know of the specific exclusions of the policies possessed by their various patients.   It seems apparent that by enunciating a per se rule we would delegate to each physician the sole discretion in determining when hospitalization is desirable, whether or not necessary.

Without determining whether the contract in this case is one of adhesion, we note that those principles that govern the interpretation of adhesion contracts do not bar the application of the coverage exclusions in the subject policy.   As explained in Madden v. Kaiser Foundation Hospitals (1976) 17 Cal.3d 699, 131 Cal.Rptr. 882, 552 P.2d 1178, “The concept that a contract of adhesion should be interpreted and enforced differently from an ordinary contract has evolved from cases which have involved contractual provisions drafted and imposed by a party enjoying superior bargaining strength—provisions which unexpectedly and often unconscionably limit the obligations and the liability of the party drafting the contract.  [Citations.]”  (Id., at p. 710, 131 Cal.Rptr. 882, 552 P.2d 1178.)

Madden further pointed out that in most adhesion contracts the weaker party lacks not only the opportunity to bargain but also any realistic opportunity to look elsewhere for a more favorable contract.  (Id., at p. 711, 131 Cal.Rptr. 882, 552 P.2d 1178.)   As in Madden, those conditions do not apply here.   Respondent had the choice of three plans from three separate companies.   Each plan had been negotiated by the County of Los Angeles with the respective insurance companies on behalf of the county's employees.   Further, for obvious reasons, the contract at issue in this case may not be characterized as a standard insurance contract marketed with the general public as was the contract considered by the court in Ponder v. Blue Cross of Southern California (1983) 145 Cal.App.3d 709, 723, modified, 146 Cal.App.3d 779 a, 193 Cal.Rptr. 632 [as modified].

Even were we to measure the effectiveness of the exclusionary clauses in this contract by the “insured's reasonable expectation of coverage” (Gray v. Zurich Insurance Co. (1966) 65 Cal.2d 263, 267, 54 Cal.Rptr. 104, 419 P.2d 168, we would not conclude that the contract at bench failed that test.   Respondent testified that he knew there were coverage exclusions in the policy.   He demonstrated by conduct his knowledge that, to recover on the policy, it would be necessary to make a claim.   He testified that he would have entered the hospital upon the recommendation of his physician whether or not his policy would cover the expenses therefore.

In ruling on respondent's motion for a directed verdict, the trial court stated, “I suppose [that plaintiff's Davis v. Blue Cross of Northern California (1979) 25 Cal.3d 418, 158 Cal.Rptr. 828, 600 P.2d 1060 grounds for a directed verdict] could be an alternative breach of covenant and good faith and fair dealing [sic] with the insured ․”  The trial court's reliance on Davis is misplaced.   The facts in Davis are clearly distinguishable from the facts in this case.   In Davis the trial court found that arbitration had been waived by Blue Cross by virtue of certain facts it found to exist.   The court in Davis found that the arbitration clause in the Blue Cross brochure was obscurely placed and employed ambiguous wording and that by reason thereof Blue Cross should have known that its insureds would have been unaware of their right to arbitration.  (Davis v. Blue Cross of Northern California (1979) 25 Cal.3d 418, 426, 158 Cal.Rptr. 828, 600 P.2d 1060.)   By contrast, the Blue Shield brochure made available to respondent contained a clear and prominent arbitration clause.   In addition to this notification, there was the notification to the hospital utilization review committee that an impartial peer physician panel review would be available and the further offer to obtain such review in a letter to respondent's attorney.   These factual issues should have been submitted to the jury for their determination as to whether respondent was notified of his rights.

Respondent contends that, even though appellant may have had a reasonable belief that the policy did not cover the loss claimed, appellant nevertheless can be held to have breached the covenant of good faith and fair dealing by denying the claim if the contract did not justify the denial.   In advancing this argument, respondent confuses the doctrine applied in third party claims with that prevailing in first party claims.   The cases relied upon by respondent for this proposition (e.g., Samson v. Transamerica Ins. Co. (1981) 30 Cal.3d 220, 237, 178 Cal.Rptr. 343, 636 P.2d 32;  Johansen v. California State Auto Assn. Inter-Ins. Bureau (1975) 15 Cal.3d 9, 12–13, 15–16, 123 Cal.Rptr. 288, 538 P.2d 744;  Comunale v. Traders & General Ins. Co. (1958) 50 Cal.2d 654, 658–661, 328 P.2d 198) were cases wherein the respective defendant insurance companies refused to settle actions brought against the insureds for the reason that the insurers did not believe that their policies covered the claims in question.   In each case the action could have been settled within the policy limits.   After the plaintiffs in the underlying actions recovered judgments against the insureds in excess of the policy limits in each of the cases, it was held that the implied covenant of good faith and fair dealing imposed a duty on the insurer to settle the claim against its insured whenever there was a substantial likelihood of a recovery in excess of policy limits.   It was further held that a company's bona fide belief that the policy did not cover the incident could not insulate that company from liability for failure to settle within the policy limits when in fact the incident was covered.

In first party claims such as the case at bar, the insurer's bona fide belief that the claim is not covered does not subject the insured to any increased risk of financial loss such as exists when a third party has brought an action against an insured for an amount greater than the policy limits.

Neither Egan v. Mutual of Omaha Ins. Co., supra, 24 Cal.3d 809, 169 Cal.Rptr. 691, 620 P.2d 141 nor Silberg v. California Life Ins. Co. (1974) 11 Cal.3d 452, 113 Cal.Rptr. 711, 521 P.2d 1103 is apposite to this case.   The insurance company's withholding of payments for an extended period of time in Silberg while the insurer awaited termination of the insured's workers' compensation proceeding is so far removed from the facts of this case as to bear no relationship thereto.  Egan merely held that “an insurer cannot reasonably and in good faith deny payments to its insured without thoroughly investigating the foundation for its denial.”  (Egan v. Mutual of Omaha Ins. Co., supra, 24 Cal.3d at p. 819, 169 Cal.Rptr. 691, 620 P.2d 141.)   There it was clear that the insurer had made almost no investigation before denying the claim.   The evidence in this case, however, does not so indicate.   Whether respondent's investigation was sufficient was a matter that could and should have been resolved by the jury.

Other contentions made by appellant basically concern the sufficiency of the evidence.   In view of our conclusion as to the propriety of a directed verdict on the issue of good faith and fair dealing, it is not necessary for us to address the remaining arguments.

The judgment is reversed.   The matter is remanded for a new trial in accordance with the views expressed herein.

DALSIMER, Associate Justice.

SPENCER, P.J., and L. THAXTON HANSON, J., concur.