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Guest Article

California Agency Barred From Using Independent Review Law to Mandate Coverage of Drugs Not Covered by Insurer

Summary: California's insurance department was prohibited from requiring a managed care organization to cover prescription weight loss drug, which the insurer excluded from coverage, as well as from requiring the insurer to submit to an independent medical review that did not seek to determine medical necessity.

A physician contacted Blue Shield of California seeking authorization for coverage of Xenical, a prescription weight loss drug, on an enrollee's behalf because no other "formulary medication" existed. Blue Shield denied coverage, citing its exclusion from coverage of weight loss drugs. After the enrollee's subsequent internal appeal was denied, she applied for an independent medical review through California's Department of Managed Health Care (DMHC) as provided for by California's Knox Keene Act -- under which Blue Shield was licensed to provide coverage. This law requires insurers to provide the following information within three days of a DMC notice.

  • a copy of enrollee's medical records that explains: (1) the enrollee's medical condition; (2) the treatment that is covered; and (3) the treatment that the enrollee requested.
  • a copy of all information that the insurer and its network health care providers provide to enrollees regarding decisions over a disputed treatment.
  • all documents on which the insurer and provider rely to determine whether a disputed treatment should have been provided.

If the independent medical reviewer determines that the treatment is medical necessary, then the insurer is given five days from when it receives the reviewer's written decision to authorize the treatment. If the insurer fails to comply with the decision within that timeframe, DMHC can fine the insurer $5,000 per day for each day the insurer fails to comply.

The DMHC notified Blue Shield that the enrollee's medical records were to be sent to the Center for Health Dispute Resolution (CHDR), which was to perform the IMR. Blue Shield refused to provide the requested records (which were eventually obtained directly from the providers, thereby delaying the review process) because it was inappropriate under California law for its denial to be submitted for an IMR. CHDR determined that Xenical was medically necessary for treating the enrollee's condition. However, the five-day period expired without Blue Shield's compliance with CHDR's determination. Blue Shield indicated that it did not consider CHDR's determination to be binding.

DMHC director Daniel Zingale sued Blue Shield in state court for refusing to comply with CHDR's determination. It sought to assess a penalty of more than $100,000 against Blue Shield for not only refusing to comply with the IMR's determination, but also for prolonging the enrollee's appeals process.

Blue Shield countersued, seeking a preliminary injunction against DMHC for: (1) assessing the penalty against it for refusing to comply with the IMR's determination; (2) using the IMR process in cases where a denial of coverage was based on a benefit exclusion; and (3) requiring it to offer a benefit that was not mandated by state law. Blue Shield noted that it agreed to provisionally cover Xenical for the enrollee, but that other enrollees have sought coverage of weight loss drugs -- despite Blue Shield's clear exclusion of coverage for such medication -- and that DMHC has submitted at least one of these claims for IMR.

Blue Shield also noted that this is the second time that DMHC attempted to force an insurer to cover outpatient prescription drugs. In 1998, DMHC attempted to force Kaiser Foundation Health Plans to cover prescription drugs that treated sexual dysfunction, such as Viagra. Kaiser filed an administrative challenge, and an administrative law judge ruled that DMHC lacked the authority to require coverage for specific outpatient prescription drugs. When DMHC refused to comply with the administrative law judge's ruling, Kaiser went to court seeking a writ of mandate. The court ruled that the Knox Keene Act did not require Kaiser or any other insurer that covers prescription drugs to cover all classes of prescription drugs.

DMHC's Authority Under Knox Keene Act Limited

Blue Shield then argued that the Knox Keene Act did not give DMHC the authority to determine which drugs or classes of drugs could be included in insurers' outpatient prescription drug benefit package. Specifically, the Knox Keene Act mandated that all insurers provide to their enrollees "basic health care services," but does not mandate coverage for outpatient prescription drugs. For those insurers that voluntarily cover outpatient prescription drugs, DMHC only has the authority to ensure that those benefits comply with the Knox Keene Act. However, the DMHC could not cite any authority under which it had the power to regulate or mandate prescription drug coverage, according to Blue Shield.

To that end, Blue Shield said that DMHC was essentially trying to enforce a prescription drug mandate through a section of California's regulations. The DMHC issued those regulations to generally require every insurer that opted to cover prescription drugs to cover all medically necessary drugs. However, Blue Shield pointed out that in the 1998 case, the court properly held that through the Knox Keene Act, the legislature explicitly showed its intent to exclusively regulate prescription drug coverage -- it is up to insurers, not DMHC -- to construct the remaining prescription drug benefits, as long as they follow the legislative intent in the Knox Keene Act.

IMRs Based on Contract Exclusions Prohibited

Blue Shield then argued that DMHC's reliance on the IMR process to force it to cover Xenical was "little more than a veiled attempt to do what [DMHC] knows it is prohibited from doing: mandating coverage for prescription outpatient drugs absent a statutory mandate."

Blue Shield further argued that DMHC was attempting to circumvent its lack of authority under the Knox Keene Act by attempting to enforce its regulations by using the IMR process.

After hearing the arguments from both sides, a state court judge issued a preliminary injunction on Jan. 15, 2002, barring DMHC from:

  • enforcing any section of the Knox Keene Act or any regulation (including the regulation at issue in the case) that mandates coverage of outpatient prescription drugs -- absent a specific statutory mandate;
  • authorizing an IMR regarding Blue Shield's outpatient prescription drug coverage when such decisions are not based on medical necessity; and
  • considering the results of any IMR regarding Blue Shield's outpatient prescription drug coverage when such decisions are not based on medical necessity -- absent a specific statutory mandate.


This case was not about ERISA preemption. Rather, it was about whether a state regulator had the authority to require coverage without express statutory authorization.

The case also has implications for self-funded plans. In the small employer market, self-funded employers sometimes try to duplicate the coverage offered by insured plans to stay competitive in the employment market. The ruling in this case eases such pressure. It also blunts criticism exhibited by state regulators and is particularly important to plans facing substantial cost increases. Coverage mandates only add to plan costs and intrude into plan management.

Excerpted from the February 2002 supplement to Employer's Guide to Self-Insuring Health Benefits, © Thompson Publishing Group, Inc., 2002. All rights reserved.

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