" Employee
Welfare Benefit Plans":
I have often heard it said that ERISA was enacted by Congress to eliminate the chaos of having 50 different state regulatory schemes impacting employee benefit plans. That's a lot of bull. The biggest beneficiary of ERISA, today, is the insurance industry -- the same insurance industry that fought for years against any attempt at federal regulation. If there ever was any chaos of state regulation of insurance, it was a chaos that the insurance industry loved.
In reality, ERISA was enacted by Congress to address irregularities in certain large pension plans, particularly the Teamsters Pension Fund. Medical and disability benefits were the furthest thing from the collective mind of Congress, when ERISA was enacted in 1974. However, almost inexplicably, a very small part of the statute included a thing called an "employee welfare benefit plan." Although that term is defined in 29 USC 1002(1) , it is not clear whether anybody, in 1974, knew precisely what an "employee welfare benefit plan" was or what it would be. Presumably, the term related to some kind of self-funded plan set up by employers or unions as a part of the collective bargaining process. The intent was apparently to allow certain larger employers or unions to "self-insure" their employee benefits plans. But by the late 1970s, just a few years after ERISA's enactment, the concept of an "employee welfare benefit plan" was given a new meaning. Life was breathed into that concept by the proprietors of the "Multiple Employer Trusts."
The METs of the 1970s
and 1980s:
In order to understand how many "self-funded" ERISA plans work, it's helpful to know a little bit of history about "self-funded" plans in general. The "self-funded" ERISA plan came into fruition in the late 1970s and early 1980s. It was then that a large segment of the group health insurance market was captured by entities known as "Multiple Employer Trusts" (METs). METs fell into two broad categories - the "fully insured" METs and the "self-funded" METs. (As explained below, even the "fully insured" METs weren't always what they professed to be).
The self-funded METs were large, uninsured, group medical plans, typically administered by "Third Party Administrators" (TPAs). The METs looked just like insurance plans and the TPAs, who administered these plans basically did everything that an insurance company might do. They sold plans that promised benefits; they charged premiums; and on a good day they even paid some claims.
The self-funded METs were particularly attractive to small business owners, who were finding it increasingly difficult to afford the skyrocketing premiums charged by the larger group health insurance companies. The MET plans offered a multitude of benefits, which were sold at prices substantially below what the traditional insurance companies were charging at the time. The TPAs were also quite generous with the insurance agents, who sold their plans -- paying commissions substantially in excess of what the traditional insurance companies were paying. As result of all these factors, the self-funded METs grew dramatically in the late 1970s and early 80s.
The proprietors of the METs (and their attorneys) were a creative bunch of folks. Using ERISA as their primary vehicle, the METs took two of the most revered legal concepts of our civil law -- that of a " Trust" and that of "fiduciary duty" -- and they annihilated them. In order to fully appreciate what the METs did, it helps if you first understand what a "Trust" is supposed to be, under our civil law. A "Trust" is a legal abstraction. Under basic Trust Law, a "Trust" is established by a "Grantor" or "Settlor," who places certain assets into a "Trust" , where they are held for the benefit of others (the "beneficiaries" ). The assets are then overseen by an independent "Trustee," who manages the assets for the benefit of the intended "beneficiaries." The "Trustee" is held by law to "fiduciary" standards of conduct in discharging his responsibilities. The concept of "fiduciary duty" is also a legal abstraction. "Fiduciary duty" is the highest duty that can be imposed by our civil law.
The METs took these legal concepts and turned them on their ear. For example, if we apply basic Trust Law concepts to the entities known as "Multiple- Employer Trusts," then the "settlors" or "grantors" of these METs would necessarily have to be the employers, since it was they, who established the METs for the benefit of their employees. Right? Hardly. The METs were not formed by groups of small business employers, banding together to create some kind of "self-insured" pool. The self-funded METs were set up by the companies who administered them -- the TPAs. Instead of having independent Trustees overseeing the assets, the "Trustees" of an MET might be the wives or secretaries of the proprietors of the TPA. Sometimes the TPA's bank, would agree to serve as "Trustee," so long as the TPA maintained its multi-million dollar claims account with the bank (an ever so slight "conflict of interest" ). After setting up the bogus "Trust," the TPA would put together a benefit Plan; market it to various employer groups and then charge a fee for providing "administrative" services. Each employer, who purchased the plan would sign a "participation agreement" provided by the TPA, by which the employer unit (i.e. the employees and their dependents) joined the MET and agreed to pay the stated monthly "premium." The TPA would then issue benefits booklets (known under ERISA as "Summary Plan Descriptions" ) to the employee / plan participants. These benefit booklets were very much like the "Certificate Booklets," which up to that point in time were commonly issued to individual insureds under various group insurance plans. In many instances the TPAs just copied old "Certificate Booklets" of various insurance companies and re-named them "Summary Plan Descriptions."
Frequently, the employees paid all or part of the monthly "premium" through payroll deductions. To be more precise, the various employer units did not actually pay "premiums" to the MET. Instead, they paid "contributions" to the "self-funded Trust," which for all practical purposes were the same thing as "premiums." In theory, these "contributions" were deposited by the TPA into a "Trust Account." Funds were then transferred periodically to a "Claims Account," upon which checks were written to cover the outstanding claims. The "Trust Account" was nothing more than an interest-bearing market-rate account. The TPA would typically charge an administrative fee of 10-15% of the gross "contributions." The TPA would also pick up sizable chunks of interest on the funds held in the "Trust Account."
As the METs proliferated, particularly in California, the State Departments of Insurance and Corporations got nervous. The METs presented a regulatory challenge, the likes of which no one had ever seen before. Although they were huge plans, "insuring" tens of thousands of people, they were not licensed by anyone. They were also of dubious solvency, since not one of them complied with even the most basic capital and surplus requirements of state insurance law. But, as they signed up more and more new participants, the METs appeared to flourish financially. In a sense, they were like giant ponzi schemes. Under-funded and under-reserved, the METs found themselves simply using new money to pay off past claims liabilities - "robbing Peter to pay Paul." But, as long as they kept growing, they were able to maintain the illusion of solvency. Eventually, the day of reckoning came for each of the self-funded METs -- the financial bubble burst. And whenever a self-funded MET went "belly-up," it was national news; shock waves spread throughout the country; millions of dollars of claims went unpaid. Horror stories would abound. Patients, who were in need of heart by-pass surgery, or dialysis were suddenly left uninsured and unable to get medical treatment. Other helpless insureds with enormous medical bills, were left to face personal responsibility for the unpaid bills and possible bankruptcy.
From the TPA's perspective, however, it really didn't matter if the METs was solvent or not. As long as the money was coming in (and we're talking about tens of millions of dollars), the TPAs were doing quite well. They were getting their 10-15% cut for "administrative fees," plus the float on the money they were holding, plus if they were using their own "captive" or "affiliate" stop-loss carrier, they were making money off the stop-loss premiums. Given the amount of money that could be made in the short term, who cared if the "Trust" eventually went "belly-up" in the long term. Anyway, even if it did, the TPAs would just go down the road and start another one.
However, the TPAs certainly did have an interest in keeping their METs going for as long a possible. (These were large administrative operations, with complex personnel requirements and substantial overhead investment). That meant keeping state regulators at bay for as long as possible. Thus, some of the very first "ERISA pre-emption" arguments were hatched by MET attorneys, who argued that ERISA pre-empted all state insurance laws, as they related to the self-funded METs. It was further argued that only the U.S. Department of Labor had regulatory jurisdiction over the METs (ERISA was enacted as part of the U.S. Labor Code.) The U.S. Department of Labor, however, did not have the means or the inclination to regulate METs, and the MET attorneys certainly knew that.
Although ERISA does contain a "pre-emption" clause, ERISA was never intended to regulate all employer-sponsored health or disability insurance plans and no one ever dreamt at the time that "ERISA Pre-emption" would turn out to be what it ultimately became. However, when the Federal Courts started buying many of the "ERISA Pre-emption" arguments, a new species of Federal common law was born. Many of the "ERISA Pre-emption" arguments that we take for granted today, were initially nothing more than ploys to keep state regulators off the backs of the METs.
Interestingly, even the METs themselves did not expect their proffered "ERISA Pre-emption" analysis to fly for very long. In fact, for a while, the U.S. Department of Labor basically gave the "green light" to state regulators to go in and regulate METs anyway they saw fit. (This meant that the state regulators could, theoretically, shut down a self-funded MET, on grounds it was operating as an unlicensed insurer or health plan). With the regulatory issue up in the air, and with the METs facing the possibility of being shut down entirely by state regulators, the METs were certainly not about to put all their eggs in the "ERISA Pre-emption" basket. In order to hedge their bets, the self-funded METs prepared to shift gears and adopt an entirely new strategy to fend off state regulators -- alas, the "front company" scam was devised. Under this arrangement, the formerly "self-funded" MET could become "fully insured" overnight, if necessary, by the simple use of a "front company."
The "Front
Company" Scam:
The "front company " scam works like this. Everything is exactly the same as with the self-funded MET scenario, described above, but with an added player -- the "front company." Here is one illustration: The TPA sets up its own "captive" or "affiliate" insurance company (usually off shore or admitted in another state where capital and surplus requirements are minimal.). We'll call the captive the "XYZ Captive Insurance Company." Then, enter the "ABC Legitimate Insurance Company," a California admitted insurance carrier, licensed to write group health insurance in California. The MET obtains a master "policy" from ABC. (Actually, the "policy" is one written up by the MET attorneys so that it will be consistent with the plan that the MET is already offering to the public -- the ABC Insurance Company just puts its name on the "policy" )
ABC then either obtains "reinsurance" from (or through) XYZ and it obtains an " indemnity agreement" by which XYZ agrees to indemnify ABC for any losses incurred by ABC as the result of its agreement to "front" for the MET. Thus, all "losses" are passed from the MET to ABC to XYZ. (XYZ may also have numerous affiliated "reinsurers" ). If you followed the money trail, it would inevitably lead from the MET through ABC, and ultimately to XYZ. ABC does not actually receive any "premiums" under this ruse, nor does it pay any claims. In theory, ABC assumes no risk at all, but receives a substantial "fronting fee" from the MET, for the use of its name and license. In theory, XYZ assumes 100% of ABC's risk..
The purpose of this "fronting" arrangement is to:
(A) satisfy state regulators that the plan is "fully insured";
(B) satisfy insureds that their claims will be paid; and
(C) allow a large part of the "Trust Funds," ostensibly held to pay claims to be converted into revenue for the "captive" or "affiliate."
(Now, we're talking about robbing both Peter and Paul).
Neither the regulators nor the insureds would necessarily know about the behind the scenes fronting deal. It doesn't take a genius to figure out that this was a dangerous game for any legitimate insurance company to play, because if an MET did go "belly-up," neither the insureds, nor the state regulators, nor the courts would care about the "fronting" deal. In my example, they would all look to the "ABC Legitimate Insurance Company" to make good on any claims. Thus, on the surface, it would seem that any "front company" arrangement would be asinine and that only the stupidest insurance company would agree to it. But many legitimate insurance companies did go for these "fronting" deals. Why?. Because the "front companies" had a totally different agenda. They weren't the least bit interested in solving the legal or regulatory problems of the METs. They were playing a different game called "hit and run," in which they would never stay on any given risk for very long. The objective of the "front company" was to go in quickly; front for the MET for a short period of time (e.g. 90 days); pick up a few million dollars in "fronting fees" ; and then run like hell, putting as much distance between the "front company" and the MET as possible. A smart "front company" would do an audit of the MET before agreeing to the deal, to make sure that the MET looked OK (i.e. that it had enough money coming in to pay claims) for at least the 90 period of the "fronting" arrangement. Beyond that, the "front company" could care less.
Of course, when a "front company" jumped off the risk, the MET was left "bare" (without "insurance" ) and once again vulnerable to state regulators, who were frequently parked outside the door of the TPA ready to pounce. Not to worry, for up until the time when the MET was ready to go "pop," a good "surplus lines broker" (for a substantial fee), could always find some other insurance company willing to "front" for the MET for a little while longer. However, with each successive "fronting" deal, the quality and "Best Rating" of the "front company" would be lower and lower, until ultimately the "insuring" or "front company" was some company no one ever heard of before.
Because of the exorbitant amounts charged by the "front companies" for their "fronting fees," these arrangements had the effect of taking a financially precarious self-funded MET and pushing it even closer to the brink of insolvency. Eventually, the MET would be left high and dry by the final "front company" - uninsured, financially drained and insolvent. But before making their exit, the "front companies," like the TPA would make their profits on the backs of unsuspecting insureds, who paid their premiums religiously, but who would receive nothing in return.
The Legacy:
The METs were infamous for poor underwriting standards and in the early 1980s the large METs all went bankrupt, leaving tens of thousands of California residents without insurance, and many with unpaid claims. However, the METs left an indelible mark on the health care and insurance industries. The METs pioneered many of the Managed Care concepts that we take for granted today, including "dual-option" plans (which were the forerunners of "preferred provider organizations" (PPOs) and "exclusive provider organizations" (EPOs)). The METs were also among the first to try to use ERISA and its "pre-emption" clause, to legitimize their operations. (See e.g.: Insurance & Prepaid Benefits Trusts v. Marshal 90 F.R.D. 703; 1981 U.S. Dist. LEXIS 14888 (CD Cal., 1981). The METs also pioneered the use of "stop-loss" coverage. (See: The Stoploss Shuffle. Although the METs of the late 1970s and early 1980s, blazed the trail, it was the conservative, insurance industry giants, following in the footsteps of the METs, who eventually took both "Managed Care" and "ERISA pre-emption" to incredible extremes over the following decade. All of the major health and long-term disability insurance companies eventually took notice of the "ERISA pre-emption" arguments and the protection that ERISA could afford them from state regulation and state consumer laws. (particularly "bad faith" lawsuits, which exposed insurance companies to punitive damages for wrongful claim denials). Although it was never the intent of Congress, before the major insurance companies would be finished, ERISA would (primarily as the result of Federal Judicial decisions) dominate the entire field of employer-sponsored health and disability plans.
Ó 1997 Michael A. McKuin - ERISA Lawyer
