Sarchett v. Blue Shield of California

• Decision Date: 02 January 1987
• Citation: 233 Cal.Rptr. 76,43 Cal.3d 1,729 P.2d 267
• Parties: , 729 P.2d 267, 55 USLW 2404 John S. SARCHETT, Plaintiff and Respondent, v. BLUE SHIELD OF CALIFORNIA, Defendant and Appellant. L.A. 31988.
• Court: California Supreme Court

Page 76

233 Cal.Rptr. 76

43 Cal.3d 1, 729 P.2d 267, 55 USLW 2404

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

L.A. 31988.

Supreme Court of California,

In Bank.

Jan. 2, 1987.

As Modified on Denial of Rehearing Feb. 24, 1987.

Hassard, Bonnington, Rogers & Huber, Howard Hassard, William B. Sturgeon, Rick C. Zimmerman, B. Thomas French and Tyler G. Draa, San Francisco, for defendant and appellant.

Munger, Tolles & Rickershauser, Daniel P. Garcia, Peter R. Taft and Lucy T. Eisenberg, Los Angeles, as amici curiae, for defendant and appellant.

William M. Shernoff, Marian Haycock, Shernoff & Levine, Claremont, Leonard Sacks, Encino, and Roni Keller, Beverly Hills, for plaintiff and respondent.

BROUSSARD, Justice.

This dispute arose when defendant Blue Shield of California (Blue Shield) denied plaintiff John Sarchett's claim for hospitalization benefits in the amount of $1,203.05. Sarchett sued Blue Shield for the hospital expenses and also for a breach of the implied covenant of good faith and fair dealing. The trial court directed a verdict for Sarchett on breach of the covenant of good faith and fair dealing, and the jury awarded his hospital costs, $20,000 in compensatory damages and $80,000 in punitive damages. Blue Shield appeals from this verdict.

FACTS AND PROCEDURAL BACKGROUND

In 1966, John Sarchett, a Los Angeles County employee, elected to be insured under a group policy provided by Blue Shield. ¹ In January 1976, Sarchett was hospitalized for three days by his family physician, Dr. Bruce Van Vranken, who is a member physician of Blue Shield. Dr. Van Vranken testified that Sarchett, usually a healthy and robust person, reported symptoms during January of fatigue, tremor, disorientation, painful swelling and distension of the stomach and back, changing bowel habits and peculiar stools. His blood test showed low hemoglobin and low white blood cell counts. Sarchett's condition appeared to be deteriorating rapidly during January, and Dr. Van Vranken feared Sarchett might be suffering from a life-threatening bleeding duodenal ulcer or leukemia.

Blue Shield paid Sarchett's medical and diagnostic testing bills, but denied his claim for the hospital stay, amounting to $1,203.05. Its denial was based on two separate provisions of Sarchett's policy: (1) an exclusion for "[s]ervices when hospitalized primarily for diagnostic purposes or medical observation, rest or convalescent care ..." (italics added) and (2) exclusion for services not "medically necessary." ² The latter exclusion reads as follows: "Medical Necessity: Benefits will be provided under this contract only for such services, whether provided on an Inpatient or Outpatient basis, as are reasonably intended, in the exercise of good medical practice, for the treatment of illness or injury." Blue Shield contended that Dr. Van Vranken's orders for Sarchett's care in the hospital were inconsistent with a belief that Sarchett was seriously ill and hospitalized for medical treatment. ³

Plaintiff, Dr. Van Vranken, and the hospital utilization review committee protested the denial of coverage. The matter was submitted to arbitration, but the arbitrator's award in favor of plaintiff was vacated by the superior court. The matter was then set for trial de novo in the superior court.

The trial court found that Blue Shield repeatedly denied Sarchett's claim without advising him of his contractual right to impartial review and arbitration. Sarchett and others acting on his behalf received several denial letters from Blue Shield, none of them mentioning the availability of review by anyone other than the single physician consultant who repeatedly denied Sarchett's claim. Only after six months of correspondence and repeated protests did Blue Shield first mention the possibility of peer review. ⁴ This came only after the hospital utilization review committee lodged a protest, and only in a letter to that committee--not to Sarchett himself. This belated offer to submit the dispute to peer review was made conditional upon the production of further "solid" information in support of Sarchett's claim, although the review provision in the subscriber's brochure placed no conditions on the right to impartial review.

The trial court directed a verdict for Sarchett on breach of the duty of good faith and fair dealing. The court found that Sarchett's policy failed to reserve for Blue Shield the right to review the "medical necessity" of a procedure ordered by his physician and not excluded from coverage by the contract. It found that Blue Shield had violated the covenant of good faith and fair dealing by "disagreeing with the judgment of the treating physician to hospitalize his patient solely on the basis of retrospective review of hospital files ... where the subscriber [was] not clearly informed of this procedure in the health plan." The trial court based its directed verdict on the fact that Blue Shield had failed to advise Sarchett of his contractual right to impartial review and arbitration in repeated denial letters to him. The jury awarded Sarchett $1,203.05 for his hospital costs, $20,000 in compensatory damages, and $80,000 in punitive damages.

I.

The trial court found that the Blue Shield policy was ambiguous because it did not indicate who would determine when the diagnostic services or medical necessity exclusion barred coverage. Construing that ambiguity in favor of the member, it concluded that he should be able to rely on the judgment of his treating physician as to the purpose and necessity of hospitalization, and that Blue Shield could not question that judgment. Blue Shield contends that the trial court erred in interpreting the policy, and that its right to review claims is inherent in the insurance contract. Sarchett, on the other hand, maintains that only the addition of an explicit statement asserting the insurer's right of retrospective review would cure the ambiguity and, going beyond the ruling of the trial judge, argues that regardless of policy language retrospective review should be banned as contrary to public policy.

We begin with the specific language of the policy. The diagnostic exclusion denies coverage for "[s]ervices when hospitalized primarily for diagnostic purposes or medical observation, rest or convalescent care." The "medical necessity" provision provides coverage "only for such services ... as are reasonably intended, in the exercise of good medical practice, for the treatment of illness or injury." When the two provisions are read together, certain ambiguities appear. In some cases, for example, some diagnostic procedures may be so difficult or hazardous that hospitalization is medically necessary. In others a patient's medical condition may be so serious as to require hospitalization even though the physician is unable to treat that condition without diagnostic tests which ordinarily could be performed on an outpatient basis. Policy coverage for both cases is unclear.

At oral argument, however, counsel for Blue Shield explained that the diagnostic exclusion is intended as a subset of the implied exclusion for unnecessary medical treatment, and that the insurer would cover "medically necessary" hospitalization even if done for diagnostic purposes. ⁵ Consequently, coverage for plaintiff's hospitalization does not turn on whether he was hospitalized for diagnosis, but simply on whether hospitalization was "medically necessary." Furthermore, strict necessity is not required. The policy language requires only that the services be "reasonably intended ... for the treatment of illness or injury." The intent in question is apparently that of the treating physician, and "treatment," Blue Shield acknowledges, includes hospitalization required by the subscriber's medical condition even if further diagnosis is essential for further treatment.

Plaintiff's insurance coverage would therefore appear to depend upon three questions of fact: (1) whether Dr. Van Vranken ordered hospitalization with the intention of treating plaintiff's illness or injury, (2) whether the physician's intention was reasonable, and (3) whether that intention conforms to good medical practice. Blue Shield concedes the question of good medical practice, but disputes the other issues, claiming that Dr. Van Vranken did not reasonably believe plaintiff's medical condition called for hospital treatment.

Plaintiff, however, seeks to eliminate even these factual questions, arguing that the policy is ambiguous as to who decides whether hospitalization is medically necessary. As we have noted, the trial court agreed, and directed the jury that Blue Shield violated its duty of good faith and fair dealing by challenging the treating physician's determination of medical necessity.

Upon review of the entire policy, however, we find no ambiguity in this respect. It is true that neither the diagnostic exclusion nor the medical necessity provision provides expressly how coverage disputes will be resolved, but neither does any other exclusionary clause. ⁶ Instead, Blue Shield has provided a separate provision, entitled "Settlement of Disputes," which applies to all disputes under the policy. That section first provides that "[a] dispute concerning the therapeutic justification for any services rendered to the member shall be resolved by the decision of the appropriate review committee of that medical society ... for the geographical area in which such services were provided...." It then states that "all other disputes, including disputes with respect to the decisions of the medical society ... shall be resolved ... in accordance with the Rules of the American Arbitration Association." ⁷

We find no ambiguity in this language relevant to the present case. The dispute between Sarchett and Blue Shield is "a dispute concerning the therapeutic justification" for plaintiff's hospitalization, and even if it were...