West Virginia Decision Imperils Insurer Anti-Fraud Activities

A recent decision by West Virginia’s highest court could – if permitted to stand – ultimately require insurers to violate their record retention obligations, destroy broad swathes of business records, and seriously compromise insurer regulatory compliance and anti-fraud activity. The author of this article discusses the decision and its implications.

What started as a tragedy in the foothills of the Allegheny Mountains has developed into a potential Supreme Court case with far-reaching implications for the insurance industry. Most state regulatory schemes require insurers to maintain claims records, including medical records, for fairly long periods of time. These requirements are intended, among other things, to permit state insurance regulators and insurers to ascertain compliance with state insurance laws, and also to facilitate insurers’ efforts to combat various forms of insurance fraud. Notwithstanding these requirements, a recent decision by West Virginia’s highest court could – if permitted to stand – ultimately require insurers to violate their record retention obligations, destroy broad swathes of business records, and seriously compromise insurer regulatory compliance and anti-fraud activity.

On the morning of March 20, 2008, Jeremy Thomas – a 19 year-old oil rig worker – was speeding along a sleepy stretch of West Virginia Route 20, near a small coal-mining town called Buckhannon. His autopsy revealed the presence of marijuana in his system. Thomas drifted across the center line, straight into oncoming traffic, and smashed head-on into a vehicle driven by Lynn Blank, a Buckhannon resident and retired family man. Thomas and Blank died in the crash, and Blank’s wife and passenger – Carla Blank – suffered serious injuries.

Mrs. Blank filed suit in February 2009, alleging sundry claims against Thomas’ estate, and also against State Farm Mutual Automobile Insurance Company, which insured both the Blanks’ vehicle and Thomas’ vehicle.

Soon thereafter, the parties became embroiled in a discovery dispute when State Farm requested the Blanks’ medical records in order to mount its defense. Although, pursuant to the Blanks’ insurance policy, Mrs. Blank was contractually obligated to provide the requested records, she refused to do so unless State Farm agreed to a protective order regarding the confidentiality of the materials. State Farm was, in fact, willing to enter into a reasonable protective order. Mrs. Blank, however, insisted upon an extremely broad order that – among other things – prohibited State Farm from electronically scanning the records and required State Farm to destroy or return the records at the conclusion of the litigation.

THE FIRST PROTECTIVE ORDER

Following extensive motion practice, the Circuit Court of Harrison County, West Virginia – the trial court where the case was pending – entered an order that directed Mrs. Blank to disclose all relevant medical records, but conditioned their disclosure on an extremely broad set of confidentiality requirements. In addition to the more prosaic privacy provisions, the order prohibited State Farm from scanning the records or, indeed, from storing them in any manner. Furthermore, the protective order prohibited State Farm from disclosing any of the Blanks’ medical records – including records that State Farm already possessed prior to the commencement of the litigation – to any third parties, including but not limited to the West Virginia Insurance Commissioner or the Department of Justice. The order also obligated State Farm to destroy not only the medical records, themselves, but also any summaries thereof, or else return the copies, and any summaries thereof, to Mrs. Blank’s attorney at the close of the litigation. In addition, the protective order required State Farm’s counsel to certify that the records had been returned or destroyed.

State Farm took issue with the scope of the protective order, and moved for a writ of prohibition from the Supreme Court of Appeals of West Virginia – the only appellate court in the state. Pursuant to West Virginia law, a writ of prohibition is a procedural device whereby the appellate court can, among other things, restrain trial courts from exceeding their authority. In its motion, State Farm contended that the West Virginia Insurance Commissioner had promulgated a regulation – with the force of law – that required insurers to maintain all claims documents, including medical records, for a period of between five and six years. Since the litigation with Mrs. Block was unlikely to last for more than five or six years, State Farm argued that the protective order effectively would require it to destroy part of its claims file before the regulatory retention period expired. State Farm therefore asserted that the protective order forced it to choose between complying with the law, and disregarding the protective order, or complying with the protective order, and disregarding the law.

State Farm also argued that Mrs. Blank had not shown the requisite good cause for those portions of the protective order that prevented it from scanning and electronically storing the Blanks’ medical records. Though Mrs. Blank posited – in conclusory fashion – that the prohibition against electronic storage was necessary to prevent State Farm from disseminating the Blanks’ medical records to third parties, she adduced no real basis for this fear beyond her own unfounded apprehension. State Farm contended that a party seeking a protective order was required to support the request with a “particular and specific demonstration of fact”, that Mrs. Blank had failed to do so, and that – in any case – the Insurance Commissioner had sanctioned the use of electronic storage and had implemented regulations to protect the confidentiality of electronically-stored medical records.

In State ex rel. State Farm Mut. Auto. Ins. Co. v. Bedell (“State Farm I”), the Supreme Court of Appeals granted State Farm’s motion for a writ of prohibition, and effectively quashed the protective order. In the decision, the court essentially adopted each of State Farm’s arguments. First, the court determined that the protective order was erroneous as a matter of law, inasmuch as it purported to require State Farm to destroy or otherwise cede medical records before the expiration of the regulatory retention period established by the Insurance Commissioner. Because the pertinent regulation had the force of law, the court reasoned that any protective order issued in contravention of the regulation could not stand.

Second, the court determined that the protective order provided no basis whatsoever for the restrictions it placed upon the electronic scanning or storage of the Blanks’ medical records. Noting the conclusory nature of Mrs. Blank’s concerns regarding the potential dissemination of the medical records, and the fact that electronic storage specifically had been authorized by the Insurance Commissioner, the court held that Mrs. Blank had not advanced any “particular and specific demonstration of fact” in support of the prohibition against electronic storage. Accordingly, the court found that the trial court’s restriction against electronic storage of the medical records constituted clear error.

THE SECOND PROTECTIVE ORDER

Undeterred, Mrs. Blank returned to the trial court and proposed that State Farm be required to enter into a slightly revised protective order as a condition precedent to disclosure of the Blanks’ medical records. Although State Farm objected to the second protective order, the trial court signed it. The revised protective order permitted State Farm to retain the Blanks’ medical records for a sufficiently long period of time so as to permit compliance with the West Virginia insurance regulations, and did not prohibit State Farm from electronically storing the records, but in all other respects was substantially the same as the earlier, defective protective order. Among other things, the revised protective order restricted State Farm’s ability to disclose the medical records, including records that it had obtained outside of litigation, to third parties (including the Insurance Commissioner) without authorization, required the records to be returned to Mrs. Blank’s counsel or destroyed following the expiration of the regulatory retention period, and required State Farm’s counsel to certify that the records – including records that it had obtained prior to the commencement of litigation – had been returned or destroyed.

Thereafter, State Farm returned to the Supreme Court of Appeals and sought a second writ of prohibition. In its motion for the writ, State Farm again contended that Mrs. Blank had failed to show the requisite good cause for the protective order.

In addition, State Farm argued that, because the second protective order prohibited State Farm from disclosing medical records that it already possessed, independent of the litigation, it was unconstitutional under Seattle Times Co. v. Rhinehart, and its progeny. In Seattle Times Co., the Supreme Court held that a protective order which restricts the dissemination of information “gained through means independent of the court’s processes” is an impermissible prior restraint on speech.

State Farm also argued that compliance with the second protective order – like compliance with the first – would require it to disregard its statutory and regulatory obligations. Specifically, State Farm observed that West Virginia law required insurers to report fraudulent activity, an obligation that – by necessity – mandated the maintenance of complete claims files in perpetuity. Without complete claims files, State Farm argued that it could not conduct the comparative analysis necessary to identify patterns of fraud. State Farm also noted that – as an Illinois company – it was subject to Illinois law, and Illinois law required State Farm to maintain its claims files forever, absent specific authorization from the Illinois Insurance Commissioner permitting their destruction.

It does not appear as if Mrs. Blank advanced any arguments that went to the merits of the legal compliance issues raised by State Farm. Instead, she contended that State Farm failed to raise its legal compliance arguments before the trial court, and that the compliance arguments therefore were not ripe for the appellate court to review.

In addition, State Farm argued that the second protective order would, by its terms, require the destruction of business records that could be necessary to defend future cases. State Farm noted that the protective order not only required the return or destruction of the Blanks’ medical records, but also any documents, notes, attorney-client correspondence, etc., that contained information referring to the Blanks’ medical records. Mrs. Blank responded that she was not seeking the return or destruction of every document making reference to the medical records, but insisted that references to the medical records be removed or redacted from the documents.

Finally, State Farm argued that compliance with the second protective order would be needlessly burdensome, inasmuch as state and local law provided adequate protection for the Blanks’ privacy interests. State Farm also argued that compliance would be impossible, in that the protective order required State Farm’s counsel to certify the return or destruction of the medical records, but counsel had no control over third parties such that it could be held responsible for their actions. Mrs. Blank apparently responded only that the protective order was proper and should have been upheld.

In State ex rel. State Farm Mut. Auto. Ins. Co. v. Bedell (“State Farm II”), the Supreme Court of Appeals denied State Farm’s second motion for a writ of prohibition, and upheld the second protective order. In the decision, the court determined that – in contrast to her previous application for a protective order – Mrs. Blank had demonstrated good cause for the second protective order by setting forth “particular and specific facts of her expectation of privacy in her, and her husband’s medical records.”

The court refused even to consider State Farm’s argument to the effect that compliance with the second protective order would require it to disregard its statutory obligations to maintain its claims files in perpetuity and to report fraudulent activity. Specifically, the court found that State Farm had not raised this argument before the trial court, and therefore the issue was not ripe for appellate consideration.

The court determined that the second protective order did not require State Farm to destroy its business records on a wholesale basis, but only to destroy or – in the alternative – redact business records containing references to the Blanks’ medical records. The court found that this approach would preserve the Blanks’ privacy and simultaneously enable State Farm to maintain the remainder of the records.

The court rejected State Farm’s undue burden and impossibility arguments, noting that protective orders have become an accepted means of safeguarding privacy interests, and that certification clauses were an accepted practice in West Virginia and in other jurisdictions.

Significantly, the court altogether ignored State Farm’s constitutional arguments pursuant to Seattle Times Co.

Two justices dissented from the majority decision in State Farm II. The first dissenter noted that public policy favored permitting insurers to retain claims information – including medical records – in perpetuity, so as to enable insurers to effectively combat insurance fraud. He added that the majority improperly had predicated Mrs. Blank’s privacy interest on HIPAA, but HIPAA does not cover the confidentiality of medical records that are provided to an adversary in the context of a personal injury lawsuit. In any case, the dissenter determined that Mrs. Blank had waived her privacy interest in the medical records by filing suit and producing the records during the course of the litigation. The dissenter also felt that the second protective order imposed, without sufficient thought, a new duty on insurers and attorneys to destroy lawfully-obtained medical records and summaries.

The second dissenter argued that the court incorrectly refused to consider State Farm’s argument to the effect that compliance with the second protective order would require it to disregard its statutory and regulatory record retention and anti-fraud obligations. The dissenter noted that while, on an appeal, the appellate court could not consider an issue not raised before the trial court, State Farm’s motion for a writ of prohibition did not constitute an appeal. Therefore, the dissenter contended that the appellate court should have considered State Farm’s compliance arguments and, upon consideration, should have issued the requested writ. Finally, the second dissenter found that the majority’s reasoning for rejecting State Farm’s business records argument was unpersuasive.

STATE FARM’S PETITION FOR CERTIORARI

In August 2011, State Farm filed a petition for certiorari with the United States Supreme Court, which currently is pending. In its petition, State Farm emphasized that the second protective order – upheld in State Farm II – not only required the return or destruction of medical records obtained from Mrs. Blank during discovery, but also any medical records that already were in State Farm’s files prior to the litigation. State Farm also observed that the second protective order, by its terms, prohibited State Farm from reporting suspected insurance fraud to any entity, including the West Virginia Insurance Commissioner. State Farm contended that – while the West Virginia Supreme Court of Appeals arguably could restrain disclosure of information obtained solely by virtue of the discovery process – it could not restrain disclosure of information lawfully obtained by State Farm outside of discovery, prior to the commencement of litigation. For this proposition, State Farm pointed to a line of Supreme Court and other federal appellate precedent – beginning with Seattle Times Co. – which stands for the proposition that it generally is unconstitutional to restrain dissemination of information rightfully obtained outside of the discovery process. While such a restraint can be appropriate in instances where it furthers a compelling government interest, State Farm contended that no such compelling interest was apparent. Indeed, State Farm observed that the West Virginia Insurance Commissioner had filed an amicus brief in State Farm II, in which the Commissioner argued that the second protective order actually frustrated the state’s interest in combating insurance fraud, and urged against its enforcement.

In its petition for certiorari, State Farm reiterated its argument that – if it complied with the second protective order – it would be forced out of compliance with Illinois record retention laws. Accordingly, State Farm contended that the second protective order violated the full faith and credit clause of the United States Constitution, which limits a state’s authority to impose requirements that, by their terms, conflict with the laws of other states. State Farm noted that, if the second protective order were permitted to stand, other courts could issue similar protective orders, forcing insurers out of compliance with state law and resulting in the piecemeal destruction of the state-based systems of insurance regulation.

Finally, State Farm observed that, by forcing it out of compliance with Illinois state law, and by forcing it to part with proprietary business records it lawfully possessed before the commencement of litigation, the second protective order ran counter to due process and fundamental fairness.

CONCLUSION

As State Farm correctly noted in its petition, insurance fraud costs Americans at least $80 billion per year, or more than $950 per family on an annual basis. To combat this fraud, and to lower insurance costs, insurers must be able to maintain the integrity of their claims files, exchange lawfully-obtained information with other insurers or industry anti-fraud organizations, and report suspected fraud to the pertinent state and federal authorities. In placing Mrs. Blank’s comparatively ephemeral privacy interests – already amply protected by West Virginia law – ahead of these anti-fraud imperatives, the West Virginia Supreme Court of Appeals ignored compelling constitutional arguments, and even the opinion of its home-state Insurance Commissioner.

Though the decision in State Farm II is troubling, the consequences could be even worse. The decision opens the door for virtually any state court to require an insurer – as a condition precedent to obtaining discovery necessary to the defense of a claim – not only to destroy any materials obtained during discovery, but also claims files and business records that it lawfully obtained and possessed before the commencement of litigation. Many insurers may opt to forego otherwise viable defenses, and pay specious claims, rather than face the gradual erosion of their business records and, by extension, their anti-fraud activities. Insurers should monitor the progress of State Farm’s certiorari petition closely – because perpetrators of insurance fraud no doubt also are watching.

NOTES

226 W. Va. 138 (W. Va. 2010).
467 U.S. 20 (1984).
Id. at 34.
2011 W. Va. LEXIS 16 (W. Va. 2011).

Reprinted with permission from the January 2012, Volume 4, Number 1 issue of the Financial Fraud Law Report.  All rights reserved.