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BLUE CROSS AND BLUE SHIELD OF NJ v. PHILIP MORRIS

April 30, 2001

BLUE CROSS AND BLUE SHIELD OF NEW JERSEY, INC., ET AL., PLAINTIFFS,
v.
PHILIP MORRIS, INCORPORATED, ET AL., DEFENDANTS.



The opinion of the court was delivered by: Weinstein, Senior District Judge.

REVISED MEMORANDUM & ORDER

I. Introduction

Plaintiff, Empire Blue Cross & Blue Shield of New York ("Empire"), is suing major tobacco product manufacturers and related entities ("Tobacco") for increased health care costs arising from deceptions about the effects of tobacco use on subscribers' health. Defendants proffer evidence that Empire shifted heightened medical outlays onto its subscribers in the form of premium increases and, consequently, that it has not suffered damage. Claiming that such a "pass on" defense is inapplicable to a RICO fraud action, plaintiff moves to exclude this evidence. For the reasons developed in part III, infra there is no pass on defense. Nevertheless, evidence of the basic facts of the insurance industry — including pass on premium practice to cover increased costs — will be admitted. This apparent anomaly under relevancy rules 401 and 402 of the Federal Rules of Evidence will be discussed in part IV, infra. The practical realities of juror decision making must be considered. It is better to shed light on the workings of the insurance industry with appropriate legal instructions then risk sub rosa speculations by an inadequately informed jury.

II Facts

The factual allegations — fraud of defendants in denying smoking caused disease, leading to increased costs to the plaintiff — as well as Empire's theories of recovery have been set out at length. See Blue Cross v. Philip Morris, 113 F. Supp.2d 345 (E.D.N.Y. 2000); see also Simon v. Philip Morris, 124 F. Supp.2d 46 (E.D.N.Y. 2000) (collecting references to related opinions).

Plaintiff moves in limine to bar evidence which shows that it has passed increased health care costs onto its insured in the form of higher premiums. Examples include the proposed testimony for the defendants of Dr. Robert Hoyt and Dr. Harvey M. Sapolsky, experts on health insurance practice. Dr. Hoyt's testimony would counter arguments that "smoking related" costs are suffered by Empire. His conclusions appear in expert reports produced pursuant to Rule 26(a)(2)(B) of the Federal Rules of Civil Procedure:

1) "Insurance companies, [Empire] included, are financial intermediaries that set their rates so as to cover all anticipated claim costs. They function as a conduit though which health care costs for the aggregate pool of insureds are transferred." Report at 4 (Feb. 15, 2000).
2) "Demand for both medical care and health insurance is relatively inelastic. Hence, increases in costs can be shifted to insurance consumers without significantly reducing demand. As a result, as costs increase, from whatever source, insurers can pass the majority of these costs onto the insurance buyers through subsequent premium increases." Id. at 6.
3) There are no economic or regulatory impediments to [Empire's] ability to pass on the costs of smoking. Report at 4 (Mar. 6, 2000).

Dr. Sapolsky would offer similar testimony. Report at 15 (Feb. 17, 2000) ("Insurance companies, [Empire] included, are largely passthroughs for hospital and physician charges. The risks, with a brief lag, are borne by the buyers. This years experience is reflected in next year's premium."). The notion that insurance companies pass on their costs to consumers would also be supported by defendants' general testimony about the health insurance business, how it sets rates, and how it is financed.

III. The "Pass On" Defense Under RICO

Empire agrees that most of its costs are eventually passed on to subscribers through premiums. Nevertheless, it argues that under the dictates of Hanover Shoe v. United Shoe Machinery Corp., 392 U.S. 481, 88 S.Ct. 2224, 20 L.Ed.2d 1231 (1968), that is not a defense to a RICO violation.

A. Law

"The `collateral benefit' rule of tort law rests on the belief that the wrongdoer should be made to pay — the better to deter like conduct — whether or not the victim has providently supplied another source of compensation." Carter v. Berger, 777 F.2d 1173, 1175 (7th Cir. 1985). Since Hanover Shoe, Inc. v. United Shoe Machinery Corp., 392 U.S. 481, 88 S.Ct. 2224, 20 L.Ed.2d 1231 (1968), federal antitrust law has rested on a similar enforcement principle. See Square D Co. v. Niagara Frontier Tariff Bureau Inc., 760 F.2d 1347, 1352 (2d Cir. 1985) ("The Supreme Court has also rejected the argument that a plaintiff cannot recover damages it was able to pass on to its customers in the antitrust context") (Friendly, J.).

In Hanover Shoe the Supreme Court disallowed a defense by antitrust defendants who claimed that plaintiff was not entitled to damages for costs passed on to its customers. Hanover Shoe, Inc. v. United Shoe Machinery Corp., 392 U.S. 481, 88 S.Ct. 2224, 20 L.Ed.2d 1231 (1968). The case involved an antitrust treble-damages action brought against a producer of shoe machinery by one of its customers, a manufacturer of shoes. Id. at 483, 88 S.Ct. 2224. The defendants argued that because Hanover Shoe had been able to recoup its losses by charging its customers more for its shoes it did not suffer any cognizable injury: it had passed on any illegal overcharge. Id. at 492, 88 S.Ct. 2224. The Court rejected the defense, holding that, except in limited circumstances, defendants may not introduce evidence that another party absorbed the plaintiff's increased costs resulting from antitrust violations. Id. at 494, 88 S.Ct. 2224.

The Court provided two reasons for the rejecting a pass on defense. First, it was unwilling to "complicate treble-damages actions" with attempts to trace the effects of an illegal overcharge on the shoe manufacturer's "prices, sales, costs and profits, and of showing that these variables would have behaved differently without" the violation. See Illinois Brick Co. v. Illinois, 431 U.S. 720, 725, 97 S.Ct. 2061, 52 L.Ed.2d 707 (1977) (discussing reasoning of Hanover Shoe). Second, the Court was concerned that allowing a pass on defense would diminish the advantages of private antitrust enforcement, increasing the likelihood that violators of antitrust laws would escape liability. It declared:

In addition, if buyers are subjected to the passing-on defense, those who buy from them would also have to meet the challenge that they passed on the higher price to their customers. These ultimate consumers, in today's case the buyers of single pairs of shoes, would have only a tiny stake in a lawsuit and little interest in attempting a class action. In consequence, those who violate the antitrust laws by price fixing or monopolizing would retain the fruits of their illegality because no one was available who would bring suit against them. Treble-damage actions, the importance of which the Court has many times emphasized, would be substantially reduced in effectiveness.

Hanover Shoe, 392 U.S. at 493, 88 S.Ct. 2224.


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