Is Your Payment Integrity Vendor Creating a Prohibited Transaction Under ERISA §406?
- Aug 7
- 8 min read
Most plan sponsors ask their payment integrity vendor one question: "How much will we save?" The question they rarely ask, and the one their ERISA counsel should be demanding is: "Does your compensation structure create a prohibited transaction under ERISA §406?"
This is not an abstract legal concern. The analytical framework is sound. The trajectory of ERISA litigation, from the Schlichter Bogard lawsuits targeting plan sponsors and their consultants, to the Sixth Circuit's Tiara Yachts v. BCBSM ruling finding that a TPA's percentage-based recovery program triggered fiduciary status and self-dealing exposure points directly at the structural conflict built into percentage-of-savings compensation models. Plan fiduciaries who have not asked this question are not exercising the independent judgment ERISA demands.
This post explains the legal argument, its implications for pre-pay and post-pay arrangements, and why ClaimInformatics' unique per-claim fee model is structurally immune to this challenge.
The ERISA §406 Framework: What Constitutes an ERISA prohibited transaction?
ERISA §406(a) prohibits plan fiduciaries from causing the plan to engage in transactions that constitute a direct or indirect transfer of plan assets to a party in interest. Section 406(b) goes further: a fiduciary must not deal with plan assets for its own benefit, nor act on behalf of any party whose interests conflict with those of plan participants.
A service arrangement exemption exists under §408(b)(2), but it is conditional. To qualify, the arrangement must satisfy three requirements:
The service must be necessary for the operation of the plan.
The contract or arrangement must be reasonable.
The compensation must be reasonable.
The third requirement — reasonable compensation — is where percentage-of-savings payment integrity arrangements are facing serious scrutiny. The question is not simply whether the fee is market-rate. The question is whether the structure of the compensation creates adverse incentives that conflict with the interests of plan participants.
How Percentage-of-Savings Pre-Pay Compensation Triggers §406 Risk
A pre-pay editing vendor compensated on a percentage-of-savings basis earns more money when it denies more claims or denies higher-dollar claims. This creates a structural conflict of interest that runs directly counter to the interests of plan participants, who have a right to have their claims evaluated against clinical and regulatory standards, not against the vendor's revenue model.
Here is the specific legal exposure:
The adverse incentive problem. A vendor that earns 20–50% of denied claim value has an economic incentive to maximize the dollar volume of denials, including denials that would not withstand clinical scrutiny or provider appeal. Plan participants bear the cost of those denials in the form of unexpected out-of-pocket expenses and delayed care. The fiduciary's obligation to act solely in the interest of participants is structurally compromised when its vendor profits from outcome manipulation.
The opacity problem. Most percentage-of-savings pre-pay vendors use proprietary edit logic that plan fiduciaries cannot independently audit. When the plan fiduciary cannot review, challenge, or validate the vendor's editing rationale, it cannot satisfy its ERISA duty to prudently select and monitor service providers. A "black box" that earns more by denying more, we believe, fails the §408(b)(2) reasonableness standard on its face.
The perpetual revenue problem. In many arrangements, the vendor continues to earn percentage-based fees on findings that have already been corrected, either by provider contract amendments or TPA system updates. There is no mechanism requiring the vendor to disclose when its edits are no longer generating new value. This raises the question of whether ongoing compensation for non-recurring value satisfies the "reasonable compensation" requirement of §408(b)(2).
The Tiara Yachts v. BCBSM decision is instructive. The Sixth Circuit found that a TPA's shared savings program, where the TPA controlled both the overpayment and the recovery, constituted self-dealing under ERISA. The DOL's amicus brief described the arrangement as creating a "perverse incentive" to allow overpayments. The same self-dealing logic applies when a pre-pay vendor controls the denial decision and earns a percentage of the denied amount.
The Post-Pay Contingency Gap: A Separate but Related Fiduciary Concern
The §406 analysis in the post-pay context is somewhat weaker, both the plan and the vendor want recoveries, which reduces the directional conflict. But a separate and equally serious fiduciary concern applies: contingency-fee post-pay vendors guarantee incomplete coverage.
The economics of a contingency model dictate that the vendor will focus exclusively on high-dollar claims, where the percentage-based recovery fee generates sufficient revenue to justify the review effort. Low-dollar and mid-dollar claims, which, in aggregate, may represent a substantial portion of total claims volume and improper spend, are systematically excluded from review.
Under ERISA's prudent person standard, a fiduciary is required to ensure the plan's assets are protected through a reasonable and comprehensive process. A post-pay arrangement that filters claims by dollar threshold is, by definition, not comprehensive. The plan fiduciary cannot demonstrate that it monitored the full claims stream when its vendor's economic model excluded a significant portion of that stream from scrutiny.
The documentation failure. When the DOL or a class action plaintiff asks, "How did you monitor payment integrity across 100% of your claims?" the answer cannot be, "Our contingency vendor reviewed the large ones." That is not fiduciary oversight. That is selective oversight driven by the vendor's economics, not the plan's interests.
Fiduciary Risk Comparison: % of Savings vs. Per-Claim Fee Model
Fiduciary Criterion | % of Savings Vendor | ClaimInformatics ’Per-Claim Model |
Compensation structure | Percentage of savings — earns more when more claims are denied | Fixed per-claim fee — unrelated to claim outcome |
Financial incentive on denials | Yes — structural conflict of interest | None — conflict-free by design |
§406 prohibited transaction risk | Credible and unresolved legal exposure | Not applicable — no adverse incentive |
§408(b)(2) "reasonable compensation" | Questionable if edits are opaque and fees perpetual | Defensible — fixed, predictable, disclosed |
Audit rights / edit transparency | Often proprietary and inaccessible to plan fiduciary | 100% transparent rationale, fiduciary-auditable |
Post-pay coverage | Dollar-threshold filters exclude low/mid-dollar claims | 100% of adjudicated claims reviewed — no gaps |
Fiduciary documentation | Partial — vendor-generated, unverified | Comprehensive — audit-ready, DOL-defensible |
The Question That Changes the Conversation
ClaimInformatics does not need to resolve this legal argument in a sales conversation. The argument does not need to be settled law to be consequential, it needs only to be a credible unresolved risk that a prudent fiduciary should evaluate before renewing a percentage-of-savings arrangement.
The question plan sponsors should be asking thei;
"Has our ERISA counsel evaluated whether our payment integrity vendor's percentage-of-savings compensation structure creates a prohibited transaction risk under §406, or fails the reasonable compensation test under §408(b)(2)?"
The question itself is the differentiator. A plan fiduciary who can demonstrate that it raised this issue, sought legal guidance, and selected a vendor with a structurally conflict-free compensation model has done what ERISA requires: documented prudence.
ClaimInformatics' per-claim fee model is immune to this challenge by design. There is no financial incentive tied to denial volume or denial value. There is no adverse economic interest in disclosing, evaluating, or justifying. Compensation is fixed, predictable, and entirely disconnected from the outcome of any individual claim decision. The edit logic and rationale behind every review is transparent and available to the plan fiduciary for independent audit.
What Fiduciaries Should Do Now
Plan fiduciaries evaluating or renewing payment integrity vendor arrangements should take the following steps:
Engage ERISA counsel. Ask directly whether the current vendor's compensation structure creates prohibited transaction exposure under §406 or fails the §408(b)(2) reasonableness test. Document the analysis and conclusion.
Request full edit transparency. Any vendor that cannot provide clear, auditable rationale for every edit decision — available to the plan fiduciary on demand — does not meet the standard of independent oversight.
Demand 100% coverage on post-pay. If the post-pay vendor's economics excludes low-dollar or mid-dollar claims from review, the arrangement cannot support a claim of comprehensive fiduciary monitoring. Require complete claims coverage or find a vendor whose model makes it possible.
Document the selection process. Under ERISA's procedural prudence standard, the process of selecting and monitoring vendors is as important as the outcome. Create a paper trail showing that you evaluated compensation structures, assessed conflicts of interest, and made an affirmative decision based on fiduciary considerations.
Assess the §408(b)(2) disclosure. Covered service providers are required to disclose direct and indirect compensation. Evaluate whether your current vendor has fully disclosed all revenue streams, including perpetual fees on corrected findings and any revenue-sharing arrangements with affiliated entities.
Is Your Payment Integrity Vendor Creating Fiduciary Risk? ClaimInformatics uses a fixed per-claim fee model with no financial incentive tied to claim outcomes. Schedule a 30-minute fiduciary risk assessment to understand your exposure. |
Frequently Asked Questions
What is an ERISA §406 prohibited transaction?
ERISA §406 prohibits plan fiduciaries from causing the plan to enter into transactions that transfer plan assets to a party in interezzst, or that involve the fiduciary dealing with plan assets for its own benefit. A service provider whose compensation is tied to claim denial volume may be treated as a party in interest whose adverse economic incentives conflict with the plan's obligation to pay legitimate claims.
Does the §408(b)(2) exemption protect percentage-of-savings payment integrity vendors?
Only if the compensation is "reasonable." A compensation structure where the vendor earns more by denying more, uses opaque edit logic the plan cannot audit, and continues earning fees on findings that have already been corrected raises significant questions about whether the reasonableness standard is satisfied. This analysis has not yet been litigated, but the framework is analytically sound and aligns with the DOL's stated enforcement priorities.
Has any court ruled that percentage-of-savings payment integrity compensation is a prohibited transaction?
This specific argument has not yet been tested in litigation. However, the Sixth Circuit's 2025 Tiara Yachts v. BCBSM decision applied substantially similar logic to a TPA's shared savings program, finding that the TPA's control over both the overpayment and the recovery constituted self-dealing under ERISA. The DOL called the structure a "perverse incentive." Plan fiduciaries should not wait for a court ruling to address the risk.
What makes ClaimInformatics' per-claim fee model different?
ClaimInformatics charges a fixed fee per claim reviewed, regardless of how the claim is adjudicated. There is no financial incentive associated with the denial decision. The edit rationale for every claim is transparent and available to the plan fiduciary for independent review. This structure eliminates the conflict of interest at the core of the §406 argument and provides defensible documentation of independent, conflict-free oversight.
What should I do if my current vendor uses a percentage-of-savings model?
Engage your ERISA counsel to evaluate the §406 and §408(b)(2) exposure. Request a full disclosure of all compensation streams, including any perpetual fees on prior-period findings. Assess whether the vendor provides transparent, auditable edit rationale. Document the analysis. And if the risk is not manageable, consider transitioning to a per-claim model that eliminates the structural conflict entirely.
Related Resources from ClaimInformatics
What's your plan's approach to evaluating vendor compensation structures? Share your experience in the comments.
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Sources & References
Source | URL |
ERISA §406 – Prohibited Transactions | |
ERISA §408(b)(2) – Service Arrangement Exemption | |
Tiara Yachts v. BCBSM, 6th Cir., No. 24-1223 (2025) | |
DOL EBSA Enforcement Overview | |
Schlichter Bogard ERISA Lawsuits – December 2025 | |
ClaimInformatics: When Shared Savings Means Shared Conflicts | |
ClaimInformatics: TPA Fiduciary Standards Checklist |
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