Is Your Payment Integrity Vendor Creating a Prohibited Transaction Under ERISA Section 406?

Avoid compensation structure create a prohibited transaction under ERISA Section 406

Most plan sponsors ask their payment integrity vendor one question: how much will we save? The question their ERISA counsel should be asking is different. Does the vendor's compensation structure create a prohibited transaction under ERISA Section 406?

This is not an abstract legal concern. 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, which found 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 a per-claim fee model is structurally immune to this challenge.

The ERISA Section 406 Framework: What Constitutes a Prohibited Transaction

ERISA Section 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 Section 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 at market rate. The question is whether the compensation structure creates adverse incentives that conflict with the interests of plan participants.

How Percentage-of-Savings Pre-Pay Compensation Triggers Section 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 a percentage 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 through 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 review. When the plan fiduciary cannot review, challenge, or validate the vendor's rationale for the edits, it cannot satisfy its ERISA duty to prudently select and monitor service providers. A black box that earns more by denying more fails the Section 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 Section 408(b)(2).

The Tiara Yachts v. BCBSM decision is instructive. The Sixth Circuit found that a TPA's shared savings program, in which 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 Section 406 analysis in the Post-Pay context is somewhat weaker, as both the plan and the vendor seek recoveries, thereby reducing 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 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 spending, are systematically excluded from review.

Under ERISA's prudent person standard, a fiduciary must ensure that 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 the plan monitored payment integrity across 100% of its claims, the answer cannot be that a 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: Percentage-of-Savings vs. Per-Claim Fee Model

The distinction comes down to whether compensation is tied to claim outcomes. A percentage-of-savings vendor earns more when more claims are denied, creating a structural conflict of interest and a credible, unresolved Section 406 prohibited-transaction exposure. Its edit logic is often proprietary and inaccessible to the plan fiduciary, and dollar-threshold filters leave low-dollar and mid-dollar claims unreviewed.

A fixed per-claim fee model is unrelated to claim outcome. There is no adverse incentive, no Section 406 conflict, and 100% of adjudicated claims are reviewed with no coverage gaps. The edit rationale is transparent and available to the plan fiduciary for independent review, and the documentation is defensible.

The Question That Changes the Conversation

The argument need not be settled law to be consequential. It need only 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 their ERISA counsel:

Has our ERISA counsel evaluated whether our payment integrity vendor's percentage-of-savings compensation structure creates a prohibited transaction risk under Section 406, or fails the reasonable compensation test under Section 408(b)(2)?

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.

The ClaimIntelligence™ per-claim fee model is immune to this challenge by design. There is no financial incentive tied to denial volume or denial value. 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 an independent review.

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 Section 406 or fails the Section 408(b)(2) reasonableness test. Document the analysis and conclusion.

Request full edit transparency. Any vendor that cannot provide a clear, defensible 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 exclude 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 conflict of interest, and made an affirmative decision based on fiduciary considerations.

Assess the Section 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?

ClaimIntelligence™ uses a fixed per-claim fee model with no financial incentive tied to claim outcomes. Schedule a fiduciary risk assessment to understand your exposure.

Frequently Asked Questions

What is an ERISA Section 406 prohibited transaction? ERISA Section 406 prohibits plan fiduciaries from causing the plan to enter into transactions that transfer plan assets to a party in interest, 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 Section 408(b)(2) exemption protect percentage-of-savings payment integrity vendors? Only if the compensation is reasonable. A compensation structure in which the vendor earns more by denying more, uses opaque edit logic that the plan cannot review, and continues to earn 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 the per-claim fee model different? ClaimIntelligence™ 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 Section 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 Section 406 and Section 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 a transparent, defensible rationale for the edit. Document the analysis. And if the risk is not manageable, consider transitioning to a per-claim model that eliminates the structural conflict.