Sunahara v. State Farm Mutual Automobile Insurance Co. , 280 P.3d 649 ( 2012 )

Justice RICE

delivered the Opinion of the Court.

1 1 We review the court of appeals' unpublished decision in Sunahara v. State Farm Mutual Automobile Insurance Co., No. 09CAO0599, slip op., 2010 WL 1796501 (Colo. App. May 6, 2010) (not selected for official publication), to determine: (1) whether the court of appeals erred under Colorado's collateral source doctrine when it admitted evidence of the amounts paid by Respondent State Farm Mutual Automobile Insurance Company (State Farm) for medical expenses that Petitioner Jack Sunahara incurred as a result of a car accident; and (2) whether the court of appeals erred in affirming the trial court's ruling that portions of State Farm's claim file and information used by State Farm to generate reserves and settlement authority were not discoverable.

2 We first hold that the court of appeals erred by affirming the admission of evidence of the amounts paid for Sunahara's medical expenses because the pre-verdict evidentiary component of Colorado's collateral source rule prohibits the admission. We also hold that the court of appeals correctly affirmed the trial court's exelusion of portions of State Farm's claim file from discovery because Silva v. Basin Western Inc., 47 P.3d 1184, 1193 (Colo.2002), requires that result in this un-derinsured motorist action.

3 Therefore, we reverse the court of appeals' decision to affirm the trial court's admission of evidence of the amount paid by a collateral source to cover Sunahara's medical expenses, and affirm its decision to uphold the trial court's refusal to allow the discovery of the claim file and other documentation used to generate reserves and settlement authority.

I. Facts and Procedural History

T4 A vehicle driven by Raymond Mallard collided with Sunahara in a parking lot. Sunahara alleged that the accident resulted in injuries to his back and shoulders that required surgery and other medical treatment. He carried a motor vehicle insurance policy with State Farm at the time of the accident that included underinsured motorist (UIM) coverage. Sunahara reported the incident to State Farm pursuant to that policy. State Farm opened a claim file, made initial liability assessments, and established reserves and settlement authority for the case. State Farm then covered Sunahara's medical expenses, paying approximately $14,000 in full satisfaction of the medical bills even though Sunahara's healthcare providers billed him over $50,000 for their services.

T5 State Farm contacted Mallard's insurer and asserted that Mallard was fully responsible for Sunabhara's injuries. In addition, State Farm's claim file log, to which Suna-hara had access, stated that Maillard owed a one hundred percent duty to Sunahara for Mallard's failure to control his vehicle. With State Farm's permission, Sunahara subsequently sued Mallard for negligence. The action settled and Mallard's insurance company paid Sunahara $100,000 in damages-the limit on Mallard's policy.

T6 Seeking additional damages, Sunahara then filed a UIM claim with State Farm pursuant to the UIM portion of his insurance policy. Sunahara's UIM coverage had a $2,000,000 limit and provided that State Farm would pay damages for bodily injury that Sunahara was legally entitled to collect from the owner or driver of an underinsured motor vehicle. State Farm argued in response to Sunahara's claim that Sunahara was at least partially at fault for the accident with Mallard, and that it was not required to pay Sunahara any damages pursuant to the UIM policy.

T7 During discovery, Sunahara requested State Farm produce the claim file it opened when Sunahara first notified State Farm of the accident. State Farm produced a partially redacted claim file in response to the request. The produced file omitted reserves and settlement authority as well as liability assessments and related fault evaluations that pre-dated the litigation between Suna-hara and State Farm. Sunahara filed a motion to compel production of the un-redacted file. State Farm again refused to produce as requested, arguing that Silvg, 47 P.8d at 1193, protected the redacted information because it contained undeveloped lability assessments that State Farm made for the purpose of determining reserves and settlement authority. The trial court agreed with State Farm and denied Sunahara's motion to compel.

T8 Sunahara also filed a motion in limine to exclude evidence of the discounted amount State Farm paid to satisfy Sunahara's medical bills. The trial court denied the motion, reasoning that the $14,000 paid was admissible for the purpose of determining the reasonable value of Sunahara's medical expenses. State Farm subsequently presented the amounts paid evidence at trial,. In addition, Sunahara's counsel explained to the jury that the difference between the $50,000 amount billed by Sunahara's healthcare providers and the $14,000 that they accepted to satisfy the bills was the result of a "managed health care contract." The trial court refrained from specifically informing the jury that the discounted payments were made by State Farm, and instructed the jury not to reduce Sunahara's damages automatically by the difference between the amount billed and the amount paid for Sunahara's medical expenses.

T9 The jury returned a verdict in Suna hara's favor, but also found that Sunahara was 25 percent at fault for the accident. It awarded him $0 in past economic damages, $50,000 for noneconomic damages, $50,000 for physical impairment, and $11,000 for future economic damages. Sunahara moved for additur, or in the alternative a new trial pursuant to C.R.C.P. 59, on the grounds that the jury's refusal to award past economic damages was inadequate as a matter of law because Sunahara incurred medical expenses for his back and shoulder treatments prior to trial. Sunahara argued that the trial court's admission of the amount State Farm paid to satisfy Sunahara's medical bills erroneously led the jury to believe that Sunahara had not suffered past economic damages due to his receipt of health insurance benefits. The trial court denied the motion.

T10 Sunahara appealed the trial court's admission of the amounts paid evidence and the trial court's denial of his motion to compel production of the un-redacted claim file to the court of appeals. 'The court of appeals affirmed both of the trial court's rulings in an unpublished opinion. We granted Suna-hara's petition for certiorari to review both the collateral source and redacted claim file issues.¹

II. Admissibility of Evidence of the Amounts Paid by a Collateral Source

111 The court of appeals erred under the common law evidentiary component of the collateral source rule when it affirmed the trial court's admission of evidence of the amounts paid by State Farm to cover Suna-hara's medical expenses because a trial court may not admit evidence of the amounts paid by a collateral source to reimburse healthcare providers for medical expenses incurred by an insured plaintiff. After describing the applicable standard of review, we discuss the common law evidentiary component of the collateral source rule and the tension between that doctrine and the reasonable value rule stated in Kendall v. Hargrave, 142 Colo. 120, 123, 349 P.2d 993, 994 (1960). We then explain why the collateral source doctrine excludes amounts paid evidence in. collateral source cases, like this one, when such evidence is offered for the purpose of determining the reasonable value of medical services.

A. Standard of Review

112 We review a trial court's evi-dentiary rulings for an abuse of discretion. Hock v. New York Life Ins. Co., 876 P.2d 1242, 1251 (Colo.1994). A trial court necessarily abuses its discretion if its ruling is based on an incorrect legal standard. BP Am. Prod. Co. v. Patterson, 263 P.3d 103, 108 (Colo.2011). Whether the trial court applied the correct legal standard is a question of law we review de novo. Corsentino v. Cordova, 4 P.3d 1082, 1087-88 (Colo.2000).

B. Common Law Evidentiary Component of the Collateral Source Rule

113 Colorado's collateral source rule consists of two components: (1) a post-verdict setoff rule, codified at section 13-21-111.6, C.R.S. (2011); and (2) a pre-verdict evidentiary component, described by the common law.² The second component remains in effect,³ applies in this pre-verdiet case, and excludes evidence of collateral source benefits because such evidence could lead the fact-finder to improperly reduce the plaintiffs damages award on the grounds that the plaintiff already recovered his loss from the collateral source. Volunteers of Am. v. Gardenswarts, 242 P.3d 1080, 1083-84 (Colo.2010) ("To ensure that a jury will not be misled by evidence regarding the benefits that a plaintiff received from sources collateral to the tortfeasor, such evidence is inadmissible at trial."); Moyer v. Merrick, 155 Colo. 73, 80, 392 P.2d 653, 656-57 (1964) (since money received from a pension plan to which an employee had contributed was within the collateral source rule, evidence of receipt by plaintiff of pension benefits in an action for damages resulting from the defendant's negligence was inadmissible); Carr v. Boyd, 123 Colo. 350, 356-57, 229 P.2d 659, 663 (1951) ("Benefits received by the plaintiff from a source other than the defendant and to which he has not contributed are not to be considered in assessing the damages.").⁴

14 As the United States Supreme Court reasoned in Eichel v. New York Central Railroad Co., 375 U.S. 253, 254-55, 84 S.Ct. 316, 11 L.Ed.2d 307 (1963), evidence of a plaintiff's receipt of collateral source benefits is not only "inadmissible to offset or mitigate damages," but also "involves a substantial likelihood of prejudicial impact" if admitted for other purposes because "evidence of collateral benefits is readily subject to misuse by a jury." Thus, the evidentiary component of Colorado's common law collateral source rule completely bars the admission of collateral source evidence because the risk of the fact-finder's prejudicial misuse of the evidence outweighs its potential probative value if offered for other purposes. Carr, 123 Colo. at 359, 229 P.2d at 664; see Eichel, 375 U.S. at 254-55, 84 S.Ct. 316; see also CRE 403 (requiring exelusion of evidence, even if relevant, "if its probative value is substantially outweighed by the danger of unfair prejudice, confusion of the issues, or misleading the jury").⁵

C. Tension between the Common Law Collateral Source and Reasonable Value Rules

115 In Crossgrove, we resolved the tension between the reasonable value rule stated in Kendall, 142 Colo. at 123, 349 P.2d at 994, and the pre-verdict evidentiary component of the collateral source rule, described above. 2012 CO 31, 1119-24, 276 P.3d 562. We held that the pre-verdict component of the collateral source rule controls in cases, like this one, in which a party offers evidence of the amount paid by a collateral source for the purpose of determining the reasonable value of the medical services rendered. Id. 120. We reached this holding by weighing the probative value of the evidence of amounts paid for the purpose of ascertaining the reasonable value of medical expenses against the likely prejudicial effect that admitting the evidence would have on the amount of damages awarded to the plaintiff. Id. 120-28. We concluded that admitting amounts paid evidence for any purpose in a collateral source case "carries with it an unjustifiable risk that the jury will infer the existence of a collateral source-most commonly an insurer-from the evidence, and thereby improperly diminish the plaintiffs damages award." Id. 120. As such, the common law evidentiary component of the collateral source rule prohibits the admission of amounts paid evidence in collateral source cases, even for the purpose of determining the reasonable value of medical services rendered.

D. Amounts Paid Evidence is Inadmissible in this Case

116 In light of Crossgrove, our de novo review of the trial court's orders admitting amounts paid evidence in this case reveals that the trial court abused its discretion because it applied an incorrect legal standard-the reasonable value rule described in Kendall-rather than the common law evi-dentiary component of the collateral source rule. Under the proper legal standard, evidence of the amount paid by State Farm to satisfy Sunahara's medical bills is inadmissible because it is evidence of a collateral source benefit. A plaintiffs insurer is a collateral source because it is a third party wholly independent of the tortfeasor to which the tortfeasor has not contributed. Van Waters & Rogers, Inc. v. Keelaon, 840 P.2d 1070, 1074 (Colo.1992) (quoting Kistler v. Halsey, 173 Colo. 540, 545, 481 P.2d 722, 724 (1971)). The amount paid in satisfaction of Sunahara's medical bills is a collateral source benefit because it is an amount paid to a healthcare provider by a collateral source on behalf of an insured plaintiff. Thus, the pre-verdict evidentiary component of the collateral source doctrine requires the exelusion of the amounts paid evidence. See Gardenswarlzs, 242 P.3d at 1088-84. As such, the court of appeals erred when it affirmed the trial court's order admitting the amounts paid by State Farm.

E. Prejudicial Effect

T17 Sunahara is entitled to a new trial on the issue of past economic damages because the trial court's erroneous admission of the amounts paid evidence prejudiced Sunghara's past economic damages award. We will only instruct the trial court to order a new trial because of the erroneous admission of evidence where the record affirmatively shows that the error was prejudicial. Francis v. O'Neal, 127 Colo. 432, 436, 257 P.2d 973, 975 (1953).

4 18 The record in this case shows that the trial court's erroneous admission of the amounts paid evidence was prejudicial, and therefore necessitates a new trial on past economic damages, because Sunahara received $0 in past economic damages, even though he sustained injuries as a result of the accident that required expensive medical treatment. Uncontroverted evidence showed that Sunahara's healthcare providers billed him over $50,000 prior to trial, and also indicated that the providers accepted about $14,000 to satisfy those bills due to the existence of a "managed health care contract." Although the trial court did not specifically instruct the jury that Sunahara carried insurance, the evidence of the amounts billed and the reference to the "managed health care contract" to explain why the medical providers accepted discounted payments almost certainly led the jury to conclude that Suna-hara sustained $0 in past economic damages because his insurer paid his medical bills. This is precisely the prejudicial result that the evidentiary component of the collateral source rule seeks to prevent. See Corr, 123 Colo. at 359, 229 P.2d at 664. Because Suna-hara suffered prejudice as a result of the trial court's erroneous admission of the amounts paid evidence, Sunahara is entitled to a new trial on past economic damages.

III. Discoverability of the Un-redacted Claim File

119 The court of appeals correctly held that the trial court did not abuse its discretion by denying Sunahara's motion to compel discovery of the redacted portions of State Farm's claim file because Silva, 47 P.3d at 1193, protects the redacted information from discovery. Subject to the limitations of C.R.C.P. 26(b)(2), parties may discover non-privileged information "reasonably calculated to lead to the discovery of admissible evidence." C.R.C.P. 26b)(1). The trial court has discretion to decide motions to compel discovery. Stone v. State Farm Mut. Auto. Ins. Co., 185 P.3d 150, 155 (Colo.2008). This Court will uphold the trial court's ruling on a motion to compel discovery absent an abuse of discretion. Id. A trial court abuses its discretion if its ruling is "manifestly arbitrary, unreasonable, or unfair." Hock, 876 P.2d at 1251.

20 In Silva, we held that reserves and settlement authority were "not reasonably calculated to lead to admissible evidence," 47 P.3d at 1193, because they do not "reflect an admission by the insurance company that a claim is worth a particular amount of money," id. at 1190. We therefore concluded that reserves and settlement authority were not discoverable under C.R.C.P. 26(a)(1). Id. at 1198. Although this case is factually distinguishable from Silva, the same rationale applies here to protect from discovery the liability assessments and fault evaluations that State Farm used to develop its reserves and settlement authority.

1 21 We first define "reserves" and "settlement authority," describe their respective roles in an insurance company's initial claim investigation, and explain why Silva protects reserves and settlement authority from discovery. We then explain why Silva also applies here to protect the liability assessments and fault evaluations State Farm redacted from the claim file it produced to Sunahara.

A. Silva Protects Reserves and Settlement Authority from Discovery

122 Upon receiving notice of a claim from an insured, an insurance company will establish reserves and settlement authority soon after opening the claim file "Reserves" are the "funds insurance companies set aside to cover future expenses, losses, claims, or liabilities" associated with a particular case. Id. at 1189 (citing Black's Law Dictionary 1307 (6th ed. 1990). Colorado law requires insurance companies to maintain reserves to assure the insurer's ability to satisfy its potential obligations under its policies. See, eg., § 10-8-201(1)(a)(V), C.R.S. (2011) (requiring insurance companies to maintain a minimum capital or guaranty fund and an accumulated surplus). Reserves are not an admission or valuation by the insurer; rather, they fulfill the insurance company's statutory obligations and reflect the insured's estimated potential liability on a particular claim. Silva, 47 P.3d at 1189.

123 The term "settlement authority" generally refers to an insurance agent's "ability to accept an offer of settlement that binds the principal up to and including a certain amount of money." Id. Like reserves, settlement authority does not constitute a "final, objective assessment of a claims [sic] worth to which an insurer may be held." Id. at 1190. Instead, both reserves and settlement authority reflect the insurer's "basic assessment of the value of a claim taking into consideration the likelihood of an adverse judgment, but do not normally entail a thorough factual and legal evaluation when routinely made as a claim analysis." Id. at 1191.

124 Taking the nature of reserves and settlement authority into account in Silva, we held that neither are reasonably calculated to lead to admissible evidence- and thus are not generally subject to discovery-because: (1) they do not accurately reflect the insurer's valuation of a particular claim; (2) they are not admissions of liability; and (3) insurance companies prepare them simply to satisfy statutory obligations and to establish bargaining tactics. See id. at 1188-91. Thus, as the court of appeals held in this case, reserves and settlement authority figures "are irrelevant to a jury's determination of liability and damages and are not reasonably calculated to lead to the discovery of admissible evidence." Sunahara, No. 09CA0599, slip op. at 18.

B. Silva also Applies to Information Used to Develop Reserves and Settlement Authority

125 Like reserves and settlement authority figures themselves, liability assessments and similar cursory fault evaluations used by an insurance company to develop reserves and settlement authority are not reasonably calculated to lead to the discovery of admissible evidence. The trial court in this case correctly reasoned that "insurance companies have to be free to make ... internal assessments" and that those internal assessments "directly bear on [the insurance company's] reserve decisions." It also correctly found that Silva should extend to this situation because it would be absurd to protect the end result of the insurance company's initial evaluation process-the reserves and settlement authority-without also protecting the assessments that led to those numbers.

126 The trial court did not abuse its discretion because State Farm used the information it redacted from the produced claim file for the limited internal purposes of setting reserves and determining settlement authority to comply with insurance regulatory standards and to estimate its potential financial liability. Like the reserves and settlement authority themselves, the information State Farm redacted from the claim file it produced to Sunahara did not contain a thorough evaluation of Sunahara's claim, did not reflect an admission of any party's lability for the accident, and did not constitute an admission by State Farm that Sunahara's claim was worth a particular amount of money. The reasoning we applied in Silva therefore applies here to protect the redacted portion of the State Farm claim file from discovery. Thus, the court of appeals correctly determined that the trial court did not abuse its discretion when it denied Suna-hara's motion to compel.

T 27 The factual differences between this case and Silva do not alter our conclusion. Silva involved a "third-party" personal injury case between an injured plaintiff and an allegedly-negligent defendant. 47 P.3d at 1191-92. The plaintiff moved the trial court to compel the production of correspondence between the defendant and its insurer regarding reserves and settlement authority because the plaintiff believed the correspondence was relevant to the defendant's insurance company's valuation of the case. Id. at 1192.

128 In contrast, the underlying action here involves a type of "first-party" claim in which Sunahara is suing his own insurance company, State Farm, for UIM benefits. We noted in Silva that first-party cases differ from third-party cases because, in a first-party action, the defendant insurance company owes the plaintiff-insured a duty of good faith. Id. at 1193. The UIM context of this case, however, places the insurance company in the "unique role" of becoming almost adversarial to its own insured. Peterman v. State Farm Mut. Auto. Ins. Co., 961 P.2d 487, 494 (Colo.1998). UIM coverage is designed to put a driver who is injured by an underinsured motorist in the same position as if the underinsured motorist had liability limits in amounts equal to the insured's coverage. USAA v. Parker, 200 P.3d 350, 358 (Colo.2009). Thus, the fact-finder in a UIM case must weigh the evidence presented by the defendant insurance company, essentially standing in the shoes of the un-derinsured motorist, against the evidence presented by the injured plaintiff. The defendant insurance company will naturally attempt to minimize the plaintiff's damages in such a case because doing so serves the company's financial interests. As such, the scope of discovery of reserves and settlement authority in first-party UIM actions is similar to the scope of discovery in third-party actions, like Silva, because the relationship between the parties is similarly adversarial.

129 Furthermore, we noted in Silva that reserves and settlement authority-and, under our reasoning in this case, the liability assessments and fault evaluations underlying those figures as well-might be relevant and reasonably calculated to lead to admissible evidence when a first-party plaintiff sues his or her insurance company for bad faith or for a declaratory judgment. Stiva, 47 P.8d at 1198. In bad faith and declaratory judgment actions, evidence of reserves and settlement authority could shed light on whether the insurance company adjusted a claim in good faith, or promptly investigated, assessed, or settled an underlying claim. Id. UIM actions differ from bad faith and declaratory judgment cases because, rather than defending its own actions, an insurance company in a UIM action must essentially defend the tort-feasor's behavior. As such, evidence of the liability assessments and fault evaluations underlying reserves and settlement authority is not reasonably calculated to lead to the discovery of admissible evidence in UIM actions, just as it is not reasonably calculated to lead to admissible evidence in a third-party action like Silva.

IV. Conclusion

{ 30 We affirm the court of appeals' interpretation of Silva and its decision to uphold the trial court's denial of Sungahara's motion to compel production of the un-redacted claim file because liability assessments and fault evaluations underlying an insurance company's reserves and settlement authority in a UIM action are not reasonably calculated to lead to admissible evidence as required by C.R.C.P. 26(b)(1).

T 31 We reverse the court of appeals' decision to affirm the trial court's ruling admitting evidence of the amounts paid by State Farm to cover Sunahara's medical expenses, however, because the trial court abused its discretion by applying the reasonable value rule rather than the common law evidentiary component of the collateral source doctrine. We therefore remand this case to the court of appeals, and direct that it remand to the trial court with instructions to hold a new trial on the issue of past economic damages only. This new trial shall be limited to the consideration of evidence relevant to the determination of Sunahara's past economic damages award. The trial court additionally may consider issues relating to statutory interest or costs.

Chief Justice BENDER concurs in part and dissents in part. Justice EID concurs in part and dissents in part, and Justice COATS and Justice BOATRIGHT join in the concurrence in part and dissent in part.

1 . We granted certiorari to determine:

1. Whether the court of appeals erred in holding that the amount accepted in full payment for medical treatment was inadmissible in light of Kendall v. Hargrave, 142 Colo. 120, 123, 349 P.2d 993, 994 (1960) and its progeny, the common law collateral source rule, Colorado's collateral source statute, section 13-21-111.6, C.R.S. (2010) and section 10-1-135(10)(a), C.R.S. (2010).

2. Whether the court of appeals erred in ruling that respondent's claim file and other documentation that attributed fault to the tortfeasor were not discoverable and were inadmissible.

2 . The Legislature codified the evidentiary component of the collateral source rule in 2010. See § 10-1-135(10)(a), C.R.S. (2011). While this opinion is consistent with section 10-1-135(10)(a), and with our opinion interpreting that statute-Smith v. Jeppsen, 2012 CO 32 (released concurrently with this opinion)-section 10-1-135(10)(a) does not govern this opinion because recovery occurred in the underlying action prior to the effective date of the statute.

3 . We analyzed the impact of Colorado's collateral source statute, section 13-21-111.6, on the pre-verdict component of the common law doctrine in Wal-Mart Stores, Inc. v. Crossgrove. 2012 CO 31, 276 P.3d 562 (released concurrently with this opinion). There, we determined that section 13-21-111.6 only applies post-verdict and therefore does not abrogate the common law rule that bars collateral source evidence from admission.

4 . We discussed the origins of the common law collateral source rule at length in Crossgrove, 2012 CO 31, 119-13, 276 P.3d 562. That case addressed the same collateral source issue we analyze here. For the sake of brevity, we find it unnecessary to fully discuss the development of the modern collateral source doctrine in this opinion.

5 . We do not opine as to whether evidence of amounts paid by a collateral source for medical expenses is relevant to the reasonable value of those expenses because, whether relevant or not, the evidence is excluded under the collateral source doctrine.