Most people purchase insurance to guard against economic losses arising from personal injuries or property damages, or the possibility of a lawsuit that will result in losses. In exchange for paying premiums, a policyholder is owed various duties by the insurer. This includes a duty to provide coverage, a duty to uphold the terms of the policy, and pay any valid claims that are covered by the policy. All insurance companies also owe an implied duty of good faith or fair dealing.
Unfortunately, there are cases in which an insurer fails to uphold its express or implied duties to the insured. In order to guard their profits, insurers sometimes commit deceptive practices, deliberately misinterpret their own policy language or records to avoid paying a claim, use unreasonable delays to avoid resolution of a claim, make arbitrary demands regarding proof of loss, use abusive tactics, ask an insured to contribute to a settlement when the insured should not have to make that contribution, or fail to conduct a thorough investigation. These breach the implied duty of good faith and fair dealing, and they may give rise to a bad faith lawsuit.
The duty of good faith owed in connection with first-party claims is generally stronger than that owed in connection with third-party claims.
Generally, bad faith occurs in connection to either first-party insurance claims or third-party bad faith. First-party insurance bad faith involves an insurer’s refusal to pay a claim without a reasonable basis or without properly investigating the claim in a timely manner. For example, suppose your house burns down because of an accident, and your homeowner’s insurance policy expressly covers the losses. When you call, an agent says it will investigate and that you cannot make any repairs until the investigation happens. However, your insurer never comes out to visit the site and refuses to answer any of your correspondence. This is likely the basis for a first-party insurance bad faith lawsuit.
Third-party insurance bad faith claims involve liability insurance. The insurer owes a duty to defend and pay all defense costs even when some or most of the lawsuit is not covered by the policy, except in the case of a “burning limits” policy, in which the defense costs consume the policy limits. The insurer also may owe a duty to indemnify, which is the duty to pay a judgment up to the policy limits when the loss is covered by the policy.
In some but not all jurisdictions, an insurer also owes the duty to settle a reasonably clear claim in which the policyholder is liable within policy limits to avoid the risk of a judgment that may exceed policy limits. For example, suppose you were drunk driving and struck a motorcyclist. The motorcyclist suffers serious injuries and sues you, making a demand for policy limits of $100,000, even though his or her actual damages are much more significant. You tender the motorcyclist’s reasonable demand for economic damages as well as your defense to your insurer, explaining that you were drunk driving. If the insurer wrongfully refuses to make a reasonable settlement within policy limits, and you are forced into bankruptcy defending the suit and paying a judgment, you have the basis for a bad-faith lawsuit against your insurer.
Addressing Bad Faith
If you believe that your insurance claim is being handled in bad faith, you should notify the adjuster, preferably in writing. Most insurance companies would rather resolve the issue directly than risk a bad faith lawsuit.
A breach of the implied covenant of good faith and fair dealing is a common-law tort claim. However, some states have enacted statutes to prohibit bad faith or to prohibit certain types of actions that are considered bad faith. For example, California addresses insurance bad faith both through the Unfair Claims Practice Act as well as common law. This means that a wronged policyholder can bring both statutory and tort claims. Federal law prohibits bad faith in connection with claims under the Employee Retirement Security Act of 1974.
An insurer that is found to have acted in bad faith can be liable for damages in excess of the policy limits, including liability for judgments in excess of the policy’s limits, statutory penalties, interest, emotional distress, consequential economic losses, attorneys’ fees, and punitive damages. In bad faith cases, punitive damages are usually determined not solely with regard to what the insured’s actual losses were, but also with regard to the insurer’s wealth.