US: when good faith turns bad

Defining insurance bad faith

Generally speaking, bad faith involves a scenario where an insurer is subject to exposure beyond policy limits (i.e., extra-contractual liability), as permitted either by state statute or state common law (federal law does not apply to insurance bad faith). The doctrine originated because courts historically have recognized the “unequal bargaining power of the parties.” See Grand Sheet Metal Prods. Co. v. Protection Mut. Ins. Co., 375 A.2d 428 (Conn. Super. 1977). Also, insureds often “surrendered to the insurer all control over the handling of the claim, including all decisions with regard to litigation and settlement.” Boston Old Colony Ins. Co. v. Gutierrez, 386 So.2d 783 (Fla. 1980). 

Bad faith occurs when an insurance company unreasonably denies, delays, or minimizes a valid claim without a legitimate or arguable basis. Important to note is that bad faith is distinct from an ordinary disagreement over claim valuation, a simple claims handling error, or a justified denial of coverage based on an explicit policy provision. Bad faith implies a degree of conscious wrongdoing, reckless disregard, or intentional unfairness by the insurer toward its client. Most often it stems from a policyholder claiming the following: 

• Unjustified claim denial: Refusing to pay out a valid, covered claim entirely, or citing ambiguous, non-existent, or distorted policy exclusions to evade liability

• Inadequate or biased investigation: Conducting a superficial review of the loss, failing to interview critical witnesses, or relying on biased third-party adjusters who are incentivized to undervalue the damages

• Unreasonable delays and stalling: Failing to acknowledge a claim promptly, delaying communication, or continuously requesting redundant paperwork to exhaust the claimant and force them into a lower settlement

• "Lowball" settlement offers: Presenting initial settlement figures that are significantly lower than the actual verified value of the damage, exploiting the insured's financial vulnerability during a time of crisis

• Misrepresenting contractual terms: Deliberately misstating policy language, coverage limits, or statutory rights to lead the insured to believe they are not entitled to compensation

Allegations of bad faith can arise in both the first-party and third-party contexts. For first-party bad faith, it occurs when an insurer acts unfairly directly toward the insured regarding a first-party claim (e.g., property damage, commercial business interruption, or health insurance). In a third-party scenario, it applies when a third party sues the insured, and the liability insurer handles (or at least has significant control over) the defense.

If an insurer unreasonably refuses to settle the lawsuit within policy limits, or controls the litigation in some other way that unreasonably exposes the insured's business or personal assets to an excessive judgment, it has acted in bad faith by failing to protect the insured's financial interests (or the financial interests of an excess insurer, which also may assert bad faith against a primary insurer). 

The general test  

Allegations of bad faith are typically reviewed under a reasonable test, and whether the insurer gave equal consideration to the insured as it did to itself. “The relevant inquiry is whether the facts pleaded show the absence of any reasonable basis for denying the claim, i.e., would a reasonable insurer under the circumstances have denied or delayed payment of the claim under the facts and circumstances.” Farmers Group, Inc. v. Trimble, 691 P.2d 1138 (Colo. 1984). The insurer must give “equal consideration to the interest of the insured in deciding whether to accept an offer of settlement.” Truck Ins. Exch. v. Bishara, 916 P.2d 1275 (Idaho 1996). (This is the normal test in states like California, Colorado, Florida, Georgia, Ohio.) 

In other states there must be some affirmative misconduct by the insurer. That is, the insurer’s conduct must involve a “deliberate and reckless failure to place on equal footing the interests of its insured with its own interests when considering a settlement offer.” Pavia v. State Farm Mut. Auto. Ins. Co., 626 N.E.2d 24 (N.Y. 1993) (Other states include Arkansas, Connecticut, Indiana.) 

Bad faith and the duty to defend 

Different states have various rules for evaluating an insurer’s duty to defend, and the consequences for failing to provide a defense. Typically an insurer cannot refuse a defense for its insured unless there is no reasonable possibility the claim will be covered. If the insurer breaches the defense obligation, then it may be prohibited from raising coverage defenses (Illinois), or the insured may be free to settle with a claimant without the insurer's consent, or the insured can assign all claims to the claimant (including bad faith) in exchange for covenant not to execute a judgment against the insured. However, an insurer may still be able to challenge coverage under the policy, and the reasonableness of a settlement or consent judgment. 

Bad faith and the duty to indemnify 

An insurer generally must "investigate the facts, give fair consideration to a settlement offer that is not unreasonable under the facts, and settle, if possible, where a reasonably prudent person, faced with the prospect of paying the total recovery, would do so.” Boston Old Colony Ins. Co. (Fla. 1980). If the insurer fails in this obligation, then it may be liable for the entire excess judgment (and possibly attorney’s fees). 

Time-limited demands for policy limits can often be a trap for insurers, especially when there are valid liability and/or coverage questions. (Note that some states do not allow an insurer to consider coverage as part of the time-limited demand analysis. Rather, it must resolve the liability claim first, and then litigate coverage.) 

In some states, a settlement demand is a condition precedent to a bad faith claim (see, e.g., California, Georgia, New York, Ohio, Texas), whereas in other states there does not need to be a settlement demand, and the insurer may have an affirmative duty to tender its limits or make a reasonable settlement offer where liability against the insured is clear (see, e.g., Kansas, Louisiana, Massachusetts, New Jersey, Michigan). “Where liability is clear, and injuries so serious that a judgment in excess of the policy limits is likely, an insurer has an affirmative duty to initiate settlement negotiations.” Powell v. Prudential Prop. & Cas. Ins. Co., 584 So.2d 12 (Fla. 3d DCA 1991). 

Bad faith and claims handling 

Bad faith also can arise as a result of poor or negligent claims handling, especially where a claims handler has acted unreasonably in processing, investigating, or paying an insured's claim.

There generally are two elements to bad faith claims handling. First, benefits due under the policy terms were withheld, despite that the insured presented a valid claim under the terms of the policy. Second, the reason for withholding benefits was unreasonable. Whether an insurer acted reasonably is evaluated objectively based on the situation, and the factfinder (usually a jury) reviews the facts as they existed at the time of the decision. 

Conclusion and tips 

Most claims handlers will be the recipient of a bad faith allegation at some point in their career. But as the vast majority of claims handlers act responsibly and reasonably, there should not be undue concern. Review the claim, acknowledge the claim, make a reasonable coverage determination, and, if required, defend and/or settle the claim. It is basically that simple. Along the way be sure to have reliable and competent defense counsel, establish a resolution strategy with defense counsel and input from the insured, and work the claim towards an appropriate resolution. Follow this path and good faith will not turn bad.