By William T. Barker, Partner, SNR Denton
Chapter 8 addresses defenses which insurers might assert in addition to their attempts to negate insureds’ claims that the insurer breached contractual duties ordinarily imposed as part of the duty of good faith and fair dealing.
Section 8.02 addresses contractual time limits. Insurance policies typically require the insured to give “prompt” notice to the insurer of any losses incurred, claims made or suits brought against the insured. Courts generally interpret that requirement to mean that notice must be given within a reasonable time under the particular circumstances of the case. In addition, many (but not all) jurisdictions require that the insurer demonstrate that it was prejudiced by any delay in notice, and will excuse noncompliance if the insured can show that the delay was reasonably justified. First-party insurance policies also commonly require that the insured furnish the insurer with proof of loss within a specified period of time. As with notice provisions, the insurer typically must prove that it was prejudiced as a result of the insured’s failure to provide timely proof of loss. Furthermore, courts often hold that delay in submitting proof of loss merely postpones the insurer's liability -- it does not eliminate it altogether.
Provisions in first-party insurance policies often limit the time within which an insured may file an action against its insurer for particular loss, and there is usually no need for the insurer to show prejudice to enforce such a contractual suit limitation. While such suit limitations will usually bar bad faith claims, as well as claims for benefits, some court hold that bad faith claims (or some specific types of bad faith claims) are not subject to those limitations. In some instances, a discovery rule may apply, but contractual suit limitations usually run from the occurrence of the loss. Some states toll such limitations from the time a claim is made until it is denied.
Section 8.02 addresses statutes of limitations. In particular, California holds that bad faith claims sound both in contract and in tort, allowing use of the longer written contract statute of limitations, though there is some disagreement whether the full range of tort damages can be sought if the claim is brought after running of the tort statute. But some states apply tort statutes to all bad faith claims; which tort statute will apply varies widely from state to state.
Section 8.02 examines accrual of a cause of action. Actions for failure to settle typically accrue upon termination of the suit against the insured, either by settlement or finalization of a judgment in excess of policy limits. First-party bad faith claims may be deemed to accrue as of the date of the loss, if a contractual suit limitation so provides, or from the date the loss is ascertained and payment is due pursuant to the policy. Insurers may not create a perception of amicable adjustment and then plead a delay caused by its own conduct as a defense to a bad faith claim. Certain jurisdictions impose an affirmative obligation on insurers to identify and explain policy provisions to the insured. Such courts have held that that duty to inform may include advising the insured of the applicable limitations period governing any claim that the insured might have against the insurer. Such notices may also be required by statutes or regulations.
Section 8.03 considers res judicata and collateral estoppel. Where the insurance policy requires that disputes be arbitrated, judicial confirmation of the arbitration award may be treated as barring a later bad faith claim. But the bad faith claim may be beyond the scope of the arbitration and not barred by the award. Most courts require a bad faith claim to be included in any suit for policy benefits, with the judgment in such a suit barring a later bad faith claim. But some courts hold that a bad faith claim is not even viable until coverage has been established. In contrast, a few states will sometimes permit a bad faith action to proceed even if coverage was correctly denied. Declaratory judgment actions for coverage may not bar later bad faith claims, even if a suit for contract benefits would.
Section 8.04 examines ERISA preemption. ERISA provides for no emotional distress, punitive, or other extracontractual remedies and, where applicable, generally preempts any state law that would provide such remedies. ERISA expressly preempts “any and all State laws insofar as they may now or hereafter relate to any employee benefit plan” that is covered by ERISA. That general rule is subject to a statutory exception (usually called the “insurance savings clause”) that “nothing in this title shall be construed to exempt or relieve any person from any law of any State which regulates insurance, banking or securities.” That exception in turn is subject to its own exception (usually called the “deemer clause”) to the effect that “no employee benefit plan [other than a death benefit plan] … shall be deemed to be an insurance company or other insurer … or to be engaged in the business of insurance … for purposes of any law of any State purporting to regulate insurance companies [or]insurance contracts ….”
Express preemption is complemented, sometimes overshadowed, by a second ERISA preemption rule, “conflict preemption.” That is, ERISA impliedly preempts any state law cause of action that provides an alternative or additional remedy to one of the exclusive civil remedies provided under Section 502(a). Establishing conflict preemption under ERISA comes with the additional advantages (for defendants) that federal question jurisdiction will exist for removal of the case from state court, and that the “insurance savings clause” does not apply to limit conflict preemption.
Of course, neither of these preemption doctrines can come into play unless there is a “plan” subject to ERISA. An insurance policy is (or is part of) an ERISA “welfare” plan if there is (1) a plan, fund, or program (2) established or maintained (3) by an employer or an employee organization, or both, (4) for the purpose of providing medical, surgical, hospital care, sickness, accident, disability, death, unemployment or vacation benefits, apprenticeship or other training programs, day-care centers, scholarship funds, prepaid legal services or severance benefits (5) to participants or their beneficiaries. A plan exists if, from the surrounding circumstances, a reasonable person can ascertain the intended benefits, a class of beneficiaries, the source of financing, and the procedures for receiving benefits. There are exceptions for governmental plans and for church plans that do not elect to be covered. The statute also exempts employee benefit plans maintained solely for the purpose of complying with applicable workers’ compensation laws. A plan that does not cover at least one employee other than the owners of the business will not be an ERISA plan. Certain voluntary group insurance plans, to which the employer does not contribute are excluded from ERISA.
Section 502(a) of ERISA provides only six types of remedies to an ERISA participant: (1) civil penalties for failure to provide plan information and materials; (2) benefits due under the terms of the plan, an enforcement of rights under the plan, or a clarification of future benefits under the plan; (3) “appropriate relief” for breach of duty by a plan fiduciary; (4) an injunction against violating any provisions of ERISA or plan terms; (5) “other appropriate equitable relief” to redress or enforce violations of ERISA provisions or plan terms; and (6) “appropriate relief” for violation of ERISA reporting provisions. Based on this exclusive remedy scheme, the United States Supreme Court has held that there can be no recovery for extra-contractual damages or punitive damages under ERISA. Thus, any state law adding to those remedies, such as for processing claims in bad faith, can be viewed as conflicting with ERISA and preempted for that reason. As a practical matter, this virtually eliminates the possibility of a bad faith claim where an ERISA plan is involved.
However, because the employer lacks standing under ERISA, ERISA did not “completely preempt” a suit by an employer with a self-insured plan against its stop loss carrier, seeking among other things to recover payments made for an employee’s medical expenses that should have been reimbursable under the stop loss policy. Similarly, suits by medical benefit providers against the payor under their network, founded on an independent ground such as breach of the provider contract with the network or misrepresentation, can avoid complete preemption. But suits by a provider as an assignee of a participant are subject to complete and conflict preemption in the same way as a suit by the participant directly, and suit by a provider founded on rights (such as reimbursement rates) set by the plan (as opposed to a separate contract) are likewise subject to preemption.
Conflict preemption of bad faith claims largely moots the question whether bad faith claims are expressly preempted under Section 514 of ERISA. But even there most courts concluded that such claims both “related” to a plan and were not saved by the insurance savings clause. Express preemption applies to state law claims that “relate to” an employee benefit plan. “Relate to” is broadly interpreted, and early on was glossed by the Supreme Court as applying where the state law “has a connection with or reference to such plan.” However, the Supreme Court had always recognized that some “some state actions may affect employee benefit plans in too tenuous, remote or peripheral a manner to warrant a finding that the law ‘relates to’ the plan.” For example, ERISA does not preempt state health care initiatives that place surcharges on medical bills of patients.
A state law “regulates insurance” and thus is saved from preemption if it is directed at “entities engaged in insurance” and “substantially affect[s] the risk pooling arrangement” between the insurer and insured. The saving clause does not actually “save” most state law claims from preemption because such claims rarely reflect statutory or common law rules specifically aimed at regulating the insurance industry.
The insurance savings clause is itself subject to a statutory exception -- the “deemer clause” -- to the effect that a state cannot “deem” a plan to be an insurance company for the purpose of regulating it. The principal impact of the deemer clause is to insulate self-funded plans from state insurance regulation.
Since ERISA does not permit a participant to recover direct damages for breach of fiduciary duty, a participant may not recover extra-contractual damages for improper processing of benefit claims, even if the breach of duty would rise to the level of “bad faith” under state law. However, the way in which claims are processed may affect the standard of review under ERISA, and therefore the likelihood that an insurer’s claims decision will be upheld in ERISA benefit litigation.
A denial of benefits challenged under Section 502(a)(1)(B) of ERISA is to be reviewed under a de novo standard unless the benefit plan gives construe the terms of the plan. If the plan grants the administrator such discretionary authority, a deferential standard of review applies to the exercise of the authority. Most plans (and many insurance policies for ERISA plans) now specify that the administrator or insurance company has discretionary authority to determine eligibility for benefits.
Even where the plan or policy has the appropriate discretionary language, the standard of review may still be altered if the administrator or insurer has a conflict of interest. An insurer will be considered conflicted in making benefit decisions, in part because employers comparing premium rates might prefer an insurance company with low rates to one with accurate claims processing, and in part because claims processing under ERISA is a fiduciary function that imposes a higher-than-marketplace quality standard on insurers. A conflict does not mean that a de novo standard of review, or something close to it should apply. Instead, the conflict should be considered as a factor, to be weighed along with all other relevant factors, in determining whether the decision was “arbitrary and capricious.”
Section 8.04 examines workers’ compensation exclusivity. Courts in a number of jurisdictions have held that the exclusive remedy provision of the workers' compensation laws bars a suit for bad faith when a workers' compensation carrier has refused to pay a valid claim or delays in making the payments, even if the carrier has acted in bad faith in so doing. The main rationale for those rulings is that permitting bad faith lawsuits would generate too much litigation, thus subverting the major objective of the workers' compensation scheme -- that a workers’ compensation claim be the employee’s lone source of recourse against his or her employer (with the employer’s insurer standing in the shoes of the employer). Another important rationale for barring bad faith claims is that many workers' compensation systems provide a statutory remedy in the form of penalties when an insurer fails to compensate an injured employee properly, which the courts deem to be the exclusive remedy for bad faith claim handling. But not all tort actions against workers’ compensation insurers will be barred by exclusive remedy provisions, even in some jurisdictions which do not recognize a cause of action for bad faith refusal to pay benefits. Specifically, if an insurer’s conduct extends beyond mere bad faith and reaches a level of extreme and outrageous conduct that would support a claim for intentional infliction of emotional distress, or an independent tort such as trespass or fraud, a tort action against the insurer might be sustained.
Courts in a growing number of jurisdictions, however, now hold that a claim for damages arising out of a compensation carrier's bad faith failure to pay benefits may, in certain circumstances, fall outside the exclusive remedy provision of workers' compensation law. They reason that the essence of a bad faith claim is nonphysical and that treating it as barred by the exclusive remedy provisions would permit benefits to be improperly withheld.
Section 8.04 considers preemption by federal labor law. Where a bad faith action claim that relates to performance of a collective bargaining agreement, it will be subject to the Labor Management Relations Act and the contractual dispute resolution mechanisms of the collective bargaining agreement, typically culminating in arbitration. A bad faith claim will be preempted if substantially dependent on analysis of the terms of an agreement in a labor contract.
Sections 8.04- consider preemption by other federal laws. The Federal Employee Health Benefits Act has been held to have preemptive effect similar to that of ERISA. Under the National Flood Insurance Program, most courts hold that state law tort claims arising from claims handling by a “write your own insurer” are preempted by federal law. Various results have been reached with respect to other federal statutes. Courts generally hold that state bad faith law can coexist with federal admiralty law.
Section 8.05 examines the effect of a plaintiff’s breach of the insurance contract. Nonetheless, courts have ruled that an insured’s non-compliance with conditions to coverage will not automatically defeat that policyholder’s bad faith claim unless the insured’s conduct, in failing to satisfy its contractual obligations, is so grave that it might permit the insurer to cancel the policy. The rationale appears to be that an insurer’s duty of good faith and fair dealing is independent both of the insurer’s and insured’s obligations under the policies. But an insured’s failure to cooperate may be taken into account in evaluating the insurer’s conduct. An insured’s breach is more likely to undermine its claim if the insurer offers an opportunity to cure the breach and the insured refuses to do so.
Section 8.06 examines the effect of a plaintiff’s bad faith. In general, this does not appear to be a defense but, like an ordinary contract breach, may be taken into account in evaluating the insurer’s conduct.
Section 8.07 addresses the negligence of an insured or insured’s attorney. Courts have expressed reluctance to permit insurers to avoid bad faith liability on the basis that the insured’s or its attorney’s alleged negligence somehow contributed to the insurer’s exposure. Again, courts have been willing to consider the insured’s negligence in making the ultimate determination of whether an insurer acted reasonably in responding to a claim for coverage.
Section 8.08 deals with application misrepresentations. If the insurer successfully rescinds the policy, the insured is generally barred from pursuing a bad faith claim.
Section 8.09 examines the effect of advice of counsel. In general, such advice is relevant only to negate an improper mental state, where that is required. Accordingly, it may be possible to defend many cases without formally relying on advice of counsel, by simply offering, as one reasonable basis for contesting coverage, the legal conclusions counsel reached. Even where an advice of counsel defense is available, any such defense will depend on showing that counsel was fully informed of the relevant facts. And, if counsel is either an employee of the insurer or a defense counsel appointed by the insurer, it may be held responsible for any negligent error by counsel.
Section 8.10 considers the effect of an insurer’s conformity to industry standards in the handling of an insured’s claim. Courts are split on the extent to which that is a defense.
Section 8.11 concludes that insurers are generally not entitled to require insureds to elect between contractual and extracontractual remedies.
Section 8.12 considers the effect of an insured’s failure to mitigate damages. Any obligation to mitigate damages would be limited to reasonable steps that the insured could have taken without any risk or burden. But one reason why insurance is purchased in the first place is that the insured believes it is unable to bear the burden of a loss. Thus, it would usually be difficult for an insurer to prove that the insured had the means to readily avoid or reduce the harm.
Section 8.13 examines defenses based on waiver or estoppel, which generally are not successful against an insured.
Section 8.14 explains that courts are split on the effect of an insured’s death on the continued viability of any bad faith claim.
Section 8.15 explains that, in the rare situations in which an insured is obligated to exhaust administrative remedies in order to recover insurance benefits (e.g., in the workers’ compensation context), courts typically find that those remedies must be exhausted before the insured might pursue a bad faith claim against the insurer.
Section 8.16 notes that sovereign immunity may bar a bad faith claim where a government entity acts as a claims administrator or where the insurer is owned by a foreign sovereign.
Section 8.17 notes that insurance policy provisions requiring arbitration of disputes are generally enforceable.
William T. Barker is a partner in the Chicago office of SNR Denton with a nationwide practice representing insurers in complex litigation, including matters relating to coverage, claims handling, sales practices, risk classification and selection, agent relationships, and regulatory matters. He is a co-author (with Ronald D. Kent) of New Appleman Insurance Bad Faith Litigation, Second Edition and author or co-author of chapters of New Appleman on Liability Insurance, Second Edition; has published over 100 articles, and speaks frequently on insurance and litigation subjects. He has been described as the leading lawyer-commentator on the connections between procedure and insurance. See Charles Silver & Kent Syverud, The Professional Responsibilities of Insurance Defense Lawyers, 45 Duke L.J. 255, 257 n.4 (1995). He is a member of the Editorial Board of New Appleman on Insurance Law and New Appleman Insurance Law Practice Guide. Mr. Barker is a member of the American Law Institute.
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