By William T. Barker, Partner, SNR Denton
The insurer's duty of good faith, and the liabilities that flow from breach of that duty, play an important role in insurance law. The duty was first developed in the context of liability insurance to limit the insurer's discretion in exercising its reserved control over settlement of claims against the insured. (See Chapter 23 above.) But most jurisdictions have extended that duty, either by common law or by statute (or sometimes both) to limit an insurer's exercise of the power to deny or delay payment for the insured's own losses. (See Section 55.01 below.) This is known as "first-party bad faith," and it is the subject of this chapter.
In the first party context, an insurer has great power in the handling of claims, because the insured has no remedy for unjustified delay or denial of benefits due other than expensive and time-consuming litigation. The bad faith tort seeks to protect insureds with valid claims against abuse of the insurer's power by permitting the insured to recover tort damages in addition to amounts owed under the policy. But if insurers failed to scrutinize the validity of claims and paid meritless claims that would increase the cost of providing the insurance, leading to inflated prices for that insurance. Accordingly, the right of insurers to challenge questionable claims must be protected. The law of bad faith represents a balance between two competing interests: the right of an insurer to reject an invalid claim and the right of the insured to receive payment for compensable claims. The ways in which this balance shapes the law of bad faith are examined in Section 55.02.
Section 55.03 considers the definitions of bad faith employed in various jurisdictions. Many jurisdictions employ definitions similar to that in California, which first recognized the bad faith tort. California holds that an insurer breaches the duty of good faith "by refusing, without proper cause, to compensate its insured for a loss covered by the policy." That breach is actionable in tort. (See Section 55.03.) A larger number of jurisdictions (though on average, less populous ones) follow the Wisconsin definition of bad faith which adds a subjective element: "To show a claim for bad faith, a plaintiff must show the absence of a reasonable basis for denying benefits of the policy and the defendant's knowledge or reckless disregard of the lack of a reasonable basis for denying the claim." (See Section 55.03.) Alabama has developed a peculiar bifurcated standard for bad faith, with "normal" bad faith judged by a standard similar to the Wisconsin definition. But it also recognizes "abnormal" bad faith for failure to investigate where the insured can show that "(1) that the insurer failed to properly investigate the claim or to subject the results of the investigation to a cognitive evaluation and review and (2) that the insurer breached the contract for insurance coverage with the insured when it refused to pay the insured's claim." (See Section 55.03.) Several other states have idiosyncratic standards. (See Section 55.03.)
Investigation is a practical necessity in handling first-party claims. The adjustment of first-party insurance claims requires the insurer to ascertain the facts regarding a reported loss and determine whether benefits are payable . Ascertaining the facts typically requires investigation of some sort. The law also imposes a duty to investigate grounds that might support a claim, but only after the insured has substantially complied with policy requirements for notice and proof of loss. The extent of the necessary investigation depends on the facts of the claim and the issues it presents. (See Section 55.04.)
Insurance claim adjusters regularly consult experts for assistance in determining whether benefits are due for a given loss. The expert's role is to assist the adjuster, not to displace the adjuster. The adjuster is entitled to manage and critically review the expert's work. In selecting an expert, the insurer may take account of whether the expert's technical approach is likely to support a questioning of coverage. In general, a lay adjuster may properly rely on the opinion of a properly selected expert, but not if the expert's opinion has obvious defects or is biased. Bona fide disputes among experts ordinarily preclude a finding of bad faith. (See Section 55.04.)
The law charges the insurer with knowledge of the facts an adequate investigation would have revealed. With rare exceptions, no liability can be based on inadequate investigation unless the loss is covered. Moreover, the deficient investigation must be the cause of any damages assessed. But an insurer can be liable for an unlawful or improper investigation. (See Section 55.04.)
Benefits not subject to bona fide dispute must be paid promptly and unconditionally. In particular, when benefits are clearly due, they should not be used as bargaining chips in negotiations about amounts in dispute. Using an undisputed amount as a bargaining chip is an aggravation of the failure to pay. A substantial part of the right purchased by an insured is the right to receive the policy benefits promptly. Unwarranted delay precipitates the precise economic hardship the insured sought to avoid by purchase of the policy. (See Section 55.05.)
In rare circumstances, an insurer mishandles a claim in a way that injures the non-insurance interests of an insured. In such cases, liability may be found without regard to coverage or most of the usual requirements of bad faith. (See Section 55.06.) Most jurisdictions hold, properly, that a valid claim for policy benefits is a necessary predicate for a bad faith claim, absent injury to noninsurance interests. A few jurisdictions hold that there can be bad faith liability even though there is no covered claim. In these jurisdictions, there is great uncertainty about the remedies available to an insured who establishes bad faith in such a situation. With no policy benefits due, the insured may not have any damages, even if the insurer mishandled the claim. (See Section 55.06.)
In some jurisdictions, an insurer has a duty to inform the insured about benefits that are or may be due. (See Section 55.07.) The clearest instance of the duty to inform occurs where the insurer knows facts which make it aware that additional benefits are due. In these circumstances, an insurer may not attempt to exploit the insured's ignorance of his rights by offering as full payment less than it knows is due. (See Section 55.07.) Some jurisdictions impose broader duties to inform. (See Section 55.07.)
No duty of good faith applies to sale or renewal of an insurance policy. The insurer's special duty of good faith arises out of an implied covenant that the insurer will do nothing which will injure the right of the insured to receive the benefits of the agreement. The resulting duty emphasizes faithfulness to an agreed common purpose and consistency with the justified expectations of the other party. Thus, this duty does not require an insurer to make additional promises, assume new obligations, or offer to do either; only performance of obligations already assumed is affected. Before the contract comes into existence, there is no basis for that duty (except in Washington, where a statute imposes such a duty). (See Section 55.08.)
Unless the insured drops or compromises the claim, a denial will lead to litigation. Sometimes the insured sues even before a decision on the claim has been reached. Courts agree that the duty of good faith continues even after litigation has begun. The primary meaning of that statement is that the insurer has a continuing duty to pay the claim if (during coverage litigation) the claim ceases to be fairly debatable. Similarly, it has a continuing duty to investigate if new information comes into its possession indicating the possible existence of other information that might support the claim. (See Section 55.09.)
In most jurisdictions, the continuing duty of good faith imposes no extra restraints on an insurer's conduct in litigating with its insured. In general, the procedural rules governing litigation specify what conduct is proper and improper and provide adequate remedies for improper conduct. The insurer's counsel is obliged and entitled to represent the insurer zealously within the bounds of the law, and zealous advocacy ought not to be penalized. Moreover, an insurer must be permitted to vigorously contest questionable claims. (See Section 55.01.) Nor should the insurer's litigation conduct be judged by a jury which lacks competence to make such judgments. (See Section 55.09[a]-[c]) But Pennsylvania and a few other jurisdictions permit some consideration in bad faith cases of the insurer's litigation conduct. (See Section 55.09[d]-[e].)
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William T. Barker is a member of SNR Denton's Insurance Litigation & Coverage Practice Group and practices in the firm's Chicago office. He has a nationwide practice in the area of complex commercial insurance litigation, including coverage, claim practices, sales practices, risk classification and selection, agent relationships, and regulatory matters. He is the co-author, with Ronald D. Kent of THE NEW APPLEMAN INSURANCE BAD FAITH LITIGATION, SECOND EDITION and with Charles Silver of the forthcoming PROFESSIONAL RESPONSIBILITIES OF INSURANCE DEFENSE COUNSEL; he has written over 100 published articles on insurance and litigation subjects. He has been described as "[t]he leading lawyer commentator" on the relationships between insurance and civil procedure. Charles Silver & Kent Syverud, The Professional Responsibilities of Insurance Defense Lawyers, 45 Duke L.J. 255, 257 & n.4 (1995). He is an Adviser to the American Law Institute project on Principles of the Law of Liability Insurance. He is a member of the EDITORIAL BOARD OF THE NEW APPLEMAN ON INSURANCE LAW LIBRARY EDITION and THE NEW APPLEMAN INSURANCE LAW PRACTICE GUIDE. He is Editorial Board Director and Senior Contributing Editor of INSURANCE LITIGATION REPORTER and a member of the Board of Editors of DEFENSE COUNSEL JOURNAL.
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