Suits against insurance companies for failing to provide policy benefits routinely allege that the insurer engaged in unfair claim settlement practices to deny or limit payment of a claim. An insurer’s alleged unfair claims practices are often characterized as a breach of the covenant of good faith and fair dealing (bad faith). In addition to the overriding question of whether the policy covers the claim at issue, coverage litigation against an insurer often includes the question of whether the insurer complied with state laws and regulations governing claims handling.
The National Association of Insurance Commissioners (NAIC) promulgated the Unfair Claims Settlement Practices Act (UCSPA) to provide guidance for states when they enact legislation to govern insurers’ dealings with policyholders, and to avoid unfair claims settlement practices. All states have enacted unfair settlement practices legislation. While individual states’ laws may vary, there are four common themes in UCSPA compliance laws that provide guidance for insurers: communication, investigation and evaluation, documentation, and resolution.
While a violation of their UCSPA is not per se bad faith in most states, such violations often are admissible as evidence that the insurer acted in bad faith. Similarly, however, insurers may point to their compliance as evidence of their reasonable conduct and good faith claims handling.
The first of a two-part series, this article will explore these themes in the context of claims that an insurer engaged in unfair claim settlement practices in response to third-party liability claims.
Duty of Good Faith and Fair Dealing
Policyholder suits against insurers arising from third-party liability suits typically allege that the insurer wrongfully denied or limited recovery of a benefit due under the policy. Usually, this focuses on either the duty to defend or the duty to indemnify. However, such policyholder suits against insurers often include claims against the insurer that allege unfair claim settlement practices and seek damages for both contractual liability and tort liability.
In 1958, the California Supreme Court stated that there is “an implied covenant of good faith and fair dealing in every contract that neither party will do anything that will injure the right of the other to receive the benefits of the agreement.” [See Comunale v. Traders & General Ins. Co., 50 Cal.2d 654 (1958)]. In upholding a liability finding against the insurer under a breach of contract theory, the court stated in dictum that the insurer’s wrongful refusal to settle “has generally been treated as a tort.” Subsequent courts relied on this analysis to impose tort liability on insurers and hold them liable for tort damages, such as accompanying financial losses or emotional distress damages resulting from alleged wrongful denials of coverage.
Most states have adopted similar conclusions and allow policyholders to seek both contractual and tort damages from insurers. Consequently, in jurisdictions that recognize the tort of bad faith, insurers often confront both contract and tort liability exposures, whereas most contract disputes are limited to contractual damages. The distinction can result in significant economic exposure for insurers.
Damages available under a breach-of-contract claim are limited to foreseeable, proximately caused damages within policy limits. In a failure-to-defend action, this typically limits recovery to defense fees and costs. To recover all or a portion of a judgment against an insured, the insured has the burden to show indemnity coverage within the terms of the policy.
In contrast, an insured that successfully prosecutes a tort theory against an insurer may recover proximately caused damages in excess of policy limits and may also seek to recover unforeseeable damages arising from tort. Damages may include automatic liability for an excess judgment against an insured, attorney’s fees for the insured’s pursuit of coverage litigation, emotional distress, or even punitive damages, depending upon the standards in a given jurisdiction.
Bad-faith litigation is often replete with allegations that the insurer engaged in delay tactics and failed to fulfill its duty to defend in a timely fashion or failed to settle third-party claims against the insured.
Claim representatives are best served by being familiar with their obligations to respond to an insured’s tender of an underlying lawsuit. While states may enact different obligations and time frames for an insurer to respond to a tender of coverage, states are uniform in their requirement that insurers communicate with policyholders who seek coverage.
The obligations most frequently identified in state UCSPA laws and regulations include the insurer’s:
• Obligation to acknowledge receipt of a tender for coverage.
• Obligation to make a coverage determination and to advise the insured of the same.
• Obligation to identify and request information from the insured relevant to its investigation into coverage.
• Obligation to disclose policy benefits.
• Right and obligation to advise the insured that it is reserving rights under the policy or applicable law.
• Obligations in advising the insured of its intent to exercise subrogation rights.
UCSPA laws generally identify specific communication obligations and often provide time frames governing insurer communications. For example, a state may require an acknowledgement in 15 days, a coverage determination in 40 days, or a letter advising why a coverage determination cannot be made to be sent every 30 days until a coverage decision is made.
It is also worth noting that most liability insurance policies have corollary terms and conditions that impose obligations on the policyholder, such as the obligation to cooperate in the insurer’s investigation, to meaningfully participate in the insurer’s defense of litigation involving the insured, not to comment on liability or damages to a claimant, or not to voluntarily make any payment to a claimant.
Given communication obligations imposed on an insurer, most attorneys involved in bad-faith litigation begin their efforts by creating a timeline. Voids in communication—from either the policyholder or the insurer—often become the focus of written discovery, depositions, and legal briefs.
Practical considerations also may need to be weighed. For example, some policyholders may ignore insurer requests for information or documents that are essential to the insurer’s investigation and coverage determination. While an insurer may be allowed to request information and to follow up with the insured on a regular basis, both the insured and insurer may be uncomfortable if, one or two years after a claim was tendered, there has been neither a response from the insured nor a decision from the insurer. If an insurer cannot make a coverage determination absent information the insured refuses to produce, the insurer should advise the policyholder of its burden to bring a claim within coverage, and that the insurer presently is unable to identify any coverage for the claim, but is willing to reconsider should the policyholder elect to comply with the request for information.
Finally, insurers are well advised to calendar compliance deadlines on individual files.
Investigation and Evaluation
Courts have found that an insurer may breach the implied covenant of good faith and fair dealing if there are unreasonable delays in its investigation, or its rendering of a coverage decision. However, in the absence of coverage under the relevant policy, there can be no breach of the implied covenant of good faith and fair dealing in most jurisdictions. Thus, a policyholder cannot create coverage where none otherwise exists based on the insurer’s conduct.
While standards for determining bad faith vary by jurisdiction, most require a policyholder to prove that the insurer’s conduct was unreasonable. A minority of jurisdictions go further and require that a policyholder show that the insurer acted vexatiously or with evil intent.
Attorneys who confront questions regarding the insurer’s investigation often focus on whether the investigation was thorough, fair, and objective, and whether it verified damages or injury.
Similarly, a review of the insurer’s evaluation often will consider whether that evaluation included: examination of coverage, liability, injury, and damages; determination of a fair payment amount; and the insurer’s reserves (although jurisdictions vary on whether such inquiries are relevant).
Critical to an attorney’s prosecution or defense of bad faith litigation is whether the insurer’s file is sufficiently documented. This includes all documents from the first notice of claim to each claim’s conclusion. Every written communication should be saved. Every oral communication should be documented in the claim notes. The file also should include all documents provided by the insured.
In some instances, the underwriting file may need to be a part of the claim file or linked thereto. The insurer’s documentation is its best evidence that it complied with UCSPA laws governing communication, investigation and evaluation, documentation, and resolution.
Litigation regarding documentation often focuses on whether the documentation is factual, adequate and accurate, and whether it includes a claim valuation with relevant data and a coverage analysis.
From a practical perspective, certain mistakes are easily avoided in documenting a file:
• Do not make gratuitous comments.
• Limit your documentation to the claim at issue—even if the insured or its coverage counsel have other claims with you.
• Avoid email references to multiple claims or unrelated administrative matters.
• Be cautious of using cut and paste for reports.
• Be wary of discarding communications that you deem irrelevant; sometimes the mere fact that you were communicating is relevant.
• Keep privileged communications privileged.
An insurer’s claim resolution process is often the primary focus of bad-faith litigation. Just a few examples include an insurer’s unwillingness to pay for uncovered portions of a claim; an insurer valuing a claim for significantly less than the policyholder values it; disputes with the insured over liability and damages; and the insurer’s rejection of a settlement demand within policy limits that subsequently results in a verdict in excess of policy limits.
The insurer’s claims handling practices often are judged by the following criteria:
• Did the insurer use objective criteria or were the settlement offers based on subjective or “it just feels right” kinds of negotiations?
• Are demands and offers documented?
• Were the demands and offers reasonable and supportable and derived from reliable sources?
• Did the insurer attempt settlement at an appropriate time?
• Did the insurer rely on an assessment from panel defense counsel or a relevant expert?
UCSPA guidelines and case law acknowledge that claim valuation is an imprecise science. However, guidelines universally preclude low-ball negotiations and encourage insurers to use objective factors in their claim resolution negotiations. While insurance adjusters and attorneys of all levels of experience may be tempted to negotiate based simply on their experience or “gut feeling” for a case, this should be avoided, just as claimants should avoid making demands that they cannot support with documentation and calculations. Indeed, insurers should request support from claimants to justify any demand and then document why such demand is inflated, unsupported, or not covered.
UCSPA laws and regulations provide insurers with measurable and tangible guidelines to aid in their claims handling. Significantly, compliance with such guidelines is often the first line of defense against claims that an insurer acted unreasonably and, in fact, often supports that the insurer’s claim settlement practices were reasonable and that the insurer acted in good faith.