The Basics of Bad Faith Insurance Litigation

The Basics of Bad Faith Insurance Litigation

words cloud with insurance in red, bad faith insuranceBad faith claims arise when insurers fail to uphold their obligations under the insurance contract, and that failure results in harm to the insured. Insurance companies are incentivized to maximize the collection of premiums and minimize the payment of claims. Some insurers take that incentive too far and harm the interests of their policyholders. Bad faith is the primary vehicle that policyholders utilize to hold insurance companies accountable.

Historical Context

New York was the first state to imply a “covenant of good faith and fair dealing” in insurance contracts. Before that ruling, policyholders were forced to rely exclusively on contract law. Unfortunately, contract law limited policyholders’ recovery to the amounts provided under the insurance contract.

Thus, many policyholders were discouraged from pursuing litigation because the potential compensation did not outweigh the cost of litigation. By applying the implied covenant, plaintiffs could recover extra-contractual damages, such as attorneys’ fees, which reduced the risk to plaintiffs.

Modern Developments

The Wisconsin State Supreme Court took the law even further and determined that insurance companies were the agents of their policyholders. The Court could then apply fiduciary obligation to insurance companies, which requires them to place the interests of the policyholders above their own.

The fiduciary duty allowed plaintiffs to sue under a separate tort-based cause of action. This latest development gave rise to the modern “bad faith” cause of action. The independent cause of action allowed plaintiffs to recover damages substantially beyond their policy limits which discouraged insurers from acting against the interests of their policyholders.

However, since this is a separate cause of action, it does not arise when the insurer simply denies a claim. The insurance company must take additional actions that violate the implied covenant of good faith and fair dealing. Thus, it is possible for an insurance company to breach the terms of a policy but not give rise to a bad faith claim.

Bad Faith Claims

There is no uniform definition of “bad faith” insurance. Most courts take a “we will know it when we see it” approach. The courts consider some of the following factors:

  • Any attempts by the insurer to compel the insured to contribute to a settlement;
  • Failure of insurer to inform the insured of a compromise or settlement offer;
  • The amount of financial exposure of each party if a settlement offer is rejected;

The courts essentially assess situations which suggest bad faith actions by the insurer.