It is an unfair practice for an insurance company to unlawfully or unreasonably withhold payment of insurance benefits. 

Contract or Tort?
The relationship between insurer (the insurance company) and insured (the customer) is governed by a contract, and failure to live up to the terms of that contract by either party can give rise to a claim of breach of contract.  A contract is formed when two parties each bind themselves to a duty to the other.  In a standard insurance contract, the insured promises to pay premiums and perform other duties (discussed later below), while the insurer promises to pay claims that arise within the scope of policy’s coverage. 

A contract breach gives rise to an action by the non-breaching party to recover compensation in the amount it was damaged by the breach.  In the case of an insured being denied insurance benefits to which it is entitled, the measure of damages is basically that amount of benefits it should have received.  But an insured forced to sue on a breach of contract will not necessarily be made whole by a judgment in its favor, because the insured had to incur significant litigation costs in the process.

However, breach of contract is not the only theory of liability under which an aggrieved insured may proceed.  Besides the express terms of the contract itself, every contract is said to include an implied covenant of good faith and fair dealing.  It is the violation of this implied covenant which leads to the bad faith insurance claim discussed here.

Breach of the implied covenant of good faith and fair dealing is an action in tort as opposed to contract.  In a breach of contract claim, recovery is limited to actual damages suffered, and only if those damages which were likely to arise or reasonably foreseeable.  In a tort action, on the other hand, a plaintiff can recover all actual damages as described above as well as non-economic losses such as emotional distress, pain and suffering, attorneys’ fees, and even punitive damages in certain cases.

Bad Faith Defined
The implied covenant of good faith and fair dealing has both subjective and objective elements.  “Good faith” is subjective, while “fair dealing” is an objective standard.  The objective standard requires a look at the customary course of business in the industry to determine if this particular insurer was reasonable in its actions.  This element is fairly straightforward, so most attention is usually focused on the subjective element of whether the insurer acted in good faith.

Bad faith requires more than a mistake, negligence or incompetence on the part of the insurer.  The insurer’s actions must be intentional and unreasonable.  The insured must act unreasonably or without good cause in denying the claim.  (Note: If the insured is merely wrong in its decision but not in bad faith, there is still a breach of contract action available, but recovery is limited as discussed above.)

Bad faith claims can arise whether the insurer owes the insured directly or a third party injured by the insured.  In either case, an unreasonable refusal to pay benefits owed on the policy can create a bad faith claim. 

Duty to Defend
Another area which can give rise to a bad faith claim is refusal to defend.  Most insurance policies provide that the insurer will defend the insured in lawsuits brought by third parties within the scope of the insurance policy.  For instance, a driver involved in an auto collision may be sued by the driver of the other vehicle.  The insurer is most likely required under its policy to pay the insured the damage he or she incurred, as well as settle with the driver whose vehicle was damaged by the insured. 

A policy may require the insurer to defend the insured even in situations where a court judgment would not be covered under the policy.  An insurer in this situation can defend the claim under a reservation of right.  Here, the insurer defends the claim at its own cost but reserves the right to deny coverage of the judgment if the insured is found liable to the other party. 

Given the options available to the insurer, a deliberate and unreasonable refusal to defend a covered lawsuit gives rise to a bad faith insurance claim.  Even absent a finding of bad faith, an insurer which does not defend a claim when it is obligated to do so may still find itself liable for any (reasonable) settlement the insured reaches with the third party, as well as the costs of litigation and other damages incurred by the insured.

Duty to Settle
Some states hold that the implied covenant of good faith and fair dealing includes a duty for the insurer to accept a reasonable settlement demand from a third party that is within policy limits.  Again, the subjective and objective standards apply.  To pursue a bad faith claim based on the insurer’s refusal to settle with a third party, the insured must prove that the third party’s offer was reasonable and within policy limits and that the insurer’s refusal to accept the offer was unreasonable.  The insured must also show that a judgment was entered against it for an amount above policy limits, and that the insurer’s defense was undertaken without a reservation of right, as discussed earlier.

Other Grounds
Failing to investigate a claim properly, or undue delay in processing a claim, can also be grounds for a bad faith claim.  A bad faith claim could be asserted for undue delay even when the insurer eventually settles, if the facts support that the insurer was acting in a deliberately unreasonable manner (i.e., in bad faith).  While it may not be unreasonable for an insurance company to consider its duty to shareholders and other policyholders and to want to watch its bottom line, deliberately “lowballing” settlement offers or benefit payments may again be bad faith if such offers are unreasonable in light of actual damages, policy limits, and what an insured or third party should reasonably expect to receive.

Defenses
The insurer may claim breach of contract by the insured.  The insured has many duties under the standard insurance contract besides just the payment of premiums.  Generally, the insured is required to provide notice of any claim in a timely manner.  Also, the insured is often required to submit a statement of proof of loss.  Another common trap for the unwary could be a limitation in the policy on the timeframe within which the insured may sue on an alleged breach. The insured may not be aware of these requirements yet may nonetheless be required to abide by the terms of the policy. 

However, courts in some circumstances may not impose all such requirements on the insured.  Some factors to consider are the sophistication of the insured, whether the terms were conspicuous or explained at the time of signing, and whether the policy is considered to be an adhesion contract (where one party is not negotiating terms but is rather presented with a standard contract and told to “take it or leave it”).  Contracts that are heavily one-sided in favor of a party with disproportionately superior bargaining power are often interpreted leniently in favor of the less powerful party.

Another defense to a claim of bad faith available to the insurer is that it relied on advice of counsel in denying the claim or in refusing to defend a lawsuit.  By the same token, however, rejecting the advice of counsel to pay the claim or defend the suit can be offered as evidence of bad faith.

Finally, there may be situations where federal law controls, and the administrative remedies provided in the federal law preempt any state actions such as a bad faith claim.  Flood claims, Medicare benefits and employee benefit plans are all examples of areas in which the federal government has acted, potentially shutting off the right of an insured to pursue a bad faith claim in state court.  Where the federal government has not occupied the field, bad faith insurance claims are controlled by the law in the particular state in which the suit is brought or the underlying event occurred.

If you believe an insurance company is acting unreasonably regarding your valid claim, you should seek the advice of an attorney immediately to protect your interests.  The lawyers of the National Justice Coalition confront insurance companies everyday and have the skill and experience to vindicate your rights and achieve a just and fair result.  Contact the National Justice Coalition to be connected with a lawyer in your area today.