What is Insurance Bad Faith?


Insurance bad faith refers to a claim that an insured person has against an insurance company for bad acts.

An insurance policy is a contract between the insurance company and the insured - the person who bought the policy. Every insurance contract contains an unwritten, invisible, or implied term referred to as the covenant or promise of good faith and fair dealing. The insurance company is required to act in good faith: to do nothing that prevents the insured from realizing the benefis of the policy. This includes a promise imposed by law upon an insurance company to always act fairly towards its insureds in handling their claims. Whether or not such a clause is included in the policy, judges will read the policy as if it were there. Carriers must meet the reasonable expectations of the policyholder and an insurer must always give as much consideration to the financial interests of its insureds as it does to its own financial interests.

Under the law of the State of California, insurance companies owe a duty of good faith in dealing with the persons they insure. If they violate that obligation, many states allow the insured person (or "policyholder") to sue the insurance company. Beginning in the 1970's in California, courts began to hold that policyholders could sue insurance companies that acted in bad faith. An insurance company has many duties to its policyholders. One, it usually has a duty to defend a claim (or lawsuit) even if some or most of the lawsuit is not covered by the insurance policy. Two, it has a duty of indemnification, which is the duty to pay a judgment against the policyholder, up to the limit of coverage, but only if the judgment is for a covered act or omission. Bad faith is a fluid concept and is defined primarily in case law. Examples of bad faith include undue delay in handling claims, inadequate investigation, refusal to defend a lawsuit, threats against an insured, refusing to make a reasonable settlement offer, or making unreasonable interpretations of an insurance policy. The policyholder would be damaged, for example, if an insurance company refuses to make a reasonable settlement offer which the policyholder wants, and the policyholder is later subject to a judgment in excess of the policy limits, that is damage. In some cases, the tort of bad faith allows punitive damages against insurance companies if the jury determines that an insurance company acting in bad faith did so with oppression, fraud, or malice to prevent future misbehavior. An insurance company may be liable for punitive damages because of the acts of its employees.

When a person files a claim of loss, the insurance company cannot make up a reason to deny the claim or look for ways to escape its obligation to pay. The insurance company must look at the claim fairly when deciding whether to pay it. This includes an obligation to investigate not only what is actually covered under the policy, but what could be potentially covered. The California Unfair Claims Practice Act (Insurance Code Section 790.03 (h) contains standards for the investigation and handling of insurance claims

If there is a question concerning what is covered under an insurance policy or what the various terms mean, the courts will usually interpret confusing, complicated or ambiguous contract terms against the insurance company to give the insured person coverage. Typically, if there is more than one way to interpret a word, phrase or clause, the interpretation that will include coverage is generally used. And, if a word, phrase or clause excludes coverage, it usually will be given a very narrow or restrictive meaning, that is, it will be read so that as little as possible will be excluded from coverage.

What the insured primarily buys is peace of mind: if a legitimate claim is filed, but denied, the insurance company is in breach of the contract. The insured can then file a law suit for the damages that should have been paid on the claims, and might be able to collect the additional expenses that arise out of the insurance carrier’s failing to pay as agreed.

An insurance company's mere refusal to pay a claim does not necessarily amount to bad faith. Although the elements of proof required for a bad faith claim vary from state to state, the insured person must usually establish that: The insurance company had no reasonable basis for denying a claim; yhe company either knew or should have known there was no basis for denial of the claim, or that the it acted with reckless disregard for the facts or the insured's rights. A bad faith claim can also arise from an insurer's failure to investigate or to process a claim.

In a bad faith action an insurance company's business practices or common course of conduct is routinely admissible to show motive, opportunity, intent, plan, knowledge or the absence of a mistake or an accident in the manner in which it dealt with its insured. It is not necessary to show that the insurer intended to cause harm in a breach of the covenant of good faith and fair dealing. The policyholder need only show that the insurer failed to honor the agreement and had no cause not to pay what was due under the contract. When a person buys an insurance policy, the very risks that are insured against make it clear that if a claim is not satisfied the policyholder will suffer financial pressure and emotional distress. Policyholders obviously will be vulnerable to oppressive tactics by a carrier and insurance companies are presumed to know that a denial of benefits will very well result in emotional distress to their insureds.