Claims files end up in litigation for a variety of reasons. Unless the reason for the litigation was intentional on the part of the insurance company or self-funding entity, the litigation may indicate unsatisfactory service by the claims department or an individual adjuster. Litigation is an extra expense on top of the value of the claim, unless the basis for the dispute was legitimate and unavoidable.

Why do claims files end up in litigation? There are a number of reasons why an insurer may elect to litigate a claim. The first is that there is a coverage dispute and the insured does not agree with the insurance company that the coverage does not apply to the claim. In such cases, the insurer may file a lawsuit with the court requesting declaratory relief, even if the insurer is actually defending the claim under a reservation of rights (ROR). The court will then review the claim and the coverage and look for the “eight-point match,” under which the “four corners of the policy” must match the “four corners of the claim or lawsuit.” If they do not match, then coverage does not apply—or at least it does not apply in totality. The parties must then agree as to what is covered and what is not covered as well as who will pay for non-covered parts of the claim. In a good claims investigation and negotiation, however, those factors should have been determined and agreed upon without the court's help. When the auditor is reviewing a claim in litigation for declaratory relief, he or she should look for evidence that the adjuster sat down and reviewed the policy with the insured, seeking advance agreement that the coverage did not apply or applied to only part of the claim. If that is missing, then the file was not well adjusted. It requires a very good and experienced adjuster to be able to do this correctly and to document any “non-waiver” agreements reached with the insured in a formalized and official way.

Source of Coverage Disputes
Coverage issues can arise from many causes involving almost any aspect of the policy. The claim may involve a question of whether the parties against whom the claim is being made are insured under the terms of the policy or by virtue of some contract. The dispute may involve a condition, such as late notice or, in a “claims made” policy, determination of when the insured first knew about the claim and whether it was made within the time prescribed by the policy. The claim may not fit—or may not totally fit—the insuring agreements. Many lawsuits against insureds are filed for financial damages. Financial damages are neither bodily injury nor property damage, except to the extent of special damages or loss of use of physical property. Perhaps the most common source of a coverage issue is an exclusion. If a loss is clearly excluded, then there is no coverage.

The problem is that many claims or lawsuits “fall in the cracks,” where part of the claim may be covered but other parts excluded. Plaintiff attorneys love to add as many counts to their lawsuits as their imaginations can dream up—and often they are only creating problems for themselves because what they may allege, to make the lawsuit sound more vicious, may be an excluded loss. “The defendant viciously and intentionally rammed his automobile into the plaintiff's vehicle when the plaintiff stopped for the red light.” Really? It's a simple rear-end collision, but now it is also a coverage issue, because intentional injury or damage is excluded.

Now, what does the adjuster do with such a lawsuit? He or she could call the insured and say, “Sorry, this lawsuit is not covered. A denial letter is in the mail.” That would make quick work of it—and would result in a lawsuit. Or the adjuster could call the insured and explain that the way the lawsuit is worded creates coverage issues. Since the insurer needs to act immediately in the insured's best interests, it would send an ROR letter reserving the right to deny coverage if the allegations turn out to be true—but in the meantime the investigation would proceed and the insured would be defended. Then the adjuster would proceed to investigate and, in 99 percent of the cases, find that the allegations of an “intentional act” were not true.

But there is that one percent of cases where it might be true. In such a case, the insurer may elect to take to court the evidence that the insured knew the plaintiff, that he was angry with the plaintiff and did intentionally ram the plaintiff's auto with the intent to injure the plaintiff—and seek declaratory relief that further defense is not owed.

A Typical Scenario That Could Result in Litigation
An insured collides with another vehicle in an intersection, and the other driver is seriously injured. The insured has a $1 million policy limit. The nature of the injury, considering its permanency, might be worth $250,000, but there is a dispute over who had the right-of-way in the intersection. The state has a modified comparative-negligence law. If the other driver was at least 50 percent at fault, his claim is barred. But there is some indication that the other driver, while partly at fault as he had the last clear chance to turn out of the insured's way, was less than 50 percent at fault—maybe only 20 percent or 30 percent at fault. The other driver's attorney alleges that the insured was 100 percent at fault and that the claim is worth well over $1 million.

This is a typical kind of claim that ends up in litigation because the parties cannot agree on the facts. How much is the claim really worth? How much did the claimant actually contribute to the accident? Here is where an auditor can really earn his pay. What did the adjuster do about the dispute? Did he throw up his hands and say, “So sue me”? Or did the adjuster fully investigate the facts of the accident, going to the scene and looking at what is known from statements of the insured, the claimant, witnesses, and the physical evidence from both perspectives? Did the adjuster examine the vehicles or retain an expert in accident reconstruction to try to figure out the physics of the accident? Maybe both parties were distracted—the insured busy talking on a cell phone, while the claimant was looking for an address and was inattentive. If there were skid marks, where did they start, and was that logical for either explanation?

Did the adjuster fully investigate the injury? Were timelines prepared showing the claimant's medical history and any prior injuries that might be an offset to the new injuries, or tracking from the time of the accident to the arrival of EMTs and the ambulance as well as arrival at the emergency room and first treatment? Was there any delay that might be considered a contributory factor, perhaps even malpractice? Misery and claims both love all the company they can acquire. Did the adjuster arrange for an independent medical examination of the claimant once the medical information was received and a degree of permanent injury stated?

Then, if all this was done and the factors discovered were favorable to the insured, did the adjuster sit down with the attorney and discuss the facts? Today it is almost unheard of for an adjuster to actually meet with a claimant's attorney and discuss the claim. If the attorney is sitting with a file a foot deep and the adjuster has a file that has only a police report and the medical bills in it, the adjuster will not be able to correctly evaluate and reserve the file and conduct a reasonable negotiation.

Litigation is costly to both sides. If the adjuster has properly investigated the facts as to coverage, liability, and damages, then every attempt to resolve the claim without litigation should be made. Few insurers today allow their adjusters to do that. Instead, there is a phone call or two, an offer, counterdemand, new offer, and a “take it or leave it” new demand followed by a delay in response while the reserves are updated. If this is what the auditor finds, then it is most likely the claim manager's limitations on the adjuster rather than the adjuster's own laziness that will be the cause of that lawsuit.

The 'Tripartite' Relationship
It is often difficult for younger claim representatives and adjusters to understand the various aspects of claim litigation. Coverage disputes are one thing; but disputes over liability and/or damages are perhaps more common in either personal lines or commercial-liability lines of insurance—especially where issues of contributory or comparative negligence are involved. A liability insurance policy generally includes, as a supplement to the policy limits, any outside investigation and defense costs. The insurer owes the insured a defense of any claim or lawsuit against the insured, if the coverage applies.

The insurer also has the right to settle or defend as it decides is appropriate, even when such a settlement would require payment of any deductible by the insured. The insurer has the right to settle a claim, whether it is owed or not. The insured—unless the insurer proceeds under an ROR or there is a “consent to settle” endorsement—must accept the insurer's defense and decision to settle or litigate. If the decision is made to defend, it is the insurer that selects the defense counsel.

That should be the best defense counsel for the jurisdiction and the type of claim involved. However, while the insurer selects and pays the defense counsel, it is the insured who is that defense attorney's client—not the insurance company. Therefore, the attorney must provide the best defense of the insured possible, subject to the insurance company's ultimate right of decision as to whether to settle or defend.

One aspect that the auditor must always examine is the anticipated value of the claim as compared with both the reserves set for the claim and the policy limits. If the file reflects that a “more than policy limit” demand has been made, has the adjuster issued any sort of excess letter to the insured, warning that the claim's value might exceed the policy limits? Does the insured have other insurance? Has the adjuster identified any co-tortfeasors or principals who might have other applicable insurance? If not, the adjuster is flirting with a potential “bad faith” claim, should the case go to trial and the verdict exceed the insured's policy limits.

Auditing Litigation Management
Too many insurance companies and adjusters simply abandon claim litigation to the defense counsel they have hired to defend the insured and let the attorney manage the litigation. If the auditor detects this, it is a serious matter. The claim management team is “in charge” of overseeing what adjusters do. If adjusters abandon litigation to attorneys, the costs are going to be far higher than if the litigation was properly managed.

It is comparable to a patient seeing a doctor. The doctor makes a diagnosis but suggests a variety of expensive tests to confirm or rule out the diagnosis, partially out of fear that if the battery of expensive tests are not run, the patient might later make a malpractice claim. But every patient must be his or her own medical manager, asking for an explanation of why each suggested test is needed and deciding whether to proceed. A patient, after all, can say “No.” If the patient doesn't, then sometimes the patient's insurance company may have to say “No.”

Likewise, the attorney must provide the best defense for the client, the insured policyholder. But it is not always necessary to depose everybody in town and obtain five tons of documents if the claim does not warrant such. Therefore, the adjuster needs to be involved in the day-to-day litigation management, with the stated objective of resolving the dispute as quickly and cheaply as possible.

What should an auditor look for? First, it should be determined whether the insurer sees the claim as one that should be settled or one that should be disputed vigorously. If the claim is owed, and the dispute is only over how much it is worth, perhaps the lawsuit was filed only to stay the statute of limitations or to give a negotiating edge to the claimant. The only defense needed in such a case is an extension while the adjuster continues to negotiate, or else the filing of an answer to prevent default while the adjuster continues to negotiate. If the adjuster can negotiate a settlement, then the basic costs of defense—which can easily exceed $50,000 to $100,000—can be avoided.

Weighing the Motion's Merits
On the other hand, if the claim is one that the adjuster and the claim department management has determined is one for defense, then the auditor must look at all the aspects of the defense to see if the adjuster is properly managing it. It is the attorney who must maintain the day-to-day control of the case, but it is the adjuster who is basically in charge of that “settle or defend” option.

The first aspect to check is whether the proper venue is being used. If the case is in state court, should it be in federal court or vice versa? Has the adjuster reviewed with the defense counsel the defense and plaintiff interrogatories and motions to produce and assisted in obtaining information that may be required? It is generally cheaper for the adjuster to do this than to have the attorney's paralegal do it. Have the defense's interrogatories been reviewed and suggestions offered of additional information that should be obtained? At this point in the litigation, the adjuster may be far more familiar with the facts of the case than the defense attorney, even if the adjuster's file was well-documented.

What sort of motions has the attorney suggested, and has the adjuster considered the merits of each? Every motion filed will require response by the plaintiff's side, making the case more expensive for both. If the reason for the litigation is a stubborn plaintiff that even his or her own attorney cannot persuade, a barrage of discovery can often help in making that plaintiff “see the light” and capitulate. Aggressive defense can leave the other side whimpering, and that can be an opening for reasonable negotiation.

Is mediation or arbitration being considered? Have there been meetings between the parties, and was the adjuster there? If there was mediation, did the adjuster have sufficient authority to settle? If not, the event was a waste of time and money. If trial is considered, then what is the defense attorney's opinion of the opposition's attorney, the judge and the jurisdiction? If it is unfavorable to defense, has any settlement offer been made?

If both liability and damages are in dispute, then will the trial be bifurcated, with liability argued first? These are all factors the auditor must consider in reviewing the file. Simply by looking for these factors, the auditor may be able to help move the case from stalemate to a successful conclusion.

Special Reports /

Claims Auditing 101: Part 4

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