An increase in the legislation that would create or expand “badfaith” insurer liability is cause for concern about the effects oninsurers, policyholders, agents and consumers. Such bills arepushed as beneficial to consumers because the bills increaseleverage in dealings with insurers (see the sidebar for a list ofsuch potential bills). But legislators who give full considerationto their potential impact and assess whether they are warrantedgiven existing legal standards governing such dealings should seethat these bills actually hurt consumers. While insurers must payall covered claims, they also are obligated–to other policyholders,stockholders, other insurers and all who buy insurance–to respondto each claim with an appropriate level of scrutiny, not to payuncovered claims and not to pay more than they should for coveredclaims. This can be challenging because it involves applyingcomplex contracts to frequently inconsistent accounts of factualsituations. So it's not surprising that disagreements amonginsurers, insureds and third-party claimants are not unheard of. Resolvingdisagreements
Because insurance is a contractual relationship, disagreementshould be resolved according to the terms of the contract: theinsurance policy. It is not only a matter of contractual obligationbut also good business for insurers to act in good faith when theyhandle claims. Insurance is all about promises and reliability, soinsurers strive to perform well when it's time to process and pay aclaim. Nevertheless, leaving such resolution solely to theinsurance policy has been viewed as unsatisfactory by many for sometime. Consequently, legal standards and remedies apart from thecontract have been developed from a number of sources. Every statehas unfair claims practice statutes, for example, to establishadministrative remedies for consumers to pursue with stateinsurance departments. What we have seen in recent years is adisconcerting increase in legislative activity involving bills thatdramatically expand insurers' liability in a variety of ways. Theterm itself, which refers to the implied duty of good faith inevery contract, is frequently not found in the text of the bill.From an advocacy standpoint, it's probably an unfortunate term,because it puts insurers on the defensive at the outset. No onewants to argue that insurers can act in bad faith withoutconsequence. But the question is what consequence is warranted orneeded to promote and encourage appropriate insurer conduct.Common provisions
Most bad faith billscreate or expand on a private right of action. Often, a bill refersto a list of prohibited actions that already give rise to anadministrative proceeding undertaken by a state insurancedepartment, and state that upon enactment private individuals canbring an action in court based on one of those prohibited actions.Bad faith bills typically provide for the recovery of new specificdamages above and beyond the limit of the insurance policy, such asinterest, attorneys' fees and exemplary or punitive damages. Theyoften contain provisions calling for punitive damages as high asthree times the amount of actual damages. Bad faith bills oftenlower the standard necessary for a plaintiff to meet to file asustainable suit. For instance, many existing statutes requireshowing that an insurer violated certain standards so often that itindicates a general business practice. Bad faith bills frequentlyseek to allow claimants to sue for a single violation.Consider the consequences
It doesn't take a great act of political courage to introduce aninsurance bad faith bill. A bill that enables constituents to sueinsurance companies more easily for more money is an easy sell. Andit's probably not a bad thing for one's political career to havethe backing of the trial bar. But those same constituents also areinsurance buyers who pay premiums, the cost of which is directlyaffected by the costs that insurers incur in the claims process.These include not only larger damage awards, but also the cost ofdefending lawsuits and paying higher settlement amounts to avoidlitigation. Legislation creating a new private right of actionleads to more lawsuits, which are expensive to defend regardless ofthe outcome. The same goes for legislation that does not create atotally new private right of action but lowers the standardrequired to bring suit. Out of balance
Increased costs from suits represent just the tip of the bad faithiceberg. The threat of litigation and the potential for expansivedamages throw the entire claims processing environment out ofbalance. Companies facing exposure to costs greatly exceedingpolicy limits naturally view claims very differently. The resultcan be claim settlements that are higher than warranted onmeritorious claims, and the payment of claims that may or may nothave merit to avoid the high costs of litigation. Another potentialconsequence of particular significance to agents is that excessiveliability could make an insurer consider withdrawing from a stateor reconsider entering a state. The ultimate impact on availabilityand competition may be hard to demonstrate, but the effect on costsis clearer. NAMIC last year published a comprehensive public policypaper, “First-Party Insurance Bad Faith Liability” available as aPDF at www.namic.org, whichexamined the unintended consequences of first-party bad faithlegislation. The paper found evidence suggesting that “allowingtort liability for insurance bad faith results in reduced insurerincentives to challenge disputable claims, and in higher claimscosts as a result.” The paper concluded that recently enacted badfaith laws in several states “will create incentive distortionsthat may lead to greater uncertainty and higher costs for insurers,higher levels of insurance fraud, and correspondingly higherinsurance premiums for consumers.” Especially in light of theeconomic crisis, legislators considering bad faith bills have todecide whether it is sound public policy to enact a law that willultimately produce higher costs for consumers.. It would be onething if proponents came armed with comprehensive findings ofwidespread inappropriate behavior by insurers, but the sponsors andsupporters of these bills typically muster nothing more than a fewunsubstantiated anecdotes. What is disconcerting is that despitethe consumer impact and lack of showing regarding their need, somelegislative bodies are giving bad faith bills seriousconsideration. Paul T. Tetrault, JD, ARM, AIM, Northeast stateaffairs manager for the National Assn. of Mutual InsuranceCompanies, advocates on behalf of NAMIC members on key legislativeand regulatory issues. He can be reached at [email protected].