Bad Faith and Beyond

Some states provide no remedy for bad faith in first-party insurance; however, most divide into two camps. About a half dozen states, of which California is the most notable, impose liability where the company denies a claim unreasonably or without proper cause. Many more states hold an insurance company to have acted in bad faith only where it unreasonably processed, investigated, or evaluated a claim and where it did so intentionally or recklessly—that is, where the claim was not "fairly debatable."

As courts developed the law of bad faith, they mostly dealt with allegations of wrongdoing by individual adjusters. In a famous California case, for example, the adjusters for Mutual of Omaha ignored the diagnosis of the treating physicians of Michael Egan, an insured under a disability policy, and failed to have the insured examined by a physician of their own before denying coverage. To add insult to injury—literally—one of the adjusters called Egan a fraud and, when he expressed concern about not having enough money during the Christmas season, the adjuster only laughed, reducing Egan to tears in front of his wife and child. 

Institutional Bad Faith
Many other cases, particularly recent cases, have focused on allegations of what has been described as "institutional bad faith." Adjusters know that the claims process has become more systematic and less discretionary than it was a generation ago. Systems are the only way that a company can achieve consistency in claims and the only way it can effectively set and monitor financial objectives. It is important to keep in mind that systems also can be misused, and that misuse is the essence of an institutional bad faith claim.

Some institutional bad faith claims attack the rules under which adjusters work because they can undercut the adjusters' responsibility to pay claims fairly. When a jury found that State Farm had unreasonably delayed paying a UIM claim for a year despite clear proof of liability, evidence that State Farm set arbitrary goals for the reduction of claims paid and used the goals to determine salaries and bonuses paid to adjusters was held to be relevant to determining its bad faith.

Other cases address the systems used to investigate, evaluate, and settle claims. An area of particular controversy has been the response to minor impact auto accidents producing only soft tissue injuries—MIST claims. Since the time of Charles Dickens, who reported suffering what became known as "railway spine" following a train crash, insurers have been concerned that injuries allegedly caused in low-speed crashes that lack tangible proof such as broken bones are a fruitful source of fraudulent claims. Therefore, companies often institute special procedures in dealing with MIST claims.

MIST Cases and Strategies
A pair of Arizona cases illustrate the attempt to use an allegation of institutional bad faith to attack the handling of MIST claims. In one case victims of an accident caused by an Allstate insured claimed that the company had abused the legal process through its MIST practices, including making lowball offers of settlement despite clear liability and damages; according to its lawyer, Allstate had decided to "draw a line in the sand" and aggressively defend even justified MIST cases. The court concluded that evidence of Allstate's redesign of its claim process in MIST cases, such as a statement in a policy manual that it needed "to send a message to attorneys of our proactive stance on MIST cases" was evidence of its ulterior motives. In the other case examining Allstate's MIST strategy, however, a federal court found that allegations of institutional bad faith in Allstate's handling of MIST cases were not supported by evidence that the strategy was "anything other than sound business and claim-handling practices." 

A widely publicized instance of allegations of institutional bad faith involved Unum, the largest seller of disability and long-term care insurance, and its predecessor companies. Several courts found that the companies engaged in a scheme to disregard the rights of their policyholders in order to increase profits. Among the tactics found to be evidence of institutional bad faith: 

• Demanding objective evidence of injuries beyond what was required by the policies, even in claims involving illnesses such as chronic fatigue syndrome for which objective evidence could not be obtained.
• Shifting the burden of claims investigation to the insured.
• Over-valuing the opinions of in-house doctors who had never examined the insured instead of the opinions of the insured's treating physicians and independent doctors. 
• Setting financial goals for adjusters without regard for the merits of claims.

Allegations of institutional bad faith such as these attack a company's claims handling operation, rather than just the actions of a single incompetent or rogue adjuster. They also portend that the law of bad faith is changing. The term "bad faith" connotes wickedness, an isolated wrongdoer in a claim department subverting an otherwise fair process. In its place we may see developing a new, broader law of claim practices. 

The new law of claims practices may focus more on standards, systems, and procedures. A claimant who asserts bad faith treatment by an insurance company still must prove harm through the mishandling of an individual claim, but the focus shifts to the institutional setting that contributed to the denial. The cases described above illustrate. A company that gives adjusters a financial incentive to deny claims, has a system in place to aggressively defend even valid MIST claims, or uses a biased investigation process to favor its own fin ancial interest over its insured's interests demonstrates an institutional culture of bad faith. 

At a recent conference sponsored by the Center for Risk and Regulation at Rutgers Law School, Camden, Professor Kenneth Abraham of the University of Virginia School of Law suggested that the rise of institutional bad faith claims may even indicate a transformation in insurance law generally. Abraham, one of the nation's leading insurance law scholars, noted that the behavior labeled as "bad faith" by insurance companies often would be tolerable if engaged in by other types of businesses. Giving employees an incentive to cut costs when dealing with customers might even be praiseworthy in other settings.

Beyond Providing A Policy
But insurance is different. Insurance companies take pride in doing more than selling a product; they provide security. Some of the iconic slogans of American advertising—"You're in good hands with Allstate." "Like a good neighbor, State Farm is there."—embody the promise that the insurance relationship is a special one. By providing security, insurance also serves an important social function, providing a safety net for the standard of living of the American middle class.

Abraham puts together the claims of institutional bad faith and other insurance law developments with the special nature of insurance to suggest that we may be seeing the development of a new conception of insurance law. Insurance companies are private companies that serve a public function, so the law should requires of them higher standards of conduct than of other private companies. A form of "due process" may be required, not as broad as the due process required of the government itself but still more than is required of other commercial enterprises.

The full-scale development of a new insurance law is still off in the future, but its precursor, a focus on institutional bad faith, is already here. The lesson for insurers and claims personnel is to renew their focus on the fairness of standards and systems. The actions an adjuster takes on an individual claim are dictated by the institutional structures designed and implemented by the company, and problems in those structures will increasingly be the basis for allegations of bad faith.