An increase in the legislation that would create or expand “bad faith” insurer liability is cause for concern about the effects on insurers, policyholders, agents and consumers. Such bills are pushed as beneficial to consumers because the bills increase leverage in dealings with insurers (see the sidebar for a list of such potential bills). But legislators who give full consideration to their potential impact and assess whether they are warranted given existing legal standards governing such dealings should see that these bills actually hurt consumers. While insurers must pay all covered claims, they also are obligated–to other policyholders, stockholders, other insurers and all who buy insurance–to respond to each claim with an appropriate level of scrutiny, not to pay uncovered claims and not to pay more than they should for covered claims. This can be challenging because it involves applying complex contracts to frequently inconsistent accounts of factual situations. So it's not surprising that disagreements among insurers, insureds and third-party claimants are not unheard of. Resolving disagreements
Because insurance is a contractual relationship, disagreement should be resolved according to the terms of the contract: the insurance policy. It is not only a matter of contractual obligation but also good business for insurers to act in good faith when they handle claims. Insurance is all about promises and reliability, so insurers strive to perform well when it's time to process and pay a claim. Nevertheless, leaving such resolution solely to the insurance policy has been viewed as unsatisfactory by many for some time. Consequently, legal standards and remedies apart from the contract have been developed from a number of sources. Every state has unfair claims practice statutes, for example, to establish administrative remedies for consumers to pursue with state insurance departments. What we have seen in recent years is a disconcerting increase in legislative activity involving bills that dramatically expand insurers' liability in a variety of ways. The term itself, which refers to the implied duty of good faith in every 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 one wants to argue that insurers can act in bad faith without consequence. But the question is what consequence is warranted or needed to promote and encourage appropriate insurer conduct. Common provisions
Most bad faith bills create or expand on a private right of action. Often, a bill refers to a list of prohibited actions that already give rise to an administrative proceeding undertaken by a state insurance department, and state that upon enactment private individuals can bring an action in court based on one of those prohibited actions. Bad faith bills typically provide for the recovery of new specific damages above and beyond the limit of the insurance policy, such as interest, attorneys' fees and exemplary or punitive damages. They often contain provisions calling for punitive damages as high as three times the amount of actual damages. Bad faith bills often lower the standard necessary for a plaintiff to meet to file a sustainable suit. For instance, many existing statutes require showing that an insurer violated certain standards so often that it indicates a general business practice. Bad faith bills frequently seek to allow claimants to sue for a single violation. Consider the consequences
It doesn't take a great act of political courage to introduce an insurance bad faith bill. A bill that enables constituents to sue insurance companies more easily for more money is an easy sell. And it's probably not a bad thing for one's political career to have the backing of the trial bar. But those same constituents also are insurance buyers who pay premiums, the cost of which is directly affected by the costs that insurers incur in the claims process. These include not only larger damage awards, but also the cost of defending lawsuits and paying higher settlement amounts to avoid litigation. Legislation creating a new private right of action leads to more lawsuits, which are expensive to defend regardless of the outcome. The same goes for legislation that does not create a totally new private right of action but lowers the standard required to bring suit. Out of balance
Increased costs from suits represent just the tip of the bad faith iceberg. The threat of litigation and the potential for expansive damages throw the entire claims processing environment out of balance. Companies facing exposure to costs greatly exceeding policy limits naturally view claims very differently. The result can be claim settlements that are higher than warranted on meritorious claims, and the payment of claims that may or may not have merit to avoid the high costs of litigation. Another potential consequence of particular significance to agents is that excessive liability could make an insurer consider withdrawing from a state or reconsider entering a state. The ultimate impact on availability and competition may be hard to demonstrate, but the effect on costs is clearer. NAMIC last year published a comprehensive public policy paper, “First-Party Insurance Bad Faith Liability” available as a PDF at www.namic.org, which examined the unintended consequences of first-party bad faith legislation. The paper found evidence suggesting that “allowing tort liability for insurance bad faith results in reduced insurer incentives to challenge disputable claims, and in higher claims costs as a result.” The paper concluded that recently enacted bad faith laws in several states “will create incentive distortions that may lead to greater uncertainty and higher costs for insurers, higher levels of insurance fraud, and correspondingly higher insurance premiums for consumers.” Especially in light of the economic crisis, legislators considering bad faith bills have to decide whether it is sound public policy to enact a law that will ultimately produce higher costs for consumers.. It would be one thing if proponents came armed with comprehensive findings of widespread inappropriate behavior by insurers, but the sponsors and supporters of these bills typically muster nothing more than a few unsubstantiated anecdotes. What is disconcerting is that despite the consumer impact and lack of showing regarding their need, some legislative bodies are giving bad faith bills serious consideration. Paul T. Tetrault, JD, ARM, AIM, Northeast state affairs manager for the National Assn. of Mutual Insurance Companies, advocates on behalf of NAMIC members on key legislative and regulatory issues. He can be reached at [email protected].