What is the trap you see insurers fall into most often in the realm of bad faith litigation?

One of the most common things is that you have claims staff who are extremely busy and may not document everything or every conversation they might have had with an insured. They say, “I know I did this,” but it's not documented in the files. So you've been set up, saying “This is in your procedure: You document every conversation you have with the insured, the insureds lawyer?” “Yes.” “Well, you're saying you had a conversation with the lawyers. Is that important to document?” “Yes, absolutely.” “Where is it in your file?” “Well, it's not there, but I know I did it.” You're setting yourself up for a classic trap. It doesn't mean you didn't do it, but you have to agree that the golden rule is that if it was not documented it wasn't done. So then you're saying you violated the golden rule. To some extent it's the claim adjuster's file that goes on trial.

Are bad faith allegations more common in certain situations? How do the issues differ depending on type?

You have third-party and first-party bad faith. It is absolutely more common that you have first-party bad faith. Ordinarily, it's a property damage case where the issue is the treatment of the insured, or the insured is unhappy with the result or the offer that is being made (or the determination that there is no coverage). Then there is the bad faith allegation along with the breach of contract allegation.

The more difficult cases, however, are the third-party, where you're defending the insured. The most difficult ones are where you have a large exposure with a very good liability defense but a limited policy. In those cases, you realize if you don't win your insured is exposed to liability beyond the limits of the policy. That's where it becomes the insurer saying, “Settle with them; give them the money.” Meanwhile, you say, “Well, no, my evaluation is that we have a very good chance of winning this case.” As a result, you get the tension between the insurer, who is usually aligned with defense counsel. That tension can create friction, as well as an environment where bad faith rears its head.

How can claims managers create a culture of adherence to best practices at their respective organizations?

First is training—both in-house and through organizations that provide seminars. This also applies to having your lawyers come in and do presentations to the claims department. Often claims departments are handling several states, or a dozen states, and you have to know the laws. What are your obligations? What is the statute of limitations? Each state has a little variation as to the requirements. [Discerning statutes] therefore becomes a difficult task for the individual claims handler. You must be acutely aware and train them to: 1) be aware of the different regulations and laws in each state; and 2) be sensitive enough to go to your in-house counsel and say, “Help me out here.” In addition, claims departments must be willing to spend the money to ensure their staff is properly trained.

Second, in this age of technology, we have to be careful that we don't overburden our claims handlers. That often leads to difficulty, and it has nothing to do with the intentions or even the structure that you have. Every now and then something slips through the cracks because we're human beings. You want to make sure (to the best of your ability) there are controls in place to make sure your claims people are following some standard procedures. And you have to make sure claims handlers have the time to do that. A lot of claims departments are doing their own in-house investigations, and they're not relying on outside adjusters for the routine investigations. That adds another level of activity for claims handlers. It might save the company money, but it means you're giving more responsibility to your individual claims handlers.

The paramount issue, regardless of where you are, whether in the first- or third-party arena, is making certain you considered the insured's interests. In the first-party arena, one of the best answers I've had is a claims rep during a deposition, in response to the question, “What's your job?” was “My job is to find coverage.” Rather than “My job is to determine if there is coverage.” This shows you are looking to help the insured. That could become the overriding philosophical approach that gets [insurers] out from under the bias against the industry.

What recent events and court decisions are influencing the realm of bad faith litigation?

I'm starting to see with Hurricane Sandy, the tension with insureds who had flood coverage, but had building coverage only and not contents. Or maybe they had building coverage but only to “X” amount.

It becomes a question of who didn't explain what. As for the agent's role in all of this? Well, this highlights the importance of communication both before and after the claim. This includes the agent thoroughly explaining what the policy covers so that insureds fully understand what the limits are.

As I said before, the laws and court decisions are state-specific. But the good practices, regardless of what's going on it each individual state, is what will allow insurers to overcome, regardless of where the case law is going.

Bad Faith Claims Across the Nation

While 19 states have laws that specifically authorize consumers to make bad faith claims against P&C insurers, bad faith is a broad, flexible concept that plays out most often in court decisions and case law. Stephen S. Ashley states in Bad Faith Actions: Liability and Damages, that almost 30 state courts recognized arguments of bad faith by the mid-1990s. Here are some examples of court decisions that have helped shaped the current arena.

• In 1958, the California Supreme Court's decision in Comunale v. Traders & General Ins. Co. established that insureds can establish tort claims in instances of bad faith on the part of insurance companies. This case specifically dealt with third-party liability insurance; however, in 1973 California extended the same rule to first-party fire insurance in Gruenberg v. Aetna Ins. Co. Other states have since followed California's lead.
• In 2003, a court overturned $145 million in punitive damages against State Farm in State Farm Mutual Auto. Ins. Co. v. Campbell. This decision affirms that due process typically caps punitive damages to ten times the amount of compensatory damages. This type of judgment is based on the degree of the plaintiff's reprehensibility and the disparity between the potential harm and the punitive damages assigned.
• Bad faith claims are particularly rampant in cases of toxic mold. For example in 2001, a Texas jury awarded Melinda Ballard (Ballard, et al. v. Fire Insurance Exchange) $32 million. Ballard had contacted her insurance company about a plumbing leak and subsequent damage to flooring. The company attributed the damage to factors not covered by the policy. The lack of repair spurred the growth of black mold, which caused illness in the Ballard family. The jury found the insurance company was unfair, and that the insurer did not appoint a competent appraiser. In 2002, the Texas Court of Appeals upheld the finding of a breach of good faith; however the court overturned the jury's conclusion that the insurer acted fraudulently and failed to appoint a competent appraiser. As a result, the punitive and mental anguish damages against the insurer were reversed.