See related: Mitigating Bad Faith Exposure During Disaster Season

Accordingly, one of the most prominent newspapers in the Northeast is priming the region against insurers' ostensible “unfair practices.” While a mistaken coverage position does not—in and of itself—result in bad faith liability, the plaintiffs' bar may attempt to use the sheer number of Sandy claims as putative evidence of improper claims handling. It therefore behooves property insurers with exposure to Sandy to establish a procedure for investigating and adjusting these claims so that a simple coverage dispute does not turn into a bad faith action.

Katrina Property Claims

It has been over half-a-year since Sandy, and we are approaching the time when insureds decide whether to settle their claim or file suit. While no two insurance claims—much less those arising from different events—are the same, the experience gleaned in the 8 years since Katrina will continue to be instructive in adjusting claims arising from Sandy and other large natural disasters.

For example, Katrina showed how the distinction between the two primary causes of hurricane damage—wind versus water—affect coverage: (i) a policy covering “hurricane” damage does not normally extend to flood damage (Mladineo v. Schmidt, 52 So.3d 1154, 1157 (Miss. 2010)) because homeowners' policies typically have “flood” exclusions (In re Katrina Canal Breaches Litig., 2009 WL 1707923, *2-3 (E.D.La. 2009)), and (ii) flood policies, unless otherwise specified, do not cover wind damage (Berk-Cohen Associates, LLC v. Landmark American Ins., 2009 WL 3738152, 1*-2 (E.D.La. 2009)).

Perhaps more saliently, Katrina demonstrates that establishing a procedure for investigating and adjusting claims may serve to ameliorate potential bad faith liability. In short, insurers that successfully defended Katrina bad faith claims were able to document their prompt and reasonable investigation of the insured's claim.

New York Insurance Law

New York has codified its claims-handling regulations, which include the duty to promptly investigate, communicate, and pay for a covered claim. While the New York statute does not confer a private right of action, violation thereof may serve as evidence of bad faith against an insurer.

Under New York law, a cause of action for bad faith requires proof that the insurer's conduct constitutes “a gross disregard of the insured's interests” such that the “insurer engaged in a pattern of behavior evincing a conscious or knowing indifference to the interests of the insured.” State Farm Cas. Co. v. Ricci, 96 A.D.3d 1571, 1572 (N.Y. 2012).

Accordingly, “[t]he carrier cannot be held liable if its decision not to settle was the result of an error of judgment on its part or even by a failure to exercise reasonable care.” DiBlasi v. Aetna Ins. Co., 147 A.D.2d 93, 98-99 (N.Y. 1989).

Under New York law, an insurer has a duty to investigate “the validity and extent of the claim” subject to the insured's “rights to both privacy and prompt payment of sums due under the terms of the contract.” SCW West LLC v. Westport Ins., 856 F.Supp.2d 514, 529 (E.D.N.Y. 2012)). An insurer's proactive conduct, such as meeting with the insured, militates against a finding of bad faith. Shapiro v. Berkshire Life Ins. Co., 212 F.3d 121, 127 (2nd Cir. 2000).

The “standard by which insurers are to process claims” (Cohen v. New York Property Ins., 65 A.D.2d 71, 78-79 (N.Y. 1978)) is set forth in New York Insurance Law section 2601 and prohibit an insurer from “unfair claim settlement practices.” Section 2601 lists certain acts, which “if committed without just cause and performed with such frequency as to indicate a general business practice, shall constitute unfair claim settlement practices.” These include:

(2) Failing to acknowledge with reasonable promptness pertinent communications as to claims arising under its policies.

(3) Failing to adopt and implement reasonable standards for the prompt investigation of claims arising under its policies.

(4) Not attempting in good faith to effectuate prompt, fair and equitable settlements of claims submitted in which liability has become reasonably clear, except where there is a reasonable basis supported by specific information available for review by the department that the claimant has caused the loss to occur by arson …

Source: N.Y. Ins. Law §2601(a) (McKinney 2000)

While it does not allow for a private right of action (DiBlasi, supra, 147 A.D.2d at 98-99), section 2601 permits “[e]vidence as to numbers and types of complaints to the department against an insurer … in any administrative or judicial proceeding.” N.Y. Ins. Law §2601(b),(c) (McKinney 2000). In this regard, allegations of frequent unfair claims practices may trigger an action by the New York department of insurance. Mavroudis v. State Wide Ins. Co., 121 A.D.2d 433, 434 (N.Y. 1986) (“[C]laims of persistent unfair settlement practices … are the exclusive province of the New York State Superintendent of Insurance.”)

Because of the sheer volume of claims, Sandy presents an increased risk that an insurer's adjustment may be “performed with such frequency as to indicate a general business practice” under section 2601. If this were to happen, then individual insureds may use a regulatory action by the department of insurance as evidence of bad faith. Given the foregoing, it is essential that an insurer establish a consistent procedure to address claims arising from Sandy.

New Jersey Insurance Law

Like New York, New Jersey has codified its claims handling regulations and—while there is no private right of action arising therefrom—a breach of these standards may serve as evidence of bad faith.

Under New Jersey law, an insurer's duty of good faith includes the obligation to protect and communicate with the insured. “An insurance company has the duty to protect its insured, the debtor, during the settlement of the insured's claims.” Maertin v. Armstrong World Industries, Inc., 241 F.Supp.2d 434, 454 (D.N.J. 2002). This includes “a duty to investigate claims in good faith, and to communicate problems and concerns to the insureds as they arise.” In re Tri-State Armored Services, Inc., 332 B.R. 690, 732-733 (D.N.J. 2005).

However, “[n]either negligence nor mistake is sufficient to show bad faith.” Miglicio v. HCM Claim Management Corp., 672 A.2d 266, 271-272 (N.J. 1995). Rather, “in order to prove a claim of bad faith under New Jersey law, a plaintiff must prove that:

1) The insurer lacked a 'fairly debatable' reason for its failure to pay a claim

2) The insurer knew or recklessly disregarded the lack of a reasonable basis for denying the claim.” Certain Underwriters at Lloyd's of London v. Alesi, 843 F.Supp.2d 517, 531 (D.N.J. 2011).

New Jersey's statutes “set forth a standard of conduct for insurers as to the settlement of claims” (Miglicio v. HCM Claim Management Corp., 672 A.2d 266, 271-272 (N.J. 1995)) and provide that “[t]he following are hereby defined as unfair methods of competition and unfair and deceptive acts or practices in the business of insurance,” which include: b) Failing to acknowledge and act reasonably promptly upon communications with respect to claims arising under insurance policies; c) Failing to adopt and implement reasonable standards for the prompt investigation of claims arising under insurance policies;…f) Not attempting in good faith to effectuate prompt, fair and equitable settlements of claims in which liability has become reasonably clear. (New Jersey Stat. Ann. §17:29B-4(9).

Like New York, while “there is no private right of action” (Weiss v. First Unum Life Ins. Co., 482 F.3d 254, 264 (3rd Cir. 2007)), an insurer's “deviation from the standards may be considered as evidence of bad faith” in New Jersey. (Miglicio, supra, 672 A.2d at 271-272).

Both New York and New Jersey excuse a good faith, but mistaken, coverage decision from the ambit of a bad faith claim. To sue for bad faith, the former requires a “gross disregard of the insured's interests” involving “a conscious or knowing indifference to the interests of the insured,” and the latter requires the absence of a “fairly debatable” reason such “that the insurer knew or recklessly disregarded the lack of a reasonable basis for denying the claim.”

No one, save Mother Nature, can control the number of claims or amount of damage arising from a mass event such as Sandy. An insurer, however, may implement a procedure to investigate and adjust claims in a prompt and consistent manner. By doing so and documenting its position, a carrier may limit its liability to the policy limits and avoid extra-contractual damages.

Moreover, given that a regulatory action in both New York and New Jersey is predicated on the “frequency” of an insurer's alleged violation of section 2601 or section 17:29B-4, respectively, an ounce of prevention in handling mass Sandy claims may be worth a pound of cure in defending and settling bad faith claims that arise.