VIII. The Realities of Insurance Coverage Litigation

VIII. The Realities of Insurance Coverage Litigation

A. The Imbalance in Bargaining Power Between The Insurance Company And The Policyholder

The practicalities and economics of denying insurance coverage weigh heavily in favor of insurance companies. This financial reality was explained by no less than, once again, a standard textbook of the insurance industry:

"When an insurance company fails to pay claims it owes or engages in other wrongful practices, contractual damages are inadequate. It is hardly a penalty to require an insurer to pay the insured what it owed all along."

The quoted textbook is part of the required materials for students preparing to obtain the professional designation of Chartered Property and Casualty Underwriters ("CPCU"). Thus, candidates for the highest professional status in the business of insurance are taught that contractual damages alone are inadequate.

Unfortunately, the stark reality is that "[a]ll that an insurance company has to sell is its promise to pay. Yet, all other things being equal, the better an insurance company is at avoiding that promise, the more money it makes." The essence of what motivates all too many insurance companies to deny insurance coverage was captured by one California court:

"[A] lot of people who regarded themselves as rather powerful got together and [rode] roughshod over [the policyholder] because they viewed him as someone who was powerless and unable to fight back."

Many courts, including the West Virginia Supreme Court of Appeals in Jarrett v. E. L. Harper & Son, Inc. and Hayseeds, Inc. v. State Farm Fire & Casualty have recognized that "the bargaining power of an insurance carrier vis-a-vis the bargaining power of the policyholder is disparate in the extreme." As noted by a California court:

[T]he relationship of insurer and insured is inherently unbalanced; the adhesive nature of insurance contracts places the insurer in a superior bargaining position. The availability of punitive damages is thus compatible with recognition of insurers' underlying public obligations and reflects an attempt to restore balance in the contractual relationship.

The Supreme Court of Oklahoma held:

Of particular importance is the delicate position of the insured after a loss is incurred: `The very risks insured against presuppose that if and when a claim is made, the insured will be disabled and in strait financial circumstances and, therefore, particularly vulnerable to oppressive tactics on the part of an economically powerful entity.'

Similarly, the Supreme Court of Arizona stated:

The special nature of an insurance contract has been recognized by courts and legislatures for many years . . . . An insurance policy is not obtained for commercial advantage; it is obtained as protection against calamity. In securing the reasonable expectations of the insured under the insurance policy there is usually an unequal bargaining position between the insured and the insurance company. . . . Often the insured is in an especially vulnerable economic position when such a calamity loss occurs. The whole purpose of insurance is defeated if an insurance company can refuse or fail, without justification, to pay a valid claim.

Even insurance companies recognize that punitive damages should be used to deter insurance company bad faith:

Punitive damages must be awarded to deter this type of action in the future. A simple judicial test will serve this purpose: If the court finds that an insurer made a determination not to settle within the policy limits based on its own self-interest, punitive damages will be awarded.

The same insurance company, Fireman's Fund, argued:

Insurance companies must realize the importance of settlement within policy limits and should realize the impact their decisions must have upon their insured. This court should establish the rule that punitive damages are to be awarded whenever the court finds that an insurance company made its decision regarding settlement based on its own interest as opposed to the interests of its insured.

Lawyers who regularly represent insurance companies have also recognized that without punitive damages, insurance companies "had nothing to lose by wrongfully denying claims or coercing unfair settlements." Thus, the consensus among the policyholders, the insurance companies and insurance company lawyers is clear: The nature of the relationship between policyholders and insurance company makes it all too easy for insurance companies to simply say "NO."

B. Claims Handling

Most bad faith conduct occurs during the claims handling process. Some insurance companies are notorious for refusing to provide insurance coverage and for engaging in sloppy, slow or deliberately bad claims handling.

With life insurance coverage, insurance company misconduct, if any, typically takes place at the point of sale. With property and casualty insurance coverage, bad faith problems would typically occur at the point of delivery (that is, when the policyholder or claimant makes a claim which is denied). Arguably, with some property and casualty claims, the bad faith occurs much earlier, because some insurance companies have no intention of ever paying sizeable claims.

Another serious question is whether claims handlers are rewarded for minimizing how much they pay out in claims. This situation has already been addressed by the courts on several occasions, usually with claims involving 'life and death' misconduct by HMO's.

C. Insurance Companies Profit From Litigation

Insurance companies profit by prolonging a coverage dispute rather than paying a claim -- even when they know the claim is valid.

First, insurance companies earn investment income, and often a profit, during an insurance coverage dispute with a policyholder. This is done by continuing to invest the policyholder's premiums and the reserves for the duration of the dispute. Second, insurance companies are bulk purchasers in the legal services market; they incur proportionately lower litigation costs than their policyholders, and can reuse work product from case to case. These two factors, combined with the insurance industry's tremendous collective resources and litigation experience, allow insurance companies to wage wars of attrition against individual policyholders who litigate an insurance dispute only once in a lifetime. This war-making ability, along with a policyholder's often critical need for money after a loss, drives policyholders to settle cases for less than their merit. Thus:

the money-for-promise arrangement makes delay a powerful strategic tool insurance companies can use against claimants, a tool that under the prevailing application of contract damages doctrine is nearly cost free. In a state adhering to traditional insurance contract damages limitations and an intent-based bad faith standard, an insurance company with a weak, but colorable, defense to a claim will almost never have to pay more in real dollars than was owed at the time the claim was presented.

Unless an insurance company is confronted with the prospect of damages well in excess of the policy limits, it will have no incentive to honor its obligations under the insurance policy:

Unlike most other commercial actors fighting for supremacy in a world where possession is nine-tenths of the law, insurers always have the nine-tenths advantage: They hold the money. Consequently, insurers always get to "play the float" in any dispute. Even where the judicial system acts rapidly and efficiently to provide compensation to wronged policyholders, the carrier may find it made money by delaying payment of the claim. If its investments have been good, it may even have made enough to cover any prejudgment interest, costs, or consequential damage award, or counsel fees collected by the policyholder.

Policyholders have attempted to level the playing field by making it less profitable and far riskier for insurance companies to breach their insurance policies by seeking, and getting, punitive damages. The threat of punitive damages adds an element of unpredictability to the insurance company's potential liability. But while greater risk and unpredictability may deter some insurance companies, the status quo is still clear: "The insurance company is in no hurry. It has the money. It has your premium. It has an army of lawyers."

D. Death or Disability of a Policyholder

Contrary to the profits realized by insurance companies, bad faith denials of insurance coverage can ruin a policyholder's credit, cause tremendous emotional distress and create a mountain debt. At worst, the policyholder may be severely disabled or forced into bankruptcy, sometimes referred to as "death of company." Death of company cases display the most egregious results of insurance company misconduct and go well beyond the realm of policy limits or purely economic loss. Moreover, there is evidence that insurance companies know far in advance that failure to timely pay a particular policyholder's claims can be devastating.

In one death of company case, the policyholder, a contractor, was sued for alleged construction defects. The position of the policyholder's insurance company was that if the policyholder refused to accept the proposed settlement, the policyholder would be responsible for any settlement or judgment which exceeded the proposed settlement amount and responsible for any additional legal fees incurred in his defense. This was despite expert testimony from five witnesses who each had concluded that the policyholder was not at fault for any defects, and despite the policyholder's desire to clear his name. The insurance company never attempted to exonerate the policyholder or to join the parties more likely to be at fault because it wanted to minimize its expenses.

After the policyholder agreed to settle because "he could not afford to take on the insurance company," the insurance company sued him to recover the amount of the settlement and for the legal fees it had incurred in the policyholder's "defense." The policyholder counterclaimed, claiming breach of contract and breach of the duty of good faith a fair dealing.

In all, the policyholder incurred over $320,000 in legal fees. He lost his business and his assets. He had already paid more than $60,000 in premiums to the insurance company for his liability insurance. There was also evidence that the insurance company may have lied about the destruction of its documents.

A jury awarded the policyholder $12 million in punitive damages against the insurance company. In affirming the award, a California appellate court held that "the award was based on the reprehensibility of [the insurance company's] conduct toward [the policyholder] and its failure to accord [the policyholder] the consideration to which he was entitled." The appellate court accorded great weight to the trial court's findings:

[T]he conduct of the insurance company in this case was egregious . . . [the insurance company's claims adjuster] somehow seemed to determine that he wasn't going to cover this claim, and that he would do what he wanted despite the evidence to the contrary. He exhibited an absolute total disregard for [the policyholder's] rights under the contract, and for his rights as a person to be treated decently.

The California Supreme Court agreed to review the case and accepted briefs in light of the U.S. Supreme Court's decision in BMW. The review was dismissed by the California Supreme Court without opinion. West America's petition of certiorari to the U.S. Supreme Court was recently denied.

BAD FAITH IN INSURANCE COVERAGE DISPUTES AND THE PUBLIC NATURE OF INSURANCE -- UNDERSTANDING THE RECOVERY TOOLS AVAILABLE TO POLICYHOLDERS

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last modified Dec 29, 2003 / 12:53 AM, GMT