The Law of Unintended Consequences and The Tort of Bad Faith

Insurance Contract Law

In a typical contract, one party has a duty to perform (construct a building, deliver goods, convey real estate, pay indemnity) and the other party has a duty to pay money or perform a task.  Breach by the performer may take the form of nonperformance, defective performance, or delay in performance. The primary purpose of damages for breach of a contract is to protect the promisee’s expectation interest in the promisor’s performance.  Damages should put the plaintiff in as good a position as if the defendant had fully performed as required by the contract. Damages should never provide a profit to the non-breaching party.

Insurance, like all parts of modern society, is subject to the deprivations of the law of unintended consequences. In the USA alone people pay to insurers more than $1.2 trillion dollars in premiums and insurers pay out in claims as much or more than they take in. Profit margins are small because competition is fierce and a year’s profits can be lost to a single firestorm, earthquake, hurricane, flood or unexpected bad faith law suit.

Neither the courts nor the governmental agencies seem to be aware that in a modern, capitalistic society, a healthy and viable insurance is a necessity.  No person would take the risk of starting a business, buying a home or driving a car without insurance. The risk of losing everything would be too great. By using insurance to spread the risk among all the costs of taking the risk to start a business, buy a home or drive a car becomes possible. The persons insured are dependent on their insurer to take the risk the insureds are not willing to take alone.

Insurance contracts can be simple or exceedingly complex, depending upon the risks taken by the insurer. Regardless, insurance is only a contract whose terms are agreed to by the parties to the contract.

What those quick to settle bad faith suits, most of the massive verdicts were reversed or reduced on appeal. The insurers who always acted in good faith were forced to raise their premiums to cover the payments to avoid bad faith suits. The bad actors also raised their premium, but not as much as the good faith insurers, and lost little business because their premiums were less. They continued to act in bad faith, paid less to insureds than their good faith competitors, and profited while those who treated their insureds in good faith, lost money.

The good faith insurers, faced with the massive verdicts, allowed fear to control reason and even paid claims that were improper or fraudulent. The extra cost was passed on to all insurance consumers, not just to the insurers who acted improperly. The bad actors continued their wrongful acts and only paid the few insureds that sued, after a long and contentious defense to the lawsuit.

Honest and professional insurers paid fraud perpetrators and claims the policy never intended to cover for fear of being accused as being the same as the bad actors. Those who exercised good faith were punished, and those who dealt with insureds in bad faith, profited.

The tort of bad faith, designed to help the innocent, resulted in punishing the honest and professional insurers, rewarding the insurers who acted in bad faith with profit. Also, because of the fear of punishment with bad faith suits, insurers allowed many frauds to succeed rather than face potential tort damages. Contract terms and conditions that were clear and unambiguous were ignored to avoid litigation.

In the more than 70 years of application across the United States, the tort of bad faith has not, in my opinion, had a salutary effect on the insurance business or the people and businesses who are insured. Insurance costs have increased more than is reasonable or necessary so that sufficient funds exist to pay claims and tort damages from those insureds who believe they were wronged.

Not all bad faith suits are certain winners. Not every bad faith suit results in a punitive damages award. In a first party claim in New Jersey brought by the insured against its own insurance company the appellate court conclude that to establish an insurer's bad faith, the insured must demonstrate that coverage was so clear it was not fairly debatable. If there is a valid question of coverage, i.e., the claim is fairly debatable, the insurer bears no liability for bad faith. [Wacker-Ciocco v. Gov't Emp. Ins. Co., 439 N.J. Super. 603, 611 (App. Div. 2015)]. Insurers in fear of a potential bad faith judgment, a plaintiff must show the lack of a reasonable basis for denying the claim or unreasonably delaying its processing, and the insurer's knowledge or reckless disregard that it was acting unreasonably. [Parko Props., LLC v. Mercer Ins. Co. of N.J. (N.J. Super. App. Div. 2020)]

Unfortunately, few insurers are willing to take a chance on convincing a jury that the decision to deny the claim was fairly debatable or that the decision made was as a result of a genuine dispute. In Louisiana and Mississippi, for example, multiple millions were paid to settle claims that flood damage was covered as a result of Hurricane Katrina, although the policies excluded flood and the plaintiff insureds failed to buy flood insurance. Mudslides in Southern California from hills denuded by wildfires, clearly excluded, are being paid because of fear of claims of bad faith and an aggressive department of insurance that construes a mudslide as a loss due to fire.

(c) 2022 Barry Zalma & ClaimSchool, Inc.

Barry Zalma, Esq., CFE, now limits his practice to service as an insurance consultant specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud almost equally for insurers and policyholders. He practiced law in California for more than 44 years as an insurance coverage and claims handling lawyer and more than 54 years in the insurance business. He is available at http://www.zalma.com and zalma@zalma.com.

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