Tuesday, February 16, 2016

Insurance "Bad Faith": What Is It?

By David Metzler

The phrase "Bad Faith" is used frequently in the context of insurance to describe the actions of an insurance carrier, typically when an insurance carrier delays or denies payment of a claim.  But not many people realize what is meant by the phrase and what it means in the context of an insurance claim.  

"Bad Faith" is typically used to refer to an assortment of legal remedies available to an insured when an insurance carrier mishandles a claim.  These legal remedies include the common law duty of good faith and fair dealing and other statutory claims enacted by the Texas legislature.  Although some states apply the “extra-contractual” duty to act in good faith in all contracts, Texas bad faith claims are typically limited to the insurance company’s obligations under the insurance contact.  This duty is imposed most often when there is a claim on a policy requiring an insurance carrier to determine whether coverage exists and, if so, how much to pay.

Importantly, many of these duties are owed only in the context of first party insurance – that is, insurance that covers losses suffered by the insured, such as health insurance or coverage for a home or other property.  An insurance carrier does not owe the same duties when the claim involves a liability policy, a policy that protects an insured from claims brought against the insured by other parties.  Examples of third party policies can be business liability policies that apply to claims when people slip and fall on a business’ property;  or auto liability policies that apply when the insured is involved in an accident and the driver of the other vehicle files suit.  

In the context of first party policies, an insurance carrier in Texas owes a common law duty of good faith and fair dealing (Arnold v. Nat'l Cnty. Mut. Fire Ins. Co., 725 S.W.2d 165, 167 (Tex. 1987)) and must abide by several statutory obligations related to handling of the asserted claims. An insurer fails to comply with that duty of good faith and fair dealing when it (1) denies or delays payment of a claim; (2) although it knows or should know that coverage for the claim was reasonably clear; and (3) as a result, the insured suffered damages.  The insured’s damages must be something other than the amount the insured would receive under the contract.  

In short, to recover on a claim for violation of the common law duty of good faith and fair dealing, the insured must establish the absence of a reasonable basis for denying or delaying payment of the claim, and that the insurer knew, or should have known, that there was no reasonable basis for denying or delaying payment.

In a recent Texas case,*1 an insured purchased a policy covering its drilling operations at an oil well.  When a blow out occurred, the driller incurred significant expense in regaining control of the well, including (1) plugging and abandonment costs; (2) re-drilling a replacement well; (3) cleaning up the resulting pollution; and (4) paying for the damage to property owned by others. Upon receipt of the claim the insurance carrier hired an oil field operations expert to review the incident.  The expert determined the insured had caused the blowout by exerting too much pressure on the well during operations.  The insurance carrier, in turn, denied the claim asserting the insured had violated the requirement of the policy that the insured exercise “due care and diligence” in the performance of its operations.  

The insured sued the insurance carrier for denial of the claim, bringing claims for breach of the common law duty of good faith and fair dealing, and asserting claims under the Texas Insurance Code and the Deceptive Trade Practices Act (DTPA).  Although the Court did not side with the carrier on the issue of whether the claim was covered, it dismissed the bad faith claims on summary judgment.  The Court held insurance carriers had a “right to deny questionable claims without being subject to liability for an erroneous denial.”  Because the insurance carrier relied upon its interpretation of the policy and the report from an expert which demonstrated that the coverage requirements of the policy were not satisfied, there was “a bona fide controversy [which] is sufficient reason for failure of an insurer to make a prompt payment of a loss.” The fact that the insurance carrier is ultimately determined to be incorrect in its denial is not determinative, rather the carrier is judged by the evidence before it at the time the decision is made.  

In Texas, an insurance carrier does not breach its duty to act in good faith just because it denied the claim.  In general, the carrier can be wrong about whether a claim is covered by the policy or how much needs to be paid as long as there is a reasonable basis for the insurance company’s position.
1  Eagle Oil & Gas Co. v. Travelers Prop. Cas. Co. of Am., 2014 U.S. Dist. LEXIS 95090 (Tex. N.D. 2014).


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