August 6, 2014

By Brian Babcock

Insurance policies are a special sort of contract which courts have described as “peace of mind” contracts. That is, part of what we pay for in our premiums is the confidence that, in the event of a loss, we will be treated fairly.

Another way that this is sometimes put is that all insurance policies contain an implied obligation that the insurance company will deal fairly and in good faith with its insured.

“Bad Faith” is simply the opposite of good faith.

This has different applications in various insurance situations.

In a “first party” claim for property damage such as a fire loss, key principles that distinguish good faith from bad faith include:

  • the insurance company cannot simply look for reasons not to pay
  • in fact, the duty of good faith may require that they look for reasons TO pay the claim
  • to do that requires that the company must make a thorough fair and balanced investigation of the claim
  • the company must fairly consider all facts that might support the claim
  • the company must not prefer its own financial interests (i.e. not paying) over the interests of the insured (i.e. paying)
  • the company must not attempt to settle at an unreasonably low amount, below what it knows the claim is worth.

Disability and life insurance are other examples of “first party” claims, and similar principles apply.

Claims in which your insurer defends you in a claim by another person are referred to as “third party” claims, or “liability insurance”. Good faith applies in these cases and requires that the insurer not prefer its interest over yours. So, for example, if the claim has the potential to exceed the available insurance coverage, the insurer may be required to settle within policy limits if possible, because they are not allowed to gamble with your money to try to save theirs.

If an insurer is found to have acted in bad faith, they may be required to pay damages to make the insured person “whole”, that is put them in the position they would have been in without the bad faith. In addition, the insurer may have to pay interest on payments not made: legal costs, damages for mental distress, and even aggravated or punitive damages (see my earlier article on “Punitive Damages”).

Not every denial or decision that an insured dislikes is necessarily bad faith, but where there are bad results for an insured, and their peace of mind is disturbed, the possibility of a bad faith claim should be considered.