“A covenant of good faith and fair dealing is implied in every insurance contract. The implied promise requires each contracting party to refrain from doing anything to injure the right of the other to receive the agreement’s benefits.” “[T]he ultimate test of bad faith liability in the first party cases is whether the refusal to pay policy benefits was unreasonable.” The duty of good faith and fair dealing includes several implied obligations, such as the duty to equally protect policyholder’s interests, the duty to process claims promptly, the duty to pay claims as they become clear, the duty to investigate, the duty to evaluate claims objectively, and the duty to not coerce compromises. Because the duty of good faith is reciprocal, California law recognizes reverse bad faith by which the policyholder must also treat the insurer fairly. Insurance policies have no express promise to treat one another fairly. As simple as the concept of bad faith is, it is widely misunderstood.
Duty of Good Faith and Fair Dealing
“Every contract imposes upon each party a duty of good faith and fair dealing in its performance and its enforcement.” The fundamental principle of the implied covenant of good faith and fair dealing is “that neither party will do anything which will injure the right of the other to receive the benefits of the agreement.”
“As to the scope of the covenant, [t]he precise nature and extent of the duty imposed by such an implied promise will depend on the contractual purposes. Initially, the concept of a duty of good faith developed in contract law as a kind of ‘safety valve’ to which judges may turn to fill gaps and qualify or limit rights and duties otherwise arising under rules of law and specific contract language. [T]he courts employ the good faith doctrine to effectuate the intentions of parties, or to protect their reasonable expectations.”
The “duty of an insurer to act in good faith and fairly [includes] handling the claim of an insured, namely a duty not to withhold unreasonably payments due under a policy. That responsibility is not the requirement mandated by the terms of the policy itself – to defend, settle, or pay. It is the obligation, deemed to be imposed by the law, under which the insurer must act fairly and in good faith in discharging its contractual responsibilities. Where in so doing, it fails to deal fairly and in good faith with its insured by refusing, without proper cause, to compensate its insured for a loss covered by the policy, such conduct may give rise to a cause of action in tort for breach of an implied covenant of good faith and fair dealing.”
2. Reasonable Denial Permitted
It is not bad faith for an insurer to behave rudely. “[A]n insurer is not required to pay every claim presented to it. Besides the duty to deal fairly with the insured, the insurer also has a duty to its other policyholders and to the stockholders (if it is such a company) not to dissipate its reserves through the payment of meritless claims. Such a practice inevitably would prejudice the insurance seeking public because of the necessity to increase rates, and would finally drive the insurer out of business.”
Application of the Duty
1. Duty to Settle
“Bad faith” was first recognized by the courts as is a liability insurer’s failure to settle. “[T]he implied obligation of good faith and fair dealing requires the insurer to settle in an appropriate case although the express terms of the policy do not impose such a duty. *** The insurer, in deciding whether a claim should be compromised, must take into account the interest of the insured and give it at least as much consideration as it does to its own interest.”
A consequence of an insurer’s bad faith breach of the duty to settle is to “pop” the policy limit. “An insurer who denies coverage does so at its own risk, and, although its position may not have been entirely groundless, if the denial is found to be wrongful it is liable for the full amount which will compensate the insured for all the detriment caused by the insurer’s breach of the express and implied obligations of the contract. The insurer should not be permitted to profit by its own wrong. It follows from what we have said that an insurer, who wrongfully declines to defend and who refuses to accept a reasonable settlement within the policy limits in violation of its duty to consider in good faith the interest of the insured in the settlement, is liable for the entire judgment against the insured even if it exceeds the policy limits.”
2. Duty to Investigate
Liability insurers have a duty to investigate claims by their policyholders to defend and indemnify them. All liability insurers must adopt and implement reasonable standards for the prompt investigation of claims. It is essential that an insurer fully inquire into possible bases that might support a policyholder’s claim. The insurer may not just focus on those facts which justify denial of the claim. The insurer may not deny a claim without first thoroughly investigating the policyholder’s claim for a defense through independent counsel. The insurer must initiate its own investigations rather than sit back and find fault with information provided by the policyholder.
The reasonableness of the insurer’s denial of a claim must be determined on the basis of the information known or reasonably available to it at the time of denial. The insurer’s the duty to investigate does not end simply because a lawsuit between the insurer and policyholder has been filed.
3. Duty of Equal Protection
“The implied covenant imposes obligations not only as to claims by a third party but also as to those by the insured. In both contexts the obligations of the insurer ‘are merely two different aspects of the same the duty. [W]hen the insurer unreasonably and in bad faith withholds payment of the claim of its insured, it is subject to liability in tort. For the insurer to fulfill its obligation not to impair the right of the insured to receive the benefits of the agreement, it again must give at least as much consideration to the latter’s interests as it does to its own.”
The duty of good faith and fair dealing requires an insurer to “careful and serious consideration to the interests and position of the assured. . . . The carrier cannot exclusively preoccupy itself with its own interests but must also weigh the real interests of the assured.” “When investigating a claim, an insurance company has a duty to diligently search for evidence which supports its policyholder’s claim. If it seeks to discover only the evidence that defeats the claim it holds its own interest above that of its insured.”
4. Duty to Process Claims Promptly
Insurance Code §790.03(h)(3) requires insurers “to adopt and implement reasonable standards for the prompt . . . processing of claims.” “A delay in payment of benefits due under
an insurance policy gives rise to tort liability only if the insured can establish the delay was unreasonable” Unreasonable delay in the processing of a claim or the payment of benefits may be evidence of bad faith by the insurer.
5. Duty to Pay as Liability Becomes Clear
Insurance Code § 790.03(h)(12) requires insurers “to settle claims promptly, where liability has become apparent.”
6. Duty of Objectivity – No Hindsight Rule
A liability insurer must use objective standards in making its claims decisions. The insurer cannot ignore evidence supporting a claim, while focusing on facts justifying denial of the claim. If it does so, it acts unreasonably towards its policyholder. The reasonableness of the insurer’s decision must be evaluated as of the time it was made, rather than on the basis of later developments. Otherwise an insurer could refuse to defend its policyholder on the slightest provocation and then resort to hindsight for the justification.
7. Duty to Not Coerce
A liability insurer may not delay payment of a claim in order to coerce a compromise of another claim. Instead, an insurer must settle claims promptly, where liability has become apparent under one portion of the insurance policy coverage but not attempt to influence settlements under other portions of the insurance policy coverage. “We conclude that an insurer potentially can be liable for unreasonably coercing an insured to contribute to a settlement fund, even though (by definition) there is no ‘excess judgment’ where a case is settled.”
As the Supreme Court summarized, “tort recovery in this particular context is considered appropriate for a variety of policy reasons. Unlike most other contracts for goods or services, an insurance policy is characterized by elements of adhesion, public interest and fiduciary responsibility. In general, insurance policies are not purchased for profit or advantage; rather, they are obtained for peace of mind and security in the event of an accident or other catastrophe. Moreover, an insured faces a unique ‘economic dilemma’ when its insurer breaches the implied covenant of good faith and fair dealing. Unlike other parties in contract who typically may seek recourse in the marketplace in the event of a breach, an insured will not be able to find another insurance company willing to pay for a loss already incurred. In addition, the tort duty of a liability insurer ordinarily is based on its assumption of the insured’s defense and of settlement negotiations of third party claims.” Limiting the insurer’s obligation to paying only policy benefits usually does not adequately compensate an policyholder and may not adequately deter the insurer from breaching the contract in the first place.
The tort measure of damage expands a liability insurer’s obligation to pay. “There can be no question that a tort action with its loaded measure of damages is a penalty.” For violations of the duty of good faith, in addition to the traditional contract measure of damages, courts have tort damages of emotional distress, prejudgment Interest, lost profits, impaired credit, cost of mitigation, value of relinquished claims, and punitive damages.
Reverse Bad Faith
The duty of good faith and fair dealing is a two-way street. “There is an implied covenant of good faith and fair dealing in every contract that neither party will do anything which will injure the right of the other to receive the benefits of the agreement.” Thus, it is possible for the policyholder to commit bad faith against the insurer. A few reported opinions mention in dicta that the policyholder acted in bad faith, usually in the context of fraud or collusion by the policyholder. However, a proper analysis of reverse bad faith calls for an examination of the language of the contract to identify the “benefits of the agreement” to which the insurer has been deprived.
Violations of Statutes and Regulations Support Bad Faith Claims
“[T]he courts retain jurisdiction to impose civil damages against insurers in appropriate common law actions, based on such traditional theories as either breach of contract or breach of the implied covenant of good faith and fair dealing.” Insurance “regulations may be used by a jury to infer a lack of reasonableness on [the insurer]’s part.” “The regulation’s purpose is salutary, designed to alert insureds to their insurance policy obligations, and to foster equity, fairness, and plain-dealing in claims handling. We see no reason not to adopt this carefully considered public policy. To do otherwise would arbitrarily undermine an applicable industry standard, one expressly designed to insure fairness in the claims process and resolution of claims on the merits. There seems no valid reason to ignore its command.” “A duty of care, and the attendant standard of conduct required of a reasonable man, may of course be found in a legislative enactment which does not provide for civil liability.”