Institutional bad faith has been called the Darth Vader of insurance litigation, the functional equivalent of an Ebola virus threatening insurance solvency.1
An ancient proverb holds that “a fish rots from the head down.” This pithy (and pungent) maxim highlights the fact that, in the corporate world, leadership is the rudder steering the direction of the business.
In financial services and insurance, this phenomenon is evident. Leadership’s rudder can steer organizations toward smooth waters or rocky shoals. It can direct organizations in dysfunctional ways that have unintentional but expensive consequences. One example is the allegation of institutional bad faith in insurance litigation.
Let us first define “institutional bad faith,” which refers to improper, codified procedures established by an organization, or institution, for handling claims—thereby serving as an indictment of the organization itself.
The offending institution is typically an insurer, a third-party claims administrator (TPA), or an independent adjusting company, and the offense goes beyond deficient claims handling, extending to management practices that incentivize denying or underpaying legitimate cases and thereby pervert the aim of insurance, which is to pay claims. Allegations around institutional bad faith center on greed: that profit motive drove the insurer to establish business practices inexorably leading adjusters to handle claims inappropriately.
Most bad-faith claims take a micro approach. They focus on alleged mishandling of a claims file. In institutional bad-faith claims, plaintiff’s counsel alleges systemic management deficiencies that make claims handling problems inevitable. Institutional bad-faith claims often assert that the defendant has a “pattern and practice,” a general business practice of claims handling that constitutes unfair or deceptive trade practices. Counsel introduces evidence of the company’s purported mishandling of other claims and lawsuits on unrelated cases in other jurisdictions. Expert testimony and/or testimony of current or former company employees may buttress an institutional bad-faith claim. If successful, such claims can produce sizable monetary awards for compensatory, extracontractual, and punitive damages.2
Even if plaintiff’s counsel ultimately loses, the legal costs of defending institutional bad-faith claims are higher than those required to litigate run-of-the-mill bad-faith cases. For example, 2017discovery requests are broader, and thereby more expensive, with plaintiff’s counsel customarily seeking information on other lawsuits, corporate documents, adjuster and supervisor personnel files, compensation information, training materials, and more.
Think of a bad-faith claim as a localized tumor, while an institutional bad-faith claim is a metastasis. And as in medicine, where conditions can progress, many institutional bad-faith claims start small—as claims arising from a single file—and later morph into a broader attack on company policies, procedures, and management practices that purportedly motivate adjusters to handle claims inappropriately. And because discovery battles are expensive and time-consuming for management, insurers may be tempted to settle even unwarranted institutional bad-faith claims.
Landmines for Institutional Bad-Faith Claims
Some disclaimers are in order. First, although I often serve as an expert witness on bad faith, I am not an attorney. Thus, the following comments are not legal conclusions or advice. Second, identifying the following management practices that can invite bad-faith claims is not to impugn such practices or to imply that they are always bad. Each practice can be structured in ways to mitigate bad-faith exposures.
However, as a magnet attracts metal filings, certain management practices attract bad-faith claims . Moreover, the following discussion should not lend the impression that such claims are a lock for the plaintiff’s victory. Anyone can make a claim. Anyone can assert bad faith. Anyone can criticize management practices. Sustaining such a claim is expensive, arduous, and fraught with uncertainty.
Nevertheless, even unsuccessful institutional bad-faith claims can drain defendant companies. And wins may be Pyrrhic victories, as successfully defending an institutional bad-faith claim exacts a toll in legal fees, consumes management’s time, affects the future cost of insurance, and even affects the ability to procure future coverage because of high loss ratios from discovery and defense expenses. In this way, an institutional bad-faith case can become the functional and financial equivalent of, “The operation was a success, but the patient died.”
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