In the 1960’s and 70’s the insurance industry abused some insureds to avoid paying legitimate claims. Without a factual basis, insureds were accused of arson or other variations on insurance fraud. Indemnity payments were refused on the flimsiest of excuses. People were found to have diseases that only horses could catch. Disability payments were refused because an insured was wheeled in her wheelchair to church one day and, therefore, was not totally house-confined. Insureds were driven into bankruptcy when reasonable demands within policy limits were refused.
To stop this abuse, the courts of the state of California invented a tort of bad faith breach of an insurance contract. Many other states have followed the lead. Until the invention of the tort of bad faith all that an insured could collect from an insurer that wrongfully denied a claim were the benefits due under the policy. In the tort of bad faith, the courts allowed the insureds to collect, in addition, the entire panoply of tort damages, including punitive damages.
It worked. Insurers treated the insureds better. The threat of punitive damages made insurers wary of rejecting any claim. The creation of the tort of bad faith was in many ways a good thing for insurers and insureds. What the courts that created the tort of bad faith did not recognize was that it was also the key to Pandora’s box. The law of unintended consequences came in play and lawyers began to take advantage of the new tort. The “Law” can be defined as the understanding that actions of people — and especially of government or the courts — always have effects that are unanticipated or unintended. Insurance is controlled by the courts, through appellate decisions, and by governmental agencies through statute and regulation. Compliance with the appellate decisions, statutes and regulations – different in the various states – is exceedingly difficult and expensive.
As Justice Kaus of the California Supreme Court noted:
The problem is not so much the theory of the bad faith cases, as its application. It seems to me that attorneys who handle policy claims against insurance companies are no longer interested in collecting on those claims, but spend their wits and energies trying to maneuver the insurers into committing acts which the insureds can later trot out as evidence of bad faith. [White v. Western Title Ins. Co., 40 Cal. 3d 870, 710 P.2d 309, 221 Cal. Rptr. 509 (Cal. 12/31/1985)]
The logarithmic growth of insurance fraud in the state of California, and other states that have allowed tort damages for bad faith breach of insurance contracts, may be directly traced, in part, to the judicial creation of the tort of bad faith. Before the tort of bad faith, insurers with a reasonable belief that an insured was presenting a fraudulent claim would refuse to pay it. Persons perpetrating the fraud did, in most cases, accept the refusal as a cost of doing business and went on to the next fraudulent claim. After the recognition of the tort of bad faith, those who perpetrated fraudulent insurance claims that were denied went to lawyers instead. Suits for bad faith popped up like wild flowers in the desert after a rainstorm.
Juries, angered by insurers accusing their insureds of fraud, punished the insurers with multimillion dollar judgments. After each judgment, hundreds of cases settled (even though no monies were owed) for fear of being painted with the same brush. Fraud units that had been instituted in the 70’s were disbanded in the late 80’s because of fear of punitive damage judgments.
The courts, legislatures and the insurance departments of the various states must recognize that an insurer with the best of all possible fraud investigation units will err. A company with a highly trained and motivated fraud investigation unit made up of professional investigators and attorneys will err. The public, and those who serve on juries, must understand that an aggressive fraud investigation, even if it reaches an incorrect result, is not malicious.
Today, if a jury believes the insurer was wrong in its decision, it will award punitive damages, regardless of the instructions read to it by the judge. Insurers are not liked. The bad publicity that was given to insurers by the early bad faith cases has poisoned the public image of insurers. Insurers are often prejudged. Some defense lawyers contend that before the first witness is sworn in three jurors are lost and counsel must convince the remaining nine while the plaintiff only needs to convince six of the jurors without anti-insurer prejudice.
As a business necessity, insurers must have the confidence of the public that they are financially sound, secure and have an overabundance of funds available to pay claims. The need to show the security of the company to the public has the effect of convincing juries that a multimillion dollar verdict against the insurer will not hurt it. Plaintiffs’ lawyers disingenuously tell juries that they don’t want to harm the insurance company, all they want to do is get its attention. They argue that a $10 million verdict might cause an itch in the corporate pocketbook sufficient to cause management to scratch away the need to reject claims. The argument is hard for a jury of working people to withstand.
The tort of bad faith, and the punitive damages that seem to go with it, have served their purpose. Insurers now have professional claims departments. Insureds are almost universally treated with courtesy and respect. Legitimate claims are paid with alacrity. Insurance fraud continues to grow. The fear of punitive damages has made the fight against fraud almost impossible.
In my practice I must contend daily with the insurer who wants to fight fraud but who must decide to pay rather than face the exposure of a punitive damage judgment. I can, as my mentors taught me 45 years ago, opinion that an insurer should spend millions for defense and not a dime for tribute. However, practical insurance professionals have a need to resolve litigation as inexpensively as possible and will make a business decision to pay the fraud rather than take a chance on an adverse verdict.
However, as with all things in insurance, the attitudes of insurers move in cycles. More often than not, I am now called upon to testify in bad faith cases that the insurer insists on taking to trial by jury rather than pay off a scofflaw. I can only hope that this cycle continues and more attempts at fraud are defeated.
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. 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.
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 700 billion 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 or a flood.
Neither the courts nor the governmental agencies seem to be aware that in a modern, capitalistic society, 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. Over the last few centuries almost every word and phrase used in insurance contracts have been interpreted and applied by one court or another. Ambiguity in contract language became certain. However, the average person saw the insurance contract as incomprehensible and impossible to understand. Ostensibly to protect the public insurance regulators decided to require that insurers write their policies in “easy to read” language. Because they were required to do so by law insurers changed the words in their contracts into language that people with a Fourth Grade education could understand. Precise language interpreted by hundreds of years of court decisions were disposed of and replaced with imprecise, easy to read language.
The law of unintended consequences came into play and instead of protecting the consumer with easy to read policy language, an attempt to force insurers to deal “fairly” with the insureds, resulted in thousands of lawsuits determined to impose penalties on insurers for attempting to enforce ambiguous “easy to read” language. The multiple lawsuits cost insurers and their insureds millions (if not billions) of dollars to get court opinions that interpret the language and reword their “easy to read” policies to comply with the court decisions. For more than thirty years the unintended consequence of a law designed to avoid litigation has done exactly the opposite.
The attempts by the Regulators and Courts to control insurers and protect consumers were made with the best of intentions. The judges and regulators found it necessary to protect the innocent against what they perceived to be the rich and powerful insurers.
In 1958 the California Supreme Court created a tort new to U.S. jurisprudence when it decided Comunale v. Traders & General Ins. Co., 50 Cal. 2d 654, 658-659, 328 P.2d 198 (1958).
A tort is a civil wrong from which one person can receive damages from another for injuries. The new tort was called the “Tort of Bad Faith” and was created because an insurer failed to treat an insured fairly and the court felt that the traditional contract damages were insufficient to properly compensate the insured. The court allowed the insured to receive, in addition to the contract damages that the insured was entitled to receive under the contract had the insurer treated the insured fairly, damages for emotional distress and punitive damages to punish the insurer for its wrongful acts.
Insureds, lawyers for insureds, regulators and courts across the U.S. cheered the action of the California Supreme Court and most of the states eventually adopted the tort created by the California Supreme Court.
In construction contracts, for example, damages for defective or incomplete construction generally are measured by the cost of repair or the cost of completion. In contracts for the sale of goods, on the other hand, damages for nonconformity with the contract generally are measured by the diminution in value of the defective goods. The purpose of both measures is to place the plaintiff in as good a position as if the defendant had performed the contract according to its specifications.
The general rule of damages in tort is that the injured party may recover for all detriment caused whether it could have been anticipated or not while contract damages are limited to that anticipated by the contract.
In more than 60 years of application across the U.S. the tort of bad faith has not, in my opinion, had a salutary effect on the insurance business. Insurance costs more than is reasonable or necessary so that sufficient funds exist to pay claims and tort damages from those insureds who believed they were done wrong. Suits relating to claims presented for the 1994 Northridge earthquake in California are still pending seeking tort and punitive damages for failure to pay what the insureds’ believed they were owed. In Louisiana and Mississippi 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. Abuse of insurers is so rampant and so successful that lawyers obtain multimillion dollar fees and have even attempted to (or successfully) bribed judges to increase their recovery.
The tort of bad faith is like the mythical Vampire. It hides in the dark. The truth about the tort of bad faith will die only if it is put into the light of day. It does not solve the problem anticipated. Rather it makes a few lawyers very rich, a few insureds receive indemnity for which they did not bargain and makes the cost of insurance to those who wish only to receive the benefits of the contract prohibitive.
In New York, for example, the courts were unwilling to adopt the widely-accepted tort cause of action for “bad faith” in the context of a first-party claim, because they recognized that to do so would constitute an extreme change in the law of this State. New York accepted the more conservative approach adopted by the minority of jurisdictions that the duties and obligations of the parties [to an insurance policy] “are contractual rather than fiduciary” [Beck v Farmers Ins. Exch., 701 P2d 795, 798-799 [Utah 1985]].
Therefore, in order to ensure the availability of an appropriate and sufficient remedy, we adopt the reasoning of the Beck court that there is no reason to limit damages recoverable for breach of a duty to investigate, bargain, and settle claims in good faith to the amount specified in the insurance policy. Nothing inherent in the contract law approach mandates this narrow definition of recoverable damages. Although the policy limits define the amount for which the insurer may be held responsible in performing the contract, they do not define the amount for which it may be liable upon a breach. [Acquista v. New York Life Insurance Company, No. 2277,2001 NYSlipOp 06087, (N.Y.App.Div. 07/05/2001)]
New York refused to allow a tort to be created out of a breach of contract. [Batas v. Prudential Insurance Company Of America, 281 A.D.2d 260, 724 N.Y.S.2d 3 (N.Y.App.Div. 03/20/2001)
In California, and most states that allow a breach of an insurance contract to support a tort cause of action only allow it to go in one direction. Insurance litigants are not equal. An insured can obtain tort damages for bad faith breach of the insurance contract but an insurer may not receive tort damages for bad faith breach of an insurance contract.
The inequality of treatment of insurers and insureds resulted in a distinction between tort and contract liabilities that convinced one state supreme court to reject comparative bad faith as a defense in a bad faith action against an insurer because “the [insurer’s] tort cannot be offset comparatively by the [insureds’] contract breach.” It characterized the differing legal concepts as “apples and oranges.” [Stephens v. Safeco Ins. Co. of America (Mont. 1993) 852 P.2d 565, 568-569]. In addition a different court rejected a comparative bad faith defense for an insured’s misperformance of its contractual duties in a bad faith action against the insurer for refusal to defend. [First Bank v. Fidelity and Deposit Ins. (Okla. 1996) 928 P.2d 298, 306-309]
In California, the decision in Agricultural Ins. Co. v. Superior Court (1999) 70 Cal.App.4th 385 agreed. Agricultural involved a bad faith action arising out of an insurance claim for earthquake damage. After the insurer paid the claim in part controversies arose, ultimately leading to the insured’s suit for breach of contract and bad faith. The trial court stayed the action to allow the insurer to complete its investigation. The insurer did, and then cross-complained, contending that the insured’s claim was in significant part falsified. A false claim is a ground usually sufficient to allow the insurer to declare the policy void and deny all payments since an insured can no more commit a little fraud than be a little dead.
The insurer pleaded various contract theories, and also the tort theories of fraud and so-called reverse bad faith, i.e., tortious breach of the covenant of good faith and fair dealing by the insured. The insured demurred to the tort theories, and the trial court sustained the demurrers without leave to amend. The decision made the following amazing conclusion:
Although there is an implied covenant of good faith and fair dealing in every contract, although each party is bound by it, and although this principle applies to insurance contracts (see, e.g., Liberty Mut. Ins. Co. v. Altfillisch Constr. Co. (1977) 70 Cal.App.3d 789, 797), the potential liability for breach is different for insurers and insureds. In summary, an insured may be held liable in contract for breaching the covenant, but cannot be held liable in tort. (Emphasis added)
The Fourteenth Amendment to the U.S. Constitution provides, in part:
No State shall make or enforce any law which shall abridge the privileges or immunities of citizens of the United States; nor shall any State deprive any person of life, liberty, or property, without due process of law; nor deny to any person within its jurisdiction the equal protection of the laws.
If the law allows an insured to sue for tort damages as a result of a breach of the covenant of good faith and fair dealing equal protection should allow an insurer to sue the insured for tort damages as a result of the breach of the same covenant. Some litigants cannot, under our system of constitutional law, be more equal than others. Yet, until a court agrees, insureds are more equal than their insurer.
Although the courts may think so, the insured’s breach of the covenant of good faith and fair dealing is also separately actionable as a contract claim and that some forms of misconduct by an insured will void coverage under the insurance policy. (Imperial Cas. & Indem. Co. v. Sogomonian (1988) 198 Cal.App.3d 169, 182. The court in Agricultural believed that contract remedies “adequately serve to protect an insurer from the insured’s misconduct without creating the logical inconsistencies and troublesome complexities of a defense of comparative bad faith.” In so doing it ignores the logical inconsistencies and troublesome complexities of the tort of bad faith. What is good for the insured should be good for the insurer.
In Kransco v. American Empire Surplus Lines Insurance Company, 23 Cal.4th 390, 2 P.3d 1, 23 Cal.4th 951, 97 Cal.Rptr.2d 151 (Cal. 06/22/2000) the California Supreme Court agreed with Agricultural and held that “[A]n insured does not bear a risk of affirmative tort liability for failing to perform the panoply of indefinite but fiduciary-like obligations contained within the concept of ‘insurance bad faith.’”
An insurer can commit the tort and is obliged to pay tort and punitive damages. An insured, who is totally evil, whose only interest in the insurance agreement is to defraud the insurer, who refuses to cooperate with the insurers investigation, who does everything possible to harm the insurer, cannot commit the tort. This decision is as logical as stating that men can commit a battery while women, cannot commit the tort of battery, regardless of how viciously the victim is battered. It is a statement that equal protection applies to all citizens of the U.S. except insurers since they can only be the tortfeasor and never the victim. Because of the lack of equal protection, plaintiffs’ lawyers and their clients take advantage of insurers and use their wits and energies to set up the insurer for bad faith.
In Wade v. Emcasco Insurance Co., 483 F.3d 657 (10th Cir. 04/10/2007) the Tenth Circuit recognized that the undisputed evidence in the record showed that Plaintiff’s counsel’s sole reason for rejecting the insurer’s offer of settlement made after the running of an arbitrary deadline was his hope to pursue a bad faith claim against the insurer. As a result it refused to allow the plaintiff to pursue the bad faith case. The Tenth Circuit also noted that although the impetus for insurance bad faith claims derives from the idea that the insured must be treated fairly and his legitimate interests protected, it is designed as a shield for insureds – not as a sword. “Courts should not permit bad faith in the insurance milieu to become a game of cat-and-mouse between claimants and insurer, letting claimants induce damages that they then seek to recover, while relegating the insured to the sidelines as if only a mildly curious spectator.”
Logically, insureds who are wronged by their insurer should limit their recovery to contract damages. They should be compelled to waive the tort and sue in assumsit. If the tort of bad faith must exist it must be applied equally. The abuse of the tort of bad faith has become so extreme that the tort must be eliminated or otherwise made fair.
If there is a tort of bad faith – as the courts seem to believe – the Fourteenth Amendment to the U.S. Constitution requires equal protection. An insurer who is wronged by its insured should have the same right to tort damages and punitive damages for breach of the covenant as can the insured. Americans do not live on George Orwell’s “Animal Farm”. No litigant should ever be more equal than another.
Insurance fraud is not a local problem. It is a depletion of the wealth of the entire country. The lawyer for the Department of Insurance of each state is the State Attorney General or States Attorney. A special unit could be established in the office of the Attorney General, funded with the monies taken from the insurance industry to support the war against insurance fraud. This unit should be given a simple mandate:
• File and prosecute every insurance fraud brought to the unit by the Fraud Division that has a better than 50% chance of success.
• The unit should not concentrate its efforts on major insurance frauds. Those can best be prosecuted by major fraud units already existing in the District Attorney’s offices and in offices of the US Attorney.
To Stop Fraud File and Prosecute Every Insurance Fraud Brought to the Unit by the Fraud Division
The state’s unit should concentrate on prosecuting every-day-insurance fraud, the frauds of opportunity that take 90% of the money paid to fraud perpetrators, in the range of $5,000 to $50,000. Single counts should be prosecuted. When prosecutors file multiple charges against individual defendants the case becomes a major action requiring a great deal of time to prosecute. Judges and juries do not want to be involved in a prosecution that takes months to prosecute. If there are multiple counts available, the prosecutor should charge only the one where the evidence of fraud is overwhelming. If the jury finds for the defendant the prosecutor can charge the next count immediately as a new charge until the statute of limitation runs. If all available are charged in one case the prosecutor will offend the judge and jury and the defendant will get mercy from the jury.
Overcharging a criminal defendant is almost as bad as not charging at all. The arrest gets the prosecutor great publicity but the convictions in such cases – except those frightened enough to plead guilty – are slim.
Teeth must be put in the posters that say “commit insurance fraud, go to jail.” Departments of Insurance are receiving reports from insurers of thousands of potential fraudulent claims a month. They do not have the staff, the ability or the desire to investigate and prosecute every case brought to them. If only 5 percent of those claims are investigated and prosecuted to conviction, the deterrent effect will be enormous. The Department of Insurance should issue a press release concerning every arrest and conviction. Newspapers should report daily that insurance criminals have been arrested and are going to trial or were convicted and are going to jail. Jail sentences should be made mandatory and remove from local judges the right to grant convicted insurance felons probation and restitution only. Sentences across the state must be consistent and true punishment. I have seen cases where after conviction sentences that ranged from 24 hours to 24 years.
It is not enough for the state to say that the insurance companies must investigate and work to fight fraud. The state must also aggressively and vigorously fight insurance fraud. Today, a person perpetrating an insurance fraud need only be concerned that an aggressive fraud investigation might delay, or reduce, the amount he might recover from his crime. Criminal prosecution for the crime of insurance fraud is so minuscule, in relation to the amount of fraud as to be nonexistent. It certainly does not act as a deterrent. In conjunction with the formation of a special insurance fraud prosecution unit in the attorney general’s office, if we lived in the best of all possible worlds, the legislatures will enact the following statutes:
1. As of the effective date of this statute there is no tort of bad faith in this state.
2. Punitive damages may not be awarded in this state for breach of an insurance contract.
3. Any insurer that, without malice, reports to the Fraud Division, Department of Insurance that it has rejected a claim because of fraud may not be sued in any court of this state, for any tort cause of action.
4. This section is not intended to eliminate the right of any insured to sue its insurer for breach of the insurance contract.
If the legislatures really want insurers to fight insurance fraud; if the legislatures wish to keep strong and viable this important industry; if the legislatures want to reduce the insurance premiums paid by their constituents, they must make practical the war on insurance fraud. As long as the tort of bad faith and the exposure of punitive damages hangs over insurance companies, the war will be one of attrition where no one will win.
The stories that follow were written to show how insurance fraud is taking money out of the pockets of innocent and honest people who buy insurance. For every dollar taken by a fraud perpetrator an insurer must collect two dollars in premiums. Every person in the US who does not commit fraud is paying to support those who do. A minimum of $20.00 for every $100.00 every person insured pays in premiums goes into the pockets of insurance criminals.
If these stories make you angry write to your local District Attorney, States Attorney, Attorney General or US Attorney and let them know of your anger. If enough people complain perhaps, the prosecution levels will increase. Although each of the stories that follow is based in fact, the names, locations and facts of the claims have been changed to protect the guilty. No resemblance to any person is intended and any resemblance is purely coincidental.
© 2014 – Barry Zalma
This article was adapted from the introduction to Barry Zalma’s e-book, “Heads I Win, Tails You Lose” published by ClaimSchool, Inc. and available at http://www.zalma.com/zalmabooks.htm.
Barry Zalma, Esq., CFE, has practiced law in California for more than 42 years as an insurance coverage and claims handling lawyer. He now limits his practice to service as an insurance consultant and expert witness specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud almost equally for insurers and policyholders. He also serves as an arbitrator or mediator for insurance related disputes.
He founded Zalma Insurance Consultants in 2001 and serves as its only consultant.
Mr. Zalma recently published the e-books, “MOM and the Taipei Fraud;” “Zalma on Insurance Fraud – 2013″, “Zalma on California Claims Regulations – 2013″; “Rescission of Insurance in California – 2013;” “Random Thoughts on Insurance” a collection of posts on this blog; “Zalma on Diminution in Value Damages – 2013,”“Zalma on Insurance,” “Heads I Win, Tails You Lose,” “Arson for Profit” and others that are available at www.zalma.com/zalmabooks.htm.
Specialty Technical Publishers recently published Mr. Zalma’s new E-Book, “Getting the Whole Truth” which is available at http://www.stpub.com/Getting-the-Whole-Truth_p_254.html.
Specialty Technical Publishers publishes Mr. Zalma’s book, “Insurance Claims: A Comprehensive Guide” where you can get additional details on this subject by purchasing the book in print or digital format at http://www.stpub.com/insurance-claims-a-comprehensive-guide-online.
Mr. Zalma’s reports on World Risk and Insurance News’ web based television programing, http://wrin.tv or at the bottom of the home page of his website at http://www.zalma.com.