Fraud Investigation & Punitive Damages

Tort Damages for Failed Fraud Investigation

Insurance fraud investigations by Special Investigation Unit (SIU) have saved the insurance industry millions of dollars that would have been paid to fraud perpetrators without the SIU investigation. Even though states require the existence of an SIU the law does not effectively protect the insurer from a suit by an insured who claims he or she has been wrongfully accused of fraudulent conduct.

The insured wrongfully accused of fraud will seek both contract and tort damages from the insurer that can wipe out the gains made by defeating hundreds of fraudulent claims. The measure of damages for a tort can include punitive damages. As a result of the availability of tort damages, every suit against an insurer claiming wrongful denial of a claim will include—if state law allows it—a suit for breach of the covenant of good faith and fair dealing, seeking contract and tort damages for the bad faith denial and punitive damages.

The US Supreme Court has restricted on the extent of available punitive damages in State Farm Mutual Automobile Insurance Co. v. Campbell, 123 S.Ct. 1513, 155 L.Ed.2d 585 (U.S. 2003), where it overturned a $145 million verdict against an insurer. It said that a punitive damages award of $145 million was excessive and violated the Due Process Clause of the Fourteenth Amendment. By reducing the exposure to excessive and debilitating punitive damages claims professionals can hope the Supreme Court’s ruling gives insurers more courage to fight insurance fraud since their exposure to punitive damages is now limited.

The Campbell case arose out of an automobile accident where one party was killed and another severely injured. The Campbells, insured by State Farm, attempted to pass six vehicles on a two-lane highway, failed, and caused the driver of an oncoming car to drive off the road to escape collision with the Campbells’ vehicle. The Campbells only had $25,000 coverage per person and $50,000 in the aggregate. The Campbells felt they were not at fault because there was no contact between the two vehicles. State Farm ignored the advice of its adjuster and counsel to accept policy limits demands and took the case to trial. The verdict at trial was over $180,000 and the State Farm-appointed counsel told the Campbells to put their house on the market since they would need the money to pay the verdict. State Farm refused to pay the judgment or to fund an appeal.

The Campbells retained personal counsel to pursue an appeal that was not successful, entered into a settlement with the plaintiffs where the plaintiffs agreed to not execute on their judgment in exchange for an assignment of 90% of all money received in a bad faith action by the Campbells against State Farm. Before suit was filed, State Farm paid the full judgment.

At trial the plaintiffs brought in evidence of actions of State Farm in first party cases across the country, in third party cases not similar to the Campbells’ auto accident, and other evidence not related to the facts of their case.

The Supreme Court found that State Farm’s “handling of the claims against the Campbells merits no praise,” but concluded “a more modest punishment could have satisfied the State’s legitimate objectives. A State cannot punish a defendant for conduct that may have been lawful where it occurred.

Due process requires federal courts to perform an “exacting” de novo review of the constitutionality of punitive damages awards to ensure “that an award of punitive damages is based upon an ‘application of law, rather than a decision maker’s caprice.’” [State Farm Mut. Auto. Ins. Co. v. Campbell, 538 U.S. 408, 418, 123 S.Ct. 1513 (2003) (quoting Cooper Indus., Inc. v. Leatherman Tool Grp., Inc., 532 U.S. 424, 436, 121 S.Ct. 1678, 149 L.Ed.2d 674 (2001); Lompe v. Sunridge Partners, LLC, USCA, Tenth Circuit, 818 F. 3d 1041 (2016)] Puntive damages serve the purpose of providing deterrence and retribution.

When a court is considering the amount, if any, of punitive damages to award, the Supreme Court’s three punitive-damages guideposts: (1) “the degree of … reprehensibility or culpability” of the defendant’s conduct, (2) “the relationship between the penalty and the harm to the victim” that the defendant caused, and (3) the sanctions other courts imposed for comparable misconduct. Id. (citing Cooper Indus., Inc. v. Leatherman Tool Grp., Inc., 532 U.S. 424, 434–35, 121 S.Ct. 1678, 149 L.Ed.2d 674 (2001)); see State Farm Mut. Auto. Ins. Co. v. Campbell, 538 U.S. 408, 418, 123 S.Ct. 1513, 155 L.Ed.2d 585 (2003) (instructing courts to review punitive damages using the three guideposts).

Not all courts follow, as gospel, the rules set forth in State Farm v. Campbell, like the Supreme Court’s observation that “[s]ingle-digit multipliers are more likely to comport with due process, while still achieving the State’s deterrence and retribution goals,” does not proclaim an iron clad rule. While “[s]ingle-digit multipliers are more likely to comport with due process,” Campbell, 538 U.S. at 410, 123 S.Ct. at 1516, 155 L.Ed.2d 585 (emphasis added), higher ratios, even double or triple digit ratios, are not per se unconstitutional. Punitive to compensatory damages ratios must be examined on a case-by-case basis. The precise award in any case, of course, must be based upon the facts and circumstances of the defendant’s conduct and the harm to the plaintiff.

Additional consideration is required “where ‘a particularly egregious act has resulted in only a small amount of economic damages.’” State Farm Mutual Automobile Insurance Co. v. Campbell, 538 U.S. 408, 425, 123 S.Ct. 1513, 155 L.Ed.2d 585 (2003) (quoting Gore, 517 U.S. at 582, 116 S.Ct. 1589). Ultimately, each case must stand upon its own facts with the decisive measure being the reasonableness of the award under the circumstances. [TXO Production Corporation v. Alliance Resources Corporation, 509 U.S. 443, 458, 113 S.Ct. 2711, 125 L.Ed.2d 366 (1993))]

The Kansas Supreme Court recognized those considerations in Hayes Sight & Sound, 281 Kan. at 1312, 136 P.3d 428. But they are not to be applied in a mechanical or scorecard fashion. Even if all of them pointed against manifest reprehensibility, a punitive damages award should then be viewed as “suspect” rather than automatically deficient. Likewise, one of them alone supporting particular blameworthiness wouldn’t necessarily compel a finding of constitutional adequacy. [Ostroski v. Kathleen S. Lynn Revocable Trust, Court of Appeals of Kansas, 326 P.3d 1090 (2014)]


The reason why the operation of an SIU loses its effectiveness is because if the SIU errs and wrongfully charges an insured of fraud or is unable to prove to a court that the insured was a fraud, will be punished with tort damages and punitive damages. In this article, adapted from my book, Insurance Claims: A Comprehensive Guide the tort of bad faith is covered in detail.

ZALMA-INS-CONSULT                      © 2017 – Barry Zalma

This article and all of the blog posts on this site digests and summarize cases published by courts of the various states and the United States.  The court decisions have been modified from the actual language of the court decisions, were condensed for ease of reading, and convey the opinions of the author regarding each case.

Barry Zalma, Esq., CFE, 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 practiced law in California for more than 44 years as an insurance coverage and claims handling lawyer and more than 49 years in the insurance business.

Mr. Zalma is the first recipient of theLEGEND-TROPHY-2 first annual Claims Magazine/ACE Legend Award.

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About Barry Zalma

An insurance coverage and claims handling author, consultant and expert witness with more than 48 years of practical and court room experience.
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