Zalma’s Insurance Fraud Letter – July 15, 2023
Zalma’s Insurance Fraud Letter – July 15, 2023
Thu Jul 27 2023 06:16:12
Quote of the Issue
“There Is Always a Well-Known Solution to Every Human Problem — Neat, Plausible, And Wrong.”
H.L. Mencken
The Effect of the Tort of Bad Faith
I
t is indisputable that in the 1950’s, 1960’s and 1970’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 the tort of bad faith. It took a universal contract remedy and decided that the breach of an insurance contract without, what the court decided was proper, genuine, or even fairly debatable reasons, was transferred from a contract breach into a new tort. 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. After the creation of 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 of abusive lawyers who found it to be a new profit center for their practices.
The law of unintended consequences struck with vigor. Lawyers flocked to every available courthouse to take advantage of the new tort.
The “Law of Unintended Consequences” can be defined as the understanding that actions of people — and especially of government or the courts — always have effects that are not anticipated nor intended.
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.
Even if a claim against an insured is fairly debatable, an insurer is nonetheless obliged to engage in settlement discussions in an effort to relieve the insured from the burden and expense of litigation. [Summit Ins. Co. v. Stricklett, 199 A.3d 523 (R.I. 2019)] Therefore insurers must understand that even if the lack of coverage if fairly debatable or there is a genuine dispute it still may be held to protect the insured regardless of the lack of a duty to defend or settle. A decision from Rhode Island and other states that use the tort of bad faith to force insurers to provide benefits the policy did not promise to provide.
As Justice Kaus of the California Supreme Court noted back in 1985:
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)] (emphasis added)
The decision in White v. Western Title was rendered on the last day three of the justices and the chief justice were forced to leave the court by a vote of the public. Some speculate that spite against those who helped them lose an election, insurers, was a consideration for the decision.
As a result of the White v. Western Title Ins. Co. case litigation and settlement in California, whenever an insurer was involved, became more difficult. An insurer could be held responsible for litigation tactics it found necessary to defeat a wrongful bad faith claim against the insurer or what defendants claimed were wrongful litigation tactics when defending an insured.
The case allowed evidence of settlement negotiations – usually protected – to be admitted to help prove the insurer acted in bad faith. The White decision that allowed such evidence in a bad faith case, has been criticized as unfairly compromising a defendant’s right to defend himself. [See California Physicians’ Service v. Superior Court (1992) 9 Cal.App.4th 1321, 1327–1329 & fn. 5, 12 Cal.Rptr.2d 95 and Gonsalves v. Ran Li, 232 Cal.App.4th 1406, 182 Cal.Rptr.3d 383 (Cal. App., 2015).]
When an insurer is sued it could be charged with bad faith for taking, what the plaintiff and a court felt were too many depositions, unsuccessful motions for summary judgment, or failing to offer an appropriate amount at a settlement conference. It is now essential, before starting settlement negotiations, directly or in a settlement conference or mediation, as a result of the White v. Western Title Ins. Co. decision to have all parties waive the holding of the Supreme Court in White v. Western Title Ins. Co. before negotiations began.
Insurers, since, began the practice of requiring what is now known as the “White Waiver” before discussing settlement at the claims stage and during litigation, insurers have asked for a release to be signed by the insured stating that settlement discussions are kept private and therefore the conduct of the insurer in providing any settlement discussion under the “White Waiver” cannot be used to establish bad faith against the insurer.
The decision in White v. Western Title Ins. Co. has proved the adage that “the road to Hell is paved with good intentions.” Although the court had the apparent good intention of protecting an insured against what it saw as wrongful conduct by an insurer devastated the ability of insurers to defend themselves against unfounded bad faith lawsuits and encouraged more bad faith litigation.
Critics of White and opponents of the admission of litigation conduct as evidence of bad faith raise four arguments.
1. Sufficient Existing Protections: The trial judge, rules of civil procedure, and ethics rules protect insureds from improper insurer litigation conduct.
2. Relevance: The litigation conduct of an insurer’s lawyer is only marginally probative of the insurer’s claim handling; furthermore, the prejudice resulting from placing litigation tactics before a jury substantially outweighs the probative value of such evidence.
3. Chilling Effect: The possibility that an insurer’s litigation conduct may be admitted as evidence of bad faith has a “chilling effect” on an insurer’s defense.
4. Attorney Compromise: Attorneys for insurers will be unreasonably constrained in their advocacy and will be required continually to evaluate whether they will be advocates or witnesses at trial.
In J.B. Aguerre, Inc. v. American Guarantee & Liability Ins. Co. (1997) 59 Cal.App.4th 6, 68 Cal.Rptr.2d 837, the Court of Appeal affirmed a judgment of dismissal on demurrer, holding a liability insurer did not act unreasonably as matter of law in refusing to meet the plaintiff’s $2 million settlement demand, despite the alleged risk of exposing the insured to uncovered punitive liability. The insured’s alleged fear of his punitive exposure coerced him to contribute to a settlement out of duress.
Looking through the form of the transaction the California Court of Appeal recognized that looking to its “economic substance,” Justice Neal observed as follows:
What we have here, at bottom, is an effort by [the insured] to concoct a bad faith claim out of whole cloth ... with the ‘ingenious assistance of counsel.’ ... [The insured] has attempted to position itself to pursue a high stake, bad faith case, seeking punitive damages, from which it hopes to emerge not only with the [underlying] claim disposed of at no cost to [the insured], but a profit as well in the form of damages recovered from [the insurer]. Bad faith litigation is not a game, where insureds are free to manufacture claims for recovery. Every judgment against an insurer potentially increases the amounts that other citizens must pay for their insurance premiums. (Emphasis added) [See also, Dynamic Concepts, Inc. v. Truck Ins. Exchange, 71 Cal.Rptr.2d 882, 61 Cal.App.4th 999 (Cal.App. 4 Dist., 1998)]
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 and file a suspected fraudulent claim report with the Department of Insurance Fraud Division or Fraud Bureau. Persons perpetrating the fraud would, 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 wildflowers 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 victims of the same out of control juries. Fraud units that had been instituted in the 70’s was disbanded in the late 80’s because of fear of punitive damage judgments and only reinstated after states passed statutes requiring insurers to maintain insurance fraud investigation units.
Insurers need to recognize that since the 1950’s when the tort of bad faith was created, courts more frequently, recognizing the abuse of the tort of bad faith, find that the a “fairly debatable” issue of law like the application of a private limitation of action provision of a policy will defeat both a breach of contract and a bad faith claim.
The Case law on the Issue of Reasonableness.
For example, when the Court found that an insureds claim was debatable, the bad-faith claim must fail. Bad-faith claims were insufficient as a matter of law where the status of Kentucky law on the issue was “fairly debatable.” [Willowbrook Invs., LLC v. Md. Cas. Co., 325 F.Supp.3d 813 (W.D. Ky. 2018)
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, on occasion, err. A company with a highly trained and motivated fraud investigation unit made up of professional investigators and attorneys who are human, will err on occasion.
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 and if negligent, not an act of bad faith.
Today, if a jury believes the insurer was wrong in its decision, it must award punitive damages, regardless of the instructions read to it by the judge about the elements of the tort. Because of the bad publicity created by the policyholders’ bar and the press reports of massive bad faith judgments, insurers are not liked by a majority of the people who serve on juries. The prudent defense lawyer will assume that at least three of the jurors will vote for the policyholder, regardless of the evidence presented, and defense counsel must win over the remaining nine.
The bad publicity that was given to insurers by the early bad faith cases has poisoned the public image of insurers. The plaintiff insured only needs to convince six of the jurors who may sit in judgment without anti-insurer prejudice to receive a majority verdict with 9 votes.
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 improperly reject claims. The argument is hard for a jury of working people to withstand.
The Tort of Bad Faith Has Served its Purpose.
The tort of bad faith, and the punitive damages that seem to go with it, have, in my opinion, served their purpose. Insurers now have professional claims departments. Insureds are almost universally treated with courtesy and respect. More than 90% of all claims are resolved without litigation or argument. Legitimate claims are paid with alacrity.
Insurance fraud continues to grow. The amount of money taken from insurers every year are in the tens or hundreds of billions of dollars. The fear of punitive damages has made the fight against fraud difficult and almost impossible. Even when an insured is arrested, tried and convicted of the crime of insurance fraud, or attempted insurance fraud. Attempts will still be made to sue the insurer for the tort of bad faith.
Before I retired from the practice of law, I contended daily with insurers who wanted to fight fraud but who found they must decide to pay a claim rather than face the exposure of a punitive damage judgment. Sometimes, the settlement of bad faith lawsuits, where there has been no bad faith and an appropriate denial of a claim or refusal to pay a policy limits demand, the insurer concludes it must pay more to avoid a potential run-away jury.
I can, as my mentors taught me 53 years ago, state with confidence the opinion that an insurer should spend millions of dollars for the defense of a non-covered or fraudulent claim and not a dime for tribute to an insured who brings a spurious bad faith lawsuit.
However, practical insurance professionals have a need to resolve litigation as inexpensively as possible to protect the shareholders who want the insurer to make a profit. As a result, the insurer will disobey the millions for defense covenant and will make a business decision to pay the non-covered loss or the fraud, rather than take a chance on an adverse verdict.
As with all things in insurance, the attitudes of insurers move in cycles. More often than not, I am now called upon to testify as an expert 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.
The Fourteenth Amendment to the U.S. Constitution
Insurance companies are understood to be persons who operate in the United States and are entitled to all the rights, benefits and protections of the U.S. Constitution. The Fourteenth Amendment provides in clear and unambiguous language:
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 Ins. Co. v. Superior Court, 82 Cal.Rptr.2d 594, 70 Cal.App.4th 385 (Cal. App. 2 Dist., 1999) 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 the California Court of Appeal ignored the logical inconsistencies and troublesome complexities of the tort of bad faith. What is good for the insured should be good for the insurer and upheld the insured’s demurrer to the reverse bad faith tort theories, and the trial court sustained without leave to amend.
The Court of Appeal, explaining its decision stated: “An insurer has no claim against its insured in tort for breach of the covenant of good faith and fair dealing. A breach of this covenant is, at base, a breach of contract. A relationship including specialized circumstances of reliance and dependence is necessary to transmute such a contractual breach into a tort.
In the only reported decision in which the Alabama Supreme Court had an opportunity to address this defense, it punted. [White v. State Farm Fire & Cas. Co., 953 So. 2d 340, 351 (Ala. 2006)]. Indeed, two federal courts, presented with a similar argument, have refused to recognize such a defense under Alabama law. [MI Windows & Doors, 2018 WL 2288288, at *6; Cook v. Trinity Univ. Ins. Co. of Kan., No. 7:06-CV-02029-LSC, 2007 WL 9717431, at *13 (N.D. Ala. Dec. 13, 2007)]
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.’ Such circumstances do not exist in the context of an insured’s responsibilities toward its insurer, or in the reciprocal context of an insurer’s legitimate expectations from its insured.”
To paraphrase what George Orwell opined in his novel Animal Farm some litigants are more equal than other litigants. Since both the insured and the insurer freely entered into the contract of insurance it would appear only fair if one is allowed to obtain tort damages for breach of the covenant of good faith and fair dealing the other should also have the same opportunity.
While Connecticut, like California, recognizes that every insurance policy carries “an implied duty requiring that neither party do anything that will injure the right of the other to receive the benefits of the agreement,” [De La Concha of Hartford, Inc. v. Aetna Life Ins. Co., 269 Conn. 424, 432–33, 849 A.2d 382 (2004)] no Connecticut court has recognized a tort of “reverse bad faith” against insureds, nor are Connecticut courts likely to do so in light of established precedent. It follows that because an insured’s breach of the covenant is not actionable in tort, an insurer cannot lessen responsibility for its own tortious conduct by putting forth an affirmative defense of bad faith. [Hartford Roman Catholic Diocesan, Corp. v. Interstate Fire & Cas. Co., 199 F.Supp.3d 559 (D. Conn. 2016)]
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.
The decisions rejecting a tort of bad faith against an insured who treats the insurer in such a way as to deprive the insurer of the benefits of the insurance contract, 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.
Specifically, echoing arguments made in several law review articles, insurers, and commentators like me, complain that without reverse bad faith, insureds can take a “no-risk gamble” by seeking punitive damages, while their insurers (and by extension shareholders and policyholders) bear the burden of the high investigation and defense costs associated with those claims. [See, e.g., Edward J. Schrenk and Jonathon B. Palmquist, Fraud and Its Effects on the Insurance Industry, 64 Def. Couns. J. 23, 30 (1997) and Douglas R. Richmond, The Two–Way Street of Insurance Good Faith: Under Construction, But Not Yet Open, 28 Loy. U. Chi. L.J. 95, 142 (1996)] Current bad faith standards appear to create a windfall for insureds.
The strongest argument for recognizing a reverse bad faith cause of action can be made where the insured commits fraud when making a claim under a first-party policy. Consider Victor E. Schwartz and Christopher E. Appel, Common–Sense Construction of Unfair Claims Settlement Statutes: Restoring the Good Faith in Bad Faith, 58 Am. U.L.Rev. 1477, 1507 (2009) that critiqued the arguments against reverse bad faith and commenting that the lack of case law to support it is strikingly reminiscent of the landscape of bad-faith law only decades ago. [State Auto Prop. & Cas. Ins. Co. v. Hargis, 785 F.3d 189 (6th Cir. 2015)]
In the most succinct of the explanations from those cases, the Ohio Supreme Court refused to recognize a claim for reverse bad faith where the insured made a fraudulent claim and then sued in tort alleging bad faith in the refusal to pay. The Court in Tokles & Son, Inc. v. Midwestern Indem. Co, 65 Ohio St.3d 621, 605 N.E.2d 936, 945 (1992) explained:
This court has never recognized such a tort and refuses to do so now. As the holder of the purse strings, the insurer has a certain built-in protection from such evils. On the other hand, the insured, who often finds himself in dire financial straits after the loss, must have the equal footing which is provided by the ability to sue the insurer for bad faith. There are other avenues for the insurer to pursue in the event that an insured submits a fraudulent claim. An insurer drafts the policy, can refuse the insured’s claim, and could assert a cause of action against the insured for fraud.
Logically, and as applied before Communale, insureds who were wronged by their insurers limited their recovery to contract damages. They should be compelled to waive the tort and sue in assumpsit (the common law name for breach of contract). 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, in my opinion, be eliminated. Since the weight of authority is that no matter how reasonable the arguments are to do away with the tort of bad faith, the tort must be applied fairly and equally to both insureds and insurers and if that is impossible the tort of bad faith is contrary to the requirements of the Fourteenth Amendment to the U.S. Constitution and its requirement for 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. No litigant should ever be more equal than another.
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