policyholders guide - san francisco conference

THE AMERICAN CONFERENCE INSTITUTEFAIRMONT HOTEL, MARCH 23-24, 1998

SAN FRANCISCO, CALIFORNIA

BAD FAITH AND PUNITIVE DAMAGES

THE POLICYHOLDER’S GUIDE TO BAD FAITH INSURANCECOVERAGE LITIGATION: UNDERSTANDING THE

RECOVERY TOOLS AVAILABLE TO POLICYHOLDERS

BY EUGENE R. ANDERSONJORDAN S. STANZLERJAMES J. FOURNIER*

ANDERSON KILL & OLICK, P.C.1251 AVENUE OF THE AMERICAS

NEW YORK, NEW YORK 10020-1182(212) 2781000

http://www.andersonkill.com

CITICORP CENTERONE SANSOME STREETSUITE 1020SAN FRANCISCO, CA 94104(415) 677-1450

SUITE 75002000 PENNSYLVANIA AVE., N.W.WASHINGTON, DC 20006(202) 278-3100

1600 MARKET STREET32ND FLOORPHILADELPHIA, PA 19103

SUITE 901ONE GATEWAY CENTERNEWARK, NJ 07102(973) 642-5858

SUITE 182522 N. STONE AVENUETUCSON, AZ 85701(520) 882-9299

1 RENAISSANCE SQUARE2 NORTH CENTRALSUITE 1910PHOENIX, AZ 85004-2393(602) 252-0002

Copyright in 1997 Anderson Kill and Olick, P.C.

Eugene R. Anderson and Jordan S. Stanzler are partners in the New York office of Anderson Kill and Olick, P.C. James J. Fournier is a member of the New York bar and Director of Insurance Coverage Projects at the same firm. The firm has offices in New York, NY; Newark, NJ; Washington, D.C.; Philadelphia, PA; San Franciso, CA; and Tucson and Phoenix, AZ. The firm regularly represents policyholders in insurance coverage disputes.

NYDOCS1-449390.1NYDOCS1-449390.1 04/11/23 4:45 PM04/11/23 4:45 PM

http://www.andersonkill.com/

THE POLICYHOLDER’S GUIDE TO BAD FAITH INSURANCE COVERAGELITIGATION — UNDERSTANDING THE AVAILABLE RECOVERY TOOLS

By Eugene R. Anderson, Jordan S. Stanzler and James J. Fournier

PART IInsurance Lore

PART IIBad Lore

PART IIIWhat Makes Insurance Different

The nature of the insurance industry makes insurance different than any other

product sold in America. To win a bad faith claim against an insurance company, these

differences, sometimes more appropriately viewed as inherent inequities between policyholders

and insurance companies, must be clearly understood.

With these differences in mind, this paper sets forth some of the issues and

techniques which lawyers and policyholders should consider when prosecuting a bad faith claim

against an insurance company.

Insurance is different. Once an insured files a claim, the insurer has a strong incentive to conserve its financial resources balanced against the effect on its reputation of a `hard-ball’ approach. Insurance contracts are also unique in another respect . . . In a typical contract, the non-breaching party can replace the performance of the breaching party by paying the then-prevailing market price for the counter-performance. With insurance this is simply not possible. This feature of insurance contracts distinguishes them from other contracts and justifies the availability of punitive damages for breach in limited circumstances.1

1 E.I. du Pont de Nemours & Co. v. Pressman, 679 A.2d 436, 447 (Del. 1996).


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An insurance policy is different from other products because of the “special

relationship” between the insurance company and the policyholder.2 The special relationship

consists of a several different elements, including:

(1) the duty of good faith and fair dealing inherent in every insurance policy and between insurance companies and their policyholders.3

(2) the fiduciary duties insurance companies owe to their policyholders;

(3) the public service nature of insurance;

(4) the imbalanced bargaining position between an insurance company and its policyholder;

(5) the information imbalance between insurance companies and their policyholders;

(6) the present payment of money in exchange for a promise to pay the costs of a future event which may or may not occur, and;

(7) the financial motivation for the insurance company to delay or deny delivery of its promise.

The policyholder purchases an insurance policy, pays premiums up front and expects insurance

coverage when a claim is made.4

A. Insurance Products And Contract Law: Apples and Oranges?

Traditional contract law provides an incentive for insurance companies to breach

the insurance policies they sell to policyholders:

2 See 2 EUGENE R. ANDERSON, ET AL., INSURANCE COVERAGE LITIGATION §11, at 2 (1st ed. 1997) for a discussion of the special relationship and public trust accorded to insurance companies. §11 of this text provides a comprehensive discussion of modern bad faith law. For a discussion of the historical origins and development of the duty of good faith, see Kenneth S. Abraham, The Natural History of the Insurer’s Liability For Bad Faith, 72 TEX L. REV. 1295 (May 1994); Robert H. Jerry, II, THE WRONG SIDE OF THE MOUNTAIN: A COMMENT ON BAD FAITH’S UNNATURAL HISTORY, 72 TEX. L. REV. 1317 (May 1994).3 Pro-insurance industry commentators acknowledge that insurance companies owe their policyholders a duty of good faith and fair dealing. See, e.g, BARRY R. OSTRAGER & THOMAS R. NEWMAN, HANDBOOK ON INSURANCE COVERAGE DISPUTES 429 (5th ed. 1992). Ostrager and Newman are attorneys who regularly represent insurance companies in insurance coverage disputes.4 The Supreme Court of West Virginia noted that policyholders buy insurance --”not a lot of vexatious, time consuming, expensive litigation with [the insurance company].” Hayseeds, Inc. v. State Farm Fire & Cas., 352 S.E.2d 73, 79 (W. Va. 1986).


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The traditional goal of the law of contract remedies has not been compulsion of the promisor [e.g. the insurance company] to perform but compensation of the promisee [e.g. the policyholder] for the loss resulting from the breach.5

But insurance is different. The Supreme Court of Delaware recently explained:

Unlike other contracts, the insured has no ability to ‘cover’ if the insurer refuses without justification to pay a claim. Insurance contracts are like many other contracts in that one party (the insured) renders performance first (by paying premiums) and then awaits the counter-performance in the event of a claim. Insurance is different, however, if the insurer breaches by refusing to render the counter-performance. In a typical contract, the non-breaching party can replace the performance of the breaching party by paying the then-prevailing market price for the counter-performance. With insurance this is simply not possible. This feature of insurance contracts distinguishes them from other contracts. . . .6

Under contract law, an opportunistic breach “[is] efficient when it creates

sufficient benefit such that promisor [the insurance company] can compensate promisee [the

policyholder] fully and still be better off by breaching than by performing and leaving one party

better off and no one worse off.”7 This is never true in cases involving a wrongful denial of

insurance coverage. Commentators have recognized that opportunistic breach by insurance

companies against their policyholders is especially inappropriate, because contract law remedies

cannot truly “make whole” a policyholder wrongfully denied insurance coverage:

The law wishes to prevent what Richard Posner calls ‘opportunistic breach’ or breach designed to take advantage of the vulnerable promisee. . . . Ordinarily the law limits recovery to expectation damages in order to foster efficient breaches. But insurance contracts are perceived differently. Insurance is far from the market ideals of complete information and no transaction costs.

5 RESTATEMENT (SECOND) OF CONTRACTS, Introductory note, Ch. 16, p.100 (1979).6 E.I. du Pont de Nemours & Co. v. Pressman, 679 A.2d 436, 447 (Del. 1996). The court also noted that these differences justified “the availability of punitive damages for breach in limited circumstances.” Id.7 See David W. Barnes, The Meaning of Value in Contract Damages And Contract Theory, 46 AM. U.L. REV. 1, 3 (Oct. 1996).


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Opportunistic breaches are especially likely, and traditional damage rules do not sufficiently deter them. Additionally, it is the very nature of the insurance contract that payment is to be made automatically without the need for a lawsuit. As one court summarized it:

‘The benefit contracted for by an insured under the terms of a policy is the availability of money promptly upon the occurrence of a particular event. When an insurer refuses unreasonably to make a payment of the benefit due, or when the insurer does not pay promptly, it deprives the insured of the essence of the bargain. The insured bargained for prompt payment, not a right of action against the insurer.’8

Also consider that insurance transactions are completed sequentially, with the policyholder first

paying the premium, in exchange for the insurance company’s promise to provide insurance

coverage in the future.

Sequencing has many advantages, but it creates an unfortunate incentive. Having received its benefit from the bargain, the party who is to perform last may be tempted to renege on its obligations. Law and economics scholars often describe the conduct of a reneging party in these situations as ‘opportunistic.’ The reneging party, perceiving an opportunity to increase its gain, yields to temptation and refuses to perform.9

Insurance companies owe their policyholders a long term obligation. Unfortunately, contract

damage rules create incentives for parties to breach when the subject matter of the contract can

be devoted to a more valuable use.

The leading text in law and economics defines the economic value of something

as “how much someone is willing to pay for it or, if he has it already, how much money he

8 Mark Pennington, Punitive Damages For Breach of Contract: A Core Sample From The Last Ten Years, 42 ARK. L. REV. 31, 54 (1989). The second portion of the quote above is taken from a decision which was later vacated. Kanne v. Connecticut Gen. Life Ins. Co., 607 F. Supp. 899, 907 (C.D. Cal. 1985), aff’d in part and rev’d in part, 819 F.2d 204 (9th Cir. 1986), op. withdrawn, reh’g granted, 823 F.2d 284 (1987), vacated, 859 F.2d (1988), cert. denied, 492 U.S. 906 (1989).9 G. Richard Bell, Opportunism and Trust in the Negotiation of Commercial Contracts: Toward A New Cause of Action, 44 VAND. L. REV. 221, 222 (Mar. 1991)(footnote omitted). See also E.I. DuPont de Nemours & Co. v. Pressman, 679 A.2d 436, 447 (Del. 1996) for judicial recognition of this principle.


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demands for parting with it.”10 Opportunistic breach, however, is wholly inconsistent with the

purposes of insurance. Unlike a contract, to a policyholder, an insurance policy is not a widget

and it is not simply a contract to pay money. It is a product.11 It is peace of mind and an

expectation that the policyholder is protected. It is an obligation backed by a fiduciary duty and

10 See David W. Barnes, The Meaning of Value in Contract Damages And Contract Theory, 46 AM. U.L. REV. 1, 2 (Oct. 1996) quoting RICHARD A. POSNER, ECONOMIC ANALYSIS OF LAW 31 (4th ed. 1992).11 An insurance policy is a product, not a mere contract right. Courts and insurance companies have referred to insurance policies as products. See, e.g., U.S. Healthcare v. Blue Cross, 898 F.2d 914, 917 (3d Cir. 1990); Omega Nat’l Ins. Co. v. Marquardt, 799 P.2d 235 (Wash. 1990) (upholding state insurance commissioner’s rule aimed at “banishing certain offensive insurance products from the state marketplace” because the policies were “inherently unfair to insurance purchasers”); State Farm Mut. Auto. Ins. Co. v. Wyoming Ins. Dep’t, 793 P.2d 1008, 1016 (Wyo. 1990) (insurance policyholders are “purchasers of the product”); New Mexico Life Ins. Guar. Ass’n v. Quinn & Co., 809 P.2d 1278, 1284 (N.M. 1991); National Claims Assoc. v. Division of Employment, 786 P.2d 495, 498 (Colo. Ct. App. 1989); C & J Fertilizer, Inc. v. Allied Mut. Ins. Co., 227 N.W.2d 169, 178 (Iowa 1975); Batton v Tennessee Farmers Mut. Ins. Co., 736 P.2d 2, 5-6 (Ariz. 1987) (en banc). See also Letter from Allstate agent to policyholder (Apr. 24, 1995)(on file with the authors); Special Notice from Aetna Life & Casualty to Aetna policyholders (ed. 11-88)(on file with the authors); Should Your Insurance Company Have a Specialty Niche Insurance Product Development Department, INSURANCE AND REINSURANCE TRENDS, Dec. 1994, at 10.

Because insurance policies are products, courts have also recognized implied warranties in the sale of an insurance policy. See, e.g., Carper v. State Farm Mut. Ins. Co., 758 F.2d 337 (8th Cir. 1985) (theory of implied warranty for a particular purpose focuses on the circumstances present at the time the insurance policy is sold). The Supreme Court of Iowa has held that a standard form insurance policy was subject to the implied warranty of fitness for its intended purpose. C & J Fertilizer, above. Similarly, the Supreme Court of Arizona has held that selling an insurance policy is no different than selling a product. Batton, above. The recognition of an implied warranty of fitness in the sale of an insurance policy was summarized by a Missouri court as follows:

Although implied warranties of fitness for intended purpose have traditionally been attached only to sales of tangible products, there is no reason why they should not be attached to “sales of promises” as well. Whether a product is tangible or intangible, its creator ordinarily has reason to know of the purposes for which the buyer intends to use it, and buyers ordinarily rely on the creator’s skill or judgment in furnishing it.

Estrin Constr. Co. v. Aetna Cas. & Sur. Co., 612 S.W.2d 413, 424 n.10 (Mo. Ct. App. 1981), (quoting from W. David Slawson, Standard Form Contracts and Democratic Control of Lawmaking Power, 84 HARV. L. REV. 529, 546-47 (1971)).


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a duty of good faith by the insurance company which sold the policyholder the insurance

coverage.12 All of these concepts are promoted by insurance companies.

An insurance company who breaches its promise to provide insurance coverage

can only leave a policyholder worse off than if the promise were fulfilled. A policyholder can

never win when an insurance company opts for an opportunistic breach.13 Moreover, unlike an

insurance company, it is impossible for a policyholder to opt for an opportunistic breach. The

policyholder has nothing tangible — only a promise from the insurance company that it will

provide insurance coverage — and an assurance of peace of mind. The insurance company

already has the policyholder’s premium dollars. If the premium is not paid, the insurance is

cancelled.

Unlike other products, or contracts generally, breach of an insurance policy does

not involve a third party vying for what the insurance company has already promised to sell to

the policyholder — the policyholder’s insurance coverage. Rather, the insurance company

merely wants to hold onto the policyholder’s money for as long as it can.14

12 U.S. v. Brennon cite holds that an insurance company is not a fiduciary] For an argument that insurance companies do not owe policyholders a fiduciary duty, see William T. Barker et al., Is an Insurer a Fiduciary to Its Insureds?, 25 TORT & INS. L.J. 1 (1989); William T. Barker, Fiduciary Duty, R.I.P., 6 BAD FAITH L. REV. 107 (1990). Mr. Barker regularly represents insurance companies.13 See, e.g., West Am. Ins. Co. v. Freeman, 46 Cal. App. 4th 1476 (1st Dist. 1995), rev. granted, 907 P.2d 1323 (Cal. 1995), rev. dismissed, 927 P.2d 1172 (1996), rev. denied, No. S049306, 1997 Cal. LEXIS 649 (Cal. Feb. 5, 1997), cert. denied, -- U.S. --, 117 S. Ct. 1695 (U.S. 1997). (Note that the appellate decision was superseded by the California Supreme Court’s grant of review and that publication has not been reinstated. See Cal. Rules of Court 976, 977).14 See Mark Pennington, Punitive Damages For Breach of Contract: A Core Sample From The Last Ten Years, 42 ARK. L. REV. 31, 54 (1989):

With regard to claims for small amounts of money, the insurance company has some incentive to refuse payment because little likelihood exists that the claimant will pursue the claim. As for large claims, the insurance company may find it profitable to delay payment as long as possible to keep for itself the time value of the amount due. Finally, prolonged delays in payment may make the insured more willing to settle for less than the amount due,


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Opportunistic breach should have absolutely no place in insurance law.

Unfortunately, contract law promotes, not discourages, opportunistic breach.15 Combined with

insurance companies litigation abilities, strict enforcement of contract law nearly guarantees an

insurance company victory. The reasonable expectations doctrine, by going beyond traditional

contract analysis and the language of the policy, enables courts to fully compensate a

policyholder for all of the damage caused by a wrongful denial of insurance coverage. The tort

duty of good faith and fair dealing “fills the void created by the parties’ disparity of bargaining

power and the insurer’s exclusive control over claim processing.”16

Contract law is in evolution.17

particularly if the insured is financially desperate.

15 David W. Barnes, The Meaning of Value in Contract Damages And Contract Theory, 46 AM. U.L. REV. 1, 2 (Oct. 1996).16 Douglas R. Richmond, An Overview of Insurance Bad Faith Law and Litigation, 25 SETON HALL L. REV. 74, 79 (providing an excellent review of the issues involved in bad faith litigation, including the development of the duty of good faith and fair dealing, differences between third-party and first party insurance, the duty to defend, the duty to indemnify, the duty to settle, comparative bad faith and reverse bad faith).17 See Sons of Thunder, Inc. v. Borden, Inc., 148 N.J. 396, 690 A.2d 575 (1997). In a non-insurance case, the New Jersey Supreme Court held that a company can be liable for bad faith damages even though the company had complied with the terms of the contract. The Court reinstated a jury award of approximately one years worth of additional profits for the breach of the implied covenant of good faith, reversing the lower court finding that the right to terminate the contract could not be eliminated by an implied covenant of good faith and fair dealing. See also Dean Starkman, Award of $738,000 is Upheld in Claims Case, WALL ST. J., Mar. 13, 1997, at B13.


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B. Systemic Imbalances Must Be Called To the Court’s Attention

1. The Information Imbalance

Insurance companies take advantage of policyholder ignorance. Policyholders do

not understand how the insurance industry works. Only the insurance companies and some of

the state insurance departments have a relatively complete understanding of the industry.

“Insurance is far from the market ideals of complete information,” the Supreme

Court of Delaware said in a recent case.18 The insurance industry is not competitive because

Congress exempted the industry from federal anti-trust regulation by the McCarran-Ferguson

Act. The move towards insurance industry exemption from anti-trust regulation began in 1944,

when the United States Supreme Court rejected insurance company arguments that insurance

was not commerce. The Court held that Congress could properly apply federal antitrust statutes

to the insurance industry.19 As one noted commentator tells it:

This decision sent shivers down the spines of insurance company executives, who feared the prospect of federal agencies, particularly the Federal Trade Commission, interfering with the insurers’ cozy relationships with the state insurance commissioners. The insurance industry devised an ingenious plan to head off federal regulation. It persuaded Congress to introduce legislation, known as the McCarran-Ferguson Act, which provided a three year moratorium on federal regulation of the insurance industry. At the expiration of the moratorium the federal regulators could then assert their authority only over those aspects of the insurance industry not regulated by the states. This moratorium gave the insurance commissioners the opportunity, through the National Association of Insurance Commissioners (NAIC), to draft model legislation intended to preempt the entire field of insurance industry regulation and thus protect the

18 E.I. du Pont De Nemours & Co. v. Pressman, 679 A.2d 436 (Del. 1996) (quoting Mark Pennington, Punitive Damages for Breach of Contract: A Core Sample from the Decisions of the Last Ten Years, 42 ARK. L. REV. 31, 54 (1989)).19 See STEPHEN S. ASHLEY, BAD FAITH ACTIONS: LIABILITY AND DAMAGES § 9:02 at 4 (1996). The United States Supreme Court decision was United States v. South-Eastern Underwriters Ass’n, 322 U.S. 533 (1944).


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commissioners’ turf from Federal Trade Commission encroachment. (footnotes omitted)20

The “ingenious plan” has crippled policyholders ever since and represented a

powerful victory for the insurance industry. The insurance industry’s exemption from federal

anti-trust regulation gives insurance companies a tremendous litigation and organizational

advantage. Exemption from anti-trust regulation allows insurance companies to exchange vast

amounts of allegedly confidential insurance industry information and documents. Policyholders

are deprived of this same information and those same documents.

The information imbalance impacts the decisions of state regulatory agencies.

For example, the New York State Insurance Department currently makes decisions and rulings

from information provided solely by the insurance industry. Even if given the opportunity,

policyholders do not have the resources to present a full actuarial or legal case to the New York

State Insurance Department. There is no advocate for policyholders before the state insurance

departments.21 Insurance companies, on the other hand, can and do hire staffs of attorneys,

economists, researchers, and actuaries. In fact, insurance companies hire more attorneys than

any other industry in the United States.22 According to one influential insurance industry source:

Of course, the insurance industry is fortunate in having at its

disposal a veritable army of qualified experts in a dizzying number

of disciplines.23

20 Id.21 Texas is the only state with a pro-policyholder watchdog; The Office of Public Insurance Counsel of the State of Texas (OPIC).22 See Zan Hale, Want a Job? Call An Insurance Company; Insurers Dominate The List Again, CORP. LEGAL TIMES, Aug. 1995, at 1. See also, Angela Ward, The Big Just Keep Getting Bigger; Doing More With. . . More, CORP. LEGAL TIMES, Aug. 1996, at 1.23 Bill Thorness, The Explosive Nature of Evidence, CLAIMS, June 1997, at 8. Mr. Thorness is the editor of CLAIMS.


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Policyholders are not so fortunate.

Equally concerning to policyholders is that most state insurance commissioners

come from the insurance industry and leave their government office in order to return to the

industry (by accepting an offer of high-level employment with an insurance company at a much

higher salary).24 Insurance companies can play a hand in determining who the insurance

department should single out for regulatory scrutiny.25 When insurance companies want their

way, they usually get it.26

24 See Walter Updegrave, Stacking the Deck, MONEY, Aug. 1996, at 50, 52 (characterizing this unfortunate phenomenon as a revolving door to the insurance industry); L.H. Otis, Pa. Regulator Named, NAT’L UNDERWRITER P/C ed., Aug. 4, 1997, at 7 (reporting that Pennsylvania’s insurance commissioner was returning to Reliance Insurance Company, her former employer, and that she was to be replaced by the vice-president and general counsel of Provident Mutual Life Insurance Company). The “revolving door” at the top at state insurance departments widens the information imbalance between the insurance companies and its policyholders by seriously questioning whether protecting policyholders’ or a potential employer is the primary concern of the state insurance department. See, e.g., Robert H. Gettlin, An Elder Statesman Moves On, BEST’S REV. P/C ed., Sept. 1997, at 16:

Insurance commissioners live in two worlds. They’re charged with protecting consumer interests, but they’re also responsible for maintaining a healthy insurance market and keeping profitable companies in the state. Commissioners tack back and forth between these twin duties. A state regulator may promote one role over the other, but can never fully escape the natural tensions of the job.

The article goes on to note that Maine’s retiring superintendent of insurance, who had held his post for five years, was “one of the grizzled veterans of the profession.” Id. According to the article, of the fifty-five sitting commissioners, only six had been at their posts longer. As of September 1997, ten insurance commissioners had resigned in 1997. Id.25 See, e.g, Peter S. Canellos, Insurance Fraud Case Attacks Mass. System, BOSTON GLOBE, Jan. 11, 1998, at A1. According to the article, while the investigative bureaus of some states accept contributions from industries to offset the cost of prosecuting their cases, those states allegedly “keep their investigative bureaus under the control of public officials -- not industry representatives.”

Massachusetts’ Insurance Fraud Bureau is funded by the industry and privately run, allowing insurance companies to “buy themselves a special Division of [the attorney general’s] office -- thereby directing more attention toward cases of special interest to them.” Id. This argument was made by the attorney for a law office facing an insurance fraud prosecution. The defendants argued that the state attorney general had “surrendered part of his prosecutorial discretion” by accepting more than $1 million from insurance industry sources to fund the state’s insurance fraud division.26 Industry efforts to clip the wings of their regulators are front page news. See Scot J. Paltrow, How Insurance Firms Beat Back an Effort for Stricter Controls, WALL ST. J., Feb 5. 1998, at 1 (discussing how the insurance companies curbed the National Association of Insurance Commissioners efforts to regulate areas which were “getting short shrift in the underfunded state insurance departments.”


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2. The Imbalance In Money and Litigation Resources

For policyholders making a claim for insurance coverage, the cooperation to be

expected from a fiduciary entrusted with a duty of good faith and fair dealing is often simply not

there. Instead, the policyholder may be confronted by a financial colossus with unmatched

expertise and resources in insurance coverage litigation. Indeed, as Liberty Mutual Insurance

Company recognized:

[the policyholder] is likely not as familiar with litigation and claims evaluation and disposition as is the insurance company

. . . [T]he insurer is a professional defender of lawsuits . . . Unlike the insured, an [insurance company] is not a novice as to matters involving litigation.27

Indeed, the disparity in bargaining power, knowledge and resources has led courts

to recognize “the unique nature of contracts of insurance” and to further hold that “judicial

regulation of insurance contracts is essential in order to prevent overreaching and injustice.”28 It

follows from the disparity in bargaining power that policyholders possess far less information

than insurance companies and thus are at a distinct disadvantage in establishing their entitlement

to insurance coverage. As recently acknowledged by the Supreme Court of Delaware,

“Insurance is far from the market ideals of complete information.”

Litigation is the bread and butter of liability insurance companies and they are

comfortable with it. Franklin W. Nutter, former president of the Alliance of American Insurers,

Relatedly, see Scot J. Paltrow, Indiana’s Regulators Have Little Budget or Clout; Conflicts at the Capitol, WALL ST. J., Jan. 14, 1998, at 1 (describing the bond between state insurance regulators and the insurance industry and the dangerous effects of chronic underfunding at Indiana’s Insurance Department).27 Liberty Mutual Insurance Company’s Memorandum in Support of Motion for Partial Summary Judgment at 7, filed July 5, 1988, National Union Ins. Co. v. Liberty Mut. Ins. Co., 696 F. Supp. 1099 (E.D. La. 1988)(No. 86-2000). Liberty Mutual has been sanctioned for being a “major league team” in the game of “hardball litigation.” See Adolph Coors Co. v. American Ins. Co., 164 F.R.D. 507, 509 (D. Colo. 1993).28 Sparks v. St. Paul Ins. Co., 495 A.2d 406, 414 (N.J. 1985).


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wrote, “The liability system is fuel for the insurance engine.”29 Insurance companies now admit

that they are waging a “war” against policyholders.30 In this “war,” insurance companies are

“institutional litigants.” Insurance companies boast that they have filed “tens of thousands of

briefs across the country in a number of courts and in a vast variety of contexts” against their

policyholders.31 Claims exceeding ten million dollars are seldom resolved without litigation.32

The insurance industry has admitted that it spends one billion dollars a year in so-called

‘coverage litigation,’33 typically in the form of declaratory judgment actions. As the Chairman of

Dow Chemical Company has lamented, “it has become standard procedure for some insurance

companies to procrastinate and dispute rather than honor policies with companies that become

embroiled in litigation.”34 Against an individual policyholder, litigating perhaps its first

29 Franklin W. Nutter, Search for Stability: Industry Must Solve Problems that Undermine a Stable Market, BUS. INS., June 17, 1985, at 21.30 See, e.g., Memorandum of Law of CNA in Support of Motion To Strike Amended Counterclaims, Cross-Claims and Third-Party Complaint of General Battery at 1, filed Feb. 2, 1996, Continental Cas. Co. v. General Battery Corp., No. 93C-11-008, (Del. Super. Ct., New Castle County). The CNA Insurance Group is compromised of approximately forty-seven insurance companies. See BEST’S INSURANCE REPORTS: PROPERTY-CASUALTY UNITED STATES (1997 ed.).31 See Brief and Appendix of Amicus Curiae Insurance Environmental Litigation Association (IELA) in Support of Continental Insurance Company, Aetna Casualty and Surety Company and Fireman’s Fund Insurance Company of Newark, N.J. at 25, n.21, filed Aug. 24, 1992, County of Columbia v. Continental Ins. Co., 595 N.Y.S.2d 988 (App. Div. 3d Dep’t 1993)(No. 65588).32 See Richard A. Archer, Preparing for a ‘Mega-Loss, BUS. INS., Oct. 10, 1994, at 23. Mr. Archer is the retired deputy chairman of Jardine Insurance Brokers, Inc. See also L. Brenner, The Polluted Open Box, CORP. FINANCE, June/July 1995, at 34, 35 (“No matter what the policy language, if there is a significant seven-digit claim, its not going to be covered [by the policyholder’s insurance company].”)33 See Brief of Amicus Curiae American Insurance Association, at 3, Affiliated FM Ins. Co. v. Constitution Reinsurance Corp., 416 Mass. 839, 626 N.E.2d 878 (1994)(No. SJC-06165); Leslie Scism, Tight-Fisted Insurers Fight Their Customers To Limit Big Awards, WALL ST. J., Oct. 15, 1996, at 1; Miller v. Fluharty, No. 23993, 1997 W. Va. LEXIS 289, at *21, n.10 (W. Va. Dec. 16, 1997)(noting that the disparity in bargaining power between an insurance company and its policyholder “is apparent in the fact that insurance companies spend over $1 billion annually in litigation battles against policyholders,” citing Eugene R. Anderson & Joshua Gold, Recoverability of Corporate Counsel Fees in Insurance Coverage Disputes, 20 AM.J.TR.ADV. 1, 3 n.5 (1996). Moreover, the $1 billion figure includes only what the insurance industry spends on property and casualty insurance litigation. When life and health insurance litigation expenditures are added, “the legal costs of coverage battles with policyholders may far exceed $1 billion[.]” Robert H. Gettlin, Fighting the Client, BEST’S REV. P/C, Feb. 1997, at 49; 34 Richard Hazleton, The Tort Monster That Ate Dow Corning, WALL ST. J., May 17, 1995, at A21.


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insurance coverage claim, insurance companies possess overwhelming advantages in resources,

experience, and previously-written briefs on similar issues. Policyholders, on the other hand,

must constantly reinvent the wheel. One insurance company put it this way: “Unlike the insured,

[an insurance company] is not a novice as to matters involving litigation.”35

It does not take a financial genius to figure out that an insurance company can

make more money by collecting premiums and NOT paying claims than the insurance company

can make by collecting premiums and paying claims. Even the pro-industry press has picked up

on this.36

A careful analysis of insurance company financial statements frequently will

disclose just when the insurance company changed its “claims paying philosophy” and under

what circumstances the change was made. “Claims paying philosophy” are insurance industry

code words. They are used to distinguish those insurance companies that pay claims from those

that do not. Ultimately, the “claims paying philosophy” will determine when, how, and if claims

get paid. The “claims handling philosophy,” however, is an intangible which cannot be found in

the insurance policy.37 Financial information about the insurance company can sometimes

provide indicators of how an insurance company handles claims. For example, a decrease in the

written premiums could force an insurance company to tighten its grip on claim payments.

35 Liberty Mutual Insurance Company’s Memorandum in Support of Motion for Partial Summary Judgment at 7, filed July 5, 1988, National Union Ins. Co. v. Liberty Mut. Ins. Co., 696 F. Supp. 1099 (E.D. La. 1988(No. 86-2000).36 See Leslie Scism, Tight-Fisted Insurers Fight Their Customers To Limit Big Awards, WALL ST. J., Oct. 15, 1996, at 1; Robert H. Gettlin, Fighting The Client, BEST’S REVIEW P/C, Feb. 1997, at 49, 50 (noting that insurance companies spend over $1 billion a year litigating against their policyholders). See also Charles E. Schmidt, Jr., Industry Executives Receive New Marching Orders, BEST’S REV. P/C, Feb. 1996, at 40 (discussing the industry-wide imperative to stay “sharply focused on bottom-line results and capital justification”).37 See Anthony J. Falkowski, The Risk Manager’s Pivotal Role in D&O, RISK MGMT., Apr. 1993, at 57; Kirk L. Jensen & Sanford Victor, Update on D&O Coverage, J. OF CORP. BD., July/Aug. 1995.


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Another indicator is a historical tendency of the insurance company to litigate disputes with

policyholders.38 A broker should also be able to provide information about claims handling

reputation, but most brokers are very reluctant to make negative comments about their

“markets.”

3. The Imbalance in Bargaining Power Between the Insurance Company and the Policyholder

Many courts have recognized that “the bargaining power of an insurance carrier

vis-a-vis the bargaining power of the policyholder is disparate in the extreme.”39 As noted by the

Supreme Court of California:

[T]he relationship of insurer and insured is inherently unbalanced; the adhesive nature of insurance contracts places the insurer in a superior bargaining position. The availability of punitive damages is thus compatible with recognition of insurers’ underlying public obligations and reflects an attempt to restore balance in the contractual relationship.40

The Supreme Court of Oklahoma held:

Of particular importance is the delicate position of the insured after a loss is incurred: `The very risks insured against presuppose that if and when a claim is made, the insured will be disabled and in strait financial circumstances and, therefore, particularly vulnerable to oppressive tactics on the part of an economically powerful entity.’41

Similarly, the Supreme Court of Arizona stated:

The special nature of an insurance contract has been recognized by courts and legislatures for many years . . . . An insurance policy is

38 See Stephen Sills, Shopping the D&O Market: Directors and Officers Liability Insurance, RISK MGMT., July 1995, at 65.39 Hayseeds, Inc. v. State Farm Fire & Cas., 352 S.E.2d 73, 77 (W. Va. 1986).40 Egan v. Mutual of Omaha Ins. Co., 620 P.2d 141, 146 (Cal. 1979), cert. denied, 445 U.S. 912 (1980)(citations omitted). See also McCullough v. Golden Rule Ins. Co., 789 P.2d 855, 856 (Wyo. 1990).41 Buzzard v. Farmers Ins. Co., 824 P.2d 1105, 1108 (Okla. 1991) (quoting Fletcher v. Western Nat’l Life Ins., 10 Cal. App. 3d 376 (1970).


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not obtained for commercial advantage; it is obtained as protection against calamity. In securing the reasonable expectations of the insured under the insurance policy there is usually an unequal bargaining position between the insured and the insurance company. . . . Often the insured is in an especially vulnerable economic position when such a calamity loss occurs. The whole purpose of insurance is defeated if an insurance company can refuse or fail, without justification, to pay a valid claim.42

The West Virginia Supreme Court of Appeals in Jarrett v. E. L. Harper & Son,

Inc.43 succinctly noted that:

Insurance is different from any other business. If a man goes into a butcher shop, asks for two pounds of ground meat, and tenders $2.89 in payment, he will expect his meat to be forthcoming from the grinder. Imagine the scene were the customer to ask for his meat, and be answered that the butcher has no intention to deliver the same. “Where is my meat”? the customer would reply, possibly in other than dulcet tones. “I won’t give you any meat,” replies the butcher firmly. “Then give me back my $2.89 and I shall go elsewhere,” says the customer. “I won’t give you the $2.89 either,” replies the butcher, “for you must bring a lawsuit to get it from me.” Sock! Pow! Blam! And much property damage of a different sort.

. . .Yet such a colloquy proceeds with regularity in the area of insurance. The case of fire insurance leaps instantly to mind when companies frequently deny liability under contracts with their own insureds. Furthermore, if a man’s car is damaged negligently by another party, the tort-feasors insurance carrier, recognizing full well the liability, may well decline to pay forthwith, relying instead upon its ability to wear the injured victim down with legal expenses and the cost of stamps for the exchange of meaningless correspondence.44

One California court captured the essence of what motivates all too many

insurance companies to deny insurance coverage:

42 Noble v. National Am. Life Ins. Co., 624 P.2d 866, 867-68 (Ariz. 1981).43 Jarrett v. E. L. Harper & Son, Inc., 160 W. Va. 399, 235 S.E.2d 362 (1977).44 160 W. Va. at 405, 235 S.E.2d at 366 (Neely, J., concurring).


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“[A] lot of people who regarded themselves as rather powerful got together and [rode] roughshod over [the policyholder] because they viewed him as someone who was powerless and unable to fight back.”45

4. Insurance Companies Profit From Litigation

Insurance companies may improperly deny insurance coverage for purely

financial reasons. This is because insurance companies profit by prolonging a coverage dispute

rather than paying a claim — even when they know the claim is valid. This financial reality was

explained by no less than a standard textbook of the insurance industry:

“When an insurance company fails to pay claims it owes or engages in other wrongful practices, contractual damages are inadequate. It is hardly a penalty to require an insurer to pay the insured what it owed all along.”46

The quoted textbook is part of the required materials for students preparing to obtain the

professional designation of Chartered Property and Casualty Underwriters (“CPCU”). Thus,

candidates for the highest professional status in the business of insurance are taught that

contractual damages alone are inadequate.

Unfortunately, the stark reality is that “[a]ll that an insurance company has to sell

is its promise to pay. Yet, all other things being equal, the better an insurance company is at

avoiding that promise, the more money it makes.”47 The essence of what motivates all too many

insurance companies to deny insurance coverage was captured by one California court:

45 See West Am. Ins. Co. v. Freeman, 46 Cal. App. 4th 1476 (1st Dist. 1995), rev. granted, 907 P.2d 1323 (Cal. 1995), rev. dismissed, 927 P.2d 1172 (1996), rev. denied, No. S049306 1997 Cal. LEXIS 649 (Cal. Feb. 5, 1997), cert. denied, 117 S. Ct. 1695 (U.S. 1997).46 JAMES J. MARKHAM, ET AL., THE CLAIMS ENVIRONMENT 274 (1993) (this is a comprehensive text used to train insurance company personnel in claims handling practices).47 Tom Baker, Symposium on the Law of Bad Faith in Contract and Insurance Agreements: Theory: Constructing the Insurance Relationship; Sales Stories, Claim Stories, and Insurance Contract Damages, 72 TEX. L. REV. 1395, 1401 (1994).


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“[A]lot of people who regarded themselves as rather powerful got together and [rode] roughshod over [the policyholder] because they viewed him as someone who was powerless and unable to fight back.”48

The practicalities and economics of denying insurance coverage weigh heavily in

favor of insurance companies.49 First, insurance companies earn investment income — a profit

— during an insurance coverage dispute with a policyholder. This is done by continuing to

invest the policyholder’s premiums and the reserves for the duration of the dispute. Second,

insurance companies are bulk purchasers of legal services; they incur proportionately lower

litigation costs than their policyholders, and can reuse work product from case to case. This is

particularly true in the property and casualty insurance industry, where the twenty largest

insurance companies have banded together to form the Insurance Environmental Litigation

Association (“IELA”). These factors, combined with the insurance industry’s tremendous

collective resources and litigation experience, allow insurance companies to wage wars of

attrition against individual policyholders who litigate an insurance dispute once in a lifetime.

This war-making ability, along with a policyholder’s often critical need for money after a loss,

drives policyholders to settle cases for less than their merit. Thus:

the money-for-promise arrangement makes delay a powerful strategic tool insurance companies can use against claimants, a tool that under the prevailing application of contract damages doctrine is nearly cost free. In a state adhering to traditional insurance contract damages limitations and an intent-based bad faith standard, an insurance company with a weak, but colorable,

48 See West Am. Ins. Co. v. Freeman, 46 Cal. App. 4th 1476 (1st Dist. 1995), rev. granted, 907 P.2d 1323 (Cal. 1995), rev. dismissed, 927 P.2d 1172 (1996), rev. denied, No. S049306, 1997 Cal. LEXIS 649 (Cal. Feb. 5, 1997), cert. denied, 117 S. St. 1695 (U.S. 1997). Note that the appellate decision was superseded by the California Supreme Court’s grant of review and that publication has not been reinstated. See Cal. Rules of Court 976, 977.49 See Eugene R. Anderson, et al., Insurance Nullification By Litigation, RISK MGMT., Apr. 1994, at 46; Eugene R. Anderson, Is Something Wrong With Claims Handling? Plaintiff: Insurers Profit From Delay, Litigation, CLAIMS, Apr. 1995, at 33.


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defense to a claim will almost never have to pay more in real dollars than was owed at the time the claim was presented.50

The sad truth is that unless an insurance company is confronted with the prospect

of damages well in excess of the policy limits,51 it may have no incentive to honor its obligations

under the insurance policy:

Unlike most other commercial actors fighting for supremacy in a world where possession is nine-tenths of the law, insurers always

50 See Tom Baker, Symposium on the Law of Bad Faith in Contract and Insurance Agreements: Theory: Constructing the Insurance Relationship; Sales Stories, Claim Stories, and Insurance Contract Damages, 72 TEX. L. REV. 1395, 1430 (1994)(citation omitted)(emphasis added). See also Garnett v. Transamerica Ins. Servs., 800 P.2d 656, 666 (Idaho 1990).51 Even insurance companies recognize that punitive damages should be used to deter insurance company bad faith:

Punitive damages must be awarded to deter this type of action in the future. A simple judicial test will serve this purpose: If the court finds that an insurer made a determination not to settle within the policy limits based on its own self-interest, punitive damages will be awarded.

Civil Action--Cross Petition for Certification and Brief in Opposition to Defendant-Appellant Petition for Certification, at 13, 16, filed Dec. 7, 1976, Fireman’s Fund Ins. Co. v. Security Ins. Co. of Hartford, 367 A.2d 864 (N.J. 1976).

The same insurance company, Fireman’s Fund, also argued:

Insurance companies must realize the importance of settlement within policy limits and should realize the impact their decisions must have upon their insured. This court should establish the rule that punitive damages are to be awarded whenever the court finds that an insurance company made its decision regarding settlement based on its own interest as opposed to the interests of its insured.

Id. at 13.

Lawyers who regularly represent insurance companies have also recognized that without punitive damages, insurance companies “had nothing to lose by wrongfully denying claims or coercing unfair settlements.” James A. McGuire & Kristin Dodge McMahon, Issues For Excess Insurer Counsel In Bad Faith And Excess Liability Cases, 62 DEFENSE COUNS. J. 337 (1995). See also James A. McGuire & Kristin Dodge McMahon, Bad Faith, Excess Liability And Extracontractual Damages: Counsel For The Excess Carrier Looks At The Issues, 72 U. DET. MERCY L. REV. 49 (1994).

The financial realities of insurance coverage and the need for punitive damages was explained by no less than a standard textbook of the insurance industry:

“When an insurance company fails to pay claims it owes or engages in other wrongful practices, contractual damages are


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have the nine-tenths advantage: They hold the money. Consequently, insurers always get to “play the float” in any dispute. Even where the judicial system acts rapidly and efficiently to provide compensation to wronged policyholders, the carrier may find it made money by delaying payment of the claim. If its investments have been good, it may even have made enough to cover any prejudgment interest, costs, or consequential damage award, or counsel fees collected by the policyholder.52

Policyholders have attempted to level the playing field by making it less profitable and far riskier

for insurance companies to breach their insurance policies by seeking, and getting, punitive

damages. The threat of punitive damages adds an element of unpredictability to the insurance

company’s potential liability. But while greater risk and unpredictability may deter some

insurance companies, the status quo is still clear: “The insurance company is in no hurry. It has

the money. It has your premium. It has an army of lawyers.”53 Ironically, the possibility of

damages in excess of the policy limits most often arises in litigation between insurance

companies, not policyholders.54

inadequate. It is hardly a penalty to require an insurer to pay the insured what it owed all along.”

JAMES J. MARKHAM, ET AL., THE CLAIMS ENVIRONMENT 274 (1993). The quoted textbook is a comprehensive text used to train insurance company personnel in claims handling practices and is part of the required materials for students preparing to obtain the professional designation of Chartered Property and Casualty Underwriter (“CPCU”). Thus, candidates for the highest professional status in the business of insurance are taught that contractual damages alone are inadequate.

The consensus among policyholders, insurance companies and insurance company lawyers is clear: The nature of the relationship between policyholders and insurance company makes it all too easy for insurance companies to simply say “NO.” Awarding punitive damages, in addition to enforcing the policyholder’s reasonable expectations of insurance coverage, is an additional means to curb insurance company opportunistic breach.52 Jeffrey W. Stempel, Interpretation of Insurance Contracts: Law and Strategy for Insurers and Policyholders § 19.3, at 466-67 (1994).53 Herb Denenberg, How Insurance Companies Avoid Payment of Claims, READING EAGLE, May 26, 1995, at A12 (Mr. Denenberg is a former Commissioner of Insurance for Pennsylvania and Professor of Insurance at the Wharton School of the University of Pennsylvania).54 See generally, PATRICK MAGARICK, EXCESS LIABILITY, §§ 17.02, 17.06 (1996). In particular, insurance companies which have sold a policyholder excess liability coverage attempt to reduce their ultimate costs by settling a policyholder’s claim after the primary insurance company has refused to do so. The policyholder then assigns its rights under the primary policy to the excess insurance company.


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5. Other Contributors to the Information Imbalance

a. The Public Relations Campaign

The imbalance in information and resources between insurance companies and

policyholders creates a disparity in the abilities of each side to organize effectively. For

example, two of the largest trade associations representing insurance companies, the American

Insurance Association (“AIA”) and the Alliance of American Insurers (“AAI”), both regularly

file “friend of the court” briefs on behalf of insurance companies in insurance litigation cases.

Two other groups, the Insurance Services Office, Inc. (“ISO”)55 and the National Association of

Independent Insurers (“NAII”) gather and analyze information for the insurance industry. The

information provided by ISO and the NAII is available to insurance companies, but not to

policyholders or the public. Members of the insurance industry are able to hone their skills

through a myriad of advanced training and educational seminars.56 Policyholders, who have not

By stepping into the shoes of the policyholder, excess insurance companies can bring a bad faith claim against primary insurance companies which wrongfully refuse to settle a claim and expose the policyholder or excess insurance company to a judgment exceeding the primary policy’s limits.55 The Insurance Services Office, Inc. (“ISO”) is a national non-profit corporation that gathers, stores and disseminates statistical information to insurance regulators as required by law and to insurance companies for their use. ISO drafts and assists insurance companies in implementing insurance coverage programs and defining insurance coverage risks faced by policyholders. ISO also distributes industry-wide advisories regarding insurance rates and rules to participating property and casualty insurance companies. See “Insurance Services Office In a Competitive Marketplace: ISO’s Role Within the Property/Casualty Insurance Industry,” Insurance Services Office, Inc., June 1987, at 2, 3. ISO drafted the 1985 revisions to the Comprehensive General Liability policy, including the so-called ‘absolute’ pollution exclusion. Predecessors of ISO include the Mutual Insurance Rating Bureau (MIRB); the National Bureau of Casualty Underwriters (NBCU), and the Insurance Rating Board (IRB)(NBCU’s successor). These groups jointly drafted the 1965 and 1973 revisions to the occurrence based Comprehensive General Liability policies and the ‘sudden and accidental’ polluter’s exclusion introduced in 1970. See John A. MacDonald, Decades of Deceit: The Insurance Industry Incursion into the Regulatory and Judicial Systems, COVERAGE, Nov./Dec. 1997, at 2 and n.3.56 See Mikel M. Benton, Adjusters See Moderate Progress In New RPA Program, CLAIMS, Feb. 1998, at 58 (discussing a newly designated program designed “to enhance the knowledge, stature and reputation of people working in the claims handling industry.”); V.P. “Champ” Codding Jr., State-By-State Requirements For Adjusters and Appraisers, Charting Credentials For Handling Claims: Charting Credentials For Handling Claims, CLAIMS, Feb. 1998, at 42, 44 (discussing the various licensing requirements of adjusters and appraisers employed by insurance companies or independently and noting that several states require continuing educational training); Ninth Annual Directory of Education


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made a career out of insurance, seldom have the time or even the opportunity to become even

remotely familiar with the most basic tricks and techniques of the insurance industry.

There is no organization specifically devoted to representing policyholders’

interests in insurance coverage actions.57 Yet there are major national organizations specifically

devoted to the legal defense of insurance companies: the American Insurance Association, the

Alliance of American Insurers, the Defense Research Institute, the Insurance Environmental

Litigation Association and the Federation of Insurance and Corporate Counsel. While the

American Bar Association has two committees largely committed to insurance coverage matters,

both are overwhelmingly dominated by insurance company lawyers. By contrast, policyholders

— aside from the FBI and the Justice Department, neither of which particularly “caters” to

policyholders — have virtually none.

Further, the National Association of Insurance Commissioners (“NAIC”)

generally excludes policyholders from its meetings and studies. At NAIC conventions, there are

thousands of insurance brokers and insurance company representatives but only four or five

Resources, CLAIMS, Feb. 1998, at 50 (listing over 40 schools which provide insurance training of every sort for members of the insurance industry).57 One policyholder organization is United Policyholders. United Policyholders is a non-profit corporation dedicated to educating policyholders on their rights and duties under their insurance policies. Specifically, United Policyholders engages in charitable and educational activities by promoting greater public understanding of insurance issues and policyholder rights. United Policyholders’ activities include distributing written materials, filing amicus briefs and responding to requests for information from individuals, elected officials, and governmental entities.

United Policyholders was founded in 1991 as a 501(c)(3) non-profit corporation organized under the laws of the State of California, funded by donations and grants and staffed exclusively by volunteers. United Policyholders’ first major project was working with over a thousand victims of a devastating October 1991 firestorm in the Oakland/Berkeley, California hills, to help them understand their policies and receive prompt, fair insurance claim settlements. Since that time, United Policyholders has conducted educational meetings and workshops on insurance issues in Florida, Texas, and throughout California. Much of United Policyholders’ work takes place in communities that have been hit by natural disasters, such as hurricanes, wildfires, earthquakes, and floods, which give rise to large numbers of insurance claims and resulting consumer confusion and frustration. United Policyholders receives frequent invitations to testify at legislative and other public hearings, and to participate in regulatory proceedings on rate and policy issues.


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consumer-policyholder representatives. It is virtually impossible for a policyholder

representative to get into an NAIC convention. The revolving door between the insurance

industry and state insurance departments, and the ability of the insurance industry to influence

legislators, worsens the information imbalance between policyholders and insurance companies

and furthers the insurance industry public relations campaign.58

b. Buying And Lying

A significant force in perpetuating the information imbalance is the ability of

insurance companies to simply buy away adverse legal decisions — one of the best examples of

the insurance industry’s tremendous influence over the development of insurance law and the

courts.59 Through the frequent use of vacatur,60 insurance companies have paid big money to

wipe out case law contrary to their interests.61 In this way, insurance companies are able to erase

the ‘bad’ decisions while retaining the ‘good’ ones. The insurance companies then relitigate the

same issues with a deck increasingly stacked in their favor. Insurance companies repeatedly

offer settlements with policyholders conditioned upon the courts vacating and withdrawing

earlier rulings.62 These mechanisms eradicate pro-policyholder case law and enables insurance

companies to shape insurance law — even after losing important cases.

58 See Walter L. Updegrave, Stacking The Deck, MONEY, Aug. 1996, at 57-63.59 See Eugene R. Anderson & James J. Fournier, Insurance Companies Buy Legal Decisions -- and Then Lie To Courts and Policyholders About It, THE ADVOCATE, Sept./Oct. 1997, at 22.60 Although the legal term for this practice is “vacatur,” the practice is also known by another name -- “buying and lying.” Buying and lying refers to a common practice of insurance companies of vacating and depublishing undesirable decisions by offering claimants attractive settlements -- after the insurance company has litigated and often after the court has written its opinion. The practice of buying and lying operates by preventing the creation of “bad” law for the insurance industry or preventing policyholders from appealing decisions favorable to the insurance industry. The practice is firmly established. See Jill E. Fisch, The Vanishing Precedent: Eduardo Meets Vacatur, 70 NOTRE DAME L. REV. 325, 356 and n.135 (1994).61 See Eva M. Rodriguez, Legal Sleight of Hand: Vacatur Policy Challenged In Supreme Court Appeal, TEXAS LAW., May 17, 1993, at 1, 34. See also Saundra Torry, It’s Magical History Tour At `Vacatur Center,’ WASH. POST, Mar. 10, 1997, at 7; Susan Dominus, Reviving Dead Rulings On The Web, AMLAW TECH, Spring 1997, at 24.


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According to one insurance industry source, fifty percent of the pro-policyholder

judicial decisions are wiped off the law books by the insurance industry.63 Contrary to insurance

company assertions, the true “majority of the courts” is not on the law books.64 Reported court

decisions do not accurately reflect insurance law:

[V]acatur becomes an important litigation tool, particularly for institutional litigators who must return to court many times with the same arguments. When a court rejects the arguments of institutional litigators such as [the defendant], an insurance company, the institutions are dealt a crippling blow not only in the case at bar but in future litigation. Vacatur allows disappointed litigators effectively to rewrite history. Vacatur allows them to control the direction and content of the jurisprudence — to weed out the negative precedent and preserve the positive — and create

62 See, e.g., Round Rock Plaza Venture v. Maryland Ins. Co., No. 03-95-00108-CV, 1996 Tex. App. LEXIS 581 (Tex. Ct. App. Feb. 14, 1996); Circle “C” Ranch Co. v. St. Paul Fire & Marine Ins. Co., No. 3-91-388-CV, 1993 Tex. App. LEXIS 1291 (Tex. Ct. App. May 5, 1993), op. withdrawn, 1993 Tex. App. LEXIS 1827 (Tex. Ct. App. May 19, 1993); Bankers Trust Co. v. Hartford Accident & Indem. Co., 518 F. Supp. 371 (S.D.N.Y. 1981), order vacated by 621 F. Supp. 685 (1981).63 Carrizosa, Making the Law Disappear: Appellate Lawyers Are Learning to Exploit the Supreme Court’s Willingness to Depublish Opinions, CAL. LAW., Sept. 1989, at 65. See also Wendy R. Leibowitz, ‘Dog’ Cases Get Around on the ‘Net, NAT’L L.J., Oct. 14, 1996, at A11; Paul M. Barrett, Critics Say that Deep-Pocketed Clients Benefit From Vacated Court Judgments, WALL ST. J., Sept. 24, 1996, at B15 (securities fraud judgment vacated).64 Id.; see also Oklahoma Radio Assocs. v. Federal Deposit Ins. Corp., 3 F.3d 1436, 1444 (10th Cir. 1993) (“A policy permitting litigants to use the settlement process as a means of obtaining the withdrawal of favorable precedents is fraught with the potential for abuse.”); National Union Fire Ins. Co. v. Seafirst Corp., 891 F.2d 762 (9th Cir. 1989) (denying joint post-settlement motion to vacate where vacatur would have preclusive effect on other parties involved in the litigation); Memorial Hosp. of Iowa County v. United States Dept. of Health & Human Servs., 862 F.2d 1299, 1300 (7th Cir. 1988) (explaining why the Seventh Circuit routinely rejects requests to vacate opinions: “[A]n opinion is a public act of the government, which may not be expunged by private agreement. History cannot be rewritten. There is no common law writ of erasure.”); Aetna Cas. & Sur. Co. v. Home Ins. Co., 882 F. Supp. 1355, 1356 (S.D.N.Y. 1995), quoting Manufacturers Hanover Trust Co. v. Yanakas, 11 F.3d 381 (2d Cir. 1993) (“[V]acatur . . . would allow a party with a deep pocket to eliminate an unreviewable precedent it dislikes simply by agreeing to a sufficiently lucrative settlement to obtain its adversary’s cooperation in a motion to vacate. We do not consider this a proper use of the judicial system.”); Benavides v. Jackson Nat’l Life Ins. Co., 820 F. Supp. 1284, 1289 (D. Colo. 1993) (noting that failure to acknowledge genuine legal precedents in insurance law means that “[t]he case law becomes what the party with the greatest resources wishes it to be. Economic prowess purchases more persuasive power than the marketplace of ideas and sound reasoning combined. Vacatur allows wealthy litigants to become, in effect, editors of their own treatises on the subjects which concern them. We have no kind words for such a practice. We can imagine few practices condoned by the judicial system that would have a less salutary effect on both the reality [and] the perception of its integrity.”).


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an artificially weighty and one-sided estimate of what comprises “the case law.”65

Insurance companies also settle with policyholders when insurance companies

win. This is done to prevent policyholders from appealing a decision favorable to the insurance

company, thereby foreclosing any chance of reversal and allowing the entire insurance industry

to cite the decision as positive precedent.66

Attorneys representing the insurance industry claim that vacatur supports

settlement.67 Nothing could be further from the truth. As many courts and commentators have

been quick to point out, an insurance company which wishes to avoid an adverse precedent need

only settle before a decision is rendered.68 Vacating judgments at the appellate court level does

65 Benavides v. Jackson Nat’l Life Ins. Co., 820 F. Supp. 1284, 1289 (D. Colo. 1993).66 This happened in Travelers Insurance Co. v. Ross Electric of Washington, Inc. (“Ross Electric”), a case involving the critically contested issue of whether CERCLA mandated environmental cleanup costs are damages covered under a standard CGL policy. Travelers Ins. Co. v. Ross Elec. of Wash., Inc., 685 F. Supp. 742 (W.D. Wash. 1988), overruled by Boeing Co. v. Aetna Cas. & Sur. Co., 113 Wash. 2d. 869, 784 P.2d 507 (1991). The federal district court for the Western District of Washington ruled in favor of the insurance company and found that cleanup costs were not covered as damages under the CGL policy. Yet at the time Travelers and Ross Electric entered the settlement agreement, Travelers knew that two Washington state trial level judges had ruled the other way in two unpublished opinions. See Roger Parloff, Rigging the Common Law, AM. LAW., Mar. 1992, at 74, 77. Moreover, the judge in Ross Electric had told the parties that he wished to reconsider his opinion in light of those decisions. See Parloff, at 77. According to the attorney for Ross Electric, following these developments, Travelers decided to pay “a substantial amount to freeze the decision as precedent.” Id. It was not until two years later that the Washington Supreme Court in Boeing Co. v. Aetna Casualty & Surety Co. (“Boeing”) halted insurance company defendants from “primarily” relying on the Ross Electric decision. The Boeing court rejected the case, holding that the Ross Electric decision had incorrectly applied Washington law and had been decided without the benefit of the reasoning of the only Washington court to have addressed the issue in question. Boeing Co. v. Aetna Cas. & Sur. Co., 113 Wash. 2d. 869, 885, 784 P.2d 507, 515 (1990)(discussing how the defendant insurance companies’ primary reliance on Travelers Insurance Co. v. Ross Electric of Washington, Inc. was erroneous based on Travelers misapplication of Washington law). Nonetheless, the strategy was an insurance industry success while it lasted: Until Ross Electric was rejected by Boeing, the decision was cited at least a dozen times by other courts. See Payoffs by Insurance Companies To Make Court Decisions Disappear Thwarted By Law Firm’s Website, PR NEWSWIRE ASS’N, Apr. 17, 1997.67 See Saundra Torry, When Decisions Are Written In Disappearing Ink, WASH. POST, July 25, 1994, at F7.68 Memorial Hosp. of Iowa County v. United States Dep’t of Health & Human Servs., 862 F.2d 1299, 1302 (7th Cir. 1988).


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not foster settlement at the trial court level — it does the opposite.69 “Vacatur is simply not

efficient judicial resource management.”70 Or perhaps even more to the point: “[W]hen the

proposed savings can be realized only at the cost of increasing the vulnerability of the judicial

system to manipulation, we view the investment as unsound.71 Parties which litigate only to

negotiate on appeal and then vacate an adverse decision are only seeking an “advisory opinion”

from the court, wasting precious judicial resources in the process.72 “The public’s interest is in

settlement before all the work is done.”73

The power to routinely vacate decisions is tremendous. In insurance coverage

litigation, legal precedents are worth far more than the sum in dispute. This is because most

insurance policies sold in the United States follow a nearly universally standardized format

dictated by the insurance industry. Thus, the same issues tend to re-emerge. The result is that

almost every state court decision, though binding only in one state, adds to the “weight of

authority” concerning the interpretation of insurance policies. This circumstance gives the

insurance industry a very strong interest in erasing pro-policyholder insurance coverage

decisions.74

The classic “sale” of pro-policyholder case law occurred in 1981 when Hartford

Accident & Indemnity Company (“Hartford”), a member of the Hartford Insurance Group, paid

69 Stolz v. American Int’l Life Assurance Co., 922 F. Supp. 435, 437 (W.D. Wash. 1996).70 Benavides v. Jackson Nat’l Life Ins. Co., 820 F. Supp. 1284, 1288 (D. Colo. 1993). (noting that post-settlement vacatur provides “no incentive for early settlement,” encourages litigants to “roll the dice” and finding the view that vacatur encourages settlement “empirically unsupported” and contrary to the court’s experience).71 Manufacturers Hanover Trust Co. v. Yanakas, 11 F.3d 381, 385 (2d Cir. 1993).72 Stolz v. American Int’l Life Assurance Co., 922 F. Supp. 435, 436 (W.D. Wash. 1996).73 Mancinelli v. Int’l Bus. Machs. Corp., 95 F.3d 799, 800-801 (9th Cir. 1996)(Kleinfeld, J., dissenting).74 Anderson Kill has a Web-site devoted to the publication of judicial decisions that have been wiped off the law books. Enter www.andersonkill.com.


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$200,000 to expunge from the case books the decision of United States District Court Judge

Morris Lasker in Bankers Trust Co. v. Hartford Accident & Indemnity Co.75 In Bankers Trust,

Judge Lasker granted Bankers Trust’s motion for summary judgment, holding that it was entitled

to insurance coverage from Hartford for cleanup costs incurred in removing oil from its property.

Nearly four months later, Judge Lasker signed an order vacating his earlier decision. Judge

Lasker indicated that he took this action to allow Hartford to submit additional materials to the

court, after which Judge Lasker would “determine Bankers’ motion for summary judgment de

novo.” But Hartford had actually reached a settlement with Bankers Trust whereby Hartford

would pay Bankers Trust $2.3 million — about $200,000 more than the amount Bankers Trust

had sought in its complaint — with the provision that Judge Lasker vacate his earlier opinion.76

Similarly, in Circle “C” Ranch Co. v. St. Paul Fire & Marine Insurance Co., a

Texas appellate court decided in favor of the policyholder on a long-awaited decision

interpreting the polluter’s exclusion in a standard-form general liability policy.77 The decision

was the first time a Texas appellate court had addressed the issue. Pursuant to a settlement

agreement, however, St. Paul paid Circle “C” $300,000, and both parties requested the court to

vacate its decision. The decision was vacated within two weeks. Although Circle “C” received

75 Bankers Trust Co. v. Hartford Accident & Indem. Co., 518 F. Supp. 371 (S.D.N.Y.), order vacated by 621 F. Supp. 685 (1981). See also Roger Parloff, Rigging the Common Law, AM. LAW., Mar. 1992 at 74, 78.76 It is telling that Hartford’s ‘arrangement’ did not come to light until 7 years later when it surfaced in another case involving Hartford. In Intel v. Hartford Accident & Indemnity Co., 692 F. Supp. 1171, 1192 (N.D. Cal. 1988), aff’d in part, rev’d in part, 952 F.2d 1551 (9th Cir. 1991), Hartford tried to use the very same arguments that had been rejected by Judge Lasker 7 years prior, arguing that Bankers Trust had no application to the present facts since it had been vacated. Hartford’s duplicity was exposed when Intel produced an affidavit from an attorney involved in the Bankers Trust which revealed the real story in Bankers Trust. The court in Intel took notice of the ‘sound guiding analysis’ of Banker’s Trust and upheld insurance coverage for Intel’s environmental liability. See 692 F. Supp. at 1192.77 Circle “C” Ranch Co. v. St. Paul Fire & Marine Ins. Co., No. 3-91-388-CV, 1993 Tex. App. LEXIS 1291 (Tex. Ct. App. May 5, 1993), op. withdrawn, 1993 Tex. App. LEXIS 1827 (Tex. Ct. App. May 19, 1993). See also Janet Elliott, For 300K, Environmental Test Case Evaporates, TEX. LAW., May 31, 1993, at 1.


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$300,000, the indemnity amount due from St. Paul had been only $5,000, which together with

the $81,000 in attorneys fees, gave Circle “C” a total claim of $86,000. Thus, the price for the

decision in Circle “C” was about the same as it was in Bankers Trust — $200,000.

In U.S. Bancorp Mortgage Co. v. Bonner Mall Partnership, 513 U.S. 18 (1994)

(“Bonner Mall”), the United States Supreme Court held that vacatur is an “extraordinary

remedy” which must take account of the public interest:

Judicial precedents are presumptively correct and valuable to the legal community as a whole. They are not merely the property of private litigants and should stand unless a court concludes that the public interest would be served by a vacatur.78

Nor was it lost on the Court that:

[W]hile the availability of vacatur may facilitate settlement after the judgment . . . it may deter settlement at an earlier stage. Some litigants, at least, may think it worthwhile to roll the dice rather than settle . . . if, but only if, an unfavorable outcome can be washed away by a settlement-related vacatur.

Id. Thus, the Court held that absent “exceptional” circumstances, “settlement does not justify

vacatur of a judgment under review.” Id. at 244. Moreover, the Court held that exceptional

circumstances does not include the mere fact that a settlement agreement provides for vacatur.

But make no mistake — the insurance company campaign continues. Despite the

seeming precision of the language in Bonner Mall, litigants routinely seek to avoid the Supreme

Court’s edict and state courts continue to legitimize buying and lying.79 Judges are simply

unable to contend with the insurance industry practice of wiping the common law off the books.

78 130 L. Ed. 2d at 243, quoting Izumi Seimitsu Kogyo Kabushiki Kaisha v. U.S. Philips Corp., 510 U.S. 27, 40 (1993)(Stevens, J., dissenting from dismissal of certiorari as improvidently granted).79 At least one state court has held that Bonner Mall “is not binding precedent because the issue decided was one of federal procedural law” and as such “does not apply to state courts’ application of state procedural law.” See Panterra Corp. v. American Dairy Queen, 908 S.W.2d 300, 301 (Tex. Ct. App. 1995).


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In one recent example, a Texas court imposed a $2 million sanction on AIG for its “systematic

and pervasive discovery abuses,” finding that AIG had violated two court orders requiring the

insurance company to produce (1) claims files; (2) claims manuals; (3) policy forms; (4) drafting

history; (5) “lost” insurance policies; (6) diaries and notes of claims handlers, and; (7) company

produced training manuals.80 One week later, the order was vacated, forever erasing any trace of

AIG’s misconduct.81 In another variation of buying and lying, the same insurance company,

AIG, was found liable for punitive damages for failing to pay its defense counsel after a case had

been settled:

By threatening unwarranted fee disputes, carriers such as National Union try first to pressure law firms to violate their duty of undivided loyalty to their clients, the insureds, and thus to interfere with the insureds right to control the litigation. Whether or not that works, such carriers build up payables to the law firms, knowing the firms cannot reasonably withdraw, and then, using economic leverage and the ‘indemnify the client’ device, seek to get a big discount.82

Cases can disappear even before a decision has been rendered or a settlement has

been reached. In a case which could be referred to as a “disappearing docket” case involving

Gold Medal Insurance Co. (a captive insurance company), and National Union Fire Insurance

80 Bristol-Myers Squibb v. AIU Ins. Co., No. A-0145,672 (Tex. Dist. Ct. Apr. 29, 1997)(order granting plaintiffs’ motion for sanctions). See also Dan Lonkevich, Texas Judge Hits AIG With $2M Sanction, NAT’L UNDERWRITER, May 12, 1997, at 41.81 See Bristol-Myers Squibb v. AIU Ins. Co., No. A-0145,672 (Tex. Dist. Ct. May 7, 1997)(order vacating sanctions), reported in MEALEY’S LITIG. REP.: INS., May 20, 1997, at G-1.82 See In re: The Arbitration of Seltzer Caplan Wilkins & McMahon, P.C. v. Shapell, No. 684799, at 44 (Cal. Sup. Ct. Nov. 25, 1996). The arbitrator found that punitive damages were required because National Union acted in “conscious disregard” of the law firm’s rights by denying their claim, while, among other things, (1) never reviewing the case file; (2) never reading any report accompanying the billing statements at issue; (3) never communicating with the law firm regarding their work in the case; (4) “completely” ignoring the National Union Claims Manual; and (5) similarly creating fee disputes with other law firms. Id. at 42-3. In sum, “[t]his type of conduct by National Union . . . is a deliberate and calculated invasion of the attorney-client relationship . . . . Public policy requires a message be sent to the industry. The message is punitive damages. Id. at 44-5. See also David Rubenstein, Insurer Pays Plenty For Haggling Over Legal Bills, CORP. LEG. TIMES, June 1997, at 1. The insurance company refusing to pay its lawyers, National Union Fire Insurance Company is one of the AIG companies.


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Company, the entire docket seemingly vanished. Although a business journal reported that

National Union had filed a declaratory judgment action, and that U.S. District Court Judge John

F. Keenan had denied a General Mills motion to move the case,83 a search of the public records

turned up nothing. Why? The case now appears on the official court docket as “A.B.C. v.

D.E.F.”84 Clearly, National Union is afraid that policyholders will discover positions it takes on

the interpretation of standard-form insurance policy language and use them against it in

subsequent litigation.

Needless to say, lawyers and policyholders should not rely on exclusively on the

lawbooks when prosecuting any insurance coverage action.

c. Arbitration

The information imbalance is further worsened by the insurance industry

preference to arbitrate insurance coverage disputes. Because arbitrations are closed proceedings

(unlike court cases, which, for the most part, are public) the insurance companies are able to

exchange information about arbitration proceedings with each other. The policyholder has no

83 David Rubenstein, Why General Mills is Suing Its Own Captive Insurance Co., U.S. BUS. LITIG., Feb. 1997, at 1.84 A.B.C. v. D.E.F., No. 96-CV-1950 (S.D.N.Y. filed Mar. 18, 1996). Interestingly, the lawyers representing the captive insurance company are lawyers who also regularly represent National Union Fire Insurance Co. and other American International Group insurance companies.


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such ability to do so.85 In court cases as well, insurance companies frequently request, and

obtain, secrecy orders.

Insurance companies, but not policyholders, can keep track of arbitrators’

decisions — and arbitrators know it. The insurance companies know about an umpire’s past

calls and a pro-policyholder arbitrator can easily be “blackballed” by insurance companies.

Arbitrators are in the business of arbitrating. They know that the insurance industry is their

major source of business. To keep the business coming, arbitrators must maintain a pro-

insurance company position a high percentage of the time.86

85 Arbitration holds numerous potential pitfalls for the policyholder. As the Supreme Court of California noted with regard to a mandatory arbitration provision:

[Kaiser’s] arbitration program is designed, written, mandated and administered by Kaiser. In regard to the latter, Kaiser collects funds from claimants and holds and disburses them as necessary to pay the neutral arbitrator. It monitors administrative matters pertinent to the progress of each case including, for example, the identity and dates of appointment of arbitrators. It does not, however, employ or contract with any independent person or entity to provide such administrative services, or any oversight or evaluation of the arbitration program or its performance. Rather, administrative functions are performed by outside counsel retained to defend Kaiser in an adversarial capacity. The fact that Kaiser has designed and administers its arbitration program from an adversarial perspective is not disclosed to Kaiser members or subscribers.

Engalla v. Permanente Medical Group, 15 Cal. 4th 951, 938 P.2d 903, 909, modifed, 16 Cal. 4th 283a (1997).

* * *

[Further,] the selection [of the so-called “neutral” arbitrator] is made by defense counsel after consultation with the Kaiser medical-legal department. Kaiser has never relinquished control over this selection.

Id. at 911.86 One article summarized these problems in the context of securities arbitration, another industry-wide, industry-dominated arbitration system very similar to the system established for insurance arbitration:


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Most courts hold that arbitration provisions are usually enforceable - even those

contained in contracts of adhesion such as insurance policies.87 Many states strongly favor

arbitration as a matter of public policy, typically holding that “contracts providing for . . .

arbitration[] are valid, enforceable and irrevocable, save upon such grounds as exist in law or in

equity for the revocation of any other type of contract.”88

The industry asserts that it is better for the customer to have an individual knowledgeable about the workings of the market sitting in judgment of fraud claims. But the public suspects that an industry arbitrator will have difficulty determining impartially whether another firm engaged in fraudulent activity . . . And will that industry arbitrator have the courage to render a multimillion-dollar award, including punitive damages, against another member of the Wall Street Club? An industry arbitrator who does that risks being blackballed by the industry in his career and in future cases.

See Madelaine Eppenstein & Theodore G. Eppenstein, An Arbitration Albatross, N.Y. TIMES, June 8, 1997, at F12.

A Massachusetts federal district court decision has held that a securities brokerage firm could not force a former employee to arbitrate her sexual harassment claim against the brokerage firm. The court expressed that it was “deeply troubled” by the “structural bias” in the New York Stock Exchange’s arbitration system. See Judge Finds Merrill Lynch Can’t Force Ex-Consultant to Arbitrate Bias Claim, WALL ST. J., Jan. 27, 1998, at B8.87 See Worldwide Ins. Group v. Klopp, 603 A.2d 788 (Del. 1992). 88 Brennan v. General Accident Fire & Life Assurance Corp., 574 A.2d 580 (Pa. 1990); Ice City, Inc. v. Insurance Co. of N. Am., 314 A.2d 236 (Pa. 1974). See also Moses H. Cone Mem’l Hospital v. Mercury Const. Corp., 460 U.S. 1, 24-25 (1983); Travelers Indem. Co. v. Greenfield, No. 88-6845, 1990 U.S. Dist. LEXIS 498 (E.D. Pa. Jan. 18, 1990); Johnson v. Pennsylvania Nat’l Ins. Cos., 527 Pa. 504, 510, 594 A.2d 296, 299-300 (1991); Federal Kemper Ins. Co. v. Reager, 810 F. Supp. 150 (E.D. Pa. 1992); Continental Cas. Co. v. Gezon, No. 94-1767, 1994 U.S. Dist. LEXIS 7190 (E.D. Pa. May 26, 1994). As an example of the power of “public policy” preferences, the court in Johnson held that although arbitration is a creature of contract, and although the third party beneficiary had signed no contract with the defendant insurance company, the third party beneficiary was still bound by the arbitration clause contained in the insurance policy which she sought to enforce. Johnson v. Pennsylvania Nat’l Ins. Cos., 527 Pa. 504, 509, 594 A.2d 296, 299 (1991). See also WILLIAM E. KNEPPER & DAN A. BAILEY, LIABILITY OF CORPORATE OFFICERS AND DIRECTORS § 19-13, at 328 (5th ed. 1996 Supp.); Schaefer v. Allstate Ins. Co., 63 Ohio St. 3d 708, 711-12, 590 N.E.2d 1242 (1992)(noting the Ohio Supreme Court’s “strong public policy favoring arbitration,” listing cases and providing in depth discussion of the “meaning” of arbitration; prohibiting any agreement between parties to non-binding arbitration). But see Nationwide Mut. Ins. Co. v. Marsh, 15 Ohio St. 3d 107, 110-11, 472 N.E.2d 1061, 1063-64 (1984)(Sweeney, J., concurring)(cited by Schaefer, 63 Ohio St. at 717; noting that endorsement in insurance policy binder which allows insurance company to escape binding result in arbitration is contrary to public policy strongly favoring final and binding arbitration).

Some states “limit the availability of arbitration to knowledgeable commercial parties.” See, e.g., Copley v. NCR Corp., 183 W. Va. 152, 156, 394 S.E.2d 751 (1990); Rashid v. Schenck Constr. Co., 190 W. Va. 363, 367, 438 S.E.2d 543 (1993); Barber v. Union Carbide Corp., 172 W. Va. 199, 202-04, 304


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Very few recent cases have broken away from the near universal enforcement of

arbitration clauses. The California Court of Appeals recently held that an arbitration clause, in a

“contract of adhesion” was unconscionable and unenforceable.89 The court’s holding is quite

favorable to the proposition that arbitration clauses contained in contracts of adhesion, such as

insurance policies, should not be enforced. Another California appellate court recently held that

a decision in a private nonjudicial arbitration cannot be used to collaterally estop a party to the

arbitration from relitigating the issue in a subsequent action.90

In Thiokol Corporation v. Certain Underwriters at Lloyd’s of London, a Utah

federal district court refused to enforce the arbitration clause found in a Lloyds policy.91 The

court held that the arbitration clause conflicted with a service of suit clause within the same

policy which required the underwriters to submit to any jurisdiction of the policyholder’s

choosing in the United States. The court found the arbitration clause ambiguous and resolved the

conflict by enforcing the more specific service of suit clause, which allows policyholders to file

claims in courts of law in the United States.92

The Missouri Court of Appeals recently came to the same conclusion of the

Thiokol Court in Transit Casualty Co. v. Certain Underwriters at Lloyds of London,93 holding

that the receivers of an insolvent insurance company were not required to arbitrate a dispute with

S.E.2d 353, 356-58 (1983); Board of Educ. v. Miller, 160 W. Va. 473, 236 S.E.2d 439 (1977).89 See Stirlen v. Supercuts, Inc., 51 Cal. App. 4th 1519, 60 Cal. Rptr. 138 (1st Dist. 1997), review denied, No. S059176, 1997 Cal. LEXIS 1973 (Cal. Apr. 16, 1997).90 See Vandenberg v. Superior Court (Centennial Ins. Co.), No. S067115, on appeal, reported in MEALEY’S INS. SUPPLEMENT, Feb. 20, 1998, at 7.91 Thiokol Corp. v. Certain Underwriters at Lloyds of London, No. 1:96-CV-028 B, slip op. (N.D. Utah May 6, 1997). Anderson Kill served as co-counsel to the Thiokol Corporation with the firm of Wood Quinn and Crapo, L.C. The decision is on file with the authors.92 Id., slip op. at *7-8.93 Transit Cas. Co. v. Certain Underwriters at Lloyds of London, No. WD 53230, 1998 Mo. App. LEXIS 70 (Mo. Ct. App. Jan 20, 1998).


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the insolvent insurance company’s reinsurance companies because the reinsurance agreements

contained both a service of suit clause and an arbitration clause. The court rejected insurance

company arguments for arbitration, and applied the rule of contract construction that a more

specific clause (here the service of suit clause) nullifies a more general clause. The court also

based its holding on the principle that ambiguous clauses are to be construed against the drafter.

Arbitration, in general, is a very unfavorable forum for policyholders.94

C. Judges

A conservative judiciary may be frustrated because it cannot legislate tort reform.

Instead, judges work indirectly toward that goal by refusing to permit injured parties to collect

insurance. This philosophy ignores what several representatives of the insurance industry have

proudly proclaimed: That “[r]ightly so, the insurance industry has been called the banker of the

tort system.”95 A good example of judicial tort reform is evidenced by a recent insurance

coverage case in Texas. The Texas Supreme Court held that mental suffering was not bodily

injury.96 To mental health professionals, this probably reeks of the Middle Ages.

94 See Barry Meier, In Fine Print, Customers Lose Ability To Sue, N.Y. TIMES, Mar. 10, 1997, at A1; David Garfield Roland, Arbitration--A Good Idea That Does Not Work, INS. ADVOCATE, June 8, 1996, at 23; Roger Parloff, Kaiser Arbitration: Waiting For Judge Godot?, AM. LAW., July 1996, at 84; Lorelie S. Masters, Arbitration Clauses In Liability Policies: A Ticket To Ride?, JOHN LINER REV., Winter 1996, at 33; Margaret A. Jacobs, Policies Requiring Arbitration Challenged, WALL ST. J., Oct. 16, 1995, at B5; Eugene R. Anderson & Paul Liben, The Perfect Insurance Or The Perfect Crime, METRO. CORP. COUNS., Jan. 1995; Editorials: Surprise Packages, N.J. LAW., Apr. 7, 1997, at 6.95 See Brief of the American Insurance Association, the National Association of Independent Insurers, Farmers Insurance Exchange, Fire Insurance Exchange, the State Farm Insurance Companies, and Truck Insurance Exchange as Amici Curiae in Support of Appellant at 3, n.1, filed Aug. 2, 1985, Aetna Life Ins. Co. v. LaVoie, 475 U.S. 813 (1986).96 See Trinity Universal Ins. Co. v. Cowan, No. 95-1160, 1997 Tex. LEXIS 45, at *1 (Tex. May 16, 1997)(holding that “absent an allegation of physical manifestation of mental anguish, a claim of mental anguish is not a bodily injury as defined in the policy for purposes of invoking the duty to defend”).


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The anti-policyholder and anti-claimant attitude of the insurance companies

results in a Gresham’s Law97 of the insurance industry: Bad Insurance Companies Drive Good

Insurance Companies Out Of Business. Another way of describing the reason insurance

companies sink to the lowest common denominator with respect to “claims paying philosophy”

is the herd mentality. Caught in the middle, the victims of judicial tort reform are the

policyholders. Policyholders pay premiums for protection against tort liability and then they pay

for their alleged torts. Insurance companies are the clear winners.

Judges need insurance companies to settle cases. The friendly Great Benefit

Insurance Company98 adjuster is a key player in clearing court dockets. Whether saints or

sinners, adjusters must be coddled by judges. Woe be unto the judge who crosses the adjuster.

For a lawyer an insurance coverage case is another case. For the insurance company, it is a holy

crusade against insurance fraud. For the judge it is another case to get off the docket, something

which can only be done with the cooperation of the insurance company.

D. The Insurance Industry Code of Conduct and Insurance Fraud: Is Insurance A De-fective Product?

Insurance industry employees and executives are indoctrinated with the

philosophy that insurance is good and that policyholders, claimants and lawyers are bad.

According to the insurance industry, nearly 50% of policyholders are actual or potential crooks.99

97 Gresham’s Law is “the theory that when two or more kinds of money of equal denomination but unequal intrinsic value are in circulation at the same time, the one of greater value will tend to be hoarded or exported.” It is “the principle that bad money will drive good money out of circulation.” See WEBSTER’S NEW TWENTIETH CENTURY DICTIONARY (unabridged ed. 1979) at 800. See also Friedman, Will Insurance Fraud be the S&L Scandal of 1993?, RISK MGMT., Dec. 1993, at 22.98 Made famous by John Grisham in “The Rainmaker”.99 See Brief on the Merits of Amicus Curiae American Council of Life Insurance in Supports of Petitioner at 13, n.4, dated April 2, 1996, West Am. Ins. Co. v. Freeman, 46 Cal. App. 4th 1476 (1st Dist. 1995), rev. granted, 907 P.2d 1323 (Cal. 1995), rev. dismissed, 927 P.2d 1172 (1996), rev. denied, No S049306, 1997 Cal. LEXIS 649 (Cal. Feb. 5, 1997), cert. denied, 117 S. Ct. 1695 (U.S. 1997). The American Council of Life Insurance states:


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One recent article, written by the President of the Insurance Information Institute,100 finds that the

perpetrators of insurance fraud are. . . “for the most part, the people we live and work among —

our neighbors. . . .”101 Moreover, the “rampant” corruption of otherwise honest, “seemingly law-

abiding people” is something that those in the insurance industry “have known for sometime.”102

Insurance company claims adjusters view themselves as underpaid, overworked vigilantes

protecting an unappreciative American public from a horde of thieving, conniving robbers intent

on pillage and plunder.

In order to deal with the insurance system, one must accept the fact that insurance

company adjusters believe what they say they believe. They may be wrong, but they think they

are right and must be dealt with on that basis. It goes without saying that there are crooked

Although fraud by the insured is not an issue in this case, it is of great concern to first-party insurers such as life and property-casualty insurance companies. Shockingly, nearly half of the individuals who responded to a recent survey reported that they were willing to engage in insurance fraud.

See also Foppert, Waging War Against Fraud, BEST’S REV. P/C, Mar. 1, 1994, at 44; Brian Cox, Michigan Bill Would Crack Down On Insurance Crime, NAT’L UNDERWRITER, May 15, 1995, at 7; Insurance Crime Is Big Money Industry, INS. ADVOCATE, Nov. 12, 1994, at 12 (executive for American Alliance of Insurers noting the “public’s seeming tolerance and indifference towards” insurance fraud); Phil Zinkewicz, The Signs And Smells Of Insurance Fraud, INS. ADVOCATE, Jan. 21, 1995, at 6.100 The Insurance Information Institute is one of the insurance industry associations involved in the fight against insurance fraud.101 Gordon Stewart, Criminals Aren’t To Blame For All Insurance Crime, BEST’S REV., June 1997, at 94.102 Id.


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policyholders and crooked claimants and there are crooked lawyers,103 but there are also crooked

insurance companies.104

There are very few organizations or associations, other than the FBI and the

Justice Department’s National Level Insurance Fraud Working Group, to combat fraud

perpetrated by insurance companies against their policyholders. Contrast that with the numerous

associations and organizations created - primarily by the insurance industry - at the national

and state levels to combat insurance fraud by policyholders, claimants and others.105 As is

known so far, there are no insurance industry sponsored fraud units designated to ferret out fraud

103 An insurance company anti-policyholder litigation association recently argued to the New Jersey Supreme Court that New Jersey automobile insurance policyholders should get less insurance coverage than policyholders in other states because a “gang” of lawyers in California ran an insurance scam. See Brief of the Insurance Environmental Litigation Association As Amicus Curiae, at 13, undated, Trustees of Princeton Univ. v. Aetna Cas. & Sur. Co., 293 N.J. Super 296, 680 A.2d 783 (App. Div. 1996), appeal granted, 147 N.J. 574, 688 A.2d 1050 (1997). This case settled pending appeal.104 See United States v. Brennan, 938 F. Supp. 1111 (E.D.N.Y. 1996); Michael Schachner, USAU, Exec Found Guilty Of Fraud In Allocation, BUS. INS., July 8, 1996, at 1; Big Aviation Insurer, Former Head Brennan Convicted Of Fraud, WALL ST. J., July 2, 1996, at B2; Adam Bryant & Barry Meier, Taking A Hard Line Amid The Wreckage, N.Y. TIMES, Oct. 6, 1996, § 3, at 1.

See also Moleski v. Molin, No. 2ND 1995 (Commw. Ct., Harrisburg, Pa.). In this case, a Pennsylvania judge found the CEO of Corporate Life Insurance Company liable for $139.7 million in compensatory damages and $1 million in punitive damages for looting the company’s assets over the course of three years, pushing the company $210 million into the red. See Verdicts and Settlements, NAT’L L.J., Apr. 21, 1997, at A8.

Larry P. Schiffer & Vanessa L. Sutter, If You Can’t Pay the Fine, Don’t Do. . ., BEST’S REV. P/C ed., Dec. 1997, at 73 (discussing how the Federal Insurance Crimes Act, passed by Congress in 1994, is being used to prosecute wrongdoing by insurance companies and insurance company executives. A conviction under the Federal Insurance Crimes Act, as with any other federal criminal statute, requires that the sentencing judge follow the Federal Sentencing Guidelines Manual. Id. at 74).105 Following is a list of insurance industry associations and organizations which assist in the fight against insurance fraud by policyholders and other claimants:

1. Alliance of American Insurers (drafter a model state insurance fraud statute);

2. American Insurance Association (AIA);

3. American Insurance Services Group (AISG) (compiles data on claims to create comprehensive fraud database);

4. Coalition To Reduce Auto Fraud And Theft (CRAFT);

5. Independent Insurance Agents of America (IIAA);

6. Insurance Committee For Arson Control;


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committed by insurance companies against policyholders. Contrast this with the many insurance

companies which have set up within their ranks special insurance fraud investigation unit,

commonly referred to as Special Investigation Units or SIUs.106

7. Insurance Fraud Bureau of Massachusetts (“industry backed”) (Fraud Investigators See Rise In Staged Accidents, J. OF COMMERCE, June 21, 1994, at 7A);

8. Insurance Fraud Investigation and Management Committee (serves insurance industry claims management and managers of anti-fraud programs);

9. Insurance Information Institute (III);

10. Insurance Institute of America (IIA);

11. Insurance Research Council (IRC);

12. Insurance Services Office, Inc. (ISO);

13. International Association of Arson Investigators (IAAI);

14. International Association of Auto Theft Investigators (IAATI);

15. International Association of Defense Counsel;

16. International Association of Insurance Fraud Agencies, Inc.;

17. International Association of Insurance Fraud Bureaus (IAIFB);

18. International Association of Special Investigative Units (IASIU) (See Appendix A for the IASIU Code of Ethics);

19. International Claim Association (ICA);

20. Loss Executives Association (LEA);

21. National Association of Independent Insurance Adjustors (NAIIA)

22. National Association of Independent Insurance Brokers (NAIIB);

23. National Association of Independent Insurers (NAII);

24. National Association of Insurance Commissioners (working group is looking into a model to stop insurance agents from making ridiculous promises regarding insurance policies (mainly life insurance policies));

25. National Association of Mutual Insurance Companies (NAMIC);

26. National Council Against Health Fraud (NCAHF);

27. National Council On Compensation Insurance (NCCI);

28. National Crime Information Center (NCIC);

29. National Fire Protection Association (NFPA);


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One conclusion from all of this crime and corruption is that insurance is a

defective product. “We have actually designed an industry for the purpose of a con man.”107

Most of the problem is with the insurance product and not with the customer. But

rather than take responsibility for a defective product, many insurance companies have decided

to blame the frequent victims of insurance fraud - their policyholders. John G. DiLiberto,

president and chief executive officer of the National Insurance Crime Bureau, warned insurance

companies that they are “in a shootout with the con men.”108 This says that the people who pay

the premiums and who are the beneficiaries of insurance are evil.

Many observers have recognized the business of insurance to be a perfect vehicle

for fraud. One FBI agent has commented that:

[I]nsurance is attractive to con artists because it is based on a simple premise: Pay me now and I promise to pay you later. The

30. National Fraud Advisory Council (“launched” by NCCI, Inc. (National Council On Compensation Insurance, Inc.));

31. National Health-Care Anti-Fraud Association;

32. National Insurance Crime Bureau (NICB);

33. New York Board Of Fire Underwriters (NYBFU);

34. Special Investigations Academy (set up by NICB to train fraud investigation techniques to SIU investigators, claims adjustors and managers from NICB member companies), and;

35. Workers Compensation Research Institute (WCRI).106 CNA, Royal Ins. Co., Zurich and Fireman’s Fund set up special claims service groups to investigate complex and potentially fraudulent claims. These companies will also sell their services to other insurance companies. See Robert G. Knowles, Fraud Can’t Be Stopped, But It Can Be Contained, NAT’L UNDERWRITER, Sept. 11, 1995, at 15. Royal & Sun Alliance Insurance Group, PLC has established Investigative Resources Global of Charlotte, N.C. and USF&G has established Nemax Claim Services, Inc., both SIUs. See Anne Colden, Small Insurers That Need Gumshoes To Fight Fraud Turn To Bigger Rivals, WALL ST. J., Feb. 24, 1997, at B9C.107 Statement by Trevor H. Jones, chairman of Insurance Security Services, Ltd., a London-based insurance consulting company. Deborah Shalowitz Cowans, Insurance Fraud By Design, BUS. INS., Sept. 25, 1995, at 24.108 Stephanie D. Esters, Insurers Urged to Unite in “Shootout With Con Men”, NAT’L UNDERWRITER, Sept. 16, 1996, at 6.


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fraud often goes undetected longest with hard-to-place risks because the premiums are high and liabilities long-tailed.109

A study on insurance company insolvencies conducted by the FBI discovered that:

[t]he business of insurance is uniquely suited to abuse by mismanagement and fraud. The very nature of insurance, which involves the payment of money in the present in exchange for a promise to pay costs associated with some future event which may or may not occur, is a con artist’s dream.”110

According to one assistant United States Attorney, “dishonest people are moving

from other industries into the insurance industry.”111 The National Association of Insurance

Commissioners has also recognized that insurance is “uniquely suited” for abuse and that

“insurance lends itself all too readily to fraud:”112

The business of insurance is uniquely suited to abuse by mismanagement and fraud. Making believable promises is a stock item in every con man’s bag of tricks. The prepayment of large, often vast, sums of money with few restrictions lends itself naturally to monumental wasting of assets through greed, incompetence, and dereliction of duty. This combination of easy money based on easy promises makes the insurance industry an irresistible target for financial knaves and buccaneers.113

Given the potential for fraud and abuse acknowledged by law enforcement agencies and

insurance companies themselves, contract remedies are insufficient to protect policyholders from

unscrupulous conduct in an alien, and potentially hostile, business environment.

109 Marilyn Ostermiller, Paper Chase, BEST’S REV. P/C, Sept. 1997, at 40, 41.110 Economic Crimes Unit White-Collar Crimes Section, Federal Bureau of Investigation, Insurance Company Insolvency Study (1991). See Alfred G. Haggerty, FBI Steps Up Campaign Against Insurance Fraud, NAT’L UNDERWRITER, Oct. 11, 1993, at 1.111 Haggerty, at 1.112 Brief of Amicus Curiae National Association of Insurance Commissioners Supporting Respondent, at 1, filed Oct. 12, 1995, Prometheus Funding Corp. v. Merchants Home Delivery Servs., Inc., 50 F.3d 1486 (9th Cir.), cert. denied, 116 S. Ct. 418 (U.S. 1995).113 Id. at 4, quoting “Failed Promises: Insurance Company Insolvencies,” Staff of House Committee on Energy and Commerce, 101st Cong. 2d Sess., (Comm. Print 101-P 1990).


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Part of the answer to this calumny would be greater insurance company respect

for the well established rule that an insurance company is required to “know” their customers.114

The insurance industry’s damning indictment of its policyholders and

beneficiaries can be analyzed in a different way. Is the insurance industry selling matches to

arsonists? Fifty percent of the people who go to church do not steal from the collection plate and

50% of the people who go to the market do not shoplift. The fault may not be with the premium-

paying policyholders. The fault may be with the insurance product. Any other product which

114 Lord Mansfield, the father of insurance law, wrote many years ago:

Every under-writer is presumed to be acquainted with the practice of the trade he insures, and that whether it is recently established, or not. If he does not know it, he ought to inform himself. It is no matter if the usage has only been for a year.

Noble v. Kennoway, 2 Doug. 511, 513 (K.B. 1780), United Kingdom. The principle that the insurance company is presumed to know the business of its policyholder is well established and was adopted by the United States Supreme Court in Buck & Hedrick v. Chesapeake Insurance Co., 26 U.S. (1 Pet.) 151 (1828):

[A] knowledge . . . of the course and incidents of the trade on which they insure, and the established import of the terms, used in their contract; must necessarily be imputed to underwriters.

Id. citing Pelly v. Royal Exchange, &c., 1 Burr. 341 (1757) (Mansfield, C.J.). See also Hazard’s Adm’r v. New England Marine Ins. Co., 33 U.S. (8 Pet.) 557, 582 (1834)(“The underwriters are presumed to know the usages of foreign ports to which insured vessels are destined; also the usages of trade, and the political condition of foreign nations.”); Clark v. Manufacturer’s Ins. Co., 49 U.S. (8 How.) 235, 248, 12 L.Ed. 106 (1850) (“The insurer must be presumed to know what is material in the course of any particular trade.”); Globe & Rutgers Fire Ins. Co. v. Indiana Reduction Co., 113 N.E. 425, 429 (Ill. App. Ct. 1916) (“The law charges insurance companies with the duty of informing themselves as to the usages of the particular business issues and a knowledge of such usage on the part of such company will be presumed”); Hazelton v. Manhattan Insurance Co., 12 F. 159, 162 (N.D. Ill. 1882), quoting Lord Mansfield in Pelly v. Royal Exch. Ass’n Co., 1 Burr. 341 (1757)(“The underwriter must adjust himself to the custom of the trade which he insured . . . . ‘[a]nd in general what is usually done . . . [in such trade] is understood to be referred to by every policy, and to make a part of it as much as if it was expressed.’“ For recent examples, see Contractors Realty Co., Inc. v. Insurance Co. Of N. Am., 469 F. Supp. 1287, 1295 (S.D.N.Y. 1979), (insurance companies were “charged with knowledge” of “the course and incidents of the policyholders trade”); Anne Quinn Corp. v. American Mfrs. Mut. Ins. Co., 369 F. Supp. 1312, 1315 (S.D.N.Y. 1973), aff’d, 505 F.2d 727 (2d Cir. 1974), (“no misrepresentation or breach of duty of good faith where plaintiff failed to disclose a trade practice that was equally open to [the knowledge of] both parties”); Compagnie de Reassurance d’Ile de France v. New England Reins. Corp., 57 F.3d 56, 76-77 (1st Cir.), cert. denied, 116 S. Ct. 564 (U.S. 1995) (reinsurance companies presumed to know the business of their policyholder).


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turned its customers into anti-social cheats and thieves would be condemned and banned from

the market.

The insurance product damages policyholders and others in many ways. First, if

the insurance industry is to be believed, insurance corrupts. Second, this corruption then justifies

corruption on the part of insurance company adjusters who engage in corrupt claims-handling

tactics. When insurance executives, underwriters, adjusters and insurance lawyers believe that

their policyholders and beneficiaries are cheats, the entire insurance mechanism is askew.

Forcing policyholders to cheat or to be treated as cheats is counterculture in the United States.

The insurance system brings out the worst in people involved in insurance claims handling; the

system encourages and may even demand “padding” by policyholders and other beneficiaries.

Insurance company vigilantes do battle against the dishonest hordes and in the process develop a

mentality that permits a “little deception and a little dishonesty”. Since the end is nobel, the

means can be ignoble.115

The insurance product sold to policyholders to protect policyholders and the

public is not the same product sold by the insurance company to the courts. Broad promises are

made at the point of sale and fine print is delivered when a loss happens. Nearly every word in

every insurance policy has a precise meaning. But all too often, the plain meaning of those

115 Policyholders and claimants are alleged to steal $120 billion a year from insurance companies. See Insurance Fraud: The Quiet Catastrophe, 1996, at 8 (a report prepared by Conning Insurance Research & Publications). Given the insurance companies sophistication, it seems reasonable to assume that insurance companies steal at least that much from the public. See also The “Other Cost of Fraud, CLAIMS, Nov. 1997, at 10 (discussing a report from the Insurance Research Council in Wheaton, Illinois). According to the Insurance Research Council report, insurance companies spent $650 million in anti-fraud efforts, up from $200 million spent in 1992. Id. The IRC researchers noted that the $650 million figure was probably low because it did not include indirect internal expenses and assessments paid to state fraud bureaus. Id. The IRC study also found that 76% of insurance companies have special investigation units (SIU’s). Id. Another article noted that 32 states have insurance fraud bureaus and that 13 other states are considering measures to establish or strengthen an existing fraud bureau. See Coalition Reports Legislative Fraud Bureau Action, WORKERS’ COMP. EXECUTIVE, June 25, 1997.


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words, whether common or technical, is far afield from the meaning attributed to them by

insurance companies in insurance coverage disputes. Compounding the injury (and expense) are

the legal theories spun by insurance law professors, insurance company lawyers, industry

representatives and judges which complicate what should otherwise be a straightforward issue: If

tens of thousands of automobile tires exploded, every judge in the United States would know the

tires were defective and would not listen to any nonsense from law professors about the

economics and theory of automobile tires and the automobile industry. A new car which

requires judicial intervention is, by definition, defective. Automobile manufacturers are not

permitted to sell lemonade and deliver lemons. Policyholders buy protection, not a ticket to the

courthouse. The massive amount of insurance coverage litigation indicates that something is

terribly wrong with the insurance product and that it has yet to be fixed.

E. Claims Handling

Most bad faith conduct occurs during the claims handling process.116 Some

insurance companies are notorious for refusing to provide insurance coverage and for engaging

in sloppy, slow or deliberately bad claims handling.117

For life insurance coverage, insurance company misconduct, if any, typically

takes place at the point of sale.118 For property and casualty insurance coverage, bad faith

problems would typically occur at the point of delivery (that is, when the policyholder or

116 See generally Lia B. Royle, Insuring Good Faith, ABA J., Oct. 1996, at 86.117 See Joseph Segal, Sluggish Claim Process Can Cause Insured Business’ Demise, CLAIMS, Feb. 1995, at 86; Jim Urban, Take It Or Leave It, EXEC. REP., Aug. 1996, at 18; Leslie Scism, Disputed Claims, Tight-Fisted Insurers Fight Their Customers To Limit Big Awards, WALL ST. J., Oct. 15, 1996, at A1.118 Certain life insurance sales tactics have drawn scrutiny and litigation from policyholders and regulators. See, e.g., Leslie Scism, Profit Is Posted By Prudential Insurance for ‘95, WALL ST. J., Mar. 4, 1996, at C20. See also Melody Petersen, The Eye On Prudential, N.Y. TIMES, Feb. 16, 1997, § 1, at 1.


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claimant makes a claim which is denied).119 Arguably, with some property and casualty claims,

the bad faith occurs much earlier, because some insurance companies have no intention of ever

paying sizeable claims.120

Another serious question is whether claims handlers are rewarded for minimizing

how much they pay out in claims.121 This situation has already been addressed by the courts on

several occasions, usually with claims involving ‘life and death’ misconduct by HMO’s.122

PART IVInsurance Companies’ Fiduciary Duties and Duty of Good Faith and Fair Dealing

A. Insurance Companies Are Fiduciaries

1. Insurance Company Admissions

Insurance companies are fiduciaries.123 Who says?

119 The same is true for managed care (“HMO”) bad faith. In one recent case, a woman diagnosed with breast cancer was advised that she needed a bone marrow transplant. The HMO refused to pay for the procedure. When the patient’s family sued the HMO to force it to pay, the patient’s doctor provided the family with a sworn declaration advocating the bone marrow transplant procedure. After the HMO called the doctor’s superior, and following a heated discussion between the superior and treating doctor, the doctor altered his declaration. See HMO May Appeal Big Award, BUS. INS., Nov. 27, 1995, at 36. An arbitration panel concluded that the HMO’s complaint to the treating doctor’s superior was “designed and intended to interfere with an existing doctor-patient relationship . . . undertaken with reckless disregard of the probability of causing severe emotional distress.” Such cases have become all too common. See Brent J. Graber, Managed Care Discontent Growing, BUS. INS., May 6, 1996, at 39 (discussing cases of egregious misconduct); Kerri Y. Capell (ed.), When Your HMO Says ‘No Way’, BUS. WEEK, May 19, 1997, at 140.120 See Eugene R. Anderson et al., Insurance Nullification By Litigation, RISK MGMT., Apr. 1994, at 46; Richard A. Archer, Preparing For A `Mega-Loss,’ BUS. INS., Oct. 10, 1994, at 23. See also Eugene R. Anderson & Paul Liben, The Perfect Insurance or The Perfect Crime?, METROPOLITAN CORP. COUNS., Jan. 1995.121 See Michael Larrick, Gain Sharing and Performance Guarantee Arrangements: Can They Be Useful For TPAs & Casualty Claim Organizations?, CLAIMS, May 1997, at 67.122 See e.g. Shea v. Esensten, 107 F.3d 625 (8th Cir. 1997). (holding that an HMO’s failure to disclose financial incentives and penalties designed to minimize referrals by doctor’s for specialized treatment violated the fiduciary duty owed to the patient. “[A] financial incentive scheme put in place to influence a treating doctor’s referral practices when the patient needs specialized care is certainly a material piece of information”).123 See BLACK’S LAW DICTIONARY (6th ed. 1990) (fiduciary refers to a person “having duties involving good faith, trust, special confidence, and candor towards another”).


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Fireman’s Fund:

An insurer stands in a fiduciary relationship to its insured; when an insurer chooses his interest over the interests of his insured his actions are indeed ‘intentional and deliberate’ . . . and when a case can be settled with no personal liability to said insured, [failure to do so] has the ‘character of outrage frequently associated with crime’.124

Continental Casualty

It has been held that an insurer who issues a [comprehensive general liability policy] is under a fiduciary duty to look after the interests of the insured as well as its own interests.125

Continental Insurance Company

Representing the insured is clearly a ‘fiduciary’ situation, especially in view of the fact that improper conduct by the insurer could expose the insured to liability beyond the amount of his insurance protection.126

National Union

Underlying all forms of insurance is a fiduciary duty to some extent simply because of the insurer’s expertise in the area of its business. In the public liability area the fiduciary duties are heavier because the insurance company is an expert in the litigation arena in all parts of the country since it has thousands of cases nationwide and trained personnel to handle them.127

National Union, again:

124 Civil Action--Cross Petition for Certification and Brief in Opposition to Defendant-Appellant Petition for Certification, at 13, 16, filed Mar. 4, 1975, Fireman’s Fund Ins. Co. v. Security Ins. Co. of Hartford, 367 A.2d 864, 866 (N.J. 1976)(court finding that the insurance company acted “in disregard to its acknowledged fiduciary duty to its insured”).125 Continental Casualty Company’s Memorandum of Law For Trial, at 27, filed Sept. 11, 1990, Continental Cas. Co. v. Great Am. Ins. Co., No. 86-C-3938, 1990 U.S. Dist LEXIS 12807 (N.D. Ill. Sept. 28, 1990). See also Continental Cas. Co. v. Great Am. Ins. Co., 711 F. Supp. 1475, 1481 (N.D. Ill. 1989)(in an earlier related decision, court rejected Great American’s request for summary judgment on the issue of the duty of good faith and fair dealing; issue of bad faith departure from company or industry custom was question for jury in light of evidence that Great American had previously involved itself in defense and settlement of claims, though not contractually obligated to do so.126 Memorandum in Opposition to Plaintiff’s Cross-motion to Dismiss Defendants’ First and Second Defenses and Plaintiff’s Request For Leave to Further Amend its Amended Complaint, at 9-10, submitted Apr. 5, 1993, New York Univ. v. Continental Ins. Co., 209 A.D.2d 231 (N.Y. 1st Dep’t 1994)(No. 11627/92), rev’d, 89 N.Y.2d 308 (1995)(No. 302).127 Memorandum in Opposition To Columbia Casualty Company’s Motion For Summary Judgment, at 18-19, dated Dec. 16, 1989, Columbia Cas. Co. v. Nat’l Union Fire Ins. Co., (E.D. Pa.)(No. 89-3506).


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[L]egal authorities have declared the relation of insured and insurer to be fiduciary and to require of the parties the utmost good faith in their dealings . . . Whenever a contract is in its essential nature intrinsically fiduciary, the utmost good faith and fullest disclosure of material facts are required from the parties

. . . Any concealment of a material fact known to a party would necessarily be fraudulent. The most familiar and illustrative of such contracts is that of insurance.128

Home

[A]n insurer is in a fiduciary relationship to its insured.129

Liberty Mutual

[T]he cases have readily acknowledged that the insurer-insured relationship gives rise to a fiduciary duty.130

St. Paul Fire and Casualty

St. Paul owes a fiduciary duty to [the plaintiff]. We don’t contest that . . . We owe a fiduciary duty to every one of our policyholders . . . .131

Hartford

The standard which attaches to the insurer-insured relationship is fiduciary in nature. . . .

[G]reat weight must be placed upon the character of an insurance policy as a contract of adhesion . . . which the insurer, as the dominant party, must honor as a fiduciary . . . .132

128 Defendant National Union Fire Ins. Co. of Pittsburgh, Pa’s Reply Memorandum in Support of its Motion for Summary Judgment, at 23, dated Oct. 20, 1995, In re: Cardinal Industries, Inc., (S.D. Ohio)(No. C-2-94-254)(internal quotations and citation omitted). 129 Defendant’s Requested Jury Instructions, Defendant’s Proposed Instruction No. 2, dated Sept. 8, 1988, Georgetown Realty, Inc. v. Home Ins. Co., No. A8708-05098 (Oregon Cir. Ct., Multnomah Cty.).130 Memorandum of Law in Support of Plaintiff’s Response, at 6, dated July 13, 1993, Liberty Mut. Ins. Co. v. Paper Mfrs. Co., 753 F. Supp. 156 (E.D. Pa. 1990)(No. 90-3787). 131 Motion For Summary Judgment Hearing, Transcript, at 24, dated Jan. 18, 1994, Richland Valley Prods. v. St. Paul Fire & Cas. Co., (Wis. Cir. Ct.)(No. 92CV149), rev’d, 548 N.W.2d 127 (Wis. Ct. App. 1996)(No. 94-1837).132 Brief and Volume I of Appendix of Plaintiff-Appellant, Hartford Accident & Indemnity Company, at 11-12, filed May 12, 1983, Hartford Accident & Indem. Co. v. Aetna Life & Cas. Ins. Co., (N.J. Super. Ct. App. Div.)(No. A-1595-82T2), aff’d, 483 A.2d 402 (N.J. 1984)(No. A-22).


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It is very telling that insurance companies often argue for a fiduciary duty when

suing their insurance company, e.g. an excess, umbrella or co-insurance company.133 In the

process, the insurance company may make two points. For example:

American Centennial

The primary carrier owes to the excess carrier the same fiduciary obligation which the primary insurer owes to its insured.134

Here is Hartford, again, arguing that its insurance company owes it a fiduciary duty:

The primary carrier owes the excess carrier the same fiduciary obligation which the primary insurer owes its insured, namely, a duty to proceed in good faith and in the exercise of honest discretion, the violation of which exposes the primary carrier to liability beyond its policy limits (citations omitted).135

Here is Liberty Mutual, again, making the same argument against its insurance company:

133 See, e.g., Brief of Plaintiff-Respondent, at 11, filed Feb. 8, 1984, Hartford Accident & Indem. Co. v. Michigan Mut. Ins. Co., 61 N.Y.2d 569 (N.Y. 1984); Civil Action--Cross Appellant Petition for Certification, at 5, filed Apr. 13, 1977, Fireman’s Fund Ins. Co. v. Security Ins. Co. of Hartford, 367 A.2d 864 (N.J. 1976); Initial Brief of Appellant United States Fire Insurance Company, at 17-18, filed May 3, 1990, United States Fire Ins. Co. v. Caulkins Indiantown Citrus Co., (Fla. Dist. App. Ct. 1990)(No. 89-3791); Reply Brief for Defendant-Appellant Executive Life Insurance Company, at 4, filed Sept. 26, 1989, United States Fidelity & Guar. Co. v. Executive Life Ins. Co., (2d Cir. 1990)(No. 89-7955); Brief in Support of Plaintiff’s Motion for Summary and Other Relief, at 87, filed Aug. 8, 1989, Christiania General Ins. Corp. of New York v. Great Am. Ins. Co., 745 F. Supp. 150 (S.D.N.Y. 1990)(No. 87 Civ. 8310); Brief of Appellant Centennial Insurance Company, at 36, filed Jan. 19, 1990, Aetna Cas. & Sur. Co. v. Great Am. Ins. Co., et al., 1991 U.S. App. Lexis 3334 (9th Cir. Feb. 28, 1991)(No. 89-55811); Continental Insurance Company’s Brief, filed Sept. 11, 1990, Continental Cas. Co. v. Great Am. Ins. Co., 1990 U.S. Dist. Lexis 12807 (N.D. Ill. Feb. 28, 1990)(No. 86C-3839); Motion for Rehearing and Request for Motion for Rehearing En Banc, at 4, filed July 31, 1987, Morrison Assurance Co. v. United States Fire Ins. Co., 515 So. 2d 995 (Fla. Dist. Ct. App. 1987)(No. BR-226); Response of Prudential Reinsurance Co. and Gibraltar Casualty Company in Opposition to Plaintiff’s Motion for Protective Order Regarding Certain Depositions, at 5-6, filed June 15, 1992, Hoechst Celanese Corp. v. National Union Fire Ins. Co., No. 89C-SE-35-1-CV, 1992 Del. Super. LEXIS 305 (Del. Super. Ct. 1992).134 Application for Writ of Error of American Centennial Insurance Company and First State Insurance Company, at 19, filed July 9, 1991, American Centennial Ins. Co. v. Canal Ins. Co., 843 S.W.2d 480 (Tex. 1992)(No. D-1213).135 Brief of Plaintiff-Respondent, at 11, Hartford Accident & Indem. Co. v. Michigan Mut. Ins. Co., 61 N.Y.2d 569, 574 (1984)(primary insurance company owes its excess insurance company the same duty to act in good faith which it owes to its own policyholders; whether primary insurance company acted in its own or policyholders’ interests was a question for trial, not summary judgment).


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When determining whether an insurer breached its duty to its insured . . . the appropriate standards to employ are described by cases involving the very issue at hand, i.e., the fiduciary duty of an insurer to act with the utmost good faith in its handling of the claims against the insured.136

One of the great ironies of bad faith litigation is that it most frequently occurs between insurance

companies, not policyholder versus insurance company.137

Hartford Steam Boiler perhaps best explained the reasoning behind recognizing a

fiduciary duty:

The essence of a fiduciary relationship is that the fiduciary agrees to act as his principal’s alter ego rather than to assume the standard arm’s length stance of traders in a market. Hence the principal is not armed with the usual wariness that one has in dealing with strangers; he trusts the fiduciary to deal with him as frankly as though he would deal with himself — he has bought candor.138

136 Appellant’s Reply Brief, at 10-11, filed Oct. 23, 1991, General Star National Ins. Co. v. Liberty Mut. Ins. Co., 960 F.2d 377 (3d Cir. 1992)(No. 91-1497)(contrary to excess insurance company’s arguments, finding no evidence of dishonesty by primary insurance company to policyholder).137 See generally PATRICK MAGARICK, EXCESS LIABILITY, §§ 17.02, 17.06 (1996). In particular, insurance companies which have sold a policyholder excess liability coverage attempt to reduce their ultimate costs by settling a policyholder’s claim after the primary insurance company has refused to do so. The policyholder then assigns its rights under the primary policy to the excess insurance company. By stepping into the shoes of the policyholder, excess insurance companies can bring a bad faith claim against primary insurance companies which wrongfully refuse to settle a claim and expose the policyholder or excess insurance company to a judgment exceeding the primary policy’s limits.138 Memorandum of Law Re Motion to Compel, at 64, filed Nov. 29, 1994, (quoting United States v. Dial, 757 F.2d 163, 168 (7th Cir. 1985), Hartford Steam Boiler Inspection & Ins. Co. v. Industrial Risk Insurers, No. CV-94-705105, 1994 Conn. Super LEXIS 3088, at *1-*2 (Conn. Super. Ct. Dec. 7, 1994)(finding that “a fiduciary relationship of some sort” existed between primary and reinsurance companies regarding selection of arbitrators to arbitrate dispute). See also Hartford Steam Boiler Inspection & Ins. Co. v. Industrial Risk Insurers, No. CV-94-705105, 1995 Conn. Super LEXIS 3013, at *6 (Conn. Super. Ct. Oct. 7, 1995)(“assuming” fiduciary duty but finding no breach of the duty).


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These are but a few examples. They are not sporadically made assertions. Insurance companies

clearly understand that a fiduciary duty is owed to their policyholders. So do the 139 and

commentators.140

139 See 2 EUGENE R. ANDERSON, ET AL., INSURANCE COVERAGE LITIGATION § 11.6, at 16-18 (1ST ed. 1997); contra, Randy Papetti, Note, The Insurer’s Duty of Good Faith in the Context of Litigation, 60 GEO. WASH. L. REV. 1931, 1933 at n.10 (1992)(listing cases. Note that Mr. Papetti supports positions regularly advocated by the insurance industry); Gibson v. Western Fire Ins. Co., 682 P.2d 725, 730 (Mont. 1984) (citation omitted); Stetler v. Fosha, 809 F. Supp. 1409, 1422 (D. Kan. 1992), aff’d without op., 7 F.3d 1045 (10th Cir. 1993); Village of Morrisville Water & Light Dep’t v. United States Fidelity & Guar. Co., 775 F. Supp. 718, 734 (D. Vt. 1991); Corrado Bros. V. Twin City Fire Ins. Co., 562 A.2d 1188, 1192 (Del. 1989) (insurance company-policyholder relationship is analogous to fiduciary relationship); Florida Farm Bureau Mut. Ins. Co. v. Rice, 393 So. 2d 552, 555 (Fla. Dist. Ct. App. 1980); Illinois Masonic Med. Ctr. V. Turegum Ins. Co., 522 N.E.2d 611, 613 (Ill. App. Ct. 1988); Pareti v. Sentry Indem. Co., 536 So. 2d 417, 423 (La. 1988); Fireman’s Fund Ins. Co. v. Continental Ins. Co., 519 A.2d 202, 204 (Md. 1987); Lisiewski v. Countrywide Ins. Co., 255 N.W.2d 714,717 (Mich. Ct. App. 1977); Varnal v. Weathers, 619 S.W.2d 825, 828 (Mo. Ct. App. 1981); Rova Farms Resort, Inc. v. Investors Ins. Co. of am., 323 A.2d 495, 504 (N.J. 1974). But see Rawlings v. Apodaca, 726 P.2d 565, 571 (Ariz. 1985) (“[A]though the insured is entitled to expect that the insurer will be `on his side’… we do not go so far as to hold that the insurer is a fiduciary.”).

In the claims handling environment, it is very clear that insurance companies owe their policyholders a fiduciary duty. Allstate Ins. Co. v. American Transit Ins. Co., 977 F. Supp. 197 (E.D.N.Y. 1997)(primary insurance company owes fiduciary duties to an excess insurance company); Hartford Accident & Indem. Co. v. Commercial Union Ins. Co. , 772 F. Supp. 741 (E.D.N.Y. 1991)(same); Emloyers Mut. Cas. Co. v. Key Pharms., No. 91 Civ. 1630, 1992 U.S. Dist. LEXIS 11091 (S.D.N.Y. July, 27 1992)(excess insurance company could not withhold from the policyholder documents regarding the underlying litigation and settlement; issue was not 'privity or the lack of privity, but defendants' fiduciary obligations'); Highlands Ins. Co. v. National Union Fire Ins. Co., 27 F.3d 1027 (5th Cir. 1994)(insurance company which sold primary policy owed its excess insurance company the same fiduciary obligation it owed its policyholders): Royal Globe Ins. Co. v. Chock Full O' Nuts Corp., 86 A.D. 315, 449 N.Y.S.2d 740, 742 (1st Dep't 1982) (policyholder allowed to maintain breach of fiduciary duty counterclaim for alleged breach of contract and negligence in handling claims under workers' compensation and employers liability policies); United Nat'l Ins. Co. v. Waterfront N.Y. Realty, 948 F. Supp. 263 (S.D.N.Y. 1996)(insurance company's fiduciary duty to the policyholder requires that the insurance company's loyalty be undivided); New York v. Blank, No. 88-CV-163, 1991 U.S. Dist. LEXIS 14582 (N.D.N.Y. Oct. 10, 1991), at *27, aff’d in relevant part, 27 F.3d 783 (2d Cir. 1994)(court agreed with policyholders' observation that 'the Insurers' efforts in these summary judgment motions to in effect prove its insureds' liability in the underlying action may be a breach of their fiduciary obligations to their insureds,” citing Hartford Accident & Indem. v. Michigan Mut. Ins. Co., 93 A.D.2d 337, 340-41, 462 N.Y.S.2d 175, 178 (1st Dep't 1983), aff’d, 61 N. Y.2d 569, 463 N. E.2d 608, 475 N.Y. S.2d 267 (1984); Fireman's Fund Ins. Co. v. Security Ins. Co., 72 N.J. 63, 367 A.2d 864 (1976)(holding that primary insurance company's failure to settle was in “disregard of its acknowledged fiduciary duty to


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2. Insurance Companies Trumpet Their Fiduciary Duties For Marketing and Litigation Purposes

Insurance companies use their fiduciary status as a litigation tactic and a

marketing tool.

Insurance companies are quick to argue the tell-tale mark of a fiduciary duty — a

“relationship of trust and confidence” — when policyholders in litigation against them request

documents or interrogatories. In a litigation tactic designed to shield their files from discovery,

insurance companies routinely deny requests for documents by claiming that disclosure would

violate the trust or confidences of their policyholders.141

its insured”); Dornberger v. Metropplitan & Life Ins. Co., 961 F. Supp. 506 (S.D.N.Y. 1997)(basis for the fiduciary obligation is quite clear in the litigation context and that under the right circumstances, the relationship between the insurance company and policyholder in non-litigation environment may be imbued with elements of trust and confidence to create a fiduciary duty); Zurich Ins. Co. v. State Farm Mut. Auto. Ins, Co., 137 A.D.2d 401, 524 N.Y.S.2d 202 (1st Dep't 1988)(primary insurance company owes the same fiduciary obligation to its excess insurance company as it owes to its policyholder); Arzonaut Ins. Co. v. Hartford Accident & Indem. Ins. Co., 687 F. Supp. 911 (S.D.N.Y. 1988)(same); Myers v. Ambassador Ins. Co., Inc., 146 Vt. 552, 508 A.2d 689, 691 (1986)("[t]he insurer's fiduciary duty to act in good faith when handling a claim against the insured obligates it to take the insured's interests into account.”); Ampower Semiconductor Corp. v. American Motorists Ins. Co., 159 A.D.2d 268, 522 N.Y.S.2d 269 (1st Dep't 1990)(by breaching its fiduciary duty to deal with its policyholder with the utmost good faith, insurance company could not take advantage of its own wrongdoing); But see Goshen v. Mutual Life Ins. Co., No. 600466/95-006, 1997 N.Y. Misc. LEXIS 486 (N.Y. Sup. Ct. N.Y. County Oct. 24, 1997)(”Although a fiduciary relationship may exist between an insurance company and its insured once the insurer is called upon to provide a defense to its insured in the context of a liability claim . . ., in general, a contract of insurance does not otherwise create a fiduciary relationship between the parties.”(citations omitted)

140 See, e.g., Willis Park Rokes, J.D., Ph.D, Agressive Good Faith and Successful Claims Handling 26 (Insurance Institute of America, 1st ed. 1987)

The nature of the insurance contract, where the insured turns over his or her financial interests to the insurance company, dictates that the insurer has no right to sacrifice those of the insured in order to save money. The relationship between the insured and the insurer under the contract closely approximates that of principal and agent, or beneficiary and trustee, and indeed, some courts have held that the insurer occupies a fiduciary position.

141 See, e.g., Commercial Union Insurance Company’s Brief In Opposition To Plaintiff’s Motion To Compel Discovery at, 2, 23, dated June 16, 1989, Minnesota Mining & Mfg. v. Commercial Union Ins. Co., (D.N.J.)(No. 88-325)(“discovery . . . concerning other insureds and claims would compromise


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Insurance companies’ advertisements contribute to the fiduciary relationship

between the insurance company and the policyholder.

Older decisions which refused to recognize a fiduciary relationship between the insurance company and its policyholder are “out of step with current concepts . . . [and] particularly

. . . outmoded when television advertising repeatedly refers to the ‘good hands’ of the insurer or how it is ‘like a good neighbor’, implying an ability to place trust and reliance upon the broad shoulders of the kindly company.142

Courts around the country have found that insurance company advertisements tell

people what to expect from insurance:

Allstate’s slogan “You’re in Good Hands,” Travelers’ motto of protection “Under the Umbrella,” and Fireman’s Fund symbolic protection beneath the “Fireman’s Hat,” exemplify the industry’s own efforts to portray itself as a repository of the public trust . . . It is noteworthy that the insurance company involved in this appeal promotes itself in national advertisements with the slogan, “Like a good neighbor, State Farm is there.”143

The unfortunate truth is that insurance companies often do the opposite of what they promised in

their marketing efforts:

confidential and proprietary information of other insureds”);

Aetna Casualty and Surety Company’s Memorandum of law In Opposition to Textron Inc’s Motion To Compel, at, 4, 12, 21, filed Aug. 21, 1989, Textron, Inc. v. Aetna Cas. & Sur. Co., (R.I. Super Ct.)(No. 87-3497)(disclosure of information concerning other insureds “threatens to breach [the insurance company’s] confidential relationship with its other policyholders;” “The very nature of the relationship between insurer and insured imparts a reasonable expectation of privacy”);

Memorandum of Defendant Employers Insurance of Wausau in Opposition to Motion to Compel Answers to Interrogatories at, 4, 14-17, filed Aug. 21, 1989, Avco Corp. v. Aetna Cas. & Sur. Co.,(R.I. Super. Ct.)(No. 87-3497)(producing documents pertaining to other policyholders would “result in disclosure of highly sensitive confidential information”).142 See Dornberger v. Metropolitan Life Ins. Co., 967 F. Supp. 506, 547 n.39 (S.D.N.Y. 1997), citing 12 J. APPLEMAN, INSURANCE LAW & PRACTICE § 7004 (1981).143 State Farm Fire & Cas. Co. v. Nicholson, 777 P.2d 1152, 1156 n.6 (Alaska 1989)(quoting McMains, Bad Faith Claims Handling -- New Frontiers: A Multi-state Cause of Action in Search of a Home, 53 J. AIR L. & COM. 901, 904 (1988)(recognizing the insurance company duty of good faith in first-party cases).


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The insurer’s promise to the insured to ‘simplify his life,’ to put him ‘in good hands,’ to back him with ‘a piece of the rock’ or to be ‘on his side’ hardly suggest that the insurer will abandon the insured in his time of need.144

Abandon the policyholder in his time of need is exactly what insurance companies frequently do.

When this happens, an insurance policy is not a shield, a safe hand, a kindly neighbor or a rock.

Not only does this abandonment violate the insurance company’s fiduciary duty, it violates the

policyholder’s fundamental expectation of peace of mind which insurance is meant to provide:

That insurers sell their product as being not only an agreement to indemnify the insured for certain kinds of loss but also to relieve the purchaser from anxiety concerning all aspects of claims is readily apparent in our society. On cannot watch televised entertainment for very long without being exposed to commercials for the sale of insurance which, for example, indicate that the purchaser will be in ‘good hands,’ that he will have the assistance of a troop of mounted cavalry, that he [will have] ‘a piece of the rock,’ or ‘like a good neighbor’ the insurer will be there. As such advertisements reflect, the relationship between insurer and insured does not merely concern indemnity for money loss.145

Insurance company advertising reveals that the insurance industry itself “recognizes that the

insurance relationship is more than the company’s promise to pay certain claims when forced to

do so:”

Advertising programs portraying customers as being ‘in good hands’ or dealing with a ‘good neighbor’ emphasize a special type of relationship between the insured and insurer — one in which

144 D’Ambrosio v. Pennsylvania Nat’l Mut. Cas. Ins. Co., 494 Pa. 501, 512-13, 431 A.2d 966, 972 (1981)(Larsen, J., dissenting), superseded by statute, Romano v. Nationwide Mut. Fire Ins. Co., 646 A.2d 1228 (Pa. Super. Ct. 1994), superseded by statute, Continental Cas. Co. v. Diversified Indus., 884 F. Supp. 937 (E.D. Pa. 1995). See also Irion v. Prudential Ins. Co., 765 F. Supp. 337, 338 n.2 (N.D. Tex. 1991), rev’d, 964 F.2d 463 (5th Cir. 1992)(“Plaintiff, at the inducement of Prudential, got herself a ‘piece of the rock,’ and now that its time for the insurance company to pay, Prudential wants to take its rocks and go home.”); Tom Baker, Constructing the Insurance Relationship; Sales Stories, Claim Stories, and Insurance Contract Damages, 72 TEX. L. REV. 1395, 1396-97 (1994).145 Andrew Jackson Life Ins. Co. v. Williams, 566 So. 2d 1172, 1175 n.5 (Miss. 1990) quoting Farris v. United States Fidelity & Guar. Co., 284 Or. 453, 479 n.4, 587 P.2d 1015, 1028 n.4 (1978)(Lent, J., dissenting).


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trust, confidence and peace of mind have some part . . . . We hold therefore that one of the benefits that flow from the insurance contract is the insured’s expectation that his insurance company will not wrongfully deprive him of the very security for which he bargained or expose him to catastrophe from which he sought protection.146

As the present debate has made all too clear, “the insurance company’s fiduciary role lies in

perpetual conflict with its profit-making role as a business,” ultimately creating an “inherent

conflict of interest” between an insurance company’s fiduciary duties and financial interests.147

Insurance companies do not merely acknowledge their fiduciary duties — they openly tout them

and use the principle to their advantage. By acknowledging, and exploiting, their fiduciary

duties to policyholders, insurance companies recognize that their responsibilities to policyholders

go far beyond the letter of the policy.

In any bad faith action, it should be called to the courts attention that insurance

companies often do the opposite of what they promised when they cultivated the policyholder’s

trust and expectations of insurance coverage. The purpose of insurance is to insure and provide

peace of mind.148

146 Rawlings v. Apodaca, 151 Ariz. 149, 154-55, 726 P.2d 565, 570-71 (1986), citing Egan v. Mutual of Omaha Ins. Co., 620 P.2d 141, 145-46 (Cal. 1979), cert. denied, 445 U.S. 912 (1980).147 See Kekis v. Blue Cross & Blue Shield, 815 F. Supp. 571, 583 (N.D.N.Y. 1993), quoting Wilson v. Group Hospitalization & Med. Servs., Inc., 791 F. Supp. 309, 312 (D.D.C. 1992); Brown v. Blue Cross & Blue Shield, 898 F.2d 1556 (11th Cir. 1990). It should be noted that while the perpetual conflict of interest between an insurance company’s fiduciary duties and financial interests is a simple matter of fact, within the Second Circuit, ‘arbitrary and capricious’ conduct is the appropriate standard of review to determine whether a plan administrator has breached their fiduciary duty. See Whitney v. Empire Blue Cross & Blue Shield, 106 F.3d 475, 476-77 (2d Cir. 1997).148 13 J. Appleman, Insurance Law & Practice, § 7403, at 302-03 (1981).


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3. FIDUCIARY DUTY OF INSURANCE COMPANIES

a. The Bad

In United States v. Brennan, 183 F.3d 139 (2nd Cir. 1999)the Second Circuit,

after extensive briefing and consideration by the District Court, and in dicta, criticized the

government's case on the issues of insurance company's fiduciary duties. The Court noted:

The Government has pointed to no precedent for criminal liability based on disclosures to sophisticated corporations in arm-length contractual insurance relationships, in circumstances like those presented here. Indeed, there was substantial reason for one in defendants position to conclude that the relationships at issue were not fiduciary under New York law or otherwise. (citations omitted). Id. at 1999 WL 459368 at *10.

b. The Good

Warren Buffett has written:

The insurance business is a fiduciary business. You get access to other people’s money under conditions where in many cases the other people have very little knowledge or control of where the money’s going.149

Justice Cardozo said:

Many forms of conduct permissible in a workaday world for those acting at arm’s length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior.150

The root of the word “fiduciary” is fides, meaning faith, confidence, reliance,

trust, and belief. Fides, or confidence, is described in Cicero as:

The command of confidence can be secured . . [first]. if people think us possessed of practical wisdom combined with a sense of justice. For we have confidence in those who we think have more understanding than ourselves, who, we believe, have better insight into the future, and who, when an emergency arises and a crisis

149 Warren Buffett, 1992 Annual Report of Berkshire Hathaway, filed with the United States Securities and Exchange Commission.150 Meinhard v. Salmon, 249 N.Y. 458, 464, 164 N.E. 545, 546 (1928).


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comes, can clear away the difficulties and reach a safe decision according to the exigencies of the occasion; for that kind of wisdom the world accounts genuine and practical. [Second], confidence is reposed in men who are just and true. . . Justice combined with practical wisdom will command all the confidence we can desire; justice without wisdom will not be able to do much; wisdom without justice will be of no avail at all.151

A modern definition of “fiduciary” states that a fiduciary is “one . . .that holds a

fiduciary relation or acts in a fiduciary capacity to another”152 And a “fiduciary relation” is one

which exists when “good conscience requires one to act at all times for the sole benefit and

interests of another with loyalty to those interests.”153

In the insurance world, there are fewer categories of “fiduciary.” Rather, a

“fiduciary” is “a person who occupies a position of trust.”154 “Fiduciary” describes “relationships

of high trust and confidence.”155

A book published by the Insurance Institute of America used to train insurance

industry personnel notes that the relationship of an insurance company and its policyholder

approximates the relationship between a beneficiary and a trustee reasoning:

The nature of the insurance contract, where the insured turns over his or her financial interests to the insurance company, dictates that the insurer has no right to sacrifice those of the insured in order to save money. The relationship between the insured and the insurer under the contract closely approximates that of principal and agent, or beneficiary and trustee, and indeed, some courts have held that the insurer occupies a fiduciary position.156

Insurance Companies Communicate That They Are Fiduciaries

151 De Officiis II, IX, at 203 1.33 (Walter Miller trans., 1943), quoted in Scott FitzGibbon, Fiduciary Relationships are Not Contracts, 82 MARQ. L. REV. 303, 339 n.126 (1999). 152 I Webster’s Third New International Dictionary of the English Language Unabridged 845 (1986). 153 Id.154 Insurance Words and Their Meanings 55 (Rough Notes 15th ed. 1996). 155 LEWIS E. DAVIDS, DICTIONARY OF INSURANCE 185 (Rowman & Littlefield Publishers 7th ed. 1990).


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4. Communication in Court

The instances of insurance companies telling courts that they are fiduciaries are

legion. Here a just a few:

Fireman’s Fund Insurance Company:

An insurer stands in a fiduciary relationship to its insured; when an insurer chooses his interest over the interests of his insured his actions are indeed ‘intentional and deliberate’ . . . and when a case can be settled with no personal liability to said insured, [failure to do so] has the ‘character of outrage frequently associated with crime’.157

Continental Casualty Company:

It has been held that an insurer who issues a [comprehensive general liability policy] is under a fiduciary duty to look after the interests of the insured as well as its own interests.158

Continental Insurance Company:

Representing the insured is clearly a ‘fiduciary’ situation, especially in view of the fact that improper conduct by the insurer could expose the insured to liability beyond the amount of his insurance protection.159

National Union Fire Insurance Company:

Underlying all forms of insurance is a fiduciary duty to some extent simply because of the insurer’s expertise in the area of its business. In the public liability area the fiduciary duties are heavier because the insurance company is an expert in the

156 Willis Park Rokes, Aggressive Good Faith and Successful Claims Handling 26 (Insurance Institute of America 1987).157 Civil Action--Cross Petition for Certification and Brief in Opposition to Defendant-Appellant Petition for Certification, at 13 (filed Mar. 4, 1975), Fireman’s Fund Ins. Co. v. Security Ins. Co. of Hartford, No. 1, 223 (N.J.) (Fireman’s Fund arguing that the primary insurance company, Security, owed a fiduciary duty to its policyholder).158 Continental Casualty Company’s Memorandum of Law For Trial at 27 (filed Sept. 11, 1990), Continental Casualty Co. v. Great Am. Ins. Co., No. 86-C-3938 (N.D. Ill.).159 Memorandum in Opposition to Plaintiff’s Cross-motion to Dismiss Defendants’ First and Second Defenses and Plaintiff’s Request For Leave to Further Amend its Amended Complaint at 9-10 (submitted Apr. 5, 1993), New York Univ. v. Continental Ins. Co., No. 11627/92 (N.Y. Sup. Ct.).


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litigation arena in all parts of the country since it has thousands of cases nationwide and trained personnel to handle them.160

[L]egal authorities have declared the relation of insured and insurer to be fiduciary. . ..161

Home Insurance Company:

Under Oregon law an insurer is in a fiduciary relationship to its insured. A fiduciary is one who is in a position of trust and confidence with another, usually called a principal, while acting for and on behalf of the other.162

Liberty Mutual Insurance Company:

[T]he cases have readily acknowledged that the insurer-insured relationship gives rise to a fiduciary duty.163

St. Paul Fire and Casualty:

St. Paul owes a fiduciary duty to [the plaintiff]. We don’t contest that . . . We owe a fiduciary duty to every one of our policyholders . . . .164

Hartford Accident and Indemnity Company:

The standard which attaches to the insurer-insured relationship is fiduciary in nature. . . .[G]reat weight must be placed upon the character of an insurance policy as a contract of adhesion . . . which the insurer, as the dominant party, must honor as a fiduciary . . . .165

160 Memorandum in Opposition To Columbia Casualty Company’s Motion For Summary Judgment at 18-19 (dated Dec. 16, 1989), Columbia Casualty Co. v. National Union Fire Ins. Co., No. 89-3506 (E.D. Pa.).161 Defendant National Union Fire Insurance Co. of Pittsburgh, PA’s Reply Memorandum in Support of its Motion for Summary Judgment at 23 (dated Oct. 20, 1995), In re: Cardinal Industries, Inc., No. C-2-94-254 (S.D. Ohio). 162 Defendant’s [Home Insurance Company’s] Requested Jury Instructions, Defendant’s Proposed Instruction No. 2 (submitted on Sept. 8, 1988), Georgetown Realty, Inc. v. Home Ins. Co., No. A8708-05098 (Oregon Cir. Ct., Multnomah Cty.).163 Memorandum of Law in Support of Plaintiff’s Response at 6, (dated July 13, 1993), Liberty Mut. Ins. Co. v. Paper Mfrs. Co., No. 90-3787 (E.D. Pa. 1990). 164 Motion For Summary Judgment Hearing, Transcript at 24 (dated Jan. 18, 1994), Richland Valley Prods. v. St. Paul Fire & Cas. Co., No. 92CV149 (Wis. Cir. Ct.).165 Brief and Volume I of Appendix of Plaintiff-Appellant, Hartford Accident & Indemnity Company at 11-12 (filed May 12, 1983), Hartford Accident & Indem. Co. v. Aetna Life & Casualty Ins.


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Frequently, insurance companies tell courts that the insurance companies that

provide them with insurance coverage are fiduciaries.166 In the process, the insurance company

may make two points: its insurance company is a fiduciary and it, as an insurance company, is a

fiduciary for the policyholder. For example, American Centennial Insurance Company told a

court: “The primary carrier owes to the excess carrier the same fiduciary obligation which the

primary insurer owes to its insured.”167 Hartford Accident and Indemnity Company also made

these two points when it, as an excess insurance company, argued that the primary insurance

company owed a fiduciary duty to the excess insurance company. Hartford told a court:

The primary carrier owes the excess carrier the same fiduciary obligation which the primary insurer owes its insured, namely, a duty to proceed in good faith and in the exercise of honest discretion, the violation of which exposes the primary carrier to liability beyond its policy limits.168

General Star National Insurance Company during a dispute with Liberty Mutual

Insurance Company told the court:

Co., No. A-1595-82T2 (N.J. Super. Ct. App. Div.).166 See, e.g., Reply Brief for Defendant-Appellant Executive Life Insurance Company at 4 (filed Sept. 26, 1989), United States Fidelity & Guar. Co. v. Executive Life Ins. Co., No. 89-7955 (2d Cir.); Brief of Appellant Centennial Insurance Company at 36 (filed Jan. 19, 1990), Aetna Casualty & Surety Co. v. Great Am. Ins. Co., No. 89-55811 (9th Cir.); Brief in Support of Plaintiff’s Motion for Summary and Other Relief at 87 (filed Aug. 8, 1989), Christiania General Ins. Corp. of New York v. Great Am. Ins. Co., No. 87 Civ. 8310 (S.D.N.Y.); Response of Prudential Reinsurance Co. and Gibraltar Casualty Company in Opposition to Plaintiff’s Motion for Protective Order Regarding Certain Depositions at 5-6, (filed June 15, 1992), Hoechst Celanese Corp. v. National Union Fire Ins. Co., No. 89C-SE-35-1-CV (Del. Super. Ct.); Initial Brief of Appellant United States Fire Insurance Company, at 17-18 (filed May 3, 1990), United States Fire Ins. Co. v. Caulkins Indiantown Citrus Co., No. 89-3791 (Fla. Dist. App. Ct.); Motion for Rehearing and Request for Motion for Rehearing En Banc at 4 (filed July 31, 1987), Morrison Assurance Co. v. United States Fire Ins. Co., No. BR-226 (Fla. Dist. Ct. App.). See generally Eugene R. Anderson and James J. Fournier, Why Courts Enforce Insurance Policyholders’ Objectively Reasonable Expectations of Insurance Coverage, 5 CONN. INS. L.J. 335, 387 (1998-1999).167 Application for Writ of Error of American Centennial Insurance Company and First State Insurance Company, at 19, filed July 9, 1991, American Centennial Ins. Co. v. Canal Ins. Co., 843 S.W.2d 480 (Tex. 1992)(No. D-1213).168 Brief of Plaintiff-Respondent at 11 (dated Feb. 8, 1984), Hartford Accident & Indem. Co. v. Michigan Mut. Ins. Co., 61 N.Y.2d 569 (1984).


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When determining whether an insurer breached its duty to its insured . . . the appropriate standards to employ are described by cases involving the very issue at hand, i.e., the fiduciary duty of an insurer to act with the utmost good faith in its handling of the claims against the insured.169

One insurance company has explained why a fiduciary relationship exists between

primary and reinsurance companies. Hartford Steam Boiler Inspection and Insurance Company

said:

The essence of a fiduciary relationship is that the fiduciary agrees to act as his principal’s alter ego rather than to assume the standard arm’s length stance of traders in a market. Hence the principal is not armed with the usual wariness that one has in dealing with strangers; he trusts the fiduciary to deal with him as frankly as though he would deal with himself — he has bought candor.170

Insurance companies are fiduciaries because they have frequently represented in

court that they are fiduciaries. In order to prevent inconsistencies in litigation,171 insurance

companies should be considered fiduciaries at all times. As the California Court of Appeal once

told an insurance company, a litigant “may not alter [its] argument as the chameleon does his

color, to suit whatever terrain [it] inhabits at the moment.”172

169 Appellant’s Reply Brief at 9-101 (filed Oct. 23, 1991), General Star National Ins. Co. v. Liberty Mut. Ins. Co., No. 91-1497 (3d Cir.).170 Memorandum of Law Re Motion to Compel at 64 (filed Nov. 29, 1994), Hartford Steam Boiler Inspection & Ins. Co. v. Industrial Risk Insurers, No. CV-94-705105 (Conn. Super. Ct., J.D. Hartford/New Britain at Hartford) (quoting United States v. Dial, 757 F.2d 163, 168 (7th Cir. 1985).171 For an exhaustive discussion of the methods used by courts to prevent inconsistencies in litigation see Eugene R. Anderson & Nadia V. Holober, Preventing Inconsistencies in Litigation With a Spotlight on Insurance Coverage Litigation: The Doctrines of Judicial Estoppel, Equitable Estoppel, Quasi-Estoppel, Collateral Estoppel, “Mend the Hold,” “Fraud on the Court” and Judicial and Evidentiary Admissions, 4 CONN. INS. L.J. 589 (1997-98).172 Aerojet-General Corp. v. Superior Court, 258 Cal. Rptr. 684, 686 (Cal. Ct. App. 1989), review denied, No. A042785 (Cal. Aug. 10, 1989).


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5. Communication Via Litigation Tactics

Insurance companies assert that they are fiduciaries and use this status as a

litigation tactic. Insurance companies are quick to argue the tell-tale mark of a fiduciary duty —

a “relationship of trust and confidence” — when policyholders in litigation against them request

documents or interrogatories. In a litigation tactic designed to shield their files from discovery,

insurance companies routinely deny requests for documents by claiming that disclosure would

violate the trust or confidences of their policyholders.173

6. Communication in the Marketplace

Insurance companies are some of the largest volume advertisers in the United

States.174 In those advertisements, the insurance companies frequently portray themselves as

fiduciaries. Allstate Insurance Company’s “good hands” advertisements clearly communicate

that Allstate wants the policyholder to place trust and confidence in Aetna. Travelers Insurance

Company’s “taking care of one another” and State Farm’s “good neighbor” advertisements

encourage the public to trust them.

173 See, e.g., Commercial Union Insurance Company’s Brief In Opposition To Plaintiff’s Motion To Compel Discovery at 2, 23 (dated June 16, 1989), Minnesota Mining & Mfg. v. Commercial Union Ins. Co., No. 88-325 (D.N.J.) (“discovery . . . concerning other insureds and claims would compromise confidential and proprietary information of other insureds”); Aetna Casualty and Surety Company’s Memorandum of Law In Opposition to Textron Inc’s Motion To Compel, at 4, 12, 21 (filed Aug. 21, 1989), Textron, Inc. v. Aetna Cas. & Sur. Co., No. 87-3497 (R.I. Super Ct.)(disclosure of information concerning other insureds “threatens to breach [the insurance company’s] confidential relationship with its other policyholders;” “The very nature of the relationship between insurer and insured imparts a reasonable expectation of privacy.”); Memorandum of Defendant Employers Insurance of Wausau in Opposition to Motion to Compel Answers to Interrogatories at 4, 14-17 (filed Aug. 21, 1989), Avco Corp. v. Aetna Casualty & Sur. Co., (No. 87-3497) (R.I. Super. Ct.)(producing documents pertaining to other policyholders would “result in disclosure of highly sensitive confidential information”).174 See Kate Fitzgerald, A New Policy: Life Insurers Tout Strength Amid Bad Press, ADVERTISING AGE, Sept. 2, 1991, at 3 cited in Tom Baker, Constructing the Insurance Relationship: Sales Stories, Claim Stories, and Insurance Contract Damages, 72 Tex. L. Rev. 1395, 1404 n.24 (1994).


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The fiduciary aspect of insurance company advertisements can be seen in

advertising campaigns by UNUM and Mutual of Omaha.175 UNUM Corporation advertised that

“[L]eadership is more than just providing a handful of policies and a promise to be there. .

[Leadership is] tailoring coverage to fit people’s lives . . .[and] making sure every conceivable

aspect of a disability plan is taken care of.”176 Mutual of Omaha used the advertising theme

“Protecting you in ways no one ever thought of before.”177 Both these advertising campaigns

emphasize that the insurance companies are leaders, worthy of the trust and confidence of the

public. Both campaigns communicate the impression that the insurance companies are

fiduciaries.

Since courts have considered an insurance company’s marketing materials when

deciding issues involving insurance coverage,178 advertisements and other marketing materials

used by insurance companies should be considered when determining that an insurance company

is a fiduciary.

Legal commentators noted almost twenty years ago that insurance company

advertising that encourages trust and reliance may impose a fiduciary relationship:

Particularly is the approach [“dog eat cat”] outmoded when television advertising repeatedly refers to “the good hands” of the insurer or how it is “like a good neighbor,” implying an ability to place trust and reliance upon the broad shoulders of the kindly company. Some [court] decisions impose a fiduciary relationship; others disagree.179

175 Tom Baker, Constructing the Insurance Relationship: Sales Stories, Claim Stories, and Insurance Contract Damages, 72 Tex. L. Rev. 1395, 1406 (1994).176 Id. (citing SPORTS ILLUSTRATED, July 12, 1993, at 55 (advertisement)).177 Id. (citing NAT’L GEOGRAPHIC, Sept. 1992, at 145 (advertisement)).178 Alice E. Graham, Use of Advertising Materials to Determine Insurance Coverage, DEF. COUNS. J., July 1990, at 332 (surveying court decisions involving insurance company advertisements and brochures when deciding issues relating to reliance and reasonable expectations).


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One court in 1997, quoting that observation, recognized that:

Older decisions which refused to recognize a fiduciary relationship between the insurance company and its policyholder are “out of step with current concepts . . . [and] particularly. . . outmoded when television advertising repeatedly refers to the ‘good hands’ of the insurer or how it is ‘like a good neighbor’, implying an ability to place trust and reliance upon the broad shoulders of the kindly company.180

As one court observed, insurance company advertisements tell people what to

expect from insurance:

Allstate’s slogan “You’re in Good Hands,” Travelers’ motto of protection “Under the Umbrella,” and Fireman’s Fund symbolic protection beneath the “Fireman’s Hat,” exemplify the industry’s own efforts to portray itself as a repository of the public trust.181

Insurance company advertisements encourage the policyholder to place trust and

confidence in the insurance company. “As such advertisements reflect, the relationship between

insurer and insured does not merely concern indemnity for money loss.”182

Insurance company advertising reveals that the insurance industry itself

“recognizes that the insurance relationship is more than the company’s promise to pay certain

claims when forced to do so:”

179 12 John Alan Appleman & Jean Appleman, Insurance Law & Practice §7004 at 52 (1981) (citations omitted).180 Dornberger v. Metropolitan Life Ins. Co., 967 F. Supp. 506, 547 n.39 (S.D.N.Y. 1997) (citing 12 J. APPLEMAN, INSURANCE LAW & PRACTICE § 7004 (1981)).181 State Farm Fire & Casualty Co. v. Nicholson, 777 P.2d 1152, 1156 n.6 (Alaska 1989)(quoting Russell H. McMains, Bad Faith Claims Handling -- New Frontiers: A Multi-state Cause of Action in Search of a Home, 53 J. AIR L. & COM. 901, 904 (1988)). See also White v. Unigard Mut. Ins. Co., 730 P.2d 1014, 1019 (Idaho 1986).182 Andrew Jackson Life Ins. Co. v. Williams, 566 So. 2d 1172, 1175 n.5 (Miss. 1990) quoting Farris v. United States Fidelity & Guar. Co., 284 Or. 453, 479 n.4, 587 P.2d 1015, 1028 n.4 (1978)(Lent, J., dissenting).


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Advertising programs portraying customers as being ‘in good hands’ or dealing

with a ‘good neighbor’ emphasize a special type of relationship between the insured and insurer

— one in which trust, confidence and peace of mind have some part . . . . We hold therefore that

one of the benefits that flow from the insurance contract is the insured’s expectation that his

insurance company will not wrongfully deprive him of the very security for which he bargained

or expose him to catastrophe from which he sought protection.183

The insurance industry has acknowledged that it is in a unique position because of

the public service nature of insurance. In 1981, the then Chairman of the American Insurance

Association noted that the insurance industry is “imbued with the public interest”184 and that

“[w]e convince others of the leading role insurance plays in society. We encourage them to

expect superior performance from us.”185

In a September 22, 1970 speech entitled “There’s Got To Be A Better Way,” the

then President of Crum and Forster Insurance Company noted:

If studied even casually, the history of our business proves that in the United States, as nowhere else in the world, insurance has functioned to set men’s minds free from economic worry so they could think about more constructive things; it has functioned to maintain productive enterprise so that more people could enjoy the fruits of our enterprise system; it has provided the means to rebuild burned and shattered cities and towns — to replace property — both private and public — that has been destroyed, damaged, or wrongfully taken away; to relieve physical pain as well as economic distress.186

183 Rawlings v. Apodaca, 151 Ariz. 149, 154-55, 726 P.2d 565, 570-71 (1986) (citing Egan v. Mutual of Omaha Ins. Co., 620 P.2d 141, 145-46 (Cal. 1979), cert. denied, 445 U.S. 912 (1980)).184 Remarks of Jack Moseley, Chairman, American Insurance Association, in “The Burgeoning of Litigation,” Proceedings of American Insurance Association Annual Meeting, New York, New York, May 28-29, 1981 at 62.185 Id.186 Speech by B.P. Russell, the President of Crum and Forster Insurance Company, delivered at the Annual Convention of the National Association of Insurance Agents at Miami, FL, Sept. 22, 1970.


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Standard textbooks used to train members of the insurance industry acknowledge

the benefits of insurance and the special duties that insurance companies have because of the

unique nature of insurance. One such textbook emphasized the need to monitor and enforce the

special duties of insurance companies:

Notwithstanding the often stated opinion that the insurance contract is affected with a public interest, insurers often view their policies as simple contractual obligations between parties. While an insurance policy does represent a contractual commitment, the attitudes of the general public, the legislatures, and the courts make clear that the insurance agreement is viewed as having broader ramifications than a mere contract. The public has a definite interest in the reliability of the insurance product. Insurance involves an obligation that affects the public interest as well as the policyholder and therefore is necessarily subject to certain restrictions.187

One insurance company told a court that “[t]he business of insurance is one

affected by the public interest, requiring that all persons be actuated by good faith, abstain from

deception, and practice honesty and equity in all insurance matters.”188

187 1 JAMES J. LORIMER ET AL., THE LEGAL ENVIRONMENT OF INSURANCE 37-38 (3d ed. 1987).

A later edition of the same text phrases it more forcefully:

Insurance contracts are different from other commercial contracts because insurance is more a necessity than a matter of choice. Therefore, insurance is a business affected with a public interest, as reflected in legislative and judicial decisions.

1 James J. Lorimer et al., The Legal Environment of Insurance 179 (4th ed. 1993) (emphasis in original).188 Appellant’s Brief at 19 (undated), Century Indem. Co. v. Truck Ins. Exch. of the Farmers Ins. Group, No. 13141-6-III (Wash. Ct. App.).


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The unique, public interest nature of insurance,189 leads to the conclusion that

insurance companies are fiduciaries. For example, one commentator noted:

The insurers’ obligations are . . . rooted in their status as purveyors of a vital service labeled quasi-public in nature. Suppliers of services affected with a public interest must take the public’s interest seriously, where necessary placing it before their interest in maximizing gains and limiting disbursements. . . . [A]s a supplier of a public service rather than a manufactured product, the obligations of good faith and fair dealing encompass qualities of decency and humanity inherent in the responsibilities of a fiduciary. Insurers hold themselves out as fiduciaries, and with the public’s trust must go private responsibility consonant with that trust.190

Warren Buffett, the principal stockholder of Allstate and General Reinsurance has

concluded that: “The insurance business is a fiduciary business. You get access to other people’s

money under conditions where in many cases the other people have very little knowledge or

control of where the money’s going.”191

Insurance companies are fiduciaries, not only because of their unique, special

relationship with their policyholder, but also because insurance is an integral part of society,

protecting the injured, neighbors, creditors, and employees.192 Insurance, offered by insurance

189 See Dolan v. Aid Ins. Co., 431 N.W.2d 790, 791-792 (Iowa 1988) (“The bad faith tort ‘is justified because of the nature of the insurance industry, which is imbued with the public interest. . . An insured is often ‘suffering from physical injury or economic loss when bargaining with the insurance company’ and hence ‘the vulnerable position justifies the additional remedy of a bad faith cause of action.’“) See also Best Place, Inc. v. Penn American Ins. Co., 920 P.2d 334, 340 (Hawaii 1996) (“insurance industry affects the public interest” (citing Haw. Rev. Stat. §431:1-102 (1993)); Braesch v. Union Ins. Co., 464 N.W.2d 769, 774 (Neb. 1991) (“The public interest in insurance contracts, the nature of insurance contracts, and the inequity in bargaining power between the insurer and the policyholder all serve to distinguish insurance contracts from other types of contracts.”).190 William M. Goodman & Thom G. Seaton, Foreword: Ripe for Decision, Internal Workings and Current Concerns of the California Supreme Court, 62 CAL. L. REV. 309, 346-347 (1974).191 1992 Annual Report of Berkshire Hathaway, filed with the United States Securities and Exchange Commission.192 Eugene R. Anderson et al. Draconian Forfeitures of Insurance: Commonplace, Indefensible, And Unnecessary, 65 FORDHAM L. REV. 825, 829 (1996) (citing Charles A. McAlear, The Emperor’s Old Clothes, BEST’S REV., Feb. 1989, at 22-23).


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companies, benefits society. A textbook published by the Insurance Institute of America,

acknowledged this benefit: “in addition to eliminating or reducing the financial uncertainty of

risks to individuals and businesses, insurance benefits society by paying for losses, providing

funds for investments, controlling losses, supporting credit, allocating resources, and satisfying

legal and business requirements.”193

The fiduciary aspect of the insurance company’s role in society is clearly

demonstrated by the large amount of money controlled by insurance companies. In a case

involving the solvency of insurance companies, the United States Supreme Court recognized that

insurance companies were essentially trustees over a fund of assurance and credit:

The contracts of insurance may be said to be interdependent. They cannot be regarded singly, or isolatedly, and the effect of their relation is to create a fund of assurance and credit, the companies becoming the depositories of the money of the insured, possessing great power thereby, and charged with great responsibility.194

The public service nature of insurance and the public’s reliance on insurance

companies are but two reasons why insurance is regulated. The United States Supreme Court

has said that insurance “is so far affected with a public interest that the State may regulate the

rates and likewise the relations of those engaged in the business.”195 Automobile insurance

coverage and workers’ compensation insurance coverage are required by most states.196

The public service nature of insurance and the special position of the insurance

company have long been recognized. Dean Roscoe Pound, more than 50 years ago in THE

SPIRIT OF THE COMMON LAW (1929), noted:

193 James J. Markham et al. The Claims Environment 2 (1st ed. 1993).194 German Alliance Ins. Co. v. Lewis, 233 U.S. 389, 414 (1914).195 O’Gorman & Young, Inc. v. Hartford Fire Ins. Co., 282 U.S. 251, 257 (1931). 196 See, e.g., N.Y. Veh. & Traf. Law §§ 310-321 (McKinney 1995). See generally, Arthur Larson, LAW OF WORKMEN’S COMPENSATION (1995).


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[W]e have taken the law of insurance practically out of the category of contract, and we have established that the duties of public service companies are not contractual, as the nineteenth century sought to make them, but are instead relational; they do not flow from agreements which the public servant may make as he chooses, they flow from the calling in which he has engaged and his consequent relation to the public.

The public service nature of insurance places the insurance company in the

position of a fiduciary, similar to the manner in which a guardian is a fiduciary for a ward. The

insurance company, like the guardian, is responsible for the vulnerable policyholder (and the

public in general). Judge Richard Posner has written:

The common law imposes [a fiduciary] duty when the disparity between the parties in knowledge or power relevant to the performance of an undertaking is so vast that it is a reasonable inference that had the parties in advance negotiated expressly over the issue they would have agreed that the agent owed the principal the high duty that we have described, because otherwise the principal would be placing himself at the agent’s mercy. An example is the relation between a guardian and his minor ward, or a lawyer and his client. The ward, the client, is in no position to supervise or control the actions of his principal on his behalf; he must take those actions on trust; the fiduciary principle is designed to prevent that trust from being misplaced.197

Insurance companies, as providers of a public service with vast power over the

public and control over vast financial assets, are fiduciaries.

7. Case law:

In Egan v. Mutual of Omaha,198 the California Supreme Court found that it is the

public nature of the service provided by the insurance company that gives rise to a fiduciary

relationship:

197 Burdett v. Miller, 957 F.2d 1375, 1381 (7th Cir. 1992) (quoted in Scott FitzGibbon, Fiduciary Relationships Are Not Contracts, 82 MARQ. L. REV. 303, 322-323 (1999)).198 24 Cal. 3d 809, 620 P.2d 141, 169 Cal. Rptr. 691 (1979).


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Suppliers of services affected with a public interest must take the public’s interest

seriously, where necessary placing it before their own interest in maximizing gains and limiting

disbursements . . [A]s a supplier of a public service rather than a manufactured product, the

obligations of insurers go beyond meeting reasonable expectations of coverage. The obligations

of good faith an The Dornberger court’s view that there is no per se rule that insurance

companies are not fiduciaries has been followed in at least two recent decisions.199 In Force v.

ITT Hartford Life & Annuity Insurance Co.,200 the court refused to dismiss a claim alleging

breach of fiduciary duty brought by a class of purchasers of life insurance policies sold by ITT

Hartford. The court, applying Florida law, noted that basic Florida law holds that the existence

of a fiduciary relationship is a question of fact.201 Finding that the reasoning of the court in

Dornberger was “instructive,” the court in Force denied ITT Hartford’s motion to dismiss.

In Parkhill v. Minnesota Mutual Life Insurance Co.,202 the court also referred to

Dornberger and, as in Force, decided that the existence of a fiduciary relationship is a question

of fact.203 The defendant insurance company in Parkhill argued that there was a per se rule that

precluded the existence of a fiduciary relationship between an insurance company and a

policyholder, but, the court said:

[A]n old case . . . best refutes defendant’s argument:

Courts of equity have carefully refrained from defining the particular instances of fiduciary relations in such a manner that other and perhaps new cases might be excluded. It is settled by an

199 Parkhill v. Minnesota Mut. Life Ins. Co., 995 F. Supp. 983 (D. Minn. 1998); Force v. ITT Hartford Life & Annuity Ins. Co., 4 F. Supp. 2d 843 (D. Minn. 1998).200 4 F. Supp. 2d 843 (D. Minn. 1998).201 Id. at 853 (citing Capital Bank v. MVB, Inc., 644 So. 2d 515, 518 (Fla. Dist. Ct. App. 1994)).202 995 F. Supp. 983 (D. Minn. 1998).203 Id. at 992.


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overwhelming weight of authority that the principle extends to every possible case in which a fiduciary relation as a fact exists, in which confidence is reposed on one side and there is resulting superiority and influence on the capital, and the relation and duties involved in it need not be legal, but may be moral, social, domestic, or merely personal.

Dale, 107 So. at 179. Indeed, the changing nature of the insurance industry gives

new vigor to this fact-specific analysis.204d fair dealing encompass qualities of decency and

humanity inherent in the responsibilities of a fiduciary.205

Courts, in deciding insurance cases, have been applying a fiduciary duty to third-

party liability insurance. Many New York courts as well as many other courts in other

jurisdictions have applied such a duty on insurance companies. It is these cases which support

the District Court's jury instruction on fiduciary relationships and prove the Second Circuits

comments regarding fiduciary duty are misplaced.

The Second Circuit Court in _______ the Brennan Case failed to discuss or even

cite any of the cases cited by the lower court regarding this issue, principally Hartford Accident

& Indemnity Co. v. Michigan Mutual Insurance Co., 93 A.D.2d 337, 462 N.Y.S.2d 175, 178

(N.Y. App. Div. 1983), aff'd 61 N.Y.2d 569, 475 N.Y.S.2d 267 (1984), the principal authority in

New York for the fiduciary obligations of insurance companies.

In Michigan Mutual the Court in making a determination regarding a Michigan

Mutual Insurance Co.'s, the primary insurance carrier, fiduciary duty to Hartford Accident &

Indemnity Co., the excess carrier it noted that the fiduciary duty owed by Michigan Mutual to

204 Id. at 991 (quoting Dale v. Jennings, 90 Fla. 234, 107 So. 175, 179 (Fla. 1925)).205 Id. at 820, 620 P.2d at 146, 169 Cal. Rptr. at 696 (citations omitted). See EUGENE R. ANDERSON ET AL., 2 INSURANCE COVERAGE LITIGATION §11.6 (1997). See also Frommoethelydo v. Fire Ins. Exch., 42 Cal. 3d 208, 721 P.2d 41, 228 Cal. Rptr. 160 (1986).


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Hartford was the same as Michigan Mutual's fiduciary duty owed to its own policyholder. The

Court held:

It is well established that, as between an insurer and its assured, a fiduciary relationship does exist, requiring utmost good faith by the carrier in its dealings with its insured. In defending a claim, an insurer is obligated to act with undivided loyalty; it may not place its own interest above those of its assured. Similarly, it has been recognized in this and other States, as well as in the Federal courts, that the primary carrier owes to the excess insurer the same fiduciary obligation which the primary insurer owes to its insured, namely a duty to proceed in good faith and in the exercise of honest discretion, the violation of which exposes the primary carrier to liability beyond its policy limits. (extensive citations omitted) Id. at 340-341.

It is this ruling which has set the stage for numerous other pro-policyholder decisions in New

York, State and Federal.206

In Dornberger v. Metropolitan Life Ins. Co., 961 F. Supp. 506 (S.D.N.Y. 1997).

Dornberger brought this action onbehalf of herself and others who had purchased policies sold

by MetLife to Americans living in Europe. MetLife failed to disclose that these policies were

sold in violation of European laws and allegedly misrepresented that local representatives in

Europe would be available to service the polices, collected from policyholders payments for a

New York franchise tax which was never paid, and misrepresented that the policies were

protected by the New York insurance law and guaranty fund. When MetLife failed to provide

assurances as to the legality of the policies and to clarify the other misrepresentations,

Dornberger ceased paying premium payments and her policies lapsed. Dornberger then filed her

complaint alleging several causes of action, including breach of fiduciary duty. Id. at 514-15.

206. In affirming this ruling, the Court of Appeals of New York held:

Michigan Mutual as the primary liability insurer owed to Hartford as the excess carrier the same duty to act in good faith which Michigan owed to its own insureds. Id. at 574.


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The court noted the "ancient vintage" of the cases cited by MetLife for the

proposition that there was no fiduciary duty and that a leading treatise stated that those cases

might now be "out of step with current concepts."207 The court cited United Sates v. Brennan,

938 F. Supp. 1111 (E.D.N.Y. 1996), rev'd on other grounds 183 F.3d 139 (2d Cir. 1999) and

Hartford Accident & Indem. v. Michigan Mut. Ins. Co., 93 A.D.2d 337, 462 N.Y.S.2d 175, 178

(N.Y. App. Div. 1983), aff'd 61 N.Y.2d 569, 475 N.Y.S.2d 267 (1984) to conclude that:

The basis for the fiduciary obligation is quite clear in the litigation context, for the insurer is undertaking to represent the insured's interest. Whether the recognition of a fiduciary obligation in the litigation context opens the door to the recognition of such an obligation in other contexts is not eminently clear.

The court noted that at least one New York case, Meagher v. Metropolitan Life Ins. Co., 119

Misc.2d 615, 463 N.Y.S.2d 727 (N.Y. Sup. Ct. 1983), had recognized the possibility of a broader

fiduciary duty. The court recognized that the cases cited by MetLife held that the relationship

between the policyholder and the insurance company is only arm's-length. It held, however, that:

under the right circumstances, the relationship between insurer and insured may be imbued with elements of trust and confidence which render the relationship more than a mere arm's-length association. Plaintiff here alleges several facts from which the existence of a relationship of trust and confidence can be inferred . . . . Such indications of a relationship closer than arm's-length were apparently absent in the aforementioned decisions which refused to recognize a fiduciary relationship between insurers and insureds . . . . In light of Meagher, we believe that New York courts do not follow a per se rule prohibiting the recognition of a fiduciary relationship in the insurance context -- rather, New York courts will permit a jury to assess the circumstances of the relationship to determine if it is one of trust and confidence.

Id. at 546-47.

207. Id. at 547 n.39 (citing 12 JOHN ALAN APPLEMAN & JEAN APPLEMAN, INSURANCE LAW AND PRACTICE §7004 (1981)).


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The court cited 12 Appleman, Insurance Law and Practice § 7004 (1981) for the

proposition that the older decisions simply do not reflect New York law or the modern day

insurance industry:

A leading treatise states that older decisions which refused to recognize a fiduciary relationship between insurer and insured may now be 'out of step with current concepts.' The treatise notes that 'particularly is this approach outmoded when television advertising repeatedly refers to 'the good hands' of the insurer or how it is 'like a good neighbor', implying an ability to place trust and reliance upon the broad shoulders of the kindly company.

Id. at 547 n.39 (citation omitted).

Another Federal Court in New York has also found a insurance company owes

fiduciary duties. In Allstate Ins. Co. v. American Transit Ins. Co., 977 F. Supp. 197 (E.D.N.Y.

1997) Allstate and Federal Insurance Co., both excess carriers, alleged that American Transit, the

primary, had breached is fiduciary duty and that the law firm hired by American Transit had

committed malpractice by failing to disclose a potential conflict of interest. Quoting extensively

from Hartford Accident & Indem. v. Michigan Mut. Ins. Co., 61 N.Y.2d 569, 475 N.Y.S.2d 267,

269 (1984), the court held that the "New York Court of Appeals has recognized that a primary

insurer owes fiduciary duties to an excess insurer." The court rejected American Transit's efforts

to characterize Allstate's claims as ones for contribution (forbidden under NY Gen. Obs. Law §

15-108(c). Rather, "[g]iven Allstate's and Federal's allegations that American Transit breached

its fiduciary duties, both parties have stated a claim against American Transit."

Similarly, in Hartford Accident & Indem. Co. v. Commercial Union Ins. Co., 772

F. Supp. 741 (E.D.N.Y. 1991), Hartford, the excess carrier, filed a claim against Commercial

Union for breach of fiduciary duty for failing to defend the policyholder in the underlying case.

Commercial Union recognized that the court in Hartford v. Michigan Mutual "upheld the right of


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the excess insurer to recover from the primary insurer based upon a direct duty owed by the

primary insurer to the excess insurer," but argued that the decision was limited to (1) a duty to

exercise good faith in handling the defense of claims, and (2) a duty to not place the interests of

the primary carrier above those of the excess carrier. Id. at 743-44. The court disagreed, holding

that the rule of Hartford v. Michigan Mut. applied.

In Zurich Ins. Co. v. State Farm Mut. Auto. Ins. Co., 137 A.D.2d 401, 524

N.Y.S.2d 202 (N.Y. App. Div. 1988). Zurich, the excess carrier, filed a claim against State

Farm, the primary, for bad faith failure to settle a claim against Zurich's policyholder. Held that:

the primary carrier owes the same fiduciary obligation to the excess insurer which the primary insurer owes to its insured. Where it is alleged that the insurer has breached that duty to its insured, the insurer may not use the attorney-client or work product privilege as a shield to prevent disclosure which is relevant to the insured's bad faith action. Thus, the same principle obtains in a bad faith action between the excess insurer and the primary insurer.

524 N.Y.S.2d at 203, citing Hartford Accident & Indem. v. Michigan Mut. Ins. Co., 93 A.D.2d 337, 462 N.Y.S.2d 175 (N.Y. App. Div. 1983), aff'd 61 N.Y.2d 569, 475 N.Y.S.2d 267 (1984) and Colbert v. Home Indem. Co., 24 A.D.2d 1080 (N.Y. App. Div. 1965).

In Continental Cas. Co. v. Pullman, Comley, Bradley & Reeves, 929 F.2d 103

(2nd Cir. 1991) the Second Circuit, interpreting Connecticut law, held that there is a duty owed

to the excess carrier by the primary. The court stated:

In the context of primary and excess insurance, it has been noted that the 'bulk of the well-reasoned authority . . . supports the existence of a duty owed by a primary to an excess carrier.'

Id. at 106-07, citing Continental Cas. Co. v. Reserve Ins. Co., 307 Minn. 5, 10 and Hartford Accident & Indem. v. Michigan Mut. Ins. Co., 61 N.Y.2d 569, 475 N.Y.S.2d 267, 269 (1984) and Zurich Ins. Co. v. State Farm Mut. Auto. Ins. Co., 137 A.D.2d 401, 524 N.Y.S.2d 202, 203 (N.Y. App. Div. 1988)(other citations omitted).


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Argonaut Ins. Co. v. Hartford Accident & Indem. Ins. Co., 687 F. Supp. 911

(S.D.N.Y. 1988). Excess carrier U.S. Fire alleged a civil conspiracy between Hartford, the

primary carrier, and Argonaut, another excess carrier, asserting a claim of breach of contract and

breach of fiduciary duty owed to an excess insurer. The Court Held:

Hartford's duty, however, to exercise the utmost good faith in its dealings with U.S. Fire, its excess insurer, is well established in the case law. New York courts have held that a primary insurer owes a fiduciary duty directly to its excess insurer to exercise good faith in handling the defense of claims and to safeguard the rights and interests of the excess insurer.

Id. at 914, citing Hartford Accident & Indem. v. Michigan Mut. Ins. Co., 61 N.Y.2d 569, 475 N.Y.S.2d 267, 269 (1984) and Zurich Ins. Co. v. State Farm Mut. Auto. Ins. Co., 137 A.D.2d 401, 524 N.Y.S.2d 202, 203 (N.Y. App. Div. 1988).

One common thread in all of these opinions is the citation to Hartford Accident &

Indemnity v. Michigan Mutual Insurance Co., 93 A.D.2d 337, 462 N.Y.S.2d 175 (N.Y. App.

Div. 1983), aff'd 61 N.Y.2d 569, 475 N.Y.S.2d 267 (1984) for their support for insurance

companies fiduciary duty. The Brennan Court, which was interpreting New York law, did not

cite to Michigan Mutual, but rather cited to cases which by there nature were not applicable.

Another New York opinion which does not cite to Michigan Mutual, but still

finds a fiduciary duty owed to an insurance companies policyholder is Ampower Semiconductor

Corp. v. American Motorists Insurance Co., 159 A.D.2d 268, 522 N.Y.S.2d 269 (N.Y. App. Div.

1990).

In 1976, the policyholder purchased a "comprehensive policy" which provided

fire loss and business interruption insurance coverage. The comprehensive policy was

accompanied by a booklet stating a two-year limitation of suit clause. The policyholder had also

purchased water damage insurance coverage in a series of forms (the HPR materials). The HPR


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materials stated that there was a one year limitation of suit clause for losses caused by water

damage.

In 1978, the policyholder suffered a flood, contacted his insurance agent, and was

told that he was covered. Although the insurance company claims representative was aware of

the additional coverage under the HPR forms, the policyholder was never advised of this and the

claim was reported to the insurance company under the "comprehensive policy" only. An

accountant for the defendant told the claims representative that the policyholder's claim was

grossly understated because the policyholder had calculated his losses at cost rather than the

selling price of the damaged goods. The claims representative did not inform the policyholder of

this, and instead told the policyholder that he had suffered no losses as a result of water damage.

The policyholder, with outside assistance, later prepared a loss calculation based

on the selling price of the goods. The insurance company failed to make a settlement offer, and

the policyholder filed suit in December 1979. After filing suit, the policyholder discovered the

additional insurance coverage under the HPR forms and sought to amend his complaint to allege

that the HPR forms be deemed part of the "comprehensive policy." The court granted this

motion.

The insurance then argued that the policyholder's entire claim was barred for

failure to institute the action within one year. The court disagreed, holding that the two year

statute of limitations applied and that the defendant had:

breached its implied covenant to the insured to refrain from taking any action which would have the effect of destroying its rights to receive the benefits of the contract. By breaching its fiduciary duty to deal with its insured with the utmost good faith, defendant cannot now take advantage of its own wrongdoing.


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Even other New York federal courts have found fiduciary duties in third-party

insurance policies. In United National Ins. Co. v. Waterfront N.Y. Realty, 948 F. Supp. 263

(S.D.N.Y. 1996). Waterfront, a realty company, was an additional insured under a policy sold by

United National to Waterfront's tenant, a dance club. Waterfront and the dance club were named

as defendants in a case alleging a rape in the dance club. Waterfront was also covered by a CGL

policy issued by AIG. Counsel for AIG informed United National that it was required to defend

Waterfront as an additional insured. United National eventually undertook Waterfront's defense

under a reservation of rights, but did not appoint independent counsel for Waterfront. The law

firm hired by United National, now representing the dance club and Waterfront, failed to comply

with several discovery orders, and the court granted a motion the strike the defendant's answer.

The case was settled the next day for $1,050,000, with United National paying $500,000 towards

the settlement. Subsequent to the settlement, an appellate court reversed a lower court ruling and

held that United National's policy excluded insurance coverage for rape.

United National now argues that it is entitled to a complete return of all funds it

paid on behalf of Waterfront. Waterfront counters that United National created a conflict of

interest by appointing the same counsel to represent it and the dance club, and that this conflict

of interest was the reason United National was forced to incur settlement costs on behalf of

Waterfront in the first place.

The court held that the United National policy did not provide insurance coverage

for rape. However, the court also found that if United National had breached its fiduciary duty to

Waterfront in the course of defending it, even though coverage was later determined not to exist,

United National was not entitled to a return of the funds advance to Waterfront:


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Neither a valid reservation of rights nor a subsequent determination of lack of coverage relieves the insurer of the duty to conduct the defense of the insured with due care and good faith. Cornwell v. Safeco Ins. Co. of Am., 42 A.D.2d 127, 346 N.Y.S.2d 59, 69 (N.Y. App. Div. 1974). Implicit in this duty is the appointment of counsel that is competent as well as free of conflicts or divided loyalties. Hartford Accident & Indem. v. Michigan Mut. Ins. Co., 93 A.D.2d 337, 462 N.Y.S.2d 175, 178 (N.Y. App. Div. 1983), aff'd 61 N.Y.2d 569, 475 N.Y.S.2d 267 (1984). The insurer's fiduciary duty to the insured requires that the insurer's loyalty be undivided. Id. at 268-69.

Furthermore:

United National disputes that it had a duty to defend Waterfront because the Policy was later determined to exclude coverage of the Ortiz claim. However, once United National undertook Waterfront's defense, it had a duty to conduct that defense with due care and good faith until a judgment was issued on the coverage of the Ortiz claim. Id. at n.3.

The court denied United National's motion for summary judgment, holding that

United National may have breached "its duty" to Waterfront by failing to appoint separate

counsel or giving Waterfront the opportunity to select independent counsel at United National's

expense. Id. at 269.

As mentioned above Courts in other jurisdictions have found a fiduciary duty in

insurance policies. In Myers v. Ambassador Ins. Co., Inc., 146 Vt. 552, 508 A.2d 689 (1986),

the Supreme Court of Vermont found there was a fiduciary duty owed to the insurance

company's policyholder.

In an action by the policyholder against the insurance company alleging a bad

faith failure to settle within the policy limits, the court held that "[t]he insurer's fiduciary duty to

act in good faith when handling a claim against the insured obligates it to take the insured's

interests into account." 508 A.2d at 691. The court further held that the policyholder must be


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informed of any potential for excess liability and that the primary carrier must convey any

demands for settlement which have been made. Id.

Even if the one looks at the first-party property cases, there is a definite trend in

cases imposing a fiduciary relationship on insurance companies. Recently, the Supreme Court of

Nevada in Williams R. Powers v. United Services Automobile Association et al., Supreme Court

of Nevada, No. 26794, 1999 Nev. LEXIS 13 (Apr. 2, 1999), held "the duty owed by an insurance

company to an insured is fiduciary in nature."

In Powers the Court, which denied a Petition by the insurance company for

rehearing, reiterates "that an [insurance company]'s duty to its Policyholder is, [as the insurance

company] concedes, "akin" to a fiduciary relationship." 1999 Nev. LEXIS at * 6. This decision

bears further supports the proposition that there is a fiduciary relationship between an insurance

company and the policyholder.

The Court stated that the jury instruction given by the district court on breach of a

fiduciary relationship was not error.

The Powers Court noted:

A fiduciary relationship exists when one has the right to except trust and confidence in the integrity and fidelity of another.

This special relationship exists in part because, as insurers are well aware, consumers contact for insurance to again protection, peace of mind and security against calamity.

1999 Nev. LEXIS at * 5-6.

Similarly, in a neighboring jurisdiction, the Colorado Supreme Court in Lira v.

Shelter Insurance Co., 913 P.2d 514 (1996), commented on the insurance companies fiduciary

obligations by stating:


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An insurer's tort liability for breach of its implied duty of good faith and fair dealing derives from the nature of the insurance contract and the relationship between the insured and insurer. Farmer Group,Inc. v. Trimble, 691 P.2d 1138, 1141 (Colo. 1984). This tort liability is based on the quasi-fiduciary nature of the insurance relationship and is predicated on the parties contractual responsibilities. Trimble, 691 P.2d at 1142; Bailey v. Allstate Ins. Co., 844 P.2d 1336, 1339-40 (Colo App. 1992).

Id. at 516.

In Fireman's Fund Ins. Co. v. Continental Ins. Co., 519 A.2d 202, 308 Md. 315

(1987). Fireman's, the excess carrier, sued Continental, the primary carrier, for negligent and

bad faith failure to settle a claim within the primary policy limits.

Fireman's argued that Continental owed it a duty of good faith and fair dealing.

The court explained that the duty of good faith and fair dealing arises because:

standard insurance policies give the insurer the exclusive control of the investigation, settlement, and defense of claims against its insureds. These provisions create the potential for conflicts of interest between insured and insurer and thus, impose a fiduciary duty on the insurance company.

Id. at 204.

B. The Public Service Nature Of Insurance

The special public nature of insurance invests insurance companies with a unique

position of trust with respect to their policyholders and the public. The public nature of

insurance complements the insurance companies’ fiduciary duties. In a case involving the

solvency of insurance companies, the United States Supreme Court recognized that insurance

companies were essentially trustees over a fund of assurance and credit:

The contracts of insurance may be said to be interdependent. They cannot be regarded singly, or isolatedly, and the effect of their relation is to create a fund of assurance and credit, the companies


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becoming the depositories of the money of the insured, possessing great power thereby, and charged with great responsibility.208

Subsequent U.S. Supreme Court decisions reemphasized the “specialness” of the insurance

industry and of the persons who work within it.209

Indeed, the insurance industry itself has repeatedly acknowledged the special

public nature of insurance. In 1981, the then-Chairman of the American Insurance Association

stated:

Insurance leaders are fond of saying, without exaggeration, that the insurance industry is imbued with the public interest — that insurance is essential to commercial activity and necessary to daily living.

We focus the spotlight on ourselves. We convince others of the leading role insurance plays in society. We encourage them to expect superior performance from us.210

As far back as 1944, in an address on comprehensive general liability insurance, an attorney for

the National Bureau of Casualty Underwriters acknowledged that those “in the business” of

insurance “are the trustees of the public interest.” One insurance company recently noted:

The business of insurance is one affected by the public interest, requiring that all persons be actuated by good faith, abstain from

208 German Alliance Ins. Co. v. Lewis, 233 U.S. 389, 414 (1914).209 See, e.g., La Tourette v. McMaster, 248 U.S. 465, 467 (1919) (“[A]s insurance is affected with a public interest, those engaged in it or who bring about its consummation are affected with the same interest and subject to regulation as it is.”); O’Gorman & Young, Inc. v. Hartford Fire Ins. Co., 282 U.S. 251, 257 (1931) (“The business of insurance is so far affected with a public interest that the State may regulate the rates and likewise the relations of those engaged in the business.”); Osborn v. Ozlin, 310 U.S. 53, 65 (1940) (“Government has always had a special relation to insurance.”); United States v. South-Eastern Underwriters Assn., 322 U.S. 533 (1944); Robertson v. California, 328 U.S. 440, 447 (1946) (“evils” in the sale of insurance “vitally affect the public interest”); Prudential Ins. Co. v. Benjamin, 328 U.S. 408, 415-16 (1946) (“[insurance] business affected with a vast public interest”); California State Auto. Ass’n Inter-Ins. Bureau v. Maloney, 341 U.S. 105, 109-10 (1951) (insurance has always had special relation to government).210 “The Burgeoning of Litigation,” Proceedings of American Insurance Association Annual Meeting, New York City, May 28-29, 1981, at 29.


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deception, and practice honesty and equity in all insurance matters.211

In a February 1985 letter to shareholders, Chairman Warren Buffet of Berkshire

Hathaway, Inc., the corporate parent of several insurance companies, stated:

The buyer of insurance receives only a promise in exchange for his cash. The value of that promise should be appraised against the possibility of adversity, not prosperity. At a minimum, the promise should appear able to withstand a prolonged combination of depressed financial markets and exceptionally unfavorable underwriting results.212

In a September 22, 1970 speech entitled “There’s Got To Be A Better Way,” the

then President of Crum and Forster Insurance Company noted:

If studied even casually, the history of our business proves that in the United States, as nowhere else in the world, insurance has functioned to set men’s minds free from economic worry so they could think about more constructive things; it has functioned to maintain productive enterprise so that more people could enjoy the fruits of our enterprise system; it has provided the means to rebuild burned and shattered cities and towns — to replace property — both private and public — that has been destroyed, damaged, or wrongfully taken away; to relieve physical pain as well as economic distress.213

The specialness of insurance company relationships with its policyholders and the

public has also been long recognized by insurance industry outsiders. Dean Roscoe Pound, more

than 50 years ago in THE SPIRIT OF THE COMMON LAW (1929), noted:

[W]e have taken the law of insurance practically out of the category of contract, and we have established that the duties of public service companies are not contractual, as the nineteenth century sought to make them, but are instead relational; they do not

211 Appellant’s Brief, at 19, Century Indem. Co. v. Truck Ins. Exch. of the Farmers Ins. Group, 887 P.2d 455 (Wash. Ct. App. 1995)(No. 13141-6-III). 212 Letter dated Feb 25, 1985 from Warren Buffet, Chairman of Berkshire Hathaway Inc., to the shareholders of Berkshire Hathaway Inc., at 9 (on file with the authors).213 Speech by B.P. Russell, the President of Crum and Forster Insurance Company, delivered Sept. 22, 1970.


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flow from agreements which the public servant may make as he chooses, they flow from the calling in which he has engaged and his consequent relation to the public.

Another commentator has noted:

The insurers’ obligations are . . . rooted in their status as purveyors of a vital service labeled quasi-public in nature. Suppliers of services affected with a public interest must take the public’s interest seriously, where necessary placing it before their interest in maximizing gains and limiting disbursements. . . . [A]s a supplier of a public service rather than a manufactured product, the obligations of good faith and fair dealing encompass qualities of decency and humanity inherent in the responsibilities of a fiduciary. Insurers hold themselves out as fiduciaries, and with the public’s trust must go private responsibility consonant with that trust.214

No less than a textbook used to train insurance company personnel has

emphasized the need to monitor and enforce the special duties of insurance companies:

Notwithstanding the often stated opinion that the insurance contract is affected with a public interest, insurers often view their policies as simple contractual obligations between parties. While an insurance policy does represent a contractual commitment, the attitudes of the general public, the legislatures, and the courts make clear that the insurance agreement is viewed as having broader ramifications than a mere contract. The public has a definite interest in the reliability of the insurance product. Insurance involves an obligation that affects the public interest as well as the policyholder and therefore is necessarily subject to certain restrictions.215

Policyholders have only the courts to rely upon for relief when their insurance

sellers “run for cover rather than coverage” or when their conduct has followed a calculated

course undermining the “test of the integrity of the insurance industry.”216 The judiciary is an

especially important gatekeeper in a society where the decision to buy insurance is no longer a

214 Goodman & Seaton, Ripe for Decision, Internal Workings and Current Concerns of the California Supreme Court, 62 CAL. L. REV. 309, 346-47 (1974).215 1 Lorimer et al., The Legal Environment of Insurance 37-38 (3d ed. 1987) (emphasis added).216 Sandoz, Inc. v. Employers Liab. Assurance Corp., 554 F. Supp. 257, 258-59 (D.N.J. 1983).


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voluntary action. Commercial insurance coverage affects a broad spectrum of individual and

corporate interests.217 Insurance protects not only policyholders, but also injured parties,

neighbors, the community, creditors and employees.218 Another insurance textbook, published

by no less than the Insurance Institute of America, described the benefits of insurance like this:

[I]n addition to eliminating or reducing the financial uncertainty of risks to individuals and businesses, insurance benefits society by paying for losses, providing funds for investments, controlling losses, supporting credit, allocating resources, and satisfying legal and business requirements.219

By acknowledging that insurance protects the public-at-large as well as the policyholder, the

insurance industry implicitly recognizes that the failure of insurance to insure also effects many

more than the policyholder who purchased the policy. That failure is an ever present threat.

The “public interest” nature of insurance is manifest in the myriad of state laws

governing insurance. For example, automobile insurance coverage and workers’ compensation

insurance coverage are required by most states.220 Another text used to train insurance company

claims personnel notes that statutes concerning the conduct of insurance companies “have been

enacted by state legislatures in order to control the activities of the insurance companies and their

relationships with policyholders.”221 Yet another text used to train insurance industry

professionals states:

217 See James R. Stirn, Environmental Risks Challenge Re Capabilities, NAT’L UNDERWRITER, June 19, 1989, at 45.218 Eugene R. Anderson et al. Draconian Forfeitures of Insurance: Commonplace, Indefensible, And Unnecessary, 65 FORDHAM L. REV. 825, 829 (1996), citing Charles A. McAlear, The Emperor’s Old Clothes, BEST’S REV., Feb. 1989, at 22-23.219 James J. Markham et al. The Claims Environment 2 (1st ed. 1993).220 See, e.g., N.Y. Veh. & Traf. Law §§ 310-321 (McKinney 1995). See generally, Arthur Larson, LAW OF WORKMEN’S COMPENSATION (1995).221 James J. Markham et al., The Claims Environment 347 (1993).


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Insurance contracts are different from other commercial contracts because insurance is more a necessity than a matter of choice. Therefore, insurance is a business affected with a public interest, as reflected in legislative and judicial decisions.222

In any bad faith insurance coverage litigation, emphasize that the fiduciary duties

of insurance companies and the public interest nature of insurance explains why insurance

companies must place policyholders’ interests before their own.223

C. The Duty Of Good Faith And Fair Dealing

1. Insurance Company Admissions Of The Duty Of Good Faith And Fair Deal-ing

In every contract there is an implied covenant of good faith and fair dealing that neither party will do anything which impairs the right of the other to receive the benefits of the agreement. This principle is applicable to policies of insurance.224

The duty owed to the policyholder by the insurance company, commonly

described as a “fiduciary” duty even by insurance companies, has been the subject of much

litigation. Some central truths are apparent.

222 1 James J. Lorimer, et al., The Legal Environment of Insurance 179 (4th ed. 1993)(emphasis in original).223 See Goodman & Seaton, Ripe for Decision, Internal Workings and Current Concerns of the California Supreme Court, 62 CAL. L. REV. 309, 346-47 (1974).224 Liberty Mut. Ins. Co. v. Altfillisch Contr. Co., 70 Cal. App. 3d 789 (1977). See also James Graham Brown Foundation, Inc. v. St. Paul Fire & Marine Ins. Co., 814 S.W.2d 273, 280 (Ky. 1991),(“When dealing with its insured, the insurance company has the obligation to exercise the utmost good faith”), modified and reh’g denied, 1991 Ky. Lexis 149 (Ky. Sept. 26, 1991); J. APPLEMAN, INSURANCE LAW AND PRACTICES, (2nd ed. 1981) § 8878 (1994 Pocket Part), at 12:

“Implicit in the duty of good faith and fair dealing is the insurer’s obligation to be fair and honest with its insured and to give equal consideration to the insured’s interests.

The duty of good faith and fair dealing that an insurer owes an insured obligates the insurer to refrain from (1) engaging in unfounded refusal to pay policy proceeds, (2) causing unfounded delay in making payment, (3) deceiving the insured, and (4) exercising any unfair advantage to pressure an insured into settlement of the insured’s claim.”


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The duty of good faith and fair dealing implicitly requires insurance companies to

be fair and honest with their policyholders:225

The duty of good faith and fair dealing that an insurer owes an insured obligates the insurer to refrain from (1) engaging in unfounded refusals to pay policy proceeds, (2) causing unfounded delay in making payment, (3) deceiving the insured, and (4) exercising any unfair advantage to pressure an insured into settlement of the insured’s claim.”226

At least one insurance company has echoed these points in its internal claims manual, stating the

“most positive way to [meet the duty of good faith] is to look for coverage in . . . policies, and

not to look for ways to deny coverage.”227 Thus:

[I]n considering coverage questions, the policyholder should be given the benefit of any reasonable doubt. Our goal is to find coverage wherever possible, not ways to avoid our obligations. Our dealings with claimants must be conducted fairly, courteously, and honestly.228

Insurance companies do not dispute that policyholders are owed an implied duty

of good faith and fair dealing under any insurance policy.229 In fact, some of the most succinct

definitions of good faith come not from the courts or from learned treatises,230 but from the

insurance companies themselves. For example, Continental Casualty has stated:

Insurance is an agreement whereby parties give valuable consideration for protection from and indemnification against loss,

225 Appleman, Insurance Law and Practices § 8878 (1994 Pocket Part), at 12.226 Id.227 Travelers Liability Coverage Manual § 16.0. See also JAMES J. MARKHAM, ET AL., THE CLAIMS ENVIRONMENT 274 (1993).228 Claim Department, Travelers Insurance Companies, Property Claims: I-General Information (1987).229 See Barry R. Ostrager & Barry R. Newman, Handbook on Insurance Coverage Disputes 429 (5th ed. 1992).230 See Appendix C for additional definitions of good faith from legal treatises, dictionaries, legal pleadings and reference texts.


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damage, injury, or liability. As servants of the public, insurance companies are held to the universally high standard of `good faith.’231

Continental further explained:

If the insurer is motivated by selfish purpose or by the desire to protect its own interests at the expense of its insured’s interest, bad faith exists, even though the insurer’s actions were not actually dishonest or fraudulent.232

Similarly, Century Indemnity has stated:

Good conscience and fair dealing require that the insurer not pursue a course which is advantageous to itself while disadvantageous to its policyholder.233

Aetna has also long acknowledged the insurance industry’s duty of good faith and fair dealing:

Over-riding all policy provisions is the insurance relationship existing by reason of the liability contract which imposes upon the company the obligation to act in good faith and in the interests of the insured in the defense and settlement of claims.234

Hartford probably said it best:

[O]ur Supreme Court has recently and emphatically held an insurer to the high standards of a fiduciary: In approaching the inquiry, great weight must be placed upon the character of an insurance policy as a contract of adhesion. It is equally important to emphasize that `[a]n insurance contract is preeminently one of the utmost good faith.’235

Hartford has been steadfast in its acknowledgement of the duty of good faith and fair dealing.:

231 Plaintiff’s Memorandum of Law For Trial at 1, filed Sept. 11, 1990, Continental Cas. Co. v. Great Am. Ins. Co., No. 86-C-3839, 1990 U.S. Dist. LEXIS 12807 (N.D. Ill. Sept. 28, 1990).232 Id. at 13.233 Appellant’s Reply Brief at 20, Century Indem. Co. v. Truck Ins. Exch. of the Farmers Ins. Group, 887 P.2d 455 (Wash. Ct. App. 1995)(No. 13141-6-III). 234 See statement of George W. Katz, Secretary, Aetna Life & Casualty Co. (Oct. 8, 1966): See also Lia B. Royle, Insurance Company Bad Faith Refusal To Settle, MEALEY’S LITIG. REP.: BAD FAITH, Feb. 15, 1996, at 1.235 Brief and Volume I of Appendix of Plaintiff-Appellant Hartford Accident & Indem. Co., at 7, filed Dec. 20, 1983, Hartford Accident & Indem. Co. v. Aetna Life & Cas. Ins. Co., No. A-1595-82T2 (N.J. Super. Ct. App. Div. 1992).


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[I]nsurance contracts require the highest degree of good faith and fair dealing with both parties to the contract236

Hartford does not dispute that insurance companies owe their policyholders a duty of good faith and fair dealing237

Bad faith has also been defined by insurance industry sources and insurance companies238:

Bad faith. Generally implying or involving actual or constructive fraud, or a design to mislead or deceive another, or a neglect or a refusal to fulfill some duty or some contractual obligation; not prompted by an honest mistake as to one’s rights or duties, but by some interested or sinister motive. It differs from the negative idea of negligence in that it contemplates a state of mind affirmatively operating within a furtive design or some motive of interest or ill will.239

An implied covenant of good faith and fair dealing exists in every insurance policy240 — first

party and third party, and to retrospectively rated premium policies.241 First party bad faith as a

236 Letter Brief In Opposition To Plaintiff’s Motion For Partial Summary Judgment With Regard To The Insurance Company’s Duty of Good Faith and Fair Dealing at 2 n.1, dated May 16, 1994, Colonial Foods, Inc. v. Aetna Cas. and Sur. Co., No. MON-L-0392-93 (N.J. Super Ct. Law Div.).237 Brief in Opposition to Plaintiff, Colonial Foods’ Cross-Motion for Partial Summary Judgment, at 14, dated May 15, 1995, Colonial Foods, Inc. v. Aetna Cas. and Sur. Co., No. MON-L-0392-93 (N.J. Super Ct. Law Div.). See also Brief in Opposition to Plaintiff’s Motion For Partial Summary Judgment and in Support of Defendant Hartford Accident & Indemnity Company’s Cross-Motion For Summary Judgment, at 40, dated Nov. 15, 1995, Biddle Sawyer Corp. v. Fireman’s Fund Ins. Co., No. MON-L-5219-91 (N.J. Super. Ct. Law. Div.)(identical quotation).238 See Allstate Insurance Company “Extracontractual Liability” Form No. C2225 attached at Appendix D.239 James H. Donaldson, Casualty Claims Practice 973-74 (4th ed. 1984), quoted in Willis Park Rokes, J.D., Ph.D, Agressive Good Faith and Successful Claims Handling 26 (1st ed. 1987).240 Gruenberg v. Aetna Ins. Co., 510 P.2d 1032 (Cal. 1973); Egan v. Mutual of Omaha Ins. Co., 598 P.2d 452 (1979), cert. denied, 445 U.S. 912 (1980).241 Several courts have held that in the context of retrospective premium policy, the insurance company has an inherent conflict of interest, since an improperly handled claim may directly increase the policyholder’s costs and future premiums, but increase the insurance company’s profits. The following jurisdictions have found that a policyholder may properly allege a bad faith cause of action for improperly handling a claim under a retrospective rated premium:

California: Security Officers Service, Inc. v. State Compensation Ins. Fund, 17 Cal. App. 4th. 887, 21 Cal. Rptr. 653 (1993);

Delaware: Corrado Bros., Inc. v. Twin City Fire Ins. Co., 562 A.2d 1188 (Del. 1989);

Georgia: Benton Express, Inc. v. Royal Ins. Co. of America, 217 Ga. App. 331, 457 S.E.2d 566 (1995);


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theory of recovery against an insurance company was first recognized by the California Supreme

Court in Gruenberg v. Aetna Ins. Co. in 1973.242 Third party bad faith theories are much older

and date back to the beginning of this century.243 The revisionist history of insurance law is that

third party bad faith was just invented. That is incorrect.

2. Judicial Recognition

Most states recognize that insurance companies owe their policyholders a duty of

good faith and fair dealing. These states recognize that policyholders possess a common law

Illinois: National Sur. Corp. v. Fast Motor Service, Inc., 213 Ill. App. 3d 500, 572 N.E.2d 1083 (1991);

Kansas: Transit Cas. Co. v. Topeka Trans. Co., 8 Kan. App. 2d 597, 663 P.2d 308 (1983);

Louisiana: Insurance Co. of North America v. Binnings Construction Co., Inc., 288 So. 2d 359 (La. Ct. App. 1974);

Maryland: Port East Transfer, Inc. v. Liberty Mut. Ins. Co., 330 Md. 376, 624 A.2d 520 (Md. App. 1993);

Massachusetts: Deerfield Plastics Co., Inc. v. The Hartford Ins. Co., 404 Mass. 484, 536 N.E.2d 322 (1989);

Minnesota: Transport Indem. Co. v. Dahlen Transport, Inc., 281 Minn. 253, 161 N.W.2d 546 (1968);

New Jersey: Liberty Mut. Ins. Co. v. President Container, Inc., 297 N.J. Super. 24, 687 A.2d 760 (App. Div. 1997);

Pennsylvania: Liberty Mut. Ins. Co. v. Marty’s Express, Inc., 910 F. Supp. 221 (E.D. Pa. 1996);

Tennessee: The Austin Co. v. Royal Ins. Co., 842 S.W.2d 608 (Tenn. App. 1992);

Virginia: National Union Fire Ins. Co. v. Roubin & Janeiro, Inc., 34 Va. Cir. 344 (1994).

242 Gruenberg v. Aetna Ins. Co., 510 P.2d 1032 (Cal. 1973).243 See, e.g., Brown & McCabe Stevedores, Inc. v. London Guar. & Acc. Co., 232 F. 298 (D. Or. 1915). See generally, Kent D. Syverud, The Duty To Settle, 76 VA. L. REV. 1113, 1116 n.4 (1990).


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private right of action for breach of that duty.244 The standard for determining whether punitive

damages apply to a breach of good faith, of course, varies from state to state.245

3. Statutory Recognition

In addition, at least 48 states have passed Unfair Claims Settlement Practices

statutes which prohibit insurance companies from breaching their duty of good faith and fair

244 The following jurisdictions recognize a common law private right of action for the breach of the duty of good faith in insurance coverage litigation:

Alabama: Turner v. State Farm Fire & Cas. Cos., 614 So. 2d 1029 (Ala. 1993); Chavers v. National Sec. Fire & Cas. Co., 405 So. 2d 1, 6 (Ala. 1981);

Alaska: State Farm Fire & Cas. Co. v. Nicholson, 777 P.2d 1152 (Alaska 1989);

Arizona: Noble v. National Am. Life Ins. Co., 624 P.2d 866 (Ariz. 1981); Sparks v. Republic Nat’l Life Ins. Co., 647 P.2d 1127 (Ariz.), cert. denied, 459 U.S. 1070 (1982), overruled in part by Ariz. Rev. Stat. Ann. § 20-461(C)(1994);

Arkansas: Aetna Cas. & Sur. Co. v. Broadway Arms Corp., 664 S.W.2d 463 (Ark. 1984); Findley v. Time Ins. Co., 573 S.W.2d 908 (Ark. 1978);

California: Gruenberg v. Aetna Ins. Co., 510 P.2d 1032 (Cal. 1973); Crisci v. Security Ins. Co., 426 P.2d 173 (Cal. 1967);

Colorado: Travelers Ins. Co. v. Savio, 706 P.2d 1258 (Colo. 1985); Farmers Group, Inc. v. Trimble, 691 P.2d 1138 (Colo. 1984);

Connecticut: Buckman v. People Express, Inc., 530 A.2d 596 (Conn. 1987); Grand Sheet Metal Prods. Co. v. Protection Mut. Ins. Co., 375 A.2d 428, 429-30 (Conn. 1977);

Delaware: E.I. du Pont de Nemours & Co. v. Admiral Ins. Co., No. 89C-AU-99, 1994 Del. Super. Ct. LEXIS 346 (Del. Super. Ct. Aug. 3, 1994); Casson v. Nationwide Ins. Co., 455 A.2d 361 (Del. Super. Ct. 1982);

District of Columbia: Washington v. Group Hospitalization Inc., 585 F. Supp. 517 (D.C. 1984);

Hawaii: Best Place, Inc. v. Penn Am. Ins. Co., 920 P.2d 334, 337-38 (Haw. 1996);

Idaho: White v. Unigard Mut. Ins. Co., 730 P.2d 1014 (Idaho 1986);

Illinois: Emerson v. Am. Bankers Ins. Co., 585 N.E.2d 1315 (Ill. App. Ct. 5th Dist. 1992);

Indiana: Erie Ins. Co. v. Hickman, 622 N.E.2d 515 (Ind. 1993);

Iowa: Dolan v. Aid Ins. Co., 431 N.W.2d 790, 794 (Iowa 1988); Higgins v. Blue Cross of Western Iowa & South Dakota, 319 N.W.2d 232 (Iowa 1982);

Kentucky: Curry v. Fireman’s Fund Ins. Co., 784 S.W.2d 176 (Ky. 1989); James Graham Brown Found., Inc. v. St. Paul Fire & Marine Ins. Co., 814 S.W.2d 273, 280 (Ky. 1991), modified and reh’g denied, 1991 Ky. LEXIS 149 (Ky. Sept. 26, 1991);

Maine: Marquis v. Farm Family Mut. Ins. Co., 628 A.2d 644 (Me. 1993);


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dealing.246 Some states also allow a bad faith claim against an insurance company under its

Consumer Protection Act.

Many of these statutes do not provide a policyholder with a private right of action.

In jurisdictions which do not permit policyholders a private right of action, complaints under the

statute can only be made by the state insurance commissioner.247 In these jurisdictions, unfair

claim settlement practices statutes are rendered a nearly worthless safeguard. Insurance

Maryland: Allstate Ins. Co. v. Campbell, 639 A.2d 652 (Md. 1994); Johnson v. Federal Kemper Ins. Co., 536 A.2d 1211, cert. denied, 542 A.2d 844 (Md. 1988);

Massachusetts: Hartford Cas. Ins. Co. v. New Hampshire Ins. Co., 628 N.E.2d 14 (Mass. 1994);

Minnesota: Fette v. Columbia Cas. Co., No. C0-96-242, 1993 Minn. App. LEXIS 954 (Minn. Ct. App. 1993); Haagenson v. National Farmers Union Prop. & Cas. Co., 277 N.W.2d 648 (Minn. 1979); Short v. Dairyland Ins. Co., 334 N.W.2d 384 (Minn. 1983);

Mississippi: Hartford Accident & Indem. Co. v. Foster, 528 So. 2d 255 (Miss. 1988);

Missouri: Young v. United States Fidelity & Guar., 588 S.W.2d 46 (Mo. Ct. App. 1979);

Montana: Lipinski v. Title Ins. Co., 655 P.2d 970 (Mont. 1982);

Nebraska: Braesch v. Union Ins. Co., 464 N.W.2d 769 (Neb. 1991);

Nevada: United States Fidelity & Guar. Co. v. Peterson, 540 P.2d 1070 (Nev. 1975);

New Hampshire: Lawton v. Great Southwest Fire Ins. Co., 392 A.2d 576 (N.H. 1978); Conductron Corp. v. American Employers’ Ins. Co., Nos. 93-E-149, 93-C-599, slip op. (N.H. Super. Ct., Apr. 9, 1997);

New Jersey: Pickett v. Lloyd’s & Peerless Ins. Agency, 621 A.2d 445 (N.J. 1993); Di Salvatore v. Aetna Cas. & Sur. Co., 624 F. Supp 541 (D.N.J. 1986);

New Mexico: Chavez v. Chenoweth, 553 P.2d 703 (N.M. Ct. App. 1976); American Employers Ins. Co. v. Crawford, 533 P.2d 1203 (N.M. 1975);

New York: Rocanova v. Equitable Life Assurance Soc’y of the United States, 634 N.E.2d 940 (N.Y. 1994);

North Dakota: Corwin Chrysler-Plymouth, Inc. v. Westchester Fire Ins. Co., 279 N.W.2d 638 (N.D. 1979);

Ohio: Hoskins v. Aetna Life Ins. Co., 452 N.E.2d 1315 (Ohio 1983);

Oklahoma: Christian v. American Home Assurance Co., 577 P.2d 899 (Okla. 1977); American Fidelity & Cas. Co. v. L.C. Jones Trucking Co., 321 P.2d 685 (Okla. 1957);

Pennsylvania: Romano v. Nationwide Mut. Fire Ins. Co., 435 Pa. Super. 545, 646 A.2d 1228, 1231 (1994)(citing Fedas v. Insurance Co. of Pa., 300 Pa. 555, 558, 151 A. 285, 286 (1930); Dercoli v. Pennsylvania Nat’l Mut. Ins. Co., 520 Pa. 471, 554 A.2d 906 (1989); Cowden v. Aetna Cas. and Sur. Co., 389 Pa. 459, 134 A.2d 223 (1957).

Rhode Island: Bibeault v. Hanover Ins. Co., 417 A.2d 313 (R.I. 1980);

South Carolina: Nichols v. State Farm Mut. Auto Ins. Co., 306 S.E.2d 616 (S.C. 1983);


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commissioners have “rarely exercised” their authority under these statutes to protect

policyholders from insurance company misconduct.248

Nonetheless, the punishment provided under these statutes can be severe. For

example, under most states’ Unfair Insurance Practices Act or Unfair Claims Settlement

Practices Act, an insurance company which violates its duty of good faith and fair dealing can

have their license to operate suspended or revoked.249 Despite the statutory authority permitting

South Dakota: In re: Certification of Question of Law From U.S. Dist. Court, 399 N.W.2d 320 (S.D. 1987);

Texas: Aranda v. Insurance Co. of N. Am., 748 S.W.2d 210 (Tex. 1988); Arnold v. National County Mut. Fire Ins. Co., 725 S.W.2d 165 (Tex. 1987);

Utah: Beck v. Farmers Ins. Exch., 701 P.2d 795 (Utah 1985);

Vermont: Phillips v. Aetna Life Ins. Co., 473 F. Supp. 984 (D. Vermont 1979);

Washington: Escalante v. Sentry Ins. Co., 743 P.2d 832 (Wash. App. Ct. 1987); Tank v. State Farm Fire & Cas. Co., 715 P.2d 1133 (Wash. 1986);

Wisconsin: Anderson v. Continental Ins. Co., 271 N.W.2d 368 (Wis. 1978);

Wyoming: McCullough v. Golden Rule Ins. Co., 789 P.2d 855 (Wyo. 1990); Hatch v. State Farm Fire & Cas. Co., 842 P.2d 1089 (Wyo. 1992).245 See RICHARD L. BLATT, ET AL., PUNITIVE DAMAGES; A STATE-BY-STATE GUIDE TO LAW AND PRACTICE § 8.2 (1991) and supplement (1996). At the time of this writing, only 4 states, Michigan, Nebraska, New Hampshire and Washington do not allow punitive damages. States which do allow punitive damages apply differing standards to evaluate the misconduct, including malice, conduct exceeding gross negligence but not malice, or gross negligence. Other states have statutes which control applicable limits for punitive damages.246 See STEPHEN S. ASHLEY, BAD FAITH ACTIONS: LIABILITY AND DAMAGES §§ 9:01-02, 9:14 (1996). Unfair Claims Settlement Practices statutes are adopted from the Model Act Relating To Unfair Methods of Competition and Unfair and Deceptive Acts in Practices in the Business of Insurance. The model act was sponsored by National Association of Insurance Commissioners, a pro-insurance industry group. In 1990, the model act was renamed the Unfair Trade Practices Act, and a separate Unfair Claims Settlement Practices Model Regulation was created. The new Model Unfair Claims Settlement Practices Act expressly rejects any interpretation of a private right of action.247 See ASHLEY at § 9:03.248 See Id. 249 See, e.g., California Insurance Code §704; Kentucky Revised Statute 304.99-010; 40 Pennsylvania Statutes § 1171.4. 40 Pa.S. § 1171.5 defines the “unfair methods of competition” and “unfair or deceptive acts or practices” covered by the Act; Ohio Unfair and Deceptive Practices, § 3901.22 (state insurance commissioner may suspend or revoke license to engage in the business of insurance); West Virginia Code 33-11-6 (same).


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administrative sanctions, insurance companies are rarely, if ever, punished for wrongful claims

practices.

However, states which have adopted statutory penalties as harsh as a revocation

of authority to operate do not take insurance company bad faith lightly. As the United States

Supreme Court made clear in BMW of North America v. Gore, an award of punitive damages

must be compared to the maximum civil or criminal penalties that could be imposed in

comparable cases.250 The revocation of an insurance company’s license to sell insurance within

the state is a much more severe punishment than almost any award of punitive damages. Indeed,

lesser punishments negate the very purpose of punitive damages — to deter future misconduct.

Whether or not policyholders have a private right of action under statutes prohibiting insurance

company misconduct, these statutes provide very important measures to determine the

permissible limits of bad faith awards under BMW.

The prime importance of these statutes is to establish minimum codes of

insurance company conduct. Even though most states do not allow policyholders to assert a

private right of action or a breach of these statutes evidence of breach can be used to establish

breach of other rights and bad motive.251

250 BMW v. Gore, 116 S. Ct. 1589, 1603 (1996) (emphasis added).251 See, e.g. Cramer v. Insurance Exch. Agency, 174 Ill. 2d 513, 519, 675 N.E.2d 897, 900 (1996). In Cramer, the Illinois Supreme Court held that although § 155 of Illinois’ Insurance Code barred recognizing the tort of bad faith as a separate and independent tort, § 155 did not bar other a policyholder from bringing other separate and independent tort claims against an insurance company:

In summary, an insurer’s conduct may give rise to both a breach of contract action and a separate and independent tort action . . . In cases where a plaintiff actually alleges and proves the elements of a separate tort, a plaintiff may bring an independent tort action, such as common law fraud, for insurer misconduct.

Id. at 675 N.E.2d at 904. Thus, the Illinois Supreme Court has said that insurance companies are liable for tortious breach of contract.


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These statutes are of major significance even though they do not give rise to an

independent claim or for relief. This should mean that the insurance law provisions can be

submitted to the jury as an evidencing exhibit.

Juries in bad faith cases should be made aware of this important consideration

when fixing an award of punitive damages.

4. The Duty of Good Faith Continues Through Insurance Coverage Litigation

Q: Does the [insurance company’s] duty of good faith and fair dealing continue after a claim is denied?

A: It always continues from the carrier’s perspective.

Q: Does it ever end?

A: Never ends.

The above testimony was given in an Oklahoma case by the general counsel of

the Travelers Insurance Company, one of the largest insurance conglomerates in the country.252

The testimony accurately states insurance industry custom and practice. Articles written in

support of the insurance industry acknowledge that the duty of good faith and fair dealing

extends through litigation.253

252 The testimony was given in an action brought by the Oklahoma City Urban Renewal Authority against Gulf Insurance Company arising out of Gulf’s bad faith conduct and denial of a claim under a directors and officers liability policy. Oklahoma City Urban Renewal Auth. v. Gulf Ins. Co., Case No. CIV-94-1760-M (W.D. Okla.). Along with the Oklahoma City firm of Batchelor & Powers, the authors of this article were counsel to the policyholder in that action.253 See Randy Papetti, Note, The Insurer’s Duty of Good Faith in the Context of Litigation, 60 GEO. WASH. L. REV. 1931, 1933 (1992).

In fact, several insurance companies have even argued that the policyholder owes the insurance company a duty of good faith which continues through litigation:

[C]onduct in pursuing its claims in this litigation has violated [an] implied duty of good faith and fair dealing under its insurance contracts. White v. Western Title Ins. Co., 40 Cal. 3d 870 (1985).

Insurer Opposition (filed by Plaisted and others) at 121, filed Sept. 3, 1993, Union Oil Co. of Ca. v. Allianz Versicherungs, Nos. BC 028270, BC 028271, BC 031367, BC 033114, C 514463 (Cal. Super. Ct.). Lloyds’ and the other insurance companies had argued that the policyholder had a continuing duty


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One insurance company adopted the Restatement (Second) of Contracts:

The obligation of good faith and fair dealing extends to the assertion, settlement and litigation of contract claims and defenses. . . The obligation is violated by dishonest conduct such as conjuring up a pretended dispute, asserting an interpretation contrary to one’s own understanding, or falsification of facts.254

Another insurance company has acknowledged that:

[I]f the controversy is based on a frivolous contention as to noncoverage, the insurer in bringing the action is breaching its duties to its insured under the policy, . . . subject[ing] the insurer to liability.”255

Like the insurance companies, the majority of courts to consider the issue have

held that the duty of good faith between an insurance company and its policyholder continues

of good faith by citing White v. Western Title Insurance Co., 40 Cal. 3d 870, 710 P.2d 309, (Cal. 1985), modified on other grounds, Maler v. Superior Court, 220 Cal. App. 3d 1592 (1990)(See Cal. Ins. Code § 790.0(h). White holds that the duty of the insurance companies continues into the courthouse, not that policyholders have such a duty.254 Emphasis added. RESTATEMENT (SECOND) OF CONTRACTS § 205, Comment e (1981).255 Appellee’s Brief at 35, American Family Life Assurance Co. of Columbus, Georgia v. United States Fire Ins. Co., 885 F.2d 826 (11th Cir. 1989) (No. 88-8755).


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through litigation over insurance coverage.256 To do otherwise renders the duty too easily

avoidable:

[I]t is not unusual for an insurance company to provide policy benefits, such as the defense of a litigation, while itself instituting suit to determine whether and to what extent it must provide those benefits. It could not reasonably be argued under such circumstances either that the insurer no longer owes any

256 See e.g. Central Armature Works Inc. v. American Motorists Ins. Co., 520 F. Supp. 283, 295 (D.D.C. 1980)(applying D.C. law; evidence of insurance company’s incorrect answers to interrogatories may indicate bad faith); Kauffman v. Aetna Cas. & Sur. Co., 794 F. Supp. 137, 140-42 (E.D. Pa. 1992) (the insurance company argued that bad faith under the insurance policy could only occur during the course of insurance coverage litigation); Rottmund v. Continental Assurance Co., 813 F. Supp. 1104, 1109-10 (E.D. Pa. 1992)(concealment of evidence by an insurance company was bad faith); Smith v. American Family Mut. Ins. Co., 294 N.W.2d 751, 764 (N.D. 1980)(letter from insurance company to defense counsel in declaratory judgment action was admissible regarding potential counterclaim against the policyholder’s attorney); Fassola v. Montgomery Ward Ins. Co., 433 N.E.2d 378, 383 (Ill. App. Ct. 1982); Spadafore v. Blue Shield, 486 N.E.2d 1201, 1203-1204 (Ohio Ct. App. 1985)(“evidence of the breach of the insurer’s duty to exercise good faith occurring after the time of filing suit is relevant so long as the evidence related to the bad faith or handling or refusal to pay the claim.”); T.D.S. Inc. v. Shelby Mut. Ins. Co., 760 F.2d 1520, 1527 (11th Cir.) (applying Florida law), modified, 769 F.2d 1485 (1985); White v. Western Title Ins. Co., 40 Cal. 3d 870, 710 P.2d 309, (1985)(insurance company must act in good faith in filing coverage action), modified on other grounds, Maler v. Superior Court, 220 Cal. App. 3d 1592 (1990); Kyriss v. Aetna Life & Cas. Co., 624 F. Supp. 1130, 1133 (D. Mont. 1986)(applying Montana law); Mohr v. Dix Mut. County Fire Ins. Co., 493 N.E.2d 638, 645 (Ill. App. Ct. 1986); Safeco Ins. Co. v. Ellinghouse, 725 P.2d 217, 225 (Mont. 1986); Sentry Ins. v. Siurek, 748 S.W.2d 104, 107 (Tex. Ct. App. 1987); Southerland v. Argonaut Ins. Co., 794 P.2d 1102, 1106 (Colo. Ct. App. 1990); Norman v. American Nat’l Fire Ins. Co., 555 N.E.2d 1087, 1109-1110 (Ill. App. Ct. 1990); Home Ins. Co. v. Owens, 573 So. 2d 343, 344 (Fla. Dist. Ct. App. 1990)(evidence of insurance company’s amended answer denying bad faith liability and a request for admission denying insurance coverage were evidence of bad faith; both were otherwise inadmissible); Claussen v. Aetna Cas. & Sur. Co., 754 F. Supp. 1576, 1583 (S.D. Ga. 1990)(applying Georgia law); Gregory v. Continental Ins. Co., 575 So. 2d 534, 541-542 (Miss. 1990); Journal Publ’g Co. v. American Home Assurance. Co., 771 F. Supp. 632, 635-636 (S.D.N.Y. 1991)(applying New Mexico law; evidence of insurance company’s during discovery may indicate bad faith); Myrda v. Coronet Ins. Co., 582 N.E.2d 274, 279, 281 (Ill. App. Ct. 1991); Harris v. Fontenot, 606 So. 2d 72, 74 (La. Ct. App. 1992); Minnesota Mut. Life Ins. Co. v. Elswood, No. A055590 (Cal. Ct. App. 1993), reported in MEALEY’S LITIG. REP.: BAD FAITH, Apr. 1, 1993; Nestle Foods Corp. v. Aetna Cas. & Sur. Co., 842 F. Supp. 125 (D.N.J. 1993)(applying New Jersey law); Palmer v. Farmers Ins. Exch., 861 P.2d 895 (Mont. 1993); UTI Corp. v. Fireman’s Fund Ins. Co., 896 F. Supp. 362 (D.N.J. 1995)(applying Pennsylvania law)(“an insurer has a continuing obligation to act in good faith toward its insured, which obligation extends through litigation.”); Tucson Airport Auth. v. Certain Underwriters at Lloyd’s, London, 918 P.2d 1063 (Ariz. Ct. App. 1996); Atlas Assurance Co. v. McCombs Corp., 146 Cal. App. 3d 135, 150, 194 Cal. Rptr. 66, 74 (3d Dist. 1983); (An insurer’s declaratory judgment action can constitute an act of bad faith when the insurer has “otherwise abandoned, compromised or rejected the insured’s claim.”); Insurer Opposition filed by Lloyd’s and others, dated Sept. 3, 1993 Union Oil Co. of Cal. v. Allianz Versicherings, No. BC 028270 (Cal. Super. Ct.); Argonaut Ins. Co. v. HGO, Inc., No. 96-1115, 1996 U.S. Dist. LEXIS 10892 (E.D. Pa. July 26, 1996); Nies v. National Auto. & Cas. Ins. Co., 199


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contractual duties to the insured, or that it need not perform those duties fairly and in good faith.257

In jurisdictions which recognize that the duty of good faith and fair dealing

continues into litigation, policyholders bringing a bad faith claim are often allowed to review

insurance company litigation practices, including settlement offers and attorney behavior.258

Simply put, “that the contractual duties of the parties to an insurance contract do

not `terminate with commencement of litigation’. . . is not particularly controversial.”259

Cal. App. 3d 1192, 245 Cal. Rptr. 518, 524-25 (1988); Orthman v. Globe Indem. Co., 759 F.2d 1458, 1467 n.11 (9th Cir. 1985)(evidence of insurance company’s disinterest in claim related misconduct after lawsuit is filed may constitute evidence of bad faith), overruled on other grounds by Bryany v. Ford Motor. Co., 832 F.2d 1080 (9th Cir. 1987); Fields v. State Farm Mut. Auto. Ins. Co., No. C93-0062-BG(H), slip op. (W.D. Ky. May 17, 1994).257 White v. Western Title Ins. Co., 710 P.2d 309, 317 (Cal. 1985), modified on other grounds in Maler v. Superior Court of Los Angeles County, 220 Cal. App. 3d 1592 (2d Dist. 1990)(See Cal. Ins. Code § 790.0(h)).

Practitioners should note that there exists a minority position. See Timberlake Constr. Co. v. U.S. Fidelity & Guar. Co., 71 F.3d 335 (10th Cir. 1995) (holding that an insurance company’s duty to its policyholder was limited to the circumstances surrounding the insurance coverage determination). Cf. Stewart Title Guar. Co. v. Aiello, 941 S.W.2d 68 (Tex. 1997) (stating that duty of good faith and fair dealing does not extend beyond settlement and agreed judgment of insurance coverage litigation). 258 See Papetti at 1943 (noting that nearly all of the growing number of cases to address the issue of post-filing conduct appear to conclude that an insurer’s duty of good faith continues through trial). 259 This admission comes from an insurance industry article intended to counter the case law supporting the admissibility of insurance company litigation practices. See Robert F. Cusumano, “Spy vs. Spy: Coverage Litigation as its Own Tort,” MEALEY’S LITIG. REP.: INS., Apr. 12, 1994.


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5. Examples of Bad Faith260

6. Reverse Bad Faith

Claims handling practices and litigation tactics often contradict with the insurance

companies professed beliefs in the duty of good faith and in upholding their fiduciary duties.261

For instance, insurance companies have brought bad faith claims against their own policyholders.

260 The following review of cases lists examples of insurance company misconduct which courts have found to be in bad faith. See also “Bad Faith Cases of Selected States” listed in Appendix B under Pennsylvania section and section on the duty of good faith and fair dealing continuing through litigation.

I. Claims Based on Bad-Faith Investigation

1. Unreasonable delay in conducting investigation or paying claim.

Authority: Rawlins v. Apodaca, 151 Ariz. 149, 156, 726 P.2d 565, 572 (1986); Robinson v. North Carolina Farm Bur. Ins. Co., 86 N.C. App. 44, 356 S.E.2d 392 (1987); McCormick v. Sentinel Life Ins. Co., 153 Cal. App. 3d 1030, 200 Cal. Rptr. 732 (2d Dist. 1984); Clark v. Bellefonte Ins. Co., 113 Cal. App. 3d 326, 169 Cal. Rptr. 832 (1st Dist. 1986); Ill. Ins. Code, § 155; Buzzard v. Farmers Ins. Co., Inc., 824 P.2d 1105 (Okla. 1991).

2. Failure to disclose facts or theories supporting coverage.

Authority: Dercoli v. Pennsylvania Nat. Mut. Ins., 520 Pa. 471, 554 A.2d 906 (1989).

3. Claims Harassment.

Examples: Asking for substantially the same information twice; requiring policyholder to provide far more information than reasonably necessary to decide claim; unreasonably refusing to investigate or decide claim until information is provided in a particular way by policyholder.

Authority: McCormick v. Sentinel Life Ins. Co., 153 Cal. App. 3d 1030, 200 Cal. Rptr. 732 (2d Dist. 1984); Hatch v. State Farm Fire & Cas., 842 P.2d 1089 (Wyo. 1992); Filasky v. Preferred Mut. Ins. Co., 152 Ariz. 591, 734 P.2d 76 (1987).

4. Claims “Extortion” -- Accusing policyholder, without reasonable basis, of wrongdoing (e.g., arson); use of abusive or coercive practices to compel compromise of claim; exploiting the policyholder’s vulnerable financial position after a covered loss.

Authority: Gruenberg v. Aetna Ins. Co., 9 Cal. 3d 566, 510 P.2d 1032 (1973); Mustachio v. Ohio Farmers Ins. Co., 44 Cal. App. 3d 358, 118 Cal. Rptr. 581 (2d Dist. 1975); Neal v. Farmers Ins. Exch., 21 Cal. 3d 910, 923, 582 P.2d 980, 987 (1978).

5. Spoliation of Evidence.

Example: Reckless or intentional destruction of insurance policies.

Authority: Upthegrove Hardware, Inc. v. Penn. Lumbermans Mutual Ins. Co., 146 Wis. 2d 470, 431 N.W.2d 689 (Ct. App. 1988).

Destroying evidence which the insurance company knows or should know is important to the claim, lying about the results of the claims investigation, and knowing that there is no


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These actions are commonly known as reverse bad faith claims.262 Every court to have

considered the issue has rejected it.263 To do otherwise would exploit the already weak

bargaining position of policyholders seeking insurance coverage:

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

reasonable basis for opposing the policyholder’s claim.

Authority: [St. Paul Fire and Casualty Company] Appellate Response Brief, at 29, dated Dec. 27, 1994, Richland, citing Upthegrove Hardware Inc. v. Penna. Lumbermans Mut. Ins. Co., 146 Wis. 2d 470, 476-77, 482-83, 431 N.W.2d 689 (Ct. App. 1988).

6. Unscrupulous Conduct.

Example: Falsification of sworn statement, surreptitious copying of confidential government records, misrepresentation of identity of investigation, and discouraging policyholder from securing legal counsel.

Authority: Timmons v. Royal Globe Ins. Co., 653 P.2d 907 (Okla. 1982); Industrial Indemnity All Lines Claim Technical Manual, Investigation, Nov. 14, 1980, at page 05.07 (“Witnesses should not be interviewed under any pretext or false pretenses.”); Id., Unfair Claim Practices, Oct. 30, 1989, at page 05.08 (Claims personnel “[m]ust avoid any statement which could be construed as advising a claimant not to obtain the services of an attorney”).

7. Inadequate Investigation or Failure to Investigate.

Authority: Egan v. Mutual of Omaha Ins. Co., 24 Cal. 3d 809, 598 P.2d 452 (1979); Zieman Mfg. Co. v. St. Paul Fire & Marine Ins. Co.,, 724 F.2d 1343 (9th Cir. 1983); Buzzard v. Farmers Ins. Co., 824 P.2d 1105 (Okla. 1991); Appellate Brief of Defendant-Appellant- Cross-Respondent St. Paul Fire & Casualty Company, dated Oct. 24, 1994, in Richland Valley Products Inc. v. St. Paul Fire & Cas. Co., No. 94-1837 (Wis. Ct. App.) (hereafter St. Paul Appellate Brief in Richland) at 30 (Persistent failure to obtain and evaluate readily available information) citing, Benke v. Mukwonago-Vernon Mut. Ins. Co., 110 Wis. 2d 356, 362-64, 329 N.W.2d 243 (Ct. App. 1982).

8. Failure to investigate claim with objectivity.

Example: Conducting investigation solely to uncover additional grounds for denial.

Authority: Colonial Foods, Inc. v. Aetna Cas. & Sur. Co., No. Mon-L-0392-93 (N.J. Super. Ct. Law Div. Apr. 21, 1995), reported in MEALEY’S LITIG. REP.: INS., May 9, 1995, at 10, leave to appeal denied, (N.J. Super. Ct. App. Div. June 20, 1995) (hereafter “Colonial Foods”). State Farm Fire & Cas. v. Simmons, 857 S.W.2d 126 (Tex. Ct. App.)(“Outcome-oriented” investigation of fire, which ignored evidence favorable to policyholder, constitutes a breach of the insurance company’s duty of good faith), aff’d in part, rev’d in part, No. D-4095, 1998 Tex. LEXIS 30 (Tex. Feb. 13, 1998); Plaintiff State Mutual’s Supplemental Memorandum in Support of Its Motion for Summary Judgment and In Opposition to Defendant’s Cross-Motion for Summary Judgment, at 12, filed July 25, 1994, State Mut. Assurance Co. of Am. v. Lumbermens Mut. Cas. Co., No. 90-12505-PBS


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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 insurers claim, and could assert a cause of action against the insured for fraud.264

Reverse bad faith is an affirmative claim by the insurance company against a

policyholder. But courts recognize that insurance companies can pursue alleged misconduct by

policyholders through other means. This is not usually the case for policyholders:

(D. Mass.) (“Lumbermens’ Refusal to Defend State Mutual, Solely On The Basis of Its Own Constricted Reading of The Hancock Complaint and Without Investigating The Factual Basis For The Claims, Constituted An Unfair Settlement Practice in Violation of Mass. Gen. L. Ch. 176D And An Unfair And Deceptive Trade Practice In Violation of Mass. Gen. L. Ch. 93A”).

9. Refusal by an insurance company to settle an underlying claim within the policy limits.

Authority: Oppel v. Empire Mut. Ins. Co., 517 F. Supp. 1305 (S.D.N.Y. 1981).

10. Failure to inform the policyholder immediately of a settlement offer in an underlying claim.

Authority: Oppel v. Empire Mut. Ins. Co., 517 F. Supp. 1305 (S.D.N.Y. 1981).

11. Failure to assert defenses available to “additional insureds” in an underlying action.

Authority: Cornwell v. Safeco Ins. Co., 42 A.D.2d 127, 346 N.Y.S.2d 59 (4th Dep’t 1973).

12. Failure on the part of the insurance company to be aware of the amount of its coverage on the eve of trial in an underlying action.

Authority: Fredericks v. Home Indem. Co., 101 A.D.2d 614, 474 N.Y.S.2d 870 (3d Dep’t 1984).

13. Allowing the risk of unfavorable results to greatly exceed the chances of a favorable outcome (in the settlement context) in an underlying action.

Authority: United States Fire Ins. Co. v. Royal Ins. Co., 759 F.2d 306 (3d Cir. 1985).

14. Failure to explore settlement possibilities in an underlying claim.

Authority: Rova Farms Resort Inc. v. Investors Ins. Co. of Am., 65 N.J. 474, 323 A.2d 495 (1974).

15. Exposing the policyholder to unreasonable risk in an underlying claim because an offer was rejected only because of policy limits.

Authority: Wierck v. Grinwell Mut. Reins. Co., 456 N.W.2d 191 (Iowa 1990).

16. Delay in delivering a settlement draft in an underlying claim.

Authority: Higgs v. Industrial Fire & Cas. Ins. Co., 501 So. 2d 644 (Fla. Dist. Ct. App. 1986).

17. Refusal to settle an underlying claim in excess of policy limits after liability already had been determined.


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We decline to adopt a tort of reverse bad faith. [The insurance company] argues that insurers should have a remedy other than abuse of process because abuse of process requires an element of a wrongful or illegal primary purpose. It asserts insurers should not be limited to such a narrow remedy . . . We believe sanctions under Iowa Rule of Civil Procedure 80(a) [the Iowa equivalent to Fed.R.Civ.P. 11] provides and adequate remedy to insurance companies when an insured files a frivolous bad faith suit.265

Authority: St. Paul Fire & Marine Ins. Co. v. United States Fidelity & Guar. Co., 43 N.Y.2d 977, 375 N.E.2d 733, 404 N.Y.S.2d 552 (1978).

18. Refusal by an insurance company to pay the difference between an appraiser’s estimate of the cost of repair and the amount the insurance company was willing to pay.

Authority: Chodos v. Insurance Co. of N. Am., 126 Cal. App. 3d 81, 178 Cal. Rptr. 829 (2d Dist. 1981).

19. Providing an inadequate defense in an underlying claim. Improper handling of the policyholder’s defense in an underlying claim.

Authority: Travelers’ Ins. v. Lesher, 187 Cal. App. 3d 169, 231 Cal. Rptr. 791 (1st Dist. 1986).

20. Making grossly insufficient settlement offers in an underlying action. Relying upon an untested legal theory in an underlying action.

Authority: Gourley v. State Farm Mut. Auto. Ins. Co., 217 Cal. App. 3d 1111, (4th Dist.), rev. granted and op. superseded by 268 Cal. Rptr. 541, 789 P.2d 374 (Cal.), reversed on other grounds, 53 Cal. 3d 121 (1991) This case may not be cited pursuant to Cal. Rules of Court 976, 977 and 979.

21. Disregarding medical information contained in an insurance company’s own files so as to mischaracterize disability and thereby avoid liability on a claim.

Authority: Fletcher v. Western Nat. Ins. Co., 10 Cal. App. 3d 376, 89 Cal. Rptr. 78 (4th Dist. 1970).

22. Making an offer to settle an underlying claim too late. Failure to make efforts to respond to settlement demands in a timely manner.

Authority: Ashbrook v. Kowalisk, 332 F. Supp. 78 (E.D. Pa. 1971), aff’d without op., 474 F.2d 1338 (3d Cir. 1973).

23. Attempting to coerce or obtain an involuntary contribution from the policyholder in order to settle an underlying action within the policy limits.

Authority: Commercial Union Ins. Co. v. Liberty Mut. Ins. Co., 426 Mich. 127, 393 N.W.2d 161 (1986).

24. Refusal to compromise claims until suit is threatened or commenced.

Authority: United Serv. Auto Ass’n v. Wesley, 526 P.2d 28 (Alaska 1974); Richardson v. Employers Liab. Assurance Corp., 25 Cal. App. 3d 232, 102 Cal. Rptr. 547 (2d Dist. 1972)

25. Expert “Shopping” where previous experts have made it clear that coverage exists.


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7. Comparative Bad Faith

Unlike reverse bad faith, comparative bad faith is an affirmative defense. Reverse

bad faith is generally raised in an insurance company’s complaint or counterclaim.266

Comparative bad faith in the context of insurance coverage litigation works as it

does in other civil litigation; by allowing tort recovery for harm caused by the tortious conduct of

Authority: St. Paul Appellate Brief in Richland, at 30, citing Benke v. Mukwonago-Vernon Mut. Ins. Co., 110 Wis. 2d at 362-64.

26. Repeated low-ball settlement offers, even after basis for denial is shown to be weak or a long-shot.

Authority: Republic Ins. Co. v. Hires, 107 Nev. 317, 810 P.2d 790 (1990) (Practice of setting “ceiling” on low and middle-income policyholder claims of 65% of appraised value of property justifies punitive damages).

27. Deliberately trying to negotiate a settlement for less than the conceded value of the claim where the insurance company does not seriously dispute liability and the amount of damages.

Authority: Brief of Defendant-Appellant-Cross-Respondent St. Paul Fire & Casualty Insurance Company, at 28, dated Dec. 27, 1994, Richland Valley Products, Inc. v. St. Paul Fire & Casualty Co., No. 94-1837 (Wis. Ct. App.), citing Davis v. Allstate Ins. Co., 101 Wis. 2d 1, 8-10, 303 N.W.2d 596 (1981).

28. Forcing policyholder to litigate.

Authority: United Serv. Auto Ass’n v. Wesley, 526 P.2d 28 (Alaska 1974); Richardson v. Employers Liab. Assurance Corp., 25 Cal. App. 3d 232, 102 Cal. Rptr. 547 (2d Dist. 1972).

29. Abusing Subrogation Rights.

Example: Pursuing underlying claim, after settling coverage claim with other PRP, in order to show that damage was “expected or intended.”

Authority: Crum & Forster, Inc. v. Monsanto, 887 S.W.2d 103 (Tex. App. 1994), vacated pursuant to settlement, No. 06-92-00100-CV, 1995 Tex. App. LEXIS 3673 (Tex. App. Mar. 9, 1995).

Example: Refusal to consent to settlement of claim where insurance company’s subrogation rights are speculative or worthless.

Authority: Brunet vs. American Ins. Co., 660 F. Supp. 843 (D. Vt. 1987).

30. Refusal to pay reasonable defense costs.; refusal to pay any defense costs where amount of costs is in dispute.

Authority: Nationwide Mutual Ins. Co. v. Lafarge Corp., No. H-90-2390 (D. Md. Aug. 21, 1995), reported in MEALEY’S LITIG. REP.: INS., Nov. 11, 1995, at A-1.

31. Failure to pay full value of claim; conditioning payment of the undisputed portion of the claim on the settlement of the disputed portion.


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another, but reducing the damages a party may recover to the extent they are due to that party’s

own conduct.

Comparative bad faith attempts to distract the trier of fact from the issue at hand

— the insurance company’s breach of fiduciary duty and the duty of good faith and fair dealing.

As the Supreme Court of Oklahoma observed:

Authority: Vernon Fire & Cas. Co. v. Sharp, 264 Ind. 599, 349 N.E.2d 173 (1976); Travelers Indem. Co. v. Weatherbee, 368 So. 2d 829 (Miss. 1979).

32. Retaliatory rescission or cancellation of policy after claim is made; retaliatory increase in premiums.

Authority: Rawlings v. Apodaca, 151 Ariz. 149, 726 P.2d 565 (1986); Herbert v. Guastella, 409 So. 2d 375 (La. Ct. App. 1982); Spindle v. Travelers Ins. Co., 66 Cal. App. 3d 951, 135 Cal. Rptr. 404 (2d Dist. 1977).

33. Attempting to coerce or obtain an involuntary contribution from the policyholder in order to settle and underlying action within policy limits; unreasonable demand that the policyholder contribute to a settlement.

Authority: Commercial Union Ins. Co. v. Liberty Mut. Ins. Co., 426 Mich. 127, 393 N.W.2d 161 (1986); Coe v. State Farm Mut. Auto. Ins. Co., 66 Cal. App. 3d 981, 136 Cal. Rptr. 331 (1st Dist. 1977).

34. Making grossly insufficient settlement offers in an underlying action; relying upon an untested legal theory in the underlying action. Failure to explore settlement opportunities in an underlying action.

Authority: Gourley v. State Farm Mut. Auto. Ins. Co., 217 Cal. App. 3d 1111, (4th Dist.), rev. granted and op. superseded by 268 Cal. Rptr. 541, 789 P.2d 374 (Cal.), reversed on other grounds, 53 Cal. 3d 121 (1991) This case may not be cited pursuant to Cal. Rules of Court 976, 977 and 979; Rova Farms Resort Inc. v. Investors Ins. Co. of America, 65 N.J. 474, 323 A.2d 495 (1974); Clayton v. United Servs. Auto. Assoc., 54 Cal. App. 4th 1158, 63 Cal. Rptr. 2d 419 (1st Dist.), review denied, No. S062134, 1997 Cal. LEXIS 4826 (Cal. July 30, 1997).

35. Failure to settle even though retained counsel believed underlying plaintiff’s demand was reasonable.

Authority: Insurance Co. of N. Am. v. Medical Protective Co., 768 F.2d 315 (10th Cir. 1985); Royal Transit v. Central Sur. & Ins. Corp., 168 F.2d 345 (7th Cir. 1948).

36. Failure to respond to policyholder’s request for clarification of rights.

Authority: Carolina Bank & Trust Co. v. St. Paul Fire & Marine Co., 279 S.C. 576, 310 S.E.2d 163 (Ct. App. 1983).

37. Exploiting vulnerability of insured.

Authority: Drop Anchor Realty Trust v. Hartford Fire Ins. Co., 126 N.H. 674, 496 A.2d 339 (1985) (Insurance company may not use knowledge of policyholder’s vulnerable


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In this action to recover for the insurer’s bad faith refusal to pay a part of the loss to be indemnified under the policies provisions, the defense based on the insured’s claimed failure timely to supplement its initial notice by providing critical information does not call upon the trier to compare the parties’ fault, one toward the other, but rather to measure the extent of the impact, if any, the insured’s alleged misperformance (by withholding vital information) may have had on the main issue in the case — the good or bad faith of the insurer’s decision not to defend the action against the insured.267

financial position to force policyholder into accepting less than a reasonable amount in settlement of the claim); Mohr v. Dix Mut. County Fire Ins. Co., 143 Ill. App. 3d 989, 493 N.E.2d 639 (1986) (Insurance company acted in bad faith in delaying settlement of claim with the hope that policyholder’s financial condition would force him to settle for a lesser amount); Buzzard v. Farmers Ins. Co., Inc., 824 P.2d 1105 (Okla. 1991) (Repeated delay in paying claim, which resulted in “marital strife,” justified submission of punitive damage claim to jury).

38. Failure to advise the policyholder of a right to arbitration.

Authority: Sarchett v. Blue Shield of Ca., 43 Cal. 3d 1, 729 P.2d 267 (Cal. 1987).

II. Bad-Faith Denial

1. Bad-faith denial of coverage without reasonably colorable basis; denial without investigation.

Authority: Gruenberg v. Aetna Ins. Co., 9 Cal. 3d 566, 510 P.2d 1032 (1973); Supplemental Memorandum of Points and Authorities In Support of Plaintiff’s Motion for Summary Judgment at 9, filed Feb. 21, 1986, Aetna Cas. & Sur. Co. v. Great American Ins. Co., No. CV 84-2995 (WPG), (C.D. Cal.); Perry v. USF&G Co., 49 Tenn. App. 662, 675-76, 359 S.W.2d 1, 7 (1962) (Unreasonable delays, failure to investigate and inadequate investigation all are evidence of bad faith).

2. Bad faith denial even where cause of loss in unknown.

Authority: Fireman’s Fund Ins. Cos. v. Alaskan Pride Partnership, 106 F.3d 1146 (9th Cir. 1997)(failure of both the policyholder and the insurance company to definitely prove how a loss occurred (a ship which sunk) did not preclude a finding of insurance coverage and bad faith).

3. Conscious disregard of successor corporation’s rights to coverage under predecessor’s policy.

Authority: Chemstar Inc. v. Liberty Mut. Ins. Co., 41 F.3d 429 (9th Cir. 1994).

4. Claims discrimination: denial of coverage or defense in circumstances where insurance company provided coverage or defense to other policyholders.

Authority: Liberty Mutual Insurance Company, “A Statement of Claims and Coverage Principles,” at 4, dated May, 1967 (“We will not refuse to pay legitimate claims simply because they are small and unprofitable for a claimant to prosecute”; “Our claims policy is the same regardless of whether or not the claimant has retained a lawyer.”

5. Post-claim underwriting.


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Other courts agree.268 Some courts have held that a policyholder’s alleged bad faith against the

insurance company could not offset the bad faith damage award against the insurance company.

Those courts have held that while the insurance company’s bad faith was in tort, the

policyholder’s conduct gave rise only to a breach of contract, which could not offset tort

damages.269

Example: Failing to secure information in underwriting process, despite opportunity to do so, which then is relied upon after development in claims investigation, to seek rescission or to deny claim.

Authority: See, e.g., W.M. SHERNOFF, ET AL. INSURANCE BAD FAITH Litigation, § 5.22[2], at 40-40.1 (1987).

6. Denial of coverage despite knowledge of contrary judicial decisions in the applicable jurisdiction; misrepresentation of controlling case law in order to deny claim.

Authority: Hanover Ins. Co. v. Jennings, 172 Ga. App. 559, 323 S.E.2d 863 (1984); Sur-Reply Memorandum of The Travelers Insurance Company in Further Opposition to Defendants’ Motions for Summary Judgment, at 10-11, filed Oct. 18, 1988, Travelers Ins. Co. v. Buffalo Reinsurance Co., No. 86 Civ. 3369 (JMC), (S.D.N.Y.); Household Mfg., Inc. v. Liberty Mut. Ins. Co., No. 85 C 8519, 1987 Dist. LEXIS 1008 (N.D. Ill. Feb. 11, 1987).

7. Intentional misrepresentation or misinterpretation of records (e.g., denial of policy issuance) or policy terms; use of improper standards to deny a claim.

Authority: Fletcher v. Western Nat’l Life Ins. Co., 10 Cal. App. 3d 376, 395-96, 89 Cal. Rptr. 78, 89 (4th Dist. 1970).

8. Unwarranted offsets.

Authority: Silberg v. California Life Ins. Co., 11 Cal. 3d 452, 521 P.2d 1103 (1974).

9. Disregarding information in insurance company’s own files so as to mischaracterize nature of claim.

Authority: Colonial Foods, supra; Fletcher v. Western Nat. Ins. Co., 106 Cal. App. 3d 376, 90 Cal. Rptr. 78 (4th Dist. 1970).

10. Adopting coverage position inconsistent with prior understanding of scope of coverage.

Authority: Brief for Defendant-Appellee, at 45, filed July 31, 1991, Unigard Security Ins. Co. v. North River Ins. Co., No. 91-7534 (2d Cir.) (“In the circumstances presented, Unigard’s position is 180 degrees contrary to what Mr. Hutt and Unigard understood the facultative certificate to provide. Unigard’s refusal to pay is therefore an act of bad faith, and violates basic contract values under New York law:

‘[A] covenant of good faith and fair dealing “precludes each party from engaging in conduct that will deprive the other party of the benefits of their agreement.” Any effort by [the defendant] to benefit by making a disingenuous determination that would create a windfall for him to the detriment of [the plaintiff] would not be an act of good faith or


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In Kransco v. American Empire Surplus Lines Insurance Co.,270 a California

appellate court decision affirmed a trial court’s decision that a policyholder’s comparative bad

faith and comparative negligence should not be considered and should not reduce the amount of

compensatory and punitive damages awarded against an insurance company for the insurance

company’s bad faith.

fairness, and thus would violate the contract.’“);

Fireman’s Fund Insurance Companies Claims Manual, dated Mar. 15, 1977, at 13-15 (Misrepresenting pertinent facts or insurance policy provisions relating to coverages at issue is unfair trade practice); June 8, 1994 letter from Aetna Cas. & Sur. Co. counsel Brian R. Ade, Esq. of Harwood Lloyd, to the Hon. Robert E. Francis, in Aetna Cas. & Sur. Co. v. Morton Intern’l, Inc., No. L-2568-93 (“The obligation of good faith and fair dealing is very basic; it is an obligation to be fair and honest. The RESTATEMENT is clear in stating that it is unfair and dishonest for a party seeking enforcement of a contract to assert an interpretation that is contrary to that party’s preenforcement understanding. Whether the asserted interpretation is supported by evolving case law, learned treatises, or other authorities is irrelevant to the fundamental issues of fairness and honesty. A party cannot fairly or honestly use the benefit of 20/20 hindsight to excuse the unconscionability of asserting an argument that is entirely inconsistent with the actual fact of its own understanding of a contract. The violation of the covenant of good faith and fair dealing comes not from claiming “the benefit of legal rulings from” the courts, but from the basic unfairness and dishonesty inherent in a contracting party’s assertion of a legal position contrary to its factual understanding. It is just not right.”) RESTATEMENT (SECOND) OF CONTRACTS 2105, comment (e) (1981) (Asserting “an interpretation contrary to one’s own understanding” constitutes bad faith).

11. Asserting clearly frivolous policy defenses and relying on testimony which the insurer knows or show knew is clearly false.

Authority: St. Paul Appellate Response Brief at 28, filed in Richland, supra, citing Poling v. Wisconsin Physicians Serv. Co., 120 Wis. 2d 603, 607-08, 357 N.W.2d 293 (1984).

III. Bad Faith Litigation

A. Forum Shopping.

Authority: Plaintiff’s Memorandum of Law in Support of Motion to Remand, filed Dec. 16, 1991, Travelers Ins. Co. v. Richard John Ratcliffe Keeling [Lloyd’s], No. 91 Civ. 7753 (JFK), (S.D.N.Y.).

B. Egregious defense tactics designed to make litigation prohibitively expensive.

Authority: T.D.S. Inc. v. Shelby Mut. Ins. Co., 760 F.2d 1520, 1527 (11th Cir.) modified in part, 769 F.2d 1485 (1985) (Litigation conduct admissible to show bad faith); Norman v. American Nat’l Fire Ins. Co., 198 Ill. App. 3d 268, 555 N.E.2d 1087 (1990) (Liability for bad faith imposed based, inter alia, upon evidence of delay caused by the discovery and trial tactics of insurance company); Downey Savings & Loan Ass’n v. Ohio Casualty Ins. Co., 234 Cal. Rptr. 835, 849-51 (2d Dist. 1987) (“Invidious practices,” including use of


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Michael Hubert (Hubert) was seriously injured on a slide toy manufactured by

Kransco. Kransco was defended in the action by American Empire Surplus Lines Insurance

Company (AES) which had issued a liability insurance policy with a limit of $900,000 in excess

of Kransco’s self-insured retention of $100,000. Kransco also had excess liability insurance.

Hubert offered to settle his suit for $750,000 during the trial but AES rejected the offer. The jury

depositions “to cause harassment, embarrassment, inconvenience or expense,” would have justified punitive damages award).

C. Interposition and continued assertion of meritless affirmative defenses; pursuit of appeal with little or no chance of success.

Note: In some states, pleadings with boilerplate defenses and low-ball settlement offers are admissible to show bad faith.

Authority: Home Ins. Co. v. Owens, 573 So. 2d 343 (Fla. Dist. Ct. App. 1990); White v. Western Title Ins. Co., 40 Cal. 3d 870, 710 P.2d 309 (1985); Kyriss v. Aetna Life & Cas. Co., 624 F. Supp. 1130, 1131-33 (D. Mont. 1986).

D. Raising legal defenses at trial that have only minimal or no chance for success.

Authority: Gourley v. State Farm Mut. Auto Ins. Co., 217 Cal. App. 3d 1111, 265 Cal. Rptr. 634, 638-9, (4th Dist.), rev. granted and op. superseded by 268 Cal. Rptr. 541, 789 P.2d 374 (Cal.), reversed on other grounds, 53 Cal. 3d 121 (1991) This case may not be cited pursuant to Cal. Rules of Court 976, 977 and 979.

E. Prosecution of meritless appeal to delay paying claim.

Authority: Myrda v. Coronet Ins. Co., 221 Ill. App. 3d 482, 582 N.E.2d 274, 279-81 (1991).

F. Appealing arbitration award to compel settlement.

Authority: Rios v. Allstate Ins. Co., 68 Cal. App. 3d 811, 137 Cal. Rptr. 441 (4th Dist. 1977).

G. Failure to respond to policyholder request or claim while suit on previous claim is pending.

Authority: Minnesota Mut. Life Ins. Co. v. Elswood, No. A055590 (Cal. App. Mar. 9, 1993).

261 This is merely one of many areas in which insurance companies have taken contradictory positions. See Eugene R. Anderson & Joan L. Lewis, Abate, Don’t Wait: New Lead Disclosure Rules Point To Insurance Coverage, TENN. BAR J., Mar./Apr. 1997 (discussing the contradictory positions of insurance companies in the context of loss mitigation issues).262 See, e.g., Biddle Sawyer v. Fireman’s Fund Ins. Co., No. MON-L-5219 (N.J. Super. Ct. Law Div. July 24, 1992). See also Marjie D. Barrows, Reverse Bad Faith, BRIEF, Summer 1996, at 17 (discussing specific “reverse” bad faith lawsuits).263 See Barrows at 19.264 Tokles & Son, Inc. v. Midwestern Indem. Co., 605 N.E.2d 936 (Ohio 1992).


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returned a verdict at over $12.3 million--$2.3 million in compensatory damages and $10 million

punitive damages.

Kransco brought a bad faith suit against AES for failure to settle the claim within

the policy limits. The jury in the insurance coverage case found that AES breached its duty of

good faith and assessed compensatory damages at $14 million (the $12.5 million Hubert

judgment plus defense and settlement costs incurred in an unrelated injury action which was paid

by Kransco and its excess insurer because otherwise available insurance coverage had been

exhausted by the Hubert claim mishandled by AES). However, the jury also found that Kransco

had breached its duty of good faith and fair dealing and attributed fault for the verdict at 90

percent to Kransco and 10 percent to AES.

Upon Kransco’s motion for judgment notwithstanding the verdict, the court found

comparative negligence was wholly inapplicable to the case and that the consideration of

265 Johnson v. Farm Bureau Mut. Ins. Co., 533 N.W.2d 203 (Iowa 1995). See also Tokles & Son, Inc. v. Midwestern Indem. Co., 605 N.E.2d 936, 945 (Ohio 1992)(holding that “[t]here are other avenues for the insurer to pursue in the event that an insured submits a fraudulent claim. An insurer . . . can refuse the insured’s claim, and could assert a cause of action against the insured for fraud.”).266 See, e.g., Tokles & Son, Inc. v. Midwestern Indem. Co., 55 Ohio St.3d 621, 605 N.E.2d 936 (1992)(insurance company alleged comparative bad faith in counterclaim against policyholder; court rejected); Johnson v. Farm Bureau Mut. Ins. Co., 533 N.W.2d 203 (Iowa 1995)(same).267 First Bank of Turley v. Fidelity & Deposit Ins. Co. of Md., 928 P.2d 298, 309 (Okla. 1996)(emphasis added).268 See, e.g., Waite Hill Services, Inc. v. World Class Metal Works, 935 S.W.2d 197 (Tex. App. 1996)(finding that Texas “has not recognized a principle of law known as ‘comparative bad faith,’ and we decline to do so now.”); United States Fire Ins. Co. v. Morrison Assurance Co., 600 So. 2d 1147, 1153 (Fla.Dist.Ct.App. 1992)(court found case not susceptible to comparative bad faith defense, “even if available”); Alexander Underwriters Gen. Agency, Inc. v. Lovett, 182 Ga. App. 769, 777, 357 S.E.2d 258 (1987)(no error in trial court’s refusal to instruct jury on comparative bad faith); Jessen v. National Excess Co., 776 P.2d 1244, 1249 (N.M. 1989)(same).269 Stevens v. Safeco Ins. Co. of America, 852 P.2d 565, 258 Mont. 142 (1993); Kelly v. State Farm Mut. Auto. Ins. Co., 764 F. Supp. 1337 (S.D. Iowa 1991).270 54 Cal. App. 4th 1171, 63 Cal. Rptr. 2d 532 (1st Dist. 1997), review granted, 942 P.2d 414 (Cal. 1997).


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comparative bad faith should have been limited to whether Kransco contributed to AES’s failure

to settle by impairing AES’s assessment of the likelihood of an excess judgment.

The appellate court’s opinion contains a detailed examination of “comparative

bad faith” under California law. The Court noted that the state supreme court has not yet

determined whether comparative bad faith is a valid defense in California [a dissenting justice

argues at length that it has “implicitly recognized” such a defense] and stated that “no state

Supreme Court has embraced the doctrine, and the weight of authority is against it.”271 The Court

explained that while an insurance company’s breach of the covenant of good faith is governed by

tort principles, the policyholder’s breach is not a tort, but is a breach of contract.272 The Court

stated:

The doctrine of comparative bad faith is marked by inconsistencies and complexities in application because it is founded on the faulty premise that the obligations of insurer and insured--and thus their bad faith--are comparable. They are not. The parties are bound by a reciprocal obligation of good faith and fair dealing, but the particular duties differ given the differing performance due under the contract of insurance. A fundamental disparity exists between the insured, which performs its basic duty of paying the policy premium at the outset, and the insurer, which hopes never to perform its basic duties of defense and indemnification. Contrary to the dissenting opinion’s suggestion, a “sophisticated” insured is not on equal footing with its insurers. The relationship between insured and insurer is inherently unequal, and the inequality rests on contractual asymmetry, not degrees of sophistication.

54 Cal. App. 4th at 1184-85 (citation omitted). The Court also determined that the amount

recoverable from the insurance company may include punitive damages as consequential

damages.

271 54 Cal. App. 4th at 1182, n.1. 272 54 Cal. App. 4th at 1183-1184.


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The California Supreme Court has decided to review the Kransco decision.273

8. The Attorney-Client Privilege and the Crime-Fraud Exception

Insurance companies will often seek to avoid liability for bad faith misconduct by

searching for shelter under the attorney-client privilege or work product doctrines. This

insurance industry code of silence is rarely broken. There are exceptions. For example, State

Farm’s destruction of evidence (spoliation) was recently and dramatically exposed. Read the

following memo from a State Farm executive to her claims personnel:

With the increase of bad faith suits being filed against State Farm, it is important that you get rid of all your old stuff I know you have lurking around in your drawers and filing cabinets. [P] Please get rid of any old memo’s [sic], claim school notes, old seminar or claim conference notes, and any old procedure guides you may have. They are trying to avoid having to come up with old records when the ‘request for production of documents’ comes in and they request ‘all training manuals, memo’s [sic], procedural guides, etc., that are in possession of your claim reps and management.’. . . That way if they subpoena our claim manual. . . for 1987, for example, we will say we don’t have it. This should be easier than trying to produce it or having to defend it. So look through all of your old stuff and dump it. You won’t ever miss it.274

This State Farm memorandum was only part of the evidence produced by the claimants in the

case. The claimants alleged fraudulent misrepresentation, destruction of documents and forgery

by State Farm275 and produced evidence that: (1) State Farm possessed claims manuals and

documents which the court had ordered to be produced and which State Farm had denied

possessing, and; (2) that the State Farm employee allegedly responsible for denying the

273 942 P.2d 414 (Cal. 1997).274 See State Farm Fire & Cas. Co. v. Superior Court of Los Angeles, 54 Cal. App. 4th 625, 635 at n.3, 62 Cal. Rptr. 2d 834 (1997). The executive who wrote this memorandum is not the former employee whose testimony is at issue in the case. 275 The evidence of State Farm’s bad faith is set forth in the fact section of the decision; the court at this time was only considering whether the testimony of State Farm’s former employee should be barred under the attorney-client privilege, work-product doctrine or trade secret laws. 54 Cal. App. 4th at 637.


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claimant’s claim was repeatedly unable to recognize her own signature or her own voice on

audio tape.276

The claimants sought to introduce the testimony of a former State Farm

employee, Amy Zirod Zuniga, to substantiate their allegations against State Farm. While she

was an employee of State Farm, Ms. Zuniga had been responsible for evaluating bad faith claims

made against State Farm and had worked on the case.277 Ms. Zuniga provided the claimants with

affidavits which stated that State Farm trained their personnel to be evasive witnesses and that

State Farm did in fact possess claims manuals and other documents which it claimed not to

have.278 In addition, Ms. Zuniga disclosed her conversations with in-house counsel and other

State Farm employees regarding the claimant’s case. Ms. Zuniga revealed in-house counsel’s

litigation and discovery strategies.279 State Farm has recently taken steps to minimize Ms.

Zuniga’s statements.280

The California appellate court held that State Farm could not prevent Ms. Zuniga

from testifying about State Farm’s internal practices and procedures or the existence of claims

manuals and other documents used by State Farm. The court found that although Ms. Zuniga

had worked closely with State Farm’s attorneys, the attorney-client privilege “does not protect

disclosure of underlying facts which may be referenced within a qualifying communication.”281

276 Id. at 633.277 Id. at 635-36.278 Id.279 Id.280 State Farm’s lawyers deposed Ms. Zuniga and claimed that her deposition testimony “although not inconsistent with her declarations -- unequivocally shows there was absolutely no fraud by State Farm or its employees.” Paul Elias, Fraud Claim Still Festering, THE RECORDER, Feb. 25, 1998, at 1, quoting counsel for State Farm. On February 16, 1998, State Farm’s lawyers requested the California Supreme Court to depublish the appellate decision containing Ms. Zuniga’s statements. Id.281 Id. at 639.


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The court then held that the crime fraud exception barred State Farm from using

the attorney-client privilege or the work-product doctrine to prevent turning over to the claimants

documents and information usually protected by those doctrines. The court held that application

of the crime fraud exception turns on two questions:

[W]hether the services of the [law firm] were retained and utilized to enable State Farm to commit a crime or a fraud; and whether there exists a ‘reasonable relationship between the crime or fraud and the attorney-client communication’. . . In that connection, it is the intent of the client upon which attention must be focused and not that of the lawyers.282

The claimants, in opposing State Farm’s motion for summary judgment on the

claimants motion to invoke the crime/fraud exception to the attorney-client privilege, presented

the declarations of Ms. Zuniga. The court quoted, in full, paragraphs 3-5 of Ms. Zuniga’s

declaration:

I am aware that there were many other State Farm claims arising out of the Northridge earthquake like the Taylors’ involving unauthorized signatures by State Farm agents or agency employees on applications omitting earthquake coverage. At the time of the Taylor claim, the company was well aware that this was a problem. As a matter of practice, the company would pay these claims, if it believed that the forgery issue would be brought to light and proven by the insured. Because of the forgery issue in the Taylor case, if the case was not dismissed on summary judgment, it was my impression that the claim was going to be reconsidered. However, we were waiting to see if we could save money on the Taylor claim by having summary judgment granted, and as part of that plan I was instructed not to provide certain relevant information at my depositions. [P] 4. Specifically, my supervisor in the SAC unit, Vanessa Gudelj, and her supervisor, John Poptanich, put pressure on me to withhold the existence of documents memorializing certain State Farm claims handling guidelines from plaintiffs’ counsel Bernie Bernheim at my deposition, which they believed, if revealed, would defeat

282 State Farm Fire & Cas. Co. v. Superior Court, 54 Cal. App. 4th 625, 645, 62 Cal. Rptr. 2d 834 (1997)(emphasis added)(internal citations omitted)(citing BP Alaska Exploration, Inc. v. Superior Court, 199 Cal. App. 3d 1240, 1261-62 (1988); People v. Superior Court, 37 Cal. App. 4th 1757, 1769 (1995); Glade v. Superior Court, 76 Cal. App. 3d 738, 746 (1978).


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summary judgment and ultimately lead to payment of the Taylors’ claim. They pressured me into not revealing the existence of claims handling documents which established guidelines under which claims like the Taylors were to be handled. These included a three ring binder called ‘CATHR Management Information and Memos Manual’ used and maintained by Claim Superintendent Tinga Nicholson who was the Claim Superintendent that denied the Taylors’ claim. It was responsive to the Taylors’ discovery request and we simply chose not to produce it. Similarly, Ms. Nicholson had prepared a breakdown of earthquake claims in her unit. . . by category of claim, and one of the categories was ‘unauthorized signatures.’ This document showed the percentage of total earthquake claims which involved unauthorized signatures. This document, too, was never produced. [P] 5. The Taylors’ claim was denied by personnel working in the so-called ‘Special Handling Unit.’ In addition to the claims handling documents mentioned above, we never produced to Mr. Bernheim a document memorializing a SHU meeting at which the subject of unauthorized signatures on applications omitting earthquake insurance was discussed.283

The court held that the information was not protected from discovery. Even though the contents

of paragraphs 3-5 of Ms. Zuniga’s declaration were protected by the attorney-client privilege,284

the court went on to hold that “the foregoing evidence is more than sufficient for application of

the crime/fraud exception to the privileged materials contained in the Zuniga declarations.”285

Further, the court held that the work product doctrine did not protect the information.286

283 54 Cal. App. 4th at 647-48.284 Id. at 640-41.285 Id. at 649. Before deciding to apply the crime/fraud exception, the court also considered portions of Ms. Zuniga’s declaration containing unprivileged material. This included a disclosure that one of State Farm’s “senior executives” had advised that “State Farm witnesses should not admit that forgeries happen, unless and until they are compelled to do by Court order.” The same executive further expounded that “should the Company be compelled to admit that it has knowledge of the ‘unauthorized signatures’ . . . we should try to make this practice look like a ‘service.’“ Another part of Ms. Zuniga’s declaration states that State Farm prepares witnesses “on how to give up as little information as possible at deposition . . . [b]ut [that] for trial, the witnesses were trained to appear helpful and polite, and to drop the evasive tactics used to keep information from being disclosed at deposition.” Id. at 649.286 The court held that “[i]n California, the crime/fraud exception only applies to attorney-client privileged materials; it does not apply to the work product doctrine.” Id. at 650. However, since Ms. Zuniga’s declarations implicated only the “qualified” as opposed to the “absolute” portion of California’s work product statute, the court held that “the same analysis we utilized for the crime fraud exception leads to the inevitable conclusion that refusal to allow disclosure of the information contained in the


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Insurance companies also invoke the crime fraud exception. For example, in a

suit filed against its insurance company, Columbia Casualty argued:

[The insurance company’s] duty of utmost good faith alone abrogates any privilege applicable to the undisclosed [insurance company] documents. In the fiduciary context, it is well settled that the existence of the fiduciary relationship creates an exception to the attorney client privilege . . . [C]ourts have found that the beneficiary of the duties of utmost good faith can prevent the fiduciary from invoking the attorney client privilege to preclude discovery if there is “good cause” for the privilege’s non-application.287

Furthermore, according to Columbia Casualty:

The protection offered by the [attorney- client] privilege, however, creates the potential for abuse by shrouding these communications in secrecy. The abuse is the use of a professional’s knowledge and advice to help commit an intentional wrong. Thus, communications between lawyer and client that are made in furtherance of criminal or tortious or fraudulent behavior are excepted from the privilege’s protection . . . . The ongoing tort and fraud exception to the attorney client privilege mandates disclosure of [the insurance company’s] documents.288

Similarly, Hartford argued:

A client who consults an attorney for advice that will serve him in the commission of a fraud will have no help from the law. He must let the truth be told. This forms the basis for what has become known as the “crime-fraud” exception to the attorney-client privilege . . . The “crime-fraud” exception also overcomes the work product immunity. A client cannot assert the work product doctrine any more than he can assert the attorney-client privilege when there has been a showing of ongoing client fraud.289

Zuniga declarations would not only unfairly prejudice real parties, it would also result in an injustice.” (citations omitted) Id. at 648-50, discussing California Code of Civil Procedure § 2018.287 Columbia Casualty’s Memorandum of Law in Opposition to North River’s Motion For A Protective Order, at 20, dated Nov. 1, 1994, North River Ins. Co. v. Columbia Cas. Co., (S.D.N.Y. 1994)(90 Civ. 2518 (MJL)(JCF))(citations omitted).288 Id. at 24, 26 (citations omitted).289 Memorandum of Law Re Motion to Compel, at 62, filed Nov. 29, 1994, Hartford Steam Boiler Inspection & Ins. Co. v. Industrial Risk Insurers, (Conn. Super. Ct. 1994)(No. CV-94-705105)(internal quotations and citations omitted).


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. . .It is thus not surprising that a breach of a fiduciary duty has been deemed sufficient to satisfy the crime fraud exception.290

Both insurance companies and policyholders understand the legitimacy of

invoking the crime fraud exception to expose misconduct by insurance companies.

D. Concealing Insurance Coverage is Bad Faith

1. Insurance Companies Must Disclose Insurance Coverage

Insurance companies have an affirmative duty to disclose information regarding

coverage to their policyholders. The duty to disclose is widely recognized as a component of an

insurance company’s duty of good faith and fair dealing. This duty is often systematically

violated by insurance companies which seek to conceal, rather than disclose, coverage for

insurance claims.

The duty to disclose information is premised on an insurance company’s

responsibility to look for insurance coverage rather than for ways to deny it:

A trier of fact may find that an insurer acted unreasonably if the insurer ignores evidence available to it which supports the claim. The insurer may not just focus on those facts which justify denial of a claim.291

A leading insurance professor has argued that the duty to disclose insurance

coverage is only one of several elements comprising an insurance company’s obligations to its

policyholders:

Following notification of an occurrence, I believe an insurer is obligated to disclose all applicable benefits, or to clearly inform insureds about the existence of rights and duties regarding all coverages, or to explain why the insurance benefits will not be paid in order to (a) fulfill the insurer’s contractual commitment, (b) comply with the obligation--implied as a matter of law in all

290 Id. at 62.291 Mariscal v. Old Life Republic Ins. Co., 42 Cal. App. 4th 1617, 1623 (1996).


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contracts--to deal fairly and in good faith, (c) protect the insured’s reasonable expectations, and (d) avoid omissions that could constitute fraudulent misrepresentation.292

This last theoretical foundation--the doctrine of fraudulent misrepresentation--

illustrates the way in which the courts have viewed the duty to disclose as an affirmative duty. If

an insurance company fails to disclose information which might have assisted the policyholder in

securing coverage, the insurance company’s omission may constitute an actionable

misrepresentation.293

An insurance company may breach its duty to disclose where it learns of a claim,

determines that the policyholder may be entitled to coverage, but nevertheless fails to inform the

policyholder of this potential for coverage. Such behavior may be characterized as a breach of

contract because “[i]nvestigation, fair evaluation, and prompt rejection or settlement constitute

`performances’ that are `the essence of what the insured has bargained and paid for . . . .’“294

In the landmark decision of Dercoli v. Pennsylvania National Mutual Insurance

Company, the Supreme Court of Pennsylvania held that “the duty of an insurance company to

deal with the insured fairly and in good faith includes the duty of full and complete disclosure as

to all of the benefits and every coverage that is provided by the applicable policy or policies

along with all requirements, including any time limitations for making a claim.”295

292 Alan I. Widiss, Obligating Insurers to Inform Insureds About the Existence of Rights and Duties Regarding Coverage for Losses, 1 CONN. INS. L.J. 67, 70 (1995).293 Id. at 85, citing Weber v. State Farm Mut. Auto. Ins., 873 F. Supp. 201, 209 (S.D. Iowa 1994)(court grants policyholders summary judgment motion “to the extent that in connection with the fraudulent nondisclosure claim the defendant was under a duty to exercise reasonable care to disclose the uninsured motorist coverage provisions of the policy”).294 Widiss at 72, quoting Beck v. Farmers Ins. Exch., 701 P.2d 795, 801 (Utah 1985). 295 Dercoli v. Pennsylvania Nat’l Mut. Ins. Co., 520 Pa. 471, 477, 554 A.2d 906 (1989), citing Gatlin v. Tennessee Farmers Mut. Ins. Co., 741 S.W.2d 324 (Tenn. 1987)(“Gatlin”); Sarchett v. Blue Shield of Ca., 43 Cal. 3d 1, 233 Cal. Rptr. 76, 729 P.2d 267 (1987). See also Darlow v. Farmers Ins. Exch., 822 P.2d 820, 827 (Wyo. 1991); Rawlings v. Apodaca, 726 P.2d 565, 571 (Ariz. 1986); MFA Mut. Ins. Co. v. Flint, 574 S.W.2d 718, 721 (Tenn. 1980).


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In one case cited by the Dercoli court, Gatlin v. Tennessee Farmers Mutual

Insurance Company,296 Tennessee Farmers Mutual Insurance Company (“Farmers Mutual”)

issued policies to each automobile involved in a two-car collision. M. Annette Gatlin, one of the

drivers, was injured in the accident. She filed suit against the other driver, James K. Williams.

When she discovered that her settlement demand was in excess of the limits of the policy held by

Williams, she turned to Farmers Mutual for coverage her own uninsured motorist insurance.

Farmers Mutual refused to pay for the reason, among others, that Gatlin’s notice of claim was

untimely. Reversing an appellate state court decision, the Tennessee Supreme Court held that

the late-notice defense was without merit. The court noted that Farmers Mutual “was an active

participant in all phases of this case,” and that the insurance company “had liability insurance

coverage on both automobiles.”297 The duty of good faith and fair dealing required Farmers

Mutual to disclose information regarding what Gatlin had to do to secure coverage:

[A]n insurer has the duty to deal with its insured “fairly and in good faith.” This includes informing an insured as to coverage and policy requirements when (1) it is apparent to the insurer that there is a strong likelihood that its insured only can be compensated fully under her own policy and (2) that the insured has no basis to believe that she must rely upon her policy for coverage.”298

In Bowler v. Fidelity & Casualty Co.,299 the New Jersey Supreme Court held that

an insurance company was estopped from asserting a statute of limitations defense because the

company had breached its duty to inform the policyholder of the steps it needed to take to secure

coverage. The court characterized an insurance company’s duty to disclose as a “contractual

undertaking”:

296 Gatlin v. Tennessee Farmers Mut. Ins. Co., 741 S.W.2d 324 (Tenn. 1987).297 Id. at 326.298 Id.299 Bowler v. Fidelity & Cas. Co., 250 A.2d 580, 587 (N.J. 1969).


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In situations where a layman might give the controlling language of the policy a more restrictive interpretation than the insurer knows the courts have given it and as a result the uninformed insured might be inclined to be quiescent about the disregard or nonpayment of his claim and not to press it in a timely fashion, the company cannot ignore its obligation. It cannot hide behind the insurer’s ignorance of the law; it cannot conceal its liability. In these circumstances it has the duty to speak and disclose, and to act in accordance with its contractual undertaking. The slightest evidence of deception or overreaching will bar reliance upon time limitations for prosecution of the claim.300

In Bowler, the policyholder endured serious fractures to his leg, and eventually

developed osteomyelitis, a serious bone infection. As a result of this condition, the policyholder

was disabled. The insurance company was obligated to pay the policyholder weekly indemnity

payments for up to 199 weeks of disability. Assuming that the policyholder was deemed

permanently disabled by the 200th week, the insurance company was then obligated to make a

final weekly payment and a lump sum payment equal to 600 weeks. Shortly before the 200th

week, the policyholder was examined by his own doctor and a doctor assigned by the insurance

company. The doctor reports both found that the policyholder was disabled within the meaning

of the policy. The insurance company sent the policyholder a number of forms to complete. The

policyholder returned the forms, but never heard again from the insurance company. More than

six years later, the policyholder filed suit against the insurance company. In litigation, the

insurance company took the position that coverage was barred on the basis of the statute of

limitations. The New Jersey Supreme Court found the insurance company’s behavior to be

“shocking and unconscionable.”301 The court noted:

Instead of fulfilling its contractual obligations, the company lapsed into silence.... Bowler, a layman obviously not versed in insurance law took no legal action until in some manner, not explained in the

300 Id. at 588 (emphasis added).301 Id.


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present record, he got into the hands of an attorney, and this suit was brought--more than six years after the end of the 200 week total disability period. When this was done, the insurer pleaded the six-year statute of limitations, N.J.S. 2A:14-1 as a bar. We regard such treatment of its policyholder as shocking and unconscionable.302

The court added that when there is doubt regarding coverage, the insurance

company is obligated to inform its policyholder of the precise steps it must take to secure

coverage:

[I]f the insurer has factual information in its possession substantially supporting the policyholder’s rights to benefits, but it has a reasonable doubt as to whether the evidence is sufficient to require payment, the obligation to exercise good faith, upon which it knows or should know the insured is relying, cannot be satisfied by silence or inaction. It must notify the insured of its decision not to pay his claim. But mere naked rejection would not be sufficient. The giving of such notice should be accompanied by a full and fair statement of the reasons for its decision not to pay the benefits, and by a clear statement that if the insured wished to enforce his claim it will be necessary from him to obtain the services of an attorney and institute a court action within the appropriate time. The “appropriate time” means the time remaining under the policy or the applicable statute of limitations within which the suit must be brought. Failure on the insurer’s part to follow such a course will bar reliance on the statute of limitations or a time restriction on court action expressed in the policy.303

An insurance company must disclose insurance coverage even when the

policyholder believes there is none.

Q. It is also correct that an insurance company should fully disclose all important facts related to an insurance policy [to] the policyholder?

A. They should.

Q. An insurance company should always tell the truth to the policyholder?

302 Id.303 Id. (emphasis added).


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A. They should.So testified the insurance company district manager in Foremost Insurance Company v.

Parnham.304 The Alabama Supreme Court in that case held:

[A] duty does arise on the part of an insurer to disclose the existence of a specific coverage under the policy when, as shown by the evidence in this case, the insurer has specific knowledge that a significant number of customers may not want or have a need for the coverage and that the coverage could be dropped with a corresponding savings in premium to the customer.305

The breadth of the duty to disclose coverage is illustrated by Travelers’ briefs in

the case of Travelers Insurance Co. v. Buffalo Reinsurance Co. Travelers sued its reinsurers to

recover $9,000,000 of losses paid in hundreds of property damage claims against its

policyholder, Koppers Company, Inc. The losses arose from premature failures of Koppers’

“KMM” roofing system. In March 1984, representatives for Koppers met with a team of

professionals from Travelers’ claims and engineering department to discuss the claims. During

that meeting, Koppers assumed that the losses were not covered for a variety of reasons —

including an erroneous view of exclusions and deductibles in the policy.306 In the face of the

reinsurers’ argument that Travelers should not have provided coverage where the policyholder

itself did not believe there was coverage, Travelers responded that “it was bound by ethical

claims-handling practices to apprise its insured . . . that indemnity coverage might exist.”307

Travelers reiterated the point:

304 Foremost Ins. Co. v. Parnham, 693 So. 2d 409 (Ala. 1997).305 Id. at 424. Foremost involved the sale of insurance coverage for adjacent structures although the policyholders did not have adjacent structures.306 See Memorandum of The Travelers Insurance Company In Opposition to Defendants’ Motions for Summary Judgment On Late Notice Grounds, at 13-14, Sept. 26, 1988, Travelers Ins. Co. v. Buffalo Reinsurance Co., 86 C.V. 3369 (JMC).307 Id. at 14-15.


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Reinsurers argue that they were prejudiced by Travelers’ decision to provide coverage at all, notwithstanding that Koppers had never claimed that coverage existed. [citation omitted]. However, once Travelers receives notice of claims that are potentially covered under its policies — even where the insured may not recognize that coverage is available — Travelers had an ethical obligation to advise its insured.308

Insurance companies have an affirmative duty to come forward and disclose

whether insurance coverage exists. That is, insurance companies must tell their policyholders --

and the courts-- of their own positions favoring coverage. Support for this proposition is found

in the RESTATEMENT (2ND) OF CONTRACTS. Comment (e) of Section 205 of the RESTATEMENT

(2ND) OF CONTRACTS (1981) states:

(e) Good Faith in Enforcement. The obligation of good faith and fair dealing extends to the assertion, settlement in litigation of contract claims and offenses. See, e.g., §§ 73, 89. The obligation is violated by dishonest conduct such as conjuring up a pretended dispute, asserting an interpretation contrary to one’s own understanding, or falsification of facts.309

Aetna Casualty and Surety Company has argued that this provision precludes a

party from arguing a position contrary to its pre-litigation understanding.

The obligation of good faith and fair dealing is very basic; it is an obligation to be fair and honest. The RESTATEMENT is clear in stating that it is unfair and dishonest for a party seeking enforcement of a contract to assert an interpretation that is contrary to that party’s pre-enforcement understanding. Whether the asserted interpretation is supported by evolving case law, learned treatises, or other authorities is irrelevant to the fundamental issues of fairness and honesty. A party cannot fairly or honestly use the benefit of 20/20 hindsight to excuse the unconscionability of asserting an argument that is entirely inconsistent with the actual fact of its own understanding of a contract. The violation of the covenant of good faith and fair dealing comes not from claiming “the benefit of legal rulings from” the courts, but from the basic unfairness and dishonesty inherent in a contracting party’s

308 Id. at 44-45.309 Emphasis added.


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assertion of a legal position contrary to its factual understanding. It is just not right.310

Under these principles, insurance companies should advise policyholders of their

positions favoring coverage. Because the duty to disclose coverage is based upon the covenant

of good faith and fair dealing, insurance companies that fail to disclose their prior positions

favoring coverage subject themselves to bad faith liability.

Insurance companies generally argue that the duty to disclose is limited to cases

in which (a) the insurance company was on notice that the policyholder was unaware of potential

coverage, and (2) where the policyholder solely relied upon the advice of the insurance company,

and was not represented by an attorney. Neither of these defenses is supported by the caselaw.311

2. Fraudulent Misrepresentation

An insurance company’s failure to disclose insurance coverage may constitute a

fraudulent misrepresentation. A fraudulent misrepresentation may be a falsehood or a “lie of

omission.”312 “A representation need not be an affirmative misstatement; it can arise as easily

from a failure to disclose facts.”313

310 Letter dated June 8, 1994 from Brian R. Ade, counsel for Aetna, to Honorable Robert E. Francis, Aetna Cas. & Sur. v. Morton Int’l, Inc. 311 See Widiss at 87-90. Widiss criticizes an article suggesting that several California precedents support the first defense. Id. at 87-88, criticizing William T. Barker & Donna J. Vobornik, The Scope of the Emerging Duty of First-Party Insurers to Inform Their Insureds of Rights Under the Policy, 25 TORT & INS. L.J. 749, 758 (1989)(discussing Sarchett v. Blue Shield of Ca., 43 Cal. 3d 1, 233 Cal. Rptr. 76, 729 P.2d 267 (1987), and Davis v. Blue Cross, 600 P.2d 1060 (Cal. 1979).312 See Restatement (Second) of Torts § 551 (1977):

One who fails to disclose to another a fact that he knows may justifiably induce the other to ... refrain from acting in a business transaction is subject to the same liability to the other as though he had represented the nonexistence of the matter that he has failed to disclose, if but only if, he is under a duty to the other to exercise reasonable care to disclose the matter in question.

313 See Widiss at 83-85, citing Sinnard v. Roach, 414 N.W.2d 100, 105 (Iowa 1977); Cornell v. Wunschel, 408 N.W.2d 369, 374 (Iowa 1987); Weber v. State Farm Mut. Auto. Ins. Co., 873 F. Supp.


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If an insurance company fails to disclose information which might have assisted

the policyholder in securing coverage, the insurance company’s omission may constitute an

actionable misrepresentation.314 In Weber v. State Farm Mutual Automobile Insurance

Company, the insurance company made indemnity payments to the claimant based on the

claimant’s automobile insurance policy but failed to disclose that there was also coverage

available under the uninsured motorist coverage. The court granted the claimant’s summary

judgment motion “to the extent that in connection with the fraudulent nondisclosure claim the

defendant was under a duty to exercise reasonable care to disclose the uninsured motorist

coverage provisions of the policy.”315

201, 209 (S.D. Iowa 1994).314 Widiss at 85, citing Weber v. State Farm Mut. Auto. Ins. Co., 873 F. Supp. 201, 209 (S.D. Iowa 1994).315 Id.


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3. The Reasonable Expectations Doctrine

a. Origins and Theory

The reasonable expectations doctrine offers an attractive alternative theory upon

which to base the duty to disclose.

[Quote into Firemans fund web site and _____ Ins. L Rew Article]

In a 1970 law review article, Professor (now Judge) Robert Keeton recognized a

broad principle underlying the “congeries of doctrines” which make up the rules of insurance

policy interpretation.316 He identified the principle as follows:

“The objectively reasonable expectations of applicants and intended beneficiaries regarding the terms of insurance contracts will be honored even though painstaking study of the policy provisions would have negated those expectations.”317

The reasonable expectations doctrine, an outgrowth of modern contract theory, is

based in part on the understanding that most policyholders do not draft, negotiate, or assent to the

specific provisions in standard-form insurance policies.318 As many commentators have noted,

most policyholders do not see their policies until after they have purchased coverage; and after

they receive the policies, most policyholders do not read them.319 In most cases, if the

316 Keeton, Insurance Law Rights at Variance with Policy Provisions, 83 HARV. L. REV. 961, 967 (part 1) & 1281 (part 2) (1970).317 See also KEETON, INSURANCE LAW: BASIC TEXT 351 (1971); Keeton, Reasonable Expectations in the Second Decade, 12 FORUM 275 (1976).318 See, e.g., Atwater Creamery Co. v. Western Nat’l Mut. Ins. Co., 366 N.W.2d 271, 277 (Minn. 1985)(“[t]he doctrine of protecting the reasonable expectations of the insured is closely related to the doctrine of contracts of adhesion”).319 See KEETON, INSURANCE LAW: BASIC TEXT 352 (1971). See also C & J Fertilizer, Inc. v. Allied Mut. Ins. Co., 227 N.W.2d 169, 174 (Iowa 1975), citing 7 S. WILLISTON, A TREATISE ON THE LAW OF CONTRACTS § 906B (3d ed. 1959)(“where the document . . . delivered to him is a contract of insurance the majority rule is that the insured is not bound to know its contents”); Atwater Creamery Co. v. Western Nat’l Mut. Ins. Co., 366 N.W.2d 271, 278 (Minn. 1985)(“in certain instances . . . the insured should be held only to reasonable knowledge of the literal terms and conditions”); 3 A. CORBIN, CORBIN ON CONTRACTS § 559 (1964)(“[o]ne who applies for an insurance policy ... may not even read the policy, the number of its terms and the fineness of its print being such as to discourage him”); Note, Unconscionable


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policyholder has assented to anything, it is only to the general scope or type of insurance

coverage provided by the policy, the premium, or the amount of the policy limits. For these

reasons, courts have concluded that the express language of the policy need not provide in literal

terms what the policyholder has come to reasonably expect. One such expectation is that the

insurance company “will respond by clearly specifying what the insured must do to initiate a

claim and, when those actions are taken, will then either pay those benefits or explain why

insurance benefits will not be paid.”320

The doctrine of reasonable expectations, as a specific principle of law, is a

relatively new addition to the body of insurance law.321 It is not, however, a surprising departure

from established legal principles. The reasonable expectations doctrine is an outgrowth of

modern contract theory and is rooted in several well established principles of common law. As

one commentator has noted, Professor Keeton ‘discovered’ the doctrine — “in the more

traditional doctrines with which lawyers are more familiar and comfortable.”322 In Professor

Contracts: The Uniform Commercial Code, 45 IOWA L. REV. 843, 844 (1960)(“[i]t is probably a safe assertion that most involved standardized form contracts are never read by the party who `adheres’ to them. In such situations, the proponent of the form is free to dictate terms most advantageous to himself”).320 Widiss at 82. While Widiss cites no cases directly on point, he quotes Rawlings v. Apodaca, 726 P.2d 565, 571 (Ariz. 1986), in which the Arizona Supreme Court held “that one of the benefits that flow from the insurance contract is the insured’s expectation that his insurance company will not wrongfully deprive him of the very security for which he bargained.” In Apodaca, the insurance company issued a policy covering Rawlings, the victim of a negligent fire. The policy insured only a small portion of the losses. The insurance company failed to disclose that it had also issued a policy to the perpetrator of the fire. The court found that the insurance company’s willful failure to disclose this information not only violated the policyholder’s reasonable expectations of coverage, but also constituted a breach of the duty of good faith and fair dealing. Id.321 Professors Widiss and Keeton write that courts in the early 1960s began to “clearly and explicitly employ[] the doctrine of honoring reasonable expectations.” See ROBERT E. KEETON & ALAN I. WIDISS, INSURANCE LAW: A GUIDE TO FUNDAMENTAL PRINCIPLES, LEGAL DOCTRINE AND COMMERCIAL PRACTICES § 6.3(a)(3), at 632 (Practitioners ed. 1988).322 ROBERT H. JERRY, II, UNDERSTANDING INSURANCE LAW § 25D, at 144 (2d ed. 1996). Professor Jerry explained the common law origins of the reasonable expectations doctrine:


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Keeton’s words, the reasonable expectations doctrine simply recognizes the broad principle

underlying the “congeries of doctrines” comprising the rules of insurance policy interpretation.323

The reasonable expectations doctrine is an objective rule — that is, it protects the

reasonable expectations of insurance coverage that most policyholders would hold — not

subjective beliefs and not idiosyncratic policyholders:

The key to understanding the role played by the expectations principle . . . [is] that the objectively reasonable expectations of the policyholder as to coverage will be honored, notwithstanding contrary policy language. The requirement that the expectations be objectively reasonable is significant . . . because objectively reasonable expectations are those that are likely to be held by the majority of policyholders.324

When the insured’s expectation is created by some kind of ambiguity or vagueness in the policy language, syntax, or organization, something like the doctrine of contra proferentem ... is operating. When the insured’s expectation comes from some assertion by an agent of the insurer or through the insurer’s advertising, something like the doctrine of misrepresentation or deceit is operating. When the insured’s expectation is grounded in an assumption that coverage for the loss in question would exist given the amount of premium charged, something like the doctrine of unconscionability is operating. When the insured’s expectation is part and parcel of the insured’s sudden surprise and dismay at the absence of coverage, something like the doctrine of mistake is operating. When the insured’s expectation comes from the insurer’s invitation to the insured to place trust in the insurer that the insured’s coverage needs will be satisfactorily met, something like an estoppel or reliance theory is operating.

Id. at 144-45 (underscoring added, footnotes omitted).323 See KEETON, INSURANCE LAW: BASIC TEXT 351 (1971); Keeton, Reasonable Expectations in the Second Decade, 12 FORUM 275 (1976).324 Kenneth S. Abraham, A Theory of Insurance Policy Interpretation, 95 MICH. L. REV. 531, 559 (1994)(footnote omitted). Professor Abraham analogized the objective focus of the doctrine of reasonable expectations to two of the doctrine’s common law ancestors:

Thus, the expectations principle does for policyholders as a group what waiver and estoppel did for the individual policyholder-plaintiff: it affords them coverage under policy provisions that are reasonably clear under the circumstances, but not sufficiently clear,


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An objective standard has limits. As Professor Corbin points out: As usually understood, the ‘objective theory’ is based upon a great illusion — the illusion that words, either singly or in combination, have a ‘meaning’ that is independent of the persons who use them. It is crudely supposed that words have a ‘true’, or ‘legal,’ meaning (described as ‘objective’), one that all persons of whatever race, origin, or education are bound to know . . . . As a good dictionary shows, all words have been used by men to convey a variety of meanings, variable with time, place and circumstance. The cheaper and more incomplete the dictionary, and the more parochial and limited the linguistic education and experience of a man, the more firmly fixed is the illusion of ‘an objective meaning’ and the more positive its assertion as the truth.325

That the reasonable expectations doctrine is rooted in the “objectively” reasonable expectations

of the policyholder reveals that the doctrine is not — and was not intended to be — a radical

departure from traditional contract law. The doctrine remains consistent with the rule that “the

terms of a contract are to be interpreted and their legal effects determined as a whole.”326 The

reasonable expectations doctrine could also be viewed as modernizing the objective standard of

contract interpretation so that the particular problems of standard form insurance policies and the

business of insurance are not ignored. Application of the reasonable expectations doctrine

ensures that an insurance policy will not be interpreted in a factual vacuum.327

or at least not sufficiently obvious, to definitively communicate their meaning to the ordinary policyholder.

Id.325 1 Arthur Corbin, Corbin on Contracts § 106, at 474 (1963).326 3 CORBIN § 549, at 183.327 See, e.g., Glidden v. Farmers Auto. Ins. Ass’n, 312 N.E.2d 247, 250 (Ill. 1974), citing Jensen v. New Amsterdam Ins. Co., 213 N.E.2d 141 (Ill. App. Ct. 1965):

An insurance policy is not to be interpreted in a factual vacuum; it is issued under given factual circumstances. What at first blush might appear unambiguous in the insurance contract might not be such in the particular factual setting in which the contract was issued.


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It can be argued that the origin of the reasonable expectations doctrine can be

traced to Lord Mansfield, the father of insurance law. Many years ago, he wrote:

Every under-writer is presumed to be acquainted with the practice of the trade he insures, and that whether it is recently established, or not. If he does not know it, he ought to inform himself. It is no matter if the usage has only been for a year.328

Lord Mansfield’s holding is consistent with the view that an insurance company is expected to

know the policyholder’s objectively reasonable expectations of insurance coverage. Courts have

held that insurance companies selling an insurance policy which specifically excludes insurance

coverage for the policyholder’s essential activities or business are required to provide insurance

coverage.329

Contrary to insurance company arguments, the fundamental purpose of the

reasonable expectations doctrine is to enforce the terms of the original bargain, not to create new

“fairer” deals as the court sees fit. This goal coincides with the aims of traditional contract law.

Insurance companies argue that if the doctrine is applied, policyholders will seek to enforce their

“post-loss” subjective expectations.

The reasonable expectations doctrine is commonly thought of as an extension of

the doctrine of contra proferentem.330 Under the doctrine of contra proferentem, ambiguities are

328 Noble v. Kennoway, 2 Doug. 511, 513 (K.B. 1780), United Kingdom.329 See Howard Ende, Eugene R. Anderson & Susannah Crego, Liability Insurance: Primer for College and University Counsel, 23 J.C. & U. L. 609, 663-68 (Spring 1997)(listing cases). See, e.g., Globe & Rutgers Fire Ins. Co. v. Indiana Reduction Co., 113 N.E. 425, 428 (Ill. App. Ct. 1916); American States Ins. Co. v. Kiger, 662 N.E.2d 945 (Ind. 1996), reh’g denied, (May 31, 1996).330 See Peter J. Kalis, et al., Policyholders Guide To The Law of Insurance Coverage § 20.04, at 20-6 (1st ed. 1997)(Mr. Kalis represents policyholders in insurance coverage disputes); 1 Eugene R. Anderson, et al., Insurance Coverage Litigation § 2.3, at 73-76 (1st ed. 1997).


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to be construed against the drafter.331 In insurance law, it has long been established that

ambiguities are to be construed against the insurance company.332

The purpose of the reasonable expectations doctrine is to provide protection

which goes beyond the doctrine of contra proferentem. While the doctrine of contra

proferentem can only be applied if the insurance policy contains an ambiguity, the Keeton

331 See BARRY R. OSTRAGER & THOMAS R. NEWMAN, HANDBOOK ON INSURANCE COVERAGE DISPUTES § 1.03[b][1], at 13-14 (7th ed. 1994)(listing cases). Ostrager and Newman are attorneys who regularly represent insurance companies in insurance coverage disputes. The term contra proferentem comes from the Latin phrase verba chartarum fortius accipiuntur contra proferentem. 3 A. CORBIN, CORBIN ON CONTRACTS § 559 (2d ed. 1960). The term is defined to mean “against the party who proffers or puts forward a thing.” BLACK’S LAW DICTIONARY 393 (4th ed. 1951). See also BLACK’S LAW DICTIONARY (6th ed. 1990), providing the same definition but spelling the doctrine as contra proferentum.332 See BARRY R. OSTRAGER & THOMAS R. NEWMAN, HANDBOOK ON INSURANCE COVERAGE DISPUTES § 1.03[b][1], at 13-14 (7th ed. 1994), quoting Liverpool & London & Globe Ins. Co. v. Kearney, 180 U.S. 132, 135-6 (1901) (“[T]he general rule . . . is . . . that where a policy of insurance is so framed to leave room for two constructions, the words used should be interpreted most strongly against the insurer”(cases in accord omitted)).


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formulation of the reasonable expectations doctrine333 recognizes that a reasonable expectation of

insurance coverage can exist without an ambiguity in the policy:

While ambiguities may be highly relevant in determining the reasonable expectations of the insured, nevertheless the invocation and application of the doctrine does not depend for its existence upon the presence of ambiguities.334

333 A term is generally considered to be ambiguous if it is “fairly susceptible to two different reasonable interpretations.” See PETER J. KALIS, ET AL., POLICYHOLDERS GUIDE TO THE LAW OF INSURANCE COVERAGE § 20.07, at 20-13 and 20-14 (1st ed. 1997)(listing cases and authorities); 1 EUGENE R. ANDERSON, ET AL., INSURANCE COVERAGE LITIGATION § 2.2, at 49 (1st ed. 1997)(a term is patently ambiguous if it is susceptible on its face to more than one reasonable interpretation). An ambiguous term is often a term which is clear until it is applied to a particular set of facts. For example, in Bird v. St. Paul Fire & Marine Insurance Co., 224 N.Y. 47, 120 N.E. 86 (1918) a fire started in some freight cars loaded with explosives. There was an explosion, causing another fire which in turn caused a much larger explosion. The last explosion caused a concussion in the air which damaged the policyholder’s boat, lying in the harbor about one thousand feet away. The policyholder owned a fire insurance policy and sought insurance coverage under the terms of the policy. Justice Cardozo, writing for the high court of New York, held that there was no insurance coverage. The decision, though discussing the meaning of proximate cause, sets forth the proper standard to determine whether a genuine ambiguity exists:

We must put ourselves in the place of the average owner whose boat or building is damaged by the concussion of a distant explosion, let us say a mile away. Some glassware in his pantry is thrown down and broken. It would probably never occur to him that within the meaning of his policy of insurance, he had suffered loss by fire. A philosopher or lawyer might persuade him that he had, but he would not believe it until they told him.

120 N.E.2d at 87. Thus:

There is no use in arguing that distance ought not to count, if life and experience tells us that it does. The question is not what men ought to think of as a cause. The question is what they do think of as a cause.

Id. (emphasis added).

In determining whether a term is ambiguous, many courts consider whether dictionaries provide differing definitions for the same term or whether other courts have reached contrary meanings for the same term. Differing judicial interpretations may either establish an ambiguity or be evidence of an ambiguity. See Kalis, id. (listing cases). For examples listed therein, see e.g. Crawford v. Prudential Ins. Co., 783 P.2d 900, 908 (Kan. 1989)(“reported cases are in conflict, the trial judge and the Court of Appeals reached different conclusions and the justices of this court [disagree]. Under such circumstances, the clause is, by definition, ambiguous and must be interpreted in favor of the insured); New Castle County v. Hartford Accident & Indem. Co., 933 F.2d 1162, 1198 (3d Cir. 1991), cert. denied, 113 S. Ct. 1846 (U.S. 1993)


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Requiring an ambiguity in the policy language before applying the reasonable expectations

doctrine would render the doctrine a mere redundancy of contra proferentem:

If the doctrine of reasonable expectations is limited to ambiguous contracts, it is not a doctrine at all; it is nothing more than the traditional rule that ambiguous contracts be interpreted against the drafter. Only if courts discard the fiction that consumers read form language, unambiguous or otherwise, will contracting parties realize their reasonable expectations.335

The RESTATEMENT (SECOND) OF CONTRACTS contains a model version of the

reasonable expectations doctrine which does not require an ambiguity in the policy. It states that

with respect to standard-form type336 contracts:

(2) Such a writing is interpreted wherever reasonable as treating alike all those similarly situated, without regard to their knowledge or understanding of the standard terms of the writing. (3) Where the other party has reason to believe that the party manifesting such assent would not do so if he knew that the writing contained a particular term, the term is not part of the agreement.337

(“That so many learned jurists throughout the nation differ on the construction of this phrase, is, in our view, additional proof that the phrase admits of two reasonable constructions.”); New Castle, at 1198 (“our dictionaries, like the district court’s, define ‘sudden’ both with and without a temporal element, thus lending considerable weight to the County’s assertion that either interpretation is reasonable.”).334 COUCH ON INSURANCE 3d § 22:11, at 22-25 (Lee R. Russ & Thomas Segalla, eds., 1995). Some jurisdictions, however, do require an ambiguity in the policy language before applying the doctrine of reasonable expectations. 335 M. Meyerson, The Reunification of Contract Law: The Objective Theory of Consumer Form Contracts, 47 U. MIAMI L. REV. 1263, 1281 (1993).336 Subsection (1) specifically states:

(1) Except as stated in Subsection (3), where a party to an agreement signs or otherwise manifests assent to a writing and has reason to believe that like writings are regularly used to embody terms of agreements of the same type, he adopts the writing as an integrated agreement with respect to the terms included in the writing.

Restatement (Second) of Contracts §211 (1979).337 Restatement (Second) of Contracts §211 (1979).


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Terms “beyond the range of reasonable expectations” are not enforceable against

the adhering party.338 Terms are considered to be “beyond the range of reasonable expectations

when “the other party has reason to believe that the adhering party would not have accepted . . .

had [the party] known that the agreement contained the particular term. This would include a

term which is “bizarre or oppressive,” “eviscerates the nonstandard terms explicitly agreed to, or

“eliminates the dominant purpose of the transaction.” The Restatement version of the reasonable

expectations doctrine was specifically adopted by the Arizona Supreme Court.339

Certainly, insurance policy terms often are ambiguous. But relying on

“ambiguity” as a catch-all solution is dangerous. Doing so “invites the drafter to keep rewriting

until the provisions, although possibly unfair, are acceptably unambiguous.”340 Nevertheless,

some courts hold that the reasonable expectations of the policyholder will be invoked only if

there is an ambiguity in the policy — effectively blending the doctrine of reasonable

expectations with the doctrine of contra proferentem.341

338 Restatement (Second) of Contracts §211, cmt. f, (1979).339 See Darner Motor Sales, Inc. v. Universal Underwriters Ins., 682 P.2d 388 (Ariz. 1984). For a discussion of the application of the Restatement version of the reasonable expectations doctrine, see Amy D. Cubbage, Note, The Interaction of the Doctrine of Reasonable Expectations and Ambiguity in Drafting: The Development of the Kentucky Formulation, 85 KY. L.J. 435 (Winter 1996/1997).340 K. Llewellyn, Book Review, 52 HARV. L. REV. 700, 701 (1939).341 The following is a non-exhaustive list of courts in thirty-four jurisdictions which have recognized some variation of the reasonable expectations doctrine:

Alabama: Travelers Ins. Co. v. Jones, 529 So. 2d 234, 239 (Ala. 1988); Lambert v. Liberty Mut. Ins. Co., 331 So. 2d 260 (Ala. 1976);

Alaska: Stewart-Smith Haidinger v. Avi-Truck, Inc., 682 P.2d 1108 (Alaska 1986); U.S. Fire Ins. Co. v. Clover, 600 P.2d 1 (Alaska 1979); Puritan Life Ins. Co. v. Guess, 598 P.2d 900 (Alaska 1979); Stordahl v. Government Employees Ins. Co., 564 P.2d 63 (Alaska 1977); INA Life Ins. Co. v. Brundin, 533 P.2d 236 (Alaska 1975); National Indem. Co. v. Flesher, 469 P.2d 360 (Alaska 1970).

Arizona: Gordinier v. Aetna Cas. & Sur. Co., 154 Ariz. 266, 742 P.2d 277 (1987); Darner Motor Sales, Inc. v. Universal Underwriters Ins. Co., 140 Ariz. 383, 682 P.2d 388 (1984); Zuckerman v. Transamerica Ins. Co., 133 Ariz. 139, 650 P.2d 441 (1982), Mason v. State Farm Mut. Auto. Ins. Co., 148 Ariz. 271, 714 P.2d 441 (Ct. App. 1985); Cain v. Aetna Life Ins. Co., 135 Ariz. 189, 659 P.2d 133 (Ct. App. 1983);


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Courts have adopted three general variations of the reasonable expectations

doctrine: (1) restricting the doctrine of reasonable expectations to ambiguous terms only; (2)

applying the doctrine to determine whether “fine print” unfairly limits the policyholder’s more

prominent reasonable expectations, and; (3) looking to the “whole transaction” to determine

whether the policyholder’s reasonable expectations have been negated.342 The doctrine of

reasonable expectations may also be properly invoked where the premium charged does not truly

California: Hanson v. Prudential Ins. Co., 772 F.2d 580 (9th Cir. 1985), modified and reh’g denied en banc, 783 F.2d 762 (9th Cir. 1985); Continental Cas. Co. v. City of Richmond, 763 F.2d 1076 (9th Cir. 1985); McLaughlin v. Connecticut Gen. Life Ins. Co., 565 F. Supp. 434 (N.D. Cal. 1983); Wilson v. Insurance Co. of N. Am., 453 F. Supp. 732 (N.D. Cal. 1978); AIU Ins. Co. v. Superior Court (FMC Corp.), 51 Cal. 3d 807, 799 P.2d 1253, 274 Cal. Rptr. 820 (1990) (en banc); Smith v. Westland Life Ins. Co., 15 Cal. 3d 111, 539 P.2d 433, 123 Cal. Rptr. 649 (1975); Gyler v. Mission Ins. Co., 10 Cal. 3d 216, 514 P.2d 1219, 110 Cal. Rptr. 139 (1973);

Colorado: Davis v. M.L.G. Corp., 712 P.2d 985 (Colo. 1986);

Delaware: Del Collo v. Houston, Civ. No. 83C-JA-121, 1986 Del. Super. LEXIS 1236 (Del. Super. Ct. May 7, 1986); Steigler v. Insurance Co. of N. Am., 384 A.2d 398 (Del. 1978);

District of Columbia: Owens - Illinois, Inc. v. Aetna Cas. & Sur. Co. , 597 F. Supp. 1515 (D.D.C. 1984);

Georgia: Macon Light House Revival Center, Inc. v. Continental Ins. Co., 651 F. Supp. 417 (M.D. Ga. 1987); Southeastern Fire Ins. Co. v. Heard, 626 F. Supp. 476 (N.D. Ga. 1985);

Hawaii: Crawford v. Ranger Ins. Co., 653 F.2d 1248 (9th Cir. 1981); Okada v. MGIC Indem. Corp., 608 F. Supp. 383 (D. Haw. 1985), aff’d in part and rev’d in part, 795 F.2d 1450 (9th Cir. 1986), amended, 823 F.2d 276 (9th Cir. 1987); Fortune v. Wong, 68 Haw. 1, 702 P.2d 299 (1985).

Indiana: Eli Lilly & Co. v. Home Ins. Co., 794 F.2d 710 (D.C. Cir. 1986), cert. denied, 479 U.S. 1060 (1987);

Iowa: Grinnell Mut. Reins. Co. v. Voeltz, 431 N.W.2d 783, 786 (Iowa 1988); Farm Bureau Mut. Ins. Co. v. Sandbulte, 302 N.W.2d 104 (Iowa 1981); Gibson v. Milwaukee Mut. Ins. Co., 265 N.W.2d 742 (Iowa 1978); Steinbach v. Continental W. Ins. Co., 237 N.W.2d 780 (Iowa 1976); C&J Fertilizer, Inc. v. Allied Mut. Ins. Co., 227 N.W.2d 169 (Iowa 1975); Rodman v. State Farm Mut. Auto. Ins. Co., 208 N.W.2d 903 (Iowa 1973); City of Cedar Rapids v. Insurance Co. of N. Am., 562 N.W.2d 156 (Iowa 1997); Global Aviation Ins. Managers v. Lees, 368 N.W.2d 209 (Iowa Ct. App. 1985);

Kansas: Dronge v. Monarch Ins. Co., 511 F. Supp. 1 (D. Kan. 1979);

Kentucky: Woodson v. Manhattan Life Ins. Co., 743 S.W.2d 835, 839 (Ky. 1987); Ohio Cas. Ins. Co. v. Stanfield, 581 S.W.2d 555 (Ky. 1979);

Louisiana: Louisiana Ins. Guar. Ass’n v. Interstate Fire & Cas. Co., 630 So. 2d 759 (La. 1994); Breland v. Schilling, 550 So. 2d 609 (La. 1989);

Maine: Peerless Ins. Co. v. Brennon, 564 A.2d 383 (Me. 1989); Baybutt Constr. Corp. v. Commercial Union Ins. Co., 455 A.2d 914 (Me. 1983)

Massachusetts: Davenport Peters Co. v. Royal Globe Ins. Co., 490 F. Supp. 286 (D. Mass. 1980); Home Indem. Ins. Co. v. Merchants Distributors, Inc., 396 Mass. 103, 483 N. E.2d 1099 (1985); Bond Bros. v.


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reflect “the actual scope of the risk that the policy provisions define.”343 In effect, “[c]onstruing

an insurance policy to protect the insured’s ‘reasonable expectations’ means different things to

different courts.”344

The “whole transaction” version of the reasonable expectations doctrine reflects

the most narrow version of the doctrine as originally set forth by Professor Keeton. This version

Robinson, 393 Mass. 546, 471 N.E.2d 1332 (1984). But see Jefferson Ins. Co. v. City of Holyoke, 23 Mass. App. Ct. 472, 477, 503 N.E.2d 474, 478 (1987) (reasonable expectations doctrine “does not appear to have been explicitly adopted in Massachusetts”);

Michigan: Crowell v. Federal Life & Cas. Co., 397 Mich. 614, 247 N.W.2d 503 (1976); Fresard v. Michigan Millers Mut. Ins. Co., 97 Mich. App. 584, 296 N.W.2d 112 (1980), aff’d, 414 Mich. 686, 327 N.W.2d 286 (1982);

Minnesota: Auto - Owners Ins. Co. v. Jensen , 667 F.2d 714, 721 (8th Cir. 1981); Atwater Creamery Co. v. Western Nat’l Mut. Ins. Co., 366 N.W.2d 271, 278-79 (Minn. 1985); Arndt v. American Family Mut. Ins. Co., 380 N.W.2d 885 (Minn. Ct. App. 1985), aff’d in part and rev’d in part, 394 N.W.2d 791 (Minn. 1986);

Mississippi: Brown v. Blue Cross & Blue Shield, Inc., 427 So. 2d 139 (Miss. 1983);

Missouri: Wright v. Newman, 598 F. Supp. 1178 (W.D. Mo. 1984), aff’d, 767 F.2d 460 (8th Cir. 1985); Katz Drug Co. v. Commercial Standard Ins. Co., 647 S.W.2d 831 (Mo. Ct. App. 1983);

Montana: Transamerica Ins. Co. v. Royle, 202 Mont. 173, 656 P.2d 820 (1983);

Nebraska: Kracl v. Aetna Cas. & Sur. Co., 220 Neb. 869, 374 N.W.2d 40, 44 (1985); Nile Valley Cooperative Grain Milling Co. v. Farmers Elevator Mut. Ins. Co., 187 Neb. 720 193 N.W.2d 752 (1972);

Nevada: Farmers Ins. Exch. v. Young, 108 Nev. 328, 832 P.2d 376 (1992); National Union Fire Ins. Co. v. Caesars Palace Hotel & Casino, 106 Nev. 330, 792 P.2d 1129 (1990) (per curiam); National Union Fire Ins. Co. v. Reno’s Executive Air, Inc., 100 Nev. 360, 364-66, 682 P.2d 1380, 1383 (1984); Prudential Ins. Co. v. Lamme, 83 Nev. 146, 425 P.2d 346 (1967); Sullivan v. Dairyland Ins. Co., 98 Nev. 364, 649 P.2d 1357 (1982) (per curiam); Catania v. State Farm Life Ins. Co., 95 Nev. 532, 598 P.2d 631 (1979).

New Hampshire: Great Lakes Container Corp. v. Nation Union Fire Ins. Co., 727 F.2d 30, 34 (1st Cir. 1984); Commercial Union Assur. Co. v. Aetna Cas. & Sur. Co., 455 F. Supp. 1190 (D.N.H. 1978); Town of Epping v. St. Paul Fire & Marine Ins. Co., 122 N.H. 248, 444 A.2d 496 (1982); Atwood v. Hartford Accident & Indem. Co., 116 N.H. 636, 365 A.2d 744 (1976);

New Jersey: Van Orman v. American Ins. Co., 680 F.2d 301 (3d Cir. 1982); McNeilab, Inc. v. North River Ins. Co., 645 F. Supp. 525 (D.N.J. 1986), aff’d without opinion, 831 F.2d 287 (3d Cir. 1987); Meier v. New Jersey Life Ins. Co., 101 N.J. 597, 503 A.2d 862 (1986); Sparks v. St. Paul Ins. Co., 100 N.J. 325, 495 A.2d 406 (1985); Gerhardt v. Continental Ins. Cos., 48 N.J. 291, 225 A.2d 328 (1966); Kievet v. Loyal Protective Life Ins. Co., 34 N.J. 475, 170 A.2d 22 (1961); Lerhroff v. Aetna Cas. & Sur. Co., 271 N.J. Super 240, 638 A.2d 889 (App. Div. 1994);

New Mexico: Woodmen Accident & Life Ins. Co. v. Bryant, 784 F.2d 1052 (10th Cir. 1986); Konnick v. Farmers Ins. Co., 103 N.M. 112, 703 P.2d 889 (1985); Pribble v. Aetna Life Ins. Co., 84 N.M. 211, 501 P.2d 255 (1972); Read v. Western Farm Bureau Mut. Ins. Co., 90 N.M. 369, 563 P.2d 1162 (Ct. App.


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evaluates both the reasonable expectations of the policyholder according to the language and

structure of the policy (the fine print approach) and also evaluates the “marketing patterns and

general practices” of the insurance company.345 Courts following the “whole transaction”

approach recognize that merely reviewing the policy language is insufficient to determine the

scope of insurance coverage a policyholder reasonably believed it had bought.346

1977);

New York: Fried v. North River Ins. Co., 710 F.2d 1022 (4th Cir. 1983); Board of Educ., Yonkers City Sch. Dist. v. CNA Ins. Co., 647 F. Supp. 1495 (S.D.N.Y. 1986), aff’d, 839 F.2d 14 (2d Cir. 1988); Champion Int’l Corp. v. Continental Cas. Co., 400 F. Supp. 978 (S.D.N.Y. 1975), aff’d, 546 F.2d 502 (2d Cir. 1976), cert. denied, 434 U.S. 819 (1977); Atlantic Cement Co. v. Fidelity & Cas. Co., 91 A.D.2d 412, 459 N.Y.S.2d 425 (1st Dep’t 1983), aff’d, 63 N.Y.2d 798, 471 N.E.2d 142, 481 N.Y.S.2d 329 (1984); I Q Originals, Inc. v. Boston Old Colony Ins. Co., 85 A.D.2d 21, 447 N.Y.S.2d 174 (1st Dep’t), aff’d, 58 N.Y.2d 651, 444 N.E.2d 1004, 458 N.Y.S.2d 540 (1982);

North Carolina: Great Am. Ins. Co. v. C.G. Tate Constr. Co., 303 N.C. 387, 279 S.E.2d 769 (1981);

North Dakota: Mills v. Agrichemical Aviation, Inc., 250 N.W.2d 663 (N.D. 1977); but cf. Walle Mut. Ins. Co. v. Sweeney, 419 N.W.2d 176 (N.D. 1988);

Pennsylvania: Tonkovic v. State Farm Mut. Auto. Ins. Co., 513 Pa. 445, 521 A.2d 920 (1987); Collister v. Nationwide Life Ins. Co., 479 Pa. 579, 388 A.2d 1346 (1978), cert. denied, 439 U.S. 1089 (1979); cf. Standard Venetian Blind Co. v. American Empire Ins. Co., 503 Pa. 300, 469 A.2d 563 (1983); Beckham v. Travelers Ins. Co., 424 Pa. 107, 225 A. 2d 532 (1967); Gdovic v. Catholic Knights of St. George, 308 Pa. Super. 6, 453 A.2d 1040 (1982);

Rhode Island: Gleason v. Merchants Mut. Ins. Co., 589 F. Supp. 1474 (D.R.I. 1984); American Universal Ins. Co. v. Russell, 490 A.2d 60 (R.I. 1985); Elliott Leases Cars, Inc. v. Quigley, 118 R.I. 321, 373 A.2d 810 (1977);

Texas: Fritz v. Old Am. Ins. Co., 354 F. Supp. 514 (S.D. Tex. 1973);

West Virginia: National Mut. Ins. Co. v. McMahon & Sons, Inc., 356 S.E.2d 488, 495-96 (W. Va. 1987);

Wisconsin: Lund v. American Motorists Ins. Co., 619 F. Supp. 1535 (W.D. Wis. 1985), aff’d in part and rev’d in part, 797 F.2d 544 (7th Cir. 1986); Gross v. Lloyd’s of London Ins. Co., 121 Wis.2d 78, 358 N.W.2d 266 (1984).

See 1 Eugene R. Anderson, et al., Insurance Coverage Litigation § 2.7, at 68-69 (1st ed. 1997); Barry R. Ostrager & Thomas R. Newman, Handbook on Insurance Coverage Disputes § 1.03[b][2][B], at 21-24 (7th ed. 1994). For an excellent discussion of many of these cases, as well as an analysis of specific jurisdictions and a comparison of how courts have interpreted Professor Keeton’s doctrine, See Roger C. Henderson, Symposium: Current Issues In Insurance Law: Article: The Doctrine of Reasonable Expectations In Insurance Law After Two Decades, 51 Ohio St. L.J. 823 (Fall 1990).342 See Stephen J. Ware, A Critique of the Reasonable Expectations Doctrine, 56 U. CHI. L. REV. 1461, 1467-75 (Fall 1989).


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While the approach to applying the reasonable expectations doctrine has varied

from court to court, the reasons supporting the application of the doctrine, however, have

remained consistent — regardless of which approach a court has chosen to adopt.

b. Standardized Form Language and Contracts of Adhesion

During the early days of Lloyd’s Coffee House in the sixteenth and seventeenth

centuries, merchant shipowners seeking insurance coverage, and the underwriters willing to

provide it, entered into transactions with relatively equal bargaining power.347 Not only were

most merchant policyholders at least as wealthy as the underwriters, but it was not uncommon

for the policyholder to prepare the insurance policy and submit it to the underwriters, who would

then agree to underwrite a specific dollar amount.348 In this respect, the policyholder’s

343 Widiss 6.3(c)(1), at 642, quoting Vargas v. Ins. Co. of N. Am., 651 F.2d 838, 841 (2d Cir. 1981). In Vargas, the insurance company argued that insurance coverage was properly denied where the policyholder’s plane crashed beyond the territorial limits “unambiguously” set forth in the policy. The court found:

The fact that coverage of the entire Caribbean, including the ocean areas, cost only an additional fifty dollars undermines the argument that substantial additional risks are involved. Moreover, INA offers no evidence that over-water flights between covered locations are more dangerous than flights over points . . . expressly covered by the policy and that include vast mountain ranges, lakes, deserts, and urban centers with heavy air traffic. Common sense and experience contradict INA’s assertion that over-water flights add materially to these explicitly covered risks.

344 Id. at 1466.345 Stephen J. Ware, A Critique of the Reasonable Expectations Doctrine, 56 U. CHI. L. REV. 1461, 1472-73 (Fall 1989), quoting Keeton, 83 HARV. L. REV. at 973. 346 Id.347 See Robert E. Keeton & Alan I. Widiss, Insurance Law: A Guide To Fundamental Principles, Legal Doctrine and Commercial Practices § 6.3(a)(1), at 627-28 (Practitioners ed. 1988). 348 Id.


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expectations of insurance coverage “were at least as accurately described as those of the

insurer(s).”349

Times have changed. Today, standard form insurance policies are drafted:

with the aid of skillful and highly paid legal talent, from which no deviation desired by an applicant will be permitted. The established underwriter is magnificently qualified to understand and protect its own selfish interests. In contrast, the applicant is a shorn lamb driven to accept whatever contract may be offered on a “take-it-or-leave-it” basis if he wishes insurance protection.350

The classic model of freely negotiated agreements is “far removed from the reality of the

business of insurance.”351 Even insurance companies have acknowledged the futility of

determining a policyholder’s reasonable expectations of coverage based on the language of the

insurance policy alone:

Because of the way the insurance industry operates, most of the relevant policy language is found in standardized insuring forms, drafted by insurance associations or bureaus, and used industry-wide. Thus, questions of intent may be addressed on a standardized basis. Predictably, there will be precious little evidence of the negotiation of individual policies. The primary evidence of the intent of the parties drafting the contracts, and their expectations about the scope of coverage, will be obtained through document productions from key industry wide organizations, and depositions of their personnel.352

It makes no sense to rely on contract remedies when even insurance companies believe that

extrinsic evidence — not the policies themselves — is the best way to determine a policyholder’s

expectations of insurance coverage.

349 Id.350 Samuel Williston, A Treatise on the Law of Contracts § 900, at 19-20 (3d ed. W. Jaeger 1973).351 Robert H. Jerry, II, Understanding Insurance Law § 25C, at 139 (2d ed. 1996).352 Travelers’ Reply Memorandum in Support of Coordination; In Opposition to GAF’s Motion of Separate Hearing, and Exhibits in Support Thereof, filed Jan. 2, 1981, Armstrong Cork Co. v. Aetna Cas. & Sur. Co., No. C315367 (Cal. Super. Ct., Los Angeles County).


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The modern standard form insurance policy has long been recognized as the

“archetypal ‘adhesion’ contract:”353 One commentator has set forth the seven qualities that

“define the model contract of adhesion.”354 Note that most standard form insurance policies

possess all of the these characteristics in some, and often, to a high degree:

(1) The document whose legal validity is at issue is a printed form that con-tains many terms and clearly purports to be a contract.

(2) The form has been drafted by, or on behalf of, one party to the transaction.

(3) The drafting party participates in numerous transactions of the type repre-sented by the form and enters into these transactions as a matter of routine.

(4) The form is presented to the adhering party with the representation that, except perhaps for a few identified items (such as the price term), the drafting party will enter into the transaction only on the terms contained in the document. The representation may be explicit or may be implicit in the situation, but it is understood by the adherent.

(5) After the parties have dickered over whatever terms are open to bargain-ing, the document is signed by the adherent.

(6) The adhering party enters into few transactions of the type represented by the form — few, at least, in comparison with the drafting party.

(7) The principal obligation of the adhering party in the transaction considered as a whole is the payment of money.355

With standard form policies and contract of adhesion, there is no freedom of

contract. As one commentator noted:

353 See Stephen J. Ware, A Critique of the Reasonable Expectations Doctrine, 56 U. CHI. L. REV. 1461, 1464 (Fall 1989). For an extensive discussion on insurance policies as contracts of adhesion, see 1 EUGENE R. ANDERSON ET AL., INSURANCE COVERAGE LITIGATION § 2.1, at 45-48 (1st ed. 1997). The term was coined nearly a century ago by a French commentator. See R. SALEILLES, DE LA DECLARATION DE VOLONTE 229-30 (1901)(translated in W. Patterson, The Interpretation and Construction of Contracts, 64 COLUM. L. REV. 833, 856 (1964). It is interesting to note that in the United States, the term was first used in an insurance coverage case. See Bekken v. Equitable Life Assurance Soc’y, 293 N.W. 200, 212 (N.D. 1940).354 T.D. Rakoff, Contracts of Adhesion: An Essay in Reconstruction, 96 HARV. L. REV. 1173 (1983).355 Id. at 1176.


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Freedom of contract enables enterprisers to legislate by contract and, what is even more important, to legislate in a substantially authoritarian manner without using the appearance of authoritarian forms. Standard contracts in particular could thus become effective instruments in the hands of powerful industrial and commercial overlords enabling them to impose a new feudal order of their own making upon a vast host of vassals.356

The insurance companies, not an activist judiciary or renegade policyholders, have destroyed the

freedom to contract. The reasonable expectations doctrine attempts to re-inject — not remove —

a limited amount of freedom to contract. Under standard form policy language, that freedom

was never there.

Insurance policies are interpreted as a reasonable lay person or ordinary purchaser

of insurance would understand them.357 Insurance policies are not always interpreted according

to a lay person’s or an average policyholder’s understanding because interpretations of insurance

policies are governed by two legal rules that severely restrict policyholders’ claims. The first is

that questions of insurance policy interpretation are for judges — not juries. The judiciary

zealously guards its self-assumed role as the arbiter of what insurance policies mean. This

means that insurance coverage is determined in large measure by the idiosyncrasies of judges.

The result is that the rules are rules of individuals and not rules of law. The second legal rule is

that judges determine what an “ordinary” purchaser of insurance would understand. Almost by

definition, judges are not “ordinary.” In most other areas of the law, we have juries to determine

what is “ordinary.” After the fire, every idiot knows that kerosene should not be stored near a

propane water heater. The real question is whether before the fire, could it have been “ordinary”

to store kerosene by the water heater? Judges engage in “post-claim” underwriting as do

356 Kessler, Contracts of Adhesion -- Some Thoughts About Freedom of Contract, 43 COLUM L. REV. 629, 640 (1943).357 See 1 Eugene R. Anderson et al., Insurance Coverage Litigation § 2.5, at 62-63 (1st ed. 1997)(listing cases).


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insurance companies.358 Judges and juries (if given the opportunity) would most likely often

differ in their reasoning and conclusions.

The reasonable expectations doctrine does not require that an insurance policy

state in literal terms the insurance coverage that a policyholder has come to reasonably expect.359

Rather, the doctrine is based in part on the understanding that most policyholders do not draft,

negotiate, or assent to the specific provisions in standard-form insurance policies.360 In nearly all

cases, if the policyholder has assented to anything, it is only to the general scope or type of

insurance coverage provided by the policy, the premium, or the amount of the policy limits. As

many commentators have noted, most policyholders do not see their policies until after they have

358 A superb description of post-claim underwriting is as follows:

THINGS PICK UP A BIT on Tuesday, partly because I’m getting tired of wasting time, partly because the witnesses either know little or can’t remember much. I start with Everett Lufkin, Vice President of Claims, a man who’ll not utter a single syllable unless it’s a response to a direct question. I make him look at some documents, and halfway through the morning he finally admits it’s company policy to do what is known as “post-claim underwriting,” an odious but not illegal practice. When a claim is filed by an insured, the initial handler orders all medical records for the preceding five years. In our case, Great Benefit obtained records from the Black family physician who had treated Donny Ray for a nasty flu five years earlier. Dot did not list the flu on the application. The flu had nothing to do with the leukemia, but Great Benefit based one of its early denials on the fact that the flu was a preexisting condition.

John Grisham, THE RAINMAKER at 295 (1st ed. 1995).359 See e.g. Storms v. United States Fidelity & Guar. Co., 118 N.H. 427, 338 A.2d 578, 580 (1978).

If a policy is so constructed that a reasonable man in the position of the insured would not attempt to read it, the insured’s reasonable expectations will not be delimited by the policy language, regardless of the clarity of the particular phrase among the Augean stable of print.

360 See, e.g., Atwater Creamery Co. v. Western Nat’l Mut. Ins. Co., 366 N.W.2d 271, 277 (Minn. 1985)(“[t]he doctrine of protecting the reasonable expectations of the insured is closely related to the doctrine of contracts of adhesion”).


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purchased insurance coverage. That most policyholders do not read their policies after they

receive them is nearly universally accepted:

[T]he adhering party is in practice unlikely to have read the standard terms before signing the document and is unlikely to have understood them if he has read them. Virtually every scholar who has written about contracts of adhesion has accepted the truth of this assertion, and the few empirical studies that have been done have agreed.361

Virtually no one expects the policyholder to have read or understood the language of a standard

form insurance policy:362

[a] party who makes regular use of a standardized form of agreement does not ordinarily expect his customers to understand or even to read the standard terms . . . . Customers do not in fact ordinarily understand or even read the standard terms.363

This includes the insurance industry:

Insurance agents and consumers usually discuss the consumer’s broad insurance needs and whether the insurer can satisfy those needs at an acceptable price. Discussion is usually limited to the few terms that are inserted into blanks in the contract. The insurer does not expect the insured to understand all the terms and usually

361 T.D. Rakoff, Contracts of Adhesion: An Essay in Reconstruction, 96 HARV. L. REV. 1173, 1179 (1983). See also KEETON, INSURANCE LAW: BASIC TEXT 352 (1971); C & J Fertilizer, Inc. v. Allied Mut. Ins. Co., 227 N.W.2d 169, 174 (Iowa 1975), citing 7 S. WILLISTON, A TREATISE ON THE LAW OF CONTRACTS § 906B (3d ed. 1959)(“where the document . . . delivered to him is a contract of insurance the majority rule is that the insured is not bound to know its contents”); Atwater Creamery Co. v. Western Nat’l Mut. Ins. Co., 366 N.W.2d 271, 278 (Minn. 1985)(“in certain instances . . . the insured should be held only to reasonable knowledge of the literal terms and conditions”); 3 A. CORBIN, CORBIN ON CONTRACTS § 559 (1964)(“[o]ne who applies for an insurance policy . . . may not even read the policy, the number of its terms and the fineness of its print being such as to discourage him”); Note, Unconscionable Contracts: The Uniform Commercial Code, 45 IOWA L. REV. 843, 844 (1960)(“[i]t is probably a safe assertion that most involved standardized form contracts are never read by the party who `adheres’ to them. In such situations, the proponent of the form is free to dictate terms most advantageous to himself”).362 See e.g., W.D. Slawson, The New Meaning of Contract: The Transformation of Contracts Law By Standard Forms, 46 U. PITT L. REV. 21, 26 (1984) (“[U]nder the conditions of modern contracting, buyers are not reasonably expected even to read the forms before they are bound.”).363 Restatement (Second) of Contracts § 211 cmt. b (1979):


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makes no attempt to explain them. Exclusions and limitations, as well as most other “boilerplate” provisions, are not discussed.364

But the insurance industry wants to have their cake and eat it too. Nearly all

insurance companies use identical standard form language drafted by the Insurance Services

Office, Inc. (“ISO”). This is why most insurance policies are identical, and why, except for

perhaps negotiating the premium to be paid, “shopping around” for different insurance coverage

is futile.365 Moreover, insurance companies know, or should know, that it is pointless for 364 Note, A Common Law Alternative to the Doctrine of Reasonable Expectations in the Construction of Insurance Contracts, 57 N.Y.U. L. REV. 1175, 1181 (1982)(footnotes omitted).365 The insurance industry’s exemption from antitrust regulation allows different insurance companies to use identical policy language. Congress exempted the insurance industry from antitrust regulation in the McCarran-Ferguson Insurance Regulation Act, 15 United States Code Annotated §§ 1011-1015 (1945). Exemption from antitrust regulation helps explain why “[i]nsurance is far from the market ideals of complete information . . . .” E.I. du Pont De Nemours & Co. v. Pressman, 679 A.2d 436, 447 (Del. 1996) (quoting Mark Pennington, Punitive Damages for Breach of Contract: A Core Sample from the Decisions of the Last Ten Years, 42 ARK. L. REV. 31, 54 (1989)). The effects of antitrust exemption supports the arguments that contract damages are inadequate for opportunistic breach of insurance policies. The insurance industry’s exemption from antitrust regulation gives insurance companies a tremendous litigation and organizational advantage. Exemption from antitrust regulation allows insurance companies to exchange vast amounts of allegedly confidential insurance industry information and documents. Policyholders are deprived of this same information and those same documents.

The McCarran-Ferguson Act was the result of the United States Supreme Court decision in United States v. South-Eastern Underwriters Ass’n, where the Court rejected insurance company arguments that insurance was not commerce and held that Congress could properly apply federal antitrust statutes to the insurance industry. United States v. South-Eastern Underwriters Ass’n, 322 U.S. 533 (1944). Exemption from antitrust regulation indicates the influence of the insurance industry over the legislative process. As one noted commentator tells it:

This decision sent shivers down the spines of insurance company executives, who feared the prospect of federal agencies, particularly the Federal Trade Commission, interfering with the insurers’ cozy relationships with the state insurance commissioners. The insurance industry devised an ingenious plan to head off federal regulation. It persuaded Congress to introduce legislation, known as the McCarran-Ferguson Act, which provided a three year moratorium on federal regulation of the insurance industry. At the expiration of the moratorium the federal regulators could then assert their authority only over those aspects of the insurance industry not regulated by the states. This moratorium gave the insurance commissioners the opportunity, through the National Association of Insurance Commissioners (NAIC), to draft model legislation intended to preempt the entire


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policyholders to attempt to negotiate standard form language, since insurance company

“[e]mployees regularly using a form often have only a limited understanding of its terms and

limited authority to vary them.”366 Though aware of the inherent limitations of standard form

language, insurance companies tout the benefits of its use:

For the insurance system to function, insurers need to be able to predict their insureds potential losses based upon known categories of risks . . . . That is why policies are written on standard forms. Standardization enables ISO [Insurance Services, Inc.] to track the claims experience of the defined coverages nationwide which in turn enables insurers to set realistic premiums and reserves. This is possible only if the words have the same meaning in New York and Washington as they do in California. Standardization also promotes the consumer interest by providing well-defined coverages which permit insureds to know what they are buying and to evaluate it comparatively.367

The benefit of using standardized language is that it increases commercial efficiency by

reducing, or eliminating, the time and expense of bargaining.368 Requiring unnegotiable standard

form language to be read — especially the language contained in a standard form insurance

policy — would produce the opposite result and obliterate the benefits of standardization.369 The

field of insurance industry regulation and thus protect the commissioners’ turf from Federal Trade Commission encroachment. (footnotes omitted)

See Stephen S. Ashley, Bad Faith Actions: Liability and Damages § 9:02 at 4 (1996).366 Restatement (Second) of Contracts § 211 cmt. b (1979).367 Real Parties in Interest [Industrial Indemnity Company and Industrial Insurance Company of Hawaii, Ltd.] Opening Brief on the Merits at 36-37, Bank of the West v. Superior Court, 833 P.2d 545 (Cal. 1992). See also Eugene R. Anderson et al., Environmental Insurance Coverage In New Jersey: A Tale of Two Stories, 24 RUTGERS L.J. 83 (Fall 1992) (reviewing the development of the pollution exclusion and the invocation of regulatory estoppel to prohibit insurance companies from adopting positions contrary to insurance company representations made when regulations were proposed).368 See E. ALLAN FARNSWORTH, CONTRACTS § 4.26 (2d. ed. 1990) and RESTATEMENT (SECOND) OF CONTRACTS § 211 cmt. c. (1979)(discussing the benefits of using standardized language).369 This is especially true with insurance policies standard form language. Consider the opening language and exclusions in a typical ISO-approved comprehensive general liability policy:

Section I – CoveragesCoverage A. Bodily Injury and Property Damage Liability


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simple solution, as one insurance company has argued, is that “Because an insurer prepares its

own contracts, it has a duty to make its meaning clear.”370

In short, reading or understanding the complicated standard form policy language

in order to alter it is not possible. And if it were possible, doing so would defeat the benefits to

the insurance industry of using standardized forms. Yet the problems with securing policyholder

expectations under standard form insurance policies is not a new phenomenon. Over fifty years

ago one commentator noted:

1. Insuring Agreement

a. We will pay those sums that the insured becomes legally obligated to pay as damages because of ‘bodily injury’ or ‘property damage’ to which this insurance applies. No other obligation or liability to pay sums or perform acts or services is covered unless explicitly provided for under SUPPLEMENTARY PAYMENTS -- COVERAGES A AND B. This insurance does not apply to ‘bodily injury’ or ‘property damage’ which occurred before the Retroactive Date, if any, shown in the Declarations or which occurs after the policy period. The ‘bodily injury’ or ‘property damage’ must be caused by an ‘occurrence.’ The ‘occurrence’ must take place in the ‘coverage territory.’ We will have the right and duty to defend any ‘suit’ seeking those damages.

. . . .

2. Exclusions

This insurance does not apply to:

a. ‘Bodily injury’ or ‘property damage’ expected or intended from the standpoint of the insured. The exclusion does not apply to ‘bodily injury’ resulting from the use of reasonable force to protect persons or property.

b. ‘Bodily injury’ or ‘property damage’ for which the insured is obligated to pay damages by reason of the assumption of liability in a contract or agreement. This exclusion does not apply to liability for damages:

1. Assumed in a contract or agreement that is an ‘insured contract;’ or

2. That the insured would have in the absence of the contract or agreement.

Commercial General Liability Coverage Form CG 00 01 01 96, p.1 (Copyright, Insurance Services Office, Inc., 1994), set forth in YOUR GUIDE TO THE ISO COMMERCIAL LINES POLICIES, Appendix B, at B-2 (6th ed. 1996).

The above-quoted policy contains 12 additional exclusions and 6 additional sections. Requiring a policyholder to read this language, much less understand it prior to purchasing insurance coverage, would defeat the purpose of using standardized language. It certainly does not make matters clearer.370 Brief of Appellees, at 42, dated Apr. 22, 1996, Associated Wholesale Grocers, Inc. v. Americold Corp., No. 95-75279-AS (Kan.). The statement was made by Arkwright Mutual Insurance Co.


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[T]he insurance policy has become overloaded with warranties, representations, conditions and exceptions, and other restrictive provisions, which tend to take on highly technical and treacherous characteristics. . . . It has been often said that if all the provisions of the modern insurance policy were literally enforced, no policyholder could recover a penny. This is an overstatement, but suggestive.371

That standard form insurance agreements and boilerplate are particularly subject

to hidden meanings and confusion has been succinctly noted by the courts:

“Although insurers have had over a hundred years to hone their policies into forms that would not ferry the unwary reader on a trip through Wonderland, they regrettably have not seen fit to do so.”372

Insurance companies have refused to remedy the situation on their own. Despite the century to

clarify their policies, the same is true today:

Ambiguity and incomprehensibility seem to be the favorite tools of the insurance trade in drafting policies. Most are a virtually impenetrable thicket of incomprehensible verbosity. It seems that insurers generally are attempting to convince the customer when selling the policy that everything is covered and convince the court when a claim is made that nothing is covered. The miracle of it all is that the English language can be subjected to such abuse and still remain an instrument of communication. But, until such time as courts generally weary of the task we have just experienced and strike down the entire practice, we feel that we must run with the pack and attempt to construe that which may well be impossible of construction.373

c. The Fallacy of The Sophisticated Policyholder

Insurance companies and their lawyers have strenuously argued that the doctrines

of reasonable expectations and contra proferentem should not apply when a claim is made by a

371 W. Vance, Cases on Insurance 211-12 (3d ed. 1940).372 Storms v. United States Fidelity & Guar. Co., 118 N.H. 427, 338 A.2d 578, 579-80 (1978).373 South Carolina Ins. Co. v. Fidelity & Guar. Ins. Underwriters, 327 S.C. 207, 486 S.E.2d 200, 204 (1997), quoting Universal Underwriters Ins. Co. v. Travelers Ins. Co., 451 S.W.2d 616, 622-23 (Ky. Ct. App. 1970).


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so-called “sophisticated” policyholder.374 So-called “sophisticated” policyholders have been

defined by one pro-insurance commentator as commercial policyholders whose “business

insurance policies . . . are typically negotiated (and often drafted) on behalf of the insured by

sophisticated brokers, risk managers and/or counsel . . . .375 This argument, and the facts upon

which it rests, are pure fabrication.

The first obvious problem with the sophisticated policyholder argument is that

standard form insurance policies contain no “sophisticated” policyholder exclusion, although

nothing prevents the insurance industry from drafting one.376 That a “sophisticated” policyholder

exclusion does not exist is strong evidence that insurance companies never intended to treat

commercial and individual policyholders differently. In fact, insurance companies apparently

have no specific criteria to determine what constitutes a “sophisticated” policyholder. One

insurance company argued (unsuccessfully) that a policyholder who had graduated from business

school was a sophisticated policyholder.377 The slippery slope character of the “sophisticated”

policyholder argument is self-evident.

Holding commercial policyholders to a higher standard based on nebulous factors

such as size or wealth “suggests that big companies ought to receive less insurance coverage than

small companies, notwithstanding that big companies pay big premiums for their coverage.”378

The size or wealth of a commercial policyholder has nothing to do with its understanding of the

374 See e.g. Barry R. Ostrager & David W. Ichel, Should the Business Insurance Policy Be Construed Against the Insurer? Another Look at the Reasonable Expectations Doctrine, 33 FED’N INS. COUNS. Q. 273 (1983).375 The sophisticated policyholder “exclusion” recently gained general support. [Cite Brennan] See Barry R. Ostrager & Barry R. Newman, Handbook on Insurance Coverage Disputes § 1.03[c], at 27 (7th ed. 1994).376 See Carl A. Salisbury, Pollution Liability Insurance Coverage, The Standard-Form Pollution Exclusion, And The Insurance Industry: A Case Study In Collective Amnesia, 21 ENVTL. L. 357, 362 (Winter 1991).377 See Brotherhood Ins. Co. v. Roseth, 177 Ill. App. 3d 443, 532 N.E.2d 354 (1988).


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language in its insurance policy. One court recently contrasted the policyholder’s purported

“sophistication” to the insurance industry’s typical business practices:

In transactions involving sophisticated and unsophisticated insureds alike, the insured has a right to expect that [it] will receive something of comparable value in return for the premium paid, yet the courts have recognized that the insured can be forced by the insurer to rely upon the oral representations of the insurance agent. The control exercised by insurers is especially problematic when the insured, whether sophisticated or not, does not receive the actual insurance policy until after offering to buy insurance and paying the first premium . . . Moreover, when the insured does not know or have reason to know of the existence of an unfavorable provision, then the insured lacks the ability to negotiate a more favorable insurance policy, and its sophistication or putative bargaining power is meaningless.379

The court, though cognizant that the reasonable expectations doctrine was “adopted to combat

the effects of the relatively unequal bargaining power exercised by insurer and insured,” reversed

the district court’s finding that the policyholder’s expectation of insurance coverage was

“irrelevant as a matter of law because of [the policyholder’s] status as a sophisticated purchaser

of insurance.”380

The truth is that America’s largest corporations purchase standard form policy

language just like everybody else.381 In fact, most large commercial policyholders do not

378 Carl A. Salisbury, Pollution Liability Insurance Coverage, The Standard-Form Pollution Exclusion, And The Insurance Industry: A Case Study In Collective Amnesia, 21 ENVTL. L. 357, 362 (Winter 1991).379 Reliance Ins. Co. v. Moessner, 121 F.3d 895, 905 (3d Cir. 1997)(internal citations and quotations omitted, quoting Collister v. Nationwide Life Ins. Co., 388 A.2d 1346, 1353 (Pa. 1978) and citing Robert Keeton, Insurance Law Rights at Variance With Policy Provisions, 83 HARV. L. REV. 961, 968 (1970) and Zuckerman v. Transamerica Ins. Co., 133 Ariz. 139, 650 P.2d 441 (1982)).380 Reliance Ins. Co. v. Moessner, 121 F.3d 895, 904 (3d Cir. 1997).381 See David B. Goodwin, Disputing Insurance Coverage Disputes, 43 STAN. L. REV. 779, 796-97 (Feb. 1991)(listing examples of cases involving large policyholders with policies containing unvaried standard form language. Among others, the article cites Eli Lilly & Co. v. Home Insurance Co., 764 F.2d 876, 879 (D.C. Cir. 1985)(policyholder’s 242 policies issued over the course of 29 years by different insurance companies contained functionally identical definitions of “injury” and “occurrence”); In re Asbestos Ins. Coverage Cases, judicial Coordination Proceeding No. 1072, Statement of Decision


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purchase “manuscript” policies, and policies which insurance companies purport to be

manuscript policies are often no more than a typewritten version of the standard form

language.382 A policy based on standard-form language, whether sold to a multinational

corporation or a residential homeowner, is offered on a take-it-or-leave-it basis.383 Even large

commercial policyholders who work with brokers are only paying to have segments of yet more

standard-form language assembled — terms are rarely rewritten. As the Illinois Supreme Court

commented:

The insurance industry is powerful and closely knit. . . . Any insured, whether large and sophisticated or not, must enter into a contract with an insurer which is written according to the insurer’s pleasure by the insurer.384

Other courts have come to the same conclusion. The Washington Supreme Court in Boeing Co.

v. Aetna Casualty and Surety Co. held that:

[O]n the facts of this case, it is questionable whether these standard rules of construction are no less applicable merely because the insured is itself a corporate giant. The critical fact remains that the policy in question is a standard form policy prepared by the company’s experts, with language selected by the insurer. The specific language in question was not negotiated, therefore, it is irrelevant that some corporations have company counsel. Additionally, this standard form policy has been issued to big and small businesses throughout the state. Therefore it would be incongruous for the court to apply different rules of construction

Concerning Phase III Issues, slip. op. at 1-3, 14 (Cal. Super. Ct. Jan. 24, 1990)(insurance agreement, injury and occurrence language is “functionally identical” for policies issued by dozens of insurance companies to several large policyholders).382 See David B. Goodwin, Disputing Insurance Coverage Disputes, 43 STAN. L. REV. 779, 796 n.100 (Feb. 1991), quoting Wondie Russel et al. Insurance Policy Construction and the Non Sequitur of the “Sophisticated Insured,” 3 ENVTL. CLAIMS J. 3, 16-17 (1990).383 See Melody A. Hamel, The 1970 Pollution Exclusion in Comprehensive General Liability Policies: Reasons For Interpretations in Favor of Coverage in 1996 and Beyond, 34 DUQ. L. REV. 1083, 1111 (Summer 1996)(arguing that the non-competitive nature of the market for pollution insurance coverage justifies application of the doctrines of contra proferentem and reasonable expectations, even where the policyholder is “sophisticated.”).384 Outboard Marine Corp. v. Liberty Mut. Ins. Co., 607 N.E.2d 1204, 1218 (Ill. 1992).


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based on the policyholder because once the court construes the standard form coverage clause as a matter of law, the court’s construction will bind policyholders throughout the state regardless of the size of their business.385

Similarly, the California Supreme Court in AIU Insurance Co. v. Superior Court held that the

mere fact a policyholder possessed “both legal sophistication and substantial bargaining power”

“has little bearing on the construction of the specific [standard-form] policy language in question

here.”386 Insurance companies simply have no reason to believe that policyholders sophisticated

in building automobiles, manufacturing chemicals or flying airplanes, for instance, are equally

sophisticated about insurance:

The particular sophisticated commercial entities involved in this case were in different businesses. [The policyholders] may have been knowledgeable about their own businesses, aviation, and security, respectively, but not necessarily insurance. Though they may have possessed some degree of generic business sophistication, it would be nonetheless reasonable for a jury to infer that both relied extensively on the superior expertise of [the insurance company].387

In addition, large commercial policyholders do not negotiate policy terms for

economic reasons created by the insurance company. The economic reasons for not negotiating

standard form language were succinctly set forth by one commentator:

The reality is that sophisticated insureds normally devote their “bargaining power resources” to obtaining higher limits of liability or coverage for a broader range of risks than to negotiating specific policy language. After all, when insurance carriers use non-standard language, the carrier is unable to use pooled risk rating information and therefore must charge a higher premium to compensate for the increased risk. Sophisticated insureds thus

385 Boeing Co. v. Aetna Cas. & Sur. Co., 113 Wash. 2d. 869, 883, 784 P.2d 507, 514 (1990)(emphasis added). See also 1 EUGENE R. ANDERSON ET AL., INSURANCE COVERAGE LITIGATION § 2.15, at 101 (1st ed. 1997).386 AIU Ins. Co. v. Superior Court (FMC Corp.), 51 Cal. 3d 807, 799 P.2d 1253, 1266, 274 Cal. Rptr. 820 (1990).387 United States v. Brennan, 938 F. Supp. 1111, 1121, (E.D.N.Y. 1996), appeal pending.


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rarely will find that the cost of purchasing non-standardized policies make financial sense.388

Nor is there any reason why large commercial policyholders should be compelled

to negotiate their policy language; the very purpose of the regulatory process is to approve

standard-form language “so that the state can negotiate with the insurance industry on behalf of

policyholders who never get that chance.”389 To force a policyholder with deep pockets to

undertake the same responsibilities is a purely opportunistic argument.

The “sophisticated” policyholder argument suffers from an additional flaw: at

what point, exactly, does an “ordinary” policyholder become a “sophisticated” policyholder?

Policyholders may not have been “sophisticated” decades ago when the policies were purchased.

Or they may not have been “sophisticated” when insurance coverage under those policies was

triggered.390 Moreover, insurance companies ‘standing in the shoes of a policyholder’ have

forcefully argued that the “sophisticated” policyholder argument is meritless. So said:

388 David B. Goodwin, Disputing Insurance Coverage Disputes, 43 STAN. L. REV. 779, 797 (Feb. 1991)(footnotes omitted).389 Melody A. Hamel, The 1970 Pollution Exclusion in Comprehensive General Liability Policies: Reasons For Interpretations in Favor of Coverage in 1996 and Beyond, 34 DUQ. L. REV. 1083, 1112 (Summer 1996) quoting Morton Int’l, Inc. v. General Accident Ins. Co., 134 N.J. 1, 629 A.2d 831, 848 (1993), cert. denied, 512 U.S. 1245 (1994):

The insurance industry’s presentation and characterization of the standard pollution-exclusion clause to state regulators constituted virtually the only opportunity for arms length bargaining by interests adverse to the industry, insureds having virtually no choice at all but to purchase the industry-wide standard CGL policy.

390 See David B. Goodwin, Disputing Insurance Coverage Disputes, 43 STAN. L. REV. 779, 798 n.5 (Feb. 1991).


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CNA Casualty of California:

[T]he level of sophistication of the insured is irrelevant when the policies are standard form policies slapped together without any negotiation as to their terms.391

Travelers Insurance Co.:

Significantly, regardless of the sophistication of the insured, the [plaintiff insurance company’s] policy is a printed FORM policy prepared by the carrier without the possibility of negotiation or modification by the assured. (129a). It follows therefore that an ambiguity which permits an interpretation of either coverage or noncoverage must be resolved as coverage in favor of the insured . . . .392

Travelers continued:

[T]he form policy was selected and prepared by [the plaintiff insurance company]. It must suffer the consequence of the carelessness of its own draftsmanship. If there exists a possibility of an interpretation by providing coverage from the viewpoint of the reasonable expectations of the insured, the court must conclude that coverage exists.393

Continental Casualty Co.:

[T]he California Supreme Court has recently and unanimously held that even where the policyholder is sophisticated (even to the extent of operating a subsidiary that drafted CGL policies identical to those at issue in the case), the usual rule of interpreting ambiguities in favor of the policyholder applies where standard form policy language is involved.394

Again from Continental Casualty Co.:

391 Reply Brief of Respondent CNA Casualty of California in Reply to Appellants Seaboard Surety Company and Insurance Company of North America and Opening Brief of Cross-Appellant CNA Casualty of California, at 20, filed Aug. 16, 1984, CNA Cas. of Ca. v. Seaboard Sur. Co., (No. 761572) 176 Cal. App. 3d 598 (1984).392 Brief for Defendant-Appellee Travelers Insurance Company, at 22, First State Underwriters Agency of New England Reinsurance Corp. v. Travelers Ins. Co., (D.N.J.).393 Id. at 23.394 Plaintiff Metropolitan’s Memorandum of Points and Authorities in Opposition to Defendant CalFarm’s Motion for Summary Judgment, at 11, dated May 22, 1991, Metropolitan Life Ins. Co. v. Calfarm Ins. Co., (No. 419329-8)(Cal. Super. Ct.), citing AIU Ins. Co. v. Superior Court, 51 Cal. 3d 807, 815, 823-824 (1990).


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The [defendant insurance company] recognizes . . . that any ambiguities in an insurance policy should be construed strictly against the insurer and in favor of the insured . . . [but] argues that the rule should not be applied in this case because [the policyholder] is a ‘sophisticated’ corporate entity . . . . [I]n this case there is ample evidence on the record that [the policyholder] would have had very limited bargaining power in obtaining the [defendant insurance company’s] policy because few general liability carriers were willing to write the sort of coverage sought by [the policyholder].395

The court accepted Continental’s argument. Another insurance company, Commercial Union,

then relied upon the favorable decision to make its own arguments against the “sophisticated”

policyholder:

Commercial Union:

[Commercial Union, citing Continental Cas. v. Canadian Universal Ins.] follows the general rule that the ‘sophisticated insured’ (or equal bargaining power) exception does not apply when the insured, no matter how large or ‘sophisticated’ has no actual participation in drafting the contract language.396

Hartford Life Insurance Co.

The [defendant insurance company] made the superficial comment that Hartford’s argument . . . is ‘perhaps a bit shameful to be made by a major insurance company.’ Hartford, however, is not, and never has been, involved in the title insurance business. Its normal practice of requiring title insurance of its real estate investments and relying on the expertise of the title insurance companies is no different from a labor lawyer seeking the advice of a tax lawyer with regard to his personal income tax problems, or a medical general practitioner referring his wife to a gynecologist.397

395 Brief for Plaintiff-Appellee Continental Casualty Co., at 12-13, undated, (internal quotations and citations omitted), Continental Cas. Co. v. Canadian Universal Ins. Co.,(Nos. 90-1406, 90-1491) 924 F.2d 370 (1st Cir. 1991).396 Brief of Appellant Commercial Union Insurance Company, at 39, dated Apr. 6, 1993, Commercial Union Ins. Co. v. Walbrook, 7 F.3d 1046 (1st Cir. 1993), citing Continental Cas. Co. v. Canadian Universal Ins. Co., 924 F.2d 370, 375 (1st Cir. 1991).397 Reply Brief of Appellant, Hartford Life Insurance Co., filed Oct. 26, 1975, Hartford Life Ins. Co. v. Title Guar. Co., 520 F.2d 1170 (D.C. Cir. 1975)(Nos. 74-1451, 74-1461).


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It is also interesting to note that despite their arguments, insurance companies treat large

commercial and individual policyholders similarly in another respect: like the individual

policyholder, the “sophisticated” policyholder does not receive their policy until weeks or

months after the premium has been paid.

PART VCivil RICO

A. Considerations

One option available to policyholders and other claimants prosecuting a bad faith

claim against an insurance company is to make a claim under the Racketeering Influenced and

Corrupt Organizations Act (“RICO”).398 The United States Supreme Court recently held that the

insurance business was subject to RICO [Cite Hummana]

Section 1962(c) prohibits a “person” from conducting or participating in the

conduct of the affairs of an “enterprise” through a “pattern of racketeering activity,” for example,

the commission of at least two “predicate” acts such as mail or wire fraud.399 To collect treble

398 18 U.S.C. § 1961 et seq.

18 United States Code Annotated § 1962(a) states in pertinent part:

It shall be unlawful for any person who has received any income derived, directly or indirectly, from a pattern of racketeering activity . . . to use or invest . . . any part of such income, or the proceeds of such income, in acquisition of any interest in, or the establishment or operation of, any enterprise which is engaged in, or the activities of which affect interstate or foreign commerce.

Similarly, 18 United States Code Annotated § 1962(c) states in pertinent part:

It shall be unlawful for any person employed by or associated with any enterprise engaged in . . . interstate or foreign commerce, to conduct or participate . . . in the conduct of such enterprise’s affairs through a pattern of racketeering activity or collection of unlawful debt.

399 See 18 U.S.C. § 1971(1).


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damages, a plaintiff must show injury to business or property and that the alleged injury was

actually and proximately caused by the racketeering predicates.400

The four greatest potential challenges to pleading a successful RICO claim are:

(1) circumventing the requirement that the RICO “enterprise” be entirely distinct from the RICO

“person” (the defendant); (2) making out a colorable “scheme to defraud” within the meaning of

the mail/wire fraud statutes; (3) showing the requisite injury to business or property of the

plaintiff; (4) proving that such injury was proximately caused by the racketeering activity; and

(5) avoiding a conflict with the McCarran-Ferguson Act.

400 Holmes v. Sec. Inv. Protection Corp., 503 U.S. 258, 268 (1992).


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1. The RICO Enterprise: Circumventing the Distinctiveness Requirement

Section 1962(c) applies only to a “person” employed by or associated with any

enterprise and makes it unlawful for such a person “to conduct or participate in the conduct of

such enterprise’s affairs through a pattern of racketeering activity.”401 Courts considering the

question hold that, as a matter of law, the same person may not be both a § 1962(c) enterprise

and a defendant and further, that corporations are not distinct from their affiliates or subsidiaries

for purposes of § 1962(c).402

The rationale of these decisions is that a corporation acts through its affiliates and

subsidiaries, particularly where the alleged conduct of the enterprise is based simply on the

regular business activity of the parent corporation.403 Thus, a plaintiff may not be able to

circumvent the distinctiveness requirement by naming a subsidiary (or affiliate) as the RICO

enterprise and the parent (or related) company as the RICO defendant. Courts have similarly

rejected allegations of an association-in-fact RICO enterprise that consists merely of a corporate

401 A “person” as defined in § 1961(3) “includes any individual or entity capable of holding a legal or beneficial interest in property.” An “enterprise” is an element of a RICO claim, not a party to the litigation. Section 1961(4) provides that an “enterprise” includes any individual, partnership, corporation, association, or other legal entity, and any union or group of individuals associated in fact, although not a legal entity.402 The leading case in this area is a Seventh Circuit case, Haroco, Inc. v. American National Bank & Trust Co., 747 F.2d 384 (7th Cir. 1984), aff’d on other grounds, 473 U.S. 606 (1985). In Haroco, the plaintiffs alleged in one of their RICO counts that defendant American National Bank & Trust (“ANB”) violated § 1962(c) by conducting the bank’s affairs through a pattern of racketeering activity (i.e., using the mails to defraud plaintiffs by overstating the prime interest rate, which determined their own variable interest payments). The court held that the “enterprise” and the “person” must be distinct for purpose of § 1962(c), and concluded that “ANB may not be held liable under section 1962(c) for conducting its own affairs through a pattern of racketeering activity.” 747 F.2d at 402. Accord Arzzuaga-Collazo v. Oriental Federal Savings Bank, 913 F.2d 5 (1st Cir. 1990); Bennett v. United States Trust Co., 770 F.2d 308 (2d Cir. 1985), cert. denied, 474 U.S. 1058 (1986); Elliott v. Foufas, 867 F.2d 877 (5th Cir. 1989); Rae v. Union Bank, 725 F.2d 478 (9th Cir. 1984).403 In practice, the determination of whether “an association in fact” is properly alleged often turns on the court’s view of whether the Copperweld doctrine -- which holds that a corporation cannot conspire with its own subsidiary in the antitrust context because the two are viewed as a single entity -- applies in the RICO context. See J. RAKOFF AND H. GOLDSTEIN, RICO: CIVIL AND CRIMINAL LAW AND STRATEGY (1997) at § 1.05[2]; Copperweld Corp. v. Independence Tube Corp., 467 U.S. 752, 777 (1984).


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defendant associated with its own affiliates or subdivisions carrying our the regular business

activities of the defendants. In short, claims will be dismissed when the enterprise and

defendant, although facially distinct, are in reality no different from each other. Several courts,

however, suggest that a corporation can be both a defendant and part of the enterprise, as long as

the enterprise can meaningfully be defined to include other corporations or individuals as well.

This result may obtain even where all of the members of an alleged association-in-fact enterprise

are named as defendants.404

A problem might arise in case the defendants are found to be affiliated. The

distinctiveness problem may be avoided if the RICO enterprise is pled to include various

corporations and individuals other than those that are named as (or affiliated with) the RICO

defendants. Adding directors and officers to the mix can help, since several courts have held that

a plaintiff can name a corporation as the RICO “enterprise” and its officers and directors as the

RICO “persons.”405

404 See C.A. Westel De Venezuela v. AT&T, 90 Civ. 6665, 1994 U.S. Dist LEXIS 14481 (S.D.N.Y. Oct. 11, 1994); River City Markets, Inc. v. Fleming Foods West, Inc., 960 F.2d 1458 (9th Cir. 1992).405 See United States v. Robinson, 8 F.3d 398 (7th Cir. 1993); Sever v. Alaska Pulp Corp., 978 F.2d 1529 (9th Cir. 1992). Adding outside agents, however, may not circumvent the distinctiveness problem. Courts in the Second, Seventh and Ninth Circuits have rejected efforts to allege an association-in-fact enterprise consisting of a defendant employer and its outside agents. See Nicholas J. Murlas Trust v. Mobil Oil Corp., No. 93 C 6956, 1995 U.S. Dist. LEXIS 12037 (N.D. Ill. Aug. 17, 1995); Barker v. E.F. Hutton Co., No. C-89-1840 EFL, 1990 U.S. Dist. LEXIS 19039 (N.D. Cal. July 6, 1990); Skylon Corp. v. Guilford Mills, Inc., No. 93 Civ. 5581, 1997 U.S. Dist. LEXIS 2104 (S.D.N.Y. Mar. 3, 1997).


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2. Racketeering Activity: Proving Mail and Wire Fraud

To prove mail or wire fraud, a plaintiff need only establish three elements:

(1) a scheme or artifice to defraud or to obtain money or property by means of false pretenses, representations or promises;

(2) a use of U.S. mails or interstate wires for the purpose of executing the scheme; and,

(3) a specific intent to defraud, either by devising, participating in or abetting the scheme.

The courts construe these elements broadly. A scheme or artifice to defraud has

been construed by the courts to include any trickery, deceit, half truth, concealment of material

facts, or affirmative misrepresentation. The omission of a material fact can constitute mail fraud

even in the absence of a specific duty to disclose the information.406 The communication need

only be in furtherance of a scheme which itself intentionally or recklessly causes the harm. In

short, nearly any communication — by any person in the racketeering association, whether to the

victim, or to any other member of the association, and whatever its content — can satisfy this

requirement, if in furtherance of the scheme.407

The third element of a mail/wire fraud violation, a specific intent to defraud by

means of false or fraudulent pretenses, representations, promises or other deceptive conduct, can

be demonstrated by circumstances which give rise to a strong inference that the defendant knew

of the falsity. An “intent to defraud” can be demonstrated either by a pattern of conduct or

(according to the Seventh and Ninth Circuits) recklessness.

406 See Emery v. General Finance, Inc., No. 95-1037, 1996 U.S. App. LEXIS 1493 (7th Cir. Jan. 13, 1996).407 Further, it is not necessary for the defendant to personally use the mails or even intend that the mails be used. United States v. Bortnovsky, 879 F.2d 30, 36 (2d Cir. 1989); Spira v. Nick, 876 F. Supp. 553, 559 (S.D.N.Y. 1995). However, if the defendant did not actually participate in the communication, the use of the mails or wires must have been “reasonably foreseeable” by him although it need not be actually known. United States v. Maze, 414 U.S. 395, 399 (1974).


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There is a split in the circuits, however, as to whether reliance is a necessary

element or proximate cause when a RICO violation is predicated on acts of wire or mail fraud.

Some courts have held that reliance is required, and that if the plaintiff was never exposed to the

misrepresentation, did not believe it, and took no action with regard to it, then the

misrepresentation could not have been a cause in fact of his injury. Others have held that

reliance need not be shown, since reliance is not an element of the underlying predicate crimes of

mail/wire fraud. Seventh Circuit precedent mandates reliance as a necessary element of mail or

wire fraud.408 The cases in the Second Circuit appear to go both ways.409

A “scheme or article to defraud” also includes a scheme to deprive another of the

“intangible right of honest services.”410 Several courts have interpreted this proviso so as to

make breaches of fiduciary duty prosecutable as mail and wire frauds.411 The courts have held

408 See Moore v. Fidelity Financial Servs., Inc., 949 F. Supp. 673 (N.D. Ill. 1997).409 Compare TCH Holdings Corp. v. Tishman, No. 93 Civ. 5393, 1996 U.S. Dist. LEXIS 7562 (S.D.N.Y. May 30, 1996) and B.V. Optische Industrie DeGude Delft v. Hologic, Inc., 909 F. Supp. 162 (S.D.N.Y. 1995) (holding that plaintiff seeking to base RICO liability on mail or wire fraud claims must prove that its injuries are the result of reliance on the fraud) with In re American Express Co. Shareholder Litigation, 840 F. Supp. 260 (S.D.N.Y. 1993) and Sterling Interiors Group v. Haworth, Inc., No. 94 Civ. 9216(CSH), 1996 U.S. Dist. LEXIS 13908 (S.D.N.Y. Sept. 19, 1996) (holding that the law of the Second Circuit does not require a RICO plaintiff to allege that he relied on the underlying misrepresentations in order to have standing under the statute; rather, the plaintiff must simply allege that the predicate acts committed in furtherance of the fraud proximately caused injury to him either by way of his own reliance or some third party’s reliance.).410 18 U.S.C. § 1346. 411 See e.g., United States v. Sawyer, 85 F.3d 713 (1st Cir. 1996)(lobbyist convicted of providing trips, gifts and entertainment to members of the Massachusetts Legislature in return for favorable legislation; §1346 broadened mail fraud to encompass schemes to defraud citizens of the intangible right to the honest services of their public officials); United States v. Gray, 96 F.3d 769 (5th Cir. 1996)(§1346 was constitutionally applied to coaches, employees of college who defrauded their employer of intangible rights to honest services by withholding material information as to their efforts to academically assist prospective basketball players in violation of NCAA rules); United States v. Neufeld, 908 F. Supp. 491 (S.D. Ohio 1995)(doctor convicted of mail fraud relating to his referral of patients for home health care services); United States v. Sancho, 957 F. Supp. 39 (S.D.N.Y. 1997)(essential elements of §§ 1343, 1346 met where defendant devised scheme to deprive the Tishman Construction Corp. of the intangible right of honest services of someone defendant believed to be Tishman’s consultant (really an undercover agent)).


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that an intangible rights scheme is only cognizable when at least one of the schemers is in a

fiduciary relationship with the defrauded person or entity.

However, courts in the Second Circuit have held that existence of a fiduciary duty

is not a necessary element of a mail/wire fraud violation under § 1346. In this connection, courts

in the Second Circuit also hold — contrary to courts in the other jurisdictions that a fiduciary

relationship exists between an insurance company and its policyholder.412

3. Two Acts of Racketeering Activity

A RICO claimant must establish that the defendants engaged in at least two acts

of racketeering activity that are related, and that they occurred over a substantial period of time

(most courts require a period of over one year), or amount to or pose a threat of continuing

criminal activity.413

4. Showing the Requisite Injury

In order to establish a RICO cause of action the plaintiff must show that it has

been injured in its “business or property” and that such injury was proximately caused by this

alleged scheme. With regard to the first of these requirements, courts have held that the injury to

business or property must constitute an actual, tangible, provable, out-of-pocket financial loss.

“Injuries that are speculative or unprovable in nature or amount are not recoverable — recovery

must wait until the nature and extent of damages becomes ‘clear and definite.’“414

412 United States v. Brennan, 938 F.Supp. 1111, 1120 (E.D.N.Y. 1996), appeal pending, “[t]he fiduciary relationship that an insurer owes to its insured is a fixture of New York law”). But see North River Ins. Co. v. Columbia Cas. Co., No. 90 Civ. 2518, 1995 U.S. Dist. LEXIS 13682, at *5 (S.D.N.Y. Jan. 5, 1995)(reinsurance company owes no fiduciary duty to its policyholder).413 See H.J. Inc. v. Northwestern Bell Tel. Co., 492 U.S. 229 (1989); Sedima S.P.R.L. v. Imrex Co., 473 U.S. 479, 496 (1985).414 Dornberger v. Metropolitan Life Ins. Co., 961 F. Supp. 506, 521 (S.D.N.Y. 1997).


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Policyholders may claim that they have been injured through unreasonable delay

and/or unjustifiable refusal to pay claims under their insurance policies. Some courts have

refused to find a RICO “injury” where the alleged harm is the plaintiff’s hypothetical inability to

recover on a judgment against the defendant. That is, where the actual injury is contingent upon

a judicial resolution of liability, and the plaintiff’s inability to collect thereupon, the plaintiff’s

RICO claim has been deemed “unripe” for adjudication.

A policyholder may claim that it has suffered a RICO injury through paying

premiums on insurance policies which the insurance company has effectively dishonored by

failing to provide adequate security for its obligations thereunder. A policyholder may argue that

the insurance company has derogated its obligation to “pay or make good” on losses covered by

its policies and has intentionally pushed back the timing of its payments on claims in order to

take advantage of the investment return on its reserves. A policyholder may argue that it has not

obtained the benefit of its bargain in that it has not received the security or service its insurance

premiums have purchased.

In Dornberer v. Metropolitan Life Ins. Co.,415 the plaintiff brought a RICO action

against a life insurance company, arguing that she did not receive the benefit of her premium

payments because the policies were tainted by the insurer’s fraud.416 Essentially, the plaintiff

argued that the policies were riskier than she had bargained for, and that she had thus suffered

injuries equal to the full amount of her premium payments. The court rejected this argument,

finding that (1) the plaintiff had not alleged that the insurer had refused to honor the policies; and

(2) the plaintiff had not alleged an actual injury by simply claiming that she had incurred an

415 961 F. Supp. 506 (S.D.N.Y. 1997).416 See 961 F. Supp. at 522.


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additional risk of loss as a consequence of the fraud.417 The court found the plaintiff’s

contentions were merely allegations of mental or emotional distress and not compensable under

RICO.418 However, the court nevertheless held that the plaintiff had sufficiently alleged a

present RICO injury to the extent she claimed that the insurance company had failed to make

certain tax payments and to provide other services which it was obligated to provide in

consideration for plaintiff’s premium payments.419 The court held that plaintiff had adequately

alleged that she had been fraudulently induced to pay a portion of her premiums toward these

items, but had not received what she had bargained for.420 These damages were not speculative

or unprovable, because the insurance company had already failed to provide what it was

obligated to provide under the insurance contract.421

5. Proving Proximate Cause

In pleading and proving a RICO violation, the plaintiff must demonstrate that the

RICO violation was the proximate cause of the injury to its business or property. This

requirement arises from the Supreme Court’s ruling in Holmes v. Securities Investor Protection

Corp.422 The holding in Holmes instructs courts to undertake an analysis of any intervening

causes of the plaintiff’s alleged injury. “[A] plaintiff who complain[s] of harm flowing merely

from the misfortunes visited upon a third party by the defendant’s act [is] generally said to stand

at too remote a distance to recover.”423 A predicate act proximately causes a RICO injury if it is

417 Id.418 Id.419 Id.420 Id.421 Id.422 503 U.S. 258, 268 (1992).423 503 U.S. at 268-69.


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a substantial factor in the sequence of responsible causation, and if the injury is reasonably

foreseeable or anticipated as a natural consequence.

Some courts, however, have applied a pass-through liability analysis in finding

proximate cause to exist notwithstanding the fact that the alleged mail or wire fraud deceived a

third party, rather than the plaintiff itself.424 As one court has stated, the RICO plaintiff “need

not be the primary victim, only an intended victim” of the scheme.425

Nonetheless, as the Second Circuit has stated, “[W]hen factors other than the

defendant’s fraud are an intervening direct cause of plaintiff’s injury, that same injury cannot be

said to have occurred by reason of the defendant’s actions.”426 Thus, the “factual directness of

the causal connection” between the insurance company’s actions and the policyholder’s failure to

obtain payment under its insurance policies may be compromised by intervening actions.

B. RICO and the McCarran-Ferguson Act

The National Association of Insurance Commissioners recently told the United

States Supreme Court that RICO absolutely applies to insurance companies:

Petitioners . . . contend that . . . to bring suit under [RICO] would ‘impair’ the enforcement of the California Insurance Code. The National Association of Insurance Commissioners (“NAIC”), whose members are the principal state insurance regulators, strenuously disagrees with the notion that RICO impairs any

424 See, e.g., Israel Travel Advisory Serv. v. Israel Identity Tours, Inc., 61 F.3d 1250, 1257 (7th Cir. 1995)(allegedly fraudulent mailings to plaintiff’s customers could be proximate cause of RICO injury to plaintiff so long as plaintiff was an intended victim of the fraud), cert. denied, 116 S. Ct. 1847 (U.S. 1996); County of Suffolk v. Long Island Lighting Co., 907 F.2d 1295, 1311-12 (2d Cir. 1990)(RICO claim based on utility’s false submissions to New York Public Service Commission could cause RICO injury to utility’s competitor); Trautz v. Weisman, 819 F. Supp. 282, 287 (S.D.N.Y. 1993) (nursing home operators’ mailing of false compliance certificates to licensing agencies in order to secure renewal of operating licenses could have proximately caused injury to nursing home residents).425 Rodriguez v. McKinney, 878 F. Supp. 744, 747 (E.D. Pa. 1995).426 First Nationwide Bank v. Gelt Funding Corp., 27 F.3d 763, 769 (2d Cir. 1994).


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state’s insurance laws. The NAIC urges, to the contrary, that RICO enhances the effective enforcement of those laws.427

Insurance companies often, but not always, argue that the McCarran-Ferguson

Act428 preempts the application of any federal laws, such as RICO, to the business of insurance.

The insurance companies then argue that the McCarran-Ferguson Act requires claimants —

including policyholders, state insurance commissioners, and lawyers — to rely solely on

remedies provided under state insurance law.429 Why? Because many state insurance laws and

courts do not award the mandatory treble damages, attorneys fees and costs that RICO allows.430

427 Brief of Amicus Curiae National Association of Insurance Commissioners Supporting Respondent, at 1, filed Oct. 12, 1995, Prometheus Funding Corp. v. Merchants Home Delivery Servs., Inc., 50 F.3d 1486 (9th Cir.), cert. denied, 516 U.S. 964 (1995). The NAIC participated as amicus on behalf of the policyholder in opposition to certiorari.428 The McCarran-Ferguson Insurance Regulation Act, 15 U.S.C. Annotated §§ 1011-1015 (West 1986).429 See e.g. Reply Memorandum of Points and Authorities in Support of Petition for Preemptory or Alternative Writ of Mandate, at 14-15, filed Mar. 14, 1990, American Int’l Group v. Superior Court of the State of Ca., 234 Cal. App. 3d 749, 285 Cal. Rptr. 765 (Sept. 25, 1991), cert. denied, 504 U.S. 911 (1992). AIG argued that “the clear mandate of California law, consistent with the McCarran-Ferguson Act, is that [the policyholder] have only a common law cause of action for fraud based on its transaction and not a statutory RICO claim.”). Similar is the Brief of Amici Curiae Alliance of American Insurers, American Insurance Association, National Association of Independent Insurers, and National Association of Mutual Insurance Companies In Support of Appeal By Defendants-Appellants, at 26, dated Oct. 31, 1997, United States v. Brennan, No. 97-1440 (2d Cir.). The insurance industry associations quoted an Ohio decision precluding the use of RICO against an insurance company to argue that the McCarran-Ferguson Act similarly precluded application of a federal mail fraud statute against an insurance company and its president:

By holding insurance companies liable under a federal law, such as RICO, when Ohio law provides for no liability, RICO would impair the regulatory framework within which Ohio expects its insurance companies to do business.

Id., quoting Kenty v. Bank One, Columbus, N.A., 92 F.3d 384, 392 (6th Cir. 1996).430 A plaintiff which can prove injury under RICO is entitled to triple the actual damages as well as their costs and reasonable attorneys fees. 18 United States Code Annotated § 1964 states in pertinent part:

Any person injured in his business or property by reason of a violation of section 1962 of this chapter may sue therefor . . . and shall recover threefold the damages he sustains and the cost of the suit, including a reasonable attorney’s fee.


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Insurance fraud and discriminatory practices are not part of the business of

insurance which the McCarran-Ferguson Act was intended to protect. Nor does RICO impair the

application of state insurance law as could some federal statutes. The truth is that RICO

complements rather than conflicts with state insurance laws.

1. RICO and the McCarran-Ferguson Act: Dueling or Complimentary Statutes?

The McCarran-Ferguson Act is both an opportunity and a unique hurdle for

claimants alleging a RICO claim against an insurance entity — usually an insurance company,

agent or brokerage firm. The McCarran-Ferguson Act states:

No Act of Congress shall be construed to invalidate, impair or supersede any law enacted by any State for the purpose of regulating the business of insurance . . . unless such Act specifically relates to the business of insurance. Provided: That after June 30, 1948, . . . the Sherman Act, and . . . the Clayton Act, and . . . the Federal Trade Commission Act . . . shall be applicable to the business of insurance to the extent that such business is not regulated by State law.431

The McCarran-Ferguson Act precludes a RICO claim only if: (1) applying RICO would

invalidate, impair or supersede (“conflict”) with applicable state law; (2) the state has enacted

laws regulating the conduct in question; (3) RICO does not specifically relate to the business of

insurance, and; (4) the acts complained of constitute the “business of insurance.”432 Failure of a

Moreover, invocation of RICO does not necessarily preclude award of state law punitive damages. See, e.g., Neibel v. Trans World Assurance Co., 108 F.3d 1123 (9th Cir. 1997)(plaintiff’s suing for damages arising out of a fraudulent tax scheme were entitled to RICO treble damages and state law punitive damages. The court noted that the text of RICO states that “nothing in this title shall supersede any provision of . . . law imposing criminal penalties or affording civil remedies in addition to those provided for under this title.”).431 15 U.S.C.A. § 1012(b). 432 This is the nearly universally cited test. See Dornberger v. Metropolitan Life Ins. Co., 961 F. Supp. 506, 516 (S.D.N.Y. 1997)(listing cases and one exception).


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defendant insurance related entity to establish any one of these requirements allows the RICO

claim to proceed, regardless of whether the other requirements of the statute are met.

Several recent cases have held that RICO does not ‘invalidate, impair or

supersede’ state insurance law. In addition, widespread insurance company use of RICO raises

serious questions regarding whether RICO might now be considered to “specifically relate” to

the business of insurance.

2. The Business of Fraud

In Merchants Home Delivery Services, Inc. v. Frank B. Hall & Co., Inc.,433 the

policyholder sued its insurance broker for overcharging premiums on particular policies,

collecting premiums for non-existent policies, and billing the policyholder for claims which were

not insured. The policyholder alleged that the insurance broker had engaged in a pattern of

fraudulent misconduct in violation of RICO.434

The United States Court of Appeals for the Ninth Circuit relied on the test

established by the United States Supreme Court in United Labor Life Insurance Co. v. Pireno in

order to determine whether overcharging for an insurance policy was within the ‘business of

insurance.’435 The Pireno test looks to whether the alleged insurance business practice in

question: (1) has the effect of transferring or spreading the policyholder’s risks; (2) is integral to

the relationship between the policyholder and the insurance company, and; (3) is limited to

entities within the insurance industry.436 The Pireno decision also emphasized that the transfer

433 Merchants Home Delivery Servs., Inc. v. Frank B. Hall & Co., Inc., 50 F.3d 1486 (9th Cir.), cert. denied, 516 U.S. 964 (1995).434 Merchants, 50 F.3d at 1488.435 Id. at 1490.436 United Labor Life Ins. Co. v. Pireno, 458 U.S. 119, 129 (1982). See also United States Dep’t of the Treasury v. Fabe, 508 U.S. 491, 497-98 (1993).


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and spreading of risk is the primary or “indispensable” characteristic of the business of

insurance.437

The Merchants court rejected the policyholder’s argument that since fraud is not

part of the business of insurance, a RICO claim alleging fraud is not preempted by the

McCarran-Ferguson Act. Such an approach, the court held, would “read the McCarran-Ferguson

Act out of existence,” since “[a]ny practice which violated any federal statute would, by

definition, not be the business of insurance . . . .”438 The proper inquiry, the court ruled, is “not

whether the defendant and the plaintiff transact the business of insurance . . . . [but] whether,

taken as a whole, the specific practice being challenged under federal law is part of the ‘business

of insurance.’“439

The Merchants court concluded that under the Pireno test, overcharging for an

insurance policy was part of the ‘business of insurance’ protected by the McCarran-Ferguson Act

because all three factors of the Pireno test were met.440 However, the court held that collecting

premiums for policies which did not exist and on claims for which there was no insurance

coverage clearly was not the ‘business of insurance’ because no risk was spread.441 Moreover,

since a non-existent policy means the policyholder was sold no insurance at all, there was no

relationship between the policyholder and the insurance company, leading the court to conclude

437 See Pireno, 458 U.S. at 127; Group Life & Health Ins. Co. v. Royal Drug, 440 U.S. 205, 211-12 (1979). See also Merchants Home Delivery Servs., Inc. v. Frank B. Hall & Co., Inc. 50 F.3d 1486 (9th Cir.), cert. denied, 516 U.S. 964 (1995).438 Merchants, 50 F.3d at 1490.439 Id. at 1489-90. See also Dornberger v. Metropolitan Life Ins. Co., 961 F. Supp. 506, 517 (S.D.N.Y. 1997)(listing additional cases which have held that insurance company fraud or misrepresentation does not automatically fall outside the “business of insurance”).440 Id. at 1490.441 Id. at 1490-91.


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that the conduct “comes close to being the ‘business of fraud.’“442 Similarly, collecting

premiums from the policyholder for false claims — and pocketing the money — “is not even

arguably the business of insurance” because there was no transfer of risk, no relationship

between the policyholder and the insurance company, and the misconduct was not limited to the

insurance industry.443

“The McCarran-Ferguson Act does not exempt the business of insurance

companies . . . . The exemption is for the business of insurance.”444 In short, the purpose of the

McCarran-Ferguson Act is to govern insurance as insurance — not to shield misconduct from

RICO simply because it involves an insurance company.

3. The Insurance Companies’ Imagined “Conflicts” With State Law

In Merchants, the defendant insurance brokerage company had argued that

allowing policyholders to make a RICO claim for treble damages, costs and attorneys fees would

“upset the balance” struck by California’s insurance code, since the code could only be enforced

by the state commissioner of insurance and only allowed actual damages. The court rejected the

“upset the balance” arguments, holding that “state and federal laws proscribing identical

misconduct do not conflict with or displace each other and may co-exist with the McCarran-

Ferguson Act.”445 Noting that the text of the McCarran-Ferguson Act requires that no less than

four separate conditions must be met before excluding a federal statute, the court held that “the

442 Id. 443 Id. at 1491.444 Id. at 1489 (internal quotations and brackets omitted), quoting Royal Drug, 440 U.S. at 210-11.445 Id. at 1492, citing NAACP v. American Family Mut. Ins. Co., 978 F.2d 287, 297 (7th Cir. 1992), cert. denied, 508 U.S. 907 (1993).


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language of the McCarran-Ferguson Act is inconsistent with a congressional intent to allow

states to preempt the field of insurance regulation.”446

Several other courts have similarly concluded that when state insurance law and

RICO prohibit the same acts, RICO does not invalidate, impair or supersede state law. In

Dornberger v. Metropolitan Life Insurance Co., in a case of first impression within the

jurisdiction of the United States District Court for the Southern District of New York, the court

specifically rejected the ‘upset the balance’ arguments of the insurance companies and held that

the McCarran-Ferguson Act does not conflict with New York state insurance law.447 The court

noted that New York’s insurance code already allowed a private right of action to policyholders.

Citing Merchants, the court held that the McCarran-Ferguson Act was not meant to cede the

entire field of insurance to the states. The court further held that the McCarran-Ferguson Act

applies only when a federal statute invalidated, impaired or superseded state law,448 and that such

is not the case when RICO and state insurance law both provide for a private right of action and

both punish the same substantive conduct. Rather than conflicting with state insurance laws,

“application of the greater federal remedies tends to further the policies which the federal and

state laws share.”449

In Pinski v. Adelman, the court held that although the sale of life insurance

policies fell squarely within the business of insurance, RICO complemented rather than

conflicted with state insurance law.450 The court found that even if Illinois’ Insurance code did

446 Id.447 Dornberger, 961 F. Supp. at 519-20. 448 Id.449 Id. at 520.450 Pinski v. Adelman, No. 94 C 5783, 1995 U.S. Dist. LEXIS 16550, at *20-*22 (N.D. Ill. Nov. 2, 1995).


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not provide for a private right of action, Illinois insurance law and RICO both prohibit

misrepresentation of insurance policy terms and benefits. Similarly, the court found that the

policyholder under Illinois law could bring a claim for common law fraud and may be entitled to

punitive damages and attorneys fees.451 As in Merchants, the court concluded held that “state

and federal rules that are substantially identical but different in penalty do not conflict with or

displace each other.”452

In J.J. White, Inc. v. William Graham Co., the court found that alleged hidden

commissions and overpayment of service fees to the insurance company fell within the scope of

the business of insurance.453 The court held that although Pennsylvania law provided

comprehensive insurance regulations, a RICO claim would “supplement[] rather than supplant

state law.” The court so ruled because not only did RICO and Pennsylvania insurance law

prohibit the same acts, but the policyholder would also have common law actions for fraud,

misrepresentation and deceit under state law.454

Additional courts have concluded that Congress simply did not intend to cede the

entire field of insurance to the states when it enacted the McCarran-Ferguson Act.455

451 Id.452 Id. at *21, quoting NAACP v. American Family Mut. Ins. Co., 978 F.2d 287, 297 (7th Cir. 1992), cert. denied, 508 U.S. 907 (1993).453 J.J. White, Inc. v. William Graham Co., No. 96-6131, 1997 U.S. Dist. LEXIS 3274, at *6 (E.D. Pa. Mar. 14, 1997).454 Id. at *8-*9.455. See also Forsyth v. Humana Health Ins., Inc., 114 F.3d 1467 (9th Cir.), cert denied, 118 S. Ct. 559 (U.S. 1997)(on facts similar to those in Merchants, the court held that over-charging premiums and not reducing co-payments is the business of insurance, but that RICO does not conflict with Nevada state insurance law); see also, Moreland v. Behl, No. C-92-1238, 1996 U.S. Dist. LEXIS 5653, at *80-*81 (N.D. Cal. Apr. 17, 1996)(per Merchants, rejecting insurance company argument that RICO conflicts with state law).


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4. Why RICO May Substantially Relate to the Business of Insurance: The True Purpose of the McCarran-Ferguson Act and Barnett Bank v. Nelson

Just as Congress did not intend to cede the entire field of insurance to the states

when it enacted the McCarran-Ferguson Act, the McCarran-Ferguson Act was not meant to

preempt every federal statute which could ultimately effect an insurance company. So said the

United States Supreme Court in Barnett Bank v. Nelson.456

Barnett Bank required the Court to determine whether the McCarran-Ferguson

Act preempted application of a 1916 federal law which allowed certain small banks to sell

insurance when a Florida state law prohibited the same banks from doing so.457 The U.S.

Supreme Court ruled that the McCarran-Ferguson Act did not preempt this federal law,

explaining that:

the [McCarran-Ferguson] Act does not seek to insulate state insurance regulation from the reach of all federal law. Rather, it seeks to protect state regulation primarily against inadvertent federal intrusion — say, through enactment of a federal statute that describes an activity in broad, general terms, of which the insurance business happens to comprise one part.458

If the goose gets cooked, why not the gander too? Considering the insurance companies’ own

enthusiastic use and sophisticated understanding of RICO, there is nothing unanticipated about

the provisions or effects of RICO on either policyholders or insurance companies. So willing an

embrace of RICO by the insurance companies can hardly constitute the “inadvertent . . .

intrusion,” which Congress had contemplated when it passed the McCarran-Ferguson Act.

456 Barnett Bank v. Nelson, 517 U.S. 25, 1996 U.S. LEXIS 2161 (1996).457 1996 U.S. LEXIS 2161, at *1.458 Id. at *25 (emphasis added).


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In Blue Cross of California, et al. v. SmithKline Beecham459 more than thirty-five

major health insurance companies charged SmithKline with RICO violations allegedly involving

improper billing and kickbacks to doctors. The plaintiff insurance companies contended that

they represented “40% of America’s health insurance industry.”460

In Chubb & Son, Inc. v. Wigand,461 not only did the court allow the insurance

companies to proceed on their RICO claims, but the court held that the insurance company

constituted an “enterprise” for the purposes of RICO. In Wigand, several insurance companies

charged an insurance adjuster with violations of RICO and conspiracy to violate RICO for

allegedly devising schemes to inflate claims.462 The defendant had unsuccessfully argued that

RICO was inapplicable because the insurance company for which he had been employed was not

an enterprise for the purposes of RICO.

The truth is that the cases involving insurance industry application of RICO are

legion.463

459 Blue Cross of California, et al. v. SmithKline Beecham, No. 397CV01795 AVC (D. Conn. filed Aug. 19, 1997).460 See Health Insurers Sue Lab SmithKline’s Lab Division, INS. COVERAGE LITIG. RPTR., Sept. 5, 1997, at 254. See also, Insurers Sue Over Lab Billing, BUS. INS., Aug. 25, 1997, at 2.461 Chubb & Son, Inc. v. Wigand, N.Y.L.J., Jan. 23, 1998, at 26 (N.Y. Sup. Ct. N.Y. County).462 Id. See also Company Adjuster Who Inflated Claims For Kickbacks, Loses Bid To Avoid RICO Liability Suit By Former Employer, Chubb, INS. L. REV., Jan. 31, 1998, at 22.463 For a non-exhaustive sampling of RICO claims brought by insurance companies in 1997 alone, See e.g., Old Republic Ins. Co. v. Hansa World Cargo Serv., 170 F.R.D. 361 (S.D.N.Y. 1997)(insurance company sought return of payments made under surety bonds alleging that defendants had engaged in scheme to import steel products into United States in violation of RICO); Nationwide Mut. Ins. Co. v. Perez, No. 97-2172 (JP), 1997 U.S. Dist. LEXIS 13744 (D.P.R. Aug. 14, 1997)(insurance company alleged that policyholder had engaged in insurance fraud by purchasing wrecked cars and registering the cars in the name of “co-conspirators” in violation of RICO); Soanes v. Empire Blue Cross/Blue Shield, 970 F. Supp. 230 (S.D.N.Y. 1997)(in response to suit for breach of a health insurance policy brought by administrators of various labor unions’ health insurance programs, insurance company filed counter-claim alleging violations of RICO).


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Insurance companies have also been quick to take advantage of pro-RICO

opinions such as the Merchants decision. For example, in Zenith Insurance Company v.

Eisenberg, the court specifically adopted the Merchants decision in favor of an insurance

company, holding that there was “no principled basis for distinguishing, for McCarran-Ferguson

Act purposes” between the insurance company’s allegations of fraud in that case and the

policyholder’s allegations of fraud in Merchants.464 Pro-RICO decisions are used by both

insurance companies and RICO claimants.

Nearly thirty years ago, the United States Supreme Court recognized that

“Congress was mainly concerned with the relationship between insurance ratemaking and the

antitrust laws, and with the power of the States to tax insurance companies.”465 The U.S.

Supreme Court in Barnett Bank similarly found that the creation of the McCarran-Ferguson Act

was motivated by a single concern — antitrust regulation of the insurance industry. The Barnett

Bank Court explained that the Act was meant to “cautiously” avoid “unanticipated interference”

with state regulation of insurance466 — a far, far cry from a carte blanche authorization to

preempt any and all federal laws touching on insurance. The Court further explained that the

genesis of the McCarran-Ferguson Act was United States v. South-Eastern Underwriters, a 1944

United States Supreme Court decision which held that the insurance industry was not exempt

from the antitrust provisions of the Sherman Act.467 As one noted commentator tells it:

This decision sent shivers down the spines of the insurance company executives, who feared the prospect of federal agencies,

464 See Zenith Ins. Co. v. Eisenberg, Nos. 94-55983, 94-56188, 94-56138, 1996 U.S. App. LEXIS 26815 (9th Cir. Jan. 11, 1996), cert. denied, 117 S. Ct. 2452 (U.S. 1997).465 SEC v. National Securities, Inc., 393 U.S. 453, 458-59 (1969).466 Barnett Bank, 1996 U.S. LEXIS 2161, at *26.467 Barnett Bank, 1996 U.S. LEXIS 2161, at *25-*27 (discussing the scope and implications of United States v. South-Eastern Underwriters Ass’n, 322 U.S. 533 (1944).


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particularly the Federal Trade Commission, interfering with the insurers’ cozy relationships with the state insurance commissioners.468

The genuine purpose of the McCarran-Ferguson Act was to protect the

“[insurance] commissioners’ turf from Federal Trade Commission encroachment.”469 Most

telling is the text of the McCarran-Ferguson Act itself, which, by providing that only “the

Sherman Act . . . the Clayton Act . . . and the Federal Trade Commission Act . . . shall be

applicable to the business of insurance to the extent that such business is not regulated by State

law,”470 reveals a concern solely with antitrust legislation.

The United States Supreme Court in Barnett Bank also noted that “[t]he word

‘relates’ is highly general, and this Court has interpreted it broadly in other pre-emption

contexts.”471 The Court went on to explain that a federal statute may specifically relate to more

than one thing:

Just as an ordinance forbidding dogs in city parks specifically relates to dogs and to parks, so a statute permitting banks to sell insurance can specifically relate to banks and to insurance. Neither the McCarran-Ferguson Act’s language, nor its purpose, requires the Federal Statute to relate predominately to insurance.472

This reasoning is crucial to determining whether a RICO claim involving an

insurance company has been properly brought. RICO is a statute about fraud and conspiracy

which is committed by a statutorily defined “enterprise.” Even more than a statute which

regulates dogs and public parks, a RICO “enterprise” may, and does, relate to much more than

468 Stephen S. Ashley, Bad Faith Actions: Liability and Damages § 9:02 at 4 (1996)(footnotes omitted).469 Id.470 The McCarran-Ferguson Insurance Regulation Act, 15 U.S.C. Annotated §§ 1011-1015 (West 1986).471 Barnett Bank, 1996 U.S. LEXIS 2161, at *22 (listing cases).472 Barnett Bank, 1996 U.S. LEXIS 2161, at *28 (emphasis added).


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one thing. RICO has been successfully applied against anti-abortion protestors, members of

traditional organized crime organizations, securities firms, and insurance companies — even

though the text of the statute does not refer to any of these groups. That RICO does not mention

“insurance” is hardly surprising — nor determinative — of whether RICO specifically relates to

the business of insurance. Given the widespread use of RICO by both insurance companies and

state insurance commissioners, it is especially difficult to understand how RICO could not

“specifically relate” to the business of insurance. So prevalent is the use of RICO by the

insurance industry that one commentator candidly noted that insurance commissioners would be

apoplectic if they suddenly discovered that they were unable to use RICO to prosecute

allegations of insurance fraud.473

5. The McCarran-Ferguson Act Does Not Protect Discriminatory Insurance Company Practices

In NAACP v. American Family Mutual Insurance Co., the United States Court of

Appeals for the Seventh Circuit held that the Federal Fair Housing Act’s474 prohibition against

redlining, the practice of charging higher premiums or refusing to provide insurance coverage to

persons within a particular, usually racially specific, geographical area, was not preempted by the

McCarran-Ferguson Act.475 Although the court agreed with insurance company arguments that

the Federal Fair Housing Act did not relate to the business of insurance, it held that it could not

find any law regulating the business of insurance which the Act invalidated, impaired or

superseded.476 Several other decisions have held that the McCarran-Ferguson Act does not

473 Christopher Winans, Insurers’ Weapon Against RICO Claims Could Backfire If It’s Too Successful, BEST’S INS. MGMT. REP., June 14, 1993, at 4.474 Title VIII of the Civil Rights Act of 1968, as amended, 42 U.S.C. §§ 3601-3631 (1988 & Supp. IV 1992).475 NAACP v. American Family Mut. Ins. Co., 978 F.2d 287 (7th Cir. 1992), cert. denied, 508 U.S. 907 (1993).476 978 F.2d at 295.


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preempt application of the Federal Fair Housing Act. These cases make clear that the McCarran-

Ferguson Act does not preempt federal laws which protect against racially discriminatory

practices in the sale of insurance.477

Insurance company discrimination, though most commonly alleged in cases

involving the Federal Fair Housing Act, is not limited to that area of law. In Duane v.

Government Employees Insurance Co.,478 a legal permanent resident of the United States

attempted to purchase a homeowners policy from the defendant insurance company. The

insurance company refused to do so because he was not a U.S. citizen and the claimant filed suit

alleging violations of the Civil Rights Act of 1991.479

The United States District Court for the District of Maryland rejected insurance

company arguments that the discriminatory practice constituted a “business of insurance”

protected by the McCarran-Ferguson Act. First, since the insurance company had refused to sell

the claimant a policy or allow him to become a policyholder, the practice failed to transfer any

risk.480 Second, the court concluded that despite insurance company arguments that the allegedly

477 See Nationwide Mut. Ins. Co. v. Cisneros, 52 F.3d 1351 (6th Cir. 1995), cert denied, 516 U.S. 1440 (1996)(following American Family in holding that the Fair Housing Act is not preempted by the McCarran-Ferguson Act); United Farm Bureau Mut. Ins. Co. v. Metropolitan Human Relations Comm’n, 24 F.3d 1008, 1010, 1016 (7th Cir. 1994)(claim brought by policyholder under the Fair Housing Act alleging that insurance company failed to renew his policy because he lived in a “racially mixed” area was not preempted by the McCarran-Ferguson Act; Fair Housing Act did not conflict with state insurance law, and that the Fair Housing Act duplicated certain substantive portions of state law did not constitute a conflict between the two); McDiarmid v. Economy Fire & Cas. Co., 604 F. Supp. 105 (S.D. Ohio 1984)(policyholder’s allegations of redlining brought under the Federal Fair Housing Act not preempted by the McCarran-Ferguson Act; no conflict with state insurance law)(listing older cases in accord); Mackey v. Nationwide Ins. Cos., 724 F.2d 419, 420,423 (4th Cir. 1984)(holding the McCarran-Ferguson Act did not preempt a claim brought under the Fair Housing Act, but that the Fair Housing Act did not prohibit redlining).478 784 F. Supp. 1209 (D. Md. 1992), aff’d, 37 F.3d 1036 (4th Cir. 1994), cert. granted, 513 U.S. 1189 (1995). GEICO later withdrew its appeal and settled the case. See GEICO Settles Lawsuit By Alien Denied Coverage, FED. AND ST. INS. WEEK, June 5, 1995.479 Title 42 U.S.C. § 1981.480 784 F. Supp. at 1221.


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discriminatory practices were “an integral part” and “at the core” of the business of insurance, it

had failed to demonstrate a “positive relationship between the policy of refusing to underwrite

aliens and the general practice of underwriting and ratemaking.”481 Finally, the court held that

the challenged insurance company practice — discrimination — was hardly limited to insurance

companies. In sum, the McCarran-Ferguson Act clearly did not preempt a claim of

discrimination brought under the Civil Rights Act of 1991.482 The United States Supreme Court

agreed to hear the case, but the insurance company soon thereafter withdrew its appeal and

settled the case.483

Courts repeated refusals to allow the insurance industry to use the McCarran-

Ferguson Act to shield discriminatory practices from the reach of federal law drives home what

the term “business of insurance” is intended to mean for the purposes of the McCarran-Ferguson

Act. The purpose of the McCarran-Ferguson Act was to allow states to regulate the business of

insurance as they had traditionally done prior to Southeastern Underwriters, not to grant states

regulatory powers beyond what they possessed prior to that decision.484 Traditional state

regulation of the insurance industry focused on the policyholder/insurance company relationship

and the financial condition of the insurance companies.485 The Pireno test, and the United States

Supreme Court’s explanations of the origins and purpose of the McCarran-Ferguson Act, remind

RICO claimants, policyholders, insurance companies and the courts that “[i]nsurance companies

may do many things which are subject to paramount federal regulation; only when they are

481 Id.482 Id.483 See GEICO Settles Lawsuit By Alien Denied Coverage, FED. AND ST. INS. WEEK, June 5, 1995.484 748 F. Supp. at 1221, quoting SEC v. National Securities, Inc., 393 U.S. 453, 459 (1969).485 Id. at 1221-22, citing SEC v. Variable Annuity Life Ins. Co., 359 U.S. 65, 90-91 (1969)(Brennan, J, concurring).


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engaged in the ‘business of insurance’ does the statute apply.”486 Decisions like American Home

and Duane should come as no surprise when “[i]ndividual civil rights and discrimination in the

making and enforcement of contracts . . . have been the proper subject of federal regulation for

over a century.”487

6. Is RICO Somehow Different From Other Federal Laws Which Interact With The McCarran-Ferguson Act?

The McCarran-Ferguson Act “was not intended to bar enforcement of federal

policies in such fields as civil rights, labor, and other areas of national concern. . . . Racketeering

activity, at which RICO is aimed, is an area of ‘national concern’. . . .”488 Several cases

concerning McCarran-Ferguson preemption of federal laws other than RICO489 have found that

the McCarran-Ferguson Act is inapplicable. These cases further illustrate the defects of the

insurance industry arguments to preclude RICO.

In Stephens v. National Distillers and Chemical Corp., the United States Court of

Appeals for the Second Circuit held that the McCarran-Ferguson Act did not preempt application

of the Foreign Sovereign Immunities Act (FSIA), holding that the FSIA was “so different from

the kind of congressional statutory action that the McCarran-Ferguson Act was meant to deal

with [that it] virtually compel[s] the conclusion that the McCarran-Ferguson Act should not be

interpreted to exclude insurance companies from the FSIA’s requirements . . . .”490 The origins

and history of RICO lends itself to the same reasoning.

486 Id., quoting SEC v. National Securities, Inc., 393 U.S. at 459-60.487 Id. at 1222.488 Dornberger v. Metropolitan Life Ins. Co., 961 F. Supp. 506, 521 (S.D.N.Y. 1997)(quotations omitted).489 See 125 L. Ed. 2d 879 (1997) for a discussion of U.S. Supreme Court decisions judging the applicability of the McCarran-Ferguson Act to various federal laws. 490 Stephens v. National Distillers & Chem. Corp., 69 F.3d 1226, 1231 (2d Cir. 1995).


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In Villafane-Neriz v. Federal Deposit Insurance Co.,491 the United States Court of

Appeals for the First Circuit rejected the Insurance Commissioner of Puerto Rico’s arguments

that application of the Federal Deposit Insurance Act (FDIA) “impaired” his ability to regulate

the business of insurance. Under the FDIA, the Commissioner was not entitled to deposit

insurance on a $50,000 certificate of deposit assigned to the Commissioner by an insurance

company which became insolvent. The Commissioner’s financial loss, the court held, was the

product of events, not a conflict between federal and Commonwealth statutes.492 Nothing

“impaired” the Commissioner’s ability to enforce the relevant insurance law. The court refused

to find that Puerto Rico’s insurance laws were “impaired” merely because the insurance

commissioner suffered a financial loss in the field of insurance.493

In Murff v. Professional Medical Insurance Co., the United States Court of

Appeals for the Eighth Circuit held that the McCarran-Ferguson Act did not preclude a claim

brought under the Federal Age Discrimination in Employment Act (ADEA) against an insurance

company in liquidation.494 The court rejected insurance company arguments that application of

the ADEA would undermine Missouri insurance law, holding that “[t]he ADEA does not

prohibit something that the [Missouri] Insolvency Act commands, nor does it command

something that the Insolvency Act prohibits. The provisions of the ADEA itself, applied to

insurance companies, are entirely compatible with the state’s regulation of insurance law.”495

491 Villafane-Neriz v. FDIC, 75 F.3d 727 (1st Cir. 1996), amended, No. 95-1492, 1996 U.S. App. LEXIS 7813 (1st Cir. Apr. 9, 1996).492 Id. at 736.493 Id.494 Murff v. Professional Med. Ins. Co., 97 F.3d 289 (8th Cir. 1996), cert. denied, 117 S. Ct. 2452 (U.S. 1997).495 Id. at 292.


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In Securities and Exchange Commission v. Waltzer & Associates, the United

States Court of Appeals for the Second Circuit held that production of information pursuant to an

SEC subpoena relating to sales of insurance by an investment adviser did not violate the

McCarran-Ferguson Act because the Commission’s request did not invalidate, impair or

supersede any state insurance law.496

7. Public Policy and the Insurance Industry Use of RICO: Conflicts and Con-tradictions

Insurance companies aggressively employ RICO on a regular basis to prosecute

allegations of insurance fraud. Permitting insurance companies to use RICO at their pleasure,

only to allow the same insurance companies to argue that RICO is inapplicable when invoked

against them, is patently unfair. Equally hypocritical are insurance company arguments that their

allegations of fraud are not part of the business of insurance, and thus not governed by the

McCarran-Ferguson Act, but that a RICO claimant’s allegations of insurance fraud are part of

the ‘business of insurance’ and foreclosed by the McCarran-Ferguson Act. When insurance

companies repeatedly use RICO against their employees and policyholders, it makes little sense

to argue that when policyholders similarly invoke RICO against an insurance company, it is

suddenly contrary to the purposes of the RICO or the McCarran-Ferguson statutes. These

arguments should not be entertained by the courts.

If insurance companies continue to fight RICO claims by arguing that RICO does

not ‘specifically relate’ to the business of insurance, they may find that courts are willing to

apply the argument against other insurance companies or themselves in other cases. Insurance

company arguments against RICO claimants may be adopted by courts to foreclose the insurance

companies from invoking RICO when it is to their benefit. Given the number of cases in which

496 SEC v. Waltzer & Assocs., No. 96-6261, 1997 U.S. App. LEXIS 23830 (2d Cir. Sept. 10, 1997).


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insurance companies invoke RICO, this is certainly not to their benefit. An insurance industry

which does not see itself as a major perpetrator of fraud has nothing to lose by acknowledging

that RICO specifically relates to the business of insurance and complements rather than conflicts

with state insurance laws.497 In this way, RICO claimants and insurance industry entities can

both more fairly and equally use RICO to prosecute fraud.

RICO’s steep penalties represent a strong public policy against fraud and

conspiracy. Enforcement of this broad public policy is especially well-directed at an industry

which is not only exempt from federal antitrust regulations, but which also drafted its own set of

laws and regulations in lieu of having states follow federal law.498 Contrary to insurance

company arguments, courts across the country are indicating that conflicts between RICO and

other federal laws and state insurance regulations are the exception, not the rule. Under the

McCarran-Ferguson Act, “[f]ederal laws that do not conflict with or supersede state rules always

apply.”499

497 See Christopher Winans, Insurers’ Weapon Against RICO Claims Could Backfire If Its Too Successful, BEST’S INS. MGMT. REPS., June 14, 1993, at 4.498 See Stephen S. Ashley, Bad Faith Actions: Liability and Damages § 9:02 at 4 (1996).

[Following the decision in Southeastern Underwriters], [t]he insurance industry devised an ingenious plan to head off federal regulation. It persuaded Congress to introduce legislation, known as the McCarran-Ferguson Act, which provided a three year moratorium on federal regulation of the insurance industry. At the expiration of the moratorium the federal regulators could then assert their authority only over those aspects of the insurance industry not regulated by the states. This moratorium gave the insurance commissioners the opportunity, through the National Association of Insurance Commissioners (NAIC), to draft model legislation intended to preempt the entire field of insurance industry regulation and thus protect the commissioners’ turf from Federal Trade Commission encroachment. (footnotes omitted).

499 Stephens v. National Distillers & Chem. Corp., 69 F.3d 1226, 1234 (2d Cir. 1995)(McCarran-Ferguson Act does not preempt the Foreign Sovereign Immunities Act); NAACP v. American Family Mut. Ins. Co., 978 F.2d 287, 295 (7th Cir. 1992), cert. denied, 508 U.S. 907 (1993)(McCarran-Ferguson


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Courts across the country are reigning in the McCarran-Ferguson Act, repeatedly

holding that RICO does not necessarily conflict with state insurance law and that fraudulent

insurance industry misconduct is not the business of insurance. The recent cases, coupled with

NAIC’s firm conviction that RICO is applicable to the business of insurance, suggest a

receptiveness by both courts and insurance regulators to allow policyholders and other RICO

claimants to bring RICO claims against insurance companies, brokers or agents. The United

States Supreme Court’s decision in Barnett Banks, as well as insurance companies’ routine use

of RICO, indicate that RICO may “specifically relate” to the business of insurance. The

McCarran-Ferguson Act is no longer the impenetrable shield that it once was for the insurance

industry.

All the same, the mandatory treble damages, attorney fees and costs awarded to a

victorious RICO claimant virtually guarantee that insurance companies will fight hard any RICO

claim. RICO claimants must also still prove the remaining elements of a RICO claim, and care

must be taken to avoid federal courts in a circuit that is hostile in general to RICO.500

Establishing that RICO does not conflict with the McCarran-Ferguson Act is an

essential first step to bringing a RICO claim. Claimants alleging fraud against an insurance

company, broker or agent should very seriously consider RICO.

PART VIOther Claims to Consider: Common Law Fraud and Negligent Misrepresentation

To constitute actionable common law fraud: (1) there must be a material

representation; (2) the representation must be false; (3) the defendant, when he made the

Act does not preempt the Fair Housing Act).500 For a discussion of the split in the courts, a list of cases on each side and a decision that RICO does conflict with state law, see Doe v. Norwest Bank of Minnesota, N.A., 107 F.3d 1297 (8th Cir.) reh’g denied, en banc, No. 96-1763MNST, 1997 U.S. App. LEXIS 11337 (8th Cir. May 12, 1997).


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representation either knew that it was false, or made it recklessly, without any knowledge of its

truth; (4) the defendant made the representation with the intention that it should be acted on by

plaintiff; (5) plaintiff acted in reliance on it; and (6) the plaintiff thereby suffered injury.

The tort of negligent misrepresentation involves a failure to use due care in

obtaining and communicating information upon which a party may reasonably be expected to

rely in the conduct of his economic affairs. The elements of a claim of negligent

misrepresentation are a misrepresentation concerning a material fact justifiably relied on by

plaintiff and loss or damages proximately caused by such misrepresentation.

An action for negligent misrepresentation is essentially an action for fraud,

without the same level of intent. Negligent misrepresentation generally requires that the

statement or omission be made without a reasonable basis for believing its truthfulness, rather

than actual knowledge of its falsity. A plaintiff, however, generally cannot recover for economic

injuries cause by defendant’s negligent misrepresentation absent actual privity of contract

between the parties or a relationship so close as to approach that of privity.

Actionable fraud may be predicted on a misrepresentation of solvency or financial

condition. To sustain a recovery, plaintiff must show all essential elements of fraud. The rule

that representations, to be actionable, must have been made with intent to induce action by the

complainant has been applied to representations of financial standing.


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PART VIIDeath or Disability of a Policyholder: Seek Consequential Damages

1. Death of Company

Bad faith denials of insurance coverage can ruin a policyholder’s credit, cause

tremendous emotional distress and create a mountain debt.501 At worst, the policyholder may be

severely disabled or forced into bankruptcy, sometimes referred to as “death of company.”502

Death of company cases display the most egregious results of insurance company misconduct

and go well beyond the realm of policy limits or purely economic loss. Moreover, there is

evidence that insurance companies know far in advance that failure to timely pay a particular

policyholder’s claims can be devastating.503 As one insurance adjuster explained the typically

bleak picture for policyholders after experiencing a loss:

The claim is starting the fourth month, the insured is behind in rent, getting threatened by suppliers, has lost his customers and all commissioned employees have left. And this is if there are no complications. The insured is lucky if he is still in business.504

In one death of company case, the policyholder, a contractor, was sued for alleged

construction defects. The position of the policyholder’s insurance company was that if the

policyholder refused to accept the proposed settlement, the policyholder would be responsible

for any settlement or judgment which exceeded the proposed settlement amount and responsible

501 Glenn E. Smith, Understanding The New Tort Of First Party Bad Faith In Wyoming: McCullough v. Golden Rule Insurance Company, 26 LAND & WATER L. REV. 226, 238 (1991); Joseph Segal, Sluggish Claim Process Can Cause Insured Business’ Demise, CLAIMS, Feb. 1995, at 86.502 See, e.g., Motion For Partial Summary Judgment And Incorporated Brief In Support Thereof, at 3, dated Aug. 29, 1995, In re: Cooper Mfg. Corp. v. Home Indem. Co., No. 94-C-901-BU (N.D. Okla.). In this case, the liquidating trustee in bankruptcy for the policyholder brought an action against the policyholder’s insurance companies for bad faith conduct and improper denials of insurance coverage. These denials constituted the sole basis for the policyholder’s need to seek bankruptcy protection. The insurance companies referred to this allegation as “death of company.”503 See Joan Hartnett-Barry, A Delicate State of Mind, CLAIMS, May 1997, at 46.504 Joseph Segal, Sluggish Claim Process Can Cause Insured Business’ Demise, CLAIMS, Feb. 1995, at 86. Mr. Segal is a CPA and public insurance adjuster.


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for any additional legal fees incurred in his defense.505 This was despite expert testimony from

five witnesses who each had concluded that the policyholder was not at fault for any defects,506

and despite the policyholder’s desire to clear his name.507 The insurance company never

attempted to exonerate the policyholder or to join the parties more likely to be at fault because it

wanted to minimize its expenses.508

After the policyholder agreed to settle because “he could not afford to take on the

insurance company,” the insurance company sued him to recover the amount of the settlement

and for the legal fees it had incurred in the policyholder’s “defense.”509 The policyholder

counterclaimed, claiming breach of contract and breach of the duty of good faith a fair dealing.

In all, the policyholder incurred over $320,000 in legal fees. He lost his business

and his assets. He had already paid more than $60,000 in premiums to the insurance company

for his liability insurance.510 There was also evidence that the insurance company may have lied

about the destruction of its documents.

A jury awarded the policyholder $12 million in punitive damages against the

insurance company. In affirming the award, a California appellate court held that “the award

was based on the reprehensibility of [the insurance company’s] conduct toward [the

505 See West Am. Ins. Co. v. Freeman, 46 Cal. App. 4th 1476 (1st Dist. 1995), rev. granted, 907 P.2d 1323 (Cal. 1995), rev. dismissed, 927 P.2d 1172 (1996), rev. denied, 1997 Cal. LEXIS 649 (Cal. Feb. 5, 1997)(No. S049306), cert. denied, 117 S. Ct. 1695 (U.S. 1997).506 46 Cal. App. 4th at 1481, 1490.507 Id. at 1482.508 Id. at 1481-82. Trial testimony also indicated that the insurance company’s greatest expense was attorneys fees, and as such, had made a “policy” decision to seek reimbursement from policyholders in cases where the insurance company had been required to pay for Cumis counsel. Id. at 1483-84.509 Id. at 1482-83.510 Id. at 1484.


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policyholder] and its failure to accord [the policyholder] the consideration to which he was

entitled.”511 The appellate court accorded great weight to the trial court’s findings:

[T]he conduct of the insurance company in this case was egregious . . . [the insurance company’s claims adjuster] somehow seemed to determine that he wasn’t going to cover this claim, and that he would do what he wanted despite the evidence to the contrary. He exhibited an absolute total disregard for [the policyholder’s] rights under the contract, and for his rights as a person to be treated decently.512

The California Supreme Court agreed to review the case and accepted briefs in light of the U.S.

Supreme Court’s decision in BMW.513 The review was dismissed by the California Supreme

Court without opinion.514 West America’s petition of certiorari to the U.S. Supreme Court was

denied.515

2. Consequential Damages, Bad Faith or Both — The Brass Ring and Meat and Potatoes

Consequential damages are very frequently overlooked by counsel in the quest for

punitive damages. Consider this: Virtually, no large punitive damage award withstands

appeals. Virtually, no consequential damages are upset on appeal.

Focus on consequential damages. This is an accounting matter first and a

causation matter second. Under established law, the policyholder is entitled to recover all

damages incurred by the policyholder as a consequence of a breach of an insurance policy under

511 Id. at 1490.512 Id. 513 See West Am. Ins. Co. v. Freeman, 46 Cal. App. 4th 1476, 907 P.2d 1323 (1995); See also Insurer Claims Petition, Due Process Violations In Request To Supreme Court, MEALEY’S LITIG. REP.: BAD FAITH, Mar. 26, 1997.514 See West Am. Ins. Co. v. Freeman, 927 P.2d 1172 (Cal. 1996), rev. denied, 1997 Cal. LEXIS 649 (Cal. Feb. 5, 1997)(No. S049306).515 See West Am. Ins. Co. v. Freeman, cert. denied, 117 S. Ct. 1695 (U.S. 1997).


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the rule announced in Hadley v. Baxendale.516 At least one insurance company has argued that

recovery of consequential damages is allowed under the state’s “bad faith” statute.517

Hadley held that the damages recoverable for breach of contract are those that

arise naturally from the breach, or those that were in the contemplation of the parties at the time

the contract was made. Consequential damages for an insurance company’s breach can include

lost profits and damages for the loss of the business without regard to policy limits. The

policyholder can recover consequential damages as a measure of contract damages entirely apart

from policy limits and any punitive damages for the insurance company’s bad faith.518

There are established methods to calculate and prove consequential damages in

insurance coverage disputes. They are not unlike the ways lawyers prove damages for bodily

injury. They are virtually identical to the ways a business calculates a business interruption

claim on a first party property insurance policy. Consider this: a farmer reports to Stonewall

Insurance Company that the John Deere tractor has been stolen. The Stonewall adjuster has

“heard” that pot has been grown in the area. Of course, Stonewall Insurance does not want to aid

in such an immoral, illicit and politically incorrect activity.519 Investigation of the claim

proceeds, with the adjuster busy doing the work of the state police and the Federal Drug

516 Hadley v. Baxendale, 156 Eng. Rep. 145 (1854).517 See Brief for Appellee, Nationwide Mutual Fire Insurance Company, at 11-12, dated Sept. 30, 1996, Polselli v. Nationwide Mut. Fire Ins. Co., No. 96-1107 (3d Cir.):

Indeed, when one reads [42 Pa. C.S.A. § 8371] in its entirety, Nationwide respectfully suggests that it is designed to include both compensatory and punitive elements for an insurer’s bad faith handling of an insurance claim.

518 See 2 Eugene R. Anderson et al., Insurance Coverage Litigation § 11.19, at 45-46 (1997).519 One might reasonably ask why Stonewall Insurance Company did not make an investigation before collecting the premium. Lord Mansfield, the father of insurance law, wrote may years ago: “Every underwriter is presumed to be acquainted with the practice of the trade he insures, and that whether it is recently established, or not.” Noble v. Kennoway, 2 Doug. 511, 513 (K.B. 1780), United Kingdom.


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Enforcement Agency. The bank holding the mortgage on the farm hears about the inquiry and

decides not to renew the mortgage. Like the proverbial Job, the farmer’s life is downhill

thereafter. Stonewall eventually pays $30,000 for the stolen tractor which it later retrieves and

offers to return to the now “former” farmer. Stonewall then demands the $30,000 back and sues

the “former” farmer. The “former” farmer defaults. One stolen tractor and the “former”

farmer’s farm is lost and the former farmer’s credit is irresponsibly damaged.

A perfect bad faith case? Maybe, but the bad faith case would not be worth much

even at 10 times the policy limits of $30,000.

What about consequential damages? There is a huge body of lore and law on

“business interruption” insurance. That lore and that law can be applied to the farm business and

it can be applied to recover much more than the value of the tractor.

Take next the case of a small business, Jones Leather Goods Co., which for

generations has manufactured leather goods and sent the scraps to the local municipal landfill.

The state and federal environmental authorities sue Jones to recover clean-up costs. Stonewall

Insurance Company denies liability insurance coverage because it does not like “polluters.”

Jones Leather defends itself, paying lawyers $275,000 and settling with the authorities for

$300,000.

A good bad faith case, maybe. What about consequential damages? Booker

Jones IV is asked what, if any, impact the failure of Stonewall to defend had on the leather

business. Among the many items he catalogues is the fact that the company lost 5% of its sales

because he and other members of management had to spend time on the governments’ claims.


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Five percent of sales over the 6 or 7 years translates into $23,000,000 in lost profits.520 In theory

at least, $23,575,000 could support a very large bad faith award, even under BMW.

3. Consequential Damages --What the Cases Say

To depart from the cardinal rule — to learn insurance lore — not insurance law

— there are many cases permitting consequential damages. As demonstrated by the following

fifty-two representative cases, courts throughout the country have granted policyholders

consequential damages for their insurance company’s breach of its insurance policy as breach of

contract damages, distinct from any bad faith recovery, and without regard to policy limits. The

cases are:

1. Gray v. Grain Mut. Ins. Co. , 871 F.2d 1128, 1130-32 (D.C. Cir. 1989) ( applying North Carolina law) (affirming the trial court’s award of consequential damages resulting from the insurance company’s breach of its duty to settle).

2. Carpenter v. Automobile Club Interinsurance Exch. , 58 F.3d 1296, 1303 (8th Cir. 1995) (applying Arkansas law) (holding that an insurance company could be required to pay, as consequential damages for failure to settle, sums that would not otherwise be covered under the terms of the insurance policy).

3. Bettius & Sanderson, P.C. v. National Union Fire Ins. Co. , 839 F.2d 1009, 1014-15 (4th Cir. 1988) (applying Virginia law) (awarding consequential damages for loss of profits of law firm forced to dissolve by insurance company’s breach of its insurance policy).

4. A&E Supply Co. v. Nationwide Mut. Fire Ins. Co., 798 F.2d 669, 677-78 (4th Cir. 1986), cert. denied, 479 U.S. 1091 (1987) (applying Virginia law) (recognizing, as a matter of contract law, that violation of the duty of good faith by an insurance company

520 Id.; see generally ALLAN D. WINDT, INSURANCE CLAIMS AND DISPUTES § 6.37, at 374-75 (1988) (“The general measure of damages available for breach of a contract to pay money is the amount due, plus interest. There is language in a few cases, therefore, indicating that an insurer, following its breach of contract, is liable only for the amount of policy benefits owed, plus interest. The dicta in those cases, however, do not accurately represent the law. Absent a statute to the contrary, consequential damages are, in fact, always available in contract actions if they arise naturally from the breach and are such that they may reasonably be supposed to have been in the contemplation of the parties at the time the contract was made. The courts that have expressly considered the issue, therefore, have consistently recognized that, under certain circumstances, the foregoing test might be met in an action against the insurance company”)(emphasis added).


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entitles policyholder to full consequential losses: “foreseeable losses, not susceptible to mitigation”).

5. Murphy v. Cincinnati Ins. Co. , 772 F.2d 273, 276-77 (6th Cir. 1985) (applying Michigan law) (recognizing that damages recoverable for breach of an insurance policy include “those that arise naturally from the breach or those that were in the contemplation of the parties at the time the contract was made,” and, in this case, included attorneys’ fees incurred in bringing the insurance coverage action).

6. Salamey v. Aetna Cas. & Sur. Co. , 741 F.2d 874, 877 (6th Cir. 1984) (applying Michigan law) (allowing, as consequential damages for the breach of an insurance policy, lost profits from the policyholder’s inability to reopen his store without an insurance recovery: “‘The policy limits restrict the amount the insurer may have to pay in the performance of the contract, not the damages that are recoverable for its breach.’“) (quotation omitted).

7. Don Burton, Inc. v. Aetna Life & Cas. Co. , 575 F.2d 702, 708 (9th Cir. 1978) (in dicta, noting that, for breach of an insurance policy, the policyholder could recover consequential damages for the loss of his business, if sufficient evidence of a causal relationship between the breach and the anticipated net profits were demonstrated).

8. Alliance Ins. Co. v. Alper-Salvage Co. , 19 F.2d 828 (6th Cir. 1927) (applying Tennessee law) (holding policyholder was entitled to damages for loss of use of its property caused by insurance company’s breach of its insurance policy).

9. Heller Int’l Corp. v. Sharp , 839 F. Supp. 1297, 1302-03 (N.D. Ill. 1993) (applying Illinois law) (noting that the “general principles of contract law apply equally well in the insurance contract context,” and that “[i]n many instances, the measure of damages is governed by the contractual policy amount. That rule is not an absolute. As noted above, Illinois law does allow recovery of consequential damages ‘where they were reasonably foreseeable, were within the contemplation of the parties at the time the contract was entered, or arose out of special circumstances known to the parties.’“).

10. Haardt v. Farmer’s Mut. Fire Ins. Co. , 796 F. Supp. 804, 811 (D.N.J. 1992) (applying New Jersey law) (holding policyholder could recover consequential damages for insurance company’s breach of its insurance policy in failure to pay for repair of house, including devaluation of property and loss of rents).

11. Pacific Employers Ins. Co. v. P.B. Hoidale Co. , 789 F. Supp. 1117, 1124 (D. Kan. 1992) (“Employers concedes that lost profits are recoverable for breach of an insurance policy. Such damages are limited to those which may fairly be considered to arise ‘“in the usual course of things, from the breach itself, or as may reasonably be assumed to have been within the contemplation of both parties as the probable result of the breach”’“) (citations omitted).

12. Red Ceders, Inc. v. Westchester Fire Ins. Co. , 686 F. Supp. 614, 616 (E.D. Mich. 1988) (applying Michigan law) (“An insured may recover consequential damages for the


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insurer’s breach of contract. . . . The policy’s limits on losses do not restrict consequential damages claimed as a breach of the policy.”).

13. Diaz Irizarry v. Ennia, N.V. , 678 F. Supp. 957, 962 (D.P.R. 1988) (applying Puerto Rico law) (holding that consequential damages are recoverable for breach of an insurance policy if “foreseeable”).

14. Earth Scientists (Petro Servs.) Ltd. v. United States Fidelity & Guar. Co. , 619 F. Supp. 1465, 1474-75 (D. Kan. 1985) (applying Kansas law) (permitting policyholder to seek as consequential damages lost profits, including those for closing down its operations, as a result of insurance company’s failure to pay for damage to policyholder’s oil rig).

15. Ingersoll Milling Mach. Co. v. M/V Bodena , 619 F. Supp. 493, 507 (S.D.N.Y. 1985) (holding policyholder was entitled to recover expenses of bringing action against other companies to cover the cost of a loss after insurance company breached its insurance policy by failing to cover the loss).

16. Strader v. Union Hall, Inc. , 486 F. Supp. 159, 164 (N.D. Ill. 1980) (applying Illinois law) (permitting policyholder to seek consequential damages for breach of an insurance policy).

17. Mann v. Glens Falls Ins. Co. , 418 F. Supp. 237, 249 (D. Nev. 1974), rev’d on other grounds, 541 F.2d 819 (9th Cir. 1976) (applying Nevada law) (adopting Reichert in toto and holding policyholder could recover consequential damages for insurance company’s breach of its insurance policy).

18. McDowell v. Union Mut. Life Ins. Co. , 404 F. Supp. 136, 140-41 (C.D. Cal. 1975) (applying California law) (holding that insurance company’s breach of an insurance policy exposed it to liability for consequential damages, including expenses associated with the policyholder’s bankruptcy, including filing fees, legal expenses, and loss of credit reputation).

19. Asher v. Reliance Ins. Co. , 308 F. Supp. 847, 852 (N.D. Cal. 1970) (applying Alaska and California law) (holding policyholder could recover as consequential damages from insurance company’s breach of its insurance policy, loss of rents because of insurance company’s failure to pay for burned property under fire insurance policy if “such damage were ‘proximately caused’ by or ‘flowed naturally and expectedly’ from the defendant’s breach”).

20. Scrima v. Insurance Co. of N. Am. , 116 B.R. 951, 960-62 (Bankr. W.D. Mich. 1990) (allowing consequential damages — loss of profits — for insurance company’s breach of insurance policy).

21. Independent Fire Ins. Co. v. Lunsford , 621 So. 2d 977, 979 (Ala. 1993) (affirming a verdict for the policyholder “of compensatory damages for breach of contract, including damages for mental anguish).


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22. State Farm Mut. Auto. Ins. Co. v. Allstate Ins. Co. , 9 Cal App. 3d 508 (1970) (“damages for breach of the duty to defend are not inexorably imprisoned within the policy limit but are measured by the consequences proximately caused by the breach”).

23. Travelers Ins. Co. v. Wells , 633 So. 2d 457, 461-63 (Fla. Dist. Ct. App. 1993), clarified, Nos. 92-2958, 92-2959, 1994 Fla. App. LEXIS 2445 (Fla. Dist. Ct. App. 1994) (allowing consequential damages — projected net profits — for breach of insurance contracts for loss of business caused by failure of insurance company to renew insurance policy causing policyholder’s business to cease: “[c]onsequential or resulting collateral damage may also be recovered if it can be sufficiently proved”).

24. Life Investors Ins. Co. v. Johnson , 422 So. 2d 32, 34 (Fla. Dist. Ct. App. 1982) (applying Hadley, and finding that a breach of an insurance policy “may give rise to damages which were in contemplation of the parties at the inception of the contract”).

25. Leader Nat’l Ins. Co. v. Smith , 339 S.E.2d 321, 331 (Ga. App. 1985) (finding that, as with other contracts, “‘[r]emote or consequential damages are not recoverable unless they can be traced solely to the breach of the contract or unless they are capable of exact computation, such as the profits which are the immediate fruit of the contract, and are independent of any collateral enterprise entered into in contemplation of the contract,’“ noting “[l]oss of profits has often been regarded as consequential damages and is recoverable in contract actions,” and noting “‘[d]amages growing out of a breach of contract . . . must have arisen according to the usual course of things, and be such as the parties contemplated as a probable result of the breach’“) (citations omitted).

26. Clark v. Standard Life & Accident Ins. Co. , 386 N.E.2d 890, 898 (Ill. App. Ct. 1979) (holding that, for breach of an insurance policy, “consequential damages may be recovered when they ‘were reasonably foreseeable and were within the contemplation of the parties at the time the contract was executed’ arising out of special circumstances communicated and known to both parties”) (citation omitted).

27. Indiana Ins. Co. v. Plummer Power Mower & Tool Rental, Inc. , 590 N.E.2d 1085, 1092 (Ind. Ct. App. 1992) (finding proper an award of consequential damages caused by insurance company’s breach of its insurance policy: “When a business owner contracts for insurance on his primary source of income, he has the expectation of prompt payment so that he can rebuild and continue his business after the occurrence of a catastrophe such as the fire involved in this case. Delayed payment, whether as a result of good or bad faith, will undoubtedly result in the failure of the owner’s business. The damages incurred from such inability to pay bills flow directly, and are proximately caused by, the insurer’s failure to pay. The likelihood of such damages is only unforeseeable to unreasonably narrow-minded insurers.”).

28. Salvator v. Admiral Merchants Motor Freight , 509 N.E.2d 1349, 1359-61 (Ill. App. Ct.), appeal denied, 515 N.E.2d 126 (Ill. 1987) (affirming award of consequential damages — loss of earnings — for insurance company’s breach of its insurance policy).


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29. Mohr v. Dix Mut. County Fire Ins. Co. , 493 N.E.2d 638, 643-44 (Ill. App. Ct. 1986) (noting “[c]onsequential damages . . . may be recovered where they were reasonably foreseeable, were within the contemplation of the parties at the time the contract was entered, or arose out of special circumstances known to the parties,” and that “[l]ost profits may be recovered where the loss is shown with reasonable certainty, the defendant’s wrongful action caused the loss, and the lost profits were within the contemplation of the parties when they entered the contract”).

30. Hochman v. American Family Ins. Co. , 673 P.2d 1200, 1203 (Kan. App. Ct. 1984) (affirming award of interest paid by a policyholder on loan to repair tractor as consequential damages for insurance company’s failure to pay for tractor repair, noting “[d]amages recoverable for breach of contract are limited to those which may fairly be considered as arising, in the usual course of things, from the breach itself, or as may reasonably be assumed to have been within the contemplation of both parties as the probable result of the breach”).

31. Hinson v. Zurich Ins. Co. , 196 So. 2d 827, 829-31 (La. App. Ct. 1967) (finding that a policyholder can recover consequential damages for loss of wages and humiliation incurred by loss of employment on account of insurance company’s breach of its insurance policy, but finding that lost wages were not sufficiently proved in this case).

32. Pennsylvania Threshermen & Farmers’ Mut. Cas. Ins. Co. v. Messenger , 29 A.2d 653 (Md. 1943) (willful failure to comply with obligations under liability insurance policy requires insurance company to respond in damages for any loss suffered as a consequence: “[t]he damages allowed for breach of a contract should compensate the injured person for the loss he has sustained as a result of the breach. The court should endeavor to place the injured person as far as possible by monetary award, in the position in which he would have been, if the contract had been properly performed”).

33. Lawrence v. Will Darrah & Assocs., Inc. , 516 N.W.2d 43, 48 (Mich. 1994) (finding policyholder could recover as consequential damages for insurance company’s breach of its insurance policy those damages “the promisor knows or has reason to know” about, including lost profits from trucking business by reason of insurance company’s failure to pay for repair of truck).

34. Miholevich v. Mid-West Mut. Auto Ins. Co. , 246 N.W. 202, 203 (Mich. 1933) (damages sustained by policyholder in body execution following failure of insurance company to pay judgment were such as were contemplated by the parties and hence recoverable).

35. Wendt v. Auto-Owners Ins. Co. , 401 N.W.2d 375, 377-80 (Mich. Ct. App. 1986) (finding policyholder could bring action for damages consequential to insurance company’s breach of its obligation to pay for the repair of a truck, including loss of use of the owed money, default on a note upon which the truck was security, loss of use of the truck, decline in policyholder’s business, and storage costs of damaged truck).


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36. Parmet Homes, Inc. v. Republic Ins. Co. , 314 N.W.2d 453, 457 (Mich. 1981) (although disallowing consequential damages for unrelated venture which policyholder could not participate in because of failure of insurance company’s to pay on policies, on the ground that damages from such unrelated venture were not foreseeable, noting “the damages recoverable for breach of contract are those that arise naturally from the breach and were within the contemplation of the parties at the time the contract was executed. Loss of profits which result from the breach may be considered in assessing damages”).

37. Olson v. Rugloski , 277 N.W.2d 385, 387-88 (Minn. 1979) (holding that policyholder, whose insurance company breached its insurance policy by failing to reimburse him for the loss of his trucks, was responsible for consequential damages from that breach, including lost profits: “When the insurer refuses to pay or unreasonably delays payment of an undisputed amount, it breaches the contact and is liable for the loss that naturally and proximately flows from the breach. . . . Lost profits may recovered if they are a natural and proximate result of the breach and are proved with reasonable, although not absolute, certainty.”) (citation omitted).

38. Aetna Cas. & Sur. Co. v. Day , 487 So. 2d 830, 835 (Miss. 1986) (“Although the insurance policy expressly limits coverage to a specific amount, this is not to say that damages for breach of contract are limited to those of mere repair. In a contract action, generally a plaintiff may recover consequential damages reasonably foreseeable at the time the contract was made and established at trial, where properly pled and supported by substantial evidence.”).

39. Landie v. Century Indem. Co. , 390 S.W.2d 558, 562 (Mo. Ct. App. 1965) (“‘Thus, all the cases agree that where it is the insurer’s duty to defend, and the insurer wrongfully refuses to do so on the ground that the claim upon which the action against the insured is based is not within the coverage of the policy, the insurer is guilty of a breach of contract which renders it liable to the insured for all damages resulting to him as a result of such breach.’“) (citation omitted).

40. A.B.C. Builders, Inc. v. American Mut. Ins. Co. , 661 A.2d 1187, 1192 (N.H. 1995) (awarding costs of financing settlement and other consequential damages proper in breach of insurance policy action “because an insurance policy is a contract” and “its breach may result in an award of consequential damages if they were foreseeable and can be proved”).

41. Drop Anchor Realty Trust v. Hartford Fire Ins. Co. , 496 A.2d 339, 342-43 (N.H. 1985) (finding compensable consequential damages from insurance company’s breach of duties under an insurance policy to pay for repair of policyholder’s hotel, including loss of good will and business reputation and lost profits for vacation season).

42. Jarvis v. Prudential Ins. Co. , 448 A.2d 407, 410 (N.H. 1982) (finding “[t]he insured may recover specific consequential damages if he can prove that such damages were reasonably foreseeable by the insurance company and that he could not have reasonably avoided or mitigated such damages”).


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43. Lawton v. Great Southwest Fire Ins. Co. , 392 A.2d 576, 578 (N.H. 1978) (holding consequential damages may be recovered for breach of an insurance policy, thereby holding that (i) consequential damages are not limited by doctrine that insurance policies are mere contracts to pay money; (ii) the policy limits are merely limits for payments owed on account of an insurable event and not limits for damages from breach of contract and (iii) financial injuries from an insurance company’s breach of its duty).

44. Pickett v. Lloyd’s (a Syndicate of Underwriting Members) , 600 A.2d 148, 155 (N.J. App. Div. 1991), aff’d, 621 A.2d 445 (N.J. 1993) (finding policyholder could recover consequential damages — including loss of use — for breach of insurance policy to pay for replacement of tractor-trailer: “we consider the damages awarded here to have been reasonably foreseeable at the time the policy was issued, and thus recoverable in an action for breach of contract. Here, the insurer knew it was insuring a commercial tractor used by [the policyholder]. Although the insurance application is not part of the record, the policy form issued on January 5, 1987 described the vehicle and its use as commercial. Thus, it was reasonably foreseeable to both parties at the time the contract was entered into that if the vehicle was totally destroyed the insured’s livelihood and income would be affected.”).

45. Exum v. Ferguson , 637 P.2d 553, 555 (N.M. 1981) (holding that policyholder was entitled to consequential damages from insurance company’s breach — failure to pay for damage to his truck — including loss of profits and loss of equity in the truck that was repossessed).

46. Mitchell v. Intermountain Cas. Co. , 364 P.2d 856, 857 (N.M. 1961) (although noting “contractual damages recoverable for breach of the contract are those damages contemplated by the parties at the time of the making of the contract,” finding that the damages were not foreseeable).

47. Bibleault v. Hanover Ins. Co. , 417 A.2d 313, 318-19 (R.I. 1980) (noting that “[t]raditionally, recovery in contract for breach of a unilateral or independent obligation to pay a certain sum of money is confined to the actual amount owed under the contract plus legal interest,” but holding “[t]he duty of an insurer to deal fairly and in good faith with an insured is implied by law. Since violation of this duty sounds in contract as well as in tort, the insured may obtain consequential damages for economic loss and emotional distress and, when appropriate, punitive damages”).

48. Brown v. South Carolina Ins. Co. , 324 S.E.2d 641, 645-47 (S.C. 1984), appeal dismissed, 348 S.E.2d 530 (S.C. 1985) (finding bad faith to be an action based on contract, but noting that “the insurer is liable for whatever consequential damages follow as a natural consequence and proximate result of the breach,” and holding that damages consequential to insurance company’s breach in failing to pay for damage to car, including lost income, were recoverable).

49. Holmes v. Nationwide Life Ins. Co. , 258 S.E.2d 924, 926-27 (S.C. 1979) (holding that “‘[i]n breach of contract actions, only such damages as may reasonably be supposed to have been in the contemplation of both parties at the time the contract was made may


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be collected,’“ and allowing, as consequential damages for insurance company’s breach, interest on loan policyholder was forced to procure to pay medical expenses) (citation omitted).

50. Beck v. Farmers Ins. Exch. , 701 P.2d 795, 801-02 (Utah 1985) (allowing consequential damages — “those reasonably within the contemplation of, or reasonably foreseeable by, the parties at the time the contract was made” — for breach of an insurance policy, noting “a broad range of recoverable damages is conceivable, particularly given the unique nature and purpose of an insurance contract. An insured frequently faces catastrophic consequences if funds are not available within a reasonable period of time to cover an insured loss; damages for losses well in excess of policy limits, such as for a home or business, may therefore be foreseeable and provable”).

51. Hayseed’s, Inc. v. State Farm Fire & Cas. Co. , 352 S.E.2d 73, 79-80 (W. Va. 1986) (noting that “[i]t is now the majority rule in American courts that when an insurer wrongfully withholds or unreasonably delays payment of an insured’s claim, the insurer is liable for all foreseeable, consequential damages naturally flowing from the delay,” and, thus, “the policyholder is entitled to damages for net economic loss caused by the delay in settlement, as well as an award for aggravation and inconvenience”).

52. Newhouse v. Citizens Sec. Mut. Ins. Co. , 501 N.W.2d 1, 6 (Wis. 1993) (finding, upon breach of its insurance policy, “[t]he insurance company must pay damages necessary to put the insured in the same position he would have been in had the insurance company fulfilled the insurance contract. Policy limits do not restrict the damages recoverable by an insured for a breach of the contract by the insurer”).521

521 But see Polito v. Continental Cas. Co., 689 F.2d 457, 461 (3d Cir. 1982) (applying New Jersey law) (an insured “is generally denied consequential damages for [the insurance company’s] failure to pay the loss, because in a suit for money due under a contract, recovery is limited to the debt plus interest.”); Walker v. American Motorists Ins. Co., 529 F.2d 1163, 1165 (11th Cir. 1976) (applying Alabama law) (“The damages claimed by [the policyholder] for breach of contract include the loss of his home and business, injury to his reputation and credit, and costs of defending the state litigation. Under Alabama law, these damages are not recoverable for breach of an insurance contract.”); Burleson v. Illinois Farmers Ins. Co., 725 F. Supp. 1489 (S.D. Ind. 1989) (applying Indiana law) (finding consequential damages precluded as a matter of law where the insurance company disputes coverage in good faith; although finding consequential damages would be allowed under a contract theory, it prohibits them as a matter of public policy to allow insurance companies to deny coverage without penalty if they act in good faith); Schwegmann Giant Super Markets v. Golden Eagle Ins. Co., 693 F. Supp. 478, 487 (E.D. La. 1988) (applying Mississippi law) (denying lost profits as a consequence of insurance company’s failure to pay timely, noting that, in insurance policies, the policyholder is limited to the amount of insurance under the policy); Brown Township Mut. Ins. Ass’n v. Kress, 330 N.W.2d 291, 298 (Iowa 1983) (finding “[t]he insurer’s obligation or liability under a policy of fire insurance is measured and defined by the terms of the policy; the insured is entitled to recover to the extent of his loss occasioned by the fire, not exceeding the maximum amount stated in the policy”); General Accident Fire & Life Assurance Co. v. Judd, 400 S.W.2d 685, 687 (Ky. 1966) (“The traditional measure of recovery for failure to pay money due under contract is the amount agreed to be paid.”); Burnside v. State Farm Fire & Cas. Co., 528 N.W.2d 749, 751 (Mich. Ct. App. 1995) (holding that attorneys’ fees and actual costs are not recoverable as a result of the insurance company’s bad-faith breach of an insurance policy); Haas v. Pacific Mut. Life Ins. Co., 41 N.E.2d 263 (Ohio Ct. App. 1941) (finding policyholder not entitled to consequential damages from


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One insurance company responded to a policyholder’s claim for consequential

damages by complaining that the cases cited by the policyholder involved first party rather than

third party claims.522 Yet the insurance company failed to note why this distinction made a

difference and then noted that where consequential damages were awarded to a third party, it was

“almost inevitably because of the insurers wrongful, bad faith, refusal or delay in settlement of a

claim against the insured.”523 In fact, the insurance company’s opening argument was that the

policyholder had misinterpreted the “ancient” case of Hadley v. Baxendale.524 The power of the

argument for consequential damages is obvious when these are the best arguments a group of

insurance companies can make in opposition.

Thus, under general principles of law, a policyholder can recover as consequential

damages for a breach of an insurance policy any losses that either (i) arose from the breach itself,

or (ii) were in the contemplation of the parties.525 In support of the first wing of this rule, a

policyholder might prove that, had the insurance company properly complied with its obligations

to investigate and defend claims against the policyholder, the policyholder’s business would

breach of insurance policy).522 Gulf Underwriter Insurance Company’s Opposition To NEMA’s Motion To Recover Consequential Damages and Motion For Rule 11 Sanctions at 2, dated May 28, 1997, National Elec. Mfr. Ass’n v. Century Indem. Co., No. 96-985-A (E.D. Va.).523 Id. at 3-4.524 Id. at 2.525 See, e.g., Royal College Shop v. Northern Ins. Co, of N.Y., 895 F.2d 670, 679 (10th Cir. 1990) (“‘[D]amages recoverable for breach of contract are limited to those which may fairly be considered as arising, in the usual course of things, from the breach itself, or as may reasonably be assumed to have been within the contemplation of both parties as the probable result of the breach.’ Thus, the disjunctive ‘or’ demonstrates that the language ‘usual course of things’ may be used in the place of ‘within the contemplation of the parties.’ Both permissible standards afford the jury a course of finding that the damage was not a remote, unforeseeable event unrelated to the breach itself. Therefore, plaintiffs were required to prove either that the damages arose in the usual course of things, from the breach itself, or that the damages were within the contemplation of the parties.”); Bettius & Sanderson, P.C. v. National Union Fire Ins. Co., 839 F.2d 1009, 1015 (4th Cir. 1988) (consequential damages recoverable if “direct and natural” result of breach).


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have been better and the financial burdens would have been ameliorated. Moreover, the

policyholder would have had some guarantee of the policyholder’s future health.

Alternatively, in support of the second wing of the Hadley rule, the policyholder

could demonstrate that the policyholder purchased millions of dollars in liability insurance

coverage and a separate defense obligation. The purchase of such massive protection rendered it

foreseeable that an insurance company’s delay in complying, or failure to comply, with

investigation, defense and indemnity obligations in the face of catastrophe would cause the

policyholder to suffer consequential damages.526 Under either wing of Hadley, it is clear that

policyholders can and should seek consequential damages.

Do not miss consequential damages; the meat and potatoes.

PART VIIIJury Charges — Do Not Reinvent Wheels

With one eye on the appellate courts, obtain and use charges that have been used

in reported cases. When requested, most lawyers who handled old cases will dig through old

files to retrieve old charges and requests to charge. With the best of luck, both the requests to

charge and the actual charge can be obtained. Tell the trial judge the case in which the charges

were used.

Usually it is not advisable to try to advance the state of the law in jury charges.

Remember that the insurance company is going to appeal.

526 See, e.g., Royal College Shop, 895 F.2d at 679; Heller, 839 F. Supp. at 1302-05 (“It does not appear objectively unreasonable that in the context of a fidelity bond designed to replace money lost through an employee’s misconduct that the need for an alternate source of the funds would be within the reasonable contemplation of the parties. Indeed, a basic reason for obtaining fidelity bond coverage is to provide a ready source of replacement funds when a covered loss occurs and to avoid the uncertainty of obtaining loans with the attendant interest costs after the loss is discovered.”); Mann, 418 F. Supp. at 249; Reichert, 428 P.2d at 864; Plummer, 590 N.E.2d at 1089-92; Mohr, 493 N.E.2d at 644; Hochman, 673 P.2d at 1204; Lawrence, 516 N.W.2d at 45-46; Kewin v. Massachusetts Mut. Life Ins. Co., 295 N.W.2d 50, 54 (Mich. 1980); Wendt, 401 N.W.2d at 380; Lawton, 392 A.2d at 579; Pickett, 600 A.2d at 155.


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Superb places to look for pro-policyholder jury charges are in the legislative

recitations given by legislatures when enacting laws regulating insurance and claims practices.

Another excellent source is the recitals written by state insurance regulators when proposing and

adopting insurance claims handling regulations.

PART IXTrial Evidence — Bulldogs or Pussycats?

Try a bad faith case on the assumption that the policyholder is going to win AND

THE INSURANCE COMPANY TO GOING TO APPEAL.

Keep an eye on the appellate courts. They are inventing new and different ways

to nullify insurance coverage and to eliminate bad faith damages against insurance companies.

With respect to evidence, if the insurance company objects to the policyholders’

evidence, think hard about pressing it. When the insurance company offers an outrageous

document, demonstration, or piece of testimony, the policyholder may be much better served by

letting the evidence in. Many items of evidence can be “flipped” and used against the insurance

company.


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PART XAvoiding Bifurcation

Fight bifurcation with facts! Juries are not dumb. The argument for bifurcated

trials rests on the erroneous assumption that juries can not assimilate judicial instructions in the

context of complex civil litigation. In fact, research shows the opposite to be true. Recent

empirical studies of juror competence indicate that juries are “capable of deciding even very

complex cases.”527 Accordingly, insurance company arguments concerning alleged prejudice are

without foundation. When bifurcation is suggested, insist on proof that there will be prejudice.

Try not to let the issue be decided on the basis of opinions of trial lawyers and trial judges.

Contrary to the typical insurance company assertions, judicial economy and

efficiency is not be promoted by bifurcation. Despite a common factual basis, policyholder’s

bad faith claims are not dependent on the success of their underlying policy claims. Rather, bad

faith claims often contain different elements and are viable regardless of the outcome of the

policy claim. Bifurcation can only result in enormous waste, duplication, delay and excess cost.

Moreover, “trial-splitting devices [such as bifurcation] prevent the jury from

hearing relevant and essential information. . . To preserve the jury’s role as the ultimate finder of

fact, the jury must hear the evidence in its full context.”528

A bifurcated trial would prejudice a policyholder’s claims, as the “empirical

research suggests that an advantage is accorded to the defendants when civil trials are

527 See Joe S. Cecil et al., Citizen Comprehension of Difficult Issues: Lessons from Civil Jury Trials, 40 AM. U. L. REV. 727, 764 (1991). See also Jennifer Granholm & William Richards, Bifurcated Justice: How Trial-Splitting Devices Defeat the Jury’s Role, 26 U. TOL. L. REV. 505, 506 (1995) (“[R]esearch has established that juries are competent, conscientious, faithful to the judge’s instructions and not often swayed by personal prejudices.”) (citing HARRY KALVEN JR. & HANS ZEISEL, THE AMERICAN JURY 55-62 (1966); David T. Wasserman & J. Neil Robinson, Extra-Legal Influences, Group Processes, and Jury Decision-Making: A Psychological Perspective, 12 N.C. CENT. L.J. 96, 101 (1980)). 528 Jennifer Granholm & William Richards, Bifurcated Justice: How Trial-Splitting Devices Defeat the Jury’s Role, 26 U. TOL. L. REV. 505, 506 (1995).


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bifurcated.”529 The prejudice and increased expense to policyholders and the Court that would

result from bifurcation is far greater than any speculative prejudice that insurance companies

might face by allowing a policyholder to proceed with all of its claims. Indeed, any concerns of

prejudice raised by the insurance companies can be easily cured by limiting instructions to the

jury. In contrast, proceeding with a single lawsuit rather than multiple lawsuits best promotes

justice, avoids prejudice and promotes judicial economy.

PART XIConsider Malicious Defense

The tort of malicious defense derives from the recognized tort of malicious

prosecution. Simply put, malicious defense provides that defendants should be liable for the

malicious assertion of false and baseless defenses.530

Until recently, the tort of malicious defense had been nearly universally rejected

by the courts. New Hampshire has recently expressly adopted malicious defense and New York

has implicitly recognized the tort as a valid cause of action for plaintiffs.

These decisions indicate that more courts may begin to take notice of this tort.

In Aranson v. Schroeder, the Supreme Court of New Hampshire held:

when a defense is commenced maliciously or is based upon false evidence and perjury or is raised for an improper purpose, the litigant is not made whole if the only remedy is reimbursement of counsel fees. It follows that upon proving malicious defense, the aggrieved party is entitled to the same damages as are recoverable in a malicious prosecution claim.531

529 Id. at 513 (citing MAURICE ROSENBERG, COURT CONGESTION: STATUS, CAUSES, AND PROPOSED REMEDIES, IN THE COURTS, THE PUBLIC AND THE LAW EXPLOSION, 29, 48 (Harry W. Jones ed. 1965); Hans Zeitel & Thomas Callahan, Split Trials and Time Saving: A Statistical Analysis, 76 Harv. L. Rev. 1606 (1963).530 See Jonathan K. Van Patten & Robert E. Willard, The Limits of Advocacy: A Proposal for the Tort of Malicious Defense in Civil Litigation, 35 HASTINGS L.J. 891, 893.


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The court noted that malicious defense should be construed as a limited and closely scrutinized

cause of action to avoid precluding defendants from raising a potentially legitimate defense for

fear of being sued.532

Aranson set forth a standard of liability for malicious defense:

One who takes active part in initiation, continuation, or procurement of defense of civil proceeding is subject to liability for all harm proximately caused, including reasonable attorney fees, if he or she acts:

(1) without probable cause;

(2) with knowledge or notice of lack of merit in such actions;

(3) primarily for purpose other than securing the proper adjudication of the claim and defense thereto, such as to harass, annoy or injure, to cause unnecessary delay or needless increase in the cost of litigation;

(4) previous proceedings were terminated in favor of party bringing malicious defense action; and

(5) injury or damage is sustained.533

In Aranson, the Supreme Court of New Hampshire accepted the plaintiffs’

argument that malicious defense would provide a remedy for false defenses just as malicious

prosecution already provides a remedy for false claims. The plaintiffs argued that, under present

law, false evidence is condemned from the plaintiff’s side but tolerated from the defendant’s

side. The plaintiffs maintained that both forms of misconduct should be treated in the same

manner. The New Hampshire Supreme Court agreed:

531 Aranson v. Schroeder, 671 A.2d 1023 (N.H. 1995).532 Id. at 1028.533 Id. at 1024.


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Is a plaintiff less aggrieved when the groundless claim put forth in the courts is done defensively rather than affirmatively in asserting a worthless lawsuit for improper purposes? We think not.534

Similarly, in Aufrichtig v. Lowell,535 the New York Court of Appeals recognized a

slight variation of malicious defense. In this case, the plaintiff’s physician provided an insurance

company with a perjured affidavit. The insurance company submitted this affidavit to the United

States District Court.

On the eve of trial, the physician admitted that the affidavit had no basis in fact.

When the Federal District Judge learned of the false affidavit, he urged the plaintiff to settle with

the insurance company due to the physician’s conflicting statements.

The plaintiff then instituted a claim against the physician. The Aufrichtig court

found that the physician may have breached his duty to provide truthful medical information as

part of the physician-patient relationship and denied the physician’s motion for summary

judgment. Thus, the holdings of Aufrichtig and Aranson are in line with each other; both hold

that the presentation of false evidence is actionable.

Moreover, if a non-party witness can be held liable for presenting false evidence,

then a party defendant should also be liable for similar activity. Insurance companies, like

doctors, are fiduciaries. Both have special obligations and duties to their clients. It may be

possible to make an especially strong argument to apply the tort of malicious defense to all

fiduciaries in order to best protect the sanctity and purpose of the fiduciary relationship. The

crime-fraud exception to the attorney-client privilege, for instance, does just that.

534 Id. at 1027.535 Aufrichtig v. Lowell, 85 N.Y.2d 540, 650 N.E.2d 401, 626 N.Y.S.2d 743 (1995).


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PART XIIPre-litigation ‘Musts’

A. Locate All Insurance Policies

Locate all insurance policies, including old ones. Old insurance policies are

extremely valuable because they tend to provide insurance coverage for any damage or injury

that took place during the policy period, no matter when the damage or injury is discovered. If a

particular policy cannot be found, secondary sources may be used to demonstrate that the policy

was purchased. The search for insurance policies should include a review of:

internal accounting records and outside accountants’ files for evidence of premium payments;

legal records and lawyers files, paying special attention to claims files;

known insurance policies for references to other policies;

insurance policies of other parties also facing potential liability in the same matter;

records of affiliated or predecessor companies;

workers compensation records to determine if an insurance company defended the workers compensation claim, since workers compensation and liability insurance are often purchased from the same insurance company;

if possible, records of companies which would have required submission of a certificate of insurance from your company before engaging in business with it, for instance, railroad company records or state and federal government records;

a search of the London insurance market for London brokers records.

There are several companies, known as insurance archaeologists, which specialize

in locating old insurance policies. These companies may be able to locate missing insurance

policies on a cost-effective basis. And never forget, despite repeated insurance company


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arguments to the contrary, that insurance companies should have copies of the insurance policies

purchased from them.

B. Give Notice To the Insurance Company

Giving notice is absolutely critical. Give notice early and often.536 A

policyholder should contact its insurance agent or broker and have them give written notice to all

possibly implicated insurance companies.537 Do not rely on the broker’s or agent’s word that

there is no insurance coverage. To repeat, insist that the insurance broker or agent immediately

forward written notice of the claim to all potentially involved insurance companies. When all is

said and done, verify that the agent or broker has promptly forwarded the notice.

The insurance industry has developed standardized forms for giving notice. “Plain

vanilla” type notice, without extensive detail, is best. When first giving notice of an event or

happening which may lead to a claim, all that needs to be provided to the insurance company is a

copy of the document that the policyholder received alleging its liability. The first notice of

claim should also state that additional insurance policies may be involved and request that the

insurance company provide a list of all policies which have been sold to the policyholder.

Additionally, the notice should request that the insurance company provide a defense, or agree to

536 There are two separate and distinct notice requirements. The first requirement is that the policyholder must give notice to its insurance companies of an event or happening (an “occurrence”) that may lead to a claim. The second requirement is that the policyholder must also give notice of an actual claim or potential claim. In either case, the policyholder should give notice to every insurance company which had sold it insurance coverage at any point in time during the alleged bodily injury or property damage. For example, if the policyholder receives from the United States Environmental Protection Agency (USEPA) a letter alleging that it may be potentially responsible for the clean-up of a municipal waste facility which opened in 1950, the policyholder should give notice to all insurance companies that sold the policyholder insurance from 1950 to the present. This is true even if the policyholder did not send materials to the site until 1960. If the claim for insurance coverage is related to a product, the policyholder should give notice to every insurance company which sold the policyholder insurance coverage from the date the product was first marketed to the date of the “occurrence” or of the actual or potential claim.537 See Eugene R. Anderson et al., A Guide to Insurance Coverage for Environmental Liability Claims, (1996). Copies of this material is available from the authors.


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pay for defense costs, provide indemnification for any past or future liabilities, and advise the

policyholder of all possible legal and factual bases that would support a finding of insurance

coverage. Again, make sure that notice is given to all potentially involved insurance companies.

Other items which may be included when giving notice, if readily available, are a general

description of the product or event giving rise to the liability, what happened, when, where, how

the policyholder is involved, and what insurance policies the policyholder believes were

purchased from the insurance company. Bear in mind, however, that initially providing

extensive detail may delay the policyholder from promptly getting notice out to the insurance

companies. If providing detail delays giving notice, it can only work to the insurance companies

advantage. Incomplete notice can be corrected. Late notice, often times, cannot.

Do not wait to give notice. Notice should be given as soon as a claim is made or

threatened against the policyholder, or as soon as the policyholder senses that an event or

happening may result in a claim against it.538

C. Contending With The Reservation of Rights Letter

If the insurance company denies insurance coverage outright, send a letter to the

insurance company disagreeing with the denial. Most insurance companies, however, do not

deny insurance coverage without undertaking some type of investigation. Thus, instead of an

outright denial, most insurance companies will send the policyholder a reservation of rights

538 Policyholders often do not give their insurance companies notice of what seem to be smaller claims. Many policyholders still believe that they should “wait for the Big One” before giving notice, assuming that this will prevent their premiums from rising. Following this misguided practice is perhaps the single best way for a policyholder to forfeit all of its insurance coverage. This is especially true when the “small problem” turns into the “Big One” which the policyholder was worried about all along; for instance, when the tank with the “small” leak turns out to have slowly contaminated an entire area water supply. Insurance companies commonly use late notice as a reason to deny insurance coverage. In some states, delaying notice by as little as 10 days may lead to the forfeiture of all insurance coverage. In those states, it is not even necessary for the insurance company to demonstrate that it was harmed, in any way, by the policyholder’s delay.


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letter. The letter is a long, tersely worded statement which sets forth a panoply of reasons

explaining why insurance coverage may be denied.

When contending with a reservation of rights letter and requests for information

from the insurance company regarding the claim, the goal should be to cooperate with the

insurance company as much as possible without giving up any rights. The insurance company

should be considered an adversary. Any information or documents subject to the attorney-client

privilege or prepared in anticipation of litigation should not be given to the insurance company.

This includes conversations and correspondence between a policyholder and its lawyer, and, in

some instances, materials prepared for the policyholder by the policyholder’s lawyer.

Answering the insurance company’s questions should not unduly burden the

policyholder with financial expense or consumption of time. For example, if an insurance

company wants to see a large set of documents, the policyholder should not bear the expense of

having the documents copied and shipped to the insurance company. Rather, the insurance

company should be invited to review the documents at the policyholder’s office.

In addition, keep records of when documents and information are provided to the

insurance company, as well as the expenses incurred in providing them. Under many insurance

policies, the insurance company is required to reimburse the policyholder for cooperating with

the insurance company.


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D. Keep In Contact With The Insurance Company

The policyholder should establish a system of periodic reports to keep the

insurance company informed of what is happening and of the status of each claim. In addition,

the policyholder should forward proposed settlement agreements to the insurance company,

before agreeing to them.

1. Complain To The State Insurance Commissioner

Complain to the office of the state insurance commissioner when it appears that

the insurance company is stalling or not acting in good faith.

PART XIIIDiscovery

Obviously, every case will present a different fact pattern which will generate

different acts of bad faith. Certainly, a common theme is that the insurance company’s

investigation was geared to finding a way to deny the claim. In effect, the insurance company

became an adversary of its policyholder. Therefore, what the insurance company did during its

investigation is important, especially any instructions it gave to investigators.

Do searches regarding other successful bad faith claims against an insurance

company (especially in your jurisdiction) and contact the policyholders’ lawyers in those cases.

Check local bar associations to see if they have recently sponsored programs on bad faith and

obtain copies of the written materials.


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A. ‘Must Have’ Documents:

The following lists that documents that must be obtained in any bad faith claim.539

1. Insurance policy.

2. All correspondence to and from the insurance company.

3. All correspondence to and from broker.

4. Underwriting file.

5. Underwriting manuals.

6. Underwriting guidelines.

7. Underwriting training materials.

8. Claims file.

9. E-mail and any other means of electronic communication or correspondence.

10. Insurance company web page.

11. Claims manuals.540

12. Claims guidelines.

13. Claims training manuals.539 See Appendix E for a more detailed list items which should be sought in discovery.540 If the insurance company contends that it does not use claims manuals, a bad faith expert may be able to testify that this failure in and of itself constitutes bad faith. See Kraeger v. Nationwide Mut. Ins. Co., No. 95-7550, 1997 U.S. Dist. LEXIS 2726 (E.D. Pa. Feb. 28, 1997)(holding that an expert witness can testify that an insurer had “no reasonable basis for its actions,” but can’t assert that it violated the law or acted in bad faith. If there are no written guidelines, find out if there is any custom and practice applicable to claims handling or no guidelines whatsoever. The absence of any guideline may be bad faith.

If the claims manuals contain positive statements you can show that the insurance company did not live up to its own standards. If the manual contains negative statements you can argue that the claim was doomed from the beginning. See, e.g., Neal v. Farmers Ins. Exch., 582 P.2d 980, 987 (Cal. 1978) (Company Manual admitted to show insurer’s “conscious course of conduct, firmly grounded in established company policy.”); Maxwell v. Aetna Life Ins. Co., 693 P.2d 348 (Ariz. Ct. App. 1984) (Manuals properly admitted to show insurance company’s knowledge that denial of a claim may cause emotional distress); Moore v. American United Life Ins. Co., 197 Cal. Rptr. 878, 883-84 (Cal. Ct. App. 1984).

For an interesting story showing, in a different context, of why insurance companies are now destroying (or claim not to have) claims manuals, see Robert B. Whitemore, Caution: For Reference Only; NFPA, A Guide For Fire And Explosion Investigations, CLAIMS, May 1997, at 38.


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14. Insurance company sales materials, advertisements and brochures.541

15. Insurance company financials certified by the state insurance department.542

16. Insurance company annual reports filed with the SEC on form 10-K. If possible, obtain a “glossy” insurance company annual report to stockholders.543

17. Insurance company Codes of Ethics,544 Ethical Guidelines, and training materials.

18. Insurance company charter and by-laws.

19. Insurance company mission statement and minutes of any committee organized to create a company mission statement. Was the mission statement drafted by a public relations firm?

20. The insurance company’s audit of its claims files.

541 See Tom Baker, Symposium on the Law of Bad Faith in Contract and Insurance Agreements: Theory: Constructing the Insurance Relationship; Sales Stories, Claim Stories, and Insurance Contract Damages, 72 TEX. L. REV. 1395 (1994).542 Obtain certified copies of financial statements of the insurance company from the State Department of Insurance. You will need to establish the insurance company’s net worth in order to obtain punitive damages. But see Pluid v. B.K., 948 P.2d 981 (Alaska 1997)(holding that sexual assualt victim was not required to introduce evidence of the defendant’s wealth worth to recover punitive damages. The Alaska Supreme Court noted that other state courts are divided on the issue, citing Hicks v. Lilly Enterprises, Inc., 608 P.2d 186 (Or. Ct. App. 1980). The Pluid court noted that the defendant is uniquely situated to enter evidence of its own net worth.

Insurance company financial statements and annual reports (discussed below) may enable an accounting, financial or economics expert to provide extensive testimony about an insurance company’s underwriting and general business practices. For example, with these documents an expert could establish a defendant insurance company’s:

(1) move towards relying on underwriting cash flow as opposed to underwriting income, determining the financial gain the insurance company realized as a result;

(2) pattern and practice of denying insurance claims for financial benefit as demonstrated in the financial reports of the defendant insurance company;

(3) financial benefit gained as a result of the pattern and practice of denying claims;

(4) available funds of the insurance company to respond to a damage award, as well as determine the financial impact of a punitive damage award on the defendant insurance company.543 See Kirk A. Pasich, Measuring True Value of Insurance Companies For Punitive Damages Purposes, MEALEY’S LIT. REP., Oct. 11, 1994, at 17, 20 (“In order to accurately determine how much of a punitive damage award is enough, but not too much, the financial condition of an insurance company needs to be evaluated . . . . The most basic and reliable source of financial information about an insurance company -- at least if its own representations are to be believed -- is its annual statement filed with various state insurance departments or insurance commissions”).544 See Appendices A and F.


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21. State insurance department files of policyholder complaints against insurance company. These are usually maintained according to state insurance regulations.

22. Insurance company annual statements filed with the state insurance department.

23. Another good place to “look for coverage” is in the drafting and regulatory history of insurance regulations.545

24. Review insurance company vs. insurance company cases.

25. Insurance company’s compliance program.546

545 See e.g. Eugene R. Anderson et al., Environmental Insurance Coverage In New Jersey: A Tale of Two Stories, 24 RUTGERS L.J. 83 (Fall 1992) (reviews the development of the pollution exclusion and regulatory estoppel to prohibit insurance companies from adopting positions contrary to what they represented when proposing regulations).546 Insurance companies often have compliance programs because these programs reduce the fine a sentencing judge is required to impose under the Federal Sentencing Guidelines for convictions under federal criminal statutes. Most notable for insurance companies is the Federal Insurance Crimes Act. See Larry P. Schiffer & Vanessa L. Sutter, If You Can’t Pay the Fine, Don’t Do . . ., BEST’S REV. P/C ed., Dec. 1997, at 73.


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B. ‘Must Have’ Depositions

Interview client and insurance brokers and agents carefully regarding all contacts

with the insurance company regarding the claim. Often an insurance company will raise and

then abandon a number of theories on which to deny coverage. These changes in position

undercut the credibility of its defenses, as well as demonstrate the insurance company’s bad faith

by showing its desperate attempt to raise any argument, even frivolous ones, to defeat insurance

coverage. To the extent that the defenses go to policy interpretation issues, policyholder’s

counsel can establish that the insurance company never told the policyholder about its

interpretation at the time it sold the policy and took the premium. Identify and review prior

depositions given by insurance company personnel regarding claims handling.547

1. Underwriters.

Remember: Underwriters believe that they sell policies to provide insurance coverage. Even an “ignorant” underwriter can be an excellent witness.548

2. Underwriting supervisor.

3. Claims handlers.549

547 See Joel P. Gumbinger, Deposing the Insurer: Practical and Strategic Considerations, THE BRIEF, ABA TORT & INS. PRACTICE SECTION, Winter 1998, at 47 (providing an in depth analysis of deposition strategy), and Betty C. Love, Discovery In Insurance Bad-Faith Cases: Guidelines for the Plaintiff’s Lawyer, TRIAL, Dec. 1987, at 23 (discussing discovery strategies). Both articles are attached at Appendix G. For an insurance industry perspective on deposition taking strategies, see Michael Sean Quinn, The Ethical Habitat of Adjusters: Part 1. Principles, Problems, and Practicalities, 10 ENVTL. CLAIMS J. 91 (Winter 1998).548 For an extensive discussion of how courts have treated testimony by underwriters, the information contained in underwriting files and the interpretive materials published by or attributed to insurance industry underwriting groups, see Douglas G. Houser & Randy L. Arthur, The Role of the Insurance Underwriter in Claims Disputes, 31 TORT & INS. L.J. 573 (Spring 1996).549 Insurance company defense counsel will sometimes act as claims handlers for the insurance company and subsequently attempt to avoid producing during litigation certain materials to the policyholder by invoking the attorney-client privilege. In the insurance context, to the extent that an attorney acts as a claims adjuster, claims process supervisor, or claims investigation monitor, and not as a legal advisor, the attorney-client privilege does not apply. See Mission National Co. v. Lilly, 112 F.R.D. 160, 163 (D. Minn. 1986)(fire loss claim)(“To the extent that [outside counsel] acted as claims adjusters, then, their work-product, communications to client, and impressions about the facts will be treated herein as the ordinary business of the plaintiff, outside the scope of the asserted privileges”); Allendale Mut. Ins. Co. v. Bull Data Systems, Inc., 152 F.R.D. 132, 137 (N.D. Ill. 1993)(“The fact that the material was


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4. Claims supervisor.

5. Agent or Broker — to avoid trial surprises.550

6. Insurance company executives551

Video depositions cost more, but save time.

C. ‘Must Ask’ Deposition Questions

Remember President Eisenhower’s rule:You learn more with your ears open than with your mouth open.

produced originally by a lawyer is irrelevant, as is the case here, the material reflects ordinary insurance information.”); Dawson v. New York Life Ins. Co., 901 F. Supp. 1362, 1367 (N.D. Ill. 1995)(attorney-client privilege did not attach where attorneys were acting more as “couriers of factual information” rather than “legal advisors”). Simply put, factual information conveyed to an attorney by a party/client is not shielded from discovery by the attorney-client privilege and such information is discoverable. See Penk v. Oregon State Bd. of Higher Educ., 99 F.R.D. 511 (D. Or. 1983) (“An attorney cannot shield from discovery purely factful information obtained from a third party in some cases, and a client cannot resist testifying as to a fact merely because he has told that fact to his attorney at some point.”).

If an outside law firm was hired to do the claims handling, this suggests that bad faith may be present. Lawyers, by nature, are adversaries representing the insurance company’s interest against the policyholder. It is unlikely that they will be neutral in the claims investigation or look for ways to find coverage. Lawyers also are trained to raise every argument, even if frivolous. Outside lawyers also try to impress the insurance company client (and compete against other law firms for the business) by being tough. Finally, an outside law firm, who represents the insurance company in coverage disputes as well as claims handling, cannot possible be neutral.550 The deposition of the broker or agent must be handled carefully, particularly because of their split loyalty. Tie them down on the duty of good faith and fair dealing so that they cannot change their testimony at trial.551 Do not forget that under Federal Rule of Evidence 612, any document used by insurance company defense counsel to prepare a witness for deposition or used in any way to refresh a witness’ recollection is discoverable by policyholder’s counsel. Federal Rule of Evidence 612 states that where a witness uses a writing to refresh their recollection for the purposes of providing deposition testimony:

before testifying, if the court in its discretion determines it is necessary in the interests of justice, an adverse party is entitled to have the writing produced at the hearing, to inspect it, to cross-examine the witness thereon, and to introduce in evidence those portions which relate to the testimony of the witness.

Senior executives and other insurance company witnesses unfamiliar with the claim typically review documents in order to familiarize themselves with the claim prior to providing deposition testimony. Under FRE 612, any documents reviewed by those witnesses, even if privileged, must be given to policyholder’s counsel for use in cross-examination. One commentator has argued that parties should waive Rule 612 in order to have a factually complete deposition and to prevent the witness from relying on memory. See Clayton H. Farnham, “How to Prepare Insurance Company Witnesses for Depositions and Trial Testimony in A Bad Faith Claim, in Extra Contractual Claims -- Bad Faith -- Punitive Damages, First and Third Party Claims Seminar,” at J-16 (Defense Research Institute, Inc. 1994).


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1. Mark the claims file as an exhibit . Does the claims file contain a written record of every significant event?

Same for underwriting file.

2. Does the claims file contain a copy of every document and every notation and every piece of information that was ever in it?

Same for underwriting file.552

3. Identify and find out what happened to any missing materials.

4. Identify every person mentioned in the files. Where are they now?

5. What is good faith?

6. Go through the claims file and ask for all documents showing that insurance company searched for insurance coverage.

7. Know what your compensatory damage expert and your bad faith expert are going to say and get as much foundation for their testimony from the insurance company witnesses as possible.

8. Prepare for an opening statement by getting the insurance companies to admit to the miracles that insurance is supposed to provide.

9. Personal and company membership in anti-policyholder trade associations.

10. Establish company management changes and ownership changes to lay the foundation for changes in “claims paying philosophy.”

11. Work on negating the “bad policyholder” defense. For example, Stonewall does not cover polluters and drunken drivers. This is the “reprehensible conduct” defense and must be approached with care. One approach is to ask claims people about “taking care” of the victims of “tortfeasors.”

12. If you could handle the claim all over again, would you do it the same way? Ask this of every witness. Almost any answer can be helpful.

D. Pleadings Considerations

Forum Consideration — Determine whether forum recognizes existence of tort

or contract cause of action (or both).

552 After obtaining the underwriting and claims files, make sure that you know by bates number which documents appear in each file. Get this tied down early in the case so that the insurance company cannot add documents to these two files as the case proceeds.


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Advantages of tort cause of action

1. greater measure of damages — no “foreseeability” requirement

2. availability of punitive damages

3. non-performance of contract conditions is not an absolute defense

4. no “collateral source” rule

Advantages of contract cause of action

1. may have longer statute of limitations

2. contractual claim may be preferable in states where an “evil mind” is required — see below

Forum Consideration — Determine the requisite standard re insurance company

state of mind for “Bad Faith” and/or Punitive Damages

There are at least three different tests for “first party” (e.g., fire or theft policy) bad faith claims:

1. California standard — Need only show conduct was objectively unreasonable.553

2. Wisconsin standard — Must show awareness or reckless disregard that position was unreasonable; but this may be inferred from lack of reasonable grounds for delay or denial.554

3. “Evil Mind” standard — Must show dishonest or oppressive motivation.555

Identify sources of duty of good faith/duty not to act in bad faith

1. Bad faith statutes.

2. Unfair or Deceptive Trade Practices Acts

3. State Fair Claims Practices Acts.

553 Gruenberg v. Aetna Ins. Co., 9 Cal. 3d 566, 510 P.2d 1032 (1973).554 Anderson v. Continental Ins. Co., 85 Wis. 2d 675, 271 N.W.2d 368 (1978).555 Aetna Cas. & Sur. Co. v. Broadway Arms Corp., 281 Ark. 128, 664 S.W. 463 (1984)


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4. Regulations promulgated by state insurance commissioners under Fair Claims Practices Acts (caution: these regulations may not be applicable to large policyholders).

5. National Association of Insurance Commissioners model good faith claims handling Act.

6. Common law doctrines.

E. Proof of Damages Considerations

1. Actual damages - breach of contract. The payment the policyholder was entitled to under the policy.

2. Interest - may be an issue for the judge to calculate after the jury returns a verdict in your favor.

3. Consequential damages - mental anguish, loss of use of money, reputation damage. Anything beyond the insurance owed under the policy. Make sure these damages are sought in the complaint.

4. Attorneys fees - check state statute.

a. Reasonableness of fees in underlying case. (This is an element of contract damages.) Will probably require the testimony of an expert on reasonableness.

b. Reasonableness of fees in coverage case may be (authorized by statute). This issue may be decided by the judge after trial, but check state law.

c. On the issue of reasonableness, look for fee applications (bankruptcy or surrogates court) submitted by counsel to the insurance company for comparison.

5. Punitives.

Punitive damages must be large enough to get the attention of upper management.

Therefore, they should be proportional to the size and net worth of the insurance company.

Under BMW v. Gore, a punitive damage award may have to be tied to the insurance company’s

conduct in the forum state. One issue is whether the jury looks at the net worth of the individual

company or related companies.556

556 There are several sources to turn to determine and insurance companies wealth. The NATIONAL UNDERWRITER often publishes information on how much money is being made by insurance companies


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F. Where Not to Look For Coverage

Policyholders are often “demonized” in the traditional legal press. This

unfortunate fact should make policyholder counsel wary of relying on the “wisdom” of treatises.

One insurance law professor explains the internal, often subtle bias of insurance law legal

treatises as follows:

It may be significant that Mr. Appleman was the former head of the Legal Department of the State Farm Insurance Companies in the 1930s when he found “much of the insurance field in chaotic condition,” and this may have influenced his treatise’s general philosophy of emphasizing the more predictable and more uniform Formalistic contractual approach to the interpretation of insurance policies . . . . As a former insurance defense attorney while writing his impressive insurance law treatise from 1939-47, Mr. Appleman arguably may not have been a strong advocate of Legal Functionalism in the academic or legal community. Furthermore, his law school training may, or may not, have predated the rise of Legal Realism as a jurisprudential model in American law school classrooms of the 1930s.

Likewise, Couch’s Cyclopedia of Insurance Law, in its discussion of the interpretation of insurance contracts, has no mention whatever of the Keeton Functionalist doctrine of reasonable expectations, other than a tangential discussion of dealing with ambiguous contract provisions. See, e.g., 1-2 GEORGE J. COUCH, CYCLOPEDIA OF INSURANCE LAW §§ 1:4, 15:16 (Mark S. Rhodes, rev. 2d ed. 1984).

Little is known of George J. Couch except that he was born in 1881, that he was a member of the New York Bar, and that he wrote his insurance law treatise from 1929-31, a time which predated the Keeton Functionalist reasonable expectations approach, and which arguably predated the predominant view of Legal Realism in American law schools. Subsequent authors and revisers to the Couch treatise include Ronald A. Anderson, a member of the Pennsylvania Bar, and Mark S. Rhodes, a member of the Illinois Bar. Both revising authors have paid little, if any,

in a particular state. BEST’S INSURANCE REPORTS also provides financial information on insurance companies. In addition, state insurance commissioners maintain financial statements for casualty insurance companies doing business in the state. Get a certified copy.


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attention to the Keeton Functionalist reasonable expectations doctrine in the Cyclopedia of Insurance Law, 2d edition.557

The views expressed in legal treatises can change. A well-known example of this

occurred when a commentator discussed the, then-new “polluters’“ exclusion in 1973. Professor

Long observed in his treatise, the LAW OF LIABILITY INSURANCE, that the polluter’s exclusion

clause was a restatement of the occurrence definition contained in standard CGL insurance

policies.558 A later commentator, proposing the opposite view of the same exclusion, a pro-

insurance industry solution, suggested “DESTROY LONG.”559 Professor Long’s comments

disappeared from later versions of his treatise.

Use treatises and journals with care.560

557 Peter Nash Swisher, Judicial Interpretations of Insurance Contract Disputes: Toward a Realistic Middle Ground Approach, 57 OHIO ST. L.J. 543, 558, n.48 (1996).558 R. Long, 3 Law of Liability Insurance, App-58 (1973).559 E. Joshua Rosenkranz, The Pollution Exclusion Clause Through The Looking Glass, 74 GEO. L.J. 1237, 160 n.119 (1986) (citing Hickman, “The Pollution Exclusion Clause: A Hazardous Wasteland,” in Insurance Law Conference: The Most Important Topics of the ‘80s, b-18 (CGL Reporter’s Seminar, Apr. 2-26, 1985)).560 There are many different treatises in addition to those discussed above. Here are some:

Eugene R. Anderson, et al., Insurance Coverage Litigation (1st ed. 1997)(probably not appropriate to comment).

Robert H. Jerry, II, Understanding Insurance Law (2nd ed. 1996)(excellent).

Peter J. Kalis, et al., Policyholders Guide To The Law of Insurance Coverage (1st ed. 1997)(brand new).

MITCHELL L. LATHROP, ENVIRONMENTAL INSURANCE COVERAGE: STATE LAW AND REGULATION (1991)(updated to 1997; comprehensive treatment by counsel who normally represents insurance companies).

BARRY R. OSTRAGER AND THOMAS R. NEWMAN, HANDBOOK ON INSURANCE COVERAGE DISPUTES (5th ed. 1992)(comprehensive treatment by counsel who normally represents insurance companies).

Defense Research Institute, Inc.; publishes books and seminar papers, i.e “Insurance Seminar: Extra-Contractual Claims - Bad Faith - Punitive Damages - First Party and Third Party Claims,” (published for Defense Practice Seminar, Feb. 22-23, 1996)(definite pro-insurance company slant).

Tort and Insurance Practice Section (TIPS)(publishes Tort & Insurance Law Journal; definite pro-insurance company slant; i.e. Anthony W. Kraus, Extension of Ratification of Torts Doctrine To Workplace Harassment Claims, 32 TORT & INS. L.J. 807 (Spring 1997).

Federation of Insurance & Corporate Counsel Quarterly (publishes quarterly journal; definite pro-insurance company slant; i.e. Michael J. Brady, et al., Dismissing Insurance Coverage Actions In Federal Court For Want of Supplemental Subject Matter Jurisdiction, 46 FED’N OF INS. & CORP. COUNS 113 (Fall


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G. BMW of North America v. Gore: Preserving Punitive Damages To Deter and Punish Reprehensible Conduct

1. The Three Guideposts of BMW

In BMW of North America v. Gore,561 (“BMW”) the issue of punitive damages

arose in the following context:

In January, 1990 Dr. Ira Gore, Jr. purchased a black BMW sports sedan for

$40,000 from an authorized BMW dealer in Birmingham, Alabama. Upon learning that the

automobile had been repainted prior to the sale, Dr. Gore brought suit against BMW of North

America. Dr. Gore alleged that the failure to disclose that the car had been repainted constituted

fraud,562 and he sought compensatory as well as punitive damages. At trial, BMW acknowledged

that its policy was to repair cars that were damaged during manufacture or transportation without

advising the dealer of such repairs when the repair cost did not exceed 3% of the retail price of

the car.

The jury found that BMW was liable for compensatory damages of $4,000 as well

as for $4 million in punitive damages. On appeal, the Alabama Supreme Court held that the

punitive damages award did not exceed the constitutionally permissible amount, yet reduced the

award to $2 million on the ground that the jury had improperly punished BMW for transactions

outside Alabama. The United States Supreme Court granted certiorari, vacated the award and

remanded the case to the Alabama Supreme Court, finding the actual harm slight and the

misconduct to be minor: “None of the aggravating factors associated with particularly

1995).

American Trial Lawyers Association (ATLA)(publishes newsletter; definite pro-policyholder slant).561 116 S. Ct. 1589 (U.S. 1996).562 Id. at 1593.


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reprehensible conduct is present.” On remand, the Alabama Supreme Court recently reduced the

punitive damages award to $50,000.563

BMW recognizes the long-standing notion564 that reprehensible conduct is a factor

in determining how much, not why not, punitive damages should be awarded to an aggrieved

party.565 The Court in BMW offered three “guideposts” to gauge whether a punitive damages

verdict violates substantive due process: First, the degree of reprehensibility of the misconduct;

second, the relationship between the punitive award and the actual harm; and third, the

relationship of the award to other civil or criminal penalties imposed for comparable conduct.566

The Supreme Court explained that “[p]erhaps the most important indicia of the

reasonableness of a punitive damages award is the degree of reprehensibility of the defendant’s

conduct.”567 The court emphasized that the primary goal in awarding punitive damages is to

punish and deter568 egregious conduct:

[W]e have consistently rejected the notion that the constitutional line is marked by a simple mathematical formula, even one that compares actual and potential damages to the punitive award. Indeed, low awards of compensatory damages may properly

563 BMW of North America v. Gore, No. 1920324, 1997 Ala. Lexis 126 (Ala. May 9, 1997).564 The concept of punitive damages as recompense for reprehensible conduct has ancient origins, dating as far back as early 2000 B.C.; the Code of Hammurabi, the earliest known legal code, provided for punitive awards. Multiple damages were also a part of other ancient legal systems such as the Hittite Laws, the Hebrew Covenant, the Hindu Code of Manu, and Roman civil law. Likewise, since their inception into American law, punitive damages have been awarded in response to reprehensible conduct. See Nathan C. Prater, Punitive Damages in Alabama: A Proposal for Reform: 26 CUMB. L. REV. 1005 (1995).565 116 S. Ct. at 1599.566 Id. at 1598, 1603.567 Id. at 1599.568 See BMW, 116 S. Ct. at 1603 (“The sanction imposed in this case cannot be justified on the ground that it was necessary to deter future misconduct.” See also International Brotherhood of Elec. Workers v. Foust, 442 U.S. 42, 48 (1979) quoting Gertz v. Robert Welch, Inc., 418 U.S. 323, 350 (1974)(“punitive damages ‘are not compensation for injury. Instead, they are private fines levied by civil juries to punish reprehensible conduct and to deter its future occurrence.’“


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support a higher ratio than high compensatory awards if, for example, a particularly egregious act has resulted in only a small amount of economic damages.569

Thus, although noting that the 500-1 ratio in actual damages to punitive damages awarded in

BMW was “breathtaking,”570 the Court refused to rule out the potential for granting high punitive

awards even where the damages are low. This point is particularly important: Insurance

company bad faith often involves relatively small amounts of damages suffered by vulnerable

parties as a consequence of egregious insurance company misconduct.

The third guidepost in the Supreme Court’s analysis in BMW requires a reviewing

court to compare “the punitive damages award and the civil or criminal penalties that could be

imposed for comparable misconduct.”571 A court determining whether an award of punitive

damages was excessive must “accord ‘substantial deference’ to legislative judgments concerning

appropriate sanctions for the conduct at issue.”572 The Supreme Court’s decision in BMW makes

clear that any review of a punitive damages award must include a thorough consideration of all

applicable criminal and civil penalties, including the maximum available penalty.573 In the

insurance context, 48 states have specifically passed statutes which have allowed penalties —

often severe, such as revocation of license — to be meted out against insurance companies who

have acted unfairly toward their policyholders.

569 BMW, 116 S. Ct. at 1602, citing TXO Prod. Corp. v. Alliance Resources Corp., 509 U.S. 443, 458 (1993).570 Id. at 1603.571 Id.572 Id., quoting Browning-Ferris Inds. of Vt. v. Kelco Disposal, Inc., 492 U.S. 257, 301 (1989) (O’Conner, J., concurring in part and dissenting in part), modified by Cooter & Gell v. Hartmarx Corp., 496 U.S. 384 (1990).573 Id.


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Further, the Court emphasized that the facts of BMW made the Court’s decision

inapplicable to many punitive damages cases, especially cases which involved reprehensible

conduct and involved more than economic damages:

[N]one of the aggravating factors associated with particularly reprehensible conduct is present. The harm that BMW inflicted on Dr. Gore was purely economic in nature . . . [T]his case discloses no deliberate false statements, acts of affirmative misconduct, or concealment of evidence of improper motive, as were present in Haslip and TXO.574

The facts of BMW are a far cry from the facts of a typical bad faith action brought

by a policyholder against an insurance company. BMW clarifies that punitive damages should

apply to situations which involve conduct as egregious and reprehensible as insurance company

bad faith. In light of the “special relationship” between insurance companies and their

policyholders, the threat of punitive damages remains one of the few effective means to curb

insurance company bad faith and enforce the duty of good faith and fair dealing. Insurance

companies do not dispute that BMW has been followed nationwide.575

2. Post BMW Decisions

BMW did not obliterate punitive damages. Although Federal courts appear more

willing than state courts to reduce punitive damage awards in light of BMW,576 it is not clear that

574 BMW, 116 S.Ct. at 1599, 1601. TXO Production Corp. v. Alliance Resources Corp., 509 U.S. 443 (1993) involved title to oil and gas rights where the jury awarded $19,000 in actual damages and $10 million in punitive damages. Pacific Mut. Life Ins. Co. v. Haslip, 499 U.S. 1 (1991) involved misappropriation of insurance premiums and fraud by the agent for the insurance company, causing insurance coverage to lapse; the jury awarded compensatory damages of $200,000 and punitive damages of over $840,000 on an out-of-pocket loss of less than $4000. Haslip, 499 U.S. at 7, n.2. The Court upheld the award of punitive damages in both cases. 575 Appellant’s Petition For Rehearing, at 2, dated Jan 21, 1997, PaineWebber Real Estate Secs., Inc. v. Fireman’s Fund Ins. Co., Inc., No. 888592 (Cal.)(stating that BMW “has been followed nationwide” and listing cases).576 See Rush v. Scott Specialty Gases, 930 F. Supp. 194 (E.D. Pa.), clarified, 940 F. Supp. 814 (1996)(reducing $3 million punitive damages award to $650,000 in sexual harassment case, citing $300,000 statutory cap, that annual earnings of the defendant company indicated it could be deterred by lesser punishment, and ratio of compensatory to punitive damages); Lee v. Edwards, 101 F.3d 805 (2d


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these awards would not have been reduced regardless of the decision in BMW577; tempering

punitive damage awards is hardly a new undertaking for most courts. State court opinions, on

the other hand, usually note that BMW was specifically concerned with purely economic harms

and that the Supreme Court had rejected a mathematical brightline test to determine the

excessiveness of punitive damage awards. For instance, the Supreme Court of South Dakota

refused to reduce a $750,000 punitive damages award for fraudulent sale in oil and gas

partnerships. Although the ratio of damages was 30 to 1, the court focused on the lack of any

mathematical standard in BMW.578

The Supreme Court of Idaho upheld a $3.2 million punitive damages award for

fraudulent sales of cancer insurance policies involving post-claim underwriting.579 In language

apropos to all claims involving insurance company bad faith, the court held:

Repainting BMWs prior to sale does not rise high on the reprehensibility scale. Misrepresenting insurance coverage and

Cir. 1996)(finding $200,000 punitive damage award in malicious prosecution case could not be justified when compared to penalties in similar cases); Patterson v. P.H.P. Healthcare Corp., 90 F.3d 927 (5th Cir. 1996), reh’g denied, No. 95-50319, 1996 U.S. App. LEXIS 26029 (5th Cir. Sept. 11, 1996), cert. denied, 117 S. Ct. 767 (U.S. 1997) (finding $150,000 punitive damages award in sexual harassment case excessive); Kimsey v. Walmart, slip op. Nos 95-4219, 95-4220 (6th Cir. Feb. 20, 1997) (reducing $5 million punitive damages award in sexual harassment case to $350,000, rejecting argument that Title VII cap limited amount of punitive damages, but holding that mitigating factors may have made the conduct less reprehensible; the dissent noted that a $4.5 million remittitur amounted to a slap on the wrist and could hardly deter a company with $32 billion in net assets; Schimizzi v. Illinois Farmers Ins. Co., 928 F. Supp. 760 (N.D. Ind. 1996)($600,000 punitive damage award for insurance company’s breach of duty of good faith was excessive, noting that defendant’s conduct was not terribly reprehensible, that punitive damages were 13 times the policyholder’s compensatory damages and that maximum penalty in Indiana for misconduct was only $10,000). 577 Claudia Maclachlan, ‘BMW’ Triggers Cuts in Punies, NAT’L L.J., Jan. 20, 1997, at A1.578 Schaefer v. Edward D. Jones & Co., 552 N.W.2d 801 (S.D. 1996).

In addition to the language in BMW rejecting any brightline mathematical test, the ratio of compensatory damages to punitive damages in the principle case relied on in BMW, TXO Production Corp. v. Alliance Resources Corp., 509 U.S. 443, was 524 to 1. The BMW court later explained that when the potential harm to the plaintiff in TXO was factored in, the ratio was 10 to 1. See BMW v. Gore, 116 S. Ct. at 1602.579 See Walston v. Monumental Life Ins. Co., 923 P.2d 456 (Idaho 1996).


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refusal to pay a claim that any reasonable person would say is due does rise high on the reprehensibility scale.580

Similarly, in addressing the BMW court’s concern over punitive damages which impermissibly

inflict punishment beyond the borders of the jurisdiction, the court succinctly noted:

The evidence in BMW v. Gore [] indicates that approximately 60 percent of the vehicles that were refinished were sold in states where failure to disclose the repair was not an unfair trade practice. The issues in this case are more fundamental in their application throughout the states . . . . It is highly unlikely that the decision in this case infringes on the interests of other states, because it is highly unlikely that any state sanctions, approves, or trivializes fraud or bad faith settlement practices.581

It was not lost on the court that BMW was unlike the traditional insurance company bad faith

case. The court noted that unlike the facts in BMW, the record in Walston “demonstrates

deliberate false statements and acts of affirmative misconduct.”582 Finally, the court stressed that

although the ratio of punitive to compensatory damages was just under 26 to 1 and greater than

the ratio in TXO, “the U.S. Supreme Court in BMW made it clear that it was not prescribing a

mathematical formula to be followed.”583

The high courts of at least two other states have partially reinstated punitive

damage awards, citing BMW.584 In addition, at least two federal cases have used BMW to uphold

580 Id. at 467 (emphasis added). 581 Id.582 Id.583 Id. The court was also concerned with deterring the insurance company and other insurance companies from similar future misconduct. The court held that punitive damages which amounted to 5% of the defendant insurance company’s annual profits would be sufficient to deter it and other similarly situated insurance companies from future bad faith settlement of claims. See id. at 466.584 See Management Computer Servs. v. Hawkins, 557 N.W.2d 67 (Wis. 1996)(partially reinstating jury’s $1.75 million punitive damage award to $650,000 after it had been reduced by trial judge to $50,000, finding conduct was egregious but limited to economic harm); Wilson v. IBP Inc., 558 N.W.2d 132 (Iowa 1996) (partially reinstating jury’s $15 million punitive damage award to $2 million after it had been reduced by trial judge to $100,000, holding that health and safety issues required a higher amount of punitive damages).


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awards of punitive damages. In Scribner v. Waffle House Inc.,585 a case involving “severe and

pervasive sexual harassment,”586 the court reviewed an award of $8 million in punitive damages

according to the BMW guideposts. The court concluded that a “significant award of punitive

damages is required to punish Waffle House for its egregious conduct and to deter it from

engaging in such reprehensible wrongdoing in the future.”587 The court stressed the need to send

a “wake-up call” in order to deter future misconduct and noted that BMW had rejected a “simple

mathematical formula” to determine the excessiveness of punitive damages.588 Similarly, the 7th

Circuit upheld an award of punitive damages in a civil rights action against prison guards, citing

BMW for the proposition that “a mechanical ratio . . . would not make good sense.”589 Since the

BMW decision, the United States Supreme Court has denied certiorari in case which found that

calculating punitive damages based on the defendant insurance company’s net worth rather than

the reprehensibility of its conduct did not violate the due process clause of the U.S.

Constitution.590

But perhaps the most telling indicator that BMW was concerned about curtailing

excessive punitive damages involving economic harms comes from the U.S. Supreme Court

585 See Scribner v. Waffle House Inc., 976 F. Supp. 439 (N.D. Tex. 1997). See also Verbatim; BMW Drives Punitives In $8 Million Sex Harassment Suit, TEX. LAW., Mar. 17, 1997.586 Id. at *1587 See Verbatim; BMW Drives Punitives In $8 Million Sex Harassment Suit, TEX. LAW., Mar. 17, 1997, at 2.588 See id.589 See Cooper v. Casey, 97 F.3d 914, 919 (7th Cir. 1996). See also Thomas R. Newman & Steven J. Ahmuty, Post-’BMW’ Punitive Damages Decisions -- Part I, N.Y.L.J., Jan. 29, 1997, at 3.590 See Fireman’s Fund v. Ins. Co. Inc. v. PaineWebber Real Estate Secs. Inc., No. S059054. 1997 Cal. LEXIS 1711 (Mar. 26, 1997)(denying request for depublication), cert denied, 118 S. Ct. 156 (U.S. 1997); reported in Andrews Ins. Ind. Lit. Rptr., Nov. 5, 1997, at 22,569. The decision let stand a $21 million bad faith punitive damage award against Fireman’s Fund. See also Petition For Review of Decision of the Court of Appeal First Appellate District, Division Three, dated Feb. 13, 1997, Fireman’s Fund v. Ins. Co. Inc. v. PaineWebber Real Estate Secs. Inc., Appeal No. A063060, (Cal. Super. Ct. San Francisco, No. 888592).


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itself. While considering BMW, the Court had accumulated an additional 18 punitive damages

cases. After deciding BMW, rather than remanding all 18 cases back for reconsideration in light

of BMW, as is customarily done, the court remanded only six cases for reconsideration - the

cases involving purely economic injury.591 The court denied or dismissed the appeals in the

remaining cases, effectively upholding the award of punitive damages in those cases. In doing

so, the court sent a clear message — BMW is concerned with cases where punitive damages are

awarded for purely economic harms.592

Conclusion

The gravity of insurance company misconduct seems to be lost on some insurance

companies.593 A group of pro-insurance industry associations recently proclaimed:

While the number of times insurers have actually been held liable for punitive damages is quite limited, thousands of punitive damage claims are brought against insurers, imposing an enormous burden on the insurers and their policyholders and the court system, until such claims are disposed of in pre-trial or trial proceedings or on appeal.594

The statement ignores the outrageous insurance company bad faith which has

been proven, time and again, in courts across the country. Such conduct imposes enormous

591 See Daniel A. Devito, Punitive Damage Awards, METROPOLITAN CORP. COUNS., Feb. 1997, at 9. See also Paul M. Barrett, Top Court’s Punitive-Damages Ruling Won’t Help Defendants In Many Cases, WALL ST. J., May 29, 1996, at A3.592 See id. 593 See Judy Greenwald, State To Review Awards, BUS. INS., Jan. 29, 1996, at 2, 12. Cf. Lee Craig, Avoid Bad Faith Liability By Handling Claims Properly, FOR THE DEFENSE, Nov. 1996, at 17 (the author is a lawyer who regularly represents insurance companies in insurance coverage disputes).594 Brief of American Insurance Association, Alliance of American Insurers, and The Surety Association of America as Amicus Curiae, at 3, New York Univ. v. Continental Ins. Co., 668 N.E.2d 1370 (N.Y. 1995)(No. 11627/92).


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burdens on policyholders.595 One court scathingly summarized the recent bad faith misconduct

of one insurance company, perhaps capturing the essence of bad faith:

[T]he [insurance company] really didn’t look into this very deeply. I get the distinct impression in reading these papers and the papers are voluminous, [the insurance company] was looking for a way to deny coverage in this particular case because of the large claims in these environmental cases because it appears as though they sent this letter out with total reckless disregard of their internal memos and what they knew to be the facts.596

The court held that the insurance company’s denial of coverage was contrary to its insurance

policies, contrary to the understanding of the insurance company employees, contrary to

memoranda that were submitted, and contrary to the investigation that was conducted by the

insurance company.597 But it denied coverage anyway.

Bad faith claims and punitive damages are necessary to deter bad faith by

insurance companies but should not obscure the compensatory damages. Insurance company

grumblings and assaults over the legitimacy of bad faith and punitive damage claims by

policyholders are undermined by the frequency of insurance company refusals to honor claims

for insurance coverage from policyholders made in good faith.

The recent Supreme Court decision in BMW clarifies the situations in which

punitive damages are appropriate. In traditional contract situations, where the harm caused by

the breach is mainly an economic harm, punitive damages have been restricted. But BMW was

not meant to restrict all large punitive awards. Where the defendant’s conduct is deemed

595 See Lia B. Royle & Paul B. Breene, Insurance Company Bad Faith In Settlement: When Insurers Put Policyholders’ Interests Last, N.J. LAW., Feb. 19, 1996, at 28. 596 Colonial Foods, Inc. v. Aetna Cas. & Sur. Co., No. Mon-L-0392-93 (N.J. Super. Ct. Law Div. Apr. 21, 1995), leave to appeal denied, (N.J. Super. Ct. App. Div. June 20, 1995).597 See Edward M. Joyce, Arizona And New Jersey Courts Tell Insurance Companies: Watch It - Bad Faith Claims Are Alive And Well, CORP. LEGAL TIMES, Feb. 1996, at 24.


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reprehensible, punitive damages remain an appropriate remedy. For bad faith insurance claims,

where insurance companies dispute valid claims in order to earn investment income, punitive

awards are particularly suitable.

Trickery and deceit remain more reprehensible than negligence.598

598 BMW v. Gore, 116 S. Ct. at 1599.


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PART XIVGOOD FAITH

A. Definitions of Good Faith

Barron’s Law Dictionary defines good faith as:

[A] total absence of any intention to seek an unfair advantage or to defraud another party; an honest and sincere intention to fulfill one’s obligations. In the case of a merchant, good faith refers to honesty in fact and the observance of reasonable commercial standards of fair dealing in the trade. U.C.C. § 2-103(1)(b). More generally, the term means “honesty in fact in the conduct or transaction concerned.” U.C.C. § 1-201(19). In property law, a “good faith” purchaser of land pays the value of the land and has no knowledge or notice of any facts that would cause an ordinary, prudent person to make inquiry concerning validity of the conveyance. See Security Trust Co. v. Tuller, 243 Mich. 570, 220 N.W. 795, 797 (1928).

BARRON’S LAW DICTIONARY (2nd ed. 1984), at 204.

GOOD FAITH

General. A term used to refer to conduct which is to be expected in any other commercial transaction; that is, all parties to a transaction are expected to have honest motives, to fully intend to perform their obligations under the terms set forth in the relationship, and to abstain from defrauding or taking unfair advantage of the other party. In may legal relationships (e.g. the employment relationship, an insurance contract, etc.), there is an “implied covenant of good faith and fair dealing” which requires both parties to treat the other party fairly and to give at least as much consideration to the other party’s welfare as it gives to its own.

RUPP’S INSURANCE & RISK MANAGEMENT GLOSSARY (1991) p.156.

Good Faith. Good faith is an intangible and abstract quality with no technical meaning or statutory definition, and it encompasses, among other things, an honest belief, the absence of malice and the absence of design to defraud or to seek an unconscionable advantage, and an individual’s personal good faith is concept of his own mind and inner


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spirit and, therefore, may not conclusively be determined by his protestations alone. Doyle v. Gordon, 158 N.Y.S.2d 248, 259, 260 (N.Y. Sup. Ct. 1954). Honesty of intention, and freedom from knowledge of circumstances which ought to put the holder upon inquiry. An honest intention to abstain from taking any unconscientious advantage of another, even through technicalities of law, together with absence of all information, notice, or benefit or belief of facts which render transaction unconscientious. In common usage this term is ordinarily used to describe that state of mind denoting honesty of purpose, freedom from intention to defraud, and, generally speaking, means being faithful to one’s duty or obligation. Efron v. Kalmanovitz, 249 Cal. App. 2d 187, 57 Cal. Rptr. 248, 251 (2d Dist. 1967). See Bona fide. Compare Bad faith.

* * *Insurance law. “Good faith” required of a liability insurer in

determining whether to accept settlement within policy limits implies honesty, fair dealing and full revelation; while “bad faith” implies dishonesty, fraud and concealment. Davy v. Public Nat. Ins. Co., 181 Cal. App. 2d 387, 5 Cal.Rptr. 488, 492 (4th Dist. 1960).

BLACK’S LAW DICTIONARY (6th ed. 1990) at 693.

[B]ad faith is the intentional failure by an insurer to perform the duty of good faith and fair dealing implied by law. Generally, an insurer may be acting in bad faith when it refuses to pay a claim and (1) has no reasonable basis for refusing to pay and has actual knowledge of that fact, or (2) has intentionally failed to determine whether it had a reasonable basis for so refusing.

“Bad Faith” And Insurer Actions, Fire Casualty & Surety (FC&S) Bull. (Personal Lines, General B-1 (The National Underwriter Co., Jan. 1995).

Bad faith . . . generally implies or involves “actual or constructive fraud, or a design to mislead or deceive another, or a neglect or refusal to fulfill some duty or some contractual obligation, not prompted by an honest mistake as to one’s rights or duties, but by some interested or sinister motive. Term bad faith is not simply bad judgment or negligence, but rather it implies the conscious doing of a wrong because of dishonest purpose or moral obliquity; it is different from the negative idea of negligence in that it


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contemplates a state of mind affirmatively operating with furtive design or ill will.” Insurance case law has softened the “ill will” or “conscious doing of wrong” into areas of more passive action . . .

Id. at General B-2 (quoting BLACK’S LAW DICTIONARY, 5th ed.)

[C]ourts have held that the cause of action against the insurer arises “where there is no reasonable basis for a denial of a claim or when the insurer fails to determine or delays in a determination of whether there is any reasonable basis for a denial of the claim . . . In order to sustain a claim for breach of good faith, the insured must establish (1) the absence of a reasonable basis for denying or delaying payment of the claim and (2) that the insurer knew, or should have known, that there existed no reasonable basis for denying or delaying payment of the claim.”

Id. at General B-5 quoting Dixon v. State Farm Fire & Cas. Co., 799 F. Supp. 691 (S.D. Tex. 1992).

When a claim is fairly debatable, an insurer is entitled to debate it, whether the debate concerns a matter of fact or law. A knowing failure on the part of the insurer to exercise an honest and informed judgment constitutes a tort of bad faith. An such may be shown where a claim is not properly investigated or reviewed.

APPLEMAN, INSURANCE LAW AND PRACTICE, § 8878.25 (1981 ed.)

“To show a claim for bad faith a plaintiff must show the absence of a reasonable basis for denying benefits of the policy and the defendant’s knowledge or reckless disregard of the lack of a reasonable basis for denying the claim. It is apparent then that the tort of bad faith is an intentional one. Implicit in that test is our conclusion that the knowledge of the lack of a reasonable basis may be inferred and imputed to an insurance company where there is reckless indifference to facts or to proofs submitted by the insured.”

UTMOST GOOD FAITH

What constitutes or what is utmost good faith has also been

addressed.


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“[T]he [insurance] company acts in utmost fair dealing with all of its insureds in any claim situation.”

Deposition of Robert E. Hyland, Aetna V.P. taken in Colonial Foods v. Aetna, supra, Mar. 28, 1995 at page 59 (emphasis added).

“The insurance transaction . . . is generally considered a personal transaction requiring complete honesty and full disclosure by both parties....both the insurance buyer and the insurance company expect utmost good faith and fair dealing from one another.”

James J. Markham, et al., The Claims Environment (1st ed. 1993) at 5-6 (emphasis added).

“It is to the insured that the insurance company owes the contractual obligation of utmost good faith and fair dealing.”

Id. at 18 (emphasis added).

“The insurance . . . business [is a] business[] of Utmost Good Faith. By custom and practice both the insurer and the insured are held to a higher level of care when dealing with each other.”

Letter dated Nov. 29, 1994 at 7, from Aetna’s Insurance Expert, Prof. Peter R. Kensicki, re Penco Prods. v. Aetna Cas. & Sur. Co., No. M-49IX (N.Y. App. Div. 1st Dep’t) (emphasis added).

Utmost good faith has also been deemed:A phrase in a legal document calling for the highest standards of

integrity on the part of the insured and the insurer

DICTIONARY OF INSURANCE, 7th Rev. ed. p. 473

utmost good faith

Insurer Operations/Reinsurance. The insurance contract is a personal contract between an insurer and insured where each party must be able to rely on the other for valid critical information.

syn: uberrimae fidei

RUPP’S INSURANCE & RISK MANAGEMENT GLOSSARY (1991) at 339.


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uberrimae fideiInsurer Operations/Reinsurance. A Latin legal term which

translates to “utmost good faith.” As respects insurance contracts, it is assumed both parties to the contract (insurer and insured, insurer and reinsurer) have entered into the contract in good faith and have disclosed all relevant facts with the intent to carry out their obligations. If a lack of such good faith is proven, an insurance contract may be declared null and void.

syn: utmost good faith

RUPP’S INSURANCE & RISK MGMT. GLOSSARY (1991) at 333.

uberrimae fidei“Utmost good faith.” The basic principle of insurance law is that

there must be utmost good faith between an insurer and an insured, especially with regard to the nature of the exposure insured.

RISK MANAGEMENT SOCIETY GLOSSARY (1985) at 78.

uberrimae fideiOf utmost good faith — certain transactions require the utmost of

good faith on both sides, and both parties must disclose relevant facts. It is a fundamental principle of all insurance contracts.

DICTIONARY OF INSURANCE, (7th Rev. ed.) at 465.

uberrimae fidei contractagreement “of utmost good faith.” Under law, it is assumed that

insurance contracts are entered into by all parties in good faith, meaning that they have disclosed all relevant facts and intend to carry out their obligations. Where lack of good faith can be proved, such as a fraudulent application to obtain insurance, the contract may be nullified.

BARRON’S DICTIONARY OF INSURANCE TERMS (2nd ed.) at 433.

uberrima fides/ yuwbehreme faydiyz/. Lat. The most abundant good faith;

absolute and perfect candor or openness and honesty; the absence of any concealment or deception, however slight. A phrase used to express the perfect good faith, concealing nothing, with which a contract must be made; for example,


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in the case of insurance, the insured must observe the most perfect good faith towards the insurer. Gulfstream Cargo, Ltd. v. Reliance Ins. Co., 409 F.2d 974, 981 (5th Cir 1969). Contracts of life insurance are said to be “uberrima fida” when any material misrepresentation or concealment is fatal to them.

BLACK’S LAW DICTIONARY (6th ed.) at 1520.


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Review of Bad Faith Caselaw and Statutes of Selected States

Kentucky

The Kentucky Supreme Court has recognized that insurance companies owe their

policyholders a duty of “utmost good faith.”599 Kentucky is also among the states which grants

policyholders a private right of action for insurance company bad faith. This was not always the

case, however. In 1986, the Kentucky Supreme Court in Federal Kemper Insurance Co. v.

Hornback held that insurance company misconduct was a breach of contract, not tortious

conduct.600 As a result, punitive damages could not apply.601

The rule of law created in Federal Kemper lasted all of three years. The

Kentucky Supreme Court overruled Federal Kemper in Curry v. Fireman’s Fund Insurance Co.,

this time underscoring the inherent unfairness of a rule that fails to punish insurance company

bad faith:

Our decision in Federal Kemper abolished tort liability to a policyholder, regardless of the conduct of the insurance carrier. Such a rule permitted an insurance carrier to deny payment without any justification, attempt unfair compromise by exploiting the policyholder’s economic circumstance, and delay payment by litigation with no greater possible detriment than payment of the amount justly owed plus interest.602

The court concluded that the “peace of mind” policyholders expected when purchasing insurance

was only an illusion if policyholders were unable to ensure prompt payment from their insurance

company for their losses.603

599. James Graham Brown Found., Inc. v. St. Paul Fire & Marine Ins. Co., 814 S.W.2d 273, 280 (Ky. 1991), modified and reh’g denied, No. 88-CA-2405-MR, 1991 Ky. Lexis 149 (Ky. Sept. 26, 1991).600. See Federal Kemper Ins. Co. v. Hornback, 711 S.W.2d 844, 845 (Ky. 1986), overruled by Curry v. Fireman’s Fund Ins. Co., 784 S.W.2d 176 (Ky. 1989). 601. See Federal Kemper, 711 S.W.2d at 845.602. Curry v. Fireman’s Fund Ins. Co., 784 S.W.2d 176, 178 (Ky. 1989).603. Id.


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The Curry opinion does not provide extensive analysis, relying nearly entirely on

Judge Leibson’s dissent in Federal Kemper.604 In essence, the law of Kentucky is the dissent in

Federal Kemper.605 The Federal Kemper dissent set forth three requirements to show that an

insurance company has acted in bad faith. The policyholder must be able to show that the

insurance company (1) is obligated to pay the claim under the terms of the policy; (2) lacked a

reasonable basis for denying coverage; and (3) knew there was no basis for denying the claim or

acted with reckless disregard for whether such a basis existed.606

In Kentucky, a complaint alleging insurance company bad faith which cannot

meet this test fails to state a cause of action.607 In Empire Fire & Marine Ins. Co. v. Simpsonville

Wrecker Service, the Kentucky Court of Appeals held that under the guidelines of Curry, if the

status of the law governing the insurance coverage question is genuinely in dispute, the

policyholder’s claim is fairly debatable and a tort claim based on the insurance company’s bad

faith failure to be pay is untenable.608

At least one federal court has used the holding of Empire Marine to reverse an

award of consequential damages arising from insurance company bad faith. In First National

Bank of Louisville v. Lustig,609 a Fifth Circuit case interpreting Kentucky law, the court held that

604. See id. at 177-78 (“Judge Leibson’s dissenting opinion in Federal Kemper contains an excellent statement of the applicable principles involved herein and we incorporate those views in this opinion”). 605. See MIKE BREEN, BAD FAITH IN KENTUCKY: A PRIMER 36-7 (coming to the same conclusion as the authors).606. See Federal Kemper Ins. Co. v. Hornback, 711 S.W.2d 844, 846-47 (Ky. 1986)(Leibson, J., dissenting), overruled by Curry v. Fireman’s Fund Ins. Co, 784 S.W.2d 176 (Ky. 1989). 607. Empire Fire & Marine Ins. Co. v. Simpsonville Wrecker Service, 880 S.W.2d 886, 890 (Ky. Ct. App. 1994).608. Id. at 890.609. First Nat’l Bank of Louisville v. Lustig, 96 F.3d 1554 (5th Cir. 1996)


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the insurance company’s failure to provide coverage was “fairly debatable.”610 In that case, the

policyholder was denied insurance coverage for loan losses caused by a former loan officer’s

fraudulent acts.611 Citing Empire Fire and Marine, the court held that insurance coverage was

properly denied because (1) the issue in question was of first impression in Kentucky and (2)

there were factual questions relating to whether or not insurance coverage existed.612 The court

found that under Empire Fire and Marine, the existence of either of these factors causes a denial

of coverage to be fairly debatable and precludes a finding of bad faith against the insurance

company. Because the denial of coverage was fairly debatable, the court held that the second

factor of the Federal Kemper three factor test613 — that the policyholder had shown the insurance

company lacked a reasonable basis in law or fact for denying the claim — was not met.

The First National decision is a good example of the hostility of Federal courts to

policyholders. Kentucky’s Unfair Claims Settlement Practices Act is KRS 304.12-230.614

Kentucky is also one of the few states granting a policyholder a private right of action against an

insurance company under the statute.615 However, the Kentucky Supreme Court has held that the

610. Id. at 1567-68. Following a bifurcated trial on the issues of coverage and bad faith, the jury had found that insurance coverage existed and returned a verdict of over $17,000,000 in damages for the insurance coverage (the bank had lost over $20,000,000 from the bad loans). The same jury found that the insurance company had acted in bad faith, awarding the policyholder over $11,000,000 in lost earnings and $5,850,000 in attorneys fees. The insurance company contested solely the bad faith judgments and attorneys fees, both of which the court reversed. Id. at 1559, 1563.611. Id. at 1559-1560 (explaining the former loan officer’s misconduct).612. First, the issue of first impression in Kentucky facing the court was the definition “manifest intent” in a banker’s blanket bond. Second, the court held that a factual issue existed as to whether the loan officer had possessed the requisite intent to injure the bank at the time he committed his acts, or if his guilty plea acknowledging willful and knowing conduct with “the intent to injure” had been drafted specifically to implicate insurance coverage. See id. at 1567.613. Judge Leibson’s three factor test was incorporated in the Kentucky Supreme Court’s decision in Wittmer v. Jones, 864 S.W.2d 885 (Ky. 1993). Judge Leibson also wrote the Wittmer opinion. For a full analysis of the far-reaching consequences of the Wittmer decision see BREEN at 45-51.614. See BREEN at 37.615. The Kentucky Supreme Court held in State Farm Mutual Automobile Insurance Co. v. Reeder, 763 S.W.2d 116 (Ky. 1988), and Wittmer v. Jones, 864 S.W.2d 885 (Ky. 1993) that first and third parties,


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standards adopted in Curry must be met before a claim can be made under Kentucky’s Unfair

Claims Settlements Practices statute.616 Kentucky also allows a bad faith claim against an

insurance company under its Consumer Protection Act, KRS 367.220.617

Kentucky does not recognize arbitration clauses between a policyholder and its

insurance company. Kentucky Revised Statute § 417.050 states:

A written agreement to submit any existing controversy to arbitration . . . is valid, enforceable and irrevocable, save upon such grounds as exist at law for the revocation of any contract. This chapter does not apply to:

. . . .(2) Insurance contracts. Nothing in this subsection shall be

deemed to invalidate or render unenforceable contractual

arbitration provisions between two (2) or more insurers, including

reinsurers.618 (emphasis added)

Thus, although the Kentucky Court of Appeals has recognized that “it requires no citation of

authority to point out that arbitration is a favorite of the law, both within and without this

jurisdiction, and if the parties to a transaction agree to such a submission it is generally

enforced[,]”619 this admonition does not apply to insurance policyholders in Kentucky.

respectively, retain a private right of action under KRS 304.12-230.

Kentucky is one of only 10 states which allow for a private right of action under their Unfair Claims Settlement Practices statute. See ASHLEY at 9:03, at 10-11 (listing cases). Note that BREEN states only two other jurisdictions allow a private right of action under their respective statutes. See BREEN at 37.616. See Wittmer v. Jones, 864 S.W.2d 885 (Ky. 1993).617. See Stevens v. Motorists Mut. Ins. Co., 759 S.W.2d 819, 820 (Ky. 1988) (holding that the purchase of an insurance policy is the purchase of a service intended to be covered by Kentucky’s Consumer Protection Act).618. KRS § 417.050 is Kentucky’s version of the Uniform Arbitration Act. See Thomas J. Stipanowich, The Kentucky Law Survey: Arbitration, 74 KY. L.J. 319, 320 (1985). Professor Stipanowich provides a history of the development of arbitration in Kentucky.619. Valley Constr. Co., et al., v. Perry Host Mgmt. Co., 796 S.W.2d 365 (Ky. Ct. App. 1990). The “et al.” includes Transamerica Insurance Company. Although the court recognized that KRS 417.050


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Pennsylvania

The Pennsylvania Superior Court in Romano v. Nationwide Mutual Fire

Insurance Company, noted that it was “because of the special relationship” between an insurance

company and its policyholder, that “[t]he Pennsylvania Supreme Court has long held that an

insurer must act with the ‘utmost good faith’ toward its insured.”620 Similarly, the Pennsylvania

Supreme Court in Dercoli v. Pennsylvania National Mutual Insurance Company, after

acknowledging that “utmost fair dealing should characterize the transactions between an

insurance company and the insured,” further stated:

The [insurance companies] were bound to deal with the policyholder on a fair and frank basis, and at all times, to act in good faith. The duty of an insurance company to deal with the insured fairly and in good faith includes the duty of full and complete disclosure as to all of the benefits and every coverage that is provided by the applicable policy . . . including any time limitations for making a claim. This is especially true where the insurer undertakes to advise and counsel the insured in the insured’s claim for benefits.621

precludes the arbitration of insurance coverage, the court found that “there was no attempt to arbitrate the contract of insurance itself.” Id. at 368. Transamerica had furnished the performance bond for Valley Construction and the case did not raise issues of insurance coverage. 620. Romano v. Nationwide Mut. Fire Ins. Co., 435 Pa. Super. 545, 646 A.2d 1228, 1231 (1994)(citing Fedas v. Insurance Co. of Pa., 300 Pa. 555, 558, 151 A. 285, 286 (1930); Dercoli v. Pennsylvania Nat’l Mut. Ins. Co., 520 Pa. 471, 554 A.2d 906 (1989); Cowden v. Aetna Cas. & Sur. Co., 389 Pa. 459, 134 A.2d 223 (1957).621. Dercoli v. Pennsylvania Nat’l Mut. Ins. Co., 520 Pa. 471, 477-78, 554 A.2d 906, 909 (1989) In Dercoli, the insurance company assured the policyholder that her claim could be processed without an attorney. The insurance company subsequently failed to inform the policyholder of a change in the law which entitled the policyholder to additional coverage. By the time the policyholder had discovered that she was entitled to additional insurance coverage, the statute of limitations to file a claim against the insurance company had expired. The court held that the insurance companies’ failure to act in good faith tolled the statute of limitations. 520 Pa. at 477, 554 A.2d at 908-09. But see Miller v. Keystone Ins. Co., 535 Pa. 531, 536, 636 A.2d 1109, 1112 (1994)(Pennsylvania Supreme Court holding that the appellate court “was incorrect in holding that Dercoli imposes an affirmative duty upon an insurer to advise and inform an insured of all potential claims when the insurer assumes the responsibility for processing the claim.” Id. The court in Keystone noted that the insurance company’s “knowing and purposeful misrepresentation was critical to this Court’s determination [in Dercoli] that the insurers were bound to disclose all of the benefits to which the claimant was entitled.” 535 Pa. at 537, 636 A.2d at 1112. Note also that the appellate court had tried to retroactively apply Dercoli.


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Pennsylvania does not recognize a common law right of action for insurance

company bad faith.622 Thus, insurance companies’ duty of good faith and fair dealing is enforced

primarily by statute in Pennsylvania. These statutes are the Unfair Insurance Practices Act623, the

Unfair Trade Practice and Consumer Protection Law,624 and 42 Pa.C.S.A. § 8371 (“8371”)625.

In 1981, the Pennsylvania Supreme Court specifically declined to create a

common law remedy for insurance company bad faith in D’Ambrosio v. Pennsylvania National

Mutual Casualty Insurance Company.626 The Pennsylvania Supreme Court held that

Pennsylvania’s Unfair Insurance Practices Act (“UIPA”)627 adequately deterred insurance

company bad faith. The court also held that only state insurance commissioner was empowered

to bring claims under the UIPA.628 Courts remain steadfast in holding that there is no private

right of action under the UIPA. Several decisions, however, have held that the UIPA does not

preclude existing common law remedies.629

622. See D’Ambrosio v. Pennsylvania Nat’l Mut. Cas. Ins. Co., 494 Pa. 501, 508, 431 A.2d 966, 970 (1981); Johnson v. Beane, 541 Pa. 449, 455, 664 A.2d 96 (1995).623. 40 Pennsylvania Statutes § 1171.5.624. 73 Pennsylvania Statutes § 201-2(4).625. 42 Pennsylvania Consolidated Statutes Annotated § 8371.626. D’Ambrosio v. Pennsylvania Nat’l Mut. Cas. Ins. Co., 494 Pa. 501, 508, 431 A.2d 966, 970 (1981). 627. 40 P.S. § 1171.4, 1171.5628. See D’Ambrosio 494 Pa. at 507, 431 A.2d at 969-970. See also Romano v. Nationwide Mut. Fire Ins. Co., 435 Pa. Super. 545, 646 A.2d 1228, 1231-32 (1994) for a good synopsis of the evolution of Pennsylvania statutory and common law with regard to insurance company bad faith.629. See Pekular v. State Farm Mut. Auto. Ins. Co., 355 Pa. Super 276, 282-83, 513 A.2d 427, 430, (1986), appeal denied, 516 Pa. 635, 533 A.2d 93 (1987)(holding that the UPIA did not preclude a policyholder from bringing a cause of action in common law tort and deceit); Wright v. North Am. Life Assurance Co., 372 Pa. Super. 272, 281, 539 A.2d 434, 439 (1988)(citing Pekular); Katz v. Aetna Cas. & Sur. Co., 972 F.2d 53, 57-8 (3d Cir. 1992). The Pekular and Katz opinions specifically rely on the concurrence by Judge Nix in D’Ambrosio. Judge Nix’s concurrence specifically states that the holding in D’Ambrosio did not preempt other common law causes of action (specifically, breach of contract and deceit). D’Ambrosio v. Pennsylvania Nat’l Mut. Cas. Ins. Co., 494 Pa. 501, 511, 431 A.2d 966, 973 (1981)(Nix, J., concurring). Because D’Ambrosio was a plurality opinion, Judge Nix’s concurrence is controlling Pennsylvania law. See Katz at 58, citing Planned Parenthood of Southeastern Pa. v. Casey,


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In 1990, the Pennsylvania legislature responded to D’Ambrosio by enacting §

8371, creating a statutory remedy for insurance company bad faith.630 § 8371 sets forth the

following:

In an action arising under an insurance policy, if the court finds that the insurer has acted in bad faith towards the insured, the court may take all of the following actions:

(1) Award interest on the amount of the claim....

(2) Award punitive damages against the insurer.

(3) Assess court costs and attorneys fees against the insurer.631

Romano v. Nationwide Mutual Fire Insurance Company was the first decision to

construe the meaning of § 8371.632 The court, finding that § 8371 did not define the meaning of

bad faith, but that “in the insurance context, the term bad faith has acquired a universally

acknowledged meaning,” provided the following definition:

Insurance: “Bad Faith” on part of insurer is any frivolous or unfounded refusal to pay proceeds of a policy; it is not necessary that such refusal be fraudulent. For purposes of an action against an insurer for failure to pay a claim, such conduct imports a

947 F.2d 682, 693 (3d Cir. 1991)(the controlling opinion in a splintered decision is that of the U.S. Supreme Court Justice or Justices who concur on the narrowest grounds), aff’d, 505 U.S. 833 (1992).630. See Tina M. Oberdorf, Bad Faith Insurance Litigation in Pennsylvania: Recurring Issues Under Section 8371, 33 DUQ. L. REV. 451, 452 (Spring 1995). The article provides a thorough review of insurance coverage litigation under § 8371, noting that the primary problems with § 8371 is the legislature’s failure to provide a statutory definition of bad faith and a failure to provide a set of standards to assist courts in determining damages. Id. at 451.631. 42 Pa. C.S.A. §8371.632. Romano v. Nationwide Mut. Fire Ins. Co., 435 Pa. Super. 545, 646 A.2d 1228, 1232 (1994).

Note, however that the only Pennsylvania Supreme Court decision to discuss § 8371 to date appears to be Johnson v. Beane, 541 Pa. 449, 664 A.2d 96 (Pa. 1995). The court in Johnson, noting that § 8371 was inapplicable to the present case, stated in dicta that § 8371 does not provide for a third party action. Id. at 455. “An obligation of the insurer to act in good faith in dealing with its insured is not intended to benefit one injured by the insured. The [insurance company’s] duty to act in good faith . . . runs only to the policyholder. Id. “The only statute in this Commonwealth providing for a direct action by an injured third party against the insurer of an alleged tortfeasor, the Act of May 24, 1933, P.L. 0987, § 1, 40 P.S. § 177, provides for such direct action solely upon the bankruptcy or insolvency of the insured and only for an amount not exceeding the policy limits. Id.


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dishonest purpose and means a breach of a known duty (i.e., good faith and fair dealing), through some motive of self-interest or ill will; mere negligence or bad judgment is not bad faith.633

The definition of bad faith supplied by the Romano court has been used by other Pennsylvania

state and federal courts.634

The Romano court noted that although the UIPA can only be enforced by the state

insurance commissioner, a policyholder “may point to bad faith conduct as defined in various

provisions of the UIPA as a basis for recovery under 42 Pa.C.S.A. § 8371.”635 Thus:

Although the trial court lacks the requisite jurisdiction to impose sanctions under the various provisions of the UIPA and insurance regulations, we find that the rules of statutory construction permit a trial court to consider, either sua sponte or at the request of a party, the alleged conduct constituting violations of the UIPA or the regulations in determining whether an insurer. . . acted in “bad faith.”636

. . .

The fact that [the policyholder] makes reference to a provision of the UIPA does not divest the trial court of its jurisdiction.637

633. Id. Perhaps a testament to the Court’s caution, the definition is quoted directly from BLACK’S LAW DICTIONARY 139 (6th ed. 1990).634. See e.g. Rottmund v. Continental Assurance Co., 813 F. Supp. 1104, 1108-09 (E.D. Pa. 1992)(this case also stands for the proposition that an insurance company owes its policyholders a continuing duty of good faith and fair dealing through litigation). See also Woody v. State Farm Fire & Cas. Co., 965 F. Supp. 691 (E.D. Pa. 1997). For courts ruling against the policyholder but adopting the definition, see Polselli v. Nationwide Mut. Fire Ins. Co., 23 F.3d 747 (3d Cir. 1994); Cabrelli v. State Farm Fire & Cas. Co., No. 96-0209, 1997 U.S. Dist. LEXIS 197 (E.D. Pa. Jan. 14, 1997).635. Id.636. Id. at 1233, citing MacFarland v. United States Fidelity & Guar. Co., 818 F. Supp. 108 (E.D. Pa. 1993)(holding that alleged conduct constituting violations of the UIPA and the regulations can be considered in determining whether the insurer acted in bad faith under § 8371); Rottmund v. Continental Assurance Co., 813 F. Supp. 1104 (E.D. Pa. 1992)(holding that courts may look to other statutes on the same or similar subjects to define bad faith under § 8371); Coyne v. Allstate Ins. Co., 771 F. Supp. 673 (E.D. Pa. 1991)(holding that the provisions of the UIPA can be used to describe conduct constituting bad faith). 637. Id.


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Several decisions have held that a bad faith claim brought under § 8371 is to be considered

independent of any claim for breach of the insurance company’s obligations under the insurance

policy:

[A] claim brought under section 8371 is a cause of action which is separate and distinct from the underlying contract claim . . . [A]s the language of section 8371 does not indicate that success on the contract claim is a prerequisite to success on the bad faith claim, we find that an insured’s claim for bad faith brought pursuant to section 8371 is independent of the resolution of the underlying contract claim.638

The court held that a policyholder’s bad faith claim brought under § 8371 is independent of a

claim brought for breach of the insurance policy, and that the statute of limitations period in the

insurance policy had no affect on the bad faith claim.639 However, the court reversed the trial

court’s summary judgment for the insurance company on the policyholder’s bad faith claim

without deciding the proper statute of limitations period under § 8371. One court has recently

held that the statute of limitations period to bring a claim under § 8371 is six years.640

A conflict is currently brewing in Pennsylvania over the scope of § 8371 and bad

faith claims can only be brought for an improper denial of insurance coverage or is more

638. Internal citations omitted. March v. Paradise Mutual Ins. Co., 435 Pa. Super. 597, 601-02, 646 A.2d 1254, 1256 (1994), appeal denied, 540 Pa. 613, 656 A.2d 118 (1995), citing Boring v. Erie Ins. Group, 434 Pa. Super. 40, 641 A.2d 1189 (1994); Okkerse v. Prudential Property & Cas. Ins. Co. , 425 Pa. Super. 396, 625 A.2d 663 (1993). The court also noted that federal courts have “consistently” held that § 8371 created a separate and independent cause of action, citing Margolies v. State Farm Fire & Cas. Co., 810 F. Supp. 637, 642 (E.D. Pa. 1992); Kauffman v. Aetna Cas. & Sur. Co., 794 F. Supp 137, 140 (E.D. Pa. 1992), recons. denied, No. 91-4450 (E.D. Pa. Sept. 18, 1992); Lombardo v. State Farm Mut. Auto. Ins. Co., 800 F. Supp. 208, 214 (E.D. Pa. 1992).639. March v. Paradise Mut. Ins. Co., 435 Pa. Super. 597, 602, 646 A.2d 1254, 1257, appeal denied, 540 Pa. 613, 656 A.2d 118 (1995). 640. See Woody v. State Farm Fire & Cas. Co., 965 F. Supp. 691 (E.D. Pa. 1997)(as a matter of first impression for either a Pennsylvania state or federal court, holding that the statute of limitations period to file a claim under § 8371 is 6 years, as provided by 42 Pa.C.S.A. § 5527. The same limitations period applies to a claim brought under the Unfair Trade Practices and Consumer Protection Law. Id. at *4).


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expansive and can include claims for alleged fraud or misrepresentation.641 Recent cases holding

that alleged misconduct supported an action for bad faith under § 8371 include:

1. Making an unreasonable, unduly restrictive and self-serving interpretation of the terms of an insurance policy. Chowdhury v. LMI Ins. Co., 107 F.3d 6 (3d. Cir. 1997)

2. Forcing an insured to pay excessive premiums on a retrospective premium insurance policy. Argonaut Ins. Co. v. HGO Inc., No. 96-1115, 1996 U.S. Dist. LEXIS 10892 (E.D. Pa. July 26, 1996)

3. Terminating an insured’s disability benefits where there has been no established change in the insured’s medical condition. DiMaggio v. UNUM Corp., No. 96-8440, 1997 U.S. Dist. LEXIS 1912 (E.D. Pa. Feb. 24, 1997)

4. Threatening an insured that if she did not accept a lump sum payment, her insurance benefits would be terminated. DiMaggio v. UNUM Corp., No. 96-8440, 1997 U.S. Dist. LEXIS 1912 (E.D. Pa. Feb. 24, 1997)

5. Intentionally making contact with an insured outside the presence of the insured’s attorney. DiMaggio v. UNUM Corp., No. 96-8440, 1997 U.S. Dist. LEXIS 1912 (E.D. Pa. Feb. 24, 1997)

6. Misrepresenting terms and provisions of an insurance policy. Certainteed Corp. and Bay Mills, Ltd. v. Federal Ins. Co., 913 F. Supp. 351 (E.D. Pa. 1995) and

7. Failing to offer a reasonable settlement of a UNIM claim. Draeger v. Nationwide Mut. Ins. Co., No. 95-7550, 1996 U.S. Dist. LEXIS 18056 (E.D. Pa. Dec. 1996).Although the Pennsylvania Supreme Court does not appear to have addressed the

issue, there is substantial authority for the proposition that policyholders may maintain a private

cause of action under Pennsylvania’s Unfair Trade Practice and Consumer Protection Law even

when the policyholder’s allegations fall within the practices prohibited by the UPIA.642

641. Compare Conners v. Metropolitan Life Ins. Co., PICS Case No. 98-0328 (C.P. Fayette Dec. 26, 1997)(§ 8371 allows suits only for bad faith denial of claims) with Ihnat v. Pover, PICS Case No. 98-0006, (Ct. C.P. Allegheny Dec. 16, 1997)(suits under § 8371 can be brought for any of the acts prohibited under Pennsylvania’s Unfair Insurance Practices Act). Both cases are discussed in Hank Grezlak, Another Debate Over Bad Faith Suits Erupts, PENN. L. WKLY, Feb. 23, 1998, at 11.642. See 73 P.S. 201-9.2 (providing for private right of action) and 73 P.S. 201-2(4) (listing prohibited practices). See also Pekular v. State Farm Mut. Auto. Ins. Co., 355 Pa. Super. 276, 285-90, 513 A.2d


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Ohio

The Supreme Court of Ohio in Zoppo v. Homestead Insurance Co. set forth the

standard for evaluating whether an insurance company has fulfilled its duty of good faith and fair

dealing:

An insurer fails to exercise good faith in the processing of a claim of its insured where its refusal to pay the claim in not predicated upon circumstances that furnish reasonable justification therefor.643

Under Ohio law:

“[A] breach of this duty will give rise to a cause of action in tort against the insurer. The tort of bad is not a tortious breach of contract, for no matter how willful or malicious the breach, it is no tort to breach a contract . . . [T]he legal duty of good faith imposed by law on the insurer applies with equal force to the company’s settlement of third party claims against its insured as it does to those claims brought by the insured himself.644

427, 432-34 (1986), appeal denied, 516 Pa. 635, 533 A.2d 93 (1987); Wood v. Allstate Ins. Co., No. 96-4574, 1996 U.S. Dist. LEXIS 16332 (E.D. Pa. Nov. 4, 1996); Wright v. North Am. Life Assurance Co., 372 Pa. Super. 272, 279-80, 539 A.2d 434, 438 (Pa. Super. Ct. 1988); Falbo v. State Farm Life Ins. Co., No. 96-5540, 1997 U.S. Dist. LEXIS 2687 (E.D. Pa. March 13, 1997). In addition, Katz v. Aetna Cas. & Sur. Co., 972 F.2d 53, 55 (3rd Cir. 1992) recognized that a private cause of action existed under the Unfair Trade Practice and Consumer Protection Law, but found that under the facts of the case, the claimants, since they were making a third party claim, did not have standing to file such a claim under the statute.643. Zoppo v. Homestead Ins. Co., 71 Ohio St. 3d 552, 554, 644 N.E.2d 397, 400 (1994).644. Internal citations omitted. Motorists Mut. Ins. Co. v. Said, 63 Ohio St. 3d 690, 590 N.E.2d 1228 (1992), overruled in part by Zoppo v. Homestead Ins. Co., 71 Ohio St. 3d 552, 644 N.E.2d 397, quoting Hoskins v. Aetna Life Ins. Co., 6 Ohio St. 3d 272, 452 N.E.2d 1315. The above quoted language reflects the Ohio Supreme Court’s recognition of the rationale set forth in the landmark case of Gruenberg v. Aetna Ins. Co., 9 Cal. 3d 566, 510 P.2d 1032, 1038 (1973):

[I]n every insurance contract there is an implied covenant of good faith and fair dealing. The duty to so act is imminent in the contract whether the company is attending to the claims of third persons against the insured or the claims of the insured itself. Accordingly, when the insurer unreasonably and in bad faith withholds payment of the claim of its insured, it is subject to liability in tort.


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An insurance company’s breach of its duty of good faith and fair dealing sounds in tort

“irrespective of any liability that might arise from a breach of the underlying insurance

contract.645 Thus, limitations clauses contained in the insurance policy are inapplicable to claims

alleging a breach of the insurance company’s duty of good faith and fair dealing.646

In Zoppo, the Ohio Supreme Court clarified that “intent is not and has never been

an element of the reasonable justification standard.”647 The court found that the insurance

company breached its duty of good faith and fair dealing to its policyholder where the

policyholder’s bar was destroyed by fire and the insurance company’s investigation: (1) focused

primarily on the policyholder; (2) failed to seriously explore evidence that other parties had

threatened to burn the building down; (3) failed to locate key suspects or verify alibis; (4) did

little more than ask cursory questions of other suspects; (5) failed to follow up with witnesses,

despite evidence that one bar patron had bragged to others about setting the fire; (6) did nothing

to verify the policyholder’s story that he was out of state when the fire started. There was also

645. Buckeye Union Ins. Co. v. State Farm Mut. Auto. Ins. Co., No. C-960282, 1997 Ohio App. LEXIS 1472 at *10 (Ohio Ct. App. Apr. 16, 1997) citing Staff Builders, Inc. v. Armstrong, 37 Ohio St. 3d 298, 525 N.E.2d 783 (1988), paragraph one of syllabus. See also Pizzino v. Lightning Rod Mut. Ins. Co., 93 Ohio App. 3d 246, 254-55, 638 N.E.2d 146 (1994)(holding that a policyholder who had settled her claim with the insurance company could bring a subsequent bad faith claim).646. Bullet Trucking, Inc. v. Glen Falls Ins. Co., 84 Ohio App. 3d 327, 333, 616 N.E.2d 1123 (1992)(rejecting insurance company’s argument that to succeed on a tort claim for a breach of fiduciary duty, the policyholder must succeed on the underlying contract claim).647. Id. The Zoppo court reaffirmed the court’s “consistent” application of the reasonable justification standard to bad faith cases, citing Hart v. Republic Mut. Ins. Co. 152 Ohio St. 185, 87 N.E.2d 347 (1949), reaffirmed, Hoskins v. Aetna Life Ins. Co., 6 Ohio St. 3d 272, 452 N.E.2d 1315 (1983); Staff Builders, Inc. v. Armstrong, 37 Ohio St. 3d 298, 525 N.E.2d 783 (1988). The court specifically overruled the portion of its decision in Motorists Mut. Ins. Co. v. Said, 63 Ohio St. 3d 690, 590 N.E.2d 1228 (1992), which only two years earlier had ruled that a breach of good faith required “an intentional failure to determine whether there was any lawful basis for such refusal.” Zoppo, 71 Ohio St. 3d 554, 644 N.E.2d at 399. The Said opinion remains viable in other respects.


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evidence that one witness was paid to change his statement and implicate the policyholder in

starting the fire.648

The Zoppo court reversed a lower court finding that under these facts, the

policyholder had failed to show bad faith by its insurance company. The court then reviewed

whether the insurance company’s bad faith warranted punitive damages:

Punitive damages may be recovered against an insurer that breaches its duty of good faith in refusing to pay a claim of its insured upon proof of actual malice, fraud or insult on the part of the insurer.649

The court found that although there was no showing of fraud, and although the insurance

company did not act with actual malice, “the trial court had the obligation to determine that there

was sufficient evidence that the [insurance company] consciously disregarded the [the

policyholder’s] rights.”650 The court found that the insurance company’s one sided investigation

justified the award of punitive damages.651 Furthermore, “an insurer who acts in bad faith is

liable for those compensatory damages flowing from the bad faith conduct of the insurer and

caused by the insurer’s breach of contract.652

648. Zoppo, 71 Ohio St. 3d at 555-56, 644 N.E.2d at 400.649. 71 Ohio St. 3d at 557-58, 644 N.E.2d at 402.650. Id.651. Id. For another Ohio case reflecting an insurance company’s apparent desire to avoid providing insurance coverage at all costs (and despite the facts), see LaForge v. Nationwide Mut. Fire Ins. Co., 82 Ohio App. 3d 692, 696-97, 612 N.E.2d 1318 (insurance company claimed that policyholders had burnt down their own home, relying on, among other things, evidence that the policyholders had clothing at the dry cleaners when the fire occurred and that a video tape of a birthday party taken in the policyholders home and recording the home’s contents was given to a relative in an artificial attempt to document damages. In addition, the insurance company ignored other factors which would seemingly cut against its theory).652. Id.


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Ohio specifically exempts insurance companies from its Consumer Sales

Practices Act.653 In addition, Ohio courts have steadfastly held that there is no private right of

action under the Unfair and Deceptive Trade Practices Act, Ohio’s statute proscribing unfair

trade practices in the insurance industry.654

653. Ohio Consumer Sales Practices Act § 1345.03 lists a series of prohibited/unfair business practices. § 1345.01(A) specifically excludes insurance companies from the Act.654. See Ohio Unfair and Deceptive Trade Practices § 3901.21 sets forth the list of practices defined to be unfair and deceptive acts in the business of insurance. Ohio Administrative Code 3901-1-07 is the corresponding regulations. Both sections are attached at Appendix D. For representative cases holding that there is no private right of action under § 3901.21 and OAC 3901-1-07 , see Strack v. Westfield Cos., 33 Ohio App. 3d 336, 515 N.E.2d 1005 (1986); Springfield Impregnators, Inc. v. Ohio State Life Ins. Co., No. 3090, 1994 Ohio App. LEXIS 1168 (Ohio Ct. App. March 23, 1994); Goodyear Tire & Rubber Co. v. Aetna Cas. & Sur. Co., C.A. No. 16993, 1995 Ohio App. LEXIS 2975 (Ohio Ct. App. July 12, 1995).


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West Virginia

“West Virginia first party insurance damage law was essentially born in 1986

with the decision in Hayseeds, Inc. v. State Farm Fire & Casualty Company”655 In Hayseeds, the

court held that

We consider it of little importance whether an insurer contests an insured’s claim in good faith or bad faith. In either case, the insured is out his consequential damages and attorneys fees.656

The court held that whenever the policyholder substantially prevails in a property

damage suit against the insurance company, the policyholder is entitled to reasonable attorneys

fees and damages for delay in the settlement, aggravation and inconvenience.657

Whether a policyholder has substantially prevailed is determined by:

the status of the negotiations between the insured and the insurer prior to the institution of the lawsuit. Where the insurance company has offered an amount materially below the damage estimates submitted by the insured, and the jury awards the insured an amount approximating the insured’s damage estimates, the insured has substantially prevailed.658

655. Vince J. King, Esq, Damages in Insurance Cases: The Plaintiff’s Perspective (program paper on file with the authors). Mr. King is an attorney practicing in Charleston, West Virginia. Among Mr. King’s specialties is insurance company bad faith.656. Hayseeds, Inc. v. State Farm Fire & Cas., 177 W. Va. 323, 352 S.E.2d 73, 79-80 (1986).657. Emphasis added. 352 S.E.2d at 80. The court explained its reasoning:

Unfortunately, awards of consequential damages currently turn on judicial interpretation of such malleable and easily manipulated concepts as “reasonable,” “wrongful,” “good faith” and “bad faith.” We believe that the interests of both the parties and the judicial system would be better served by the enunciation of a clear, brightline standard governing the availability of consequential damages in property damages insurance cases.

Id.658. Thomas v. State Farm Mut. Auto. Ins. Co., 181 W. Va. 604, 383 S.E.2d 786 (1989). Thomas was the first court to interpret Hayseeds “substantially prevails” requirement. It has been widely adopted. See McCormick v. Allstate Ins. Co., 197 W. Va. 415, 475 S.E.2d 507, 517; Shamblin v. Nationwide Mut. Ins. Cos. 183 W. Va. 585, 396 S.E.2d 766 (1990).


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However, determining whether the insurance company acted in good faith

towards its policyholder remains important in establishing an insurance company’s bad faith

failure to settle. In Shamblin v. Nationwide Mutual Insurance Companies, the court held:

[W]henever there is a failure on the part of the insurer to settle

within the policy limits where there exists the opportunity to so

settle and where such settlement within policy limits would release

the insured from any and all liability, that the insurer has prima

facie failed to act in its insured’s best interest and that such failure .

. . constitutes bad faith towards the insured.659

The court held that it then becomes the insurance company’s burden to establish that it attempted

to reach a settlement and that any failure to do was based on reasonable grounds.660 “The proper

test is whether the reasonably prudent insurance company would have refused to settle within the

policy limits, “keeping in mind always its duty of good faith and fair dealing with its insured.”661

Among the factors that the trial court should consider in determining a bad faith failure to settle

is whether:

(1) the insurance company conducted an objective investigation;

(2) the insurance company had a reasonable basis to conclude that there was a genuine and substantial issue as to the liability of the insured;

(3) there was a potential for a substantial verdict in excess of the policy limits against the insured.662

659. Shamblin v. Nationwide Mut. Ins. Cos. 183 W. Va. 585, 595, 396 S.E.2d 766, 776 (1990). 660. Id.661. Id. See also Marshall v. Erie Ins. Co., 192 W. Va. 94, 101, 450 S.E.2d 791, 798 (1994).662. Id.


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Policyholders in West Virginia also are entitled to a private right of action under

West Virginia’s Unfair Trade Practices Act (“UTPA”).663 The first case to recognize a private

right of action under the UTPA was Jenkins v. J.C. Penney Cas. Ins. Co., decided in 1981.664

Since then, Jenkins and its progeny have clearly set forth the requirements to file a claim under

the UTPA. A claim brought under the UTPA relies on a violation of the statute which indicates

a “general business practice” by the insurance company.665 To establish a general business

practice, the policyholder must show that there was more than a single isolated violation of the

UTPA. Doing so requires:

1. Proof of several breaches by an insurance company of 33-11-4(9), or;

2. Proof of multiple violations of 33-11-4(9) occurring in the same claim, or;

3. Proof of other violations by the same insurance company to establish the frequency issue. Proof can be obtained from other claimants and attorneys who have dealt with such company and its claims agents, or from any person who is familiar with the company’s general practice in regard to claim settlement666

In addition, the policyholder asserting a private right of action under the UTPA need not show

that it has “substantially prevailed as required under the Hayseeds common law approach.667 At

least one court has found a private right of action under 33-11-4(1)(a) of the UTPA prohibiting

misrepresentation and false advertising of insurance policies.668

663. W. Va. Code § 33-11-4(9) attached as Appendix E.664. Jenkins v. J.C. Penney Cas. Ins. Co., 167 W. Va. 597, 280 S.E.2d 252, 258 (1981), overruled in part by State Farm Fire & Cas. Co. v. Madden, 192 W. Va. 155, 451 S.E.2d 721 (1994).665. See McCormick v. Allstate Ins. Co., 197 W. Va. 415, 475 S.E.2d 507, 519 (1996); citing Jenkins at 167 W. Va. at 610, 280 S.E.2d at 260. See also 33-11-4(9) (“No person shall commit or perform with such frequency as to indicate a general business practice”).666. See McCormick at 519, Jenkins at id.667. McCormick v. Allstate Ins. Co., 197 W. Va. 415, 475 S.E.2d 507, 519 (1996); Maher v. Continental Cas. Co., 76 F.3d 535, 543 (4th Cir. 1996). 668. See Morton v. Amos-Lee Securities et al., 195 W. Va. 691, 466 S.E.2d 542 (1995)(holding that sale of annuities are covered by the UTPA). Equitable Life Assurance was among the defendants.


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Punitive damages are allowed under causes of action brought under a Hayseeds

approach or the UTPA.669

669. See e.g. Hayseeds, Inc. v. State Farm Fire & Cas., 177 W. Va. 323, 352 S.E.2d 73 (1986)(insurance company can only be held liable for punitive damages upon a showing of a malicious intention to injure or defraud)(syllabus note 1); Poling v. Motorists Mut. Ins. Co., 192 W. Va. 46, 450 S.E.2d 635 (1995)(punitive damage awards in insurance bad faith cases are not prohibited under 33-11-4(9))(syllabus note 3); Shamblin v. Nationwide Mut. Ins. Cos. 183 W. Va. 585, 396 S.E.2d 766 (1990)(policyholder may recover punitive damages from insurance company in case alleging bad faith upon establishing actual malice)(syllabus note 1); McCormick v. Allstate Ins. Co., 197 W. Va. 415, 475 S.E.2d 507 (1996)(insurance company not liable for punitive damages absent a showing of a malicious intention to injure or defraud).


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PART XVDISCOVERY CHECK LIST - GENERAL

1. Complete paper and electronic claim files: home office, regional, and local.

(1) Reports and correspondence(2) Memos of any type, i.e. telephone slips, inter office communications,

handwritten notes, etc.(3) Tapes - Video and Audio(4) Photographs - original negatives(5) Instructions regarding investigation, coverage questions, etc.(6) Statistical documents and draft copies(7) Copy file jacket (Note: examine original files for evidence of authenticity

or alterations)

2. Testimony and statements of client and any witnesses.(1) Depositions - including past cases(2) Original tapes(3) Claims handler affidavits and testimony

3. Claims Manuals(1) Property loss handling procedures(2) Liability claim handling procedures(3) Supervisor’s and manager’s manuals(4) Data processing/systems manuals(5) Fraud/arson or Special Investigation Unit (S.I.U.) manuals

4. Information on the handling adjusters and supervisors.(1) Job descriptions(2) Original application for employment(3) Annual performance evaluations(4) History of salary and promotions/demotions(5) Educational records (including company courses) and curriculum (taped or

written) used for these courses(6) Letters of commendation or complaint(7) Memberships in professional organizations

5. Personnel or salary administration manuals.(1) Job descriptions(2) Salary grade classifications(3) Criteria for promotion/demotion(4) Plans for adequate staff levels(5) Performance evaluations and activity reviews(6) Incentive programs and retirement funds(7) Profit sharing and stock ownership

6. Documents which show the Legal history of the claim.


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(1) Legal opinions prior to the date of denial(2) Legal analysis of issues at any time (as when the defend was devising the

program or policy)(3) Correspondence to/from counsel

7. Reports, correspondence, and materials provided by “outside” investigators.(1) Confidential reports(2) Surveillance tapes (audio or video)(3) Activities checks(4) Investigations to determine level of disability(5) List of investigators used for similar claims

8. Reports, correspondence, and materials provided by Experts.(1) Testing results(2) Tapes (video or audio)(3) List of experts used for similar claims(4) Surveys/Research

9. Loss reserve history:(1) Documents showing original reserves and all changes(2) Documents showing methods and criteria for setting reserves

10. Reinsurance information, facultative or treaty:(1) Reinsurance policies(2) Reinsurance treaties(3) “Loss pooling” agreements(4) Documents concerning the acquisition, negotiation, an drafting of the

agreements including bills, payments, claims, inspections, or other(5) Job descriptions, personnel files, and addresses of person most

knowledgeable about reinsurance(6) List of reinsurers with whom the company had contracts

11. Documents pertaining to programs designed to control claim costs (including both indemnity and allocated/unallocated claim costs).

(1) Medical cost containment(2) Medical management(3) Peer review(4) Bill review

12. Videotaped, recorded, or written training materials on the subjects of:(1) Property loss adjusting(2) Fire or accident investigation(3) Investigation, evaluation, and handling of disputed claims Liability claims

handling(4) Fraud & arson detection, S.I.U. units(5) Hiring outside experts or investigators(6) Interpretation of coverage


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(7) Medical training(8) Resolving ambiguous policy language(9) Other specific issues

13. Employee Handbook.(1) Orientation manual or booklets(2) Information regarding benefits and disability plans(3) Information regarding profit-sharing, stock ownership, and incentive plans(4) Company philosophies and policies(5) Personnel administration manual

14. Newsletters(1) Company-wide(2) Regional(3) Local(4) Claims(5) “Sales”

15. Quality control audits or surveys for the offices handling the claim.(1) Home office or regional audits(2) Manuals or guidelines for audits(3) Claim handling quality criteria

16. Records of public complaints.

17. Records of other property loss litigation or bad faith complaints.

18. Forms, publications and manuals available for use by the claims staff.(1) Index or inventory of available materials(2) Copies of bulletins, memoranda, or other not part of the “official” manuals

used to convey instructions from management to claim handlers(3) Job descriptions, personnel files, and addresses of the authors of the

materials

19. Company guides for letter writing or correspondence.(1) Index of form letters

20. Description of the data processing equipment in use in the insurer’s claim department:

(1) Language of the system(2) Programs available for specific loss situations

(a) Bulletins and manuals explaining the capabilities and capacities of the programs

(b) Orientation bulletins or manuals used to train employees on the use of the equipment

(3) Location of data “centers”


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(4) Job descriptions, personnel files, and addresses of those most knowledgeable about the data processing system

21. Documents of any type which provide information on the organization and officers of the Insurance company.

(1) Diagram or chart of the claim department “chain of command”(2) Management documents which show the company structure by line and

levels of authority(3) Manuals or bulletins on the issuance of management reports and the

preparation of operations displays(4) Job descriptions, personnel files, and addresses of those most

knowledgeable on annual reports, management reports, and/or organization charts

(5) Job descriptions, personnel files, and addresses of those most knowledgeable of writing the manuals and bulletins

22. Annual reports:(1) 10K reports to the Securities and Exchange Commission

(2) Reports to the shareholders(3) Reports to regulators/insurance departments

(Note: Agreement that Best’s Key Rating Guide is authentic source of defendant’s wealth will sometimes suffice)

23. Advertising or promotional materials used to sell the specific policy.(1) 5 video ads displayed in area prior to loss(2) 5 audio ads displayed in area prior to loss(3) 5 print ads displayed in area prior to loss

24. Archives or records storage:(1) Bulletins or manuals on the subject of records retention and destruction

policies(2) Index of retained materials, including instructions for retrieval(3) Documents which explain the establishment, location, and accessibility of

archives or records storage centers(4) Location of historical material(5) Job descriptions, personnel files, and addresses of the people most

knowledgeable about records storage and archives

25. Documents which detail the services, procedures, and activities of loss control, engineering, or risk inspection services.

(1) “Inspections” of risk subject

26. Agency manuals(1) Service instructions for premiums, claims handling, communications,

access to medical information, handling of complaints and disputed claims, and other related actively


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(2) Advertising, representations, specifications, and descriptions of any nature used to attract the policyholder

27. Seating plan of claims department showing physical proximity of the individuals handling the claim.

28. Documents pertaining to the establishment, existence, consistency of, and activities of a “claim committee”.

(1) Names of the committee members(2) Any reports or directives issued by the committee with regard to this case(3) Documentation of any “committee” deliberations

29. List of organizations by name and address of which the company is a member or subscriber:

(1) Dates such associations began(2) Codes of ethics or by-laws

30. Underwriting files on the property and insured In question.(1) Inspection reports(2) Any manuals used in any phase of the process of issuing the policy

31. Corporate liability insurance policies for E & 0, professional liability, bad faith, or suits:

(1) Copies of the policies(2) Reports and correspondence to such insurers(3) Names of the persons handling the investigation and adjustment

32. Any separate file on the loss which deals with “fieldwork”, salvage, accounting, subrogation, cause and origin investigation, or any other subject.

33. “Binders”, course materials, audio/video tapes of local, regional, or home office conferences for adjusters, managers, or others.

(1) Course materials, audio/video tapes kept by adjusters or supervisors for personal reference.

34. Documents of any type which set forth the insurer’s philosophies on:(1) Claims handling policies(2) Providing service to policyholders(3) Good/bad faith claim handling(4) Extra-contractual damages and suits(5) Compliance with unfair claim practices statutes(6) Wrongful claims handling

35. Speech transcripts.(1) Executive officers(2) Claims officers(3) “House” counsel


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TABLE OF CONTENTS

Page

PART I INSURANCE LORE..............................................................................................1

PART II BAD LORE............................................................................................................1

PART III WHAT MAKES INSURANCE DIFFERENT.......................................................1

A. Insurance Products And Contract Law: Apples and Oranges?...............................2

B. Systemic Imbalances Must Be Called To the Court’s Attention............................8

1. The Information Imbalance........................................................................8

2. The Imbalance In Money and Litigation Resources.................................11

3. The Imbalance in Bargaining Power Between the Insurance Com-pany and the Policyholder........................................................................14

4. Insurance Companies Profit From Litigation...........................................16

5. Other Contributors to the Information Imbalance....................................20

C. Judges...................................................................................................................35

D. The Insurance Industry Code of Conduct and Insurance Fraud: Is Insur-ance A Defective Product?...................................................................................37

E. Claims Handling...................................................................................................45

PART IV INSURANCE COMPANIES’ FIDUCIARY DUTIES AND DUTY OF GOOD FAITH AND FAIR DEALING...............................................................46

A. Insurance Companies Are Fiduciaries..................................................................46

1. Insurance Company Admissions..............................................................46

2. Insurance Companies Trumpet Their Fiduciary Duties For Market-ing and Litigation Purposes......................................................................51

3. FIDUCIARY DUTY OF INSURANCE COMPANIES..........................55

4. Communication in Court..........................................................................57

5. Communication Via Litigation Tactics....................................................61

6. Communication in the Marketplace.........................................................62


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TABLE OF CONTENTS(continued)

Page

7. Case law:...................................................................................................69

B. The Public Service Nature Of Insurance..............................................................80

C. The Duty Of Good Faith And Fair Dealing..........................................................85

1. Insurance Company Admissions Of The Duty Of Good Faith And Fair Dealing..............................................................................................85

2. Judicial Recognition.................................................................................90

3. Statutory Recognition...............................................................................92

4. The Duty of Good Faith Continues Through Insurance Coverage Litigation..................................................................................................94

5. Examples of Bad Faith.............................................................................98

6. Reverse Bad Faith...................................................................................105

7. Comparative Bad Faith...........................................................................106

8. The Attorney-Client Privilege and the Crime-Fraud Exception.............110

D. Concealing Insurance Coverage is Bad Faith.....................................................115

1. Insurance Companies Must Disclose Insurance Coverage.....................115

2. Fraudulent Misrepresentation.................................................................123

3. The Reasonable Expectations Doctrine..................................................125

PART V CIVIL RICO.......................................................................................................154

A. Considerations....................................................................................................154

1. The RICO Enterprise: Circumventing the Distinctiveness Require-ment........................................................................................................156

2. Racketeering Activity: Proving Mail and Wire Fraud............................158

3. Two Acts of Racketeering Activity........................................................160

4. Showing the Requisite Injury.................................................................160

5. Proving Proximate Cause.......................................................................162


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Page

B. RICO and the McCarran-Ferguson Act..............................................................163

1. RICO and the McCarran-Ferguson Act: Dueling or Complimentary Statutes?..................................................................................................165

2. The Business of Fraud............................................................................166

3. The Insurance Companies’ Imagined “Conflicts” With State Law........168

4. Why RICO May Substantially Relate to the Business of Insurance: The True Purpose of the McCarran-Ferguson Act and Barnett Bank v. Nelson........................................................................................171

5. The McCarran-Ferguson Act Does Not Protect Discriminatory In-surance Company Practices....................................................................175

6. Is RICO Somehow Different From Other Federal Laws Which In-teract With The McCarran-Ferguson Act?.............................................178

7. Public Policy and the Insurance Industry Use of RICO: Conflicts and Contradictions..................................................................................180

PART VI OTHER CLAIMS TO CONSIDER: COMMON LAW FRAUD AND NEGLIGENT MISREPRESENTATION..........................................................183

PART VII DEATH OR DISABILITY OF A POLICYHOLDER: SEEK CONSEQUENTIAL DAMAGES......................................................................184

1. Death of Company..................................................................................184

2. Consequential Damages, Bad Faith or Both — The Brass Ring and Meat and Potatoes...................................................................................186

3. Consequential Damages --What the Cases Say......................................189

PART VIII JURY CHARGES — DO NOT REINVENT WHEELS...................................198

PART IX TRIAL EVIDENCE — BULLDOGS OR PUSSYCATS?................................199

PART X AVOIDING BIFURCATION............................................................................200

PART XI CONSIDER MALICIOUS DEFENSE..............................................................201


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Page

PART XII PRE-LITIGATION ‘MUSTS’............................................................................204

A. Locate All Insurance Policies.............................................................................204

B. Give Notice To the Insurance Company............................................................205

C. Contending With The Reservation of Rights Letter...........................................206

D. Keep In Contact With The Insurance Company.................................................208

1. Complain To The State Insurance Commissioner..................................208

PART XIII DISCOVERY.....................................................................................................208

A. ‘Must Have’ Documents:....................................................................................209

B. ‘Must Have’ Depositions....................................................................................212

C. ‘Must Ask’ Deposition Questions......................................................................213

D. Pleadings Considerations....................................................................................215

E. Proof of Damages Considerations......................................................................216

F. Where Not to Look For Coverage......................................................................217

G. BMW of North America v. Gore: Preserving Punitive Damages To Deter and Punish Reprehensible Conduct....................................................................219

1. The Three Guideposts of BMW..............................................................219

2. Post BMW Decisions..............................................................................223

PART XIV GOOD FAITH....................................................................................................229

A. Definitions of Good Faith...................................................................................229

PART XV DISCOVERY CHECK LIST - GENERAL.......................................................255


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