Defending Institutional Bad Faith Claims, Part I – A Primer on Institutional Bad Faith
Broadly speaking, there are two types of bad faith claims that may be alleged against an insurance company—traditional or non-institutional bad faith, and institutional bad faith. For the former, a policyholder would seek to hold an insurer liable for its acts or omissions that directly and adversely affected the policyholder. For example, in the third-party context, a policyholder may file a bad faith claim against its insurer if the insurer failed to settle a lawsuit against the policyholder within policy limits and a judgment is entered against the policyholder in excess of policy limits.
Institutional bad faith, in contrast, goes beyond a single policyholder. In claims of institutional bad faith, the plaintiff or plaintiffs will attempt to demonstrate a company plan and culture that denies policyholders the reasonable benefits of their insurance policies. A classic example would be where an insurer creates an incentive structure that encourages its adjusters to deny, delay or underpay claims.
The differences between traditional and institutional bad faith manifest in the costs of discovery and the cost of an adverse verdict. Stated simply, institutional bad faith claims are expensive and time consuming to defend. Because institutional bad faith claims pertain to the practices of the insurer or its claims department at a macro level, plaintiffs will seek voluminous company documents and high-level depositions. Plaintiffs may seek copies of the insurer’s policies and procedures, department bulletins, training manuals, compensation programs, and audits and statistics, to name just a few. Given the breadth and expense of e-discovery, institutional bad faith claims pose significant costs.
Further, in any state that has adopted the Unfair Claims Settlement Practices Act, plaintiffs are likely to allege a defendant insurer commits unfair claims practices “with such frequency as to indicate a general business practice.” See, e.g., Fla. Stat. 626.9541; Nev. Rev. Stat. § 686A.310; N.C. Gen. Stat. § 58-63-15; Conn. Gen. Stat. § 38a-816. In Florida, for example, Florida Statutes § 624.155(5) permits punitive damages where the conduct giving rise to the violation occurs with such frequency as to constitute a general business practice, and is either willful, wanton or malicious, or with reckless disregard of the rights insured.
To minimize the risk of institutional bad faith claims, we recommend the following practices:
- Always be mindful that it is the purpose of an insurance company to pay covered losses and to provide the policyholder the benefits of the insurance policy. Not every claim is covered, however, and some claims involve elaborate fraud schemes. While it is reasonable and necessary to investigate claims, denial of coverage should always be based upon defensible, reasoned conclusions.
- Train your adjusters properly and train them often. Training should include the procedures for handling claims, the meaning and effects of policy provisions, and legal standards and other jurisdictional-specific requirements. Make sure your adjusters have access to coverage counsel when they are uncertain of how to proceed.
- Use statistics cautiously. Insurance is a business and it is reasonable for a business to measure performance or outcomes. But, those statistics are likely to become an exhibit at a bad faith trial. Beware of the metrics that are used and how questions are presented. Also consider who has access to the information. Is the information shared with different departments (e.g., underwriting and claims)? Is the information given to managerial employees as well as claims adjusters? Prior to collecting and disseminating information, think defensively—how might a bad faith plaintiff argue this information is nefarious?
- Review your claim handling guidelines with outside counsel—using a fresh set of eyes is critical because someone with experience with the guidelines may interpret them based on their understanding of the guidelines, as opposed to strictly analyzing the text. Ambiguities in a claim manual may permit a bad faith plaintiff to argue an interpretation of otherwise innocuous text in a manner that supports a finding of institutional bad faith. Further, a claim manual may also create unrealistic claim handling standards beyond that required by the law. In those instances, the claim manual may have the effect of raising the standard of care in the eyes of the jury.
- Consider employee incentives carefully. Incentives relating to payout on claims are more obviously problematic. Other incentives may be well intentioned but have unintended consequences. For instance, incentivizing speedy closure of clams may seem like an effective way of delivering policyholders prompt payments or claim decisions, but it may also cause adjusters to conduct inadequate investigations. Any use of performance targets or quotas should be carefully considered to ensure that their effect is to promote fair, prompt, and comprehensive evaluation of claims. Reward claims handlers for providing superior customer service—those satisfied customers will in turn reward the company with future business.
While these practices may help prevent bad faith suits, lawsuits are bound to happen regardless of their merits. To avoid costly and intrusive discovery in a bad faith action, it is necessary to analyze the lawsuit and discovery in terms of their specific component parts. Under Federal Rule of Civil Procedure 26(b), “[p]arties may obtain discovery regarding any nonprivileged matter that is relevant to any party’s claim or defense and proportional to the needs of the case….”
In this series, we will focus on cutting discovery off at the pleadings—by narrowing the plaintiff’s claim, you limit the scope of relevance in discovery. Plaintiffs often allege institutional bad faith by providing a small amount of information pertaining to the company at large, and then making significant inferences and conclusions and offering those inferences as factual allegations. A skilled attorney can make such logical leaps appear valid. To avoid general business practices discovery, the battle begins with the initial pleadings. If the complaint does not allege institutional bad faith, then it will be much easier to argue that such discovery is not relevant. If, on the other hand, the complaint alleges institutional bad faith, limiting discovery will become more difficult and more dependent on the specific circumstances of the lawsuit and the discovery requests.
 However, “[a]ny person who pursues a claim under this subsection shall post in advance the costs of discovery. Such costs shall be awarded to the authorized insurer if no punitive damages are awarded to the plaintiff.” § 624.155(5).
 Under North Carolina law, it is not necessary to allege violations of N.C.G.S. § 58-63-15(11) occur with the frequency of a general business practice in order to allege a cause of action under N.C.G.S. § 75-1.1, which prohibits unfair or deceptive trade practices. Gray v. N.C. Ins. Underwriting Ass’n, 529 S.E.2d 676, 683 (N.C. 2000). However, a plaintiff might allege general business practices as aggravating factors in favor of a claim for punitive damages.
 See All Moving Servs., Inc. v. Stonington, Ins. Co., No. 11-61003-CIV, 2012 WL 718786, at *5 (S.D. Fla. Mar. 5, 2012) (holding that if the general business practices allegations are deemed legally sufficient, or are not challenged, the plaintiff may pursue discovery relevant to its claim for punitive damages).