Accusations of bad faith negotiations against insurers in third-party bodily injury cases are a serious concern to insurers. Understanding the root cause and focusing on best liability claim practices can mitigate negative outcomes associated with these cases as well as contribute to a well balanced liability and litigation strategy.

The Property Casualty Insurers Association of America, PCI, indicates that in eighty percent of the states that allow third-party bad faith claims, auto bodily injury liability cost trends exceeded the national average (Albright, 2009). Bad faith claims can also adversely impact an insurer’s reputation and its ability to draw new customers and retain existing ones.

Bad faith claims put an insurer’s entire claims liability structure on trial. In this article we will examine how a liability decision support system that enables best practices to be consistently used as well as fully documenting each element of the liability claim handling process,  can specifically provide essential protection for an insurer against bad faith claims.

Background

For insurers the liability claim handling process provides numerous opportunities for insureds and claimants to bring bad faith actions. There are any number of ways that an insurer can be held to have committed bad faith. An article by Robert J. Prahl, Director of Education for the American Association of Insurance Services summarizes the areas of claim handling that are potential sources of bad faith:

• Investigation – The investigation of a claim (both first and third party claims) must be complete and thorough concerning both the liability question and the damages aspect. (2010, p2)
• Settlement Negotiations – Another possible source of bad faith is the conduct of settlement negotiations, particularly with respect to third party liability claims. (2010, p2)
• Inadequate Defense – Occasionally insurers may be uncertain whether coverage applies until the outcome of the trial. If an insurer simply refuses to defend a claim involving a question of coverage, it may subject itself to a bad faith claim, including an award for punitive damages. (2010, p3)
• Unfair Claim Practices Acts – Unfair claim practices acts, in effect in all states, address many aspects of claim handling…Although the provisions of such acts generally do not permit a claimant to sue an insurer for the violation of the act, some states permit a claimant to bring a separate tort action for bad faith directly against an insurer. (2010, p3)
• Claim File Reporting – Claim adjusters can unwittingly make written or electronic remarks in a paper or electronic claim file which may come back to haunt them in the event the file is later subpoenaed in a bad file suit. (2010, p3)

Within each of the broad categories listed by Mr. Prahl, there are multiple elements, each of which could lead to a bad faith claim. For example, regarding the liability investigation element, Mr. Prahl notes that an incomplete liability claim file could in and of itself be demonstrable proof of an inadequate investigation providing an opportunity for bad faith claims both by the insured and the injured third party.

According to the American Insurance Association there are currently 6 states that have statutory third party bad faith causes of action – Florida, Kentucky, Louisiana, Massachusetts, Montana and New Mexico. In states without a statutory right to third party bad faith causes of action, third party claimants can frequently sue insurers via assignment of rights of the insured. Author and attorney William T. Barker notes:

Absent rights flowing from a statute, third-party claimants ordinarily have few rights of their own regarding insurer refusal to settle and must rely primarily on assignments of the rights of the insureds they have sued…When a third-party claimant has a statutory right to have the insurer attempt settlement when liability has become reasonably clear, the most obvious consequence is that the claimant can assert a breach of this duty even if the insured was never exposed to any excess or non-covered liability. (2010, p.3)

Bad Faith Cases – setting the stage

Clegg v. Butler and Utica Mutual Ins. Co. – Massachusetts

Summary:

Clegg v Butler established that a third party claimant can sue an insurer for bad faith in refusing to settle after the insured’s liability has become clear. The case also established that insurers can be sued for treble damages for knowing or willful violation of the Massachusetts good faith practices.

The trial judge found for the plaintiff for $250,000 and imposed treble damages plus attorney fees and costs finding that – “Plaintiff is entitled to treble damages for Utica’s knowing and willful failure to effectuate a prompt and equitable settlement of his claim.”

(Clegg v Butler – Middlesex Superior Court, Civil Action No 93-0640, Conclusions, 18)

Key Points of the Case

Plaintiff James Clegg was badly injured in an automobile accident that occurred solely as a result of the negligence of Jeffrey Butler, Utica Mutual’s insured. Clegg sued Butler and brought a bad faith suit against Utica Mutual for refusing to settle.

The trial judge found, and the Supreme Court affirmed, that Utica’s adjuster and his supervisor determined that the insured was completely liable and at “no time did Utica consider the case to be anything but a so-called 100% liability case against its insured.” (Clegg v Butler – Middlesex Superior Court, Civil Action No 93-0640, Findings of Fact, 6)

Both the trial judge and the Supreme Court found that Utica then proceeded to engage in a series of actions that were sufficient to constitute a finding of bad faith in refusing to settle a claim where liability was clear and established. Among those actions:

• Repeatedly requesting medical documentation that had already been furnished.
• Failure to respond to an initial settlement demand and subsequent failure to make a settlement offer to a second settlement demand.
• Violating its own policies which prohibited interviewing claimants represented by counsel.
• Failure to perform more than an initial medical exam, because as the trial judge found, Utica believed “the results of an IME would be more likely to harm Utica’s interests than to help them.” (Clegg v Butler – Middlesex Superior Court, Civil Action No 93-0640, Findings of Fact, 14)
• Making an offer of settlement a series of structured settlements well under the policy limits, which the trial judge found, “unrealistic, unreasonable, and unjustified.”

Clegg v Butler clearly illustrated a flawed liability claim management process as well as a failure to adhere to a rigorous best practices regimen. Had best practices been established and been implemented and reinforced in a liability decision support system, many of the specific elements constituting the bad faith claim would not have been allowed to occur. For example, a properly configured liability decision support system would have alerted the adjuster to the existence of required medical documentation and prevented multiple requests for such documentation. See “The Role of Liability Decision Support Systems in Mitigating Bad Faith Claims” section below for further information.

Hovet v. Allstate – New Mexico

Summary:

In Hovet v Allstate the New Mexico Supreme Court combined two different accident cases. In both cases plaintiffs alleged that Allstate violated unfair and deceptive claims practices by failing to offer an adequate settlement amount even though both insureds admitted fault.

The New Mexico Supreme Court used Hovet to extend the right of third party claimants to bring private causes of action directly against a liability insurer for violations of the unfair claims practices sections of the New Mexico Insurance Code.   (NM Supreme Court Decision – Hovet v. Allstate Insurance Company Docket No. 27,969, Opinion Number: 2004-NMSC-010, (April 8, 2004))

Key Points of the Case

At trial a jury found that plaintiff Hovet incurred in excess of $11,000.00 in direct medical bills as a result of an accident with a vehicle driven by Steven Lujan and owned by Arthur Lujan, Allstate’s insured. The Lujans admitted liability. Allstate’s highest settlement offer was $7,200 – substantially less than the plaintiff’s medical bills alone. The jury awarded $62,050.00 in damages.

 (The second case was similar, with the injured parties combined medical bills totaling $5410.00 and Allstate offering $3000.00. At trial a jury found for the plaintiffs in the combined amount of $8700.00)

 In both cases, after appeals, the New Mexico Supreme Court affirmed the third party right to sue an insurer.

 Hovet’s suit against Allstate alleged unfair and deceptive trade practices. These practices were outlined in an Amicus brief filed by the New Mexico Trial Lawyers Association, which asserted:   (Hovet v Lujan and Allstate – New Mexico Court of Appeals Decision, April 7, 2003. Discussion, 10)

• Allstate’s treatment of Hovet was a single instance of a nationwide practice adopted by Allstate of a “Settle for ‘X’ or Litigate policy applicable to cases where the liability of Allstate’s insured is reasonably clear at the outset.
• Allstate makes a “one time ‘take it or leave it’ offer” generated by a computer program that evaluates claims “without any real regard for the individual characteristics of any particular claim or claimant.”
• The settlement offers generated by Allstate’s computer program are “approximately 25-40% of the historical values” for similar claims and frequently do not even equal the amount of claimant’s medical bills.”

Hovet v Allstate offers a perfect example of the need for a comprehensive liability decision support system that combines and reinforces liability claim management best practices, with an objectively fair and defensible settlement range analysis engine. In determining settlement ranges for general damages, a liability decision support system must apply fair and consistent rules for liability claims of a similar type, while still allowing an adjuster the flexibility to account for the individual variations found in a particular liability claim. Such a system will allow an insurer to rebut claims of bad faith whether through “low-balling” settlement offers, or analyzing liability claims using a “cookie-cutter” approach.

The Role of Liability Decision Support Systems in Mitigating Bad Faith Claims

What does a liability decision support system have to do with these litigation cases?  In our opinion, everything.

For insurers the key to avoiding, or failing that, defending against bad faith actions is consistent adherence to a set of carefully developed, fully documented, and rigorously enforced liability claim management best practices. Those best practices must be applied consistently to every liability claim handled by the organization. The liability decision support system used by adjusters in evaluating liability claims must not only provide settlement range suggestions which are justifiable and fair, it must also reinforce the best practices of the organization throughout the entirety of the liability claims management process.

Examples of Liability Best Practices and Their Application to Mitigating Bad Faith Claims

• General damage calculations should use the same metrics for all liability claims of similar type and take into account specifics for individual liability claims such as injury severity, long term implications, prior injuries, contributory negligence, etc. The liability decision support system must evaluate each claim using clearly understood and defined rules which have been incorporated into the liability claim management best practices of the organization. Those rules (reflecting the best practices) should be based on the historic evaluation of cases of similar characteristics previously settled by the company. The rules must be unambiguous and fully documentable.
• Adjusters must fully document all encounters made during the life of a liability claim. Each contact with claimants, attorneys, witnesses etc., needs to be fully documented so as to avoid charges of bad faith negotiations or failure to fully investigate, etc. The liability decision support system plays a key role prompting and aiding adjusters in fully documenting all encounters with parties to the case. It can be configured to remind adjusters of the importance of not incorporating unnecessary commentary into their documentation.
• Adjusters must respond to demand letters. Failure to do so can be evidence of failure to negotiate in good faith, or ignoring an opportunity to settle – both frequent elements of bad faith claims. The liability decision support system should prompt and ensure that adjusters respond in a timely and appropriate manner to demand letters.
• Complete and full documentation of the case including medical reports, police and witness statements, photos, investigation results, etc., must be available to, and used by, adjusters as they make decisions throughout the course of the liability claim. One of the most frequent elements of bad faith claims is a claim of failure to fully investigate. A complete liability claim file can rebut a charge of failure to fully investigate. The liability decision support system is key to this element. It plays two roles, prompting the adjuster if there is missing or incomplete information, and providing the adjuster instant real-time access to all documentation regarding the claim.

Exposure Management – Litigation Management and the Liability Decision Support System

The best way to mitigate a bad faith claim is not to have one arise in the first place. The liability decision support system can play a key role in preventing bad faith claims before they start. It can do that in two ways. In an earlier article in this series, “Information is Key to Successful Negotiations,” we quoted author Mikel Benton in an article in Claims in which he quotes attorney Allen Church as saying:

Adjusters need to say to themselves, “I’m going to do everything I can, professionally, to prevent this claimant – each and every claimant – from acquiring the title of plaintiff, hiring an attorney. (Benton, 1999 p.90)

The first way that the liability decision support system can prevent a claimant from becoming a plaintiff (and possibly filing a bad faith claim) is for the adjuster to use that system to satisfy the claimant that he or she is being offered fair compensation for their damages or injuries. The ability of an adjuster to prove to a claimant that they are using fair and objective criteria to analyze and settle the liability claim is based almost entirely upon the best practices built into the liability decision support system. If those criteria can be rationally explained to a claimant during the negotiation process the chances of settling the liability claim before it goes to litigation are substantially improved. Even if a claimant does eventually retain an attorney, the same elements hold true assuming that the claimant’s attorney is using a common sense approach to the negotiations. In either case the liability decision support system itself can play a decisive role in preventing a claim of bad faith.

The second way that a liability decision support system can prevent a bad faith claim is by providing the adjuster with an accurate estimate of the true strength of case for both the insurer and the claimant. The most advanced liability decision support systems will take into account all aspects of the liability claim, even including participating attorney records and the dynamics of the venue in which the case would be heard. Such systems can provide the adjuster an accurate indication of the overall strength of the case and whether or not a decision to settle prior to trial is in the best interest of the insurer. In such cases settling would prevent later claims of bad faith and the potential for large punitive judgments.

Medical Specials Documentation and the Liability Decision Support System

Medical specials represent an area where sophisticated liability decision support systems, combined with an adjuster’s experience and expertise, can convince a court or jury that a settlement offer was reasonable in light of the totality of the circumstances of the liability claim. In order to do so, complete and accurate documentation of the adjuster’s decision process is vital.

The liability decision support system should provide the factual foundation upon which the adjuster decides the amount of a settlement offer.  State of the art decision support systems allow adjusters to assess diagnostic and treatment related medical specials using both the insurer’s historical data and standardized government reimbursement guidelines such as the annual physician fee schedule (PFS) published by the Centers for Medicare and Medicaid Services (CMS). In addition, adjusters can use the decision support system to assess the appropriateness and effectiveness of treatments provided to a claimant using medically authoritative ICD9 diagnostic and CPT treatment databases.

The liability decision support system should also provide a fact-based, objective, documentable, and defensible settlement value range. Adjusters can then assess the unique elements of a liability claim such as contributory negligence, comparative fault, pre-existing conditions, etc, – clearly documenting each element and its effect upon the adjuster’s valuation of the liability claim.

Having a relatively transparent liability workflow process that an adjuster can point to and explain during a litigation proceeding can play a significant part in overcoming a claim of bad faith.

The Importance of Providing Consistency Across Liability Claims

A well-defined and managed liability claim workflow that conforms to and supports liability strategy and best practices will ensure consistency across liability cases. In combination with a liability decision support system designed to reinforce those best practices, an insurer will be able to minimize the variations in settlement values among claims of a similar nature. Being able to prove that an insurer is applying the same objective standards across all liability claims, and that those standards are fair, reasonable, and in line with industry standards, is an important element in defending against, or even preventing bad faith claims.

Because bad faith claims represent serious threats to insurers on many levels it is imperative for insurers to act preemptively to avoid being placed in bad faith situations. The best way to do this is to ensure consistent, provably fair, liability claim standards which are adhered to by all claims adjusters and which are reinforced by well defined organizational best practices that are incorporated into the liability decision support systems used by the organization.

The Vatti-Manhattan Group team would like to acknowledge and thank the American Insurance Association for their valuable assistance in researching elements of this article.

Albright, Brian (March 12, 2009): p3: New legislation challenges “bad faith” claims practices. Auto Body Repair News (ABRN). Retrieved from: http://abrn.search-autoparts.com/abrn/article/articleDetail.jsp?id=586762

Barker, William T (June 14, 2010): Legislative Approaches to Bad Faith Litigation – New Appleman Insurance Bad Faith – Chapter 10. LexisNexis Communities – Insurance Law Community Blog. Retrieved 11/28/2010 from: http://www.lexisnexis.com/Community/insurancelaw/blogs/insurancebytespoweredbynewappleman/
archive/2010/06/14/legislative-approaches-to-bad-faith-litigation-new-appleman-insurance-bad-faith-litigation-chapter-10.aspx

Benton, Mikel (June 1999): p90: Adjuster’s Repertoire Should Include Negotiation. Claims

Prahl, Robert J. (Undated): Bad Faith and Excess Liability – Insurer Conduct on Trial. American Association of Insurance Services (AAIS). Retrieved 11/29/2010 from: http://www.aaisonline.com/articles/badfaith.html

Case References

Clegg v Butler

Middlesex Superior Court, Civil Action No 93-0640 (http://www.bwglaw.com/lawyer-attorney-1369135.html)

Appeal of Trial Court Decision to Supreme Judicial Court of Massachusetts, Middlesex – Clegg v. Butler, 07216 (Mass. March 12, 1997) (http://caselaw.findlaw.com/ma-supreme-judicial-court/1418069.html)

Hovet v Allstate

New Mexico Court of Appeals – 66 P.3d 980 (2003): 133 N.M. 611: 2003-NMCA-061 Hovet v Lujan and Allstate http://scholar.google.com/scholar_case?case=9086812093971735021&q=related:5iZ8SIuH9d4J:scholar.google.com/
&hl=en&as_sdt=40000002&as_vis=1

NM Supreme Court Decision – Hovet v. Allstate Insurance Company Docket No. 27,969, Opinion Number: 2004-NMSC-010, (April 8, 2004). http://www.supremecourt.nm.org/pastopinion/VIEW/04sc-010.html

(CC) December 2010 Vatti-Manhattan Group
This article may be copied and distributed freely provided that you keep this copyright notice intact and is provided for free and without charge.  We have to the best of our knowledge abided by all copyrights, trademarks and quoted material.  Any comments, omissions, misuse concerns etc. regarding the use of trademarks and copyrights should be directed to
info@vatti-manhattangroup.com.