Dispelling the Myth of Insurance Bad Faith

By Mike A. D’Amico
August 2012

Under what cause of action may an insurance company be held accountable for an excess verdict having failed to settle a liability claim within its insured’s policy limits? There appears to be a popular myth that the insurance company can only be held liable for an excess verdict if it acted in “bad faith”; and that “bad faith” means more than just negligence and must include proof that the insurance company acted with a “dishonest purpose,” “furtive design,” or “ill will.” This myth should be dispelled. Consider the thoughtful reasoning of Judge Grillo in the case of Knudsen v. Hartford Accident and Indemnity Company, 26 Conn. Supp. 325 (Com. Pl. 1966):

In effect the defendant, in maintaining that although it is subject to a suit based on bad faith it is immune to an action grounded on its alleged negligence, seeks to assume a status that is historically and constitutionally enjoyed by few: those whose immunity relates to subjects involving the public welfare and considerations of public policy. The activities alleged in the complaint do not fall within that category.

26 Conn. Supp at 327 (internal citations omitted).

In Knudsen, John E. Knudsen, Jr. sued his liability insurance company after it failed to settle a claim against him that ended in an excess verdict. Mr. Knudsen then had to pay the excess amount, which led to this claim against his insurer. Judge Grillo wrote:

Conduct which threatens the interests of others or which is extrahazardous with respect to such interests should not be insulated from liability when the circumstances do not disclose a situation in which it is socially desirable that the invasion be made. The butcher, the baker and the candlestick maker are all required to answer in a court of law to an aggrieved litigant for their tortious conduct in the marketplace. No compelling reasons have been advanced as to why the defendant’s duty should be less. The standard of due care would seem to require that the insurer cannot be too venturesome and speculate with the trial of the issue in an accident case at the risk of the assured. The Supreme Court of Alabama, in a suit against an insurer, put it thusly: “We know of no other situation where a negligent act proximately resulting in damages to another requires that there must have been bad faith also in order to give rise to a cause of action. They constitute different concepts. Either may exist without the other.”

26 Conn. Supp at 327-28 (internal citations omitted).

In concluding, Knudsen quoted a decision by then retired Justice Bordon of the Supreme Court of Connecticut written when he was a judge of the Court of Common Pleas:

From all of the pertinent literature enjoyed by the court, it is concluded that the trend of judicial and text opinion favors the more just and modern theory of holding an insurer accountable for want of due care in handling a case against its assured.

26 Conn. Supp at 328-29, citing Capitol Fuel Co. v. New York Casualty Co., 16 Conn. Supp. 155, 158 (Comm. P. 1949).

Judge Grillo aptly noted that this precise issue had been considered but not “directly decided” by the Supreme Court of Connecticut at the time he wrote his well-reasoned opinion in 1966. See Knudsen, 26 Conn. Supp. at 326, citing Hoyt v. The Factory Mutual Liability Insurance Company of America, 120 Conn. 156, 159 (1935).

In Hoyt, Bessie N. Hoyt injured an 8 year old child, Minelda Lange, while driving her car. Lange’s attorney offered to settle her claim within the policy limit of Hoyt which was $5,000. The insurance company refused the offer of settlement and the case was tried resulting in a judgment against Hoyt that exceeded the policy by $2300. Hoyt then sued her liability company for the excess amount. The Supreme Court of Connecticut stated:

In situations analogous to that presented by this case courts have applied varying standards by which to determine whether or not an insurer is liable to an insured for failing to settle a claim. These may be generally summarized as a requirement of good faith and honest judgment on the part of the insurer or one that the insurer should use that care and diligence which a person of ordinary prudence would exercise in the management of his own business.

Hoyt v. The Factory Mutual Liability Insurance Company of America, 120 Conn. 156, 159 (1935), citing Bartlett v. The Travelers Insurance Company, 117 Conn. 147, 155 (1933).

In deciding the insurance company was properly found not liable, the Hoyt court stated:

The record does not present a situation where we can say as a matter of law that the defendant failed to use that degree of care and prudence which a person in such a situation as that in which it was placed would have used in the management of a business in which no one other than himself had an interest. The conclusion of the trial court that the defendant was not negligent must stand and this disposes of the case.

120 Conn. at 161.

Since Hoyt, this issue has not been addressed by the Supreme Court of Connecticut. In the case of Hutchinson, Administratrix v. Farm Family Casualty Insurance Company, however, when discussing in dicta the obligations of an insurance company to settle a claim by a third party, the Supreme Court stated: “When a liability insurer undertakes to defend its insured, ‘it has a continuing duty to use the degree of care and diligence a person would exercise in the management of his or her own business.’” Hutchinson, Administratrix v. Farm Family Casualty Insurance Company, 273 Conn. 33, 47 (2005), citing Liberty Mutual Fire Ins. Co. v. Kaufman, 885 So.2d 905, 908 (Fla. App. 2004).

Other courts have discussed the basis for imposing liability on the insurance company when it fails to reasonably settle a claim within its policy limit. In 1972, Chief Judge Friendly writing for the United States Court of Appeals for the Second Circuit in the case of Bourget v. Government Employees Insurance Company, 456 F.2d 282, stated:

The basis for judicial imposition on liability insurers of a duty to exercise good faith or due care with respect to opportunities to settle within the policy limits ‘is that the company has exclusive control over the decision concerning settlement within policy coverage, and company and insured often have conflicting interests as to whether settlement should be made’.’what gives rise to the duty and measures its extent is the conflict between the insurer’s interest to pay less than the policy limits and the insured’s interest not to suffer liability for any judgment exceeding them’.

456 F.2d at 285 (internal citations omitted).

As is apparent from Chief Judge Friendly’s quote, judicial opinions which address this issue frequently conflate the concepts of good faith and negligence. This same observation was made by Judge Grillo in Knudsen, 26 Conn. Supp.at 326This distinction has been said to be of little consequence since the same factors are generally relied upon whether the standard is good faith or negligence. 44 Am. Jur. 2d Insurance 1391 (2011):

Therefore, it is generally indicative of either bad faith or negligence that

  • the evidence as to liability and damages is strongly against the insured in the action by the injured claimant
  • the insurer recognizes the advisability of settlement but attempts to get the insured to contribute thereto
  • the insurer fails to properly investigate the claim so as to enable it to intelligently assess the probabilities
  • the insurer rejects the advise of its own attorneys or agents urging a settlement
  • the insurer fails to accept the compromise even after a trial court judgment against the insured is obtained
  • the insurer fails to inform the insured of the compromise offer or the status of the settlement negotiations

There are six factors to be considered in determining whether an insurer’s refusal to settle a claim is bad faith: whether a verdict greatly in excess of policy limits is likely, whether a verdict on liability is doubtful, whether the insurer has given due regard to the recommendations of his or her trial counsel, whether the insured has been informed of all settlement demands and offers, whether the insured has demanded that the insurer settle within the policy limits, and whether any offer of contribution has been made by the insured. No one factor is decisive, and all circumstances must be considered as to whether the insurer has acted in good faith.[1]

44 Am. Jur. 2d Insurance 1391 (2011)(footnotes omitted).

Although the distinction between claims based on good faith or negligence has been blurred at times, lack of good faith is not the equivalent of dishonesty, fraud or concealment:

Several cases, in considering the liability of the insurer, contain language to the effect that bad faith is the equivalent of dishonesty, fraud, and concealment. Obviously a showing that the insurer has been guilty of actual dishonesty, fraud, or concealment is relevant to the determination whether it has given consideration to the insured’s interest in considering a settlement offer within the policy limits. The language used in the cases, however, should not be understood as meaning that in the absence of evidence establishing actual dishonesty, fraud, or concealment no recovery may be had for a judgment in excess of the policy limits. ‘liability based [on] an implied covenant exists whenever the insurer refuses to settle in an appropriate case and that liability may exist when the insurer unwarrantedly refuses an offered settlement when the most reasonable manner of disposing of the claim is by accepting the settlement. Liability is imposed not for bad faith breach of the contract, but for failure to meet the duty to accept reasonable settlements, a duty included within the implied covenant of good faith and fair dealing’.

Crisci v. Security Insurance Company of New Haven, Connecticut, 66 Cal.2d 425, 430, 426 P.2d 173 (Cal.1967).

The Crisci court went on to conclude that the defendant “knew that there was a considerable risk of substantial recovery beyond said policy limits and that the defendant did not give as much consideration to the financial interest of its insured as it gave to its own interests. That is all that was required.” 426 P.2d at 432.[2]

Similarly the Court of Appeals of Maryland in the case of State Farm Mutual Automobile Insurance Company v. White, 248 Md. 324, 236 A.2d 269 (Md. 1967) discussed the interplay between good faith and negligence in the context of a failure to settle within the policy limits:

The prevailing view appears to be that recovery should be rested on the theory of bad faith, because the insurer has the exclusive control, under the standard policy, of investigation, settlement, and defense of any claim or suit against the insured, and there is a potential, if not actual, conflict of interest giving rise to a fiduciary duty. All authorities seem to agree that the liability is in tort, not contract, although arising out of a contractual undertaking. But many courts hold that the obligation is not merely to exercise good faith but to use due care. Professor Keeton seems to think that there is no practical difference in the results, since on either theory the question is one for the jury. Many courts allow recovery on both theories, and some courts that restrict recovery to bad faith permit evidence of negligence in the proof’.[3]

236 A.2d at 271 (internal citations omitted).

The State Farm court quoted Chief Judge Thomsen of the Federal District Court in the case of Gaskill v. Preferred Risk Mutual Insurance Company, 251 F.Supp. 66 (D.Md.1966):

It seems clear that the duty includes elements of both good faith and of reasonable care. This court concludes that the proper test of liability in such a case as this is the good faith test, with the amplifications and limitations suggested by the New Jersey Court (Radio Taxi Service, Inc. v. Lincoln Mutual Insurance Co., 31 N.J. 299, 157 A.2d 319 (1960))’.

The New Jersey case referred to by Judge Thomsen amplifies the good faith test by stating:

Those gifted with the expertise of judging issues of liability and extent of injury actually suffered by a plaintiff, would probably be the first to admit that an informed judgment arrived at in good faith after reasonably diligent investigation represents the limit that should be demanded of human capacity.

236 A.2d at 272.

The State Farm decision, authored by Judge Finan, went on to discuss American Casualty Company of Reading, Pa. v. Howard, 187 F.2d 322 (4th Cir. 1951) and Lee v. Nationwide Mutual Insurance Co., 184 F.Supp 634 (D.Md.1960):

The Fourth Circuit case referred to, American Casualty Co. of Reading Pa., supra, speaks at p. 329 of 187 F.2d of the insurer’s counsel having to act ‘reasonably, in good faith and without negligence,’ and Judge Watkins in Lee, supra, stated:

“However an insurer is obligated to exercise a reserved power to negotiate and settle with proper regard for the interest of the insured, and is liable for damage resulting from wrongful failure to settle within policy limits.”

State Farm, 236 A.2d at 272.

The State Farm court continued:

Consonant with the expression of Judge Thomsen in Gaskill, is the following statement found in 7 Am.Jur.2d Automobile Insurance s 156, p. 486 (1963):

“And in a large number of the more recent cases the two tests of ‘good faith’ and ‘negligence’ have tended to coalesce, with many of the courts which have in terms rejected the ‘negligence’ test agreeing, nevertheless, that the insurer’s negligence is a relevant consideration in determining whether or not it exercised the requisite good faith.”

It should be borne in mind that when employing the term ‘good faith’ in conjunction with the actions of the insurer in these cases, the courts do not intend to connote or imply by the use of the term that dishonesty, misrepresentation, deceit or a species of fraud must be present. Obviously, if fraud is attendant as an element of motivation on the part of the insurer, liability will attach.

We believe [the] terminology was placed in proper context by the Appellate Court of Illinois in Cernocky v. Indemnity Ins Co. of North America, 69 Ill.App.2 196, 219 N.E.2d 198(1966), wherein the Court stated:

“We agree that the words ‘good faith’ and ‘bad faith’ are not particular words of art as used here. They mean either being faithful or unfaithful to the duty or obligation that is owed.”

In applying the ‘good faith’ theory the courts have found that the presence of one or more of the following acts or circumstances may affect the ‘good faith’ posture of the insurer: the severity of the plaintiff’s injuries giving rise to the likelihood of a verdict greatly in excess of the policy limits; lack of proper and adequate investigation of the circumstances surrounding the accident; lack of skillful evaluation of plaintiff’s disability; failure of the insurer to inform the insured of a compromise offer within or near the policy limits; pressure by the insurer on the insured to make a contribution towards a compromise settlement within the policy limits, as an inducement of settlement by the insurer; and actions which demonstrate a greater concern for the insurer’s monetary interests than the financial risk attendant to the insured’s predicament.

Labels, in an inexact science as the law, are more often noxious than helpful; courts, understandably, are reluctant to apply them to legal theories and abstract principles. However, they are helpful in the necessary pursuit of ascertaining the weight of legal authority by giving identification of the rule adopted within a jurisdiction.

236 A.2d 272-273 (citations omitted).

Judge Moraghan, in Hennessey v. Travelers Property Casualty Insurance Company, 1999 Conn. Super. LEXIS 986, when discussing good faith noted that “the definition of good faith requires not only honesty in fact but also ‘observance of reasonable commercial standards of fair dealing.’” Id.at *5, citing Cadle Company v. Ginsburg, 51 Conn.App. 392, 399 (1998). Judge Moraghan concluded that “an insurance company may be liable for the breach of good faith and fair dealing if its behavior is unreasonable and beyond accepted commercial standards.” 1999 Conn. Super. LEXIS 986, *6.

In Connecticut, as stated previously, the test which the Supreme Court chose to apply in Hoyt, 120 Conn. 156, was the negligence test. But regardless of whether the test is identified as the ‘negligence test’ or the ‘good faith’ test, the question is whether the insurer acted reasonably. Proof beyond negligence, such as proof of dishonesty, misrepresentation, deceit, or fraud is not required. It would lead to less confusion if these claims were referred to as “insurance negligence.” Let the myth be dispelled.

[1] The analysis of the insurer’s liability to the insured is to be done on a case-by-case basis. Hennessey v. Travelers Property Casualty Insurance Company, 1999 Conn. Super. Lexis 986, citing Verrastro v. Middlesex Ins Co., 207 Conn. 179, 190. It is therefore uniquely a question of fact.

[2] Other courts have likewise held that “where it appears that the probability of an adverse finding on liability is great and the amount of damages would exceed the policy limits, the insurer has a duty to settle within the policy limits or face an excess liability claim for a breach of the duty owed to the insured.” Phelan v. State Farm Mutual Insurance Company, 114 Ill. App. 3d 96, 448 N.E.2d 579, 585(1983). Also see Levier v. Koppenheffer, 19 Kan. App. 2d 971, 879 P2d 40 (1994); Johnson v. Allstate Insurance Company, 262 S.W.3d 655 (Mo. App. W.D., 2008).

[3] A fiduciary duty typically gives rise to a heightened duty not a lesser duty. So it makes little sense to hold an insurer to a standard of conduct which is lower than negligence. In other words to act in good faith in this context should impose a more exacting standard of conduct than negligence. The Supreme Court of Vermont discussed this fiduciary duty in the context of failure to pay within the policy limits: “The insurer’s fiduciary duty to act in good faith when handling a claim against the insured obligates it to take the insured’s interest into account. The company must diligently investigate the facts and risks involved in the claim, and should rely upon persons reasonably qualified to make such an assessment. If demand for settlement is made, the insurer must honestly assess its validity based on a determination of the risks involved(citation omitted)”..In addition,”the insurer must fully inform the insured of the results of its assessment of the risks, including any potential excess liability, and convey any demands for settlement which have been made. ‘The insurer must be careful to give its insured full and accurate information as to settlement possibilities’” Myers v. Ambassador Insurance Co., Inc., 146 Vt. 552, 508 A.2d 689(1986)(internal citations omitted).