What Is an Insurance Bad Faith Claim?

What Is Third Party Insurance Bad Faith?

When someone is injured in a way that's covered under a liability insurance policy that you've taken out to protect yourself financially, and they make a claim under your policy, that's known as a "third party" claim. You and the insurance company are the two parties to the contract (your insurance policy) in this scenario, and the claimant is the third party.

Most "third party insurance bad faith" claims are made by the policyholder against their own insurance company, when the company acts in a way that's unreasonable, that's contrary to its obligations under the policy, and that exposes the policyholder to financial harm. "Bad faith failure to settle" is the most common variety of this kind of claim.

What Is "Bad Faith Failure to Settle"?

Let's say a visitor falls down a stairway in your house because the stairway railing came loose. You knew about the problem and meant to fix it, but didn't get around to it before the accident happened. The visitor has suffered serious injuries, including a lumbar fracture, and had to undergo surgery. You're clearly at fault, you carry $150,000 in homeowner's insurance liability coverage, and the injured visitor has filed a lawsuit against you in court. They've made a settlement demand to your homeowner's insurance company, saying they'll accept a settlement of $150,000 (the policy limits) in exchange for dropping the lawsuit.

Despite your clear fault for the accident, and even though the visitor's injuries are obviously legitimate, your insurance company refuses to accept the offer to settle for the policy limits. The injured visitor's lawsuit proceeds in court and they're awarded $250,000. Now your insurance company is on the hook for the $150,000 policy limits, and you're personally responsible for the remaining $100,000.

In this situation, you might be entitled to make a bad faith claim against your own insurance company, for its failure to settle the third party claim made under your liability coverage. But when and if this kind of claim might be possible depends on the specifics of the situation, and on what's allowed under the law in your state.

Not all states recognize "bad faith failure to settle" actions. And in states that do, you'll almost certainly need to be able to establish a fairly specific set of elements. For example:

• an insurance claim or lawsuit has been filed by someone who was injured in an incident that's covered under your liability insurance policy
• there's a reasonable likelihood that you were liable for the incident that led to the injury
• there's a reasonable likelihood that the injured person's losses will exceed the limits of your liability coverage
• the injured person has made a settlement demand to your insurance company, asking for compensation at the policy limits
• settling for policy limits would be the reasonable and prudent course of action, considering your interests as well as the insurance company's, and
• a court judgment was entered against you (after a lawsuit filed over the incident) in an amount that's above the policy limits, or you were otherwise financially harmed because of the insurance company's failure to settle.

These last two elements are often crucial to a bad faith "failure to settle" claim in states that recognize this kind of action. Your insurance company isn't usually obligated to act proactively to resolve a claim with any specific result in mind. But if the other factors outlined above are present, and the claimant has demanded a settlement at the limits of your liability coverage, your "failure to settle" claim might be a valid one if the insurance company's actions were unreasonable or went against your interests, and you suffered harm as a result.

Can You Make a Bad Faith Claim Against Someone Else's Insurance Company?

What if you're making a claim against someone else's liability coverage, as with a third-party car insurance claim? Can you make a bad faith allegation against the other party's insurer if you think they're not handling your injury case in a fair and reasonable way? As a rule, the other side's insurance company has no contractual obligation to you in this situation; its duty is owed to the insured. But an implied promise of good faith and fair dealing might apply here too.

Just keep in mind that even if this kind of bad faith claim is an option in your state, the other party's insurance company doesn't owe you the same level of obligation it owes its policyholder, so your case will likely be a serious uphill climb. It might make sense to discuss your situation with an attorney to understand the viability of your case.

What Kinds of Damages Are Available In an Insurance Bad Faith Claim?

In the language of the law, "damages" is just a term for the types and amounts of losses that can be compensated in an insurance claim or lawsuit. Most states set their own rules (often by statute) when it comes to the kinds of damages that are available in a bad faith insurance claim. But typically, recoverable losses in an insurance bad faith claim include:

• the amount of compensation the insured person was wrongfully denied (plus interest), if it's a "first party" bad faith action
• any money the insured person was ordered to pay, above the policy limits (with interest), if it's a "third party/failure to settle" action
• any financial losses resulting from the insurance company's action
• the insured person's attorney's fees in bringing the bad faith action
• any financial penalties that are payable to the insured person by statute, and
• punitive damages.