Under a liability insurance policy, an insurer has duties to defend and indemnify the policyholder for claims brought by third parties against the policyholder. As part of the duty to defend, the insurer has a duty of good faith to make reasonable settlement decisions in the course of defending the insured. Insurers who fail to meet their obligations regarding settlements may be found liable for breaching their duty of good faith.
Duty to Make Reasonable Settlement Decisions
An insurer who is defending a policyholder in a legal action generally controls the defense. But when the claimant makes a settlement offer that is less than the insurance policy limit, the motivations of the insurer and the insured to accept the settlement may diverge. After all, the insurer’s liability is capped at the policy’s limit, while the policyholder could end up being on the hook for an amount above the policy limit if litigation were to continue. Therefore, the insured may want the insurance company to pay to settle the dispute, while the insurer may want to roll the dice and continue with litigation.
However, the insurer has a duty of good faith to the insured to make reasonable settlement decisions to protect the insured from a judgment in excess of the policy limit. A reasonable settlement decision is one that would be made by a reasonable insurer who bears the sole financial responsibility for the full amount of the potential judgment.
Duty to Inform Insured about Settlement Demands
The insurer has a duty to inform the insured immediately of all settlement demands, including those in excess of the policy limit. Failure to do so may be considered evidence of bad faith on behalf of the insurer. As one court stated, “The implied covenant of good faith and fair dealing imposes a duty upon insurers to give an offer its intelligent and informed consideration; that the insurer advised the insured of any settlement offers, together with the results of its investigations; and that the insurer give equal consideration to the interests of its insured.” 1
Sometimes, the insurer chooses to settle, and the insured objects. But absent unusual circumstances, courts will not generally entertain bad faith claims against insurers who accepted settlements over the insured’s objections.
Good Faith vs. Bad Faith Settlement Decisions
Just because a claim can potentially expose the insured to a judgment that exceeds the policy limit does not mean an insurer has an absolute duty to settle a claim. For instance, in an action brought by an insured based on his insurer’s alleged bad faith failure to settle a medical malpractice claim against the insured, the court sided with the insurer, holding, “Good-faith denials, offers of compromise, or other honest errors of judgment are not sufficient to establish bad faith.”2 When a manufacturer brought an action against its insurer for breaching the implied covenant of good faith in its handling of a products liability lawsuit against the insured, the court held that the insurer “had no absolute duty to settle the claim merely because [the insured] risked a punitive damage award.”3 As another court stated, an insurance company “is not ‘an insurer against the uncertainties inherent in the settlement process’ and is not liable for a reasonable litigation decision which goes awry.” 4
Whether an insurer acted in bad faith in its failure to settle a case is generally a question of fact. Insureds can demonstrate bad faith by proving that the risk of unfavorable results was out of proportion to the chances of a favorable outcome. As one court stated, bad faith can generally only be established “where the liability is clear and the potential for recovery far exceeds the insurance coverage.” However, this court noted, “It does not follow that whenever an injury is severe and the policy limits are significantly lower than a potential recovery the insurer is obliged to accept a settlement offer. The bad-faith equation must include consideration of all the facts and circumstances relating to whether the insurer’s investigatory efforts prevented it from making an informed evaluation of the risks of refusing settlement. In making this determination, courts must assess the plaintiff’s likelihood of success on the liability issue in the underlying action, the potential magnitude of damages and the financial burden each party may be exposed to as a result of a refusal to settle.” Additional considerations, according to the court, include whether the insurer failed to properly investigate the claim and any potential defenses; the information that was available to the insurer at the time the settlement demand was made; and any other evidence that would establish or negate the insurer’s bad faith in refusing to settle. 5
In most states, insurers are required to give equal consideration to the insured’s interests and their own interests in making settlement decisions.
If you are involved in a dispute with your business insurance company, contact us. We have the expertise, experience and tenacity to make insurance companies keep their promises to you and your business.
1 Anguiano v. Allstate Ins. Co., 209 F.3d 1167, 1169 (9th Cir. 2000)
2 Benkert v. Medical Protective Co., 842 F.2d 144, 149 (6th Cir. 1988)
3 In Zieman Manufacturing Co. v. St. Paul Fire & Marine Insurance Co., 724 F.2d 1343, 1345 (9th Cir. 1983),
4 Certain Underwriters of Lloyd’s v. General Accid. Ins. Co. of Am., 699 F. Supp. 732, 737 n.4 (S.D. Ind. 1988)
5 Pavia v. State Farm Mut. Auto. Ins. Co., 82 N.Y.2d at 454-55, 626 N.E.2d at 28, 605 N.Y.S. at 212 (citations omitted)