Institutional Bad Faith: Putting the Insurer's Practices, Procedures, and Integrity on Trial
In broad terms, institutional bad faith (and the allegation of) is that an insurer’s policies and procedures related to claim evaluation and resolution, claim adjustment protocols, and performance and compensation criteria for claims personnel are either individually or collectively intended to unfairly drive down aggregate claim payments or deprive insureds of policy benefits to which they are otherwise entitled.
Individual elements baked into the definition include:
(a) Intentional or unreasonable conduct; (b) as a general business practice; (c) to drive down aggregate claim payments; and (d) in order to lower costs and/or increase profits at the expense of policyholders.
Although institutional bad faith may be thought of as occurring when a corporate structure or policies encourage bad faith claim handling, not all institutional business practices to drive down aggregate claim payments, vis-à-vis costs and profits, are inherently bad faith practices.
For example, it is quite reasonable for an institutional practice to be in place to combat fraud, reduce exaggerated claims, eliminate waste, and/or conserve resources for the benefit of all policyholders. In other words, driving down aggregate claim payments through better claim practices is not intrinsically bad faith.
Commonly used examples include:
Systemic Unethical Conduct: The work of adjusting insurance claims engages the public trust, and, accordingly, claim adjusters are held to a high ethical standard. In every instance, the adjuster must put a duty of fair and honest treatment of a claimant above his or her own
interest or the interest of the insurer.
Consider, for instance, the following:
“An insurer, in handling the defense of claims against its insured, has a duty to use the same degree of care and diligence as a person of ordinary care and prudence should exercise in the management of his own business. For when the insured has surrendered to the insurer all control over the handling of the claim, including all decisions with regard to litigation and settlement, then the insurer must assume a duty to exercise such control and make such decisions in good faith and with due regard for the interests of the insured.” Boston Old Colony Ins. Co. v. Gutierrez, 386 So.2d 783, 785 (Fla. 1980).
It should be fair to say that any systemic claim conduct (as opposed to a particular claim) to deprive a company’s insureds of the benefit of the bargain they made when entering into a contract of insurance, is, in practice and effect, institutional bad faith.
Compensation: The most important measure of an insurer’s profitability is the combined ratio, which is the claims expenses, plus the other cost of claims, divided by the total premiums collected. This ratio helps the insurer to measure its performance. Adjuster bonus programs often include the metric of meeting the company’s combined ratio objectives.
It is improper within the insurance industry to provide any financial incentive to endorse the underpayment of claims. The adjuster’s job is not to turn a profit for the company or max out any incentivized compensation. Thus, a significant conflict is created if claim adjusters are incentivized to reduce claim payments without a reasonable and sound reason for doing so.
Post-Claim Underwriting: Post insurance claim underwriting occurs when an insurance company refuses to pay a claim for a loss that should have been covered on the grounds that the policy should never have been issued in the first place and then cancels or rescinds the policy.
When this occurs, the insurance company ignores its commonly understood obligation to do underwriting when a policy application is made rather than conducting its risk assessment after a claim is submitted. This after-the-fact evaluation effectively rids the company of an insured it contends should never have received coverage in the first place and serves as the pretext for a lower or lowball claim evaluation.
Consider, for instance, the following:
Claim manager to claim adjuster: “I received your 12-5-03 report. The engineer’s report is not very clear as to what damage was the result of improper construction and what damage was the result of wind damage. I want you to go back to the engineer and request that he identify the damages caused by improper construction versus wind. If this is an example of the quality of his work, we do not need to use him in the future.”
Marketing executive to claim executives: “Since it appears that claims procedure will be to send out an engineer to inspect the structures, we need to give the agent better underwriting guidelines as to what is acceptable and what kind of construction details we are looking for at the time that we insure these. If the engineer or the claims department has more specific guidelines than those I have attached, we need to give those to the agents and train them as to what we are looking for.”
Discovery in institutional cases:
At the core of any institutional bad faith case is the allegation that an insurer impermissibly underpaid claims in the aggregate in order to achieve a pre- determined financial objective. For the claimant, the most compelling evidence of institutional bad faith is that which links the unlawful practices with the means by which the insurer ensures claim department compliance: how and why the company engages in systemic abuse.
Common discovery to the insurer:
> Compensation programs and employee evaluations
> Internal company financial reporting
> Claim file audits and quality assurance
> Underwriting files
> Home office claim files
> Internal claim metrics
Claim metrics: Metrics are measures of data-drive quantitative assessments commonly used for assessing, comparing, and tracking performance or production. Generally, a group of metrics will typically be used to build a dashboard that management reviews on a regular basis to maintain performance assessments, opinions, and business strategies. Some common examples include claims settlement cycle time, claims processed per claims employee, average cost per claim, and components of claim cost.
Insurers need to be aware of the potential for metrics to be deemed "schemes." Often times Plaintiffs’ attorneys use statistical evidence against insurers to show bad faith. For example, they could look for statistical evidence that claims handlers with a higher incidence of denied claims have higher scores on reviews. Such could be used to show a pattern and practice of encouraging the declination of claims.
When insurers keep these metrics and statistics already, in some respects they are doing the Plaintiffs’ attorneys’ work for them. The way to avoid this is to make sure your metrics are based on a range of "successes." Look at the metrics you keep with a critical eye and make sure they cannot be turned against you in the, hopefully rare, event of an institutional bad faith claim.
Reasonable use of claim metrics:
> Claims projections based on experience, not corporate goals
> Consider not publishing individual adjuster claim statistics
> Don’t create incentives for particular claim outcomes
> Be careful of rewarding adjusters for “cost savings”
> Avoid use of quotas
> Measure success by customer satisfaction and superior service
> Conduct frequent training in best practices
Keys to minimize institutional claims:
Flexibility: Flexibility is the key to minimizing the risk of institutional bad faith claims: handle every claim on its own merits, give adjusters authority to deviate from the rules where appropriate (in consultation with management), encourage best practices, and proactively find and fix mistakes.
Claim handling practices:
> Adopt fair claims practices and procedures
> Train fully on proper practices by merit not outcome
> Review claim procedures to avoid undercutting adjuster authority
> Be prepared to articulate good faith reasoning based on practical realities
> Document and have written explanations for all practices and incentives
Procedural safeguards and risk management: Quality assurance and claim file audits should be encouraged and not avoided simply because they may give rise to possible information for a claimant to obtain in discovery. While a claims audit is accepted as a systematic and detailed review of claims files and related records to evaluate the adjuster's performance, the insurer can gain more benefit from the process to offset risks incurred – especially when undertaken with a view toward continual improvement of fairness, customer
satisfaction and reasonable outcomes.