Insurance 101 Insights for Young Lawyers:

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1 Insurance 101 Insights for Young Lawyers: Holding the Insurer s Feet to the Fire: The Insured s Perspective on First-Party Coverage Investigations and Bad-Faith Claims by Angela R. Elbert and Emily L. Mulder hangela R. Elbert is a Partner with Neal, Gerber & Eisenberg LLP in Chicago, Illinois and a member of the firm s General Litigation practice group. Ms. Elbert focuses her practice on representing policyholders in the purchasing and maintenance of insurance and in advising them with respect to claims, including handling complex insurance coverage litigation and arbitrations. Ms. Elbert can be reached at aelbert@ngelaw.comand (312) hemily L. Mulder is an associate with Neal, Gerber & Eisenberg LLP in Chicago, Illinois and a member of its General Litigation Practices Group. Ms. Mulder also represents policyholders in insurance coverage disputes and practices in diverse commercial and criminal litgation matters. Ms. Mulder can be reached at emulder@ngelaw.comand (312) The opinions expressed in this article are not necessarily those of Neal, Gerber & Eisenberg LLP, its attorneys or its clients. Fire and burglary. Two words capable of striking fear into the hearts of homeowners. Many people attempt to conquer this fear by purchasing an adequate amount of insurance that they believe will protect them in their time of need. With an insurance policy in place, James Weiss, a Wisconsin homeowner who leaves his residence in Iron River to celebrate the holidays with family, believes he will have somewhere to turn for assistance when he gets news upon his arrival in Onalaska that, shortly after his departure, his house burned to the ground and is a complete loss. 1 Clydelho Frommoethelydo, a homeowner in California, believes he will have someone to call for help when his home is repeatedly burglarized and his expensive stereo and video equipment are among the items stolen on two separate occasions. 2 Mr. Weiss and Mr. Frommoethelydo believe they can rely on their homeowners policies to shield them from the financial consequences of their circumstances, turning the protection provided by their respective policies into dollars payable towards re-built homes and new entertainment systems. Payment of a claim, however, is hardly automatic,

2 and even if Mr. Weiss and Mr. Frommoethelydo promptly file proper claims with their insurers, there is no guarantee of prompt disbursement of funds. In fact, the claims process in these so-called firstparty cases that is, cases involving claims made by an injured insured for payment under his/her own insurance policy 3 can be frustrating and drawn out. This is especially true when the coverage for the claim involved is at all questionable, causing the insurer to embark upon an extensive investigation of the scope of the coverage at issue. Thankfully, insureds like Mr. Weiss and Mr. Frommoethelydo can follow a few relatively simple steps to greatly increase their chances of having a claim paid in the first instance, while at the same time making sure that they are doing what is required of them and holding their insurer to its obligations under the policies. If the insurer does not live up to its obligations under the policy by wrongfully denying coverage under the policy after an incomplete or otherwise improper coverage investigation, this paper provides guidance to a policyholder on how to lay the groundwork to go on the offensive against the insurer in a bad-faith first-party action. I. The Claim Game The Limited (but Indispensable) Role of the Insured Picking up where we left off, Mr. Weiss returns to Iron River to a heap of ashes that once was his home while Mr. Frommoethelydo sits in a silent house wanting nothing more than to enjoy a little music on his now-vanished stereo system. For these homeowners, returning life to normal begins with making a claim under their homeowners insurance policies. A. Making a Claim Notice of Injury and Proof of Loss The first steps in the claims process are outlined in the terms of the applicable insurance policy and must be taken by the insured. Most often, the process begins when an insured notifies its insurer of the loss it has suffered. 4 After the initial notification, and within the time allowed by either the policy or applicable statute, 5 the insured must file with its insurer a timely, complete and accurate proof of loss which consists of written information and supporting documentation which set forth in detail the inventory, the cost and the value, and the amount claimed in respect to the damages sustained. 6 The purpose of the proof of loss is to provide the insurer with all of the information necessary to investigate the claim being made against the policy. 7 The documentation provided in a proof of loss varies depending upon the type of injury suffered. After filing his claim for a loss of $8,871, Mr. Frommoethelydo submitted a proof of loss to his insurer that attached a copy of a bill of sale from Matthew s TV and Stereo, which documented his purchase of $3,000 worth of stereo and video equipment prior to the date of the burglary. 8 Mr. Weiss proof of loss indicated that the value of his home and other property lost in the fire was $149, B. The Coverage Investigation Upon submission of a comprehensive and prompt proof of loss, the duty of action shifts to the insurer who must then begin to investigate the claim. The insurance policy at issue will require an insurer to investigate a claim before denying it and the covenant of good faith and fair dealing implied in each and every policy subjects the insurer to liability in tort for a bad faith failure to investigate a claim. 10 The insurer, however, is not the only party with duties during a coverage investigation. The insured has a contractual duty to provide certain assistance to the insurer s investigation. Fulfillment of these obligations, which often is defined by the terms of the policy and/or by statute, is an indispensable step on the road to the ultimate payment of a claim. The scope of a coverage investigation necessarily will be dictated by the claim being made. 11 Insurers utilize a variety of investigative techniques in coverage investigations, ranging from taking sworn statements from the insured to conducting physical investigations of the site of the loss. Upon receipt of Mr. Weiss proof of loss, United Fire & Casualty Company sent an investigator to his home to determine the cause of the fire and began to investigate Mr. Weiss financial standing. 12 Fire Insurance Exchange hired a private investigator to interview employees at Matthew s TV and Stereo regarding Mr. Frommoethelydo s purchase of stereo and video equipment and hired an attorney to depose Mr. Frommoethelydo regarding erasures and handwritten information on the Matthew s bill of sale submitted with the proof of loss. 13 Whatever form the investigation takes, it is imperative that the insured assist the insurer and investigate the claim as required by its policy, most likely by at least providing a sworn statement and permitting the insurer access to the premises and records. The insured s assistance in the investigation may help ensure that the insurer stays on track in its investigation and is led to the evidence that leads to the conclusion that coverage exists for the claim at issue. C. Battling an Inadequate Investigation After completing its investigation, an insurer either pays benefits or informs its insured that the claim has been denied. In the latter situation, the insurer routinely advises its insured in writing of the reasons for denial. In Mr. Weiss case, United Fire

3 informed him that it was denying his claim because it believed that he had set the fire that ultimately destroyed his home. 14 Fire Insurance Exchange advised Mr. Frommoethelydo that his claim was denied due to a lack of verification of losses and fraud in connection with the bill of sale submitted with his proof of loss. 15 All is not lost, however, upon notification that a claim has been denied. Rather, the true battle for coverage of that claim has just begun. This is especially true when the insured suspects that the denial of the claim was a result of a failure on the part of the insurer to properly and fully investigate the claim. After receiving a denial, an insured has a few options. The best option often depends both upon the conduct of the insurer during its investigation of the claim and the ultimate goal of the insured. Shortly after being notified that his claim was denied, Mr. Weiss brought suit against United Fire for breach of contract and bad faith, claiming that United Fire s sub-par investigation failed to uncover facts justifying his claim and resulted in an improper refusal to pay Mr. Weiss benefits under his homeowners policy. 16 Given the protracted and expensive nature of insurance coverage litigation, opting, as Mr. Weiss did, to immediately file suit is most often done when the conduct of the insurer is particularly egregious or reprehensible. This option also may be attractive to an insured more interested in punishing its insurer for bad-faith conduct than in obtaining immediate payment of its claim. 17 Perhaps the more routine course of action for an insured following denial of a claim is to follow up with the insurer regarding the perceived inadequacies of its coverage investigation. Communications with an insurer after denial of a claim may be oral or in writing, by the insured or through an attorney, or any combination of all of these. After Fire Insurance Exchange denied Mr. Frommoethelydo s claim, evidence surfaced regarding witnesses who could testify that he did, in fact, have stereo and video equipment in his home prior to the second burglary that gave rise to his claim. 18 Mr. Frommoethelydo s attorney attempted to appeal the insurer s denial of coverage for the claim with this new information that called into doubt the thoroughness of Fire Insurance Exchange s coverage investigation. 19 Another way to raise questions regarding the adequacy of a coverage investigation is through a letter to the insurer detailing the reasons why its investigation was lacking. The letter serves a dual purpose; it again requests payment under policy for the claim made and also impresses upon the insurer the ultimate consequences of its bad faith conduct. Best addressed to the senior management of the insurer, the letter should: 1) notify the insurer of the inadequacies of the investigative process (including steps the insurer failed to take and specific details that support the claim that may have been overlooked); 2) put the insurer on notice of claimed damages arising out of its breach of the policy; 3) demonstrate that the insured has fulfilled its obligations under the policy by dutifully accommodating the insurer s investigation of the claim; 4) indicate a willingness to comply with further investigation; and 5) reiterate a demand for payment of the claim. 20 A carefully drafted letter that accomplishes each of these goals may well result in payment of the claim. If an insurer maintains its denial in the face of the letter, the insured has laid the groundwork for a bad-faith lawsuit to recover the insurance benefits and, potentially, other more significant damages. II. Litigating a Claim for Bad-Faith Despite Mr. Frommoethelydo s attorney s best efforts to convince Fire Insurance Exchange that its investigation was lacking, it maintained its denial of the claim without interviewing the witnesses with knowledge of facts justifying the claim. 21 If postdenial communication with an insurer regarding an improper coverage investigation does not result in further investigation and the ultimate payment of the claim, the next step is to determine whether or not a bad-faith suit properly can be filed against the insurer. 22 A. Standards of Proof for Bad-Faith Claims As stated above, attendant to every contract of insurance is an implied duty of good faith and fair dealing. This duty requires both parties to the contract to refrain from doing anything to injure the right of the other to receive the agreement s benefits. 23 In the context of first-party insurance claims, an insurer has a duty to act in good faith by fairly handling claims made by its insured. 24 Two primary standards exist for proof of bad faith on the part of the insurer. 25 The majority position first was articulated by the Wisconsin Supreme Court in Anderson v. Continental Insurance Co. 26 In that case, Anderson sought to recover for damages arising out of Continental Insurance Company s bad-faith refusal to honor a claim under his homeowners policy for damages resulting from a fire. Anderson alleged that Continental refused to accept a sworn proof of loss and to negotiate the claim in good faith in order to avoid its obligations to Anderson under the policy. Recognizing that other jurisdictions had approved of such claims in the first-party context, the Anderson court held that an insured may show a claim for bad faith by proving the absence of a reasonable basis for denying benefits of the policy

4 and the [insurer s] knowledge or reckless disregard of the lack of a reasonable basis for denying the claim. 27 The Anderson court went on to hold that the tort of bad faith is an intentional one, and that an insurance company... may challenge claims which are fairly debatable and will be found liable only where it has intentionally denied (or failed to process or pay) a claim without a reasonable basis. 28 The California Supreme Court in Gruenberg v. Aetna Insurance Co. 29 set forth what has become the minority position on the standard of proof for bad-faith claims. In Gruenberg, Aetna refused to pay Gruenberg s claim for injuries arising out of a fire at his business due to his failure to appear for an examination regarding the circumstances surrounding the fire. While Gruenberg admittedly refused to be examined at Aetna s first request, he did so because criminal charges for arson were pending against him at that time. As soon as the charges were dismissed, Gruenberg agreed to be examined. Despite its knowledge of the reason for Gruenberg s initial refusal to submit to an examination, Aetna refused to examine him when he later made himself available, instead reiterating its denial of the claim based upon his initial failure to appear for an examination. In upholding Gruenberg s right to pursue a bad-faith claim against Aetna, the California Supreme Court held that when the insurer unreasonably and in bad faith withholds payment of the claim of its insured, it is subject to liability in tort. 30 A minority of jurisdictions have adopted the unreasonableness standard announced by the Gruenberg court, which is considered to be a broader test than that set forth in Anderson. 31 Many claims settlement practices can give rise to a bad-faith claim, 32 among them inadequate investigation. In Egan v. Mutual of Omaha Ins. Co., the California Supreme Court applied the Gruenberg unreasonableness standard and aptly described the duty of the insurer to perform a competent investigation of claims made by its insured: [I]t is essential that an insurer fully inquire into possible bases that might support the insured s claim... an insurer cannot reasonably and in good faith deny payments to its insured without thoroughly investigating the foundation for its denial. 33 This standard was applied in Mr. Frommoethelydo s case against Fire Insurance Exchange, where he alleged that Fire Insurance Exchange acted in bad faith when it failed to interview witnesses who had information justifying Mr. Frommoethelydo s claimed damages. Citing to Egan, the court held: [O]nce the insurer was advised of the existence of witnesses who had observed the equipment in plaintiff s house, it had a duty to fairly investigate to determine whether plaintiff had a valid claim. The evidence is undisputed that the insurer failed to investigate... the undisputed evidence establishes a breach of the covenant. 34 B. Bad-Faith Claims for Inadequate Investigation Many claims settlement practices can give rise to a bad-faith claim, among them inadequate investigation. In deciding Mr. Weiss bad-faith claim against United Fire for inadequate investigation of his claim, the Wisconsin Supreme Court applied the twopronged Anderson test that is, absence of a reasonable basis for denial and knowledge or reckless disregard of the lack of reasonable basis for denial. 35 As to the first prong, the Weiss court held that to determine whether the insurer acted in bad faith the trier of fact measures the insurer s conduct against what a reasonable insurer would have done under the particular facts and circumstances to conduct a fair and neutral evaluation of the claim. 36 The second prong is demonstrated by, a reckless disregard of a lack of a reasonable basis for denial or a reckless indifference to facts or to proofs submitted by the insured. 37 Upholding the verdict of the jury finding bad faith on the part of United Fire in its investigation of Mr. Weiss claims, the Weiss court noted that United Fire unreasonably ignored information that the fire may have been accidental, failed to fully investigate Mr. Weiss financial status, and failed to take into account the fact that Mr. Weiss was underinsured. From these facts, the Weiss court ultimately concluded that there was credible evidence from which the jury could have inferred that United Fire lacked a reasonable basis for denying the benefits of the plaintiff s policy and had a reckless indifference to the proof submitted by Mr. Weiss in support of his claim. 38 In proving up bad faith for improper investigation, insureds can benefit greatly from careful and strategic actions during the coverage investigation, including fulfilling their own contractual obligations, notifying their insurers of failures to perform competent and complete coverage investigations, and documenting any stones left unturned by the insurer in their investigative processes. The Weiss and Frommoethelydo cases highlight how fact intensive bad-faith claims can be. In proving up bad faith for improper investigation, insureds

5 can benefit greatly from careful and strategic actions during the coverage investigation, including fulfilling their own contractual obligations, notifying their insurers of failures to perform competent and complete coverage investigations, and documenting any stones left unturned by the insurer in their investigative processes. C. Damages Available Upon Proof of Bad- Faith Failure to Investigate The damages available to an insured in a firstparty bad-faith action vary by jurisdiction. In many states, damages for bad faith in the first-party context are provided by statute. 39 In those jurisdictions allowing first-party tort claims for breach of the implied covenant of good faith and fair dealing, either in addition to or to the exclusion of statutory damages, a successful insured may recover a few distinct types of damages. These damages can include compensatory damages (the value of the loss or, in some instances, the proceeds of the policy), 40 consequential damages (those proximately caused by the breach and reasonably foreseeable to the insurer), 41 emotional distress damages, 42 costs of litigation, prejudgment interest, 43 and importantly, punitive damages. 44 At trial, the jury awarded Mr. Frommoethelydo compensatory damages, consequential damages based on economic losses, as well as punitive damages. Based on certain facts of the case, a large portion of the compensatory damages were set aside on appeal. Recognizing the inability of the insured under California law to obtain punitive damages in the absence of compensatory damages, the California Supreme Court remanded the case for a trial on damages arising directly as a result of Fireman s Insurance Exchange s failure to investigate Mr. Frommoethelydo s claims. Mr. Weiss also was awarded compensatory and punitive damages at trial. Following the reversal of the damage award on appeal, the Wisconsin Supreme Court reinstated the jury verdict on damages, noting that Mr. Weiss had proven outrageous conduct on the part of United Fire entitling him to the full amount of damages awarded by the jury. These damages can include compensatory damages (the value of the loss or, in some instances, the proceeds of the policy), consequential damages (those proximately caused by the breach and reasonably foreseeable to the insurer), emotional distress damages, costs of litigation, prejudgment interest, and importantly, punitive damages. III. Conclusion As is evident from the discussion above, the claims process in the first-party context can be a lengthy one. Thankfully, it also can be a lucrative one for insureds like Mr. Weiss and Mr. Frommoethelydo who comply with the obligations set forth by their policies while documenting and ultimately proving up improper, bad-faith conduct by their insurers during the coverage investigation. 1 Weiss v. United Fire & Cas. Co., 197 Wis.2d 365 (1995). 2 Frommoethelydo v. Fire Ins. Exchange, 42 Cal.3d 208 (1986). 3 First-party claims can be made on a wide variety of insurance policies, including, but not limited to, automobile (Gooch v. State Farm Mut. Auto. Ins. Co., 712 N.E.2d 38 (Ind. Ct. App. 1999)), homeowners (Anderson v. Continental Ins. Co., 85 Wis.2d 675 (1978)), health and disability (Egan v. Mutual of Omaha Ins. Co., 24 Cal.3d 809 (1979)), life (Hays v. Jackson Nat l Life Ins. Co., 105 F.3d 583 (10th Cir. 1997)), and commercial liability (Commercial Union Ins. Co. v. F.R.P. Co., 172 Ga.App. 244 (1984)) policies. 4 DENNIS J. WALL, Litigation and Prevention of Insurer Bad Faith (2d ed. 1994). 5 See DENNIS J. WALL, Litigation and Prevention of Insurer Bad Faith 9:14 at 1, n. 105 (collecting cases). 6 See DENNIS J. WALL, Litigation and Prevention of Insurer Bad Faith 10.06, citing Anderson v. Continental Ins. Co., 85 Wis. 2d 675 (1978); Continental Casualty Co. v. Howard, 775 F.2d 876 (7th Cir. 1985) (Indiana law). 7 See DENNIS J. WALL, Litigation and Prevention of Insurer Bad Faith 10.06, at 438, n. 37 (collecting cases on duty of insured to provide information necessary to support claim). 8 Frommoethelydo, 42 Cal.3d at Weiss, 197 Wis.2d at See, e.g., Frommoethelydo, 42 Cal.3d at ; Buais v. Safeway Ins. Co., 275 Ill. App. 3d 587 (1st Dist. 1995); Parsaie v. United Olympic Life Ins. Co., 29 F.3d 219 (5th Cir. (Tex.) 1994); Hollock v. Erie Ins. Exchange, 842 A.2d 409 (Pa. 2004); Weiss, 197 Wis.2d at Bad-faith claims based on improper coverage investigations are discussed in greater detail in Section II below. 11 While the duration of a coverage investigation also may vary according to the claim, the timeline for a response to a first-party claim often is set by statute. See DENNIS J. WALL, Litigation and Prevention of Insurer Bad Faith and Weiss, 197 Wis.2d at Frommoethelydo, 42 Cal.3d at Weiss, 197 Wis.2d at Frommoethelydo, 42 Cal.3d at Weiss, 197 Wis.2d at 376, STEPHEN S. ASHLEY, Bad Faith Actions Liability and Damages (1997).

6 18 Frommoethelydo, 42 Cal.3d at Frommoethelydo, 42 Cal.3d at STEPHEN S. ASHLEY, Bad Faith Actions Liability and Damages 10.04, Frommoethelydo, 42 Cal.3d at In addition to a bad-faith tort claim, an insured may pursue a claim for breach of contract or a statutory violation when its insurer wrongfully refuses to pay insurance benefits under its policy. 23 Frommoethelydo, 42 Cal.3d at Gruenberg v. Aetna Ins. Co., 9 Cal.3d 566, 573 (1973). 25 Not every jurisdiction recognizes the tort of bad faith in the first-party context. See STEPHEN S. ASHLEY, Bad Faith Actions Liability and Damages 2.15, n. 19 (indicating that New Hampshire, New Jersey, Utah, Virginia, Florida, Georgia, Illinois, Kansas, Louisiana, Maine, Maryland, Michigan, Minnesota, Missouri, New York, Oregon, Pennsylvania and Tennessee do not recognize the tort of bad faith in the first-party context). Some of these jurisdictions do, however, have statutory provisions to address bad faith on the part of the insurer in handling first-party claims. See, e.g., 215 ILCS 5/154.6; NY Ins. Law. 2601; 40 Pa. Cons. Stat (a)(10) Wis.2d 675 (1978). 27 Anderson v. Continental Insurance Co., 85 Wis.2d at Anderson v. Continental Insurance Co., 85 Wis.2d at Gruenberg, 9 Cal.3d Gruenberg, 9 Cal.3d at Indiana (Erie Ins. Co. v. Hickman by Smith, 622 N.E.2d 515 (Ind. 1993)); North Dakota (Seifert v. Farmers Union Mut. Ins. Co., 497 N.W.2d 694 (N.D. 1993); Fetch v. Quam, 623 N.W.2d 357 (N.D. 2001)) Oklahoma (Roach v. Atlas Life Ins. Co., 769 P.2d 158 (Okla. 1989)); Pennsylvania (American Franklin Life Ins. Co., 776 F.Supp (E.D. Pa. 1991)); Washington (Safeco Ins. Co. of America v. JMG Restaurants, Inc. 680 P.2d 409 (1984)). See ASHLEY, supra, 5.02, n The following unreasonable claims settlement practices have been recognized: Claim denial with no reasonable basis, delay, deception, misinterpretation to avoid coverage, threats, false accusations, exploitation of insured s vulnerable position, oppressive demands, conditioning payment of undisputed portion of the claim on settlement of disputed portion, insurer s failure to communicate, abuse of the arbitration process, wrongful cancellation and non-renewal, abuse of subrogation rights, unfair imposition of increase in premiums for filing claim, and destruction of evidence. STEPHEN S. ASHLEY, Bad Faith Actions Liability and Damages 5:06 5: Cal.3d 809, 819 (1979) Cal.3d at Wis.3d at Weiss, 197 Wis.2d at 378. The Weiss court further indicated that it is appropriate for the trier of fact to determine whether the insurer properly investigated the claim and whether the results of the investigation were subjected to reasonable evaluation and review. Weiss, 197 Wis.2d at Weiss, 197 Wis.2d at Weiss, 197 Wis.2d at See, e.g., 215 ILCS 5/155 (Illinois statute allowing for penalty and attorneys fees for vexatious or unreasonable denial or delay in paying claim); NY Ins. Law 5106 (New York statute allowing for interest and attorneys fees); Tex. Ins. Code. Ann. Art (Texas statute allowing for penalty and attorneys fees in life, accident and health insurance claims). STEPHEN S. ASHLEY, Bad Faith Actions Liability and Damages 9:15, n. 89, Egan v. Mut. of Omaha Ins. Co., 24 Cal.3d 809 (1979). 41 Although a few courts have awarded attorney s fees as consequential damages, the vast majority of jurisdictions do not allow recovery of attorney s fees as damages in a first-party bad faith claim, unless allowed by the policy itself or by statute. STEPHEN S. ASHLEY, Bad Faith Actions Liability and Damages 8: See, e.g., Silberg v. California Life Ins. Co., 521 P.2d 1103 (Cal. 1974). 43 The availability of prejudgment interest is often governed by statute. The following statutes are among those allowing for recovery of interest on claims against insurers: Wis. Stat. Ann ; Utah Code Ann. 31A ; Mich. Comp. Laws ; Me. Rev. Stat Ann. Title 24-A, 2436; La. Rev. Stat. Ann. 22: ; NY Ins. Law Most jurisdictions have statutes that allow for recovery of punitive damages in bad faith claims in the first-party context, however, the standards of proof for recovery of such damages varies widely by jurisdiction. STEPHEN S. ASHLEY, Bad Faith Actions Liability and Damages 8.06 at 8 19, citing case law from various states.