Insurance Bad Faith A Year In Review For The Insurer: The Right To Be Wrong MEALEY S LITIGATION REPORT

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1 MEALEY S LITIGATION REPORT Insurance Bad Faith 2005 A Year In Review For The Insurer: The Right To Be Wrong by Thomas F. Segalla Esq. and Kevin T. Merriman, Esq. Goldberg Segalla LLP Buffalo, New York A commentary article reprinted from the February 7, 2006 issue of Mealey s Litigation Report: Insurance Bad Faith

2 MEALEY S LITIGATION REPORT: Insurance Bad Faith Vol. 19, #19 February 7, 2006 Commentary 2005 A Year in Review For The Insurer: The Right To Be Wrong By Thomas F. Segalla and Kevin T. Merriman [Editor s Note: Thomas F. Segalla, one of the founding partners of Goldberg Segalla LLP, is a nationally recognized insurance expert whose active practice focuses on the defense and insurance coverage aspects of matters involving bad faith; construction site personal injury accidents; and toxic tort and environmental issues. He is the co-author of the renowned insurance law treatise Couch on Insurance 3d and he has been retained by numerous insurance carriers and policyholders as an insurance-related expert. Mr. Segalla can be reached at tsegalla@goldbergsegalla.com. Kevin T. Merriman concentrates his practice in insurance coverage and insurance defense litigation. He is a partner of Goldberg Segalla and represents insurance companies in a broad range of commercial and personal lines coverage issues, providing complex coverage opinions, underwriting advice and representing litigants in coverage disputes. His practice also includes insurance defense litigation, with an emphasis in toxic tort claims. Mr. Merriman can be reached at kmerriman@goldbergsegalla.com. This commentary, other than the quoted material, is the authors opinions; not their law firm s, and not Mealey s Publications. Copyright 2006 by the authors. Responses are welcome.] From the insurers perspective, the development of a significant body of case surrounding the fairly debatable standard was critically important to the defense of bad faith claims during the year of While various jurisdictions have developed slightly different definitions of this standard, the United States District Court for the District of New Jersey best defined the standard in the case Enright v. Farm Family Casualty Insurance, F.Supp.2d (D.N.J. 2005); 2005 WL as follows: The fairly debatable standard is intended to allow insurers to deny coverage when they have a reasonable basis to believe that no coverage exists for a particular claim. Hudson Univ. Ltd., 98 F.Supp. at 341. Even if the insurer is later held to have been wrong, in such a situation, the insurer should have the right to litigate [the] claim and have the question of law or fact... decided before it in good faith is required to pay the claimant. Id. at 341. A plaintiff cannot sustain a claim for bad faith denial or postponement of coverage unless it can establish its substantive claim for coverage as a matter of law. Pickett, 131 N.J. at 474. In this paper, we provide the reader with citations from the various jurisdictions that have treated the fairly debatable standard in This will facilitate an understanding of the standard, and provide a ready reference to a current body of case law. Alaska 1. United States of America v. CNA Financial Corp., 381 F.Supp.2d 1088 (D. Alaska 2005). Fairly Debatable Standard Rejected (Commercial General Liability Policy) The United States sued its insurer for failure to defend it in an action arising out of a personal injury action at a tribal alcohol abuse facility operated by the insured. The court found bad faith and rejected the fairly debatable standard because the insurer did not articulate in its denial letter the 1

3 Vol. 19, #19 February 7, 2006 MEALEY S LITIGATION REPORT: Insurance Bad Faith reason raised during the litigation for denying either coverage or a defense. Arizona 1. Verhulst v. General American Life Insurance Co., 2005 WL (D. Ariz. 2005) (Sept. 26, 2005). Fairly Debatable Standard Limited (Disability Policy) The insurer denied the insured s disability benefits for a period of time. In denying the insurer s motion for summary judgment, the court noted... even if the insurance company can show fair debatability and that its actions were objectively and subjectively reasonable in denying a claim, it still might be liable for bad faith based on its actions during the claims handling process. 2. Roehrs v. Minnesota Life Insurance Co., 228 F.R.D. 642 (D. Ariz. 2005) (Jun. 14, 2005). Fairly Debatable Standard Rejected (Disability Policy) This case involved the production of certain documents from the insurer s claim file. The court held that the insurer impliedly waived the attorney-client privilege as to certain documents. With respect to the fairly debatable standard, in footnote 4, the court references the impropriety of giving a fairly debatable instruction in a third-party bad faith case. Connecticut 1. McCulloch v. Hartford Life and Accident Insurance Co., 363 F.Supp.2d 169 (D. Conn. 2005)(Mar. 28, 2005). Fairly Debatable Standard Applied (Disability Policy) The insurer terminated its insured s long-term disability benefits. Thereafter, the insured sued the insurer and reinsurer. The reinsurer sought dismissal of the bad faith claim. The court noted that... a plaintiff cannot recover for bad faith if the insurer denies a claim that is fairly debatable, i.e., if the insurer had some arguably justifiable reason for refusing to pay or terminating the claim. Idaho 1. Strong v. Unumprovident Corp., 383 F.Supp (D. Idaho 2005) (May 13, 2005). Fairly Debatable Standard Applied (Disability Policy) The insured had submitted an application for disability benefits and instituted an action against the insurer for a denial of the benefits. The court dismissed the bad faith claim and noted that [t]o demonstrate bad faith under Idaho law, the insured must show: (1) the insurer intentionally and unreasonably denied payments of the claims; (2) the claim was not fairly debatable; (3) the insurer s denial was not the result of a good faith mistake; and (4) the resulting harm was not fully compensable by contract damages. Iowa 1. Etten v. U.S. Food Service, Inc., 2005 WL (N.D. Iowa 2005) (Nov. 14, 2005). Fairly Debatable Standard Applied (Workers Compensation Policy) In a claim involving an alleged bad faith refusal to pay workers compensation benefits, the court held that [a] reasonable basis for denial of the claim exists if the claim is fairly debatable. 2. Keystone Nursing Care Center v. Craddock, 705 N.W.2d 299 (Iowa 2005); (Nov. 8, 2005). Fairly Debatable Standard Applied (Workers Compensation Policy) In a split decision, the court held that there is not substantial evidence to support the commissioner s decision that the issue of industrial disability was not fairly debatable. The court also refused to award penalties against the employer. 3. Schuller v. Great-West Life & Annuity Insurance Co., 2005 WL (N.D. Iowa 2005) (Sept. 15, 2005). Fairly Debatable Standard Applied (Disability Policy) The claimant sued insurer contending there was no reasonable basis for it to delay or deny benefits. The court held that where an objectively reasonable basis for denial of a claim actually exists the insurer cannot be held liable for bad faith as a matter of law. The insurer has the right to debate claims that are fairly debatable. 4. Bellville v. Farm Bureau Mutual Insurance Co., 702 N.W.2d 468 (Iowa 2005); (Aug. 29, 2005). Fairly Debatable Standard Defined (Automobile Uninsured Motorist Policy) In an underinsured motorist case, the insured sued the insurer for bad faith, extra-contractual 2

4 MEALEY S LITIGATION REPORT: Insurance Bad Faith Vol. 19, #19 February 7, 2006 and punitive damages. The court dismissed the bad faith claim because it held that it was fairly debatable when it is open to dispute on any logical basis. Stated another way, if reasonable minds can differ on the coveragedetermining facts or law, then the claim is fairly debatable. 5. Galbraith v. Allied Mutual Insurance Co., 698 N.W.2d 325 (Iowa 2005) (Jun. 24, 2005). Fairly Debatable Standard Applied (Automobile Uninsured Motorist Policy) The insured sued the insurer for a delay in payment of underinsured motorist benefits after an alleged oral agreement to settle the underlying tort claim. The court dismissed the bad faith and noted,... if the underlying third-party tort action is fairly debatable as to either the facts or the law, this circumstance provides reasonable basis for denial of underinsured-motorist benefits. 6. Cornwell v. State Farm Mutual Automobile Insurance Co., 396 F.Supp.2d 1020 (S.D. Iowa 2005) (Jun. 2, 2005). Fairly Debatable Standard Applied (Automobile Uninsured Motorist Policy) A police officer instituted an action to recover UIM benefits from her insurer. The insurer denied the insured s benefits based on the Fireman s Rule and the previous benefits and settlements received by the insured. The court dismissed the bad faith claim because the insured s claim is fairly debatable on both grounds for denial. 7. Malecek v. State Farm Mutual Automobile Insurance Co., 395 F.Supp.2d 767 *(N.D. Iowa 2005) (May 24, 2005). Fairly Debatable Standard Defined (Automobile Uninsured Motorist Policy) The insurer had denied UIM benefits and the insurer instituted an action for breach of contract and bad faith. The court held there were issues of fact as to whether the insurer s position was fairly debatable. Specifically, the court reviews the principles of bad faith under Iowa law. 8. Brcka v. The St. Paul Travelers Companies, Inc., 366 F.Supp.2d 850 (S.D. Iowa 2005) (May 2, 2005). Fairly Debatable Standard Applied (Workers Compensation Policy The Workers Compensation Commission found that [c]laimant s claim for benefits was fairly debatable. The court applied issue preclusion and refused to relitigate the issue again. 9. Farm Bureau Mutual Insurance Co. v. Iowa District Court for Pottawattamic County, 695 N.W.2d 503 (Iowa App. 2005) (Jan. 13, 2005). Fairly Debatable Standard Applied (Mobile Home Policy) The insured s mobile home sustained property loss due to fire; however, it was undisputed that the fire was the result of arson. The insured filed a claim with its insurer and when the insurer refused payment, the insured instituted a bad faith action. The jury returned a verdict in favor of the insurer. Thereafter, the insurer sought sanctions, which were the subject of the action. The court awarded sanctions against the insureds and their attorney and considered the fairly debatable standard. Kentucky 1. Ehlschide v. Colonial Life & Accident Insurance Co., 2005 WL (Ky. App. 2005) (Dec. 14, 2005). Fairly Debatable Standard Defined (Cancer Policy) At issue in this case was the scope and amount of coverage for the insured s chemotherapy expenses. The court dismissed the bad faith claim holding [i]f the claim is fairly debatable, as to either the law or the facts, the insurer may debate it. There must be evidence of the insurer s evil motive, or reckless indifference to the rights of the insured. 2. Adams v. Westfield Insurance Co., 2005 WL (W.D. Ky. 2005) (Nov. 8, 2005). Fairly Debatable Standard Limited (Automobile Policy) In discussing the application of the Kentucky Unfair Claims Settlement Practices Act (KUC- SPA), to a property damage claim, the court noted, Although elements of a claim may be fairly debatable, an insurer must debate the matter fairly. Further, the court noted that an insurer... cannot lowball claims or delay claims hoping the insured will settle for less. 3. Bentley v. Bentley, 172 S.W.2d 375 (Ky. 2005) (Sept. 22, 2005). Fairly Debatable Standard 3

5 Vol. 19, #19 February 7, 2006 MEALEY S LITIGATION REPORT: Insurance Bad Faith Applied (Automobile Policy) The court held that the insurer s refusal to settle the claim in a third-party context did not constitute bad faith because [i]n view of... existing law... that defense was not only fairly debatable, it had substantial merit. The insurer can challenge a claim and litigate it if the claim is debatable on the law or facts. 4. Shepherd v. Unumprovident Corp., 381 F.Supp.2d 608 (E.D. Ky. 2005) (Jun. 8, 2005). Fairly Debatable Standard Applied (Disability Policy) The specific issue before the court was whether the testimony of the insured s expert pertaining to insurance industry standards was admissible. The court, citing Daubert v. Merrell Dow Pharmaceuticals, Inc., 509 U.S. 579 (1993), held that the insured s expert was qualified to testify. The court further noted that there was a jury question in the application of the fairly debatable standard. Nebraska 1. LeRette v. American Medical Security, Inc., 270 Neb. 545, 705 N.W.2d 41 (2005) (Oct. 28, 2005). Fairly Debatable Standard Defined (Health Insurance Policy) The court stated that [t]he question whether a claim is fairly debatable is appropriately decided by the court as a matter of law... and such a determination is based on information available to the insurance company at the time the demand is presented. Is there an arguable basis to deny the claim? 2. Stumbaugh v. Allstate Insurance Co., 2005 WL (Neb. App. 2005) (May 24, 2005). Fairly Debatable Standard Applied (Automobile Uninsured Motorist Policy) The insured instituted an action seeking coverage of a claim under an uninsured motorist provision in her policy and also for bad faith concerning the insurer s settlement of the claim. The court held that the insurer had a reasonable basis for its evaluation of the insured s claim and specifically that the value of the claim was fairly debatable. New Jersey 1. Enright v. Farm Family Casualty Insurance Co., 2005 WL (D.N.J. 2005) (Dec. 29, 2005). Fairly Debatable Standard Applied (Homeowner s Policy/Contractor s Advantage Policy) Citing to Pickett v. Lloyd s and Peerless Ins. Agency, Inc., 131 N.J. 457, 481 (1993), the court applied the fairly debatable standard setforth above and noted neither negligence nor mistake is sufficient to show bad faith. 2. Feit v. Great-West Life and Annuity Insurance Company, a Colorado Corporation, 2005 WL (D.N.J. 2005) (Oct. 18, 2005). Fairly Debatable Standard Defined (Life Insurance Policy) The court decided under the fairly debatable standard the insurer was entitled to summary judgment. In doing so, the court noted that the insured must show (1) absence of a reasonable basis for denying the benefits of the policy; and (2) the defendant s knowledge or reckless disregard of the lack of a reasonable basis for denying the claim. 3. Tri-State Armored Services, Inc. v. Subranni, 332 B.R. 690 (D.N.J. 2005) (Oct. 3, 2005). Fairly Debatable Standard Applied (Employee Dishonesty, Crime and Disappearance Policy) The bankruptcy trustee contended that the insurer s refusal to pay the trustee s claim constituted an unconscionable commercial practice under the Consumer Fraud Act. The court, citing to Pickett, applied the fairly debatable standard and dismissed the bad faith claim. The court also discussed the limitations of the fiduciary relationship between the insurer and insured. 4. Optica, Inc. v. Metro Public Adjustment Inc., 2005 WL (D.N.J.) (July 21, 2005). Fairly Debatable Standard Defined (Property Casualty Policy) In denying the insured s bad faith claim, the court noted that [i]n order to establish a claim for bad faith in the insurance context, a plaintiff must show two elements: (1) the insurer lacked a fairly debatable reason for its failure to pay a claim, and (2) the insurer knew or recklessly disregarded the lack of a reasonable basis to deny the claim. 5. NN&R, Inc. v. One Beacon Insurance Co., 2005 WL (D.N.J. 2005) (Jun. 28, 2005). 4

6 MEALEY S LITIGATION REPORT: Insurance Bad Faith Vol. 19, #19 February 7, 2006 Fairly Debatable Standard Applied (Property and Liability Policy) The insurer denied a claim by the insured for damage to its policy that occurred when contiguous property was legally demolished. The court dismissed the bad faith claim noting, the mere denial of insurance benefits to which... plaintiffs believe they [are] entitled does not comprise an unconscionable commercial practice. The court also noted [i]n the context of a denial of insurance benefits, New Jersey applies that fairly debatable standard Cohen v. Unumprovident Corp., 2005 WL (D.N.J. 2005) (6/21/05). Fairly Debatable Standard Defined (Disability Policy) The insured sued the insurer alleging an improper termination of his disability benefits. Citing to the Pickett case, the court referenced the two-part inquiry need to evaluate the fairly debatable standard and noted [s]hould the insured be able to demonstrate the absence of a reasonable basis, in order to demonstrate bad faith, he or she must show that the insurer knew or recklessly disregarded the lack of a reasonable basis for denying the claim. 7. NN&R, Inc. v. One Beacon Insurance Group, 362 F.Supp.2d 514 (D.N.J. 2005) (Mar. 15, 2005). Fairly Debatable Standard Defined (Property Liability Policy) The court again citing the Pickett case noted: In the context of a denial of insurance benefits, New Jersey applies the fairly debatable standard [i]f a claim is fairly debatable, no liability in tort will arise. 8. American Hardware Mutual Insurance v. Harley Davidson of Trenton, Inc., 124 Fed. Appx. 107 (3d Cir. 2005) (Feb. 22, 2005). Fairly Debatable Standard Limited (Garage Liability Policy) The insurer instituted the declaratory judgment action seeking a declaration that it was not liable for the excess verdict above its insurance policy limits rendered against its insured. The court held that the insurer in this third-party bad faith case failed to act in good faith to settle the claim against the insured. The court held that the fairly debatable standard only supplies part of the equation and does not take into consideration the likelihood of an excess verdict. Contrast the Pickett case with Rova Farm, 323 A.2d 495 (1974) (recognizes a positive fiduciary duty. ). Rova, 323 A.2d at 498. Ohio 1. Keyser v. UNUM Life Insurance Company of America, 2005 WL (S.D. Ohio 2005) (Sept. 12, 2005). Fairly Debatable Standard Applied (Disability Insurance Policy) In a case involving an insurer s termination of benefits, the court held there were issues of fact as to whether reasonable minds could differ as to whether the insurer acted without reasonable justification. To grant a motion for summary judgment brought by an insurer on the issue of whether it lacked good faith, a court must find, after reviewing the evidence in a light most favorable to the insured, that the claim was fairly debatable and the refusal was premised on either status of the law at the time of the denial or the facts that gave rise to the claim. 2. Siemientkowski v. State Farm Insurance Co., 2005 WL (Ohio App. 8 Dist. 2005) (Aug. 18, 2005). Fairly Debatable Standard Defined (Homeowners Insurance Policy) The court rejected the homeowner s property damage claim and noted [w]here a claim is fairly debatable, the insurer is entitled to refuse the claim as long as such refusal is premised on a genuine dispute over either the status of the law at the time of the denial or the facts giving rise to the claim. 3. Abon, Ltd. v. Transcontinental Insurance Co., 2005 WL (Ohio App. 5 Dist. 2005) (Jun. 16, 2005). Fairly Debatable Standard Defined (Property Policy) The insured sustained a fire loss and the insurer denied the claim on various grounds. The court held that the... evidentiary materials indicate that the facts underlying the... loss were subject to fair debate, and [the insured] failed to present any evidence that [the insurer] had actual knowledge of a lack of a reasonable justification for refusing to pay the claim or that the insurer intentionally failed to determine whether there was any such justification. 5

7 Vol. 19, #19 February 7, 2006 MEALEY S LITIGATION REPORT: Insurance Bad Faith 4. Garrett v. Ohio Farmers Insurance Co., 2005 WL (Ohio App. 11 Dist. 2005) (Feb. 4, 2005). Fairly Debatable Standard Defined (Automobile Policy) The insured instituted a bad faith and breach of contract action against the insurer and claims adjuster for a delay in paying the insured s claim for medical costs. The court utilizes a reasonable justification standard which is defined as: Reasonable justification does not exist where the insurer acts arbitrarily or capriciously. If an insurer determines that a claim is fairly debatable and the insurer s refusal of coverage is based on a genuine dispute over either the facts giving rise to the claim, or the status of the law at the time the claim arose, the insurer may refuse a claim. South Dakota 1. Culhane v. Western National Mutual Insurance Co., 704 N.W.2d 287, (SD ) (Sept. 7, 2005). Fairly Debatable Standard Applied (Automobile Policy) The policyholder sued the insurer claiming he was entitled to be compensated for the cost of repairs plus post-repair loss of market value. The court rejected the insured s claim and held that the insurer did not in bad faith. The court noted that an insurance company is entitled to 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. Utah 1. Machan v. UNUM Life Insurance Company of America, 116 P.3d 342, 2005 UT 37 (Utah 2005) (Jun. 17, 2005). Fairly Debatable Standard Applied (Disability Policy) The insured instituted an action against the insurer for failure to pay a claim. The insurer paid the claim and moved for summary judgment. In discussing the bad faith claim, the court noted when an insured s claim is fairly debatable, the insurer is entitled to debate it and cannot be held to have breached the implied covenant if it chooses to do so. 2. Nelson v. Safeco Insurance Company of North American, 396 F.Supp.2d 1274 (D. Utah 2005) (Jun. 10, 2005). Fairly Debatable Standard Applied (Homeowners Policy) The insureds home was destroyed by fire and the insurer denied the claim, having concluded that the insureds intentionally set the fire and/or arranged to have the fire set. While the court held that the insurer failed to establish arson, the court held that the jury must decide if the denial was reasonable, or in other words, fairly debatable. Wisconsin 1. Travelers Insurance Co. v. Sconzert, 2006 WI App. 1; 2005 WL (Wis. App. 2005) (Nov. 9, 2005). Fairly Debatable Standard Limited (Workers Compensation Policy) The insurer denied the claim for permanent partial disability. The court, in holding that the delay in payment was inexcusable, stated [t]he fairly debatable test is an objective one, which asks whether a reasonable insurer under similar circumstances would have denied or delayed payment. 2. Menasha Corp. v. Lumbermens Mutual Casualty Co., 361 F.Supp.2d 887 (E.D. Wisc. 2005) (Mar. 18, 2005). Fairly Debatable Standard Limited (Liability Policy) The insured instituted an action against the insurers alleged that the insurers breached their duties to defend it in an automobile parts manufacturer s lawsuit. They noted that an insurer has a duty to defend its insured when the complaint at least arguably asserts liability covered by the policy. The court notes that fairly debatable is an synonym for arguable. Wyoming 1. Cathcart v. State Farm Mutual Automobile Insurance Co., 123 P.3d 579, 2005 WY 154 (Wyo. 2005) (Dec. 1, 2005). Fairly Debatable Standard Defined (Automobile Policy) Within the third-party bad faith context, the court noted that [t]he logical premise of the debatable... standard is that if a realistic question of liability does not exist, the insurance carrier is entitled to reasonably pursue that debate without exposure to a claim of violation of its duty of good faith and fair dealing. Gainsco Ins. Co. v. Amoco Production Co., 2002 WY 122 (Wyo