Article, 1021 UTBJ, Vol. 34, No. 5. 38
| Author | by Burke A. Christensen |
| Position | Vol. 34 5 Pg. 38 |
September, 2021
by Burke A. Christensen
With respect to an insurer fulfilling its promises to pay claims, what is required for an insurer to be acting in good faith with its insureds? Conversely, what is an act that indicates the insurer is acting in bad faith? This article will explain the origin, evolution, and current status of the concept of insurance bad faith actions in the United States.
While the idea of insurance goes back as far as the third millennia BCE, modern insurance contracts date from the early seventeenth century. In 1628, Robert Hayman, an English merchant, owned a policy insuring the safe arrival in Guyana of a ship owned by Hayman. It was maritime insurance policies like that one that initiated the principle of good faith as it applies to insurance.
The History of Insurance Underwriting and the Obligation to Act in Good Faith
A seventeenth century shipowner located in London might have a ship and its cargo in Genoa, and he wants to spread the risk that the ship might not successfully arrive in London. To do that, the shipowner might go to Lloyd's Coffee House in London and seek wealthy investors who, for a price, would be willing to share the risk of loss. He would bring a slip of paper with him describing the ship, the nature and value of its cargo, and what he was willing to pay to those who would accept some of the risk.
For example, for every 1,000 pounds sterling of risk accepted, the shipowner (the insured) might be willing to pay ten pounds as a "premium" to the investor. Those investors who were willing to assume some of the risk would accept the premium from the insured, write on the slip the portion of the risk they were willing to accept, and sign their name under the description of the risk and so they came to be known as "underwriters." If the ship and its cargo arrived safely, the underwriters kept the premium. If it did not, the underwriters would each pay the shipowner the portion of the risk that they had agreed to accept. This practice continued into the modern era; the author has a copy of the Lloyd's underwriting slip that insured the Titanic in 1912.
But in the seventeenth century, if the ship and its cargo are in Italy and the underwriters are in London, how could the underwriters assess the risk to determine if the shipowner was telling the truth about the existence and value of the cargo and the seaworthiness of the ship? They could not. So the law imposed the principle of uberrimae fldei, translated as "utmost good faith." The principle requires that all parties to the insuring agreement (but primarily the person seeking the insurance) must act in utmost good faith. This meant that the shipowner had a duty to make a full declaration of all facts that would be material to the decision of the underwriters to accept the risk-even if the underwriters don't ask about that fact.
Except for some aspects of maritime insurance, the "utmost good faith" principle no longer applies to the person (like the shipowner) seeking insurance coverage. Over the years, the duty of both parties to act in utmost good faith has changed, so that insurance applicants now generally have only a duty to truthfully answer the questions asked. If an insurer does not ask about a condition affecting the risk, the applicant is not under a duty to disclose it. And now, with the exception of a material misrepresentation in the application permitting a rescission, only an insurer, and not an applicant or an insured, can be sanctioned for acting in bad faith.
Under standard insurance industry customs and practices today, an insurer investigates all claims, pays only the valid claims, and denies the invalid claims. Investigating and denying the invalid claims is just as important as investigating and paying valid claims. The process of collecting information is an objective one, and the insurer seeks relevant information regardless of whether it supports payment of the claim or a denial.
An insurer must make one of three decisions when a claim for benefits is received. It must promptly investigate each claim to determine if the claim is: (1) valid and should be paid; (2) incomplete and needs further information; or (3) invalid and should be denied.
The investigation itself is an expensive part of the underwriting process. Defending against a plaintiff's...
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