How Insurance Companies Defraud Their Policyholders, and What Courts and Legislators Should Do About it

• Publication year: 2023

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Robert D. Chesler, Amy Weiss, and Jade Sobh ^*

Abstract: Insurance companies have legitimate reasons for denying claims, but sometimes denials or significant delays are the result of unfair practices or even fraud. Such actions may be systemic or undertaken by an individual. What rights do policyholders have? What can they do to combat illegitimate denials? What are the barriers individuals face when they are wrongfully denied coverage? Should there be a private right of action under the Unfair Trade Practices Act? Should policyholders' attorneys' fees be covered? What should courts and legislatures do to protect insurance consumers? In this article the authors answer these questions and more.

The insurance industry devotes substantial resources to a lobbying campaign against insurance fraud. These efforts have borne fruit, and rightly so. Insurance fraud, though, is a two-way street. It is now time to address the fraud and wrongful practices that the insurance industry perpetrates on policyholders.

Over the past 20 years, state courts and regulators have found on several occasions that major insurance companies had procedures in place that systemically denied or underpaid policyholders' legitimate claims. In other cases, courts have found that misrepresentations or other dishonest behavior on the part of insurance company personnel have wrongfully denied claims. Below, we overview illustrative cases, as well as various forms of recourse provided by state law to policyholders who have been wrongfully denied or outright cheated out of coverage.

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It Is Judicially Established That Insurance Companies Defraud Their Policyholders

In Campbell v. State Farm, ¹ a driver made a dangerous maneuver that caused two cars to collide. The driver was insured by State Farm, which investigated the accident and produced a report that stated there was evidence of fault on behalf of its policyholder. Despite this evidence, and despite that it seemed likely there could be an excess judgment in the resulting litigation against its policyholder, State Farm rejected offers to settle and "never departed from its 'no settlement stance.'" Instead, State Farm's superintendent and divisional superintendent rejected their own claim investigator's report and ordered the claim investigator to alter the facts and analysis of liability that indicated exposure for its policyholder and the potential of a high settlement value. The superintendent also demanded that the claim investigator return a letter proving the superintendent had agreed with the claim investigator's initial analysis, whereafter the claims investigator's involvement was discontinued in the case.

Although State Farm's appointed attorney reassured the policyholder that his assets were safe, and that he had no liability for the accident, the jury found the policyholder 100% at fault for the accident. The jury entered a judgment of $185,849 in damages, greatly exceeding any proposed settlement amount and resulting in $135,849 in excess liability. Subsequently, the three parties to the accident entered into an agreement compelling the policyholder to pursue a bad faith action against State Farm. In doing so, the policyholder uncovered how his claim was part State Farm's larger "national scheme to meet corporate fiscal goals by capping payouts on claims company wide"—known as State Farm's Performance, Planning and Review (PP&R) policy.

The Utah Supreme Court, in laying out the PP&R scheme, summarized just three examples of the "most egregious and malicious behavior" from 28 pages of extensive findings. First, to meet financial goals, State Farm "repeatedly and deliberately deceived and cheated its customers," consistently targeting "poor racial or ethnic minorities, women, and elderly individuals"—groups State Farm believed would be less likely to object or take legal action. For instance, agents would change the contents of claim files to

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distort the assessment of the value of claims against State Farm's policyholders. In the underlying lawsuit, the claim adjuster was instructed to falsely report that the victim was "speeding to visit his pregnant girlfriend."

Second, State Farm "engaged in deliberate concealment and destruction of all documents related to this profit scheme" to avoid potential disclosure through discovery requests. To shield itself from bad faith actions, it created company policy not to retain any corporate records related to lawsuits against the company.

Finally, State Farm "systematically harassed and intimidated opposing claimants, witnesses, and attorneys" to deter litigation. It did this by mandating attorneys to ask claimants personal, intrusive questions—sometimes bribing third parties in exchange for scandalous information—and using its large company resources to employ "mad dog defense tactics" and "'wear out' opposing attorneys by prolonging litigation, making meritless objections, claiming false privileges, destroying documents, and abusing the law and motion process." The Utah Supreme Court found that this scheme supported the imposition of a higher-than-normal punitive damages award. ²

This is not a case of a rogue employee. This is a deliberate and conscious fraud perpetrated by a major insurance company—"the good neighbor"—on its most vulnerable policyholders.

Campbell v. State Farm is just one example of insurance companies consciously and deliberately committing fraud. Unum, one of the nation's leading disability insurers, was investigated in 2005 and found to have to have committed widespread fraud. ³ The investigation concluded that the company was engaged in pervasive violations of state insurance regulations and in fraudulent denial practices. Those included using phony medical reports, policy misrepresentations, low-balling tactics, and biased investigations as pretexts for cutting off legitimate claims of disabled, and often destitute, policyholders.

In another example of blatantly fraudulent behavior, in March 2007 California's Department of Managed Health Care fined Blue Cross of California and its parent company, WellPoint, $1 million after an investigation revealed that the insurer routinely illegally rescinded individual plan members' policies after they became seriously ill and filed expensive claims. While at that time individual

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market health plans were medically underwritten, and policies could be rescinded if applicants had concealed preexisting conditions, the suit alleged that the insurance company routinely abused that process, selling people false promises of coverage and concealing a scheme to renege on the policies for those with conditions including cancer and congestive heart failure. ⁴

Farmers Insurance Groups' most high-profile run-in with state regulators occurred in California after the 1994 Northridge earthquake, which killed 72 people, injured nearly 12,000, and caused over $12 billion in damages. ⁵ Many of the affected homeowners were covered by Farmers. Despite paying out over $1.9 billion for 37,000 claims, the company was hit with a wave of bad faith lawsuits for failing to pay policyholders the full value of their homes. In one case, a Farmers' subsidiary was sued for bad faith and fraud by a condominium homeowners association after the insurance company refused to pay to rebuild the severely damaged building. The homeowners, who were mostly minorities, were aided by the testimony of a former claims adjuster, Kermith Sonnier, who admitted that a supervisor told him to settle the claim for a target amount, despite never having seen the damage firsthand.

Legal scholars have also written about the extensive fraud committed by insurance companies. In The Disaster After the Disaster: Insurance Companies' Post-Catastrophe Claims Handling Practices, Kelsey D. Dulin explains the fraud that followed in the wake of Hurricane Katrina, and the ways that independent adjusters may have contributed or participated in that fraud alongside insurance companies. ⁶ The article explains that insurance companies have been held liable for committing fraudulent claims-handling practices in Oklahoma, as well as on the Gulf Coast, "for hiring biased engineering firms to produce predetermined reports against the interest of policyholders and hiring ill-trained independent adjusters and falsely representing that the adjusters are employees of the...