Arnett & Arnett PC - What is Insurance Bad Faith?

Notice: The following is for educational purposes only and is not legal advice.

First Party Bad Faith in Arizona.
Arizona courts recognize a “duty of good faith and fair dealing” as an implied term or requirement in every contract. Rawlings v. Apodaca, 151 Ariz. 149, 153-154, 726 P.2d 565, 569-570 (1986). When an insurance company breaches the duty of good faith and fair dealing, Arizona allows the insureds to sue not only for breach of the insurance contract, but in tort for breach of the duty of good faith and fair dealing (often abbreviated as “bad faith”).

The elements of bad faith require the insured to prove that the insurance company (1) intentionally denied the claim (or otherwise financially injured the insured) without a reasonable basis for such action; and (2) knew that it acted without a reasonable basis, or defendant failed to perform an investigation or evaluation adequate to determine whether its action was supported by a reasonable basis. Noble v. Nat'l American Life Ins. Co., 128 Ariz. 188, 190, 624 P.2d 866, 868 (1981). Insurance companies may delegate responsibility, but they remain liable for the actions taken by the delegates. Walter v. Simmons, 169 Ariz. 229, 818 P.2d 214 (Ct. App. 1991).

Breach of contract allows the insured to recover only the financial injury, certain costs associated with the litigation, and perhaps some money to help pay attorney's fees. A bad faith claim allows for the recovery of additional damages to compensate the insured for the emotional distress, humiliation, inconvenience, and anxiety experienced, and reasonably probable to be experienced in the future. Farr v. Transamerica Occidental Life Ins. Co., 145 Ariz. 1, 7, 699 P.2d 376, 382 (App. 1984).

Punitive damages may also be awarded in bad faith cases if the facts warrant. Punitive damages are not a separate count under Arizona law. Rather, it is an element of damages in the bad faith claim. In the case of Bradshaw v. State Farm Mutual Automobile Ins. Co., 157 Ariz. 411, 758 P.2d 1313 (1988), the Arizona Supreme Court reviewed prior cases regarding punitive damages and restated the three different circumstances under which punitive damages are to be awarded in Arizona: 1) Facts showing the defendant intended to cause injury, 2) Facts demonstrating that defendant’s wrongful conduct was motivated by spite or ill will, 3) Facts from which the jury can conclude that even though defendant had neither desire nor motive to injure (i.e., neither intent nor spite), he acted to serve his own interests, having reason to know and consciously disregarding a substantial risk that his conduct might significantly injure the rights of others. Bradshaw v. State Farm Mutual Automobile Ins. Co., 157 Ariz. 411, 422, 758 P.2d 1313, 1324.

Punitive damages must be proven by clear and convincing evidence rather than a mere preponderance of the evidence. Arizona Courts have noted that clear and convincing evidence does not mean that the evidence must be undisputed. See, In re Weiner, 120 Ariz. 349, 586 P.2d 194, 198 (1978) (most of the facts, including the “crucial” facts were disputed, yet the evidence was held to be clear and convincing); In re Neville, 147 Ariz. 106, 107, 708 P.2d 1297, 1301 (1985) (requirement of clear and convincing evidence can be met even if there is a direct conflict in the testimony). Nor must evidence be “unambiguous” or “certain” to be clear and convincing, as these terms raise the standard too high. State v. Renforth, 155 Ariz. 385, 746 P.2d 1315 (Ct. App. 1987), cited with approval in State v. King, 158 Ariz. 419, 763 P.2d 239 (1988). These are only the requirements under Arizona law. Federal law which may affect the constitutionality of punitive damages is not covered here.

Keep in mind that the duty of good faith and fair dealing is owed only to the insured. The court has held that even an insured spouse, who was also an insured under a separate policy with the same insurance company, did not have standing to bring an action for breach of the duty of good faith and fair dealing for the insurance company’s actions against her husband. Fobes v. Blue Cross and Blue Shield, 176 Ariz. 407, 861 P.2d 692 (Ct. App. 1993), review granted then denied. Additionally, a liability insurer does not owe a duty of good faith to a claimant who is not an insured. There are other tort theories which might apply. For example, if the liability carrier wrongfully files a counterclaim it may be guilty of malicious prosecution. See, Bradshaw v. State Farm, 157 Ariz. 411, 758 P.2d 1313 (1988).

There are numerous ways in which an insurance company can breach the duty of good faith and fair dealing. The most common is when it knowingly denies a claim or delays the payment of a claim without a reasonable basis. However, Arizona courts have made it clear that even if the claim is paid in a timely manner, the insurance company may still be liable for the breach of the duty of good faith and fair dealing if the insurance company knowingly acts without a reasonable basis in such a way as to impair the insured’s right. Rawlings v. Apodaca, 151 Ariz. 149, 726 P.2d 565 (1986); Deese v. State Farm Insurance Co., 172 Ariz. 504, 838 P.2d 1265 (1992).

Similar practices by an insurance company may also be admitted as evidence in a bad faith claim. Arizona courts have condoned testimony of an adjuster who left Allstate fifteen years before the claim, who testified concerning Allstate’s practice of wrongfully taking a routine tire wear deduction even though the issue in that case was a routine cleaning fee. Hawkins v. Allstate Insurance Co., 152 Ariz. 490, 733 P.2d 1073 (1987).

The primary source for evidence needed to prove bad faith is often the claims file. In Arizona, an insurance company is under an obligation in a bad faith suit to produce the entire claims file. Brown v. Superior Court, 137 Ariz. 327, 670 P.2d 725 (1983).

Third Party Bad Faith in Arizona.
The term “third party bad faith” is misleading. As stated above, a third party does not have standing to bring a lawsuit against the insurance company for bad faith. An insurance company does not owe a duty of good faith and fair dealing on a liability claim of a non-insured. The insurance company is free to give the claimant the run-around or choose to completely ignore the claimant’s claim. The claimant has no recourse except to bring his or her action against the insured.

While the insurance company does not owe the third party claimant a duty of good faith and fair dealing in adjusting the claim, it does owe its insured a duty of good faith and fair dealing when adjusting a third party claim. The insurance company must give the same consideration to the insured’s interest as it gives to its own interest in considering settlement offers. In other words, it is a breach of the duty of good faith and fair dealing for an insurance company to fail to accept an offer to settle within policy limits when the insurance company knows or should know that the offer is reasonable.

Third party bad faith was designed to prevent an insurance company from gambling at trial, exposing the insured to significant risk of a judgment over policy limits. The insurance company gambles that it might be able to pay less than policy limits on the off-chance that things go well. Knowing that the most that it will have to pay is policy limits, why not give it a shot?

While the insured has the ability to bring a first party bad faith action, more commonly than not, the person who was injured by the insured enters into an agreement not to execute on the judgment in exchange for the insured signing over his or her rights to bring the bad faith action against the insurance company. Arizona recognizes that this is a valid agreement. United States Automobile Association v. Morris, 154 Ariz. 113, 741 P.2d 246 (1986).

It must be understood that the only right that the insured can transfer to a third party is the right to the benefits under the insurance policy. The right to recover damages for credit reputation or emotional distress cannot be transferred to a third party. Therefore, the claim of the third party who receives an assignment is often significantly less than the claim that the insured would have if he were to bring the action.

A.R.S. §20-443
A.R.S. §20-443 prohibits misrepresentations and false or misleading statements in connection with the sale or advertisement of an insurance policy. A violation of this statute creates a private right of action for deceptive practices. Sparks v. Republic National Life Ins. Co., 132 Ariz. 529, 647 P.2d 1127 (1982).

Because this cause of action is statutory, it also carries a one-year statute of limitations. Although this is a viable cause of action in Arizona, the damages recoverable seem to be identical to those recoverable in bad faith. Unless there is some specific reason to bring an action under A.R.S. §20-443, such as naming a non-diverse defendant, there seems to be little advantage to doing so.

A.R.S. §20-3151 et seq.
Recently, Arizona passed a statute which codifies the bad faith cause of action against certain types of insurers as a part of its state's insurance code. The statute is found at A.R.S. §20-3151 et. seq. There are significant differences between the statute and common law bad faith, so care must be taken before choosing to bring an action under the statute. This statute is unlikely to be applicable in cases subject to federal ERISA law (Employee Retirement Income Security Act of 1974), given the Supreme Court's ruling in Aetna v. Davila, 542 U.S. ___ (2004).

More
There is of course additional law and other concepts beyond what is summarized here. Hopefully this will act as a good springboard for further research about Arizona law. If you have been mistreated by an insurance company, contact an attorney. Arnett & Arnett PC offers free consultations to insureds whom we believe we might be able to help. Please call Arnett & Arnett (480) 839-4600.