CRITICAL STEPS EVEN IF YOU THINK THERE IS NO COVERAGE:
SAFEGUARDS AGAINST HIGH ANXIETY
By Stan Beck and
Jennifer McMillan Beyerlein
Introduction.
So you’ve decided that there is no coverage. What do you do? Write “denied” on the claim
and go home? No. If you believe there is no coverage, there are many steps that need to be done to
protect you from later fright nights. The thoughts and ideas, investigation planned and conducted,
the evaluations regarding other parties and counsel, and the references so casually jotted down,
which at the time were innocent enough, might appear with 20/20 hindsight to demonstrate sloppy
practices or bad faith claims handling. The standards by which your investigations are conducted,
the manner in which and reasons for which you denied coverage, your awareness or lack of
awareness of code provisions in handling claims (e.g., WAC 284-30, et seq.), internal e-mails, and
attorney work product are all potentially discoverable and could demonstrate that you acted in bad
faith when denying a claim. Even if you are correct that the claim is not covered, if you do not
investigate, document, reserve your right to deny, and timely deny a claim you could be liable for
bad faith or a Consumer Protection Act violation.
What constitutes bad faith?
In order to be guilty of bad faith, an insurer’s actions must be unreasonable, frivolous, or
unfounded. Kirk v. Mt. Airy Ins. Co., 134 Wn.2d 558, 560, 951 P.2d 1124 (1998). The unfair claims
settlement practice regulations, contained in the Washington Administrative Code (WAC) 284-30,
define the minimum standards for the insurance industry. Any violation of the Code constitutes a
per se unfair or deceptive trade practice of the Consumer Protection Act, RCW § 19.86. Indus.
Indem. Co. of the Northwest, Inc. v. Kallevig, 114 Wn.2d 907, 923, 792 P.2d 520 (1990); Int’l
Ultimate, Inc. v. St. Paul Fire & Marine Ins. Co., 87 P.3d 774, 786 (Wn. App. Div. I, 2004). The
regulations of the Insurance Commissioner, provided in WAC 284-30, are considered the basic
guidelines for insurers to follow when denying a claim. Woe is to you if the guidelines were not
followed!
999999.0020/1144206.1
Stanton Phillip Beck
(206) 223-7000
becks@lanepowell.com
November 9, 2004
Jennifer McMillan Beyerlein
(206) 223-7000
beyerleinj@lanepowell.com
©Lane Powell Spears Lubersky LLP
1
Mistakes and clumsiness alone do not amount to bad faith. Ins. Co. of the State of Pa. v.
Highlands Ins. Co., 59 Wn. App. 782, 786, 801 P.2d 284 (1990). In fact, the test is not whether the
insurer’s interpretation is correct, but whether the insurer’s conduct was reasonable. Roberts v.
Allied Group Ins. Co., 79 Wn. App. 323, 326, 901 P.2d 317 (1995). A denial of coverage based on a
reasonable interpretation of the policy is not bad faith and, even if incorrect, does not violate the
Consumer Protection Act if the insurer’s conduct was reasonable. Transcon. Ins. Co. v. Wash. Pub.
Utils. Dists.’ Util. Sys., 111 Wn.2d 452, 470, 76-77 P.2d 337 (1988). If a court or jury, however,
determines that an insurer’s conduct was not reasonable the insurer is then estopped from denying
coverage, regardless of the terms of the policy.
If you think coverage should be denied, here are the Ten Commandments to Denial of
Claims to keep your conduct reasonable so as not to constitute bad faith. If you break these
commandments you could end up in the bad faith nightmare.
“Ten Commandments” to Denial of Claims.
1.
Adopt and implement reasonable standards for the prompt investigation of claims.
2.
Do not deny a claim without conducting a reasonable investigation based upon all
available information.
3.
Acknowledge and act reasonably promptly upon communications with respect to
4.
Deny coverage of claims within a reasonable time after proof of loss statements have
claims.
been completed.
5.
Promptly provide a written explanation based on a specific policy provision,
condition, or exclusion and explain why the provision mandates denial.
6.
Promptly list all reasons for denial in the explanation, and, if additional reasons
spring up after investigation, promptly amend the explanation of denial.
7.
Promptly disclose to first party claimants all pertinent benefits coverages and other
provisions of any policy that are pertinent to a claim.
8.
Do not misrepresent pertinent facts or insurance policy provisions relating to
coverage.
9.
If you believe a claim should be denied but denial is questionable, promptly reserve
your rights to deny the claim before defending or investigating a claim.
999999.0020/1144206.1
Stanton Phillip Beck
(206) 223-7000
becks@lanepowell.com
November 9, 2004
Jennifer McMillan Beyerlein
(206) 223-7000
beyerleinj@lanepowell.com
©Lane Powell Spears Lubersky LLP
2
10.
If you reserved your rights, properly defend the claimant until it is clear that the
policy does not cover the claim or until you get a declaratory judgment stating the same.
General Observations.
Adopt a reasonable claims manual, and follow it. If your company has established written
procedures for the handling of claims, and you deviate from the established procedures, you are
exposing the company to liability for failing to follow its own standard of care. It is great to have
high ideals but make sure the standards in the manual are practical and not just ideal. If you set
standards that are unreachable, you will be faulted for failing to achieve them. Of course, the
manual must comply with all state regulations. In a plaintiff’s guide to bad faith litigation,
specialists emphasize that discovery should include training materials and reference manuals used
within the insurance company. They state that “frequently such manuals will set high standards for
claims handling which can be difficult to meet.” B. Winchell & G. Harper, The Ins and Outs of
Discovery Plaintiff’s View, Bad Faith Litigation in Washington, NBI, Inc., pp. 20-21 (2001). This
advice is given because “[n]othing alienates a jury more than an insurer’s deviation from its own
written procedures.” Id. at 24. If you don’t have a claims manual, however, you will be criticized
for poor insurance trade practices.
Additionally, obvious items to avoid are inappropriate references to an insured or a witness
in terms that have long been held improper. References that a particular insured should be denied
because of race, sex, age, apparent wealth or poverty, or disability are red flags that will ring in the
ears of the jury during closing argument.
Similarly, expressions of hostility toward the person, or threats or use of the economic
advantage possessed by the company must be avoided.
Proper Investigation and Documentation.
“The failure of a liability insurer . . . to properly investigate . . . has frequently been held to
evidence its bad faith. . . .” Couch, Section 51:14, p. 403. “[A]n insurer must make a good faith
investigation of the facts before denying coverage and may not deny coverage based on a supposed
defense which a reasonable investigation would have proved to be without merit.” Kallevig, 114
Wn.2d at 916. Investigation is extremely important because an “insurer does not have a reasonable
basis for denying coverage and . . . acts without reasonable justification when it denies coverage
based upon suspicion and conjecture.” Kallevig, 114 Wn.2d at 916. An insurer can be held liable
999999.0020/1144206.1
Stanton Phillip Beck
(206) 223-7000
becks@lanepowell.com
November 9, 2004
Jennifer McMillan Beyerlein
(206) 223-7000
beyerleinj@lanepowell.com
©Lane Powell Spears Lubersky LLP
3
under the tort of bad faith or for a violation of the Consumer Protection Act regardless of whether
denial of the claim was ultimately correct. Coventry Ass’n v. Am. States Ins. Co., 136 Wn.2d 269,
279, 961 P.2d 933 (1998).
In the following cases, insurance companies were held liable for damages because their
investigations of claims were shown later to have been inadequate. In Coventry, 136 Wn.2d 269, an
insurance company’s investigation was inadequate where the adjuster looked at only two of the six
forms submitted by the insured and did not investigate the cause of damage. Even though the
insurer was ultimately correct in determining that the insured’s damages were not covered by the
policy, the court still held that the insured could bring a claim for bad faith investigation and
violation of the Consumer Protection Act.
Similarly, in Kallevig, 114 Wn.2d 907, although there was some evidence that an insured
started a fire to collect the insurance proceeds, the insurer failed to investigate its own claims
examiner’s statement that the fire may have been the result of an electrical contractor’s faulty
workmanship.
The court upheld a jury verdict for bad faith investigation and a Consumer
Protection Claim. It is imperative, when denying a claim, to do a thorough investigation. Even if
your claims adjuster is correct in determining that a claim should be denied, it is unreasonable to
base a denial on an uninvestigated set of facts.
Contact with Insured.
Document all attempts to contact the insured, whether by phone or in person. Use your
diary to explain why you were not successful, or the substance of what was discussed if you were
successful. Document broken appointments, complete with copies of any correspondence sent to
the insured confirming the meeting. Maintain a complete chronological log of your activity on the
file. The WAC 284-30-350 mandates insurers to keep files for all claims that contain all notes and
work papers pertaining to the claim. The file must contain adequate detail to reconstruct pertinent
events and the dates of such events.
Additionally, document any knowledge regarding the failure on the part of the insured to
(1) provide timely notice of the underlying claim; (2) provide timely notice or adequate information
regarding the underlying claim; (3) provide information relating to the defense of the underlying
claim; and/or (4) impede your investigation in any way.
999999.0020/1144206.1
Stanton Phillip Beck
(206) 223-7000
becks@lanepowell.com
November 9, 2004
Jennifer McMillan Beyerlein
(206) 223-7000
beyerleinj@lanepowell.com
©Lane Powell Spears Lubersky LLP
4
There are numerous Washington provisions regarding how and when to contact the insured
that are specific to denial of claims. WAC 284-30-380(1) provides that a denial of a claim must
include the grounds of a specific policy provision. If an insured fails to include this information, it
is prevented from asserting any defense based on the policy that was not claimed in the original
denial. This denial must be given to the claimant in writing and the claim file of the insurer must
contain a copy of it. Moreover, an insurer, within ten working days, must acknowledge receipt of a
claim, respond to communications from a client that reasonably suggest that such a response is
expected, and provide necessary claim forms. WAC 284-30-360.
Setting of Reserves.
Reserving a case is an important part of the claims handling process. You are ordinarily
required to evaluate a claim based upon its merits, and without regard to policy limits. Eastham v.
Oregon Auto Ins. Co., 542 P.2d 895 (Or. 1975). You should consider the claim first as if there were
no limits and consider what the claim would be worth. You should then compare that evaluation
with the limits. If the file reflects an evaluation that places the claim far in excess of limits, it will
be risky to reject a settlement offer within limits. Failure to do so can make the company liable for
the entire judgment when it is later learned that settlement offers within limits were rejected even
though the file indicated the company felt all along that the case had excess potential. Similarly, if
you set the reserve unrealistically low and refuse to settle for more than the reserve, you could also
be liable for bad faith if you refuse to settle.
Reserves should be set realistically but then reviewed periodically. Failure to do so can be
an important factor in holding the company liable for an excess verdict, as in Kunkle v. United
Security Insurance Company, 168 N.W-2d 723, 729 (S.D. 1969). In that case the insurance
company was held liable for bad faith in the handling of a liability claim where the file indicated an
initial $9,500 reserve was never increased, despite $5,000 in specials and a letter from counsel
which said that the “doctor’s opinion . . . plus the flagrant conduct spells dynamite.” The claimant
had a fusion and was rated at a 50% whole person permanent impairment. There was an offer to
settle for the $25,000 limits, but it was rejected, and there was a $45,000 verdict.
By the same token, if you have over-reserved the case, and then deny a settlement demand
within that reserve, you will open yourself to an excess verdict. Kabatoff v. Safeco Insurance
Company, 627 F.2d 207 (9th Cir. 1980). The case was reserved at $22,500, but a $10,000 demand
999999.0020/1144206.1
Stanton Phillip Beck
(206) 223-7000
becks@lanepowell.com
November 9, 2004
Jennifer McMillan Beyerlein
(206) 223-7000
beyerleinj@lanepowell.com
©Lane Powell Spears Lubersky LLP
5
was refused. Later an excess verdict on a $25,000 limits policy resulted in the insurance company
being held liable for the excess.
Following Washington Claims Handling Rules When Denying Coverage.
A frequent source of bad faith claims is the alleged failure to comply with claims handling
regulation requirements. The most important claims handling regulation is WAC 284-30-330,
which lists 19 specific unfair claims practices that are violations of RCW § 48.01.030, which, in
turn, are per se violations of the Consumer Protection Act. There are, however, other regulations
within the chapter that should be considered, especially involving time limits. Even though not all
of the provisions are per se violations like those in WAC 284-30-330, a violation of these provisions
creates a question of fact as to whether the insurer’s conduct was reasonable.
Under WAC 284-30-370, an insurer must complete an investigation within 30 days after
notification of a claim or give notice to the insured why it cannot do so. Most importantly, though,
when dealing with the denial of claims, the insurer must advise the claimant of the denial of the
claim within 15 working days after receipt of the proof of loss. WAC 284-30-380. Failure to follow
the statutory prescribed time limits can give rise to a bad faith claim based on the Washington
Administrative Code.
Reservation of Rights.
If the company intends to challenge coverage, certain steps must be taken to prevent a claim
of bad faith.
The general rule is that if an insurer conducts an insured’s defense without timely reserving
its right to deny coverage, it cannot later deny the claim based on any policy defense if it had or
should have had notice at the time it assumed the insured’s defense. An insurer, therefore, should
set out in its reservation of rights letter every reason of which it is aware, or should then be aware,
why the insured ultimately might not be entitled to coverage.
To be effective, a denial of coverage needs to be specific. If you start out with a reason for
the denial and change bases later on, you may well be precluded from asserting the latter defense.
Some companies use a “waiver of rights” form when they begin an investigation of a questionable
claim. It will be most effective if, along with the general statement that by proceeding with
investigation the company is not estopped from denying the claim, the waiver contains a reference
999999.0020/1144206.1
Stanton Phillip Beck
(206) 223-7000
becks@lanepowell.com
November 9, 2004
Jennifer McMillan Beyerlein
(206) 223-7000
beyerleinj@lanepowell.com
©Lane Powell Spears Lubersky LLP
6
to the specific reason that you initially suspected a coverage defense and specific policy language
where appropriate. If the policy term appears to have lapsed, say so. If the driver was no longer a
resident relative using the insured’s car on a regular basis, say so. If the event that caused the loss is
not a covered one, say so. If further investigation shows there are other reasons for the denial,
supplement your letter when the later information is discovered.
A coverage defense, if not timely asserted, may later be foreclosed by your failure to
document your file with the facts and not following that up with an appropriate letter. In one
Washington Supreme Court case, the court held that although the accident was not covered by the
insurance policy, the insurer may have acted in bad faith by failing to notify the insured of its
decision to defend under a reservation of rights for two months, delaying the insured’s attorney and
using that delay to enhance its own position, failing to investigate the claim properly, and exhibiting
more interest in its financial risk than the interests of the insured. Safeco Ins. Co. of Am. v. Butler,
118 Wn.2d 383, 395, 823 P.2d 499 (1992). If found to have acted in bad faith, the insurer is
estopped from denying coverage even though the claim was not covered by the insurance policy.
Id.
If you believe that there is no coverage, you still have a duty under a reservation of rights to
provide an adequate defense for the insured until you have received a declaratory judgment
determining your liability. Insurers defending under a reservation of rights have an “enhanced
obligation of fairness” to the insured, which means that you must (1) thoroughly investigate all
issues involved in the claim; (2) retain competent defense counsel; (3) keep the insured informed of
all developments in the lawsuit and the insurance policy; and (4) refrain from engaging in any
action that shows more concern for your monetary interest than in the insured’s financial risk. Tank
v. State Farm Fire & Cas. Ins. Co., 105 Wn.2d 381, 388, 715 P.2d 1133 (1986). As with all dealings
with an insured, the insurer “must always give equal consideration in all matters to the well being of
its insured.” Tank, 105 Wn.2d at 390. This enhanced obligation is created by the potential conflict
of interest between the insurance company and the insured. Failure to satisfy the obligation may
result in liability of the insurance company, or retained defense counsel, or both. Id. at 387-88.
Additionally, a reservation of rights demands that the retained counsel understand that he
represents only the insured and not the company. The defense counsel owes a duty of full and
ongoing disclosure to the insured when advising him of potential conflicts of interest between the
999999.0020/1144206.1
Stanton Phillip Beck
(206) 223-7000
becks@lanepowell.com
November 9, 2004
Jennifer McMillan Beyerlein
(206) 223-7000
beyerleinj@lanepowell.com
©Lane Powell Spears Lubersky LLP
7
insurer and the insured. He must also inform the insured of all information relevant to the insured’s
defense including realistic and periodic assessment of an insured’s chances to win or lose the
pending suit. Finally, all offers of settlement must be disclosed to the insured as those offers are
presented. Tank, 105 Wn.2d at 388-89.
If there is a duty to defend the insured under your policy and you believe that the act/claim
is not covered, it is best if you reserve your right to deny first, then determine whether or not the
claim is covered. If you cover your bases in this manner, provide an adequate investigation and
defense up until you are sure you are correct in your decision to deny, you will avoid a bad faith
claim for failing to defend and estoppel for failing to reserve your rights.
Use of Attorney-Client Privilege and Work Product.
If you use an attorney to help determine whether or not to deny a claim, it would behoove
you to remember that the work product performed and the advice given may be discoverable. It is
unsettled whether advice from counsel is a defense against bad faith in Washington.
Other
jurisdictions that do allow a defense of advice of counsel, however, require the waiver of the
attorney-client privilege once it is asserted.
While the assertion of attorney-client privilege and work product may be successful in some
instances, you may not count on these doctrines as guarantees against disclosure or as protection
from a bad faith claim. A judge or jury will still have to determine whether or not relying on such
advice was reasonable given the circumstances. The safest practice, when you do need the advice
of counsel, is to follow the attorney’s advice honestly and in good faith. It will look even worse if
the other side learns that your attorney advised you to settle a claim that you later denied.
Conclusion.
Even though you believe the claim should be denied, there is a lot to do to protect yourself
from bad faith claims in the future. The best strategy is to document all aspects involving a claim
and follow any mandates of the law. Remember, mistakes, clumsiness, and reasonable denials do
not count as bad faith. “As long as the insurance company acts with honesty, bases its decision on
adequate information, and does not overemphasize its own interests, an insured is not entitled to
base a bad faith or [Consumer Protection Act] claim against its insurer on the basis of a good faith
mistake.” Coventry, 136 Wn.2d at 280.
999999.0020/1144206.1
Stanton Phillip Beck
(206) 223-7000
becks@lanepowell.com
November 9, 2004
Jennifer McMillan Beyerlein
(206) 223-7000
beyerleinj@lanepowell.com
©Lane Powell Spears Lubersky LLP
8