Bad Faith Insurance Claims: An Overview

Insurance bad faith refers to an insurer's unreasonable failure to honor its obligations to its policyholder — denying valid claims without basis, delaying payment unreasonably, failing to investigate, or refusing to settle claims within policy limits when settlement is warranted. It is a claim by the policyholder against their own insurer, distinct from the underlying injury claim.

The duty of good faith is implied in every insurance contract: insurers must act reasonably and in the policyholder's interests when handling claims. In the liability context, this includes the duty to defend the policyholder against lawsuits and the duty to settle within limits when a reasonable insurer would do so. An insurer that gambles with its policyholder's money — refusing a reasonable within-limits settlement and exposing the policyholder to an excess verdict — commits the classic bad faith.

First-party bad faith involves the insurer's handling of the policyholder's own claim: unreasonably denying or delaying payment of UM/UIM benefits, disability claims, or property losses. The standards vary by state, with some requiring proof of the insurer's knowledge that its position was unreasonable.

Remedies

Bad faith remedies go beyond the policy benefits: consequential damages caused by the insurer's conduct, attorney's fees, and in egregious cases punitive damages. The availability of extra-contractual damages is what gives bad faith claims their force — without them, insurers would have little incentive beyond the policy amount itself to handle claims fairly.

Some states allow third-party claimants (the injured person, not the policyholder) to bring bad faith claims directly in limited circumstances; most restrict bad faith to the policyholder-insurer relationship, with the injured person benefiting indirectly when the policyholder assigns the claim after an excess verdict.

In Practice

Bad faith shadows serious injury negotiations: when an insurer refuses to tender limits on a claim clearly worth more, the policyholder's attorney may set up the bad faith claim through time-limited demands and careful documentation. The dynamic disciplines insurers — the risk of extra-contractual exposure encourages reasonable settlement behavior.

Bad faith law is, at bottom, about the insurance bargain: policyholders pay premiums for peace of mind, and the law requires insurers to deliver it. When they do not, the remedy reflects the betrayal of that bargain.

The Duty to Settle Within Limits

The duty to settle within policy limits is bad faith law's core: when a claimant offers to settle for the policy limits and a reasonable insurer would accept — because the claim's value clearly exceeds the limits and trial risks an excess verdict — the insurer must accept. Refusal exposes the policyholder to personal liability for the excess, and the insurer to bad faith liability for the resulting harm.

Time-limited demands are the claimant's tool for crystallizing the duty: a settlement offer for limits, open for a defined period, with the necessary releases and information for the insurer to evaluate. The demand's reasonableness — supported by the liability facts and damages documentation — determines whether rejection constitutes bad faith. Manufactured 'gotcha' demands with impossible deadlines generally fail; genuine opportunities to protect the policyholder succeed.

Excess verdicts following rejected demands create the classic bad faith fact pattern: the jury awards more than the limits, the policyholder faces personal exposure, and the insurer's rejection is examined for reasonableness. The policyholder typically assigns the bad faith claim to the injured claimant, who then pursues the insurer directly for the excess.

Insurer defenses focus on the demand's genuineness and the evaluation's reasonableness: debatable liability, incomplete information, or demands exceeding what was reasonably knowable at the time. The inquiry is fact-intensive and retrospective — judging the rejection decision by what the insurer knew when it decided, not by the verdict that followed.

First-Party and Third-Party Bad Faith Compared

First-party bad faith — the insurer's unreasonable handling of its own policyholder's claim — is widely recognized: the contractual relationship implies good-faith claims handling, and unreasonable denials or delays breach the implied duty. The remedies include contract damages plus the consequential and sometimes punitive damages that give the claim its force.

Third-party bad faith — the injured claimant's direct action against the at-fault driver's insurer — is recognized in only a minority of states, with most limiting bad faith to the insurer-policyholder relationship. The majority view reasons the insurer owes duties to its policyholder, not to the adversary claimant; the minority view finds duties to the claimant in the settlement context.

The practical consequence is that most bad faith leverage operates through the policyholder: the claimant's time-limited demand creates the policyholder's bad faith claim, which the policyholder assigns to the claimant after an excess verdict. The indirect route achieves substantially what direct third-party bad faith would, through assignment rather than direct action.

Related reading: Homeowner's Insurance and Dog Bite Claims

This article provides general information only and is not legal advice.

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This article is general information, not legal advice. It does not create an attorney-client relationship.