Steps Disability Insurers Can Take To Stay Out Of The Courtroom

In recent years, bad faith lawsuits against disability insurers have resulted in tens of millions in jury awards.

For example, in May 2001, a Florida jury awarded $36.7 million to an eye surgeon, Dr. John Tedesco, whose claim was denied even though Parkinson’s disease made his hands tremble.

In February 2002, a California judge upheld a $7.67 million jury award (including $5 million in punitive damages) to a former chiropractor, Dr. Joan Hangarter, and sternly warned the insurer against future violations.

In April 2003, an Arizona jury awarded a cardiologist, Dr. Joanne Ceimo, $84.5 million (including $79 million in punitive damages) after it concluded that the insurer had unfairly denied her $12,000-a-month claim, although a judge later reduced the award to less than $20 million.

What can disability insurers do to avoid litigation and the potential for huge punitive damage awards?

The first step is to understand the nature of a disability bad faith claim and why it opens the door to extracontractual and punitive damages. An important motivation for obtaining disability insurance is to provide income during periods when the insured cannot work because of illness or injury. Insureds do not seek to obtain a commercial advantage by purchasing disability coverage–they seek protection against calamity. Disability insurance provides peace of mind and security in the event the insured cannot work.

To protect these interests it is essential that insurers fully inquire into all possible bases that might support the insured’s claim. Insurers must thoroughly investigate the claim and not withhold payment of claims unreasonably. If an insurer ignores evidence, it acts unreasonably toward its insured and breaches the implied covenant of good faith and dealing.

In Amadeo v. Principal Mutual Life Insurance Company, 290 F.3d 1152, 1164-65 (9th Cir. 2002), the 9th Circuit revisited the reasons courts allow tort remedies, including punitive damages, against insurers that deny disability claims in bad faith. As the court explained:

“The availability of punitive damages is…compatible with recognition of insurers’ underlying public obligations and reflects an attempt to restore balance in the contractual relationship. These considerations are particularly acute in disability insurance cases where the very risks insured against presuppose that if and when a claim is made, the insured will be disabled and in strait financial circumstances and, therefore, particularly vulnerable to oppressive tactics on the part of an economically powerful entity. Punitive damages are therefore made available to discourage the perpetuation of objectionable corporate policies that breach the public’s trust and sacrifice the interests of the vulnerable for commercial gain. Consistent with this goal, a plaintiff may meet the state of mind requirement for an award of punitive damages by showing that the insurer’s bad faith was part of a conscious course of conduct, firmly grounded in established company policy.”

The next step is to make sure disability claims are handled in good faith in accordance with insurance industry standards. Some of the standards:

–Insurance companies have a duty to treat their insureds fairly. First party claims handling is not an adversarial process.

–Insurance companies must treat the interests of the policyholder with at least equal consideration to their own interests.

–Insurance companies must thoroughly and fairly investigate and evaluate each claim, making a diligent effort to collect all facts necessary for good faith judgment on the claim and to weigh facts in a fair and honest way.

–When an insurance company is evaluating a claim for benefits, the financial impact on the insurance company should not be considered.

–The insurance company must not place undue emphasis on information favorable to itself. It must give fair consideration to information favorable to its insured.

–The insurance company should pay the claim unless there is a good reason not to–denial should not be based on speculation.

And finally, if a disability insurer is going to operate according to the spirit of the recent multistate settlement agreement negotiated by state regulators, it should be sure its claims handling procedures:

–Give significant weight to Social Security disability awards.