Defensive moves: assessing whether to try or settle a bad faith lawsuit involves many factors with much at stake for various parties.

Insurance companies are being sued with increasing frequency for violating an insurance policy's implied duty of good faith and fair dealing--or acting in "bad faith"--in the handling of a claim. Although appropriate internal policies along with sufficient training for claims handlers can limit bad faith exposure, these suits are on the rise nationwide and are costing insurance companies hundreds of millions of dollars every year. With so much at stake, insurance company executives, claims analysts, and attorneys increasingly face the enormously difficult and risky decision of whether to take these bad faith suits to trial or to settle them.

Many bad faith suits arise when an insurance company denies or delays payment of a claim made by its insured. Known as "first-party bad faith" (the first party is the policyholder), these suits arise in a wide variety of circumstances involving, for example, health or life insurance claims, property damage under a homeowners policy, or claims under an automobile policy for injuries caused by an uninsured motorist.

The stakes in any first-party bad faith lawsuit can be huge. Typically, damages sought are not limited to the actual insured loss, such as the medical bills, property damage or physical injuries; but rather, damage demands also include a host of difficult-to-quantify, but potentially enormous, claims for emotional harm, mental anguish and punitive damages.

Prevention From Within

Perhaps the most effective protection from bad faith is a well-trained and knowledgeable claims handling staff. Training should ensure that claims professionals understand their state's relevant unfair insurance practices acts and regulations. It also should ensure that professionals have a basic knowledge of insurance policies, bad faith law, medical terminology and treatment. In addition, claims professionals need to be aware of tactics used by plaintiff's counsel to elicit responses that can help them build--even manufacture--a bad faith case. These tactics can include a deluge of faxes and other correspondence designed to be confusing, confrontational and accusatory--even to the point of misstating conversations between the claimant and claims professional.

Of course, internal company policies on the handling of claims also go a long way toward thwarting bad faith claims. Examples of effective claims handling include requiring the claims professional to contact the insured and to obtain relevant information in a timely manner. However, policies can do little if claims professionals do not have the best tools to do their job. Many insurance companies rely on outdated form letters that can be insensitive and confusing--the result is a claimant who might be intimidated and annoyed enough to call a lawyer. Studies show that claims involving the insured or claimant represented by counsel cost more than those in which counsel is not involved. Thus, prompt, well-informed and professional claims handling can save millions in potential damages from a bad faith case.

Weighing the Options

Despite good internal controls and training, most of America's largest insurance companies eventually face bad faith allegations. To be sure, many first-party bad faith lawsuits are legally defective. For example, they allege bad faith when an insurance company denies a claim that is not covered by the policy, when an insurance company reasonably, but incorrectly, believes a claim is not covered or the injuries alleged are overstated, or when a claims analyst makes an honest mistake in handling a claim. The law in few jurisdictions will find insurers guilty of bad faith under these circumstances. Insurers should file motions to dismiss such lawsuits and, if the law is properly applied, they will likely be successful.

When a case is not dismissed, the threat of a trial frequently forces a settlement even if a case has no legal or factual merit. Trials are expensive, time-consuming and risky for both parties. A trial is particularly problematic for an insurance company because it disrupts normal operations; it forces the company to incur the costs of having its employees participate in trial proceedings and it requires the company to pay the steep legal costs for a trial that can last for weeks or months. Moreover, the company must consider whether the case justifies the risk of having its fate decided by a jury that is almost certain to hold sympathy for the underdog  plaintiff.

One of the most difficult decisions facing an insurance company executive and trial counsel is whether to fight a bad faith claim by taking it to trial or to simply pay a settlement that may be far more than the claim is worth, but likely cheaper than the cost of a trial or, worse, paying a runaway jury verdict. Moreover, if the claim goes to trial, the decision whether to move forward or settle must be re-evaluated constantly in the face of new evidence and analysis.

The following are specific areas where an insurance company and its lawyers should focus their attention and expertise:

Does the case present legal issues for an appellate court to reverse an adverse verdict? From the moment a bad faith lawsuit is brought, an insurance company and its attorneys must not only ask themselves the question "How do we win this case if it goes to trial?" but also "How do we win this case on appeal?" Even the worst trial result imaginable can be reversed if the case presents a solid legal issue that has been properly pursued and preserved before the trial court.

How will the judge and jury view the case? Assessing the likelihood of a favorable trial verdict is at the core of any decision to try or settle a bad faith lawsuit. The heart of any trial strategy requires a simple story that tells the jury how the insurance company views the case. Any strategy also must include anticipating the plaintiff's story and developing themes to rebut it. Finally, one must consider the reactions of the judge and the jury to the competing story themes and to the witness testimony and documentary evidence. The following should be considered when assessing how a judge and jury may view a case:

How will the witnesses and documents come across at trial? Ultimately a trial is won or lost by the testimony and the documents that are presented to the jury. The company and its lawyers should assess the likability and credibility of company and plaintiff witnesses, as well as any experts who testify. Documents and internal communications presented to the jury should not reflect overly critical or flippant attitudes toward the plaintiff, his or her attorney or the judge handling the case.

Will the company's actions make the judge or the jury angry? Regardless of the actual legal issues presented by the case, a jury is more likely to find against an insurance company if the company has acted in a way that angers the jury. Because human nature loves the underdog, particularly if its opponent is perceived to be a wealthy, faceless corporation, virtually every jury will be predisposed to favor the plaintiff. This predisposition will be magnified if the plaintiff's attorney can present any evidence that the insurance company handled the plaintiff's claim callously, unfairly, without compassion, with needless delays, or in a way that appears greedy. Some studies show that plaintiffs win bad faith trials more than half of the time, a significantly higher average than the 40% win ratio for general tort claims. This data indicates juries empathize more with plaintiffs in bad faith cases and/or view insurer defendants less favorably than other types of defendants.

How seriously has the plaintiff been injured? If a plaintiff is badly hurt, a jury is likely to be sympathetic toward the claim and want to compensate him or her for injuries regardless of who caused them. Any consideration of whether to try a case must anticipate this reaction and any trial strategy must attempt to deal with the plaintiff's injuries or lack of injuries. A claim for mental anguish can be serious, but it is less likely to inflame a jury than a claim for an actual physical injury that the insurer has allegedly caused. For example, if the insurance company denies a claim or delays a payment and that causes the plaintiff to forgo some critical medical treatment, the jury is far more likely to want to award huge damages against an insurer.

Will punitive damages be considered by the jury? Perhaps the biggest wild card in bad faith cases is the threat of punitive damages. Though punitive damage awards have been restricted by recent court decisions that seek to rectify the most egregious awards, the threat of punitive damages still represents an enormous risk to an insurance company. According to studies by General Cologne Re and Jury Verdict Research, the average compensatory award for bad faith cases ranges from $600,000 up to $1 million. In contrast, the average punitive damage award range for these cases is $7 million up to $10 million, and in some cases, the cost can be much more.

Of course, a single large award can skew these figures. However, it is safe to say that punitive damage awards can increase an insurance company's bad faith exposure by millions of dollars. Clearly, if the jury has the discretion to award punitive damages at trial, that factor must be carefully considered in assessing whether to settle the case or take it to trial.

The Cost-Benefit Analysis 

Whether an insurance company takes a case to trial ultimately depends on how the company assesses the relative costs and benefits of doing so. The short-term cost of a settlement is obviously the amount of money that the plaintiff will accept to settle the case. Sometimes, plaintiffs' lawyers never move to a settlement demand that is within the company's range of consideration, making the decision to go to trial an easy one. The short-term benefits of a settlement are equally obvious. The risk of a huge adverse verdict with the attendant bad publicity is avoided. More tangibly, settling will avoid the often enormous cost of taking a case to trial.

But the company also should consider the long-term costs and benefits settlement will have within the company and in the outside world:

* Internal costs/benefits. How will settlement of this case affect the people who handle hundreds of similar claims for the company? If a meritless case is settled for an inflated value, the analysts who handle these claims may feel that the company has abandoned them. If the company stands behind its analysts and fights meritless claims, its employees may be more likely to reward the company with similar loyalty.

* External costs/benefits. How will the settlement affect other cases? If the company is perceived as settling almost any bad faith case that is filed against it, the result may be more bad faith suits by more plaintiff's attorneys eager to get more "easy money." If the company settles, it may lose an opportunity to make good law or to demonstrate it is not afraid to fight cases that should be fought.

Clearly it is in the best interest of every insurance company to build internal controls and provide training for claims professionals with the goal of avoiding bad faith allegations. However, with the enticement of lucrative verdicts, plaintiff's lawyers will continue to file more and more bad faith lawsuits, and the expense of litigating these cases will increasingly become a cost of doing business. The decision to take a first-party bad faith case to trial is always a difficult one for the insurance executive and counsel. But it also is an important decision that has serious implications lot the company and the industry.

The Litigator's Toolkit

When a trial is imminent, and with so much at stake in a bad faith litigation, making full use of trial tools and the latest technology is of critical importance. A growing number of tools exist to help evaluate and present the insurance company's argument, for example:

Mock juries: Presentations to mock juries test possible trial themes and the likely reaction of the actual jury to the arguments, witnesses, and other evidence that will be presented at trial.

Shadow juries: Provide neutral observations and reactions to the actual trial proceedings. Each day after trial their comments are collected and analyzed to help shape the next day's arguments and testimony.

Technical support: Technical support presents documents, video excerpts of key depositions and explanatory graphics to reinforce key arguments and themes for the jury.

William H. Briggs Jr. is a partner in the law firm of Ross, Dixon & Bell LLP.