Running on faith: for disability insurers, the good, the bad and the ugly of bad faith litigation depends on how well they investigate an insured's claim.

In recent years there has been a proliferation of bad faith lawsuits against disability insurers resulting in tens of millions of dollars in jury awards.

For example, in May 2001,a Florida jury awarded $36.7 million to an eye surgeon whose claim was denied even though Parkinson's disease had 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 and sternly warned the insurer against future violations. And in January 2003, a California jury awarded $31.7 million (including $30 million in punitive damages) to another eye surgeon. Although the verdict was reduced to $6.1 million, the judge rebuked the insurer for the "creation of a claims-handling procedure that appears designed to avoid performing a thorough, competent and objective investigation of a plaintiff's claim."

So, 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 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 vs. Principal Mutual Life Insurance Company, the 9th Circuit revisited the reasons courts allow tort remedies, including punitive damages, against insurers who 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. Insurance companies:

* Have a duty to treat their insureds fairly. First-party claims handling is not an adversarial process;

* Must treat the interests of the policyholder with at least equal consideration to their own interests;

* 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 evaluating a claim for benefits, the financial impact on the insurance company should not be considered;

* Must not place undue emphasis on favorable information and must give fair consideration to information favorable to the insured;

* Should pay claims unless there is a good reason not to--denials should not be based on speculation.

And finally, companies should take a page from the recent Multistate Settlement Agreement between Unum-Provident (the largest writer of disability insurance in the United States) and state insurance regulators--be sure claims handling procedures include:

* Giving weight to Social Security disability awards.

* Giving weight to objective/subjective findings and the treating doctors' opinions when evaluating impairment.

* Looking at comorbid claims collectively.

* Selecting unbiased, financially disinterested, fully trained medical examiners for independent medical examinations.

These new claim objectives create a good-faith checklist and should help disability insurers avoid bad-faith litigation.

Frank N. Darras, a Best's Review columnist, is a partner with Shernoff Bidart Darras LLP, Claremont, Calif. He is a plaintiff's lawyer representing disabled insureds. He can be reached at [e-mail].