How to Avoid Bad Faith Setups

Insurance companies are in the business of providing important financial and logistical assistance when customers experience some kind of event or incident covered by a policy. Those things—often unexpected, and almost always unwanted—can also happen to insurance companies, so they need protections in place to deal with similar situations.

Using a Q&A format, this article will explain why insurance companies should consider securing Insurance Company Professional Liability (ICPL) coverage and offer tips on organizational best practices for dealing with claims situations.

Q: Why is ICPL coverage so important?

Insurance companies have unique needs. This is especially true when it comes to an insurance company’s own professional liabilities. To meet those needs, it’s important for insurance companies to partner with an ICPL coverage provider that can offer the right products and services. Insurance companies face the risk of lawsuits from customers or third parties alleging errors or omissions in areas such as claim handling, the decision to rescind a policy, or loss control and safety inspection services, among others.

ICPL policies can either be written primary to or excess of the company’s reinsurance treaties.

If an insurance company is faced with a lawsuit alleging errors or omissions, an ICPL policy can be triggered to help pay for legal expenses, as well as provide coverage for extra-contractual damages such as punitive damages, emotional distress and statutory damages, among others.

In today’s litigious environment, insurers are increasingly seeing claims made against them alleging bad faith actions. In certain jurisdictions, insurance companies can face aggressive tactics by plaintiff attorneys who have the goal of obtaining damages that exceed the policy limit through bad faith allegations. These are often referred to as bad faith setups.

Q: How can insurance companies avoid these bad faith setups?

Understanding the legal requirements and case law in particular jurisdictions is vital, as is recognizing the most common tactics that plaintiff attorneys may use to open up policy limits. Having access to an ICPL claim professional with expertise in handling extra-contractual claims is extremely important.

Insurance companies should look to engage an ICPL carrier whose claim team will help them navigate bad faith claims and whose underwriting team will work closely with the insurance company’s agent or broker to make sure policy language addresses the nuances of how bad faith claims are brought against insurers today.

Establishing open communication with your ICPL carrier and building a relationship with your ICPL claim team allows for early dialogue when concerning matters arise, and it helps reduce late-notice issues. Additionally, getting your ICPL carrier involved early on during catastrophic injury matters, even before they become a claim, may help avert a dangerous bad faith situation.

One way that Travelers helps inform and equip its ICPL customers against such legal tactics is through our continuing education Good Faith Claim Handling training. This program is led by members of the Travelers Enterprise Claim Legal Extra Contractual team to educate our customers’ claim handlers on critical issues that can drive losses and has been found to be a valuable risk management tool. For attending claim adjusters, continuing education course credits are available in many states throughout the U.S.

Q: If an insurance company does receive an allegation of bad faith or a demand for extra-contractual damages, who in the company should be involved in those situations?

In this scenario, there are multiple people who need to be made aware of the matter and be appropriately involved in its resolution. For example, if an adjuster receives an allegation of bad faith in a demand letter or during a verbal conversation with their insured, that should be a trigger to flag the claim file and alert appropriate claim management.

Ensuring that the company’s ICPL broker and carrier are brought into the matter as soon as possible will also help protect the company’s coverage rights under their policy. The ICPL carrier and its adjusters may be knowledgeable of the venue, the plaintiff’s attorney, and the set-up tactic. Also, they will often be aware of experts and outside defense counsel to help ward off the bad faith situation.

The organizational best practice is for the company to have an established chain of command for any extra-contractual situations. Having a clear threshold on who gets involved at what stage will help ensure these matters receive the proper attention and that nothing is missed. The chain of command should have a delineated process in place for notifying its broker and ICPL carrier of the potential issue, along with a procedure to track the matter in case the situation worsens. These situations could, and likely should, include leaders within the claim organization, risk management, the general counsel’s office, and the reinsurance department, where applicable.

Q: How does the reinsurance department play a role in ICPL claims?

Some reinsurance treaties contain coverage extensions for extra-contractual obligations (ECO) and excess of policy limit (XPL) liabilities. When this coverage exists in a treaty, it is important that the ICPL policy and the reinsurance treaty are aligned to work in tandem. There are several points to consider when purchasing an ICPL policy in conjunction with ECO/XPL reinsurance coverage.

Unlike ICPL coverage, reinsurance treaties typically do not provide protection for alleged errors in non-claim handling arenas of the insurance operations, such as risk management, loss control, actuarial consulting, premium financing, or other services provided in connection with a company’s insurance products.

Additionally, a consideration should be made for the potential exhaustion of limits within the reinsurance treaty by contractual matters, leaving no remaining cover for ECO/XPL matters. For example, occurrence-based casualty treaty limits purchased years ago may not be sufficient to deal with both the contractual and extra-contractual losses stemming from a nuclear verdict in today’s environment.

Lastly, it is important for insurance companies to consider how certain exclusions in reinsurance treaties may impact ECO/XPL coverage. If an insurance company makes an underwriting concession to accept a unique risk outside of its normal business appetite, that class of business may be excluded by the reinsurance treaty. It should be noted that any facultative reinsurance purchased in such a scenario would not typically cover ECO/XPL claims. Similarly, if ECO provisions in the treaty contain fraud or criminal conduct exclusions, the treaty will not be able to provide coverage to the same extent as a well-crafted ICPL form.

Insurance companies should make sure to discuss with their agent or broker how to best align their ICPL coverage and any available ECO/XPL coverage available in their treaties. ICPL policies can either be written primary to or excess of the company’s reinsurance treaties. On an excess basis, for example, Travelers has structured certain ICPL policies to dovetail with a reinsurance treaty by dropping down to cover the company’s coinsurance responsibilities and allowing any ECO/XPL treaty payments to fund the ICPL retention. It is important to ensure that the language in the reinsurance treaty and the ICPL policy designate which party is taking the lead and how the two will work together.

In today’s environment, being adept at handling extra-contractual matters is an important part of an insurance company’s risk management function. Surrounding yourself with experts in the legal, coverage, and risk-sharing arenas of extra-contractual litigation, and having a clear plan in place to manage through these scenarios, is paramount to helping keep your company protected.