Research & Commentary: Bad Faith Insurance Legislation

Published September 1, 2010

All insurers of homes or cars reject at least some claims. Most rejections are because the claimant is simply not covered for the claim. Some result from strong suspicions—or even evidence—of fraud. Some represent honest, inadvertent mistakes by the insurer. Finally, there are cases in which insurers deny claims without legitimate reason. This is called “bad faith.”

When a company acts in bad faith, all states allow the affected individual to sue the insurer for damages. This system largely works well, with state agencies policing insurers and consumers working through the courts to receive damages when insurance companies act irresponsibly.

In the past several years, however, states have begun considering legislation to expand the definition of bad faith and create new ways to sue for claim denials, including some wrongful denials that don’t involve bad faith. New bad faith legislation has been proposed in several states, including Colorado, Florida, Georgia, New York, and Pennsylvania.

According to the American Legislative Exchange Council, these laws would “create new or expansive private causes of action, lower existing viable and fair standards that need to be met in order to file an action, and allow for recovery of additional penalties, including damages multipliers, punitive damages and one-way attorneys’ fees.”

Proponents of these laws, mostly groups supported by trial lawyers, say the new laws will “level the playing field” for consumers. Critics argue the new policies would weaken filing and recovery standards and cause an influx of new lawsuits, both frivolous and otherwise, claiming bad faith on the part of insurers even when such behavior did not occur.

The following documents examine the effects of bad faith legislation on claims handling and the insurance market as a whole.

The Law and Economics of First-Party Insurance Bad Faith Liability
This article analyzes automobile insurance claim settlement data in states with different bad faith regimes to identify potential incentive distortions.

The Effect of Bad-Faith Laws on First-Party Insurance Claims Decisions
This empirical study of the effect of bad faith laws on claims decision-making by insurance companies uses the 1992 database developed by the Insurance Research Council, drawn from thousands of “closed claims” under automobile insurance policies from more than 60 insurance companies.

PCI Analysis: The Impact of Enacting “Bad Faith” Legislation on Michigan’s Insured Consumers$file/MichiganBadFaith.pdf
This document from the Property Casualty Insurers Association of America describes the cost impact of bad faith legislation.

Washington Referendum 67 Opponents Fight to Stop Enactment of Bad Faith Law
This Issue Brief looks at the circumstances that gave rise to passage of Engrossed Substitute Senate Bill 5726, the so-called Insurance Fair Conduct Act, and the efforts of a broad-based coalition of consumer, business, and taxpayer groups known as Consumers against Higher Insurance Rates that is trying to defeat the referendum.

Frivolous Claim: The Need for Bad Faith Legislation
This commentary examines the general concept of bad faith, outlines the arguments often made for and against bad faith laws, and explains why such legislation does more harm than good.

The Effects of Third-Party, Bad Faith Doctrine on Automobile Insurance Costs and Compensation
This study examines the compensation paid by auto insurers to accident victims in California during a period (1979 to 1988) when punitive damage claims were permitted.

Expanding Insurance Liability Will Hurt Businesses, Consumers
This article from the Seattle Times examines some of the negative consequences bad faith legislation can have on consumers and businesses.

Trade Groups Highlight Oregon Bad Faith Bill’s Impact on Lawsuits, Insurance Costs
This release from the American Insurance Association, NAMIC, and PCI argues the Oregon Bad Faith Bill (HB 2791) “would clog courtrooms with frivolous lawsuits and drive up insurance costs by layering a new private right-of-action on top of the existing enforcement mechanism for the unfair claims practice statute.”

Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit the FIRE Policy News Web site at, The Heartland Institute’s Web site at, and PolicyBot, Heartland’s free online research database, at

If you have any questions about this issue or The Heartland Institute, contact Heartland Legislative Specialist Matthew Glans at 312/377-4000 or [email protected].