Insurer Liability For Failure to Pay Promptly

Every attorney who represents policyholders dreams of “hitting the big one” and holding an insurance company liable for treble damages for unfair settlement practices.  In the process, Texas’ Prompt Payment of Claims statute is often overlooked or under appreciated as an avenue of recovery.

The Prompt Payment statute (previously known as Art. 21.55) is now codified at sections 542.051-061 of the Texas Insurance Code.  This statute provides an 18% per year penalty for first party claims that are not paid after the insurer has had an opportunity to ask for information and conduct a reasonable investigation. What the statute lacks in damages, it makes up for in simplicity.  Recovery is automatic for any covered claim that has been delayed without regard to whether the insurer had a reasonable basis for the delay.

For example, suppose an insurance company offers $100,000 to settle a claim and insists on a release. The insured refuses and wants $200,000.  If the case is tried after three years of litigation, and the jury awards the insured the same amount offered (i.e., $100,000), the insurance company will still owe three years worth of prompt-payment damages ($54,000).  From the insured’s perspective, this is not a bad pay day for being wrong on the issue of valuation.

Note that the insurance company could avoid the foregoing result by tendering the $100,000 to the insured in a timely manner and not requiring a release. In this manner, it would meet its obligation to pay promptly and leave the insured free to pursue the additional value.  Under this scenario, the insurer would only owe the 18% penalty on the amount of covered damages found by the jury in excess of the $100,000.

If coverage is disputed by the insurer, the effect of the Prompt Payment statute is “all or nothing.”  That is, if the insurer is wrong and it is ultimately determined that the claim is covered, the 18% penalty is owed regardless of whether the insurer was acting reasonably in disputing the claim.  Conversely, if it is ultimately determined that the claim is not covered, no penalty is owed even if the insurer violated various deadlines under the statute for acknowledging the claim, investigating, and making its decision.

The Prompt Payment statute has been found to be applicable to costs associated with a breach of the duty to defend under a liability policy based on the characterization of such costs as a first party coverage.

Overview of First Party Bad Faith in Texas

Under most types of contracts, contractual damages are all that the law allows a party  to recover for  breach.  But the law has long recognized the unequal bargaining power between consumers and insurance companies and the need for special protections to prevent abuse by insurers. The usual mechanism by which these protections work is to expose the insurer to additional damages if it fails to handle a claim properly.  Because such damages are not contemplated by the insurance contract, they are generally referred to as “extra-contractual” damages and liability imposed on this basis is known as “extra-contractual” liability. A blanket term for this type of claim that is frequently used by attorneys without much precision is “bad faith”.  The remainder of this article discusses the extra-contractual remedies available to policyholders in Texas in a first party context.

In the context of a first party claim, a policyholder can bring a claim for breach of the common law duty of good faith and fair dealing as well as a claim for Unfair Settlement Practices under Subchapter 541 of the Texas Insurance Code.  There is considerable overlap in these two remedies.  Under both causes of action, the policyholder must prove that the insurer had no reasonable basis for denial or delay in payment of the claim.

Any reasonable basis is sufficient to allow the insurer to avoid bad faith liability.  Examples of what is considered to be a reasonable basis for denial include a legitimate dispute over the scope of damage to property or the cost of repair. A bona fide dispute over whether a claim is covered will also suffice. In addition, if it turns out that there is in fact no coverage for a claim, the insurer cannot held liable no matter how poorly it handled the matter.  In other words, the insurer can avoid bad faith liability if it was “right for the wrong reason”.

The principal difference in the common law and statutory causes of action  for bad faith relate to damages.  Under the common law, punitive damages are theoretically available but the current standard for recovery is so high that few if any plaintiffs have ever met it. The statutory cause of action is more attractive because it allows for recovery of treble damages if the insurer acted “knowingly”, as well as for recovery of attorneys fees.

But with a statutory claim, there is likely to be a dispute as to what qualifies as damages.  Some courts have held that policy benefits that are owed do not count because such benefits constitute contractual damages.

In the case of an individual policyholder, mental anguish damages can qualify as extra-contractual damages (subject to trebling) if the insurer is found to have acted knowingly.  Mental anguish damages are not available to corporate policyholders.  (Even though the U.S. Supreme Court has held that corporations are people, they still don’t have feelings.).

First Party and Third Party Claims Explained

If you are new to the study of insurance law, you may be confused by references  to “first party” claims and “third party” claims.  Who are these people, and what happened to the “second party”?  These terms derive from reference to the insurance policy as a contract.

There are two parties to the insurance contract: the insured and the insurance company.  By custom and practice, the insured is universally referred to as the “first party”.  The insurance company is the “second party” but for some unexplained reason, it is seldom if ever referred to in this manner. A “third party” is a stranger to the policy: that is, someone who is neither an insured or the insurer.

A first party claim is one which must be paid directly to the insured.  A claim for property damage under a homeowners policy is an example of a first party claim: the insured has suffered a loss of his own property and, if covered, the insurance company is required to pay him directly for it. Coverage that provides such benefits is usually referred to as  “first party coverage”.

A third party claim is one that involves damage or harm to a third party (i.e., someone other than the insured).  This is usually if not always  a liability claim.  If and when such a claim is settled, money will be paid to the claimant (the third party) rather than to the insured.  A typical example of a third party claim is a lawsuit against an insured driver who negligently caused an auto collision. Coverage that protects an insured from exposure to liability in this manner is called “third party coverage”.