March 1, 2013

Supreme Court says insurance companies can't shield their claim-adjusting process

Riper

In a case decided last week, the Washington Supreme Court declared that insurance companies must investigate, process and resolve insurance claims openly with the insured, even if that means forfeiting the insurer's attorney-client privilege.

An insurance company faces a conflict of interest whenever it gets a claim. On the one hand, the policy promises that the insurer will investigate the claim, decide whether there is coverage, and pay whatever benefits are owing under the terms of the policy. But at the same time the insurer's financial interests weigh toward denying coverage whenever possible, and paying out as little as possible any time there is coverage for a claim.

So Washington law requires that whenever an insurer receives a claim for policy benefits, the company must process the claim fairly (or in “good faith,” as the law calls it).

Insurance regulations require the insurer to adjust claims evenhandedly, giving equal consideration to the insured's interests as to the insurer's interests. The insurance company must conduct a prompt and reasonably thorough investigation of the claim, must decide whether there is coverage, and must decide how much in benefits are owing if there is coverage.

The insurer must communicate the results of its investigation and its coverage determinations to the insured. And the insurer must document all of its conduct in a claim file.

If the insurer fails to comply with those duties, it may be found to have acted in bad faith. The consequences to the insurer can be substantial:

• The insurer may be deemed to cover the claim even where the policy terms didn't provide coverage.

• The insurer may become liable for consequential damages or even punitive damages to the insured.

• The insurer may be liable for the legal fees of its insured in a suit over the insurer's bad faith.

When an insurer and its insured get into a dispute over insurer bad faith, the insured asks to look at the insurer's claim file, since that file is supposed to document what the insurer did in adjusting the claim. Insurance companies often contend that contents of their claim file are privileged, so that the insured isn't allowed to see them.

In extreme cases, insurance companies use attorneys to perform some or all of the claim-adjusting process, and then assert that everything the attorney has done is protected from review under the attorney-client privilege. That strategy will no longer be viable in light of the Supreme Court's recent decision. Indeed, any attempt by an insurer to shield its claim file from review by the insured will be much more difficult than previously thought.

The recent case arose out of a fire that destroyed the upper floor of a house insured by Farmers. The fire marshal found no evidence of arson, and concluded the fire probably resulted from an ornamental candle that the homeowner's girlfriend had placed on the headboard of their bed.

The homeowner made claim under the policy, which covered property damage from accidental fire. A Farmers adjuster estimated that the value of the insured's property damage was more than $100,000. But Farmers refused to make a coverage decision, and failed to tell the insured how much he was entitled to under the policy.

Months went by, and Farmers would not even return the calls from the insured asking about the status of the claim.

Farmers then hired an attorney, who performed tasks that were part of Farmers' adjustment of the claim.

The attorney examined the insured and his girlfriend under oath. The attorney communicated with the insured about possible coverage positions that Farmers might take. But neither the attorney nor anyone else at Farmers actually made a coverage decision, or told the insured how much he was owed. Instead, the attorney wrote a letter making a one-time offer to settle for $30,000, and saying the offer had to be accepted within 10 days.

The insured tried calling the attorney to discuss the offer, but his calls were ignored.

Ultimately, the insured hired his own attorney and started suit against Farmers alleging insurer bad faith. The insured asked to see the contents of Farmers' claim file, but Farmers released only a heavily redacted version of it, claiming most of it was protected from disclosure by the attorney-client privilege.

The insured objected.

The trial judge reviewed the claim file privately, then overruled Farmers' claim of privilege. But before the insured could see the file, Farmers appealed. That appeal eventually reached the Supreme Court.

The Supreme Court ruled in favor of the insured, and established principles that will prevent insurers from shielding their claim adjusting process from their insureds.

The court first declared that the presumption in bad faith cases is that nothing related to the insurer's adjusting of a claim is privileged from disclosure to the insured. The insurance company can hire counsel to provide legal advice to the insurer, but the insurance company will need to make certain that the attorney is not participating in the claim adjustment process or else communications between the company and the attorney will be unprivileged.

Moreover, even when an insurer insulates the investigation and adjustment of a claim from its communications with its own attorney, an insured can have a court privately review the allegedly privileged materials to see whether they relate to a credible claim of insurer bad faith. If they do, the insurance company forfeits its attorney-client privilege over those materials.

The Supreme Court's decision creates a powerful incentive on insurance companies to investigate and adjust claims evenhandedly. Knowing that their claim process will be subject to after-the-fact review by the insured (and possibly by a judge and jury) should encourage insurers to be scrupulous in dealing fairly with their insureds.

John Riper is the managing partner at Ashbaugh Beal and focuses on construction and insurance recovery law.