DEFINITION of 'Bad Faith Insurance'

An insurance company’s appalling or malicious refusal to pay a policyholder’s legitimate claim. Bad faith insurance can also refer to an insurer’s refusal to investigate and process a policyholder’s claim within a reasonable period. Insurance companies act in bad faith when they misrepresent an insurance contract’s language to the policyholder to avoid paying a claim. They also act in bad faith when they fail to disclose policy limitations and exclusions to policyholders before they purchase a policy, or when they make unreasonable demands on the policyholder to prove a covered loss.

BREAKING DOWN 'Bad Faith Insurance'

Only looking for evidence that supports the insurance company’s basis for denying a claim and ignoring evidence that supports the policyholder’s basis for making a claim is also considered bad faith.

A difference in opinion between the policyholder and the adjuster over an adjuster’s opinion of the loss amount does not constitute bad faith, unless the adjuster refuses to provide reasonable support for his findings. Simply making a mistake does not constitute bad faith, either. The concept of bad faith applies to all types of insurance, from health insurance to homeowners insurance to disability insurance. Further, bad faith applies to any type of contract, not just insurance contracts.

State laws that specifically address bad faith practices, also called unfair claims practices acts, are meant to protect consumers against malicious behaviors by insurance companies. California law has served as a model for many other states’ bad faith laws. Laws provide for an insurance company that has acted in bad faith to pay basic damages to help compensate the victim for having a claim denied, above and beyond the amount owed under the claim. The policyholder may have had to pay out of pocket or borrow money to repair damage that insurance should have paid for, and may have missed work and spent money on attorney’s fees to pursue the claim against the insurance company.

Further, if an insurance company’s behavior is particularly egregious, a jury may award punitive damages to the policyholder to punish the insurance company for its wrongdoing and to discourage it from acting in bad faith with other policyholders. If the insurance company simply makes a mistake and has not acted in bad faith, the proper remedy is only to pay the claim; damages are not involved.

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