What Is Bad Faith Insurance?

Bad faith insurance refers to an insurer’s attempt to renege on its obligations to its clients, either through refusal to pay a policyholder’s legitimate claim or 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.

There are many ways in which an insurance company may act in bad faith. If a policyholder suspects bad faith, they should confront their insurance company or consult a lawyer.

Key Takeaways

  • Bad faith insurance refers to the tactics insurance companies employ to avoid their contractual obligations to their policyholders.
  • Examples of insurers acting in bad faith include misrepresentation of contract terms and language and nondisclosure of policy provisions, exclusions, and terms to avoid paying claims.
  • Simple mistakes do not constitute bad faith.
  • States have enacted laws to protect consumers from insurance companies' bad faith actions.

Understanding Bad Faith Insurance

Bad faith insurance can apply to any type of insurance policy—including homeowners' insurance, health insurance, auto insurance, and life insurance—and any type of contract.

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 their findings. Simply making a mistake does not constitute bad faith, either.

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 considered bad faith. If an insurer fails to promptly reply to a policyholder’s claim, that act of negligence, willful or not, is considered bad faith. To avoid acting in bad faith, insurers must also explain why they refuse to cover a claim or partly cover it.

Fighting Bad Faith Insurance

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 is a model for many other states’ bad faith laws.

Some laws require an insurance company acting 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. This compensation covers not only out-of-pocket expenses or borrowed funds to address damage but also missed work and attorney's fees.

If an insurance company acts particularly egregiously, 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.