Bad faith: what it means and when it applies

An insurance policy is a contract, and in most states insurers owe policyholders something beyond ordinary contractual obligations — a duty of good faith and fair dealing.

Where that duty is breached, remedies may extend beyond the amount owed under the policy.

The reasoning

Courts have recognized that the insurance relationship is not an ordinary commercial one.

The policyholder pays premiums over years for protection at a moment of vulnerability. The insurer controls the investigation, the evaluation and the payment. The bargaining power is unequal, and the consequences of wrongful denial fall on someone already suffering a loss.

Ordinary contract remedies — payment of what was owed — would leave an insurer with little incentive to pay promptly, since the worst outcome of delay would be paying later.

Bad faith doctrine addresses that asymmetry.

What can constitute bad faith

The standards vary substantially by state, and common categories include:

Denying a claim without a reasonable basis, where the insurer knew or recklessly disregarded that there was no reasonable basis.

Failing to conduct a reasonable investigation before denying.

Unreasonable delay in investigating, evaluating or paying.

Misrepresenting policy provisions or the facts relevant to a claim.

Failing to communicate, including not responding to inquiries or not explaining a denial.

Offering substantially less than the claim is worth to pressure a settlement.

Failing to settle a liability claim within policy limits when there was an opportunity to do so and the insured was exposed to an excess judgment.

That last category deserves emphasis because it is the most consequential.

Third-party bad faith

Where an insurer defends you against a claim, it controls the defense and the settlement decision.

If a claimant offers to settle within your policy limits, and the insurer refuses, and a judgment is then entered above the limits, you are personally exposed to the excess.

Most states hold that an insurer that unreasonably refuses a within-limits settlement opportunity may be liable for the entire judgment, including the portion above the limits.

The reasoning is that the insurer gambled with the insured's money.

This is the most established form of bad faith liability and the one with the largest awards.

First-party bad faith

Where the insurer wrongfully denies or delays your own claim — property, disability, health, life.

Recognition varies more here. Some states allow tort claims for first-party bad faith; some limit remedies to contract damages; some provide statutory remedies instead.

Available remedies where recognized may include the policy benefits, consequential damages such as costs incurred because of the wrongful denial, emotional distress damages in some jurisdictions, attorney fees, and punitive damages where the conduct was sufficiently egregious.

What is not bad faith

Important to state, because the term is used loosely.

A genuine dispute about coverage is not bad faith. Insurers are entitled to deny claims they reasonably believe are not covered, and to litigate genuine disputes.

Most jurisdictions apply a standard along the lines of whether the insurer had a reasonable basis for its position — sometimes called the genuine dispute doctrine.

Being wrong is not bad faith. Being unreasonable is.

Which means a denial you disagree with, based on a coverage position with some support, is a contract dispute rather than a tort.

Unfair claims practices statutes

Separately from common law bad faith, most states have statutes defining unfair claims settlement practices.

These typically prohibit specific conduct: misrepresenting facts or provisions, failing to acknowledge communications promptly, failing to act reasonably promptly on claims, failing to adopt reasonable standards for investigation, not attempting good faith settlement where liability is clear, and compelling litigation by offering substantially less than amounts ultimately recovered.

Whether these statutes create a private right of action, or only a basis for regulatory enforcement, varies by state.

Even where they do not, they are a useful reference in complaints to the regulator and in framing an argument.

ERISA plans

A significant limitation worth knowing.

Claims under employer-sponsored benefit plans governed by federal law are generally subject to that framework, which preempts state law claims including bad faith.

Remedies are generally limited to the benefits owed, and in some circumstances attorney fees, with no extra-contractual or punitive damages.

Courts also frequently apply a deferential standard of review where the plan grants discretion to the administrator.

This is why disability and health denials under employer plans are litigated very differently from individual policy denials, and why the administrative appeal record matters enormously — courts often will not consider evidence outside it.

Practical steps

Build the record: written communications, a claim log, documented delays and unanswered inquiries.

Request the claim file, which many states allow policyholders to obtain.

Complain to the state insurance department, which creates a regulatory record and frequently produces movement.

And consult an attorney experienced in insurance disputes where the amount justifies it. Many work on contingency, and an initial consultation is usually free.

General information about legal concepts, not legal or insurance advice. Bad faith law, available remedies and preemption rules vary substantially by state and plan type. Consult a qualified attorney in your jurisdiction.