Sharon Tennyson & William J. Warfel

Abstract

States differ in the legal avenues available to policyholders pursuing actions against their insurers for bad faith in claims settlement. This article discusses the various approaches that states have taken to first-party insurance bad faith law and examines the potential benefits and costs of each. Legal regimes that are likely to award large damages to aggrieved policyholders provide the strongest deterrent to insurer bad faith, but they may also encourage fraudulent insurance claims and discourage insurers from conducting rigorous claim investigations. The article evaluates the empirical significance of these potential incentive distortions by analyzing automobile insurance claim settlement data from states with different bad faith regimes. The data indicate that claim characteristics and investigative practices differ significantly in states permitting tort-based bad faith actions compared to those with other approaches, in ways consistent with the hypothesized incentive effects.

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