By J. Clark Kelso
Director, Institute for Legislative Practice
McGeorge School of Law, University of the Pacific
Copyright © 2000 by University of the McGeorge School of Law
Table of Contents
Late last year, the Legislature passed and the Governor signed two bills to create a a limited form of third-party insurance bad faith liability. SB 1237 (Escutia, D-Huntington Park); AB 1309 (Scott, D-Altadena). Before the bills could go into effect, a referendum petition secured sufficient signatures to put the statutes on the March ballot pursuant to the California Constitution=s referendum provision.
Although there are two separate ballot propositions (because there technically were two separate bills), Propositions 30 and 31 should be considered as a pair since it appears unlikely that Governor Davis would have signed the legislation that is the subject of Proposition 30 without passage of the legislation that is the subject of Proposition 31. For purposes of this report, the two bills will be considered in tandem.
A "Yes" vote on Propositions 30 & 31 would permit both statutes to go into effect thereby creating the new cause of action for bad faith liability; a "no" vote on Propositions 30 & 31 would prevent both statutes from going into effect.
Under current law, an insured can recover in tort or contract against his or her own insurance company for breach of the covenant of good faith and fair dealing (a Afirst-party@ bad faith claim) if the insurance company engages in unfair or bad faith claims settlement practices. However, a third-party claimant (that is, someone who has been injured by an insured and who has a claim against the insured to recover damages for that injury) does not have a direct action against the insured=s liability insurance company for breach of the covenant of good faith and fair dealing if the liability insurance company engages in unfair or bad faith claims settlement practices.
This report presents background information regarding the development of the law regarding insurance company liability for breach of the covenant of good faith and fair dealing and for unfair claims settlement practices (Chapter 2). This background provides the context for considering Propositions 30 & 31 which would create a limited third-party bad faith claim against a liability insurance company for unfair claims settlement practices (Chapter 3). The Institute for Legislative Practice published a study last fall which examined jury verdicts in first-party insurance bad faith cases over the last decade. J. Clark Kelso & Kari C. Kelso, Jury Verdicts in Insurance Bad Faith Cases. That study reveals that punitive damages constitute approximately 77% of all the damages imposed by juries against insurance companies for breach of the covenant of good faith and fair dealing. Punitive damages were awarded in 42% of the cases (which is substantially higher than the 4-6% rate of punitive damages in all civil litigation). When a jury decides to award punitive damages, the mean punitive award is $16,655,895, and the median punitive award is $2,816,000. These results indicate that it is the frequent availability of substantial punitive damages that drives this type of litigation. In light of this empirical research, it is likely that the passage of Propositions 30 & 31 would increase costs to liability insurance companies. However, evaluating the probable consequences of Propositions 30 & 31 is a complex endeavor, and there are quite a few uncertainties, including the magnitude of cost increases to insurance companies, if any, the extent to which any cost increases would result in higher premiums, and the extent to which insurance companies would alter their behavior.
A. The Insured=s Contract Remedy for Breach of the Covenant of Good Faith and Fair Dealing
The story of insurance bad faith claims begins with the Supreme Court of California=s decision in Comunale v. Traders & General Insurance Co., 50 Cal.2d 654 (1958). The plaintiffs were injured by the defendant=s insured in an automobile accident. The insurance policy had limits of liability in the sum of $10,000 for each person injured and $20,000 for each accident. The insurance company refused to defend the action on the ground that the truck the insured was driving at the time did not belong to him. The insured retained counsel to represent him. On the second day of trial, the plaintiffs indicated they would settle the case for $4,000, and the insured communicated this offer to the defendant, explaining that he did not have enough money to effect the settlement. The insurance company refused to settle, and the trial proceeded to judgment in favor of one of the plaintiffs for $25,000 and in favor of the other plaintiff for $1,250.
The insured did not pay the judgment, and the plaintiffs recovered a judgment up to the policy limits from the insurance company in a suit brought pursuant to Insurance Code ' 11580(b)(2), which permits a direct action by a judgment creditor against an insurance company up to policy limits. The plaintiffs then obtained an assignment from the insured of the insured=s rights against his insurance company, and the plaintiffs sued the insurance company upon that assignment to recover the excess portion of the judgment.
The court unanimously held that an insured has a claim against his or her insurance company for breach of the covenant of good faith and fair dealing if the insurance company wrongfully declines to defend and refuses to accept a reasonable settlement within the policy limits. The law implies in every contract a covenant of good faith and fair dealing that neither party will do anything which will insure the right of the other to receive the benefits of the agreement. The court explained the application of the covenant in the insurance context as follows:
The insurer, deciding whether a claim should be compromised, must take into account the interest of the insured and give it at least as much consideration as it does to its own interest. . . . When there is a great risk of a recovery beyond the policy limits so that the most reasonable manner of disposing of the claim is a settlement which can be made within those limits, a consideration in good faith of the insured=s interest requires the insurer to settle the claim. Its unwarranted refusal to do so constitutes a breach of the implied covenant of good faith and fair dealing.@ Id., 50 Cal.2d at 659.
Having recognized the existence of a claim, the court then turned to the question of what damages the plaintiff might recover. The issue in Comunale was whether the insured could recover damages in excess of the policy limits. Arguably, since the policy limits indicated the insurance company=s maximum exposure on the contract, damages for breach of contract should have been limited to the policy limits. The court rejected this contention. It reasoned that A[t]he policy limits restrict only the amount the insurer may have to pay in the performance of the contract as compensation to a third person for personal injuries caused by the insured; they do not restrict the damages recoverable by the insured for a breach of contract by the insurer.@ Id., 50 cal.2d at 659 (emphasis added).
The measure of damages for breach of contract is found in Section 3300 of the Civil Code, which provides as follows:
For the breach of an obligation arising from contract, the measure of damages, except where otherwise expressly provided by this code, is the amount which will compensate the party aggrieved for all the detriment proximately caused thereby, or which, in the ordinary course of things, would be likely to result therefrom.@
The court found that A[a] breach which prevents the making of an advantageous settlement when there is a great risk of liability in excess of the policy limits will, in the ordinary course of things, result in a judgment against the insured in excess of those limits.@ Id., 50 Cal.2d at 660-61. Accordingly, the court held that an insurer, who wrongfully declines to defend and who refuses to accept a reasonable settlement within the policy limits in violation of its duty to consider in good faith the interest of the insured in the settlement, is liable for the entire judgment against the insured even if it exceeds the policy limits.@ Id., 50 Cal.2d at 661.
Having held that a cause of action existed in favor of the insured for the entire judgment, the court turned to the question of whether the insured could assign that cause of action to the plaintiff in the underlying suit. Based on long-standing precedent, the court held that the cause of action was assignable, notwithstanding a provision in the insurance contract that purported to preclude assignment absent the insurer=s consent. Id., 50 cal.2d at 661-62.
In summary, Comunale endorsed a contract cause of action that could be asserted by the insured against his or her insurance company for breach of the implied covenant of good faith and fair dealing and permitted the insured to recover as damages the full amount of an underlying judgment in excess of the policy limits. That contract cause of action was assignable to third-party claimants.
B. The Insured=s Tort Remedy for Breach of the Covenant of Good Faith and Fair Dealing
The next significant case in the development of the law was Crisci v. Security Insurance Company of New Haven, 66 Cal.2d 425 (1967). Rosina Crisci owned an apartment building. One of her tenants was injured when a tread on a wooden staircase gave way. The tenant sued Mrs. Crisci and claimed damages in the amount of $400,000. Mrs. Crisci=s general liability insurance policy had a limit of $10,000. The tenant ultimately offered to settle for $10,000, but the insurance company refused, indicating that it was willing to pay only $3,000 for the tenant=s physical injuries and nothing for her claimed emotional injuries. A jury awarded the tenant $100,000. The insurance company paid $10,000 of the judgment, and the tenant entered into a settlement with Mrs. Crisci which included an assignment of her cause of action against her insured for breach of the covenant of good faith and fair dealing.
The trial court awarded Mrs. Crisci $91,000 (plus interest) in economic damages resulting from the insurance company=s unwarranted refusal to settle, and an additional $25,000 for mental suffering. The $91,000 award was consistent with Comunale. However, the award of $25,000 for mental suffering created the issue of whether damages for mental suffering could be recovered in a cause of action against an insurance company for breach of the covenant of good faith and fair dealing.
The court noted that language in the Comunale opinion had indicated that the cause of action for breach of the covenant of good faith and fair dealing A>sounds both in contract and tort.=@ Id., 66 Cal.2d at 432 (quoting Comunale, 50 Cal.2d at 663). Drawing upon this language, the court in Crisci unanimously endorsed a tort cause of action against an insurance company for breach of the covenant of good faith and fair dealing.
The measure of damages in torts is set forth in Civil Code ' 3333 as follows:
For the breach of an obligation not arising from contract, the measure of damages, except where otherwise expressly provided by this code, is the amount which will compensate for all the detriment proximately caused thereby, whether it could have been anticipated or not.@
The court explained in Crisci that, A[i]n accordance with the general rule, it is settled in this state that mental suffering constitutes an aggravation of damages when it naturally ensues from the act complained of, and in this connection mental suffering includes nervousness, grief, anxiety, worry, shock, humiliation and indignity as well as physical pain.@ Id., 66 Cal.2d at 433. The court held that mental distress damages could be recovered by an insured against an insurance company for tortious breach of the covenant of good faith and fair dealing. See also Gruenberg v. Aetna Insurance Co., 9 Cal.3d 566 (1973) (reaffirming right to recovery emotional distress damages).
Although the issue was not before the court in Crisci, by holding that the cause of action arose in tort, the court clearly made punitive damages available in appropriate insurance bad faith cases under Civil Code ' 3294(a), which now provides as follows:
In an action for the breach of an obligation not arising from contract, where it is proven by clear and convincing evidence that the defendant has been guilty of oppression, fraud, or malice, the plaintiff, in addition to the actual damages, may recover damages for the sake of example and by way of punishing the defendant.@
See Silberg v. California Life Ins. Co., 11 Cal.3d 452 (1974) (approving recovery of punitive damages for bad faith refusal to settle).
C. The Third-Party Claimant=s Right to Sue for Breach of the Covenant of Good Faith and Fair Dealing
Since the insured clearly had a cause of action in tort for breach of the covenant of good faith and fair dealing, and the insured could easily assign that claim to the third-party claimant in the underlying lawsuit, the issue naturally arose whether the third-party claimant had a claim for breach of the covenant in the absence of an assignment by the insured. The court first addressed this issue in Murphy v. Allstate Insurance Co., 17 Cal.3d 937 (1976). The third-party claimant had received only partial satisfaction of her judgment against the insured tortfeasor, and the plaintiff sought the remainder from the insurance company for refusing to settle within policy limits. There was no allegation that the insured had assigned to the third-party claimant the insured=s claim against his insurance company.
The court unanimously held that the insurance company=s duty under the covenant of good faith and fair dealing runs only to the insured (i.e., the person with whom the insurance company had contracted). The court explained that A[t]he duty to settle is implied in law to protect the insured from exposure to liability in excess of coverage as a result of the insurer=s gamble on which only the insured might lose.@ Id., 17 Cal.3d at 941 (emphasis added). The court further noted that A[t]he insurer=s duty to settle does not directly benefit the injured claimant. In fact, he usually benefits from the duty=s breach. Instead of receiving an award near policy limits, he stands to obtain judgment exceeding policy coverage.@ Id. The court rejected the argument that the third-party claimant was also a third-party beneficiary under contract law principles, reasoning that A[a] third party should not be permitted to enforce covenants made not for his benefit, but rather for others. He is not a contracting party; his right to performance is predicated on the contracting parties= intent to benefit him.@ Id., 17 Cal.3d at 944. Accordingly, the court held that an insurance company does not owe a duty to settle directly to a third-party claimant.
The court noted that an insured can assign his or her cause of action to the third-party claimant pursuant to Comunale and other cases. However, the court held that the assignment was limited to the economic loss suffered by the insured (i.e., the amount of the excess judgment). Citing precedents denying the assignability of personal tort cause[s] of action,@ the court held that the insured could not assign his or her claims for emotional distress or punitive damages to the third-party claimant. Id., 17 Cal.3d at 942.
After Murphy, the law provided that an insured could recover in tort or contract against his or her insured for breach of the covenant of good faith and fair dealing, and that an insured could assign to a third-party claimant only his or her economic damages (which essentially means the contract damages were assignable, but the tort damages were not assignable). Thus, third-party claimants could recover excess judgments if the insured was willing to assign his or her claim, but the third-party claimant could not recover damages for the insured=s emotional distress or punitive damages.
Three years later, in Royal Globe Ins. Co. v. Superior Court, 23 Cal.3d 880 (1979), the court held, by a 4 to 3 vote, that a third-party claimant could sue an insurance company directly for a violation of subdivision (h) of Section 790.03 of the Insurance Code which prohibits insurers from engaging in certain unfair claims settlement practices. A Royal Globe claim sounded in tort, and the third-party claimant could recover from the insurance company damages for economic loss in excess of policy limits, emotional distress suffered by the third-party claimant, and punitive damages. Almost ten years later, the court overruled Royal Globe, holding in Moradi-Shalal v. Fireman=s Fund Insurance Cos., 46 Cal.3d 287 (1988), by a 7 to 2 vote, that the court had erred in its interpretation of Section 790.03 of the Insurance Code and that Section 790.03 did not create a tort cause of action in favor of the third-party claimant.
Royal Globe and Moradi-Shalal were statutory interpretation cases. The court in both cases focused its primary attention upon the language and history of the relevant statutory provisions. In Moradi-Shalal, the court devoted some effort to reviewing criticisms of Royal Globe and contentions that Royal Globe had created adverse social and economic consequences.@ Moradi-Shalal, 46 Cal.3d at 301. Those criticisms included concerns that Royal Globe encourages two lawsuits by the injured claimant, encourages unwarranted settlement demands by claimants, may result in escalating insurance costs to the general public, and creates a serious conflict for the insurer who must protect the interests of its own insured while trying to avoid adverse claims from the third-party claimant against the insured. Id., 46 Cal.3d at 301-02. The court reviewed these criticisms not to second-guess the Legislature=s judgment, but only to assist the court in deciding whether the court should continue to follow Royal Globe even if Royal Globe had been wrongly decided as a matter of statutory interpretation. The court expressly noted that Awe are not in a position to verify the accuracy of each of@ the criticisms leveled at Royal Globe. Id., 46 Cal.3d at 301.
As a result of Moradi-Shalal, the law now stands essentially as it did after Murphy v. Allstate Insurance Co. That is, an insured can recover in tort or contract against his or her insured for breach of the covenant of good faith and fair dealing (a Afirst-party@ claim), and an insured can assign to a third-party claimant only his or her economic damages. A third-party claimant does not have a direct action against an insurance company for breach of the covenant of good faith and fair dealing.
Last year, the Legislature passed and the Governor signed two bills that would reinstate a limited form of third-party insurance bad faith liability. The first statute, SB 1237, was passed by the Legislature in early August. Governor Davis threatened to veto SB 1237 (Escutia, D-Huntington Park) unless its provisions were modified, and in light of the threat, the Legislature passed AB 1309 (Scott, D-Altadena) which amends and limits certain portions of SB 1237.
Propositions 30 and 31 are on the ballot as a result of the California Constitution=s referendum provision. Section 9(a) of Article II of the California Constitution provides in pertinent part that A[t]he referendum is the power of the electors to approve or reject statutes or parts of statutes . . . .@ Although there are two separate ballot propositions (because there technically were two separate bills), Propositions 30 and 31 should be considered as a pair since it appears unlikely that Governor Davis would have signed the legislation that is the subject of Proposition 30 without passage of the legislation that is the subject of Proposition 31. For the remainder of this report, the two bills will be considered in tandem.
A. Types of Insurance and Claims Covered by Statutes
Propositions 30 & 31 create a third-party action for bad faith insurance practices only with respect to certain types of insurance and claims. The limits can be summarized as follows:
First, the plaintiff in a third-party action must be a natural person or entity.@ Civil Code ' 2870(a)(2). As the Legislative Analyst observes in the Supplemental Voter Information Guide at p. 9, A[o]nly individuals can sue.@
Second, a third-party claim can arise only if the underlying claim involves (a) bodily injury; (b) wrongful death; or (c) property damage resulting from an incident involving a motor vehicle. Civil Code ' 2870(a)(1). Thus, a third-party action cannot be maintained with respect to property damage claims arising out of non-auto-accident property loss, such as loss resulting from a fire. In addition, bodily injury@ is defined narrowly to exclude emotional distress resulting from economic loss and to exclude emotional distress resulting from a cause other than economic loss unless the emotional distress is accompanied by actual physical symptoms. Civil Code ' 2870(a)(5).
Third, a third-party claim cannot be brought by A[a] person injured in an accident arising out of the operation or use of a motor vehicle, who at the time of the accident was operating a motor vehicle in violation of Section 23152 or 23153 of the Vehicle Code, and was convicted of that offense.@ Civil Code ' 2871(e). Sections 23152 and 23153 make it unlawful to drive a vehicle while under the influence of any alcoholic beverage or drug, to drive a vehicle while having 0.08 percent or more, by weight, of alcohol in one=s blood, and to do any act forbidden by law while driving under the influence which proximately causes bodily injury to someone other than the driver. Section 2871(e) of Propositions 30 & 31 is intended to ensure that persons convicted of drunk driving are not given the option of filing a third-party bad faith claim against another driver=s liability insurance carrier. As drafted, this provision appears to require that the third-party claimant have actually been convicted of (or pled guilty to) a violation of Section 23152 or 23153 of the Vehicle Code. This provision would therefore not apply to a driver who was actually driving under the influence and who might have been convicted under Sections 23152 or 23153, but who was actually not convicted under those sections.
Fourth, a third-party claim can be brought only against a liability insurer@ which is defined as an insurance program, fund or plan that provides liability coverage for bodily injury@ or for property damage resulting from an incident involving a motor vehicle,@ but which excludes workers= compensation insurance and liability insurance for public entities. Civil Code ' 2870(a)(4).
Fifth, a separate provision prohibits third-party claims against A[a] professional liability insurer for medical, health care, or legal malpractice@ in circumstances where A[t]he consent of the policyholder to settlement is a prerequisite to settlement@ (which is often the case in professional liability insurance policies), and A[t]he policyholder withholds consent to settlement.@ Civil Code ' 2871(d). This provision ensures that a liability insurance company cannot be held liable in a bad faith lawsuit for failure to settle when the failure is a result of the insured=s refusal to consent to settlement.
In light of these restrictions on the type of underlying claims and type of liability insurance that can give rise to a third-party bad faith lawsuit, it is likely that Propositions 30 & 31 will have their greatest application to cases arising out of automobile accidents where the plaintiff has not be convicted of driving under the influence in violation of Sections 23152 or 23153 of the Vehicle Code.
Propositions 30 & 31 contain a series of prerequisites which must exist before a third-party claim for bad faith can be brought. The prerequisites are as follows:
First, the third-party claimant must Aobtain in the underlying action a final judgment after trial, a judgment after default, or an arbitration award arising from a contractual predispute binding arbitration clause or agreement.@ Civil Code ' 2871(b)(1). A judgment is not Afinal@ until resolution of any appeal from the judgment. Civil Code ' 2871(f). This provision is designed to ensure that the insurance company is not faced with two lawsuits simultaneously, one raising claims for the underlying harm and the other raising claims for bad faith insurance practices.
Second, the third-party claimant must make a written demand by certified mail to settle the underlying claim for an amount no greater than the applicable insurance policy limits, and the claimant=s final judgment or arbitration award on the underlying claim must have exceeded the written demand. Civil Code ' 2871(b)(2). This provision is designed to ensure that a bad faith lawsuit can be filed only when the consequence of an insurance company=s refusal to settle is a larger judgment in the underlying action (which means the insurance company, in retrospect, should have accepted the settlement offer since it would ultimately have paid less in settlement than for the final judgment).
C. Standards for Finding Bad Faith
Assuming the prerequisites are satisfied, a third-party claimant may file an action against a liability insurer for commission of any unfair claims settlement practice specified in paragraph (1), (2), (3), (5), (8), (9), (10), (11), (12), (13), (14), or (15) of subdivision (h) of Section 790.03 of the Insurance Code as it relates to a third-party claimant.@ Civil Code ' 2871(a)(1).
The listed subdivisions in Section 790.03(h) of the Insurance Code proscribe certain unfair claims settlement practices as follows:
Section 790.03. The following are hereby defined as unfair methods of competition and unfair and deceptive acts or practices in the business of insurance: . . . (h) [Unfair claims settlement practices] Knowingly committing or performing with such frequency as to indicate a general business practice any of the following unfair claims settlement practices:
(1) Misrepresenting to claimants pertinent facts or insurance policy provisions relating to any coverages at issue.
(2) Failing to acknowledge and act reasonably promptly upon communications with respect to claims arising under insurance policies.
(3) Failing to adopt and implement reasonable standards for the prompt investigation and processing of claims arising under insurance policies. . . .
(5) Not attempting in good faith to effectuate prompt, fair, and equitable settlements of claims in which liability has become reasonably clear. . . .
(8) Attempting to settle claims on the basis of an application which was altered without notice to, or knowledge or consent of, the insured, his or her representative, agent, or broker.
(9) Failing, after payment of a claim, to inform insureds or beneficiaries, upon request by them, of the coverage under which payment has been made.
(10) Making known to insureds or claimants a practice of the insurer of appealing from arbitration awards in favor of insureds or claimants for the purpose of compelling them to accept settlements or compromises less than the amount awarded in arbitration.
(11) Delaying the investigation or payment of claims by requiring an insured, claimant, or the physician of either, to submit a preliminary claim report, and then requiring the subsequent submission of formal proof of loss forms, both of which submissions contain substantially the same information.
(12) Failing to settle claims promptly, where liability has become apparent, under one portion of the insurance policy coverage in order to influence settlements under other portions of the insurance policy coverage.
(13) Failing to provide promptly a reasonable explanation of the basis relied on in the insurance policy, in relation to the facts or applicable law, for the denial of a claim or fort the offer of a compromise settlement.
(14) Directly advising a claimant not to obtain the services of an attorney.
(15) Misleading a claimant as to the applicable statute of limitations.
Propositions 30 & 31 provide that an insurance company's honest mistake in judgment in connection with the settlement of a claim@ cannot be the basis for a finding of bad faith (Civil Code ' 2871(a)(2)(A)) and that an insurer=s failure to settle is not necessarily proof of bad faith@ (Civil Code ' 2871(a)(2)(B)). These provisions are intended to protect an insurance company from a finding of bad faith where the evidence does not establish some culpable conduct by the insurance company. A mere failure to settle or an honest mistake should not be grounds for a finding of bad faith absent evidence of culpable conduct.
In addition, Propositions 30 & 31 provide a limited safe harbor@ with respect to those automobile accident cases that are subject to an arbitration system which the propositions authorize when the insurance company requests or agrees to submit a claim to arbitration.@ C.C.P. ' 1778. In cases that are subject to the arbitration system (which, oversimplifying somewhat, means cases where the total claims are within policy limits and under $50,000 and the claimant is represented by counsel), if the insurance company requests or agrees@ to arbitration, The insurer shall be conclusively presumed to have complied with the duties under subdivision (a) of Section 2871 of the Civil Code.@ C.C.P. ' 1778. In other words, in cases subject to the arbitration system, an insurance company can avoid the possibility of a third-party bad faith claim by requesting or agreeing to arbitration of the underlying claim.
This safe harbor provision may divert a significant number of automobile accident cases where the amount in controversy is less than $50,000 away from the court system and to a binding arbitration system since it seems likely that an insurance company faced with such a case is very likely to request arbitration to avoid the potential for a bad faith lawsuit. Whether the cases are ultimately diverted depends upon how frequently claimants would agree to arbitration. In cases which are adjudicated under the arbitration system, damages shall not exceed the available policy limits and shall not include damages that are not covered by the applicable insurance policies.@ C.C.P. ' 1776(g). The results of an arbitration are generally binding and are reviewable in court only on very narrow grounds as set forth in C.C.P. ' 1286.2.
The proponents and opponents of Propositions 30 & 31 have very different assessments of the likely consequences of approving these two statutes. Proponents of the statutes (i.e., those in favor of creating a third-party claim for bad faith insurance practices) assert that the propositions are necessary to stop unfair insurance practices that unfairly delay legitimate payments, which can make a claimant=s life Amiserable.@ See Supplemental Voter Information Guide, p. 10 (Argument in Favor of Proposition 31). Opponents assert that passage of Propositions 30 & 31 would double the number of lawsuits filed in auto accident cases and would increase insurance rates up to 15% (i.e., around $200-300 per year). See Supplemental Voter Information Guide, p. 6 (Rebuttal to Argument in Favor of Proposition 30). Proponents respond that lawsuits would increase only if insurance companies fail to behave reasonably in settling claims, that lawsuits might actually go down as a result of the arbitration provisions, and that insurance rates will not necessarily rise since current law prohibits companies from raising premiums to pay for penalties for violating the law. See Supplemental Voter Information Guide, p.7 (Rebuttal to Argument Against Proposition 30).
It seems likely that Propositions 30 & 31 would increase the costs of those insurance companies subject to its provisions. Costs would increase in two ways: First, the imposition of damages in bad faith lawsuits would be a new cost. Those damages can include economic loss in excess of policy limits, emotional distress damages resulting from delayed payment of claims, and punitive damages. The Institute for Legislative Practice published a study last fall which examined jury verdicts in first-party insurance bad faith cases over the last decade. J. Clark Kelso & Kari C. Kelso, Jury Verdicts in Insurance Bad Faith Cases. That study reveals that punitive damages constitute approximately 77% of all the damages imposed by juries against insurance companies for breach of the covenant of good faith and fair dealing. Punitive damages were awarded in 42% of the cases (which is substantially higher than the 4-6% rate of punitive damages in all civil litigation). When a jury decides to award punitive damages, the mean punitive award is $16,655,895, and the median punitive award is $2,816,000. These results indicate that it is the frequent availability of substantial punitive damages that drives this type of litigation.
Second, the threat of large punitive damage recoveries is likely to result in insurance companies paying slightly more in settling claims. The precise magnitude of this increase would depend upon a variety of factors, including the number of claimants who are represented by counsel, the insurance company=s assessment of the risk of a bad faith claim versus the risk of paying a possibly fraudulent claim (either as to the existence of the claim or the amount of the claim), and the extent to which, in practice, a bad faith lawsuit can be avoided by requesting arbitration.
Whether these likely cost increases will result in increases in premiums is a more complex question which depends upon, among other things, the structure of the competitive marketplace for insurance both within California and nationally, the current level of profits for automobile insurance and whether those profits can absorb any cost increase resulting from Propositions 30 & 31, and how state regulators would react to any petitions to increase auto premiums in response to any increased costs.
Even if Propositions 30 & 31 increase costs, and even if those cost increases are passed on to consumers in the form of higher premiums, these potential cost increases should be weighed against possible benefits to injured claimants resulting from the threat of liability for bad faith insurance settlement practices. According to traditional tort theory, the existence of a third-party bad faith insurance claim should deter insurance companies from engaging in the sort of unfair insurance practices that can give rise to liability. Whether Propositions 30 & 31 would have an appropriate deterrent effect depends in part upon whether courts and jurors can reliably apply general standards of reasonableness in assessing the behavior of insurance companies in handling claims. There does not appear to be any substantial scholarship attempting to evaluate the reliability of bad faith insurance judgments.
As the above makes clear, evaluating the probable consequences of Propositions 30 & 31 is a complex endeavor, and there are quite a few uncertainties, including the magnitude of cost increases to insurance companies, if any, the extent to which any cost increases would result in higher premiums, and the extent to which insurance companies would alter their behavior.