Insurance Basics

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Insurance adjusters often don’t know how to properly interpret the language of the very insurance policies their companies sell their policyholders.  My experience tells me adjusters often read the insurance policy looking for any arguable as (even outlandish) way to deny coverage.  They take language out of context, misapply language to the facts of the claim and generally look harder for reasons to deny than for reasons to pay.  This is exactly the opposite of what the duty of good faith requires them to do – they should be looking harder for reasons to pay than for reasons to deny.

This phenomenon takes on many, many forms.  But one of the most common examples of the problem is when an adjuster makes a knee-jerk decision on coverage without knowing all of the facts of the claim that are required to make a fair decision about whether the claim is covered.  Adjusters too often don’t seem to fully grasp the concept that the duty of good faith requires them to conduct a full, fair and timely investigation of the coverage issues before denying coverage.

An insurance policy cannot be fairly interpreted in a vacuum.  A policy cannot be fairly interpreted based solely on the language of the policy, without an understanding of the claim facts to which the language of the policy is being applied.  A policy is a contract between the insurance company and the policyholder requiring the insurance company to provide coverage under certain circumstances, and not under others.  Therefore, how can an adjuster know if there is coverage if they don’t fully understand the circumstances of the claim?

The adjuster absolutely must investigate the circumstances before deciding to deny coverage.  Instead, the coverage “investigation” conducted by adjusters often consists of nothing more than a cursory reading of the policy language, a failure to gather all the pertinent facts of the claim, and a coverage denial lacking any thoughtful analysis.

If you’re like me early in my career, you may be wondering why adjusters do this.  The easy explanation (one that is often true) is that they look for ways to save the company money because that kind of behavior is rewarded by the management of the insurance company.  Denying claims is easier on an adjuster with his or her boss than paying claims.  But, as the years have gone by and I’ve taken more depositions of adjusters than I care to recall, it has become apparent to me that adjusters receive little to no training on how to properly conduct a good faith coverage analysis.  As a result, adjusters often know little about what the duty of good faith requires of them before they take a stab at interpreting difficult policy language and making an uneducated guess about coverage.  When this happens, the insurance company wins and the policyholder loses.  And the duty of good faith is violated.

When an insurance company receives a claim from its policyholder, the first thing the adjuster does is “check coverage.”  This means they verify the policy is in force by making sure the premiums have been paid and the policy period is in effect.  Then, the adjuster looks at the facts of the claim the policyholder is presenting to determine if the insurance policy language provides coverage for the claim.

This may sound simple (and it often is) but sometimes whether the facts of the claim are covered by the policy is not a black and white question.  Often, there are shades of gray on whether coverage exists.  Anyone who has read an insurance policy (or even part of one) knows they can be extremely hard to understand.  It might be surprising, but this is true of lawyers, even lawyers who practice insurance law.  There is a reason for this.  Most insurance policies are written in such a way that they are almost impossible to understand.

Over the years, I have come to believe that insurance companies attempt to write insurance policies so that only they know what they really mean.  If the language of the policy is incomprehensible and the policyholder has no idea what it really says, then the adjuster has the power to tell the policyholder what is covered and what isn’t without the policyholder being able to dispute it.  Way too often, policyholders hear an adjuster say “there’s no coverage for your claim,” throw up their hands and walk away.  They feel like they can’t take on the big, bad insurance company and win.  This is not true.

In reality, most insurance adjusters have very little training or ability to fairly read and interpret policy language, even if they think they do.  Insurance adjusters have a tendency to look for reasons there is not coverage, as opposed to broadly interpreting the policy language to attempt to find coverage.  Also, adjusters often overlook the fact that the duty of good faith requires them to fully, fairly and timely investigate and even-handedly evaluate coverage questions, just like liability or damage issues.  As a result, coverage denials are often based on superficial, knee-jerk readings of policy language by untrained or unknowledgeable adjusters.

Policyholders who are told there is “no coverage” for their claim should demand a written, detailed explanation of the adjuster’s position, including reference to specific policy provisions the adjuster says preclude coverage.  Then, if the policyholder has questions, they should contact an experienced lawyer to help them understand their rights.

As discussed in previous posts, an insurance company violates the duty of good faith and fair dealing when it attempts to alter the terms of its policy bargain with the policyholder by attempting to use its claim department as a profit center.

How does an insurance company get its claim personnel to buy in to the idea they should do everything they can to pay as little as possible on every claim, even where it means underpaying if necessary?  In my experience, the answer is:  by using both the “carrot” and the “stick.”

The delivery system for both the carrot and the stick is the employee performance review systems most every insurance company has in place.  I have reviewed hundreds of claim handlers’ personnel files over the years in bad faith cases I’ve handled.  The various insurance companies give their employee performance review systems different names, but clear patterns emerge.  Typically, every employee has a regular evaluation by their supervisor.  During these evaluations, the supervisor rates the performance of the employee as compared to goals that were set for the employee in the previous period.  The ratings are usually expressed on scale of “1” to “5”.  Goals for the coming period are also set.

Let’s start with the “stick” part of the equation.  Insurance companies often rate the performance of their adjusters who pay more on claims lower than those who pay less.  Performance ratings lead to pay raises, bonuses and advancement up the food chain of management in the company.  So, adjusters who pay more on claims are often shown the “stick” by not receiving the same positive treatment in their employment than stingier claim people.  As I’ll address in a later post, insurance companies often keep close track of an adjuster’s claim payment history, sometimes by way of a “quality assurance” file-auditing program.  Then, if that history is inconsistent with the company’s profit-making goals, it is used against the claim handler.

Now for the “carrot” aspect of the equation.

Insurance companies are sometimes quite creative in the way they reward their claim personnel for restrictive claim payment practices.  I’ve seen many manifestations of the same basic idea, in which the insurance company pays claim people more money based on the claim people helping the company make profits.

Some have “profit-sharing” plans for claim handlers, while others pay bonuses based on the results of contests in which adjusters compete to see who can save the company the most money on claims.  I will address some of these “carrots” in more detail in a later post.

Suffice to say, if the upper management of an insurance company encourages claim delays, denials or underpayments by the use of policies and procedures (like employee evaluation systems, illicit bonus programs or contests, etc.), the duty of good faith and fair dealing has gotten lost in the pursuit of the almighty profit.

As discussed in my last post, insurance companies (not policyholders) gamble when an insurance policy is issued.  The insurance company takes on the risk of paying claims under the policy in exchange for the policyholder’s premium.  The policyholder does the opposite of gambling.  She does away with (or at least protects against) the risk of an insurable loss.  The risks and rewards of the policy contract are put in place up front, at the beginning of the policy period.

Insurance company claim departments often profess a pro-policyholder claim handling philosophy.  I have heard this “philosophy” expressed many times, by many companies, for many years in many, many bad faith depositions as something like:  “We pay what we owe on claims.  Nothing more, nothing less.”  Obviously, this saying sounds fair and looks good written on the front page of an insurance company’s claim handling manual.  It also sounds pretty reasonable when an adjuster or supervisor says it in their deposition testimony in a bad faith case.

Unfortunately, as policyholders can learn when they make a claim, the old “we pay what we owe” mantra is too often little more than lip service.  Some claim departments generally and some claim offices specifically seem to conduct themselves contrary to the old slogan.

Some adjusters and their management people seem to take a great deal of pride or satisfaction from saving the insurance company every nickel they can squeeze out of a claim settlement, even when it means the policyholder suffers in the process and ends up underpaid.  Some claim personnel seem to believe there is no such thing as an underpayment of a claim, no matter what.

I am not of the belief that all claim people are evil or act with improper motives.  To the contrary, many are real professionals who take their duty of good faith owed to the policyholder seriously.  So how do certain insurance company claim departments earn their reputations as being prone to push the limits of good faith by consistently playing hardball with their policyholders?  How do companies get their claim personnel (some of whom really want to do right by their customers) to take such unyielding, hardline positions on claims?

The big picture answer is insurance companies often create the culture in their claim departments that those claim personnel who are the toughest, who take the most extreme positions, who pay the absolute least amount of money possible on every claim regardless of what’s fair, are treated more favorably than those who don’t do these things.  The insurance companies who do this are attempting to use their claim operation as a profit-making oufit or “profit center.”  In other words, they are attempting to alter the risk they took when they issued the policy or “rig the game” in their own favor.

No one can argue doing so is consistent with the duty of good faith and fair dealing.  The questions often in play in an insurance bad faith case are:  “Specifically how does an insurance company create a ‘denials are better than payments’ culture?”  My next post will give some answers.

As discussed in earlier posts, insurance is not a gamble taken by a policyholder.  Instead, the policyholder buys insurance to protect himself from the risk of a loss, whether it be a medical bill, damage to the policyholder’s property, an untimely death or a liability claim made against the policyholder by a third party.  The insurance company sells the policyholder a set of promises to pay covered claims.  Those promises are set forth in the insurance policy itself.  Once the policy is in place, the insurance company’s obligations to the policyholder and the policyholder’s rights and coverages are set, and cannot be changed until the policy is later renewed or is canceled for some reason.

Before the insurance company ever actually sells and issues the policy to the policyholder, it has gone through a process of determining how it intends to make a profit on the policy.  Insurance companies employ actuaries and underwriters who study the company’s risk associated with selling insurance policies.  Based on its analysis of its risk, the insurance company either agrees to sell the policy to the policyholder or decides not to do so because it does not believe the risk is a good one.  If an insurance company decides to sell a policy, it then decides (with some oversight by the Department of Insurance) how much money it will charge the policyholder in premiums.

When an insurance company decides to write a policy and sets the premium for that policy, the company has decided to take a risk that the losses the insured suffers under the policy will not cost more money than the premiums the policyholder pays.

In effect, the gamble the insurance company takes is taken at the time the policy is underwritten, priced, sold and issued to the policyholder.  If you think about it, an insurance company’s business model is based on taking risks.  And, judging by their bottom lines, they are very good at it.

Once the insurance company has done this, it must live with the consequences.  If it turns out the policyholder’s claims exceed the premium collected by the insurance company, so be it.  The insurance company doesn’t have a right to make a profit.  Instead, the insurance company in such a situation has lost its gamble.  The policyholder is entitled to the coverage he purchased for the price he paid.  If the insurance company no longer wants to take the risk of insuring a given policyholder, they can choose to change the bargain with the insured at the end of the policy period for renewal of the policy.  They can either refuse to renew or charge a higher premium.  Likewise, the policyholder can choose to go elsewhere for insurance.

However, regardless, the insurance company’s obligations and the policyholder’s rights are established up front.  As will be discussed in my next post, the insurance company cannot try to lessen the impact of paying claims on its bottom line at the time a claim is made under the policy by attempting to pay less than what is owed on claims.  To do so violates the duty of good faith and fair dealing.

Most of us define insurance by what it does for us under the policies we have purchased.  If asked “what is insurance?,” most people would say “it pays for damage to my car” or “it pays my medical bills if I get sick” or something to that effect.  These are good working definitions, but a closer look at what the nature of the insurance policy really is can be instructive.  One relatively simple definition states:

Insurance is a contract, represented by a policy, in which an individual or entity receives financial protection or reimbursement against losses from an insurance company. The company pools clients’ risks to make payments more affordable for the insured.  Insurance policies are used to hedge against the risk of financial losses, both big and small, that may result from damage to the insured or her property, or from liability for damage or injury caused to a third party.

It’s easy to see from this definition that an insurance company’s business model involves it taking (and managing) risks.  It agrees to pay losses under the contract in return for a premium from the insured, with the hopes that it will take in more premium dollars from its pool of policyholders than it will have to pay out on clams.  Another key aspect of an insurance company’s business model is to make money investing the premium money it takes in before it has to pay that money out on claims.  This will be the subject of a later post.

The insurance company is not guaranteed (nor does it have a right) to make a profit in its business.  If the company is smart and takes good risks, it can most definitely make a profit.  Many companies make huge profits (it’s easy to see this is true by checking their stock prices or imagining how much money they spend on all those TV ads).  But, if the company takes bad risks or is unfortunate enough to suffer big losses from a natural catastrophe (like the hurricanes we’ve seen so often recently), it might not make a profit in a given year.

Whether the insurance company makes a profit in a given year or not is not the policyholder’s problem.  The policyholder has bought with her premium money the promises of coverage the insurance company is selling.  Those promises include peace of mind, security and protection from financial harm if the policyholder is unfortunate to suffer a loss.  The insurance company has promised in the insurance contract (the policy) to pay covered claims, and they must live up to that promise regardless of whether doing so will adversely affect the company’s profitability.

One of the fundamentals of good faith claim handling is that an insurance company must never place its own financial interests ahead of its insured’s financial interests.  When an insurance company attempts to use its claims department as a profit center (by delaying, denying or underpaying valid claims to try to improve the company’s profitability),  it is in bad faith.

Unfortunately, all too often insurance adjusters, supervisors, managers and claim department executives lose sight of this bedrock principle.  When they do, and the policyholder suffers as a result, a bad faith lawsuit it likely to follow.