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Press Release

    Issue Analysis 103 - This Is Not Insurance Reform: An Update On National Efforts To Codify Third-Party ‘Bad Faith’ Liability

    05/15/2000

    An overwhelming majority of Californians in that state’s March 7th balloting rejected Proposition 30, a proposal that would have restored third-party "bad faith" liability claims against insurance companies as a cause of action in civil lawsuits. This proposal, and others like it around the country, would allow accident victims to sue the insurance companies of the persons allegedly responsible for their injuries, not just the parties at fault. The crux of such a suit against an insurance company has no relation to the underlying injury claim. Rather, "bad faith" claims are based upon the actions of the insurance company, whether real or perceived, after the accident during the settlement process.

    Third-Party ‘Bad Faith’ lawsuits allow accident victims to sue not just those at fault, but the companies insuring the persons allegedly responsible as well, thereby increasing insurance premiums for everyone.

    In recent years, trial lawyers across the country have spent untold amounts of money to get "bad faith" legislation passed by building the perception that insurance companies have a poor track record dealing with claimants who are not their own policyholders. Of course, who would benefit most from such legislation? One of the most powerful special interest groups around – the trial lawyers.

    A necessary reality check. Some facts are required here to correct trial lawyer spin. In 1998, the California Department of Insurance received only 39 complaints per 100,000 automobile insurance policies in effect.1 Mike Johnson, executive director of Voter Revolt, a Los Angeles-based consumer-rights group, put it this way, "the number of complaints alleging bad faith of any kind, not just with respect to third-party claims, is trivial. I guarantee you that there were more complaints of attorney misconduct for every 100,000 attorneys that were retained."2 Furthermore, third-party lawsuits are not necessary given existing consumer protections.3 California’s Fair Claims Practices Act, among the toughest in the nation, already protects individuals from insurers who engage in unfair claims handling practices. And California, like every other state, a regulatory body (the Department of Insurance) to police the insurance industry.

    When the voters of California realized that Proposition 30 would lead to higher premiums as insurers passed on to their customers the added costs of litigation, not to mention actual payments of damages, citizens revolted. Allan Zaremberg, president of the California Chamber of Commerce, estimated a 15 percent increase in insurance premiums due to third-party bad faith legislation.4 This figure excludes the $25 million in costs to the legal system that an increase in litigation creates.5 Once these facts came to light, Proposition 30 and the trial lawyers who backed it were doomed. In the end, 68.5 percent of voters rejected the trial lawyers’ arguments and sent them down to defeat.6

    Those who learn from history do not repeat it. Between 1979 and 1988, California law actually provided for bad faith lawsuits. In California, this legal doctrine is known as "Royal Globe" after the name of a 1979 state Supreme Court decision that authorized lawsuits of this nature.7 In those days, trial lawyers often accused insurance companies of acting in bad faith simply for defending policyholders in disputes. Insurance fraud soared, as trial lawyers labeled any attempt by an insurance company to legitimately investigate a claim as "bad faith."

    Such practices deterred insurance companies from performing one of their most basic functions, defending their own policyholders. Persons in accidents automatically expect their insurance companies to defend them, making certain that any damages they may have to pay are reasonable. Royal Globe drastically altered this.

    As a result, premiums in California – already one and a half times the average of the other 49 states in 1979 – ballooned to well over twice the 49-state average by 1988 when the California Supreme Court reversed itself and prohibited third-party bad faith lawsuits.8 Likewise, in terms of claims costs, before California allowed third-party bad faith lawsuits, the average auto insurance claim was $3,600. By the time the court overturned Royal Globe in 1988, the average claim had risen to $10,000.9

    In 1999, trial lawyers in California sought legislation that would re-instate the Royal Globe doctrine by expressly allowing third party bad-faith lawsuits. Their initial lobbying campaign was successful, and both the Senate and the Assembly approved legislation to allow third party bad-faith lawsuits. Governor Gray Davis signed the laws and they were to go into effect January 1, 2000. However, in December the issue was qualified for a referendum for the March 2000 ballot. Implementation of the legislation was delayed pending the outcome of the March vote. For Royal Globe to become law, trial lawyers now needed to pass Proposition 30, which reaffirmed the third party bad-faith legislation. Here, the trial lawyers failed. By a margin of more than 2 to 1, California voters rejected the trial lawyers’ costly proposal to re-instate Royal Globe.

    Exposing the trial lawyers’ next targets and plans. Having been soundly beaten at the ballot box by a well-informed public in California that had already experienced the perils of such a law, the trial lawyers are now turning to a number of unsuspecting states as their next targets. Arizona, Illinois, Michigan, New Jersey, New York, and Pennsylvania are all high on their list. In New Jersey, for example, the leaders of both political parties in the State Senate and State Assembly are co-sponsoring identical bills that would open the courts to "bad faith" claims against insurance companies. These bills, S. 265 and A. 1805, provide an "individual cause of action for unfair practices in the settlement of insurance claims and makes unfair practices subject to consumer fraud law."10

    In recent years, New Jersey has made great progress in changing its famously troubled insurance industry and civil justice system. In the legal arena, reforms of joint and several liability, evidence standards for punitive damages, and collateral sources have all been put into place. The high cost of automobile insurance premiums became such a potent issue in 1997 that Governor Christie Todd Whitman nearly lost her bid for re-election until she responded with a plan of action. Now, in the guise of "reform," bad faith legislation threatens to forfeit these gains and send insurance rates skyrocketing once again.

    This is how the trial lawyer scheme works. Not content to reap as much as 40 percent in contingency fees from any settlement that their clients may receive for damages incurred, they seek deeper pockets. Why just take a percentage of the settlement money from the insurance policy of the individual at fault when they can go after the insurance companies themselves, legitimate businesses that have done nothing more than insure someone. What this is really about is the trial lawyers getting their hands on additional cash cows currently beyond their reach.

    The State of the States. Aside from the above evidence detailing the inflationary impact on automobile insurance premiums as seen by California’s past experience with Royal Globe, other states continue to suffer similar fates to varying degrees. Today, Florida, Massachusetts, Montana, and West Virginia all have "weak" versions of third-party lawsuit causes of action. According to an analysis performed by economist William G. Hamm, the presence in a state of a weak Royal Globe-type doctrine – one that requires plaintiffs to demonstrate that an insurer violated the state’s bad-faith law as a general business practice – was associated with an average increase in premiums of approximately 6.4 percent as compared to states without third-party lawsuit doctrines (after other factors are taken into consideration).11

    In states that have adopted a "strong" third-party lawsuit doctrine – which only require a plaintiff to demonstrate a single violation of the state’s bad faith law – the effect on automobile liability insurance premiums is even more staggering. Kentucky currently has a strong third-party lawsuit doctrine similar to California’s during the Royal Globe era, and premiums have escalated by approximately 14.5 percent since the doctrine was introduced in 1988.12

    Californians currently spend just under $9 billion on automobile liability insurance premiums. Reinstating some version of the Royal Globe doctrine would result in increased costs of between $560 million (under a "weak" state model) and $1.3 billion (under a "strong" state model).13 The 14.5 percent general estimate figure for a "strong" doctrine is in line with the California Chamber of Commerce’s estimate that the law put forth by Proposition 30 would have increased insurance premiums by 15 percent.

    The battle has only just begun. The predatory nature of these lawsuits and other such abuses of our legal system rob each and every one of us in more ways than we can imagine – from the dollars that we pay in higher insurance premiums, to the inflated cost of goods and services that we purchase, and to our personal economic freedom itself. Real reforms give back our legal system to decent, honest Americans with real grievances. This "reform" secretly championed by trial lawyers will do nothing of the sort. Instead, it will only serve to further clog our court system with cases brought by lawyers who are trying to get even richer, even quicker.

    The people of California have already spoken and done so loudly. It is now up to the elected officials and citizens of New Jersey and other states to remain vigilant to ensure progress continues to be made in restoring fairness and justice to our legal system. Increased public awareness is the only way to thwart the trial lawyers’ agenda of bigger lawsuits and bigger government.

    Just because something is given the label of reform does not mean that the public will benefit from it. Passing "bad faith" claims legislation would do little in terms of actually protecting consumers. In fact, this proposed "reform" only serves to negate the hard-fought positive steps that already have been made across America in recent years, instead benefiting the special interests of the trial lawyers.

    1 Stefani Mingo, "Third-party Lawsuits Might Raise Costs," Insurance Journal, May 17, 1999.

    2 Ibid.

    3 "Why Consumers Pay The Price For Third-Party Lawsuits," Californians for Affordable Insurance Rates (CalFAIR).

    4 J.C. Howard, "Calif. Stops Bad-Faith Suits," National Underwriter, March 13, 2000, Volume 104, No. 11, p. 37.

    5 CalFAIR Web site.

    6 California Secretary of State Home Page, Vote 2000 State Ballot Measure returns from March 7, 2000 voting.

    7 592 P.2d 329 (1979).

    8 William G. Hamm, "The Economic Effect of the Royal Globe Doctrine in California," (report prepared for Californians for Affordable Insurance Rates, April 14, 1999, p. 6).

    9 CalFAIR Web site. (Numbers are not adjusted for inflation.)

    10 Senate, No. 265, State of New Jersey, 209th Legislature, sponsored by Senators Bennett and Codey. Assembly, No. 1805, State of New Jersey, 209th Legislature, sponsored by Assemblymen Digaetano and Doria. Both the house and senate versions were introduced on January 11, 2000 and respectively referred to the Assembly Consumer Affairs and Regulated Professions Committee and to the Senate Commerce Committee where they are currently pending.

    11 Hamm, p. 8.

    12 Ibid.

    13 Ibid., p. 10.