THE RHA REVIEW
Volume 6, No. 2, First Quarter 2000

YOU REAP WHAT YOU SOW

By Charles Richard Mills

The insurance industry has once again sown its seeds of cost-cutting and is now poised to reap a crop that could have been foreseen. The gnashing of teeth by some insurance companies over the newest codification of "bad faith" in California is no more than the maturing of the crop sown by the cost-cutting, reengineering, and efficiency experts working their magic to enhance short-term profits.

What is this most recent insurance crop? Effective January 1, 2000, California Civil Code Sections 2870-2871, a third-party bad-faith statute, became law in California.* The first bad-faith actions started as first-party litigation when third-party liability insurers were sued for violation of the duty of good faith and fair dealing with their policyholders, or customers. As could be expected, the insurance industry had a number of substantial verdicts rendered against it, which increased its costs dramatically. Since they were not designed to be eleemosynary societies, insurance companies responded by increasing premium rates tremendously in the span of only a few years. On the positive side, insurers also responded by conducting prompter, more comprehensive, and fairer evaluations and settlements. Eventually the California Supreme Court reversed itself in a decision styled Moradi-Shalal. This decision eliminated the tort of first-party bad faith in California. The California decision was generally followed eastward by other states across the country.

Guess what? With the elimination of bad-faith exposure, claims handling once again became a situation in which the carriers and/or adjuster was supreme, and it began to look like a return to the old days. It became difficult to get a fair and even-handed evaluation and settlement in many cases. The "dumbing down" of the insurance industry caught fire, and the efficiency experts and corporate reengineers returned with a vengeance.

Qualified and professional staff were downsized, laid off and replaced with cheaper, younger, inexperienced and unprepared individuals. Suddenly clerks became adjusters without qualifications to do the job adequately. There was little training - and less education. Supervisions became the exception rather than the rule. Many insureds were treated arbitrarily and capriciously, and the general public became incensed.

As Pogo said, "We have met the enemy, and it is us." The California legislature reacted, enacting the aforementioned third-party bad-faith statute, which became effective January 1, 2000, in response to this perceived abuse of the public by the insurance industry.

What caused this situation? Insurance companies are in business to make money and provide a needed service for the community. Claims personnel are not generally evil, and they do not get a reward for treating someone badly. In my opinion, a good portion of the problem can be blamed on the fact that far too many claims people have been promoted above their current ability, paid lower salaries, and basically thrown to the wolves without support.

Was the new California statute justified? Probably. There is no question that, with the tort of third-party bad faith codified, litigation will increase, judgments will get larger, and premiums will rise.

The best defense against a claim of bad faith is the affirmative practice of good faith and fair dealing on the part of the insuring organization. This may sound like a scripture lesson, but it is what an intelligent person should expect.

Insurance companies excel at marketing their products and have embraced what is commonly known as "best practices." These best practices usually spell out how a company does its business in the best and most ethical manner. Most companies have best practices for their claims area. The problem arises when they espouse actions and performances that they do not comply with.

Let's get back to the tort of third-party bad faith and what to do about it. There is a law against shooting people, and the majority of people obey this law. Those who do not are prosecuted if caught. There is now a law against third-party bad faith in the state of California — break the law and pay the penalty.

How to respond and comply with the law is not rocket science. As a start, the insurance industry should do the following:

1. Hire as adjusters only people with the mental and moral capacity to function as professionals.

2. Provide adequate training and support to those adjusters.

3. Offer continuing education in order to maintain the professional level of your staff.

4. Require that every insured, claimant, vendor, etc., be treated with good faith and fair dealing.

5. Demand honest, excellent and ethical performance from your professional claims staff.

6. Provide supervision and coaching by a staff of competent supervisors.

Will insurance companies voluntarily do this? Probably not until their position in the marketplace becomes threatened.

This new statute sounds like a heavy blow to the insurance industry, but it is in fact doing no more than telling it to deal fairly with its public or pay a fine. Mistakes will always be made, but the mark of a company is the way they deal with these mistakes.

In my opinion, this California law trumpets a renewed emphasis on fairness and morality in the insurance industry in this country.

*Editor's Note:  This issue was put on the ballot as a proposition in elections held after this article went to press. At the urging of the insurance industry, the electorate rejected the bill, so California stayed put with regard to third-party bad faith.