DTCI: You get what you pay for

By William A. Ramsey

Overview of established bad-faith law
 

Ramsey

An insurance company has a well-established duty to deal in good faith with its named insureds. See Erie Ins. Co. v Hickman, 622 N.E.2d 515, 517 (Ind. 1993). Breach of this duty gives rise to a tort claim. See id. at 519. Such a duty arises from the “unique character of the insurance contract” and the resulting “special relationship” between an insurance company and its insured. See id. at 518.

It is equally well established that a plaintiff has no right to bring a bad-faith claim against the defendant’s insurance company. See Menefee v. Schurr, 751 N.E.2d 757, 761 (Ind. Ct. App. 2001), trans. denied. Although a few states recognize such actions, “the overwhelming majority of courts in other jurisdictions have rejected the third party bad faith theory.” Id.

Similarly, the Indiana Supreme Court has held that third-party beneficiaries to an insurance contract cannot sue the insurance company for bad faith. See Cain v. Griffin, 849 N.E.2d 507, 515 (Ind. 2006). The court in Cain explained that no such right exists because “[t]he relationship between a third-party beneficiary and the insurer is not one intentionally created by a close, fiduciary, or potentially adversarial contract and, as such, is not the ‘special relationship’ anticipated by this Court in Erie.” Id.

These three principles raise no significant legal debate. The open issue (arguably, at least) is whether a plaintiff who did not purchase a policy of insurance, but brings a claim based on a theory that the plaintiff qualifies as an “insured” under the terms of another’s insurance policy, has a right to bring a bad-faith claim against the insurance company. Indiana caselaw and the policies behind this caselaw compel the conclusion that only actual parties to the insurance contract have the right to bring bad-faith claims; nonparties to the insurance contract have no such right, even if they qualify as “insureds” under the contract.

Unnamed insureds should be considered third-party beneficiaries.

The Cain decision involved parties attempting to collect benefits under a policy’s medical payments coverage, which required the insurance company to pay medical expenses for injuries caused by an accident on the insured’s premises. Cain, 849 N.E.2d at 514. The court’s conclusion that such third parties cannot bring a bad-faith claim should apply to third parties attempting to qualify as insureds.

The duty of good faith arises out of a contract between the insurance company and the named insureds. See Erie, 622 N.E.2d at 518. Indeed, the court in Erie explicitly noted that the relationship between an insurance company and its insureds “exists because they are in privity of contract.” Id. at 518-19. People who are covered under others’ insurance policies do not become parties to the contract entered into between the insured and the insurance company. See Crabtree ex rel. Kemp v. Estate of Crabtree, 837 N.E.2d 135, 141 (Ind. 2005); see also Harden v. Monroe Guar. Ins. Co., 626 N.E.2d 814, 817 n.2 (Ind. Ct. App. 1993) (recognizing a party who sought coverage as an “unnamed insured” was not a party to the insurance contract), trans. denied.

In Crabtree, the court addressed a situation in which two children were injured in a vehicle driven by their father. The children brought a claim against their father’s estate and obtained a jury verdict. The estate argued that Indiana’s advance payment statute, Ind. Code § 34-44-2-3, required the court to reduce the verdict by the amount the children had already received under the medical payments portion of the applicable insurance policy. The issue turned on whether the children received the medical payments as parties to the insurance contract. The Supreme Court concluded that, although the children qualified as insureds under the terms of the policy, “this does not make them parties to the insurance contract.” Crabtree, 837 N.E.2d at 141. The court went on to state that “it is clear that a person injured in a car owned and insured by someone else is not a party to the owner’s policy.” Id.

Although the Crabtree decision involved medical payments coverage and did not discuss the bad-faith doctrine, the court’s logic applies equally to the situation in which a person who purchased no insurance attempts to qualify as an insured under another’s policy. Such a person was not a party to the contract and (assuming he actually qualifies as an insured) should be considered a third-party beneficiary to the insurance contract. See Shelter Ins. Co v. Woolens, 759 N.E.2d 1151, 1155 (Ind. Ct. App. 2001) (describing a passenger covered under the driver’s UIM policy as a “third party”), trans. denied. Indeed, unnamed insureds attempting to find coverage under another’s policy meet the black-letter meaning of third-party beneficiary: “A person who, though not a party to a contract, stands to benefit from the contract’s performance.” DLZ Ind., LLC. v. Greene County, 902 N.E.2d 323, 329 n.4 (Ind. Ct. App. 2009) (quoting Black’s Law Dict. 149 (7th ed. 1999)). Not surprisingly, courts from other states have clearly stated that people attempting to qualify as insureds under others’ policies are third-party beneficiaries. See Dyess v. Am. Hardware Ins. Group, Inc., 709 So. 2d 447, 450 (Ala. 1997); Allgor v. Travelers Ins. Co., 654 A.2d 1375, 1379 (N.J. App. Div. 1995); Gardner v. Erie Ins. Co., 722 A.2d 1041, 1046 (Pa. 1999).

Unnamed insureds are third-party beneficiaries under Indiana law. This conclusion places them squarely within the Cain rule and prohibits them from bringing bad-faith claims.

The rationale for precluding bad-faith claims in the third-party context applies to bad-faith claims by unnamed insureds.

Among the reasons for precluding bad-faith claims in the third-party context are that such claims could (1) create conflicts of interest; (2) lead to unwarranted settlement demands by claimants; (3) create multiple and unnecessary litigation; and (4) increase insurance costs. See Menefee v. Schurr, 751 N.E.2d 757, 761 n.1 (Ind. Ct. App. 2001) (discussing with approval Moradi-Shalal v. Fireman’s Fund Ins. Cos., 758 P.2d 58, 66 (Cal. 1988)); York v. Globe Life & Acc. Ins. Co., 734 F. Supp. 340, 343 (C.D. Ill. 1990). These concerns apply equally to bad-faith claims by unnamed insureds.

Like bad-faith claims in the third-party context, bad-faith claims by unnamed insureds could easily lead to a conflict of interest for an insurance company and compromise the duties owed to the named insured. For example, in the relatively common situation of an automobile accident in which a driver and passengers are injured by an uninsured or underinsured driver, the driver’s uninsured motorist (UM) or underinsured motorist (UIM) policy provides primary coverage to the driver and passengers. See Ind. Code § 27-8-9-7. What if the UM/UIM policy has insufficient limits to satisfy all claimants? The insurance company clearly owes a duty to settle its named insured’s claim in good faith. But if the insurance company also owes a good-faith duty to the unnamed insureds, the insurance company would be forced to choose between (1) paying its named insured, who paid for the policy, less than the company in good faith believes its insured is owed; and (2) facing a bad-faith claim from the unnamed insured. The bad-faith doctrine should not jeopardize the rights of insureds.

Precluding unnamed insureds from pursuing bad-faith claims would also prevent unnecessary and costly litigation. Bad-faith claims can be incredibly time-consuming and expensive. Plaintiffs often issue broad discovery requests inquiring into an insurance company’s procedures, prior bad-faith litigation, and finances. Extensive briefing often ensues over the permissible scope of these requests.

Further, courts often bifurcate bad-faith claims from the contractual claims. See generally State Farm Mut. Auto. Ins. Co. v. Gutierrez, 866 N.E.2d 747, 752 (Ind. 2007). Bad-faith claims, therefore, often result in additional or substantially longer trials. Limiting these situations to disputes between insurance companies and their own insureds is a reasonable restriction that does not jeopardize the protections afforded to people who purchase insurance.

An insurance company’s relationship with its premium-paying customers differs from its relationship with unnamed insureds.

Purchasing an insurance policy is an investment that necessarily involves a cost-benefit analysis. See generally Shinn v. Fam. Res. Ins. Co., 33 So. 2d 741, 742 (Ala. Ct. App. 1947) (recognizing that insurance premiums are based on a “careful calculation of the hazard assumed; and they should be enforced, not a new or enlarged contract made for the parties” (quoting Life & Cas. Ins. Co. of Tenn. v. Tollison, 134 So. 805, 807 (Ala. 1931)); Green v. Great American Ins. Co., 516 SW.2d 739, 740 (Tex. Civ. App. 1974) (“Public policy dictates the allowance of partial rejection of such coverage in order to allow insureds in that situation to secure insurance they can afford.”). When choosing a policy, the insured makes a conscious decision to pay the insurance company premiums in exchange for the expectation that the insurance company will, in good faith, protect the insured’s interests and indemnify the insured for losses covered by the policy. A person seeking compensation under another’s policy has gone through no such analysis and has no reasonable expectation of coverage from another’s insurance company.

The Indiana Supreme Court recognized the difference between a premium-paying insured and an unnamed insured in Indiana Lumbermens Mutual Ins. Co. v. Statesman Ins. Co., 260 Ind. 32, 291 N.E.2d 897 (1973). The court concluded that the general rule that courts construe ambiguities in insurance policies against an insurance company does not apply to unnamed insureds. The court explained that, when deciding a dispute between an insurance company and an unnamed insured, a court is “not dealing with the two parties to the contract. The party claiming to be an insured in this case never paid a penny’s premium to the insurer.” Id. at 34, 291 N.E.2d at 899; see also Harden v. Monroe Guar. Ins. Co., 626 N.E.2d 814, 818 n.2 (Ind. Ct. App. 1993) (“If the person claiming coverage has never paid ‘a penny’s premium to the insurer,’ he should not get the benefit of the general rule of construction against the insurer.”), trans. denied.

The reason an unnamed insured deserves the benefit of neither favorable construction nor the policy also illustrates that an unnamed insured who has paid no premiums should be barred from bringing a bad-faith claim. Named insureds have provided a benefit to the insurance company in exchange for protection and deserve the right to complain of unfair treatment. An unnamed insured has provided nothing to the insurance company, is attempting to recover based on the named insured’s foresight to purchase insurance, and, like a third-party beneficiary, did not enter into a special relationship with the insurance company. An unnamed insured, therefore, has no right to complain of any perceived bad faith in processing or refusing to honor the claim.

The lack of a bad-faith claim does not incentivize insurance companies to behave badly.

One may question whether the absence of a right to sue an insurance company for bad faith would incentivize an insurance company to litigate in bad-faith claims that are brought by unnamed insureds. The absence of a bad-faith claim provides no such incentive.

First, the lack of a bad-faith claim has no effect on the insurance company’s obligations to comply with the terms of the insurance contract. See Stewart v. Walker, 597 N.E.2d 368, 375 (Ind. Ct. App. 1992). Unnamed insureds can, therefore, still enforce the contract and recover whatever benefits are owed.

Second, other safeguards protect unnamed insureds (and all litigants) from bad-faith litigation. For example, Indiana statutes allow parties to recover costs and attorney fees if a party litigates in bad faith. See Ind. Code §§ 34-13-3-21; 34-52-1-1. Courts also have the inherent power to sanction parties for discovery violations, contempt and other wrongful conduct. See Allied Prop. & Cas. Ins. Co. v. Good, 919 N.E.2d 144, 153 (Ind. Ct. App. 2009), trans. denied. Although these safeguards apply to bad faith that occurs in litigation and bad-faith claims generally involve pre-litigation conduct, if an insurance company takes an unreasonable position regarding an unnamed insured’s claim during litigation, the unnamed insured will have recourse. And if the insurance company ceases to maintain a pre-litigation bad-faith position and litigates only good-faith defenses, any harm caused by the pre-litigation conduct would be minimal.

Conclusion

An insurance company has a legal and ethical obligation to treat with good faith the people who sought and purchased protection from the company. This duty should not extend to people who failed to seek the insurance company’s protection. Recognizing such a duty has no basis in law and would ultimately harm – by reducing potential coverage or by increasing premiums – named insureds, the people whom the bad-faith doctrine exists to protect.•

Mr. Ramsey is senior associate at Murphy Ice LLP in Fort Wayne. The opinions expressed in this article are those of the author.