The Emergence and Potential Consequences of First Party Insurance Bad Faith Liability

Abstract

This article discusses the approaches to first-party insurance bad-faith law that have been taken by the states, using legal and economic reasoning to illuminate the potential benefits and costs of different approaches. Theory suggests that allowing policyholders to recover damages over and above the value of the insurance benefit owed will provide insurers with added incentives to engage in fair claims settlement. However, excessive or uncertain liability for insurance bad faith might create incentives for policyholders to file questionable claims and disincentives for insurers to investigate claims for fraud. The article analyzes a large dataset of first-party automobile insurance claims to investigate whether these adverse effects appear to have empirical relevance. The data show that claim characteristics in states that permit tort-based bad faith differ from those in other states. The findings are consistent with the idea that permitting tort-based firstparty insurance bad-faith settlements might reduce insurer incentives to challenge disputable claims