Insurance Bad Faith - Historical Background

Historical Background

Most laws regulating the insurance industry in the U.S. are state-specific. In 1869, the Supreme Court of the United States held, in Paul v. Virginia (1869), that United States Congress did not have the authority to regulate insurance under its power to regulate commerce.

In the 1930s and 1940s, a number of U.S. Supreme Court decisions broadened the interpretation of the Commerce Clause in various ways, so that federal jurisdiction over interstate commerce could be seen as extending to insurance. In March 1945, the United States Congress expressly reaffirmed its support for state-based insurance regulation by passing the McCarran-Ferguson Act (found at 15 U.S.C. §§ 1011-15) which held that no law that Congress passed should be construed to invalidate, impair or supersede any law enacted by a State regarding insurance. As a result, nearly all regulation of insurance continues to take place at the state level.

Such regulation generally comes in two forms. First, each state has an "Insurance Code" or some similarly named statute which attempts to provide comprehensive regulation of the insurance industry and of insurance policies, a specialized type of contract. State insurance codes generally mandate specific procedural requirements for starting, financing, operating, and winding down insurance companies, and often require insurers to be overcapitalized (relative to other companies in the larger financial services sector) to ensure that they have enough funds to pay claims if the state is hit by multiple natural and man-made disasters at the same time. There is usually a Department of Insurance or Division of Insurance responsible for implementing the state insurance code and enforcing its provisions in administrative proceedings against insurers.

Second, judicial interpretation of insurance contracts in disputes between policyholders and insurers takes place in the context of the aforementioned insurance-specific statutes as well as general contract law; the latter still exists only in the form of judge-made case law in most states. A few states like California and Georgia have gone farther and attempted to codify all of their contract law (not just insurance law) into statutory law.

Early insurance contracts were considered to be contracts like any other, but first English (see uberrima fides) and then American courts recognized that insurers occupy a special role in society by virtue of their express or implied promise of peace of mind, as well as the severe vulnerability of insureds at the time they actually make claims (usually after a terrible loss or disaster).

In turn, the development of the modern cause of action for insurance bad faith can be traced to a landmark decision of the Supreme Court of California: Comunale v. Traders & General Ins. Co., 50 Cal. 2d 654, 328 P.2d 198, 68 A.L.R.2d 883 (1958). Comunale was in the context of third-party liability insurance, but California later expanded the same rule to first-party fire insurance in Gruenberg v. Aetna Ins. Co., 9 Cal. 3d 566, 108 Cal. Rptr. 480, 510 P.2d 1032 (1973). Other state courts began to follow California's lead and held that a tort claim exists for policyholders that can establish bad faith on the part of insurance carriers. According to Stephen S. Ashley's treatise, Bad Faith Actions: Liability and Damages, 2nd ed. (Eagan, MN: Thomson West, 1997), §§ 2.08 and 2.15, courts in nearly thirty states recognized the claim by the late 1990s. In nineteen states, state legislatures became involved and passed legislation that specifically authorized bad faith claims against insurers.