In ethics or metaphysics, the “law of unintended consequences” states that, for any willed action, there are consequences that occur which are not intended.  The concept has long existed, but was named and popularized in the 20th century by American sociologist Robert K. Merton.

Merton would have been fascinated by laws that were intended to protect policyholders (like ERISA) that often have the opposite effect.

Consider bad faith law in New Jersey.  One of the important cases regarding the insurance company’s duty of good faith and fair dealing is Pickett v. Lloyd’s, 131 N.J. 457 (1993).  In Pickett, the New Jersey Supreme Court crystallized the issue as follows:

“An insurance company may be held liable to a policyholder for bad faith in the context of paying benefits under a policy. The scope of that duty is not to be equated with simple negligence.  In the case of denial of benefits, bad faith is established by showing that no debatable reasons existed for denial of the benefits.  In the case of processing delay, bad faith is established by showing that no valid reasons existed to delay processing the claim and the insurance company knew or recklessly disregarded the fact that no valid reasons supported the delay.”

Bad faith liability exposes the insurance company to extracontractual damages, such as (under Pickett) “consequential economic losses that are fairly within the contemplation of the insurance company.”  Extracontractual damages can also include punitive damages.  Insurance company bean counters can’t set proper reserves on a claim when the possibility of extracontractual damages exists.  Insurance companies therefore hate bad faith liability the way Ohio State hates Michigan.

Leave it to insurance companies to find the gap in the armor, though.  In Pickett, the Court unfortunately commented:  “Perhaps [the] rule is easiest to understand in the context of the denial of benefits on the basis of noncoverage, such as for experimental surgery under a medical-insurance policy.  Under the ‘fairly debatable’ standard,  a claimant who could not have established as a matter of law a right to summary judgment on the substantive claim would not be entitled to assert a claim for the insurer’s bad-faith refusal to pay the claim.”

Note that, in its comment, the Pickett court gave the example of experimental surgery, which would generally not be covered.  Insurance companies and their lawyers, however, have twisted this passage to mean that if they deny coverage under any policy on any basis, and if the policyholder later is unable to obtain summary judgment against the carrier in a coverage lawsuit, there’s no bad faith liability.  And, a number of carrier-friendly judges have bought into that rationale.  The cynic in me thinks that some of these judges may want to make coverage cases settle by removing the policyholder’s biggest hammer.  In business coverage cases, also, I suspect that some judges figure that all’s fair as long as no one’s dying.  

Now, New Jersey state senator Nicholas Scutari, a plaintiff’s personal injury lawyer by trade, has attempted to plug some of the holes in the state’s bad faith law through a new bill, S-766.  The bill would create a private right of action against an insurer “arising from the insurer’s breach of its duty of good faith and fair dealing, which breach shall include the insurer’s failure to attempt in good faith to effectuate a prompt, fair and equitable settlement of a claim in which liability has become reasonably clear.”  To recover damages, the claimant must “prove that the insurer acted unreasonably in the investigation, evaluation, processing, payment or settlement of the claimant’s claim for coverage under the policy or without a reasonable basis for denying coverage.”

While perhaps a laudable effort, the Scutari bill falls many miles short in a number of major respects.  First, a private right of action for bad faith already exists, as shown under Pickett.  I think the bill meant to create a private right of action under the Unfair Claims Settlement Practices Act, codified in New Jersey at N.J.S.A. 17:29B-4(9), which some states permit, but New Jersey does not.  Second, what does it mean that liability must be “reasonably clear”?  Are we back to the standard enunciated by the Pickett-twisters,  that is to say, no liability exists unless the policyholder can prevail on summary judgment on the coverage issues? Third, what does it mean that the carrier acted “unreasonably”?  Carriers will argue that as long as they deny coverage on a basis that gets past the red-face test, no matter how tenuous, they’re in the clear – and if past performance is a predictor of future events, many judges are apt to agree.  Fourth, under the bill, claims of bad faith are to be determined solely by a judge, not a jury.  At the risk of going out on a limb here, jurors are much more likely than judges to be attuned to the real-world problems caused by carrier recalcitrance, and the threat of a jury verdict is much more likely to serve as a deterrent to insurance company bad behavior. 

Finally, the bill allows a wronged policyholder to recover damages in excess of policy limits, such as punitive damages, prejudgment interest, reasonable attorneys’ fees, and reasonable litigation expenses. But all of the damages enunciated by bill are already allowed under Pickett, with one notable exception.  Due to a quirk in the New Jersey Court Rules [R. 4:42-9(a)(6)], attorneys’ fees are only recoverable by a successful claimant in a liability coverage case.  The Rules do not permit a policyholder in a first-party case to recover fees (and they should). 

If I were King for a Day, I would scuttle S-766.  (My guess is that it will be dead on arrival anyway.)  It doesn’t add anything that really helps policyholders, and in fact, takes some valuable rights away.