The duty of good faith of insurers is recognised in both the United States (US) and the United Kingdom (UK). However, the precise duties of insurers in this regard and the consequences of a breach in these duties vary fundamentally in these two jurisdictions. This blog will compare how these legal systems address the concept of insurer’s good faith and remedies for a breach thereof, and will identify opportunities where these nations could learn from each other. The text of the blog including all footnotes can be read here.
Overview of insurer’s duty of good faith
Although each US State enforces its own insurance regime, most have recognized an insurer’s implied duty of good faith and fair dealing towards its policyholder. Due to their unequal bargaining power, the insurer must not divest the latter of benefits under its policy. Such a general duty exists in every insurance contract, as well as at various stages of insurer-policyholder relationships. This implied duty was first established in third-party liability insurance, where the insurer should reasonably settle covered claims against a policyholder. The California Supreme Court subsequently used it to prevent insurance providers from unreasonably denying policy benefits and forcing their policyholders into coverage litigations. In first-party insurance, such as health insurance, insurer’s good faith is triggered when an insurer unreasonably refuses or delays paying legitimate claims. A violation of this duty results in an actionable claim in tort of bad faith, whose liability threshold ranges from mere negligence to intentional wrongdoing across different States and contexts
The UK adopts a uniform approach to the concept of utmost good faith in insurance contracts. It originates from Lord Mansfield’s dictum in 1776 Carter v Boehm, creating the governing principle of utmost good faith that was applicable to all contracts. Subsequent judgments limited its applicability to certain agreements, including all insurance undertakings pursuant to a codification in section 17 of the Marine Insurance Act 1906. Although the duty was reciprocal between the parties to an insurance contract, it was mostly used to ensure disclosure and to prevent misrepresentation by policyholders at the pre-contractual stage. Under the referred section, the insurer could avoid an insurance contract upon a breach of utmost good faith by the policyholder, thereby affirming its insurer-friendliness. The current Insurance Act 2015 - regulating commercial insurance contracts - abolishes such a draconian solution under its section 14.
Meanwhile, section 3 of the Insurance Act 2015 sets out more nuanced remedies for policyholders’ pre-contractual misstatement or non-disclosure under their duty of fair presentation. The duty of utmost good faith is left untouched, albeit with an unclear role to play as an ‘interpretative principle’ in insurance contracts. Nonetheless, some authors have argued that its reciprocity remains so insurers may owe some pre- and post-contractual duties to their policyholders, such as to equally disclose material circumstances and to consider policyholder’s interests in concluding settlements with third parties.
Remedies for a breach of insurer’s duty of good faith
In the US, the award of damages in cases of insurer’s bad faith is well established due to the fact that US States recognize the breach of insurer’s duty of good faith in both third-party and first-party insurance contracts as tort, namely the tort of bad faith
Most US States allow the award of extra-contractual damages in such cases. Recoverable damages can include legal expenses, damages for economic loss, mental suffering and distress. Additionally, if the insurer’s conduct was wilful or in reckless disregard of the insured’s rights, malicious or fraudulent, most states permit the award of punitive damages.
In the UK, on the other hand, damages for a breach of insurers’ duty of good faith have not been awarded so far. Instead, the main remedies available in such cases include the tort of deceit and remedies under the MA 1967.
The prerequisites of the tort of deceit are likely to be met in cases of insurer’s fraudulent misrepresentation in breach of its pre-contractual duty of good faith. The insured party is then entitled to damages, putting it in the position it would have been in but for the tort. Pursuant to the MA 1967 the insured party can claim damages to the same amount, if the insurer’s misrepresentation was merely negligent. However, cases where the insurer fraudulently or negligently makes a misrepresentation hardly ever occur in practice.
Despite the decision in Banque Financière obliging the insurer to disclose relevant facts, the court did not award damages, holding that the MIA 1906 did not enable it to grant damages nor did it find a way to establish an alternative cause of action.
The removal of ‘avoidance’ from the MIA 1906 by the Insurance Act 2015 could enable courts to introduce new remedies, particularly damages, the award of which has been denied so far. One possibility would be to acknowledge that the insurer’s pre-contractual duty of good faith originates from common law and to grant damages as a direct consequence of a breach thereof. Alternatively, a new tort could be established based on the fact that the remedy of avoidance has been removed without defining a new remedy for the insurer’s breach of its duty of good faith. However, there have not been any decisions since the abolishment of avoidance in this context and it is thus uncertain how the award of damages in these cases will look in the future.
Pursuant to Sprung v Royal Insurance, late payment of insurance claims constitutes a claim for unliquidated damages due to contract breach. Hence, the only remedy available is the discretionary award of interest pursuant to statute. However, as there has not been any case law concerning insurer’s breach of its post-contractual duty of good faith since the enactment of the Insurance Act 2015, courts might be inclined to award damages in such cases in the coming years.
When comparing an insurer’s duty of good faith in the US and the UK, it can be concluded that this legal issue as well as the remedies for a breach in this duty are far better established in the US than in the UK, especially with regard to the protection of policyholders. Unlike in the US, UK insurers’ duties are still being developed without clear remedies for their breach, since the UK removed the remedy of ‘avoidance’ in the MIA 1906through the Insurance Act 2015, without introducing a new remedy. In this context, the UK could learn from the US bad-faith tort to provide a single remedy for policyholders against their insurers, since the latter already have various remedies for a breach of policyholders’ duty of fair presentation. Just like in the US, UK courts could introduce such a tort to insurers’ pre- and post-contractual obligations based on their good faith. Furthermore, in order to avoid creating another draconian solution, a breach of insurers’ duty of good faith should result in damages depending on certain factors. All in all, the creation of a one-stop remedy for policyholders would not only enhance legal certainty, but also level the playing field between the parties to commercial insurance agreements.