THE PUBLIC NATURE OF INSURANCE --

BAD FAITH IN INSURANCE COVERAGE DISPUTES AND THE PUBLIC NATURE OF INSURANCE -- UNDERSTANDING THE RECOVERY TOOLS AVAILABLE TO POLICYHOLDERS

By Eugene R. Anderson, Bennett Ellenbogen, James J. Fournier and Jordan S. Stanzler.
--------------------------------------------------------------------------------
II. Insurance Industry Motivations

Knowing What Makes the Insurance Industry Tick and What Makes Judges Tick Is Essential.

A. Code of Conduct

Insurance industry employees and executives are indoctrinated with the philosophy that insurance is good and that policyholders, claimants and lawyers are bad. According to the insurance industry, nearly 50% of policyholders are actual or potential crooks. One recent article, written by the President of the Insurance Information Institute, finds that the perpetrators of insurance fraud are. . . "for the most part, the people we live and work among -- our neighbors. . . . " Moreover, the "rampant" corruption of otherwise honest, "seemingly law-abiding people" is something that those in the insurance industry "have known for sometime." Insurance company claims adjusters view themselves as underpaid, overworked vigilantes protecting an unappreciative American public from a horde of thieving, conniving robbers intent on pillage and plunder.

In order to deal with the insurance system, one must accept the fact that insurance company adjusters believe what they say they believe. They may be wrong, but they think they are right and must be dealt with on that basis. It goes without saying that there are crooked policyholders and crooked claimants and there are crooked lawyers, but there are also crooked insurance companies.

There are no organizations or associations, other than the FBI and the Justice Department's National Level Insurance Fraud Working Group, to combat fraud perpetrated by insurance companies against their policyholders. Contrast that with the numerous associations and organizations created -- primarily by the insurance industry -- at the national and state levels to combat insurance fraud by policyholders, claimants and others. As is known so far, there are no insurance industry sponsored fraud units designated to ferret out fraud committed by insurance companies against policyholders. Contrast this with the many insurance companies which have set up within their ranks special insurance fraud investigation unit, commonly referred to as Special Investigation Units or SIUs.

B. Insurance Is a Defective Product

One conclusion from all of this crime and corruption is that insurance is a defective product. "We have actually designed an industry for the purpose of a con man."

Most of the problem is with the insurance product and not with the customer. But rather than take responsibility for a defective product, many insurance companies have decided to blame the frequent victims of insurance fraud -Ä their policyholders. John G. DiLiberto, president and chief executive officer of the National Insurance Crime Bureau, warned insurance companies that they are "in a shootout with the con men." The people who pay the premiums and the beneficiaries of insurance are evil.

A study on insurance company insolvencies conducted by the FBI concluded that "[t]he business of insurance is uniquely suited to abuse by mismanagement and fraud. The very nature of insurance, which involves the payment of money in the present in exchange for a promise to pay costs associated with some future event which may or may not occur, is a con artist's dream." According to one assistant United States Attorney, "dishonest people are moving from other industries into the insurance industry."

The insurance industry's damning indictment of its policyholders and beneficiaries can be analyzed in a different way. Is the insurance industry selling matches to arsonists? Fifty percent of the people who go to church do not steal from the collection plate and 50% of the people who go to the market do not shoplift. The fault may not be with the premium-paying policyholders. The fault may be with the insurance product. Any other product which turned its customers into anti-social cheats and thieves would be condemned and banned from the market.

The insurance product damages policyholders and others in many ways. First, if the insurance industry is to be believed, insurance corrupts. Second, this corruption then justifies corruption on the part of insurance company adjusters who engage in corrupt claims-handling tactics. When insurance executives, underwriters, adjusters and insurance lawyers believe that their policyholders and beneficiaries are cheats, the entire insurance mechanism is askew. Forcing policyholders to cheat or to be treated as cheats is counterculture and brings out the worst in people involved in insurance claims handling; the system encourages and may even demand "padding" by policyholders and other beneficiaries. Insurance company vigilantes do battle against the dishonest hordes and in the process develop a mentality that permits a "little deception and a little dishonesty". Since the end is nobel, the means can be ignoble.

The insurance product sold to policyholders to protect policyholders and the public is not the same product sold by the insurance company to the courts. Nearly every word in every insurance policy has a precise meaning. But all too often, the plain meaning of those words, whether common or technical, is far afield from the meaning attributed to them by insurance companies in insurance coverage disputes. Compounding the injury (and expense) are the legal theories spun by insurance law professors, insurance company lawyers, industry representatives and judges which complicate what should otherwise be a straightforward issue: If tens of thousands of automobile tires exploded, every judge in the United States would know the tires were defective and would not listen to any nonsense from law professors about the economics and theory of automobile tires and the automobile industry. Automobile manufacturers are not permitted to sell lemons and deliver lemonade. The massive amount of insurance coverage litigation indicates that something is terribly wrong with the insurance product and that it has yet to be fixed.

C. The Code of Silence: The Attorney-Client Privilege and the Crime-Fraud Exception:

The insurance industry code of silence is rarely broken. There are exceptions. For example, State Farm's destruction of evidence (spoliation) was recently and dramatically exposed. Read the following memo from a State Farm executive to her claims personnel:

With the increase of bad faith suits being filed against State Farm, it is important that you get rid of all your old stuff I know you have lurking around in your drawers and filing cabinets. [P] Please get rid of any old memo's [sic], claim school notes, old seminar or claim conference notes, and any old procedure guides you may have. They are trying to avoid having to come up with old records when the 'request for production of documents' comes in and they request 'all training manuals, memo's [sic], procedural guides, etc., that are in possession of your claim reps and management.'. . . That way if they subpoena our claim manual. . . for 1987, for example, we will say we don't have it. This should be easier than trying to produce it or having to defend it. So look through all of your old stuff and dump it. You won't ever miss it.

This State Farm memorandum was only part of the evidence produced by the claimants in this case. The claimants alleged fraudulent misrepresentation, destruction of documents and forgery by State Farm and produced evidence that: (1) State Farm possessed claims manuals and documents which the court had ordered to be produced and which State Farm had denied possessing, and; (2) that the State Farm employee allegedly responsible for denying the claimant's claim was repeatedly unable to recognize her own signature or her own voice on audio tape.

The claimants sought to introduce the testimony of a former State Farm employee, Amy Zirod Zuniga, to substantiate their allegations against State Farm. While an employee of State Farm, Ms. Zuniga had been responsible for evaluating bad faith claims made against State Farm and had worked on the case. Ms. Zuniga provided the claimants with affidavits which stated that State Farm trained their personnel to be evasive witnesses and that State Farm did in fact possess claims manuals and other documents which it claimed not to have. In addition, Ms. Zuniga disclosed conversations which she had with in-house counsel and other State Farm employees regarding the claimant's case. Ms. Zuniga also revealed in-house counsel's litigation and discovery strategies.

The California appellate court held that State Farm could not prevent Ms. Zuniga from testifying about State Farm's internal practices and procedures or the existence of claims manuals and other documents used by State Farm. The court found that although Ms. Zuniga had worked closely with State Farm's attorneys, the attorney-client privilege "does not protect disclosure of underlying facts which may be referenced within a qualifying communication."

The court then held that the crime fraud exception barred State Farm from using the attorney-client privilege or the work-product doctrine to prevent turning over to the claimants documents and information usually protected by those doctrines. The court held that application of the crime fraud exception turns on two questions:

[W]hether the services of the [law firm] were retained and utilized to enable State Farm to commit a crime or a fraud; and whether there exists a 'reasonable relationship between the crime or fraud and the attorney-client communication'. . . In that connection, it is the intent of the client upon which attention must be focused and not that of the lawyers.

The claimants, in opposing State Farm's motion for summary judgment on the claimants motion to invoke the crime/fraud exception to the attorney-client privilege, presented the declarations of Ms. Zuniga. The court quoted, in full, paragraphs 3-5 of Ms. Zuniga's declaration:

I am aware that there were many other State Farm claims arising out of the Northridge earthquake like the Taylors' involving unauthorized signatures by State Farm agents or agency employees on applications omitting earthquake coverage. At the time of the Taylor claim, the company was well aware that this was a problem. As a matter of practice, the company would pay these claims, if it believed that the forgery issue would be brought to light and proven by the insured. Because of the forgery issue in the Taylor case, if the case was not dismissed on summary judgment, it was my impression that the claim was going to be reconsidered. However, we were waiting to see if we could save money on the Taylor claim by having summary judgment granted, and as part of that plan I was instructed not to provide certain relevant information at my depositions. [P] 4. Specifically, my supervisor in the SAC unit, Vanessa Gudelj, and her supervisor, John Poptanich, put pressure on me to withhold the existence of documents memorializing certain State Farm claims handling guidelines from plaintiffs' counsel Bernie Bernheim at my deposition, which they believed, if revealed, would defeat summary judgment and ultimately lead to payment of the Taylors' claim. They pressured me into not revealing the existence of claims handling documents which established guidelines under which claims like the Taylors were to be handled. These included a three ring binder called 'CATHR Management Information and Memos Manual' used and maintained by Claim Superintendent Tinga Nicholson who was the Claim Superintendent that denied the Taylors' claim. It was responsive to the Taylors' discovery request and we simply chose not to produce it. Similarly, Ms. Nicholson had prepared a breakdown of earthquake claims in her unit. . . by category of claim, and one of the categories was 'unauthorized signatures.' This document showed the percentage of total earthquake claims which involved unauthorized signatures. This document, too, was never produced. [P] 5. The Taylors' claim was denied by personnel working in the so-called 'Special Handling Unit.' In addition to the claims handling documents mentioned above, we never produced to Mr. Bernheim a document memorializing a SHU meeting at which the subject of unauthorized signatures on applications omitting earthquake insurance was discussed.

The court held that although the contents of paragraphs 3-5 of Ms. Zuniga's declaration were protected by the attorney-client privilege, "the foregoing evidence is more than sufficient for application of the crime/fraud exception to the privileged materials contained in the Zuniga declarations." Further, the court held that the work product doctrine did not protect the information.

Insurance companies also invoke the crime fraud exception. For example, in a suit filed against its insurance company, Columbia Casualty argued:

[The insurance company's] duty of utmost good faith alone abrogates any privilege applicable to the undisclosed [insurance company] documents. In the fiduciary context, it is well settled that the existence of the fiduciary relationship creates an exception to the attorney client privilege . . . [C]ourts have found that the beneficiary of the duties of utmost good faith can prevent the fiduciary from invoking the attorney client privilege to preclude discovery if there is "good cause" for the privilege's non-application.

Furthermore, according to Columbia Casualty:

The protection offered by the [attorney- client] privilege, however, creates the potential for abuse by shrouding these communications in secrecy. The abuse is the use of a professional's knowledge and advice to help commit an intentional wrong. Thus, communications between lawyer and client that are made in furtherance of criminal or tortious or fraudulent behavior are excepted from the privilege's protection . . . . The ongoing tort and fraud exception to the attorney client privilege mandates disclosure of [the insurance company's] documents.

Similarly, Hartford argued:

A client who consults an attorney for advice that will serve him in the commission of a fraud will have no help from the law. He must let the truth be told. This forms the basis for what has become known as the "crime-fraud" exception to the attorney-client privilege . . . The "crime-fraud" exception also overcomes the work product immunity. A client cannot assert the work product doctrine any more than he can assert the attorney-client privilege when there has been a showing of ongoing client fraud.

. . .

It is thus not surprising that a breach of a fiduciary duty has been deemed sufficient to satisfy the crime fraud exception.

Both insurance companies and policyholders understand the legitimacy of invoking the crime fraud exception to expose misconduct by insurance companies.

D. Money

It does not take a financial genius to figure out that an insurance company can make more money by collecting premiums and NOT paying claims than the insurance company can make by collecting premiums and paying claims. Even the pro-industry press has picked up on this.

A careful analysis of insurance company financial statements frequently will disclose just when the insurance company changed its "claims paying philosophy" and under what circumstances the change was made. "Claims paying philosophy" are insurance industry code words. They are used to distinguish those insurance companies that pay claims from those that do not. Ultimately, the "claims paying philosophy" will determine when, how, and if claims get paid. The "claims handling philosophy," however, is an intangible which cannot be found in the insurance policy. Financial information about the insurance company can sometimes provide indicators of how an insurance company handles claims. For example, a decrease in the written premiums could force an insurance company to tighten its grip on claim payments. Another indicator is a historical tendency of the insurance company to litigate disputes with policyholders. A broker should also be able to provide information about claims handling reputation, but most brokers are very reluctant to make negative comments about their "markets."

E. Politically Correct Judges

A conservative judiciary may be frustrated because it cannot legislate tort reform. Instead, judges work indirectly toward that goal by refusing to permit injured parties to collect insurance. This philosophy ignores what several representatives of the insurance industry have proudly proclaimed: That "[r]ightly so, the insurance industry has been called the banker of the tort system." In the words of the former president of the Alliance of American Insurers: "The liability system is the fuel for the insurance engine." A good example of judicial tort reform is evidenced by a recent insurance coverage case in Texas. The Texas Supreme Court held that mental suffering was not bodily injury. To mental health professionals, this probably reeks of the Middle Ages.

The anti-policyholder and anti-claimant attitude of the insurance companies results in a Gresham's Law of the insurance industry: Bad Insurance Companies Drive Good Insurance Companies Out Of Business. Another way of describing the reason insurance companies sink to the lowest common denominator with respect to "claims paying philosophy" is the herd mentality. Caught in the middle, the victims of judicial tort reform are the policyholders. Policyholders pay premiums for protection against tort liability and then they pay for their alleged torts. Insurance companies are the clear winners.

F. Judges Need Insurance

Judges need insurance companies to settle cases. The friendly Stonewall Insurance Company adjuster is a key player in clearing court dockets. Whether saints or sinners, adjusters must be coddled by judges. Woe be unto the judge who crosses the adjuster. For a lawyer an insurance coverage case is another case. For the insurance company, it is a holy crusade, and for the judge it is another case to get off the docket, something which can only be done with the cooperation of the insurance company.