When James W. Marshall found gold in 1848 in California, over 300,000 prospectors migrated to California to take part in the new financial economy. The Oregon gold rush started a few years later at Josephine Creek, and a smaller rush happened in Washington State in the early 1880s starting at Swauk Creek. As a result of this influx of prospectors to the gold-rich West Coast, and the high risk/high reward nature of the business, appetite for risk in the region increased dramatically. Prospectors knew that it was a big risk to get a big reward.

This appetite for risk continues to this day in the realm of third-party liability coverage. When you purchase a general liability policy, the insurer agrees that it will pay any covered settlement or judgment up to the “policy limits,” an amount negotiated when the policy is purchased. But the insurance policy does not typically require an insurer to settle a case before trial. Courts have changed that.

California Damages

In 1958, 110-years after the gold rush began, California told insurers that all insurance policies included an implicit duty of good faith and fair dealing, requiring the insurer to accept a reasonable settlement demand made to its policyholder within policy limits. This means that if an insurance company has an opportunity to settle the case before trial for an amount less than the policy limits, it has a legal obligation to do so.

This makes sense. If you are presented with the option to settle a case using the insurance policy you purchased, it’s often reasonable to want to take that option and avoid the risk of a larger judgment at trial. This way, you are not exposed to liability, and the insurer does not have to pay more than the amount it promised. But insurance companies are adept at assessing risk and sometimes want to take a case to trial to avoid or lower their own financial obligations.

The law is fair in this regard – if the policyholder wants to settle a case within policy limits and the insurer does not, the insurer is taking the risk and will get all of the benefit if it wins. However, if it loses, the insurer must then carry all of the losses. Therefore, an insurer that refuses to accept a policy limits demand and opts to try the case must pay the full amount of any judgment – not limited to its negotiated policy limits.

Oregon Damages

The assumption held by many insurers – that Oregon has no tort of insurer bad faith – is wrong. In Oregon, like California, when an insurer fails to negotiate or act reasonably in the defense of the policyholder, it may be obligated to pay damages in excess of the policy limits. Oregon includes some additional protections for policyholders: insurers have an affirmative duty to initiate settlement efforts where it would be reasonable to do so.

Oregon, unlike other states, recognizes that negotiating the claim is part of the defense of the case, and sometimes requires an insurer to reach out with a settlement offer. It blends the risk and defense theories of the bad faith refusal to settle tort and allows for punitive damages for egregious breaches.

Washington Damages

Washington State takes this principle even a step further. In 2007, the voters approved the Insurance Fair Conduct Act, which allows a court to award three times the “actual damages” caused when an insurer unreasonably fails to pay benefits. Although there is some dispute over the scope of this statute, Washington courts have applied its protections to an insurer’s unreasonable failure to settle a liability action against its policyholder. 

This statute is admittedly punitive, forcing an insurer to overpay if it unreasonably handles a claim.  But it generally aligns with the risk theory at the core of the insurer’s decision to reject a demand within limits.  Washington statute makes it riskier for an insurer to refuse to accept a policy limits demand. While some observers argue this has the unfortunate effect of inflating plaintiffs’ demands to the maximum policy limits, this concern is counter-balanced by the policyholder’s interest in receiving the expected policy benefits. The entire purpose of the insurance policy is to protect the policyholder from liability, so placing more risk on an insurer that chooses not to is entirely in line with this premise. 

 Insurers must go “all-in“

The prospectors who journeyed West in the latter half of the 19th century risked it all for a mother lode. Today’s insurers follow that tradition when they refuse a policy limits settlement demand, seeking a low damages award or a full defense verdict from the jury. But if insurers want to pursue this benefit, they must also assume the whole risk. 

The risk profiles of the states in the West Coast puts these states at the forefront of codifying this dynamic. Insurance policymakers should take note – to protect their citizens the law must be crystal clear that policyholders are fully protected from an insurer’s decision to roll the dice at trial. The insurer must bear all risks, and perhaps even additional risks, for declining an opportunity to remove the policyholder from liability.