Reserves Are Important in Insurance Coverage and Bad Faith Claim Disputes

Most of you are familiar with the concept of reserves. How many of you are familiar with the role of reserves in a bad faith case? Is this type of information even discoverable? Although it might not sound terribly significant, it is an important factor that should be evaluated and which many attorneys may overlook.

Let’s start with what we mean by “reserves.” Well, of course, there is lots of room for argument there, too, but let’s try to keep it simple for purposes of this week’s blog. In the insurance context, a reserve for a claim is basically an estimation of the money that will eventually be paid for the costs associated with that claim. Charles Miller, Insurance Law Center, Discovery in Insurance Bad Faith Cases, Part I.

Modern statutes, including Colorado statutes, require insurers to maintain reserves to assure the insurer’s ability to satisfy its potential obligations under its policies…The insurer must reasonably estimate the amount necessary to provide for the payment of all losses and claims for which the insurer may be liable [citation omitted]. The reserves must also reflect all potential claim expenses and any claim the insurer undertakes to defend since the insurer will have claim handling expenses, including attorney fees and court costs [citation omitted]. The reserve requirement therefore reflects a desire on the part of the states and the insurance companies themselves to ensure that resources are available to cover the insurer’s future liabilities…

Silva v. Basin Western, Inc., 47 P.3d 1184, 1189 (Col. 2002).

The amount of the reserve established for a particular claim can change throughout the life of that claim. Lipton, et al., v. Superior Court of Los Angeles County, et al., 48 Cal.App.4th 1599 (2d DCA Cal. 1996). The insurer can increase or decrease the amount of a reserve as new information is revealed. As a result, a particular reserve amount may be substantially more or less than the amount ultimately paid on a particular claim.

You are probably thinking to yourself, “Ok, so I can think of a reserve as a safety net – a savings account set up by the insurer to make sure there’s enough money to pay on a claim.” It sounds like a good idea. Statutory and regulatory reserves are probably set up in an acceptable fashion. So where does the problem lie? How can reserves can play a critical role in a bad faith claim against an insurer? How is it that insurers have used this as a way to pinch pennies? I’m going to let the courts explain this one to you…

Evidence of an insurer’s reserve setting procedures can show whether the insurer was following statutory and regulatory requirements. Grange Mutual Ins. Co., v. Trude, et al., 151 S.W.3d 803, (Ky. 2005). If an insurer is not complying with applicable statutory and regulatory requirements, the failure to comply can constitute bad faith per se. Past blogs have discussed performance based incentive plans for adjusters and software implemented by insurers, all of which are designed to cut payments on claims across the board. An insurer’s reserve setting procedures can also demonstrate whether the specific system for setting reserves is aimed at achieving unfairly low values. Like the incentive programs and cost-cutting software, this type of information is relevant to a bad faith claim.

It is important to remember that an insurer owes its insureds a common law duty of good faith and fair dealing. At first blush, it might not be obvious why reserves are important to a determination of bad faith against an insurer. The Supreme Court of Colorado explained that the establishment of reserves can be relevant and reasonably calculated to lead to admissible evidence regarding whether the insurance company adjusted the claim in good faith or made a prompt investigation, assessment or settlement of a claim. Silva v. Basin Western, Inc., 47 P. 3d 1184 (Col. 2002).

…[E]xamination with respect to the reserve may develop evidence on the issue of defendant’s [insurer’s] bad faith. Bad faith is a state of mind which must be established by circumstantial evidence. The actions of defendant [insurer] in respect to the reserve are relevant. Negligent investigation and uninformed evaluation of the worth of the Rosen [insured’s] claims go to the heart of the case since serious and recurring negligence can be indicative of bad faith.

Groben v. Travelers Indemnity Co., 266 N.Y.S. 2d 616, 17 (N.Y. 1965).

In cases where there is an excess judgment in the amount of the reserve, this may serve as an indicator of what the company thought the claim was worth. Charles Miller, Insurance Law Center, Discovery in Insurance Bad Faith Cases, Part I. This is even more important in those instances where the insurer never offered an amount equal to the reserve. In a case where the insurer denied coverage or took the position that a claim was not covered, a substantial reserve may indicate that, despite the insurer’s arguments otherwise, the insurer actually considered the claim covered.

So, if many insurers are required to establish reserves on certain claims, then why don’t they just pay the claim? Clearly, they have the money– not to mention the fact that they statutorily obligated to follow specific guidelines for reserves. But why don’t they pay? Your guess is as good as mine. I think it goes back to the unfortunate perception that claims handling should be a profit center for insurance companies. Harsh, but unfortunately true for many insurers.

In your bad faith cases, please don’t overlook reserves. Ask for this information in discovery and find cases in your jurisdiction to support your requests. You are entitled to it. So go get it!

Happy Friday!