An insurer's duty to deal fairly with its own policyholder - and the separate claim that arises when it does not.
An insurance policy is a contract, so an insurer that refuses to pay what it owes can be sued for breach of contract. Bad faith is the additional idea layered on top: that because the insured has already paid, cannot shop elsewhere once the loss has happened, and is often in financial distress at exactly the moment the claim is made, the insurer owes something more than ordinary contractual performance. Most states recognise an implied duty of good faith and fair dealing in every insurance contract, and many allow a separate cause of action when it is breached.
The distinction that organises the whole subject is first-party versus third-party bad faith. First-party is your own insurer refusing or underpaying your own claim - the fire loss, the health claim, the disability benefit. Third-party arises where your insurer is defending you against someone else's claim and mishandles that defence, most commonly by refusing a settlement offer within your policy limits and then losing at trial for more, leaving you personally exposed for the excess.
Conduct commonly alleged includes denying a claim without a reasonable investigation, misrepresenting what the policy covers, ignoring or unreasonably delaying communications, demanding documents already supplied, offering an amount with no rational relation to the loss, and applying an interpretation of the policy language that no reasonable reader would reach. Being wrong is generally not enough. Most states require something more than an incorrect denial - typically that the insurer had no reasonable basis for its position, or knew it had none. A genuine dispute over coverage, honestly maintained, is usually a defence.
Two structural points change the practical picture. Remedies for bad faith are frequently larger than the policy benefit itself and may include consequential losses, attorney fees, interest and in some states punitive damages, which is why the claim exists at all - without it, an insurer's worst case for wrongly refusing would be paying later what it owed anyway. And in most states there is a parallel regulatory route: a market conduct complaint to the state insurance department, which is free, does not require a lawyer, and sometimes resolves the claim on its own. Whether a violation of those regulations creates a private right to sue varies significantly by state.
One large category sits outside all of this. Most employer-provided health, disability and life benefits are governed by the federal ERISA statute, which generally displaces state bad-faith law for those plans and substitutes a narrower federal remedy. The practical consequence is severe and frequently discovered too late: for an ERISA plan the usual outcome of winning is the benefit itself, and the case is often decided on the administrative record built during the plan's own internal appeal rather than on new evidence.
Two moments are worth advice. The first is before you accept a denial as final: denials are routinely reversed on internal appeal, and the appeal is where the record that a court may later be limited to is built - which matters enormously for an employer-provided plan, where new evidence may not be admitted afterwards. The second is any time an insurer defending you asks you to accept exposure above your policy limits, or refuses a settlement within them; that is the classic third-party scenario and your interests and your insurer's have just diverged. Free routes exist in parallel and are worth using: a complaint to your state insurance department costs nothing, and most states publish a consumer claims-handling guide. Keep every communication in writing, and ask for the reason for denial and the policy language relied on in writing too, because a denial that will not identify its own basis is itself informative.
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