Insurance Bad Faith: When the Insurer's Conduct Is the Claim

Most claim disputes are just disputes — the insurer values your claim lower than you do, and you negotiate. Occasionally the insurer’s own conduct crosses a line and becomes a separate legal wrong in its own right, with its own damages, sometimes far exceeding the policy that started it. Knowing where that line sits keeps you from either missing real leverage or, more commonly, threatening “bad faith” over conduct that is merely ordinary hard bargaining.

Quick answer: Bad faith requires unreasonable conduct, not merely an unfavorable one — unreasonable denial, failure to investigate properly, unreasonable delay, misrepresenting policy terms, or refusing a reasonable within-limits settlement. First-party bad faith is your own insurer mishandling your claim; third-party bad faith is an insurer exposing its own insured to an excess judgment by unreasonably refusing to settle. The most consequential mechanism is the policy limits demand: refuse a reasonable one unreasonably, and the insurer can end up owing the whole judgment, limits or not.

What Bad Faith Is Not

Clearing this first, because the term gets used loosely and using it loosely costs you credibility with an adjuster:

• A low offer is not bad faith. Opening low is a negotiating posture, and our guide to how insurers calculate settlements explains why first offers are structurally low.
• Losing a coverage dispute is not bad faith. Where coverage is genuinely debatable and the insurer’s position has a reasonable basis, it can be wrong without being in bad faith. Many states describe this explicitly as the “genuine dispute” or “fairly debatable” principle.
• An employer-sponsored long-term disability denial almost never gets to use this doctrine at all. Where a disability plan is governed by ERISA, federal preemption displaces state bad-faith law entirely, regardless of how unreasonable the insurer’s conduct was — see our guide to why ERISA changes everything about a disability denial for why that single fact reshapes the entire claim.
• Ordinary delay is not automatically bad faith. Unreasonable, unexplained delay can be. A claim taking time while records are gathered is not.

The Conduct That Does Qualify

Typically framed as an absence of a reasonable basis for the insurer’s action, combined with knowledge or reckless disregard of that absence:

• Denial without a reasonable basis for the stated reason
• Failure to conduct a reasonable investigation before denying — a recurring and provable failure, because the claim file shows what was and was not done
• Unreasonable delay in investigating, deciding or paying
• Misrepresenting policy provisions or the claimant’s rights under the policy
• Refusing to settle within policy limits where liability is clear and the claim’s value plainly exceeds the limits
• Failing to explain a denial or to provide a reasonable basis in writing where required

First-Party vs. Third-Party: Different Claims, Different Claimants

First-party bad faith — your own insurer, on your own policy. This is the structure of most bad-faith claims a reader is likely to have personally: a UM/UIM claim denied or slow-walked, a PIP claim cut off, a property claim underpaid — a wildfire-destroyed home stuck on an actual-cash-value offer well past the point it should have converted to replacement cost is a concrete, currently common example, covered in our guide to what a homeowners insurer actually owes after a wildfire. You have a contract with them, and with it the implied duty of good faith and fair dealing that every insurance contract carries.

Third-party bad faith — the at-fault party’s insurer, and the duty runs to its own insured, not to you. Its classic form: the insurer refuses a reasonable offer to settle within its policy limits, the case goes to verdict for far more, and its own insured is now personally exposed for the excess. The wronged party in that story is technically the insured, not the claimant.

Which is why you generally cannot sue the other side’s insurer directly. In most states the route is indirect: the insured, saddled with an excess judgment, assigns their bad-faith claim against their own insurer to the claimant, who then pursues it. A minority of states allow some form of direct action. This is one of the most state-variable points in the whole area.

The Policy Limits Demand: Where the Exposure Is Created

This is the mechanism that turns a limited policy into unlimited exposure, and it is worth understanding even if you never use it yourself.

When a claimant makes a clear, reasonable, time-limited demand to settle within the policy limits, on a claim where liability is clear and damages plainly exceed those limits, the insurer faces a decision with asymmetric consequences. Accept, and its exposure is capped at the limits. Refuse unreasonably, and in most states it can become responsible for the entire eventual judgment — including everything above the limits it was trying to protect.

The demand’s form matters technically: what it must include, how long the insurer gets, what documentation supports it, and whether the release offered is adequate. Requirements are state-specific and some states have codified them. A demand that is defective, ambiguous, or gives an unreasonably short window may forfeit the very leverage it was meant to create — which is a specific, concrete reason this is not a DIY exercise on a serious claim. Our guide to writing a demand letter covers the ordinary settlement demand; a policy-limits demand engineered to create bad-faith exposure is a different and more technical instrument.

Evidence That Proves Bad Faith

The claim file is the case. In litigation it becomes discoverable, and it shows:

• The adjuster’s notes and internal claim log — what was known, when, and what was done about it
• The internal evaluation of the claim’s value, against what was actually offered
• Whether an investigation happened at all, and what it consisted of
• Reserve entries — an insurer that internally reserved far above what it offered has a problem explaining the gap
• Supervisor and committee referrals, and whether authority was actually sought
• Correspondence timelines, which make unexplained delay visible

This is also why documenting everything in writing during an ordinary claim matters beyond the immediate claim: a paper record of unanswered letters and unexplained delays is exactly what a later bad-faith claim is built from. See dealing with insurance adjusters for the habits that produce that record.

Practical Steps

1. Put everything in writing and keep the timeline — a bad-faith claim is built from a documented record.
2. Ask for the denial’s basis in writing, citing the specific policy provision relied on.
3. Do not use the phrase as a threat over an ordinary low offer; it reads as noise and costs credibility.
4. Check whether your state’s unfair claims act creates a private right of action or only regulatory enforcement — this determines whether the statute is a claim or merely evidence.
5. On a serious claim against a limited policy, get counsel before making a policy-limits demand — a defective demand wastes the one real source of leverage.
6. Complain to your state insurance department where conduct is genuinely improper; the regulatory file can matter later.

Sources & Further Reading

• State unfair claims settlement practices acts, most modeled on the NAIC Unfair Claims Settlement Practices Model Act — note that many states’ versions provide for regulatory enforcement only, not a private right of action
• State common law on the implied covenant of good faith and fair dealing in insurance contracts, and on the “genuine dispute” or “fairly debatable” defense
• State law and case law governing the form and effect of a policy-limits settlement demand, which several states have codified
• See our guides to dealing with insurance adjusters for building the written record, how insurance companies calculate settlements for why a low first offer is structural rather than wrongful, and the bad faith glossary entry
• A bad faith claim and a punitive damages claim frequently travel together, and the constitutional ratio limits described there apply to a punitive award against an insurer as much as against any other defendant