Courts throughout the USA generally have held that insurance companies are required to settle claims when liability is clear and the legal damages are reasonably ascertainable. The duty to settle is implied by the insurance policy itself, which says the company will defend and indemnity its customer. This contractual obligation has been interpreted by case law and is further governed by regulations and statutes. Among other things, an insurance company is required to open a claim, investigate the claim, defend the customer, and if possible settle the claim for an amount up to the limits of the policy.
The breach of any of these duties might give rise to a claim against the insurance company itself for "bad faith" breach of contract or negligence or both. Courts have struggled with drawing a line between conduct that justifies denying a claim, and conduct so unjustified that the insurer should be held responsible for paying not just the policy limits but the entire judgment (i.e., the policy limits plus the portion of the judgment exceeding the policy limits).
The distinction between those two causes of action essentially pertains to whether the insurance company's decision not to settle within policy limits was egregious or simply a mistake. As set forth in Southern Farm Bureau Casualty Insurance Co. v. C.H. Parker 341 SW2d 36 (Ark. Supreme Court 1960):
"It may be negligence to refuse to settle, even though the negligent person may be acting in good faith. One may in good faith make an honest mistake which hurts another, and still be liable for negligence in making the mistake even though no harm was intended."
If a bad faith claim is suspected, careful legal research is required because the states apply these principles differently. There is a second line between conduct that makes the insurer liable for paying an entire judgment, and conduct so wrongful that it warrants the imposition of punitive damages (such as a percentage of the insurance company's entire net worth) in addition to making the insurer liable for paying an entire judgment.
For a good summary of the related laws of all the states, see and compare both of the following:
- Scott G. Ball, The Right and Duty to Settle Third-Party Liability Claims: a 50-State Survey (rev. 2015).
- United Policyholders Advocacy and Action Program, 50 State Survey of Bad Faith Laws and Remedies (2014).