The Fundamental Distinction
Insurance bad faith claims fall into two broad categories based on the relationship between the policyholder and the claim:
First Party Bad Faith
You are making a claim under your own policy
Common Examples:
- Your homeowner's insurer denies your fire damage claim
- Your health insurer refuses to cover a medical procedure
- Your auto insurer lowballs your collision claim
- Your disability insurer terminates your benefits
- Your life insurer denies a death benefit to your beneficiaries
Key Characteristic:
You are the insured, seeking benefits under your own policy. You paid the premiums; they owe you coverage.
Third Party Bad Faith
Someone is making a claim against your policy
Common Examples:
- Your auto insurer fails to settle a claim against you within policy limits
- Your liability insurer refuses to defend you in a lawsuit
- Your insurer rejects a reasonable settlement, exposing you to excess judgment
- Your business liability insurer delays resolution, increasing your exposure
Key Characteristic:
A third party (not you) is making a claim against you, and your insurer is supposed to defend and/or indemnify you.
First Party Bad Faith Explained
The Basic Claim
In first party bad faith, you are seeking coverage under your own insurance policy. The insurer's duty is straightforward: fairly evaluate your claim and pay covered benefits promptly. When insurers unreasonably deny, delay, or underpay claims, they may be liable for bad faith.
Elements of First Party Bad Faith
To prove first party bad faith, you typically must show:
- Coverage exists - The claim is covered under the policy terms
- Benefits were withheld - The insurer denied, delayed, or underpaid the claim
- No reasonable basis - The insurer lacked a reasonable basis for its conduct
- Knowledge or recklessness - The insurer knew or recklessly disregarded the lack of reasonable basis
You have homeowner's insurance. A kitchen fire causes $50,000 in damage. Your insurer denies the claim, saying the damage was caused by "wear and tear" despite a fire department report confirming it was an accidental fire. This denial, ignoring clear evidence, may constitute first party bad faith.
Common First Party Bad Faith Scenarios
- Wrongful denial: Denying a valid claim without investigation or based on inapplicable exclusions
- Unreasonable delay: Dragging out claims handling without justification
- Lowball offers: Offering far less than the claim is worth to pressure settlement
- Improper investigation: Failing to investigate facts supporting coverage
- Misrepresenting policy terms: Telling you something is not covered when it is
California has well-developed first party bad faith law. The seminal case Gruenberg v. Aetna Ins. Co. (1973) 9 Cal.3d 566 established that an insurer's unreasonable denial of a first party claim gives rise to tort damages, including emotional distress.
California's Fair Claims Settlement Practices Regulations (Cal. Code Regs. tit. 10, section 2695.1 et seq.) provide detailed standards for claims handling. Violations of these regulations can serve as evidence of bad faith.
Third Party Bad Faith Explained
The Basic Claim
Third party bad faith arises from the insurer's duty to defend and indemnify the policyholder when someone else makes a claim against them. The insurer controls the defense and settlement decisions. When the insurer unreasonably refuses to settle, the policyholder may face a judgment exceeding their policy limits.
The Duty to Defend vs. Duty to Indemnify
- Duty to Defend: The insurer must provide (and pay for) a legal defense when a covered claim is made against you. This duty is broad and triggered by the potential for coverage.
- Duty to Indemnify: The insurer must pay covered damages up to policy limits. This duty is narrower and determined by actual coverage.
The Classic Third Party Bad Faith Scenario
The most common third party bad faith claim involves failure to settle within policy limits:
- Someone sues you (e.g., for causing a car accident)
- Your liability insurer has a duty to defend you
- The injured party offers to settle for your policy limits (e.g., $100,000)
- Your insurer unreasonably rejects the settlement offer
- The case goes to trial and you face a $500,000 judgment
- You are personally liable for the $400,000 excess
In this scenario, the insurer's unreasonable failure to settle exposed you to personal liability. The insurer may be liable for the entire judgment, including the amount exceeding policy limits.
You have auto insurance with $100,000 in liability coverage. You cause an accident injuring someone seriously. The injured person offers to settle for $100,000 (your policy limits), and all evidence suggests you were at fault. Your insurer refuses to settle, hoping to win at trial. The jury awards $750,000. Without bad faith law, you would owe $650,000 personally. With third party bad faith, the insurer may owe the entire judgment.
California has strong third party bad faith protections. In Comunale v. Traders & General Ins. Co. (1958) 50 Cal.2d 654, the California Supreme Court held that an insurer must consider the insured's interests equally with its own when evaluating settlement.
Under California law, an insurer that unreasonably refuses a settlement offer may be liable for the entire judgment, even if it far exceeds policy limits. This is sometimes called "opening up the policy."
Key Differences Comparison
| Aspect | First Party | Third Party |
|---|---|---|
| Who makes the claim? | You (the policyholder) | Someone else against you |
| What coverage is involved? | Property, health, disability, life | Liability, defense |
| Primary insurer duty | Pay covered benefits | Defend and settle reasonably |
| Typical harm | Not receiving covered benefits | Excess judgment exposure |
| Emotional distress damages | Yes (in most states) | Limited (in most states) |
| Punitive damages | Yes (with proper showing) | Yes (with proper showing) |
| Who sues the insurer? | The policyholder | The policyholder (or assignee) |
Damages Available
First Party Bad Faith Damages
- Contract damages: The policy benefits owed
- Consequential damages: Financial harm caused by the denial (lost business, foreclosure, etc.)
- Emotional distress: Anxiety, depression, stress caused by the misconduct
- Punitive damages: If conduct rises to requisite level of malice or oppression
- Attorney fees: In some states (including California "Brandt fees")
Third Party Bad Faith Damages
- Excess judgment: The amount above policy limits the policyholder faces
- Defense costs: If the insurer wrongfully refused to defend
- Consequential damages: Harm from the excess exposure
- Emotional distress: More limited than first party claims in most states
- Punitive damages: Available in egregious cases
In California, emotional distress damages are more readily available in first party bad faith cases than third party cases. In third party cases, emotional distress typically requires showing the insurer's conduct was especially egregious or outrageous.
California allows assignment of bad faith claims, meaning a third party claimant can sometimes pursue bad faith claims directly against the insurer after obtaining a judgment against the policyholder.
State Variations
Not all states treat first party and third party bad faith the same way:
States Recognizing Both
Most states recognize both first party and third party bad faith as actionable torts. This includes California, Texas, Florida, and most other major states.
States with Limited Recognition
Some states have limitations:
- New York: Does not recognize first party bad faith as a separate tort; limited to contract damages plus consequential damages
- Virginia: No private cause of action for bad faith; remedies limited to contract
- Michigan: Limited bad faith remedies; primarily statutory
Statutory vs. Common Law Claims
Some states provide statutory bad faith claims that supplement or replace common law claims:
- Florida: Section 624.155 provides a statutory framework for bad faith claims
- Texas: Insurance Code Chapter 541 provides statutory remedies
- Pennsylvania: 42 Pa.C.S. section 8371 creates statutory bad faith cause of action
The availability and scope of bad faith remedies varies significantly by state. What constitutes actionable bad faith in California may not be actionable in New York. Always consult an attorney familiar with your state's law.
Which Type Applies to You?
Ask yourself these questions to determine which type of bad faith may apply:
Is This First Party Bad Faith?
- Did you buy this insurance policy to protect yourself or your property?
- Are you making a claim for benefits you believe you are owed?
- Has the insurer denied, delayed, or underpaid your claim?
- Are you dealing with property insurance, health insurance, disability insurance, or life insurance (as beneficiary)?
If you answered yes to these questions, you likely have a first party situation.
Is This Third Party Bad Faith?
- Has someone else made a claim or filed a lawsuit against you?
- Do you have liability insurance that should cover this claim?
- Has your insurer refused to defend you or refused a reasonable settlement?
- Are you at risk of personal liability exceeding your policy limits?
If you answered yes to these questions, you likely have a third party situation.
Need Help Identifying Your Bad Faith Claim?
I can help you determine whether you have a first party or third party bad faith claim and develop a strategy to pursue your remedies.