Third-Party Vendors in Insurance Claims Investigations: A Framework for
Evaluation
November 2010
The trend toward use of third-party vendors
in claim investigations continues unabated and largely unregulated. For example,
the June 2010 issue of Claims Magazine
contains over 50 pages of advertising by companies providing some type of claim
service. Further, America's Claims Event (ACE), the National Underwriter sponsored
annual conference, attracts dozens of vendors promoting their services and products
to insurers. These vendors—engineers, mold remediation services, arson investigators,
accountants, computer software companies, attorneys, and others—are heavily
involved in claims investigation and are often defendants when disagreement
between policyholders and their insurers turns into litigation.
by Tim Ryles,
Ph.D.
Tim Ryles Consulting
In addition to facing an insurer's claims representative, a homeowner with
a fire claim may have to deal with engineers, roofing specialists, mold experts
(possible because fire departments use water to put out the fire), and arson
investigators (if the insurer wants to rule out the owner as a suspect). Rebutting
multiple "expert" reports may significantly increase the cost of securing a
fair settlement. Confronted with overwhelming odds, some insureds may give up.
This article and a subsequent one suggest a framework for analyzing the relationships
among insurers, independent contractors, and policyholders. This commentary
initiates description of the framework by describing (1) the special nature
of the insurance contract; (2) the insurer's duty to investigate claims; (3)
the nondelegable character of the duty to investigate; and (4) the insurer's
responsibility to secure competent personnel to conduct claim investigations.
The Special Nature of the Insurance Contract
For almost a century, the business of insurance has been characterized as
an undertaking "clothed with a public interest," reflecting the U.S. Supreme
Court's opinion in German Alliance Ins. Co. v. Lewis,
Superintendent of Ins. of the State of Kan., 233 U.S. 389 (1914). In
German Alliance, the court opined:
We have shown that the business of insurance has very definite characteristics,
with a reach of influence and consequence beyond and different from that
of the ordinary businesses of the commercial world ... The transactions
of the latter are independent and individual, terminating in their effect
with the instances. The contracts of insurance may be said to be interdependent.
They cannot be regarded singly, or isolatedly, and the effect of their relation
is to create a fund of assurance and credit, the companies becoming the
depositories of the money of the insured, possessing great power thereby
and changed with great responsibility.
Contracts of insurance … have greater public consequence than contracts
between individuals to do or not to do a particular thing whose effect stops
with the individuals.
State governments' highest courts have adopted the Supreme Court's view.
For example, in Universe Life Ins. Co., et al. v. Giles,
950 S.W.2d 48 (Tex. 1997), the Texas Supreme Court affirmed, "We have long recognized
that the insurance industry is peculiarly affected with the public interest."
Quoting favorably from German Alliance in 1939,
the Georgia Supreme Court said: The business of insurance is one so clothed
with a public interest, affecting the community at large, as to render it peculiarly
subject to government regulation." (Cooper Co. of Gainesville
v. State, 187 Ga. 497, 500).
State insurance codes recognize the public interest character of insurance,
as indicated in the state of Washington's Revised Code, RCW 48.01.030, which
states, "The business of insurance is one affected by the public interest…."
Idaho's Insurance code concurs:
The business of insurance is one affected by the public interest, requiring
that all persons be actuated by good faith, abstain from deception, and
practice honesty and equity in all insurance matters. Upon the insurer,
the insured, and their representatives, and all concerned in insurance transactions,
rests the duty of preserving the integrity of insurance. (Idaho Code § 41–113.)
Prelicensing materials approved for use by regulators for prospective insurance
agents,1 study material for designations,2
and leading college texts3 affirm the special status
of the insurance arrangement as one of utmost good faith. Consistent with these
traits, insurance policies are not based on a caveat
emptor tradition.4
Third-party vendors are unlikely to have familiarity with the special status
of insurance contracts; consequently, it is of utmost importance for an insurer
that outsources any part of its claim function to assure that its vendors understand
the unique qualities of insurance contracts. Similarly, any policyholder who
encounters difficulty in securing a fair investigation should inquire as to
whether the insurer conducted this third-party vendor training.
Handling Claims Is the Special Province of Insurers
Although the duty to investigate a claim rests exclusively with the insurance
company, some insurers have argued otherwise. In Coventry
Assoc. v. American States Ins. Co., 136 Wash. 2d 269 (1998) American
States, joined in amicus briefs by several other insurers, argued against an
insurer's duty to investigate claims, contending that insureds pay for insurance,
not for insurance services (such as claims investigations). Rejecting this position,
the court wrote:
Contrary to American States' and amicus Insurance Companies' assertions,
an insured receives more for its premium than just the possibility its claim
will be covered when appropriate. In the relationship between insured and
insurer, the insurer receives both the premium and control over the arrangement.
In first party situations, the insurer establishes the conditions for making
and paying claims. The insurer evaluates the claim, determines coverage,
and assesses the monetary value of the coverage.
The Insurer's Duty To Investigate a Claim Is Nondelegable
Most vendors are independent contractors. Generally, whether the independent
contractor is assisting with a first-party or a third-party claim, he is acting
as an agent of the insurer. In a claims situation, the contractor (the servant)
is assisting an insurer (the master) in performing an insurer's nondelegable
duty. According to the Restatement (Second) of Agency, Section 219:
(1) A master is subject to liability for the torts of
his servants committed while acting in the scope of their employment.
(2) A master is not subject to liability for the torts
of his servants acting outside the scope of their employment, unless (a) the
master intended the conduct or consequences, or (b) the master was negligent
or reckless, or (c) the conduct violated a nondelegable duty of the master,
or (d) the servant purported to act or speak on behalf of the principal and
there was reliance upon apparent authority, or he was aided in accomplishing
the tort by the existence of the agency relation.
To illustrate the point, in a duty to defend case, a Wisconsin court held
insurers liable for the negligence of their hired counsel. In
Majorowicz v. Allied Mut. Ins. Co., the attorney
hired to represent Majorowicz in an automobile liability claim had independent
medical testimony that the plaintiff's injuries were sufficient to warrant tendering
of policy limits. Majorowicz's appointed counsel, however, did not offer policy
limits, failed to communicate material matters to her, conducted insufficient
discovery and committed other errors detrimental to the insured. Allied took
the position that an insurer has no right to control the professional judgment
of an attorney and since an insurer cannot practice law, it, of necessity, must
delegate the authority; therefore, it contended, an insurer is not liable for
an independent contractor attorney's conduct.
Rejecting Allied's argument, the court ruled that the claims function is
nondelegable, reasoning:
The nondelegable exception [to independent contractor status] is based upon
the theory that certain responsibilities of a principal are so important
that the principal should not be permitted to bargain away the risks of
performance.
Here, we have a special fiduciary duty created by an insurance contract
… [I]t is clear that an insurance company owes an affirmative duty to the
insured of good faith treatment of any covered claims against the insured.
Insurers Must Select Competent Vendors
Insurers have a responsibility to choose claims investigators who are suitable
to the task, whether they work directly for the insurer or operate as independent
contractors. Failure to choose suitable persons can lead to serious problems
for an insurer. Examples from the extensive caselaw on independent medical examiners
in health, disability, and workers compensation claims illustrate the point.
In Grady v. Paul Revere, a Rhode Island federal
district court threw out the testimony of a company medical doctor who opined
that Kathleen Grady did not meet the total disability definition in the company's
policy. Here is how the court explained why the doctor's opinion carried "no
weight":
Dr. Goldstein is a paid, full-time employee of defendant who does not specialize
in back or knee problems, and who never treated plaintiff, but instead completed
a cursory review of the medical records he received. (Grady
v. Paul Revere Life Ins. Co., 10 F. Supp. 2d 100, 06/01/1998)
On another disability claim, a major telecommunications company used an independent
medical examiner's opinion to support its position that a beneficiary under
an employment benefit plan was not disabled. Rejecting the medical examiner's
conclusions, a Middle District Federal Court in Florida concluded,
The opinions of [insured's] primary treating physicians … should have been
given greater weight than that given by Dr. Gold who only examined [her]
once for approximately one hour and fifteen minutes and who relied on the
less than reliable testing conducted by his mental health counselor. (Brown
v. BellSouth Telecommunications, Inc., 73 F. Supp 2d 1308, M.D. Fla.
08/04/1999)
Concluding Observations
In summary, the insurance contract is a unique product, imposing on both
insurers and insureds special duties that may exceed the customs and practices
to which third-party vendors are accustomed in their own occupational undertakings.
The special nature of the insurance contract is a starting point in assessing
the conduct of vendors that provide claims services to insurers.
Generally, irrespective of the quality of the vendor's work, the insurer
is accountable for it. Consistent with this notion, errant vendors may seek
protection from liability to insureds on the theory that they are accountable
to the insurance company, not the policyholder.
What standards may an insurer and a policyholder apply in evaluating the
work of third-party vendors? What sources are available? I will address these
questions in a subsequent commentary.
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not necessarily held by the author's employer or IRMI. Expert Commentary articles
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