Third-Party Vendors in Insurance Claims Investigations: A Framework for Evaluation
Tim Ryles | November 1, 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.
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 texts 3 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:
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 case law 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.
Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.
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