It’s Time For The Massachusetts Legislature To Close This Insurance Loophole

The Massachusetts Consumer Protection Statute incentivizes insurers to commit bad faith

The Duty of Good Faith

Under Massachusetts law, insurers are required to act in good faith when processing insurance claims. Good faith is the foundation on which the claims process rests.  It promotes transparency, builds trust, and fosters a cooperative relationship between the parties. An absence of good faith creates a fundamentally flawed claims process fraught with frustration, conflict, litigation, and expenditure of valuable court resources.

Good faith requires insurers to investigate claims promptly and fairly, and to evaluate claims honestly based upon the facts. Once a fair investigation reveals that liability is reasonably clear, insurers must promptly make a reasonable offer to pay the claim. Unreasonable delays, incomplete investigations, unfair assessment of the facts, or lowball offers constitute a breach of an insurer’s duty of good faith.

The Legislature Tries to Deter Bad Faith

In 1989, the Massachusetts Legislature amended the State’s Consumer Protection Statute, General Law Chapter 93A, to promote good faith in business and to punish and deter bad faith conduct. The legislature intended the amendment, as applied to insurers, to greatly increase the potential liability an insurer would face if it intentionally violated its duty of good faith.

Before the amendment, an insurer that intentionally or negligently violated its duty of good faith paid interest, or loss of use damages, for the delay in making a good faith offer. For example, a homeowner with a $200,000 property damage loss could recover from an insurer the interest the homeowner could have earned on the $200,000 during the period of time the insurer wrongfully delayed its offer to pay the claim.

The amendment to Chapter 93A added a hefty penalty for insurers that intentionally violated their duty of good faith, measured not by lost interest but by a multiple of 2 or 3 times the total judgment amount on the underlying claim. Under the new “93A” law, the homeowner with the $200,000 property damage claim who won at trial would recover between $400,000 and $600,000 in punitive damages for an insurer’s bad faith on top of the $200,000 judgment in compensation for the property damage loss.

The legislature intended the 93A amendment to change the math for bad faith insurers. Insurance is a business, and insurers like other companies are driven to maximize profit. It stands to reason that if rather than making reasonable and prompt claim payments, an insurer can make more money by delaying good faith offers and wearing down claimants to accept unreasonably low claim settlements, then some insurers are going to intentionally violate their duty of good faith. The hefty 93A penalty, in replacement of lost interest, was expected to disincentivize insurers to act in bad faith and tip the scales in favor of good faith.

Legislation Gone Awry

Unfortunately, the language of the 93A amendment allows bad faith insurers a way around the penalty, leaving the economic calculus unchanged. The amendment has a protocol designed to promote settlement. It requires the claimant to send the insurer a “93A demand letter” explaining why the claimant maintains the insurer violated its duty of good faith. This typically happens after the insurer has delayed or lowballed its offer. The insurer has 30 days to respond to the demand letter. If the insurer responds with an offer that fairly values the claim and includes lost interest, then the insurer will avoid the hefty 93A penalty. Insurers call this the “safe harbor” provision. Safe harbor allows them to intentionally violate the statute with virtual impunity, having at worst to pay interest on the claim if and when they receive a 93A demand letter.

The safe harbor provision has far reaching implications for the insurance claims process in Massachusetts. Bad faith insurers are able to profit by strategically offering claimants less than fair value, making and defending meritless arguments, and incrementally raising offers over time. The strategy is intended to frustrate, stress, and pressure claimants to settle. Claimants generally are unfamiliar with the claims process and unaware of their 93A rights; often are in a financially vulnerable place; and typically are motivated to resolve claims as quickly as possible. They get worn down by the process and accept lowball offers.

Massachusetts courts have highlighted the inherent inconsistency in the 93A amendment. Eight years ago, one judge wrote expressly that the 93A amendment unintentionally incentivizes insurers to continue their practice of deliberately delaying settlement knowing at worst their penalty exposure will be limited to interest on the claim.  Any fix to the language of the statute, the judge concluded, must come from the legislature, not the courts.

A Proposed Fix

The problem with the amendment is not with the 93A demand letter and response protocol itself. The protocol is designed to promote settlement. It incentivizes an insurer to make a good faith offer in response to a claimant’s demand letter. What the protocol doesn’t do, however, is change the bad faith insurer’s economic calculus to choose good faith from the start of the claims process. If anything, the 93A amendment further encourages bad faith insurers to disregard their duty of good faith, because they know only a small percentage of claimants will send them a 93A demand letter, and when they receive a demand letter they will be able to gain safe harbor at the relatively nominal cost of accrued interest.

To change the economic calculus of bad faith insurers, there must be an unavoidable substantial penalty at the demand letter stage for intentional violation of the statute. If an insurer has intentionally violated the statute, the insurer must include in its offer in response to the demand letter the payment of the penalty to have safe harbor from the heftier 93A penalty of up to treble the judgment amount. 

The most obvious penalty is to increase the rate of interest bad faith insurers must include in their response to a 93A demand letter since interest accrues over time and an accruing penalty will incentivize insurers to settle sooner rather than later.  Currently, there being no set rate in Chapter 93A, courts have given insurers safe harbor if they offer to pay interest at a rate between 6% and 12% per annum in their demand letter response. The latter is the Massachusetts statutory interest rate for torts and contract actions. It is well known that these interest rates do not incentivize bad faith insurers driven by economic analysis, rather than fidelity to the law, to exercise good faith from the start of the claims process.

The penalty interest rate needs to be a significantly higher than the prevailing rates and significantly less than the hefty penalty of 2 or 3 times the underlying judgment amount. In that way, the penalty interest rate may serve the dual purposes of promoting settlement at the demand letter stage and punishing and deterring bad faith conduct before the demand letter stage. On the one hand, bad faith insurers would be incentivized to make a good faith offer in response to a claimant’s 93A demand letter to gain safe harbor from the hefty judgment-based penalty. On the other hand, when choosing to violate the statute, bad faith insurers would be forced to factor into their economic calculus a much higher cost than the prevailing interest rates.

My suggestion would be penalty interest of three times the 12% Massachusetts statutory rate for contracts and torts, or a rate of 36% per annum. The legislature has used a penalty rate of interest to deter bad faith conduct in other contexts, notably to deter frivolous lawsuits. There, the legislature chose an 18% penalty rate, but there are other means of deterring bad faith litigation, including dismissal of the lawsuit.  Here, the only means of deterrence is what the legislature provides in the statute.

I would expect most claimants to send a demand letter within six to eighteen months of the beginning of the insurer’s bad faith, so in most instances bad faith insurers seeking to gain safe harbor in response to a claimant’s 93A demand letter would have to pay penalty interest of 18% to 54% on top of the fair value of the claim itself. There will be exceptions. Currently, some bad faith insurers strategically wait until the eve of trial, as long as three years into the claims process, to make a good faith offer, hoping to place maximum pressure on claimants to settle. I would expect bad faith insurers having to offer 100% penalty interest for safe harbor to rethink that strategy. Expert input on the relevant economics of the bad faith/good faith choice can help the legislature choose the appropriate rate of penalty interest.

There is no good reason for Massachusetts to maintain a law that encourages insurers to intentionally violate their duty of good faith when processing insurance claims. The safe harbor built into the current 93A demand letter and response mechanism perpetuates intentional violation of the law and promotes a fundamentally flawed claims process. It’s time for the legislature to fix the 1989 amendment to Chapter 93A.