By virtue of its contract with an insured, an insurer is under a duty to exercise good faith and fair dealing with regard to the insured’s rights under the contract. This duty requires the insurer to act so as not to prevent the insured from receiving the benefits of the agreement. In most jurisdictions, the duty applies to the insurer’s conduct in settling an action that is brought by a third party against the insured.

Duty to settle

If an insured is involved in an accident with or causes harm to a third party, the third party may bring an action against the insured to recover damages. If the insured has an insurance policy by which his insurer has assumed the defense of third-party actions against the insured, the insurer generally will have the right of election to settle or not settle the case. The insurer must exercise its duty of good faith and fair dealing in making such a decision. Prior to imposing such duty, however, it must be shown in some jurisdictions that the insurer assumed the defense of the third-party action and that the insurer had an opportunity to settle.

Determining when to settle

In deciding whether a third party’s claim should be settled, the insurer must give the insured’s interest at least as much consideration as it does its own interest. Because most liability policies contain dollar limits on the insurer’s obligation to indemnify, a conflict of interest between the insurer and the insured may arise if the third party’s claim exceeds the policy limits. Generally, if there is a high probability of the third party recovering from the insured beyond the policy limits so that the most reasonable manner of disposing of the claim is settling within those limits, the insurer should most likely settle the claim.

Consequences of not settling

An insurer may decide not to settle and to gamble on a finding of no liability against the insured rather than accept a settlement offer from a third party within the policy limits. However, the gamble may not pay off. A failure to settle the action may result in a judgment against the insured that exceeds his policy limits. If the insurer did not act in good faith in deciding not to settle, the insured may bring an action against the insurer to recover the excess that he is required to pay. Car accident lawyer can give you important advice in this circumstance.

Breach of duty for failure to settle

Most courts find that an insurer breached its duty if it acted in bad faith in making its settlement decision. The bad faith test involves a determination of whether the insurer failed to give sufficient consideration to the insured’s interests, which could have conflicted with those of the insurer, in refusing to settle. Some courts, on the other hand, determine if the insurer was negligent and failed to exercise the care that a reasonable person would have exercised in making the settlement decision. In some jurisdictions, both tests are applied.

Last modified: October 4, 2021

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