Insurance policies are unique among widely used financial contracts. Insurance is rooted in risk pooling. Insurers collect premiums from policyholders and use these funds to pay claims to those who suffer losses. This allows the financial burden to be spread efficiently across many participants. The fortunate ones who avoid losses subsidize those who suffer, creating a sense of shared responsibility.
Insurance serves a social need by providing financial protection, stability, and resilience in the face of unexpected events or risks. It offers a safety net that helps society cope with unforeseen and often catastrophic events, such as accidents, illnesses, death, and property damage, preventing financial distress and ensuring people can maintain their quality of life even in challenging circumstances. It supports economic growth by allowing individuals and businesses to transfer the financial burden of potential dangers to a collective fund, enabling people to pursue activities and investments that might otherwise be considered too risky without protection.
Insurance offers peace of mind to individuals and families by reducing anxiety about potential future losses and reducing stress. It often requires policyholders to follow safety guidelines and take precautions to mitigate risks, which promotes responsible behavior and reduces the likelihood of accidents or losses. Insurance is part of a broad, interconnected, complex system of protection on which policyholders, dependents, tort victims, and society depend to provide security in the event of unforeseen harm.
The insurer’s and insured’s relationship is typically characterized as “special” or “quasi-fiduciary” based on various factors. This characterization and its unique underlying factors provide grounds for extraordinary legal treatment. They permit the integration of tort principles to evaluate an insurer’s performance under the policy—in what had historically been the exclusive domain of contract law. Four principal distinctions emerge from the hybrid contract-tort approach to insurance law:
(1) Duty of Care. Unlike ordinary contracting parties, insurers are held to a high duty of care standard. Insurers must consider the insured’s interests at least as much as they consider their own.[1] An even higher true-fiduciary standard applies for policies issued under ERISA, which designates certain parties as true fiduciaries with a duty of loyalty to the plan and its participants and beneficiaries.[2]
(2) Additional Implied Duties. While every contract contains an implied covenant of good faith and fair dealing that neither party will do anything to injure the right of the other to receive the benefits of the agreement,[3] the implied covenant is treated differently in insurance and has far greater application.[4] It gives rise to additional implied duties for insurers not recognized in other contracts. They include a duty to settle a third-party liability claim within policy limits when there is a great risk of recovery beyond the policy limits[5] and a duty to conduct a thorough, fair, and objective investigation.[6] Above all, there is an overarching duty to act honestly and fairly towards the insured.[7]
(3) Comprehensive Damages. While recovery for breach of contract is typically limited to those damages reasonably foreseeable when the parties entered into the agreement, an insured generally may recover all damages from an insurer’s breach of its duties, foreseeable or not.[8] Often described as extracontractual or tort-like damages, insureds may recover lost income, non-economic losses such as emotional distress, attorney’s fees and costs, and sometimes punitive damages.
(4) Tortious Breach Standard. An insurer’s breach of its duties is evaluated using a tort-like standard. While a contract breach typically occurs when a party fails to perform its obligations, an insured must show that the insurer unreasonably breached its duty.[9] Many states use an even higher standard for breach, requiring a showing of an insurer’s wrongful intent.[10]
The California Supreme Court initially relied on the implied covenant of good faith and fair dealing—and the insured’s reasonable expectations under the covenant—to treat insurance differently than other contracts in a way that supported the application of tort principles. The Court originally applied the covenant to third-party liability claims.[11] The Court later extended the tort principles to first-party loss claims, relying on the implied covenant.[12] Yet, given that the implied covenant is found in every contract, and the covenant is designed to effectuate the reasonable expectations of the parties, this approach failed to meaningfully distinguish between insurance and other contracts in a way that would justify the application of tort principles in one and not the other. While identifying additional insurer-specific duties is easy to explain simply from the implied covenant and the party’s reasonable expectations, applying tort principles to breach and damage calculation is not nearly as defensible.
Attributes of the Special Relationship
In Egan v. Mutual of Omaha Ins. Co.,[13] the California Supreme Court finally offered a few grounds for treating insurance differently and applying tort principles. The Court began by addressing the insurance standard of care and comparing the first-party claims to third-party claims, stating that “[i]n both contexts the obligations of the insurer “are merely two different aspects of the same duty.” … For the insurer to fulfill its obligation not to impair the right of the insured to receive the benefits of the agreement, it again must give at least as much consideration to the latter’s interests as it does to its own.”[14]
The Egan court highlighted several key differences between insurance and other contracts, noting that the insured seeks protection and peace of mind when entering the policy, not profit. The court analogized the insurance relationship to that of a fiduciary, noting the characteristics of a “special relationship” that merit the imposition of extracontractual damages for a breach of the duty of good faith and fair dealing, including that “[t]he insurers’ obligations are … rooted in their status as purveyors of a vital service labeled quasi-public in nature,” “[t]he obligations of good faith and fair dealing encompass qualities of decency and humanity” and “the adhesive nature of insurance contracts places the insurer in a superior bargaining position.”[15] In all, Egan introduced the “special relationship” and three factors supporting this characterization: the purpose of insurance (peace of mind), the overriding function as a public service, and the disparate bargaining power of the parties.
A decade later, the California Supreme Court revisited the underlying grounds for characterizing the insurance relationship as special. In Foley v. Interactive Data Corp.,[16] the Court declined to apply tort principles to a wrongful employment termination, reasoning that the insurer-insured relationship differs significantly from an employer-employee’s.[17] While noting the Egan factors, the Court offered a few additional grounds for the unique tort treatment afforded insurance, each of which the court determined was missing from the employer-employee context.
First, the insurer’s and insured’s interests are not aligned but financially at odds. A benefit to one is a cost to the other, resulting in the potential for adversarial treatment by the insurer.[18] Second, the insured, having made their payments in advance, places their trust in the insurer and relies on it to perform in the event of calamity.[19] And finally, ordinary contract damages are inadequate to compensate the insured for their loss. While an employee must mitigate their damages by seeking alternative employment, an insured cannot purchase a replacement policy to cover a loss that has already occurred. Insurance covers fortuity, not a pre-existing loss.[20]
Egan has been widely cited for the unique features of insurance that characterize the insurer-insured relationship as “special,” “quasi-fiduciary,” or “fiduciary” to justify the application of tort principles.[21] Like Foley, courts nationwide have expanded on the original Egan grounds for treating insurance differently, collectively offering the following reasons:[22]
(1) Public service. Insurers are purveyors of a vital service affected by the public interest, whose obligations encompass qualities of decency and humanity. Unlike ordinary commercial transactions, insurance plays a critical role in societal stability and economic security. Policies offer a crucial safety net for personal and financial well-being. Given their role in mitigating financial risks, insurers are called upon to uphold qualities of decency and humanity.[23]
(2) Purpose of Insurance. Unlike other commercial transactions, the insured is motivated not by pursuing commercial gain when purchasing an insurance policy but by the desire for peace of mind and security. The insured pays premiums to ensure they have a safety net in times of need.[24]
(3) Trust & Reliance. The performance dynamics of an insurance policy are unique. As a contract that transfers risk, the insured fulfills their obligation by paying premiums regularly, while the insurer’s performance obligation may never arise unless a claim is made. This sequential nature means the insured demonstrates continuous good faith by fulfilling their part of the contract, trusting that the insurer will honor its obligations when needed. Most policyholders are not experts in the intricacies of insurance contracts and thus depend on the insurer to fulfill its obligations faithfully. This trust places the insurer in a position of power, which must be exercised responsibly.[25]
(4) Unequal Bargaining Power (Contract of Adhesion). Insurance policies are built on inequality and dependence. They are often described as contracts of adhesion, meaning the insurer drafts them with little to no input from the insured. The insurer enters into many such policies, but insureds enter into only a few. The insured typically has limited bargaining power and must accept the terms as they are presented.[26]
(5) Control & Discretion. Insurers wield significant, if not unfettered control and discretion over the investigation, evaluation, and resolution of claims. This level of control places the insurer in a position of authority.[27]
(6) Vulnerable Insured. The insured is often vulnerable after a calamity. They face the dual challenges of emotional distress and potential economic devastation. This vulnerability increases the possibility of opportunistic behavior by insurers, who may exploit the insured’s desperate circumstances to avoid paying claims.[28]
(7) Misaligned Interests. The financial interests of the insurer and insured are directly at odds. In other contracts, the party’s interests may align. Parties enter into employment agreements to work together to build a sustainable, profitable business. Insurance, though, is a zero-sum game. If the insurer pays a claim, it diminishes its resources. This competition for resources incentivizes the insurer to treat the insured as an adversary rather than a partner responding to a calamity—the opposite of the dynamic insureds sought and for which they pay premiums.[29]
(8) Breach Incentive. Without the threat of having to pay the plaintiff’s attorneys’ fees or tort damages, insurers face no financial risk from wrongfully denying claims. The only financial penalty is paying the amount that would otherwise be due. They are incented to deny, delay, and defend against claims if only to force favorable settlement terms upon the insured.[30]
(9) Inadequate Damages. In typical commercial contracts, ordinary damages aim to compensate for financial losses resulting from a breach. However, ordinary contract damages are inadequate for insurance claims because they do not require the party in the superior position to account for its action, and they do not make the inferior party whole or compensate the insured for their reason to purchase a policy—peace of mind.[31]
(10) Defeated Purpose. Insurance’s principal purpose is to provide policyholders with financial protection and peace of mind. If insurers can refuse to pay valid claims without reasonable justification, the fundamental purpose of insurance is undermined, rendering the contract meaningless.[32]
(*) Reasonable Expectations. The insured’s reasonable expectations have been suggested as grounds for characterizing the relationship as special. However, the implied covenant of good faith and fair dealing is found in every contract, and its very purpose is to effectuate the parties’ reasonable expectations. While the insured’s reasonable expectations may be crucial to interpreting the policy and defining the insurer’s duties, no meaningful distinction has been offered for treating the insured’s reasonable expectations differently from other contracting parties to support the extraordinary treatment, except perhaps as incorporated in the above factors (e.g., the purpose of insurance, or trust and reliance).[33]
These attributes highlight the unique and special relationship between insurers and insureds.[34] Recognition by the courts of this special relationship underscores the importance of fairness, transparency, and good faith in the insurance industry. The special relationship is critical to evaluating the insurer’s duties, particularly those invoking fairness and honesty. This relationship ensures that policyholders receive the protection and peace of mind they seek, reinforcing the fundamental purpose of insurance in our society. While each factor is critical to evaluating an insurer’s use of biased experts, two are particularly so: the parties’ unequal bargaining power and the insurer’s unfettered discretion and control over evaluating and resolving the claim.
[1] See, e.g., Wilson v. 21st Century Ins. Co., 42 Cal.4th 713, 720 [171 P.3d 1082] (2007) (Wilson); Egan v. Mutual of Omaha Ins. Co., 24 Cal.3d 809, 818 [620 P.2d 141] (1979) (Egan); Crisci v. Security Ins. Co., 66 Cal.2d 425, 429 [426 P.2d 173] (1967) (Crisci); Comunale v. Traders & General Ins., Co. 50 Cal.2d 654, 659 [328 P.2d 198] (1958) (Comunale).
[2] See 29 U.S. Code §§ 1102 and 1104.
[3] See, e.g., Wilson, supra, 42 Cal.4th at 720; Comunale, supra, 50 Cal.2d at 658.
[4] Gruenberg v. Aetna Ins. Co., 9 Cal.3d 566, 577-578 [510 P.2d 1032] (1973) (describing the duty of good faith and fair dealing as implied in law and independent of the performance of the insured’s contractual obligations).
[5] See, e.g., Crisci, supra, 66 Cal.2d at 429; Comunale, supra, 50 Cal.2d at 659.
[6] See, e.g., Wilson, supra, 42 Cal.4th at 720-723, 726; Egan, supra, 24 Cal.3d at 819.
[7] Major v. Western Home Ins. Co., 169 Cal.App.4th 1197, 1209 [87 Cal.Rptr.3d 556] (2009) (An insurer must act fairly, honestly, decently, and humanely towards its policyholder). See also, Best Place, Inc. v. Penn Am. Ins. Co., 82 Hawai’i 120, 126 [920 P.2d 334] (1996) (“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” [citations omitted]); Rawlings v. Apodaca, 151 Ariz. 149, 163 [726 P.2d 565] (1986) (insured may maintain an action to recover tort damages if the insurer, by an intentional act, also breaches the implied covenant by failing to deal fairly and honestly with its insured’s claim); White v. Unigard, 112 Idaho 94, 99 [730 P.2d 1014] (1986) (“insurance contract … requires that the parties deal with each other fairly, honestly, and in good faith.”).
[8] See, e.g., Neal v. Farmers Ins. Exchange, 21 Cal.3d 910 [582 P.2d 980] (1978) (awarding punitive damages); Gruenberg v. Aetna Ins. Co., supra, 9 Cal.3d 566 (permitting recovery for emotional distress in first-party claim); Crisci, supra, 66 Cal.2d 425 (permitting recovery for emotional distress in third-party claim).
[9] See, e.g., Wilson, supra, 42 Cal.4th at 720 (“When the insurer unreasonably and in bad faith withholds payment of the claim of its insured, it is subject to liability in tort.” (citing Frommoethelydo v. Fire Ins. Exchange, 42 Cal.3d 208, 214–215 [721 P.2d 41] (1986).)
[10] See, e.g., Missler v. State Farm Ins. Co., 41 N.E.3d 297, 302 (Ind. Ct. App. 2015) (citations omitted); Habetz v. Condon, 224 Conn. 231, 238 [618 A.2d 501] (1992).
[11] See, e.g., Crisci, supra, 66 Cal.2d 425; Comunale, supra, 50 Cal.2d 654.
[12] See, e.g., Silberg v. California Life Ins. Co., 11 Cal.3d 452 [521 P.2d 1103] (1974); Gruenberg, supra, 9 Cal.3d 566.
[13] Egan, supra, 24 Cal.3d 809.
[14] Id., at 819.
[15] Id., at 820.
[16] Foley v. Interactive Data Corp., 47 Cal.3d 654 [765 P.2d 373] (1988) (Foley). Following Egan, numerous cases attempted to extend the application of tort-like principles to breach of the implied covenant of good faith and fair dealing in other contracts. The initial focus was on banking and employment cases, as these actions were imbued to a degree with the same social welfare and unequal bargaining power found in insurance. The California Supreme Court initially gave some life to the movement in Seaman’s Direct Buying Service, Inc. v. Standard Oil Co., 36 Cal.3d 752, 769 [686 P.2d 1158] (1984), suggesting in dicta that a tort cause of action might lie “when, in addition to breaching the contract, [defendant] seeks to shield itself from liability by denying, in bad faith and without probable cause, that the contract exists.” However, the Court quickly retreated. The Court cast doubt on the Seamen’s dicta In Foley. The Court finally halted the expansion in Freeman & Mills, Inc. v. Belcher Oil Co., 11 Cal.4th 85 [900 P.2d 669] (1995), declining to extend tort-like duties and damages to contracts (other than insurance) absent a violation of “an independent duty arising from principles of tort law.” Id., at 102.
[17] Id., at 692-693.
[18] Id., at 693.
[19] Id., at 690.
[20] Id., at 693.
[21] Many jurisdictions have elected not to recognize a special relationship. Nevertheless, many have adopted tort principles for insurance, while others provide either statutory remedies or an expansive view of contract damages that include as foreseeable many damages that would generally be characterized as tort based. See, e.g., NY: Acquista v. New York Life Ins. Co., 285 A.D.2d 73 (2001) (rejecting a tort duty for insurers and cataloging jurisdictions with an expansive view of damages for an insurer’s breach of contract); KS: Spencer v. Aetna Life & Cas. Ins. Co., 227 Kan. 914, 917-918 [611 P.2d 149] (1980) (discussing the Kansas statutory scheme for insurer breach).
[22] Four cases provide more complete analyses of the factors and are often cited by other courts: CA: Egan, supra, 24 Cal.3d 809 at 819–820; AK: State Farm Fire & Cas. Co. v. Nicholson, 777 P.2d 1152, 1155–1157 (Alaska 1989) (Nicholson); HI: Best Place, Inc. v. Penn Am. Ins. Co., 82 Hawai’i 120, 128–132 [920 P.2d 334] (1996) (Best Place); and ID: White v. Unigard, 112 Idaho 94, 99 [730 P.2d 1014] (1986) (White). Collectively, they identified nine of the ten factors for insurance’s extraordinary tort treatment, with Nicholson, Best Place, and White citing eight factors each. Each of the five cases cited the parties’ unequal bargaining power, the public service nature and the purpose of insurance, which are the most widely cited reasons in other jurisdictions. Exhibit C-1 to this E-Treatise includes a chart summarizing the recognition of the relationship and supporting factors for many jurisdictions, including the cases cited in the footnotes below and others. For further insight on the factors supporting the special relationship, see Anderson & Fournier, Why Courts Enforce Policyholders’ Objectively Reasonable Expectations of Coverage, 5 Conn. Ins. L.J. 335, 385–391 (1998-1999).
[23] See e.g., CA: Egan, supra, 24 Cal.3d 809 at 819–820; AK: Nicholson, supra, 777 P.2d at 1155–1157; HI: Best Place, supra, 82 Hawai’i at 128–132.; ID: White v. Unigard, 112 Idaho at 99.
[24] See ns. 22, 23. See also, NV: Ainsworth v. Combined Ins. Co., 104 Nev. 587, 592, 763 P.2d 673, 676 (1988), cert. denied, 493 U.S. 958, 110 S.Ct. 376, 107 L.Ed.2d 361 (1989).
[25] See, e.g., AL: Alabama Mun. Ins. v. Munich Reinsurance Am., Inc., 526 F. Supp. 3d 1133, 1136–1137 (M.D. Ala. 2021); CA: Egan, supra, 24 Cal.3d 809 at 819–820; ID: White, supra, 112 Idaho at 99.
[26] See ns. 22, 23. See also, NM: Young v. Hartford Cas. Ins. Co., 503 F. Supp. 3d 1125, 1182-83 (D. N.M. 2020) (citing Bourgeous v. Horizon Healthcare Corp., 117 N.M. 434 [872 P.2d 852] (1994)); SD: Trouten v. Heritage Mut. Ins. Co., 2001 S.D. 106, ¶ 30 [632 N.W.2d 856, 863–864] (2001); WY: Long v. Great W Life & Annuity Ins. Co., 957 P.2d 823, 829 (Wyo. 1998) (citing McCullough v. Golden Rule Ins. Co., 789 P.2d 855 (Wyo. 1990)). For more on insurance policies as adhesion contracts, see Case Study: Insurer’s Unfettered Discretion in Homeowner’s Claims.
[27] See ns. 22, 23. See also, IL: Roberts v. Western-Southern Life Ins. Co., 568 F. Supp. 536, 554–555 (N.D. Ill. 1983); TX: Universe Life Ins. Co. v. Giles, 950 S.W.2d 48, 52-53 (Tex. 1997) (citing Arnold v. National County Mut. Fire Ins. Co., 725 S.W.2d 165(Tex. 1987)); WI: Danner v. Auto-Owners Insurance, supra, 245 Wis.2d 49, 67–72.
[28] See ns. 22, 23. See also, AZ: Noble v. National American Life Insurance Co., 128 Ariz. 188, 189–190 [624 P.2d 866] (1981); Rawlings v. Apodaca, 151 Ariz. 149, 155 [726 P.2d 565] (1986); CT: Grand Sheet Metal Products Co. v. Protection Mutual Ins. Co., 34 Conn. Supp. 46, 51 [375 A.2d 428] (Conn. 1977); MS: Andrew Jackson Life Ins. Co. v. Williams, 566 So.2d 1172, 1189 (Miss. 1990) (favorably citing Egan, Rawlings, and Arnold to support punitive damage award); MT: Puryer v. HSBC Bank USA, 2018 MT 124, 391 Mont. 361, 370–371 [419 P.3d 105] (Mont. 2018) (citing Story v. City of Bozeman, 242 Mont. 436 [791 P.2d 767] (Mont. 1990)); OH: Hoskins v. Aetna Life Ins. Co., 6 Ohio St.3d 272, 275–277, 6 OBR 337, 339 [452 N.E.2d 1315, 1319] (1983); OK: Wathor v. Mutual Assurance Administrators, Inc., 2004 OK 2 [87 P.3d 559, 561–562] (2004) (citing Christian v. American Home Assur. Co.,1977 OK 141 [577 P.2d 899] (1977)); TX: Universe Life Ins. Co. v. Giles, supra, 950 S.W.2d at 52-53.
[29] See Foley, supra, 47 Cal.3d at 692–693.
[30] See ns. 22, 23. See also, AK: State Farm Fire & Cas. Co. v. Nicholson, 777 P.2d 1152, 1155–1157 (Alaska 1989); OK: Wathor v. Mutual Assurance Administrators, Inc., supra, 87 P.3d at 561–562]; TX: Universe Life Ins. Co. v. Giles, supra, 950 S.W.2d at 52-53. Several courts have considered and dismissed the insurer’s arguments that statutory schemes are exclusive remedies or provide sufficient disincentives to breach. See, e.g., HI: Best Place, Inc. v. Penn Am. Ins. Co., supra, at 126–127; AK: State Farm Fire & Cas. Co. v. Nicholson, supra, 777 P.2d at 1158; ID: White v. Unigard, supra, 730 P.2d at 1019 n. 3; IL: Roberts v. Western-Southern Life Ins. Co., 568 F. Supp. 536, 555 (N.D. Ill. 1983). The lack of a statutory disincentive may be particularly so when it fails to provide a private cause of action, and the caselaw likewise fails to show enforcement action by regulators. However, there remains disagreement among the courts about the statutory frameworks. In Spencer v. Aetna Life & Cas. Ins. Co., 227 Kan. 914, 917-918 [611 P.2d 149] (1980), the court provided a survey of the critical factors used in other states to support tort treatment but held that the statutory scheme adequately protects the insured.
[31] See ns. 22, 23. See also, MT: Puryer v. HSBC Bank USA, supra, 391 Mont. 361, 370–371.
[32] See ns. 22, 23. See also, MS: Andrew Jackson Life Ins. Co. v. Williams, supra, 566 So.2d at 1189; AZ: Noble v. National American Life Insurance Co., 128 Ariz. 188, 189–190 [624 P.2d 866] (1981; WI: Danner v. Auto-Owners Insurance, supra, 245 Wis.2d 49, 67–72.
[33] See, e.g., 8 New Appleman on Insurance Law Library Edition § 90.01 (2024) (identifying 8 cases).
[34] The special relationship and factors applicable to insurers appear derivative of the “special relationship” doctrine and test in tort law applicable to professionals and others. See, e.g., CA: Brown v. U.S.A. Taekwondo, 11 Cal.5th 204, 215–216 [483 P.3d 159] (2021) (adopting a two-part test for recognizing a duty to protect others, including first ascertaining whether a special relationship exists). The two share many similarities, particularly concerning the creation of a duty that is based on dependency. The “existence of such a special relationship puts the defendant in a unique position to protect the plaintiff from injury.” Id., at 216. See also Robert F. Schopp and Michael R. Quattrocchi, Tarasoff, The Doctrine of Special Relationships, and the Psychotherapist’s Duty to Warn, 95 J. Psychiatry & Law 13 (1984) (discussing the reach and application of the doctrine and the duty to warn or otherwise protect third parties under California law).