Opinion
Does the implied covenant of good faith and fair dealing require a workers’ compensation insurer to defend and resolve claims with due regard to the impact of outstanding claims and reserves on the premiums
The immunity contention having been soundly discredited by two recent decisions in similar cases, we confront the primary issue of liability they did not reach. We hold that under an insurance regime in which the insured’s annual claims experience inexorably influences its premiums, the insurer may be liable if it processes claims and sets reserves without good faith regard for their impact on the insured’s premiums and potential dividends. We therefore reverse the dismissal and direct that plaintiff be allowed to proceed with a new amended complaint.
Factual Statement
We summarize the allegations of plaintiff’s second amended complaint, as supplemented by matters of which judicial notice is mandatory under Evidence Code sections 451, subdivisions (a), (b), and 459, subdivision (a)(2). (These include the Workers’ Compensation Insurance Rating Bureau of California [rating bureau] manual, rating plan, and statistical plan, of which SCIF has requested judicial notice.)
Defendant SCIF is a public workers’ compensation insurance enterprise, governed under Insurance Code sections 11770-11881. In December 1986, plaintiff entered into three insurance contracts with SCIF (collectively the policy), affording workers’ compensation insurance for the period December 1, 1986, to December 1, 1988. Under the policy, SCIF agreed to “pay promptly when due to those eligible under this policy the benefits required of [plaintiff] by the workers’ compensation law.” The policy also obligated SCIF to defend claims, stating in relevant part: “We have the right and duty to defend at our expense any claim, proceeding or suit against you for benefits payable by this insurance. We have the right to investigate and settle these claims, proceedings or suits.”
Part five of the policy provided that premiums would be determined by the rating bureau’s manuals of rules, rates, rating plans, and classifications, and that plaintiff would accept any increased premiums or rates which might be
Plaintiffs policy premiums are determined by the rating bureau, as a function of the “manual rate” for the industry in question (prescribed by Cal. Code Regs., tit. 10, § 2350), the employer’s annual payroll, and its loss “experience rating,” as modified with regard to the number of claims outstanding at the end of the year, and the amount of reserves SCIF has established for those unresolved claims. (See Cal. Code Regs., tit. 10, § 2353 [rating bureau experience rating plan].) Not only does this “experience modification” affect plaintiffs premiums, the claims history also affects its entitlement to dividends.
Against this backdrop, plaintiff alleges the following contractual violations, in overlapping causes of action for breach of contract and “contractual breach of the implied covenant of good faith and fair dealing.” First, SCIF breached its policy duty to pay benefits promptly, by unjustifiably allowing claims against plaintiff to remain open. For example, using its own hired consultant, plaintiff was able to resolve within three months several of the oldest such claims, some of which had been open for as long as three years. These claims were closed “for payments of approximately $7,500,” whereas SCIF had assigned them reserves in excess of $100,000, in violation of an implied standard of reasonableness in allotting reserves. SCIF also ignored plaintiffs offer to provide investigators to expedite processing outstanding claims. In consequence of SCIF’s conduct, plaintiff’s experience modification rating increased, causing plaintiffs premiums to rise to unwarranted levels.
Plaintiff further alleges that by its sloth in resolving claims, SCIF breached its duty to defend and resolve them in requisitely diligent fashion, and thereby similarly adversely affected plaintiffs experience modification rating and consequent premiums. Moreover, by the described acts and omissions—not promptly paying claims when due, not diligently defending claims, and not reasonably reserving them—SCIF breached its policy obligations to plaintiff in respect of dividends. This breach also derived from a failure to “follow the rules and conditions for the declaration of a dividend.” On information and belief, plaintiff would have received such dividends had SCIF complied with its duties.
In a final cause of action, for “negligent misrepresentation," plaintiff alleges that in December 1988 SCIF negligently understated plaintiff’s payroll to the rating bureau, by reporting a nine-month payroll as being a full year’s, thereby improperly increasing plaintiff’s attributed percentage of claims to payroll. This miscalculation, together with SCIF’s negligent evaluation of claims, and consequent imposition and reporting of inflated reserves, once more inflated plaintiffs experience modification rating and enhanced its premiums. (The “false" report also is alleged to have constituted a further breach of the implied covenant of good faith and fair dealing.) Plaintiff alleges it suffered actual damages of in excess of $250,000 on each cause of action, and prays for punitive damages on the third.
SCEF demurred to each cause of action, alleging failure to state a cause of action and that SCIF was immune from tort liability. Concurrently, SCIF moved to strike the punitive damages allegations. The court sustained the demurrer without leave to amend and ruled the motion to strike moot. Plaintiff appeals from the ensuing judgment of dismissal.
Discussion
1. The Immunity Issue.
The parties again join issue on SCIF’s two general grounds of demurrer below: affirmative failure to state a cause of action and immunity from suit in tort. The latter may be disposed of compactly, so we treat it first.
SCIF’s contention that it may not be sued in tort has only limited potential significance, because, as pled, plaintiffs claims sound principally in contract. In any event, the asserted immunity does not appear. SCIF grounds its claim principally on provisions of the California Tort Claims Act (Gov. Code, § 810 et seq.), together with an antecedent decision,
Rauschan
In
Courtesy Ambulance Service
v.
Superior Court
(1992)
2. The Contract and Implied Covenant Claims.
The theory of plaintiff’s principal, contract claims is that SCIF breached either the express terms of the policy, or its implied covenant of good faith and fair dealing, or both, by an interwoven pattern of failing to pay claims promptly, defend them diligently, or assign them reasonable reserves, followed by improperly failing to pay plaintiff dividends. SCIF’s position is that the complaint on its face shows no such breach of either express or implied contractual duties, because SCIF’s alleged practices are consonant with the policy’s allocation of responsibility and discretion. We consider these positions with respect to SCIF’s various policy obligations, to pay benefits, defend claims, and where appropriate declare and pay dividends.
The policy specifically requires SCIF to “pay promptly when due to those eligible under this policy the benefits required of [plaintiff] by the workers’ compensation law.” SCIF contends this language prescribes only a duty to
The allegedly slow and expensive claims resolution also occurred as part of SCIF’s defending, investigating, and settling claims, which the policy grants SCIF “the right” and, as to defense, the “duty” to do. Because the policy language granting and imposing these rights and duty says no more about how they are to be carried out, SCIF correctly argues that its challenged practices do not violate that language. But this does not end the inquiry. SCIF’s contention that “the [p]olicy does not require [it] to handle claims ‘properly’ or ‘expediently’ or in any other manner” must also be tested against the policy’s implied covenant of good faith and fair dealing.
That covenant is implied by law in all contracts, but it has received most attention in insurance policies, as to which alone a breach may be remedied in tort as well as contract.
(Foley
v.
Interactive Data Corp.
(1988)
The foregoing authorities (and others) clearly instruct that the implied covenant of good faith and fair dealing imposes limits on the insurer’s latitude in discharging its contractual right or duty to defend, investigate and settle claims. In traditional cases, involving whether or not settlement should have been preferred and pursued over trial, insurers have been held to a “standard . . . premised on the insurer’s obligation to protect the insured’s interests in defending the latter against claims by an injured third party.”
(Egan, supra,
SCIF argues that so long as it defends and pays claims against plaintiff, plaintiff has received the benefits of SCIF’s obligations in respect of defense and payment, and it is not plaintiff’s contractual concern that SCIF may elect to prolong claims unreasonably and marshal reserves excessively, even if doing so predictably and inevitably enhances plaintiffs premiums and perhaps deprives it of dividends. We conclude that this contention and its premises are deficient.
SCIF primarily contends that plaintiffs assertions of duty conflict with the basic proposition that the express terms of the contract, and its purposes, delineate and limit the requirements of the covenant of good faith, which cannot be construed to forbid something the contract requires, or vice versa.
(Carma Developers, supra,
This case involves premiums (and dividends) rather than liability exposure, and so SCIF further contends that to recognize responsibility on account of premium increases would conflict with plaintiff’s agreement, in the policy, to “accept any increase in premium or in the rates of premium which may be promulgated under any rating plan approved by the Insurance Commissioner . . . .” However, the plain significance of this provision points in the opposite direction. Under the policy, plaintiff did not agree to pay such premiums as SCIF might discretionarily charge. Rather, plaintiff agreed to pay premiums fixed by law and regulations. The “Premium” section of the policy, which SCIF quotes, begins by stating that “All premium for this policy will be determined by the Workers’ Compensation Rating Bureau’s manual of rules, rates, rating plans and classifications.” The complaint alleges that this regulated system computes premiums based in part on the policyholder’s experience modification, derived from the quantity of outstanding claims and the reserves therefor, which plaintiff alleges SCIF has intentionally and unreasonably failed to minimize or reduce. Thus, plaintiff is bound to pay SCIF—or, allegedly, any successive insurer—a policy premium that SCIF’s claims and reserves handling will directly influence. Because the powers so confided in SCIF’s discretion will impact the degree of plaintiff’s primary burden under the policy, it appears logical that the covenant of good faith and fair dealing indeed requires SCIF to conduct its claims resolution and reserve allocation processes with good faith regard for plaintiff’s interests.
This conclusion has been reached by a number of state courts in the context of workers’ compensation or other liability insurance policies for which premiums were contractually based, in part, on the amount of money the insurer paid in settlements. Most illustrative is
National Sur. Corp.
v.
Fast Motor Serv.
(1991)
The court held that the counterclaim stated a cause of action for breach of the policy’s implied covenant of good faith and fair dealing. Analogizing to
SCIF disputes that there can be an obligation of good faith and fair dealing in this respect, asserting that even if SCIF predictably and perhaps intentionally enhances plaintiffs required premiums by the way it processes and reserves claims, that does not deprive plaintiff of the benefits of the policy. SCIF relies principally on
New Plumbing Contractors, Inc.
v.
Nationwide Mutual Ins. Co.
(1992)
New Plumbing
does not control here, in part because of the very distinction the court there noted. The present case does challenge the good faith and fair dealing of SCDF’s claims settlement practices. Unlike the right of subrogation, which the
New Plumbing
court perceived to be entirely personal to the insurer, these practices have been held subject to the implied covenant, where the insurer’s willingness to settle was too low (see
Egan, supra,
SCIF asserts that to measure its practices under a good faith standard would improperly conflict with the workers’ compensation rights of claimants, to whom SCIF is directly liable, but who are limited to compensation remedies for insurers’ delay (see
Ricard
v.
Pacific Indemnity Co.
(1982)
We therefore conclude, in light of all of the authorities heretofore discussed, that the policy’s implied covenant of good faith and fair dealing required SCIF to conduct its functions of defending, investigating, reserving, and settling claims with good faith regard for their effect upon plaintiffs premiums, as determined under the policy and governing regulations.
Moreover, a similar conclusion holds true regarding plaintiffs contingent entitlement to dividends under the policy. Although SCIF’s allegedly deficient performance does not violate the express terms of the policy concerning dividends, it does potentially qualify as a breach of the obligation of good faith and fair dealing with respect to that policy benefit. In
Mission Ins. Group
v.
Merco Construction Engineers, Inc.
(1983)
Plaintiffs third cause of action, entitled “fraudulent claims practice,” essentially set forth a number of instances in which SCIF allegedly delayed resolving claims against plaintiff and increased the reserves for them, both excessively, while concealing these misdeeds from plaintiff. Plaintiff now acknowledges that these allegations do not state a further basis of liability, but rather belong under the heading of breach of the implied covenant of good faith.
Plaintiff makes the same suggestion regarding its final cause, for “negligent misrepresentation,” which charges that SCIF negligently underreported plaintiffs payroll to the rating bureau and negligently evaluated the claims and reserves reported, thereby adversely affecting plaintiff’s experience modification rating. These allegations do not state a claim for negligent misrepresentation, because the representations in question were not made to plaintiff or relied upon by it. However, the charges concerning claims evaluation and reserving do fit under the rubric of breach of implied covenant. Moreover, the allegations that SCIF negligently miscalculated and reported plaintiff’s payroll appear to state a claim for ordinary negligence.
SCIF contends that such a cause of action is barred by the doctrine of exhaustion of administrative remedies, because the rating bureau is empowered to correct erroneous premiums upon a claim by the insured. (See Ins. Code, § 11753.1.) But whether plaintiff has exhausted its administrative remedy, or whether such pursuit has reduced or eliminated plaintiff’s alleged damages, cannot be determined on the present record. That record does not foreclose plaintiffs alleging a negligence claim.
Finally, although plaintiff pled its implied covenant claims as being for “contractual breach,” it now urges that they also support a tort remedy. In the insurance context, that is so.
(Foley
v.
Interactive Data Corp., supra,
47 Cal.3d at pp. 684-685.) Plaintiff is entitled to elect between suing in contract or in tort, and the original pleading designations do not bind it.
(Frazier
v.
Metropolitan Life Ins. Co.
(1985)
In summary, we hold that the allegations of the first through third causes of action, and part of the fourth, state a cause of action for breach of the implied covenant of good faith and fair dealing, but do not state one for simple breach of the policy, except with respect to the obligation to pay benefits promptly, the meaning of which obligation remains to be clarified.
Disposition
The judgment is reversed and the superior court is directed to grant leave to file an amended complaint. Plaintiff shall recover costs.
Gates, Acting P. J., and Nott, J., concurred.
Respondent’s petition for review by the Supreme Court was denied October 21, 1993.
Notes
In addition, SCIF cannot avail itself of
Isaacson
v.
California Ins. Guarantee Assn.
(1988)