Does the Threat of Insurer Liability for ‘Bad Faith’ Affect Insurance Settlements?

Economic reasoning predicts that policyholders in states that treat for insurer bad faith in settling claims as a tort should receive higher payments from insurers because of the greater potential damages insurers face in claims disputed in court. We test this hypothesis using data on automobile insurance claims for accidents occurring during 1972–1997, exploiting differences in states ‘laws and variation in timing of states’ adoption of bad faith rules to identify the effects of tort liability. We find that the presence of tort liability for insurer bad faith increases settlement amounts and reduces the likelihood that a claim is underpaid.