Duty to Settle: When an Insurer Must Protect You from Excess Judgments
Understanding the Duty to Settle in Good Faith
When you buy insurance—especially auto liability insurance—you expect your insurer to defend you and pay claims up to your policy limits. But what happens if a lawsuit’s potential damages exceed those limits, and the insurer refuses to settle?
In such cases, U.S. courts have recognized a “duty to settle in good faith.” This means that insurers must act as a reasonable and prudent insurer would—considering not just their own financial interests, but also the policyholder’s exposure to an excess judgment (a court award exceeding the policy limit).
If an insurer acts unreasonably or in bad faith by refusing to settle when it could have, it can be held liable for the entire judgment, even beyond policy limits.
The Legal Foundation of the Duty to Settle
The duty to settle arises under both common law and statutory good faith obligations across U.S. states. While the exact standard differs slightly, courts generally impose this duty when:
- The insured faces a clear risk of liability.
- The claimant offers to settle within policy limits.
- The insurer unreasonably rejects or delays that offer.
A landmark case, Comunale v. Traders & General Insurance Co. (1958), established the principle in California law:
“An insurer who refuses to accept a reasonable settlement within policy limits is liable for the full amount of the judgment against the insured.”
This precedent shaped how other U.S. states interpret an insurer’s duty to protect policyholders from financial ruin caused by negligent or bad-faith refusal to settle.
Good Faith vs. Bad Faith: The Critical Distinction
The duty to settle in good faith means insurers must put the insured’s interests on par with their own. But when insurers prioritize their own profits or gamble with the insured’s financial safety, courts may find bad faith.
Good faith behavior includes:
- Conducting a prompt and fair investigation.
- Evaluating settlement offers honestly and realistically.
- Keeping the insured informed of settlement discussions.
- Accepting reasonable settlement offers within limits when liability is clear.
Bad faith behavior includes:
- Ignoring settlement opportunities to “test” the case at trial.
- Delaying investigation or response to settlement offers.
- Misrepresenting claim value to avoid payment.
- Failing to inform the insured of critical settlement negotiations.
In Rova Farms Resort, Inc. v. Investors Insurance Co. (1974), the New Jersey Supreme Court held that insurers must give “equal consideration” to the insured’s interest as their own. Failing to do so can expose them to bad faith tort liability—a claim separate from breach of contract.
Duty to Settle in Auto Liability Cases
The most frequent disputes arise in auto accident liability cases. For example, if you cause an accident and are sued for $500,000, but your liability policy covers only $100,000, your insurer has a duty to negotiate in good faith to settle within those limits if possible.
If the insurer refuses a $100,000 settlement offer—believing it can win at trial—but loses and a jury awards $500,000, you could personally face a $400,000 excess judgment.
Courts have consistently ruled that in such situations, the insurer may be responsible for the entire judgment, including the amount above the policy limit.
This not only protects consumers but also incentivizes insurers to act prudently and ethically during claim settlement.
How Courts Evaluate Bad Faith Refusals to Settle
Courts look at the totality of circumstances to decide whether an insurer breached its duty. Key factors include:
- Strength of the claimant’s case – Was liability clear or debatable?
- Potential damages – Were they likely to exceed policy limits?
- Settlement opportunity – Was there a valid, time-limited offer within policy limits?
- Claims handling conduct – Did the insurer investigate, communicate, and act promptly?
- Insurer’s motives – Did it prioritize its own interests over the insured’s?
For instance, in Boston Old Colony Ins. Co. v. Gutierrez (Fla. 1980), the Florida Supreme Court noted that an insurer must “advise the insured of settlement opportunities, the probable outcome of the litigation, and the possibility of an excess judgment.” Failure to do so constituted bad faith.
Remedies for Policyholders
If your insurer fails in its duty to settle in good faith, you have legal remedies under both tort and contract law:
- Bad Faith Lawsuit – You can sue your insurer for bad faith refusal to settle.
- You may recover the full amount of the judgment, even beyond your policy limits.
- In some states, you may also recover punitive damages and attorney’s fees.
- Assignment to Claimant – In many cases, insureds assign their bad faith claim to the injured plaintiff in exchange for a covenant not to execute the excess judgment. This lets the plaintiff pursue the insurer directly.
- State-Specific Remedies –
- California: Under Cal. Ins. Code §790.03(h), unfair claims practices like unreasonable refusal to settle are actionable.
- Florida: Fla. Stat. §624.155 allows policyholders to file civil bad faith actions.
- Texas: The Texas Insurance Code imposes a duty of “good faith and fair dealing” on insurers.
Preventing Disputes: What Policyholders Can Do
While the duty to settle protects you, proactive steps help minimize risks:
- Stay informed: Request regular updates from your insurer during litigation.
- Document communications: Keep records of all settlement offers and insurer responses.
- Consult legal counsel: An independent attorney can ensure your interests are not compromised.
- Report misconduct: File complaints with your state Department of Insurance if you suspect bad faith.
Understanding your rights early can prevent devastating financial exposure if your insurer gambles with your future.
Final Thoughts
The duty to settle in good faith is a cornerstone of U.S. insurance law, ensuring that insurers act responsibly when your financial security is on the line. Whether it’s an auto accident or another liability claim, your insurer must weigh your interests equally with its own—and settle when a reasonable opportunity exists.
If your insurer refuses to settle and you end up facing an excess judgment, you have legal recourse. Courts consistently hold that insurers who fail in this duty must bear the consequences, not the policyholder they promised to protect.
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