We help people when insurance companies don't keep their promises.


By Mike Abourezk and Marialee Neighbours


Insurance companies set financial goals and objectives for their employees, including their claims personnel. Employee incentive plans reward personnel for achieving these financial goals with promotions, salary increases, and/or bonuses. For claims personnel, this may mean denying or minimizing claims.

Basically, discovery of an insurance company's employee incentive plans is an effort to discover the motives, intent or lack of mistake behind bad faith conduct. As the term "incentive plans" suggest, such plans are obviously intended to influence the behavior of insurance company employees. If claims handlers or their supervisors are vying for personal cash bonuses or other awards, this information is highly relevant in a bad faith case.

In South Dakota, this evidence is even more crucial because our Supreme Court has specifically ruled that evidence that wrongdoing is part of a company policy or practice is a crucial factor in supporting a punitive damages award. See Roth v. Farner-Bocken Co., 667 N.W.2d 651 ¶ 52. (SD 2003) (South Dakota Supreme Court remanded invasion of privacy case for new trial on punitive damages because there was no evidence that the conduct reflected a company policy or practice.) Thus, Roth makes discovery of company policies or practices, including employee incentive plans, highly relevant in proving punitive damages.

Company Financial Goals Mold Employee Behavior

It is widely accepted by business executives that internal incentives mold employee behavior. For instance, the April 4, 2005 edition of Newsweek magazine contains a feature article about the well-known former CEO of General Electric, Jack Welch. In that article, Mr. Welch says:

If you want people [employees] to live and breathe the vision, "show them the money" when they do, be it with salary, bonus, or significant recognition. To quote a friend of mind, Chuck Ames, the former chairman and CEO of Reliance Electric, "Show me a company's various compensation plans, and I'll show you how its people behave."

See Jack Welch and Suzy Welch, "How To Be A Good Leader," pp. 45-47 Newsweek, April 4, 2005.

The same point applies to an insurance company's incentive or compensation plans for its employees. Discovery of these plans will show whether personnel involved in claims handling were influenced by incentive or compensation plans to deny or reduce insurance claims.

Insurance Authorities Agree That Creating Payment Incentives For Insurance Claims Handlers Is A Forbidden Practice

Legitimate experts in the insurance business agree that incentives for claim handlers are an illicit practice. For instance, one of the primary trade journals for the claims industry is "Claims Magazine." In its October, 2004 edition, the magazine printed an article about the 2004 South Dakota Federal District Court verdict in Torres v. Travelers Insurance Co. The article discussed the jury's award of $12 million dollars in punitive damages in response to evidence of Traveler's employee incentive programs.

This is what Claims Magazine said:

The adjuster's job is not to turn a profit for the company, to advance a company's A.M. Best Rating, or to max out on the incentive compensation plan. Once these factors seep into the adjuster's consciousness at the file handling level, mischief creeps in.

* * *

Doubtlessly, when they launch such plans, insurer's top management teams applaud themselves for their result oriented thinking in linking adjuster pay to the corporation's financial goals.

Right on. About time we held those claim people accountable for financial results.

Right on indeed. Right on ... into the bad faith cesspool.

In Torres, Travelers Insurance Company repeatedly denied that it had any employee incentive programs. However, information contained in the personnel file of claims managers and other claims personnel helped prove these denials false and eventually exposed an entire network of cash bonuses based directly on reducing the amount paid on claims.

Example of Actual Program

In order to understand the effect of an insurer incentive plan on claims personnel, it is helpful to review the details of an actual program. For instance, Farmers Insurance Group, Inc. has instituted a number of employee incentive programs. One program is called "Quest for Gold." It was implemented by Farmers in 1998. Quest for Gold is a contest in which Farmers pays cash prizes and bonuses to the personnel of the Branch Claims Offices that perform best in achieving various predetermined goals. In 1999, the North Dakota/South Dakota (Bismarck) Branch Claims Office excelled in the Quest for Gold contest. The Office achieved a silver medal entitling each of the Bismarck Branch Claims Office personnel to a share of the cash prizes.

One of the goals used in the contest rules is the reduction of "combined loss ratio." An insurer's "loss ratio" is the ratio of:

Claims Paid

Premiums Collected

The "combined ratio" is the ratio of:

Claims Paid +Loss Adjustment Expenses

Premiums Collected

Obviously, the efforts of claims personnel cannot affect the premiums collected. So the only factors in the combined ratio that claims personnel can affect are claims payments and expenses. Of these two, claims payments hugely outweigh the amount that can be saved on paper clips and other administrative expenses. Therefore, when an insurance company demands that claims personnel strive to affect combined ratio, it means that they will cut claim payments. The effect, as shown in the Farmers' example, is that claims personnel are pitted against each other in contests that have an objective of reducing aggregate amounts paid out in claims in order to reduce the overall ratio.


In a Kentucky bad faith case, the plaintiff alleged that compensation of the insurer's employees could be tied to obtaining low settlements which might encourage bad faith practices by adjusters and other employees. Grange Mut. Ins. Co. v. Trude, 151 S.W.3d 803, 815 (Ky. 2004). In Grange Mutual, the plaintiff requested information about the insurer's overall compensation system such as incentive programs as well as wage, salary and bonus data related to specific kinds of employees. In that case, the Kentucky Supreme Court held that personnel records related to compensation of involved employees as well as the insurer's overall compensation system were discoverable:

Wage, salary, and bonus data as to the employees described in the discovery requests shed light on this subject, as would the discovery requests as to how Grange's overall compensation system works. Thus, insofar as the requested personnel records relate to compensation of the employees involved and the other records relate to how Grange's overall compensation system works, they are discoverable.


Courts recognize that setting financial goals and tying compensation to those goals is an illicit practice when applied to claims handlers. For instance, an institutional bad faith case, decided by the Arizona Supreme Court, illustrates how salaries and bonuses paid to claims representatives were influenced by what the representatives paid out in claims.

In Zilisch v. State Farm Mut.l Auto. Insur. Co., 995 P.2d. 276 (Ariz. 2000), the plaintiff produced evidence at trial that State Farm set arbitrary claim payment goals for its claims personnel. Promotions and salary increases for claims personnel were based on reaching these goals. On appeal, the Arizona Supreme Court upheld a punitive damages award against State Farm saying, "Thus, 'an insurer may be held liable in a first-party case when it seeks to gain unfair financial advantage of its insured through conduct that invades the insured's right to honest and fair treatment' " Id. at 279-80, quoting Rawlings v. Apodaca, 151 Ariz. 149, 156, 726 P.2d 565, 572 (1986). See also Albert H. Wohlers and Co. v. Bartgis, 969 P.2d 949 (Nev.1999)(In bad faith action, policy administrator exposed to bad faith liability because it had a direct pecuniary interest in optimizing insurer's financial condition by keeping claims costs down.)


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