Tort of Bad Faith Does Not Apply to a Reinsurance Relationship

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Last year, I discussed a California case where tort claims were brought in the reinsurance context and the court threw them out. A federal court in Alabama recently addressed a similar issue, where a municipal insurer brought bad faith tort claims against its reinsurer when the reinsurer failed to pay certain losses under a series of reinsurance contracts. Like California, the federal court in Alabama ruled that the tort of bad faith did not extend to reinsurance and dismissed the claims.

In Alabama Municipal Insurance Corp. v. Munich Reinsurance America, Inc., No. 2:20cv300-MHT, 2021 WL 981495 (M.D. Al. Mar. 16, 2021), a federal court had to decide whether, under Alabama law, the tort of bad faith is recognized in the reinsurance context. No Alabama Supreme Court case directly resolved the issue, so the court had to make an educated guess as to how the Alabama Supreme Court would decide the issue.

In dismissing the bad faith claims, the court performed a detailed analysis of Alabama law and articulated how narrowly Alabama interpreted the tort of bad faith. Essentially, Alabama had narrowed the tort down to the consumer-based insurance relationship and refused to apply the tort to general commercial contracts. The court ultimately held that:

Given the Alabama Supreme Court’s repeated efforts to limit the application of the tort, as well as its emphasis on the primary purpose of the tort as a means to protect consumers, this court concludes
that the Alabama Supreme Court would not extend the tort of bad faith to the reinsurance context.

The court distinguished the difference in motivation and sophistication between a reinsurance transaction and a standard insurance transaction (citing my former colleague Dean Hansell) in concluding that the Alabama Supreme Court would not extend the tort of bad faith to a reinsurance dispute.

What was interesting here is that the cedent was a non-profit municipal insurer composed of local Alabama municipalities and tried to show that it was different from a typical for-profit insurance company that purchases reinsurance. The court rejected this, finding that it did not change the fact that the policy
considerations generally do not support extending the tort into this context. The court concluded:

This legal battle between two insurance companies does not support the application of the
tort of bad faith.

Thanks to Paul Thomson for passing this case along.

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