Big Bucks from "Bad Faith"

A California lawyer vs. the insurance industry

In 1970 Michael Egan, a roofer in Pomona, Calif., fell off a ladder and seriously injured his back. Though he could walk, he was no longer able to work. But Egan thought he was protected: he had taken out an insurance policy that guaranteed him $200 a month for life in the event of a totally disabling injury. He did indeed start getting checks from his insurer, Mutual of Omaha, but after a while a Mutual claims adjuster began harassing him as a fraud and malingerer. In 1971 the company decided that Egan, who had a history of back trouble, was not disabled by his injury after all, but rather by an illness. Under his policy, that entitled him to benefits for only three months.

Egan fought back by hiring William Shernoff, a Claremont, Calif., lawyer whose specialty is suing insurance companies for dealing in "bad faith" with their customers. In 1974 Shernoff not only persuaded a jury to award Egan $123,600 in damages for lost benefits and emotional distress, but he also won a whopping $5 million in punitive damages. That was a blow to Mutual's image as well as to its pocketbook: under California law, punitive damages are awarded to punish and deter "oppression, fraud or malice."

As the biggest in a series of punitive damage awards handed down by California's notably proconsumer juries, the Egan judgment shocked the insurance industry. It fears that juries everywhere will begin handing out huge awards in bad faith cases, despite the industry's complaint that genuine cases of wrongdoing are rare and reflect only isolated mistakes. Indeed more than 20 states in the past ten years have ruled that juries can award punitive damages in bad faith cases.

Insurers have taken some comfort from the latest turn in the Egan case: the California Supreme Court has ordered the punitive award to be cut. Noting that the $5 million sum amounted to nearly 60% of Mutual's 1974 net income, the court said that the award was bloated by the "passion and prejudice" of the jury. A new trial must now be held to set a fairer award, but the decision left no doubt that courts could continue to exact punitive damages from insurance companies.

When the California court was ruling on the Egan case, Lawyer Shernoff was off in Mississippi instructing another jury in what he calls "the therapeutic concept of punitive damages." His client this tune was Wilfred Fayard, 58, a sheet metal worker, who had suffered a back injury while carrying a bathtub. Fayard lost his disability benefits because his injury was considered by his insurance company to be "nonconfining." That was because Fayard, on doctor's orders, managed to walk a few hundred yards every day for exercise. At the trial, a former claims adjuster for Fayard's insurers, Pennsylvania Life, testified that adjusters were under a quota to "close," or terminate, half their customers' claims. The jury awarded Fayard $175,000.

Shernoff says that the nonconfinement clause is only one lever that unscrupulous adjusters may use to squeeze customers out of their benefits. Another device is the common requirement that insured people fully disclose their medical histories. In one California case, a Shernoff client with a back injury had been denied coverage because she failed to report that she had rhinitis and amenorrhea. Rhinitis is the medical term for a runny nose; amenorrhea means that she had an erratic menstrual cycle. Shernoff settled that case for $50,000.

Shernoff, 41, describes himself as "a one-man prosecutor going around the country imposing fines and penalties on insurance companies for illegal conduct." He argues that punitive damages offer the only effective way to protect consumers from wrongdoing by insurers, since claims practices are not closely regulated. In all of 1978, Shernoff points out, the California Department of Insurance collected $7 million for 13,000 claimants; but in just two months last spring, Shernoff won awards and settlements totaling $3 million for 26 claimants.

Insurance executives, however, argue that punitive damages are nothing but a windfall for the plaintiff and his attorney. Big awards, they say, make it easier for people with dubious claims to bargain companies into paying large settlements, which in turn are paid for by others in the form of increased premiums. Says William Adams, associate general counsel of Occidental Life: "People with unquestionable claims, and that's about 95%, are not benefited by ShernofF's activities. He should not be pounding the table claiming he's helping the consumer. He's hurting most of them."

Insurance men grudgingly admire Shernoffs courtroom mastery. Says one: "He can get a jury really worked up." Yet Shernoff, who grew up in Wisconsin farm country, has none of the slickness of the stereotypical, California personal-injury lawyer. Says he: "My English isn't the greatest, but I know what I'm doing: the little guy against the insurance giant."

With fees ranging from one-third to 40% of what damage payments he wins, Shernoff is understandably sensitive to suggestions that he and his clients are reaping windfalls. With the California Trial Lawyers Association, he is pushing for a bill in the California legislature that would allow judges to give 25% of whatever punitive damages are awarded in bad faith cases to any group or agency established as an insurance industry watchdog.

Shernoff and the trial lawyers have also successfully lobbied against bills, backed by the insurance companies, that would sharply limit punitive damages. sb

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