The standard of bad faith was originally phrased in the negative under the 1988, Texas Supreme Court case, Aranda v. Insurance Co. of N. Am. Under that case, the first element of bad faith required an objective determination of whether a reasonable insurer under similar circumstances would have denied plaintiff’s claim. The second element balanced the right of the insurance company to investigate and pay compensable claims. This element was met by establishing that the insurance company actually knew there was no reasonable basis to deny the claim or that, based on its duty to investigate, the insurance company should have known that there was no reasonable basis for denial. Under the test, insurers maintained the right to deny invalid or questionable claims and would not be subject to liability for an erroneous denial of a claim.
The Texas Supreme Court, in the 1997 opinion, Universal Life Ins. Co. v. Giles, rephrased the standard in an attempt to ease the incompatibility between the no-evidence standard of review and the bad faith standard of liability. Pursuant to this decision, the insured must prove the insurer: (a) either denied or delayed payment of the claim; and (b) with respect to which the insurer’s liability has become reasonably clear.
An insurer’s liability is not reasonably clear, and liability must not be imposed under Texas Insurance Code, Section 541.001, unless the insured shows that: (1) the policy covers the claim; (2) the insured’s liability is reasonably clear; (3) the claimant has made a proper settlement demand within policy limits; and (4) the demand’s terms are such that an ordinarily prudent insurer would accept it. A proper settlement demand generally must clearly state a sum certain and propose to fully release the insured. These elements comprise the statutory liability standard against which to measure legal sufficiency. An insurer’s denial of a claim it was not obligated to pay might nevertheless be in bad faith if it’s conduct was extreme and produced damages unrelated to and independent of the policy claim. However, an insurer does not breach its duty merely by erroneously denying a claim. Evidence that only shows a bona fide dispute about the insurer’s liability on the contract does not rise to the level of bad faith.