Insurance Disputes: Five Rules Insurers Need to Know




By: Donna Thomisee

The Texas Supreme Court has announced five rules intended to address contractual claims under an insurance policy versus tort claims under the Texas Insurance Code. The rules were set forth in conjunction with the Court’s opinion in the case of USAA Texas Lloyds Company v. Menchaca and are meant to clarify confusion regarding the treatment of statutory bad faith claims in insurance coverage disputes brought before state courts. 

Breaking down the details of Menchaca

USAA Texas Lloyds Company v. Menchaca – ___ S.W.3d ___ [Tex. 2017]

The Menchaca case itself is a fairly common property damage scenario. Homeowner Gail Menchaca filed a property damage claim with her insurance carrier, USAA Texas Lloyds Company, after Hurricane Ike hit Galveston in September 2008. Two separate inspections made five months apart by different adjusters found that the damage was covered under Menchaca’s deductible. After USAA denied her claim for property damage, Menchaca sued USAA for breach of contract and violations of the Texas Insurance Code. The jury’s verdict in the case was split, and confusion arose over its treatment of several key questions.

In regards to whether USAA failed to comply with the policy terms, the jury answered “no.” However, the jury answered “yes” as to whether USAA refused to pay without conducting a reasonable investigation. The jury assessed policy benefit damages at $11,350.00 and attorneys’ fees at $130,000.00. Following the verdict, both USAA and Menchaca sought judgment in their favor. The trial court took into account the jury’s answers to several questions, including the “yes” as to whether USAA failed to conduct a reasonable investigation, but disregarded the “no” on whether USAA failed to comply with the terms of the insurance policy. The trial court entered judgment in favor of Menchaca based on failure to conduct a reasonable investigation. After the appeals court affirmed the judgment, USAA petitioned for a review by the Texas Supreme Court.

Justice Jeffrey Boyd wrote the opinion for the Menchaca case, providing extensive detail on the decision. Justice Boyd’s opinion goes through each of the arguments made by Menchaca, which primarily relied on Vail v. Texas Farm Bureau1, and USAA, which primarily relied on Provident American Ins. Co v. Castaneda2. He stated both arguments were wrong, and because of the confusion in this area, the Court reversed the Court of Appeals decision and remanded the case for a new trial.

Justice Boyd’s opinion includes several footnotes that provide additional context and clarification. Of significant note in the decision is footnote 2, which specifically states, “Although the policy provided for an appraisal process to resolve disputes over the amount of covered losses, it appears that neither party ever invoked that alternative method for resolving this dispute.” Given this statement, the decision appears to leave intact court rulings about the effect of ending some disputes through appraisal.

Further, in the process of clarifying the perceived conflict between Vail and Castaneda, the Court reaffirmed the basic principle that an insurance policy is a contract, but the unique relationship between carrier and policyholder justifies the imposition of a common-law duty of good faith and fair dealing. The Court also noted the role of the Texas Insurance Code, but specifically stated, “the Code does not create insurance coverage or a right to payment of benefits that does not otherwise exist under the policy.”

Justice Boyd stated the “primary question in this case is whether an insured can recover policy benefits as actual damages caused by an insurer’s statutory violation absent a finding that the insured had a contractual right to the benefits under the insurance policy.” The Court answered this question with a general “no” and went on to announce “five distinct but interrelated rules that govern the relationship between contractual and extra-contractual claims in the insurance context.”

The Five Rules

1. General Rule: An insured cannot recover policy benefits as damages for an insurer’s statutory violation if the policy does not provide the insured a right to receive those benefits.

2. Entitled to Benefits Rule: An insured who establishes a right to receive benefits under the insurance policy can recover those benefits as actual damages under the Insurance Code if the insurer’s statutory violation causes the loss of benefits.

3. Benefits-Lost Rule: Even if the insured cannot establish a present contractual right to policy benefits, the insured can recover benefits as actual damages under the Insurance Code if the insurer’s statutory violation caused the insured to lose that contractual right.

4. Independent Injury Rule: If an insurer’s statutory violation causes an injury independent of the loss of policy benefits, the insured may recover damages for that injury even if the policy does not grant the insured a right to benefits.

5. No-Recovery Rule: An insured cannot recover any damages based on an insurer’s statutory violation if the insured had no right to receive benefits under the policy and sustained no injury independent of a right to benefits.

What do these rules mean in practice?

The first and fifth rules will continue to be the trump cards laid out by insurance carriers. The Court reinforced the applicability of these rules by repeatedly affirming the commonly cited general rule that an insured cannot bring a bad faith claim if there is no coverage and cannot assert statutory damages, which are only policy benefits. 

In essence, the second, third and fourth rules are narrow exceptions to the general rule. The second rule was basically announced in Vail. However, the Court noted the parties in Vail did not dispute the insured’s entitlement to policy benefits – the only issue was whether policy benefits could be awarded as statutory damages. Essentially, the carrier in Vail “wrongfully denied” a “valid claim.” Once again, a footnote in Justice Boyd’s opinion offers clarification. Specifically, footnote 18 states: “Vail should not be read, however, as suggesting that an insured can recover benefits for a statutory violation when the insured fails to establish and the insurer does not concede that the insured has a contractual right to the benefits.”

In practical application, the third rule creates a narrow exception to most claims handling cases. The Court recognized this rule in the context of alleged misrepresentation of coverage or waiver/estoppel as to coverage. The fourth rule requires the insured to assert damages that are truly independent of any policy benefits. When an insured seeks to recover damages stemming from policy benefits, the general rule applies and precludes recovery unless the policy entitles the insured to those benefits. Mental anguish damages was the only example noted by the Court, but the ability to prove true mental anguish damages in a contract case is very limited. The Court noted the application of this rule “would be rare, and we in fact have yet to encounter one.”

The fifth rule flows from the other four rules. The Court listed a number of various cases that all held in favor of carriers because the insured did not establish a right to benefits and could not prove an injury independent of the policy coverage.

The Final Word

In conclusion, the Menchaca decision did not change the law in this area. It simply clarifies how prior insurance coverage decisions inter-relate and attempts to provide guidance to practitioners and trial judges on how to properly submit these issues to a jury. Insurance carriers should be aware of claimants’ ability to keep claims alive with proper pleading and should recognize that the Texas Insurance Code was put in place to accomplish prompt and fair claims handling and to act accordingly. Policyholders and their attorneys should recognize an insurance claim is not meant to be a windfall, and an honest disagreement on the value of a claim should not be the basis of treble damages.

Click here to read the full opinion (No. 14-0721).

1. Vail v Texas Farm Bureau Mutual Insurance Co., 754 S.W.2d 129 (Tex. 1988)

2. Provident American Insurance Co. v Castaneda, 988 S.W.2d 189 (Tex. 1998)

Lugenbuhl shareholder Donna Thomisee has nearly 30 years of experience practicing in the areas of litigation, insurance coverage and defense, with a focus on defense of personal injury and commercial claims. View her profile to learn more about her experience or visit our Insurance practice section to learn more about our firm’s expertise and services.


The content of this article is not intended to serve as an exhaustive review of the laws, statutes or issues related to bad faith claims and is not intended to provide legal advice. The opinions expressed through this article may not reflect the opinions of the firm, individual attorneys or clients.

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