Underpayment of Prompt Pay Penalties

Definition and Legal Framework

Underpayment of prompt pay penalties occurs when insurance companies fail to pay the correct penalty amounts required under state prompt payment statutes after violating claim processing deadlines. Most states with prompt payment laws impose automatic interest penalties when insurers exceed statutory timeframes for claim acknowledgment, investigation, or payment. These penalties typically accrue at rates of 10-25% annually from the date payment was due until actually paid. When insurers calculate or pay insufficient penalty amounts, they commit additional violations that can trigger further penalties, regulatory action, and potential bad faith claims. The underpayment issue often arises from disputes about penalty calculation methods, applicable interest rates, or the timeframes used to determine violation periods.

Common Calculation Errors

Insurance companies frequently make errors when calculating prompt pay penalties that result in underpayment situations. Incorrect interest rate applications represent a common mistake, with insurers sometimes using lower rates than statutorily required or applying simple rather than compound interest calculations. Date calculation errors occur when insurers dispute when statutory deadlines begin running or when payments are actually due. Some companies attempt to reduce penalty amounts by deducting deductibles or other offsets that shouldn't apply to penalty calculations. Coverage disputes don't excuse prompt payment violations, yet some insurers incorrectly reduce penalties based on partial coverage positions. These calculation errors often appear intentional rather than accidental, as they consistently favor insurers over policyholders.

Regulatory Enforcement Actions

State insurance departments increasingly scrutinize prompt pay penalty compliance and pursue enforcement actions against insurers with systematic underpayment patterns. Regulatory examinations often reveal widespread calculation errors affecting thousands of claims, resulting in substantial fines and corrective action orders. Market conduct examinations specifically target prompt payment compliance, with examiners reviewing claim files to verify proper penalty calculations and payments. When underpayment patterns are discovered, regulators typically require insurers to identify all affected claims and pay additional penalties plus interest on the underpaid amounts. These enforcement actions often result in multi-million dollar settlements when applied across large claim volumes over extended periods.

Policyholder Remedies

Policyholders discovering prompt pay penalty underpayments have several remedial options beyond the additional penalty amounts owed. Bad faith insurance claims may incorporate underpayment issues as evidence of systematic improper claim handling practices. Class action lawsuits sometimes arise when underpayment affects large numbers of policyholders using similar calculation errors. State insurance department complaints can trigger investigations that reveal broader underpayment patterns affecting other consumers. Legal action for prompt pay violations often includes attorney fee recovery provisions, making litigation economically viable even for smaller underpayment amounts. Documenting underpayment issues requires careful review of penalty calculations and comparison with statutory requirements to establish the basis for additional recovery.

Example - State Farm Lloyds

The Texas Department of Insurance (TDI) fined State Farm Lloyds in Consent Order No. 2023-7843, underpaying statutory interest on approximately 7,800 late-paid homeowner property claims. Starting in 2017, the insurer had incorrectly applied a lowered ~10% interest rate—meant for disputed claims under Chapter 542A—to all "force of nature" claims, even those not in litigation, which legally needed 18% interest. Texas Insurance Code Section 542.058, 542.060, and 542A.002 were violated. According to TDI, the order fined State Farm Lloyds $350,000 and mandated that they recalculate and pay the full interest due to impacted policyholders. The corporation consented to the fines even though it acknowledged no misbehavior. Based on a single complaint, the case emphasizes TDI's dedication to upholding consumer protection and enforcing prompt payment policies.