129 Wis.2d 496 (1986) 385 N.W.2d 171

Bradley MOWRY, Plaintiff-Respondent,
v.
BADGER STATE MUTUAL CASUALTY COMPANY, a Wisconsin corporation, Defendant-Appellant.^[†]

No. 84-1635.

Supreme Court of Wisconsin.

Argued November 25, 1985. Decided April 18, 1986.

*502 For the defendant-appellant there were briefs by Steven J. Caulum, Thomas A. Lockyear, Jan A. Smokowicz and Bell, Metzner & Gierhart, S.C., Madison, and oral argument by Mr. Caulum.

*503 For the plaintiff-respondent there was a brief and oral argument by Alan M. Clack, Santa Rosa, California.

Amicus curiae brief was filed by James T. Murray, Jr., Randy S. Parlee and Peterson, Johnson & Murray, S.C., Milwaukee, for the Wisconsin Insurance Alliance.

LOUIS J. CECI, J.

This is a review of the circuit court's decision and judgment against Badger State Mutual Casualty Company (Badger State) in the amount of $159,000. In a decision filed on May 23, 1984, the circuit court for Waukesha county, Robert T. Mc-Graw, circuit judge, held that Badger State breached its contract and committed bad faith in refusing to defend its insured and in refusing to settle the third-party claim of victim Bradley Mowry within the liability limits of an insurance policy. We reverse the judgment of the circuit court.

This case comes to us on certification from the court of appeals, district II, pursuant to sec. (Rule) 809.61, Stats.^[1] The issue is whether the circuit court erred in holding that Badger State breached its contract with its insured and committed the tort of bad faith in refusing to defend its insured and in refusing to negotiate a settlement within policy limits when Badger State had sought a separate trial on the issue *504 of coverage, under sec. 803.04(2)(b).^[2] We address whether an insurer who receives and loses a separate trial on the issue of coverage and then immediately offers the policy limits under an insurance contract may be held liable for damages adjudged against its insured which exceed the liability limits of the insurance policy. We determine that, under the facts of this case, Badger State should not be held responsible for the excess judgment entered against its insured. The trial court erred in holding that Badger State breached its contractual duty to defend and that it committed bad faith in refusing to settle Mowry's claim within its insured's policy limits.

The historical facts of this case are undisputed. On May 3, 1975, Bradley Mowry, then age 19, was injured in an automobile accident and suffered serious bodily injury, including the amputation of part of one foot. He *505 was a passenger in an automobile driven by Steven McCarthy. The vehicle left a roadway and collided with a bridge abutment. McCarthy's parents were insured by Badger State and had policy limits of $15,000 for damages to any one person and medical coverage up to $1,000.

Upon being notified of the accident, Badger State began to investigate the circumstances surrounding the accident. The claims manager for Badger State, John Graeber, concluded after reading the police report and interviewing all of the automobile's occupants that the case was one of probable liability on McCarthy's part. He also determined that the case would probably involve damages to Mowry in excess of the $16,000 policy limits.

Badger State's investigations indicated to it, however, that a question of policy coverage existed. The question revolved around the ownership of the vehicle which McCarthy was driving at the time of the accident. The insurer believed that it was unclear whether McCarthy or his parents were the true owners of the automobile involved in the accident. Its investigation disclosed that the car was titled in McCarthy's mother's name, but that McCarthy had paid for the car with his own money, did not need permission to drive the car, and had told several people at the scene of the accident that he owned the vehicle and that it was uninsured. Given these circumstances, Graeber concluded that the issue of ownership was debatable and that a serious question of coverage had arisen.

In March, 1976, ten months after the accident, Mowry filed suit against McCarthy, McCarthy's parents, Badger State, and an insurance agent. In its answer dated March 2, 1977, Badger State denied any coverage *506 under the policy for the automobile driven by McCarthy on the date of the accident, based on its belief that the automobile was not owned by its insureds, McCarthy's parents.

On September 13, 1977, Mowry issued a formal demand of settlement for the full amount of the liability insurance coverage, $15,000. Badger State's attorney, Kurt Frauen, responded that Badger State had denied coverage under the policy, but that he would inform Badger State of the offer. Badger State did not accept the offer.

At a pretrial conference on September 26, 1977, Attorney Frauen requested that Mowry's counsel and other parties present agree to a bifurcated trial in which a determination on coverage would precede any trial on the issue of liability. In relating the events of the pretrial conference to Badger State, Attorney Frauen wrote, "Everyone seemed to feel that if the coverage issue were resolved, the rest of the case would not have to be tried." Mowry's counsel reiterated Mowry's offer of settlement on September 26, 1977, but Badger State again refused to accept it.

A subsequent stipulation and order set April 4, 1979, as the commencement date for the trial on the issue of coverage; the issues of liability and damages were to be held in abeyance until the resolution of the coverage issue. On March 12, 1979, approximately three weeks before the coverage trial, Mowry once more demanded that Badger State pay the limits of McCarthy's liability insurance policy plus $1,000 under the medical payments coverage; he set a March 23, 1979, deadline for its acceptance. Badger State's counsel, in correspondence to Mowry's counsel, stated that he felt the settlement demand was contrary to the *507 stipulation and order separating the coverage issue from the liability and damages issues: "The court has in fact bifurcated the trial... to resolve the coverage dispute before proceeding with the plaintiff's case." Mowry's counsel responded that he believed that stipulating to a bifurcation of issues "should not in any way be construed as barring plaintiff from attempting to negotiate settlement of his entire claim."

Badger State refused Mowry's March 12 settlement offer. On April 4, 1979, the coverage issue was tried before a jury. The jury returned a verdict the next day which found that McCarthy's parents owned the vehicle in question at the time of the accident. Coverage was thereby afforded Steven McCarthy under the policy.

On April 6, 1979, Badger State offered the limits on its liability policy and medical payments coverage. On January 10, 1980, Badger State's counsel informed McCarthy that it would assume McCarthy's defense in the action. Following negotiations between counsel for Mowry and Badger State, the parties entered into a stipulation of judgment in October, 1980, thereby rendering a trial on the liability and damages issues unnecessary. The judgment was in favor of Mowry and against Badger State for $16,000 and against Steven McCarthy for $175,000. The stipulation further called for McCarthy to assign to Mowry any and all causes of action which McCarthy might have against Badger State, in satisfaction of Mowry's judgment against McCarthy. Following that stipulation and entry of judgment, Mowry, suing under McCarthy's assignment of rights, brought the present action against Badger State for bad faith and breach of contract.

*508 The circuit court, in holding that Badger State breached its contract in refusing to defend and that it committed bad faith in refusing to negotiate a settlement, was indignant that an insurer would delay settlement negotiations until the coverage issue has been judicially determined, particularly when liability and excess damages are undisputed. The court felt that Badger State's posture of not negotiating a settlement until the determination of the coverage issue placed all the risk of an excess judgment on the insured. It found that an insurance company who refuses to defend and refuses to negotiate may not protect itself from a claim for damages in excess of policy limits by tendering the policy limits only upon losing the coverage issue of a bifurcated trial. Citing Luke v. American Family Mut. Ins. Co., 476 F.2d 1015 (8th Cir. 1973), Judge McGraw stated that the proper rule should be "`when an offer of settlement within the policy limits has been made and ignored, a good faith refusal to defend is not a valid defense to a claim in excess of the policy limits....'" Luke, 476 F.2d at 1021. The court then awarded Mowry damages in the amount of $159,000, representing the stipulated amount of liquidated damages for which Badger State would be liable in any action brought by Mowry as assignee against Badger State.

Badger State appealed. The court of appeals, in its certification memorandum, framed the issue to be whether an insurance carrier "should be held liable for damages in excess of its policy coverage where its belief that there was no coverage led it to reject" an earlier offer of settlement within the policy limits. The court noted that this particular scenario presents an unaddressed area of insurance law in this state.

*509 The parties assert the same arguments here as they did below. Mowry states that, in refusing to negotiate a settlement and in refusing to defend McCarthy, Badger State breached contractual and fiduciary duties it owed to McCarthy. Badger State argues that it committed no bad faith in pursuing a fairly debatable coverage question within the framework of a bifurcated trial. In effect, it argues that any duty to negotiate a settlement is suspended when a bifurcated trial has been granted on a threshold issue of coverage. If it breached its contractual duty to defend, Badger State believes that damages should be limited to the liability limits of the policy. Because we hold that Badger State did not act in bad faith, nor did it breach its contractual duties owed to McCarthy, we do not reach the matter of calculation of damages.

We note the competing interests on each side of this case. When an insurer is certain of its insured's liability for an accident and where damages to the victim exceed policy limits, the insurer would normally be responsible for indemnifying its insured to the extent of its policy limits. The insurer, however, experiences a conflict of interests whenever an offer of settlement within policy limits is received where a legitimate question of coverage under the policy also exists. See, Keeton, Liability Insurance and Responsibility for Settlement, 67 Harv. L. Rev. 1136 (1954). See also, Hilker v. Western Automobile Ins. Co., 204 Wis. 1, 14, 235 N.W. 413 (1931) (on rehearing). The insurer will be reluctant to settle within policy limits if there is a likelihood that coverage does not exist. On the other hand, an insurer's failure to settle a victim's claim within policy limits may subject an insured to a judgment in excess of his *510 policy limits. This case presents a good example of these conflicting interests.

BAD FAITH CLAIM

An insurer owes a general duty to its insured to settle or compromise a claim made against the insured. Hilker, 204 Wis. at 13. This duty does not arise out of an express contractual provision; rather, it is implied from the terms of the contract which give the insurer the absolute control of the defense of the action against the insured. Id. at 13-14.

The insurer has the right to exercise its own judgment in determining whether a claim should be settled or contested. But "exercise of this right should be accompanied by considerations of good faith." Id. at 14. In order to be made in good faith, a decision not to settle a claim must be based on a thorough evaluation of the underlying circumstances of the claim and on informed interaction with the insured. This gives rise to several obligations on the part of the insurer. First, the insurer must exercise reasonable diligence in ascertaining facts upon which a good-faith decision to settle or not settle must be based. Second, where a likelihood of liability in excess of policy limits exists, the insurer must so inform the insured so that the insured might properly protect himself. Id. at 15-16. Third, the insurer must keep the insured timely abreast of any settlement offers received from the victim and of the progress of settlement negotiations. Baker v. Northwestern Nat. Casualty Co., 22 Wis. 2d 77, 83, 125 N.W.2d 370 (1963).

*511 These three obligations arise as a result of the insurer's general duty owed to its insured to settle a claim. The duty to settle, in turn, emanates from the contractual terms giving the insurer the absolute control of the defense of the victim's action against the insured. Because the insured has given up something of value to the insurer—namely, the right to defend and settle a claim—the insurer has been said to be in the position of a fiduciary with respect to an insured's interest in settlement of a claim. See, Alt v. American Family Mut. Ins. Co., 71 Wis. 2d 340, 348, 237 N.W.2d 706 (1976). Whenever a question of policy coverage exists, however, an insurer's duty to settle under the contract is in doubt. Its duty to settle is dependent upon whether the policy extends coverage for the circumstances underlying the harm sustained. Mowry argues that the insurer's mistaken decision about the nonexistence of coverage should render Badger State liable for the excess judgment entered against the insured. He does not assert that Badger State breached any of the three traditional obligations arising out of the general duty to settle. Rather, he asserts that Badger State acted in bad faith in deciding to disclaim coverage where it was convinced that no real issue as to liability or damages existed. Moreover, he argues that Badger State's liability for damages caused by its refusal to settle an excess liability claim is not excused by a good-faith failure to defend.

To support his argument, Mowry cites cases from other jurisdictions which ostensibly are on point. In Luke, 476 F.2d 1015, the court held that an insurer who denied coverage to its insured because the insurer doubted that coverage existed under the contract was *512 liable to the insured's assignees for the entire excess judgment for the breach of its duty to settle. Like the instant case, the insurer in Luke believed that an issue as to automobile ownership had arisen. The insurer denied coverage on that basis. It also received several offers of settlement within policy limits. However, the offers were ignored. In addition, the insurance company refused to consider a declaratory action concerning the coverage issue. Despite this conduct, the lower court held that the insurer exercised good faith in refusing to provide coverage. Id. at 1018-20.

The Eighth Circuit Court of Appeals found that the insurer refused to settle and refused to defend and, therefore, had breached its contract with the insured. Good faith, the court found, is irrelevant to a breach of contract action. "When an insurer refuses to defend and, additionally, refuses to accept a reasonable settlement within the policy limits, the company's liability for damages may be measured as well by its rejection of the offer to settle and may thus exceed the policy limits." Id. at 1020.

We do not find Luke to be persuasive in the present situation. First, in this case there was no breach of contract for failure to defend (for reasons which will be discussed below) as there was in Luke. Good faith, although of no importance in breach of contract actions, is a consideration in actions claiming a breach of the duty to settle, which arises out of fiduciary principles. Alt, 71 Wis. 2d at 348. Johnson v. American Family Mut. Ins. Co., 93 Wis. 2d 633, 646, 287 N.W.2d 729 (1980). Second, the insurer in Luke refused the plaintiff's offer to hold the suits in abeyance in order to give the insurer an opportunity to file a declaratory judgment suit. Here, Badger State sought out an agreement *513 based on a statutory provision whereby the coverage issue could be judicially determined prior to any liability and damages issues. It did not simply ignore the victim's claim, as the insurer in Luke apparently did.

Mowry also cites Comunale v. Traders & General Ins. Co., 50 Cal. 2d 654, 328 P.2d 198 (1958). Comunale involves another "refusal to defend" case. The insurer, believing that the insurance contract did not provide coverage for the victim's injury, refused to defend its insured. The trial proceeded to judgment against the insured, which included an award to the victim in excess of the insured's policy limits. Under assignment, the victim sued the insurer. The Supreme Court of California stated,

"When there is great risk of a recovery beyond the policy limits so that the most reasonable manner of disposing of the claim is a settlement which can be made within those limits, a consideration in good faith of the insured's interest requires the insurer to settle the claim. Its unwarranted refusal to do so constitutes a breach of the implied covenant of good faith and fair dealing." 50 Cal. 2d at 659, 328 P.2d at 201.

That court then held the insurer liable for the excess judgment entered against the insured, representing the insured's damages for breach of the duty to settle.

The Comunale rule, in effect, renders an insurer strictly liable for any decision not to settle within policy limits, whether or not made in good faith, when a subsequent judgment against the insured exceeds policy limits:

"`An insurer who denies coverage does so at its own risk, and, although its position may not have been entirely groundless, if the denial is found to be *514 wrongful it is liable for the full amount which will compensate the insured for all the detriment caused by the insurer's breach of the express and implied obligations of the contract. 50 Cal. 2d at 660, 328 P.2d at 202.'" Johansen v. California State Auto. Assn. Inter-Ins. Bureau, 15 Cal. 3d 9, 15, 538 P.2d 744, 123 Cal. Rptr. 288 (1975).

In Johansen, the California court further explained the upshot of its strict liability approach:

"[T]he only permissible consideration in evaluating the reasonableness of the settlement offer becomes whether, in light of the victim's injuries and the probable liability of the insured, the ultimate judgment is likely to exceed the amount of the settlement offer. Such factors as the limits imposed by the policy, a desire to reduce the amount of future settlements, or a belief that the policy does not provide coverage, should not affect a decision as to whether the settlement offer in question is a reasonable one." 15 Cal. 3d at 16, 538 P.2d at 748-49.

Although we acknowledge the apparent goal of the California approach—to protect the insured from liability for an excess judgment by placing the risk of an erroneous decision not to settle on an insurer—we decline to accept that strict approach for this jurisdiction. Such a policy is unduly oppressive on insurance companies and would force them to settle claims where coverage may be dubious. The California approach is particularly unseemly in a jurisdiction such as our own, where an insurer may seek judicial determination of coverage issues prior to litigating liability and damages issues. See, sec. 803.04(2)(b), Stats. The California approach is unrealistic if only to the extent that an insurer's belief that an insurance policy does or does not *515 provide coverage must necessarily "affect a decision as to whether the settlement offer in question is a reasonable one." Johansen, 15 Cal. 3d at 16, 538 P.2d at 749.

We have held that an insurer has a right to exercise its own judgment in deciding whether to settle or contest a claim, within parameters of good faith considerations. Hilker, 204 Wis. at 14. An insurer need not accept every offer of settlement within policy limits under sanction of liability for an excess judgment against its insured. See, Johnson, 93 Wis. 2d at 645-46. The Hilker and Johnson cases did not involve an issue of coverage as a basis for denial of settlement offers. Whether an insurer who rejects an offer to settle within policy limits because of a coverage question shall be liable for some measure of damages upon a determination of coverage depends upon whether the insurer acted in bad faith in determining that a coverage question existed. The tort of bad faith is "the knowing failure to exercise an honest and informed judgment." Anderson v. Continental Ins. Co., 85 Wis. 2d 675, 692, 271 N.W.2d 368 (1978). To hold that Badger State breached its duty to settle requires a finding that it committed the tort of bad faith.^[3] Badger State asks this court to adopt the standard set forth in Anderson.

Bad faith in deciding to litigate rather than settle a claim involves more than a mere finding of negligence on the part of the insurer. Warren v. American *516 Family Mut. Ins. Co., 122 Wis. 2d 381, 385, 361 N.W.2d 724 (Ct. App. 1984). Where there is no bad faith, an insured (or an insured's assignee) may not "surcharge an overage against his insurance company merely because of" any possible negligence on the insurer's part in deciding to litigate rather than to settle. Baker v. Northwestern Nat. Casualty Co., 26 Wis. 2d 306, 314-15, 132 N.W.2d 493 (1965).

In Anderson, a first-party claim case, this court held that an insurance company may challenge claims which are fairly debatable. 85 Wis. 2d at 693. We said,

"To show a claim for bad faith, a plaintiff must show the absence of a reasonable basis for denying benefits of the policy and the defendant's knowledge or reckless disregard of the lack of a reasonable basis for denying the claim." Id. at 691.

An insurer will have committed the tort of bad faith only when it has denied a claim without a reasonable basis for doing so, that is, when the claim is not fairly debatable.

This court has held that in third-party claim situations, it is not bad faith for an insurer to refuse to settle a victim's claim "under the bona fide belief that the insurer might defeat the action...." Johnson, 93 Wis. 2d at 646. See also, Maroney v. Allstate Ins. Co., 12 Wis. 2d 197, 200-01, 107 N.W.2d 261 (1961). Although the "bona fide belief" language applies to a third party's action against the insured, we similarly hold that it is not bad faith for an insurer to refuse to settle an injured's claim within the policy limits when the question of policy coverage is fairly debatable and when the grounds for the refusal, if determined in the insurer's *517 favor, would wholly defeat the indemnity responsibility of the insurer to its insured.

We hold that the circuit court erred in finding in this case that Badger State committed bad faith by refusing to settle and negotiate a settlement within policy limits. A finding of bad faith must not be measured solely against a backdrop that coverage was ultimately found to exist under the policy. Bad faith should be found in this case only if there was no fairly debatable coverage question. However, the circuit court, sitting without a jury, did not use this standard to reach its bad faith conclusion. The court concluded that Badger State's posture of waiting to defend the action and to negotiate a settlement until the coverage issue was determined itself constituted bad faith. Because the circuit court did not rely on appropriate and applicable law in making its bad faith determination, its holding is an abuse of discretion and, as such, is erroneous. See, Hartung v. Hartung, 102 Wis. 2d 58, 66, 306 N.W.2d 16 (1981).

The upshot of the trial court's holding would be to require the insurer to accept an offer within policy limits even where a fairly debatable coverage question exists. We have, however, rejected the California approach, which would make an insurer strictly liable for an offer of settlement within policy limits.

Although this court might otherwise remand a matter to the circuit court for further consideration where the appropriate law has not been applied, we choose to decide the bad faith issue as a matter of law.

Bad faith is a determination to be made by the trier of fact. Baker, 26 Wis. 2d at 315. Like negligence, *518 whether certain conduct constitutes bad faith raises a mixed question of fact and law. See, Millonig v. Bakken, 112 Wis. 2d 445, 450, 334 N.W.2d 80 (1983). First a question is raised with respect to what the party allegedly in bad faith did or failed to do. The second inquiry is whether a reasonable insurer would have denied policy coverage under the facts and circumstances of the particular case. See, Anderson, 85 Wis. 2d at 692. In instances in which such a matter is tried to a jury, and when the facts are undisputed and the evidence permits only one reasonable inference or conclusion, then the issue of bad faith is to be decided by the court as a matter of law, rather than by the fact finder as a question of fact. See, Millonig, 112 Wis. 2d at 450-51. In this case the issue of bad faith was tried to the court, not to a jury. With respect to the court's findings in such an instance,

"[w]hen the principal facts in a case are undisputed and the controversy centers on what has been called ultimate conclusions of fact, or conclusions of law, this court has indicated it will not be bound by the findings of the trial court." Chicago, Milwaukee, St. Paul & Pacific R.R. Co. v. Milwaukee, 47 Wis. 2d 88, 96, 176 N.W.2d 580 (1970).

Here, because the principal facts underlying the bad faith claim are undisputed and because there is only one reasonable inference, we may review the matter of bad faith as a question of law without deference to the trial court or court of appeals.

Badger State's grounds for refusing the settlement offers within policy limits were that it did not believe that the car involved in the accident was owned by its insureds, McCarthy's parents. Badger State, therefore, concluded that the policy did not extend coverage to *519 McCarthy through his parents. Mowry disputes Badger State's conclusion that the coverage question was fairly debatable. He notes that whether a matter is fairly debatable "implicates the question whether the facts necessary to evaluate the claim are properly investigated and developed or recklessly ignored and disregarded." Anderson, 85 Wis. 2d at 691. He asserts in his brief that Badger State recklessly ignored the fact that the automobile in question was registered in the name of Mildred McCarthy (who is one of the policy's two named insureds and Steven McCarthy's mother), that McCarthy's father contributed to the purchase price of the car, and that Mildred had driven the car as well as Steven, among other relevant facts.

Badger State responds that McCarthy did not need parental permission to operate the car, that McCarthy said at the accident site that the car was uninsured, and that McCarthy's father told McCarthy to obtain insurance on the car. In addition, Mowry's counsel conceded during the underlying bad faith trial before Judge McGraw that evidence existed which presented a jury issue on coverage. Mowry's counsel stated:

"I'm willing to stipulate as I have always been that there was a jury issue on the question of coverage[,] period. As attempting to cloak it in the terms of the wise men to the west as being fairly debatable and so on, I object to, but your Honor, there is no question but what there was evidence which presented a jury issue on coverage."

Significantly, the original trial court bifurcated the liability and damages issues from the coverage issue and ordered that the issues of liability and damages be held in abeyance until the determination of the coverage issue. The court of appeals in its certification memorandum *520 stated that the evidence for and against coverage "was at least somewhat balanced."

We hold that Badger State did not act in bad faith in initially denying coverage to McCarthy. The record establishes a reasonable basis for Badger State's denial of coverage. Although the vehicle was registered in Mildred McCarthy's name, other items within the record suggest Steven McCarthy's ownership of the vehicle. Eugene McCarthy, Steven's father, stated that Steven paid for the car with money from Steven's own checking account, but that Eugene also "gave him some money." McCarthy apparently had approached his father about the idea of "buy[ing] the car" from a third party. Steven, according to the elder McCarthy, paid $150 for the car, but Mildred McCarthy's name appeared on the title. McCarthy never had to ask his father or mother for permission to use the car. Eugene McCarthy suggested that his son obtain insurance on the vehicle. In a statement made to a Badger State representative, McCarthy claimed that his mother owned the car on the date of the accident but that he had paid for it. One of the vehicle's occupants on the date of the accident stated that McCarthy said at the accident scene that he owned the car and that it was uninsured.

Although the record itself does not conclusively establish that the vehicle in question was covered under the elder McCarthy's insurance policy) that task was undertaken and resolved by the jury in the coverage trial), the record sufficiently establishes that Badger State was presented with a fairly debatable coverage issue. There is no absence of a reasonable basis for Badger State's denial of coverage. The record gives no indication that Badger State failed to properly investigate *521 the claim, or that important facts were recklessly ignored and disregarded. Badger State did not commit bad faith in failing to settle Mowry's claim within policy limits even though McCarthy's liability for the accident was probable and damages were concededly in excess of policy limits. The question of coverage under the policy was fairly debatable.

Badger State could have protected both its interests and its insured's interests by settling under a reservation of rights agreement, Mowry and the circuit court assert. The record reflects that Badger State's counsel and its claims manager considered such an option, but ultimately decided to pursue the bifurcation procedure. A reservation of rights agreement would result in a settlement of the injured's claims, while preserving the insurer's right to litigate the coverage issue. The insured benefits from this procedure because it is protected from excess judgment. Badger State argues, however, that the reservation of rights procedure will rarely result in the insurer's recouping the payments it made to the victim from the insured where coverage is found not to exist under the policy, because the insured may be judgment-proof.

An insurer is always at liberty to seek a reservation of its rights in settling a claim. But Badger State's failure to seek such a reservation in this case does not, by itself, constitute bad faith. Badger State merely sought a statutory mechanism to bifurcate the coverage issue from the liability and damages issues. To require an insurer to enter into a reservation of rights agreement in addition to proceeding within a separation framework would run contrary to the bifurcation allowed by sec. 803.04(2)(b), Stats. Even though Badger *522 State's determination that coverage did not exist was wrong, its mistake does not mean that it acted in bad faith in refusing to settle if the issue of coverage was fairly debatable. Although the mere ordering of a separate trial on the coverage issue is not conclusive that the coverage issue was fairly debatable, we cannot conclude that failure to enter into a reservation of rights agreement when a bifurcated trial has been granted is bad faith. We note that none of the cases cited by Mowry (e.g., Luke, Comunale, and Johansen) dealt with situations where the insurer sought and was granted a statutory separation procedure similar to sec. 803.04(2)(b).

Mowry argues that it is inherently unfair for McCarthy to be liable for a judgment in excess of policy limits when the judgment could have been wholly avoided had Badger State settled within policy limits when it had the opportunity to do so. But to require an insurer to settle any claim within policy limits where the insured's liability and the victim's damages in excess of policy limits are relatively certain, without consideration as to whether coverage exists, may result in extortionate lawsuits against the insurer. See, Anderson, 85 Wis. 2d at 693. Section 803.04(2)(b), Stats., provides some measure of protection against pressure settlement situations in which an insurer might find itself. We cannot penalize an insurer merely for utilizing such a mechanism. The bad faith standard, moreover, strikes an acceptable balance between the insurer's and insured's competing interests concerning settlement offers within policy limits where liability and damages in excess of policy limits are apparent.

*523 We note that this court has endorsed the use of the separation mechanism to avoid conflicts of interest between the insured and the insurer. Allstate Ins. Co. v. Charneski, 16 Wis. 2d 325, 331,