If an insurance company has denied a claim and upheld the denial through internal appeal and grievance procedures, the insured can sue on a number of legal theories. The theories include breach of contract, breach of the implied covenant of good faith and fair dealing (bad faith) and under some circumstances infliction of emotional distress and fraud.

The two primary legal remedies available in most cases are breach of contract to recover the value of the denied benefit or service and any incidental damages and bad faith. Bad faith is the unreasonable denial of a benefit and may allow recovery for emotional distress, interest on out-of-pocket losses, damages for any attorney fee obligations incurred and, in limited circumstances involving malicious or willful misconduct, punitive and exemplary damages. These legal remedies are ones that are available under state law, not federal law. In addition, especially with regard to the tort remedies of bad faith, infliction of emotional distress and fraud, the availability of the remedy and the nature and extent of damages recoverable vary from state to state.

All insurance policies contain an implied obligation applicable to the insurance company of "good faith and fair dealing" towards its insured. When a claim is presented, this implied obligation means that an insurance company cannot simply look for reasons not to pay. Instead, the company must make a thorough investigation of the claim, must consider all reasons and circumstances that might support the claim, and must give as much consideration to the financial interest of the insured as it gives to its own financial interest.

If an insurance company refuses to pay a claim that should be paid or offers to settle a claim for less than it knows the claim is worth or denies a claim without adequate investigation, this could give rise to a so-called bad faith claim against the insurance company, i.e., a claim that the company has breached its implied obligation of good faith and fair dealing. If the company is found to have acted in bad faith in its handling of a claim, the insured is entitled to all damages resulting from that action, including certain types of damages that would not be available just for breach of contract. In cases of extreme or outrageous misconduct by an insurance company, the insured also may be entitled to receive punitive damages.