Last year, Americans paid $168.5 billion to insurance companies for life, health and property-casualty coverage. They paid just 26.5 percent more -- $213.1 billion -- to their government in individual income taxes.

For regulation of the vast insurance industry, they have relied since 1945, when Congress passed a law, on the states. But some consumers complain that state insurance commissioners give them inadequate help with claims that insurers refuse to pay.

In recent years, shock waves have been sent through the industry by the growing use of a potent alternative weapon for consumer protection -- one that imposes no taxes and creates no new bureaucracies.

The weapon is the lawsuit intended to punish alleged wrongdoing: fraud, malice or oppression, defined as conscious disregard of a policyholder's rights.

In such a suit, the policyholder seeks the customary payment of the sum due under the policy and compensatory damages for mental and emotional distress and economic hardship. But the policyholder also asks for big bucks in punitive damages -- dozens of times as much as the benefit in the policy.

No one has wielded the weapon more often, and with more devastating effect, than a team of five lawyers led by William M. Shernoff of Claremont, Calif. They are the only lawyers in the country who do nothing else, Shernoff told a reporter.

In the industry, said team member David T. Lipsky, "the general impression of Bill is that he eats insurance companies for breakfast."

By Shernoff's estimates, his small firm -- in 600 settlements involving 120 insurers -- has won more than $21 million in the last four years. He calculated that at least 60 percent of the total was punitive.

Almost one-quarter of the total came from the first multimillion-dollar wrongdoing verdict against an insurance carrier -- a stunning $5 million in punitive damages, 110 times the actual damages of $45,600. Compensatory damages for distress were $78,000.

The carrier was Mutual of Omaha, which says it is "the largest exclusive health and accident company in the world." Its 1978 assets were $1,265,196,000.

The plaintiff was Michael Egan, now 64, a Pomona, Calif., roofer who in 1970 fell from a ladder, injuring his back and legs. After unsuccessful surgery his doctors pronounced him totally disabled.

Egan had a policy providing for lifelong payments of $200 a month in event of total disability resulting from "injury" but less if he had a "nonconfining sickness."

Initially, Mutual regarded Egan as "injured." After paying him $1,827, however, the company decided he had a "nonconfining sickness."

In 1973, Egan sued Mutual, which processes more than 4.2 million claims transactions a year and, it says, handles "over 99.8 percent . . . without complaint." The 70-year-old company's slogan is "People you can count on . . . "

The $5 million punitive damage award, after being upheld by the trial judge, was halved by an appeals tribunal. Mutual appealed to the California Supreme Court, which, after holding the case for more than two years, ruled against the insurer Aug. 14.

In a 4-to-2 decision, the court held that Egan was entitled to punitive damages, but also held that $5 million was excessive.

In the majority opinion with which the court sent the case back to the trial court for a re-determination of the punitive damages Justice Stanley Mosk had a warning for the industry: "Insurers hold themselves out as fiduciaries, and with the public's trust must go private responsibility consonant with that trust," he wrote.

The infrequency of claims complaints cited by Mutual is shrugged off by Shernoff on the ground that most policyholders with reason to challenge a refusal to pay, if they pursue the matter at all, will accept as final a letter from a state insurance commissioner saying that they are not entitled to benefits.

This year, in May and June alone, the Shernoff firm won $3,154,017 in 24 settlements averaging $76,704 and in two precedent-setting judgments.

One case involved Joe Ingram, a truck driver and father of a handicapped child. He bought a car on the installment plan so his wife could make a weekly 120-mile round trip to a hospital where their son received therapy. To be sure that the payments would be made even if he were to be disabled and unable to work, Ingram also bought a credit-disability policy.

Later, Ingram suffered a disabling back injury. But after making a few installment payments, Commercial Bankers Life Insurance Co. stopped, causing the car to be repossessed. A Riverside, Calif., jury awarded Ingram $1,000,001 -- $872,001 of it punitive.

The second judgment was an award against Blue Shield of California for refusing to pay John E. Sarchett for a hospital stay deemed by his doctors to have been "completely justified and indeed urgently needed." Blue Shield physicians who reviewed the claim concluded he need not have gone to the hospital.

The judgment, awarded by a member of the American Arbitration Association, was the largest against an insurer in an arbitration proceeding: $1,116 for the bill, $300,000, or 269 times as much, in punitive damages for "oppression" and $12,000 for emotional and mental distress.

Both Shernoff and Blue Shield attorney Rick Zimmerman said the judgment, which the insurer is appealing in Superior Court, may affect Blue Shield members everywhere.

"Blue Shield will now be forced to accept the opinion of treating doctors and hospitals rather than to deny claims on a wholesale basis simply because its claims adjuster or medical auditor disagrees with the treating doctor," Shernoff said.

By contrast, Zimmerman offered a warning. He foresaw a "rippling effect" across the land in which lawyers will be encouraged to litigate Blue Shield claims, some carriers may start paying unworthy claims simply to avoid litigation and subscribers will be forced to pay more for coverage.

Shernoff scorns the protection against wrongful insurers conduct provided by the states, partly because of "the revolving door in which former insurance executives become regulators and then return to the industry.

"One lawsuit like the multimillion-dollar Egan case does more to improve claims practices than anything state regulation has done in years," he said in a phone interview.

His principal case in point is California, whose citizens pay $22 billion a year in insurance premiums, most in the nation.

In 1976, California ranked third in outlays for regulation of insurance, which accounts for about 12 cents of every $1 of disposable consumer income. It spends $9 million, or 41.7 cents per person. New York spent $15.7 million (87 cents) while Texas spent $12.8 million ($1.01).

Shernoff, relying on what Ralph Nader termed a "self-help, decentralized, nonbureaucratic, nontax-supported system of enforcement in the courts," said, "There is no doubt in my mind that we have taken more from the insurance industry by way of compensatory and punitive damages for policyholders than the entire [California] Department of Insurance."

California's commissioner of insurance is Wesley J. Kinder. In 1969 and 1970, when Ronald Reagan was governor, Kinder was chief deputy commissioner. He left to become an executive of General Reinsurance Corp. Then, in 1975, Gov. Edmund G. (Jerry) Brown Jr. named him to his present post. He also is vice president and chairman of the executive committee of the National Association of Insurance Commissioners (NAIC).

Just a few weeks ago, in a letter to Brown, Nader assailed Kinder as "anticonsumer," and asked that he be fired. Kinder could summarize his enforcement activity against bad-faith insurer conduct "on a single sheet of paper and still leave it virtually blank," Nader charged.

According to Shernoff, no insurer has been prosecuted under the state's 5-year-old Unfair Claims Practice Act. Even if one had been, the maximum penalty is a civil fine of $50, or,for a willful violation, $500. Such mild deterrents create "a climate for insurance companies to be abusive," Shernoff contended.

In 1977, the department logged 17,000 complaints and routinely followed up each with an inquiry to the carrier. All told, Kinder estimated, the companies then paid out $6 million to $7 million to perhaps 8,500 persons, most of whom had claimed benefits for disabilities.

The average -- roughly $706 to $824 -- is a fraction of Shernoff's average settlement and a tinier fraction of his average verdict.

Even so, Kinder acknowledged to a reporter, it overstates reality because, "in many instances, we may be simply expediting a claim that was about to be paid in any event."

In Kinder's view, the main obstacle to better performance is that the state legislature has not given his department sufficient powers. Similarly, NAIC president H. Pete Hudson of Indiana said that many complaints can be resolved only in court, but that state insurance commissioners lack the authority and resources to litigate.

Kinder conceded that something has to be done about the kind of conduct targeted in Shernoff's suits, such as making insurance executives personally responsible.

But, Kinder said, "I do not believe that huge monetary penalties that go to individual claimants -- amounts far in excess of any economic loss that they have suffered -- benefit policyholders generally, because the cost of those penalties gets built back into the premiums that all of the rest of us pay."

That is "the industry line," and Kinder "is just a parrot for it," Shernoff charged. "If Kinder was doing his job, he would issue regulations that punitive damages for fraud cannot be built into the rates, but must be taken out of profit."

The concept of passing through punitive damages to consumers, in the form of higher premiums, also was challenged last year by the California Supreme Court.

Seeing no reason for the punished firm's competitors to raise their rates, the court said that "the principles upon which the American system of free enterprise is based would suggest to the contrary, i.e., that other companies would proceed to capitalize upon the resulting competitive disadvantage."

If the offender loses business, the court said, "the objective of deterrence will be well-served, resulting in an ultimate benefit to insurance consumers as a whole."

Shernoff also does not see any point in small awards of punitive damages. Unless they are large, he said, "they won't have the meaningful effect to bring about reform. It's the size that makes the companies shape up."

There is no dispute that the large awards won by Shernoff and others, including California lawyers John C. McCarthy and Clifford Mitchell, have triggered internal reforms.

In 1975, for example, Earl Clark, chairman and chief executive of Occidental Life Insurance Co. of California and chairman of the American Life Insurance Association, said in a speech: "Every judgment on a suit of this type impairs the industry's character in the eyes of the public. The best defense against punitive damages suits is to avoid them by thoughtful, careful, equitable administration of our contracts."

In San Francisco, attorney Guy Kornblum, who represented Mutual of Omaha in its appeal of the Egan case, said "a lot of companies have refined, upgraded and revised their procedures."

Kornblum also said some insurers that never have been sued in California have come to him for "preventive counseling" about their claims and underwriting processes so as to forestall problems.

Shernoff says executives and counsel of reputable companies have told him privately that they believe punitive damage suits, in the long run, will be "healthy" because they will tend to eliminate competition from insurers that engage in fraudulent practices.

But the industry also has been busy in Sacramento, where it has gotten through the Senate a bill that would allow only the state insurance commissioner -- not a policyholder -- to sue an insurer for any of 15 specific offenses.

"Shernoff has been so successful in developing a private law enforcement right for consumers that the insurance industry, unable to defeat him in court, is trying to choke him with legislation," Nader said. "It's trying to slam shut the door of the courts by legislative edict."

The bill is pending in the Assembly. Insurance Commissioner Kinder said, "We didn't initiate that bill, and we don't support it in its present form."

One lawyer on Shernoff's team, Harvey R. Levine, a University of San Diego law professor, devised and teaches the first "bad faith" insurance course, Shernoff said.

Levine, who staffs the law firm's San Diego office, and Shernoff go around the country together to spread the punitive damage gospel to other lawyers at regional seminars.

For the past year, the firm has been aided by Patrick J. Little, who for 20 years was a claims manager for several large insurers.

"In reality," Shernoff said, "we are one prosecuting law firm going around the country imposing 'fines' and 'penalties' on insurance carriers for illegal conduct."

He has been busy building a "network" of lawyers with whom he consults in other states, including Alabama, Mississippi, Nevada, New York and North Carolina.

In most jurisdictions, including Maryland, Virginia and the District of Columbia, Shernoff said, "Nobody's really grabbed the ball" to pursue punitive damages for insurer wrongdoing.

The basic reason is that in these jurisdictions, the courts generally have held that a policyholder seeking to recover benefits is suing for a breach of contract and thus is not entitled to compensatory and punitive damages. Few precedents for punitive awards exist, Shernoff said.

By contrast, California began in 1958 to develop a new body of law. Essentially, its theory is that a denial of benefits may have serious consequences, such as foreclosure on a home or car, and that compensatory damages and punitive damages for fraud or other wrongdoing, consequently should be permitted.

Shernoff admittedly does well by doing -- as he sees it -- good. Indeed, he has become a millionaire by working on a contingent fee basis, in which he gets 40 percent of the portion of a settlement that exceeds the benefit specified in the policy (50 percent if there is a verdict).

He said he agrees in part with criticisms that there is a windfall for lawyers in these cases that may be too large. His response, he said, has been to participate in drafting legislation under which a portion, perhaps 25 percent, of a large punitive damage award could go to a public advocacy organization dedicated to eradicating the abuses that gave rise to the litigation.