One of the many consequences of a tight insurance market during tough economic times is that potential insureds may have difficulty obtaining coverage if they have bad loss records or conditions that may indicate greater than normal risk.
Over the last several years, there has been a dramatic increase in the number of circumstances where significant omissions or misstatements have been discovered in insurance applications that insureds had filled out to obtain coverage. In cases as far ranging as equine insurance policies to medical malpractice coverage, again and again we have found important information left off of applications or blatantly false answers given.
The increasing frequency of these cases was such that we began to question other insurance coverage attorneys at various state and national insurance conferences to see whether they were also encountering an increase in these situations.
Indeed, not only did we find, in this very unscientific poll, a considerable upswing in such cases, but also noted that many bar association groups are including this topic in continuing legal education courses. It is apparent that in this economy, insurance carriers and their attorneys are closely examining the information provided by insureds.
Most misrepresentations or material omissions are never discovered. A policy is issued and no claims or circumstances arise that require the carrier to question the information in the insurance application. The problem normally arises when a substantial claim comes in and in the course of the litigation of the claim it is determined that significant misleading information was provided by the insured that would have dramatically affected either the premium or whether the insurance would have been placed at all.
For example, consider a physician who fills out an application and notes he has had no claims over a 20-year period, and the premium and policy are placed on that basis. After the physician is sued, a deposition reveals that, in fact, he has been sued numerous times over decades, many of which were in the last few years. In that instance, it becomes a central issue for the carrier as to whether the insurance was properly procured.
What does a carrier do when it discovers such information? Does it simply withdraw from the defense of the claim? Does it seek to set aside the insurance policy, or at least obtain a premium more in line with reality?
What to Do?
While it may seem self-evident, the best safeguard from these problems is better investigation and checking of information prior to the placement of coverage. However, such reviews can only do so much. Agents and underwriters have limited resources and cannot verify all facts.
Thus, the usual circumstance is that the misrepresentation is not found until after the policy is placed and a claim has arisen. In cases where a significant misrepresentation is found after a claim is presented, there are several options. One option is to cancel the policy, but that does not prevent a potential obligation to defend the claim that has been made.
A second option is to file a declaratory judgment suit seeking a finding that the policy does not provide coverage for the claim because the policy was issued based on false premises. This is rescission and its purpose is to void the policy, in essence to set aside the policy, which will likely require a return of the premium.
A successful rescission precludes coverage for the current claim. Simply put, where there is no policy, there is no coverage. The absence of coverage applies not only to the claim at issue, but also to any future claim that may potentially arise under the rescinded policy.
At the outset, it is important to remember that rescission is an equitable remedy. That means that the remedy is guided by equitable principles. The equitable remedy of rescission is to prevent a party from gaining a benefit due to a misrepresentation and to restore the parties to the status quo. Rutgers Casualty Ins. Co. v. Lacroix, 194 N.J. 515 (NJ 2009). To further this objective, courts have the power to apply the remedy of rescission to the specific facts of a particular case. Generally, there are five elements to be established before an insurer can avoid payment on an insurance policy due to misrepresentation.
Those elements are: 1) representation by the insured; 2) falsity of the representation; 3) reliance by the insurer; 4) intent to deceive by the insured; and 5) the materiality of the misrepresentation. Mayes v. Massachusetts Mutual Life Ins. Co., 608 S.W.2d 612 (Tex. 1980). However, an insurer may not always have to demonstrate that the insured actually intended to deceive. Even innocent misrepresentations can, in some cases, amount to equitable fraud justifying rescission.
Of those five elements, usually the most difficult to establish is that the insured intended to deceive the carrier. In requiring an “intent to deceive” the Texas Supreme Court held that “the utterance of a known false statement, made with the intent to induce action … is equivalent to an intent to deceive.” Union Bankers Ins. Co. v. Shelton, 889 S.W.2d 278 (Tex. 1994). The usual action “induced” is the placement of the coverage. If the insured knew, or should have known, that the honest answers would likely prevent policy placement, intent may be shown.
For example, an intent to deceive was found in Sharp v. Lincoln American Life Ins. Co., 752 S.W.2d 673. Sharp filled out an application for insurance on the life of her daughter. Her daughter signed the application without reading it. One year after the policy was issued, the daughter died. The insurer refused to pay the policy proceeds citing a material misrepresentation because of the failure to disclose the daughter’s years of drug abuse.
The trial court found the daughter misrepresented information with an intent to deceive. The court held that a person who signed the application is presumed to know the content and to have ratified any false statements. However, such a presumption alone does not establish an intent to deceive.
Recognizing that an intent can be shown by circumstantial evidence, the court held that a fact finder, in comparing the representation made on the insurance application with the insured’s knowledge, could determine that the misrepresentation was so outrageous and removed from truth that it must have been made with the intent to deceive. Since the daughter had been repeatedly hospitalized for drug use, but represented she “had not received any treatment,” the court concluded there was evidence to support the trial court’s finding of intent.
In addition to intent, the insurer must show that the false information was important, or “material,” to its decision to issue the policy. In most cases, the underwriter involved can address that issue, explaining why the information was important. The key is to avoid complaining about unimportant or incidental mistakes.
Rescission should be attempted only where the false information is significant and would have affected the placement of coverage or the premium. Falsified information on applications is always a concern, but in the current marketplace it is of heightened concern.
Verifying important facts is the best way to avoid problems, but where information becomes suspect after issuance, investigating applications for accuracy is a valid consideration.
Carsey is an associate and Martin is a partner in the Insurance Litigation and Coverage Practice of the law firm Thompson, Coe, Cousins & Irons LLP.
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