The Power of Policy Rescission as a Tool to Combat FraudJanuary 6, 2012 | |
Rescission of an insurance policy based on a policyholder’s material misrepresentations during the application process is one of the most potent weapons that an insurance company has to combat insurance fraud. A proper rescission not only results in a denial of a particular claim, but voids the policy.
On a national basis, insurance companies’ interest in the rescission remedy is evident from the plethora of court decisions on the topic. In recent months, in fact, federal and state courts across the country have issued numerous decisions in cases involving requests for rescission of a variety of insurance policies. Federal courts in the U.S. Court of Appeals for the Second Circuit have been well represented in these cases. For example, the Second Circuit affirmed a district court decision, applying California law, that granted a life insurance company’s request to rescind a policy after the district court found that the omission of the insured’s hepatitis B diagnosis and treatment was a material misrepresentation. The Second Circuit also affirmed a district court decision, applying New York law, that rescinded a disability insurance policy based on the district court’s finding that the insured had made intentional misrepresentations in her application that were intended to mislead the insurer.
As the following discussion demonstrates, claims of rescission are carefully scrutinized by the courts. When the standard is met, courts in New York and elsewhere are quite willing to find that a policy should be rescinded.
Generally speaking, the standard for rescission of an insurance contract under New York law is rather straightforward. To establish its right to rescind an insurance policy, an insurer must demonstrate that the insured made a “material misrepresentation.” Courts have explained that even if a misrepresentation was made innocently or without the intent to deceive, it is sufficient to void a policy if it is material. A misrepresentation is material “when the insurer would not have issued the policy had it known the facts misrepresented.” Materiality usually is a question of fact for the jury; however, where the evidence concerning the materiality is clear and substantially uncontradicted, the matter is one of law for the courts to determine.
Conclusory statements by insurance company employees, unsupported by documentary evidence, are insufficient to establish materiality as a matter of law. To establish materiality as a matter of law, an insurer typically presents documentation concerning its practices, such as underwriting manuals, bulletins, or rules pertaining to similar risks, that show that it would not have issued the policy if the correct information had been disclosed in the application.
Life Insurance Policy
The U.S. District Court for the Southern District of New York applied this standard in a recent case, American General Life Ins. Co. v. Bolden, in which an insurer sought rescission of a $500,000 life insurance policy.
As the court explained, the insurer issued the policy on March 18, 2008, at the “preferred plus” rate – the best rate offered by the insurer on its life insurance policies. The insured died less than one year later, on March 5, 2009, from renal cancer. The insurer then commenced an investigation in which it compared the answers on the insured’s life insurance application against his medical records.
One of the questions on the application was, “Other than previously stated in the past 10 years, has the Proposed Insured . . . been advised to have any diagnostic test, hospitalization, or treatment that was NOT completed?” The insured marked the response “no,” although he previously had seen two doctors for gross hematuria (visible blood in the urine) and had been told to undergo further testing, including cytology, which was never completed and which he did not disclose on the application.
Another question on the application asked, “Has the Proposed Insured ever . . . sought or received advice, counseling or treatment by a medical professional for the use of alcohol or drugs, including prescription drugs?” The insured marked the response “no,” although his doctor actually had advised him to stop consuming alcohol.
With the goal of demonstrating the significance of these two questions and responses, the insurer explained to the court that its underwriting guidelines indicated that individuals with hematuria presented “a significant underwriting challenge,” and that the guidelines suggested a “thorough assessment” of the patient was needed. Additionally, the insurer’s director of underwriting services declared that the insurer, “would not have issued the policy at all without additional follow up testing concerning the cause of the gross hematuria” if it had known of the uncompleted diagnostic test.
The insurer also pointed out that its underwriting guidelines indicated that, “[t]o adequately assess a case of alcohol abuse,” the underwriter should develop, among other things, “[d]etails of past and present levels of alcohol consumption[,] . . . [r]esults of all investigations, including liver enzymes and alcohol markers[,] . . . [a]ny medical complications[, and] . . . [o]ther increased risks for accidents such as history of driving offenses or participation in a hazardous sport or occupation.” According to the insurer’s director of underwriting services, if the insured had disclosed that he had been advised to stop drinking by his doctor, this information “would have raised red flags . . . and would have changed the underwriting risk analysis” so that the insurer would have required additional information from him, including a drug and alcohol questionnaire before issuing any policy.
The court agreed with the insurer. The court found that the insured had made a misrepresentation when he answered “no” to the question as to whether he had “been advised to have any diagnostic test, hospitalization or treatment that was NOT completed” because, in fact, he had not completed a cytology test that his doctor had directed him to undergo in connection with his gross hematuria. This misrepresentation, the court found, was “material,” as it was undisputed that the insurer would not have issued the policy to the insured on the basis of his application without further testing had he included the correct information on his application.
Moreover, the court continued, the insured also made a misrepresentation when he answered “no” to the question, “Has the Proposed Insured ever . . . sought or received advice, counseling or treatment by a medical professional for the use of alcohol or drugs, including prescription drugs?” because it was not disputed that he had received advice from his physician that he should stop consuming alcohol. The court found that this misrepresentation was material because, had the insurer known that the insured had been instructed to abstain from alcohol, it “would not have offered the policy without first having [him] complete an additional questionnaire.”
In light of these “material misrepresentations,” the court concluded that the insurer was entitled to judgment as a matter of law for the rescission of the life insurance policy.
Other courts in New York recently have reached similar conclusions. For example, Southern District Judge Shira A. Scheindlin ruled that a homeowner’s policy should be rescinded after the house was destroyed in a fire. The homeowner had misrepresented in his application that he occupied the house, which induced the insurance company “to approve a policy it would not have otherwise issued.” Judge Scheindlin found that the misrepresentation was “material as a matter of law.”
The Appellate Division, Second Department, also decided that a homeowner’s policy should be rescinded where the insured failed to disclose that he did not reside in the home and where the insurer demonstrated that it would not have issued the policy because dwellings that were not owner occupied were an unacceptable risk under its underwriting guidelines. Similarly, the Third Department found that a homeowner’s policy was void ab initio where the homeowner had responded “no” on the application to the question whether he had “any animals or exotic pets,” but he owned a dog.
Of course, not every rescission request is approved. In one recent case, a clothing retailer submitted a commercial insurance application on or about April 1, 2008, and responded “none” to a question that required that it “[e]nter all claims or losses (regardless of fault and whether or not insured) or occurrences that may give rise to claims for the prior 5 years (3 years in KS & NY).” Several months later, after water entered the building and damaged the insured’s inventory, the insured submitted a property damage claim. The insurance company notified the insured that the policy was void, explaining that its investigation had revealed that there were three previous water damage losses or occurrences at the location on or about March 5, 2005, October 28, 2006, and July 15, 2007. The insurer contended that the insured’s claim of “none” in response to the application’s question of “all claims or losses (regardless of fault and whether or not insured) or occurrences that may give rise to claims,” despite the fact that there had been three prior water damage losses at the same premises, constituted a material misrepresentation on the insured’s part in its insurance application.
In rejecting the insurer’s argument that the policy was void, the court explained that, assuming that the insured was required to report the prior losses on the application and made a misrepresentation by claiming “none,” the insurer did not meet its burden of providing clear and uncontradicted evidence of the materiality of the misrepresentation. It noted that the insurer had indicated that its underwriting guidelines required that “any risk or premises which had sustained more than two prior losses or occurrences due to water damage was not eligible for coverage,” but that the application directed the insured to provide claims, losses, or occurrences for the prior three years. Thus, the court reasoned, if the insured had provided the prior water damage occurrences on the application, it would have only had to include two out of the three prior water damage occurrences because the third occurrence fell outside the relevant time period. The court was not persuaded that the insurer would not have issued the policy if the insured had disclosed the two prior occurrences.
Insurance companies can deny claims that they believe are fraudulent and can cancel policies (subject to certain regulatory requirements) that they believe should not have been issued. But the act of rescinding a policy, making it void from the beginning, is an extremely powerful weapon in the fight against fraud. Policyholders that make material misrepresentations in their applications can expect to see more and more rescission claims in the future.
 See, e.g., Pettinaro Enterprises, LLC v. Continental Cas. Co., 2011 U.S. App. Lexis 22614 (3d Cir. Nov. 9, 2011) (affirming decision voiding property insurance policy); Assurance Co. of Amer. v. Defoor Station, LLC, 2011 U.S. Dist. Lexis 131910 (N.D. Ga. Nov. 15, 2011) (material misrepresentations void builder’s risk insurance policy); and Dodd v. American Family Mut. Ins. Co., 956 N.E.2d 769 (Ind. Ct. App. 2011).
 Lin v. Metropolitan Life Ins. Co., 2011 U.S. App. Lexis 3483 (2d Cir. Feb. 22, 2011). See also Landmark Amer. Ins. Co. v. S&S Pub, 2011 U.S. Dist. Lexis 132659 (E.D.N.Y. Nov. 14, 2011) (presence of issues of fact preclude entry of summary judgment on issue of insurance’s right to rescind liquor liability policy).
 Dormer v. Northwestern Mut. Life Ins. Co., 2011 U.S. App. Lexis 2154 (2d Cir. Feb. 2, 2011).
 In certain instances, insurance companies may be required to stop accepting premiums and to return premiums they have received before they are able to rescind a policy. See discussion at Evan H. Krinick, “Should Premiums Be Returned When Policies Are Obtained by Fraud?,” NYLJ Sept. 2, 2011, at 5. See, also, American Gen. Life Ins. Co. v. Salamon, 2011 U.S. Dist. Lexis 27118 (E.D.N.Y. March 16, 2011) (insurance company waived right to rescind policy by accepting premium payments).
 Insurance carriers may not be permitted to rescind certain insurance policies ab initio. For example, Vehicle and Traffic Law § 313(1)(a) supplants an insurance carrier’s common law right to cancel an automobile insurance policy retroactively on the grounds of fraud or misrepresentation and mandates that cancellation may only be effected prospectively. See, e.g., Matter of Global Liberty Ins. Co. of N.Y. v. Pelaez, 84 A.D.3d 803 (2d Dep’t 2011).
 See, e.g., American Gen. Life Ins. Co. v. Bolden, 2011 U.S. Dist. Lexis 82527 (S.D.N.Y. July 27, 2011).
 A misrepresentation is a false “statement as to past or present fact, made to the insurer . . . at or before the making of the insurance contract as an inducement to the making thereof.” N.Y. Ins. Law § 3105(a).
 Varshavskaya v. Metropolitan Life Ins. Co., 68 A.D.3d 855 (2d Dep’t 2009)) (quoting Zilkha v. Mutual Life Ins. Co. of New York, 287 A.D.2d 713 (2d Dep’t 2001). See also N.Y.S. Ins. Law § 3105(b) (“No misrepresentation shall avoid any contract of insurance or defeat recovery thereunder unless such misrepresentation was material. No misrepresentation shall be deemed material unless knowledge by the insurer of the facts misrepresented would have led to a refusal by the insurer to make such a contract.”).
 See, e.g., Vermont Mut. Ins. Co. v. Moslem, 2011 U.S. Dist. Lexis 77374 (S.D.N.Y. July 14, 2011).
 2011 U.S. Dist. Lexis 82527 (S.D.N.Y. July 27, 2011).
 Vermont Mut. Ins. Co. v. Moslem, supra.
 Interboro Ins. Co. v. Fatmir, 2011 N.Y. Slip Op. 8565 (2d Dep’t Nov. 23, 2011).
 Security Mut. Ins. Co. v. Perkins, 86 A.D.3d 702 (3d Dep’t 2011). See also East 115th Street Realty Corp. v. Focus & Struga Building Developers LLC, 85 A.D.3d 511 (1st Dep’t 2011) (policy void ab initio where application falsely stated that no structural alterations to building would be done),
 Sportswear, Inc. v. Those Certain Underwriters at Lloyd’s of London, 32 Misc. 3d 1245A (Sup. Ct. N.Y. Co. 2011).
This article is reprinted with permission from the January 6, 2012 issue of the New York Law Journal. Copyright ALM Properties, Inc. Further duplication without permission is prohibited. All rights reserved.