When Agents or Applicants Lie to Insurers
March 2007
Some years ago my solution to a mid-life crisis
was to buy a custom-made replica of the Studebaker Avanti, a fiberglass sports
car powered by a 5-liter V-8. After I bought my dream car, I found it was almost
impossible to insure because the manufacturer only made 400 a year.
by Barry
Zalma
Barry Zalma Inc.
My insurer canceled me because it could not calculate an appropriate premium.
I went to my neighborhood direct writer who had no problem insuring the car.
He filled out a lengthy application form and handed it to me to sign. Much to
the agent's surprise, I actually read the application and found he had marked
the form showing "no cancellations." I had told him of the cancellation and
asked why he had put a false statement in the application.
"It's not important," he responded "you weren't canceled for cause."
The application only asked if I was canceled, so I insisted he correct the
application. The insurance was issued. Had I allowed the application to go through
as filled out, and then had a claim, I would have faced a situation where I
might have had no coverage. Of course, if I could prove that the agent of the
direct writer had the knowledge of the prior cancellation, I could have defeated
a claim of rescission, but with difficulty. If I did, the agent would have found
himself liable to the insurer for any claim it paid to me.
The Case for Rescission
In most states, a mutual mistake of material fact, a unilateral mistake of
material fact, a breach of a warranty, a material concealment, or a material
misrepresentation can all be grounds for rescission. When an insurer is deceived,
regardless of the intent of the deceiver, the remedy of rescission is available
to the insurer. Rescission is an equitable remedy that was created by ancient
ecclesiastical courts in England. When an insurance policy is rescinded, it
places the parties back in the position they were in before the contract date.
The insured gets the premium back, and the insurer gets back the policy as if
there was never a contract.
Insurers usually use the remedy with care. As one court put it after agreeing
that a rescission was proper:
- Our conclusion here should not result in an assumption by insurers that
policy liability can, with impunity, be avoided or delayed by assertion
of a claim for rescission. That is a tactic
which is fraught with peril. Where no valid ground for rescission
exists, the threat or attempt to seek such relief may itself constitute
a breach of the covenant of good faith and fair dealing which is implied
in the policy. (Emphasis added.)
Imperial Casualty & Indemnity Company v. Levon Sogomonian,
198 Cal. App. 3d 169 (1988).
A recent decision of the California Court of Appeal involved a commercial
building that was destroyed by an arson fire. The insurance policy provided
the insured with coverage for a commercial building in Los Angeles. During the
policy period, the building was destroyed by arson. The insurer discovered several
misrepresentations in the insured's application for insurance, obtained the
advice of counsel, and rescinded the policy. The insured sued.
The trial court granted summary judgment because the application made material
representations on which the insurer's underwriter relied in deciding to insure
the building, which included matters that should have been learned by his agent
and avoided. For example:
- The property was not owned by the named insured but by a family trust.
- The property was vacant.
- The property had been previously insured by the FAIR Plan, an insurer
of last resort, who had canceled the insurance.
- The property had been condemned by the city.
The trial court granted summary judgment in the insurer's favor, and the
court of appeal affirmed, finding that, as a matter of law on the undisputed
facts, the information sought by the underwriter and denied to it by the insured's
false answers and omissions was material to the insurer's decision to provide
insurance coverage. [James E. Mitchell, Individually
and as Trustee of the Mitchell Family Trust v. United National Insurance Company,
127 Cal. App. 4th 457, 25 Cal. Rptr. 3d 627 (2005).]
Avoid Even the Implication
To avoid litigation from the client of an insurance agent or broker when
the clients' policy is rescinded, the insurance agent or broker must, when obtaining
an application for insurance, explain to the proposed insured the importance
of truthful and accurate responses to the questions. The agent or broker should
never make subjective decisions on the importance of facts to a particular insurer.
The prudent agent or broker should ask the proposed insured about each and
every question on the application for insurance. None should be skipped even
if they seem to have no relevance to the particular insured.
The agent or broker should also insist that the insured read the application
and affirm that all of the answers are correct before it is signed. If the insured
refuses, or cannot read English, the agent or broker should read the application
to the insured. The application process should be noted in the log, and the
insured should be asked to sign the application.
Defense counsel, faced with grounds for rescission should always contact—if
an agent is involved—the agent to determine if his records or memory establish
that he knew (but did not disclose to the insurer) the facts that were misrepresented
or concealed. If the facts were known to the agent, the remedy of rescission
is not available to the insurer, and the claim should be paid. Claim must then
be made to the agent for the amount paid. Insurers must consider the agent to
be a source of indemnity for the costs of investigation and payment of claims
on a policy that should never have been issued.
Claims Best Practices
The agent who learns of a material fact that is not reported to the insurer
faces suit from either the insurer or the insured, or both. The prudent insurance
agent will always report to the insurer and its underwriter all facts he or
she learns from the potential insured. If the agent is not prudent, and hides
material information from the insurer he or she represents, the agent should
immediately give notice of a potential claim to his errors and omissions insurer.
The insurance adjuster, needing to complete a thorough investigation as required
by fair claims practices statutes, must make a habit of asking each insured
every question on the application for insurance. If there is a discrepancy between
the statements made by the insured at the time of the investigation and those
made by the application, the adjuster must not assume the investigation is complete.
The adjuster must:
- Go to the offices of the agent or broker and obtain a complete copy
of the file and ask the agent or broker if he knew of the true facts as
related by the insured.
- Collect the contract between the agent or broker and the insurer to
clarify their relationship.
- Submit the findings of the investigation to competent coverage counsel
for advice on whether the remedy of rescission or voidance is available
to the insurer.
© 2007 Barry Zalma, Esq., CFE
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