Recent court decisions across a variety of industries highlight the importance of submitting accurate and complete insurance applications and renewals. When submitting an insurance application, the applicant should accurately and completely answer all questions and fulfill all document and data requests. Oversights, misstatements and missing documents can lead to rescission of the insurance policy and leave the organization or individual without any coverage for a claim.
When faced with a claim or potential claim, insurance companies can and will review both the policy, application (including supporting documents), and underwriting files to determine potential defenses to coverage. After a claim arises, an insurer that discovers a discrepancy in the application, renewal or underwriting file will likely attempt to rescind the policy and deny coverage for the claim, potentially unraveling the organization’s risk management planning and creating substantial, unexpected liabilities.
Under the wrong circumstances, insurance company rescission arguments can persuade a judge or jury by creating the impression that the organization misled or misrepresented critical information to obtain lower premiums. The insurer’s ability to frame a coverage dispute as a referendum on the policyholder’s honesty, rather than a simple contract dispute, can profoundly impact the course of the litigation. Some courts’ apparent willingness to more liberally permit rescission emphasizes the importance of a thorough review of policy applications to mitigate the potential of rescission.
Five Best Practices to Minimize Rescission Risk
- Carefully review the values and conditions of assets reported in other company documents, especially publicly reported documents (because these documents are often incorporated by definition into the application), and ensure that the values and conditions reported on insurance applications conform to these other reported values and conditions. The key to implementing this best practice is information sharing and collaboration within your organization. Most organizations regularly review the values and conditions of their holdings; incorporating updated information into the insurance bidding or renewal process requires collaboration with others in your organization. Information-sharing and collaboration can be time and resource intensive, but is essential to minimizing the risk of rescission.
- Assess the scope of your organization’s operations to ensure disclosure of all relevant business operations, including related and new business operations. Proper disclosure avoids an insurer contention that your organization misrepresented the scope of its operations in its application. Again, the key here is information sharing and collaboration. Applications should properly report all relevant business operations; pay careful attention to the scope of information sought in the application.
- Track prior incidents, claims and losses to ensure disclosure if required by the application. Address the scope of coverage for any future claims or losses that are arguably related to prior events when obtaining new or renewal coverage. Insurers are eager to point to earlier unreported incidents, claims and losses to rescind their policy; disclosure avoids this rescission tactic. Accurately tracking and maintaining records of past incidents and losses (whether or not insured) as well as claims is essential to effective risk management. Insurers routinely track detailed claims histories to improve their risk assessments. Many policyholders similarly utilize internal claims tracking to develop a clear understanding of past risks and losses and their potential impact on future losses and claims. With tracking systems in place, tracking and reporting prior incidents, claims and losses becomes significantly easier because the information is readily available.
- Do not rely on good intentions as a defense to rescission. Under some state laws, courts may uphold rescission based on the insured’s material misrepresentation even if the misrepresentation was accidental and not intentional. In these states, a negligent misrepresentation can be the basis for rescission. Ambiguity in the application questions or policy terms strengthens the viability of this insurer defense. Carefully review the disclosure requirements in the insurance application as well as any policy terms related to the application. Seek to limit the scope of information provided in a response to an application question by setting forth the parameters of the responsive information (e.g., date ranges, claim value thresholds). Do not rely on good intentions; carefully poll appropriate individuals in the organization to obtain all required information and to avoid an inadvertent omission or error that can lead to rescission.
- Be aware of differing legal standards for disclosure of material information in insurance applications. An applicant should always answer questions accurately and completely, including providing all requested supporting documents. In certain lines of insurance and in certain jurisdictions, accurate and complete answers do not suffice, however. In the marine market and some foreign markets, the applicant may have an affirmative duty to disclose all material information, whether or not requested. An insured must know whether a heightened duty to disclose applies under the governing law. Consult with your organization’s legal department on the applicable legal standard. This analysis can be complex because the law related to disclosure standards on insurance applications is not consistent from jurisdiction to jurisdiction. Incorporating a choice-of-law provision into the policy can reduce the complexity of the analysis. Even with a choice-of-law provision, however, some exceptions may apply. For example, with marine policies, admiralty law imposes a higher standard of disclosure regardless of the local jurisdiction.
Recent Cases Underscore the Need for Accurate Applications and Disclosures
Failure to Report Prior Losses Leads to Rescission of Policy
Just this month, the Third Circuit Court of Appeals affirmed a lower court decision rescinding a product contamination insurance policy based on four material misrepresentations in the policyholder’s application upon which the insurer relied. In H.J. Heinz Co. v. Starr Surplus Lines Insurance Co., following an advisory jury’s determination that the policyholder failed to disclose at least two prior incidents involving contamination of baby food, the federal judge upheld rescission even though the insurance company purportedly ratified the policy by invoking the policy’s choice of law provision. On appeal, the policyholder argued that the insurance company’s attempt to enforce the choice of law provision in the policy ratified the policy and precluded rescission. The policyholder also argued that the insurance company knew of the prior product contamination issues through news reports in the insurance company’s file. The appellate court rejected both of these arguments and in strong language criticized the insured for failure to disclose prior losses: “For the ten-year period identified in the Application, Heinz disclosed only one loss in excess of a $5 million SIR. In reality, however, Heinz experienced three losses exceeding a $5 million SIR, totaling more than $20 million, a figure far exceeding the single $5.8 million disclosed loss. Heinz’s misrepresentations were of such magnitude that they deprived Starr of ‘its freedom of choice in determining whether to accept or reject the risk upon full disclosure of all the facts which might reasonably affect that choice.” The appellate court also found that the evidence established the insurer’s reliance on these misrepresentations: “Starr underwriters testified that they looked to Heinz’s loss history in calculating the appropriate risk and conducting their loss ratio analysis.”
This appeal illustrates the strength of a rescission defense based on omitted information. The policyholder contended that the insurance company’s ratification of the policy precluded rescission, but the court instead relied on the policyholder’s omission of two potentially related prior incidents from the application.
Failure to Disclose Additional Business Activities Leads to Rescission of Policy
The Seventh Circuit Court of Appeals recently upheld the rescission of an insurance policy sold to a doctor and a related MRI center because both made material misrepresentations in their insurance policy applications. In Essex Insurance Co. v. Galilee Medical Center S.C., the court, applying Illinois law, upheld rescission because the applications stated that the doctor and the MRI center did not perform non traditional weight loss procedures or treatments, but a post-claim investigation indicated otherwise.
After a patient sued the doctor and the MRI center for complications from a loss treatment not approved by the U.S. Food and Drug Administration, the court found that the doctor recommended nontraditional weight loss procedures and treatments to a client while at the MRI center and then completed those treatments at a different location. The court rejected the MRI center’s argument that the doctor performed the nontraditional weight loss procedure at another location and that the doctor’s actions at the MRI center were limited to making a referral to himself for the nontraditional weight loss procedure.
Incorrect Reporting of Property Condition Leads to Rescission of Policy
The Second Circuit Court of Appeals affirmed a lower court’s decision to rescind two insurance policies for misrepresentations regarding the condition of a dry dock that sank after the policyholder attempted to repair the structure. In Fireman’s Fund Insurance Co. v. Great American Insurance Co., two insurance companies, an excess property insurer and a marine pollution insurer, sought rescission of their respective insurance contracts because the policyholder’s insurance application and renewals valued a dry dock owned and operated by the policyholder at several million dollars, when internal documents show that, due to deterioration and lack of repairs by a prior owner, the dry dock had no monetary value.
Applying admiralty law, which requires a heightened duty of “utmost good faith” of disclosure on the part of the applicant, the court rescinded the marine policy because the policyholder, over a period of multiple years, reported that the value of the dry dock as if it were in good condition when it was in need of repairs. The court upheld rescission despite the policyholder’s argument that it provided all the information requested on the insurance application and the underwriter did not request surveys or additional information about the condition of the dry dock. This holding highlights the need to ascertain when a heightened duty to disclose applies for certain types of policies.
Similarly, applying Mississippi law, the court upheld rescission of the excess property policy because the applicant reported the value of the dry dock as if it were in good condition and reported the likelihood of a maximum probable loss — the dry dock sinking — as an “extremely low probability.” The court rejected the applicant’s arguments that it did not complete an application, but rather provided a property insurance submission of its own creation, and that the insurer did not request additional information about the condition of the dry dock in light of the “material misrepresentation” of the condition of the dry dock in the insurance submission. The court rescinded the policy even though the insurer did not intend to deceive the insurer. The court did not require intent or a reckless disregard of the facts often required for a misrepresentation defense.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
Republished with permission. This article first appeared in Law360 on February 14, 2017.