Recent court decisions across a variety of industries highlight the importance of submitting complete and accurate insurance applications and renewals. When submitting an application for insurance, the applicant should accurately and completely answer all application 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 applicable policy, policy applications, and the 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 because the insurance company may create the impression that the organization misled or misrepresented key details 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 presents a worrying trend that should be closely monitored, coupled with a thorough review of policy applications to mitigate the potential of rescission.
Five Best Practices to Minimize Rescission Risk
- Carefully review the reported values and conditions of assets 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 are consistent and accurate.
- Assess and review the scope of the organization’s operations during policy renewal to disclose all relevant business activities and avoid inadvertent omission of related business operations and new business operations to avoid an insurer contention that the organization misrepresented the scope of its operations in its renewal application.
- Disclose prior related incidents or losses to ensure that an insurer cannot use an earlier claim or loss to rescind the policy.
- 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 alleged misrepresentation was accidental and not intentional.
- Be aware of differing legal standards for disclosure of material information in insurance applications. An applicant should always answer questions fully and accurately and provide all requested supporting documents. In certain circumstances, however, such as the marine market and some foreign markets, the applicant may have an affirmative duty to disclose all material information, regardless of whether the underwriter requested the information. An insured must know whether a heightened duty to disclose applies under the governing law.
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 precludes 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 presents an interesting test case: The policyholder’s position that rescission is inappropriate because the insurance company ratified the contract is legally sound, but the insurance company’s argument that the omission of two potentially related prior incidents from the application highlights the risks of incomplete disclosures in insurance applications. The Third Circuit held oral argument on December 6, 2016, and took the matter under advisement.
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 non-FDA approved weight loss treatment, the court found that the doctor recommended non‑traditional 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 non-traditional 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 non‑traditional 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.