Written by Gary Reinhardt, Esq.
Editors Note: This article first appeared in the Winter 2019 Edition of SIU Today
Rate evasion refers to when an individual materially misrepresents information on an insurance application. The applicant evades a higher premium, or obtains insurance she may not be eligible for, by submitting or omitting material information on the insurance application.
Rate Evasion can lead to an insurer voiding the policy ab initio, or from inception. Many in the industry also refer to this as “rescission.” When an insurer voids/rescinds a policy, it does so on the basis of fraud in the inducement, essentially claiming that the insurer would never have contracted with the applicant had the applicant told the truth. The remedy is to put each party back to where they were prior to the contract. The insurer refunds the premium paid and treats the policy as if it never existed.
Voiding/rescinding the policy differs from a claim denial. An insurer can void a policy, often resulting in non-coverage for a valid claim one that would ordinarily be covered by the terms and conditions of the policy. Voiding also allows the insurer to escape liability from any prior non-disclosed claims and from any claim that might arise subsequently.
Denying coverage impacts only the particular claim at issue. The policy remains in force and subject to providing coverage for any prior claims and any that may arise. This is important because carriers may intend to cancel a policy rather than voiding a policy. This keeps the carrier exposed while it completes the statutory cancellation procedures and timeframes.
Rate evasion indicators, or “Red flags,” signal the need to go beyond a loss investigation and undertake review of the application. Most investigators have their own indicators based on years of experience. Some of the more obvious include undisclosed drivers (and even passengers) that are residents of the household, multiple losses out of state, and medical care and car repair done out of the state of residence. Fraudulent activity in the rest of the claim may also lead to finding misrepresentations in the application.
An often-overlooked indicator of rate evasion is the applicant’s failure to disclose a prior carrier, or claiming current coverage to be a first policy. Homeowners, unless in their first home, have had coverage before. Likewise, drivers usually have previous coverage. Omitting prior coverage is often an attempt to hide a previous claim or cancellation, often important underwriting factors.
To prove rate evasion, first the investigator must have an application. That once was a simple process for the investigator to obtain a copy of a paper Accord form or something similar and then interviewing the agent about the interview process that resulted in the issuance of a policy. Now phone sales and online binding of policies render this task difficult. Proving that the insured was the person giving the information over the phone or on a website seems like a daunting task.
The Uniform Electronic Transactions Act (UETA) helps here. The UETA defines “electronic signature” as “an electronic sound, symbol, or process attached to or logically associated with a record and executed or adopted by a person with the intent to sign the record.”[1] An electronic record or electronic signature is attributable to a person as if it was the act of the person. The act of the person may be shown in any manner, including a showing of the efficacy of any security procedure applied to determine the person to which the electronic record or electronic signature was attributable.[2] This allows an insurer to use IP addresses, passwords or anything else to prove that the person “signed” the application and provided the information necessary for policy issuance. Proof of acceptance of the policy and the premium set can also be evidence to show a possible application misrepresentation, that the applicant provided the information and “signed” the application.
After obtaining the application, a clear misrepresentation needs to be identified. A misrepresentation could be either an affirmative false statement or the failure to disclose complete information. While a “misrepresentation” seems easy to find, an applicant is required to disclose only what is asked on the application. It is incumbent upon the insurer to ask clear, unambiguous questions that solicit the information needed to assess the risk. If an application question could have more than one reasonable meaning or understanding, that question, and the applicant’s answer, will be construed against the insurer.
Insuring corporate entities, such as S-Corps or LLCs set up by individuals to operate small businesses, have created problems for carriers because of the nature of the application questions. The “applicant” on most applications will be the corporate entity. As corporations are separate legal entities, all questions about the applicant apply only to that LLC or S-Corp, not the actual individual completing the application. Therefore, questions such as “Has any applicant been convicted of any degree of the crime of fraud, arson . . .” means, “has the LLC/CORPORATION been convicted of . . .” not the member or CEO of that corporate entity. Even if the corporation has just one member and that one member has an insurance fraud conviction, if he answers “no” to a question like this, he is answering as the corporation and has not misrepresented the answer. [3]
Carriers must revise commercial business applications. Questions can easily be tweaked. For instance, instead of asking “Has the applicant . . .,” a simple change of the question to read “Has the applicant or any officer, director, member or shareholder . . .” would obtain the information actually sought, better educating underwriting for risk assessment.
After identifying the misrepresentation, the investigator must determine if the applicant intended to mislead. Most states require that the applicant intentionally provide or omit information in order to void the policy.[4] Even in states that allow an insurer to void a policy for wrong, as opposed to false, information, application language can save the applicant. Above the signing block, most insurance applications contain a disclaimer asking that the applicant, by signing (or assenting to coverage for phone/on-line coverage), gave the insurer information “to the best of his knowledge and belief.” This language allows the applicant to retain coverage, even if he provided wrong information innocently, because all the application requires is his intent to tell the truth “to the best of his knowledge.” This will force the investigator, even if he can prove that the application contains misinformation, to prove that the applicant gave false information purposely.
Determining a misrepresentation involves many steps, including an Examination Under Oath. Besides that formal policy condition, the investigator can use “old-fashioned” methods of canvassing neighborhoods and reviewing court documents. The applicant’s social media often gives away the person’s true location, condition and a lot of information the person probably does not want the insurer to know. Database searches could find undisclosed bankruptcies or even criminal convictions that an underwriter would find important in setting premium or determining the acceptance of the applicant.
Even in this digital age, the insurance agent is the most important witness to the misrepresentation. If the applicant obtained the policy through an agent, the applicant will certainly blame the agent for the misinformation on the application, either claiming that the agent never asked the question or recorded the information incorrectly. It is imperative that the investigator interview the actual agency employee that took down the information. The agent should obtain this information from the applicant but many times the agent delegates this task to an unlicensed assistant. Regardless, the agent needs to disclose all policies the agency has with the insured, any potential personal relationship with the insured and the process the agency uses to get information for the application.
When no agent is in the picture, things get a little tougher. If the insured purchased insurance via phone call, the investigator will need a recording of the call. She will also need to know the procedures used for recording the call and how that information is retained to help with verification of the call. Finding the actual sales representative on the call would be ideal. If that can be done, then the investigator can attempt the same interview with this sales representative as with a traditional agent.
For an online, no agent, no human being involved policy, the investigator will need to find an electronic version of what the insured completed. The investigator will have to learn how the information is transmitted to underwriting and how the process produced approval of the policy and the setting of premium. To use the application to prove misrepresentation, verification procedures that square with the UETA will be necessary.
For the last step, the carrier must determine if the misrepresentation mattered. This test for materiality asks if the misrepresentation would reasonably influence the company’s decision to issue the policy or charge a higher premium.[5] Many states establish their test of materiality through case law while others, such as New York and Georgia, have statutes stating what constitutes the materiality of an application misrepresentation.[6]
Materiality has both subjective and objective tests. The subjective tests allow for different carriers to assert different underwriting criteria, criteria that allows minimum limits insurers to have one set of underwriting standards while carriers writing higher limits can have more stringent tests for policy acceptance. The objective test is simply that the carrier must have a reasonable basis to assert their underwriting criteria.
Underwriting controls the materiality. There are no per se material misrepresentations, so every investigation will require an underwriting opinion. Underwriting must re-analyze the application, this time with the truth completely disclosed. If after considering the truthful information, underwriting concludes that the carrier would not issue the policy or issue the policy at a higher premium[7], then the misrepresentation is material and the policy subject to recission.
The impact of voiding a policy on the existing claim varies from state to state. Universally, if a first-party claim is at issue, the insured cannot recover. However, in most states, a liability claimant still will receive the benefit of coverage under a third-party beneficiary theory.[8] The carrier gains subrogation rights against its insured, for whatever that is worth. In some states, the entire policy is wiped out and even third-party liability claimants cannot recover. In these states, the misrepresentation does not have to relate to the actual loss.[9]
When carriers assert their right to rescind/void a policy, a familiar refrain from insureds that commit rate evasion, and their lawyers, concerns waiver. An insurer will hear a complaint like this: “Insurer, you did not have a problem accepting our money when we applied for the insurance. You only looked into the application questions when it came time for you to pay money. How come you did not investigate at the time of the application?” This is some sort of attempted waiver argument.
Insureds that make that argument are complaining that the insurer took too long to catch the applicant lying. In other words, these people are complaining that the carrier believed them when they agreed to give information to the “best of his/her knowledge and belief.” While common, this argument is not successful.[10]
Waiver can be a problem if claims and underwriting are not on the same page about the voiding of a policy. For instance, if claims intends to rescind a policy but at the same time, underwriting renews the policy based on the same application information being investigated, courts may perceive that as a waiver of the application misrepresentation.[11] Also, failing to return the premium after rescinding a policy is “inconsistent” with the intent to void the policy.[12] Not taking prompt action when learning of a material application misrepresentation can also lead to a waiver of the right to rescind a policy.[13]
Finally, a disclosed lienholder, as always, gets preferential treatment. Once an insurer refunds the premium, it would seem that there would be no consideration for a contract supporting a lienholder claim against the policy. However, courts protect a lienholder regardless of the lack of a premium.[14]
Voiding a policy (rescinding) has great power. Courts have upheld policy voiding for undisclosed teenagers, medical conditions, lying about residency and many other issues. Courts have allowed voiding in just about all lines of insurance from auto to life. It rids the carrier of a dishonest insured and potentially avoids unreported claims. Investigating the application should be part of every SIU investigation.
[1] Va. Code Ann. §59.1-480. References to the Code of Virginia are used as examples. 47 states, the District of Columbia, Puerto Rico and the US Virgin Islands have adopted the UETA. Some states amended the Act so it is important that you refer to your specific state law. New York, Illinois and Washington have not adopted the UETA but each have laws recognizing the validity of electronic signatures.
[2] Va. Code Ann. §59.1-487.
[3] See, for instance, Jeb Stuart Auction Services, LLC v. West American Insurance Company, 122 F.Supp.3d 479 (W.D. Va. 2015).
[4] “For a material misrepresentation to render a contract voidable under Connecticut law, the misrepresenting party must know that he is making a false statement. ‘Innocent’ misrepresentations — those made because of ignorance, mistake, or negligence are not sufficient grounds for rescission.” Pinette v. Assurance Co. of Am., 52 F.3d 407 (4th Cir. 1995). See also Royal Maccabees Life Ins. Co. v. Montgomery, 716 So. 2d 921, 925 (La. 1998).
[5] USF&G v. Haywood, 211 Va. 394, 177 S.E.2d. 530 (1970).
[6] New York Ins. Law §3105; OCGA §33-24-7.
[7] How much higher of a premium? No state seems to provide a definitive percentage or dollar figure. Some carriers use 20% as a rule of thumb.
[8] Progressive N. Ins. Co. v. Corder, 15 S.W.3d 381 (KY 2000), Van Horn v. Atlantic Mut. Ins. Co., 334 Md. 669 (1994).
[9] Hopkins v. Life Ins. Co. of Ga., 218 Ga. App. 591, 593 (1995), Heinzelman v. State Farm Mut. Auto. Ins. Co., 41 Va. Cir. 505 (Fairfax County, 1997).
[10] Utica Mut. Ins. Co. v. National Indem. Co., 201 Va. 769, 173 S.E.2d 855 (1970), finding that an insured’s failure to disclose his epilepsy condition resulted in voiding the policy. No waiver existed as the application completed by the insured did not provide any reason to suspect the insured lied.
[11] Virginia Mut. Ins. Co. v. State Farm Mut. Auto. Ins. Co., 204 Va. 783, 133 S.E.2d 277 (1963).
[12] Fla. Int. Indem. v. Osgood, 233 Ga.App. 111 (1998).
[13] Foremost Guar. Corp. v. Meritor Savings Bank, 910 F.2d 118 (4th Cir. 1990).
[14] Reeves v. Granite State Ins. Co., 1999 Tenn. App. LEXIS 624, (Tenn. Ct. App. Sept. 17, 1999).