Insurers commonly discover misrepresentations during the course of a claims investigation. Often, these misrepresentations conflict with information provided by the policyholder in the policy application. In fact, the Insurance Research Council estimates that between 11 and 30 cents of every claim dollar is lost to “soft fraud,” meaning false statements or claim exaggeration by individual insureds. However, only one in four insurance companies further investigate misrepresentations on applications. The scope of this article focuses on false statements made to obtain insurance, as opposed to those made post-loss. While both types of misrepresentations co-exist in many investigations, the coverage ramifications can be very different.
The authority to void a policy for fraud in the application can arise from the common law or the terms of the policy itself. Policies obtained through fraud, broadly speaking, create no rights or duties under the law. Therefore, much like annulling a marriage, certain misrepresentations can void a policy ab initio, or from the inception. Many policies contain provisions which void the policy if obtained by fraud, concealment, or misrepresentations by the insured. These provisions largely have been upheld and enforced by courts when an insured knowingly makes a fraudulent misrepresentation that is material to the carrier’s initial assessment of the risk. Below is a discussion of the identification of the “knowing,” “materiality” and “intent” elements of this analysis, along with a general discussion of statutory regulation of policy voidance.
Materiality
Before issuing a policy, a carrier must examine the level of risk involved and the appropriate type of coverage for that particular risk. As a general matter, what seems to be solely an underwriting function becomes germane to claims handling when a misrepresentation occurs. Misrepresentation that interferes with the carrier’s right to accurately assess or reject the risk, or to charge a greater premium, is material. In essence, any fact that may have caused the carrier to assume a different position, had that fact been known, can be material.
There is no shortage of case law on the test to determine materiality. The issue is a recurring one in the world of claims adjusting. When trying to determine whether a misrepresentation is material, analyze the information needed by the carrier to accept the risk. For example, if a homeowner’s application states that a house is 1,200 square feet and twenty years old, a carrier may assess the risk and amount of premiums on this basis. From an underwriting standpoint, if the house is actually 3,000 square feet and one hundred years old, the carrier may offer a different level of coverage or even reject the risk. Therefore, a misrepresentation at this level could be material to the decision to issue the policy. Moreover, in the same context, if the risk is alleged to be an owner-occupied, primary personal residence, but instead is rented to a commercial tenant who runs a busy, under-the-table, day care, the materiality of the misrepresentation is evident. However, it may be apparent only after a loss when an adjuster visits the property and then reviews the policy application.
Courts define materiality because the terms of the policies rarely do. Therefore, the particulars of what a carrier must demonstrate to establish materiality varies by jurisdiction. In some states, for example, a carrier must show that they would not have issued the policy or would have rejected the application had they known the true facts. In other jurisdictions, if a company is misled into issuing a policy, they do not have to show that they would have modified the terms of the coverage. In either situation, the inquiry remains very fact-specific, though straightforward.
Knowing
A key requirement in proving fraud in the application is that the false statement be made willfully. There must be evidence that the insured intended to conceal the truth. This element of proof prevents the severe sanction of voiding a policy when an insured makes an inadvertent misrepresentation. Some jurisdictions even require that knowledge of the falsity be proven by clear and convincing evidence, a higher burden of proof than most civil actions where the burden is the preponderance of evidence.
In the easiest case scenario, knowledge or willful misrepresentation can be demonstrated when an insured admits in an Examination under Oath or deposition that a prior statement was false. As this situation does not always present itself, other collateral evidence may be necessary to establish knowledge of the falsity. Regarding an application, it certainly is helpful when the insured who made the misrepresentation signed a copy of the application. However, agents often fill out applications which are later signed by the insured, and some jurisdictions will not hold an insured conclusively responsible for an agent’s misrepresentation. Therefore, it is critical to obtain the original file from the agent to ascertain if the insured: (1) provided the incorrect information; and, (2) was aware that it was on the application.
In more complex scenarios, applications to different insurers with conflicting information, or information submitted to a government agency which conflicts with application information, can lay the foundation for a carrier’s lawyer to later analyze the element of knowledge. In short, once a misrepresentation is identified, a thorough investigation by the claims adjuster—such as obtaining tax filings, rental permits, prior insurance applications, and housing inspections made prior to purchase or mortgage refinancing—can be very useful to distinguish between an honest mistake and willful misrepresentation.
Intent
Although knowledge and intent appear related, they represent very different elements of your case. Knowledge goes to whether the insured knew he was making a misrepresentation, while intent goes to why it was done. Most concealment provisions void a policy regardless of motive. However, courts are split as to whether a carrier must prove that the insured intended to deceive the carrier. The majority of jurisdictions hold that when a fraudulent representation was knowingly made as to a material matter, the intent to defraud the insurer will be presumed. In short, the motive is irrelevant. Although it did not involve false statements made in an application, the case of Pacific Indemnity Company v. Golden, 985 F.2d 51, (2d Cir. 1993), illustrates this principle nicely. During the investigation of an insured’s house fire, large amounts of gasoline were found stored in garbage cans in his garage. The insured claimed he stored the gasoline for powering snowmobiles. Later, in his Examination under Oath, the insured admitted lying about the gasoline previously, which he really stored for the purpose of poisoning his neighbor’s lawn. The insured argued that although he intended to lie to the carrier, he did not intend to defraud the carrier. Rather, he lied because he was embarrassed about poisoning his neighbor’s lawn. In the declaratory judgment action, the court reasoned that his motive for lying was irrelevant under Connecticut law if the falsehood was willingly made.
Perhaps because the repercussions of voiding a policy are so severe, the minority position mirrors the classic elements of fraud in the criminal context, requiring proof that the misrepresentation was made with the intent to defraud the insurer. Even in jurisdictions which allow the presumption of intent to operate, often a carrier must first prove that the insured’s statements were false by clear and convincing evidence. Other jurisdictions use a preponderance of the evidence standard.
Statutory Considerations
Most states regulate a carrier’s ability to void personal lines of coverage, such as automobile and homeowners’ insurance, for fraudulent misrepresentations. The most common example is automobile policies, which some states only permit a carrier to void during a proscribed window of time after the policy is issued. Some states also preclude fraud actions based upon the application if the carrier fails to append the application to the policy as issued. Moreover, in many jurisdictions, paid premium dollars must be returned to the insured when a policy is voided.
In sum, evidence of false statements prior to a loss may be relevant to a post-loss coverage determination. Due to the nature of misrepresentations in the application, insurers often do not become aware of the full extent of the risk insured until after a loss has occurred. Yet false statements, knowingly made, that induce a carrier to issue coverage at a lower premium rate—or to accept rather than reject coverage—have the potential to vitiate coverage in the same manner as a fraudulent claim.
Robert Horst, a founding partner of Nelson Levine deLuca & Horst, LLC, specializes in the representation of his insurer clients in fraud litigation, complex coverage disputes, class actions and bad faith litigation. Melanie Bork, an associate in the coverage department of Nelson Levine deLuca & Horst, LLC, specializes in complex coverage, indemnity and bad faith litigation.