The term "rescission" can be generally described as the cancellation or abrogation of an agreement or contract, effective from its inception, returning the parties to the positions they would have occupied had the contract never been made.1 While all contracts may theoretically be subject to rescission, this article will be limited to the discussion of the rescission of insurance contracts. Rescission may be voluntary, such as in the case of the commutation of a reinsurance agreement between the parties, or it may be involuntary where, for example, initiated by an insurer following its determination that there was fraud, or a material misrepresentation or omission by the insured at the inception of the agreement.
As one writer has said, the rescission of an insurance policy is serious business.2 Rescission is indeed serious business since the rescission of an insurance policy during its term typically results in the denial of a claim and will, if successful, leave the former insured exposed not only to the financial impact of that claim, but perhaps others that might have occurred during the policy period. At the same time, the right to rescind an insurance policy is one of the most important weapons insurers hold to combat insurance fraud.3 The balancing of interests between the concern for harm to an insurance policyholder caused by the rescission of the contract and the right of an insurance company to void an insurance policy for fraud or misrepresentation has resulted in legislation and countless judicial decisions.
Although this article will focus on non-health care rescissions, it is health insurance rescissions which have received recent attention by the media, the courts and Congress. In an editorial published in The New York Times,4 the editors applauded recent changes to federal law, to wit, the Patient Protection and Affordable Care Act ("PPACA"), which, among many other things, imposes restrictions upon health insurance policy rescissions. That editorial stated, in part, that the new law5 requires health insurance companies "to end their most indefensible practice: rescinding coverage after a policyholder gets sick."6 The applicable provision of the PPACA provides, in pertinent part:
A group health plan and a health insurance issuer offering group or individual health insurance coverage shall not rescind such plan or coverage with respect to an enrollee once the enrollee is covered under such plan or coverage involved, except that this section shall not apply to a covered individual who has performed an act or practice which constitutes fraud or makes an intentional misrepresentation of material fact as prohibited by the terms of the plan or coverage....7 (Emphasis added).
This provision of the PPACA became effective for the first plan year of a plan beginning on or after September 23, 20108 and will, absent revision by a future Congress, govern health insurance policy rescissions in the future.
While there is nothing inherently evil about the rescission process, individual circumstances, particularly in the case of individuals facing large medical bills, have given rise to an effort to either severely restrict or perhaps eliminate rescissions of health insurance policies. It has been said more than once that bad facts make bad law. In a 2010 article describing the rescission process, rescission was characterized as "the insurance industry practice of revoking an insurance policy retroactively, after a policyholder has racked up hefty medical bills."9 The author referred to a case in which a husband and wife's health insurance policies were rescinded ostensibly for their failure to disclose a blood sugar issue in one case and a height variance in another and quoted the California based Advocacy Group Consumer Watchdog as having said that typically insurers "cancel [policyholders] when they're at their weakest and they're worst."10
While the ability to rescind a health insurance policy is unquestionably in a state of flux, the ability of insurers writing other types of coverage, such as property, casualty, and life insurance, to rescind policies remains generally subject to state statutory provisions and interpretative case law. As a general proposition, an insurer's ability to rescind, ab initio, an insurance policy for fraud or misrepresentation by the insured remains a viable tool to combat insurance fraud. While insurers are often hesitant to rescind coverage, the number and wide range of cases, both in state and federal court, across the country leave little doubt that rescission remains a valuable anti-fraud remedy, depending upon the circumstances of each individual case. That having been said, the specific circumstances and the extent to which rescission may be allowed by statute or case law vary dramatically.
For example, many states follow what is generally a three-pronged approach to rescission.11 In those states, to rescind an insurance policy there must generally have been:
- A misrepresentation, omission, concealment of facts or incorrect statement made to the insurer;
- Which was material to the acceptance of the risk; and
- The insurer would not have issued the policy in its current form if the true facts had been known.
Some states, such as Arizona, distinguish between actual and legal fraud where actual fraud is evidenced by a false statement with intent to deceive, while legal fraud is simply a material misstatement or omission of fact. Many states allow rescission so long as there has been a false statement made by the applicant or insured with the intent to deceive that is material to the risk being insured.12 Some states allow rescission only if the misrepresentation by the insured actually contributed to the contingency or event triggering policy coverage.13 Other states allow a misrepresentation to be grounds for rescission only if it deceived the company to its injury.14 In many cases, however, rescission may be accomplished if a concealed or misrepresented fact was material to the risk, irrespective of whether the misrepresentation related to the insured contingency at issue.15 In addressing the rescission of motor vehicle liability policies, several states either prohibit rescission following an accident in which an innocent third party was injured or limit rescission to coverages above those required by the state's financial responsibility laws.16 A review of the law and cases on rescission in Arizona is illustrative.
Arizona is fairly typical of those states which generally follow the three-prong approach described above. In Arizona, an insurance company's right to rescind a policy is governed by A.R.S. § 20-1109. Arizona courts interpreting this statute have determined that insurers must prove, by a preponderance of the evidence, that the insured's representation was fraudulent and material and that the insurer either would not have issued the policy, would not have issued the policy in as large an amount, or would have excluded the hazard giving rise to the disputed claim had the actual facts been known.17
1. Fraudulent representation/statement
Rescission of a policy can be based on either legal or actual fraud. Actual fraud requires intent to deceive, whereas legal fraud does not. Legal fraud occurs when an insured makes an incorrect statement of fact in an insurance policy.18 Put another way, legal fraud exists if the question asked in an insurance application is one where the facts are presumably within the personal knowledge of the insured, and are such that the insurer would naturally have contemplated that his answers represented the actual facts. If the representation is false, the insured is guilty of legal fraud, although as a matter of fact he may not have intended to deceive the insurer. However, where the question is of such a nature that it seeks merely the opinion of the insured, there must be actual intent to deceive on the part of the insured.19 Whether a question calls for a factual response or an opinion depends on the facts of each case and is generally an issue for the trier of fact to resolve.20 Where there is no intent to deceive the insurer, there can be no actual fraud "where the omitted information was not within the applicant's personal knowledge."21 Moreover, an insurer cannot rescind a policy "based on an insured's misrepresentations if the insurer has actual knowledge of the true facts."22 Nor can an insurer rescind a policy based on a misrepresentation when the insurer has sufficient facts to put a reasonable person on notice that further inquiry into the truthfulness of the representation is required.23
In addition to proving the insured made a misrepresentation amounting to legal or actual fraud, the insurer must also prove that the misrepresentation was material. Materiality exists "if the facts, truly stated, might have influenced a reasonable insurer in deciding whether to accept or reject the risk."24 The materiality of a misrepresentation can be proven through underwriting standards and practices addressing the risk or misrepresentation involved as well as the insurer's treatment of similar disclosures by the insured.25 For example, a doctor's failure to disclose a malpractice claim in an application to increase malpractice coverage limits may not be material if the insurer issued coverage after learning of an earlier potential claim.26
3. Insurer would not have issued the policy it issued
Finally, in order to rescind a policy in Arizona, the insurer must prove that it would not have issued the policy, would have issued a policy with lower limits of coverage, or would have issued a policy excluding the hazard that was the subject of the insured's misrepresentation had the true facts been disclosed by the insured. An insurer cannot, however, rescind a policy if it would have issued a rated policy, or a policy requiring higher premiums, had it known the true facts.27 If an insurer argues that it would have excluded coverage for a certain risk, that risk must be the one which actually caused the loss.28
Whether the insurer would not have issued the policy it issued can be demonstrated through evidence of the insurer's underwriting standards, practices and policies or actions taken after learning the true facts.29 For example, an insurer's continuation of coverage after learning that the insured misrepresented the extent of his use of a vehicle demonstrates that the insurer probably would have issued the policy had the true facts been disclosed, precluding rescission under A.R.S. § 20-1109.30 Similarly, if an insurer's underwriting standards do not require rejection of an application for a potential medical malpractice claim, the insured's failure to disclose a similar potential claim may not entitle the insurer to rescind an increase in limits.31 However, an insured's failure to disclose blood pressure readings that mandate rejection of coverage under the insurer's underwriting standards would justify rescission.32
Potential Defenses to Rescission
Estoppel is an equitable defense that bars recovery based on the insurer's own actions. In order to prevail on this defense, the insured must demonstrate that the insurer took action that induced the insured to believe in certain material facts, which inducement results in the insured justifiably taking action in reliance thereon, and which causes injury.33 Thus, an insurer that sends a letter to an insured directing the insured to cancel all other insurance coverage and explaining that failure to do so would void coverage under the policy at issue may estop the insurer from later attempting to rescind the policy.34
Waiver is "either an express, voluntary, intentional relinquishment of a known right or such conduct as warrants inference of such intentional relinquishment."35 The insured bears the burden of proving the insurer waived its right to rescind, which requires a "clear showing of intent to waive, with doubtful cases to be decided against waiver."36
An insurer seeking rescission of a contract "must act promptly under the existing circumstances in stating its intent to rescind."37 Thus, one who has knowledge of a fraud as grounds for rescission but continues to treat the contract as in effect is deemed to have waived the fraud, at least for purposes of rescission.38 Moreover, a person who can rescind a contract due to a misrepresentation loses such right if, after learning of the misrepresentation, he manifests an intention to continue the contract to the other party.39 In light of the foregoing, because an insurer may waive its right to rescind an insurance policy under A.R.S. § 20-1109,40 if an insurer learns that the insured made a misrepresentation in the insurance application that would permit rescission of the policy but fails to act promptly in notifying the insured of its intent to rescind and continues to treat the policy as in effect, the insurer may be found to have waived its right to rescission.41
Manner of alleging rescission
There does not appear to be a generally prescribed method by which an insurer can attempt to rescind an insurance policy or deny coverage due to an insured's alleged misrepresentation in an insurance application. Insurers may rescind a policy after investigating a claim and later file suit seeking a declaratory judgment that its rescission was proper.42 Alternatively, insurers can file a rescission counterclaim in response to an insured's lawsuit seeking benefits43 or initiate a lawsuit by filing a claim for rescission of the policy without first rescinding the policy.44 Insurers can also plead as a defense in the answer to a lawsuit seeking benefits that recovery is prohibited by the applicable statutory standards.45 Arizona courts have found that if the insurer was entitled to rescind an insurance policy due to the insured's misrepresentation in the insurance application, the insurer can prevail in a lawsuit by raising the defense without first rescinding the insurance policy.46
It is probably safe to say that rescission will, for the immediate future, remain an important tool with which insurers may address fraud. But as experience under the PPACA and several state and federal court decisions illustrate, policyholders, legislators, courts and consumer groups are very diligent and sensitive to the potential for abuse. It is critical that insurers use the rescission remedy judiciously in order to avoid regulatory or legislative backlash in response to allegations of post- claim underwriting that have been so problematic for the industry in the past.
1. Black's Law Dictionary (6th Ed. 1991).
2. Insurers: To Rescind or Not to Rescind by Akos Swierkiewicz, Expert Pages (date unknown), http://expertpages.com/news/insurers_rescission.htm.
3. The Power of Policy Rescission as a Tool To Combat Fraud, New York Law Journal (January 6, 2012).
4. End to Rescission, and More Good News, published May 2, 2010.
5. 42 U.S.C.A. § 300gg-12; Title XXVII PHSA, § 2712; See, also 26 CFR 54.9815-2712T, 29 CFR 2590.715-2712, and 45 CFR 147.128.
6. See note 4, supra.
7. See note 5, supra.
8. Specifically, this statute became effective for plan years beginning on or after the date that is six months after March 23, 2010.
9. Health Insurance Changes Come Too Late For Some by Julie Rovner (September 23, 2010).
11. See, e.g. Ala. Code § 27-14-7(a)(3); Ark. Code Ann. § 23-79-107(c);Ky. Rev. Stat. Ann. § 304.14-110(3); Idaho Code Ann. § 41-1811(c); N.Y.Ins. Law § 3105(b)(1); S.D. Codified Laws § 58-11-44(3).
12. See, e.g. Fla. Stat. Ann. § 627.409; Mass. Gen. Laws Ann. ch. 175, § 186; Wis. Stat. Ann. § 631.11; Va. Code Ann. § 38.2-3441; Tex. Ins. Code Ann. § 705.004; D.C. Code § 31-4314; Fla. Stat. Ann. § 627.409.
13. Kan. Stat. Ann. § 40-418.
14. Neb. Rev. Stat. § 44-358.
15. See, e.g. W. Va. Code § 33-6-7 (b) and (c) (1957); Ala. Code § 27-14-7 ; A.R.S. § 20-1109; Ark. Stat. Ann. § 66-3208; Cal. Ins. Code §§ 331, 359;D.C. Code Ann. § 35-414 ; Fla. Stat. Ann. §§ 627, 409; Ga. Code Ann. § 56-2409; 215 ILCS 5/154; Ky. Rev. Stat. § 304.14-110; Me. Rev. Stat. Ann. tit.24-A, § 2411; Md. Ins. Code Ann. § 374; Mass. Gen. Laws ch. 175, § 186;Mich. Stat. Ann. § 24.12218(1); N.C. Gen. Stat. § 58-30; Or. Rev. Stat. § 743.042; Pa. Stat. Ann. tit. 40, § 757; R.I. Gen. Law § 27-18-16; S.D.Codified Laws Ann. § 58-11-44 ; Tenn. Code Ann. § 56-7-103; 14B Tex. Ins.Code Ann. art 21.16 ; Utah Code Ann. § 31-19-80; Va. Code § 38.2-309.
16. See, e.g. A.R.S. §28-4009; Ala. Code § 27-23-1; Conn. Gen. Stat. § 38a-321; Me. Rev. Stat. Ann. tit. 29A, § 1606; Mass. Gen. Laws ch. 175, § 112.
17. Smith v. Republic National Life Ins. Co., 107 Ariz. 112, 115, 483 P.2d 527, 530 (1971); Medical Protective Co. v. Pang, 606 F.Supp.2d 1049,1057 fn. 1 (D. Ariz. 2008).
18. Centrust Mortgage Corp. v. PMI Mortgage Ins. Co., 166 Ariz. 50, 55,800 P.2d 37, 42 (App. 1990).
19. Valley Farms, Ltd. v. Transcontinental Ins. Co., 206 Ariz. 349, 353 ¶ 12, 78 P.3d 1070, 1074 (App. 2004) (internal citations omitted).
20. Pang, 606 F.Supp.2d at 1058.
21. Golden Rule Ins. Co. v. Montgomery, 435 F.Supp.2d 980, 992 (D. Ariz.2005).
22. Id. at 993 (citing Centrust Mortgage Corp., 166 Ariz. at 56, 800 P.2d at 43).
23. Centrust Mortgage Corp., 166 Ariz. at 56, 800 P.2d at 43.
24. Pang, 606 F.Supp.2d at 1058.
26. Id. Similarly, a misrepresentation that does not affect the risk or hazard being insured, such as a misrepresentation concerning the year of manufacture of a car, is not a material misrepresentation that would justify rescission of the policy. London Assurance v. Lufty, 184 F.2d 40,41-42 (9th Cir. 1950).
27. Greves v. Ohio State Life Ins. Co., 170 Ariz. 66, 73, 821 P.2d 757,763 (App. 1991) (finding that the language "would not have issued the policy" means that the insurer would not have issued any policy). The Court in Greves further found that the language of A.R.S. § 20-1109 means that if the insurer would have issued a policy with some changes, rescission is permitted only if the changes are those listed in the statute itself, i.e. excluding the hazard at issue or issuing a policy with lower limits. Id. at 73, 821 P.2d at 764.
28. State Compensation Fund v. Mar Pac Helicopter Corp., 156 Ariz.348, 353, 752 P.2d 1, 6 (App. 1988); Central National Life Ins. Co. v. Peterson, 23 Ariz.App. 4, 7, 529 P.2d 1213, 1216 (App. 1975).
29. Continental Casualty Co. v. Mulligan, 10 Ariz.App. 491, 495, 460 P.2d 27, 31 (App. 1969); Keplinger v. Mid-Century Ins. Co., 115 Ariz. 387,392, 565 P.2d 893, 898 (App. 1977).
30. Keplinger, 115 Ariz. at 392, 565 P.2d at 898.
31. Pang, 606 F.Supp.2d at 1059.
32. Mulligan, 10 Ariz.App. at 495, 460 P.2d at 31.
33. Darner Motor Sales, Inc. v. Universal Underwriters Ins. Co., 140 Ariz. 383, 394, 682 P.2d 388, 399 (1984); Montgomery, 435 F.Supp.2d at 993.
34. Montgomery, 435 F.Supp.2d at 994.
35. Centrust Mortgage, 166 Ariz. at 58, 800 P.2d at 45 (internal citations omitted).
36. Id. (Internal citations omitted).
37. Dewey v. Arnold, 159 Ariz. 65, 71, 764 P.2d 1124, 1130 (App.1988).
39. Id. (citing Mackey v. Philzona Petroleum Co., 93 Ariz. 87, 91, 378 P.2d 906, 908 (1963)).
40. Centrust Mortgage, 166 Ariz. at 58, 800 P.2d at 45.
41. The U.S. District Court for the District of Arizona, in Jobe v. International Ins. Co., 933 F.Supp. 844 (1995), determined that an insurer waived its right to rescind a policy for concealing its intent to rescind for a period of three years. However, the parties later settled the dispute and successfully moved the court to withdraw the decision and order.
42. Centrust Mortgage Co., 166 Ariz. at 54, 800 P.2d at 41; Prudential v. Estate of Rojo-Pacheco, 192 Ariz. 139, 142, 962 P.2d 213, 216 (App.1998).
43. Stewart v. Mutual of Omaha Ins. Co., 169 Ariz. 99, 102, 817 P.2d 44, 47 (App. 1991).
44. Pang, 606 F.Supp.2d at 1055; Montgomery, 435 F.Supp.2d at 983.
45. Valley Farms, 206 Ariz. at 352 ¶¶ 8-10, 78 P.3d at 1073. Arizona courts have also permitted an insurer to amend its answer to a complaint to add rescission as a defense if, after its answer is filed, it has discovered additional information that would allegedly allow rescission.Valley Farms, 206 Ariz. at 352 ¶¶ 8-10, 78 P.3d at 1073; Russell v. Royal Maccabees Life Ins. Co., 193 Ariz. 464, 466 ¶ 5, 974 P.2d 443, 445 (App.1999).
46. Mar Pac Helicopter Corp., 156 Ariz. at 354, 752 P.2d at 7 (setting aside workers' compensation award because the State Compensation Fund was entitled to rescind a workers' compensation policy due to the insured's misrepresentations in its application).