Surprised insurers are unhappy insurers. And unhappy insurers are more likely to resist paying claims. As are insurers who fail to heed their good faith and other obligations to their policyholders.
So if you seek coverage for a loss arising from circumstances that your insurer complains—rightly or wrongly—it didn’t anticipate, expect your insurer to scour your policy application looking for “missing” or “misleading” information that it can use to deny coverage for the loss or even to rescind your entire policy.
More Complex Insurance Applications Mean More Application-Based Denials and Rescissions
Unfortunately for (honest) policyholders, the complexity of applications for many coverage lines has grown significantly. Cyber liability policies are a good example. In Travelers Property Cas. Co. v. Int’l Control Svcs, No. 22-cv-02145, 2022 WL 2532994 (C.D. Ill. 2022), an insured ultimately stipulated to rescission when its application had included detailed—and inaccurate—attestations that it used MFA, short for multifactor authentication, for administrative or privileged access when it only required MFA for some administrative access. The trouble is that growth in complexity increases the risk that unintentional errors or omissions will find their way into an insurance application, and with it the risk that an insurance company will seek to rescind the policy in order to avoid coverage for otherwise insured losses.
Common Traits and Distinctive Features of Rescission Law from State to State
Fortunately for (again, honest) policyholders, rescission may not be so easy a task for an insurer to accomplish. In most states, an insurer seeking to rescind a policy must prove that the policyholder misstated or omitted material information in the insurance application. Information is generally material if it could have influenced whether the insurer would offer coverage, the scope of the coverage it would offer, or the premium it would charge. The insurer must also prove that it relied on the incorrect information.
Many states go further and require the allegedly flawed application to be physically attached to, or otherwise incorporated into, the policy; if not, the application may not be admissible in a proceeding to rescind the policy. See, e.g., Wash. Rev. Code § 48.18.080(1); Alaska Stat. § 21.42.230. Still others require the insurer to refund all premiums paid as a condition to seeking rescission.
Then there are states require the insurer to prove that the policyholder acted with an intent to deceive, sometimes by clear and convincing evidence, a notoriously difficult standard to meet. Moreover, questions of intent often are not amenable to summary judgment. See, e.g., Naxos, LLC v. Am. Family Ins. Co., C18-1287JLR, 2020 WL 777260, at *18 (W.D. Wash. Feb. 18, 2020) (denying motion for summary judgment regarding policyholder’s intent when the parties provided “competing” testimony to support their positions).
The Ninth Circuit’s reversal of a district court’s finding of fraudulent misrepresentation reinforces the difficulty of proving that a policyholder acted with fraudulent intent. James River Ins. Co. v. Hebert Schenk, P.C., 523 F.3d 915 (9th Cir. 2008) (Arizona law). In that case, the insured law firm failed to disclose that a client had recently fired it for non-responsiveness in response to a question asking whether any lawyers in the firm were aware of circumstances “which may result in a claim.” The Ninth Circuit reasoned that the application asked the firm to make “a judgment call” as to whether they believed their former client would eventually file a claim against the firm, and an error in judgment was not tantamount to fraud.
Other states don’t require proof of intent to deceive. This is true in Virginia, and the Fourth Circuit’s decision in Medical Mutual Insurance Co. of N. Carolina v. Gnik, 93 F.4th 192 (4th Cir. 2024), serves as a compelling reminder of the significance of this fact in predicting the outcome of a rescission case. In Gnik, an insured medical clinic answered “no” when asked whether any of the clinic’s employees had ever been “subject of disciplinary investigative proceedings or a reprimand by a governmental or administrative agency, hospital, or professional association.” But the clinic was aware that state regulators had investigated whether a particular employee was practicing without a license (she was) but denied knowing any details. The investigation closed without a determination and the employee stayed on at the clinic until her arrest for fraudulent conduct at the clinic. The Fourth Circuit held that the clinic’s unequivocal “no” (as opposed to a qualified answer that the clinic believed the answer to be “no, to the best of its knowledge”) was false and that, standing alone, justified rescission.
Still, policyholders are not without other defenses to a rescission claim. Innocent insureds—those who played no role in completing the application—may be able to avoid rescission if the policy contains a severability provision that prevents one insured’s misconduct from affecting another insured’s right to coverage.
Also, doctrines of waiver and estoppel may bar rescission by an insurer who fails to promptly seek rescission upon learning of a misrepresentation, or takes actions inconsistent with an intent to rescind, such as by renewing a policy after it has begun an investigation into possible misrepresentations.
Finally, a policyholder’s failure to divine the meaning of an unclear question posed by an insurer may defeat a rescission claim. Thus, while an insurance application asked a policyholder to disclose “any uncorrected fire code violations,” the fact that five witnesses understood this question in five different ways, combined with the fact that the question was a sentence fragment that lacked a verb “which could have clarified the question,” doomed an insurer’s effort to seek rescission. See Starr Indem. & Liab. Co. v. Monte Carlo, LLC, 190 A.D.3d 441, 442, 139 N.Y.S.3d 57, 58–59 (N.Y. App. Div. 2021).
Policyholder Takeaways
What can policyholders take away from all this? The axiom that an ounce of protection is worth a pound of cure perhaps best captures the point. Gone are the days when someone without insurance industry experience can complete insurance applications unaided in a matter of hours. Instead, applications will frequently require the assistance of a sophisticated broker with experience in the insured’s industry and with the coverage line in question.
First, therefore, insureds should choose their brokers with care.
Second, insureds should likewise take care to involve subject matter experts in answering questions of a technical nature. An insured answering detailed technical questions in an application for cyber policies had best involve its IT personnel in answering them.
Third, insureds should never answer questions that they don’t understand. Instead, the question “What does this mean?” should be the policyholder’s perennial byword. Answers to these questions should be documented in writing. Don’t be surprised if you ask an insurer and are told, “Don’t worry about that question; it’s not important.” And if you hear that answer from an insurer, be sure to get it in writing.
Finally, if a policyholder can’t accurately answer a question because, for example, it seeks a binary (yes / no; always / never) response, the policyholder should attach an addendum that provides the context and information needed to make the answer accurate. This will help forestall any future claims that the insurer did not understand the risk that it agreed to insure.
Following these application guidelines will help prevent future surprises when you present a claim to your insurer. Because when it comes to knowing whether they have insurance coverage, policyholders hate surprises too.
This article is provided for informational purposes only—it does not constitute legal advice and does not create an attorney-client relationship between the firm and the reader. Readers should consult legal counsel before taking action relating to the subject matter of this article.
