Misrepresentations and Concealments in the Application for Insurance: An Analysis of the Insurer's Right to Rescind Coverage


This article focuses on the insurer's right of rescission based upon fraud, i.e., misrepresentations or concealments in the application for insurance.

BACKGROUND

Most property policies provide the insurer with the right to rescind a policy or to deny a claim to an insured who intentionally conceals or misrepresents material facts concerning the insurance. It is important to distinguish between a misrepresentation made by an insured before a loss, i.e., in the application for insurance, versus a misrepresentation made afterwards, i.e., in the presentment of claim.

Misrepresentations or concealments of material facts made by an insured prior to a loss will typically provide the insurer with a right to rescind the policy. Whereas, those made after a loss will typically provide the insurer with a right to deny coverage for the submitted claim.

The applicable policy provision respecting the insurer's right typically provides as follows:

Concealment or Fraud. The entire policy will be void if, whether before or after a loss, an "insured" has:
  • Intentionally concealed or misrepresented any material fact or circumstance;
  • Engaged in fraudulent conduct; or
  • Made false statements; relating to this insurance.

COMMON LAW APPROACH

Under Illinois law, an insurance policy may be revoked for the same reason as any other written contract, i.e., when clear and convincing evidence compels a conclusion that an instrument, as it stands, does not properly reflect the true intention of the parties, and there has been either a mutual mistake or mistake by one party and fraud by the other. Board of Trustees of University of Illinois v. Insurance Corp. of Ireland, 969 F.2d 329 (1992).

Under the common law, an equitable claim for rescission on the basis of fraud voids the policy ab initio, i.e., at its inception, and may be asserted by establishing:

  1. a representation in the form of a statement of material fact, made for the purpose of inducing the other party to act;
  2. that the statement is false and known by the party making it to be false, or not actually believed by him to be true; and
  3. the party to whom it is made is ignorant of its falsity, must reasonably believe it to be true, must act thereon to his damage, and in so acting must rely upon the truth of the statements.

Chapman v. Hosek, 86 Ill.Dec. 379 (1 Dist. 1985); Allstate Insurance Co. v. National Tea Co., 25 Ill.App.3d 449, 323 N.E.2d 521 (1975).

In Stone v. Those Certain Underwriters at Lloyds, 81 Ill.App.3d 333 (5 Dist 1980), the court adopted the Restatement of Contracts, ยง 472 (1)(b), which requires the insured to disclose information not known to the insurer, and which is so vital to the contract that if the mistake were mutual the contract would be voidable. If the non-disclosing party knows the other party does not know the facts, non-disclosure is not privileged and is fraudulent. Stone at 336.

STATUTORY REQUIREMENTS

Most Illinois Courts strictly construe and adhere to the language of the Ill.Rev.Stat., ch. 73, 6 766, which provides:

Misrepresentations and False Warranties. No misrepresentation or false warranty made by the insured or in his behalf in the negotiation for a policy of insurance or breach of a condition of such policy shall defeat or avoid the policy or prevent its attaching unless such misrepresentation, false warranty or condition shall have been stated in the policy or endorsement or rider attached thereto, or in the written application therefor, of which a copy is attached to or endorsed on the policy, and made a part thereof.

An insurer satisfies the basic requirements of the statute if the insurer is able to establish either an intent to deceive or a material misrepresentation. The elements of "intent to deceive" and "material misrepresentation" should be read in the disjunctive, i.e., if a misrepresentation is deemed to be material, it need not have been made with the intent to deceive. Campbell v. Prudential Insurance Co., 15 Ill.2d 308, 155 N.E.2d 9 (1958); Roberts v. National Liberty Group of Companies, 159 Ill. App. 3d 706, 512 N.E.2d 792 (4th Dist. 1987); Logan v. Allstate Life Insurance Co., 19 Ill. App. 3d 656, 312 N.E.2d 416, 420 (2d Dist. 1974).

INTENT TO DECEIVE

Courts define "intent to deceive" as the intent of the insured to induce his acceptance as an insurance risk by false statements. Courts will typically examine a wide range of circumstantial evidence in order to determine whether there was fraudulent intent. Roberts v. National Liberty Group of Companies, 159 Ill. App. 3d 706, 512 N.E.2d 792 (4th Dist. 1987); Fireman's Fund Insurance Company v. Knutsen, 324 A.2d 223 (1974).

In Fireman's Fund, the Court held that similar fraudulent acts, if committed sufficiently near in time so that the same motive may reasonably be inferred to exist, are admissible to establish intent, on the sound logical principle that such similar acts diminish the possibility that an innocent mistake was made in an untrue and misleading statement.

MISREPRESENTATION

Illinois Courts have interpreted "material misrepresentation", as it pertains to insurance contracts, as an untrue fact which affects the risk undertaken by the insurer. Thus, the insured's misrepresentation must be shown to have caused a substantial increase in the risk insured against, and would have, if the misrepresentations were known by the insurer, caused a rejection of the application. American Country Ins. Co. v. Mahoney, 148 Ill.Dec. 438, 560 N.E.2d 1035 (Ill.App. 1 Dist. 1990).

The Mahoney court concluded that an insurance applicant has a duty to act in good faith, and that an insurer is entitled to truthful responses so that it may determine whether the applicant meets its underwriting criteria. Nevertheless, a good faith mistake does not excuse a material misrepresentation on an insurance application and does not preclude an insurer from rescinding a policy under Illinois law. Bageanis v. American Bankers Life Assur. Co. of Florida, 783 F.Supp 1141.

It is interesting to note that an insurer is not required to attempt an independent verification of the information provided by the insured. Allstate Insurance Company v. National Tea Co., 323 N.E.2d 521 (1 Dist 1975). For example, in Bade v. Badger Mutual Ins. Co., 142 N.E.2d 218 (1966), the court allowed the insurer to rescind the policy even though the misrepresentations were discovered four years - and several renewals - after they were made.

MATERIALITY

Materiality is a question for a trier of fact and is judged by an objective standard. Accordingly, the insured must disclose any facts requested on the application that, objectively considered, might give rise to a claim, regardless of the insured's subjective belief. However, materiality may also be proven by the testimony of an insurer's underwriter or employee regarding the significance of the information sought, or based upon the underwriter's experience or the practices of the insurance industry. It is important to note, however, that if the insurer fails to request the information in the application, such information may be deemed immaterial. Garde v. County Life Insurance Co., 147 Ill. App. 3d 1023, 498 N.E.2d 302, 308 (4th Dist. 1986); Ratcliffe v. International Surplus Lines Insurance Co., 194 Ill. App. 3d 18, 550 N.E.2d 1052, 1057 (1st Dist. 1990); International Insurance Co. v. Peabody International Corp., 747 F. Supp. 477, 480 (N.D. Ill. 1990); and Bowman v. Zenith Life Insurance Co., 67 Ill. App. 3d 393, 384 N.E.2d 949, 950-51 (1st Dist. 1978).

In Farmers Automobile, the Court construed against an insurer a declaration in an insurance policy which amounted to a warranty that "NO INSURER HAS REFUSED TO ISSUE", because the language according to the Court, could have been misunderstood, and because, the insured would have to search through definitions, exclusions and conclusions many times more voluminous than the insuring agreement in order to interpret the declaration. Farmers Automobile at 737.

CONCEALMENT

Courts have held that an insurance applicant's failure to disclose information to an insurer may rise to the level of a material misrepresentation. Stone v. Those Certain Underwriters at Lloyds, 36 Ill.Dec. 781, 401 N.E.2d 622 (Ill.App. 5 Dist 1980). Thus, representations in an application for insurance should not only be true but full; i.e., the insurer has a right to know the whole truth in order to make its own inquiries, and in order to determine whether or not the risk should be assumed. Government Employees Insurance Co. v. Chavis, 176 S.E.2d 131 (1970). For example, in Garde by Garde v. Country Life Insurance Co., 101 Ill.Dec. 120, 498 N.E.2d 302 (Ill.App. 4 Dist 1986), the court allowed an insurer to rescind its policy based upon the insured's nondisclosure of twenty-two policies of insurance already in force.

The fact that an insurer conducts an independent investigation does not absolve an insured from speaking the truth. Nor, does it lessen the right of the insurer to rely upon the insured's representations, unless, the investigation disclosed facts sufficient to expose the falsity of the representation made, or, the misrepresentation was of such a nature as to place on the insurer the duty of making further inquiry. Allstate Ins. Co. v. Meloni, 236 A.2d 402 (1967).

It is important to note an exception to the general rule regarding an insured's duty to disclose. In Boyles v. Freeman v. State Farm Mutual Automobile Insurance Company, 315 N.E.2d 899 (1st Dist 1974), the Court held that where a prospective insured, in good faith, admitted that his driver's license had been suspended or revoked, but qualified his statement by saying that he couldn't remember whether it occurred in the preceding five years, and where the insurer had an election of ignoring the qualification or refusing the risk, but elected to ignore the qualification and issue the policy, it could not later seek to rescind the policy because the statement without the qualification was false.

APPLICATION MUST BE ATTACHED TO POLICY

Illinois courts have consistently upheld the statutory requirement that the application be attached to the policy if the insurer intends to rely upon the representations in the application.

As previously cited, the Illinois Insurance Code provides that [n]o misrepresentation... shall defeat or avoid the policy...unless such misrepresentation, false warranty or condition shall have been stated in the policy or endorsement or rider attached thereto, or in the written application therefor, of which a copy is attached to or endorsed on the policy, and made a part thereof... (emphasis added).

The primary purpose of the law requiring that the application be attached to the policy is to give notice to the insured that he/she is to review all statements made and to correct any misstatements which appear therein. Alperin v. National Home Life Assurance Company, 336 N.E.2d 365 (1 Dist. 1975). It should be noted, however, that an insured is given the benefit of the doubt when the agent fills out the application because the agent may insert conclusions of his own or answers inconsistent with the facts. Boyles v. Freeman v. State Farm Mutual Automobile Insurance Company, 315 N.E.2d 899 (1 Dist 1974).

Courts generally require strict compliance with the statute, i.e., misrepresentations must be reduced to written form and attached to the policy in order to meet the requirements of the statute. International Amphitheater Co. v. Vanguard Underwriters Ins. Co., 126 Ill.Dec. 808 (1 Dist 1988). Furthermore, Illinois Courts have concluded that no matter how egregious a misrepresentation that is made in an application for insurance, or how much a misrepresentation may have altered the nature of the insured risk, the insurer may not rescind the policy unless the application is physically attached to the policy. Gibraltar Casualty Co. v. A. Epstein & Sons Int'l. Inc., 206 Ill. App.3d 272, 562 N.E.2d 1039, 1042-43 (1st Dist. 1990).

In Gibraltar, the court held that the insurer must attach the written application to the policy, or include unambiguous language which specifically incorporates the application into the policy. the Court further held that a mere statement in the policy that the insured's statements were made part of the policy, or a general reference to the application in the policy does not fulfill the requirements of the statute. Gibraltar at 239.

At least one Illinois Court has recognized an exception to the "attachment" requirement of Section 766, i.e., when the insured's continuing duty to supplement and disclose events that occur after submission of an application but prior to issuance of a policy. Carroll v. Preferred Risk Insurance Co., 60 Ill. App. 2d 170, 208 N.E. 2d 836, 839 (1965). The Court in Carroll specifically concluded that Section 766 was inapplicable in such cases, stating:

We think the purpose of Section 766 is to preclude the insurance company from charging misrepresentation of facts which have occurred up to and at the time the application for insurance is executed. This Section does not alter the duty of the insured to disclose the existence of facts materially affecting the acceptance of the risk which come to the knowledge of the insured after the application is made and before the policy is issued. Id. at 839.

RESTORATION OF STATUS QUO

It is a general principle of the doctrine of rescission that a person demanding rescission restore the other party to the status quo existing at the time the contract was made. Puskar v. Hughes; Luciani v. Bestor, 106 Ill.App.3d 878, 882, 62 Ill.Dec. 501, 436 N.E.2d 251 (1982). Accordingly, if an insurer fails to give prompt notice of its election to rescind and fails to restore the insured to the status quo existing at the time the contract was made, it may lose its rights in that regard. International Ins. Co. v. Sargent & Lundy, 182 Ill.Dec. 308, 609 N.E.2d 842 (1993).

It is important to note, however, that the granting of rescission is not necessarily precluded in those cases where it is impossible to restore the other party to status quo. Thus, restoration to status quo will not be required when the restoration has been rendered impossible by circumstances not the fault of the party seeking rescission, where the insured has obtained a benefit from the contract, and where, by the nature of the insured's fraud or other act, it is impossible to restore the status quo. John Burns Construction Co. v. Interlake, Inc., 105 Ill. App.3d 19, 27, 60, Ill.Dec. 888, 433 N.E.2d 1126 (1982).

Conversely, however, rescission will not be granted where the actions of the party seeking rescission have created an impediment to the Court's ability to restore the status quo. Klucznik v. Nikitopoulos, 152 Ill.app.3d 323, 328, 105 Ill.Dec. 141, 503 N.E.2d 1147 (1987).

WAIVER AND ESTOPPEL

An insurer's right to rescind a policy of insurance is a privilege which may inadvertently be waived by the insurer, or, the insurer because of its conduct may be estopped to deny coverage. Thus, an insurer's rights under the policy may be lost by waiver or estoppel where the conduct of an insurer induces the insured to believe that he need not comply with certain policy provisions or that such provisions will not be enforced. Downing v. Wolverine Insurance Co., 210 N.E.2d 603 (2nd Dist. 1965).

An insurer may have a right to rescind a policy of insurance even though it failed to reserve its right of rescission in the policy. It must, however, be shown by an insured claiming waiver that the insurer had at all relevant times knowledge, actual or constructive, of the existence of their rights or facts upon which they depended, i.e., waiver cannot be established by consent given under a mistake of fact. Government Employees Insurance Co. v. Chavis, 176 S.E.2d 131 (1970).

It is important to note that lack of good faith on the part of an insured does not prevent consideration of the issue regarding whether an insurer waived a coverage defense based on misrepresentations in the application for insurance. Thus, a "lack of good faith" defense is applicable only to the doctrine of estoppel and not to waiver which involves acts or conduct of one of the parties to the contract. Fireman's Fund Insurance Company v. Knutsen, 324 A.2d 223 (1974).

CONCLUSION

The burden of making out a case for rescission is on the insurer, who must prove the grounds relied upon. Fraud, needless to say, can be established by a number of evidentiary factors. However, a verdict in favor of the insurer based upon rescission usually results when the burden of proof has been sufficiently satisfied by clear and convincing evidence.