By RICK HAMMOND, J.D., CLU
Most property policies provide the insurer with the right to avoid coverage when there is a finding of fraud. The fraud defense may arise either from a misrepresentation made by the insured in the procurement of the insurance policy or in the presentation of a claim.
The two kinds of misrepresentations are treated differently in terms of the issues of reliance, statutory language, and policy language. The following column addresses an insurer's right to avoid coverage based upon fraud in the presentation of a claim.
Common Law Approach
Under the common law, an equitable claim for avoidance of a contract due to fraud may typically be asserted by establishing:
- a representation in the form of a statement of material fact, made for the purpose of inducing the other party to act;
- 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
- 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, 475 N.E.2d 593, 131 Ill.App.3d 180 (1 Dist. 1985); Allstate Insurance Co. v. National Tea Co., 25 Ill.App.3d 449, 323 N.E.2d 521 (1st Dist. 1975).
However, avoidance of a contract for insurance due to post-loss fraud can be distinguished from the general common law approach in that:
- there need be no reliance by the insurer on the misrepresentation; and
- the misrepresentation may relate to a circumstance relevant to the insurer's investigation and can have occurred at virtually any point during the investigation.
Fraud and False Swearing
The applicable policy provision (i.e., Fraud and False Swearing Clause) respecting the insurer's right to deny coverage 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.
It is very important to note that while the typical Fraud and False Swearing Clause "voids the policy", the voiding of the policy typically takes place at the time that the concealment or misrepresentation occurs, and not necessarily at or before the time that any underlying loss occurred.
Accordingly, an insurer may have a duty, in accordance with the terms of the policy, to defend and indemnify an insured for any liability suits that trigger coverage under the policy and which arose out of the underlying property damage loss, notwithstanding the fact that the insured later committed fraud in the presentment of the property claim.
Concealment, misrepresentation, or fraud within the meaning of the Fraud and False Swearing clause is an affirmative defense that the insurer must plead and prove. Gipps Brewing Corp. v Central Manufacturers Ins., 147 F.2d 11 (7th Cir. 1945). Under Illinois law, fraud and false swearing is ordinarily a question of fact for a jury, but it becomes a question of law if the insured's misrepresentations cannot in any way be seen as innocent. Lykos v. American Home Ins. Co., 609 F.2d 315 (7th Cir. 1979).
The clause is usually invoked by an insurer in the following instances:
- overvaluation of the covered property;
- false statements as to the cause and origin of the loss or damage;
- false statements as to title or ownership of the covered property lost or damaged; and/or
- inclusion in the proof of loss of either property not covered under the policy or covered property not lost or damaged.
The Fraud and False Swearing Clause has been interpreted in Illinois as requiring that the alleged fraud or false swearing take place before the filing of suit. Tarzian v. West Bend Mutual Fire Ins. Co., 74 Ill.App.2d 314, 221 N.E.2d 293 (1st Dist. 1966). Thus, the Court in Tarzian opined that before the filing of suit, the parties are not adversaries, and the obligation of good faith requires an insured to tell the truth to its insurer.
Burden of Proof
Illinois courts generally hold that in order for an insurer to deny coverage based on fraud and false swearing, the insurer must prove that the insured's misrepresentations or concealments were intended to deceive and defraud the insurer. Gipps Brewing Corp. v. Central Manufacturers Ins., 147 F.2d 11 (7th Cir. 1945).
Thus, the burden of proof is on the insurer to prove that an insured has intentionally concealed or misrepresented material facts respecting their claim. However, the insurer can establish such proof with a preponderance of circumstantial evidence rather than by the standard of "beyond a reasonable doubt".
It should be noted that when an insured can prove only a small percentage of his claimed loss, a presumption may arise that the statement of value or quantity set out in his proof of loss is false and fraudulently prepared. Saks & Co. v. Continental Ins. Co., 295 N.Y.S.2d 668, 23 N.Y.2d 161, 242 N.E.2d 833 (1968).
The presumption that the proof of loss is false and fraudulently prepared becomes conclusive when it is shown that the difference between the amounts claimed in such proof of loss and those actually proved to have been destroyed are grossly disparate, and the explanation tendered is so unreasonable or fantastic that it is inescapable that fraud has occurred.
Nevertheless, it is important to note that an intent to defraud will not be presumed and that Courts will give all reasonable allowances for the possibility of an innocent mistake by the insured. Moreover, an insurer must do more than create a mere suspicion of fraud by an insured. Werner's Furniture Inc. v. Commercial Union Insurance Co., 349 N.E. 2d 616, 39 Ill.App.3d 59 (1976). Harrold J. Warren Co. v. Federal Mutual Ins. Co., 386 F.2d 579, 581 (1st Cir. 1967).
Reliance by Insurer Unnecessary
Under the common law, the defrauded party must show that they relied to their detriment on false statements in order to establish fraud. In insurance law, however, Courts have generally upheld forfeiture of the insured's rights where the insured misrepresented material facts concerning the loss, even if the misrepresentation did not actually mislead the insurer in its adjustment and determination of the loss.
Thus, post-loss insurance fraud is not subject to the common law burden of proving some form of detrimental reliance by the defrauded party. Passero v. Allstate Insurance Co. 554 N.E.2d 384, 196 Ill.App.3d 602 (1st Dist. 1990).
In Passero, the Illinois Appellate Court refused to impose reliance as an element of fraud. Passero at 387. In that case, the insureds submitted a proof of loss for stolen property which included a stereo system and video equipment. However, at their examination under oath, the insureds allegedly misrepresented the receipts for those items.
The insurer's investigation uncovered the contrary facts about the claimed items and the insurer later prevailed on a motion for summary judgment based on the insured's misrepresentations.
On appeal, the insureds argued that their misrepresentations were immaterial because the insurer knew the truth. The Court rejected the argument, noting that fraud in insurance law does not require reliance and, as such, differs from fraud under the common law and statutory remedies.
Whether a misrepresentation is considered "material" depends upon the nature of the claim and is generally a question for a trier of fact. In Passero, the Court held that attempts calculated to discourage, mislead, or deflect the insurer's investigation into a relevant area, e.g., questions regarding the ownership of property, by concealing facts surrounding their acquisition of the property constituted material misrepresentations. Passero at 389.
The Passero Court also adopted the holding in Fine v. Bellefonte Underwriters Insurance Co. (725 F.2d 179, 184 [2nd Cir. 1984]) that a representation is material if the false statement concerns a subject relevant to the insurer's investigation as it is then proceeding. Passero, at 388. This holding indicates that the misrepresentation or concealment must be viewed at the time it occurs and recognizes the insurer's need to obtain information at the time it is useful during an investigation. Passero at 388.
However, an insured is only required to give the best information obtainable at the time. Thus, unintentional false statements do not constitute grounds for forfeiture. It should be noted, however, that for a defense of fraud to apply, false statements of an insured need not be made while under oath. Jay-Bee Realty Corp. v. Agricultural Ins. Co., 50 N.E.2d 973, 320 Ill.App. 310 (1st Dist. 1943).
Misrepresentation by Overvaluation of Loss
When an insured knowingly and willfully overestimates the value of the property in his proof of loss with the intention of deceiving an insurer, such overvaluation may allow the insurer to avoid the policy and defeat any right of the insured to recover thereon. Furthermore, the insured's knowledge of the overvaluation is not necessary in order to work a forfeiture of this right under the policy. It is sufficient if he swears with disregard to the truth. In order words, a reckless overvaluation of the property claimed equally voids the policy. 16 ALR 3d 779.
On the other hand, Courts generally hold that the term "fraud or false swearing", as used in a fire insurance policy, does not refer to unintentional error. Thus, the rights of the insured are in no way prejudiced by overvaluation of property which the insured inadvertently and innocently made in his proof of loss. Werner's Furniture Inc. v. Commercial Union Insurance Co., 349 N.E. 2d 616, 39 Ill.App.3d 59 (1st Dist. 1976). Harrold J. Warren Co. v. Federal Mutual Ins. Co., 386 F.2d 579, 581 (1st Cir. 1967).
It is important to note that most Courts hold that the extent of the overvaluation is a very important factor in determining whether there was a fraudulent intent on the part of the insured. Thus, it has been said that overvaluation raises the presumption of fraud in proportion to the amount of the overvaluation, and a mere trivial and immaterial overvaluation is rarely considered sufficient to void the policy. 16 ALR 3d 779, 788.
Recovery by Innocent Coinsured
It is well-settled in Illinois that the wrongdoing of one coinsured will not be imputed to an innocent coinsured to preclude recovery of insurance proceeds under a policy of insurance. Economy Fire & Casualty Company v. Warren, 71 Ill.App.3d 625, 390 N.E.2d 361 (1st Dist. 1979). The Court in Economy Fire first addressed the right of a coinsured to proceeds payable under the policy. In its analysis, the Court followed the "reasonable person" standard:
. . . in construing an insurance contract, the test is not what the insurance company intended the words of the policy to mean but what a reasonable person in the position of the insured would have understood them to mean. The ordinary person owning an undivided interest in the property, not versed in the nice distinctions of insurance law, would naturally suppose that his individual interest in the property was covered by a policy which named him without qualification as one of the persons insured.
Economy Fire at 627, 390 N.E.2d at 363 citing Mercantile Trust Co. v. New York Underwriters Ins. Co., 376 F.2d 505, 506 (7th Cir. 1967) quoting Hoyt v. New Hampshire Fire Ins. Co., 92 N.H. 242, 29 A.2d 121, 123 (1942).
The Court in Economy Fire concluded that the husband, as an innocent coinsured, was entitled to one-half of the insurance proceeds. Economy Fire at 628, 390 N.E.2d at 364.
Since the Court's holding in Economy Fire, most Illinois Courts have taken a favorable view towards recovery by innocent co-insureds, and have generally allowed an innocent coinsured to recover for the loss under a property policy even though the loss was caused by another insured. Fittje v. Calhoun Co. Mutual Insurance, 195 Ill.App.3d 340, 552 N.E.2d 353 (4th Dist. 1990).
For example, in State Farm Fire & Casualty Insurance Co. v. Miceli, 164 Ill.App.3d 874, 518 N.E. 2d 357 (1st Dist. 1987), the Court's decision to extend coverage was based upon a finding that the following policy provision is ambiguous as to innocent co-insureds:
This policy is void if any insured has intentionally concealed or misrepresented any material fact or circumstances relating to the insurance.
The Court in Miceli interpreted the policy provision described above in a manner most favorable to the insured and as meaning that only the insured responsible for the loss is barred from recovering under the policy. Miceli at 361.
Needless to say, subsequent to the Court's holding in Miceli, many insurers revised their applicable policy language similar to the following:
This policy is void as to you and any other insured, if you or any other insured under this policy has intentionally concealed or misrepresented any material fact or circumstance relating to this insurance, whether before or after a loss.
It is interesting to note a contrasting opinion regarding the rights of innocent coinsureds in the Washington Court's opinion of U.S.F & G Ins. Co. v. Brannan, 589 P.2d 817 (Wash Ct. App. Div. 3 1979):
. . .it has become settled law of this state that, if the tortious act of the husband be committed in the management of community, property or for the benefit of the marital community, such community is thereby rendered liable for the act, under the doctrine of respondeat superior.
* * * * *
. . .To permit the other spouse, in this case the wife, to get the benefit of the insurance would mean that the community would benefit from the wrongful act of one of its members. This would be contrary to public policy.
Right to Recovery by Mortgagee
Fraud and false swearing by the insured will generally not operate to defeat a mortgage holder's right to receive payment for covered loss or damage to covered property. However, a mortgagee must comply with the terms of the policy which typically provides:
The word "mortgagee" includes trustee.
If a mortgagee is named in this policy, any loss payable under Coverage A or B will be paid to the mortgagee and you, as interests appear. If more than one mortgagee is named, the order of payment will be the same as the order of precedence of the mortgages.
If we deny your claim, that denial will not apply to a valid claim of the mortgagee, if the mortgagee:
Notifies us of any change in ownership, occupancy or substantial change in risk of which the mortgagee is aware;
Pays any premium due under this policy on demand if you have neglected to pay the premium; and
Submits a signed, sworn statement of loss within 60 days after receiving notice from us of your failure to do so. Policy conditions relating to Appraisal, Suit Against Us and Loss Payment apply to the mortgagee.
* * * * *
If we pay the mortgagee for any loss and deny payment to you:
- We are subrogated to all the rights of the mortgagee granted under the mortgage on the property; or
- At our option, we may pay to the mortgagee the whole principal on the mortgage plus any accrued interest. In this event, we will receive a full assignment and transfer of the mortgage and all securities held as collateral to the mortgage debt.
Subrogation will not impair the right of the mortgagee to recover the full amount of the mortgagee's claim (emphasis provided).
Waiver and Estoppel
An insurer's right to avoid coverage is a privilege which may be inadvertently waived by the insurer. Thus, 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, e.g., Fraud and False Swearing Clause, or that such provisions will not be enforced. Downing v. Wolverine Insurance Co., 62 Ill.App.2d 305, 210 N.E.2d 603, at 606 (2nd Dist. 1965).
In fact, the Court in Gipps Brewing Corp. v. Central Manufacturers Ins., 147 F.2d 11 (7th Cir. 1945), held that policy provisions which state that no waiver can occur without the waiver being in writing, may still be waived by the conduct of the insurer. Accordingly, it is not uncommon for an insurer to request the insured's execution of a "non-waiver agreement", i.e., a mutual agreement acknowledging that no rights of either party are being waived.
Needless to say, many insureds, particularly those suspected of fraud, will not readily agree to sign a non-waiver agreement. In such cases the insurer will typically issue a reservation of rights letter to the insured which will, for all intents and purposes, unilaterally accomplish the same goal.
Civil Remedies by Insurer
A recently enacted statute may provide insurers with a weapon to combat fraudulent claims. Illinois Revised Statues 720 ILCS 5/17010.5 (a) Civil Damages for Insurance Fraud, provides a civil cause of action which can brought by a defrauded insurer, and the recovery of double or treble damages based upon the value of the property:
A person who knowingly obtains, attempts to obtain or causes to be obtained, by deception, control over the property of any insurance company by the making of a false claim on a policy of insurance issued by an insurance company, intending to deprive an insurance company permanently of the use and benefit of that property, shall be civilly liable to the insurance company that paid the claim or against whom the claim was made or to the subrogee of that insurance company in an amount equal to [three] times the value of the property wrongfully obtained or twice the value of the property attempted to be obtained, plus reasonable attorneys fees.
It is important to note, however, that under the statute the insurer itself can be held liable for bringing an action against its insured in bad faith:
An insurance company that brings an action against a person... in bad faith shall be liable to that person for twice the value of the property claimed, plus reasonable attorneys fees. In determining whether an insurance company acted in bad faith, the court shall relax the rules of evidence to allow for the introduction of any facts or other information on which the insurance company may have relied in bringing an action under... this Section.
As the number of cases involving allegations of insurance fraud continue to increase, it seems fitting to close by reflecting on the Court's somber warning to insureds in Lykos, et al. v. American Home Ins. Co., 609 F.2d 314, 316 (1979):
A design on the part of the insured to gain a position of advantage in the settlement of the loss through false representation is a fraudulent design and the making of such representations knowingly for that purpose is an attempt to defraud, even though the insured may not have expected or intended ultimately to obtain more than compensation for actual loss. Although the penalty is heavy and seemingly harsh, it is one way of stopping the presentation of false, fictitious or inflated claims.