Health and life insurance applications: their role in the claims review process.

• Author: Schuman, Gary
• Position: Health Care and the Law

INSURANCE companies are permitted to select their risks and to restrict or even deny coverage for life and health insurance to individuals when, in the opinion of the insurer, restriction is necessitated by the applicant's medical condition or personal history. The goal is not equal treatment of policyholders, but equitable treatment based on the risk that applicants represent to the insurer. Insurance, by its very nature, is recognized as being "discriminatory."(1)

Because of the significance of the life and health insurance industry in society, however, the business of insurance, its companies and its products are heavily regulated.(2) Insurance companies constantly face barriers when they seek to enforce the provisions of a policy. State statutes and case law attempt to balance the insurers' legitimate interests in avoiding risks it did not intend to undertake with the interests of insureds who in good faith have relied on coverage.

On the one hand, there increasingly is an attitude that the general public lacks the ability to inform or to protect itself on insurance matters. Statutes and regulations focus on protecting the public through the promotion of fair dealing, availability of information and full disclosure of an insurance policy's benefits and limitations. On the other hand, state legislatures and courts recognize that not permitting an insurer to rescind for an insured's misrepresentation and allowing the insured or the beneficiary to recover benefits will give dishonest applicants an advantage by minimizing the chances that their misrepresentations could be used to rescind a policy obtained through deception.(3)

The costs of allowing an insured or a beneficiary to receive benefits irrespective of that insured's misrepresentation will be borne initially by the insurer, but ultimately they will be passed on to consumers--other policyholders--in the form of increased premiums. The honest policyholders will pay for the insurers' losses caused by misrepresentation, as insurers must be allowed to charge premiums commensurate with the risk they will be required to assume.(4) In fact, insurance fraud has reached epidemic proportions, costing insurers and the public at least $15 billion a year and increasing some policy premiums by as much as 25 percent.(5)

These issues are especially important in today's competitive climate. Insurance policies are being sold in increasing numbers to individuals about whom insurers know less than they did in the past, and insurers have less time to assess the risk. For example, bulk sales of field-issued insurance through financial institutions, automobile dealerships, mass mailings and similar means of distribution reduce or even eliminate an insurance agent's familiarity with individual applicants, unlike a dedicated agent selling insurance to friends and referrals.(6)

So too, in order to meet the needs of the insurance applicant and the increasing competition in the market place, insurance often is sold through simple applications, premium structures and underwriting conditions that permit quick and routine approval without further investigation if the applicant does not list any adverse health or personal history.

Finally, agents most often are compensated only on a commission basis once the application is accepted by the insurer's underwriting department and the first premium is paid. So it is not surprising that an applicant's readily observable problems, which are either not noticed or conveniently ignored by the agent, give rise to contentions that the insurer should have been on notice and to claims of waiver or estoppel by insureds and beneficiaries.

Prospective insureds with medical problems have an economic conflict. If they answer the application's question honestly, they may have to pay a higher premium, accept a rider that excludes the medical problem for which they are most likely in need of insurance, or be unable to get coverage at all. If they lie and survive two years, they are covered. Even if they die, incur medical expenses or becomes disabled within two years, at the worst, they will lose the coverage they otherwise would not have received. In the face of these competing factors, it is not surprising that probably the single most litigated issue in life and health insurance is whether there was a misrepresentation in the application for insurance entitling the insurer to avoid paying the contracted benefits.(7)

What are the means by which insurance companies inquire about and evaluate an applicant's insurability, both at the time insurance is purchased and at the time a claim is filed? What requirements must an insurer satisfy in order to rescind coverage once it is determined that an insured made a misrepresentation in the application? An examination of these questions will demonstrate that insurers must decide whether to investigate their applicants at the beginning, in which case they will accept fewer applications but also insure better risks, or increase sales by simplifying their underwriting requirements at the time of purchase and risk adverse selection.

ASSESSING THE APPLICANT'S INSURABILITY

1. Insurance Application

   Information supplied by the applicant is critical to the proper evaluation of risk. The application is one of the most important and fundamental of the underwriter's risk assessment tools and serves as the basis of the contract between the company and the policyholder. The necessity for accuracy of the information in applications cannot be overstated, and insurers must be able to rely on the honesty of the applicants in answering application questions.(8)

   Many applications are approved routinely and without further investigation by the underwriter. These decisions often are based on information provided in a simple and short questionnaire completed by the applicant-insured, which serves as a substitute for a detailed medical statement or physical examination. In fact, some applications either limit the inquiries to whether the insured is now in "good health" and/or has been diagnosed or treated for certain medical conditions within a specified time period. Or perhaps they don't ask any health questions at all.

   Of course, insurers should have every incentive to conduct prompt and thorough investigations of applicants, but to avoid the inherent delay resulting from an in-depth investigation into applicants' health and personal status, which in any event may not reveal material information applicants may be withholding, insurers often choose to rely on the information furnished in the application.(9) This is so not only because of the competitive pressure to make a quick decision, but also because insurers are entitled, under the law, to rely on representations made in an application. Insurers determine, based on the applicant's responses, whether further inquiry into health status is necessary.

2. Underwriting Insurance Risks

   Underwriters are charged with the primary responsibility of assessing the risk. "Underwriting" is the process that an insurer uses to determine whether, and on what basis, it will accept an application for insurance. It is not a mechanical process; it requires specialized skill, experience and judgment.(10)

   One of the most important prerequisites to good underwriting is consistency. The amount of information required for decisions varies with the size of the policy, the age of the applicant and other factors. Similarly, the values assigned to insurance risks vary from company to company.(11)

   Two tools used by the underwriter are the application completed by the insured and the insurer's underwriting manual.(12) The underwriting manual is a summary of the method used by a particular company to evaluate and rate risks. It contains a detailed listing of various health and social conditions, provides background information on these impairments and serves the underwriter as a guide to suggested underwriting action when various impairments are present.

   Often, on receipt of the completed application from the field agent, the underwriter has the opportunity to review this document and accept, reject or further investigate the risk prior to the issuance of coverage. When the insurer receives a completed application indicating that the insured has no health problems, however, the coverage is usually issued, and the underwriter plays a role only at claim time, when medical information obtained during the course of processing a claim indicates that the insured failed to disclose true medical history. Only then does the underwriter decide whether the risk would have been acceptable had the insured answered the application truthfully. Once it is determined that by omission or commission the insured did not reveal the true medical condition or personal history, the question arises whether this misrepresentation justifies the insurer to rescind coverage.

3. Insured's Duty to Disclose

   From the view point of the insured, the frequency with which applications contain inaccuracies is explainable. It has been variously argued that the information contained in an insurance application is detailed and technical. The fields of medicine and insurance underwriting are not generally familiar subjects to the average applicant. The applicant may fail innocently or conveniently to recall personal activities in the past. Yet, in a number of states, an innocent misrepresentation is sufficient to justify a rescission.(13) In fact, courts have uniformly held that the duty to disclose information requested on an application rests with the insured, not the insurer.

   Insurers rely on their ability to base underwriting decisions on the truth of applicants' written representations on the application. Courts hold that there is a duty of good faith and fair dealing on the part of both parties.(14) As the U.S. Supreme Court stated in Stipcich v. Metropolitan Life Insurance Co.:

   Even the most unsophisticated person must know that in...