Misrepresentations in insurance applications: dangers in those lies.

• Author: Segalla, Thomas F.

THE most critical stage in forming a contract of insurance is the application process. During this stage parties to the insurance contract define their respective expectations. The applicant must clearly read all the questions, terms, and conditions of the application; listen to the representations and instructions made by the agent or broker; and remain sensitive to the impact of the oral and written statements. What is seen, what is spoken, and what is heard during the course of these processes can conclusively affect the rights of the parties at the time of a loss. Therefore, before understanding the effect of the representations made at any stage of the application and renewal process, practitioners and claim professionals must have a clear understanding of the application process and its effect on the insurance contract.

1. Application Process

   One out of five adults believes it is acceptable to lie when completing an insurance application. (1) Such a statistic is disheartening when most insurance applications contain a provision that says:

   I have read the above application and I declare that to the best of my knowledge and belief all of the foregoing statements are true; and that these statements are offered as an inducement to the company to issue the policy for which I am applying. (2) When faced with such a disturbing statistic, the insurer must become more sensitive to the nature and extent of the questions asked on the application, the manner and method of how applications are administered, and the individual who signs the application. During this process, the insurer determines the nature and extent of the risk from an underwriting standpoint and whether or not to issue the policy of insurance prior to setting the premiums. (3)

   1. The Application

      Courts have traditionally held that, because the insurer drafts the insurance contract, ambiguities should be construed in favor of the insured and against the insurer. The same principle has been applied to ambiguities in the insurance application. As one court noted:

      Conditions and provisions must be strictly construed against the insurers, because they have for their object to limit the scope and defeat the purpose of the principal contract, and as the insurer prepares the contract and furnishes the language used, any ambiguity in the contract must be taken most strongly against him. (4) It should become abundantly clear to insurance companies that the questions asked on an application must be appropriately drafted to solicit the information that is important to their underwriters. The insurer should know the information that it considers material to the underwriting process, and if the insurer requires certain information, it must ask for it in an unambiguous manner. (5)

      An answer to an ambiguous question in an insurance application cannot be the basis of a misrepresentation claim by the insurer. (6) Whether a question is ambiguous should be determined by "[t]aking the language of the question according to its normal usage...." (7) Contract language is unambiguous "when it has a definite and precise meaning, unattended by danger of misconception in the purport of the [contract] itself, and concerning which there is no reasonable basis for a difference of opinion." (8) Conversely, ambiguity in an application has been found where a reasonably intelligent person who has examined the context of the entire agreement could find more than one meaning. (9) Thus, the questions "must be so plain and intelligible that any applicant can readily comprehend them." (10) In general, the insurer has the burden of proof that the questions asked are subject to no reasonable interpretation other than the one given by the insurer. (11)

      In some contexts, an insured must disclose information that it has reason to believe that the insurer would rely upon and would influence its decision to assume the risk. (12) This duty of utmost good faith, also referred to as "uberrimae fidae," requires an applicant to disclose to the insurer all material facts about the risk being insured. The insurance contract is voidable if the reinsured breaches the duty. (13) This duty, however, is typically enforced only in the reinsurance and marine insurance contexts. Typically, there is no duty to volunteer information unless a "question plainly and directly requires it to be furnished." (14)

   2. Agent

      The insurance agent plays an important role in the application process because he or she customarily completes the application based on information supplied by the insured. The agent significantly affects the insurer's ability to deny coverage based upon an alleged misrepresentation in the application. Within the context of the application process, the interjection of a third party, the agent, raises the following questions:

      1) What happens if the agent misrepresents the facts?

      2) What happens if the agent makes a mistake?

      3) What happens if the agent knows of the misrepresentation in the application?

      The answers to these questions turn on the resolution of whether the agent was, in fact, acting as an agent of the insurer when he or she completed the application. Some jurisdictions follow traditional agency principles and hold that the knowledge of the agent is imputed to the insurer and the insurer is bound by the actions of its agent that are within the scope of its duties. (15) Other jurisdictions have enacted statutes that determine when an agent's knowledge is imputed to the insurer. (16)

      The authority of the agent is often considered where the insured has provided the correct information but the agent fills out the application incorrectly, the responses are incomplete, or questions are left unanswered. Courts in some jurisdictions have held that, under such circumstances, the insurer is estopped from denying coverage. (17)

      Other jurisdictions, however, focus on the insured's obligation to read the application as completed prior to its execution and therefore, is bound by the representations and information contained in the application. (18) Still, courts in other jurisdictions have held that where the application contains a clear and unambiguous limitation of an agent's authority to bind coverage, modify or waive any requirements of the policy provisions, the insured cannot rely on the advice and assurance of the agent. (19)

      Further, if the application that has been executed by the insured is attached to the policy at the time of delivery, courts have held that the knowledge or acts of the agent are not imputed to the insurer. (20) Similarly, when the application is attached to the policy, some jurisdictions find that the insured has the burden of reading the questions and answers and to supply the insurer with corrected information if any of the answers or information is erroneous. (21)

   3. Attachment to Policy

      Whether an application is considered a part of the policy under common law is generally determined by the insured and insurer's intent. Currently, most policies contain explicit and clear language that the application must be attached to the policy, and many states have enacted statutes that require that the application be annexed to, incorporated in, endorsed on, or referenced in the policy. (22) The obvious purpose for statutes or common law principles that address these issues is to identify the entire and complete contract and to assist the court in interpreting whether the misrepresentation in the application can be utilized by the insurer as a defense. (23) In other words, such a statute "prevents an insurer from providing only part of a lengthy and confounding application and then predicating its fraud defense on an attached part, even though the unattached part might easily explain apparently fraudulent statements made in the attached part." (24)

      An insurer's failure to attach the application to the policy may bar the insurer from relying on false answers in the application in a rescission action. (25) As a result, it is important for the practitioner to review the legislative history of the particular statute to determine the overall impact of the statutory requirement that the application be attached. Generally, the insurer is required to attach the application to the policy as a condition precedent to the insurer's reliance upon the application and misrepresentation contained therein as a defense to a claim by the insured on the policy. (26)

      Other jurisdictions hold that an application that has not been attached to the policy as required by statute may still be admitted as evidence to show a misrepresentation that induced the insurer to issue the policy. (27) Where statute requires that the application is attached to the policy, it often specifies whether the application is admissible if the statute is not followed. (28) Such statutory requirements, however, may only apply to specific types of insurance; therefore, the practitioner must carefully review both the applicable statute and the common law where the requirement is not applicable to the type of insurance under consideration. (29) Once the insured receives the policy, the majority of jurisdictions hold that the insured has a duty to examine the policy and confirm that the proper coverage is provided. (30)

2. Misrepresentation

   1. General Principles

      Where the insured fails to provide or misrepresents information during the application process, the insured faces an analysis of his or her actions or inactions that could result in the loss of insurance coverage. Initially, a practitioner must determine whether a representation is involved or whether the case involves a warranty. A warranty is a provision incorporated in the insurance contract that is essential to the validity of the contract. For example, a provision incorporated into a burglary policy issued pursuant to the Federal Crime Insurance Program requiring that certain protective devices are installed on the insured's premises is a warranty...