How to Lose a Rate Evasion Defense in Arbitration

NO-FAULT – APPLICATION FRAUD – MATERIAL MISREPRESENTATION – RATE EVASION – ARBITRATION
Matter of Comprehensive Psychological Evaluation PC and Esurance Insurance Co.
AAA Case No. 412009047088
Arbitrator Andrew M. Horn, decided 3/31/2010

While doing some research earlier this week on no-fault claim presentment fraud and the concept of "fraud in part, fraud in whole" as it applies to no-fault claims, I ran across a number of American Arbitration Association no-fault arbitration decisions on policy procurement or application fraud and misrepresentation. 

Provable insurance fraud is often a moving target, as insureds and claimants are often slippery and indefinite in their answers about conduct suspected to have been fraudulent.  Sometimes what looks like, sounds like and walks like a duck, however, turns out to not be a duck.  And sometimes even honest insureds and claimants who perceive they are being investigated for possible fraud understandably will be guarded in their answers, requiring more effort in obtaining definite and precise answers.  My experience is that insurers know this and require an appreciable quantum of evidence before they will deny a claim based on fraud in the policy application, loss commission, or claim presentment. 

This was a $339 claim for a psychiatric diagnostic interview examination, psychotherapy and review of records by the applicant's owner.  The insurer denied and defended the claim based on the assignor's asserted policy application misrepresentation about her residence, a/k/a rate evasion.  Arbitrator Horn's decision lays out  a road map of what a no-fault insurer must do to establish a rate evasion/application material misrepresentation defense, economies of scale notwithstanding.

Fatal to Esurance's application fraud defense in this matter were:

• what Arbitrator Horn determined was unclear and indefinite proof from the assignor's EUO of her misrepresentations about her Rhinebeck, New York residence in applying for her personal auto policy;
• the lack of the policy application offered into evidence; and
• the lack of an underwriter's affidavit averring either that the policy would not have been issued or that its premium would have been higher had the assignor revealed her Brooklyn residence address.

The fact that Esurance's counsel, who appeared by telephone, attempted to prove that the Rhinebeck address given by the assignor during the application process was a commercial building by stating that she had called the building's owner and he had told her so probably didn't help. 

Arbitration Horn's decision does set forth some seminal statutory and case law on this issue, however, that is worth bookmarking:

Applicant's attorney objected to the timeliness of the denial. However, I find that it was made within the statutory 30-day period as extended by a valid and timely verification request -- namely, the EUO of the provider's assignor. In any event, "the defense of fraudulent procurement of an insurance policy ... is nonwaivable and hence exempt from the 30-day preclusion rule, (and) may be asserted as against ... providers in this action seeking to recover assigned no-fault benefits". A.B. Med. Servs. PLLC v. Commercial Mut. Ins. Co., 12 Misc.3d 8, 2006 NY Slip Op 26118 (App Term 2d Dept.).

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In the arena of No-Fault insurance coverage, it is well settled that a policy cannot be cancelled retroactively under Insurance Law § 3105 (b) even if an insured has made misrepresentations in procuring it. See, e.g., Matter of Insurance Co. of N. Am. v. Kaplun, 274 A.D.2d 293, 713 N.Y.S.2d 214 (2000); Matter of Liberty Mut. Ins. Co. v. McClellan, 127 A.D.2d 767, 512 N.Y.S.2d 161 (1987); Teeter v. Allstate Ins. Co., 9 A.D.2d 176, 192 N.Y.S.2d 610 (1959), affd 9 NY2d 655, 173 N.E.2d 47, 212 N.Y.S.2d 71 (1961). Rather, Vehicle and Traffic Law § 313 "supplants an insurance carrier's common-law right to cancel a contract of insurance retroactively on the grounds of fraud or misrepresentation, and mandates that the cancellation of a contract pursuant to its provisions may only be effected prospectively".  Matter of Liberty Mut. Ins. Co. v. McClellan, 127 A.D.2d 767, 769, 512 N.Y.S.2d 161 (1987).  See Cruz v New Millennium Constr. & Restoration Corp., 17 A.D.3d 19, 793 N.Y.S.2d 548, 2005 N.Y. Slip Op. 02336 (3rd Dept., March 24, 2005); Matter of Insurance Co. of N. Am. v. Kaplun, 272 A.D.2d 293 (2d Dept. 2000). See DiDonna v. State Farm Mut. Auto. Ins. Co., 259 A.D.2d 727, 687 N.Y.S.2d 175 (1999).

The statute "places the burden on the insurer to discover any fraud before issuing the policy, or as soon as possible thereafter, and protects innocent third parties who may be injured due to the insured's negligence". Matter of Insurance Co. of N. Am. v. Kaplun, 272 A.D.2d 293 (2d Dept. 2000). (There has been no allegation that the instant insurance carrier effectively cancelled the subject insurance policy pursuant to section 313 prior to the accident).

However, case law has made clear that whereas the policy may not be retroactively cancelled, thereby protecting "innocent third parties who may be injured due to the insured's negligence", Id. at 298, in "an action to recover benefits under a policy, the insurance carrier may assert as an affirmative defense that the insured's misrepresentations and/or fraud in obtaining the policy precludes any recovery by the insured". Id. at 298-299. See AA Acupuncture Serv., P.C. v. Safeco Ins. Co. of Am., 25 Misc.3d 30, 2009 NY Slip Op 29311 (App Term 1st Dept.); A.B. Med. Servs. PLLC v. Commercial Mut. Ins. Co., 12 Misc.3d 8, 2006 NY Slip Op 26118 (App Term 2d Dept.).

To be entitled to bar recovery, an insurer must establish by clear and convincing evidence that an applicant obtained the subject insurance policy by making “material misrepresentations” on the insurance policy application. See Insurance Law § 3105 (b). A misrepresentation is deemed “material” if “knowledge by the insurer of the facts misrepresented would have led to a refusal by the insurer to make such contract”. Id.

Without clear and convincing proof of both a misrepresentation and the materiality of that misrepresentation, a policy application fraud/misrepresentation defense will fail.  Every time.  Even if the amount in dispute is only $339.