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.).

* * * * *

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.

Denial of Summary Judgment to Property Insurer on its Material Misrepresentation Defense Affirmed

COMMERCIAL PROPERTY – MATERIAL MISREPRESENTATION – SUMMARY JUDGMENT
Classon Realty Corp. v. Tower Ins. Co. of N.Y.
(2nd Dept., decided 12/8/2009)

It's tough winning summary judgment on a fraud/material misrepresentation defense during a first-party action.  Intent to defraud and materiality are issues that often involve questions of fact, requiring a trial.  Such was the case in this matter. 

Tower denied first-party property coverage to the plaintiff based , at least in part, on what Tower contended were the insured's material misrepresentations during Tower's investigation of the insured's claim.  The insured commenced this breach of contract action against Tower, and Tower moved for summary judgment on its material misrepresentation defense.

In AFFIRMING Kings Supreme's denial of Tower's motion, the Second Department held:

The proponent of a motion for summary judgment must establish its entitlement to judgment as a matter of law by demonstrating that there are no triable issues of fact (see Winegrad v New York Univ. Med. Ctr., 64 NY2d 851, 853). The defendant failed to demonstrate that there are no triable issues of fact regarding whether the plaintiff insured made material misrepresentations during the defendant's investigation of the plaintiff's claim (see Christophersen v Allstate Ins. Co., 34 AD3d 515; Fine v Bellefonte Underwriters Ins. Co., 725 F2d 179, 183, cert denied 469 US 874). Accordingly, the Supreme Court properly denied the defendant's motion for summary judgment dismissing the complaint.

Christophersen involved a fraudulent claim exaggeration defense.  Allstate contended that the insured had attempted to defraud Allstate by including inaccurate information in his sworn proofs of loss.  In affirming the motion court's denial of Allstate's request that it search the record and award it summary judgment, the Second Department reiterated several principles applicable to first-party property insurers' fraud and material misrepresentation defenses:

A policy of insurance is vitiated where the insured has " 'willfully and fraudulently placed in the proofs of loss a statement of property lost which he did not possess, or has placed a false and fraudulent value upon the articles which he did own' " (Saks & Co. v Continental Ins. Co., 23 NY2d 161, 165 [1968], quoting Domagalski v Springfield Fire & Mar. Ins. Co., 218 App Div 187, 190 [1926]). However, "unintentional fraud or false swearing or the statement of any opinion mistakenly held are not grounds for vitiating a policy" (Sunbright Fashions v Greater N.Y. Mut. Ins. Co., 34 AD2d 235, 237 [1970], affd 28 NY2d 563 [1971]). While there is no question that the plaintiff gave the defendant Allstate Insurance Company (hereinafter Allstate) inaccurate information in his original proof of loss statements, a triable issue of fact exists as to whether the plaintiff thereby intended to defraud Allstate (see e.g. St. Irene Chrisovalantou Greek Orthodox Monastery v Cigna Ins. Co., 226 AD2d 624 [1996]; cf. Pipo Bar & Rest., Inc. v Certain Underwriters at Lloyd's at London, 15 AD3d 556, 557 [2005]; Rickert v Travelers Ins. Co., 159 AD2d 758, 760 [1990]).

Further, a triable issue of fact exists regarding whether the plaintiff's other alleged misrepresentations were sufficiently material to warrant the denial of coverage under the policy. Indeed, "[t]he issue of materiality is generally a question of fact for the jury [and] . . . [c]onclusory statements by insurance company employees . . . are insufficient to establish materiality as a matter of law" (Parmar v Hermitage Ins. Co., 21 AD3d 538, 540-541 [2005]; see Lenhard v Genesee Patrons Co-op. Ins. Co., 31 AD3d 831 [2006]).

Policy Rescission Granted for Material Misrepresentations in Application

COMMERCIAL PROPERTY – FIRE LOSS – MATERIAL MISREPRESENTATION IN APPLICATION – RESCISSION – WAIVER – ESTOPPEL – TIMELINESS OF DENIAL
Precision Auto Accessories, Inc. v. Utica First Ins. Co.
(4th Dept., decided 6/6/2008)

Plaintiff's business was destroyed by fire. After an investigation, Utica First notified plaintiff that it was denying coverage and rescinding the policy based on material misrepresentations made in plaintiff's insurance application with respect to plaintiff's prior loss and claims history. Plaintiff sued for coverage, and the parties moved and cross-moved for summary judgment. Supreme Court denied both motions.

The Fourth Department MODIFIED and granted summary judgment to Utica First, holding that it was entitled to rescind the policy because it established as a matter of law that plaintiff had made material misrepresentations such that Utica First would not have issued the policy had it known the true facts. "To establish materiality of misrepresentations as a matter of law, the insurer must present documentation concerning its underwriting practices, such as underwriting manuals, bulletins or rules pertaining to similar risks, to establish that it would not have issued the same policy if the correct information had been disclosed in the application[.]"

In support of its motion, Utica First submitted the affidavit of its president, who set forth Utica First's minimum underwriting guidelines for prior losses for a risk such as plaintiff's business. Attached to the affidavit was a copy of defendant's underwriting guidelines "for the relevant period," which corroborated the applicable minimum underwriting requirements set forth by Utica First's president concerning prior losses for risks such as plaintiff's business. Utica First's president further stated in his affidavit that, "if [defendant] had been aware of plaintiff's true loss history . . . [defendant] would not have issued a policy of insurance to plaintiff."

The Fourth Department agreed with Utica First that the misrepresentations did not need to be willful in order to rescind the contract.

Insurance Law § 3105 (b) does not specify that a misrepresentation must be willful, and '[w]hether or not plaintiff intended to provide inaccurate statements or misrepresentations at the time [it] filled out the application is irrelevant" (Curanovic, 307 AD2d at 437). Rather, a "material misrepresentation, even if innocent or unintentional, is sufficient to warrant a rescission of the policy" (citations omitted). Although plaintiff contends that, pursuant to the terms of the policy, defendant is required to establish that plaintiff's misrepresentations were willful, when an insurance policy is void ab initio based on material misrepresentations in the application, it is as if the policy never came into existence, and an insured cannot create coverage by relying on the terms of a policy that never existed[.]

Plaintiff argued that Utica First could not rely on any misrepresentations in the application because they were the result of the negligence of Utica First's alleged agents. In rejecting that argument, the appellate court noted:

Plaintiff is bound by the misrepresentations in the application, inasmuch as "[t]he signer of a contract is conclusively bound by it regardless of whether he or she actually read it" (citation omitted). Further, an insured "ha[s] a duty to review the entire application and to correct any incorrect or incomplete answers". Additionally, "an insurance broker is generally considered to be an agent of the insured" (citation omitted). "To establish that the broker was acting as the insurer's agent, [t]here must be evidence of some action on the insurer's part, or facts from which a general authority to represent the insurer may be inferred" (citation omitted). Although the insurance agency that bound the coverage may have been an agent of defendant, the broker who completed the application was hired by plaintiff as its agent and was an independent contractor with no connection to defendant.

Plaintiff next argued that Utica First waived its right to rescind the policy because it knew of plaintiff's misrepresentations concerning plaintiff's loss history before the fire. The court rejected that argument, finding deposition testimony of the plaintiff's insurance broker that she heard within two hours of the fire that Utica First was going to rescind the policy based on the plaintiff's prior losses to be both speculative and inadmissible hearsay. "Moreover, even assuming that defendant acquired knowledge of plaintiff's actual loss history before the fire, we conclude that such knowledge, by itself, is insufficient to constitute a waiver because plaintiff has failed to establish that it paid a premium to defendant after defendant allegedly acquired that knowledge."

Plaintiff's final argument was that Utica First was estopped from disclaiming coverage because it took eight months to do so. In opposition to that argument, Utica First contended that its investigation into plaintiff's loss history was ongoing and was delayed based on the lack of cooperation by plaintiff in providing an adequate authorization for its previous insurer's records. In rejecting the plaintiff's untimely disclaimer argument, the Fourth Department held:

Here, even assuming, arguendo, that defendant's notice of disclaimer was untimely, we conclude that defendant is not estopped from rescinding the policy as void ab initio inasmuch as, contrary to plaintiff's contention, plaintiff failed to demonstrate any prejudice based on defendant's alleged delay in disclaiming coverage (citations omitted). Although plaintiff contends that it was prejudiced because, without the insurance proceeds, it was unable to pay its suppliers and otherwise to re-start its business, it failed to identify any triable issue of fact whether it was prejudiced by the delay with respect to the asserted ground for rescission, i.e., the purported misrepresentations made in the insurance application.

With respect to the plaintiff's untimely disclaimer argument, it is important to bear in mind that Insurance Law § 3420(d) applies only to liability coverage disclaimers and denials for bodily injury or death claims arising from accidents that occur in New York. It does not apply to first-party property coverage denials. Only the equitable doctrines of waiver or estoppel can apply to preclude an insurer from denying first-party property coverage.

Interior Painting or General Contracting? -- Question of Fact Found on Insurer's CGL Policy Rescission Defense

CGL – APPLICATION MISREPRESENTATION – RESCISSION – MATERIALITY – PROOF OF PAST UNDERWRITING PRACTICES
Kiss Construction NY, Inc. v. Rutgers Cas. Ins. Co.
(Sup.Ct., NY Co., decided 4/16/2008)

There are plenty of reported New York cases addressing the legal consequences of an insured's policy application misrepresentations on first-party property coverage claims. Ones involving third-party claims and coverages are much rarer.

In May 2002, Kiss Construction applied for a new CGL policy covering its business. Kiss Construction’s application for coverage stated that the nature of its business was “Painting-100% - 100% Interior”. Rutgers Casualty issued the new CGL policy for the inception period of May 30, 2002-2003. The Declarations page of the inception policy identified Kiss Construction’s business solely as a “painting contactor”.

Prior to the policy’s first renewal, Rutgers’ underwriting department required Kiss Construction to submit a Policyholder’s Report, which asked for certain information regarding the number of employees, annual payroll, and gross annual receipts in order to determine the premium’s basis. Rutgers did not require Kiss Construction to complete and submit any renewal applications. The policy was renewed for 2003-2004 and again for 2004-2005.

On August 9, 2004, during the second renewal period, Kiss Construction entered into a contract to build a three-family home in Bronx, New York. On November 11, 2004, a passerby allegedly was injured in a slip and fall on the sidewalk/roadway bordering the project. In early 2005, that person commenced a personal injury action against Kiss Construction and the property’s owner.

Kiss Construction notified Rutgers of the lawsuit promptly and requested defense and indemnification coverage. By letter dated March 2, 2005, Rutgers reserved its rights and assigned counsel. The ROR letter stated that Rutgers was reserving its right to disclaim coverage based on a possible violation of the following policy language:

[b]y accepting this policy, you agree:

a. The statements in the Declarations are accurate and complete;
b. Those statements are based upon representations you made to us; and
c. We have issued this policy in reliance upon your representations[.]

Two weeks later, Rutgers disclaimed coverage based on what Rutgers asserted was the insured’s policy application misrepresentation regarding the nature of its business. The D&D letter stated that:

[i]t was in reliance of this statement that a Commercial Insurance Policy was issued to you. Had we known that your company was actually engaged in the building of homes, this policy would never have been issued. Therefore this constitutes a material misrepresentation and as such we are at this time disclaiming coverage.

The disclaimer letter also advised Kiss Construction that Rutgers would no long be affording defense and indemnification coverage in relation to the underlying personal injury action. [Query: I thought it was the "rule" in New York that retained defense counsel once appointed cannot be withdrawn without a judicial declaration of non-coverage.]

Kiss Construction then commenced this action, seeking a declaratory judgment against Rutgers. In its answer, Rutgers asserted several affirmative defenses, including that “[a]s a result of Plaintiffs material misrepresentation the Rutgers’ policy is void ab initio”. Rutgers eventually made a motion to dismiss the complaint on this ground.

In denying Rutger’s initial motion to dismiss, the court found that Rutgers: (1) had not established that the insured’s application representation – that it only did interior painting – was false at the time of the policy’s application in May 2002; and (2) had failed to meet its burden of establishing the materiality of the alleged misrepresentation by “clear and substantially uncontradicted evidence”, as it had failed to proffer evidence sufficient to show that its underwriting guidelines would have prohibited it from issuing the policy to Kiss Construction, or that it previously had denied coverage to other businesses under similar circumstances.

Following the completion of discovery, both Kiss Construction and Rutgers moved for summary judgment. In again denying Rutgers' motion, Justice Herman Cahn held that although Rutgers

has proffered adequate documentation to establish that contractors engaged in demolition, foundation work, roofing work, or general contracting were ineligible for coverage under its underwriting guidelines, it has offered only unauthenticated emails and correspondence as proof that it refused to underwrite coverage for such activities in the past; these unauthenticated submissions are insufficient to prove Rutgers’s [sic] underwriting practices with respect to similar applicants under similar circumstances. Moreover, although Rutgers has produced evidence sufficient to establish that Kiss Construction was engaged, as a general contractor, in the construction of a multi-family dwelling on the date of the occurrence, the parties have presented conflicting accounts as to when Kiss Construction first became involved in home construction or general contracting activities, and thus, whether it had been involved in such activities at the time it first applied for the commercial general liability policy at issue.

The court granted partial summary judgment to Kiss Construction and ordered Rutgers to provide a defense in the underlying action until a judicial determination was made on Rutgers' rescission defense. The court rejected plaintiff's argument, however, that Rutgers' failure to rebate the policy premium estopped or precluded Rutgers from seeking to rescind the policy in this litigation, holding:

Where, as here, Rutgers must await a judicial determination in order to rescind the policy retroactively, it is, at best, arguable, whether Rutgers’s [sic] failure to tender the return of Kiss Construction’s premium, or its subsequent issuance of a letter of non-renewal, should be deemed an estoppel on its right to seek such rescission. Nevertheless, in the event that Rutgers does establish a right to rescind, and the policy is declared void ab initio, Kiss Construction will then be entitled to the return of all premiums and other payments made to Rutgers.

In the end, after two rounds of dispositive motions, Rutgers was found obligated to defend Kiss Construction while its rescission defense proceeded to trial.