Are Insurance Policy Applications Traps for the Unwary?
Are Insurance Policy Applications Traps for the Unwary?
By David A. Gauntlett
Introduction
When applying for insurance coverage, the policyholder must complete a policy application. Completing the policy application can be a tedious process containing a number of questions that, to the average person, can seem convoluted and confusing. This is especially the case as policyholders face questions that do not have objective answers. The complicated nature of policy applications raises serious issues where insurers have the ability to rescind the policy contract if the policyholder misrepresents information provided in their policy application.
Misrepresentation or Concealment of Any Material Information in Policy Applications
California coverage law offers one of the least sympathetic forums to any discrepancy in providing notice of a potential claim in connection with the execution of a policy application. Homeowner’s Associations often delegate the task of executing the application form to board members who may not have complete knowledge of all claims that may necessarily need to be reported to an insurer at the time of its completion. There is a critical distinction between a known lawsuit, which may be easier to acknowledge, understand and reference, than a potential claim based on an event that could create liability but has not yet done so.
Under the California Insurance Code, when a policyholder conceals or misrepresents a material fact on an insurance application, the insurer is entitled to rescind the policy. Specific provisions provide that “each party to a contract of insurance shall communicate to the other, in good faith, all facts within his knowledge which are or which he believes to be material to the contract ….”[1] Concealment, which is the “[n]eglect to communicate that which a party knows, and ought to communicate”[2], “entitles the injured party to rescind insurance.”[3] Similarly, “[i]f a representation is false in a material point … the injured party is entitled to rescind the contract from the time the representation becomes false.”[4]
In a recent case, Atain Specialty Ins. co. v. Lake Lindero Homeowners Association,[5] the Ninth Circuit determined that in completing a policy application, Lake Lindero Homeowners Association (“LLHOA”) concealed material information in response to one of the questions on the policy application thereby entitling Atain to rescission of the policy with no further duty to defend or indemnify Lake Linder Homeowners Association.
When completing a policy application, the newly elected president of the LLHOA allegedly concealed material information when answering the question: Is any person proposed for this insurance aware of any fact, circumstance or situation, which may result in a claim against the Organization or any of its Directors, Trustees, Officers, Employees or Volunteers? The court determined that because the LLHOA had received letters from residents threatening legal action regarding their intention to terminate their contract with the existing management company, in answer Question 19 with “No”, the LLHOA had concealed material information in their policy application. It reasoned:
These circumstances clearly presented risks that claims would be filed against LLHOA or its directors. It is irrelevant that these risks had not yet materialized; the question's purpose was to enable Atain to assess the risks it was underwriting. See Williamson & Vollmer Eng'g, Inc. v. Sequoia Ins. Co., 64 Cal. App. 3d 261, 271-272, 134 Cal. Rptr. 427 (1976). Nor can it be genuinely disputed that the board members knew that termination of the management contract would likely lead LLHOA to be sued. If the board members were aware, so was LLHOA. See Cal. Civ. Code § 2332 (imputation of knowledge). Thus, LLHOA's nondisclosure of the likely contract termination thus amounted to a concealment.[6]
No right to recoupment of defense fees arose as the insurer did not reserve a right to seek reimbursement of the fees paid.[7]
Disputes Arise When Policy Applications Asks Subjective Questions
Unlike the questions in Bleich, some application questions are not objective.[8] Questions that call for information that was not within Insured’s knowledge and may be a more subjective raise concern for policyholders completing a policy application. For these subjective questions, it is unclear what facts and circumstances were being referenced that “may” result in a claim against the Organization or their insured persons. Any answer to this question would require speculation because no objective standard exists to determine what facts or circumstances may lead to a claim by third parties against the insured. In Clarendon National Ins. Co. v. Insurance Co. of the W.[9], the insurer, Clarendon, asserted allegations that an owner of a trucking company intentionally concealed information when answering questions on the policy application. The court held that there was no evidence demonstrating that the company owner, when completing the policy application knew or understood the question on the policy application so as to intentionally conceal information from the carrier. In so ruling, the court established:
Even where misrepresentation or concealment need not be intentional to constitute a defense, rescission of a contract is not permitted for an incorrect or incomplete response if the applicant had no present knowledge of the facts sought or failed to appreciate the significance of information related to him. Trinh v. Metropolitan Life Insurance Co., 894 F.Supp. 1368, 1373 (N.D. Cal. 1995). Where an applicant, acting in good faith, does not understand the significance of the information he fails to disclose, the applicant is not at fault.
Policy Application Question’s Language Creates Ambiguity
Since subjective question in policy applications can be problematic, it is often the case that an average person may be lead astray by the question language causing them to negligently misrepresent themselves. In such cases, it is incumbent on the insurer, as the drafter, to expressly include instances of innocent, negligent conduct leading to misrepresentation of information. [10]
Like Clarendon, in Thompson v. Occidental Life Ins. Co.,[11] the insurer alleged that Thompson failed to report to approximately 10 medical consultations he had at Kaiser Hospital with five different doctors two months before the insurance medical examination. The court found several grounds to support the finding that Thompson did not misrepresent or conceal the material facts. Specifically, the court reasons that Thompson, as an ordinary layman, might have failed to appreciate the significance of the subject matter of the various Kaiser consultations because of the difficult and ambiguous medical terms. [12]
Conclusion
A policy application can grow into a critical aspect of insurance coverage if policyholders, when applying, are not aware of the many traps hidden with the numerous questions. As such it is pertinent that policyholders complete their policy applications mindfully and, if possible, under advisement of coverage counsel who has expertise in interpreting and potential concerns when addressing the complexities of policy language.
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[1] Ins. Code, § 332.
[2] Ins. Code, § 330
[3] Ins. Code, § 331
[4] Ins. Code, § 359
[5] Atain Specialty Ins. co. v. Lake Lindero HOA, Case No. 21-55319, 2022 U.S. App. LEXIS 3313 (9th Cir. (Cal.) Feb. 7, 2022)
[6] Id. at *3-4
[7] Scottsdale Ins. Co. v. MV Transportation, 36 Cal. 4th 643, 656 (2005) (“[The insurer must] announce… [reservation of rights to] permit the insured to decide whether to accept the insurer’s terms for providing a defense…”); See also, David A. Gauntlett, The Implied Right to Recoupment – A Tale of Smoke and Mirrors. www.gauntletlaw.com (Jun. 21, 2021).
[8] Allianz Life Ins. Co. of Am. v. Estate of Bleich, 2012 U.S. Dist. LEXIS 28406, *21 (D.N.J. Mar. 5 2012) (“In determining whether Bleich made a misrepresentation, this Court must first consider whether the misrepresentation was in response to a subjective or objective question on the application... A question is objective if it "call[s] for information within the applicant's knowledge, 'such as whether the applicant has been examined or treated by a physician’… [subjective questions] seek to probe the applicant's state of mind… [As such], [c]ourts have been more lenient when reviewing an applicant's misrepresentation made in response to a subjective question than to an objective question.’”)
[9] Clarendon Nat'l Ins. Co. v. Ins. Co. of the West, 442 F. Supp. 2d 914, 936-37 (E.D. Cal. 2006)
[10]Id. at 931-933 (“An insurer has an obligation to use such language as to make the conditions, exceptions and provisions of a policy clear to the ordinary mind engaging in a plain, commonsense reading of the terms; if the insurer's language should fail, any ambiguity or reasonable doubt must be resolved in favor of the insured and against the insurer. It is established that ambiguous terms are resolved in the insured's favor, consistent with the insured's reasonable expectations. Safeco Ins. Co. of America v. Robert S., 26 Cal.4th 758, 763,..(2001).”)
[11] Thompson v. Occidental Life Ins. Co., 9 Cal. 3d 904 (1973)
[12] Id. at 912 (“[A]ny such condition must state in conspicuous, unambiguous and unequivocal language which an ordinary layman can understand. As the insurer is responsible for drafting the application, it is appropriate that he be required to choose plain and unequivocal terms”)