Ignorance of the Law Creates Dangerous Falsehoods

Agents Who Lie to Insurers

Some years ago my solution to a mid-life crisis was to buy a custom made replica of the Studebaker Avanti, a fiberglass sports car powered by a 5 Liter V-8.

After I bought my dream car I found it was almost impossible to insure because the manufacturer only made 400 a year. My insurer cancelled me because it could not calculate an appropriate premium. I went to my neighborhood direct writer who had no problem insuring the car. The agent filled out a lengthy application form and handed it to me to sign.

Much to the agent’s surprise I actually read the application and found he had marked the form showing “no cancellations.” I had told him of the cancellation and asked why he had put a false statement in the application.

“It’s not important,” he responded “you weren’t cancelled for cause.”

The application only asked if I was cancelled so I insisted he correct the application. The insurance was issued. Had I allowed the application to go through as filled out and had a claim I would have faced a situation where I might have had no coverage. Of course, if I could prove that the agent of the direct writer had the knowledge of the prior cancelation, I could have defeated a claim of rescission, but with difficulty. If I did, the agent would have found himself liable to the insurer for any claim it paid to me.

In most states a mutual mistake of material fact, a unilateral mistake of material fact, the breach of a warranty, a material concealment, or a material misrepresentation can all be grounds for rescission. When an insurer is deceived, regardless of the intent of the deceiver, the remedy of rescission is available to the insurer. Rescission is an equitable remedy that was created by ancient ecclesiastical courts in England. When an insurance policy is rescinded it places the parties back in the position they were in before the contract date. The insured gets the premium back and the insurer gets back the policy as if there was never a contract.

Insurers usually use the remedy with care. As one court put it after agreeing that a rescission was proper:

Our conclusion here should not result in an assumption by insurers that policy liability can, with impunity, be avoided or delayed by assertion of a claim for rescission. That is a tactic which is fraught with peril. Where no valid ground for rescission exists, the threat or attempt to seek such relief may itself constitute a breach of the covenant of good faith and fair dealing which is implied in the policy.  (Emphasis Added) [Imperial Casualty & Indemnity Company v. Levon Sogomonian, 198 Cal. App. 3d 169 (1988)]

In a decision of the California Court of Appeal a man named Mitchell was the named insured of an insurance policy issued by United National Insurance Company whose commercial building was destroyed by an arson fire. The policy provided Mr. Mitchell with coverage for a commercial building in Los Angeles. During the policy period, the building was destroyed by arson. United National discovered several misrepresentations in Mitchell’s application for insurance, obtained the advice of counsel and rescinded the policy. Mitchell sued. The trial court granted summary judgment to the insurer because the application made material representations upon which United National’s underwriter relied in deciding to insure Mitchell which included matters that should have been learned by his agent and avoided. For example Mitchell misrepresented:

  • The property was not owned by Mr. Mitchell but by a family trust.
  • The property was vacant.
  • The property had been previously insured by the FAIR Plan, an insurer of last resort, who had cancelled.
  • The property had been condemned by the city. [James E. Mitchell, Individually and as Trustee of the Mitchell Family Trust v. United National Insurance Company, 127 Cal.App.4th 457, 25 Cal.Rptr.3d 627 (2005)]

The trial court granted summary judgment in United National’s favor and the Court of Appeal affirmed finding “as a matter of law on the undisputed facts that the information sought by United’s underwriter and denied to it by plaintiff’s false answers and omissions was material to United’s decision to provide insurance coverage.”

The investigation of the broker, and the broker’s actions can provide an insurer with an opportunity to recover losses due to fraud from a person with assets rather than a fraud perpetrator whose only source of income may have been the fraudulent claim. The Fourth District California Court of Appeal, in Century Sur. Co. v. Crosby Ins., Inc., 124 Cal. App. 4th 116 (2004), allowed an insurer to seek damages from the insurance broker who submitted to it a fraudulent and false application for insurance.

The case established that Crosby Insurance Inc. submitted to Century Surety Co. an insurance application for Baroco West Inc. The application classified Baroco as a “drywall” contractor. Century issued a policy in reliance upon the facts represented in the application. A construction defect action was filed against Baroco as the “general” contractor. Century undertook the defense but later withdrew after discovering Baroco’s insurance application contained false information. Century sued Crosby for losses caused by Crosby’s alleged fraud, negligence and negligent misrepresentation. The application incorrectly classified Baroco and was supported by a forged letter from Crosby’s office stating that Baroco had no losses for two years.

Crosby argued that Century’s exclusive remedy was against the insured, Baroco. The trial court agreed and sustained the demurrers without leave to amend. The Court of Appeal reversed the trial court decision. The Court of Appeal concluded that liability may be imposed on a broker in an insurer’s action to recover losses caused by a broker’s fraud in the application process. It also found that public policy supports imposing a duty on brokers to prepare applications with reasonable care. Failure to use reasonable care can result in the broker paying for the insurer’s loss.

The case established that Crosby Insurance Inc. submitted to Century Surety Co. an insurance application for Baroco West Inc. The application classified Baroco as a “drywall” contractor. Century issued a policy in reliance upon the facts represented in the application. A construction defect action was filed against Baroco as the “general” contractor. Century undertook the defense but later withdrew after discovering Baroco’s insurance application contained false information. Century sued Crosby for losses caused by Crosby’s alleged fraud, negligence and negligent misrepresentation. The application incorrectly classified Baroco and was supported by a forged letter from Crosby’s office stating that Baroco had no losses for two years.

Crosby argued that Century’s exclusive remedy was against the insured, Baroco. The trial court agreed and sustained the demurrers without leave to amend. The Court of Appeal reversed the trial court decision. The Court of Appeal concluded that liability may be imposed on a broker in an insurer’s action to recover losses caused by a broker’s fraud in the application process. It also found that public policy supports imposing a duty on brokers to prepare applications with reasonable care. Failure to use reasonable care can result in the broker paying for the insurer’s loss.

To avoid litigation from the client of an insurance agent or broker when the clients’ policy is rescinded, the insurance agent or broker must, when obtaining an application for insurance, explain to the proposed insured the importance of truthful and accurate responses to the questions. The agent or broker should never make subjective decisions on the importance of facts to a particular insurer.

In that regard consider Century Sur. Co. v. Crosby Ins., Inc., held that policy reasons support imposing a duty on insurance brokers to exercise reasonable care in preparing insurance applications under the facts alleged in the cross-complaint. When the broker knows of actual misstatements, the broker may be held liable for transmitting those misrepresentations in an insurance application knowing the insurer will reasonably rely on them.

The prudent agent or broker should ask the proposed insured each and every question on the application for insurance. None should be skipped even if they seem to have no relevance to the particular insured. The agent or broker should also insist that the insured read the application and affirm that all of the answers are correct before it is signed. If the insured refuses, or cannot read English, the agent or broker should read the application to the insured or have it translated into a language the applicant understands. The application process should be noted in the agent or brokers log and the insured should be asked to sign the application.

Defense counsel, faced with grounds for rescission should always contact – if an agent is involved – the agent to determine if his records or memory establish that he knew (but did not disclose to the insurer) the facts that were misrepresented or concealed. If the facts were known to the agent the remedy of rescission is not available to the insurer and the claim should be paid. Claim must then be made to the agent for the amount paid.

Insurers whose agents – by misrepresentation or concealment – must consider the agent to be a source of indemnity for the costs of investigation and payment of claims on a policy that should never have been issued.

The agent who learns of a material fact that is not reported to the insurer faces suit from either the insurer or the insured, or both. The prudent insurance agent will always report to the insurer and its underwriter all facts he or she learns from the potential insured. If the agent is not prudent and hides material information from the insurer he or she represents should immediately give notice of a potential claim to his errors and omissions insurer.

The insurance adjuster, needing to complete a thorough investigation as required by fair claims practices statutes, work as a regular practice, asking each insured every question on the application for insurance. If there is a discrepancy between the statements made by the insured at the time of the investigation and those made by the application the adjuster must not assume the investigation is complete. The adjuster must go to the offices of the agent or broker and obtain a complete copy of the file and ask the agent or broker if he knew of the true facts as related by the insured.  The adjuster must collect the contract between the agent or broker and the insurer to clarify their relationship. Finally, the adjuster should submit the findings of the investigation to competent coverage counsel for advice on whether the remedy of rescission or voidance is available to the insurer.


© 2019 – Barry Zalma

This article, and all of the blog posts on this site, digest and summarize cases published by courts of the various states and the United States.  The court decisions have been modified from the actual language of the court decisions, were condensed for ease of reading, and convey the opinions of the author regarding each case.

Barry Zalma, Esq., CFE, now limits his practice to service as an insurance consultant  specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud almost equally for insurers and policyholders. He also serves as an arbitrator or mediator for insurance related disputes. He practiced law in California for more than 44 years as an insurance coverage and claims handling lawyer and more than 50 years in the insurance business. He is available at http://www.zalma.com and zalma@zalma.com.

Mr. Zalma is the first recipient of the first annual Claims Magazine/ACE Legend Award.

His newest book:

THE HOMEOWNERS INSURANCE POLICY

HOW TO BUY AN APPROPRIATE HOMEOWNERS POLICY AND SUCCESSFULLY MAKE A CLAIM TO THE INSURER

Insurance is a contract between a person seeking insurance and an insurer. It is obtained by making contact with the insurer as a prospective insured seeking insurance. The homeowners policy is a specialized policy of insurance that protects the homeowner from certain risks of loss to the real and personal property at the home, the exposure the insured faces for injury to a household employee, and the exposure the insured faces to liability for bodily injury or property damage caused to third parties. The book explains how to buy a homeowners policy and how to collect on any claim made to the homeowners insurer.

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About Barry Zalma

An insurance coverage and claims handling author, consultant and expert witness with more than 48 years of practical and court room experience.
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