Rescission and Application Disclosures

Some insurance applicants aren’t always fully forthcoming on their applications. The reasons for doing it vary, but there are many instances when this approach doesn’t work out well for applicants, and unfortunately sometimes the agent or broker gets swept up in the ensuing storm.

It’s an old subject, but what brings it to mind is the August edition of the Wiley Rein & Fielding newsletter for professional liability insurers. That edition of the law firm’s newsletter had several reports of case decisions adverse to insureds in rescission cases.

Here is one case in point. A law firm, Draper & Goldberg, was the insured. The firm specializes in mortgage foreclosures for lenders. In representing its clients, the firm is routinely named as the successor trustee.

The debtors, in an effort to stop foreclosures, often sue the law firm in its capacity as successor trustee. Sometimes debtors have brought suit alleging violation of statutes regulating debt collectors. In the five years before the insurance application was submitted, the firm was named as a defendant in about 500 such suits, and it received “countless” other claim letters.

The firm viewed most of the claims and suits as frivolous, defended itself and did not report the claims to its professional liability carrier. The firm considered some claims to be problematic; it didn’t report those claims to the carrier, either, but paid settlements from $1,000 to $20,000.

The firm viewed five claims or suits as being serious enough to report to its carriers.

In 2002, the firm’s insurer withdrew from that market. The firm was not happy with quotes it obtained from other carriers. One of the firm’s lawyers met another broker and explained the situation, including the multitude of suits. The broker asked how many claims the firm had reported to the previous carriers. Hearing that it was only a few, the broker felt she could help.

Carolina Casualty Insurance Company was approached. The application in question asked how many “professional liability claims” had been made against the firm in the past five years, and it asked for details on “each claim, suit or circumstance” in the past five years in a supplemental form, one form for each claim or circumstance. One question on the supplemental form asked whether the claim or circumstance had been reported to any carrier.

The firm listed only the five claims it had reported to previous carriers. The lawyer completing the application said he interpreted the question as seeking information only about the claims previously reported to a carrier. He said his interpretation was influenced by the broker’s comments to him at the meeting, in the court’s words, “suggesting the carrier would decide whether to issue a policy based on the reported suits and claims only.”

Based on five claims, the underwriter deemed the firm a slightly higher risk and agreed to insure the firm for a higher deductible and premium. Four months after inception, the firm was sued in a foreclosure action, which it reported to the new carrier. The claim was pled as a class action. Two weeks later a similar case, seeking class action status, was filed in another court. It, too, was reported.

The insurance company’s personnel conducted a computer search which revealed eight prior suits against the firm that had not been disclosed on the application. The carrier hired a law firm to help it, and that firm discovered 24 suits that had not been disclosed. The insured was contacted for an explanation, and the firm responded that it felt only the five reported claims met the question’s criteria as “professional liability claims.”

The carrier brought an action to rescind the policy. The U.S. District Court granted summary judgment for the insured law firm. Carolina Casualty appealed to the U.S. Court of Appeals for the Fourth Circuit which reversed the decision and held that the law firm had made a material misrepresentation on its application. Under applicable law (Virginia), that proof would entitle the carrier to rescind the policy.

The appeals court sent the case back to the district court for further handling, but the Fourth Circuit panel’s decision appears likely to doom the insured’s case. Remaining options would appear to be to ask the three-judge Fourth Circuit panel to reconsider. Reconsideration is rarely fruitful, but there was a dissent by one of the judges, lending some slight hope. Another option might be to gain a hearing by the entire Fourth Circuit panel of judges. The odds of that happening aren’t great. Another option would be to gain relief from the U.S. Supreme Court, perhaps the most difficult accomplishment of all, even to persuade that court to take the case.

Even if the insured firm does prevail, it has incurred significant problems: the cost and time of this litigation with its carrier and potential reputation issues.

If the firm loses the rescission case, it loses coverage for the two proposed class actions. But obviously the damage would not stop there. If the firm is sued an average of 100 times per year and the policy is rescinded, the firm loses coverage for at least the four-month period and for any claims made during that period. That’s assuming the firm was able to immediately replace coverage. Wouldn’t that be a daunting project for a producer under the circumstances? Seems probable there’s an even longer period without coverage.

Even if the firm can find new coverage, it has another problem. It likely has been and will be insured on a claims made basis, and it will have had a disruption in coverage, a gap. Will it be able to keep its prior acts date, or will it have to start anew and lose coverage for all its past acts that might generate claims?

The damage still doesn’t necessarily stop there. Sometimes the insurance producer is brought into non-disclosure and rescission-related cases, either by the insurer accusing the producer of participating in the non-disclosure at issue or by the insured accusing the producer of having led the insured into the problem or failing to properly advise.

Remember in this case the lawyer saying his answer was influenced by the broker’s statements? There is no indication in the case heading that the broker is a defendant. That may not necessarily prevent the firm from attempting to lay blame on the broker in the future. If that did happen, the broker would be fortunate that the client was a law firm because it should provide additional arguments in the broker’s defense.

We remember a case where the client persuaded the producer to not disclose a particular, high risk, new aspect of its business in its renewal application materials to its then-current carrier. But the client directed the producer to provide full information to other carriers when it was seeking competitive quotes. That had the effect of looking like the insured was trying to protect its current coverage by keeping that carrier in the dark, in the event the insured couldn’t find a carrier that would knowingly agree to cover the new high-risk activity. That broker did end up in expensive litigation over a very large sum of money.

The potential injury done by not being complete and accurate in an application can far outweigh the potential detrimental effects of being thorough and accurate. Producers may wish to include in oral and written communications with clients language encouraging the client to fully and accurately disclose all information that is requested in insurance applications. A producer may not know whether the applicant is providing complete and accurate responses, but the producer can help protect the client by advising them to be thorough and can help protect themselves by documenting that the advice was given.

Producers should be especially cautious in how they proceed – and document – when an applicant asks the producer for help in completing an application or supplemental form.

Is there reason to be fearful of full disclosure? Perhaps, if the facts are bad and will affect the terms offered by the underwriter, or will prevent the undewriter from offering terms at all. But clearly non-disclosure can be even worse.

Might some underwriters over-react, in the view of insurance producer and buyer, to some information? Perhaps, but there should then be an opportunity to educate, to try to change the mind of the underwriter. But if material information that is requested by the insurer is not fairly and fully disclosed, the harm can be extensive. And the insured may not be the only party harmed.