Kenneth A. McLellan, Esq.
It’s likely that you’ve been there more than once in your career. A potential customer --- a prospective insured ---makes an inquiry concerning his needs for life, disability or other kinds of insurance, but something just doesn’t seem right, and the alarm bells start to go off. Your customer won’t look you in the eye. He seems nervous. Your customer seems overly anxious or overly insistent that you submit the application as soon as possible. He answers questions in a way that make you think there might be more to the story, using qualifiers such as “not that I can remember right now” or has a suspicious lack of memory with regard to events one should remember such as past surgeries or hospitalizations. Perhaps the applicant who told you he’s never smoked cigarettes has minty-fresh breath, but nicotine-stained fingers. Or, the person who claims to have a seven-figure net worth is wearing a shabby pair of shoes and an inexpensive wrist-watch. Perhaps the proposed insured asks questions that are a little too precise for your liking, or seems to know more about the process than the average applicant, making you wonder if he’s been through the process before. Maybe your potential customer is asking detailed questions about the contestability period or using specialized vocabulary only someone in the industry would normally use. The instincts you’ve developed over the years in dealing with people raise your suspicions. So what do you do?
This situation places the professional insurance agent in a difficult predicament. On the one hand the agent wants to serve his customer, educate him on the best product for his needs, get him the best deal possible, place insurance for him and, ideally, have a happy customer who will hopefully be a repeat customer and generate more sales leads. On the other hand, the insurance carrier for whom you are an agent considers you a field underwriter. What are your duties? How do you protect the interests of your customer? How do you protect yourself from exposure to liability and litigation? The short answer is --- make your potential customer aware that being less than honest could harm his family or himself by jeopardizing the very coverage for which he is applying. Misrepresentation of a material fact in an application can lead to rescission [voiding] of the policy. With respect to protecting yourself from liability, the more carefully you can document and muster evidence that you made your customer aware of the consequences of misrepresentation, the better your position, should litigation ensue at a later date.
The keys are to educate yourself about your duties in this situation, educate the customer about the consequences of a misrepresentation (even an innocent one) on an application and document your practices.
There are five basic steps you can take to protect your customer and yourself in this situation:
1. Warn of the consequences of a material misrepresentation, and educate your customer about the manner in which a claim for rescission (voiding of the policy) will present itself procedurally;
2. Encourage your customer to be forthcoming;
3. Highlight the fraud warnings;
4. Document...document...document; and
5. As a last resort, do not accept the application.
An Insurance Agent’s Duty --- Generally Speaking
A jurisdiction such as New York charges the agent with simply obtaining the requested coverage or informing the client that he cannot within a reasonable amount of time. In contrast, a jurisdiction such as New Jersey places higher burdens on its agents, calling them fiduciaries --- i.e., a relationship of trust and confidence --- where the agent is called upon to possess reasonable knowledge of the types of policies, their different terms and the coverage available in the area in which his principal seeks to be protected. A client may successfully argue in New Jersey that he does not have the obligation to read the policy upon receiving it, as the broker, not the customer is the expert. That being said, even in New Jersey, a client cannot impede the broker or agent by withholding information.
In order to determine what an insurance agent’s duties are when he suspects his client is being less than forthcoming in connection with his application for insurance, it is helpful to review an insurance agent’s duties, generally speaking. These duties vary from state to state. For example, in New York, the leading case is Murphy v. Kuhn, 90 N.Y. 2d 266; 682 N.E.2d 972; 600 N.Y.S.2d 371 (1997). In that case, New York’s highest Court, the Court of Appeals, held that “insurance agents have a … duty to obtain requested coverage for their clients within a reasonable time or inform the client of the inability to do so; however they have no continuing duty to advise, guide or direct a client to obtain additional coverage.” The Court in the Murphy case reviewed the law in other jurisdictions, including Iowa, Arizona and Michigan, finding that an additional duty of advisement can occur in exceptional circumstances in three situations, which are: (1) when an agent receives compensation for consultation apart from the payment of premium; (2) when there was some interaction regarding a question of coverage, relying on the expertise of the agent; and (3) when there is a course of dealing over an extended period of time which would have put objective reasonable insurance agents on notice that their advice was being sought. See 90 N.Y.2d at 272. However, the Court made it clear that it is well settled that agents “have no continuing duty to advise, guide or direct a client to obtain additional coverage. “ See 90 N.Y.2d at 273. And further, the Court pointed out that “insurance agents or brokers are not personal financial counselors approaching guarantor status. Insureds are in a better position to know their personal assets and abilities to protect themselves more so than general insurance agents and brokers. “ See 90 N.Y.2d at 273. The Court was concerned with opening the ”flood gates of liability” to insurance agents and brokers, and further, held that “unlike a recipient of the services of a doctor, attorney or architect…the recipient of the services of an insurance broker is not at a substantial disadvantage to question the actions of the provider of services.” See 90 N.Y.2d 273.
The New York State Court of Appeals, a few years after Murphy, in the context of analyzing a statute of limitations issue, held that insurance agents and brokers were not subject to the statute of limitations applicable to non-medical malpractice. In essence, the Court held that insurance agents and brokers are not “professionals.” See Chase Scientific Research, Inc., v. NIA Group, Inc., 96 N.Y.2d 20; 749 N.E.2d 161; 725 N.Y.S.2d 592 (2001). This holding seems to be harmonious with the Court of Appeals’ earlier holding in Murphy in that the Court is unwilling to expand the liability of insurance agents and brokers beyond either procuring coverage for a customer or advising they cannot do so.
In contrast to New York, New Jersey takes a different view of an insurance agent’s duties and liability. In Aden v. Fortush, 169 N.J. 64, 776 A.2d 792 (2001), the New Jersey Supreme Court essentially prohibited an insurance broker from blaming his customer’s damages on his customer’s own failure to read his policy. In that case, the Court specifically held that the comparative negligence defense is unavailable to a professional insurance broker who asserts that the client failed to read a policy and failed to detect the broker’s own negligence. The Court went on to find that it is the broker, not the insured, who is the expert and the client is entitled to rely on that professional’s expertise in faithfully performing the very job he was hired to do.
In Aden the Court held that an insurance broker has a fiduciary relationship with his client. In fact the Court held that “…insurance intermediaries in [New Jersey] must act in a fiduciary capacity to the client ‘because of the increasing complexity of the insurance industry and the specialized knowledge necessary to understand all of its intricacies.’(internal citation omitted).” See 169 N.J. at 24-5. However, it is important to note that the Court found that if a client impedes the professional by, for example, withholding information or failing to provide certain information, the client’s conduct may constitute comparative negligence unless the professional’s scope of employment included an obligation to prevent such conduct.
States like New Jersey place a greater burden on insurance brokers expecting them to “possess reasonable knowledge of the types of policies, their different terms and the coverage available in the area in which his principal seeks to be protected” and holding them liable if they fail to procure insurance, if the policy is void or materially deficient, or does not provide the coverage they undertook to supply because of their failure to exercise the requisite skill or diligence. See 169 N.J. 25-6.
Material Misrepresentations --- What are the Consequences?
Quite simply, a material misrepresentation in an application can support an insurance carrier’s claim of rescission --- that is, setting aside or voiding the policy contract --- leaving the applicant or his beneficiaries without the benefits the Insured applied for. If the agent is aware of a material misstatement, and knows the insurer will reasonably rely on them, he himself could be held liable to the insurer. When the carrier takes the position that it is going to rescind the policy, it can lead to accusations by the beneficiaries that the agent made mistakes on the application, didn’t record answers to questions on the application properly, didn’t ask all the questions on the application, and the situation can easily devolve into a he-said vs. she-said. You may have been a couple’s friendly insurance agent for years, but when a husband and wife were present at the execution of an application, and the husband dies, the widow may have a very different recollection of your interactions and events at the meeting when the application was taken. A seven-figure benefit hanging in the balance sometimes changes or influences a witness’ recollection. You may have taken hundreds of applications in the year when an application in question was taken, and the application in question may have been taken years before a claim is made against you. You may not have documentation about discussions you had with the proposed Insured, and his or her spouse.
This can sometimes place the agent in a position of fighting a war on two fronts: (1) against the beneficiaries of his deceased customer who claim that the agent was somehow negligent in the taking of the application, and (2) the insurance carrier who takes the position that the policy should be rescinded, and, if there were any errors or fraud associated with the taking of the application, it is the agent’s fault. Some carriers will opt to press claims or threaten to pursue claims for indemnification --- that is, payment --- by the agent of any award against the carrier, and for defense costs incurred by the carrier in defending the claim, which can be substantial (easily six-figures.)
But the trouble caused for an agent by his customer’s material misrepresentations can go further. Suppose a Court finds that a misstatement is attributable to the misconduct or even fraud of an agent. Assume the policy contains a statement to the effect that “no agent is authorized to make or alter contracts or to waive any of the insurance carrier’s rights or requirements.” In that instance, if an agent is named in a suit, the insurance carrier might be dismissed from the case, while, theoretically, the customer may still have a potentially valid claim against the agent. The carrier may seek indemnity --- that is, payment or reimbursement --- from the agent based on its contract with the agent, for costs [attorneys’ fees and expenses] it expended in defending itself against the customer claims.
It is instructive to look at how Courts treat rescission claims in some of the more heavily populated jurisdictions.
New York
New York Courts will not hesitate to grant an insurance carrier's claim for rescission if they find a material misrepresentation. In Northwestern Mutual Life Ins. Co v. Colaio, 1997 U.S. Dist Lexis 23896, (EDNY 1997), a case involving Northwestern Mutual's claim for rescission of a disability income insurance policy, the Court discussed New York's Insurance Law Section 3015(b) which states that "no misrepresentation shall avoid a contract of insurance unless the representation is 'material,' and no representation is to be deemed material unless knowledge by the insurer of the facts misrepresented 'would have led to a refusal by the insurer to make the contract.'" In that case, the customer argued that "the insurance agent and the medical examiner told him that only major medical matters had to be disclosed." The customer failed to disclose a visit to a doctor who diagnosed lower spinal stenosis. The Court was not swayed by the customer's argument, finding that his "contentions had no substance" and pointing out that "nothing in the application suggests that the applicant is to disclose only visits to doctors concerning ailments he believes serious. Whether a matter is serious or trivial is for the insurer not the applicant to decide. Citing Leamy v. Berkshire Life ins. Co., 39 N.Y.2d 271, 383 N.Y.S.2d 564, 347 N.E.2d 889 (1976)." Fortunately, it does not appear the agent was a party to the case.
In Mutual Benefit Life Insurance Company v. JMR Electronics Corp., 848 F.2d 30 (2nd Cir. 1988), the Court granted rescission of a life insurance policy when the applicant misrepresented that he had never smoked cigarettes. The Court rejected the applicant’s contention that the misrepresentation was not material, and that the insurer, aware of the smoking history would have provided insurance, but simply have charged a higher premium. The Court observed that “the question is not whether the company might have issued the policy if the information had been furnished, the question in each case is whether the company has been induced to accept an application which it might otherwise have refused." See 848 F.2d. at 32.
Massachusetts
In another case involving a disability insurance policy, the Court discussed Massachusetts’ standard for rescission. The Court noted that "under Massachusetts’ law, in order to void or rescind a policy of insurance or deny a claim based upon misrepresentations in an application for insurance, the insurer must demonstrate the misrepresentations were made with intent to deceive or that they increased the risk of loss to the insurer." See Northwestern Mutual Life Ins. Co. v. Peter P. Iannacchino, 950 F. Supp. 28 at 31 (D. Mass. 1997). Importantly, the Court noted that an insurer may void and/or deny a claim even if the insured made an innocent misrepresentation of a material fact, and the disclosure of the truth would have influenced the judgment of the underwriter in making the insurance contract in estimating the degree and character of the risk. See 950 F. Supp at 31. In that case, the Court granted the insurance carrier's motion for summary judgment seeking rescission of the policy because the Insured admitted he withheld information responsive to questions contained in the application regarding psychological treatment, a diagnosis of depression and a prescription for Prozac. See also Massachucetts Mutual Life Ins. Co. v. Fraidowitz, 360 F. Supp. 2d 243 (D. Mass. 2005).
Florida
In Massachusetts Casualty Insurance Company v. Forman, 516 F.2d 425 (5th Cir. 1975), the U.S. Court of Appeals for the Fifth Circuit had the occasion to interpret Florida law. In that case, the Court granted partial rescission based on a failure to disclose a diagnosis of diabetes. The Court, clearly displeased with the set of facts presented, specifically pointed out that the applicant made "egregious false statements concerning prior illnesses, treatment and hospitalization, including specific denials that the applicant ever had diabetes." See Id. at 516 F.2d at 427.
New Jersey
Under New Jersey law, "a misrepresentation is material if it naturally and reasonably influences the judgment of the underwriter in making the contract at all, or in estimating the degree or character of the risk, or in fixing the premium." See Scalia v. The Lafyaette Life Insurance Co., et al., 1995 U.S. Dist. Lexis 15944 (DNJ 1995). In that case involving a disability income insurance policy, a dentist failed to disclose the extent of injuries he had suffered in a prior "horrific motor vehicle accident." Even though the applicant disclosed some of his injuries, i.e., that he had broken his right ankle and right arm, and that he was hospitalized for three weeks, he failed to disclose ulnar neuropathy [which was a nerve injury near his wrist]. The Court had little sympathy for the applicant, calling his omission of "extensive medical history...purposefully misleading and inexcusable." See 1995 U.S. Dist. LEXIS 15944 at 22 The insurance carrier's request for rescission was granted.
California
One California Court has held that when the broker knows of "actual misstatements [in an application], the broker may be held liable for transmitting those misrepresentations in an insurance application knowing the insurer will reasonably rely on them." Therefore, an agent or broker who believes his client may be lying must take note not only of the fact that his client may be left without coverage, but that he could become a target in a law suit. Century Surety Co. v. Crosby Insurance, 124 Cal. App. 4th 116; 21 Cal. Rptr. 3d 115; (Ct of Appeal, 4th Appellate District, Division Two 2004)
Recommended Strategies
What is the best way for an insurance agent to deal with a situation in which he believes his client is being less than forthcoming in connection with the application?
1. Warn of the consequences of a material misrepresentation, and educate about the manner in which a claim for rescission will present itself, procedurally. It goes without saying that a client who might be misrepresenting his medical status or otherwise giving you inaccurate information is placing you in a difficult position. You are, after all, trying to build a rapport with the proposed insured. The first step is to simply make sure your client knows that putting inaccurate information in an application, or misrepresenting information, is not simply a technicality that will increase a premium payment or slow down payment of benefits. A material misrepresentation could lead to rescission --- in essence, voiding --- of the policy. And, this scenario will likely not play itself out when the application is submitted. The applicant should not be under the mistaken impression that simply because he has submitted an application, the insurer has cashed his premium check and he has received a policy, he is "out of the woods." A claim for rescission can be brought years later, and the carrier may not allow the applicant to amend an application. Indeed, by the time a rescission claim is in Court, it will be too late to amend the application.
2. Encourage your customer to be forthcoming. A customer may assume he will not be able to obtain coverage if he is a smoker, overweight, or had prior treatment for a serious ailment such as heart disease or depression. Advise that the way you can best serve his needs is to be aware of all these factors, and make the carrier aware of all these issues. Yes, there is a possibility that the premiums may be higher, but the difference in premiums is a pittance when considered against the cost of an insurer rescinding a policy with a seven-figure benefit.
3. Highlight the fraud warnings. Insurance applications contain fraud warnings, such as, in New Jersey: "Any person who includes any false or misleading information on an application for insurance policy/certificate is subject to civil and criminal penalties." Oklahoma comes straight out and says you are "guilty of a felony." There could be consequences beyond a simple rescission of the policy.
4. Document...document...document. The more documentation you have, particularly in a questionable situation, the better off you will be should a claim materialize. Consider emailing your clients that you reviewed with them the consequences of rescission and confirming that the answers to all the questions are accurate and complete. Consider sending a letter in a way that delivery can be confirmed. Forward a copy of the completed, signed application with a cover letter, stating that if any changes or amendments need to be made to advise you immediately. Keep records of who is present at the meeting during which the application is taken, and save copies of your notes. While this may not be practical in every situation, it may be warranted if you believe your client may be withholding information.
5. Do not accept the application. As a last resort, if your instincts tell you that your customer is lying and, you do not believe accurate information is being provided in the application, refuse to take the application. Confirm the refusal in a manner that can be documented, and receipt of same can be confirmed.
Please note this is intended to serve as general information, and not specific information for your state or situation. Please feel free to contact us if you have any specific questions.
Kenneth A. McLellan is an attorney with WINGET, SPADAFORA & SCHWARTZBERG, LLP in New York City. Email: mclellan.k@wssllp.com; http://www.wssllp.com.
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