After a claim is made, and despite the obligation to objectively, fairly, and reasonably investigate a claim with an eye toward providing coverage and without putting the insurance company’s interests ahead of their insured’s, some insurers actively look for ways to deny coverage. One of the ways some insurers do this is by using the claim investigation to search for information that the insured provided in its insurance application that is or was inaccurate.
Insurers do this so they can rescind the policy on the ground that the insured made a material misrepresentation in the application. Insurers argue that the misrepresentation was material, and that had the insurer known the truth at the time the policy was issued, it would have charged more in premium and/or would not have issued the policy. This strategy is referred to by some as post-claim underwriting because the insurer fails to do its due diligence during the underwriting process, gladly accepts premium, and then—only after a claim is made—looks to investigate the insured with a fine-toothed comb.
A recent non-published decision by the Ninth Circuit Court of Appeals explains that insurers who fail to properly investigate an evaluate an insured during the underwriting process at the time the policy is issued cannot use information later obtained during a claim investigation to support rescission if the insurer had access to the information previously.1
Sunwest Metals owned a recycling plant that suffered a catastrophic fire. After it filed its insurance claim for the fire damage, Star Insurance Company denied the claim after it learned that Sunwest’s insurance applications had misrepresented the extent of its paper and plastic operations. Star Insurance Company claimed that in practice, a policyholder deriving more than 15 percent of its annual revenue from paper or plastic products wouldn’t be eligible for coverage under the scrap dealer program that Sunwest was insured under and through. Therefore, Star Insurance Company filed a lawsuit seeking to rescind Sunwest’s insurance policy.
The evidence presented in the lawsuit demonstrated that Sunwest’s insurance agents made multiple misrepresentations on insurance applications, including stating that the company’s annual sales were composed of 80 percent aluminum and 20 percent iron and steel, while nonmetals such as paper and plastic made up a negligible percentage of sales. However, Sunwest actually received a large percentage of its revenue from paper products. The evidence also showed that Sunwest did not review the representations on the applications before they were submitted to the insurer.
The trial court ruled in favor of Sunwest because it found that Star Insurance Company and its agents had received several documents and communications calling into question the extent of Sunwest’s paper and plastics business but failed to heed those “red flags” and investigate the company’s business further before the fire loss. As a result, the trial court ruled that Star Insurance Company had waived its right to rescind the policies.
Star Insurance Company appealed, and the Ninth Circuit Court of Appeals upheld the trial court’s decision. Its rationale was as follows:
As a general rule, an insurer may “rely upon [the insured] . . . for such information as it desires” in determining whether to provide coverage. Old Line
Life Ins. Co. v. Superior Court, 229 Cal. App. 3d 1600, 1604 (1991) (internal quotation marks omitted). But it may not blindly ignore evidence of misrepresentation, collect premiums, and then opportunistically rescind once a claim is filed. Under California law, “[t]he right to information of material facts may be waived . . . by neglect to make inquiries as to such facts, where they are distinctly implied in other facts of which information is communicated.” Cal. Ins. Code § 336. Where an insurer has “before it information that plainly indicate[s] that the insured’s statements [are] not true,” it has a “duty of further inquiry” to determine the “pertinent facts.” Rutherford v. Prudential Ins. Co. of Am., 234 Cal. App. 2d 719, 733–34 (1965). This includes a duty to investigate “information which if pursued with reasonable diligence” would reveal misrepresentations.
The district court identified numerous pieces of evidence spanning nearly two years that “distinctly implied” the falsity of information in Sunwest’s insurance applications and subsequent communications with Star. For example, (i) Sunwest’s website advertised paper and plastic recycling as a main part of its business; (ii) a September 2011 site inspection of Sunwest revealed that Sunwest “fill[ed] large dumpster bins” with, inter alia, paper products; and (iii) two other site inspections—one in January 2012 and one in 2008, the report of which Star received in February 2012—noted substantial paper processing. Star was clearly aware that the application information was inconsistent with these facts, as indicated by its repeated inquiries into Sunwest’s operations. The answers Star received from Dunlap were non-responsive, and simply reiterated that 100 percent of Sunwest’s annual revenue came from metal products.
The district court did not clearly err in finding that Star had before it information that “distinctly implied” material misrepresentations, and that it failed to satisfy its duty to investigate such evidence. The duty of inquiry requires an insurer to not only ask questions, but also to investigate answers. (citation omitted). Star made inquiries, but then ignored the inadequacy of the answers it received. Having turned a blind eye for nearly two years, Star waived its right to rescind when Sunwest filed a claim.
This is a powerful decision that, although unpublished, gives policyholders, public adjusters, and policyholder advocates a strong roadmap concerning how to avoid rescission where the insurer’s position is nothing more than a blatant attempt to use post claim underwriting to avoid paying a claim.
1 Star Ins. Co. v. Sunwest Metals Inc., No. 15-56562 & 15-56568, 2017 WL 2198969 (9th Cir. May 18, 2017).