If an insurance carrier discovers that its insured has misrepresented information provided in an insurance application, the insurer may have a remedy under Indiana common law: Rescind the insurance policy.
An insurer has a right to rescind a policy of insurance if an insured makes a material misrepresentation or omission of fact in its insurance application. Colonial Penn Ins. Co. v. Guzorek, 690 N.E.2d 664, 672 (Ind. 1997). The policy is voidable at the insurer’s option. Id. Some courts have stated that rescission is possible because the material misrepresentation by the insured prevents the required “meeting of minds” between the parties to the contract regarding the risk to be insured. Foster v. Auto-Owners Ins. Co., 703 N.E.2d 657, 659 (Ind. 1998).
The function of contract rescission is to restore the parties to their pre-contract position. Gary Nat’l Bank v. Crown Life Ins. Co., 392 N.E.2d 1180, 1182 (Ind. Ct. App. 1979); American Standard Ins. Co. v. Durham, 403 N.E.2d 879, 881 (Ind. Ct. App. 1980). Therefore, an insurer must return any and all premiums paid by the insured in order to effectively rescind an insurance policy. Id.
Materiality of the misrepresentation
The materiality of the misrepresentation or omission that is the basis of the rescission is a question of fact to be resolved by the fact-finder unless the evidence is such that there can be no reasonable difference of opinion. Prudential Ins. Co. of Am. v. Winans, 325 N.E.2d 204, 206 (Ind. 1975). What exactly constitutes a “material misrepresentation” has been debated. Some courts in Indiana have found a misrepresentation is material if the insurer would have refused to insure the risk or would have charged a higher premium to insure the risk had the insurer known all the facts. Colonial Penn v. Guzorek, 690 N.E.2d at 672-73. This position focuses on whether the misrepresentation was material to the underwriting decision to issue the policy and rescinds the entire policy. The materiality may also be weighed not against the underwriting decision but instead against the loss incurred. In other words, “coverage of the incurred loss would be voided if the misrepresentation affected that risk, but not all coverage would necessarily be voided” (i.e., partial rescission). Id.
The Indiana Supreme Court spoke to these issues in Colonial Penn v. Guzorek. In Guzorek, Colonial Penn sought a declaration that the automobile insurance policy it issued to Dorothy Guzorek was void and thus provided no liability coverage for an accident that occurred while Dorothy’s husband, Donald, was driving an insured vehicle. Id. The application for insurance asked for a list of all licensed drivers in the house. Since Donald had a suspended license at the time of completing the automobile insurance application, Dorothy listed only herself as a licensed driver. In addition, in the application Dorothy listed only herself as a “customary operator” even though she knew Donald drove (without a license) to and from work.
The trial court entered summary judgment in favor of Dorothy and Donald and the Court of Appeals affirmed. Id. at 667. On transfer to the Indiana Supreme Court, Colonial Penn argued that there was no coverage for Donald for the accident because the policy was void ab initio (from its inception) due to Dorothy’s failure to include in her application that (1) Donald lived with her, (2) Donald had a suspended license, and (3) Donald drove on a regular basis. Id. at 671. Colonial Penn stated that had it been aware of this information, it would not have insured Dorothy or Donald based on its underwriting guidelines. Id. In analyzing the two materiality definitions regarding material misrepresentations, the court stated:
Under the first view of materiality, Colonial Penn could rescind the policy even if Dorothy had been the driver, because Colonial Penn claims it would not have written a policy for her due to Donald’s presence in the household. We accept Colonial Penn’s assertion of its underwriting guidelines. Under the second view, Dorothy would still receive the coverage that would have issued had the facts represented in the application and relied on by the insurer actually been true. Stated another way, the insurer would retain those risks it knew it was accepting based on the information in the application, and if Dorothy rather than Donald were the operator coverage would be found. Under either view, Donald is not covered because his existence as a spouse and his driving record are clearly material to the loss actually incurred. However, the parties do not address and we do not decide whether the law would permit complete rescission of the policy or only reformation to conform to the facts represented in the application.
Id. at 673-74.
Reconciling the materiality definitions
In discussing whether an insurer’s common-law right to rescind a policy can coexist with financial responsibility laws requiring drivers to carry minimum levels of liability insurance, the court in Guzorek recognized that a public policy existed against rescission of automobile insurance policies because rescission may put other innocent drivers at a disadvantage and place them in a position where they may not be fully compensated for a loss. Id. at 671. Ultimately, the court found that an automobile policy could be rescinded in circumstances where the accident victims could be compensated through their own uninsured motorists coverage. Id. at 672. The court “[left] for another day” the issue of whether an insurer can rescind an automobile policy when an accident victim has no uninsured motorists protection. Id.
Based on the discussion in Guzorek regarding financial responsibility laws, other courts in Indiana have limited the application of the second definition of materiality to cases involving automobile insurance policies. See Allianz Ins. Co. v. Guidant Corp., 884 N.E.2d 405 (Ind. Ct. App. 2008); Allied Prop. & Cas. Ins. Co. v. Good, 938 N.E.2d 227 (Ind.Ct.App. 2010). In limiting the use of the second definition, the court in Guidant, noted that “[i]t is apparent that ‘the law’ to which the [Guzorek] court was referring was the financial responsibility law, not contract law, because general contract law plainly permits the complete rescission of a contract.” Allianz v. Guidant, 884 N.E.2d at 415.
The two materiality definitions can be reconciled. The first definition measuring the materiality against the underwriting decision deals with situations where the underwriting decision would have been affected by the information misrepresented. Rescission based on this definition will typically be effective when an insurer has a written underwriting guideline specifying its policy to not insure certain types of risks or can otherwise affirm that such types of policies would never have been written. The second definition measuring the materiality against the loss incurred suggests that, even if the insurer would have written the risk otherwise, the misrepresentation can still lead to bar coverage for a particular loss if the misrepresentation affected the loss. Although it is unsettled whether the second definition is applicable only to the rescission of automobile insurance policies, it arguably can be applied in any circumstance in which at least a portion of the coverage would have been issued irrespective of the misrepresentation.
Waiver of right to rescind
An insurer can rely on the representations made in an insurance application and has no independent duty to extend its resources to conduct investigations to determine the truthfulness of the information contained in an application. Colonial Penn v. Guzorek 690 N.E.2d at 674; State Farm Mut. Auto. Ins. Co. v. Price, 396 N.E.2d 134, 137 (Ind. Ct. App. 1979). However, an insurer can waive its ability to rescind a policy if it has actual knowledge of a misrepresentation or has sufficient information to place it on inquiry notice of a misrepresentation in an application. Colonial Penn v. Guzorek, 690 N.E.2d at 674; Allied Prop. v. Good, 938 N.E.2d at 232; see also American Family Mut. Ins. Co. v. Kivela, 408 N.E.2d 805 (Ind. Ct. App. 1980) (insurer’s right to rescind the policy was waived when before the date of loss the insurer had actual notice of a misrepresentation on the application regarding the spouse’s poor driving record). If an insurer has sufficient information to place it on inquiry notice of a potential falsity in the application at issue, it may wish to conduct a reasonable investigation of the potential false information. If it does not, whatever facts would have been discovered in a reasonable investigation may be imputed to the insurer and can result in the insurer waiving its right to rescind the policy.
An insured’s intent to deceive the insurer in an application is irrelevant to an insurer’s right to rescind a policy in Indiana. However, if an insured knowingly makes a misrepresentation in an application, an insurer may be able to overcome a waiver argument presented by an insured and successfully rescind a policy. As noted in Guzorek, even if an insurer takes steps to investigate the truthfulness of the application information and fails to notice inconsistencies in the application, the insurer’s actions amount only to negligence. Colonial Penn v. Guzorek, 690 N.E.2d at 675. Although negligent, the insurer’s actions will not trump a material misrepresentation made by the insured with knowledge of, or reckless disregard for, the falsity of the representation. Id. Therefore, if an insured intentionally misrepresents facts because, for instance, the insured knows the disclosure will result in no coverage, the insurer’s failure to reveal the inaccurate information during an investigation will not waive the insurer’s right to rescind the policy.
Effect of rescission on mortgagees
A question that may arise when a property insurance policy is rescinded is whether the insurer has a duty to indemnify the mortgagee for the amount of the loss sustained by a property owner despite the fact the policy was rescinded. Indiana courts have found that a mortgagee is entitled to payment when a claim is denied because of an insured’s actions (e.g., arson), if certain policy language is present. Property Owners Ins. Co. v. Hack, 559 N.E.2d 396, 400 (Ind. Ct. App. 1990). However, Indiana appellate courts are silent on the specific issue of whether, under a standard mortgage clause, an insurer’s rescission of a policy due to the insured’s material misrepresentations relieves it of its duties to a mortgagee.
Some jurisdictions suggest that, under a standard mortgage clause that provides that the insurance will not be invalidated by an act of the insured, the mortgagee is entitled to receive insurance benefits even if the insured, through its actions or omissions, caused the rescission of the insurance policy. The reasoning is usually that a standard mortgage clause creates an independent and separate contract between the insurer and mortgagee. See May v. Market Ins. Co., 387 So. 2d 1081 (La. 1980); Jones v. WestBanco Bank Parkersburg, 460 S.E.2d 627 (W. Va. 1995); Nationwide Mut. Ins. Co. v. Hunt, 488 S.E.2d 339 (S.C. 1997); Hartford Fire Ins. Co. v. Associates Capital Corp., 313 So. 2d 404 (Miss. 1975). Other jurisdictions have treated the issue differently, finding that an insurer could void a policy as to a mortgagee due to misrepresentations made on an insurance application by the insured. See Pacific Ins. Co. v. Kent, 120 F. Supp. 2d 1205 (C.D. Cal. 2000); Weekly v. Missouri Property Ins. Placement Facility, 538 S.W.2d 375 (Mo. Ct. App. 1976).
Because of the uncertainty under Indiana law surrounding an insurer’s obligation to a mortgagee included on a policy after rescission of the policy, if the insurer chooses not to pay the mortgagee for the principal of the loan (up to the policy’s “limits of liability”), an insurer may file a declaratory judgment action and seek a determination of its obligations by a court.
Although rescission is an area of law that continues to develop in Indiana and some questions remain regarding the application of the materiality definitions outlined in Guzorek, Guzorek provides a good road map of the law surrounding rescission that may be useful to insurers, insureds and their attorneys as they navigate the issues presented when a misrepresentation in an insurance application is discovered.•
Ms. Stafford is an attorney in the Indianapolis office of Kightlinger & Gray and is a member of the DTCI Insurance Coverage Section. The opinions expressed in this article are those of the author.