Don’t Forget About Application Defenses
When faced with losses, insurers often look first to the policy language for potential defenses. However, an important defense is often overlooked: the defense based on false statements made by the insured in the application for insurance. It is important to identify circumstances that could give rise to an application defense early in a claim. This is because the remedy for a defense based upon misstatements in the application is to rescind the entire policy. If an insurance company chooses to rescind the policy, it must treat the policy as if it never existed. That usually requires the company to return all premiums to the insured. Accordingly, it typically is a business decision for the company whether to assert an application defense (and lose the potential for an ongoing business relationship with the insured) or to pay an otherwise covered claim.
A defense based on a false statement in the application is an affirmative defense that must be raised by the insurer, and the insurer must prove the false statement “clearly.” In Virginia, the framework for an application defense is governed by a statute:
When answers or statements of applicant do not bar recovery on policy. All statements, declarations and descriptions in any application for an insurance policy or for the reinstatement of an insurance policy shall be deemed representations and not warranties. No statement in an application or in any affidavit made before or after loss under the policy shall bar a recovery upon a policy of insurance unless it is clearly proved that such answer or statement was material to the risk when assumed and was untrue.
Va. Code Ann. §38.2-309. Under this statutory standard, an insurer is not obligated to honor a contract of insurance if it clearly proves that there is a misstatement of fact in the insurance application and that such misrepresentation was “material” to the risk when assumed. Importantly, this standard does not require an intentional or knowing false statement: it only requires that the statement be “untrue when made” and “material to the risk.” There is one caveat to the first criterion. The language of the application itself may create a requirement that the statute does not. For example, if the application signature page contains a statement that the application was prepared “upon knowledge, information or belief” or similar language, then Virginia courts have held that the insurer must honor the policy if the insured’s false statement was not knowingly made. Accordingly, insurers should avoid including such a requirement in their applications.
For example, the United States Court of Appeals for the Fourth Circuit recently had the opportunity to consider such application language in Medical Mutual Ins. Co. of North Carolina v. Gnik. 2024 U.S. App. LEXIS 3697 (4th Circuit Feb. 16, 2024). In that case, the Fourth Circuit affirmed the district court’s rescission of a professional liability policy on the grounds that the insured physician made “material misrepresentations” in her application for insurance.
In Gnik, a pediatric medical practice hired an “educational advocate,” a position that did not require a license. However, the employee later sought a position in the same practice as an in-house psychologist, claiming that she had recently earned a Ph.D in General Psychology and would soon earn a Psy.D. in Clinical Psychology. In fact, the employee had neither of the degrees and was lying. She nevertheless was promoted to Director of Cognition and Instruction, a position that required a license. When asked to provide proof of her license to practice psychology, the employee lied further, alleging that she held a three-year provisional license because she herself had autism. She did not actually produce a provisional license because she was lying about that, too. Instead, she produced fake Ph.D. and Psy.D. diplomas to her employer, who accepted those documents, and the employee began administering cognitive testing to patients and holding herself out as a psychologist.
In the spring of 2014, the Virginia Department of Health Professions (“VDHP”) received a complaint that the employee was practicing psychology without a license. A VDHP investigator visited the practice and spoke with the physician about the complaint. The Fourth Circuit found that, while the physician knew the complaint concerned the employee’s alleged practice of psychology without a license, it was not clear whether the physician knew the details of the complaint. In May 2014, VDHP sent the employee a letter stating that it had investigated the complaint and closed the matter as “undetermined.”
Later in 2017, the physician applied for professional liability insurance through Medical Mutual for her practice, including her employees. The application asked the physician if any of her employees had “ever been the subject of disciplinary investigative proceedings or a reprimand by a governmental or administrative agency, hospital, or professional association.” Even though the physician was aware of the 2014 VHDP investigation, she responded “no” to the question. The Fourth Circuit relied upon the physician’s knowledge of the VDHP investigation and her failure to reveal that investigation in her application to support the insurer’s rescission of the policy.
The physician attempted to avoid the rescission by arguing that the physician did not subjectively know that her statements in the application were false. In finding that Medical Mutual appropriately rescinded the policy for the physician, the Fourth Circuit noted that the application included the following language:
[The physician] certified the truth of her representations and affirmed that she understood that “the policy, if issued, is conditioned upon the truth of the representations in this application” and “that the falsity of any representation made in this application for insurance could cause the denial of a claim or the cancellation of my protection[.]”
Gnik, 2024 U.S. App. LEXIS 3697, at *6-7. In light of this language in the application, the Fourth Circuit held that “Medical Mutual was not required to show that [the physician] knew her representations were false.” Id. at *13.
Importantly, if an insurance carrier intends to rely upon an application defense, it must rely upon its underwriting department to establish the “materiality” of the false statement. Typically, an underwriter must be able to assert that, had the company known the true facts, either the company would not have issued the policy or that the company would have issued the policy with a higher premium or different terms. Gnik, 2024 U.S. App. LEXIS 3697, at *18; see Mut. of Omaha v. Dingus, 219 Va. 706, 250 S.E.2d 352, 355 (Va. 1979) (holding that a fact is material to the risk if it would reasonably influence the company’s decision to issue a policy); Buckeye Union Cas. Co. v. Robertson, 206 Va. 863, 147 S.E.2d 94, 96 (Va. 1966) (holding that misstatement was material if the company would have issued the policy at an increased premium). Accordingly, companies must question their underwriting departments prior to rescinding a policy to ensure that the misstatement would have affected the issuance of the policy, the premium, or policy terms. If the underwriters would have issued the policy without change, even in light of the false statement, the company may not rely upon the false statement to void the policy.
Companies also should carefully evaluate their application forms to remove any language in the attestation clauses that would require the company to prove the applicant was aware of the falsity of any answers. Virginia law does not require such proof unless the company opens the door.