Fraud and the Contestability Clause

[adjusterjack]

The thread about USAA denying a claim due to the insured's material misrepresentation of a medical condition

https://insurance-forums.com/commun...-1-million-life-insurance-policy.95920/page-4

raised the question as to whether an insurance company should or could be allowed to deny a claim on the basis of fraud even after the two year contestability period expired.

Comments were made that some states allow it, some companies have done it, some policies have it written into the contestability clause.

I hope that those who wish to participate in this discussion would contribute factual material rather than anecdotal material.

By factual material I mean a link to an appellate court decision regarding the issue in any particular state or upload a sample life insurance policy that includes the fraud wording in the contestability clause.

To that end let's start with a 2017 decision of the US Court of Appeals for the Second Circuit: AEI Life LLC, Plaintiff-Appelle v. Lincoln Benefit Life Company, Defendant-Appellant.

https://cases.justia.com/federal/appellate-courts/ca2/17-224/17-224-2018-06-08.pdf?ts=1528470006

The upshot of that decision is that:

The laws with respect to such incontestability clauses in New York and
New Jersey differ in a crucial respect: Unlike New York, New Jersey allows an
insurance company to contest the validity of a policy obtained by fraudulent
means even after two years have expired since the policy became effective.

That gives us two states:

New Jersey allows it.
New York doesn't.

 

[Robert Barney]

I would like to add that I think the "exception for fraud" is a BAD loophole for companies to escape their obligations to a beneficiary. In the insurance industry we sell a promise on a piece of paper, and we should be strongly opposed to anything that would invalidate the promise. If consumers have doubts about the promise, they won't buy the paper.

 

[adjusterjack]

I would like to add that I think the "exception for fraud" is a BAD loophole for companies to escape their obligations to a beneficiary.

I agree. The two year period is long enough for any life insurance company to be able to investigate fraud and misrepresentation.

Now here's another state that agrees - Massachusetts:

FindLaw's Supreme Judicial Court of Massachusetts case and opinions.

The court struck down a policy provision that included the fraud exception and upheld the two year limitation.

 

[rousemark]

I would like to add that I think the "exception for fraud" is a BAD loophole for companies to escape their obligations to a beneficiary. In the insurance industry we sell a promise on a piece of paper, and we should be strongly opposed to anything that would invalidate the promise. If consumers have doubts about the promise, they won't buy the paper.

So if I pose as Robert Barney and then you die, the insurance company should pay me because I got away with the deception for more than two years?

 

[VolAgent]

I would like to add that I think the "exception for fraud" is a BAD loophole for companies to escape their obligations to a beneficiary. In the insurance industry we sell a promise on a piece of paper, and we should be strongly opposed to anything that would invalidate the promise. If consumers have doubts about the promise, they won't buy the paper.

Fraud is a completely different ballgame than misrepresentation. We aren't talking simply forgetting to disclose a condition, DUI, etc. But an intentional act to deceive an insurance company for profit. That should always be contestable.

I can think of two of which I am aware. Fortunately neither got beyond two years.

In the first, a woman wanted to get life insurance (final expense) on her mother. Her mother was in the hospital in very bad shape. So she had her aunt pose as her mother. She requested the agent meet her at the hospital as she was visiting her "aunt". Fortunately someone else came in as the agent was discussing it and inadvertently revealed the ruse. It didn't go anywhere.

In another, a man wanted to get life insurance (final expense) on his mother. She also was in the hospital, in a coma in this case. He had someone pose as his mother for the recorded phone interview, his girlfriend I believe. The policy was issued and the mother died shortly thereafter. When reviewing records the insurance company found something suspicious and referred it to the appropriate DOI who began a fraud investigation. I am not aware of the outcome, but I believe they intended to prosecute him for insurance fraud. I'm sure they went after the woman as well if they were able to identify her.

While it is fortunate both were discovered within two years, there should be no limit on situations like this. The beneficiary was the one perpetrating the fraud.

 

[Robert Barney]

This is a response to both these points.

Life insurance companies, when they accept and issue insurance, are supposed to do a thing call "underwrite", which includes investigating the applicants and insured for the policy. It is my experience that where "fraud" is considered a basis to deny payment of a claim AFTER the two year contestable period, that companies will exploit that loophole and declare fraud even where there has been no one charged with a crime or a conviction obtained.

I would have no problem with "criminal fraud" permitting a company to circumvent payment of a claim, but in Canada I know with certainty that "fraud" does not have to be criminal. That opens to door to all kinds of mischief by life insurance companies, and it provides an incentive to companies to underwrite polices AFTER a claim, versus before issuing a policy.

 

[VolAgent]

I'm not familiar with the Canadian legal system. I suspect our system in the US would keep that down. Many contested claims end up in court anyway. To contest for fraud without a clear smoking gun would be inviting a bad faith lawsuit you'd have no chance of winning. Also, as mentioned in the article that got this all started, most states have a consumer protection law. Depending upon how the law is written and exactly what happens, many of these would be ripe for claims under it as well.

Now please know, I'm not saying either party has clean hands. There are plenty of bad actors on both sides, consumer and corporate.

I think any company denying a claim for fraud without first getting a court ruling is playing with fire. You'd end up on the wrong side of the courtroom as you tried to prove your claim to defend the inevitable bad faith lawsuit.

 

[adjusterjack]

So if I pose as Robert Barney and then you die, the insurance company should pay me because I got away with the deception for more than two years?

No. You would not get paid.

What you describe is a STOLI policy (Stranger Takes Out Life Insurance) which is prohibited in Tennessee and, thus, void "ab initio" (from the beginning). See Sun Life v. Conestoga Trust Services:

https://scholar.google.com/scholar_...6,364,365,366&sciodt=4,43,111,126,364,365,366

Fraud is a completely different ballgame than misrepresentation. We aren't talking simply forgetting to disclose a condition, DUI, etc. But an intentional act to deceive an insurance company for profit. That should always be contestable

For a STOLI policy, yes. For fraud on the part of the insured himself, that might or might not be the case in Tennessee.

Tennessee statute 56-7-2307 addresses provisions and conditions required in life insurance policies. Paragraph 3:

Policy is Entire Contract; Incontestability; Exceptions. A provision that the policy shall constitute the entire contract between the parties, and shall be incontestable after it has been in force during the lifetime of the insured for a specified period, not more than two (2) years from its date, except for nonpayment of premiums and except for violations of the conditions of the policy relating to naval and military services in time of war;

2017 Tennessee Code :: Title 56 - Insurance :: Chapter 7 - Policies and Policyholders :: Part 23 - Mandated Insurer or Plan Coverage :: § 56-7-2307. Provisions and conditions required in life insurance policies.

Like the Massachusetts statute, the Tennessee statute does not allow for a fraud exception. The Massachusetts court ruled that if the legislature wanted to include the fraud exception it would have done so.

I have not found a Tennessee case on point so it's anybody's guess whether a Tennessee court would create a fraud exception when the two years are up or not.

I do know, however, that when an appellate court reviews an issue on "first impression" (no prior decisions on the issue in that state) it will look to the decisions of other states for guidance.

While it is fortunate both were discovered within two years, there should be no limit on situations like this. The beneficiary was the one perpetrating the fraud.

True but, unlike a STOLI policy, the beneficiary had an insurable interest. Had a policy been issued and had the insured lived past the two year mark we are back to the question of whether a Tennessee court would create a fraud exception or enforce the two year limit.

I think any company denying a claim for fraud without first getting a court ruling is playing with fire. You'd end up on the wrong side of the courtroom as you tried to prove your claim to defend the inevitable bad faith lawsuit.

True. Which is why it is a common practice in the insurance industry, for all types of insurance, for an insurance company to seek a declaratory judgment before denying the claim, especially when the stakes are high.

 

[VolAgent]

True but, unlike a STOLI policy, the beneficiary had an insurable interest. Had a policy been issued and had the insured lived past the two year mark we are back to the question of whether a Tennessee court would create a fraud exception or enforce the two year limit.



True. Which is why it is a common practice in the insurance industry, for all types of insurance, for an insurance company to seek a declaratory judgment before denying the claim, especially when the stakes are high.

Both situations were not in Tennessee. The one were the DOI intended to prosecute was in New Jersey.

I guess this is one of those things were we will just have to wait to see. No attorney, but I do find the law interesting. And from what I have read, a contract entered fraudulently is also generally considered "ab initio". Perhaps a smart company would move to have an insurance contract voided in this manner as well? I suspect this is just one of those things we will have to wait on. Fortunately it is rare in comparison.

 

[Robert Barney]

Here is Illinois' explanation of life insurance fraud:

Misrepresentations and Concealments in the Application for Insurance: An Analysis of the Insurer's Right to Rescind Coverage - FindLaw

So would non-disclosure of a health problem, allow a company to deny a claim after 2 years under Illinois law, because the company argues it is fraud?