1 FRAUD IN DISABILITY CLAIMS ELIZABETH B. LYALL, PARTNER, FASKEN MARTINEAU DuMOULIN LLP INSIGHT CONFERENCE VANCOUVER APRIL 30, 2004 The author gratefully acknowledges Michael Dery of Fasken Martineau DuMoulin LLP who assisted with the research for this paper.
2 FRAUD IN DISABILITY CLAIMS INDEX Introduction... 1 General duties of the insurer and the insured... 1 Disclosure obligations... 2 Contestability... 5 Materiality... 6 Page Recission of the contract of insurance or the coverage under the contract of insurance... 7 What is fraud in the civil context?... 8 Pursuing overpayments... 13
3 FRAUD IN DISABILITY CLAIMS Introduction This paper sets out the law in relation to fraud in disability claims from the defence perspective. Also included, is a brief discussion of overpayments within the fraud context. General duties of the insurer and the insured There is much commentary in the case authorities about insurers obligations of good faith in respect of their insureds. This discussion is not complete, however, without noting the reciprocal obligation owed by insureds to insurers. The law is clear that insureds also have an obligation to act in good faith in their dealings with insurers. Contracts of insurance are described as contracts of utmost good faith. This is an obligation borne by both the insurer and the insured. In negotiating an insurance contract, the parties must fully and accurately disclose to each other everything relevant. This mutual obligation distinguishes insurance contracts from most other types of contracts which allow the parties to keep silent on any matter, however relevant to the transaction, unless asked about it. The mutual duty of utmost good faith was described long ago by Lord Mansfield in Carter v. Boehm (1766) 97 E.R (K.B.), as follows: Insurance is a contract upon speculation. The special facts upon which the contingent chance is to be computed lie most commonly in the knowledge of the insured only. The underwriter trusts to his representation, and proceeds upon confidence that he does not keep back any circumstances in his knowledge to mislead the underwriter into a belief that the circumstance does not exist, and to induce him to estimate the risk as if it did not exist. Keeping back such circumstance is a fraud, and, therefore the policy is void. Although the suppression should happen through mistake without any fraudulent intention, yet still the underwriter is deceived, and the policy is void, because the risk run is really different from the risk understood and intended to be run at the time of the agreement. The policy would equally be void, against the underwriter if he concealed... Good faith forbids either party, by concealing what he privately knows, to draw the other into a bargain from his ignorance of that fact and his believing the contrary.
4 - 2 - The applicant bears the greater burden to act in good faith at the time of negotiating an insurance contract. It is at this stage in the relationship that the insurer is in the most vulnerable position; the insurer is being asked by an applicant to undertake a specified risk, the details of which the applicant is conversant, and the insurer is ignorant. The insurer s obligation to act in good faith is most strictly scrutinized at the time of assessment of a claim for benefits. It is at this stage of the relationship that the power balance shifts, and the insured is at a potential disadvantage when making a claim. Fraud against an insurance company is most likely to occur at the time of application for insurance coverage or at the time a claim is made. Most of the law and authorities referenced below concern misrepresentation or fraud in the application process. However, Andrusiw v. Aetna Life Insurance Co. of Canada (2001), 33 C.C.L.I. (3D) 238 (Alta. Q.B.), discussed in detail in this paper, concerns fraud in the claim process. Disclosure obligations At the time of application, the duty rests with the applicant to disclose all information which would be regarded by a reasonable insurer as material to the risk. Typically, the insurer is most interested in the health of the applicant, or the applicant s financial circumstances. However, other personal circumstances or habits, or the denial and/or the existence of other insurance, can also be material to the risk. The duty to disclose all matters within the applicant s knowledge which are relevant in determining the nature and extent of the risk applies even in the absence of questions from the insurer. An applicant cannot argue that the insurer s failure to conduct an investigation, which would have disclosed the true state of affairs, relieves the applicant of the consequences of misrepresentations.
5 - 3 - In respect of the duty to disclose medical information, the applicant s duty is well stated in the often-quoted passage from Norwood on Life Insurance Law in Canada (2d. ed.) (Toronto, Carswell: 1992) at 299 as follows: They (the insured) must, however, reveal everything they know, whether it be a symptom or a medical test or a consultation, since these are actual facts which will enable the insurer to assess the insurability of the life insured, even though the insured or life insured does not believe or has no reason to believe that they indicate any kind of illness or anything material to the risk. In other words, the life insured may not know exactly what their symptoms indicate, but if aware of certain symptoms the life insured must disclose them. The life insured may genuinely feel that their surgical operation was successful, that a diagnostic prognosis was reassuring, or be quite unaware of or untroubled by the results, but the life insured certainly knows they had surgery and that they undertook the diagnostic test. While the life insured may not know what their doctor knows, and it may be that the doctor chose not to disclose fully the state of health to the life insured, however this does not alter the fact that the life insured did consult a doctor or was treated by a doctor. Essentially, therefore, the life insured s duty is to disclose to the insurer the fact of all of their symptoms, consultations, and medical treatments or tests, regardless of the life insured s own belief as to their importance or significance or that they feel they are cured. An applicant s obligation to make full disclosure may be modified in the group mortgage insurance context: see Tansey Estate v. Mutual Life Assurance Co. of Canada (1999), 15 C.C.L.I. (3d) 139 (B.C.S.C.) and Taylor v. National Life Assurance Co. of Canada (1990), 7 C.C.L.I. (2d) 146 (B.C.C.A.) where the courts concluded that with respect to this class of insurance, the only medical information required is that which is provided in response to the questions posed (ie. the applicant need not provide additional medical information having honestly answered the questions asked). In Armstrong v. North West Life Insurance Co. of Canada (1990), 46 C.C.L.I. 18 (B.C.C.A.), the plaintiff argued that in the material before the underwriter there were warnings which should have put the insurer on notice that two answers on the application form were not correct and, had inquiries been made by the insurer, the true facts would have come to light. The court held that the statements in the application form relied upon by the plaintiff to support his
6 - 4 - submission that sufficient warnings were contained in the material before the underwriter, were not sufficiently indicative of something more to be tantamount to notice of the unrevealed. The Court cited with approval the following passage from Cherkes v. Postal Life Insurance Co., 138 N.Y.S. 2d 788 (S.C. App. Div., 1955) at 790: Defendant s negligence in not making further inquiry may be conceded, but that is not the equivalent of knowledge, nor does it cancel out or counteract the insured s fraud. Knowledge that the insured was not a favourable risk did not cast the burden upon the defendant of looking suspiciously and searchingly beyond the facts disclosed for undisclosed ailments, Zeldman v. Mutual Life Insurance Co., 269 App. Div. 53, 53 N.Y.S. 2d 792. The test is not one of what prudent inquiry would have revealed. The question is whether the information given, although partial, was sufficiently indicative of something more to be tantamount to notice of the unrevealed. We hold that it was not in this case. There was no indication whatever of the kidney condition or that further enquiry might reveal more than the application disclosed. Inquiry by the defendant under the circumstances was optional. It was entitled to rely upon the insured s representations. The plaintiff may not shift the burden of truthfulness which was upon the insured into a burden of distrust and additional inquiry on the part of the defendant. In Silva v. Sizoo (1997), 50 C.C.L.I. (2d) 293 (Ont. Gen. Div.), the court stated that an insurer is not required to be a detective. It need not automatically distrust statements made on an application so as to be required to look behind them. In Ipapo Estates v. Citadel Life Insurance Co. (1989), 37 C.C.L.I. 259 (Man. C.A.), the Manitoba Court of Appeal stated: An insurer may be under a duty to make further inquiries of the insured s doctor if the facts disclosed by the insured are such as would alert a reasonably prudent insurer of the need to do so. If the insurer, in those circumstances, fails to make further inquiry it might be argued that it could not rely on the insured s failure to make fuller disclosure. This argument would, however, be premised on the sufficiency of the information disclosed... An applicant s failure to reveal an extensive history of treatment for anxiety, insomnia, bronchitis, and smoking was seen as material in Dyck v. National Life Assurance Co. of Canada (1997), 47 C.C.L.I. (2d) 289 (B.C.S.C.).
7 - 5 - In Hoffart v. Paul Revere life Insurance Co.,  1 W.W.R. 636 (Sask. Q.B.), the applicant failed to disclose kidney x-rays, frequency of urination, blood in the urine, headaches, stress, allergies, problems with his right knee, and a referral to a urological surgeon. The court found that it was the plaintiff s duty to disclose to the defendant all of his symptoms, consultations and medical treatments, regardless of his belief as to their importance or significance. These material facts which the plaintiff misrepresented or failed to disclose on his application for insurance were such that if disclosed, would have influenced a reasonable insurer to decline coverage. The court concluded as follows: It may well be that the plaintiff genuinely believed that the procedures were successful and that the diagnostic prognosis was reassuring or he may have been unaware of or untroubled by the results. However, he knew that he had medical consultations for specific problems and that he had undergone or was advised to undergo certain diagnostic tests and procedures. It was the plaintiff s duty to disclose to the defendant the fact of all of his symptoms, consultations and medical treatments regardless of his belief as to their importance or significance. This he failed to do. It is well settled in the law that an applicant must disclose material financial information in his/her application for insurance. See, for example, Gregory v. Jolley et al. (2001), 54 O.R. (3d) 481 (Ont. C.A.); Armstrong v. North West Life Insurance Co. of Canada (1990), 46 C.C.L.I. 18 (B.C.C.A.); McArthur v. Prudential Life Insurance Co. of America,  2 O.R. 689 (H.C.J.). Contestability The Insurance Act, R.S.B.C. 1996, c. 226 provides that material non-disclosure, material misrepresentation, or fraud in an application for insurance will render the contract voidable by the insurer, if the contract of insurance has been in effect for less than 2 years. This two year period is referred to as the contestability period. See: s. 41 if the disability policy is part of a life policy and therefore covered under Part 3; and s. 97 if the disability policy is not part of a life insurance contract and is therefore covered under Part 4.
8 - 6 - However, if the contract of insurance has been in effect for 2 years or longer, an innocent or negligent misrepresentation or non-disclosure will not render the contract voidable. If the contract of insurance has been in effect for 2 years or longer, the contract will only be voidable if the misrepresentation or non-disclosure was fraudulent. See: ss. 42 and 98. In the case of a contract of group insurance, a failure to disclose, material misrepresentation, or fraud with respect to a person insured under the contract, does not render the contract voidable, unless evidence of insurability is specifically requested by the insurer, in which case the insurance in respect of such a person is voidable by the insurer. The 2 year incontestability period also applies in respect of group insurance. Most policies of insurance contain so-called incontestability clauses. If there is a conflict between the provincial insurance act and the policy of insurance, the most generous to the insured of the two will likely prevail: Bogh v. National Life Assurance Company of Canada (1991), 54 B.C.L.R. (2d) 79 (C.A.). Materiality Non-disclosure, misrepresentation or fraud can render a contract of insurance voidable only if the non-disclosure, misrepresentation or fraud is material to the risk being underwritten. The burden of proving materiality rests with the insurer: see Kehoe v. British Columbia Insurance Co. (1993), 15 C.C.L.I. (2d) 25 (B.C.C.A.) at 30, and Ontario Metal Products Company Limited v. Mutual Life Insurance Company of New York,  1 W.W.R. 362 at 367 (J.C.P.C.). The test for materiality is laid out in Ontario Metal Products Company Limited v. Mutual Life Insurance Company of New York,  1 W.W.R. 362 at 367 (J.C.P.C.):... it is a question of fact in each case whether if the matters concealed or misrepresented had been truly disclosed, they would, on a fair consideration of the evidence, have influenced a reasonable insurer to decline the risk or to have stipulated for a higher premium.
9 - 7 - In Kruska v. Manufacturing Life Insurance Co. (1984), 54 B.C.L.R. 343 (S.C.) aff d (1985), 63 B.C.L.R. 209 (C.A.) the British Columbia Supreme Court made it clear that the test of materiality is an objective one and described the question of materiality as follows: The test of materiality is whether the facts in question would influence the judgment of a prudent (or reasonable) insurer in fixing the premium or in deciding whether to accept the risk... The test is objective in the sense that it refers to any prudent insurer in the normal practice of that sort of insurance business. The opinion or belief of the insured as to materiality is irrelevant. The reason for this is that if it were otherwise, material information could be suppressed and it would be very difficult to show that the insured thought the information to be material; whereas if the insured s belief is not relevant, it will be in his interest to disclose all information within his reach. It is irrelevant if the loss ultimately suffered by the insured is in no way related to the non-disclosure or misrepresentation. Materiality is determined at the time that the application for insurance is being considered by the insurer, not after the fact: McLean v. Paul Revere Life Insurance Co. (1990), 43 C.C.L.I. 273 (B.C.S.C.). In order to prove that the non-disclosure or misrepresentation was material to the risk, the insurer ought to call evidence from one of its own underwriters who will testify as to the insurer s own underwriting guidelines and confirm that the insurer would have declined to accept the risk or would have charged a higher premium, had it known the true facts. As well, the insurer should adduce expert evidence from an independent underwriter who can speak to generally accepted insurance practice and testify as to whether a reasonable underwriter would have declined the risk or charged a higher premium had the true facts been known. Recission of the contract of insurance or the coverage under the contract of insurance Upon learning of the material non-disclosure, material misrepresentation, or fraud, the insurer must, within a reasonable amount of time of learning of the true facts, take steps to rescind the contract of insurance (in the case of individual insurance) or rescind the individual s coverage under the policy of insurance (in the case of group insurance). If the insurer fails to
10 - 8 - rescind the policy when it learns of the true facts, it will be considered to have waived the misrepresentation and will, therefore, be estopped from later rescinding the policy. In the case of non-disclosure or misrepresentation, the insurer must, as part of the act of recission, refund the premiums paid. This is because the insurer is seeking to have the agreement undone : Battle v. Fidelity & Casualty Co. (1923), 54 O.L.R. 24 (H.C.) aff'd (1924), 55 O.L.R. 330 (C.A.). In the case of non-disclosure or misrepresentation that is fraudulent, the insurer is not obliged to reimburse the insured for premiums paid: General Casualty Insurance Co. v. Lambert and Vance,  D.L.R (B.C.S.C.); Manufacturers Life Insurance Co. v. Ellis et al. (1988), 32 C.C.L.I. 38 (B.C.C.A.); Moscarelli v. Aetna Life Insurance Co. of Canada,  I.L.R (Ont. Gen. Div.), appeal quashed,  I.L.R , at 3476 (note) (Ont. Div. Ct.). What is fraud in the civil context? The classic description of fraud in civil cases is set out in the following passage from Derry v. Peek (1889), 14 App. Cas. 337 (H.L.): fraud is proved when it is shown that a false representation has been made (1) knowingly, or (2) without belief in its truth, or (3) recklessly, careless whether it be true or false. Although I have treated the second and third as distinct cases, I think the third is but an instance of the second, for one who makes a statement under such circumstances can have no real belief in the truth of what he states. To prevent a false statement being fraudulent, there must, I think, always be an honest belief in its truth. And this probably covers the whole ground, for one who knowingly alleges that which is false has obviously no such belief. Thirdly, if fraud be proved, the motive of the person guilty of it is immaterial. In Kruska v. Manufacturers Life Insurance Co. (1984), 53 B.C.L.R. 343 (S.C.), aff d (1985), 63 B.C.L.R. 209 (C.A.) the plaintiff was the beneficiary of his wife s individual life insurance policy. Over two years after the policy was issued his wife died in an accidental drowning. The wife was an alcoholic with a recent medical history for treatment for this illness.
11 - 9 - Although the court concluded that there had been misrepresentation and non-disclosure of material facts, it was unable to conclude that there had been fraudulent intent. This case is useful as it sets out the test for civil fraud, as follows: The accepted test of fraud in civil cases derives from Derry v. Peek (1889), 14 App. Cas. 337 (H.L.). There must be a false representation, made knowingly, without belief in its truth, or recklessly, without care whether it is true or false. Nothing less than this will suffice for the defendant to succeed in this case. Conduct without fraudulent intent which, before the statute, might have been characterized as fraud will no longer so qualify. The effect of the statute is that the insured is still bound by her duty of utmost good faith until the incontestability clause takes effect. After that time, she will be held covered if her material misrepresentation or non-disclosures were made innocently, or negligently. The incontestability clause protects her from false representations of that kind. But it will not protect her if she has the fraudulent mind described in Derry v. Peek. Then the law will deprive her, or her beneficiaries, of the proceeds of the contract. The court in Kruska also commented on the standard of proof required for civil fraud. Fraud, as defined for these purposes, must be proven by the defendant insurer on the balance of probabilities, the ordinary civil standard of proof: Hanes v. Wawanesa Mut. Ins. Co.,  S.C.R However, the seriousness of the conduct alleged is a circumstance to be considered in determining whether the matter has been sufficiently proven: Smith v. Smith,  2 S.C.R. 312 at While the standard for proving the occurrence of a criminal offence (fraud) for the purposes of a civil case remains the balance of probabilities, the degree of proof may vary with the gravity of the offence alleged. The standard of proof is therefore considered to be a slightly higher standard than just a balance of probabilities: see Brown and Menezes, Insurance Law in Canada (2d ed.) (Toronto, Carswell: 1991). The test for fraud is a subjective one. It is this subjective element that presents a challenge for insurers seeking to prove fraud. Essentially, the insurer must prove fraudulent intent; that is that the insured intended to deceive the insurer. This is a significant and onerous
12 burden for the insurer to satisfy. (Although see Gregory v. Jolley et al. (2001), 54 O.R. (3d) 481 (Ont. C.A.), infra, where the court may have lowered this burden). In McLean v. Paul Revere Life Insurance Co. (1990), 43 C.C.L.I. 273 (B.C.S.C.), the plaintiff made a claim for disability benefits under an individual disability policy of insurance issued in October, Two weeks after the policy was issued, the plaintiff was injured in a motor vehicle accident. The insurer paid benefits for 3 years, at which time the insured was accidentally shot in the abdomen. The insurer continued to pay benefits until June 1998 at which time it rescinded the policy. The insurer rescinded the policy on the basis that the plaintiff had failed to disclose medical information in her application for insurance, relating to events that occurred in the 2 years preceding her application, from 1979 to The insured sued the insurer for payment of benefits and the insurer made a counterclaim for judgment in the amount of the benefits paid to the insured pursuant to the policy. In 1979, the plaintiff had been arrested for theft and fraud. As part of her defence against the criminal charges, she was assessed by a psychologist and psychiatrist. These two physicians concluded that she suffered from an hysterical personality. Upon her release from prison, the plaintiff obtained a referral to a psychiatrist and saw him five times between September 1980 and February In September 1981 the plaintiff completed the application for insurance and failed to disclose the consultations or treatment by these physicians. She was also visited by a nurse on behalf of the insurer and failed to disclose these facts to her as well. The court found that the questions on the application were clear and that it must have crossed her mind that these medical facts should have been disclosed. The court held that the plaintiff must be assumed to have realized that the insurer would have acted upon the representations in the application forms when issuing the policy. The court concluded that the plaintiff knew at the time that she made the representations that they were false. The court commented on the plaintiff s motives as follows: That the plaintiff s motive was not to cause the defendant harm, thereby, is irrelevant. It is also irrelevant that the loss which she ultimately suffered was in no way related to the misrepresentations which she made. Materiality, or risk, must be determined at the time that the application for insurance is being considered by the insurer, not after the fact.
13 Through her deceit, no matter what her motive, the plaintiff has placed herself in a position whereby the defendant not only can successfully resist her claim for further benefits, but it can also claim back the benefits which it has given to the plaintiff to date. This is a harsh result, but reflects the laws abhorrence of those who make conscious decisions to gamble with the truth. The court declared that the insurance policy was void and granted judgment to the insurer on its counterclaim in the amount of $123,000 plus interest and costs. In Dyck v. National Life Assurance Company of Canada (1997), 47 C.C.L.I. (2d) 289 (B.C.S.C.), the plaintiff brought an action claiming entitlement to the proceeds of an individual life insurance policy on the death of the insured, who had died from pneumonia, resulting from AIDS. The insurer defended with allegations of fraudulent misrepresentation on the basis that, contrary to the medical history provided by the applicant, the applicant had an extensive history of treatment for anxiety, insomnia and bronchitis. He also smoked cigarettes, contrary to the representations made by him in his application. The court heard from witnesses who testified that he had smoked since he was 13 or 14 years of age and continued to do so throughout the years. It was clear from the application that the applicant had elected a Non-Smoker Plan and had executed a Non-Smoker Declaration, even though he was a heavy smoker. The court found that the applicant had made misrepresentations relating to his smoking status and that he had done this knowingly or without belief in its truth, so as to fix him with a fraudulent intent. The court will often find it difficult to make a finding of fraud. One such case was Mitchell v. Mutual of Omaha Insurance Co. (1996), 39 C.C.L.I. (2d) 136 (B.C.S.C.) (see also Kruska v. Manufacturers Life Insurance Co. (1984), 53 B.C.L.R. 343 (S.C.), aff d (1985), 63 B.C.L.R. 209 (C.A.) previously discussed). The plaintiff, a dentist who had had neck surgery and who held five other disability policies, applied for an individual disability insurance policy issued by the defendant. The plaintiff became totally disabled 32 months later. When the insurer learned, five months after that, that the plaintiff had not disclosed that he had had neck surgery and that he held five other disability policies, it cancelled the policy and returned the premiums paid. The plaintiff sued for a declaration that the policy was in full force and for judgment for
14 the amount payable under the policy. The court concluded that the insurer did not meet the onus on it to prove that the misrepresentations were made fraudulently, without belief in their truth, or recklessly, without regard for their truth. The court held that the wording of the questions on the application form and the manner of asking them by the insurance agent, led to some information being inadvertently omitted or incompletely recorded. The insurer argued, however, that the insured had an opportunity to rectify these mistakes, when he was asked to review and sign the questionnaire. The insured responded that he had signed the form but without reading it, which the court found to be possibly negligent, but not fraudulent or reckless. The court concluded that on a balance of probabilities, the misrepresentations were not made with the required intent to defraud, and proof of nothing less would suffice for the insurer to succeed. A case where the court found fraud with ease was Andrusiw v. Aetna Life Insurance Co. of Canada (2001), 33 C.C.L.I. (3d) 238 (Alta. Q.B.). Here, the insured, who was insured under an individual disability policy held by the company he owned, commenced receiving disability benefits from the insurer following a stroke. The insurer paid the benefits for more than 10 years. Following receipt of an anonymous tip that the plaintiff was working, the insurer conducted an investigation which included surveillance of the insured. The insurer discovered that the plaintiff was gainfully employed with his company and that he was misrepresenting the level of income he earned. The insurer discontinued payment of disability benefits. The insured sued the insurer for payment of total disability benefits. The insurer counterclaimed for reimbursement of the total disability benefits and waiver of premium payments made in the amount of $260,000. The court concluded that the plaintiff was able to perform the important duties of his occupation and that he had been able to do so for at least 10 years. The court was also satisfied that the plaintiff failed to inform the insurer of his ability to work when requested by the insurer, and falsely advised the insurer that he had not returned to work and was unable to perform such physical and mental duties as were needed to perform in his role as president of the company. He also misled the doctors treating him such that their reports to the insurer misrepresented the plaintiff s ability to be gainfully employed in his occupation.
15 In Andrusiw the court declared the contract void as a result of the fraudulent misrepresentations of the insured. The court ordered the insured to pay the sum of $260,000 plus interest to the insurer. In addition, the court ordered the insured to pay punitive damages to the insurer. In respect of punitive damages, the court concluded that: A great deal has been made in the case law, to which this Court was referred, of the fact that insurers vis à vis their insureds are in a superiour bargaining position and one which places the insureds in positions of dependency and vulnerability. Equally, insurers must not be looked upon as fair game. It is a two-way street founded upon the principle of utmost good faith arising from the very nature of the contract. Thus, it is appropriate that punitive damages be awarded and I do so in the sum of $20,000. In Gregory v. Jolley et al. (2001), 54 O.R. (3d) 481 (Ont. C.A.) the insured failed to disclose in his application for individual disability insurance that he had undergone surgery on his left knee. He also made serious misrepresentations with respect to his income, estimating his income as $90,000 in 1989 and $100,000 in 1990 when in fact he had a loss of income of $58,000 in 1989 and a loss of income of $10,000 in The court found that where an insured is in possession of facts that any reasonable person would know could make him or her uninsurable, there is a duty to disclose those facts even if the insurer does not ask for a written application. This case is significant because it could be said to have lowered the burden on an insurer when proving fraud. Previous cases (as cited above) require that there be proof that the insured made a false representation knowing it was false or without belief in its truth. Gregory indicates that reckless disregard for the truth may be sufficient to establish fraud. Pursuing overpayments Insurers frequently have cause to pursue their insureds for overpayment. Some examples of overpayments which most commonly occur include: (a) Other benefits. When an insurance company has paid disability benefits to an insured when it was unaware that the insured was receiving other benefits such as Canada