THE IMPACT OF A POLICYHOLDER S MISREPRESENTATIONS IN ILLINOIS JOHN D. DALTON AND MARK A. SWANTEK An insurer s options when the insured is making misrepresentations depend on the timing of those misrepresentations and the existence of a policy provision concerning fraud. First, misrepresentations made in a policy application allow the insurer to void the policy. Second, misstatement made in the proof of loss can be grounds to deny coverage or void the entire policy under a policy provision prohibiting fraud or concealment. I. MISREPRESENTATIONS IN APPLICATION The Illinois Insurance Code allows an insurer to defeat or avoid a policy when an insured makes material misrepresentations with actual intent to deceive the insurer. 215 ILCS 5/154. This statute is applicable to the negotiation stage, and not after. Inter Insurance Exchange of Chicago Motor Club v. Milwaukee Mut. Ins. Co., 61 Ill. App. 3d 928, 930 31 (1978). A misrepresentation in an application is a statement purported to be a fact, yet is untrue, and affects the risk undertaken by the insurer. Ratcliffe v. Int l Surplus Lines Inc. Co., 194 Ill. App. 3d 18, 25 (1990). Material omissions or incomplete answers may constitute a misrepresentation when the omission prevents the insurer from adequately assessing the risk involved. Garde v. Country Life Ins. Co., 147 Ill. App. 3d 1023, 1031 (1986). The effect is that a material misrepresentation affecting either acceptance or risk assumed by an insurer will void the insurance contract regardless of whether the misrepresentation was made innocently or with intent to deceive. Ratcliffe, 194 Ill. App. 3d at 18; Methodist Medical Center of Illinois v. American Medical Sec. Inc., 38 F.3d 316, 320 (7th Cir. 1994) (finding health policy applicant s failure to disclose diagnosis a material misrepresentation voiding coverage). As such, either an intent to deceive, or a material misrepresentation can avoid an insurance policy. Johnson Maday v. Prudential Ins. Co. of America, 276 Ill. App. 3d 371, 375 (1995) (failure of health insurance applicant to disclose extensive history of hospitalizations provided grounds for rescission).
This section, however, is not by itself grounds for denial of coverage. Roberts v. Nat l Liberty Group of Companies, 159 Ill. App. 3d 706, 708 (1987). It allows rescission of a policy as long as the insurer elects to do so promptly after hearing of the fraud. Farmers Auto Ins. Ass n v. Pursley, 130 Ill. App. 2d 980 (1971). This provision has been used to rescind an insurance policy for overvalued property. Stone v. Underwriters at Lloyd s, 81 Ill. App. 333, 338 (1980) (valuing property at $275,000 that insured had purchased for $19,800). As such, material misstatements in a policy application that overstate inventory, and understate other assets in order to keep premiums artificially low would likely be grounds for rescission under Illinois Insurance Code 154 as it is written with intent to deceive or materially affect the risk assumed by the insurer. II. MISREPRESENTATIONS IN PROOF OF LOSS Notwithstanding the application for coverage, an insurer may also deny coverage because of fraud during the proof of loss submission, typically in an affirmative defense. COUCH ON INSURANCE notes that one of the primary purposes of the proof of loss requirement and the insurer s subsequent investigation is to determine the legitimacy of the claim and avoid fraudulent claims. To this end, most policies provide that in the event of fraud, false swearing, or willful misrepresentation, the policy will be voided and recovery will be barred. 13 COUCH ON INS. 197:1 (3d ed. 2012). a. Fraud Clause Illinois law provides that policy provisions voiding coverage when an insured willfully conceals any material fact are valid, and a court may deny recovery to an insured that has made deliberate material misstatements in a sworn proof of loss. Marvel Engineering Co v. Commercial Union Ins. Co., 118 Ill. App. 3d 844, 848 (1983). Materiality is an essential element of this defense, and courts are willing to give an insured s representations a fair amount of deference. See A&A, Inc. v. Great Cent. Ins. Co., 259 Ill. App. 3d 73, 82 83 (1994) (finding a possible innocent construction and thus a question of fact for the jury). 2
In Barth v. State Farm Fire and Cas. Co., 371 Ill. App. 3d 498 (2007), the court examined an insurer s affirmative defense under a concealment/fraud provision. That case involved a house fire and suspected arson. The insurance policy contained a provision stating that [t]his policy is void as to you and any other insured, if you or any other insured under this policy has intentionally concealed or misrepresented any material fact or circumstance relating to this insurance, whether before or after a loss. Id. at 504 (emphasis in original). The trial court gave jury instructions based on that provision. On appeal, the plaintiff argued that additional elements of a common law fraudulent misrepresentation claim should have been given to the jury as elements of the defense. The court determined that contract law should guide the interpretation of the provision, and the common law fraud notions of actual fraud and detrimental reliance were unnecessary. Under this provision, defendant only had to show: 1) the plaintiff concealed or misrepresented a fact or circumstance, or made a false statement relating to the insurance at issue; 2) that fact was material; 3) the concealment, misrepresentation, or false statement was made to the insurer or its agents; and 4) the concealment, misrepresentation, or false statement was made knowingly, willfully, and with intent to deceive the insurer. Id. at 504. In State Farm General Ins. Co. v. Best In The West Foods, Inc., 282 Ill. App. 3d 470, 485 (1996), the court found that a grocery store s misrepresentations with respect to an inventory claim voided the policy under a concealment or fraud provision. There, a natural gas explosion occurred at a grocery store and the store made a claim for lost inventory and business interruption. The insurer denied the claim under a policy provision that declared the policy void when an insured intentionally concealed or misrepresented a material fact relating to the insurance, later filing a complaint for declaratory judgment. That complaint alleged the policy was void because the grocery store had overstated the contents and lost earnings as a result of the explosion and asked the court to declare the policy void, thus denying coverage. 3
The insurer s expert determined there was no documentation to support the claimed inventory losses, and the only evidence supported an inventory value at about half of the claimed loss. The value of equipment was also overstated, and financial projections showed that the grocery store would have suffered substantial losses in the future, negating any claims for lost profits. Id. at 474 75. The concealment or fraud condition stated [t]his policy is void if, whether before or after a loss, any insured has intentionally concealed or misrepresented any material fact or circumstance relating to this insurance. Id. at 476 (emphasis in original). Based on expert testimony regarding inventory accounting and tax returns, the judge found that the grocery store had misrepresented the amount and value of inventory damages in the explosion in the proof of loss and examinations under oath. As such, the policy was void under the policy s concealment or fraud provision. Id. at 485. Similarly, the court in Passero v. Allstate Ins. Co., 196 Ill. App. 3d 602, 604 (1990) voided a policy because the insured vastly overstated the value of property. That policy contained a provision stating [t]his policy is void if you intentionally conceal or misrepresent any material fact or circumstance, before or after loss. Id. at 605. There, the insured made a sworn statement in the proof of loss claiming $9,040 as the actual cash value of stolen property, including a $900 stereo system and $1,500 worth of video equipment. The insurer s investigation of the losses revealed one of the insureds purchased the stereo system for $454.71, and the receipt reflected an employee discount. The stereo system with the serial number matching the claim of the loss was not even purchased by one of the insureds. However, the insureds made sworn statements contrary to all these discoveries. As such, the insurer won on summary judgment. Id. at 604 05. On appeal, the insureds argued that these misrepresentations were immaterial to the policy itself, thus avoiding the misrepresentation provision. The court rejected this notion in a narrow context and a broad view, noting that the concept of materiality is different in insurance law than it is in common law, statutory construction, and consumer fraud. First, it stated that the misstatements were 4
material in light of the policy itself. That policy required true receipts, an examination under oath, and a sworn proof of loss specifically to protect the insurer from reimbursing the insured for stolen property that did not truly belong to them. Therefore, these were material aspects of the insurance policy. Second, the court observed that it is well established that, in general, all questions relevant and pertinent to an insurer s need to protect itself against false claims are material because the answers ultimately affect the obligations of the insurer. Id. at 607, citing Clafin v. Commonwealth Ins. Co., 110 U.S. 81, 94 95 (1884). The Passero court sought to solidify the definition of materiality in an insurance law context. It stated, [f]alse sworn answers are material if they might have affected the insurer s action or attitude, or if they may be said to have been calculated to discourage, mislead, or deflect the insurer s investigation in any area that might have seemed to it, at the time, a relevant area to investigate. Passero, 196 Ill. App. 3d at 608, citing Fine v. Bellefonte Underwriter s Ins. Co., 725 F.2d 179, 184 (2d Cir. 1984). Thus, the insurer was proper in conducting the searches it did, and was permitted to void the policy based on the insured s material misrepresentations as a matter of law. Passero, 196 Ill. App. 3d at 607. While false swearing is typically a jury question, it is a question of law when the insured s misrepresentations cannot be seen as innocent. Id. at 610; Folk v. Nat l Ben Franklin Ins. Co., 45 Ill. App. 3d 595, 597 (1976) (finding no possible innocence when insured listed property as lost in fire when insured actually sold the property). b. No Fraud Clause It does not appear that fraud or false swearing can be an independent ground to deny coverage under Illinois law. See Folk, 45 Ill. App. 3d at 596 (stating [u]nder Illinois law, fraud and false swearing by the insured made in the proof of loss will render the policy void if, as here, the policy provides for such a result from such conduct. ). COUCH ON INSURANCE observes several possibilities for an insurer faced with fraud. First, it suggests an affirmative civil action based on common law and statutory fraud. 13 5
COUCH ON INS. 197:8. In Illinois, the elements of common law fraud are 1) a false statement of material fact; 2) defendant s knowledge that the statement was false; 3) defendant s intent that the statement induce the plaintiff to act; 3) plaintiff s reliance upon the truth of that statement; and 5) damages resulting from reliance on the statement. Connick v. Suzuki Motor Co., Ltd., 174 Ill. 2d 482, 496 (1996). In at least one instance, an insurer has brought this cause of action against an insured during a coverage dispute. See Truck Ins. Exchange v. Kafkam 911 F.Supp 313 (N.D. Ill. 1995) (dismissal based on a lack of reliance). Using an insured s fraud as a sword rather than a shield, however, is mostly unsuccessful. 13 COUCH ON INS. 197:8 (3d ed. 2012). On that note, comparative bad faith is a possible affirmative defense that can allow a jury to apportion fault and offset any recovery of damages. Id. Illinois courts have not addressed this. Finally, COUCH hints the possibility of criminal prosecution or RICO violations. Id. III. CONCLUSION Illinois law provides two opportunities to avoid paying a false claim. Illinois Insurance Code 154 allows an insurer to void a policy if the insured makes an intentional written material misrepresentation in the insured s application or a rider. Otherwise, an insurer can enforce a fraud or concealment clause in a policy by showing that the insured has made an intentional or knowing material misstatement or omission to an insurer or its agent during the proof of loss, with intent that the insured rely on that misrepresentation. These provisions are common, but can only be decided as a matter of law when the facts of the case do not permit any innocent interpretation. Dated: April 23, 2013 6