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When people think of insurance fraud, they likely imagine someone intentionally causing a loss in order to receive policy proceeds, but most insurance policies do not limit a carrier’s right to deny coverage or void the policy to fraud alone. Rather, all kinds of policies (homeowner, commercial general liability, and more) often include in their fraud-related provisions misrepresentation of a material fact as well. But what constitutes a “material misrepresentation” exactly? The answer, of course, depends on which state law applies.
Take for example an insurance carrier that filed an action in California, asking the federal district court to declare that there was no coverage under a cyber liability policy because, among other reasons, the insured had represented in its policy application that its medical records system had certain security measures in place to protect personally identifiable information and other sensitive data while, allegedly, patient information was accessible online with no encryption.
Although the court did not make a ruling on this issue, incorrect statements that are made by an insured in a policy application, even if unintentional, are very likely to support rescinding and voiding the policy ab initio (from its inception) under California law. This is because California’s test for materiality is the effect which truthful answers would have had upon the carrier in its evaluation of risk (such as requiring additional underwriting or charging additional premium): the fact that the carrier requires answers to specific questions in an application for insurance is usually in itself sufficient to establish the materiality as a matter of law.
The rule under Georgia law is a similar one, although from a more clearly objective standpoint: A material misrepresentation is one that would influence a prudent insurer in determining the nature, extent, or character of the risk and whether or not to accept it or fix a different amount of premium. And a Georgia statute sets forth specifically that all that is required in a policy application to give grounds to deny or rescind is a material misrepresentation, omission, concealment or incorrect statement (as opposed to proof of intent to defraud).
Going back to our example, the data security measures implemented by the insured would likely be material under Georgia law by increasing or decreasing the risk assessed by a prudent carrier of a cyber liability policy, such that any incorrect statement in the application as to those measures could entitle a carrier to deny or rescind. Under California law, since this carrier alleged it actually asked the insured in the application about checking for security patches, replacing factory default settings, etc., the insured’s responses would likely be found material as a matter of law.
Again, the meaning of material misrepresentation can involve other inquiries depending on the applicable law, such as proof of actual reliance by the carrier on that representation or other prejudice to the carrier, so when faced with a potential false statement or omission, a carrier should seek counsel to determine which state law(s) could be applicable.
For any questions, please contact Jessica Samford at [email protected].