LIFE INSURANCE CLAIMS

American Bar Association, Tort Trial & Insurance Practice Law Journal, Winter 2022
By:  Kenneth Anspach and Jeremy M. King

The law governing life insurance policies and related disputes is based upon a patchwork of statutory and common law principles that the legislature and courts have developed over the years. These rules frequently protect beneficiaries from overreaching or inequitable practices by insurance companies. In 2020, the “life/annuity” insurance sector in the United States, which includes “annuities, accident and health, and life insurance,” comprised more than 1,000 insurance companies underwriting products yielding $624 billion in life insurance premiums.[1] This amounts to approximately 49% of the total $1.28 trillion net premiums underwritten by the United States insurance industry (excluding specialized health insurance companies) in 2020, with the other 51% being underwritten by “property/casualty” insurers.[2] Yet the legal structure and framework surrounding this insurance on which Americans expend almost half of their insurance premium dollars every year are less well-known and often less well-developed than its property/casualty cousin.

Federal law requires that in almost every instance, the law governing insurance issues will be state law. The McCarran-Ferguson Act provides that “regulation and taxation by the several States of the business of insurance is in the public interest,” and its gives states the broad authority to regulate the “business of insurance” without interference from federal regulation, unless federal law specifically provides otherwise.[3] Given the prominence of state law, some states, such as Illinois and New York, have put measures in place that limit the power of insurance companies to deny coverage and otherwise restrict the practices of the insurance industry in the life/annuity insurance markets. For example, Illinois law specifically states that the Director of Insurance may issue rules that prohibit life insurance policy provisions that the director deems “unjust, unfair, or unfairly discriminatory to the policyholder.”[4] Illinois and New York life insurance laws in particular offer snapshots of consumer-protective principles that can serve as templates for other jurisdictions.

This article addresses Illinois and New York consumer protections that involve: (1) limitations on an insurance company’s ability to rescind a policy and deny coverage based upon purported misrepresentations made by the insured, (2) limitations on an insurance company’s ability to rely on application materials in seeking rescission, (3) limitations on an insurance company’s ability to rely on materials other than the specific policy application, (4) limitations on an insurance company’s ability to cancel coverage without proper notice to the insured, (5) limitations on an insurance company’s ability to deny coverage without an explanation of the reasons therefor, and (6) requirements for an insurance company to act upon an application for life insurance within a reasonable time and for insurance agents to adhere to a standard of due care in the procurement of life insurance. Each of these issues affords special protections to the policyholder beyond the simple terms of the contract and provides protections against potential pitfalls for unwary insureds and beneficiaries. In part, these protections serve to level a playing field where the insurance company has far more expertise, sophistication, and experience than its customers.

I. Limitations On An Insurance Company’s Ability To Rescind Or Deny Coverage Due To An Insurance Application’s Alleged Misrepresentations

Life insurance companies typically ask questions on their insurance applications regarding the health of the prospective insured. Ordinarily, any material misrepresentation made during contract formation constitutes grounds for rescission, whether or not such misrepresentation was made with the intent to deceive.[5]  State legislators in both Illinois and New York have altered this rule by statute for life insurance policies.

In both Illinois and New York law, insurance companies may refuse coverage and seek rescission based upon such purported misrepresentations, but they must do so within two years of issuance of the policy of life insurance.[6]  Section 224 of the Illinois Insurance Code[7] sets forth the standard provisions on this issue that must be included in life insurance policies issued in Illinois. Subsection (c) of section 224 contains the requirements for the period of time during which an insurer can contest the validity of the contract based upon purported misrepresentation:

[N]o policy of life insurance . . . may be issued or delivered in this State, unless such policy contains in substance the following provisions . . .

* * *

(c) A provision that the policy, together with the application therefor, a copy of which shall be endorsed upon or attached to the policy and made a part thereof, shall constitute the entire contract between the parties and that after it has been in force during the lifetime of the insured a specified time, not later than 2 years from its date, it shall be incontestable except for nonpayment of premiums . . . .[8]

Thus, an insurance company in Illinois must plainly state in its life insurance policy that the contract is only contestable up to two years from the date of issuance.[9]

New York enacted a similar contestability provision in section 3203 of its Insurance Law.[10] The relevant portion, subsection (3), reads:

All life insurance policies, except as otherwise stated herein, delivered or issued for delivery in this state, shall contain in substance the following provisions, or provisions which the superintendent deems to be more favorable to policyholders . . .

* * *

(3) that the policy shall be incontestable after being in force during the life of the insured for a period of two years from its date of issue . . . .[11]

New York law reflects the same legislative policy as Illinois with respect to an insurer’s ability to contest the validity of the policy more than two years after issuance. In fact, New York was the first state to enact this protection for life insurance policies, doing so in 1906 following “extensive inquiry into every aspect of the insurance industry.”[12]

These protections should not be seen as an endorsement of fraud. Instead, they place a duty of investigation on an insurance company and are premised on the notion that two years affords the insurer ample opportunity to investigate the truthfulness of the application responses and take action if necessary. Incontestability clauses first arose in the middle nineteenth century.[13] English life insurance companies began including such clauses in policies to assuage public sentiment that insurers were obstinately refusing to pay benefits based upon purported misstatements in policy applications after the death of the policyholder, who was therefore unavailable to testify on the subject.[14] Justice Oliver Wendell Holmes praised these provisions, stating that the purpose was “plain and laudable—to create an absolute assurance of the benefit, as free as may be from any dispute of fact except the fact of death, and as soon as it reasonably can be done.”[15] In this way, the two-year window to contest is akin to a statute of limitation on such actions, albeit without the benefit of a discovery rule.[16] New York law does allow certain types of policies to include a provision allowing for rescission even after the incontestability date based on actual fraudulent misstatements.[17] But the incontestability rule for life insurance is inviolate.

The strength of this rescission defense can be seen in Judge Weinstein’s decision in AEI Life, LLC v. Lincoln Benefit Life Co.,[18] which was later affirmed by the United States Court of Appeals for the Second Circuit. In AEI Life, following bench trial on the issues of fraud and contacts with the State of New Jersey, Judge Weinstein found that a so-called “stranger-owned life insurance policy” was procured through fraud.[19] A trust purchased a life insurance policy on the life of Gabriela Fischer. The trust’s beneficiary was Ms. Fischer’s son, Irving Fischer. Later, the trust sold the policy, which ultimately was purchased by AEI Life, LLC, which sought a declaration of rights after it became clear that the insurer would refuse to pay a benefit upon the death of Ms. Fischer.

Judge Weinstein did not mince words: “All three witnesses—mother, son, and broker—lied” when testifying.[20] The assets of the insured were vastly overstated and misrepresented, as was the place of execution.[21] Because of “extensive fraud in the inducement” during the formation of the policy, Judge Weinstein found that the policy’s New Jersey choice of law clause did not apply.[22] Applying New York law, he held that this fraudulently obtained policy was enforceable on its terms because the contestability period had passed.[23]

The life insurance policy’s validity is therefore protected from attack based upon problems in contract formation after the two-year mark in both Illinois and New York. But, Illinois and New York have placed additional restrictions on insurance companies’ ability to contest coverage, whether through rescission or on the policy’s terms, or avoid coverage through cancelation. But these restrictions vary as between the states.

II. In Illinois, An Insurer May Not Rely Upon Purported Misrepresentations Made In An Unsigned Life Insurance Policy Application

It is well settled in the State of Illinois that an insurer may not rely on an unsigned policy application in seeking rescission of an insurance policy.[24] Even if the policy application contains misrepresentations on which the insurer relied during underwriting, such misrepresentations “would not serve to defeat recovery” if the insurer issued the policy based upon an application that was not signed by the insured.[25]

Not so in New York, which addresses the problem of the insured’s attestation to the veracity of the statements made in the application in a different way. New York law prohibits an insurance company from introducing a policy application into evidence unless a “true copy” of that application is physically attached to the policy at the time of issuance.[26] In Hidary v. Maccabees Life Ins. Co.,[27] the court confronted the question of whether an insurer could seek rescission of a life insurance policy (within the contestability period) based upon an application that was unsigned. The application did not bear the insured’s signature because it was a transcription by an insurance company employee from an original application intended for use in a different state to an application form approved for use in the insurer’s state.[28]

The court held that even the unsigned application constituted a “true copy” for the purposes of the New York rule, and the steps taken by the insurance company to attach the unsigned application to the policy at the time of issuance satisfied the “purpose and intent” of the statute.[29] By attaching the application, the insurer provided everything it relied upon in issuing the policy, and the policyholder had every opportunity “and, in fact, a duty” to review that information and correct any errors.[30] The court allowed the insurer to rescind based upon clear misrepresentations in the unsigned policy application.[31]

III. In Illinois Rescission Is Only Available Based Upon The Application For The Specific Policy At Issue

In Illinois, an insurer may not rely upon a representation in an application for a policy of life insurance unless it is an application for that specific policy.  This requirement has significance given the practice of insurance brokers of sending a single application to multiple carriers in order to shop for the best quote. Section 154 of the Illinois Insurance Code[32] provides, in pertinent part, as follows:

Misrepresentations and false warranties.

No misrepresentation or false warranty made by the insured or in his behalf in the negotiation for a policy of insurance, or breach of a condition of such policy shall defeat or avoid the policy or prevent its attaching unless such misrepresentation, false warranty or condition shall have been stated in the policy or endorsement or rider attached thereto, or in the written application therefor.

Accordingly, the Illinois Insurance Code makes clear that the relevant document for policy rescission is the “written application therefor” and mandates that coverage may not be defeated based upon other application materials or documents related to other policies.

Notably, New York insurance statutes do not contain similar language, but at least one New York court has found that misrepresentations to a third party cannot form the basis of a rescission claim.[33] As noted above, insurance application materials are inadmissible in New York courts if they are not physically attached to the policy, meaning that any New York insurer must attach the documents on which it relies during underwriting, whether that is an application for the specific policy at issue or not.[34] Illinois removed a similar physical attachment requirement from its statutes effective as of June 1, 1996.[35]

The Illinois rule was construed in Illinois State Bar Ass’n Mutual Insurance Co. v. Brooks, Adams & Tarulis,[36] when an insurer sought to rescind one policy based upon an alleged misrepresentation contained in an application for coverage for the previous policy year.  Citing section 154 of the Illinois Insurance Code, the court stated:

[T]he ISBA argued to the trial court that the alleged misrepresentation in the application for the 2008 policy infected the application for the 2009 policy, even though the 2009 policy and the application for the 2009 policy did not incorporate the representations from the application for the 2008 policy. We cannot reconcile the ISBA’s argument with the words of the [Illinois Insurance] Code . . . .

The Code does not make a misrepresentation in one application nullify all subsequent contracts between the parties. We cannot add language to the Code to make one misrepresentation defeat all subsequent insurance contracts, when the insured made no misrepresentations in its applications for the subsequent insurance.

Because the ISBA showed no misrepresentation in the application for the 2009 policy, and it did not present any evidence concerning any other statutory grounds for avoiding the policy, the [Illinois Insurance] Code required the ISBA to honor its commitments to BAT under the 2009 policy.[37]

Thus, the court held that an insurer may not disclaim coverage for one policy based upon misrepresentations in an application for a different policy, even though the application for a different policy was from the same insurance company and the policy was an annual renewal of claims-made coverage.

This reasoning applies with even more force in the life insurance context.  As one court noted, “section 154 says what it says, and we are powerless to rewrite it.”[38] While life insurance policies are not subject to annual applications for renewals, the simple text of the statute should apply with equal force. Any insurer seeking rescission likely cannot rely on statements made in other application materials, even if that insurer has reviewed them during underwriting.

Under Illinois law, the only basis on which a purported misrepresentation can support rescission, is if it is in the application for that policy or in the policy itself. If an insurance company has additional materials it deems material during underwriting, its available option is to attach such materials to the policy as a “rider” to the policy.[39] As stated in National Union Fire Insurance Co. v. Continental Illinois Corp., interpreting a prior version of the statue:

To rely on the alleged misrepresentations …as a basis for rescinding the Policies, Insurers must be able to allege in good faith that copies of the relevant documents were physically attached to the Policies…[40]

That court held that, even absent the “physical” attachment requirement, the insurer was required to establish that the documents in question “were a part of the insurance contract” and that the policyholder “warranted the accuracy of those documents.”[41]  An Illinois court therefore will require that a life insurance application containing purported misrepresentations be the application itself for a given policy, or otherwise contained in a document that is a physical component of that application, rather than just in a document related in substance, before serving as grounds for an insurer to refuse coverage.[42] An insurer cannot deny coverage based on alleged misrepresentations made in any other papers.[43]

This sound rule is reflected in the common law.  In Bristol v. Commercial Union Life Insurance Co. of America, the court held: “In the United States the rule is that a representation to one insurer cannot be evidence of a like representation to another insurer, on application for a different policy, on the same … risks.”[44]  Similarly, in Federal Land Bank of Spokane v. Rocky Mountain Fire Insurance Co.,[45] where an insurance application from one company was submitted to a second company, the court held,

In application of most fundamental principles of law to the facts, it is apparent that the application in this instance did not and could not be considered as a part of the contract. It must be manifest that an application made to one company constitutes no part of the contract with a wholly different company. We are astonished that the insurance company should attempt to escape liability upon such flimsy pretext.[46]

Rescission is a drastic remedy, and courts protect policyholders with these restrictions on an insurance company’s ability to seek to void a policy on which the policyholder has been dutifully paying premiums.

IV. Strict Statutory Grace Periods and Notice Requirements Govern An Insurer’s Ability To Cancel a Life Insurance Policy

Certainly insurance companies rely on policyholders making timely payment of premiums.[47] But state legislators have determined that policyholders are entitled to protection and flexibility in case of a missed payment.[48] Inequity likely would result if a single missed payment created forfeiture of an insurance product on which the insurance company has been collecting premiums, often for years. Therefore, statutory grace period provisions require that insurance companies grant extensions of time during which a policyholder can meet its obligations and cure the lapse.[49] While short lapses of premium payment will not result in a loss of coverage, if the insured dies during the grace period, the amount of unpaid premiums may be deducted from the policy’s proceeds.[50]

The Illinois legislature has mandated just this sort of protection against the arbitrary cancellation of policies of life insurance for lapse in premium payment.  The legislature has determined that all policyholders are entitled to a grace period of thirty days or one month following a missed premium payment before a policy can be cancelled.[51] Section 224(1)(b) specifically provides that:

[N]o policy of life insurance…may be issued or delivered in this State, unless such policy contains in substance the following provisions:

***

A provision that the insured is entitled to a grace period of either 30 days or of one month within which the payment of any premium after the first may be made…during which period of grace the policy shall continue in force…[52]

Similar grace periods of at least one month are most common amongst the States.[53]

Illinois courts have strictly enforced specific statutory requirements of grace periods, ruling favorably to uphold the statutory protections afforded to the insured and provide the insured every opportunity to pay and avoid forfeiture. In Benatti v. John Hancock Mutual Life Insurance Co., the court granted a plaintiff who missed a premium payment a full thirty calendar day month in computing the end of a grace period, rather than calculating based on the shortened month of February.[54]

New York insurance law provides for one of the longest statutory grace periods of any state, in certain circumstances. For policies involving varying frequency and amount of premiums, Section 3203(a)(1) of the New York Insurance Code requires insurance companies to give a sixty-one day grace period after missing a premium payment.[55] The insured must have at least paid the first premium payment to be protected by the grace period.[56] For all other individual life insurance policies, the grace period is 31 days.[57] Life insurance companies and insured persons may negotiate additional extensions to a grace period, but a negotiated-for extension does not automatically get the additional benefit of the statutory grace period.[58] Section 3203(a)(1) specifically provides that:

[F]or policies in which the amount and frequency of premiums may vary, after payment of the first premium, the policyholder is entitled to a sixty-one day grace period, beginning on the day when the insurer determines that the policy’s net cash surrender value is insufficient to pay the total charges necessary to keep the policy in force for one month from that day, within which to pay sufficient premium to keep the policy in force for three months from the date the insufficiency was determined. For all other policies, after payment of the first premium, the policyholder is entitled to a thirty-one day grace period or of one month following any subsequent premium due date within which to make payment of the premium then due. During such grace period, the policy shall continue in full force.[59]

Policyholders have additional statutory protections in the form of specific requirements that insurance companies give notice that a premium payment has been missed before canceling a policy.  Failure to give the required notice triggers lengthy time periods during which the policyholder may cure the premium payment lapse.

Section 234(1) of the Illinois Insurance Code mandates that a life insurance company doing business in Illinois may not declare a policy immediately forfeited or lapsed due to nonpayment of a premium unless written notice stating the amount due is given to the insured.[60] The notice must be addressed and mailed to the person whose life is insured at least fifteen days prior to the beginning of the grace period.[61] Section 234(1) specifically provides:

No life company doing business in this State shall declare any policy forfeited or lapsed within six months after default in payment of any premium installment or interest or any portion thereof, nor shall any such policy be forfeited or lapsed by reason of nonpayment when due of any premium, installment or interest, or any portion thereof, required by the terms of the policy to be paid, within six months from the default in payment of such premium, installment or interest, unless a written or printed notice stating the amount of such premium, installment, interest or portion thereof due on such policy, the place where it shall be paid and the person to whom the same is payable, shall have been duly addressed and mailed with the required postage affixed, to the person whose life is insured…at his last known post office address, at least fifteen days and not more than forty-five days prior to the day when the same is due and payable, before the beginning of the period of grace…[62]

This notice requirement has been strictly enforced by Illinois courts. Errors in the amount due and a failure to adequately disclose the consequences of non-payment have been sufficient for a court to hold that an insurance company’s attempt at notice did not preclude the application of the six-month no action period.[63] The statutory notice requirement, however, does not apply when policy premiums are payable monthly, as ruled in Cooke v. Jackson National Life Insurance Co.[64]

New York law mandates a similar notice requirement. The notice is must state the amount of the payment due, the due date, and the place where and the person to whom it is payable.[65] Section 3211 of the New York Insurance Law specifically provides that:

No policy of life insurance or non-cancellable disability insurance delivered or issued for delivery in this state, and no life insurance certificate delivered or issued for delivery in this state by a fraternal benefit society, shall terminate or lapse by reason of default in payment of any premium, installment, or interest on any policy loan in less than one year after such default, unless, for scheduled premium policies, a notice shall have been duly mailed at least fifteen and not more than forty-five days prior to the day when such payment becomes due, or for life insurance policies in which the amount and frequency of premiums may vary, no earlier than and within thirty days after the day when the insurer determines that the net cash surrender value under the policy is insufficient to pay the total charges that are necessary to keep the policy in force. A separate notice shall not be required for insurance that is supplemental to a policy of life insurance.[66]

New York courts also strictly construe these statutory requirements in an effort to avoid forfeiture for non-payment of premiums.[67] But some courts in New York have been willing to overlook errors, such as an inaccurate date payment was due, as long as the notice provided accurate details of the amount owed and the policyholder had sufficient notice that a deadline was looming.[68]

V. An Insurer Must Provide a Reasonable Explanation for a Denial of Coverage.

Illinois law has specific requirements governing an insurance company’s ability to deny coverage, including rules applicable to the manner and substance of the insurer’s communication of that denial to the policyholder. Pursuant to section 919.50 of title 50 of the Illinois Administrative Code, entitled “Required Practices for all Insurance Companies[,]” all first party insurers in Illinois are required to do the following:

On first party claims . . . if the claim is denied, the company shall provide to the insured a reasonable written explanation of the basis of the . . . denial . . . . Notice of Availability of the Department of Insurance shall accompany this explanation.[69]

Furthermore, Pursuant to section 919.40 of title 50:

“Notice of Availability of the Department of Insurance,” as required by this Part, shall be no less informative than the following:

Part 919 of the Rules of the Illinois Department of Insurance requires that our company advise you that, if you wish to take this matter up with the Illinois Department of Insurance, it maintains a Consumer Division in Chicago at 122 S. Michigan Ave., 19th Floor, Chicago, Illinois 60603 and in Springfield at 320 West Washington Street, Springfield, Illinois 62767.[70]

Thus, insurers must both provide reasonable written explanations for coverage denials and must notify the insured in writing of their right to take the matter up with the Illinois Department of Insurance if the denial is erroneous.

New York similarly places an obligation on an insurer to timely accept or reject claims and to provide a clear explanation of its position. Under New York law, it is an unfair claim settlement practice to either “fail to acknowledge with reasonable promptness” communications regarding a claim or not attempt in good faith to effect prompt and fair settlement of insurance claims on which “liability has become reasonably clear.”[71] Further, New York Insurance Regulation 64 prevents an insurer from denying “any element of a claim on the grounds of a specific policy provision” unless the insurer makes reference to that provision to the policyholder in writing.[72]  It also requires that an insurer “explain its specific reasons for disclaiming coverage” and that it do so “as soon as it is determined” that the insurer will deny.[73]

The New York State Department of Financial Services (the “DFS”) recently investigated violations of these regulations in connection with the “contestable claim practices” of a life insurance company over a ten year period.[74] The result was a consent order finding that the insurer was unlawfully rescinding policies when the insured died during the contestability period and also was not informing beneficiaries of any specific policy provisions that were the grounds of a denial or citing any specific reasons for disclaiming coverage, among other things.[75] The relief granted in the consent order included injunctive relief, appointment of a third-party administrator to oversee contestable claims, restitution, and civil penalties.[76] While there is no private right of action under these regulations,[77] aggrieved policyholders may bring their situation to the attention of the DFS and Superintendent of Insurance.

VI. Illinois Requires An Insurance Company to Act on an Application for Life Insurance Within a Reasonable Time.

Illinois law imposes a duty of care on a life insurance company to respond to an application for life insurance with reasonable promptness. In Talbot v. Country Life Insurance Co.,[78] the court noted the “peculiar urgency of the need for prompt attention in these matters.” In that case, the insured submitted an application for life insurance and paid the first premium.[79]  The insurer waited over five months before attempting to reject the application and return the premium two days after the insured’s death.[80] The court held that an insurance company obtaining an application for life insurance is under a duty to accept it or reject it within a reasonable time.[81] The court further held that a captive insurance agent may be liable for unreasonably delaying action on an application for life insurance.[82] The court’s ruling was based on the negligence principle of an affirmative undertaking, which provides that a person who begins a service for another must exercise reasonable care in performing it to avoid injury to the beneficiary of the undertaking.[83]

The United States Court of Appeals for the Seventh Circuit reaffirmed this principle in reversing a district court’s grant of summary judgment for a life insurance company.[84]  The court noted that, while the insurer does not have a legal obligation to issue an insurance policy after receiving an application, “it does have a legal duty to rule on applications promptly, either by issuing the policy or rejecting it so the applicant can obtain insurance elsewhere.”[85]  If the insurance company “delays and does not promptly rule on the application, it may be liable for any damages caused by the delay.”[86]

By contrast, New York courts have been reluctant to recognize such a duty.[87] As one court stated, the insurer “can not be held liable for any delay or negligence in processing the application or arranging for a medical examination of the applicant.”[88] New York courts have even rejected a duty of care to accept or reject life insurance applications within a reasonable time period despite allegations by an insured that an insurance agent made assurances that the policy and coverage were in place.[89] One court described such statements as “in many cases, merely an expression of opinion or a mere statement of a conclusion or relationship, that a contract was in effect and that the proposed insured was covered by the policy.”[90] While an applicant may allege that it relied upon such statements to its detriment, courts in New York give heavy weight to language in insurance applications noting that coverage is not in effect until the application is accepted.[91]

While recovery against an insurer in these situations appears unlikely in New York, the Empire State does recognize a common law duty of a broker to procure coverage reasonably promptly.  “An insurance agent or broker has a common-law duty to obtain requested coverage for a client within a reasonable amount of time, or to inform the client of the inability to do so.”[92] Life insurance applicants in New York would be well-advised to make clear to their broker of the importance of having the policy application accepted or rejected quickly in order to avoid prejudice if an unfortunate casualty takes place while the application is under consideration.