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The postclaims underwriting 'gotcha': when life insurers refuse to pay claims, alleging fraud or mistakes in policy applications, consumers have few options. But legal reform - and smart trial strategies - can provide them with needed protection.

Article Excerpt
Purchasing life insurance is no fun. But worse is when the insurer refuses to pay the policy.

Most states specify that for two years after a life insurance policy is issued, an insurer can contest its validity on the ground that a material misrepresentation was made in the application. (1) Afterward, the insurer can no longer challenge the policy and must pay the beneficiary.

When an insured person dies within this two-year contestability period, insurers typically scour his or her medical history for a misrepresentation that can serve as grounds for the rescission of the policy. This process, known as postclaims underwriting, can result in hardship for those who rely on the life insurance.

The laws of most states facilitate postclaims underwriting. When consumers sue after being denied payment, for instance, states often impose a strict liability standard, requiring insurers to prove only that any misrepresentation, if it had been known, would have caused an increase in the premiums, no matter what the amount. And insurers need not show a causal connection between misrepresentation and cause of death.

Also, many laws fail to take into account that misrepresentations are frequently the result of the consumer's lack of sophistication as well as the insurer's sloppy and sometimes fraudulent practices. For instance, many life insurance companies do not adequately investigate potential customers before signing them up for a policy.

Reform is needed to make life insurance laws fair to consumers and controlled by the same legal framework that governs other consumer transactions. By requiring that insurers better evaluate the risk posed by consumers before taking them on as customers, prove intent to deceive, and provide a causal connection between any misrepresentation and cause of death, state laws would balance the interests of both consumers and insurers.

Companies would still be able to void a policy if they could establish the legal elements of fraud and would have more incentive to do their homework ahead of time, while consumers would be given much-needed protection from careless, and sometimes unscrupulous, insurers and their agents.

Contestability period

The contestability period is similar to a statute of repose, limiting the time in which an insurance company can disclaim coverage. Currently, 43 states have enacted contestability laws? The purpose of these laws is to prevent insurance companies from asserting years after a policy is issued that it was invalid from its inception.

If contestability laws did not exist, courts would be flooded with cases involving polices issued many years before; in those cases, it would be difficult, if not impossible, for beneficiaries to prove the health history of the insured and the circumstances under which the application was completed. (Imagine, for instance, a 40-year-old beneficiary having to prove the facts surrounding an application submitted by a deceased parent when the beneficiary was only a teenager.) Contestability periods satisfy the need for security in the area of life insurance benefits.

Postclaims underwriting has been applied to other forms of insurance as well. In 2007, when a health insurance company rescinded health care coverage after the insured was involved in an accident that left him permanently disabled, a California appeals court in Hailey v. California Physicians' Services issued a stinging critique of the practice:

It is patently unfair for a claimant to obtain a policy, pay his premiums, and operate under the assumption that he is insured against a specified risk, only to learn after he submits a claim that he is not insured, and, therefore, cannot obtain any other policy to cover the loss.... If the insured is not an acceptable risk, the application should [be] denied up front, not after a policy is issued. (3)

In California, health insurance policies are governed under a separate statutory framework, prohibiting postclaims underwriting except where there is a willful misrepresentation. This rule should apply also to life insurance policies, and not just in California but in all states. After all, with both types of insurance the consumer justifiably believes that coverage is in effect, the insurer could have (but did not) properly investigate the veracity of the insurance application at the outset, and the consumer may suffer serious hardship if the policy is rescinded.

So why don't life insurance companies better investigate the risk posed by applicants at the outset, when evaluating applications? The simple answer is that...

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