When a policyholder, particularly a commercial policyholder, applies for insurance coverage, a key part of the application process is the disclosure of the policyholder’s relevant loss history. When an insurance company receives an application for insurance, that loss history is a critical part of the insurer’s underwriting process to determine whether it is willing to write an insurance policy, the terms and conditions of that insurance policy, and the premium it will charge for that insurance policy. The insurer relies on the insured and its broker to provide complete and accurate loss information. The failure to do so may result in a complete loss of coverage should a loss occur after a policy is issued based on incomplete loss information.
Rescission is a rare remedy. To rescind an insurance policy, the insurer generally has to demonstrate that it was misled by the policyholder’s application and information provided, that it relied on that information to issue the policy, which it would not have issued if it had all the information, and that it sought rescission in a timely manner. In a recent case in the Third Circuit (not precedential), the court affirmed the district court’s order rescinding an insurance policy after a loss because of the policyholder’s failure to provide a full loss history. H.J. Heinz Co. v. Starr Surplus Lines Ins. Co., No. 16-1447, 2017 U.S. App. LEXIS 510 (3d Cir. Jan. 11, 2017).
This case involved a specialized insurance policy to protect a food manufacturing and distribution company from claims based upon contaminated food products and government recalls of products because of accidental contamination. Food contamination cases and recalls have been big news in recent years and this type of insurance is critical in protecting food product companies from the economic impact of a recall or an outbreak of illness caused by accidental contamination.
Critical to obtaining this type of insurance is the provision of an accurate loss history of claims related to the coverage. These policies typically have large limits of liability and large self-insured retentions. Here, according to the court, the application provided to the insurer (a new insurer for the policyholder) through the insured’s broker answered several questions about prior history of regulatory fines and penalties and the withdrawal of products from the market. The answers were negative or answered by merely providing a loss history. In this case, the court noted that the loss history disclosed only one loss over ten years greater than the proposed $5 million self-insured retention (which was markedly lower than its previous $20 millions self-insured retention). Based on this information, the policy was issued with the lower $5 million self-insured retention.
The opinion indicates that two weeks later, Chinese authorities advised the insured that baby food it manufactured in China was contaminated with lead. Accordingly, the product was recalled and the insurer was put on notice. In investigating the loss, the insurer found out that the insured had incurred another loss concerning contamination of baby food manufactured in China, which was not disclosed in the application.
The policyholder sued for breach of contract and bad faith after the insurer issued a reservation of rights letter. the insurer counterclaimed for rescission and the rescission claim was tried first. After trial, the district court declared that the policy void ab initio and entered judgment for the insurer. The policyholder appealed.
In affirming the rescission determination, the court addressed a number of issues, including holding that the service-of-suit clause did not override the unambiguous choice-of-law provision. The appellate court found that the district court did not err in its findings concerning the loss history misrepresentation and its materiality. The insurer’s internal documentation, according to the court, supported the underwriting testimony that the insurer would not have issued the policy with a $5 million self-insured retention if it had known about the additional undisclosed losses that well exceeded $5 million. The court found that the overwhelming evidence was that the insurer relied on the policyholder’s misrepresentations in offering the policy.
The court also rejected the argument that the insurer had waived its right to seek rescission. The court held that the five-month period between when the insurer learned of the loss history omissions and the filing of the rescission counterclaim was unobjectionable.
The lesson here is that full disclosure of all relevant loss history is necessary to accurately underwrite a policy and to fairly apprise the insurer of the potential risk of loss.