Insurance Law Lesson 52: Rescission (2)

Michigan insurers have had broad rights to rescind a policy based on material misrepresentation. In the wake of the Supreme Court’s decision in Bazzi v. Sentinal (see Lesson 50), that right is no longer automatic, but conditioned on an equitable finding. In the coming years we will see how the trial – and undoubtedly the appellate courts – apply the new Bazzi rule.

Moreover, rescission has always been limited to cases where the policyholder’s misrepresentation was “material.” In Oade v. Jackson Nat’l Life Ins. Co. of Mich., the High Court explained that the proper materiality question “is whether ‘the’ contract issued, at the specific premium rate agreed upon, would have been issued notwithstanding the misrepresented facts.” 465 Mich. 244, 254 (2001). So, if the misrepresentation would have resulted in a substantial change in premium, then the insurer may seek rescission.

Consider: The policyholder signs an application prepared by an agent, not knowing that there is a mistake that leads to a substantially lower premium. Then there is a loss. The insurer rescinds, and the agent doesn’t have liability (see Lesson 3). How is this fair?

It’s easy to think of a situation where a person makes an innocent mistake, pays the premium, has a loss, and the insurer takes advantage of the innocent mistake and rescinds.

But, there are other cases where the policyholder intentionally (whether maliciously or not) fudges the truth or withholds information because he fears that the truth will make him uninsurable or cost way more premium. In other words, the “white lies” are not always innocent.

Moreover, as we know, an insurance policy is a contract. Imagine if I told you that I had $100 in my right pocket, and then we agree that you will give me your watch for all of the money that is in my right pocket. We then find out – to both of our surprise – that I actually have only $50 in my right pocket. The lie was not intentional. I legitimately believed I had $100 in my pocket. Then we find out that the watch is actually worth $10,000. I would certainly want to simply pay you an additional $50, but you would have the right to rescind our contract based on my misrepresentation.

This is true for insurance as well. The persons misrepresentations got him a significantly cheaper premium. Maybe it should have been $3000, but instead it was $1,500. When the loss occurs, all of the sudden that coverage is worth many times the full premium. The policyholder would gladly fill in the difference on the premium. But, it may well be too late at that point.

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