Rescission of a Life Policy Can be Tricky in Kentucky
Barry Zalma, Esq., CFE
Insurance claims expert, consultant at Barry Zalma, Inc. and author/Publisher at ClaimSchool, Inc.
Posted on August 26, 2020 by Barry Zalma
State Statutes and Regulations Limit Life Insurer’s Right to Rescind
Chad Jude replaced a $500,000 life insurance policy with a $1.5 Million policy but misrepresented material facts to the insurer that allowed them to effectively rescind the $1.5 million policy. His estate claimed, however, that the policy that was replaced required the insurer to pay the limits of the original policy regardless of Jude’s agreement to cancel that policy.
In American General Life Insurance Co. v. Estate Of Chad Jude, et al., No. 19-5950, United States Court Of Appeals For The Sixth Circuit (August 21, 2020) the Sixth Circuit applied Kentucky law proving that even a valid rescission can be dangerous to an insurer because of regulations and statutes limiting its rights in the state of Kentucky.
FACTS
Chad Jude was not completely forthright regarding his health condition when he obtained a larger life insurance policy to replace his existing policy from American General Insurance Company (American General). Mr. Jude’s health changed between the time that he applied for the new life insurance policy in August 2015 and when he paid the first premium for this policy in October 2015. Mr. Jude’s changed health condition should have altered his responses to questions in the life insurance policy application. But Mr. Jude did not disclose these changes in his health condition and represented to American General that his health had not changed during this period.
Mr. Jude signed the application on August 4, 4015. That same day, Mr. Jude also signed a “Notice Regarding Replacement,” acknowledging that the new life insurance policy was intended to replace the 2014 policy.
Eleven days later, on August 15, 2015, Mr. Jude had a magnetic resonance imaging (MRI) scan and was diagnosed with Chiari I malformation, which is a condition where the brain extends into the spinal cord. Mr. Jude subsequently consulted with a physician on August 20, who referred Mr. Jude to neurosurgery because of his neurologic symptoms.
Sixteen days later American General sent Mr. Jude a letter advising him that replacing his life insurance coverage would result in the termination of the 2014 policy.
On September 4, 2015, American General issued Mr. Jude the new $1.5 million replacement policy (the 2015 policy). Ten days later, on September 14, 2015, Mr. Jude had a second MRI, which confirmed his Chiari I malformation diagnosis. Then, on September 21, Mr. Jude signed a “Policy Acceptance and Amendment of Application” (PAA) form that was part of the 2015 policy. Although Mr. Jude had consulted with multiple physicians, Mr. Jude represented that there have been no changes since the date of the application in his health or in any other condition.
An American General underwriter, Laura Stout, conducted a routine investigation of Mr. Jude’s medical records. The investigation revealed that Mr. Jude’s answers in his application were incorrect and incomplete. On March 30, 2017, American General therefore sent Mr. Jude a letter seeking to rescind Mr. Jude’s 2015 policy and render coverage null and void because the Company’s underwriting department would not have issued this policy had it been aware of Mr. Jude’s medical history and diagnosis.
Mr. Jude refused to sign the voluntary rescission agreement. Mr. Jude died on December 30, 2017 and Ms. Jude did not make a claim for death benefits to American General, American General in August 2018 reinstated the 2014 policy and paid Ms. Jude $533,424.21, which included the $500,000 in death benefits from the 2014 policy plus interest but minus the back premiums needed to reinstate the 2014 policy.
The court concluded that the third condition—that there had not been a change in Mr. Jude’s health that would change the answers to any question in the application before the policy was delivered and accepted and before the full first premium had been paid—was a condition precedent.
DISCUSSION
The trial court found that there was no genuine issue of material fact that the third condition precedent to the policy’s formation was not met and so no insurance policy was formed. The court therefore granted summary judgment to American General and held that the 2015 policy was null and void ab initio.
The court determined that there was no genuine issue of material fact that American General would not have issued the 2015 policy had the application been completed truthfully. Thus, the 2015 policy was void ab initio.
The court rejected the Judes’ claim that American General violated Kentucky’s replacement life insurance statute by rescinding the 2015 policy.
Kentucky law states that: “(2) No replacing insurer shall issue any life insurance policy or annuity contract in a replacement transaction to replace an existing life insurance policy or annuity contract unless the replacing insurer shall agree in writing with the insured that: (a) The new life insurance policy or annuity contract issued by the replacing insurer will not be contestable by it in the event of such insured’s death to any greater extent than the existing life insurance policy or annuity contract would have been contestable by the existing insurer had such replacement not taken place provided, however, that this paragraph shall not apply to that amount of insurance written and issued which exceeds the amount of the existing life insurance. Ky. Rev. Stat. Ann. § 304.12-030(2).
The District court determined that there was no “new life insurance policy” to be contested so the statute did not apply. Further, the court concluded that even if American General had violated the replacement life insurance statute, the issue was moot because Ms. Jude received the benefits from the 2014 policy when American General sent her a check for $533,424.41.
That the 2015 policy was void ab initio, however, does not alleviate American General’s responsibilities to comply with Kentucky’s insurance laws and regulations.
Notwithstanding American General’s initial rescission of the entire 2015 replacement policy, failing to provide the Judes the required contestability credit for the replaced 2014 policy for a significant period of time would violate Kentucky’s replacement life insurance regulation and, therefore, may violate Kentucky’s statute prohibiting unfair competition and unfair and deceptive practices.
American General’s contesting of the entire $1.5 million replacement 2015 policy and then later payment of the $500,000 2014 policy amount after a significant delay, rather than rescinding only the replacement 2015 policy up to the replaced 2014 policy value from the outset, violated Kentucky’s replacement life insurance regulation. Although this may be in some circumstances only a formal distinction, it can be significant where, as in this case, there is a significant delay.
American General was only permitted to rescind $1 million of the Judes’ 2015 policy based on Mr. Jude’s material misrepresentations under this regulation. American General’s conduct led the Judes to worry that they would not receive anything from American General, as Mr. Jude had terminated the 2014 policy when he obtained the 2015 policy. So American General’s efforts to rescind and void the 2015 policy seemed to the Judes to leave them with no life insurance protection whatsoever.
The Sixth Circuit concluded that the district court erred in granting summary judgment to American General on the ground that it did not violate the regulation. Therefore, a remand was warranted to determine whether the Judes can recover damages for injury suffered from that violation. To do so, the Judes will have to show that a violation of the regulation amounted to a violation of the Insurance Code, and that Ky. Rev. Stat. Ann. § 446.070 provides a damages cause of action for such a violation. If so, the Judes must then presumably show that the regulation so incorporated protects against the injuries they assert.
When American General learned of Mr. Jude’s passing, it eventually (though belatedly) reinstated the 2014 policy and paid Ms. Jude the benefits under that policy. Further, American General did not act unreasonably or with reckless disregard in seeking to rescind the 2015 policy and have it declared void. The district court’s ruling in American General’s favor demonstrates that the company did not act in bad faith—even if its actions ultimately violated Kentucky’s replacement life insurance regulation—as this shows there was room for reasonable disagreement as to the proper outcome of the contested legal issues in this case.
For the reasons stated above, the Sixth Circuit affirmed in part and reversed in part, and remanded the case to the district court for further proceedings in accordance with the opinion to determine if they are entitled to damages for the delay in paying as required on the 2014 policy that Jude agreed had been terminated.
ZALMA OPINION
Rescission is an equitable remedy. The court’s decision must, therefore, be fair and reasonable. Some states, like Kentucky, have statutes and regulations that limit the right of an insurer to rescind a policy. There is no question that Mr. Jude tried to cheat his insurer and that fraud failed. If this case had occurred in a different state the results could have been different. If the statute allows damages for the delay in payment the trial court will award it. If not, the trial court will not. Any insurer should learn from this case that before rescinding a policy of insurance the insurer should consult with an experienced insurance coverage lawyer to protect them from the type of error that might cost them a suit like this one and the possibility of additional damages for properly rescinding a policy of insurance but failing to follow the state statute to the letter.
? 2020 – Barry Zalma
Barry Zalma, Esq., CFE, now limits his practice to service as an insurance consultant specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud almost equally for insurers and policyholders. He also serves as an arbitrator or mediator for insurance related disputes. He practiced law in California for more than 44 years as an insurance coverage and claims handling lawyer and more than 52 years in the insurance business. He is available at https://www.zalma.com and [email protected].
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