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In their never-ending quest to remain profitable, insurance companies have embarked on a new, even more aggressive approach to den claims -- accusing policyholders of committing fraud or misrepresentation as a result of asserting claims under their insurance policies. After paying thousands of dollars in premiums and then suffering a potentially devastating loss, the last thing a policyholder needs is a denial of coverage from its insurance company. But the blow is even worse when that denial is accompanied by a claim that the policy is void because the policyholder committed fraud or misrepresentation.

The policyholder now has to fight two overwhelming battles: the battle to get the insurance company to reverse its denial; and the battle to get the fraud or misrepresentation claims dismissed (or withdrawn). An accusation of fraud or misrepresentation alone can have devastating effects on the policyholder both personally and with respect to the success of his/her business.

Manpower Inc. and Dana Montana also successfully defended similar attacks. Their insurance companies argued that they so overvalued their business income claims that the overvaluation amounted to fraud or misrepresentation, thereby voiding their respective insurance policies. In Manpower Inc. v. Insurance Company of the State of Pennsylvania, the policyholder (Manpower Inc.) sought reimbursement for losses resulting from the collapse of a building that housed its subsidiary's offices. No. 08-C-0085, 2010 WL 3809695 (E.D. Wis. Sept. 24, 2010). The insurance policy was void if the policyholder "makes misrepresentations or engages in fraud with respect to the policy or a loss under the policy."

ICSOP argued that two of Manpower's accounting experts made false statements and, therefore, voided the policy. One allegedly false statement related to the expert's calculation of the gross margin rate using the policyholder's tax returns (which resulted in a rate different from the rates in the policyholders' profit and loss statements). Another allegedly false statement related to a different expert's projection of loss based on an upward growth rate in the five months prior to the loss instead of a negative growth rate over a longer term.

The Court concluded that ICSOP was essentially challenging the experts' methodology. In granting summary judgment to Manpower on the fraud and misrepresentation claims, the Court explained: "[ICSOP's] attack on [the expert's] report comes down to a difference of opinion over the proper assumptions and methods to use when calculating business-interruption losses, and this difference of opinion cannot give rise to fraud under Wisconsin law."

In General Star Indemnity Company v. Bankruptcy Estate of Lake Geneva Sugar Shack Inc., another Wisconsin case, the court rejected another attempt by insurers to call a claim valuation dispute fraud. 572 N.W.2d 881 (Wis. Ct. App. 1997). The case related to an insurance claim on the Sugar Shack, a tavern and male dance club owned by Dana Montana. The court concluded that "the evidence does not rise to the level of fraud or misrepresentation contemplated by the law?."

The Sugar Shack had been damaged by a fire. Montana hired a public adjusting company to help file claims under her insurance policy. The "fraud" was an alleged over-valuation of business-interruption losses. The court explained: "Even though an overvaluation may be so grossly exaggerated as to raise the presumption of fraud, it is generally agreed that a mere overvaluation in proof of loss is not conclusive that fraud has been committed. Rather, it must be shown that the misstatements were made knowingly and with the intent to deceive the insurer concerning some matter material to the insurance."

The auditor's assumptions, which the insurance company disagreed with, were chosen by the auditor alone.

"What [the insurance company] simply ignores is the fact that Montana utilized an independent auditor to assess her loss and that the auditor's projections were based on his own accounting assumptions. Montana was not consulted."

There was, therefore, no fraud or misrepresentation by the policyholder.

Frederick and Lucretia Mali were not as successful in battling their insurer's claims of fraud. Last month a Connecticut federal jury found that the Mali's misrepresented their insurance claims. This conclusion relieved the Mali's insurance company (Federal Insurance Company) of responsibility for a $2.3 million insurance claim. The case concerned a barn on the Mali's property which burned. The alleged misrepresentations related to the size of the living space in the barn and the quality of the barn's construction. Federal's persistence paid off. As its counsel noted, "Being aggressive early in the litigation paid dividends as trial approached as it allowed us to limit the scope of plaintiffs' bad faith claims and focus the trial on what really mattered -- the physical evidence that confirmed the plaintiffs had materially misrepresented their claim."C. Norton, "Chubb Escapes $2.3M Barn Fire Coverage Action," Law360 (2011).

Policyholders need to understand their rights. This requires not only understanding the coverage afforded under the insurance policies (which often contain exclusions related to fraud or misrepresentation), but also understanding the law with respect to voiding a policy based on fraud and misrepresentation. So, know the law in your state. In Wisconsin, for example, an insurance company asserting such a claim against its policyholder has a heavy burden. The insurer must prove by "clear and convincing evidence" that the policyholder made a false statement, knowing it was false and intending to deceive its insurance company. But, the insurance company won't be required to demonstrate it relied on the misrepresentation or damages. Manpower, Inc., 2010 WL 3809695 at *1 (citations omitted).

Policyholders should strongly resist unfounded claims of fraud and misrepresentation and, if appropriate, turn the tables on their insurers by seeking damages for bad faith. Simply put, just because you and your insurer disagree on the value of your claim does not mean you committed fraud. Nevertheless, when a policyholder's claims stretch the bounds of credulity, that representation is unlikely to pass unnoticed. And once your credibility in the claims process is lost it will be impossible to regain it.

DOUGLAS CAMERON is a partner and practice group leader of the firm-wide Insurance Recovery Group at Reed Smith.

September 14, 2011

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