RLLI Section 8

A misrepresentation by an insured during the application for, or renewal of, an insurance policy is material only if, but for the misrepresentation, a reasonable insurer in this insurer’s position would not have issued the policy or would have issued the policy only under substantially different terms.

Comment:

a. The function of the materiality requirement. The misrepresentation defense encourages the sharing of truthful and relevant information. The materiality requirement addresses the objective relevance of that information and encourages efficient underwriting practices on the part of insurers. A material misrepresentation is one that so significantly understates the risk presented by the policyholder’s application or renewal that the misrepresentation would induce an objectively reasonable insurer in this insurer’s position either to (a) issue a policy when it would not otherwise have done so or (b) issue a policy on substantially different terms than it would otherwise have done. This definition of materiality is sometimes referred to as the “material to the risk” or “increased risk” test of materiality, in the sense that the falsity of the misrepresented fact would lead a reasonable insurer in this insurer’s position to bear a substantially greater risk than it believed it was insuring.

b. In this insurer’s position. This Section states a tailored objective understanding of materiality that considers the relevance of the misrepresented information from the perspective of a reasonable insurer in the position of the actual insurer. This tailored objective understanding may in some cases differ from that of an average or ordinary insurer. The question is not what an average or ordinary insurer would have done, but rather what a reasonable insurer in the position of this insurer would have done. Evaluating materiality from the perspective of an average or ordinary insurer could have the undesirable effect of inhibiting insurers from developing innovative underwriting categories or other underwriting practices that differ from the norm.

c. Distinguishing materiality from reliance. In some jurisdictions the materiality test is stated in a way that either expressly adopts or could be interpreted as adopting a subjective standard. In those states the materiality requirement asks, in effect, whether the particular insurer in the case would have issued the policy under the same terms had it known of the true facts. This is a subjective causation test that is indistinguishable from the subjective element of the detrimental-reliance requirement. In this Section, materiality is a purely objective inquiry. The materiality requirement requires the insurer to demonstrate that there is an objectively reasonable basis for the judgment embodied in its regular underwriting practices.

d. An objectively reasonable basis for the underwriting judgment. Perhaps the most common way to demonstrate that an insurer had an objectively reasonable basis for the judgment embodied in its underwriting practices is to demonstrate that a reasonable insurer—with “reasonable” understood here as ordinary or average—would regard the misrepresented information as very important. Because most misrepresentation cases concern misstatements that almost any insurer would regard as important, courts rarely confront situations in which an innovative insurer asks questions that most other insurers do not. In such an unusual case, the proper inquiry is not whether the information would be sufficiently important to an average or ordinary insurer. If that were the proper inquiry, the materiality element would make it impossible for insurers to insist upon honest answers to innovative questions. Rather, the proper inquiry is whether the information would be sufficiently important to a reasonable insurer in this insurer’s position.

It is important to emphasize that the materiality analysis focuses on a “reasonable insurer in this insurer’s position,” not on “this insurer.” The work that the reasonableness requirement is doing in this context is to require that there be some evidence supporting the actual insurer’s judgment that the information is important, so that there is a basis for the trier of fact to evaluate whether a reasonable insurer in this insurer’s position would agree with that judgment. This evidence can consist of an actuarial opinion, an empirical study, testimony regarding custom and practice, or any other evidence that a reasonable insurer would use to decide whether a category of information is sufficiently important for the purpose of deciding whether to insure an applicant and, if so, at what price.

e. Substantiality. For the materiality standard to be met, the insurer must demonstrate that, knowing the correct facts ex ante, a reasonable insurer in its position would have offered the policy, if at all, only with substantially different terms, such as a substantially higher premium. The misrepresentation defense is not available in circumstances in which a reasonable insurer in this insurer’s position would regard the misrepresentation in question as trivial or inconsequential. Courts have used a wide variety of verbal formulations to express the requirement encapsulated in this Section by the phrase “substantially different terms.” Although courts have not often used this precise expression, it best gives effect to the principal purpose of the materiality requirement by making clear that a fact having only an insubstantial effect on policy terms is not of sufficient objective relevance to the risk being insured.

  Illustrations:

  1. On an application for a standard homeowner’s insurance policy, the policyholder is asked whether in the past 10 years he has been a defendant in a civil lawsuit. The policyholder who has in fact been sued three times during that period nevertheless checks the “no” box on the application. The insurer issues the policy. Had the insurer known the truth with respect to this question, it would not have issued the policy. The insurer can demonstrate that other insurers also decline to issue homeowner’s insurance policies to applicants who have been sued three times in the past 10 years. Accordingly, the policyholder’s misrepresentation was material.

  2. On an application for a standard automobile-insurance policy, the policyholder is asked how far she commutes to work each day. The policyholder answers “two miles,” when the correct answer is “five miles.” The insurer issues the policy with a premium of $1000 for six months. Had the insurer known the truth with respect to this question, it would have charged $25 more for a policy. The policyholder’s misrepresentation was not material.

  3. An insurer conducts research that demonstrates to its reasonable satisfaction that people who frequently play a certain kind of online video game are more likely to suffer a substantial loss under their automobile-insurance policy. The insurer adds a question asking whether the applicant plays this kind of video game to its application for auto insurance. A policyholder who regularly plays the game more than 10 hours a week provides the false answer “no” to the question, “Have you played [this kind of video game] within the last 60 days?” Had the policyholder answered yes to this question, the insurer would not have issued the policy. The policyholder’s misrepresentation was material.

  4. An insurer adds a question regarding history of sexually transmitted disease to its application for homeowner’s insurance based on the belief of a senior executive that people with a history of sexually transmitted disease are likely to pose a higher liability risk. A policyholder who does have a history of sexually transmitted disease provides a false answer “no” to the question, “Have you ever been diagnosed with a sexually transmitted disease?” Had the policyholder answered yes to this question, the insurer would have charged the policyholder 50 percent more for the liability coverage. At trial in a case in which the insurer raises this false answer as the basis for a rescission, the insurer is unable to present any evidence supporting the senior executive’s belief that it considered before adopting the policy, nor is it able to present any evidence from its claims records supporting the association between sexually transmitted disease and liability risk. The policyholder’s misrepresentation was not material.