Life Insurance Fraud Fails

Reinstatement of Life Policy Like New Policy

States, in an attempt to protect life insurance beneficiaries, make it impossible to contest the viability of a life insurance policy, even if obtained by fraud, unless the coverage is contested within two years of the inception of the policy. In Texas the requirement for an incontestability clause is mandated by statute. Even if the policy does not contain the language the courts will assume the existence of the clause as mandated by statute. The states that have enacted incontestability statutes conclude that it is in the best interest of the people of the state that an insurer that does not catch a fraud with- in two years should pay, rather than make the beneficiary of the fraud perpetrator lose the benefit of the fraud.

United of Omaha Life Insurance Company (United) denied the claim of Elvia Cardenas (Cardenas) for benefits from a life insurance policy taken out by Cardenas’ daughter, Elvia Sierra. The pol- icy had lapsed and was subsequently rein- stated. Sierra died thirteen months after the reinstatement. As required by the Texas Insurance Code, the policy contained a provision that it would become incontestable if it remained in force “for two years from its date of issue during the life- time of the insured.”

The policy does not have a provision dealing with contestability following rein- statement. The parties agree there is such a period. They differ over how the death of the insured during the contestability period will affect the reinstatement.

The trial court found that the reinstated policy never became incontestable because Sierra died before the two-year period ran. Cardenas appealed. She argues that a section of the Texas Administrative Code controls and requires finding that the reinstated policy became incontestable.

FACTUAL BACKGROUND

United issued a life insurance policy to Elvia Cardenas’s daughter, Elvia Sierra, on March 26, 2001. The policy lapsed for non- payment of premiums in June 2005. United of Omaha reinstated the policy on January 3, 2006, after Sierra submitted a reinstatement application. Sierra made several misstatements about her health in the rein- statement application. The application required Sierra to certify that she had not lost more than ten pounds in the prior year, and that in the prior five years, she had not undergone any blood tests, laboratory tests, or special examinations, been ill or injured, or received medical or surgical advice or treatment. In fact, Sierra suffered from Crohn’s disease and had been hospitalized for four weeks during June and July 2005. She lost thirty pounds between March and July 2005, including eighteen pounds in one week.

SIERRA LIED WHEN SHE APPLIED FOR REINSTATEMENT

Sierra died on February 20, 2007. Her death certificate lists toxic megacolon, sepsis, cachexia, and Crohn’s disease as the causes of death. Cardenas filed a claim for benefits. United denied the claim and informed Cardenas that it was rescinding the policy due to misrepresentations it found in the reinstatement application. Cardenas filed suit in state district court claiming that United had failed to pay the $150,000 death benefit under the policy. United removed the case to federal court based on diversity of citizenship. The parties filed cross-motions for summary judgment. In its motion, United argued that it satisfied the requirements for rescinding an insurance policy procured by fraud, and that the policy remained contestable because Sierra died before the two-year period ran. Cardenas contended that the reinstated policy was incontestable because United of Omaha failed to contest it within the requisite two years. Both motions were denied and the case went to trial. The jury returned a verdict in favor of United finding that Sierra’s representations in the reinstatement application were material and intentional.

DISCUSSION

Cardenas’s challenge to the district court’s ruling turns on a question of statutory construction. An appellate court interprets a state statute the way it believes the state Supreme Court would, based on prior precedent, legislation, and relevant commentary. The key issue is whether a life insurance policy, after it has been reinstated, automatically becomes incontestable after two years, or whether the insured must survive two years after the reinstatement.

The Texas Insurance Code provides, in relevant part, that “[i]f a reinstatement is contested for misrepresentation, no representation other than one causing the rein- statement may be used to contest the pol- icy, any contest of the reinstatement may be for a material and fraudulent misrepresentation only and reinstatement may not be contested more than two years after it is effectuated . . . .”

The Fifth Circuit concluded that the statute applies to reinstatements and that a contestability period following a policy reinstatement is subject to the “lifetime of the insured” requirement.

The Insurance Code’s incontestability provision for life insurance policies states, in relevant part: “[a] life insurance policy must provide that a policy in force for two years from its date of issue during the life- time of the insured is incontestable, except for nonpayment of premiums.” This bar to contestability applies even if the insured intentionally made a material misrepresentation in the policy application. The statute does not expressly address how incontestability periods operate following a policy reinstatement.

ANALYSIS

The conclusion that the statute’s “life- time of the insured” provision applies to a reinstated policy when the policy does not expressly so provide is analogous to policies that fail to include an incontestability clause at all. Even when the incontestable clause does not appear in the insured’s pol- icy, that circumstance is wholly immaterial because the statute makes the clause a part of the policy, whether written in the policy or not.

The Fifth Circuit found it logical to conclude that the statute treats policy issuances and policy reinstatements in a uniform manner. In so doing the Fifth Circuit followed the vast majority of jurisdictions’ hold that where a policy of life insurance is reinstated as a result of misrepresentations, the contestable period begins to run anew.

The result is not inconsistent with the rationale behind incontestability clauses. There is no reasonable argument that the legislature intended to protect beneficiaries, to the detriment of insurers, where the insured committed fraud and failed to satisfy the requirements of the statute.

ZALMA OPINION

Incontestability clauses are invitations to fraud. Ms. Sierra blatantly and without compunction lied on her application to reinstate her life insurance policy. She knew she was suffering from Crohn’s disease – that eventually killed her – at the time she submitted her application for reinstatement. She knew, or should have known, the policy would not have been reinstated had she told the truth. She hoped she would live the two years past the reinstatement after which United would have no defense to fraud. Her mother, attempting to get the benefits, unsuccessfully asked the court to count the two years from the original inception of the policy even though the fraud took place at the time of reinstatement.

The decision is logical and well-reasoned and, although it enforces the incontestability statute, is clear evidence that such clauses add to the expense of life insurance and allow fraud to succeed if the life insured can last two years after the inception of the policy or the reinstatement of a cancelled policy. There should be no limit on the right of a defrauded insurer to defend against a fraudulently obtained policy.