“Skinnying” Down Or Reducing Insurance Coverage When A Policy Is Renewed – Notice Requirements Under California Law

When insurance policies are renewed, insurers sometimes change the coverage provided, often including new exclusions or limitations.  When insurance policy coverage or benefits are reduced upon renewal, it is sometimes referred to as “skinnying” down the policy.  An example of reductions in coverage include policy changes to limit benefits for post-traumatic stress disorder or wildfire smoke damage.

Under California law, to the extent coverage is reduced when the policy is renewed, the insurer must provide adequate notice of the new exclusion, limitation, or reduction.  Thus, the California Supreme Court has held that “no change may be made in the terms of the renewal policy without notice to the insured.”  (Industrial Indemnity Co. v. Industrial Accident Commission of California(1949) 34 Cal.2d 500, 506.)  For property insurance, the California Insurance Code explicitly provides that an insurance company must, “at least 45 days prior to policy expiration,” provide notice in a renewal offer of “any reduction of limits or elimination of coverage.” (California Insurance Code §678(a).)

Further, California law requires that when an insurance  company changes, reduces, or limits the coverage or benefits of a policy upon renewal, the notice of such change must “be provided in a ‘plain, clear and conspicuous writing.’” (Everett v. State Farm General Ins. Co. (2008) 162 Cal.App.4th 649, 663.)  To be conspicuous, the notice must be “displayed or presented” in a way that it would be “noticed” by a reasonable person.  (Broberg v. Guardian Life Ins. Co. of Am.(2009) 171 Cal.App.4th 912, 922-23.)  Examples of conspicuous notice “includes . . . a heading in capitals . . . larger type than the surrounding text, or in contrasting type, font, or color to the surrounding text of the same size . . .”  (Id. at 923.)

Moreover, the notice of reduction in coverage must be “specific.”  (Davis v. United Services Auto Ass’n (1990) 223 Cal.App.3d 1322, 1332.)  Thus, “a general admonition to read the policy for changes is insufficient.”  (Id.)  The failure to provide “adequate notice” renders the attempted reduction or limitation in coverage “ineffective.”  (Id. at 1333.)

Insureds should review insurance policy renewal notices closely to determine whether there is any new exclusions, limitations, or reductions in the coverage being provided.  In practice, policyholders often only become aware of a reduction in coverage when they suffer a loss, make a claim believing they have coverage, and then learn that coverage they expected has been excluded or reduced.  If the policy included the coverage when it incepted, then there must be an adequate notice of the reduction of coverage during subsequent renewals in order for the reduction or limitation to be enforceable.

Insureds faced with a situation where there coverage has been reduced, resulting in a denial or limitation of payment of benefits for a claim, should ask his or her insurer for the notice they provided of the reduction in coverage.  If the insurer cannot provide the notice, or it appears that the notice is inadequate, there may be an avenue to challenge the coverage reduction.  Policyholders faced with such a situation may want to seek legal counsel to determine if there is a way to prevent the new exclusion, limitation, or reduction in policy coverage from impacting their claim.

Post-Claims Underwriting In California: Rescinding An Insurance Policy After The Insured Has Suffered A Loss

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When insureds make a claim under a policy, they are sometimes unexpectedly hit with a decision to rescind the insurance policy based on a purported misrepresentation in the insurance policy application.  This can happen in connection with any insurance policy, but is a particularly prevalent practice in the context of health, disability, and life insurance policies, and claimed misrepresentations regarding pre-existing health conditions.

An insurance company’s attempt to rescind a policy after a loss has occurred is often referred to as “post-claims underwriting,” which  “occurs when an insurer ‘waits until a claim has been filed to obtain information and make underwriting decisions which should have been made when the application for insurance was made, not after the policy was issued.’” (Hailey v. California Physicians’ Service (2008) 158 Cal.App.4th 452, 465.) Post-claims underwriting is “patently unfair” because a policyholder “obtains a policy, pays his premiums and operates under the assumption that he is insured against a specified risk, only to learnafter he submits a claim that he is not insured, and, therefore, cannot obtain any other policy to cover the loss.” (Id. (italics in original))

When an insurance company engages in post-claims underwriting, and attempts to rescind a policy after a loss, it sets up a high-stakes, all-or-nothing battle over the insurance claim.  If an insurance company prevails on an attempt to rescind, the policyholder is left without any coverage for his or her loss.  This can be a devastating result, as an insured is denied any policy benefits.  On the other hand, attempting to rescind can also backfire on the insurance company.  If a jury believes an insured is unjustly accused of fraud in order to support an attempt to rescind and avoid payment of policy benefits, it is likely to find bad faith conduct, and may also award punitive damages.

Under California law, an insurance company can rescind an insurance policy after a loss if it can prove the policyholder “has misrepresented or concealed information in seeking to obtain insurance.”  (DuBeck v. California Physicians’ Service (2015) 234 Cal.App.4th 1254, 1264.)    Some policies, like disability and life insurance policies,  have incontestability clauses, whereby after a certain period under some circumstances a policy cannot be rescinded based on misstatements in the policy application.  (See e.g., California Insurance Code §§10113.5 and 10350.2.)

In order to rescind an insurance policy, the insurance company must move “promptly upon discovering the facts” giving rise to rescission, give notice to the insured, andrefund all premiums.  (California Civil Code §1691.)  A right to rescind can be waived, including by failing to comply with these requirements.  (DuBeck,supra, 234 Cal.App.4th at 1264.)

Where an insurer affirmatively seeks to find a misstatement in the policy application to avoid a claim, they will usually find one.  As on California court of appeal noted, “given sufficient impetus — such as chronic illness — it is likely that any health insurer will be able to find some detail within an insured’s medical history that, post hoc, amounts to misrepresentation.” (Hailey, supra, 158 Cal.App.4th at 465.)

Where a policyholder makes a claim, and after making the claim, they are subjected to a rescission attempt, they may be experiencing a case of bad faith, post-claims underwriting. Under such circumstances, the insured should evaluate the alleged misstatement, and whether such information should have been discovered before the policy was issued.

An Insurer’s Duty of Good Faith And Fair Dealing In California: First Party Versus Third Party Claims

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California’s laws and remedies for an insurance company’s breach of the implied covenant of good faith and fair dealing are uniquely favorable to policyholders.  Breach of the good faith duty, which occurs when an insurance company withholds policy benefits unreasonably or without proper cause, allows for tort damages and a punitive damage claim under California law.

That duty, however, only extends to first party claims, not third party claims.  Where an insurance company has a direct relationship to the insured making the claim, it is known as a first party claim.  Where an insurance company is defending and paying to settle a claim or lawsuit brought by a third person (known as a third party) who was injured or suffered a loss caused by the insured, it is known as a third party claim.  Third party claims are essentially liability claims against the insured.  Under California law, the insurer’s covenant of good faith “runs in favor of the other contracting party . . . and . . . a ‘third party claimant’ may not bring an action for breach of the covenant or its duties.” (Hand v. Farmers Insurance Exchange (1994) 23 Cal.App.4th 1847, 1855.)

The distinction, therefore, between first and third party claims is critical.  In addition to determining whether the duty of good faith and fair dealing apply, there are also different standards for “causation analysis” with respect to coverage and exclusions.  (Garvey v. State Farm Fire & Casualty Co. (1989) 48 Cal.3d 395, 406.)

In essence, only your own insurance company owes you a duty of good faith and fair dealing.  The insurance company for someone else, even if you were injured by that person and are making a claim against his or her insurance company, does not owe you that duty.

An example where people can experience the difference between first-party and third-party claims is in the context of an underinsured motorist claim.  When a person is injured in a car accident, and is making a claim against the negligent driver’s insurance company, that injured person is a third-party claimant because they are making a claim under someone else’s (the negligent driver’s) insurance policy.  After the injured person obtains policy benefits from the negligent driver’s insurance company, he or she can pursue an underinsured motorist claim against his or her own insurer.  The insurance company for the negligent driver, while it owes a duty of good faith to the negligent driver because that is its insured, owes no duty of good faith to the injured person because they do not have an insured-insurer relationship.  The injured person is only owed a duty of good faith from the insurer on the underinsured motorist claim, because that is the only insurance company that directly insured him or her.

When making a claim for insurance benefits, it is important to understand whether you are a first-party or third-party claimant.  This will dictate important aspects of your claim, including whether you are owed a duty of good faith and fair dealing.

The Unique California Law: An Insurance Company’s Duty of Good Faith And Fair Dealing

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Insurance is a unique contract.  It is one of the only products people buy in the hope they will never have to use it.  The California Supreme Court has explained that, when someone buys an insurance policy, they do “not seek to obtain a commercial advantage” but only “protection against calamity.” (Egan v. Mutual of Omaha Ins. Co.(1979) 24 Cal. 3d 809, 818.) When a loss has occurred and a claim is made, insurance companies are in a powerful position, as they write the contract, know the rules, have already received the insurance premiums, and have unlimited resources if they choose to contest the claim.

In California, every contract has an implied covenant of good faith and fair dealing.  This is a promise the law implies into every contract that the parties will act in good faith to fulfill the contract.  Only in the context of an insurance contract, however, does California law allow a policyholder to sue his insurance company for tort damages (as opposed to just contract damages) for breach of the implied covenant of good faith and fair dealing, also known as insurance bad faith.  The unique aspects of an insurance policy, the disparity in power, and the vulnerable position of the insured, are all reasons that California law allows tort claims against insurance companies for bad faith breach of contract.

A bad faith claim is an extremely powerful tool for insureds, as tort remedies allow the insured to pursue all consequential damages, including emotional distress and a claim for punitive damages.

The duty of good faith and fair dealing is “is unconditional and independent” of any obligations owed by the policyholder. (Gruenberg v. Aetna Insurance Company (1973) 9 Cal.3d 556, 578.)  To pursue an insurance bad faith case, an insured must prove his insurance company unreasonably withheld policy benefits.  The key is unreasonable conduct.  If the insured can show that the insurance company failed to pay benefits unreasonably, the insured can recover tort damages, and potentially punitive damages, in addition to contract damages.

An insurance company’s unreasonable conduct in withholding benefits can occur in a myriad of contexts.  This includes unreasonably investigating the claim, interpreting the policy, estimating the damages, and making settlement offers.  Any such unreasonable conduct gives rise to a bad faith case if policy benefits were withheld.

Not all states allow for tort claims for breach of an insurance policy as California does.  This is an important rule that insurance companies are well aware of.  Potential bad faith liability is a threat which insurance companies take seriously.  Insurance companies don’t like being sued for bad faith, as they do not face such rules throughout the country.

In making an insurance claim in California, policyholders should be aware they are in a state that has uniquely favorable law protecting policyholders.  The rules relating to good faith and fair dealing with respect to insurance policies and claims provide a potent tool for California insureds who have been denied insurance benefits unreasonably.