On May 28, a much-watched case against Blue Shield ofCalifornia–for revoking medical coverage of an injuredpolicyholder–ended abruptly when the plaintiffs, Cindy and SteveHailey of Cypress, admitted that they “willfully” made crucialerrors and omissions on their insurance application to obtainhealth coverage. They obtained the policy by deceiving the insurerwith intentionally and willfully false representations.

The verdict came after years of reports in newspapers, radio andtelevision claiming that insurers engaged in improper “post-lossunderwriting” and deprived honest and ill people of their “right”to insurance. The pleas of the wronged were taken up by the mavensof the plaintiffs' bar, the state Dept. of Insurance, legislatorsand others who refused to accept that an insurance policy is acontract in which both parties owe the utmost good faith to theother. In this case, the Haileys filed suit claiming their healthinsurance was improperly rescinded and the insurer did them wrongsufficient to require their insurance to be reinstated and for theinsurer to pay excessive exemplary damages.

By admitting that the insurer was correct when it rescindedtheir policy because the Haileys had willfully lied on theapplication gave the insurer a Pyrrhic victory. Blue Shield and allBlue Shield policyholders' premiums will rise to pay for themedical bills of frauds like the Haileys and hundreds of thousandsof dollars to the lawyers representing the insurers to defendsimilar spurious actions because of news stories planted by theplaintiffs' bar claiming that the insurer acted wrongfully.

In Blue Shield's case, Insurance Commissioner Steve Poizner in2007 accused its life & health insurance unit of 1,262 “seriousviolations” over a 4-year period that “completely undermined thepublic's trust in our healthcare system and are potentiallydevastating to patients.” Poizner proposed $12.6 million in finesbut ultimately declined to impose any, perhaps because he isresponsible for prosecuting insurance fraud. In fact, immediatelyafter the Hailey case was dismissed, the California Dept. ofInsurance announced the issuance of special regulations to protectpeople like the Haileys from attempts to defeat their fraud.

The California Dept. of Managed Health Care collected more than$13 million in fines, including $1 million from Blue Shield.Plaintiffs' lawyers claim that rescission is an “industry practiceof revoking policyholders' coverage over technical errors oromissions on the application” rather than by statutory grounds.

Fraud, whether in property, casualty, liability, surety orhealth insurance, is never a “technical error.” It is anintentional misrepresentation or concealment of material factissued to deceive, which deceived the insurer to its detriment. Italways should be, as it was with the Haileys, an industry practiceto rescind and fight claims presented by persons who obtainedinsurance by fraud.

It also was the case that resulted in a far-reaching appellatedecision that sided with policyholders. That decision said insurerscould not rescind unless they could prove sick and needy patientslike Steve Hailey, who was rescinded after a near-fatal autoaccident, had actually “willfully misrepresented” himself becauseof a special statute related only to health insurance policies.

Insurance professionals should consider this case as one wherean insurer refused to give in to bad press and governmentalpressure when dealing with a potential fraud. Rescission because offraud in the inception of insurance policies, like that admitted toby the Haileys, is an important defense to the multi-billion dollarcrime of insurance fraud. Insurers with a policy applicant whomisrepresented or concealed a material fact should seek legalcounsel to determine if the policy may be rescinded under the lawof the state in which the policy was issued. Insurance agents andbrokers should be careful to obtain truthful responses to questionsposed by applications to avoid errors and omissions claims whentheir insured's policy is rescinded.

Every person concerned with insurance and insurance fraud mustremember that California law has long held that:

An insurance company is entitled to determine for itself whatrisks it will accept, and therefore to know all the facts relativeto the applicant's physical condition. It has the unquestionedright to select those whom it will insure and to rely upon him whowould be insured for such information as it desires as a basis forits determination to the end that a wise discrimination may beexercised in selecting its risks. (Robinson v. Occidental LifeIns. Co. [1955] 131 Cal. App. 2d 581, 586 [281 P.2d 39]) (64Cal. App. 3d at p. 273)

In LA Sound USA Inc. v. St. Paul Fire & Marine Ins.Co. (156 Cal. App. 4th 1259 [2007]), the court upheld therescission of a policy of insurance for an innocentmisrepresentation and concealment of material facts in anapplication for insurance and relied upon (Imperial Casualty& Indemnity Co. v. Sogomonian [1988] 198 Cal.App.3d169).

In the case that allowed the Haileys to go to trial (Haileyv. California Physicians' Service, 158 Cal.App.4th 452, 69Cal.Rptr.3d 789 [Cal.App. Dist.4 12/24/2007]), the Court of Appealstated a concern about what the plaintiffs' bar has coined as“post-loss underwriting.” The case, although it refused to allow aparty to rescind and couched in phrases of insurance, dealt with adifferent statutory scheme that governed health care payers (HMOs)and not insurers that required an intentional misrepresentation toallow rescission.

That it does not apply to insurance rescissions of policiesother than health insurance is clear since the same court, within30 days decided (LA Sound, supra).

Blue Shield should be commended for protecting itself and goingto trial when it knew it was right even though Mr. Hailey, comingto court in a wheelchair, made a compelling sight to gain theemotional backing of a jury.

The press has ignored the fact that the Haileys have nowadmitted in open court that their attempts to obtain money anddamages from Blue Shield was criminally fraudulent. CaliforniaPenal Code ? 550 provides, in part, that:

(a) It is unlawful to do any of the following:

(1) Knowingly present or cause to be presented any false orfraudulent claim for the payment of a loss, including payment of aloss under a contract of insurance.

(5) Knowingly prepare, make, or subscribe any writing, with theintent to present or use it, or to allow it to be presented insupport of any false or fraudulent claim.

The admission of a false claim in court is an admission ofcriminal conduct. It is clear and convincing evidence that theHaileys were guilty of felony insurance fraud and should facecriminal prosecution.

The lesson: If an insurer believes it has been deceived and hasa valid ground for rescission as did Blue Shield, Imperial and St.Paul Fire & Marine, a fraud can be defeated even inCalifornia–even when the press and the Dept. of Insurance decry theinsurer's efforts to protect itself from fraudulently obtainedpolicies and fraudulent claims.