Boston--Rescinding policies is never an easy road forprofessional liability insurers==and a recent court decision makesit even more difficult, a defense lawyer told an insurance industryconference here.

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His advice came during a session of the International Conferenceof the Professional Liability Underwriting Society, which alsoheard a claims professional, an underwriter and a broker review themany considerations and processes to be undertaken before arescission action.

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The details concerning the court decision were presented byHarvey Weiner, a defense lawyer for Peabody & Arnold.

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According to Mr. Weiner, the Massachusetts U.S. District CourtJudge Richard G. Stearns in deciding the case of Federal InsuranceCompany vs. HPSC said insurers need to go back and ask theirinsureds why they provided false information that the carrierrelied on to issue a policy before pursuing rescission actions tovoid the policy based on the false information.

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In a rescission case, carriers effectively seek to nullifycoverage they've written because the insured made a materiallyfalse representation when applying for or renewing coverage. Insuch actions, insurers contend that they wouldn't have issued apolicy at the same terms, if they knew, at the outset, informationthat has now come to light.

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Rescissions, Mr. Weiner explained, are most prevalent in thelife and health world, but the possibility of misrepresentationsabout the financial health of companies explain their prevalence inthe directors and officers liability world and other professionallines.

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Considerations regarding potential bad faith claims and evenpolicy renewal negotiations complicate decisions to proceed withrescission actions, speakers at the conference said.

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Statutes, which vary by state, typically require insurers toconduct "prompt and appropriate investigations" to support theirrescission actions, they said.

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"This is usually a big problem," Mr. Weiner noted, explainingthat, on the one hand, an insurer will want numerous people to signoff on such an important decision and will want to conduct a fullinvestigation to help prevent bad faith claims.

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"Unfortunately, you can't wait too long, because it has beenheld by courts that claims of rescission can be waived due toinaction," he added.

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In the Federal Insurance case, decided Sept. 12 in Boston, theinsurer had brought a rescission claim relative to a $1 millionexecutive risk policy in the face of a $4.7 million crimeclaim.

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The basis of the action was an inaccurate answer to a questionon the insurance application. The question asked whether employeeswho reconciled monthly bank statements either signed checks,handled deposits or had access to check-signing machines orsignature plates.

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The insured answered no. But after the claim was filed, theinsured hired an accounting expert as an investigator, and theexpert found that the thief reconciled "at least one account" overwhich he had signatory authority, Mr. Weiner said.

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The insurance claims handler concluded, based on this reportcommissioned by the policyholder, that the thief had signed checksand reconciled the statement of all the bank accounts.

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Two senior insurance company officials then authorized a suitfor rescission. And the decision of whether or not to bring a suitwas discussed with inside and outside counsel, he said. There wasalso discussion with the underwriter who issued the policy "as tothe hypothetical increase in risk entailed by failure of theinsured to segregate check-writing and reconciliation duties."

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"You would have thought that might be enough," Mr. Weiner said.The steps, in fact, are among the steps that other speakers duringthe session said were appropriate to take before pursuingrescission.

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When Mr. Weiner read the decision in the case, however, itturned out that these activities on the part of the insurer wereactually too much in many respects, but lacking in one==the failureto ask the insured to explain itself.

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After the suit was brought, the insurer was informed that thethief had check-writing authority over only one of severalaccounts, Mr. Weiner said.

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"The jury was very unhappy," he said. "It found that theincrease in risk was not material. And the judge found that theinvestigation was unreasonable" and that the insurer engaged in"willful violation" of the Massachusetts Unfair Claims statute,assessing double damages and double attorneys fees.

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Judge Stearns ruled the insurer should have asked the insuredwhy the discrepancy existed between the answer to the question inthe insurance application and the information contained in theaccountant's report.

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"The insured was no stranger to the insurer, having purchasedinsurance continuously from the insurer for some 14 years," Mr.Weiner reported that the judge said, adding that the rulingcontinued, "Given this longstanding relationship, one would expectat least some consideration by the insurer of the interests of aloyal customer."

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Mr. Weiner concluded that an investigation must be thorough andin this case, involve consultation with the insured. But theinsurer can't be too late in bringing a rescission action, he said,suggesting the kind of tightrope insurers need to walk when theypursue rescission actions.

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