An oxymoron is a rhetorical figure in which incongruous orcontradictory terms are combined. Rescission is an equitable remedythat has existed before the American Revolution and is an essentialpart of British and American common law. In California the remedyof rescission is governed by statute. To call a rescission“illegal” is to state an oxymoron.

Regardless, the California Insurance Commissioner stated that“Illegal rescissions are a repugnant industry practice.” Becauserescission is a remedy available to parties to a contract itcannot, by definition, be illegal. It might be unenforceable orexercised in bad faith, but it can never be “illegal.” Similarly,the U.S. Congress, in its more than 2,000-page health insurancestatute, limits the right of insurers to rescind a policy.

Related: Read Barry Zalma's September column, “Provingnegligence.”

The Assn. of California Life & Health Insurance Cos.(ACLHIC) filed a lawsuit in an effort to keep California fromenforcing new anti-rescission regulations presented by theCalifornia Dept. of Insurance (CDOI), which attempts to changeCalifornia statutory and common law. ACLHIC, based in Sacramento,alleges in a petition filed in a state court in Sacramento that theregulations are too expensive and too difficult to implement, andthat California Insurance Commissioner Steve Poizner exceeded hisauthority when he developed the regulations. Poizner has put out astatement calling the suit “unconscionable.”

A regulator is not a legislator. A regulator cannot, and shouldnever, attempt to change a statute and deprive a party of the rightto obtain a remedy hoary with age by a mere regulation.As early as1937, the California Supreme Court confirmed the rule of law ofrescission in California as follows:

A false representation or a concealment of fact whetherintentional or unintentional, which is material to therisk vitiates the policy. The presence of an intent todeceive is not essential. Telford v. New York LifeInsurance Co. (1937), 9 Cal 2d 103, 69 P.2d 835; Barrerav. State Farm Mutual (1969), 71 Cal 2d 659, 79 Cal. Rptr. 106.(Emphasis added.)

When an insurer learns that it issued a policy based uponmisrepresentation or concealment of a material fact, it can declarethe policy void from its inception by returning to the putativeinsured the premium paid so that both parties are in the positionthey were in before the policy was issued. If an insurer attemptsto rescind a policy where it knows there is no misrepresentation orconcealment, it can be subject to litigation for the tort of badfaith. Under no circumstances, regardless of the comments made bythe insurance commissioner, can the rescission be illegal. To callit such in a regulation is a canard and an indication that the CDOIeither has no idea about the law of rescission or is ignoringstatutory and case law. The regulations, as the CDOI now tries toenforce them, are acting in such a way as to allow a health insurerto be easily defrauded since it will be “illegal” to rescind evenif it is the victim of material misrepresentation or materialconcealment. Rather, it must immediately prove that the insuredintended, at the time they applied for insurance, to defraud theinsurer, an obligation much more stringent than the statutory andcase law.

The CDOI has accused health insurers of using rescissions torescind policies issued to individuals who had made innocentmistakes on applications or left out information that was notrelevant to their current health status. The statutes with regardto health insurance only allow rescission for intentionalmisrepresentation–unlike property-casualty policies that byCalifornia statute may be rescinded for innocent materialmisrepresentation or innocent material concealment. It is, bydefinition, impossible to rescind a health policy for innocentmistakes by current statutes.

In regulations that were set to take effect Aug. 18, 2010, theCDOI's regulations required insurers to start investigations ofpossible omissions of material information from health insuranceapplications within 15 days of learning of the omissions; tocomplete investigations within 90 days; to send an investigationtarget a notice about the investigation every 30 days; and to sendthe target a written notice about the final determination within 7days of concluding the investigation. The time limits make italmost impossible to comply and obtain sufficient information toprove fraud.

The issue of rescission of health insurance policies was firstraised in California in Hailey v. California Physicians'Service (158 Cal.App.4th 452, 69 Cal.Rptr.3d 789 [Cal.App.Dist.4 12/24/2007]), which could have helped the Hailey familywhile making health insurance so expensive as to become extinct forthe rest of the citizens of California. The rescission regulationsthat are the subject of the ACLHIC suit follow Hailey,which revealed that in California, the test of rescission isdifferent for health plans:

[S]ection 1389.3 precludes a health services plan fromrescinding a contract for a material misrepresentation or omissionunless the plan can demonstrate (1) the misrepresentation oromission was willful, or (2) it had made reasonable efforts toensure the subscriber's application was accurate and complete aspart of the precontract underwriting process.

What the CDOI fails to note is that after the Court of Appealsdecided Hailey, the case was tried and the Haileys admitted thatthey intentionally misrepresented material facts and the trialcourt dismissed their suit. This decision should have resolved theissue.

There is a statute that requires a willful misrepresentation torescind a health plan. The Haileys admitted to willfulmisrepresentation and the rescission of their policy was upheld.They never would have made the admission if the insurer wascompelled to complete its investigation in 90 days.

The decision with regard to misrepresentation on a healthinsurance application is a factual issue that requires willfulness.If the Haileys had told the truth originally, their policy wouldhave been rescinded and the Court of Appeals decision would neverhave been issued. Rather than what actually happened, summaryjudgment would have been granted for the insurer.

A thorough investigation of all of the facts stated in anapplication, as required by the regulations for a health plan or aninsurance policy, can take months to complete and will cost theinsurers thousands. If every one of the more than 30 million peopleliving in California applies for insurance, they would not pay the$5,000 it would cost, at a minimum, to allow the insurer tocomplete the investigation required by the regulations.

A proper pre-risk investigation like that contemplated by Haileywould require checking all medical records of all members of thefamily seeking insurance, all of their finances, their claimshistory, their litigation history and interviews of the people theyknow to determine if the prospective insured is honest, reliable,of high moral character and healthy.

The insurer that does not conduct an investigation will payclaims on risks it would not take had it received complete andhonest responses to its inquiries and could not predict actuariallythe losses it might incur in the future. The insurer that desiredto conduct the investigation required by Hailey would sell nopolicies, and the insurer that does not conduct the investigationwill sell policies and be subject to losses caused by applicantswho are not truthful.

Rescission is an ancient equitable remedy and should be honoredand enforced. People like the Haileys, who obtain insurance bymisrepresentation or concealment of material fact, should not behonored with insurance coverage which they were not eligible tobuy. Insurance is not a right; it is a contract that requires thatboth parties exercise utmost good faith in negotiations for thecontract.

The new health insurance law has similar requirements.

Insurance agents and brokers selling health insurance policiesshould be careful to explain to their customers the importance oftruthful responses to questions on applications for insurance,whether they are health or property and casualty policies. The lawof rescission varies by state, with the right more difficult toobtain in some states than others. If an insurer attempts torescind a policy and the insured sues the insurer, it is acertainty that the agent or broker who placed the insurance will benamed as a defendant. Files should be documented so there is noquestion that each inquiry on the application was made to theproposed insured in words the proposed insured understood, and theanswers were those of the insured and not the agent or broker. Theprudent agent or broker will never suggest or change an answer.