Investigating Fraud in Closed Files

Raising The Dead:  Investigating Fraud in Closed Files

Insurance adjusters are under pressure to promptly investigate, adjust and settle losses. In the face of bad faith claims, regulatory pressure and internal policies requiring the highest level of policyholder service consistent with the company’s marketing promises, this can lead to the payment of claims which later prove to be fraudulent. When an insurer pays a seemingly valid claim and later learns the claim was a fraud, what can be done?

• Insurers can recover payments from insured's…under the right circumstances

The first consideration to re-opening an investigation after the file is closed is determining what the insurer can expect to recover.  On this subject, consider that “[w]hen an insurer has paid a claim as a result of fraud, a false statement by an insured, or mistake, courts have permitted the insurer to recover the payment.”  South Carolina Farm Bureau Mut. Ins. Co. v. Kelly, 547 S.E.2d 871, 876 (S.C. Ct. App. 2001) (citations omitted).  The reason for this is that “it would be unwise to discourage insurers from making payments, even if the payments were made in error, by refusing to permit later adjustments.”  Id.(citations omitted).   Some courts recognize an exception to this rule where the insured demonstrates that he significantly “changed position” in reliance on the payment so that it would be inequitable to require restitution .  Id.n.6 (citations omitted).

• Whether the insurer may rely on the insured’s representations

In Perovich v. Glen Falls Ins. Co., the insurer paid a theft claim and later discovered that the insured had made numerous material misrepresentations.  401 F.2d 145, 146 (9th Cir. 1968).  The insurer sued the insured for a refund.  Id.The insured argued that the insurer could not claim it was misled because it could have discovered the insurer’s misrepresentations by pursuing its own investigation.  Id.  The court disagreed, finding that an insurer “may recover money paid in reasonable reliance on its insured’s fraudulent claim.”  Id.  The court held that the insurer was entitled to recover the full payment made under the policy.  Id.at 147.

The court in Mutual Benefit Life Ins. Co. v. Lindenman found differently. 911 F. Supp. 619, 629 (E.D.N.Y. 1995).  In that case, the insurer sought to recover benefits the insured wrongfully received.  Id.The court found that while money paid under a mistake of fact may generally be recoverable, insurers “have an obligation ‘to investigate the facts upon which its liability depends before making payment under the policy . . .’”.  Id.(citation omitted).  This being the case, the court found “nothing inequitable in requiring an insurance company to investigate before paying, at least where . . . it has notice of the need for investigation and there is then available to it all the evidence which it adduces as the basis of its action.”  Id.(citation omitted).  The court cited the insurer’s internal memoranda showing the insurer knew of the insured’s misrepresentations but ignored them or forgot about them.  Id.at 630.  The court found that because this was not a situation where the insurer was unable to ascertain the true facts, the insurer could not recover from the insured.  Id.

• Recovery of payment resulting from fraud

In one case, a fire destroyed the insureds’ house and the insured's made a claim on their homeowner’s policy.  Parasco v. Pacific Indem. Co., 920 F. Supp. 647, 649 (E.D. Penn. 1996).  After an investigation, the insurer concluded that the insured's were responsible for the fire and refused to pay the claim.  Id.The insured's sued, and the carrier responded with a counterclaim to recover all payments it made under the policy as well as the expenses it incurred investigating the loss.  Id.at 650.  The insurer moved for summary judgment not only against the insured's on their initial claim, but also on the insurer’s counterclaim.  Id.

The court noted that where an insurer denies liability to the insured but pays the mortgage under the policy’s mortgage clause, Pennsylvania law allows the insurer to recover from the insured.  Parasco, 920 F. Supp. at 657 (citation omitted).  The court noted further that Pennsylvania law permits an insurer to recover money it paid to an insured if it is later determined that the insured violated the fraud or concealment provisions of the policy.  Id.(citation omitted).  The court had already awarded summary judgment in favor of the insurer on the insured’s initial claim, id. at 655-656, finding that the insured had made material misrepresentations to the insurer in the course of the insurer’s investigation, id. at 655.  There was no dispute that the insurer had paid $167,011.54 to the mortgage and a $5,000 advance to the insured's.  Id.at 657.  Accordingly, the court granted summary judgment to the insurer on its counterclaim and entered judgment in the amount of $172,011.54.  Id.

This rationale applies in cases of innocent co-insured's as well.  Tyler, 255 Mont. 174.  In Tyler, the insurer paid a claim for loss caused by fire when the insured's, two business partners, threatened to file a bad faith claim.  Id.at 175.  The insured's filed a bad faith claim anyway, and the insurer answered their complaint and later filed a counterclaim after learning one of the insured's was responsible for the fire.  Id.

The court found that the insured's obtained insurance proceeds based on a fraud, even though one of the insured's was unaware of the fraud.  Id.at 178.  The court found that the policy was therefore void and that the insurer could recover the insurance proceeds.  Id.

• Recovery of payment resulting from false statement

• False statements in the application

In Republic Mut. Ins. Co. v. Wilson, the insured made certain misrepresentations in his application for car insurance.  35 N.E.2d 467, 468 (Ohio Ct. App. 1940).  The insurer issued a policy in reliance on these misrepresentations.  Id.  Over time, the insurer paid several claims on the policy, but when it discovered the insured’s misrepresentations, it filed suit.  Id.The court found that the insured’s misrepresentations voided the policy, and “[t]here is no doubt but that the insurance company is entitled to recover back money that it has paid for losses under a void contract of insurance.  Id.at 526 (citations omitted).

• False statements in the investigation

In Frontier Exploration v. Am. Nat’l Fire Ins. Co., the insured claimed a loss of $175,050 to a specialized truck outfitted with seismic activity detection equipment.  849 P.2d 887, 889 (Colo. Ct. App. 1992).  The insurer paid $117,050 of this amount, and the insured spent $77,174 of this to upgrade a used truck.  Id.When the insurer learned of this, it refused to pay the $58,000 balance.  The insured sued for the claim balance and for bad faith; the insurer counterclaimed for fraud.  Id.  The jury found in favor of the insurer and awarded a judgment for $117,050.  Id.at 890.  The appellate court upheld this award.  Id.at 892.

• Recovery of payment resulting from mistake

Generally, “an insurer can recover amounts paid under a mistake of fact, but not amounts paid under a mistake of law.”  Hartford Accident & Indem. Co. v. Chicago Housing Auth., 12 F.3d 92, 96 (7th Cir. 1993) (citations omitted).  However, “there is no bright line test between mistakes of law and mistakes of fact.”  Id.(citation omitted) . 

• Mistake of law

In The Hartford v. Doubler, the insureds’ livestock policy excluded loss of livestock while in a public sale barn.  434 N.2d 1189, 1190 (Ill. Ct. App. 1982).  When the insureds’ steers were stolen from a public sale barn, the insured's filed a claim.  Id.The insured's noted on their notice of loss that the loss occurred at the public sale barn.  Id.The insurers paid the claim anyway.  Id.Some time later, some more of the insureds’ steers were stolen from the same barn.  Id.The insured's informed the adjuster that the steers were stolen from the public sale barn, but the adjuster again approved the claim, notwithstanding the exclusion.  Id.

Over a year later, the insurer sued the insured's seeking restitution.  Doubler, 434 N.E.2d at 1190.  The insurer alleged that the adjuster did not know about the public sale barn exclusion in the policy and mistakenly authorized payment on the claim.  Id.at 1191.

The court found that “an erroneous conclusion of the legal effect of known facts is a mistake of law and not of fact.”  Id.at 1191.  The court noted that the insurer paid without any fraud or misrepresentation by the insured (i.e., all facts were known).  Id.The court rejected the insurer’s argument that the adjuster’s ignorance of the relevant exclusion made her mistake one of fact.  Id.The court found that because the insurer drafted the insurance policy, the insurer will be deemed to have knowledge of its provisions.  Id. The court held that the insurer could not recover for its mistake of law.  Id.

In Lindsay Mfg. Co. v. Hartford Accident & Indem. Co., the insurers sought restitution of over $2.3 million paid under a CGL policy.  911 F. Supp. 1249, 1258 (D. Neb. 1995), rev’d on other grounds, 118 F.3d 1263 (8th Cir. 1997).  The insurer argued that it paid under the policy because of a “mistake of fact”; specifically, “a mistake of fact that the terms of an insurance contract require such payment.”  Id.at 1259.  The court noted the difficulty in determining whether the insurer’s mistake was one of law or fact.  Id.(citation omitted).  After a short discourse on the subject, the court found that the insurer should not be penalized for “its good faith, albeit erroneous, payments to [the insured] as the result of [the insurer]’s mistaken belief that the policies required the payments . . . .”  Id.at 1260.  Accordingly, the court found that the insurer should prevail on its counterclaim for restitution, despite the fact it appeared to be based upon a mistake of law.  Id.

• Mistake of fact

The policy at issue in Admiral Ins. Co. v. Am. Nat’l Savings Bank was all risk for residential property but covered only certain named perils for commercial.  918 F. Supp. 150, 151 (D. Md. 1996).  An apartment building the insured owned suffered a loss caused by freezing pipes, which was covered under the residential policy but not the commercial.  Id.at 152.  The insured submitted a loss notice listing the property as “residential occupied”.  Id.The insured paid the claim, and the insured later requested that the classification of the property be changed from “residential occupied” to “commercial”.  Id.The insurer sued for recoupment of the policy proceeds.  Id.

The court found that the insurer made a mistake of fact.  Admiral Ins., 918 F. Supp. at 154.  The court distinguished Doubler, finding that the insured's in that case had not made any omissions or misrepresentations.  Id.at 155.  In Admiral Insurance, however, the insured's misrepresented that the property was residential.  Id.The court found that while the misrepresentations may have been innocent, they caused the insurer to pay the claim.  Id.

The insured's argued that the insurer’s negligence in failing to investigate whether the property was improperly classified should bar recovery.  Admiral Ins., 918 F. Supp. at 155.  The court disagreed, finding that one who confers a benefit by mistake may maintain an action for restitution even if the mistake was due to lack of care.  Id.

In Terra Nova Ins. Co. v. Assoc. Comm. Corp., the insurers, after an investigation, strongly suspected the insured submitted a fraudulent claim for loss of his truck, but paid the claim anyway.  697 F. Supp. 1048, 1049 (E.D. Wisc. 1988).  The insurers paid the insured and the lien holder on his truck “because they were worried about their duty to act in good faith in their dealings with [the insured].”  Id.It turned out that the insured arranged for the truck to be stolen and stripped for parts, and he was later convicted of mail fraud.  Id.After the conviction, the insurer sued the lien holder for restitution.  Id.

The court found that the insurers were not entitled to restitution.  Terra Nova, 697 F. Supp. at 1052.  The court noted that where an insurer waives an investigation after the insurer is aware of the possibility of the existence of a fact, the insurer is not acting under a mistake of fact .  Id. (citing Meeme Mut. Home Protective Fire Ins. Co. v. Lorfeld, 216 N.W. 507 (Wisc. 1927)).  In Lorfeld, the insurer had knowledge that the insured may have been responsible for the fire underlying the loss, but it failed to investigate and paid the claim notwithstanding.  216 N.W. at 509.  The court found that under these circumstances, “it cannot be said that [the insurer] acted under a mistake of fact in the legal sense.”   Id. 

The court in Terra Nova noted that, contra Lorfeld, the insurers vigorously investigated the loss. 697 F. Supp. at 1052.  However, the insurers paid the claim even though they knew the claim may have been fraudulent.  Id.The court found the insurers made a “business decision . . . a calculated choice that payment of a dubious claim was a better risk than defending against a suit . . . .”  Id.Under Wisconsin law, the court found that the insurers could not recover for their mistake of fact “in the factual but not legal sense.”  Id.

• Conclusion

It is difficult to draw clear lessons from these cases.  It seems relatively uncontroversial that an insurer can recover money paid on a claim under the right circumstances, and that these “right circumstances” include fraud, false statement, and mistake, at least so long as the insured did not change position in reliance on the payment.  Unfortunately, this does not really answer the question and merely substitutes one set of slogans for another.  For example, in “mistake” cases, the general pattern seems to be that the insurer will argue that it paid under a mistake of fact, the insured will argue that it was a mistake of law, and there is enough precedent either way so that the court can do what it wants.  For now, the best lesson to draw from these cases is to gain the insight of qualified counsel who is well-versed in the law of the particular jurisdiction at issue, as this seems to make quite a bit of difference (in mistake cases, insurers will apparently have an easier time in Nebraska and Maryland, while insured's will have an easier time in Illinois and Wisconsin). 

The answer to this quandary may lie in the growing recognition that the distinctions invented by courts to grapple with these problems—reliance vs. requirement to investigate, mistake of law vs. mistake of fact—are neither useful nor wise.  Instead, the courts should find that the general policy underpinning restitution—to prevent one from being unjustly enriched at the expense of another—should control.