Utmost Good Faith—Representations, Concealments, and Warranties
Because the insured usually has a much greater knowledge about the thing insured, and because insurance companies need to know this information to decide whether they want to insure it, and, if so, at what rate, the insurance company depends on the insured for this vital information. If a loss occurs, and the insurance company finds that material information was false, it can deny coverage. Utmost good faith (sometimes encountered in legal texts as the Latin uberrimae fidei) is complete and total honesty—all statements must be true and all material facts must be revealed; otherwise, insurance could not be provided economically.
The principle of utmost good faith also makes the application for insurance easier, since most insurance companies do not check the facts before they issue the policy. Since losses are rare, it is more economical to investigate a loss when it actually occurs. If a material fact listed in the insurance application is false or was not revealed, then the insurance company will be able, in most cases, to void the contract and deny the payment of any claims. Thus, for insurance applicants, honesty is the best policy, since dishonesty could lead to no compensation for losses even though premiums were paid.
Utmost good faith is usually divided into 3 components: representations, concealments, and warranties.
Representations are the statements made by the insured on the insurance application. Many of these representations are responses to questions to determine whether the applicant is insurable and how much should be charged. For instance, for auto insurance, insurers will ask how far you travel to work, whether you had any accidents or citations, and so on.
An insurance contract is voidable by the insurer if any representation is
- was relied upon by the insurer,
- and was known to be false by the insurance applicant.
A material representation is one that was relied upon by the insurer in issuing the policy. If the truth were known, the insurer either would not have issued the policy, or would have issued it with different terms, and probably would have charged higher premiums. However, the insurance company cannot deny a claim for a false representation unless it can prove that the applicant lied and intended to deceive the company—not because the applicant merely expressed an opinion that later turned out to be false.
Any misrepresentations after a loss can also void an insurance contract. A common example of this type of misrepresentation is when the insured suffers the loss of property, but files a claim for much more than the property was actually worth.
In most jurisdictions, an insurance company can also void a contract if there was an innocent misrepresentation of a material fact.
Concealment is closely related to misrepresentation—it is the failure to disclose material information. However, before an insurance company can deny payment for concealment it must prove:
- the insured knew that the fact was important in regard to the insurance being applied for;
- and there was an intention to defraud the insurer.
Misrepresentations and concealments are common strategies used by people with higher risks, and leads to adverse selection by insurance companies, which, in turn, raises premiums for everyone else.
A warranty is a promise by the insurance applicant to do certain things or to satisfy certain requirements, or, it is a statement of fact that is attested by the insurance applicant. The warranty becomes part of the insurance contract. If the insured breaches the warranty, the insurer can void the contract and deny payment of a claim. An affirmative warranty is a statement of fact, which is basically the same as a representation, while a promissory warranty is a promise to do something or that something will be done in a specific way. An express warranty is specifically stated in the contract, while an implied warranty is one that is presumed.
Years ago, if a warranty was breached even a little, it allowed the insurer to void the contract and deny coverage, which lessened the value of insurance, and led to great financial losses by the insured for a slight breach of the warranty, many times due to facts that were not material. The states and courts have since lessened the harshness of the doctrine: application statements are considered representations and not warranties; a warranty is not breached if the increase in risk is temporary or minor; in some states, there is no breach of warranty unless it increases the hazard of an insurable loss, and some states require that the breach in warranty actually contributed to the loss.