A common strategy in rescission cases where life insurance carriers are primarily litigating with market investors is for the carrier to seek to retain all premiums as an offset to damages it has allegedly sustained. The first federal appellate court to reject the carrier position recently issued its decision in PHL Variable Ins. Co v. Jolly, No. 11-12188 (11th Cir. Mar. 14, 2012). Applying Georgia law, the US Court of Appeals for the Eleventh Circuit held that PHL Variable Insurance Company (PHL) could not both rescind a life insurance policy and retain the premiums paid for it, even though it was undisputed that the policy had been obtained with fraudulent representations made by the insured in the policy application, because the owner of the policy, the trust, had not committed fraud. This decision has significant application for market investors who own policies that are in litigation where, unbeknownst to the investor at the time of its investment, an underlying fraud tainted the policy.

In Jolly, PHL claimed that the Policy should be rescinded and/or declared void ab initio because of misrepresentations that were allegedly made in the policy’s application by the insured and the trustee of the trust that was created by the insured to own and maintain the policy concerning the insured’s net worth and annual income. In addition, PHL sued the insured and trustee for common law fraud, negligent misrepresentation and civil conspiracy, and claimed that allegedly false representation equitably entitled it to retain the premiums paid by the trust in the event of rescission.

The application signed by the insured and trustee contained the following attestation:

I have reviewed this application, and the statements made herein are those of the proposed insured and all such statements made by the proposed insured in Part I or and in Part II of this application are full, complete, and true to the best knowledge and belief of the undersigned and have been correctly recorded.

At the trial court level, PHL was able to obtain a default judgment against the insured, meaning that the PHL’s fraud claims were deemed true by the court. PHL’s remaining claims against the trustee, as well as its claim to retain premiums, were dismissed by the trial court. PHL appealed the dismissal of the negligent misrepresentation and premium retention claims to the Eleventh Circuit.

The Eleventh Circuit affirmed the trial court’s ruling on both claims. With respect to the negligent misrepresentation claim, the appellate court found that, in the application, the trustee had not verified the veracity of the financial representations concerning the insured, but rather had simply stated in the application, pursuant to the attestation provisions quoted above, that he had reviewed the application and that the information therein was, to the best of his (the trustee’s) knowledge, true. Since there was no evidence demonstrating either that the trustee failed to review the application or that the trustee had knowledge of facts that contradicted any of the information in the application when he signed it, including the income and net worth information represented therein, the Eleventh Circuit agreed with the trial court that the negligent misrepresentation failed as a matter of law.

With respect to the premium retention claim, the Eleventh Circuit recognized that “Georgia law generally requires an insurer seeking to rescind an insurance contract to return any premiums paid under the contract, even where the insured person originally obtained the policy by fraud.”  The appellate court also noted that the default judgment had no bearing on the premium retention claim. Rather, the only claims relevant to premium retention were those asserted against the trustee because the trust, not the insured, was the party that had paid the premiums for the policy. Since all of the claims against the trustee had been dismissed, there was no basis for PHL to retain premiums because “the Trust does not owe PHL anything, as the Trust did not commit any fraud or other wrong that harmed PHL.” 

Jolly appears to be the first federal appellate court decision to reject the position taken by many life insurers that premiums may be retained upon rescission where fraud is involved. In addition, the Eleventh Circuit in Jolly recognized that a trust/trustee which/who has no independent knowledge that there are misrepresentations in a policy application regarding information concerning the insured cannot be held liable for those misrepresentations. The Jolly decision may also prove significant with respect to the dismissal of the negligent misrepresentation claims, since many insurers in rescission actions base their misrepresentation claims on policy application language that is the similar to the attestation provisions quoted above.

If you have any questions regarding the Jolly decision or its potential impact, please contact Elliott Kroll, Jule Rousseau, Michael Cryan, James Westerlind, or Eric Biderman from Arent Fox LLP’s Insurance & Reinsurance Practice Group.