Union Bankers Insurance Co. v. Shelton

889 S.W.2d 278, 1994 WL 278131

• Court: Texas Supreme Court
• Decided: November 22, 1994
• Docket: D-3930
• Status: Published

Opinions

HIGHTOWER, Justice,

delivered the opinion of the Court,

in which DOGGETT, GAMMAGE and SPECTOR, Justices, join.

This case requires that we determine (1) whether an insured’s intent to deceive must be proved in order for an insurance company to successfully raise a defense of misrepresentation to a breach of contract action in connection with the cancellation of an individual health insurance policy within two years of the date of its issuance when the cancellation is based upon the insured’s misrepresentation in the application for insurance; and (2) whether a cause of action for breach of the duty of good faith and fair dealing exists when an insurer cancels an insurance policy without a reasonable basis. We conclude that (1) an insured’s intent to deceive is required for an insurer to cancel an individual health insurance policy within two years of the date of its issuance on the grounds of a misrepresentation in the application and (2) the duty of good faith and fair dealing extends to an insurer’s cancellation of a policy.

Thomas and Ann Shelton sued Union Bankers Insurance Company (“Union Bankers”) and its agent Donny Stone (“Stone”) after Union Bankers cancelled Mr. Shelton’s health insurance policy on the basis of an alleged misrepresentation in his application. Among other things, the Sheltons alleged that Union Bankers breached the contract and the duty of good faith and fair dealing by improperly cancelling the policy. The trial court rendered a take-nothing judgment in favor of Union Bankers and Stone. The court of appeals reversed and remanded the case to the trial court for a new trial concerning the duty of good faith and fair dealing. 853 S.W.2d 589. For the reasons explained herein, we affirm the judgment of the court of appeals.

I.

In April 1988, Mr. Shelton applied to Union Bankers for a health insurance policy. Mr. Shelton completed the application form with Stone’s assistance. In response to certain medical history questions, Mr. Shelton indicated that he had never been treated for, and had no indications of, any disorders of the skeletal or muscular systems. Union Bankers issued a health policy to Mr. Shelton on April 9, 1988.

In November 1988, seven months after the policy was issued, Mr. Shelton underwent total hip replacement surgery to correct necrosis in his left hip joint. Shortly thereafter, the Sheltons filed a claim for benefits under the Union Bankers policy. Union Bankers concluded that the necrosis was an undisclosed pre-existing condition, notified Mr. Shelton that it was denying the claim, and requested that Mr. Shelton execute a rider specifically excluding hip disorders. When he refused to sign the rider, Union Bankers refunded all premiums and can-celled the policy on the ground that the failure to disclose the hip condition was a material misrepresentation in the application for insurance.

The Sheltons sued Union Bankers and Stone, alleging breach of contract, violations of the Deceptive Trade Practices Act and Texas Insurance Code, and breach of the duty of good faith and fair dealing. The jury answered all questions against the Sheltons, except that the jury failed to find that Mr. Shelton intended to deceive Union Bankers when he made the misrepresentation. Based on the jury’s verdict, the trial court rendered a take-nothing judgment in favor of Union Bankers and Stone. The court of appeals reversed, holding that because the jury failed to find that Mr. Shelton intended to deceive Union Bankers by misrepresenting his condition, Union Bankers breached the contract as a matter of law when it cancelled the insurance policy. The court of appeals remanded the ease to the trial court for a new trial concerning whether Union Bankers breached the duty of good faith and fair dealing in connection with its cancellation of Mr. Shelton’s policy.¹

II.

Union Bankers contends that the jury’s failure to find that Mr. Shelton intended to deceive Union Bankers is irrelevant because article 3.70-3(A)(2)(a) of the Texas Insurance Code implies that an insurer may cancel a health insurance policy within two years from the date of its issuance on the basis of an insured’s innocent misrepresentation in the application for insurance. We disagree. Article 3.70-3(A) sets forth minimum standards for provisions that must be contained in each accident and sickness policy delivered or issued for delivery to any person in this state.² See Tex.Ins.Code Ann. art. 3.70-3(A) (Vernon 1981). Among the required provisions contained in the policy issued to Mr. Shelton, is the following clause:

Time Limit on Certain Defenses: (a) After two years from the date of issue of this policy no misstatements, except fraudulent misstatements, made by the applicant in the application for such policy shall be used to void the policy or to deny a claim for loss incurred or disability (as defined in the policy) commencing after the expiration of such two-year period.

(The foregoing policy provision shall not be so construed as to affect any legal requirement for avoidance of a policy or denial of a claim during such initial two-year period, nor to limit the application of Section 3(B), (1), (2), (3), (4), and (5) in the event of misstatement with respect to age or occupation or other insurance.)

Id. art. 3.70-3(A)(2)(a).³

The primary rule in statutory interpretation is that a court must look to the intent of the legislature and must construe the statute so as to give effect to that intent. Monsanto Co. v. Cornerstones Mun. Util. Dist., 865 S.W.2d 937, 939 (Tex.1993); Knight v. International Harvester Credit Corp., 627 S.W.2d 382, 384 (Tex.1982). When determining legislative intent, the courts may look to the language of the statute, legislative history, the nature and object to be obtained, and the consequences that would follow from alternate constructions. Sharp v. House of Lloyd, Inc., 815 S.W.2d 245, 249 (Tex.1991) (considering the nature and object of the act and the consequences of alternate constructions); Irving Fireman’s Relief & Retirement Fund v. Sears, 803 S.W.2d 747, 750 (Tex.App.—Dallas 1990, no writ) (considering the language of the statute and the legislative history).

The language of article 3.70-3(A)(2)(a) derives from section 3(A)(2)(a) of The Uniform Individual Accident and Sickness Policy Provision Law (“section 3(A)(2)(a)”) which was promulgated by the National Association of Insurance Commissioners (“Commissioners”) in June 1950.⁴ Note, Insurance Law — Accident and Sickness Policy Provisions Law— Time Limit on Certain Defenses, 27 N.Y.U.L.Rev. 670, 671 n. 4 (1952) [hereinafter Insurance Defenses ]. Section 3(A)(2)(a) was the first nationwide effort to create a type of incontestability provision for all accident and sickness policies. Id. at 674.⁵

The phrase “except fraudulent misstatements” represents the “prime feature of compromise in the time limit provisions,” functioning to distinguish section 3(A)(2)(a) from the incontestability provisions traditionally contained in life insurance policies, which provide that the policy is not contestable after two years for any reason. Id. at 678-79; Charles L. Levy, Policyholder Misrepresentation and Rescission, The Second Annual Ultimate Insurance Seminar 22 (State Bar of Texas 1993) (“The language relat[ing] to fraud being necessary after the first two years makes sense when one considers that life insurance policies are typically not contestable after two years for any reason.”).⁶

It appears that the Commissioners did not intend for section 3(A)(2)(a) to apply to an insurer’s right to void its policy or deny a claim during the initial period. Insurance Defenses, 27 N.Y.U.L.Rev. at 679. This intent is expressed in both parts of section 3(A)(2)(a). The first part provides that accident and sickness policies may not be rescinded after three years from issuance, except for fraudulent misstatements. Model InsuRance Laws Regulations & Guidelines, Uniform Individual Accident and Sickness Policy Provision Law, § 3(A)(2)(a) (National Association of Insurance Commissioners 1977). The second part expressly states that the foregoing provision governing rescission after three years does not affect the law of rescission within the initial three year period. Id.; see Taylor v. Metropolitan Life Ins. Co., 106 N.H. 455, 214 A.2d 109, 115 (1965) (recognizing that the New Hampshire statute by its terms applies only to a loss incurred or to disability commencing after the expiration of two years from the date of issuance of the policy); see also Insurance Defenses, 27 N.Y.U.L.Rev. at 679-80. We find it significant that the Commissioners considered the matter of such importance that they took the additional step of directing the judiciary not to interpret section 3(A)(2)(a) as affecting the law of rescission within the initial three year period.

We believe that this conclusion equally applies to article 3.70-3(A)(2)(a), which mirrors the language of section 3(A)(2)(a), except that it requires an intent to deceive after two years, not three. Thus, construing article 3.70-3(A)(2)(a) to imply that an insurer may cancel a health insurance policy within two years from the date of its issuance on the basis of an innocent misrepresentation conflicts with the apparent intent of the Commissioners and the Texas legislature as expressed in the additional provision concerning the avoidance of a policy or denial of a claim during the initial two-year period.

We hold that article 3.70-3(A)(2)(a) was not intended to affect the determination of whether an intent to deceive must be proved to cancel a health insurance policy within two years of the date of its issuance when the cancellation is based on the insured’s misrepresentation in the application for insurance. Thus, we must examine both the relevant statutes and the common law to determine whether the insurer must prove the insured’s intent to deceive in order to successfully raise a defense of misrepresentation to a breach of insurance contract action.

III.

By statute, a misrepresentation in an application for any type of insurance must be material in order to avoid the policy. See Tex.Ins.Code Ann. art. 21.16 (Vernon 1981). The proposition that an insured’s intent to deceive is likewise required is well established in the common law of this state. See Couch On INSURANCE 2d §§ 35:119, 35:122 (1985). The rule was first announced by this court in a personal property fire insurance case, Lion Fire Insurance Co. v. Starr, 12 S.W. 45, 46 (Tex.1888), and more recently in several life insurance policy cases. Mayes v. Massachusetts Mut. Life Ins. Co., 608 S.W.2d 612, 616 (Tex.1980); Allen v. American Nat’l Ins. Co., 380 S.W.2d 604, 607-08 (Tex.1964); Clark v. National Life & Accident Ins. Co., 145 Tex. 575, 200 S.W.2d 820, 822-23 (1947). In Mayes, we stated:

It is now settled law in this state that these five elements must be pled and proved before the insurer may avoid a policy because of the misrepresentation of the insured: (1) the making of the representation; (2) the falsity of the representation; (3) reliance thereon by the insurer; (4) the intent to deceive on the part of the insured in making the same; and (5) the materiality of the representation.

608 S.W.2d at 616.

All of the cases cited by the court of appeals and Mr. Shelton properly stand for the proposition that, in Texas, an insured’s intent to deceive must be shown in order for an insurance company to successfully raise a defense of misrepresentation on the basis of a false statement made by the insured in the application for any type of insurance. See Mayes, 608 S.W.2d at 616 (life policy); Clark, 200 S.W.2d at 822-23 (life policy); Lion Fire Ins. Co., 12 S.W. at 46 (fire policy); Flowers v. United Ins. Co. of Am., 807 S.W.2d 783, 785 (Tex.App.—Houston [14th Dist.] 1991, no writ) (life policy); Progressive County Mut. Ins. Co. v. Boman, 780 S.W.2d 436, 439 (Tex. App.—Texarkana 1989, no writ) (motorcycle policy); Republic Bankers Life Ins. Co. v. Coffey, 490 S.W.2d 231, 233 (Tex.Civ.App.—Amarillo 1973, writ ref'd n.r.e.) (hospitalization, surgical, and medical policy);⁷ Republic Bankers Life Ins. Co. v. Hoffman, 483 S.W.2d 268, 269 (Tex.Civ.App.—Dallas 1972, no writ) (health policy); Trinity Reserve Life Ins. Co. v. Hicks, 297 S.W.2d 345, 350 (Tex. Civ.App.—Dallas 1956, no writ) (hospitalization policy); United Am. Ins. Co. v. Harp, 290 S.W.2d 392, 395 (Tex.Civ.App.—Amarillo 1956, no writ) (health policy); General Am. Life Ins. Co. v. Martinez, 149 S.W.2d 637, 639 (Tex.Civ.App.—El Paso 1941, writ dism’d) (disability policy); American Cent. Ins. Co. v. Buchananr-Vaughn Auto Co., 256 S.W. 610, 612 (Tex.Civ.App.—Texarkana 1923), affd, 271 S.W. 895 (Tex.Comm’n App. 1925, judgm’t adopted) (auto dealers fire policy); Aetna Accident & Liab. Co. v. White, 177 S.W. 162, 165 (Tex.Civ.App. —Dallas 1915, writ ref'd) (theft policy);⁸ Phoenix Ins. Co. v. Swann, 41 S.W. 519, 519 (Tex.Civ.App. 1897, no writ) (fire policy).⁹

We hold, therefore, that an intent to deceive must be proved to cancel a health insurance policy within two years of the date of its issuance when the cancellation is based on the insured’s misrepresentation in the application for insurance. Because the jury failed to find that Mr. Shelton intended to deceive United Bankers when he misrepresented his physical condition, we affirm the judgment of the court of appeals in so far as it holds that, as a matter of law, Union Bankers breached the insurance contract when it improperly cancelled the policy based on the misrepresentation.

IV.

A.

This holding requires us to determine whether a cause of action for breach of the duty of good faith and fair dealing exists when the insurer cancels an insurance policy without a reasonable basis. The court of appeals reasoned that because the duty of good faith and fair dealing arises from the special relationship between the insurer and the insured, its application should not be limited solely to the denial or delay in payment of individual claims. Therefore, the court of appeals held that there is a cause of action for breach of the duty of good faith and fair dealing when the insurer cancels the policy without a reasonable basis. We agree.

This court first recognized the existence of the duty of good faith and fair dealing in the insurance context in Arnold, v. National County Mutual Fire Insurance Co., 725 S.W.2d 165, 167 (Tex.1987). We held that the duty arises from the special relationship that is created by the contract between the insurer and the insured. Id.; see also Viles v. Security Nat’l Ins. Co., 788 S.W.2d 566, 567 (Tex.1990) (recognizing that the duty arises “not from the terms of the insurance contract, but from an obligation imposed in law” as a result of the special relationship). A claim for breach of the duty of good faith and fail' dealing is separate from any claim for breach of the underlying insurance contract, Viles, 788 S.W.2d at 567, and the threshold of bad faith is reached only when the breach of contract is accompanied by an independent tort. Transportation Ins. Co. v. Moriel, 879 S.W.2d 10, 17 (Tex.1994). A cause of action is stated when the insured alleges that the insurer had no reasonable basis for the denial or delay in payment of a claim and that the insurer knew or should have known of that fact. Id. at 18; Aranda v. Insurance Co. of N. Am., 748 S.W.2d 210, 213 (Tex.1988).

In Arnold, we identified several factors giving rise to the special relationship requiring the duty of good faith and fair dealing. The overriding factor is the parties’ unequal bargaining power and the nature of insurance contracts. Arnold, 725 S.W.2d at 167. The insurer has exclusive control over the evaluation, processing, and denial of claims. Id. Without a cause of action for breach of the duty of good faith and fair dealing, unscrupulous insurers would be able to take advantage of their insureds’ misfortunes in bargaining for settlement or in resolving claims by “arbitrarily denying] coverage and delay[ing] payment of a claim with no more penalty than interest on the amount owed.” Id.

These factors equally apply, and perhaps are even more compelling, when the insurer unilaterally cancels the insured’s policy without a reasonable basis. The insured is not merely at the mercy of the insurer to treat him fairly in the processing of a single claim, but must rely on the insurer’s good faith for the continued existence of any coverage. The insurer’s ability to unilaterally cancel an insurance policy and the insured’s inability to prevent cancellation demonstrates a great disparity in bargaining power between the two parties. Furthermore, a failure to extend the duty of good faith and fair dealing to the cancellation of an insurance policy would allow insurers to avoid bad faith liability by cancelling the entire policy rather than denying a single claim.

We hold that a cause of action for breach of the duty of good faith and fair dealing exists when the insurer wrongfully cancels an insurance policy without a reasonable basis. A cause of action is stated by alleging that the insurer had no reasonable basis for the cancellation of the policy and that the insurer knew or should have known of that fact.

B.

Because the jury failed to find that Union Bankers breached the contract when it canceled the policy, it did not reach the issue of bad faith in connection with the cancellation. Because we hold as a matter of law that Union Bankers breached the insurance contract when it canceled the policy, this cause must be remanded for a new trial concerning the breach of the duty of good faith and fair dealing issue.

Union Bankers argues that remand is improper because there is no evidence of bad faith in connection its cancellation of Mr. Shelton’s policy. We disagree. There is some evidence in the record to support Mr. Shelton’s assertions that Union Bankers’ initial correspondence concerning the claim stated that the information omitted from the application was “probably an oversight,” and that Union Bankers failed to discuss the application, condition, or claim with Mr. Shelton before making its final determination. In addition, the policy itself states in offset print on the first page:

IMPORTANT NOTICE ABOUT STATEMENTS IN THE APPLICATION

Please read the copy of the application which is a part of this policy. Check to see if any medical history has been left out. Write Us if any information shown isn’t right or complete. We issued this policy on the basis that the answers to all questions are right and complete. Any wrong or left out statements could cause an otherwise valid claim to be denied.

(emphasis added). This notice contains no indication that a wrong statement might result in an attempted exclusion of coverage for certain medical conditions or cancellation of the entire policy, it may even indicate to the contrary. We hold that this evidence constitutes some evidence of bad faith in connection with the cancellation of the policy, and requires the remand of this cause to the trial court for a new trial.

For the reasons explained herein, we affirm the judgment of the court of appeals.

CORNYN, J., joined by GONZALEZ and HECHT, JJ., concurs in part and dissents in part, with opinion to follow. ENOCH, J., not sitting.

1 . Jury questions No. 5, 6, and 7 addressed the duty of good faith and fair dealing associated with the cancellation of the insurance policy. These questions were conditioned on a "Yes” answer to jury question No. 4, asking whether "Union Bankers ... failed to comply with the insurance agreement by canceling the policy...." The jury answered question No. 4 "No,” and therefore did not reach questions 5, 6, and 7. Because the court of appeals held that Union Bankers breached the policy as a matter of law when it cancelled the insurance contract, it remanded the case for a new trial on the unanswered duty of good faith and fair dealing questions.

2 .Texas insurers may afford their insureds more protection than that required by article 3.70-3(A). Tex.Ins.Code Ann. art. 3.70-3(A) (“[T]he insurer may, at its option, substitute for one or more of such provisions, provisions of different wording ... which are in each instance not less favorable in any respect to the insured....").

3 . Article 3.70-3(A)(2)(a) applies to and governs most individual accident and sickness insurance policies delivered, or issued for delivery, in the State of Texas. See Tex.Ins.Code Ann art. 3.70-1(C) (Vernon Supp.1994). No Texas case interprets the language of article 3.70-3(A)(2)(a).

4 . The language in article 3.70-3(A)(2)(a) is identical to that in section 3(A)(2)(a) of The Uniform Individual Accident and Sickness Policy Provision Law, except that the time period in section 3(A)(2)(a) is three years rather than two. See Model Insurance Laws Regulations & Guidelines, Uniform Individual Accident and Sickness Policy Provision Law, § 3(A)(2)(a) (National Association of Insurance Commissioners 1977).

5 . Because most accident and health insurance is subject to cancellation by the insurer or subject to the insurer’s right to refuse renewal, the insurer retains the power to nullify the effect of any incontestability provision by terminating the policy before the date that incontestability attaches. Insurance Defenses, 27 N.Y.U.L.Rev. at 675. Consequently, the drafters of section 3(A)(2)(a) were careful not to use the term "incontestable” in connection with policies other than non-can-celable policies. Id.

6 . The Texas statute requiring the incontestability provision to be contained in all life insurance policies states "[tjhat the policy ... shall be incontestable after it has been in force during the lifetime of the insured for two (2) years from its date_" Tex.Ins.Code Ann. art. 3.44(3) (Vernon 1981 & Supp.1993).

7 . The court of appeals stated with regard to Coffey that "making a misrepresentation to induce an insurer to issue a policy is the equivalent of intending to deceive an insurer.” 853 S.W.2d at 592 n. 6. We believe, however, that the relationship between the intent to induce and the intent to deceive is more properly explained by the statement in Allen v. American National Insurance Company, that "[t]he utterance of a known false statement, made with intent to induce action ... is equivalent to an intent to deceive." 380 S.W.2d 604, 608 (Tex.1964) (citing Texas Industrial Trust, Inc. v. Lusk, 312 S.W.2d 324 (Tex.Civ.App.—San Antonio 1958, writ ref'd)).

8 . Like Provident Life & Accident Insurance Co. v. Flowers, 91 S.W.2d 847 (Tex.Civ.App.—El Paso 1936, writ dism'd w.o.j.), discussed by the court of appeals, Aetna Accident & Liability Co. relates more to the materiality requirement than to the intent to deceive requirement.

9 . Some treatises and courts cite Inter-Ocean Insurance Co. v. Ross, 315 S.W.2d 71 (Tex.Civ. App.—Fort Worth 1958, no writ), for the proposition that Texas adopts the view that proof of an intent to deceive is not required to avoid a policy of insurance based upon a misrepresentation. To the extent that Inter-Ocean Insurance Co. may be read to allow avoidance of a policy of insurance based upon a misrepresentation defense without a finding of intent to deceive, it is disapproved.