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Rescission, an equitable remedy, has been granted in cases where an insured makes deliberately false representations in an insurance application or otherwise defrauds the insurer in connection with the issuance of a policy. However, as part of the unwinding of the insurance transaction, courts often order insurers to return the paid premiums to the applicant.  The reason is that rescission generally requires that the parties be returned to the same position they were in before the policy was issued. Accordingly, if the policy is ruled to be void ab initio, as if the policy had never been issued, and the insurer does not receive any premiums unless the policy is issued, that  means that premiums would never have been paid either. From time to time, however, the argument has been made that allowing insurers to retain premiums might deter attempts to procure insurance policies by fraud. If the risk of engaging in the fraud is heightened, so that the fraudsters face the loss of premiums paid as well as benefits, they may think twice before acting. Those who have advanced this argument must have been heartened by the First Circuit’s recent decision in PHL Variable Insurance Co. v. P. Bowie 2008 Irrevocable Trust, No. 12-2243, 2013 U.S. App. LEXIS 9638, (1st Cir. May 13, 2013). There the U.S. Court of Appeals decided that an insurer was entitled to retain premiums - - as special damages - - in seeking to rescind an insurance policy issued because of fraud.

In PHL an insurance broker and an attorney representing a trust submitted an application on behalf of a third party for a $5 million life insurance policy naming the trust as the beneficiary.  The application stated that the proposed insured had an annual salary of $250,000, and a personal net worth of approximately $7.5 million, neither of which was true. And the application was rife with other misrepresentations. PHL uncovered the fraud and filed an action in the U.S. District Court for the District of Rhode Island, seeking to rescind the policy.  PHL also sought to obtain the premiums paid in order to compensate it for costs incurred in connection with issuance of the policy. 

The trial court determined that the court’s equity powers enabled it to permit PHL to retain the the $192,000 in premiums paid as special damages.  The retained premium, therefore, could be used to offset the $172,365 PHL paid in commissions to the insurance broker, and the balance could be applied toward the various costs referenced in PHL’s complaint, which included those related to underwriting, administration, and servicing of the policy, investigation into the misrepresentations contained in the application, and attorney’s fees. The First Circuit affirmed. It rejected the trust’s argument that Rhode Island case law required an insurer to return premiums when seeking to rescind an insurance policy. Principles of equity found in the state's case law, the Court ruled, permit courts to make whole a party who is deceived into entering into a contract. 

The take-away here is that courts may, in given circumstances, be open to the idea that allowing the insurer to retain paid premiums does not create a windfall but simply represents an effort to make the insurer whole, which in the context of a fraudulent application, comports with equitable principles.