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Clearing up confusion on contestable clauses

February 1999

The topic of Contestable Clause is raised over and over by people just acquiring health, life or disability insurance or by those contemplating purchasing such insurance.

Most state insurance codes, including California's, require that a statement be placed in every insurance contract that makes the policy incontestable after two years except for non-payment of premium. In other words, an insurance company cannot challenge the validity of an insurance contract after it has been in force for two years. As with most laws, however, there is a considerable difference between the statute as it is seemingly written and actual interpretation by the courts.

Long legacy in industry

These clauses originated in response to early life insurance practices. In the 19th century, insurance companies were successful in voiding life contracts at time of claim payment even though the policy had been in force for many years. They were able to find minor discrepancies in the answers given on the application and used that as an excuse to void the contract and avoid paying the claim.

Since the statutes put a time limit on the questioning of those answers made with the application, the importance of the Contestable Clause is limited to policies in which health questions were asked as part of the application process. Thus, even though the Clause is found in all such insurance contracts, only individual policies and some small group contracts are really impacted by them.

To complicate matters in California, the law provides for two Contestable Clauses: one for life insurance and another for health and disability income, lumped under California law as "disability" policies.

In California, the clause for life insurance policies is relatively clear and the courts have made it even clearer. Within the past few years, the California Supreme Court has ruled that the Contestable Clause provides an absolute limit to an insurance company's ability to investigate the validity of a life insurance policy once it has been issued. Basically it cannot be questioned after the policy has been in force for two years, regardless of the reason.

Policy expired before policy-holder's death

In the case that the court reviewed, a person with HIV applied for and purchased a life insurance policy, then died of AIDS four years later, after the two-year Contestable Period had expired.

The insured actually had someone else take the physical exam for him and provide the blood for an HIV test. In processing the claim, the insurance company realized that the policy was obtained fraudulently.

The Supreme Court ruled, however, that the Contestable Clause limited such investigations to the first two years. Even though the policy was obtained fraudulently, the insurance company was ordered to pay the claim.

With that clear of a precedent, it is safe to assume that once a life policy has been in force for two years, nothing short of stopping premium payments will affect that coverage. Note that if the policy ever lapses and is reinstated, the Contestable Period must start all over again.

Other policies not so clear

Things are not so clear with the Contestable Clauses in health and disability policies.

First, the wording required under law is different, although in some ways it seems even clearer in its intent than the life insurance version. One portion even states that no claim can be reduced or denied after two years on the grounds that the disease or condition existed prior to the effective date of the coverage. Seems clear enough.

However, the courts in California have not interpreted it so clearly. Until now, they have permitted insurance companies to claim that the two-year limit does not apply if the disability "first manifested" itself prior to the effective date of the policy. As one can imagine, the difference between "existed" and "first manifested" is something that only insurance company attorneys seem to understand clearly. This convoluted reasoning has allowed insurance companies to void the coverage on many people with HIV and other diseases, usually just when they needed the benefits.

Now in the courts

A current case that should settle the question once and for all has been granted a hearing before the California Supreme Court.

The case concerns a person who, although HIV-positive prior to applying for insurance, had absolutely no symptoms at the time of application and the company neither asked the applicant his status nor tested him for HIV as they have a legal right to do. Now they are trying to get out of paying the claim after the policy has been in effect for almost five years.

If the court sides with the lower courts, then people will never be sure that their policy is solidly in force as the insurance company may challenge its validity on the grounds of prior manifestation at any time.

It is hoped that the court will reverse the lower court's decision and rule that, like life insurance contracts, a policy is truly incontestable after two years. This certainly is the trend in other states where the question has been raised. Just last year, the Hawaii Supreme Court issued a similar ruling, and similar decisions have been made in other states in recent years.

Even if the court rules in favor of the claimant, it won't solve the problems with all contracts. It would be expected that insurance companies would start to examine applicants much more closely before issuing coverage, maybe even continuing an active investigation during the first two years.

Also, the law provides an alternative wording that hasn't been used by the industry for competitive reasons. That alternate allows fraudulent misstatements to be exempted from the two-year limit. The industry could move to that wording, but it would only affect new contracts. Contracts already issued cannot be changed.

Finally, most health insurance policies for individuals do not come under the California Insurance Code and are exempt from the Contestable Clause mandate. This is because Health Maintenance Organizations (HMOs) and Health Service Plans (Blue Cross and Blue Shield) are regulated by the California Department of Corporations and not the Department of Insurance. Blue Cross, for example, has its own wording in place of the Contestable Clause, and Blue Shield contracts do not have one at all, effectively making the policy contestable for the life of the contract.

It will be interesting to see which direction the California Supreme Court will go -- with the trend which would benefit consumers, or continue to protect business interests of the insurance industry.

AIDS Project Los Angeles Benefits Program provides education, assistance and advocacy in public benefits and insurance, both private and employer benefits, for anyone impacted by HIV. For information, call (323) 993-1472.

This article has been reprinted at The Body with the permission of AIDS Project Los Angeles (APLA).

This article was provided by AIDS Project Los Angeles. It is a part of the publication Positive Living.
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