The Vanishing Premium and the Non-Disclosure
Priya applies for a 20-year term policy with a $500,000 death benefit. On the application she answers 'no' to a question asking whether she has used tobacco in the past 36 months. The underwriter issues the policy at preferred non-smoker rates. Fourteen months later, Priya dies in a car accident. The insurer's claims investigation finds pharmacy records showing she filled a nicotine-replacement prescription 20 months before applying and that she had a documented smoking history in her primary-care notes. The application contained a clause making the answers the basis of the contract and a two-year contestability period. The beneficiary argues the cause of death was an accident, unrelated to smoking.
1. Can the insurer rescind the policy and deny the death benefit? Explain the reasoning.
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Likely yes. The misstatement is material: tobacco use was a direct rating factor that determined preferred non-smoker pricing, so the insurer would have issued different terms had it known. The 'cause of death unrelated' argument fails because material misrepresentation voids the contract based on the inducement to issue, not on causation of the loss. The two-year contestability window had not closed (14 months), so the insurer may rescind and return premiums. The 'basis of the contract' clause strengthens the insurer's position in jurisdictions that still give it effect, though modern rules often treat it as a materiality test rather than an automatic warranty.
2. If Priya had died in month 30 instead, how would the analysis change?
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After the contestability period lapses, the insurer generally cannot rescind for innocent or negligent misrepresentation discovered later; the policy becomes incontestable. The claim would then be payable unless the insurer can prove fraud that a statute allows to be challenged beyond the contestability period, or the misstatement is tied to a separate exclusion. The accident cause of death would not independently bar payment.