The insurance industry is plagued with fraudulent claims for arson, burglary, boat sinking, auto accident, and other types of fraudulent claims. The public winds up paying billions of dollars each year as a result of insurance fraud. This article discusses the remedies an insurance carrier has when it can prove that it was the victim of insurance fraud.



A carrier can rescind a policy based on a false statement in the insurance policy application or on a misrepresentation in the presentation of the claim. The standard differs: If a statement in an insurance policy application is both false and material, the carrier can rescind even if the insured did not intend to provide false information. Insurance Code sections 331, 359; Thompson v. Occidental Life Ins. Co. of Cal. (1973) 9 Cal.3d 904, 109 Cal.Rptr. 473; Imperial Cas. & Indem. Co. v. Sogomonian (1988) 198 Cal.App.3d 169, 243 Cal.Rptr. 639. The standard for materiality is subjective, the critical question being the effect of truthful answers on the insurance carrier that issued the policy. <span style="text-decoration: underline">Id</span>.

Where the false statement is made in the presentation of the claim, the carrier can rescind based on a "false swearing" clause in the policy authorized by Insurance Code section 2071. However, the carrier can rescind only if the false statement was intentional (Miller v. Fireman's Fund Ins. Co. (1907) 6 Cal.App. 395, 398, 92 P. 332) and material (Cummings v. Fire Ins. Exch. (1988) 202 Cal.App.3d 1407, 1414, 249 Cal.Rptr. 568). The test for materiality is an objective one, and depends upon the effect the false statement would have on a reasonable insurer. Cummings, supra.

Claim Denial

A carrier presented with a fraudulent claim is not required to rescind. Rather, it can deny the claim based on a false statement in the policy application (Resure, Inc. v. Superior Court (1996) 42 Cal.App.4th 156, 49 Cal.Rptr.2d 354) or in the presentation of the claim (Cummings, supra).


An insurance carrier, having spent money to investigate a fraudulent claim, is permitted to recover those amounts and perhaps more from those who presented the claim. Where proof of the insured's fraud is strong enough, the insurance carrier may seek to file a cross-complaint in an action brought against it or even file a separate action against the insured. What causes of action are available?

Breach of Contract

An insured may be liable to its insurance carrier for losses suffered by the carrier as a result of the insured's breach of contract. But a breach of contract leads only to contract remedies, not attorneys' fees or punitive damages. Liberty Mut. Ins. Co. v. Altfillisch Constr. Co. (1977) 70 Cal.App.3d 789, 797, 139 Cal.Rptr. 91.


An insured's breach of duties is not actionable as negligence. "[A]ny negligence law duty of care which might devolve upon an insured when that insured enters into an insurance contract would be coterminous with the insured's contractual duties." Agricultural Ins. Co. v. Superior Court (1999) 70 Cal.App.4th 385, 389, 82 Cal.Rptr.2d 594, fn. 1.

Reverse Bad Faith

A covenant of good faith and fair dealing is implied in all insurance contracts. It binds the insured as well as the insurance carrier. Liberty Mut. v. Altfillisch, supra; Commercial Union Assurance Companies v. Safeway Stores, Inc. (1980) 26 Cal.3d 912, 918, 164 Cal.Rptr. 709. While an insured can sue its insurance carrier for breach of the implied covenant of good faith and fair dealing (bad faith), the insurance carrier cannot bring a bad faith cause of action against its own insured (reverse bad faith). California Fair Plan Ass'n v. Politi (1990) 220 Cal.App.3d 1612, 1618, 270 Cal.Rptr. 243. Tort liability based on a contract breach has been limited to instances where the insurance company – not the insured – acts in bad faith. Politi, supra, at 1618.


A carrier can sue its own insured for common law fraud. Agricultural Ins. Co. v. Superior Court, supra. The elements of a fraud claim are (1) misrepresentation (false representation or concealment); (2) scienter (knowledge of falsity); (3) intent to defraud; (4) justifiable reliance; and (5) resulting damage. Id. at 402.

In Agricultural, the insurance carrier issued a policy that included earthquake coverage for the partner of an upscale health club in Los Angeles. At the time of the earthquake, the health club's building allegedly was already in need of building code upgrades and other remedial work. The insureds' public adjuster submitted a report to the insureds estimating the earthquake damage at about $2 million. The insureds then fired their adjuster and obtained a second estimate from a construction supervisor for about $9 million. The second estimate, unlike the first, provided for substantial remodeling. The insureds concealed the first estimate from their insurance company and gave it only the second estimate. The insurance carrier, unaware of the first damage estimate, paid nearly $3 million as a partial payment.

The insureds sued for bad faith. The trial court stayed the case to allow the insurance carrier to conduct examinations under oath and otherwise investigate the claim. The carrier then denied the claim and demanded a refund of money already paid. When the insureds refused, the carrier filed a cross-complaint against the insureds, alleging reverse bad faith and fraud. The trial court sustained the demurrer without leave to amend as to both causes of action. The court of appeal, citing Politi, refused to allow the reverse bad faith cause of action. However, the court of appeal allowed the fraud claim. In comparing the two causes of action, the court stated:

"The fraud claim presents a question separate from the bad faith question. The relatively modern concept of ‘bad faith' is quite indistinct, and can mean many different things to different people. The relatively ancient concept of fraud, by contrast, is far more well-defined and, consequently, far more circumscribed." Agricultural, supra, 70 Cal.App.4th at 401.

The Agricultural court cited Civil Code section 1542, which defines fraud, and held that it encompasses fraudulent misrepresentations made during the insurance claims process by either party to the contract. The court noted that, of the various elements of fraud, discussion in other opinions focused on justifiable reliance. The court stated that, when an insured makes a claim to its carrier, the carrier has a duty to investigate. When the carrier investigates a false claim, it incurs unnecessary expenses and is therefore damaged so that the justifiable reliance element is satisfied. Id. at 402-403.

The Agricultural court criticized the court of appeal opinion in Orient Handel v. United States Fid. & Guar. Co. (1987) 192 Cal.App.3d 684, 237 Cal.Rptr. 6671. In Orient Handel, the court of appeal stated essentially that because an insurance carrier has a duty to investigate a claim anyway, the carrier cannot suffer damage by incurring costs in investigating a fraudulent claim. The Agricultural court stated that the reasoning of Orient Handel was ambiguous and of "dubious validity." Id. at 403. This author believes that Agricultural's attack on Orient Handel was appropriate. The reasoning of Orient Handel – that a carrier is obligated to investigate a fraudulent claim anyway – limits an insurance carrier's remedies to denying the claim and does not go far enough to discourage insurance fraud. The Agricultural court allowed the insurance carrier to plead its fraud claim and to seek punitive damages against its insured.

No court has yet had the opportunity to take sides between the Orient Handel decision and the recent Agricultural opinion on the element of detrimental reliance. Thus, as to that issue, there is a split of authority. Commentators have agreed with Agricultural that Orient Handel is of "dubious validity." Croskey, Kaufman, et al., Cal. Prac. Guide: Insurance Litigation (The Rutter Group 1999). Because Agricultural is the better reasoned and more recent view, courts are more likely to follow it.

Based on Agricultural, an insurance company that incurs expenses on a fraudulent claim can sue its own insureds for fraud and can seek punitive damages.


The Racketeer Influenced and Corrupt Organizations Act (RICO), a series of federal statutes, is an effective tool in the fight against insurance fraud. RICO's attraction is that a prevailing plaintiff gets attorneys' fees and tripled damages.

RICO was originally designed to prevent organized crime from infiltrating legitimate business through racketeering. However, courts have expanded RICO to include insurance fraud. Aetna Casualty Surety Co. v. P&B Autobody, et al., 43 F.3d 1546 (1st Cir. 1994). RICO outlaws four categories of activities. 18 U.S.C. §1962. The most common is sub-division (c), which prohibits a person or entity from conducting an interstate enterprise through a pattern of racketeering activity.

As applied to insurance fraud, the primary wrong under RICO is "mail fraud." 18 U.S.C. §1961. The term "mail fraud" is misleading, because it requires only a "scheme to defraud" and the use of the mail to execute or further the scheme. Aetna v. P&B Autobody, supra, at 1560. The intentional filing of false insurance claims constitutes a "scheme to defraud." A plaintiff does not need to prove that each defendant personally used the mail but only that the defendant acted under circumstances where the defendant could reasonably foresee that use of the mail would follow in the ordinary course of the activity. Id. at 1560.

In P&B Autobody, the leading RICO insurance fraud case, Aetna sued its insureds, claimants, and auto repair shops over a widespread fraudulent scheme. The court stated that, for a defendant to be liable under §1962(c), Aetna had to show that: (1) Aetna was an enterprise affecting interstate commerce; (2) the defendant was associated with Aetna; (3) the defendant participated in the conduct of Aetna's affairs; and (4) the defendant's participation was through a pattern of racketeering activity. Id. at 1558. As used in the statute, "enterprise" includes legitimate businesses such as Aetna. Id. at 1558.

The "interstate commerce" requirement of the first element is satisfied where an insurance carrier does business in many states. It is not necessary that the transactions forming the basis for the RICO claim be conducted across state lines. Id. at 1558.

The second element, association, includes not just an insured or an employee of the plaintiff enterprise, but anyone connected with the plaintiff enterprise. The Aetna insureds, claimants, and body shop operators all were "associated with" Aetna. Id. at 1558-1559.

The third element, participating in the conduct of Aetna's affairs, was satisfied where the defendants acted intentionally to cause Aetna to make payments on false claims. Id. at 1559-1560. Finally, the fourth element, a "pattern," is satisfied where each defendant committed two acts of racketeering activity – such as mail fraud – in a ten-year period. Id. at 1560.

A benefit of RICO is that, unlike fraud, justifiable reliance is not an element. Also, unlike punitive damages, which requires that a plaintiff prove malice, fraud, or oppression as well as the defendant's wealth, an insurer can obtain triple damages under RICO without such proof. On the other hand, unlike fraud, RICO requires proof of a "pattern," which requires more than one act of racketeering activity.


In view of the differing elements of proof and recovery, an insurance carrier bringing an action based on insurance fraud should consider suing for both fraud and for RICO. Regardless of the claim pleaded, an insurance carrier that has been defrauded should consider suing, both to obtain a recovery and to deter insurance fraud.

End Notes

1 The author of this article was one of the trial attorneys for the insurer in Orient Handel.

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