Practical Approaches for Recouping Good Faith Payments

What happens when an insurer makes good faith payments on legitimate elements of an insurance claim but subsequently uncovers fraud in other elements of the claim?

March 21, 2013 Photo

Faced with growing losses, insurance companies are focusing on fraud management and implementing risk mitigation controls, while at the same time remaining cognizant of their duty of good faith to policyholders. So what happens when an insurer makes good faith payments on legitimate elements of an insurance claim but subsequently uncovers fraud in other elements of the claim? Is the insurer entitled to recover all monies paid as part of the claim? Or only the amount paid in reliance on the insured’s misrepresentations?

Previously, there was no clear answer. It was safe to assume that an insurer could recover monies paid on a claim under the right circumstances—the difficulty occurred when trying to recover payments made prior to the established fraud date. For example, in California, the insurance code states, “If a representation is false in a material point, whether affirmative or promissory, the injured party is entitled to rescind the contract from the time the representation becomes false.”

Recent trial court rulings in favor of insurance companies, however, are changing the claims landscape. These rulings will impact the way insurance companies handle genuine claims that are subsequently tainted by fraud, encouraging them to be proactive in recouping good faith payments.

Steps for Recouping

What options do insurance companies have to recoup these payments? There are several avenues available.

Deny the Claim. When the SIU has completed a claims investigation and determined that an insured has breached the policy by materially misrepresenting facts, the claim can be denied—even the legitimate part. Appropriate cases should be referred to law enforcement for prosecution. In addition, the insured has a duty to present and prove the merits of the claim. Failure to cooperate with insurance company representatives can independently result in denial of the claim. This includes an examination under oath (EUO), which plays a key role in obtaining information. Typically, the named insured (or others, as dictated by the policy) is required to submit to an EUO as a precondition for claims settlement. Failure to do so can result in denial of the claim.

Void the Policy. An insurer may void or cancel its policy in the event of material misrepresentation or concealment of facts by the insured. This includes fraudulent claims.

Litigation. If a policy is voided for fraudulent claims, insurers must then decide whether to sue the insured to recoup payments—even legitimate ones. One advantage with litigation is that it allows for a pretrial discovery process, including depositions and the ability to subpoena documents previously unavailable during the claims process.

A Case in Point

A recent case illustrates that insurance companies are entitled to recoup good faith payments when fraud is uncovered. Here is some background on the case.

An insurer issued a fire insurance policy to the owner of a dry cleaning business located in Southern California. A fire destroyed the business, so the owner submitted claims for replacement equipment, debris removal, damage to customer goods, and loss of business income. Based on these claims, the insurance company paid the owner $527,000.

However, during the insurance company’s investigation of additional claims, a forensic accountant uncovered inconsistencies in a laundry services contract submitted as part of the owner’s claim for loss of business income. As a result, the owner was asked to sit for an EUO. The owner declined and withdrew his pending claim. The insurer then declined the claim, rescinded the policy, and sued the business owner to recoup all loss payments.

At trial, evidence and witness testimony was presented that showed the owner had falsified the laundry contract and also inflated amounts paid for replacement equipment, debris removal, and payroll, among other items. Attorneys argued that the insurer was entitled to full recovery (payments made before the fraud occurred) for several novel reasons, including:


    • The outcome in Perovich v. Glen Falls Insurance Co. (9th Cir. 1968), where the court ruled that an insurer “may recover money paid in reasonable reliance on its insured’s fraudulent claim.” The court held that the insurer was entitled to recover the full payment made under the policy.
  • Compelling the insured to return only a portion of the money would circumvent the purpose of the fraud statutes and create bad public policy. The insured’s fear of losing even the legitimate claim payments should deter him from committing fraud. An insured who knew he could recover for “honest” claims would be incentivized to calculate the risk of getting caught into his claims submission, determining that some things are worth lying about.


Though portions of the claim were legitimate, the judge ruled in favor of the insurer and its decision to rescind the fire insurance policy. The insured was ordered to repay $452,064, which represented all payments less monies paid to customers who lost clothing in the fire and the policy premium.

Implications for Insurers

This decision is important as it reinforces the rights of insurance companies not only to decline a claim when fraud is uncovered but also to rescind a policy and sue the insured to collect good faith payments. Previously, the law was not clear about what happens to monies paid as part of a legitimate claim, or the legitimate portion of a claim, when fraud is discovered in a separate area. It is now clear that fraud in part of a claim translates to fraud in the entire claim.

Claims managers should have an open discussion with claims adjusters and SIU team members, with the goal of establishing a claims review protocol that outlines what to look for and what to do if fraud is suspected. This is critical, as claims adjusters are the first line of defense against fraud. Once fraud is uncovered, insurance companies should not hesitate to consult with an attorney and pursue the insured in order to recover monies already paid. In the end, both insurance companies and policyholders will benefit by reducing the high cost of fraud.   


Larry M. Arnold, P.C., is a senior partner at Cummins & White, LLP. He is a speaker at next month’s Litigation Management conference in San Antonio, and has been a CLM Member since 2010. He can be reached at (949) 852-1800,


About The Authors
Larry M. Arnold

Larry M. Arnold, P.C., is a senior partner at Cummins & White LLP. He has been a CLM Member since 2010, and can be reached at (949) 852-1800,

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CLM’s Insurance Fraud Committee identifies, analyzes, and offers education on emerging fraud schemes and tactics; monitors and reports on developments in case law, state fraud statutes and applicable regulations; collaborates with other anti-fraud industry organizations and associations; and seeks to provide amicus support in matters of importance in the fight against insurance fraud.

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