OGC Opinion No. 09-09-02
The Office of General Counsel issued the following opinion on September 10, 2009, representing the position of the New York State Insurance Department.
RE: Commercial Insurance Policy Cancellation
Question Presented:
Is an insured’s failure to comply with an insurer’s recommendations, in of itself, a valid basis for canceling a new or renewed commercial lines insurance policy under N.Y. Ins. Law § 3426(c)(1)(D) (McKinney 2007)?
Conclusion:
No. An insured’s failure to comply with an insurer’s recommendations, in of itself, is not a valid basis for canceling a new or renewed commercial lines insurance policy under Insurance Law § 3426(c)(1)(D).
Facts:
An inquirer reported that several insurers have canceled their insureds’ commercial lines insurance policies due to non-compliance with recommendations, which they claim is a proper basis for cancellation under Insurance Law § 3426(c)(1)(D). The inquirer disagrees with these assertions, contending that a renewed commercial lines insurance policy may not be canceled on such basis, because “[f]rom a practical standpoint, loss control visit[s] must be secured before [the] renewal date and if recommendations are not properly addressed, appropriate non-renewal notice must be tendered.” The inquirer also questioned whether a new commercial lines insurance policy may be canceled based on non-compliance with an insurer’s recommendations under Insurance Law § 3426(c)(1)(D).
Analysis:
Insurance Law § 3426, which applies to most property/casualty commercial lines insurance, is relevant to the inquiry. That statute sets forth, among other things, the minimum cancellation provisions applicable to such policies.
Pursuant to Insurance Law § 3426(b), an insurer may cancel a new commercial lines insurance policy during the first sixty days the policy is in effect for any reason not prohibited by law. Insurance Law § 3426(b) reads as follows:
(b) During the first sixty days a covered policy is initially in effect, except for the bases for cancellation set forth in paragraph one, two or three of subsection (c) of this section, no cancellation shall become effective until twenty days after written notice is mailed or delivered to the first-named insured at the mailing address shown in the policy and to such insured’s authorized agent or broker.
Insurance Law § 3426(b) provides a “free look” period of sixty days, during which time an insurer may complete its review of the risk, and determine whether the risk meets its underwriting standards. The Insurance Department explained the rationale behind this “free look” period in its November, 1989 issue of “The Bulletin,” as follows:
Regarding mid-term cancellation, while [Insurance Law] § 3426 clearly gives insurers the authority to cancel policies, the circumstances under which they may do so are limited. And, in order to provide for the legitimate underwriting needs of the insurers, the statute introduced to commercial lines insurance cancellation rules a concept that had been used in personal lines cancellation for many years – the sixty-day “free look.”
Property/casualty insurance is not purchased with the same time and deliberation that might be attendant to the obtaining of, say, a mortgage. Whereas a bank might have weeks or months to thoroughly investigate the mortgage applicant, inspect the property, verify assets, etc., an insurance policy might need to be procured in days or hours. Accordingly, insurers usually have to base their underwriting decisions upon whatever information is available at the time of application, no matter how incomplete or unverified.
The so called sixty-day free look permits an insurer to cancel any newly issued commercial lines policy, upon twenty days written notice, for virtually any reason, during the first days such policy is in effect. This is intended to give the insurer the opportunity to conduct such inspections, verify such information, obtain such experience, etc., as it may deem necessary to properly underwrite the risk. It also gives company officials the opportunity to review the underwriting decisions which may have been made by general agents, lower echelon underwriters, or others who have been given the “power of the pen.” Where deemed appropriate, rating adjustments may be made during the sixty-day period.
The absence of the opportunity to conduct such a review would have serious repercussions regarding the ready availability of commercial property/casualty insurance products. Without the knowledge that they have an appropriate time period to reflect on their underwriting decisions, and correct any major errors which may have been made, insurers would be much less willing to quickly offer coverage unless complete and verified information was in their possession before coverage took effect.
Accordingly, an insurer initially has sixty days in which to review a new risk that it has accepted, and to cancel coverage if the risk is incompatible with its underwriting standards. After the sixty-day “free look” period has expired, however, an insurer may not cancel coverage during the policy term or any renewal thereof unless cancellation is based on one of the criteria specified in Insurance Law § 3426(c). The specific criteria that are relevant to this inquiry are set forth in Insurance Law § 3426(c)(1)(D), which reads as follows:
(c) After a covered policy has been in effect for sixty days unless cancelled pursuant to subsection (b) of this section, or on or after the effective date if such policy is a renewal, no notice of cancellation shall become effective until fifteen days after written notice is mailed or delivered to the first-named insured and to such insured's authorized agent or broker, and such cancellation is based on one or more of the following:
(1) With respect to covered policies:
* * *
(D) after issuance of the policy or after the last renewal date, discovery of an act or omission, or a violation of any policy condition, that substantially and materially increases the hazard insured against, and which occurred subsequent to inception of the current policy period[.]
The Department addressed the purpose of Insurance Law § 3426(c)(1)(D) in its Office of General Counsel opinion, dated August 14, 1990. The Department stated therein:
By enacting [Insurance Law] § 3426(c) the Legislature sought to encourage insurers to thoroughly evaluate the risk and underwrite carefully with the understanding that after the first sixty days they would be on the risk for the remainder of the policy period unless one of the statutorily enumerated reasons for cancellation applied. This section is intended to guarantee reasonable protection against unwarranted cancellation while at the same time permitting insurers the flexibility to operate responsibly.
The [Insurance Law] § 3426(c)(1)(D) requirement that the act substantially and materially increase the hazard insured against embodies the legislative purpose that an insurer be permitted to cancel a policy only when there has been a major change in the scale of the risk subsequent to policy issuance. The conjunctive substantially and materially was used to underscore the stringent criteria that must be met before the subparagraph may be invoked.
The inquirer reported that several insurers have canceled their insureds’ commercial lines insurance policies due to non-compliance with recommendations, which the inquirer states they claim is a proper basis for cancellation under Insurance Law § 3426(c)(1)(D).
However, Insurance Law § 3426(c)(1)(D) only applies when there is a substantial and material increase in the risk after the policy has been issued, but that is not the situation when the policy is nonetheless renewed and the insured fails to comply with the insurer’s recommendations. In the latter instance, the insurer has inspected, and knows the condition of, the risk when it makes its recommendations prior to the renewal date; the risk itself has not been altered after policy issuance. Failure to comply with an insurer’s recommendations thus is not a permissible basis for canceling a policy under Insurance Law § 3426(c)(1)(D).
For further information you may contact Associate Attorney Sally Geisel at the New York City Office.