Viewpoint: Non-renewal, Cancellation, Reformation and Rescission of Insurance Policies in Texas

The Texas Legislature this year adopted House Bill 1900, which amends the notice requirements for non-renewal and policy changes in Texas Insurance Code Section 551.105. The statutory changes, effective Sept. 1, increase the notice period from 30 days to 60 days and generally only impact non-renewal of residential and auto policies and policies issued to governmental agencies.

While the newly adopted deadlines are noteworthy, non-renewal is only one of several mechanisms available to insurance carriers that wish to cease insuring a particular risk on the terms initially agreed. It is important that insurers understand the distinctions between non-renewal, cancellation, reformation, and rescission of insurance policies, as well as the standards and deadlines applicable to residential versus commercial properties in the context of each of these mechanisms. This is particularly true where there is an open claim, or where there is good cause to non-renew, cancel, reform, or rescind a policy due to misrepresentations by an insured or a material change to an insured risk during the course of a policy term. The Texas Legislature’s recent change of the rules relating to non-renewal should serve as a reminder to insurance practitioners that a general familiarity with all of the available tools for ending or modifying a contractual relationship with an insured is key. Knowing when and how to properly employ these tools can aid in avoiding the proverbial “bad breakup” when the time comes to part ways with an insured.

Non-renewal is the most common method for insurance carriers to end a contractual relationship when they no longer wish to insure a risk. As the end of the policy term policy draws near, there may be many reasons to no longer insure a certain property or risk, including economic reasons, a change in underwriting approach or risk portfolio, a change in the condition of the insured property, or a history of difficulty in collecting insurance premiums.

While no showing of good cause is required, an insurance carrier canceling or refusing to renew a Texas commercial property or liability policy must state the reason, in a notice letter to the policyholder. Under Texas law, the reason for non-renewal can be “any reason at all.” This makes sense from a contract perspective. The parties agreed to terms for a set period of time and that time limit is expiring. Because many policies renew automatically, Texas law merely requires that an insurer notify the policyholder to find coverage elsewhere.

However, insurers should review and be familiar with their policies when considering non-renewal, as Texas courts will enforce policy language modifying the general notice rule. For example, the Supreme Court of Texas in Farmers Group., Inc. v. Geter analyzed whether the policy, which stated, “we may not refuse to renew this policy because of claims for losses resulting from natural causes,” precluded the carrier from non-renewing the policy at issue due to the nature of the claims at issue. While the court ultimately upheld the non-renewal, the issue turned on interpretation of the relevant non-renewal policy wording.

As for the timing of the non-renewal notices in Texas, the deadlines for commercial, liability, and residential policies are now the same. For commercial property and liability policies, an insurance carrier must mail or deliver the notice no later than the sixtieth day before the policy expires. If the carrier misses the deadline, the policy remains in effect until the sixty-first day after the notice is delivered or mailed. Prior to the Texas Legislature’s recent adoption of HB 1900 and the amendment to Texas Insurance Code Section 551.105, the deadline to provide notice of non-renewal for residential, auto, and certain governmental policies was only 30 days. An important distinction, however, is that if an insurance carrier misses the new 60-day notice of non-renewal requirement for residential and auto policies, the carrier must renew the policy at the request of the insured. The policy will, however, terminate once the insured has found a replacement policy. Accordingly, if an insurer desires to non-renew a residential or auto policy for “any reason at all,” timing is of the essence.

In concept, cancellation is the same as non-renewal, it just occurs during the policy term. Because one party is terminating the prior agreement before the term is completed, the notice deadlines are different, and an insurance carrier must have a good reason.

Texas Insurance Code Section 551.052 generally does not allow insurance carriers to cancel liability or commercial property insurance policies that are renewal or continuation policies. And a carrier generally cannot cancel a policy during the initial policy term within 60 days of when the policy was issued. But what if the insured is not paying the premiums, the risk has changed, or the insurer suspects the insured of fraud?

Section 551.052 provides exceptions to the no cancellation rule, allowing a carrier to cancel a policy at any time during the policy period for fraud in obtaining coverage, failure to timely pay premiums, an increase in hazard within the control of the insured that would produce a rate increase, or loss of the insurer’s reinsurance covering all or part of the risk covered by the policy. An insurer may also cancel a policy at any time if the insurer is placed in supervision, conservatorship, or receivership, and the cancellation or non-renewal is approved or directed.

Under Section 551.104, an insurer may cancel a residential policy if the insured does not timely pay the premium, the insured submits a fraudulent claim, or if there is an increase in the hazard covered by the policy that is within the control of the insured and that would produce an increase in the premium rate of the policy. An insurer may cancel a homeowners insurance policy if the policy has been in effect less than sixty days and 1) the insurer identifies a condition that creates an increased risk of hazard that was not disclosed in the insurance application and is not the subject of a prior claim, or 2) before the effective date of the policy, the insurer does not accept a copy of a required inspection report completed by a qualified inspector that is dated not earlier than the ninetieth day before the effective date of the policy.

For both commercial and residential policies, the insurer must provide the insured with written notice of cancellation not later than the tenth day before the date of cancellation. Tex. Ins. Code §§ 551.053, 551.104. The cancellation should be accompanied by any unearned premiums paid.

A key aspect of non-renewal and cancellation is that they are both prospective or forward looking, meaning if non-renewal or cancellation is appropriate, there will be no coverage for future claims under the policy. They are not retrospective or backward looking. Accordingly, neither non-renewal or cancellation will permit an insurance carrier to avoid liability on a claim for loss or damage sustained before the policy is canceled. This differs from rescission, which is discussed below.

Reformation is a remedy available to modify the terms of an insurance policy when there is a mutual mistake of the parties reflected in the terms of their written contract. Specifically, reformation may be appropriate where the parties reasonably thought they were agreeing to one set of terms, but the final version of the policy reflects something different. This usually involves some type of clerical or scrivener’s error.

Disputes involving reformation and mutual mistake primarily arise from questions about what property is insured by the policy and the identity of named insureds or additional insureds. But these disputes sometimes also involve which perils are covered or excluded. Whatever the circumstance, in order to reform the policy, the parties must have had a meeting of the minds, and the mistake must have been common to both of the parties. The party seeking reformation must prove that there was an agreement which is conflicting with the writing. “The underlying objective of reformation is to correct a mutual mistake made in preparing a written instrument, so that the instrument truly reflects the original agreement of the parties.” Inherent in an argument for reformation based on mutual mistake is the necessity to introduce evidence outside of the insurance policy. Accordingly, courts applying Texas law allow extrinsic evidence to show what the parties’ real agreement was.

Reformation is also available when there is a mistake by one party accompanied by fraud of the other party. In this instance, the mistake is not mutual but was enticed by misrepresentations and an intent to deceive by one of the parties.

To the extent a policy is reformed, the policy remains in effect, unlike in the context of non-renewal or cancellation, but with differing terms than what was reflected in the original policy. Reformation is both forward looking and backward looking in that the reformed policy is considered as having always existed in its reformed state and treated as such.

Where cancellation and non-renewal are forward looking and reformation is both forward and backward looking, rescission effectively results in a policy being treated as null and void from its inception – as if it never existed at all.

Texas Insurance Code Section 705.004 nullifies any policy provision that purports to void a policy on the basis of false statements made in the policy application or in the policy itself. However, Section 705.004 also carves out an exception to this general rule if the misrepresentation at issue was material to the risk or contributed to the contingency or event on which the policy became due and payable. Thus, rescission is available to insurers who find themselves in this circumstance, if certain elements of proof are met and the rescission is sought in a timely fashion after learning of the misrepresentation.

The Texas Supreme Court has outlined five elements an insurance carrier must establish in order to rescind an insurance policy based on a material misrepresentation: 1) the making of the misrepresentation; 2) the falsity of the misrepresentation; 3) the reliance thereon by the insurer; 4) the intent to deceive on the part of the insured making the misrepresentation; and 5) the materiality of the representation.

While Texas Insurance Code Section 705.004 does not explicitly require an intent to deceive, which is often the most arduous element to substantiate, the Texas Supreme Court has required it nonetheless. Moreover, under Texas Insurance Code Section 705.005, an insurer must provide notice to an insured of the material misrepresentation and its refusal to be bound by the policy within 90 days after the date the insurer discovers the falsity of the representation. Otherwise, the insurer loses the right to rely on the material misrepresentation.

In the context of a property insurance policy, the following example of rescission in action is instructive:

A policy application submitted by a prospective insured states that the property sought to be covered was constructed in 1990 and the roof was replaced in 2019. Contrary to the insured’s statement and unknown to the carrier, the roof is actually original to the property and only minor maintenance has been completed since the original construction in 1980. The insurance carrier’s company policy is to only underwrite roofs aged twenty-five years or less. In reliance on the insured’s representation, the insurance carrier nevertheless accepts the application and issues an all-risk policy covering the property in full.

On a perfectly clear day in March of the first policy year, the roof collapses. Setting aside any potential exclusions for wear and tear, deterioration, rot, etc., collapse is a covered peril under the policy and there are no exclusions that apply to preclude coverage. At the first inspection of the property following the collapse, the insurer discovers the roof was very old and deteriorated.

The insurer issues a reservation of rights letter with requests for information regarding age of the roof and its purported replacement in 2019. The insured responds to the requests acknowledging that the roof has never been replaced. The insurer promptly sends notice that the condition of the roof is different from that represented in the application and that the insurer is rescinding the policy and returning all premiums paid.

Is rescission a viable option for the insurer in this context under Texas law?

Under this scenario, it is clear that the misrepresentation was made and that it was false. It is also clear that the age of the roof was material to risk and the premium charged, and that the insurer relied on the representation by issuing the policy, which it would not have done had it known the true age of the roof. What is unclear is whether the insured intended to deceive the insurer by making the misrepresentation, or whether the representation was simply a mistake. What if the insured’s agent filled out the application and provided the wrong information? What if the insured recently purchased the property and was told at the time of the sale that the roof was replaced in 2019? Under those or similar factual scenarios, an insurer’s effort to establish an intent to deceive and rescind the policy may end like a bad romance – time consuming, expensive and ultimately disappointing.

Rescission is the most drastic mechanism available to insurers as it annuls the insurance relationship entirely. Because of that, the burden is heavy for an insurance carrier seeking to rescind a policy, although it is justified in the right circumstances. The savvy insurance practitioner should be familiar with the concept of rescission so that it can be timely asserted when the facts support it.

In closing, insurers writing policies in Texas have several mechanisms at their disposal to remove themselves from insuring a particular risk. Some are very common that require no reason or justification at all, others are more drastic that require careful analysis and the right factual support. A general familiarity with these concepts and the rules and deadlines that apply to each will make parting ways with an insured more like a “conscious uncoupling” and less like a nasty divorce.