This excellent blog at Taunter Media, titled 'Unconscionable Truth', examines the Insurance executives claims before the House committee that the practice of 'Rescission', or canceling policyholders policies due to inaccuracies on applications, is rare.  Don Hamm, (CEO of Assurant), stated in prepared testimony that:

Rescission is rare. It affects less than one-half of one percent of people we cover. Yet, it is one of many protections supporting the affordability and viability of individual health insurance in the United States under our current system.

Taunter makes a cogent case that in fact the practice is "amazingly common".  In order to understand why, you need to understand a little mathematics, in particular some basics of conditional probability.  I will not go into the depth that Taunter does in his blog, which I highly recommend you read, but will try to summarize his conclusions.

1.  Insurance companies don't examine all their policy holders applications for errors looking for ways to exclude them from coverage.

2.  They do examine the most expensive policyholders once they have been diagnosed with a critical/expensive condition.

3.  It is when you examine the 99th percentile of Americans with regard to health expenditures that you see the truly sick and consequently expensive Americans for an insurance company to underwrite a healthcare policy.  This group accounts for individual costs of over $35k/year and collectively account for 22% of all of our healthcare costs in the country. 

4.  This top 1% of the population is the group that is targeted by the insurance companies for errors on applications and other forms as a means to exclude the policyholder from coverage, and the company from financial liability.

5.  In Taunter's own words:  "If the top 5% is the absolute largest population for whom rescission would make sense, the probability of having your policy cancelled given that you have filed a claim is fully 10% (0.5% rescission/5.0% of the population).  If you take the LA Times estimate that $300mm was saved by abrogating 20,000 policies in California ($15,000/policy), you are somewhere in the 15% zone, depending on the convexity of the top section of population.  If, as I suspect, rescission is targeted toward the truly bankrupting cases - the top 1%, the folks with over $35,000 of annual claims who could never be profitable for the carrier - then the probability of having your policy torn up given a massively expensive condition is pushing 50%. One in two.  You have three times better odds playing Russian Roulette."

6.  Got that?  If you get really, really sick, the probability of having your policy rescinded due to errors on your application could be 50%.  All this from the misleading testimony of health insurance executives.

Conditional probability is tough for the human brain.  We tend to think of things as either completely correlated (once the market tanked, McCain had to lose) or completely uncorrelated (coin tosses).  To a certain extent, we make the calculations in everyday speech: when someone says that pancreatic cancer is exceptionally lethal, he doesn't mean that it is likely to kill an enormous number of people; he means it will kill an enormous percentage of the people who contract pancreatic cancer. 

So working that in reverse, when Don Hamm of Assurant says recission only affects 0.5% of insurance policy holders, what he's not telling you is that if you get really sick, and really need that great insurance coverage you're so pleased with now, your chances of losing your coverage could be approaching 50%.

The insurance industry has a bit of a historical difference, in that pretty much everything in health insurance is similar to a liar loan.  I tell the company if I have been sick, just like stating an income on a mortgage application.  For a host of administrative and medical privacy reasons, the insurance industry has not historically wanted a comprehensive inventory of medical records before taking a client.  Few people could probably deliver such a record even with the best of intentions.  

It is in the health insurer's interest to have application fraud, not only because it saves time and expense on the front end, but also because it lets them get out of any policy that isn't going well for them. If the health insurer had to verify the information - if, in essence the insurance company had to behave as an accredited investor with adequate expertise to make a decision without reliance - it wouldn't have the opportunity to bail out.  It would catch more genuine liars, but many of these liars would have turned out to be healthy, profitable customers, and what the carrier really wants is a population devoid of expensive claims, not devoid of liars.

Bernie Madoff made people promises, and people believed them, because was it really possible that the former chairman of the NASD was running a scam?  Come on.  But he was, and his reputation was no more a shield to the defrauded than the huge balance sheets of the health insurance companies mean an individual claimant is going to get covered.  The minute he began transferring money from one account to another and then raising external capital to try to square the numbers, he knew exactly where this was going.  The insurance companies know too; they just know well enough to avoid outrunning the law.

Update:  My apologies for basically covering Obey's first point in his excellent blog the other day.  I'm going to leave this up as I think it adds some more to the case in point.