UK: Reinsurers’ Rights To Inspect - A Closed Door?

The purpose of inspections by reinsurers is to "allow the reinsurer, who was exposed to some extent to liability which may be difficult to quantify at any given time, to monitor the manner in which the insurance company was writing business¹ ", per Keane J. Simple, or is it?

Information critical to reinsurers’ management and development of the underlying business is often limited to monthly or quarterly bordereaux of claims and premiums and the business being ceded may provide for a whole range of different terms, conditions and attachment points. If reinsurers are to be certain of what they are protecting, capable of monitoring their own exposure and making their own retrocessional recoveries they must ensure in advance that they are able to carry out the necessary inspection and audit of their cedant’s books and records.

Before embarking on an inspection, there are a number of areas, both legal and non-legal, which must be considered:

• Is there a contractual right to inspect, express or implied?

• Are there any restrictions on the scope of the inspection?

• What steps should be taken to protect reinsurers’ position?

• How should the audit be conducted?

Assuming that no provision is made in the slip or wording, are reinsurers able to invoke inspection rights? In Phoenix v Halvanon² , reinsurers sought to conduct an inspection where no express provision existed. Hobhouse J found that, on the principle of business efficacy, there must be an implied duty on a cedant to "obtain, file or otherwise keep in a proper manner, all accounting, claims and other documents and records and make them reasonably available to the reinsurer". By contrast, in SAIL v Farex³ a full wording had been agreed but without an inspection of records clause. Hoffman LJ’s observations illustrate the court’s position that, if reinsurers feel aggrieved over their entitlement to information, there is only one person to blame:

If certainty is required (and given the plethora of disputes arising from contractual uncertainty it should be a pre-requisite), reinsurers must always ensure that they know what their inspection needs are and ensure that this is reflected in the wording.

As the onus is on the parties to agree the scope of an inspection of records clause, a court or arbitration tribunal is likely to interpret any agreed clause strictly. If the wording contains a clearly restrictive clause, then that will represent the totality of reinsurers’ entitlement. For example, under the standard LMX PA1 wording (admittedly an Excess of Loss example) , the reinsurer is only "entitled to inspect all books, relevant records, correspondence, documents and vouchers in possession of or accessible to the reinsured and in any way connected with the adjustment of a loss applying to this agreement …". Reinsurers would therefore have no difficulty in auditing claims but they would no doubt find any request for a broader audit rebuffed.

Reinsurers should note in passing that, whilst inspection rights do not ordinarily over-ride the application of privilege to documents, they may be able to take advantage of the doctrine of common interest.

It is all well and good to have an inspection of records clause but, as the right is contractual, reinsurers must carefully guard their position before invoking it. In Iron Trades v Imperio⁴ , reinsurers, through their solicitors, invoked their right to inspect the cedant’s books and records. However, such invocation was not made subject to any reservation of rights or non-waiver leading Hobhouse J to comment: "This was the express invocation of a contractual right. No qualification or reservation of rights was introduced and it can only have been a further affirmation of the contract."

Reinsurers are familiar with the dangers of waiver, affirmation, estoppel or election, and inspections are an area where, in the rush to get access to information, such pitfalls can be overlooked.

Therefore, any request to conduct an inspection must be made strictly under a full reservation of rights and a specific non-waiver and reinsurers are well advised to ensure that, prior to taking any steps whatsoever, a boiler plate non-waiver agreement is entered into by all parties so as to encompass all actions taken by the reinsurer and its representatives.

As an aside, it is becoming increasingly popular for cedants to insist that such inspections are subject to confidentiality agreements. Whilst it is arguable that cedants cannot, in the context of an existing contractual relationship, compel reinsurers to enter into a confidentiality agreement, if a reinsurer is asked to do so, then, as with non-waiver agreements, these must be carefully drafted so as to ensure that reinsurers are not restricted against disclosure to other relevant parties. An obvious example would be the difficulties engendered if no provision were made for disclosure by reinsurers to their own retrocessionaires, or indeed to regulators.

Finally, reinsurers should be aware that, unless there is specific contractual

provision to the contrary, a cedant cannot seek to delay an audit subject to payment of outstanding claims. If such a demand is made, it may of course, depending upon the nature of the relationship between the parties, make commercial sense at the very least to pay funds into an escrow account pending the conclusion of the audit.

Having considered whether and how an audit can take place, the key to achieving a successful outcome is undoubtedly in the preparation, with the pre-audit phase being as crucial as the audit itself. In this phase, reinsurers should:

1. Decide in advance what they are concerned with. The emphasis on each audit will vary but the purpose will be, in broad terms, to ensure that the cedant’s book of business is being correctly managed, that claims and premium are being correctly handled and accounted for, with reinsurers only being liable for business which properly attaches under the terms of reinsurance. As a result, the following are all items which should be considered:

• claims reporting: what business is being ceded?

• are all applicable exclusions in the underlying policies being properly applied?

• are there aggregation issues to monitor?

• are original retentions being applied?

• is the ceded business within the relevant year of account?

• are underwriting guidelines being adhered to?

• how are claims handled?

• are claims adequately reserved?

• are premium and relevant adjustments being reported?

• are common account recoveries being applied?

2. Review the information already to hand before attending the audit. Are there specific issues which are apparent and which should be focused upon? How will the information and analysis prepared before the audit contrast with material produced at the audit?

3. Make pre-audit requests for information. Request up to date lists of cessions, premium and claims bordereaux. It is often helpful to pre-select particular risk files in order to have a bench-mark to work against. If material is pre-supplied electronically, database analysis can be readily undertaken on site.

4. Choose the right audit team. The key to a successful audit is to assemble a team capable of addressing the whole range of issues, and it is rarely the case that the reinsurer himself conducts the audit. Even if the wording does not provide for the inspection to be conducted by "the reinsurer or its authorised representative", a tribunal is unlikely to have difficulty, through the operation of the ordinary law of agency, in permitting specialists to conduct the audit. So long as the appointee is not engaged in bad faith, there is no legitimate objection to third parties attending. Similarly, unless the inspection is invoked in bad faith, no objection as to the identity of the party inspecting can be taken.⁵

Lawyers, accountants and specialist reinsurance auditors can all contribute to a successful audit. Having a lawyer on site enables immediate problem solving if issues arise as to the scope or entitlement of the audit and it is often helpful if a lawyer spots issues as the audit progresses, allowing further enquiries to be raised at the time rather than after the event. Similarly, reinsurance auditors who are familiar with the class of business should be chosen as their market experience will assist in spotting anomalies. Accountants in turn are crucial to on-site number processing and can again address issues immediately as they arise.

5. Establish an audit protocol with the cedant - what information will they make available and in what form? Often it will be inappropriate and impractical to undertake a full review and analysis of the information on site. A question which therefore often arises is whether, once the scope of entitlement has been established, copies can be taken? Very few, if any, inspection clauses make explicit provisions for this, be it by photocopying, or increasingly, by electronic transfer of information. However the limited case law on point⁶ does indicate that to exclude such a right is contrary to the purpose of the inspection itself, and it must be a necessary consequence of the parties’ intentions. Reinsurers should therefore clarify in advance what copying arrangements will be provided. If data is being provided in electronic format, consider whether there are key personnel who should be made available to explain systems and facilitate document retrieval.

6. Choose the right time. The timing of the audit can have a significant bearing on the attitude of a tribunal, notwithstanding strict contractual rights. Inspection can be confused with a request for disclosure in litigation, often in the face of an application for summary judgment made by a disgruntled cedant. Reinsurers must not be seen to make strategic use of inspections and, if an inspection of records clause exists, reinsurers should take advantage of it in a timely fashion.

In summary, planning is the key:

1. Define and agree what inspection rights are required before coming on risk.

2. Use inspection as a business tool and not as a weapon to attack when problems emerge.

3. Assemble all relevant information prior to requesting or making the audit.

4. Make sure safeguards are in place prior to requesting an audit.

5. Know what your objectives are.

6. Utilise the most appropriate team for each audit.

If the cedant feels comfortable that the audit is not simply a general fishing expedition, but is a genuine and focused exercise, and that it is being undertaken in a spirit of co-operation, it will generally produce the optimum result and reinsurers will obtain maximum benefit.

The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.