UK: Sword Or Shield: A Comparative Study Of The Follow The Fortunes Doctrine As Applied In The USA And The UK

London Market reinsurers of US property and casualty business would be forgiven for wishing that they didn’t have to follow the fortunes of their colleagues across the pond, as over the last few decades mass tort claims from asbestos, environmental liabilities and more recently losses from the events of September 11^th have inevitably percolated back to the London and European Markets. For the purpose of this article, the phrases "follow the fortunes" and "follow the settlements" are synonymous.

Lord Mustil drove to the heart of the "follow the fortunes doctrine" in Hill v. M&G Re Company [1996] when he described the tension between on the one hand preventing reinsurers from investigating the same issues twice and on the other insuring the integrity of a reinsurer’s bargain is not eroded by a settlement agreement over which he has no control. He concluded that in essence there were only two rules both of them obvious:

• A reinsurer is not liable unless the loss falls within the original cover and the reinsurance; and
• The parties can agree on how to prove that these requirements are satisfied.

The position in the USA is somewhat different:

Most reinsurance contracts contain some provision defining the extent of the obligation of the reinsurer to pay losses which the reinsured has been held legally liable to pay and loss settlements. Three questions arise when the cedent asks his reinsurer to pay a loss:-

1. Is there a loss?
2. Is the loss covered under the original insurance contract?
3. Is the loss covered under the reinsurance contract?

The difficulty is that the answers to those above questions are different when they are asked in the UK compared to the USA. It is those differences which are considered in this article.

The basic elements of the follow the fortunes doctrine to claims settlement are:

1. The doctrine does not alter the terms or override the language of the reinsurance policy – Bellefonte Reinsurance Co. v. Aetna Casualty & Surety Co. (1990);
2. The claim is arguably within the terms of the original policy and a fresh review, by the reinsurer, of the cedent’s determination to make payment is not permitted – Mentor Insurance Co. (UK) Ltd v. Noreges Brannkasse (1993) and International Surplus Lines Insurance Co v. Lloyd’s (1994);
3. The reinsurer cannot second guess the good faith liability determination made by the cedent – Christiania (1992); and
4. The reinsurer cannot second guess the cedent’s good faith decision to waive defences of which it may be entitled - Christiania (1992) .

However, the cedent may not when settling a claim act unreasonably or in bad faith, for example, by making ex gratia payments – American Insurance Co. v. North American Co. for Property & Casualty Insurance (1982). The test for bad faith in the USA is that there should be "deliberate deception, gross negligence or recklessness" – Reliastar Life Insurance Co. v. OAI Re Inc. (2002). In addition, the claim must fall within the terms of the reinsurance policy – Bellefonte (1990).

The starting point is the decision in ICA v. SCOR (1985) The reinsurer agrees to indemnify the cedent in the event they settle their claim by the assured if:

1. the original claim falls within the risks covered by the reinsurance contract as a matter of law; and
2. the reinsured acted honestly and took all proper and business like steps in making the settlement (even if

So the reinsurer can’t go behind settlement of the original claim unless there is express evidence of fraud or collusion. But the reinsurer is always free to argue that the reinsurance contract does not cover the underlying loss. The same applies to treaty reinsurance Hiscox v Outhwaite (N0 3) (1991).

What is the effect of a judgement of a foreign court? This was considered in Commercial Union v. NRG Victory Reinsurance [1998].

English courts held they would not interfere with a decision of a foreign court if :-

1. The foreign court was a court of competent jurisdiction in the eyes of the English cout.
2. The judgment in the foreign court wasn't obtained in breach of an exclusive jurisdiction clause which prevented the original insured from proceeding in the foreign court.
3. The cedent took all proper defences; and
4. Judgment was not "manifestly perverse".

If the question of recovery by the cedent against the reinsurer was going to be subject to US law, then it was considered that an American arbitration award would be sufficient evidence to support such recovery.

Most reinsurance contracts contain some form of follow the fortunes provision. However, what is the position if a contract does not? In the UK, generally such a provision will not be implied. However, in the US, the contrary is the position and most courts and arbitration panels, will imply such a term because of the custom and practice in the reinsurance market – Mentor Insurance Co. (1993), ISLIC (1994) and Aetna Casualty & Surety Co v. Home Insurance Co. (1995).

What issues can be raised by a reinsurer, assuming the doctrine applies, in connection with a claims settlement?

The main ones are the terms of the settlement between the cedent and policyholder and the allocation of the payments made pursuant to that settlement by the cedent to the policyholder through the policies issued by the cedent which drives the billing to the cedent’s reinsurers.

The settlement between the cedent and policyholder is usually memorialised in a written document. The provisions to be considered are:

1. what period of coverage was settled
2. what policies were included

3. what types of coverage were released as a result of the settlement

4. parties

There have been few cases in English law on the question of allocation. The leading one is Municipal Mutual Insurance Ltd v. Sea Insurance Co Ltd (1996).

Reinsurers issued excess of loss reinsurances for three consecutive years of account.

As there was no binding apportionment the court had to look at which of the three reinsurance policies responded to the loss which occurred over an 18 month period and straddled three policy years. The Court came to the pragmatic conclusion that all loss fell into one policy year because this was the year in which the bulk of the vandalism had occurred.

The position, however, is different in the US where there have been a number of cases dealing with the follow the fortunes doctrines which also looked at allocation. Generally the position is and has been that the settlement itself does not include the subsequent allocation by the cedent to its policies. Accordingly, reinsurers are able to question the allocation without falling foul of the follow the fortunes doctrine. That was the position until recently. Commercial Union v. Seven Provinces Insurance (2000) held that an allocation formed part of the settlement. If there was more than one method of allocation available to the cedent the reinsurer could not question the cedent’s selection because it was not as beneficial to the reinsurer as other methods of allocation. That case had not been followed see Travelers v. Lloyds (2001), until earlier this year in the case of North River Insurance Co v. ACE American Reinsurance Co (2002). Certainly, cedents have relied heavily on the Seven Provinces’ decision to support their views of allocation, nevertheless, where the allocation does not take into account some of the factors described above, then the US courts will allow the review of the cedent’s allocation.

In any contractual dispute, the starting point is to review the terms of the contract. If there is a claims co-operation clause in the reinsurance contract, the reinsurer should avail itself of its terms.

Assuming that there is no claims co-operation clause, are there any other avenues open to the reinsurers? These arise from reinsurers’ right of inspection. The reinsurer should consider undertaking an inspection of the cedent’s books and records.

What should the reinsurer be looking for? Documents in electronic or hard copy form that relate to the settlement negotiations to see what, if any, discussions were undertaken with regard to exposure, exclusion provisions and allocation. Drafts of the settlement agreement to ascertain if any of those key issues were discussed at any stage during the preparation of the final agreement.

At some stage the cedent would have had to consider the allocation. Allocation would usually be based on formulae worked out by either its assumed (inwards) or ceded (outwards) department as well input from its own employees and/or external counsel. All of this material should be reviewed. Finally, any documentation, where there is any reference to reinsurance and recoveries from reinsurers.

It is evident that the follow the fortune doctrines whether in this country or in the USA, is a very strong weapon in the cedent’s armory to obtain recovery against its reinsurers. If the reinsurer wants to query a settlement or subsequent allocation then the doctrine is a protective shield which the reinsurer must pierce in order to succeed.

Steven Blair is a partner and Amanda Mochrie an associate in the London office of Bryan Cave*, a US law firm, specializing in insurance and reinsurance.*

The views expressed herein are solely those of the authors and not necessarily those of the firm or their clients.