If a softening market heralds more reinsurance disputes, it is a fair bet that "follow the settlements" clauses will feature heavily.
In Aegis, the underlying cover was against all risks of physical loss to an oil refinery. The insurer was reinsured under a policy which was stated "To follow the terms, clauses, conditions, exceptions and settlements of the original policy wording as far as applicable hereto". The reinsurance incorporated Additional Conditions which excluded loss caused by "explosion". The reinsured presented a claim to its reinsurers in respect of two settled claims relating to incidents at the oil refinery.
Reinsurers sought to deny cover for one of the losses on the basis of an explosions exclusion in the Additional Conditions. The reinsured argued that the claim had been settled on the basis that the proximate cause of the loss was not explosion and the follow provision precluded the reinsurer from disputing the factual basis on which the claim had been settled.
In the absence of an effective follow provision, a reinsurer is only obliged to indemnify the reinsured for losses that fall within the scope of both the insurance contract and the reinsurance. A reinsurer can take all defences which would have been open to the reassured against the original assured.
An effective follow provision changes this: reinsurers agree to indemnify the reinsured provided the claim falls within the risks covered by the policy of reinsurance as a matter of law, and provided that in settling the claim the insurer acts in an honest and businesslike manner.
In addition, if the insurance and reinsurance are fully back-to-back, the inclusion of a full follow clause means that the reinsurer can only raise legal issues relating to the terms and conditions of the reinsurance. The reinsurer cannot question whether the loss is within the terms of the reinsurance as a matter of fact in these circumstances, since to do so would be, indirectly, to challenge the underlying settlement: the very thing the follow clause is intended to avoid.
In the Aegis case, however, the court found that the insurance and reinsurance were not fully back-to-back not least because of the incorporation into the reinsurance of the "Additional Conditions". In the circumstances, the Court held that the reinsurer was entitled to question the factual basis of the loss and rejected the argument that the follow clause prevented the reinsurers contending that the proximate cause of the loss was in fact an explosion. Since the insurance and reinsurance were not fully back-to-back, it could not be assumed that because the loss fell within the direct insurance, it automatically fell within the terms of the reinsurance. The terms of the direct policy could not override those of the reinsurance.
The Aegis case illustrates how relatively easily a reinsured can become exposed to claims and deprived of reinsurance protection, even where there is an effective follow clause. In the absence of back-to-back coverage, a reinsurer will be entitled to re-examine the facts of the original loss in order to ensure that the claim falls within the terms of the reinsurance. A follow clause is not a guarantee that reinsurance coverage is in place.
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