United States: For A Surprised Reinsurer, That First Step Can Be A Big One

When a reinsurer discovers facts contrary to those it contemplated when making its reinsurance contract, the first step it makes to address the problem can be critical.

Suppose a ceding insurer has specifically represented that the policyholder would comply with recommendations made in an engineering survey. Also suppose the reinsurer later discovers that the policyholder had rejected most of these recommendations when the insurer made this representation and that the insurer knew it. This could be a good case for rescission of the reinsurance contract.¹ But suppose the reinsurer then cancels the contract. This action could kill any chance for rescission.²

How does a surprised reinsurer avoid a misstep that forfeits a chance to rescind an reinsurance contract?

To avoid a misstep, a reinsurer must be aware that the circumstances may justify rescission. The law governing rescission of a reinsurance contract is not simple (for example, the doctrine of uberrimae fidei imposes an obligation of utmost good faith that is specific to reinsurance), and the outcome of disputes over rescission are heavily fact dependent. Nevertheless, a short checklist of questions may be useful to identify situations where rescission may be appropriate. First, are the newly discovered facts contrary to an explicit understanding with the ceding insurer?³ Second, even if they are not contrary to an explicit understanding, are the newly discovered facts contrary to an implicit understanding, i.e., would a prudent underwriter have considered them important to the risk and relied upon them in accepting or pricing the business?⁴ And third, do the newly discovered facts substantially change the risks assumed by the reinsurer?⁵

If answers to these questions are positive, a reinsurer would be well advised to proceed cautiously. Seemingly appropriate actions may diminish the reinsurer's rights irretrievably.

Rights to rescind have been lost, for example, where the reinsurer, shortly after learning of the facts, cancelled or terminated the contract rather than declaring the contract rescinded.

In Wise, Ltd. v. Grupo National Provincial SA⁶, the court rejected a reinsurer's claim of rescission because the reinsurer had issued a notice of cancellation after a large loss. The reinsurer accepted coverage for a shipment of cargo that was described, because of a mistranslation, as "clocks," when the cargo in fact was Rolex watches. Because the reinsurer issued a notice of cancellation after learning of the loss, the court held that the reinsurer affirmed the contract, instead of rescinding it, and accordingly denied the reinsurer's rescission claim.

Similarly, in Iron Trades Mutual Insurance Co. Ltd. v. Companhia De Seguro Imperio,⁷ a retrocessionaire (Imperio) terminated its contract with a reinsurer (Iron Trades) after discovering that some of the business retroceded had originated with reinsurers other than Iron Trades and that changes in the business and parties involved had occurred over several renewal periods without any notice to Imperio. Because Imperio, after its investigation, terminated its contract with Iron Trades, the court concluded that Imperio had affirmed the contract and therefore denied Imperio's rescission claim.

Needless to say, issuing a certificate that confirms an earlier agreement to provide reinsurance may be an impediment to a subsequent rescission claim. In Sumitomo Marine & Fire Ins. Co. v. Cologne Reinsurance Co. of America,⁸ defendant reinsurers sought to void their reinsurance on the ground that they had not been informed of an unusual risk that the ceding insurer had agreed to cover, a business interruption loss caused by incidental radioactive contamination of metal at a steel mill. After agreeing to provide reinsurance, the reinsurers learned of the full extent of the underlying coverage and of the loss itself. Nevertheless, they issued a formal reinsurance certificate without asserting any right to rescind. Because the reinsurers had not immediately asserted their rights, the court held that they had waived any rescission claim.

These fact patterns highlight the importance for a reinsurer to consult with experienced counsel promptly after discovering facts on which a rescission claim may be based, to ensure that the reinsurer's conduct thereafter is consistent with any right of rescission that it may have. When a potentially material misrepresentation or omission is discovered, careful attention must be paid as to the appropriate reaction and communication with the reinsured. The value of a reinsurer's possible right to rescind may be substantially reduced if the reinsurer's actions after discovery are inconsistent with that claimed right.

1. See Allendale Mut. Ins. Co. v. Excess Ins. Co., 992 F. Supp. 278, 282-85 (S.D.N.Y. 1998).

8. 75 N.Y. 2d 295, 552 N.E.2d 139 (1990).

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