United States: A Brief Review Of Reinsurance Trends In 2005

There was a dearth of reinsurance decisions in 2005 regarding the question of arbitrability under the Federal Arbitration Act, 9 U.S.C. § 1 et seq. (the "FAA"). From the few decisions rendered, it is evident that courts continue to interpret arbitration agreements liberally and favor arbitration.

For instance, in Ace USA v. Travelers Indemnity Co., No. CV030828066S, 2004 Conn. Super. LEXIS 3085 (Conn. Super. Ct. Oct. 15, 2004), a Connecticut state court held that a statute of limitations question was subject to arbitration because the court could not state with "positive assurance" that the parties did not intend the statute of limitations issue to be resolved in arbitration. The cedent had moved to compel arbitration of its dispute with its reinsurer on a facultative reinsurance agreement. The reinsurer made several objections to arbitration, including the cedent’s standing to commence the action, the statute of limitations, and whether the parties’ arbitration clause provided for arbitration of the statute of limitations question. The arbitration clause provided that "any difference of opinion between the Reinsurer and the Company with respect to the interpretation of this Certificate or the performance of the obligations under the Certificate shall be submitted to arbitration." The court, in considering relevant authority, held that if the arbitration agreement is broadly drafted, every issue should be submitted to arbitration unless the court can state with "positive assurance" that the parties did not intend the issue to be arbitrated. The court further observed that any doubts or ambiguities must be resolved in favor of arbitration. In this case, the court could not find with "positive assurance" that the parties intended the statute of limitations to be considered by the court, concluding that the statute of limitations issue "would appear to be one to be resolved in arbitration."

Some courts did not, however, hesitate to parse arbitration clauses carefully. In an insurance case, a New York federal court addressed the scope of a narrow arbitration clause and its effect on fraud in the inducement claims. In Bristol-Myers Squibb Co. v. SR International Business Insurance Co. Ltd., 354 F. Supp. 2d 499 (S.D.N.Y. 2005), the court refused to compel arbitration of fraudulent inducement claims, where the arbitration clause in an insurance policy covered "dispute[s] arising under" the policy with no other inclusive language. The court, while acknowledging the "emphatic federal policy in favor of" arbitration, refused to compel arbitration based on In re Kinoshita & Co., 287 F.2d 951 (2d Cir. 1961). In Kinoshita, the Second Circuit held that an arbitration clause would not apply to fraudulent inducement claims if it covered only claims that "arise under" the contract. While the Second Circuit has repeatedly refrained from overruling Kinoshita, it has limited the case to its precise facts. For instance, in a 1984 case, the Second Circuit held that Kinoshita did not apply to an arbitration clause using the language "arise or occur under." In a 1987 case, the court held that the words "disputes of whatever nature arising under" sufficiently distinguished Kinoshita. Finally, in Louis Dreyfus Negoce S.A. v. Blystad Shipping & Trading, Inc., 252 F.3d 218 (2d Cir. 2001), the Second Circuit distinguished between "arising from" and "arising under," upholding Kinoshita. In the Bristol-Myers Squibb case, the court found that the arbitration clause was indistinguishable from that in Kinoshita.

Last year also produced some key non-reinsurance cases where the courts closely examined arbitration agreements to discern the parties’ intent to submit their disputes to arbitration. In Contec Corp. v. Remote Solutions Co., Ltd., 398 F.3d 205 (2d Cir. 2005), the Second Circuit compelled arbitration of the question of arbitrability, finding that the intent of the parties to have questions of arbitrability decided by an arbitrator was clear. While the court acknowledged that the general presumption is that arbitrability should be resolved by the courts, it held that the issue may be referred to the arbitrator if there is clear and unmistakable evidence from the arbitration agreement that the parties intended for the arbitrator decide the question of arbitrability. The court found that in this case the arbitration provision’s explicit incorporation of the American Arbitration Association (AAA) Commercial Arbitration Rules, which provide that the arbitrator shall have the power to rule on his or her own jurisdiction, including any objections to the existence, scope, or validity of the arbitration agreement, was clear and unmistakable evidence of the parties’ intent to delegate the issue of arbitrability to an arbitrator.

In contrast, the Second Circuit in Sarhank Group v. Oracle Corp., 404 F.3d 657 (2d Cir. 2005), vacated an order confirming an international arbitral award, because, although the district court had jurisdiction to hear the matter under the Convention on the Recognition and Enforcement of Foreign Arbitral Awards, the district court was not bound by the Egyptian arbitrators’ determination of arbitrability under Egyptian law where the intent of the parties to arbitrate was not clear. The court found no evidence that the parties intended to submit their dispute to arbitration. Accordingly, because the arbitrability decision was made by Egyptian arbitrators under Egyptian law, the case was remanded to the district court to determine under federal arbitration law whether the relevant party was bound to arbitrate. See also Masefield AG v. Colonial Oil Industries, Inc., No. 05 Civ. 2231 (PKL), 2005 U.S. Dist. LEXIS 6737 (S.D.N.Y. April 18, 2005) (enjoining arbitration of arbitrability of non-signatories to a contract containing an arbitration clause because the contract did not contain clear and unmistakable evidence that the non-signatories agreed to arbitrate the question of arbitrability, and finding no theory on which to permit the arbitration agreement to be enforced against the non-signatories).

In an interesting decision, the Third Circuit made clear that courts maintain some level of jurisdiction over claims subject to arbitration. In Winward Agency, Inc. v. Cologne Life Reinsurance Co., No. 03-4855, 2005 U.S. App. LEXIS 1797 (3d Cir. Feb. 3, 2005), the Third Circuit affirmed the dismissal of a case for failure to prosecute a court-ordered arbitration where, after more than six years from the issuance of the district court’s order compelling the parties to arbitrate, the arbitration panel had not been selected and the arbitration proceedings had not begun. In affirming the dismissal, the court noted that an agreement to arbitrate does not completely oust a district court of jurisdiction over the claims subject to arbitration. Other circuits, the court stated, have held that a stay of proceedings pending arbitration contemplates continuing supervision by a court to ensure that the arbitration proceedings are conducted within a reasonable amount of time. The court reasoned that where a party fails for many years to abide by a district court order to initiate arbitration proceedings, it is an issue for the district court and not the non-existent arbitration panel.

In a strange case of competing contractual arbitration provisions and arbitrator appointments, Certain Underwriters at Lloyd’s v. Mutual Marine Office, Inc., No. 603452/04 (N.Y. Sup. Ct. Apr. 8, 2005), a New York state motion court declined to make any appointments and left the parties to their original appointments to pursue arbitration. The parties entered into a series of reinsurance treaties, some of which had arbitration clauses that allowed one party to appoint the other party’s arbitrator on default and others which had arbitration clauses that required application to an "appointer" if the other party defaulted in naming its arbitrator. The cedent demanded arbitration. The reinsurer claimed that the cedent did not appoint its arbitrator on time, and sought to have the court appoint an arbitrator for the cedent.

There was confusion about which arbitration clause applied to the cedent’s demand of arbitration because it did not specify which contracts were at issue and which arbitration clause was being invoked. The demand only requested that the reinsurer appoint its arbitrator within the stated period or the cedent would appoint an arbitrator on the reinsurer’s behalf. In sorting out the confusion, the court essentially ruled that neither party complied fully with either arbitration provision, but both had timely appointed their arbitrators. Thus, the court suggested that the party-appointed arbitrators take the opportunity to decide upon an umpire and that the parties continue with their arbitration. The requests for appointments were denied and the court rendered a nullity the attempts by the reinsurer to appoint the cedent’s arbitrator and the umpire. The practical effect of the court’s decision was to let the parties go forward with the arbitrators each had appointed and to allow those arbitrators to appoint an umpire so the arbitration could proceed.

Clearly specifying which contracts were in issue and which arbitration clause was being invoked would have avoided the confusion that was engendered by the ambiguous demand for arbitration.

Courts last year continued the trend, with rare exception, of not second-guessing panel decisions in confirming arbitration awards under the FAA.

In Nationwide Mutual Insurance Co. v. Home Insurance Co., 429 F.3d 640 (6th Cir. 2005), the Sixth Circuit affirmed a district court’s decision denying a cedent’s motion to vacate an arbitration award primarily on the grounds of evident partiality. The cedent alleged that the reinsurer’s party-appointed arbitrator’s non-disclosure of certain business and social relationships with the reinsurer alone mandated vacatur under a "reasonable impression of bias" or "appearance of bias" standard. In affirming, the Sixth Circuit upheld the Apperson standard, Apperson v. Fleet Carrier Corp., 879 F.2d 1344 (6th Cir. 1989), which followed Second Circuit precedent rejecting the standards urged by the cedent. Under Apperson, evident partiality will be found only where a reasonable person would conclude that an arbitrator was partial to one party to the arbitration. The standard requires proof of circumstances "powerfully suggestive of bias."

The Sixth Circuit noted that the circumstances in this case did not warrant deviation from the Apperson standard, particularly because the allegation of evident partiality concerned a party-appointed arbitrator, as opposed to a neutral arbitrator. Moreover, the court noted that because the arbitration clause required that arbitrators be from the insurance industry, some degree of overlapping representation and interest would inevitably result. To disqualify any arbitrator who had professional dealings with one of the parties (to say nothing of a social acquaintanceship) would make it impossible, in some circumstances, to find a qualified arbitrator at all. Thus, "[g]iven the arbitration format voluntarily chosen by the parties in this case, to permit vacatur based upon the mere ‘appearance of bias’ of a party-appointed arbitrator ‘would be to render this efficient means of dispute resolution ineffective in many commercial settings.’" The court also found that the arbitrator made full and timely disclosures regarding his business relationship with the reinsurer. Those disclosures were not deficient and the cedent failed to show with specificity how the substance of the disclosures pertaining to the arbitrator’s continued service in the reinsurance industry, and his prior and ongoing contacts with the reinsurer in numerous unrelated matters, manifested evident partiality under section 10(a)(2) of the FAA and were "powerfully suggestive of bias." Further, the arbitrator’s social engagements with the reinsurer did not involve any communication regarding this arbitration and, therefore, were not improper or prohibited ex parte contacts.

Also, in Industrial Risk Insurers v. Hartford Steam Boiler Inspection & Insurance Co., 273 Conn. 86 (2005), the Connecticut Supreme Court affirmed a judgment denying a reinsurer’s motion to vacate an arbitration award and holding that the award conformed to the parties’ agreement and was "perfectly reasonable." The agreement between the reinsurer and cedent included an "unrestricted" arbitration clause in that the provision did not limit the breadth of the issues, reserve any rights, or provide any conditions upon which the arbitration or any award were to be limited. In confirming the award, the court first noted that judicial review of arbitration awards is narrowly confined. It stated that the extent of judicial review was delineated by the scope of the parties’ agreement and where an arbitration agreement, and thus an arbitration submission, is unrestricted courts will not review the evidence or the legal decisions of the arbitrators. The court concluded that the award in this case conformed to the submission in that the arbitration panel completed the task assigned to it, and only the task assigned to it. Moreover, the court, while again noting that generally courts will not review the evidence where the submission was unrestricted, found that, in fact, the evidence supported the award and that the panel’s decisions regarding the evidence were "perfectly reasonable."

Underscoring the limits of judicial review of an arbitration award, the First Circuit in Puerto Rico Telecommunication Co., Inc. v. U.S. Phone Management Corp., 427 F.3d 21 (1st Cir. 2005), held that the judicial review provision of the FAA can only be displaced by explicit contractual language evincing the parties’ clear intent. The court affirmed a district court judgment denying a motion to vacate and confirming the arbitration award on the ground that the language of the parties’ contract in this case did not intend to displace the standard of review of an arbitration award set forth in the FAA. The court held that the mere inclusion of a choice-of-law clause within the contract, which incorporated Puerto Rican law, is insufficient to indicate the parties’ intent to contract for the application of state law concerning judicial review of an arbitration award. The court reasoned that when the policies of the FAA are implicated, as in this case, the extremely limited judicial review contemplated by the FAA clearly implicates federal policy favoring final resolution of arbitration disputes. To allow searching judicial review would inherently limit the authority of arbitrators. Moreover, while the court agreed that parties can by contract displace the FAA standard of review, it held that displacement can be achieved only by clear contractual language. The court examined the contract between the parties and found that the language fell far short of the explicit language required by federal law to displace the FAA standard of review and that the FAA creates a presumption that the FAA’s more limited standard will govern.

Although a non-reinsurance case, the importance of this case is the First Circuit’s explicit recognition that if clearly stated in the contract, parties may require a more rigorous standard of review for arbitration awards than provided by the FAA.

In what is a relatively rare occurrence, however, some courts vacated arbitration awards. For instance, in HCC Aviation Insurance Group, Inc. v. Employers Reinsurance Corp., No. 3:05-CV-744-M, 2005 U.S. Dist. LEXIS 19992 (N.D. Texas, Sep. 13, 2005), a Texas federal court vacated an award on the grounds that an arbitration panel exceeded its authority when it concluded that the cedent’s claims handling facility and agent was entitled to indemnification under a reinsurance agreement between the cedent and its reinsurer. Before arbitration began, the parties agreed on the scope of the arbitration proceedings, which was essentially limited to the reinsurer’s claims of whether the cedent’s agent "was negligent in their claims handling of the [accident]," whether the Management Agreement was breached, and whether the cedent’s agent breached its duty of utmost good faith" to the reinsurer.

The arbitration panel issued a final award in favor of the claims facility and agent, finding that the reinsurer and claims facility intended for coverage to be provided to the claims facility and agent under the reinsurance agreement. Therefore, the reinsurer was precluded from recovering against them. While the court noted the extraordinarily narrow review of arbitral awards under the FAA, it found that the arbitration panel had exceeded its powers in ruling that the agent was entitled to indemnification under the reinsurance agreement. This issue, the court reasoned, was not within the scope of the parties’ submissions.

Similarly, in Garamendi v. California Compensation Insurance Co., No. B177760, 2005 Cal. App. LEXIS 11799 (Los Angeles County Super. Ct. Dec. 21, 2005), a California appellate court vacated an arbitration award that granted rescission of a reinsurance contract because the award necessarily reflected an impermissible set-off against the insolvent cedents. In this case, a number of the cedents became insolvent (conservatorship to liquidation) and stay orders were issued by the state court enjoining any actions or arbitrations or any rights of set-off against the insolvent cedents. The arbitration panel issued an award rescinding the treaty and requiring the reinsurers to return to the insolvent and solvent cedents $2.5 million in aggregate, which related to the cedents’ demand for return of premium and related costs. The reinsurers sought to confirm the award and the Liquidator moved to vacate the award. In vacating the award, the appellate court noted that under California law, the cedents were entitled to a return of "the whole premium" because the rescission order meant that the reinsurers had not been exposed to any risk of loss. Because the award did not order the reinsurers to return the entire premium, the arbitrators exceeded their powers and violated the cedent’s statutory right to a return of the whole premium.

The court essentially ruled that a set-off was improper because the reinsurers had no right to set-off under the contract and because mutuality was lacking on the amounts set off. The amounts offset were post-liquidation debts and could, therefore, not be set off against pre-liquidation premiums. Moreover, the court held that the award violated the various injunction orders, which precluded any payment of any claim against the insolvent cedents until approved by the liquidation court. Because the award was incapable of correction, it was vacated in its entirety.

Courts last year continued to delineate the impact of the follow-the-fortunes doctrine on discovery. In American Re-Insurance Co. v. United States Fidelity & Guarantee Co., 796 N.Y.S.2d 89 (App. Div. 1st Dep’t 2005), a New York state appellate court held that a cedent could not invoke the "follow-the-fortunes" doctrine to thwart discovery into whether the underlying settlement with its insured included bad-faith claims. The reinsurer sought the documents to discover whether any portion of the cedent’s settlement payment involved a payment for release of bad-faith claims. The court held that settlement documents were discoverable because they were "material and necessary" to the reinsurer’s defense. The court also found that a "settlement privilege" did not apply because the reinsurer did not seek the documents to establish the cedent’s liability in the underlying action.

Discovery disputes also continued to emerge in cases involving the enforcement of an arbitration subpoena issued to a non-party. For example, in the non-reinsurance case of Atmel Corp. v. LM Ericsson Telefon, AB, 371 F. Supp. 2d 402 (S.D.N.Y. 2005), a New York federal court quashed a deposition subpoena issued by an arbitration panel to a non-party, noting that the weight of judicial authority favors the view that the FAA does not authorize arbitrators to issue deposition subpoenas to non-parties. Essentially, the court agreed that the power to require depositions of third parties would increase the burden on non-parties, which is not an additional power granted by the statute. The court cited favorably to a reinsurance case, Integrity Insurance Co. v. American Centennial Insurance Co., 885 F. Supp. 69 (S.D.N.Y. 1995), in which the court refused to enforce a deposition subpoena against a third party. The court rejected the attempt to analogize the power to require depositions of non-parties to the implied power to compel production of documents at the hearing.

Also last year, a New York appellate court, in Gulf Insurance Co. v. Transatlantic Reinsurance. Co., 788 N.Y.S.2d 44 (App. Div. 1st Dep’t 2004), answered with an emphatic "no" the question of whether a reinsurer’s right of inspection based on an access to records clause waived the cedent’s claim of attorney-client or attorney work product privilege. The court held that access to record clauses in reinsurance agreements, no matter how broad, are not intended to act as a per se waiver of the attorney-client or attorney work product privileges. Even the common interest between cedents and reinsurers in the outcome of the underlying litigation does not prevent the assertion of privilege in an adversary situation.

In yet another significant follow-the-fortunes decision, the Second Circuit in Travelers Casualty & Surety Co. v. Gerling Global Reinsurance Corp. of America, 419 F.3d 181 (2d Cir. 2005), upheld the applicability of the "follow-the-fortunes" doctrine in post-settlement allocation situations, even when the allocation is based on a coverage position the cedent had seemingly abandoned in order to settle with its insured. Here, the cedent provided insurance under primary and excess policies covering losses for products and operations hazards. The primary policies each contained a liability limit of $1 million per occurrence and a $1 million aggregate limit for products coverage. On top of the primary coverage, the cedent issued excess policies with liability limits of $25 million per occurrence. The reinsurer reinsured a portion of the excess policies.

After years of arbitration, the cedent and its insured concluded a settlement agreement that explicitly disclaimed any particular theory of coverage and reached no conclusion as to whether the claims arose from a single occurrence or multiple occurrences. In billing its reinsurers, the cedent allocated most of the settlement as a single additional occurrence of non-products claims. Using the "rising bathtub" methodology, the cedent allocated the settlement evenly across policy years. Under this methodology the $1 million per occurrence limits were quickly exhausted, leaving the majority of the settlement covered by the excess policies, including those reinsured by the reinsurer. The reinsurer disputed the cedent’s allocation methodology, arguing that, under the cedent’s policies with the insured, each of the 700 job sites at issue should have been treated as separate occurrences, thus reducing the need to resort to the excess coverage reinsured by the reinsurer. The reinsurer argued that the "follow-the-fortunes" doctrine did not apply to its objection because the allocation of the settlement was unreasonable. Specifically, the reinsurer contended that by agreeing to a settlement payment, the cedent had already abandoned the single-occurrence theory it adopted in the underlying litigation. Because the cedent would owe no additional money under a single-occurrence theory, the cedent had seemingly accepted the multiple-occurrence theory.

The court rejected the reinsurer’s argument, holding, in reliance on North River Insurance Co. v. ACE American Reinsurance Co., 361 F.3d 134 (2d Cir. 2004), that "a cedent’s post-settlement allocation is subject to follow-the-fortunes, regardless of any pre-settlement position taken by the cedent, whether that position is articulated in a pre-settlement risk analysis, or implicit in the settlement with the underlying insured." The court noted that where, as here, "the cedent’s earlier position as to a particular coverage issue is unclear, it is even less appropriate than it was in North River for the reinsurer to claim an inconsistency between that position and the cedent’s subsequent allocation." The court also noted that the reinsurer faced a "very heavy burden" in showing bad faith, as "a cedent choosing among several reasonable allocation possibilities is surely not required to choose the allocation that minimizes its reinsurance recovery to avoid a finding of bad faith." In short, "[a]n allocation that increases reinsurance recovery … would rarely demonstrate bad faith in and of itself."

The Second Circuit has now made it clear that challenging a cedent’s allocation of a settlement, especially in multi-year and multi-policy long-tail situations, will unlikely be successful except in the most extreme circumstances where the cedent’s allocation is made in bad faith or is outside the terms of the coverage.

Similarly, in two companion cases, Commercial Union Insurance Co. v. Swiss Reinsurance Am. Corp., 413 F.3d 121 (1st Cir. 2005), and American Employers’ Insurance Co. v. Swiss Reinsurance Am. Corp., 413 F.3d 129 (1st Cir. 2005), the First Circuit reversed and remanded two district court decisions that had sustained a reinsurer’s challenge to its cedents’ billing of environmental claim settlements on an annualized basis under the applicable certificates of facultative reinsurance. In reversing, the court upheld the cedents’ rights under a follow-the-fortunes clause to bind reinsurers to reasonable and good faith settlements of underlying claims.

Each of the cases involved significant environmental claims over multiple sites over multiple years. In Commercial Union, the reinsurer challenged the cedent’s annualization of the per-occurrence limit on three-year facultative certificates. The facultative certificates followed a series of multi-year umbrella policies, which provided excess coverage over a series of primary policies issued by another carrier. While including definitions of "occurrence," the excess policies also included following form clauses that incorporated occurrences covered by the terms of the primary polices. The settlement with the insured was based on nine "focus" waste sites allocated pro rata across the years of relevant insurance coverage at each site and based on the per-occurrence limit on each policy viewed as applying separately to each policy year. The court acknowledged that on a "mechanical" basis, and without consideration of the following form and follow-the-settlements language, the reinsurer might have the better argument. But, when considering the "following" clauses, the court held that the cedent’s view on annualization is binding on the reinsurer "so long as the settlement was reasonable and made in good faith." The court did, however, point out that if the settlement were flatly inconsistent with the cedent’s policy, the reinsurer would not be bound by a follow-the-settlements clause in the facultative certificates. The court also indicated that this decision does not control a case where there is extrinsic evidence that better illuminates the dispute.

In American Employers, the facts were somewhat similar. The settlement also was based, in part, on the cedent’s annualization of the per occurrence limits. The reinsurer challenged the use of annualization, but also claimed that the allocation of a portion of the settlement to sites for which the cedent had no information was unreasonable and not made in good faith. The First Circuit left open the reinsurer’s right, on remand, to challenge the cedent’s good faith if it had evidence to support the claim. The court pointed out that the binding nature of the follow-the-settlements clause can be overridden by clear language in the certificate that cuts off liability. But in this case, there was no clear-cut anti-annualization language in the facultative certificates.

In an unusual twist to recent follow-the-fortunes/allocation cases, however, a Rhode Island federal court refused to apply the follow-the-fortunes doctrine, holding that the doctrine would not operate to create reinsurance coverage where none existed in a facultative reinsurance certificate. In Affiliated F.M. Insurance Co. v. Employers Reinsurance Corp., No. C.A. 02-419S, 2005 U.S. Dist. LEXIS 8932 (D. RI, May 12, 2005), the cedent issued a $5 million excess insurance policy. With 85 days left in the policy period, the insured requested that the limits be increased to $10 million. The cedent increased the limits and purchased facultative reinsurance for the additional $5 million for the remaining policy term. The reinsurance certificate only provided coverage for 85 days for "Nil% of $5,000,000 and 100% of 5,000,000 excess of 5,000,000."

The flood of asbestos-related lawsuits in the late 1970s affected the insured, and it notified its excess insurers, including the cedent, that its primary insurance was exhausted. The cedent entered into an interim agreement with the other excess carriers whereby the carriers agreed to share costs on a "continuous trigger" and "time on the risk" basis. Over $2 million in indemnity and over $850,000 in expenses were paid during a four-year period by the cedent. Thereafter, based on projections that the cedent’s $10 million limit would be exhausted, the cedent settled with the insured for $6,000,000. The cedent sought reimbursement under the reinsurance certificate for the full amount paid, including the settlement and expenses, less the $5 million retention.

The reinsurer denied the claim, and both parties moved for summary judgment. The court found that the cedent’s arguments on the allocation of loss and defense costs, which relied on the follow-the-fortunes/follow-the settlements doctrine, were "a game effort," but "[fell] short of the mark." As a threshold matter, the court found that there was no lack of concurrence between the policy and the reinsurance certificate. Therefore, both the policy and the certificate excluded expenses from the definition of loss and were payable in excess of the express limits of liability. The court went on to reject the follow-the-fortunes/follow-the-settlements arguments, holding that it would not use the doctrine to create reinsurance coverage where none existed under the express terms of the reinsurance agreement. Therefore, the court held that the reinsurer was entitled to explore whether a portion of the underlying settlement was for the payment of defense costs. The court reiterated the Second Circuit’s distinction between looking behind a settlement to determine whether the loss claimed is covered by the reinsurance, which is allowed, and questioning the allocation of a covered loss, which is not permitted. The court held that in this case the reinsurer was simply attempting to "gain clarity" as to whether the cedent was trying to improperly submit claims, which was "not akin to challenging an allowable allocation of risk of loss." Further, the court was not persuaded by policy considerations surrounding the follow-the-fortunes/follow-the-settlements doctrine, holding that the reinsurer’s defense to payment did not implicate any incentive on the part of the cedent to settle with its insured.

Courts last year presented a balanced approach in deciding reinsurance-related claims in the insolvency context.

In the Matter of The Home Insurance Company, No. 03-E-0106 (N.H. Super. Ct. Sept. 22, 2005), once again the liquidation court overseeing a liquidation approved an agreement entered into between the Liquidator and certain cedents that provided the cedents with monetary incentives to file claims against the estate. In 2004, the supreme court of New Hampshire vacated the liquidation court’s initial order approving the agreement for failure to make an independent determination regarding the fairness of the agreement, and for failure to make findings of fact. The final agreement provided for sharing of reinsurance recoveries as an incentive for the cedents to file claims against the estate. The Liquidator had expressed concern that, absent these incentives, no claims would be filed because the cedents were unlikely to receive distribution from the estate due to their status as low-priority creditors. The filing of claims by the cedents would have enabled the Liquidator to collect from the estate’s reinsurers.

On remand, the liquidation court noted that the test it was obliged to employ was an objective one: whether a reasonable liquidator under the circumstances would have thought that the agreement was necessary, fair, and reasonable. The court concluded that the agreement satisfied the test, finding that the cedents would not have filed claims with the estate absent some sort of incentive, and the failure to do so would have deprived the estate of significant reinsurance recoveries. In addition, it found that, had the Liquidator not entered into the agreement, it was possible that the reinsurers would have attempted to circumvent the liquidation process by entering into side agreements with the cedents to prevent the filing of claims.

In an unusual action arising out of the insolvency of a professional liability insurer, Law Offices of David J. Stern, P.A. v. Scor Reinsurance Corp., No. 04-60170-CIV-MOORE (S.D. Fla. Feb. 2, 2005), a Florida federal court refused to dismiss a direct action by an insured against a reinsurer. The insured obtained a professional liability policy through an insurer that was now insolvent. The insured had a claim that eventually was settled, but the insurer refused to indemnify the insured for the settlement amount. A coverage action was commenced against the insurer, but it was ultimately stayed when the insurer was placed into rehabilitation (and later liquidation). The insured then brought an action against the reinsurer alleging breach of contract by an undisclosed principal and, in the alternative, tortious interference with the insurance contract by inducing the insurer to breach the contract. In denying the reinsurer’s motion to dismiss, the court noted that because the insured was not seeking recovery under the reinsurance contract, the reinsurer’s arguments against a direct right of action by an insured were misplaced. The court also rejected the reinsurer’s arguments that the insured had elected its remedy by first suing the insurer and that the insurer was a necessary party to determine the reinsurer’s liability as an undisclosed principal.

In a brief memorandum decision, in B.D. Cooke & Partners, Ltd. v. Nationwide Mutual Insurance Co., 791 N.Y.S. 2d 103 (App. Div. 1st Dep’t 2005), a New York appellate court rejected a reinsurer’s attempt to avoid paying reinsurance recoverable based on the closing of its cedent’s liquidation. The order closing the estate specifically approved of the liquidator’s assignment of the reinsurance recoverable, which was not to be limited by the closing of the estate. Yet, the court went further and modified the partial summary judgment order in favor of the assignee by dismissing the reinsurer’s affirmative defense of offset. In doing so, the court stated that the closing of the liquidation proceeding concluded all possible defenses against the estate, which should have been asserted and adjudicated in the liquidation proceeding. Thus, the assignment of reinsurance proceeds was unencumbered by any offsets once the liquidation was concluded.

Serving to caution actuaries with intimate knowledge of reinsurance programs, in Walton Risk Services, Inc. v. Clarendon American Insurance Co., No. 01 C 0398, 2005 U.S. Dist. LEXIS 431 (N.D. Ill. Jan. 11, 2005), an Illinois federal court refused to dismiss an insurer’s counterclaim against its insolvent reinsurer’s actuaries alleging professional negligence and negligent misrepresentation. The insurer claimed that it maintained its relationship with the reinsurer because of the actuaries’ failure to disclose the reinsurer’s financial problems. The actuaries moved to dismiss the claim based on the statute of limitations. In denying the motion to dismiss, the court applied Illinois’ discovery rule for tort claims and held that the claims were not time-barred.

While there is no assurance that the actuaries will ultimately be held liable in this case, it certainly is a warning for actuaries with intimate knowledge of reinsurance programs to make sure that their actuarial opinions are not being used to prop up what would otherwise be an insolvent reinsurer.

In Philadelphia Indemnity Insurance Co. v. Federal Insurance Co., No. 04-2667, 2005 U.S. App. LEXIS 15464, (3d Cir. July 27, 2005), the Third Circuit affirmed summary judgment in favor of a reinsurer, holding that the reinsurer had permissibly refused to pay a claim submitted by the cedent on the ground that the cedent had failed to comply with the condition precedent established by the reinsurance policy’s notice provision. The notice provision stated: "The [cedent] shall, as a condition precedent to exercising their rights under this Policy, give to the [reinsurer] written notice as soon as practicable . . . of any Claim against [cedent] for a Wrongful Act, of which the [cedent’s] General Counsel or equivalent officer first becomes aware of such Claim."

Written notice of the claim was provided to the reinsurer sixteen months after the filing of the complaint related to the claim. Prior to providing written notice of the claim, outside counsel was hired to litigate the claim and a settlement offer was rejected by the cedent. The court found that the cedent’s officers had received the complaint and failed to examine it months before notice was given. The court rejected the cedent’s argument that the officers had not read the complaint, or the "ostrich farm defense," and found this argument inconsistent with any reasonable construction of the policy. While the court stated that it was acceptable for the cedent to adopt internal procedures for subordinate employees to review complaints in the first instance, it was the cedent’s burden to ensure that an appropriate officer is notified of any claims that could be covered by any reinsurance policy’s notification provision.

This article was previously published in the March 2006 edition of the LeBoeuf, Lamb, Greene & MacRae LLP Reinsurance Newsletter and is reprinted here with permission and acknowledgment of its copyright.

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