Insurance Post

To follow or not to follow.

Peter Chaffetz and Steven Schwartz warn that uncertainty persists in the US over whether reinsurers will be made to follow their cedants' settlements, particularly in the light of two recent decisions in Ohio.

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The 'follow the settlements' doctrine can profoundly affect the breadth of reinsurance coverage, yet it is still unclear whether US courts will read such a term into a reinsurance contract that is silent on this point.

Reinsurance professionals should watch the impact of two recent decisions from a federal court in Ohio, North River Insurance Co. v Employers Re Corp., No. CV-2-00-1221, 2002 U.S. Dist. LEXIS 7118 (S.D. Ohio, 11 March 2002), and North River Insurance Co. v Employers Re Corp., No.
C2-00-1221, 2002 U.S. Dist. LEXIS 11711 (S.D. Ohio 3 June 2002), which refused to find that a follow the settlements term should be implied into all reinsurance agreements.

Instead, the court held that one must look to the applicable state law governing interpretation of industry custom. In this case, that meant determining the parties' intent at the time they entered into the contract.

The court ultimately found that there was no reinsurance industry custom of implying a follow the settlements term for settlements that fell outside a contract's terms and, in this case, refused reinsurance coverage for such settlements.

Asbestos claims

North River v Employers Re involved the efforts of North River to recover on a facultative reinsurance contract that Employers Re provided for a liability policy that North River issued to Owens-Corning Fiberglas Corp.

Owens-Corning made large asbestos liability claims on this policy. North River paid those claims and Employers Re in turn paid a share of those losses under the reinsurance contract.

Subsequently, Owens-Corning made (non-product) asbestos claims against North River relating to the installation of asbestos. North River resisted payment and a lawsuit followed.

Eventually, the parties reached a settlement and North River attempted to cede a share of that settlement to Employers Re. Employers Re refused to pay. North River sued and the two parties eventually filed cross-motions for partial summary judgement on the question of whether Employers Re was obliged to follow North River's settlements where there was no follow the settlements clause in the reinsurance contract. The court noted that:

"The follow the settlements doctrine imposes on the reinsurer a contractual obligation to indemnify the reinsured or ceding company for payments the reinsured makes pursuant to a loss settlement under its own policy, provided that such settlement is not fraudulent, collusive or otherwise made in bad faith, or an ex gratia payment, such as one made to avoid the costs of litigation even though there is no legal obligation to pay." (Id. at *7, citing Aetna Casualty and Surety Co. v Home Insurance Co., 882 F. Supp. 1328, 1346 (S.D.N.Y. 1995).)

Keeping faith

The court noted that this doctrine permits cedants to make good-faith settlements without fear that their reinsurers will be able to avoid paying losses on the basis of defences to coverage that the cedants reasonably chose not to assert.

The court looked to reinsurance industry custom and practice to determine, as an issue of fact, whether a follow the settlements term is implied into reinsurance contracts. In its earlier decision, the court stated that the case law was divided on whether a follow the settlements or follow the fortunes clause should be read into reinsurance agreements.

Individual testimonies

Each party provided extensive expert testimony on this matter. However, the court appears not to have found that the testimony resolved the issue.

Instead, it found that the fact that many reinsurance certificates include a follow the settlements term "strongly militates" against finding that such a term is automatically implied. If it were, said the court, an explicit clause would be unnecessary. The court therefore held that a follow the settlements clause could not be automatically implied into every reinsurance contract.

The court looked to New Jersey law to resolve the dispute. This required a determination of the parties' intent on entering into the contract and a reading of the contract according to its plain and ordinary meaning.

The court found that while there was no express follow the settlements term in the contract, the parties had a genuine dispute regarding their intentions on this point. Summary judgement was therefore denied.

In its June decision, the court held that the terms of the reinsurance contract required Employers Re to indemnify North River for that portion of its settlement that was within the terms of the contract.

In contrast, the court held that Employers Re did not have to indemnify North River for that portion of the settlement that was outside the terms of the contract, since neither the terms of the reinsurance contract nor industry custom dictated such an obligation.

Tried and tested

Other US cases have found that there is an automatically implied follow the settlements term (see, for example, Mentor Insurance Co. (UK) Ltd v Norges Brannkasse, 996 F.2d 506, 516 (2d Cir. 1993), and National American Insurance Co. v Certain Underwriters at Lloyd's London, slip op. 91-4021 (C.D. Cal. 1991).

However, the court in North River noted that National American was later reversed by National American Insurance Co. v Certain Underwriters at Lloyd's London, 93 F.3d 529 (9th Cir. 1996), in which the Ninth Circuit held that courts must do a case-by-case analysis in which they look to the state law governing the contract in question to determine whether there is an implied follow the settlements term.

In the case of North River, this meant first looking to see whether the parties intended to adopt such a term when they negotiated the reinsurance agreement, then to industry custom.

It is possible that another state's law governing the parties' intent and the custom on this point would permit such a term to be automatically implied. This, unfortunately, lends itself to uncertainty for cedants and reinsurers alike.

In contrast, it is well settled that courts in England will not oblige reinsurers to follow their cedants' settlements if there is no follow the settlements clause in the relevant reinsurance contract (see Chippendale v Holt, (1895) 1 Com. Cas. 197, and Gurney v Grimmer, (1932) 44 Ll.L.R.
189).

In England courts will permit a reinsurer to contest paying a share of settlements that its cedant has made on the grounds that those settlements were not in fact losses covered by the original insurance policy.

Custom dictates

In light of the fact that US courts may look to the laws determining reinsurance custom and usage of each state, companies should be aware that they may be held to follow their cedants' settlements if the law of a given state holds that that is reinsurance custom, even if there is no such term in the contract.

Alternatively, they may be forced to prove that they did not intend to follow the settlements when they entered into their reinsurance agreement.

This area of the law is worth watching to see whether US courts adopt the reasoning in North River.

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