Insurance Post

US reinsurance watch

Looking back at the significant US legal and regulatory developments in 2003

Looking back, the year 2003 saw no cataclysmic change in the US legal and regulatory landscape - no earth-shattering decisions were issued, no regulatory landslides were begun, no Atlantis was swallowed in a sea of insolvency.

Rather, 2003 saw steady grinding and shifting, as doctrines and regulations continued to develop in lower courts and committee sub-groups.

Allocation and aggregation

As market observers are well aware, multi-million-dollar insurance disputes concerning environmental and asbestos claims are a frequent phenomenon in the US. In turn, there are frequent disputes between cedants and reinsurers concerning how the settlements of those disputes should be allocated against reinsurance contracts. Those disputes also often involve issues respecting how the underlying claims are aggregated for purposes of triggering excess layers of coverage. The year 2003 saw several lower court decisions go against cedants on these issues. If affirmed by courts of appeal, these decisions may represent a shift in the trend, which had seen cedants prevailing in earlier allocation cases by arguing that the cedants' allocation against the reinsurance contracts was based on the deal struck in the settlement, and that the reinsurers were therefore bound to accept the allocation under the follow the settlements doctrine.

Travelers Casualty & Surety Co. v Gerling Global Reinsurance Corp., 2003 WL 22273321 (D. Conn. 30 September 2003) concerned the allocation of an asbestos claims settlement. The reinsured had issued to Owens Corning various primary and excess policies, none of which contained aggregate limits, but all of which had occurrence limits. The policies were reinsured under five facultative certificates. The reinsured settled with Owens Corning, paying approximately $273.5m and allocating the "vast majority" of its payments against the certificates on a single occurrence basis.

The reinsurer refused to accept the allocation and moved for summary judgement based on several factors, including that the bulk of the settlement was for claims at 700 job sites. The reinsurer argued that the definition of "occurrence" contained in the underlying policies required that each of the 700 job sites be treated separately for allocation purposes. The court granted summary judgment in favour of the reinsurer, holding that the payments made by the reinsured under the underlying policies "required a multiple occurrence allocation as a matter of law under the definition of 'occurrence' in the policies". The court also held that the follow the settlements doctrines did not apply, because the cedant had not settled with the insured on any occurrence basis, and thus under the court's thinking, there was no settlement to follow.

Two other significant decisions in 2003 involved the annualisation of policy and reinsurance certificate limits. Commercial Union Ins. Co. v Swiss Re America Corp., 2003 WL 1786863 (D. Mass. 31 March 2003); American Employers' Insurance Co. v Swiss Re America Corp., 275 F. Supp. 2d 29 (D. Mass. 2003). Each case followed the holding in Bellefonte Reins. Co. v Aetna Cas. and Sur. Co., 903 F.2d 910 (2d Cir. 1990), which is that neither the other provisions of a reinsurance certificate nor the follow the settlements doctrine can trump the express limits of liability stated in a facultative certificate.

In Commercial Union, the reinsured sought more than $18m from its reinsurer under facultative reinsurance agreements with single limits of liability that covered multi-year, umbrella policies. In settling, the cedant annualised the limits in its policies, paying multiple annual limits. It then billed its reinsurer on the same basis. The reinsurer only paid the first $7.8m on the grounds that the reinsured had inappropriately annualised the reinsurance claims in contravention of the facultative certificates' single, per occurrence limits. The US district court for the district of Massachusetts ruled in favour of the reinsurer, holding that the facultative certificates did not permit annualisation in excess of the stated per-occurrence and aggregate limits.

Similarly, in American Employers, another Massachusetts court held that a single occurrence spanning multiple years did not constitute a separate annual "occurrence" for reinsurance recovery purposes where the underlying policies did not contemplate annualisation of either limits or occurrences.

The court also ruled that because the cedant had not obtained "any" documentation with respect to 27 pollution sites, the reinsurer had no duty to follow as to the portion of the settlement relating to those 27 sites.

Late notice

Unlike many London market claim co-operation and control clauses, the majority of US notice and co-operation clauses do not make the cedant's timely notice to the reinsurer a condition precedent to recovery; rather, typical US clauses provide that notice must be prompt, and under them, the reinsurer is given the right to associate in the control or defence of the claim.

Under New York law, a reinsurer cannot avoid liability in the event that the cedant breaches the late notice clause, unless the reinsurer demonstrates that it was financially prejudiced by the breach. It is also fairly well understood that most US reinsurance arbitrators will similarly require a showing of prejudice when they are deciding under industry custom rather than strict law. Nevertheless, the law is unsettled in many US states, and reinsurers may argue under those states' laws that mere late notice is sufficient to allow a reinsurer to avoid liability, regardless of a showing of prejudice.

This issue was addressed in 2003 under New Jersey law by the Federal Court of Appeals for the Third Circuit in British Ins. Co. of Cayman v Safety Nat'l Cas. Corp., 335 F.3d 205 (3d Cir. 2003). In that case, the Third Circuit predicted that the New Jersey Supreme Court would follow the New York rule, and thus held that the reinsurer was required to demonstrate prejudice in order to avoid the claim. In that connection, the court ruled that the reinsurer's loss of its right to associate in the control or defence of the claim could not, in and of itself, constitute prejudice, because reinsurers rarely exercise their right of association. The court remanded for a determination of whether the reinsurer was in fact prejudiced, an inquiry that was not addressed in the opinion. Significantly, the nature of the prejudice required to avoid liability is elusive in US jurisprudence, because no court has yet found that a reinsurer alleging late notice had in fact been prejudiced.

Declaratory judgement expenses

An often contentious US reinsurance issue is whether a reinsurer is bound to indemnify its cedant for the expenses of litigating declaratory judgement (DJ expenses) actions with its insureds. For almost a decade, there was only a single decision, Affiliated FM Ins. Co. v Constitution Reinsurance Corp., 626 N.E.2d 878 (Mass. 1994), concerning the issue. In that case, the Supreme Judicial Court of Massachusetts found that certificate language providing that the reinsurer would pay "expenses ... incurred by the (reinsurer) in the investigation and settlement of claims or suits" was ambiguous respecting coverage of DJ expenses. The court remanded the case for a determination whether trade usage would clarify the ambiguity. The controlling factor in the decision was the parties' use of the mere term "expenses", which the court found ambiguous as a matter of law, even when read against the rest of the certificate. There are now, however, three other decisions that address the issue, all being decided within the last year and a half.

In 2002, in Employers Reinsurance Corp v. Mid-Continent Casualty Co., 202 F. Supp.2d 1221 (D. Kan. 2002) a Kansas federal district court found that the reinsurer was obligated to reimburse its reinsured for DJ expenses.

The reinsurance agreement covered expenses arising out of the insurer's conduct "in the investigation, trial or settlement of any claim for failure to pay or delay in payment of any benefits under any policy". The court found that those included DJ expenses.

Earlier this year, a Wisconsin federal district court also held that the reinsurer was obligated to reimburse DJ expenses. In Employers Insurance Co. of Wausau v American Re-Insurance Co., 256 F. Supp. 2d 923 (W.D. Wisc. 2003), the reinsurer conceded that the definition of allocated loss expenses - "all expenses incurred in the investigation and settlement of claims or suits" - could include DJ expenses. However, it argued that DJ expenses were barred from coverage by an exclusion for "expenses incurred by the company in regard to any actual or alleged liability that is not within the circumscribed provisions of the policy reinsured". The court found that this exclusion did not exclude DJ expenses, but only expenses relating to the reinsured's extra contractual or tortious conduct.

Most recently, in British International Insurance Co. Ltd. v Seguros La Republica, 342 F.3d 98 (2d Cir. 2003), the court found no coverage for DJ expenses. The court ruled that there could be no coverage of DJ expenses based solely on language in the certificate making the reinsurance "subject to the same risks, valuations, conditions, endorsements ... assignments and adjustments as are or may be assumed, made or adopted by the reinsured".

In that case, in contrast to the other decisions, the term "expenses" did not appear at all.

Collateralisation

A regulatory issue of continuing interest to US industry observers is the push to reduce the collateral requirements for alien reinsurers assuming liabilities from US cedants. Currently, alien reinsurers are required to provide collateral to US cedants equal to 100% of ceded liabilities, usually by forming a trust, posting a letter of credit, or by permitting the cedant to withhold funds from premium ceded to the alien reinsurer.

Many alien reinsurers have objected to the 100% collateral requirement and some industry observers - both alien and from the US - have argued that this requirement constitutes a protectionist barrier to entry to the US market. These observers argue that reducing the required collateral percentage from 100% would make the US reinsurance market more inviting to alien reinsurers and therefore more competitive. The year 2003 saw little positive development for alien reinsurers on this issue.

First, the National Association of Insurance Commissioners (NAIC), which standardises state reinsurance law, has continued to show minimal interest in reducing collateral requirements. At the September NAIC meeting in Chicago, the reinsurance task force discussed reducing collateralisation but made no meaningful decisions. The task force specifically focused on two issues which continue to be stumbling blocks to a reduction - the harmonisation of international accounting standards and the enforceability of foreign judgments. The task force created sub-groups to study these issues further. Any action by the NAIC to reduce collateral requirements will likely be delayed while these two sub-groups explore these issues.

In addition, US cedants have shown a desire for greater collateralisation, not less. Some US cedants have demanded collateral on long-tail business from domestic reinsurers who are not required to provide it under existing state laws. If US cedants are requesting and are, as reported, able to obtain collateral from domestic reinsurers, it is unlikely that domestic cedants and reinsurers would be willing to support measures to reduce the amount of collateral already required from alien reinsurers.

- Peter Maloney is counsel and Jeanne Kohler is an associate with the law firm of Edwards & Angell, LLP in New York.

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