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The Question of Whether the “Follow the Fortunes” Doctrine Can Be Implied in a Reinsurance Agreement Becomes Even Murkier

The “follow the fortunes” doctrine – also sometimes referred to as the “follow the settlements” doctrine – means that a reinsurer is generally bound by the claims handling decisions of its reinsured – or cedent – as long as there is no evidence of fraud, collusion with the insured, or bad faith on the part of the reinsured. It is a long-established principle that a reinsured must have the ability to make good faith underlying claims handling decisions – including the settlement of claims – without being concerned that it will have to relitigate those same decisions with its reinsurer.

Over the years, courts and arbitration panels have applied this doctrine by holding that a reinsurer is bound by the reinsured’s decisions to pay settled claims where the decision was made reasonably and in good faith. Although a reinsurer may inquire into the results of coverage disputes between reinsureds and their insureds, a reinsurer may not conduct a de novo review of these results. As a result, by preventing a court or arbitration panel from conducting a de novo review of a cedent’s claims handling decisions, the follow the fortunes doctrine requires a reinsurer to reimburse the reinsured for any payouts or settlements made to its insured unless the reinsurer can prove that the reinsured acted in bad faith or did not conduct a reasonable investigation of the underlying claim.

The issue of whether the follow-the-fortunes doctrine really exists in those circumstances where there is no explicit follow-the-fortunes provision in the reinsurance agreement has been the subject of much examination. While some early decisions and commentary seemed to indicate an unwillingness to read follow-the-fortunes provisions into reinsurance contracts where such provisions were absent, the more recent trend has been to suggest that the follow-the-fortunes doctrine should apply to all reinsurance agreements, even where the agreements did not contact an express follow-the-fortunes provision. A desire to read into a reinsurance agreement the follow-the-fortune doctrine even where it is not contained in the contract language, stems from the long held belief that the follow-the-fortunes doctrine embodies the very basis of the special relationship that has long been seen to exist between a cedent and a reinsurer, and that special relationship exists even where there is no written embodiment contained in the agreement between the two parties.

The argument for reading a follow-the-fortunes clause into a reinsurance agreement even where there wasn’t one, was not found to be compelling by the Eleventh Circuit Court of Appeals in its recent decision in Public Risk Management of Florida v. Munich

Reinsurance America, Inc., 38 F.4th 1298 (11th Cir. 2022). In that decision, the Eleventh Circuit had examined a case in which a cedent claimed that its reinsurer had a duty to follow its fortunes and reimburse it for a settlement and defense costs although the reinsurance contract did not contain an explicit follow-the-fortunes clause, and refused to infer a “follow the fortunes” clause into a treaty. See Sharon D. Stuart,” Eleventh Circuit Reiterates Uphill Battle for Cedents Seeking to Imply Follow-the-Fortune Clauses in Reinsurance Contracts,” DRI The Brief Case, October 2022.

Not long after the Public Risk Management decision was issued, on February 21, 2023, the United State District Judge Myron H. Thompson of the Middle District of Alabama, in Alabama Municipal Insurance Corp. v. Munich Reinsurance America, Inc., No. 20-300, slip op. (M.D. Ala. Feb. 21, 2023), 2023 U.S. Dist. LEXIS 28240, a court within the Eleventh Circuit, had cause to look at a dispute over the coverage available under a reinsurance agreement that also did not contain a follow-the-fortunes clause.

In Alabama Municipal Insurance Corp., the District Court ruled in favor of the defendant reinsurer Munich Reinsurance America Inc. (“Munich”) on its motion for summary judgement, in an action concerning certain payments that were made by the plaintiff Alabama Municipal Insurance Corp. (“AMIC”), to its insured, the town of Spanish Fort, Alabama (“Spanish Fort” or “town”), that were subsequently ceded to Munich under certain treaties. The Court held that Munich’s liability to AMIC under respective 2009 and 2014 reinsurance treaties was governed by AMIC’s underlying coverage obligations to its insured, and that it was the scope of the underlying insurance policy between AMIC and its insured that was the determinative question for the Court to resolve.

In order to resolve that question, the District Court looked to see how the Alabama Supreme Court applied the “trigger of coverage” coverage rule in a property damage case. Tellingly, the issue of whether Munich was obligated to “follow the fortunes” of AMIC’s underlying coverage decisions did not merit discussion by the Federal District Court.

The action at issue involved disputes between AMIC and Munich over assertions that each party failed to honor its obligations to the other under a series of reinsurance treaties. Several of the disputes also involved competing interpretations of AMIC’s underlying insurance contracts with its clients, which bound Munich under the terms of the reinsurance treaties. AMIC asserted five breach-of-contract claims and sought compensatory damages and pre-judgment interest as remedy. Munich denied that it had breached any treaties. This action was before the court on Munich’s motion for summary judgment on one of AMIC’s breach-of-contract claims: the claim arising out of AMIC’s insurance policy with Spanish Fort.

The Court noted that AMIC was a non-profit insurance company wholly owned by Alabama municipalities and regulated by the Alabama Department of Insurance. It was chartered to insure Alabama’s cities, towns, and subsidiary corporate entities, including bus services and police forces. Munich was a national provider of property and casualty reinsurance, and for at least ten years, between 2005 and 2015, AMIC and Munich entered into annual reinsurance agreements, formally known as “Casualty Excess of Loss Reinsurance Agreements,” or treaties, wherein Munich took on a portion of AMIC’s risk in exchange for a portion of the premiums AMIC received from its insured clients. All of the underlying incidents at issue in this case occurred during that 10-year period.

The action began in May 2020, when AMIC accused Munich of five counts of breach of contract based on five insurance claims that AMIC had ceded to Munich between 2015 and 2018, none of which Munich agreed to reimburse in full. Munich denied that it breached any of its treaties with AMIC and filed six counterclaims, seeking declaratory relief regarding the interpretation of other treaties between Munich and AMIC and other contracts held by AMIC with its insured clients. Munich then filed a motion for summary judgment on all eleven claims and counterclaims. However, only one of AMIC’s claims was before the Court on the motion for summary judgment – the one arising out of its policy with Spanish Fort.

As set forth in the Court’s decision, the facts underlying the Spanish Fort claim were as follows. In March 2009, a major rain event resulted in the collapse of drainage systems, culverts, and catch basins in Spanish Fort. This collapse led to a partial erosion of the bluffs upon which a subdivision was built. In response to the collapse and erosion, property owners filed two lawsuits against the town (the “Kessler lawsuit” and the “Amburgey lawsuit”), both alleging that the town’s negligent maintenance of the drainage system had resulted in the continuing erosion of the bluff and a de-stabilization of the bluff in its entirety. At the time the lawsuits were filed, Spanish Fort held a commercial general liability policy with AMIC. AMIC and Munich do not dispute that the initial Kessler and Amburgey lawsuits against the town triggered AMIC’s coverage obligations under the terms of 2009 policy.

In 2013, after several years of litigation, a jury awarded the homeowners in the Kessler lawsuit $1,335,800 against Spanish Fort, which was later remitted to $500,000 under a statutory tort cap. The trial court in that underlying action also ordered the town to repair the bluffs. Separately, the Amburgey lawsuit was settled in March 2014 for $75,000. In April 2014, one month after the Amburgey lawsuit was settled, Spanish Fort experienced another major rain event, and the bluffs further eroded, leaving the homes of the Kessler plaintiffs in “imminent danger” of collapse. In opposing Munich’s summary judgment motion, AMIC argued that the 2009 erosion and the 2014 erosion have “only one cause,” namely, the alleged negligent maintenance of the drainage system by Spanish Fort, which set this sequence of events in motion. Munich disagreed, arguing that the 2009 erosion was the result of the 2009 rain event, and that the 2014 erosion was attributable to the entirely separate 2014 rain event.

In the summer of 2014, the Kessler plaintiffs entered into a new round of mediation with Spanish Fort, arguing that the injunctive relief provided by the first lawsuit was not enough to provide a remedy for the new damage. The parties reached a settlement in which the homeowners agreed to release all claims surrounding the bluff, including future litigation. In exchange, AMIC agreed to satisfy the original $500,000 judgment and pay an additional $350,000.

The town also agreed to pay an additional $473,000 to resolve the injunction and take physical possession of the properties at issue. AMIC combined its “Ultimate Net Loss” regarding all of these events and all related litigation into one single claim, which it submitted to Munich under the 2009 reinsurance treaty, for the amount of $906,798. In response to this bill, Munich agreed to pay $544,395.12, calculated as follows: Kessler lawsuit – $500,000; Amburgey settlement – $75,000; and other unspecified costs accrued during litigation – $319,395.12, with a subtotal of costs totaling $894,395.12. Applying the retention amount under the treaty of $350,000 resulted in a total reimbursement amount of $ 544,395. As such. Munich declined to pay $362,402.88 ($906,798 less $ 544,395.12) of the amount sought by AMIC under the 2009 treaty, arguing that these charges (which consisted of $350,000 for the 2014 cost mediation, and other charges) arose from a series of events and litigation that could not be ceded under the 2009 treaty.

Munich argued that the costs of the 2014 settlement negotiations between Spanish Fort and the property owners were the result of further erosion damage that did not “occur” until 2014, and, further, that these separate damages constituted a separate “occurrence,” requiring an additional retention that applied under the 2014 treaty. Munich agreed to pay the outstanding balance, less the obligatory $ 350,000 per-incident retention on AMIC’s part, under the 2014 treaty.

Because the parties had agreed that the dispute is governed by Alabama law, the Court stated that, in order to determine whether Munich was entitled to summary judgment on the Spanish Fort claim, the Court first had to examine Munich’s obligations to AMIC under the treaties between the parties. The Court noted that under the 2009 treaty, Munich’s obligations with AMIC under it were as follows: “The Reinsurer agrees to indemnify the Company, on an excess of loss basis, for Ultimate Net Loss paid by the Company as a result of losses occurring under the Company’s Coverage Documents attaching during the term of this Agreement.” The Court concluded that AMIC’s obligations pursuant to the underlying insurance policy between AMIC and its insured was the question upon which the case ultimately turned.

The text of Spanish Fort’s insurance policy with AMIC reads, in relevant part as follows: “[AMIC] will pay those sums that the insured becomes legally obligated to pay as Damages because of Bodily Injury or Property Damage to which this insurance applies.” The policy also limited coverage in that the insurance applied to property damage “only if … the Bodily Injury or Property Damage occurs during the policy period.” The Court held that this language was not ambiguous as written: it capped AMIC’s coverage obligations for the policy period to costs Spanish Fort was legally obligated to pay as a result of property damage that actually occurred during that period.

The Court stated that AMIC’s arguments in opposition to summary judgment were not persuasive, and that even if the subdivision properties in Spanish Fort remained imperiled by the threat of continued erosion at the close of the 2009 policy coverage period, this was not enough to extend the coverage policy to property damage that did not actually “manifest” until five years later. The Court noted that the gradual continuation of erosion over a period of five years, and any property damage resulting in separate lawsuits during that period, cannot rightfully override the plain text of the AMIC insurance policy.

The Court stated that the Alabama Supreme Court has consistently indicated that, where a policy explicitly restricts coverage to damage that “occurs during the policy period” – as was the case before it – later damage was not covered. Specifically, the Court cited American States Ins. Co. v. Martin, 662 So. 2d 245, 250 (Ala. 1995), where the Alabama Supreme Court held that the language of similar policies at issue “clearly provide that an injury, and not an occurrence that causes an injury, must fall within the policy period for it to be covered.”

The Court also cited to the Alabama Supreme Court’s holdings in State Farm Fire & Cas. Co. v. Gwin, 658 So. 2d 426 (Ala. 1995), and Liberty Mut. Ins. Co. v. Wheelwright Trucking Co. Inc., 851 So. 2d 466, 482 (Ala. 2002), in holding that the “plain language” reading of AMIC policy explicitly limited coverage to damage and injury occurring during the coverage period. Because the Court noted that the sole question before it was the extent of coverage under the 2009 policy between AMIC and the town, the Court held that the unambiguous language of that policy did not cover the disputed damages that “occurred” after the end of the 2009 policy.

In Alabama Municipal Insurance Corp., Munich argued that it was “undisputed” there was no specific “follow the fortunes” or “follow the settlements” provision contained in the 2009 treaty. Munich further asserted that, even if the District Court in Alabama Municipal Insurance Corp. were to find that a “follow the fortunes” provision could be inferred in the reinsurance contract, nevertheless, the District Court should still rule in favor of Munich because there was no coverage existing as a matter of law under the reinsurance contract, citing Utica Mutual Ins. Co. v Fireman’s Fund Ins., 957 F.3d 337, 347 (2d Cir 2020), a case involving a dispute between an insurer and a reinsurer, held that a reinsurer cannot be held accountable for an allocation that is contrary to the express language of the reinsurance policy.

Munich argued that in Utica Mutual, Fireman’s Fund had reinsured umbrella policies issued by Utica. Utica had sought to have Fireman’s Fund pay for bodily injury claims even though those claims did not trigger the umbrella policies. The Utica Mutual Court held that Fireman’s Fund had no obligation to pay because Utica’ allocation decision was directly contrary to the express terms of the Fireman’s Fund umbrella policies. Munich noted that in the Utica Mutual case, the court held the insurer to the language of the treaty even though that reinsurance contract had a “follow the settlements” provision, which would arguably insulate some decisions of the insurer from question by the reinsurer.

In contrast, AMIC, citing Unigard Security Insurance Co. v North River Insurance Co., No. 92, 79 N.Y.2d 576, 583 (1992), argued in its opposition to Munich’s motion for summary judgment: 1) that reinsurers are generally bound by the primary insurer’s settlement; 2)that “the interests of a reinsurer and the ceding primary insurer with respect to apending claim are generally identical”; and 3) “[t]he ‘follow the fortunes’ clause in most reinsurance agreements leaves reinsurers little room to dispute the reinsured’s conduct of the case.”

As noted above, the Alabama Federal District Court in Alabama Municipal Insurance Corp., however, did not even mention the “follow the fortunes” doctrine in its decision, perhaps because of the recent decision by the Eleventh Circuit in Public Risk Management, where the Circuit Court had refused to infer a “follow the fortunes” clause into a treaty. The Eleventh Circuit in Public Risk Management had declined to address whether a court might appropriately infer the follow the fortunes doctrine under other circumstances such as where the reinsurance agreement contained neither a “follow-the-fortunes” clause nor other language plainly inconsistent with the “follow-the-fortunes” doctrine. Public Risk Management, 38 F.4th at 1311. One such circumstance might be where a cedent seeks to infer a “follow the fortunes” clause into a certificate or treaty by use of evidence of the “custom and practice” of the parties to the reinsurance agreement.

In North River Insurance Co. v. Employers Reinsurance Corp., 197 F. Supp. 2d 972 (S.D. Ohio 2002), for example, the Ohio Federal District Court, applying New Jersey law, found that while a “follow the fortunes” provision should not be implied into every reinsurance agreement as a matter of law, even in the absence of any ambiguity, “evidence of the situation of the parties and the surrounding circumstances and conditions is admissible in aid of interpretation.” Id. at 988. This principle of looking to evidence of the “custom and practice” of the parties to the reinsurance agreement as to whether a “follow the fortunes” provision might be implied the reinsurance agreement, could be demonstrated, the Court stated, where there is established evidence of the parties’ intention, and the parties’ “intent may not be disregarded to create a new or better contract or to add to, subtract from, modify, or alter any terms of the agreement.” Id. at 988-89.

The Ohio District Court in North River also noted that any such alleged “custom and usage” must be established by “clear and explicit proof,” and must be “clearly established” and known to the parties or so notorious in the trade as to charge them with notice thereof.” Id. The Court had examined the reinsurance certificate at issue in the case and had determined that, on its face, the certificate contained no language which could reasonably be construed as a “follow the settlements” clause. Id. at 990. The District Court noted, however, that while there was no ambiguity in that regard in the actual language of the certificate, in light of the fact that New Jersey law allowed the Court to look beyond the face of the contract to determine the intent of the parties, even in the absence of any ambiguity in the contract language, the Court determined that it would review the additional evidence bearing on intent which had been submitted by the parties. Id. at 990.

The North River Court thereupon considered an affidavit submitted by a former underwriter for the reinsurer, who opined that the “follow the fortunes” doctrine was “inherent” in all reinsurance relationships, and that this doctrine obligates the reinsurer to pay its share of all settlements made by the reinsured so long as those settlements are reasonable and in good faith. Id. The Court also considered an affidavit submitted from an expert that opined that according to the custom and practice of the business at the time this certificate was issued, reinsurers would expect to follow the settlements of insureds, even in the absence of an express “follow the settlements” clause, in the absence of fraud, collusion, bad faith, ex gratia payment or gross negligence in the handling of the claim, and would not require insureds to undergo a de novo proof of liability. Id. at 990-991.

The North River Court also considered the affidavit of another expert who opined that clauses such as “follow the settlements” are subject to negotiation in the reinsurance industry, and that they have the effect of waiving the reinsurer’s right to insist on proof of the reinsured’s liability. This expert further opined that no reinsurance “custom, usage, or practice” actually existed which implied a duty to “follow the settlements” in the absence of such a clause actually being present in the reinsurance contract. Id. at 991.

The North River Court also considered various treatises submitted by the parties whose authors gave conflicting opinions on custom and practice. Based on the evidence submitted by the parties, the Court found that genuine issues of fact existed which precluded the award of partial summary judgment to either party on the issue of whether a “follow the settlements” clause should be read into the policy based on custom or practice in the industry. Id.

The Alabama District Court’s failure to even mention the “follow the fortunes” doctrine in Alabama Municipal Insurance Corp. may not be all that surprising given the differences between Alabama and New Jersey law. Unlike the law in New Jersey, as noted in North River, Alabama does not appear to allow a court to look beyond the face of the reinsurance contract to determine the intent of the parties as to whether a “follow the fortunes” provision might be inferred, in the absence of any ambiguity in the contract language. See Cain v. Saunders, 813 So.2d 891 (Ala. Civ. App. 2001) (holding that where the terms of a written settlement agreement are clear and unambiguous, the terms of that agreement may not be varied by the introduction of parol evidence regarding an alleged mutual mistake of fact). In Alabama Municipal Insurance Corp., the Alabama District Court determined that under Alabama law, the reinsurance treaty was not “ambiguous.” As such, the Court would not have considered any parol evidence of the “custom and practice” based on precedent.

Nonetheless, in those jurisdictions where courts are willing, even in the absence of any ambiguity in the reinsurance agreement, to consider the custom and practice of the reinsurance business at the time the reinsurance agreement was issued, reinsurers might still be required to “follow the fortunes” of their cedents, even in the absence of an express “follow the fortunes” provision in the reinsurance agreement, depending upon the situation of the parties and the surrounding circumstances and conditions under which the reinsurance agreement was formed. In such cases, courts and arbitration panels might be more inclined to infer a follow-the-fortunes provision even in the absence of an express “follow the fortunes” provision in the reinsurance agreement and thereby recognize the long-established special relationship that exists between a reinsurer and cedent that provides that a reinsured must have the ability to make good faith underlying claims handling decisions without relitigating those same decisions with its reinsurer.