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Some Basics of Reinsurance Right-to-Associate & Claim Control Clauses
This article was written by Sulloway & Hollis attorneys Alexander G. Henlin and Robert A. Whitney for DRI Magazine (Article Link)
Reinsurance is a $400-billion industry. Despite the significant sums of money involved, the legal issues that reinsurance contracts present are often not well developed in decisional law. As a result, practitioners can find themselves grasping for answers when creative claimants’ counsel seek to take discovery of reinsurance agreements, reinsurance reporting, and reinsurance reserving information. The ultimate goal may be to ascertain what funds are available to meet the facts of a particular claim, or to open up a bad faith claim against a reinsurer.
The purpose of this article is to provide practitioners with a primer on the rights that reinsurance agreements can grant to reinsurers regarding the handling of underlying claims. As a general proposition, the more control over an underlying claim that the contract grants to the reinsurer, the more likely it is that a court will find that steps taken by the ceding carrier to impair those rights will result in the loss of reinsurance coverage. For the same reason, too, the more control that the reinsurer exercises over the claims-handling process, the greater the risk that the reinsurer will face exposure to bad-faith and third-party claims from which it is ordinarily insulated.
Some understanding of reinsurance vocabulary is essential to the discussion that follows. Reinsurance is insurance for insurance companies. The insurance company that buys reinsurance—the ceding carrier—is called the cedent. The insurance company that sells reinsurance coverage is called the reinsurer.
The contracts between a cedent and its reinsurer can have different names. At a very basic level, a facultative reinsurance contract (sometimes called a facultative certificate) reinsures specific insurance policies for a specified period of time. A treaty reinsurance agreement (sometimes called a program) reinsures multiple policies, and can encompass several policy periods; the point is that the treaty automatically covers a defined class of underlying policies, and does not have to be renegotiated.
In almost all cases, the cedent and its reinsurer owe one another a duty of uberrimae fidei, or “utmost good faith.” See, e.g., Compagnie de Reassurance d’Ile de France v. New England Reinsurance Corp., 944 F. Supp. 986, 992-93 (D. Mass. 1996). Two doctrines, which are separate but related, spring from that duty and are a part of virtually every reinsurance relationship. First, the “follow the fortunes” doctrine requires reinsurers to accept their cedent’s good-faith decisions about whether a particular loss is covered by the underlying policy. Second, the “follow the settlements” doctrine requires reinsurers to abide by their cedents’ good-faith decisions to settle, rather than litigate, claims against those underlying policies. See, e.g., Commercial Union Ins. Co. v. Seven Provinces Ins. Co., 9 F. Supp. 2d 49, 66 (D. Mass. 1998). These traditional obligations are sometimes expressly incorporated into the reinsurance agreement.
Right to Associate Clauses
The “follow the settlements” doctrine requires the reinsurer to cover settlements made by the cedent, so long as those settlements are not fraudulent, collusive, or made in bad faith. See id. As a result, reinsurance contracts may contain language that grants the reinsurer rights about the handling of the underlying claim. These clauses are more likely to appear in facultative contracts than in treaty programs. In sum and substance, the “right to associate” is the right of a reinsurer to “consult with and advise the reinsured in its handling of a claim.” See Unigard Sec. Ins. Co. v. N. River Ins. Co., Inc., 594 N.E.2d 571, 575 (N.Y. 1992).
The scope of these clauses varies substantially, but they might take the following form:
Prompt notice shall be given by the reinsured to the reinsurer of any occurrence which appears likely to involve this reinsurance, and while the reinsurer does not undertake to investigate or defend claims or suits, it shall nevertheless have the right and be given the opportunity to associate with the reinsured at the reinsurer’s expense in the defense and control of any claim, suit, or proceeding which may involve this reinsurance, with the full cooperation of the reinsured.
- Ostrager & M.K. Vyskocil, Modern Reinsurance Law and Practice § 6.02 (2000).
A “right to associate” is not the right to control the investigation and defense of a claim, and it does not necessarily give the reinsurer the right to control settlement. See Unigard, 594 N.E.2d at 574; see also British Ins. Co. of Cayman v. Safety Nat’l Cas., 335 F.3d 205, 214 (3d Cir. 2003). Indeed, the purpose of most “association” clauses is to give the reinsurer information about the underlying claim, not to compel the reinsurer to undertake to investigate or defend claims or suits.
The cases tend to focus on two elements of the association clause. First, they consider whether late notice by the cedent impairs the reinsurers’ contractual rights, such that performance under the reinsurance contract is excused. The modern trend has been to require the reinsurer to demonstrate prejudice caused by its inability to exercise its right to associate. New York’s courts, for example, adopted a notice-prejudice rule in the reinsurance relationship long before the notice-prejudice rule was applied to direct insurance policies by statute. See Unigard Sec. Ins. Co. v. N. River Ins. Co., Inc., 594 N.E.2d 571, 574–75 (N.Y. 1992); Utica Mut. Ins. Co. v. Fireman’s Fund Ins. Co., 287 F. Supp. 3d 163, 172 (N.D.N.Y 2018). See also British Int‘l Ins. Co. of Cayman v. Safety Nat. Cas. Corp., 335 F.3d 205 (3rd Cir. 2003)(The Third Circuit stated that it believed that the Supreme Court of New Jersey would follow the rule set forth in Unigard and would rule that, under New Jersey law, a reinsurer must show the likelihood of appreciable prejudice in order to prevail on a late notice defense asserted against its reinsured.: “Since a reinsurer is not obligated to investigate, litigate, settle or defend claims, the failure to give the required prompt notice is of substantially less significance for a reinsurer than for a primary insurer. Consequently, prompt notice is not as critical to a reinsurer as it is to a primary insurer, and ritualistic adherence to prompt notice clauses in reinsurance contracts in the absence of prejudice to the reinsurer does little more than provide the reinsurer with a convenient and inequitable avenue to escape from its obligations under its policy with its reinsured.”)(internal citations omitted.) There is a minority view, however, mainly in older decisions, holding that a cedent’s failure to abide strictly by a provision that expressly made timely notice a condition precedent to liability precluded coverage under the reinsurance agreement. See, e.g., Liberty Mut. Ins. Co. v. Gibbs, 773 F.2d 15 (1st Cir. 1985).
Second, the cases consider whether the reinsurer’s exercise of its association rights exposes the reinsurer to bad-faith and other direct claims. Courts in New York and Pennsylvania have articulated a rule that reinsurers cannot be subject to bad-faith claims, because the reinsurer is not responsible for providing a defense to the cedent’s policyholder and therefore has no ability to control settlements. See, e.g., Unigard, 594 N.E.2d at 574; Reid v. Ruffin, 469 A.2d 1030 (Pa. 1983). An older case from the Fourth Circuit, however, held that the cedent and the reinsurer were “unquestionably” engaged in a joint enterprise when the reinsurer had full knowledge of settlement negotiations with the underlying claimant, even though the reinsurer had never formally exercised its right of association, such that the reinsurer was liable for its proportionate share of an excess verdict. See Peerless Ins. Co. v. Inland Mut. Ins. Co., 251 F.2d 696 (4th Cir. 1958). (The New York Appellate Division declined to follow Peerless in U.S. Fid. & Guaranty Co. v. American Re-Ins. Co., 93 AD 3d 14, 28 (N.Y. App. Div., 1st Dept. 2012). The court stated that that there is no evidence before it that the reinsurer had participated in the handling of insured Western MacArthur’s claim against USF&G, or acquiesced in USF&G’s strategy to deny that the underlying policies provided coverage to Western MacArthur. The court further stated that “[e]ven if defendants had participated, a ‘follow the fortunes’ clause does not serve to create coverage where there is none.”)
Claim Control Clauses
A “claim control” clause can be a part of a “right to associate” clause, as the example quoted above shows. Sometimes called a “claim cooperation” clause, the effect is to give the reinsurer either the option, or the obligation, to exercise actual control over all or a portion of the claim handling process. The clause may, depending on how it is written, give the reinsurer the right to consent to settlement, or the right or obligation to investigate, adjust, or resolve claims. Because the clause gives the reinsurer the right to exercise actual control over the claim, the related notice provisions may specify a fairly short timeframe and a particular form of notice. The clauses tend to appear more frequently in reinsurance agreements where the cedent has retained little or no risk.
For “claim control” clauses, as distinguished from “right to associate” clauses, timely notice of the claim can be critical. The issue has received mixed treatment in the United Kingdom. What case law exists in the United States has tended to apply the notice clauses strictly. In La Reunion Francaise v. Martin, 101 F.3d 682 (2d Cir. 1996) (unpublished), for example, the Second Circuit affirmed an arbitration award ruling that a claims-control clause required only that the reinsurer indemnify its cedent for expenses incurred after the date on which the reinsurer instructed the cedent on how to handle the claim.
A reinsurer should carefully consider how and whether to exercise any right to control the underlying claim. If it does, depending on the language in the reinsurance agreement, the reinsurer can expose itself to direct claims by the insured or by the underlying claimant—or even by third parties that, ordinarily, would not be in privity with the reinsurer. One of the more lurid examples of such exposure was provided in the case of Law Offices of David J. Stern, P.A. v. SCOR Reinsurance Corp., 354 F. Supp. 2d 1338 (S.D. Fla. 2005). In that case, a law firm purchased a lawyers’ professional liability insurance policy from Legion Insurance Company. When the law firm sued for alleged breach of the policy, the Florida federal district court declined to dismiss the claim that the reinsurer was an undisclosed principal of Legion, which had become insolvent. The reinsurer had the right to control the handling and resolution of claims, and the court held that that fact was sufficient to state a claim either that the reinsurer had breached the liability policy because it had induced Legion to refuse to indemnify the attorney, or that it had tortuously interfered with the insurer’s contractual obligations to the attorney.
Ceding insurers, as well as reinsurers, need to be aware of their association and claim-control rights, and the consequences of invoking them. The more that the reinsurer injects itself into the claim-adjustment process and defense of the underlying claim, the more likely it is to find that its protections from liability have been waived.
Cedents, however, must take care to honor their duties to their reinsurers. Impeding the gathering of information about a claim, particularly in response to direct requests for information from the reinsurer, can result in the loss of stop-loss coverage provided by the reinsurance agreement. Arbitrators and courts alike tend to take a dim view of actions that breach the duty of utmost good faith.