In 2007, cedants on both sides of the Atlantic were reminded that follow-the-settlements/fortunes clauses do not guarantee recovery from reinsurers. Ian McKenna and Sarra Zemmel review some of the major legal battles.
One of the most high profile cases of 2007 was Wasa International Insurance Co Ltd v Lexington Insurance Co. Here, the English Commercial Court confirmed that a reinsurer is not obliged to payout to the cedant unless the loss falls within: (i) the cover of the insurance contract; and (ii) the cover created by the reinsurance contract.
The cedant must prove both of these but the parties can agree how they should be proved, usually by way of a follow-the-settlements clause. While reinsurers are bound by proper and business-like settlements made by the cedant, the cedant still has to prove that the claims recognised by the settlement fall within the cover created by the reinsurance contract.
Lexington provided property insurance to Alco for the period 1977-1980. Lexington was found liable for the clean-up costs at various Alcoa sites concerning environmental damage which occurred from 1942-1986. The insurer settled with Alcoa for just over $100m and sought recovery under its facultative reinsurance contract for the same period. While Lexington’s settlement of losses was proper and business-like, the reinsurance only covered property damage occurring within the policy period.
Manipulating the system
The New York Appellate Court in Allstate Insurance Co v American Home Assurance Co found that reinsurers were not required to follow the fortunes of the cedant, despite the presence of a follow-the-fortunes clause in the reinsurance contract. The cedant’s post-settlement allocation of environmental pollution occurrences at various sites was “neither reasonable nor reflective of good faith”.
According to the court, the cedant’s different treatment of losses for the purposes of settlement in the underlying litigation (where it treated losses as multiple occurrences per site) and for the purposes of its reinsurance claim (where it treated losses as one occurrence per site) was a “manifest manipulation of the allocation process in total disregard of the cedant’s obligation to act in good faith”.
The importance of time limits was also underlined on both sides of the Atlantic this year. In Kosmar Villa Holidays v The Trustees of Syndicate 1243, a clear breach of a notification condition entitled public liability insurers to repudiate the insured’s claim. However, they had sufficient information to decide whether to do so within two weeks of the insured’s late notification. By failing to give this notification, the insurers waived the right to rely on the breach. The Court of Appeal commented wearily that it had: “once again… [been] called upon to construe a standard form Claims Co-Operation Clause in a reinsurance policy which is apt for property insurance but inapt for liability insurance.”
Out of time
AIG Europe (Ireland) Ltd v Faraday Capital Ltd concerned a shareholder action started in the US. It alleged that, as a result of financial statements made by the original insured, the value of its shares was artificially inflated beyond their true worth. It was a condition precedent to reinsurers’ liability that the cedant: “upon knowledge of any loss or losses which may give rise to a claim, advise the reinsurers thereof as soon as is reasonably practicable and in any event within 30 days… ”.
Notification was properly given under the original liability policy. However, reinsurers were not notified until after the US action was settled. At first, the Court said the cedant had complied with its notification as the “loss” had to be an actual and not an alleged or potential loss. It argued that an actual loss was established by way of settlement of the underlying shareholder action. The Court of Appeal disagreed, holding that an earlier sharp fall in the original insured’s share price was a “loss which may give rise to a claim” within the meaning of the clause.
In Certain Underwriters at Lloyd’s London v Argonaut Insurance Co, the US Court of Appeals for the Seventh Circuit held that the 30-day time limit in a reinsurance arbitration agreement did not allow for extension for federal holidays or Sundays. Lloyd’s complied within 30 days of Argonaut’s arbitration demand. However, Argonaut’s deadline expired on Sunday 5 September 2004, 30 calendar days after Lloyd’s request. Lloyd’s informed Argonaut on 5 September (Labor Day in the US) that the deadline had expired and that Lloyd’s had the right to select the second arbitrator. Argonaut sought to nominate its arbitrator on 7 September, the first business day after expiry of the deadline.
Duty of care
Brokers’ duties have also been under the spotlight in the UK. In HIH Casualty and General Insurance Limited v JLT Risk Solutions Limited, the Court of Appeal confirmed that brokers may, in certain circumstances, owe a continuing duty of care to the cedant to advise it of potential coverage issues.
The brokers placed pecuniary loss indemnity insurance with HIH to cover investors’ funding of three slates of films. The brokers also placed back-to-back reinsurance for HIH. Fewer films were made than were originally specified at placement, so the returns fell short and the investors made a loss. HIH made payments under the insurance of over $55m and sought to recover from reinsurers. The reinsurers did not pay out as a result of a breach of contract relating to the number of films which were to be made.
HIH brought proceedings against its brokers. The Court of Appeal found that the brokers owed HIH a duty of care to advise it of the coverage implications of fewer films being made and that they were in breach of that duty. Nevertheless, even if HIH’s broker had alerted it to the potential coverage issue it would not have made any difference to reinsurers’ later repudiation of liability. HIH’s loss was not therefore caused by the broker’s breach of duty.
In Limit No 2 Ltd v AXA Versicherung AG (formerly Albingia), the issue was whether Albingia was entitled to avoid first loss facultative obligatory reinsurance treaties protecting the energy accounts of a Lloyd’s syndicate. Albingia said it had relied on a representation made by the broker as to the underwriting of the inwards account contained in a fax cover sheet. It said that “as a matter of principle they maintain high standards and would not normally write construction risks unless the original deductible were at least £500,000 and preferably £1,000,000”. The fax cover sheet attached an information sheet prepared by the class underwriter of the energy account and certain statistical information which included that the operating risk market had been under “severe strain” and “pressure”.
The syndicate maintained that the broker’s comment was merely their opinion and was not intended to be read as a statement of practice. However, the Court found that “it was intended… to put the proposed treaty into context and to convey some important headline messages to Albingia”. Moreover, the representation was false as this was not the syndicate’s normal underwriting policy for construction risks and any competent reinsurer was bound to want to know this. The Court found that Albingia had been induced to enter into the reinsurance on the basis of the misrepresentation and accordingly was entitled to avoid the treaty.
An endorsement extending the policy period for seven months could also be avoided on the basis that its effect was to replace the original 12-month period with a 19-month period. Albingia also successfully avoided the subsequent treaty renewal on the basis that the broker’s statement was a continuing material misrepresentation, despite market conditions having deteriorated.
In addition, there had been a steep deterioration in the account. Whilst the syndicate had disclosed a loss bordereaux on the expiring treaty “as at 31/1/98”, Albingia did not put down its scratch for a further five weeks during which time the loss position inevitably changed. The syndicate had failed to disclose significant additional loss reserves. The key question was whether “claims and incidents… were sufficiently serious to alter the balance of overall presentation”.
Continuing the line of cases arising out of the September 11, 2001 terrorist attacks, a Minnesota federal judge confirmed that losses incurred as a result of the attacks arose out of one event under the definition of “accident” in a catastrophe excess-of-loss reinsurance contract (ReliaStar Life Insurance Co v Certain Underwriters at Lloyd’s London).
At issue was whether the syndicates should pay ReliaStar’s claims arising from September 11 on a multiple event (or occurrence) basis or on a single event basis. The judge confirmed the majority determination of the arbitral panel, to which the dispute had been submitted initially by the parties, that the attacks arose out of one event.
Ian McKenna is a partner and Sarra Zemmel is a solicitor at Mayer Brown International LLP.