Insurers increasingly find they are compelled to honour D&O claims despite not having all the information necessary to take an objective view on coverage The knock-on affect is strain on the insurer/reinsurer relationship, explains Richard Murray.
While the fact of change has been a constant in the general insurance industry, the pace of change has been escalating dramatically. During the final quarter of the last century, large evolutionary development was measured in decades. As the 20th century came to an end, that cycle had shortened to, perhaps, three years. Today, emerging trends that require the development of new perspectives and responses can occur in a matter of months - often with a significant impact on the insurer/reinsurer relationship.
Consider, for example, the current level of activity arising from the cluster of claims filed by investment banks arising out of the WorldCom, Enron, and IPO episodes. Until December 2000, when Eliot Spitzer and the Securities and Exchange Commission announced a stunning regulatory settlement with a large number of major investment banks, investment banking had been deemed to be a relatively low risk commercial enterprise. But then Worldcom and Enron imploded and investment banks now find themselves targeted with civil damage claims almost as routinely as auditors.
While that represents a dramatic change over the past five years, from an insurance perspective the dramatic consequences have evolved over an even shorter timeframe. Essentially, this has occurred over the space of a year in which the underlying claims against investment banks have begun to settle, resulting in several new challenges for insurers. Indeed, there has never been an episode that, within a timeframe as short as the past six months, has presented so many new issues and challenges for insurers, in particular surrounding the intersection of cedants and reinsurers.
Reflecting on the rapidly changing context in which these issues occur, at least five major conditions must now be recognised and addressed:
- Settlements involving the simultaneous resolution of multiple large exposures, either through policy buybacks or other means of packaging claims resolutions;
- The clustering of settlement packages in which multiple banks settle in rapid succession, and often under very similar terms and conditions to one another;
- Settlements in large sums achieved either very early in the cycle of underlying litigation, or at least in circumstances where the information that is most fundamental to determining whether the fact or quantum of coverage fall properly within the terms of the applicable insurance policies is, at best, only partially available;
- Settlements arising in an atmosphere in which it is at least possible that the insured banks have been motivated into settlement for a blend of legal liability and commercial prudence objectives; and
- The rapid acceleration and more aggressive techniques used by attorneys for insureds to deny insurers access to documents asserted to be privileged or otherwise confidential. The improved techniques often involve the voluntary submission to insurers of masses of documents, while withholding those which have relevance to determining the questions of coverage and quantum.
The insurance industry is just beginning to recognise and process conditions that are either new, or uniquely frequent and massive in their consequence. Insurers have been largely deprived of information on which coverage evaluations are normally based. When the underlying litigation provides little insight into either the insureds' legal liability or to the facts that will assist in determining coverage issues, and the documents that would offer valuable insight are withheld as privileged, insurers find themselves asked to pay substantial sums. Very often this involves entire towers of available coverage - with only two points of reference on coverage and quantum: the underlying complaints against the insureds drawn up by the "kings of tort", who are very adept at pleading the defendant into insurance coverage entitlement; and the fact that the insured has paid sometimes substantially more than policy limits. The insured's presumption in these circumstances is that coverage must be available because there is nothing in the visible record to demonstrate otherwise.
When settlements are concluded in this manner, with associated demands upon insurers, the industry's traditional ability to base decisions on relatively objective data is unavailable. As a result, insurers are confronted with the difficult dilemma of making subjective determinations about their coverage obligations or denying coverage with a significant prospect that bad faith claims would be presented in the event of denial. The result is an emerging pattern of subjective payment agreements, sometimes at discounted levels, but nearly always lacking in any objective basis for demonstrating that the decision to pay is reasonable and prudent.
This, in turn, produces a new generation of difficulties between cedants and their reinsurers. The multitude of treaty provisions regarding a reinsurer's right of independent decision complicates the matter further. However, most treaties contain some form of consultative obligation to the reinsurers and, even in the stronger follow-form treaties, there is a condition of the reinsurer's obligation that the cedants will have made payment within the terms of the policy. When the cedant's decision has been burdened by the need for subjectivity (ie in cases where all the necessary information has not been provided by the insured), and the reinsurers have some right of independent inquiry, the intersection with reinsurance can be fraught with difficulty.
It would be inappropriate, at this point, to comment on the specific treatment of reinsurance issues. However, the situation does lend itself to some observations about the environment surrounding the intersection of insurers and reinsurers. The issues almost universally arrive in a micro context, meaning that they involve a single cedant, a single reinsurer, an individual or small cluster of settlements, a specific set of treaty issues and an easily defined understanding of each party's desired outcomes within the four corners of the micro event. Once locked within those four corners, the issues and the relationship can easily become strained.
However, we all operate within a macro environment as well where the interests of cedants and reinsurers are not so immutably in conflict. For example:
- The size of settlement pies can have a larger shared value for both parties than the shape of the slices. Beyond the four corners of the immediate issue are relationships, other transactions, future developments and circumstances in which the collegial resolution of micro issues can lead to the mutually more favourable outcome of other and more substantial interests;
- The stress points within the four corners of a micro dispute can often be reduced by early recognition and action. Whatever the form of the cooperation clause, the fact of cooperation and collaboration between cedants and reinsurers can lead to a reduction in conflict; and
- One of the leading ways in which such collaboration can be of assistance involves the joint design of the form and extent to which cedants should impose the highest possible standards for obtaining objective and useful information from the insureds, before either approving settlement or agreeing to payments.
Applying the tools of early engagement and a broader perspective on the collective best interests of insurers and reinsurers alike, is a natural consequence of the rapidly evolving settlement conditions described above. It is also a natural consequence of the fact that very few of us wear only a single hat at all times. In any gathering of the industry, it is difficult to identify representatives of firms whose sole activity is either the direct placement of insurance or solely the acceptance of reinsurance exposures.
In most cases, firms may be viewed as historically dominated by one or the other discipline, but the blending of roles is one of the factors of our time. Rather than looking at the issue in isolation, and asking "what do I as an insurer or as a reinsurer wish to accomplish in dealing with the adversary across the table?", we should contemplate that the adversary across the table might be a mirror image of ourselves, and that colleagues from both organisations might be meeting elsewhere at the same time, disputing the same issues from opposite perspectives. Or, as more eloquently put by the cartoon character Pogo about 25 years ago, "We have met the enemy and he is us."
- Richard Murray is chief claims strategist at Swiss Re.