Vincent J Vitkowsky details the basic steps that are vital in managing reinsurance to avoid disputes, and outlines how industry relationships have changed in recent years.
In the last two decades, the relationship between ceding companies and their reinsurers has fundamentally changed. In the past, differences of opinion regarding the parties' rights and obligations were resolved amicably, often through informal discussions by the business people involved. Disputes were uncommon. Resolution by adversarial means - arbitration or litigation - was rare. The quaint and dated term `gentlemen's agreement' was often invoked and applied.
During the 1980s this relationship became much more adversarial, and the impact was felt first in the property/casualty insurance industry. Poor financial results contributed; so did the influx of new capital, often involving individuals from other segments of the financial services industry.
A concurrent cause was the increase in insurance industry insolvencies. When the liquidator appears, not even the vestiges of common business interests remain to restrain aggressive prosecution of reinsurance disputes. Thus, over time, adversarial dispute resolution has increased, perhaps not to the point at which it has become common, but certainly to the point at which it now has become acceptable.
Within the last decade, these changes have also been felt in the life and health insurance industry. Often these involve business written by managing general underwriters. This article will describe the nature of some of the disputes, identify the principles of reinsurance law and practice most commonly arising in such disputes, and offer some guidelines for managing the reinsurance relationship to avoid disputes.
Types of disputes
Disputes in the life and health industry involve a broad range of issues. The most fundamental issues are attacks on entire treaties, in which a reinsurer seeks rescission. These are typically based on misrepresentations or non-disclosure of material information at the time of placement, such as actuarial studies reflecting mortality rates or appropriate premium levels.
Other disputes include the following types of assertions: particular risks, lives, or groups could not be ceded automatically to a treaty, but rather required a special acceptance; inappropriate mortality rating and premium charges were assigned, especially when a program included substandard lives; appropriate premium has not been paid to the reinsurer when coverages are updated and the ceding company's entire retention has already been exhausted; and glaring deficiencies in treaty administration such as systematic late notice of claims warrant relief. The remedies can include retrospective premium adjustments, the reversal of objectionable cessions, or relief from liability on particular claims.
Reported legal decisions are of limited use in life and health reinsurance disputes. Most reinsurance agreements contain arbitration clauses, which provide, in essence, that all disputes are to be resolved in a private arbitration under which the panel is not required to apply judicial formalities or the strict rules of law. Moreover, there are very few reported legal decisions relating to life and health reinsurance. Finally, most disputes are unique, relating to the particular contract language, facts and issues involved.
Thus, rather than review case law, it is more appropriate to look at the key general principles of reinsurance practice which tend to be invoked in life and health reinsurance disputes.
Utmost good faith
The first principle has greatest application to the ceding company. It is the duty of utmost good faith, uberrimae fides, which is implicit in every reinsurance agreement and exists in addition to the duties expressly imposed by the agreement.
The duty of utmost good faith pervades the reinsurance relationship. It first appears with respect to the disclosure of material information at the time of placement of the reinsurance by the ceding company with the reinsurer. The ceding company should clearly describe the financial history of the business reinsured, and the underwriting principles and parameters. It should carefully describe the circumstances under which a risk is subject to a facultative submission or other special acceptance.
The duty of utmost good faith may extend into the ongoing underwriting and administration of in-force business. Guidelines as to rates and classes of business should be strictly adhered to: when in doubt, the reinsurer should be consulted. Facultative submissions and special acceptances should be documented in writing.
This principle remains significant in a ceding company's claims activities. To avoid breaching this duty, the ceding company should comply with all provisions requiring that notice of loss be given to the reinsurers. Claims cooperation clauses and right to associate clauses should be adhered to. In claims settlements requiring a high degree of subjective judgment, the reinsurer's advice may be solicited, even if the agreement does not specifically require consultation. This will limit the reinsurer's ability to second-guess difficult claims calls, and make it more likely that the principle of follow-the-fortunes will be available to protect the ceding company.
Duty of vigilance
The duty of utmost good faith is a well-established, long-standing and commonly accepted concept in reinsurance practice. The duty of vigilance is new. It is a phrase used (by the author) to describe the most important thing a reinsurer can do to manage a reinsurance agreement in order to avoid disputes, and to protect its position in the event of a dispute. In legal terms, it means a reinsurer should conduct itself in such a way as to minimize the likelihood that its remedies will be limited by operation of the doctrines of waiver, estoppel and laches. The classic legal definitions of these doctrines are:
l waiver - the intentional or voluntary relinquishment of a known right, or such conduct as warrants an inference of the relinquishment of such right, or when one dispenses with the performance of something he is entitled to exact or when one in possession of any right, whether conferred by law or by contract, with full knowledge of the material facts, does or forbears to do something the doing of which or the failure of forbearance to do which is inconsistent with the right, or his intention to rely upon it;
l estoppel - a party is prevented by his own acts from claiming a right to the detriment of the other party, who was entitled to rely on such conduct and has acted accordingly; and
l laches - this doctrine is based upon the maxim that equity aids the vigilant and not those who slumber on their rights. It is defined as neglect to assert a right or claim which, taken together with lapse of time and other circumstances causing prejudice to the adverse party, operates as bar in a court of equity. The neglect for an unreasonable and unexplained length of time under circumstances permitting diligence, to do what in law, should have been done.
In practical reinsurance terms, the duty of vigilance means the reinsurer should pay attention, participate in monitoring the administration of the agreement, and make a written record that it has done so. In a dispute, the reinsurer may allege that the ceding company abused the treaty by deviating from the approved guidelines, applying underwriting and rating standards too liberally, or withholding vital information from the reinsurer. In its defence, the ceding company will assert that the reinsurer knew or should have known of the conduct it complained of, and that the reinsurer implicitly approved of the conduct, or acquiesced in it by silence, and thus has no basis for relief. This issue arises in a great many reinsurance disputes.
Thus, the reinsurer should do several things. It should exercise its rights and conduct routine, systematic and thorough audits. It should also be very active in supervising the underwriting and administration of the business, especially within the first year of a new reinsurance agreement. In addition, the reinsurer should advise the ceding company of any objections it has to matters such as the application of underwriting standards, the use of facultative submissions and special acceptances, and the processing, handling and settlement of claims. The reinsurer should make a written record of its efforts and let the ceding company know that it is paying close attention, and actively work to establish a pattern and practice of full communication. The reinsurer should act in accordance with the reality that ultimately its own money is at risk.
General underwriters and`program business'
Often, the most challenging issues arise when insurers or reinsurers delegate underwriting or claims-handling authority to entities such as managing general underwriters, managing general agents (MGAs) and third-party administrators. The risks become compounded when the entity is acting on behalf of multiple companies in a reinsurance pooling arrangement (sometimes referred to as `program business').
Several issues tend to arise. First, questions regarding material misrepresentations arise with greater frequency in program business. The alleged misrepresentations may involve matters such as loss history, the nature of the business to be ceded, the ownership of other entities placing business with the MGA, the criteria and process for selecting risks, and the identity or likely identity of the other participants.
Issues also arise regarding the rights and obligations of the participants in respect of each other. These include the extent of the rights and duties of the issuing insurer, the sponsoring insurer or reinsurer, the fronting insurer or reinsurer and the lead reinsurer. One or more companies can play each of these roles, or can play different roles for different purposes in the program. The key point is that the usual relationships between the ceding company, the reinsurers and the other participants do not necessarily apply. They can be altered by the context of a particular transaction. The duty of vigilance to monitor, supervise and control managing general agents, MGAs or third-party administrators may fall upon several parties.
To protect themselves in such transactions, prior to committing to participate, each of the parties should review all contract materials and all agreements relating to all parties, the business, and the structure and operation of the pool. Secondly, to the maximum extent possible, the parties should set forth their expectations of each other expressly, in written management agreements and pool participation agreements. To this end, some companies engage outside counsel to assist in the pre-commitment review of the legal documentation relating to program business.
The reinsurance relationship requires careful management. The ceding company should take pains to communicate often and clearly with the reinsurer. The reinsurer should take pains to monitor and supervise the ceding company. These basic steps are fundamentally important in managing reinsurance to avoid disputes.
By Vincent J Vitkowsky
Vincent J Vitkowsky is a senior partner in the insurance and reinsurance practice group of Edwards & Angell, LLP, New York Office. He has represented insurers and reinsurers in more than a 100 reinsurance disputes.