Reinsurers often complain about how US insurance company liquidators, rehabilitators, and receivers treat them. Reinsurers are warned about the “natural incentive for the liquidator to maximize reinsurance recoveries” and urged to “watch liquidators carefully” until a “full settlement” can be reached. 1 This distrust may extend to how and when claims are reported, whether the reinsurer can rely on the estate's reserves, and how long it takes to wrap up the estate.
So it was a breath of fresh air to read a reinsurance claims person write about “silver linings” in a US insurance insolvency. See J. Cuff, Insurance Insolvencies: The Reinsurer's View, Mealey's Litigation Report: Insurance Insolvency, Vol. 12, No. 5 at 21(8/10/00). Mr Cuff, who was a senior claims person at both Munich Re and General Re, observed that shortly after the storm that surrounds an insurance company failure, the clouds part, and the sun shines down on the “brighter side: lower settlements and delayed payments.” Nevertheless, the “brighter side” is often obscured by misunderstandings, false starts, and a lot of wasted motion as reinsurers adjust to their new reinsurance partner.
Having seen the “reinsurance relationship” from both sides of the liquidation process - as counsel for companies that both ceded to and assumed business from failed companies and as counsel for the liquidators of insolvent insurers - I've concluded that reinsurers waste a lot of time, good will, and money because they try to apply the same accounting, claims, and reporting standards to the insolvent company's receiver that they applied to the cedant as an on-going entity. And much of this misunderstanding derives from their not focusing on why the liquidator can't respond or perform the way the ceding company responded or performed.
Here are ten steps to take or observations to make when you learn that a company you reinsured has been liquidated. Whether you're dealing with a fresh failure or an estate that's been in liquidation for years, these suggestions may eliminate some of the confusion and distrust that often accompanies a liquidation, and make it easier to find that “silver lining.”
1. Read the statute. As most of our readers know, every state has specific legislation to oversee the liquidation of a failed insurance company. Many believe that these state laws are based on a “model law” and are pretty much the same. In the broadest sense, that's true. All of these statutes require that the liquidator marshal assets, compute liabilities, and distribute moneys to claimants on a priority basis. As always, however, devils live in the details.
Most insurance insolvency statutes are derived from model laws, including the Uniform Insurers Liquidation Act and the NAIC's Insurers Rehabilitation and Liquidation Model Act. See S. Kimball, History and Development of State Insurer Insolvency Proceedings, in Law and Practice Of Insurance Company Insolvency (1986). But state legislatures have tinkered with these models. Insolvency laws in a given state may, therefore, have unique provisions with respect to offset, arbitration, interest on premium due the estate, or specific additional powers for the liquidator. For that reason, the relevant insolvency statute should be reviewed, particularly inasmuch as US courts charge insurers (and reinsurers) with knowledge of these laws. See California State Auto Assn. vs Maloney, 341 U.S. 105, 109, n. 2 (1951).
A quick review of the relevant insolvency law serves another purpose. It sets out the structure of the liquidation and outlines the liquidator's powers, his or her fiduciary obligations, the role of the liquidation court, the priority of claims payments, and the steps needed to close the estate. The liquidator's powers often include the power to hold hearings, subpoena witnesses, and take testimony under oath.
There are often separate provisions that permit the liquidator to audit the books and records of the company's agent. Some states allow the liquidator to issue a written demand that funds belonging to the estate be returned within twenty days, and, if challenged, to conduct a hearing to determine ownership of funds. See Fla. Ins. Laws, Ch. 631.154 (2000). Often this authority isn't used, but just because the reinsurer hasn't heard from the liquidator's staff doesn't mean that the reinsurer can close its file and ignore requests for information.
2. Read the order. The liquidation order is the key legal document in the insolvency. The order “fixes the rights and liabilities” of every party with an interest in the estate. The order cancels underlying policies and triggers the obligation to return unearned reinsurance premium. The order also sets a date for the submission of proofs of claim (and often reinsurers have claims against the estate).
The liquidation order may specifically require that the insolvent company's reinsurers cooperate with the estate's liquidator. The order may shift the burden to the reinsurer to account for moneys being held. The statute and the order set the tone for discussions to follow, and highlight how the reinsurance relationship has changed, largely because of the “insolvency clause.”
3. Consider the “insolvency clause.” Almost every reinsurance contract with a US cedant contains a standard insolvency clause. This provision states that in the event of the cedant's insolvency, the “contract shall be payable directly to the Company or to its liquidator, receiver, conservator or statutory successor on the basis of the liability of the Company without diminution because of the insolvency of the Company or because the liquidator, receiver, conservator, or statutory successor of the Company has failed to pay all or a portion of any claim.” After liquidation, the relationship between reinsurer and cedant is no longer an indemnity arrangement.
The clause goes on to provide that, within a “reasonable time”, the liquidator or receiver shall give written notice to the reinsurer of any claim that might reach the reinsurer's contracts. This allows the reinsurer to “investigate and interpose, at (the reinsurer's) own expense any defense or defenses that (the reinsurer) deems available to the company or its liquidator.” Taking over the defense of a claim, however, requires that an understanding be reached with the liquidator about how the claim will be defended.
For example, if there are multiple insureds on a liability policy, should separate counsel be retained? If counsel has already been retained, how are the files to be transferred? Does the liquidator need to approve any defenses raised? This is particularly important because the clause allows the interposing reinsurer to raise any defense available to the company or the “liquidator, receiver, conservator, or statutory successor.”
Interposing a defense raises other interesting questions. For example, does the reinsurer assume the risk that any verdict entered may subject it to judgment in excess of policy limits? What about the defense costs themselves? The clause usually provides that this expense can be charged, subject to the liquidation court's approval, as part of the expense of the liquidation, but only to the “extent of a pro rata share of the benefit which may accrue to the Company solely as a result of the defense undertaken by the Reinsurers.” Thus, the parties might want to consider the following:
These issues can be resolved, but the parties should address them early in the process.
4. Letters of credit (LOCs) and trust agreements. An immediate review of all existing letters of credit, trust agreements, and other security devices may also be in order. The liquidator steps into the insolvent company's shoes and assumes control of its assets and liabilities, including any security devices in place to secure payment. A premature drawdown of a letter or a peremptory strike on a trust agreement is always a possibility.
In a relatively recent case, an insolvent company entered into a reinsurance contract and a letter of credit effective 31 December, 1983, terminable after twelve months on fifteen days notice. The company went into rehabilitation on 26 December, 1984. The rehabilitator drew down the entire LOC the following day, 27 December, 1984, a few days before the LOC expired. This led to a proof of claim, litigation over the proof, an appeal, and a remand to a hearing officer. See referee's report dated 2 October 1998, in In Re Ideal Mutual Ins. Co. (Harbour Ass. Co.), Index No. 40275/85 (Sup. Ct., N.Y. County). Perhaps this drawdown couldn't be avoided, but addressing the issue promptly might have avoided conflict and litigation.
5. Call the liquidator. Liquidators and their staffs vary, but there's certainly nothing wrong with contacting the liquidator's staff at the outset of the insolvency. The reinsurer has the right to reasonable notice of open claims pursuant to the insolvency clause. Putting aside access to records provisions in the treaties or certificates themselves, reinsurers can point to the insolvency clause as buttressing their need to review open claim files.
Of course, the files may not be in one location. Open claims, for example, may have been assigned to state insurance guaranty associations (IGAs). If an insolvent Illinois insurer issued a policy to an insured living in Mississippi, the defense of that claim may have been taken over by a Mississippi guaranty association, which has retained Mississippi counsel to defend the claim. The “file” for this open claim may consist of: (a) records and reports in the liquidator's office; (b) a file in the IGA's office; and (c) a “working file” in the office of the attorney handling the claim. A review of these files may raise attorney-client privilege issues, but a curious reinsurer should review all these records.
6. Realize that reporting formats and reserves may have changed. It's a cliche that an insolvent company's records are in disarray, and in many cases that's true. On the other hand, soon after the liquidation process begins, the insolvent company's accounts and records may be in better order than they were when the cedant and reinsurer were doing business.
For one thing, the estate isn't a failing company struggling to stay above water. The danger that reports or reserves may be distorted by a failed company's management disappears. The insolvent company's policies have been cancelled. All pending litigation has been stayed, at least for several months.
Whereas the failing company was casting about for more premium, dealing with regulators, and still accepting claims, the liquidator is now concentrating on closing the estate. A new set of eyes may have evaluated the claims, combed through the premium records, and tied accounts together, but this process may work in the reinsurer's favor.
During the insolvency, the liquidator may change reporting formats or accounting software. Even if the reports look precisely the same, the information being reported may have changed. Before the insolvency, the company's managers oversaw the claims and any related litigation, and retained counsel from an approved list. Claims were reserved and reported using a standard that management had followed for years.
Now the claims are handled by various IGAs, with new counsel defending them. The standards for reserving and handling the claim may have changed, largely due to the role of the IGA, but not necessarily for the worse.
7. Recognize the role of the IGA. After the liquidation, the day-to-day supervision of pending cases and open claims shifts to the IGA in the state where the insured resided. Litigation may now be overseen by many different IGAs that have retained counsel, for the most part new counsel, to defend these cases. The IGAs have established reserves for these cases, but the IGA's obligation to pay is subject to statutory caps, typically $300,000 per claim, which the IGA will eventually submit to the estate as a claim for reimbursement. See, for example, IGWILCO vs Property & Casualty Ins. Guaranty Corp., 750 A. 2d. 646 (Ct. Sp. App. Md. 2000).
In an open case, the estate establishes a further reserve to cover a claim or suit that may exceed the guaranty fund's cap. The total reserve for a claim, therefore, may be a combination of a reserve established at the IGA level, and a separate reserve set by the estate. Regardless of whether the liquidator retains the insolvent company's reporting format, the reserve information necessarily differs from reserves that were established while the company was writing business. The estate can project a reserve, but the underlying circumstances - different counsel, caps on liability, the number of IGA caps per “occurrence,” and the effect of the insolvency itself on the willingness of claimants to compromise - has to be factored in to arrive at a meaningful reserve figure.
This doesn't mean that the reserve figures are necessarily less reliable than reserves posted before the insolvency. Indeed, the reserves now reported may be far more realistic. Too often, however, reinsurers focus on changes in reporting format, inevitable lags in reporting between the IGAs and the estate, and changes in reserve figures, and conclude, without further review or analysis, that the reported figures are suspect. The explanation for a reserve change can, in most instances, be found in the estate's files, but it may take patience, persistence, and pluck to make that determination.
8. Dispute resolution. Before liquidation, the insolvent company primarily answered to one regulator, but many courts. After the insolvency, the liquidator answers to only one court - the “liquidation court.” The insolvency statute and the liquidation order usually give the liquidation court “exclusive jurisdiction” over all disputes relating to the insolvency. This prevents the liquidator from being forced to defend actions in many different jurisdictions. The liquidator, however, can commence suits in other courts if she elects to pursue a claim against a party over whom she lacks “personal jurisdiction.”
Meanwhile, almost all reinsurance contracts contain arbitration agreements which, if enforced, confer upon an arbitration panel the power to decide issues that directly affect the estate. These clauses also raise the possibility that the liquidator will be subject to arbitral proceedings in another state or country. There are literally dozens of reported US cases on the issue of whether a liquidator can be compelled to arbitrate. These cases raise the following issues:
There are states in which liquidators cannot be compelled to arbitrate, for example, New York and Missouri. Corcoran vs Ardra Insurance Co., 77 N.Y. 2d 225 (1990), cert. denied, 500 U.S. 953 (1991); Transit Cas. Ins. Co., in Receivership vs Certain Underwriters at Lloyd's, 995 S.W. 2d 32 (Mo. App. W.D. 1999). There are states in which liquidators have been compelled to arbitrate, for example, Pennsylvania and Montana. Koken vs Cologne Reinsurance (Barbados), Ltd, 34 F. Supp. 2d 240 (M.D. Pa 1999); Bennett vs Liberty Nat'l Fire Ins. Co., 968 F.2d 969 (9th Cir. 1992).
There are cases in which a district court recently ordered the parties to arbitrate, but a circuit court reversed. Stevens vs American Inter. Insurance Co., 66 F.3d. 41 (2nd Cir. 1995). And you will also find a case in which a magistrate and district court concluded that reinsurers had waived their right to remove a fight over arbitration to the federal court, implying that there was no right to arbitrate, but a circuit court, by a two to one vote, overturned the two lower court judges. Suter vs Munich Reinsurance Co., 2000 WL 1093308 (3rd Cir. 2000). There are even cases in which the same liquidator of the same insolvent insurer avoided arbitration in one court, but was compelled to arbitrate by another court. Compare Nichols vs Vesta Fire Ins. Corp., 56 F. Supp. 2d 778 2d (E.D. Ky. 1999) with Stevens, 66 F.3d 41.
Three points emerge from these cases. First, in most instances, the “right” to arbitrate isn't guaranteed. Second, the liquidator has less authority than did the cedant when it comes to resolving disputes outside the liquidation court through arbitration, mediation, or some other method of dispute resolution. Third, a liquidator may be willing to arbitrate some “garden variety” contract cases, but unwilling to arbitrate a case that touches on provisions in the state's insolvency laws or would alter the terms of a proposal to close the estate.
9. Fiduciary obligations. It's not unusual for a commutation contract or settlement to include a personal release for the liquidator himself. The liquidator is in a difficult position when he steps into the insolvent's shoes. He or she is responsible for dividing the estate's assets (and liabilities) among:
In most respects, the reinsurer, who answers primarily to its shareholders and the US Treasury, has more freedom to negotiate and compromise claims than does the liquidator and his or her staff.
10. Reinsurance as a contact sport. It's tempting when a cedant fails to sit back and wait for the receiver to come to you. Or hide behind the intermediary, if the intermediary continues to play that role. In some instances, the intermediary has no choice but to become involved, particularly if it holds earned or unearned premium, unearned brokerage, or moneys that were in the pipeline when the liquidation order was entered.
The intermediary can play a critical role in resolving reinsurance questions because its records are the best source of information on how the treaties were entered into, administered, and accounted for. The intermediary, however, also insulates the parties. Attorneys add value to this process. See F. Semaya, Lawyers - We Can't Live With Them - We Can't Live Without Them, 1992 NAIC Workshop for Rehabilitators and Liquidators Task Force( Feb. 6-7, 1992). But unless the parties stay in touch with one another, this may further stretch the lines of communication.
Rather than waiting for the inevitable call, reinsurers and their agents and intermediaries would profit from reaching out to the cedant's receiver as soon as possible. It often takes years to wind up an insolvent company, but liquidators have long memories. And in some instances claims for unpaid premium or other funds due the estate accumulate interest until paid (even though a reinsurer's general creditor claim against the estate won't earn interest). Regardless of whether you can find a “silver lining” in your cedant's liquidation, personal contact, engagement, and a willingness to learn how the estate operates may be the best way to handle your new “reinsurance relationship.”
1 Hammesfahr & Wright, The Law Of Reinsurance Claims at p.254 (1994).
James Veach is a partner in the New York office of Mound, Cotton & Wollan. Mr Veach concentrates his practice on insurance and reinsurance litigation, arbitration, and insolvency.
Thanks to Catherine Megret for her contribution to this article but the views expressed are those of the author alone, who takes full responsibility for any errors or hyperbole.