Captive reinsurance disputes can be lengthy and expensive. David McCarthy offers some simple but effective solutions to avoid such quarrels.
The financial and operational benefits of utilising a captive insurer or reinsurer are well documented. Careful structuring of reinsurance and claims management remain the two aspects of captive management that can materially affect such financial and operational benefits. Due to the unique nature of a captive, considerable care is required in both areas to try to avoid disputes with reinsurers. Such disputes can significantly delay or reduce claim payments or, in a worst case scenario, result in reinsurers not being liable for a claim.
The normal duties of disclosure owed under English law are complicated by the chain of contracts typically involved in captive insurance or reinsurance. As well as the insured, the captive and its reinsurers, there may well be a local insurance company “fronting” the risk for the captive.
Reinsurers will wish to guard against the possibility that the insured has failed to disclose material facts to the fronting company. Such a failure can lead to difficulties for reinsurers because duties of disclosure are owed at each level of the contractual chain, yet the real underwriting is only occurring between the reinsurers and the insured.
If the insured has failed to disclose a material fact to the fronting company, the captive may not have had knowledge of that when making its own disclosure to reinsurers. The reinsurers may not therefore be able to exercise the normal remedies for non-disclosure against the captive.
Reinsurers will want to avoid such a situation by requiring that the insured discloses all material facts. Alternatively, reinsurers may want the insured specifically designated as an agent of the captive to reinsure.
In these circumstances, the captive must have adequate systems in place to ensure all material facts are disclosed by the insured. It will no longer be shielded from any disclosure failure by the insured and could suffer its reinsurance being avoided as a consequence of any non-disclosure.
“The normal duties of disclosure owed under English law are complicated by the chain of contracts typically involved in captive insurance or reinsurance
The number of parties and contracts in a captive insurance programme can be substantial. Care must be taken on placement to ensure that the captive’s insurance or reinsurance is completely “back to back” with its outwards reinsurance coverage. Reinsurers raising an allegation that the captive’s outwards reinsurance coverage was not “back to back” will lead to an ongoing coverage dispute.
The splitting of risk between multiple reinsurers by way of different contracts should also be minimised or, if possible, avoided. This only increases the potential for each reinsurer to argue that any claim by the captive falls to other reinsurers or that there is a “gap” in coverage.
Location, location, location
A captive should consider the ideal jurisdiction or forum and law for resolution of any disputes with its reinsurers. To the extent possible, these should be selected based on where the captive believes it will obtain a favourable and cost-effective determination of any disputes.
The inclusion of an express choice of law and exclusive jurisdiction or arbitration clause will help to achieve certainty as to where disputes will be resolved. This reduces the risk of a very expensive battle over jurisdiction or forum before the substantive issues in dispute have started to be considered. In many circumstances, it may also have a considerable impact on how any coverage issues are determined and may even be determinative of those issues.
Some local or extra-territorial laws may seek to override an exclusive jurisdiction clause or forum selection. These should also be considered. An example, in the context of European insurance, is Article 12 of EC Regulation 44/2001. This can override an exclusive jurisdiction clause in favour of the courts of the insurers’ country of residence, provided a “large risk” exception is not fulfilled.
A number of US States also have “anti-arbitration” statutes which can be relied upon by insureds domiciled in those states to try to invalidate foreign arbitration clauses in favour of the jurisdiction of their state’s local courts.
“Jurisdictions should be selected based on where the captive believes it will obtain a favourable and cost-effective determination of any disputes
A captive must exercise careful management of its claims settlement process in order to avoid any dispute with its reinsurers. In particular, three areas of a captive’s claim management process have the potential to give rise to disputes with reinsurers. These are the notice period of the claim, claims cooperation and follow-the-settlements.
The terms of a captive’s reinsurance will normally provide for the timely notification of claims to reinsurers. If such a clause is expressed as a condition precedent to liability, then a captive must have in place proper systems to ensure that any notice period is not breached. This is necessary as under English law, a breach of a condition precedent will inevitably lead to a valid rejection of the claim.
Even if the clause is not expressed as a condition precedent, a captive ought to ensure that claims are notified in a timely manner to avoid the reinsurers seeking to argue they have suffered damage.
A captive will typically be required to grant its reinsurers some level of claims cooperation or control. Reinsurers will normally require such an obligation given the likely position of the captive as a subsidiary of the insured and their financial exposure to its claims handling decisions.
Claims cooperation (or control) clauses will require the involvement (or agreement) of reinsurers before any admission of liability or settlement of a claim by the captive. Such clauses can be expressed to be a condition precedent to liability. A captive must therefore have adequate systems to avoid non-compliance, resulting under English law in a valid denial of any claim. A captive may also wish to obtain its own claims cooperation from its fronting insurer to enable it to exercise control over their behaviour.
Follow the settlements
“Reinsurers may not always be prepared to follow the settlement of a captive
Reinsurers may not always be prepared to accept an obligation to follow the settlement of a captive. It is far more typical for reinsurers to wish to have some involvement in claims handling. Thus, they will maintain some level of overview of the professionalism of a captive in investigating, assessing and presenting a claim.
Nevertheless, with the benefit of a follow settlements obligation, a captive cannot be less rigorous in the way it handles claims as compared with a third- party insurer.
Reinsurers will be alive to their rights under English law to challenge any settlement to which the captive is trying to bind them. Typically, the reinsurers can take the points that either the claim did not fall within the terms of the reinsurance, or that the captive had not taken all proper and businesslike steps in making the settlement. If the reinsurer can re-open coverage issues on either of these fronts, then the benefit of a follow settlements obligation to the captive is limited.
A particular problem with captives is that they may forfeit their ability to rely on a follow settlements obligation where the reinsurer can establish collusion in the treatment of the claim. Where a captive and its parent have attempted to “structure” a settlement intending to bind the reinsurer, the captive will forfeit the benefit of the follow settlements obligation under English law. This is because the captive has not acted in a proper and businesslike manner.
Careful structuring of reinsurance and proper claims management are two critical elements for a captive. Achieving success in both will help a captive to avoid disputes with their reinsurers and any resulting restriction of a fast and efficient claims settlement.
David McCarthy is an associate director in the insurance and reinsurance group of Berwin Leighton Paisner LLP.