Political pressure on insurers to settle Katrina claims without dispute, and the likely objections from reinsurers if they do, spell tough times ahead, warn Gavin Coull and Peter Hodgins
The direct market is increasingly finding itself between a rock and a hard place in relation to Hurricane Katrina losses. The scale of the loss is unprecedented for a natural peril with estimates suggesting that the total damage caused by Katrina is in excess of $125bn (of which the insured loss could reach $60bn).
To further complicate matters the US state regulators are bringing pressure to bear on insurers to pay claims without dispute. The Mississippi Attorney General Jim Hood is in the process of suing a number of insurance companies to force them to pay for flood damage to homes notwithstanding that their policies typically exclude such loss (see box on page 16). Whether the Louisiana Attorney General will follow suit remains to be seen.
There is also considerable pressure on insurers to make payments before they have had the opportunity to investigate claims. Indeed, the scale of the destruction and the lack of access to many areas have made it practically impossible for loss adjusters to consider every claim.
These pressures inevitably place insurers on a collision course with their own reinsurers. Compliance with the demands of the US state regulators risks the accusation from reinsurers that claims are not being dealt with in a proper and business-like way. Furthermore, the fact that many of the initial payments being made will effectively be ex gratia means that they will not be recoverable from reinsurers in the absence of clear language to the contrary.
As with any claims, the best way for insurers to avoid disputes with their reinsurers is to provide timely notification of losses, to inform their reinsurers about loss settlement and, if possible involve their reinsurers in them. There is nothing new in this statement. However, given the sheer scale of claims that the insurance industry is facing, it would be easy to overlook these practicalities. The consequences of such an oversight may well place a cedant in breach of any express claims notification or cooperation provisions contained in its reinsurance contracts.
Claims notification provisions have become commonplace in reinsurance contracts; partly because they can act as a trigger for a reinsurer's decision as to whether it wishes to exercise any rights to control of the defence of a claim that it may have, and partly because they help to reduce the risk of a surprise. Although the concept of claims notification is fairly straightforward, there are a number of issues to be considered with regard to each clause:
What is the trigger for notification? - It is important for a cedant to understand what it is required to notify. For example, does the reinsurance contract require notification of a "loss" or merely a "circumstance"? If the reinsurance is an excess of loss contract, it may provide for notification only when a loss is likely to exceed a specified percentage of the cedant's deductible. This raises the question, in the case of the recent hurricane losses, whether cedants should take a pessimistic view and assume total losses on all policies or whether they should wait until there has been an initial adjustment.
Whose knowledge is the trigger? - A cedant does not generally have an obligation to proactively seek details of a loss. But the claims notification provision will be triggered by actual knowledge irrespective of how this knowledge is obtained. The fact that a cedant learns of a loss other than through its insured is irrelevant.
What is the timeframe for notification? - Many reinsurance contracts require that notice be given "immediately" or "as soon as reasonably practical". Although vague, neither provision tends to be controversial provided that a cedant acts with due despatch. However, given the volume of claims facing most insurers in respect of Hurricane Katrina there may be delays in reporting losses and cedants would therefore be well advised to at least make precautionary notifications to their reinsurers.
Who is to be notified? - Cedants should check their reinsurance contracts carefully to see whether notification must be given to a specific person at the reinsurer or whether notice to the broker will suffice. Contrary to the usual rules the broker may be deemed to be the agent of the reinsurer for notification purposes.
What is the effect of a breach? - The effect of a breach of a claims notification clause will depend upon whether or not the provision is expressed to be a condition precedent. If the clause is clearly expressed as a condition precedent and is free of ambiguity, or was clearly intended to act as a condition precedent, its breach will result in a cedant being unable to recover from its reinsurers, notwithstanding that the cedant has a legal liability to its insured.
In contrast, if a notification provision cannot be interpreted as a condition precedent, its breach will only entitle the reinsurer to claim damages. Typically, it is difficult for reinsurers to demonstrate that they have suffered any actionable loss and as such they are only entitled to nominal damages. In serious cases, however, it may be possible for a reinsurer to argue that breach of a notification provision is also a breach of the cedant's continuing duty of good faith during the life of the reinsurance contract and/or a repudiatory breach of the contract. It is clear from the courts that late reporting through mere negligence will not amount to a breach of a post-contractual duty of good faith or a repudiatory breach.
Claims control/claims cooperation
Following notification of a loss, a cedant needs to be aware of what its ongoing obligations are with regard to a claim. For example, what information is it required to provide to its insurers on an ongoing basis and how often is this information to be provided? Is the cedant required to involve the reinsurer in the negotiation and settlement of a claim? In general the effect of claims control/claims cooperation clauses is to limit the freedom of a cedant to handle a claim. The extent of the limitation will vary from clause to clause under the original insurance.
Cooperation - The inclusion of a claims cooperation clause will require the cedant to provide information on the nature, scope and amount of any loss and whether the loss is covered under the original policy. It enables the reinsurer to make a sensible decision on any settlement proposal.
Control - In contrast, claims control clauses typically allow the reinsurer to dictate any negotiation of settlement with the original insured. On notification of a claim, such clauses require that the reinsurer elect whether it wishes to exercise its right of control.
What are the consequences of a breach? - In the event of a breach of a claims cooperation/claims control clause the cedant may be required to prove its legal liability under the original insurance to the underlying insured notwithstanding that its contract includes a "follow the settlements" provision. Where the claims cooperation clause is expressed as a condition precedent, the outcome may be different in the event of non-compliance. In such circumstances, the reinsurer will not be liable to indemnify the reinsured even if it can prove that the claim paid by it fell within the scope of the original policy.
The danger for cedants is that a claims control clause may be capable of interpretation as a condition precedent notwithstanding that it is not expressly stated to be a condition precedent. In Eagle Star Insurance Co Ltd v J M Cresswell the court found that the following clause was a condition precedent: "(Reinsurers) shall control the negotiations and settlements of any claims under this policy. In this event the (reinsurers) hereon will not be liable to pay any claim not controlled as set out above" on the basis of the pre-emptory sentence beginning "In this event ..." was found to demonstrate a clear intent to exclude liability for claims not controlled by reinsurers.
Reinsurer's failure to respond - One issue that may arise in the context of Katrina losses, is what happens if a reinsurer fails to consent to a settlement where its consent is not a condition precedent? This issue is yet to be decided by an English Court. However, unless the cedant can show that the reinsurer had waived its right to consent it runs a risk by settling a claim without receiving such consent in writing. In this regard silence is not usually deemed waiver at least unless it is for an unreasonably long period.
Insurers face a difficult period ahead as a consequence of Hurricane Katrina. They need to carefully balance their duties to their insureds, the demands of the US state regulators and their obligations as cedants to their reinsurers. With regard to these latter obligations, at least, insurers can take control of their own destiny by carefully reviewing their reinsurance policies and putting in place measures to ensure compliance with their claims notification/claims cooperation/claims control obligations. Whether the same is true for their inwards books remains to be seen.
Gavin Coull is a partner and Peter Hodgins a solicitor in Reynolds Porter Chamberlain's Reinsurance Group.