EXCESS,
SURPLUS LINES AND REINSURANCE
Friday, August 26, 2005 In two companion cases, the First Circuit Court of Appeals reversed and remanded two district court decisions that had sustained a reinsurer's challenge to its cedents' billing of environmental claim settlements on an annualized basis under the applicable certificates of facultative reinsurance. In reversing, the appellate court clearly upheld the cedents' rights under a follow-the-fortunes clause to bind reinsurers to reasonable and good faith settlements of underlying claims. Each of the cases involved settlements by the cedents of significant environmental claims over multiple sites over multiple years. In the first case, the reinsurer challenged the cedent's annualization of the per occurrence limit on three-year facultative certificates. The facultative certificates followed a series of multi-year umbrella policies, which provided excess coverage over a series of primary policies issued by another carrier. While including definitions of "occurrence," the excess policies also included following form clauses that incorporated occurrences covered by the terms of the primary polices. The facultative certificates also contained following form language, as well as follow-the-settlements language. The settlement was based on nine "focus" waste sites allocated pro rata across the years of relevant insurance coverage at each site and based on the per occurrence limit on each policy viewed as applying separately to each policy year. The reinsurer challenged the cedent's annualization of the per occurrence limit and the district court agreed. In reversing, the First Circuit acknowledged that on a "mechanical" basis, and without consideration of the following form and follow-the-settlements language, the reinsurer might have the better argument. But, when considering the "following" clauses, the court held that the cedent's view on annualization is binding on the reinsurer "so long as the settlement was reasonable and made in good faith." The court did, however, point out that if the settlement were flatly inconsistent with the cedent's policy, the reinsurer would not be bound by a follow-the-settlements clause in the facultative certificates. The court also indicated that this decision does not control a case where there is extrinsic evidence that better illuminates the dispute. In the second case, the facts were somewhat similar. The settlement also was based, in part, on the cedent's annualization of the per occurrence limits. The reinsurer challenged the use of annualization, but also claimed that the allocation of a portion of the settlement to sites for which the cedent had no information was unreasonable and not made in good faith. The district court ruled in favor of the reinsurer on both issues. In reversing, the circuit court left open the reinsurer's right, on remand, to challenge the cedent's good faith if it had evidence to support the claim. The court pointed out that the binding nature of the follow-the-settlements clause can be overridden by clear language in the certificate that cuts off liability. Here, the court found that there was no clear-cut anti-annualization language in the facultative certificates. The court held that ". . . absent a clear limitation in the certificate, the principle of congruent liability between cedent and reinsurer - adopted by [the parties] in the certificates' follow-the-form and follow-the-settlements clauses, [citation omitted] suggests that [the reinsurer's] liability should follow the gloss (assuming it is reasonable and made in good faith) given to the underlying policies by the settlement." In rejecting, without further findings, the allocation of the settlement to sites with no information, the court noted that settling numerous claims based on detailed information about only a subset of those claims is consistent with modern practice in similar cases. The court stated that [t]here is no rule of law . . . that there is some fixed quantum of investigation or individualized computation required for a reasonable, good faith settlement." The court concluded by suggesting that the parties settle. Submitted by Larry P. Schiffer The Second Circuit Court of Appeals has reversed a decision of the District Court of Connecticut and has upheld the applicability of the "follow-the-fortunes" doctrine in post-settlement allocation situations, even when the allocation is based on a coverage position the cedent had seemingly abandoned in order to settle with its insured. In so doing, the court concluded that the reinsurer was bound by the cedent's single-occurrence allocation of settlement payments to its insured for asbestos-related losses. From 1953 to 1972, the insured distributed and/or manufactured an asbestos product. It also operated a separate division that installed, maintained, and removed its asbestos product and asbestos products manufactured by other asbestos manufacturers. From 1952 to 1979, the cedent provided insurance under primary and excess policies for bodily injury and/or property damage caused by an "occurrence." The policies covered losses for products and completed operations hazards (products coverage), and for premises and operations hazards (non-products coverage). The "primary" policies each contained a liability limit of $1 million per occurrence. In addition, each primary policy contained a $1 million aggregate limit for products coverage, but no aggregate limits for non-products coverage. On top of the primary coverage, the cedent issued "excess" policies with liability limits of $25 million per occurrence. The reinsurer reinsured a portion of the excess policies. Beginning in the 1970s, the insured faced thousands of suits for asbestos-related injuries. The cedent and its insured initially treated the insured's asbestos liabilities as products claims arising from a single occurrence. By the early 1990s, the cedent had paid the insured more than $400 million, and had exhausted the policies' products coverage limits. The insured then began to submit its asbestos claims as non-products claims. The cedent disputed any additional coverage for these claims under the non-products provisions. In March 1993, the cedent and its insured arbitrated the coverage dispute. The insured argued that the claims fell under non-products coverage, and that each claim (or at least set of claims arising from a particular job site) constituted a separate claim. The cedent argued that the insured had not adequately documented its claim for non-products coverage, and that all of the claims -- products and non-products alike -- arose from a single occurrence. If either of the cedent's claims were upheld, it would not owe any additional amount because it had already reached the aggregate limit for products claims and the single occurrence limits for all policies. After waiting almost two years with no decision from the arbitrator, the cedent and its insured concluded that the length of the delay signaled that neither side would win a complete victory. A settlement agreement was signed in September 1995. The agreement dismissed the arbitration and obligated the cedent to pay $273.5 million (roughly equivalent to one additional occurrence limit for all the policies). The agreement explicitly disclaimed any particular theory of coverage and reached no conclusion as to whether the claims arose from a single occurrence or multiple occurrences. The cedent informed the reinsurer and its other reinsurers of the settlement agreement. After the settlement agreement, the cedent allocated most of the settlement as a single additional occurrence of non-products claims. Using the common "rising bathtub" methodology, the cedent allocated the settlement evenly across policy years. Under this methodology the $1 million per occurrence limits were quickly exhausted, leaving the majority of the settlement covered by the excess policies, including those reinsured by the reinsurer. On November 18, 1996, the cedent notified the reinsurer of the single-occurrence methodology being used. The reinsurer disputed the cedent's allocation methodology, and the cedent sued the reinsurer in Connecticut federal court for breach of contract. In the district court proceeding, the reinsurer argued that, under the cedent's policies with the insured, each of the 700 job sites should be treated as separate occurrences, thus reducing the need to resort to the excess coverage reinsured by the reinsurer. The cedent countered that under the "follow the fortunes" doctrine, neither the reinsurer nor the court may second-guess the allocation of settlement payments. The reinsurer responded that the "follow-the-fortunes" doctrine should not apply because, by agreeing to a settlement payment, the cedent had already abandoned the single-occurrence theory. Because the cedent would owe no additional money under a single-occurrence theory, the reinsurer argued, the cedent had seemingly accepted the multiple-occurrence theory. The district court granted summary judgment to the reinsurer. The district court stated that the purpose of the "follow-the-fortunes" doctrine is to encourage settlement by preventing reinsurers from raising the same defenses that the cedent might have raised against the insured. The court went on to find that use of the doctrine was inappropriate when, as in this case, the cedent has, by entering into a settlement, abandoned the position challenged by the reinsurer. By insisting on a multiple-occurrence allocation, the court held, the reinsurer was not second-guessing the cedent's decision to abandon its single-occurrence position, but instead was arguing the original insured position, which the cedent had seemingly acceded to in settling the case. Thus, the district court held that a reinsurer is not obligated to "follow-the-fortunes" where the cedent's allocation is based on a position that it had earlier abandoned in order to settle with its insured. In reversing the district court and granting summary judgment to the cedent, the Second Circuit relied on its holding in North River Insurance Co. v. ACE American Reinsurance Co., 361 F.3d 134 (2d Cir. 2004) as controlling. The court held that "a cedent's post-settlement allocation is subject to follow-the-fortunes, regardless of any pre-settlement position taken by the cedent, whether that position is articulated in a pre-settlement risk analysis, or implicit in the settlement with the underlying insured." The court noted that where, as here, "the cedent's earlier position as to a particular coverage issue is unclear, it is even less appropriate than it was in North River for the reinsurer to claim an inconsistency between that position and the cedent's subsequent allocation." As long as the cedent's allocation meets the typical follow-the-fortunes requirements of good faith, reasonableness, and within the applicable policies, the follow-the-fortunes doctrine extends to a cedent's post-settlement allocation decisions. The court also explicitly rejected the notion that "mutuality of interest" between the cedent and the reinsurer is required to invoke the "follow-the-fortunes" doctrine, quoting language from North River. "The existence of a mutuality of interest is not the only factor underlying the follow-the-[fortunes] doctrine. In fact, the main rationale for the doctrine is to foster the goals of maximum coverage and settlement and to prevent courts, through de novo review of the cedent's decision-making process, from undermining the foundation of the cedent-reinsurer relationship." In granting grant summary judgment to the cedent, the court found that the reinsurer was unable to raise any "genuine issue of material fact as to [the cedent's] good faith that might prevent us from applying follow-the-fortunes at this phase." The court noted that the reinsurer faced a "very heavy burden" in showing bad faith, as "a cedent choosing among several reasonable allocation possibilities is surely not required to choose the allocation that minimizes its reinsurance recovery to avoid a finding of bad faith." In short, "[a]n allocation that increases reinsurance recovery…would rarely demonstrate bad faith in and of itself." Submitted by Larry P. Schiffer and Summer Clerk Charles Korsmo Back To ESLR Committee Home Page For enrollment in a committee of the Tort Trial & Insurance Practice Section, simply fill out the on-line committee application form. 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