Insurance and reinsurance underpins global commerce and trade. It is an important tool to mitigate the financial risks associated with commercial transactions and ventures, particularly in jurisdictions that are perhaps developing and have more unstable economies and political regimes as well as carrying risk through hazardous geographies. From our experience, both recent and historic, there are a number of issues which all parties involved in placing insurance and reinsurance should be aware.
We have seen the exponential increase in the relevance of fronting on global programmes with captives and the use of facultative reinsurance placements where there is no, or no material, local insurance capability or retention. The main growth areas for the insurance and reinsurance industry in London, Munich and Zurich has been the LatAm, MENA, Africa and Asia Pacific regions where specialist business is written facultatively and is reliant on reinsurance markets due to limited local know how of insuring large and complex risks, particularly in the energy, property and liability sectors.
Insurance and reinsurance
The first issue is recognition of the fact that because of local regulatory regimes, what would ordinarily be direct insurance, becomes reinsurance. Often a local fronting insurer will have little or no retention and correspondingly little expertise in specialist areas with little appetite to acquire it.
The reinsurer deals with this through the retention of claims control where possible and the insured seeks a direct relationship with reinsurers. However in some jurisdictions such a direct relationship may be unlawful, unenforceable and even criminal.
Governing law and jurisdiction
The governing law of an insurance policy can significantly impact upon the breadth of cover. Local law and jurisdictions can also dilute well known safeguards under English law contracts. For example, in some South American territories the law governing insurance contracts has emanated from banking law. This creates a significant amount of uncertainty over policy coverage where a law more suited to banking products is used to construe complex wordings.
The choice of governing law can significantly affect the attempts to obtain back to back cover as between the fronting insurance and the reinsurance, particularly where the fronting policy and reinsurance have different governing law provisions, or where they are silent on the governing law. This can create a mismatch between the two contracts and cover.
Decentralisation of claims control
In jurisdictions requiring fronting, claims are likely to be dealt with locally leading to a loss of central control which can have significant implications in large and complex loss scenarios. Retaining a degree of central control of the inwards claim can be achieved by utilising “claims control” or “claims co-operation” clauses. Also, reinsurance policies should be checked for “follow the settlements” clauses to assess the obligations to a fronting insurer.
Issues can develop over the operation of claims control and claims cooperation clauses, particularly the question of who takes the lead in dealing with claims. Tensions may arise in a claims context between the priorities of the local fronting insurer and the reinsurers. Any such tensions will need to be resolved in accordance with the terms of the policies.
Who decides to settle a claim can also provide tensions. The question of which reinsurer has authority to act on behalf of the others is often dealt with by way of a “follow the leader” clause where the reinsurers delegate authority to settle a claim to the “leading” reinsurer providing the fronting insurer and the policyholder (the ultimate beneficiary) with the comfort that the leader’s decision to settle the reinsurance claim will bind the other, following, reinsurers.
Loss of protectionist terms and conditions
There are certain terms and conditions that are common place in English law and language policies and which are considered by (re)insurers as essential protections. These may become irrelevant when transposed into a local fronting policy either because they are unenforceable under local law or because there is no local jurisprudence to interpret them. This creates a lack of certainty.
Direct access to reinsurance
Generally, no privity of contract is enjoyed by the policyholder on a reinsurance contract but a policyholder may want the ability of claiming directly against the reinsurer in circumstances where there is an issue with the fronting insurance or perhaps the local fronting insurer becomes insolvent.
A cut-through clause allows a party that is not in privity with the reinsurer to have such rights as part of the agreement between reinsurer and fronting insurer, although careful consideration is needed of the governing law of the policy to assess the validity of such clauses.
In jurisdictions requiring fronting, often claims paid under a master or reinsurance policy cannot be ceded back to the policyholder locally without breaching laws, for which there can be significant repercussions to the policyholders. When claims monies are paid to a policyholder locally, there can be exchange issues, the transfer of money may trigger tax penalties or, more seriously, lead to investigations by local regulators as to the policyholder’s compliance with insurance regulations. Careful consideration, therefore, has to be given to the local regulatory environment.
It may be that the same insurance broker is used for placing the local insurance and the reinsurance, despite the inherent risk of conflicts arising in acting for two principals with potentially competing interests. A broker undertaking such a role should ensure it understands the risks and that the risks have been fully explained and accepted by its two principals. It should also ensure that it has internal systems in place to deal with conflict scenarios. This is particularly so with split placements.
Competing dispute resolution clauses
It is not uncommon for there to be competing dispute resolution clauses as between the fronting insurance and the reinsurance contract. Where possible identical dispute resolution clauses should be agreed to ensure that disputes can be resolved in one forum, limiting the chances of inconsistent findings by different tribunals.
Local tribunal advantage
In many jurisdictions there is no distinction between sophisticated and unsophisticated insureds. This means that an insured with, say, a large, complex industrial risk will be treated in the same way as a consumer purchasing personal lines insurance. Often the result is that standard terms, conditions and exclusions are ignored by the local tribunal or interpreted in favour of the insured. This removes from insurers the protection of well drafted wordings which benefit from lessons learnt over many years.
In an age of contract certainty, local fronting issues in the rapidly gaining LatAm, MENA, Africa and Asia Pacific markets create contract uncertainty and should be clarified at placement to avoid uncertainty when the claims arise.