This edition provides an update of recent developments of interest to the global reinsurance industry.  On the US side, the US Case Note highlights a recent decision in which a federal district court denied a reinsurer’s request to compel a third party to join an arbitration.  The US Regulatory Note addresses federal income tax rules applicable to offshore reinsurance companies.  On the European side, the London Case Note focuses on an appellate decision concluding that the State is responsible for some of the burden of riot damage.  The EU Case Note addresses a decision that may subject reinsurers to VAT in certain instances.

US Case Note

In Transatlantic Reinsurance Co. v. National Indemnity Co., No. 14-C-1535, 2014 WL 2862280 (N.D. Ill. June 26, 2014) the US District Court for the Northern District of Illinois denied a reinsurer’s motion to compel a third party to participate in an arbitration between the reinsurer and its cedent.  The court held that the arbitration clause in the reinsurance agreement was not sufficiently broad to bind non-signatories, nor did the third party otherwise consent to arbitration.

The arbitration related to a blanket excess of loss reinsurance agreement, pursuant to which Transatlantic Reinsurance Company (Transatlantic) reinsured a variety of risks for Continental Insurance Company (Continental).  Id.  at *1.  Continental had “transferred its liability” to National Indemnity Company (NICO) for $2 billion, and NICO agreed to collect reinsurance proceeds and pursue reinsurance recoveries “on behalf of and in the name of Continental.”  Id.  After the transfer, Transatlantic ceased making payments for certain classes of reinsured business.  Id. Continental commenced arbitration to recover the outstanding claim payments.  Id.  Transatlantic sought to compel NICO to participate in the arbitration.  Id.

Transatlantic raised four arguments in favor of compelling NICO to participate: (1) the breadth of the arbitration clause in the reinsurance agreement could bind non-signatories; (2) through its side agreements with Continental, NICO assumed Continental’s rights and obligations under the reinsurance agreement; (3) the reinsurance agreement was incorporated by reference into NICO’s separate agreements with Continental; and (4) NICO was estopped from denying its obligation to arbitrate because it sought a direct benefit from the reinsurance agreement.  Id. at *2-3. 

The court rejected all four arguments.  First, the court concluded that the arbitration clause in the reinsurance agreement did not cover NICO because it only applied to disputes “between the COMPANY [Continental] and the REINSURERS [Transatlantic].”  Id. at *2 (quoting agreement).  Second, the court concluded that NICO’s separate agreements with Continental did not obligate it to arbitrate because nothing in those agreements demonstrated that NICO assumed Continental’s obligation to arbitrate or that NICO had any intention of pursuing arbitration.  Id. at *2-3.  Third, the language of the Continental/NICO agreements was “not sufficiently explicit and specific to incorporate by reference the arbitration provision of the Reinsurance Agreement,” as the agreements simply provided that “reinsurance collection services” would be provided “in accordance with the contractual terms of the applicable Third Party Reinsurance Agreements.”  Id.  Finally, the court rejected the estoppel argument because NICO’s benefit was only indirectly related to the reinsurance agreement; a non-signatory must seek a direct benefit from the agreement in order for estoppel to apply.  Id. at *4. 

Thus, as is typical, the court interpreted strictly the arbitration agreement to ensure that only those parties who specifically consented to arbitration were bound to litigate in that forum.  Companies considering selling or transferring reinsurance business should continue to bear in mind that arbitration is a creature of contract.  Therefore, agreements effectuating a transfer of business should state clearly whether the successor will assume the arbitration obligations of the original contracting party. 

US Regulatory Note

In recent months, policymakers have increasingly focused on the US federal income tax rules applicable to offshore reinsurance companies.  In June 2014, Senate Finance Committee Chairman Wyden (D-OR) wrote to the US Department of Treasury, requesting that Treasury and the IRS explain why they “have failed to follow through on past promises to close the reinsurance loophole exploited by hedge funds.”  The structure referred to by Chairman Wyden involves a hedge fund (or hedge fund investors) that make a capital investment in an offshore reinsurance company, which reinvests that capital (and premiums that it receives) in the hedge fund.  The owners of the reinsurance company take the position that they are not taxed until the company’s earnings are distributed or the investors sell their stock.  The basis for this position is that certain US tax rules (the “passive foreign investment company” or PFIC rules) intended to prevent tax deferral through offshore corporations provide an exception for income earned in the active conduct of an insurance business.

On August 8, 2014, Treasury responded to Chairman Wyden’s letter, stating that Treasury and the IRS are “explor[ing] whether there is a regulatory and/or legislative approach that could be appropriately tailored to address the arrangements of concern, in particular by setting forth objective rules for determining when offshore reinsurance companies are PFICs.”  Senator Wyden responded on September 11, 2014, stating that “action needs to be taken sooner rather than later” and requesting Treasury’s view on legislative and administrative options to address the issue.

Industry groups have expressed concerns about potential changes to the relevant tax rules.  For example, in a July 31, 2014 letter to Treasury, the Reinsurance Association of America warned that overbroad changes capturing bona fide, active insurers could have  unintended negative economic consequences. 

It is likely that Congress and Treasury will continue to focus on offshore reinsurance tax issues, including potential legislative or administrative changes to the PFIC rules.  Additional IRS scrutiny of offshore reinsurance structures through audits is also possible.

London Case Note[1]

In Mitsui Sumitomo Insurance Co (Europe) Ltd and others v Mayor’s Office for Policing and Crime, [2014] EWCA Civ 682, the Court of Appeal ruled that consequential losses from riots are recoverable under the Riot (Damages) Act 1886.

The Riot (Damages) Act 1886 (the Act) is the current incarnation of legislation, stretching back to 1714, that aims to shift the costs of damage caused by riots from injured parties on to the community in which the damage occurred.

In 2011, there was widespread rioting in the UK.  Various insurers and uninsured parties (the Claimants) suffered losses, and they claimed compensation from the Mayor’s Office for Policing and Crime (the Mayor) under section 2(1) of the Act. The Claimants claimed compensation for direct losses (damage to property) and consequential losses (loss of rent and profit).

In the High Court, Mr Justice Flaux held that: (1) the rioters were within the description “persons riotously and tumultuously assembled together,” and the Mayor was therefore liable under the Act for direct losses; but (2) the Act does not provide any compensation for consequential losses.

Neither side was satisfied with that outcome.  The Mayor appealed on the first issue, arguing that it ought not to have been found liable at all.  The Claimants appealed on the second issue, arguing that the Act required the Mayor to indemnify consequential losses as well as direct losses.  The Court of Appeal found in favour of the Claimants. 

As to the Mayor’s appeal, whether the actions of the rioters were within the scope of the Act was largely a factual question.  The Judge had directed himself correctly as to the law, and his evaluation had been one which he was entitled to reach.  The Mayor’s appeal on this point was therefore dismissed. 

As to the Claimant’s appeal, the general principle for the assessment of damages is restitutio in integrum (the injured party should be placed in the position that it would have been in if the tortious act had not been committed) subject to the condition that the damage in question is not too remote.  Section 2(1) of the Act provided a broad right to compensation for damage to property caused by trespassers in the course of a riot, subject only to statutory exclusions.  The Court of Appeal analysed the Act, its antecedent legislation and the principles that underpinned it, and decided that Parliament’s intention was to cover all heads of loss which are compensable under the English law of damages as it develops over time.  Consequential losses are now an accepted head of loss, and compensation for this falls within the Act.  The Claimant’s appeal on this point was therefore allowed.

This decision is favourable to insurers and reinsurers, as it transfers some of the burden of riot damage away from private individuals (and their carriers) and on to the State (and ultimately the taxpayer).  It is foreseeable that the UK government may seek to amend the legislation, to transfer some of that burden back to the private sector.

EU Case Note[2]

On 17 September, the Court of Justice of the European Union (CJEU) handed down a judgement in case C-7/13, Skandia America Corp. (USA), filial Sverige v Skatteverket.  The case concerns the treatment under Directive 2006/112/EC (the VAT Directive) of services supplied by the main establishment of a company with its seat in a third country to an EU branch of that company.

The CJEU ruled on questions referred to it for a preliminary ruling by a Swedish administrative court.  In the national proceedings, Skandia Sverige, the Swedish branch of Skandia America Corp. (SAC), a corporation established in the United States, challenged the decision of the Swedish tax authority to charge it for the VAT payable on the IT services that SAC supplied to Skandia Sverige.

The relevant facts of the case are as follows:

  • SAC supplied IT services, which constitute “electronically supplied services” within the meaning of Article 56 of the VAT Directive, for consideration to Skandia Sverige in 2007 and 2008.
  • The VAT Directive (Article 11) allows Member States to treat a group of legally independent persons established in their territory as a single taxable person for VAT purposes (a VAT group).  Sweden has exercised this option provided by the VAT Directive.
  • For VAT purposes, Skandia Sverige was registered with the Swedish tax authority as a member of a VAT group in Sweden.

The CJEU has concluded that Skandia Sverige is not a taxable person on its own because, as a branch of SAC, it does not operate independently and does not bear the economic risks of its business.  Because Skandia Sverige is part of a VAT group in Sweden, however, it forms a single taxable person with the other members of that group and not with SAC.  As a result, for VAT purposes, the services provided by SAC to Skandia Sverige must be considered to be supplied to the VAT group and are therefore taxable transactions liable to VAT.  Thus, pursuant to the exception to the general VAT rule (i.e., VAT is payable in a Member State by a taxable person supplying taxable service) in Article 196 of the VAT Directive, the VAT group (i.e., the taxable person to whom the IT services are supplied), is liable for the VAT payable on those services where SAC, the supplier, is not established in the same Member State as the VAT group.

As insurance and reinsurance transactions are generally exempt from VAT, this judgement may have significant consequences for international reinsurance groups in which (re)insurers in the group call upon other members to provide various services, such as IT services.  Groups should review their VAT arrangements in the Member States which have introduced VAT grouping schemes into their national legislation (according to the European Commission, at least 15 Member States use the VAT grouping option) and the intra-group supply of services to branches established in those Member States.