Sometimes called by practitioners “the Bellefonte issue,” the question of the costinclusiveness of the stated limit of liability in a facultative reinsurance certificate has been a controversial one for over 20 years. The issue has created a conflict between the courts of different jurisdictions; between courts and arbitrators; and, needless to say, between reinsureds and reinsurers. There have been new developments on this topic of late, which should be studied by every practitioner in the field who wants to be current on this perpetually difficult issue. The Issue A facultative reinsurance certificate, particularly an older certificate, is likely to set forth, on its first page, a “Reinsurance Accepted” amount, sometimes described as the “limit” or “limit of liability.” This is usually in the form of a blank filled in with a dollar figure, and often is expressed in the alternative as a part of, or percentage of, the limits of the policy reinsured. Frequently, there is also a stated dollar amount over which the Reinsurance Accepted amount shall be excess. On its “Terms and Conditions” page, which is usually the second page, the certificate is also likely to include a follow-the-fortunes provision, stating that the reinsured’s payment or settlement of claims shall be “binding upon” the reinsurer, and requiring the reinsurer to pay its share of such payments or settlements. Crucially, the certificate is also likely to include a provision on the second page requiring the reinsurer to reimburse the reinsured for a specified share of the expenses incurred in connection with the adjustment of the claim. Such a provision might read as follows: All claims involving this reinsurance, when settled by the Company, shall be binding on the Reinsurer, which shall be bound to pay its proportion of such settlements, and in addition thereto, in the ratio that the Reinsurer’s loss payment bears to the Company’s gross loss payment, its proportion of expenses incurred by the Company in the investigation and settlement of claims or suits.1 Let us assume that the reinsured pays a claim in such a way that the indemnity loss is within the limit of Reinsurance Accepted, but that the total payment exceeds that limit when expenses are added in. Is the reinsurer obliged to pay only its share of the limit of Reinsurance Accepted, or is it also responsible for its share of the overage created by the expenses? For example, assume that the Reinsurance Accepted amount is $5 million. 2 Assume further that the reinsured, on account of a major claim under the reinsured policy, pays $4 million to (or on behalf of) the insured on account of the loss and incurs $2 million in legal and other adjustment expenses defending the claim. Is the reinsurer liable to the reinsured for $5 million (the stated limit of the reinsurance), or for $6 million (the total amount paid)? Stated differently, is the limit of Reinsurance Accepted “cost-inclusive,” such that it applies to both indemnity and expense, or “non-cost-inclusive,” such that the reinsurer may have liability over and above the limit for expenses? 1 The form of language set forth above is taken from the Bellefonte decision itself, described more fully below. Emphasis has been supplied. It is important to note that this language is only an example; nearly all certificates vary in their precise terms and, indeed, that is part of the overall issue, again as discussed below. 2 As noted above, the Reinsurance Accepted amount is more likely to be phrased as something like “$5 million part of $10 million excess of $1 million.” To highlight the issue that concerns us, however, we will treat the Reinsurance Accepted amount as a simple dollar figure that is not excess of another figure. …is the limit of Reinsurance Accepted “cost-inclusive,” such that it applies to both indemnity and expense, or “non-cost-inclusive,” such that the reinsurer may have liability over and above the limit for expenses? Sidley Insurance & Reinsurance Law Report | 2016 23 The Bellefonte Decision The United States Court of Appeals for the Second Circuit addressed this issue in Bellefonte Reins. Co. v. Aetna Cas. & Sur. Co., 903 F.2d 910 (2d Cir. 1990). That case presented the cost-inclusiveness issue in classic form, as the reinsured paid the policyholder’s claim in the full amount of the limit, and incurred substantial defense expenses as well. The court ruled in favor of the reinsurer, holding that the reinsurance limit is cost-inclusive and acts as a firm cap on the reinsurer’s entire liability under the certificate, whether for indemnity loss or expense. The reinsured argued that the follow-the-fortunes language in the certificate, requiring the reinsurer to pay its share of any and all losses, compelled the reinsurer to pay more than the Reinsurance Accepted limit. The court rejected this argument, holding that the follow-the-fortunes language was intended to “coexist with, rather than supplant,” the Reinsurance Accepted language. 903 F.2d at 913. The result of this synthesis of clauses was that the reinsurer was bound to pay its share of all judgments and reasonable settlements (giving effect to the follow-the-fortunes doctrine), but only up to the amount of the stated limit (giving literal effect to the Reinsurance Accepted language). The court opined that this result was required by the principle that contracts should be construed “so as to give effect to all of their material provisions.” 903 F.2d at 912, citing Spencer, White & Prentis, Inc. v. Pfizer Inc., 498 F.2d 358, 363 n.23 (2d Cir. 1974). To allow the follow-the-fortunes language to create a payment obligation in an amount in excess of the limit of liability “would strip the limitation clause…of all meaning.” 903 F.2d at 913. Next, the court rejected the argument that the reinsurer was liable for defense expenses over and above the Reinsurance Accepted amount because its liability for such expenses was stated by the certificate to be “in addition” to its liability for settlements. According to the court, the “in addition” language was not intended to mean that liability for expenses was outside the limit of liability; its intent was “merely to differentiate the obligations for losses and for expenses.” In other words, by characterizing the liability for expenses as “in addition” to the liability for losses, the court concluded that the certificate was “merely outlin[ing] the different components of potential liability,” not placing one inside the limit and one outside it. 903 F.2d at 913. In reaching this conclusion, the court emphasized the introductory language on the certificate’s first page, which provided that the reinsurance was “subject to the terms, conditions and amount of liability set forth herein.” If the entire agreement was “subject to” the limit of liability, the court reasoned, the “in addition” language could not take the liability for expenses outside that limit. 903 F.2d at 914. Unease With Bellefonte and Its Progeny The Second Circuit’s holding in Bellefonte came as a surprise to some in the reinsurance industry. As one commentator has stated, the decision “created great consternation in the industry.” Robert M. Hall, “Expenses in Addition to Limits and Facultative Certificates” (2010) available at http://www.robertmhall.com/articles/ ExpenseFacCerArt.pdf (2010). The opinion has been described as “one of the most important—and, at least in some circles, controversial — decisions in reinsurance jurisprudence.” Robert A. Kole, “NY Courts Are Both Affirming and Limiting Bellefonte,” Law360, Feb. 24, 2015, available at http://www.law360.com/ articles/624465/ny-courts-are-both-affirming-and-limiting-bellefonte. Some of the “consternation” may have stemmed from a sense that the result in Bellefonte was contrary to a putative general consensus in the industry, shaped through a long course of dealing among insurers and reinsurers together with rulings by many arbitration panels. Under this supposed general consensus, the “limits” provisions of a facultative reinsurance certificate apply to the insurer’s (and hence the reinsurer’s) liability for indemnity loss, which is the primary focus of any contract of In reaching this conclusion, the court emphasized the introductory language on the certificate’s first page, which provided that the reinsurance was “subject to the terms, conditions and amount of liability set forth herein.” 24 New Developments Regarding the Cost-Inclusiveness of Facultative Certificate Limits insurance (or reinsurance). Under this school of thought, a reinsurer’s liability to reimburse an insurer for defense expenses is separate and apart from the indemnity obligation and, where the reinsurance certificate indicates (as it did in Bellefonte) that the defense expense obligation is “in addition to” the indemnity limit, that obligation is not capped by the stated limit on indemnity loss. Furthermore, the “consternation” was arguably fueled by the fact that the court in Bellefonte held the reinsurance certificate before it to be unambiguous, thus obviating any extrinsic evidence as to its meaning. For some in the industry, this conclusion seemed to cut off all debate on the cost-inclusiveness issue. The court viewed the contractual language as bringing defense expenses within the limit of liability, without any opportunity for argument as to the intent of the parties, the facts and circumstances relating to the making of the reinsurance agreement, or the customs and practices of the industry. Nevertheless, Bellefonte became the law of the land, at least within the boundaries of the Second Circuit. Indeed, in Unigard Secur. Ins. Co. v. North River Ins. Co., 4 F.3d 1049 (2d Cir. 1993), the Second Circuit reaffirmed Bellefonte. In Unigard, the court stated that the facultative certificate had language “virtually identical” to the one in Bellefonte, and ruled that the follow-the-fortunes language therein “did not override the limitation on liability.” 4 F.3d at 1070. Bellefonte was followed by the lower federal courts within the Second Circuit, of course, see, e.g., Allendale Mut. Ins. Co. v. Excess Ins. Co., 992 F. Supp. 271 (S.D.N.Y. 1997), and by district courts in other circuits as well. See, e.g., Pacific Employers Ins. Co. v. Global Reins. Corp., 2010 U.S. Dist LEXIS 40506 (E.D. Pa., Apr. 23, 2010). In Excess Ins. Co. v. Factory Mut. Ins. Co., 3 N.Y.3d 577 (2004), the New York Court of Appeals adopted the Bellefonte rule for the courts of the State of New York. In Excess, the reinsurance agreement was even more succinct than the typical facultative certificate; it may have been a stamped slip or perhaps an acknowledged cover note. Apparently, the only provisions pertinent to the cost-inclusiveness issue were a “Limit” provision and a single “Conditions” paragraph. The “Limit” provision identified the limit of the reinsurance as $7 million per any one occurrence. The “Conditions” paragraph included (a) a following form clause, making the reinsurance subject to the “same valuation, clauses and conditions as contained in the original policy”; and (b) a follow the settlements clause, requiring the reinsurers to “follow the settlements of the Reassured in all respects and to bear their proportion of any expenses incurred.” The Court of Appeals, citing Bellefonte, held that the “Limit” provision “is intended to cap the reinsurers’ total risk of exposure,” 3 N.Y.3d at 584, and thus the follow the settlements language cannot be read so as to require any additional payments, lest that language “render meaningless the liability cap negotiated.” 3 N.Y.3d at 583. 3 After Excess, an observer might have concluded that Bellefonte was black letter law and that the cost-inclusiveness issue had been decided once and for all. Such a conclusion, however, would have been premature, as the industry unease with Bellefonte never fully went away. There were contrary voices, and on rare occasions they attracted judicial support. For example, in TIG Premier Ins. Co. v. Hartford Acc. Indem. Co., 36 F. Supp. 2d 348 (S.D.N.Y. 1999), the Southern District of New York, applying the substantive law of California, held that there was a question of fact as to whether the limit in a facultative certificate having wording similar to the Bellefonte certificate was cost-inclusive. California is more hospitable than New York to the admission of extrinsic evidence, and the court held that such evidence was admissible to determine whether there was a “latent ambiguity” in the certificate. 3 Judge Susan Phillips Read filed a vigorous dissenting opinion challenging the majority’s rationale on two key points. Judge Read opined that, unlike the certificates in Bellefonte and Unigard, the certificate at issue did not include language explicitly making the reinsurance transaction “subject to” the stated limit. Id. at 588. She also asserted that the majority had paid too much attention to the follow the settlements language in the “Conditions” paragraph and too little to the “following form” language; since the latter adopted the terms and conditions of the underlying policy, it was plausible that the parties to the reinsurance certificate intended that the reinsurance limit would be cost-exclusive, as the underlying policy’s limit was. Id. at 585. …an observer might have concluded that Bellefonte was black letter law and that the cost-inclusiveness issue had been decided once and for all. Such a conclusion, however, would have been premature, as the industry unease with Bellefonte never fully went away. Sidley Insurance & Reinsurance Law Report | 2016 25 New Developments On December 4, 2014 — nearly a quarter of a century after Bellefonte and 10 years virtually to the day after Excess—a new dimension was added to the cost-inclusiveness debate. The new contribution came from precisely the same place as Bellefonte: the United States Court of Appeals for the Second Circuit. The case was Utica Mutual Ins. Co. v. Munich Reinsurance America, Inc., 594 F. App’x 700 (2d Cir. 2014). In Utica Mutual, the cedent and reinsurer had executed a facultative reinsurance certificate having the following introductory language: The Reinsurer agrees to indemnify the Company against losses or damages which the Company is legally obligated to pay under the policy reinsured, resulting from occurrences taking place during the period this Certificate is in effect, subject to the reinsurance limits shown in the Declarations… 594 F. App’x at 703. The certificate also stated: The Reinsurer shall be liable for its proportion of allocated loss expenses incurred by the Company in the same ratio that the Reinsurer’s share of the settlement or judgment bears to the total amount of each settlement or judgment under the policy reinsured… Id. After the cedent paid out the full limits of the underlying policy plus substantial sums in defense expense, it sought the reinsurance certificate limit plus a share of the expenses from the reinsurer. The reinsurer contended that it was not responsible for any amounts above and beyond the reinsurance certificate limit. The district court granted summary judgment to the reinsurer, citing Bellefonte, Unigard, and Excess. The Second Circuit, however, vacated the judgment, holding that the certificate was ambiguous and that it would be necessary for the district court to consider extrinsic evidence as to whether the limit was intended to be cost-inclusive. The court began its analysis by observing that the cedent’s interpretation of the certificate as non-cost-inclusive was one reasonable construction of the language. The court stated that, because only the reinsurer’s obligation to indemnify the cedent for “losses or damages” was explicitly made “subject to the reinsurance limits,” it was reasonable to conclude that the obligation to indemnify for expenses was not subject to those limits. 594 F. App’x at 703. The court stressed, however, that the cedent’s interpretation was not the only reasonable one. It noted that expenses might plausibly be considered to be part of “losses or damages,” in which case the reinsurer’s obligation to pay them would indeed be “subject to the reinsurance limits” and thus not the reinsurer’s obligation beyond the stated limit. 594 F. App’x at 703. Faced with two reasonable interpretations of the certificate language, the court held that it was ambiguous, and that the certificate’s proper interpretation could not be determined on summary judgment without the benefit of extrinsic evidence. 594 F. App’x at 704. 4 In the portion of the opinion that will be most gratifying to those who never accepted the rationale of Bellefonte, the Second Circuit distinguished and limited Bellefonte and Unigard. The court stated that those opinions, [t]urned on a provision in the policies [i.e., certificates] at issue that expressly made all of the reinsurers’ obligations “subject to” the limit of liability; they did 4 The court adopted the definition of ambiguity set forth in Lightfoot v. Union Carbide Corp., 110 F.3d 898, 906 (2d Cir. 1997): “more than one meaning when viewed objectively by a reasonably intelligent person who has examined the context of the entire integrated agreement and who is cognizant of the customs, practices, usages and terminology as generally understood in the particular trade or business.” Id. at 703. The court, however, made the determination that the certificate was ambiguous without the benefit of testimony from experts familiar with the reinsurance industry. Faced with two reasonable interpretations of the certificate language, the court held that it was ambiguous, and that the certificate’s proper interpretation could not be determined on summary judgment without the benefit of extrinsic evidence. 26 New Developments Regarding the Cost-Inclusiveness of Facultative Certificate Limits not hold that a limit of liability, without such “subject to” language, is presumptively expense-inclusive. 594 F. App’x at 704. The Second Circuit also commented on Excess. It recognized that Excess can “arguably” be viewed as holding that “a limit of liability, standing alone, is presumptively expenseinclusive, because it serves to cap a reinsurer’s total exposure (for losses and expenses) at a specific, negotiated amount.” 594 F. App’x at 704. The Second Circuit held, however, that any such presumption can be rebutted, and that the rebuttal evidence need not be so strong as “express language or a separate limit for expenses.” Id. The court held that in the particular case before it, the certificate’s statement that “losses or damages” are “subject to” the reinsurance limit “reasonably implies that expenses are not,” thus overcoming any presumption of cost-inclusiveness. Id. The Utica Mutual decision is a “Summary Order” of the Second Circuit, not signed by an individual judge and not published in the official Federal Reporter. It bears a legend reminding readers that “Rulings by Summary Order do not Have Precedential Effect.” Its impact is thus a matter subject to debate. 5 594 F. App’x at 700. It has, however, already spawned one notable new precedent. In Century Indem. Co. v. OneBeacon Ins. Co., 2015 Phila. Ct. Com. Pl. LEXIS 25 (Mar. 27, 2015), the Pennsylvania Court of Common Pleas, Philadelphia County, joined Utica Mutual in distinguishing and limiting Bellefonte. In Century, the introductory language to the facultative certificates at issue stated that the reinsurance “was subject to the general conditions set forth on the reverse side hereof.” The “General Conditions” side of the page provided, among other things, that the reinsurer would be responsible for its proportionate share of settlements “and in addition thereto…its proportionate share of expenses…incurred by the” reinsured. The Pennsylvania court denied the reinsurer’s motion for summary judgment limiting any recovery to the stated reinsurance limit, which was made in explicit reliance on Bellefonte. The court pointed out that the case presented, in essence, the reverse of the Bellefonte fact pattern. Instead of the entire reinsurance transaction, including the general conditions, being subject to the stated limit as in Bellefonte, the transaction, including the limit, was subject to the “General Conditions.” Thus, the “slight variations” in the certificate language mandated a precisely contrary result. Indeed, the court commented: “If anything, the terms of the certificates may have created a presumption of expenseexclusiveness.” 2015 Phila. Ct. Com. Pl. LEXIS 25 at *8 (emphasis in original). The court also stated that, in light of Utica Mutual, Bellefonte cannot be taken as establishing “a blanket rule that all limits of liability are presumptively expense-inclusive.” Instead, such a presumption may or may not arise, based on the precise language of the “subject to” clause, and even if it does arise, it may be overcome by examination of the certificate as a whole. 2015 Phila. Ct. Com. Pl. LEXIS 25 at *7. A similar result was reached in Utica Mut. Ins. Co. v. R&Q Reins. Co., 13-cv-01332 (BKS) (N.D.N.Y. June 4, 2015). In that case, the district court relied upon the Second Circuit Utica Mutual decision (which it described as “instructive” even if not “precedential”) in holding that a facultative certificate was ambiguous as to cost-inclusiveness. Conclusions The next steps in the ongoing cost-inclusiveness debate cannot be predicted with any degree of certainty. Would the Second Circuit decide Bellefonte the same way today if faced with the same certificate language? Does Bellefonte — which held a certificate unambiguous on its face — have any meaning at all in jurisdictions that allow extrinsic 5 The legend refers to Federal Rule of Appellate Procedure 32.1 and Second Circuit Local Rule 32.1.1. Both of those rules allow citation of Summary Orders issued after January 1, 2007, but the latter rule prescribes that Summary Orders “do not have precedential effect.” Thus, the Utica Mutual decision is not officially published and without “precedential effect,” yet has been published in the Federal Appendix for all to see and comments upon weighty issues. What all this means in terms of its impact on the state of the law is a topic beyond the scope of this article. Sidley Insurance & Reinsurance Law Report | 2016 27 evidence to be admitted to prove “latent ambiguity”? And what of New York, the state where so many reinsurance disputes are litigated? Will it give full effect to the apparent holding in Excess that the mere statement of a reinsurance limit creates a presumption of cost-inclusiveness, which some have said goes even further than Bellefonte? There are no ready answers. Two things appear clear, however. The first is that there are no longer any simple answers — if there ever were —to the cost-inclusiveness issue. Blanket statements such as “all facultative reinsurance certificates are cost-inclusive and the reinsured cannot recover any amounts beyond the stated limit” are no longer valid. Each case will be decided only after careful parsing of the language of the applicable certificate. Second, those in the reinsurance industry who were never comfortable with the holding of Bellefonte will now, emboldened by new developments, continue their efforts to limit or overrule it, leading to further litigation on this difficult topic.