In February 2013, the highest appellate court in New York issued its judgment in USF&G v American Reinsurance Co.17 This confirms the high standard the reinsurer will need to satisfy to challenge its cedant’s settlements. As such, it seems on the face of it that the English and New York courts now adopt a very similar position to follow settlements clauses.

Background to USF&G v American Reinsurance Co

The case concerned the underlying asbestos liabilities of Western Asbestos Company (Western) which dissolved in 1967. Western was repeatedly sued in the US. In 1993, Western sued USF&G seeking insurance coverage for these claims, and also alleged bad faith against USF&G. The litigation ensued for almost a decade. In the meantime, Western was left to handle the asbestos claims on its own. In the absence of defence costs being advanced by insurers, Western consented to default judgments being entered, with the plaintiff attorneys agreeing to stay execution of the judgment until the USF&G lawsuit was resolved (as Western had no other assets).

A settlement agreement was finally reached in 2002. Western was dissolved and USF & G paid $975 million to a trust established to compensate plaintiffs. The policies issued by USF&G contained “per person” and “per accident” limits in varying amounts. The settlement agreement did not allocate the loses to any particular policy year.

USF&G, in consultation with MacArthur, allocated the loss to the 1959 policy year as this had the highest per-person limits ($200,000) which had the effect of maximising USF&G’s available reinsurance. The reinsurance was a $200,000 xs $100,000 policy for any loss occurring during the period covered by the policy. USF&G calculated the reinsurers’ obligation to it at approximately $391 million, which reinsurers refused to pay. The reinsurance treaty contained a follow the settlement clause but reinsurers argued that they were not bound to pay because (i) part of the settlement related to bad faith claims which reinsurers were not liable to indemnify and (ii) USF&G’s allocation was done in such a way as to maximise reinsurers’ liability (with USF&G allocating as many losses as possible at the maximum $200,000 effectively to ensure reinsurers paid 50% of the total settlement).

The court ultimately concluded that the reinsurers were bound to follow USF&G’s settlements but, importantly, the reinsurers were entitled to challenge some parts of USF&G’s allocation of claims as well as the allocation of any element of a bad faith settlement. The matter has been referred back to a trial court to determine the detailed allocation issues.

The New York court’s comments on “follow the settlements”

Whilst the New York Appeals Court allowed reinsurers to re-visit certain aspects of the underlying allocation, it made a number of general comments concerning ‘follow settlements’ clauses:

  1. A cedant’s allocation and settlement should be approached with deference.
  2. Any underlying settlement and allocation of losses must be done in “good faith” and must be objectively reasonable, and it was for a reinsurer to prove this was not the case.
  3. A cedant was entitled to present losses in a way that maximised the reinsurance coverage available.

Although a cedant’s allocation decision should be treated with “deference”, this did not mean that a cedant would be immune from scrutiny. A reinsurer would be bound only by a cedant’s “good faith” decision. The court explained that the standard for determining the validity of an allocation of underlying losses should be that of “objective reasonableness”. As such, a cedant’s allocation must be one that the parties to the underlying insurance claims might reasonably have arrived at in arm’s length negotiations as if the reinsurance had not existed. The burden is on reinsurers to prove the contrary and if they cannot, the allocation will be reasonable.

The court stated that, “There seems to be no good alternative to giving a measure of deference to a cedant’s allocation decisions. To review each decision de novo would invite long litigation over complex issues that courts may not be well equipped to resolve, creating cost and uncertainty and making the reinsurance market less efficient”.

The court also clarified that “reasonableness” does not imply a disregard of a cedant’s own interests. The court stated that insurers are not the fiduciaries of their reinsurers and should not be required to put the interests of their reinsurers ahead of their own. As the court summed up, “We think it unrealistic to expect that the cedent will not be guided by its own interests in making the choice.

Is this the same as in England?

The position on follow the settlements clauses in English law is long established. Subject to the specific wording at issue, the reinsurer is generally required to follow any settlement so long as:

  1. The reinsured has acted honestly and taken all proper and business-like steps in reaching the settlement.
  2. The claim so recognised by the reinsured falls within the risks covered by the reinsurance as a matter of law.

This again is a high standard for reinsurers to discharge as, for example, cedants are not required to show that, as a matter of law, the claim falls within the risks covered by the underlying insurance contract. This automatically precludes reinsurers from re-litigating the question.

Recent English decisions have focussed on the question of proof, much like in the USF&G US case. In Equitas Ltd v R&Q Reinsurance Co (UK) Ltd,18 the court determined what evidence was required for a cedant to “prove” his loss. There, the English High Court allowed the use of an actuarial model to prove the amount of the cedant’s underlying settlements. Despite commenting that the actuarial model employed by Equitas was “complex, expensive [and] imperfect”, Mr Justice Gross ruled that Equitas was entitled to recover its losses based on the modelling. In IRB Brasil Resseguros SA v CX Reinsurance Co Ltd,19 on an appeal from an arbitration award, the English High Court again outlined what was required under a ‘double proviso’ follow settlements clause. The standard of proof required for an insured to prove his case is “on the balance of probabilities”. In considering the question of proof of loss under such a clause, it was held that the correct approach is to look at the facts on the basis of the claim as settled (as opposed to looking at the underlying facts of the original claim).

Conclusion

It seems that both the English and the US courts are aware that follow the settlements clauses must balance the conflicting interests of the reinsured and the reinsurer. Both jurisdictions, however, seem to have concluded that limiting a reinsurer’s ability to re-start litigation is important to ensure the efficiency and well-being of the insurance market. A cedant may be given a head start but must still ensure it settles reasonably and in good faith, otherwise the settlements will be open to challenge.