In a recent decision originating from the United States District Court for the Western District of Oklahoma, Oklahoma v. Employers Reinsurance Corp., No. Civ-06-0426-HE, (W.D. Okla. Sept. 13, 2007), the court refused to imply a "follow the fortunes" clause into a facultative certificate in the absence of the explicit inclusion of such a term by the parties. The court also found that the cedent was bound to allocate an underlying settlement for purposes of its reinsurance recoveries in a manner consistent with a previous agreement with its reinsurer.

Kim Holland, the Insurance Commissioner for the State of Oklahoma (the "Receiver"), brought suit against Employers Reinsurance Corporation ("ERC") in her capacity as receiver of Hospital Casualty Company ("HCC"), contending that HCC was entitled to reinsurance recoveries from ERC for certain claims arising under facultative certificates issued by ERC to HCC. The Receiver pursued two unrelated claims in a single proceeding.

The first claim involved the question of whether ERC was obligated to reimburse HCC for a portion of a settlement payment attributable to punitive damages. ERC argued it was not responsible for these damages, since Oklahoma’s public policy generally prohibits insurance coverage for punitive damages. Although the court recognized this general rule, it noted that an exception exists where the insured’s liability for punitive damages is based on vicarious liability. Notably, while the underlying action against HCC included both direct and vicarious liability claims, the jury did not distinguish between the claims in awarding damages. Under these circumstances, the court found that that punitive damages were "presumed" to be covered by the underlying policy and thus within the scope of the reinsurance certificate at issue. Therefore, ERC was obligated to reimburse HCC for such losses.

As for the second claim, HCC entered into a global settlement with its insureds and sought indemnification from ERC based upon an initial allocation of settlement liability (to which ERC agreed). Subsequently, HCC sought to "re-allocate" the underlying settlement between policy years and contended that the "follow the fortunes" doctrine required that HCC’s re-allocation be followed by ERC.

ERC objected to HCC’s purported re-allocation on several grounds. First, ERC contended that it was not obligated to follow the allocation because the reinsurance certificate at issue did not contain a follow the fortunes clause. While the court did not resolve this issue, it noted that it was "reluctant" to imply a follow the fortunes clause into the certificate in the absence of a specific agreement by the parties to include such language, particularly where the parties are sophisticated entities capable of protecting their interests during contract negotiations.

Moreover, the court found that, even assuming that follow the fortunes doctrine were applicable to the dispute, it would not bind ERC to the allocation since HCC was effectively seeking to "re-allocate" the loss on an entirely different basis than it had previously agreed. The court distinguished HCC’s re-allocation from the pro-cedent, follow-the-allocation cases it relied upon, in that those cases involved allocations that were not subject to an explicit agreement by the cedent with respect to the nature of the allocation or situations in which a reinsured allocated a settlement in a manner different from its pre-settlement analysis. The court held that since HCC had entered into an express agreement with ERC to allocate the loss in a specific manner after the settlement, it was bound to that allocation and could not have a "second bite at the apple."

Click here to review a copy of the District Court's decision.