Recently, the United States District Court for the Western District of Washington held that a facultative reinsurer was not bound to follow the fortunes of its cedent for a loss that was outside the scope of the reinsured policy and not paid in good faith. The City of Renton, et al. v. Lexington Ins. Co., et al., 2007 WL 2751356 (W.D. Wash., Sept. 19, 2007).

The City of Renton sought coverage in connection with structural repairs to a city bridge that was insured by the Washington Cities Insurance Authority ("WCIA"). WCIA paid the loss and, along with the City, sought indemnification from Lexington Insurance Company ("Lexington"), which reinsured the WCIA under two facultative certificates. Lexington moved for summary judgment, asserting that the underlying loss was excluded under WCIA's policy and thus it was not liable to pay the claim as a matter of law. The plaintiffs cross-moved for summary judgment claiming, among other things, that Lexington was bound to follow the fortunes of WCIA under the terms of the facultative certificates at issue and that the "inherent vice" exclusion in the policy, upon which Lexington relied upon in denying coverage, did not apply. Both parties agreed that the cause of damage to the bridge was a design defect that resulted in the gradual deterioration of its structure. Indeed, the City filed suit against the engineers that designed the bridge and ultimately settled for $450,000. Thus, the issue for the court was whether the error in design was covered under the WCIA policy.

The WCIA policy excluded loss or damage caused by or resulting from, among other things, an inherent vice, but did not define that term. Relying upon other cases that addressed the scope of this exclusion, including a decision originating from the Washington Court of Appeals, the court defined an inherent vice as "any existing defects, diseases, decay or inherent nature of the commodity which will cause it to deteriorate with a lapse of time" and "a cause of loss not covered by the policy, [which] does not relate to any extraneous cause but to a loss entirely from internal decomposition or some quality which brings about its own injury or destruction...[that] is inherent in the property for which recovery is sought." Id. at *7. Applying that definition to the claim at issue, the court found that the design defect that caused the underlying loss was an "inherent vice," since the "ill-designed bridge 'brought about its own injury' and no application of external events was necessary." Id. at *8. As such, Lexington was not obligated to follow the fortunes of the WCIA, as the claim was outside the scope of the coverage provided by WCIA's policy. The court further found that the WCIA paid the underlying claim in bad faith, since the claim was paid several years after Lexington had declined to cover the claim and without further notice to or consultation with them.

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