Follow-the-Fortunes Updated

April 2004

In an update of a 2001 article, the follow-the-fortunes doctrine is rexamined, focusing on how some new reinsurance cases have interpreted the doctrine in environmental and asbestos contexts.

by Larry P. Schiffer
LeBoeuf, Lamb, Greene & MacRae, L.L.P.

In our October 2001 commentary, we provided an overview of the follow-the-fortunes doctrine, including its early history and general application. In its pure form, the doctrine precludes the reinsurer from second-guessing the reinsured's good faith claims decisions. But reinsureds have attempted to use the doctrine to bind reinsurers to a variety of claims-related decisions, including payment of declaratory judgment expenses and the methods used by the reinsured to settle underlying claims and allocate those claims to the relevant insurance policies.

In the last few years, a number of new cases have been decided, which, while not radically changing the general application of the doctrine, provide some insight into how some courts have interpreted the doctrine in the context of the more difficult settlement of environmental and asbestos cases.

Follow-The-Fortunes and Limits of Liability

Courts, particularly in New York, have made it clear that a follow-the-fortunes clause will not override the limits section of the reinsurance contract. Typically these decisions have interpreted facultative certificates rather than treaties, where attempts to charge the reinsurer for declaratory judgment expenses in addition to the reinsurance certificate limits have met with stiff resistance in the courts.

Recent cases on this subject continue to follow the reasoning that the follow-the-fortunes clause does not supersede or supplant the overall reinsurance limit in a facultative certificate. Courts generally find that the reinsurance terms in facultative certificates are unambiguous and will not allow evidence of custom and practice in the industry to override the clear terms of the certificates. This means that even if the majority of the insurance industry understands that certain expenses typically are paid by the reinsurer in addition to the limits of the facultative certificate, the courts likely will not consider that industry understanding if the terms of the facultative certificate are unambiguous. For these types of cases the lesson is clear: if the reinsured wants certain expenses to be paid in addition to the stated limits in a facultative certificate, that intent must be expressed in clear and unambiguous language in the certificate.

But how does the limits clause in a facultative certificate work with the reinsured's decision to annualize environmental settlements? Recent case law suggests that some courts will not read the follow-the-fortunes clause to expand the reinsurance contract to allow annualization of claims, thereby circumventing the stated limits in the contract.

In Commercial Union Insurance Co. v Swiss Reinsurance American Corp., No. Civ 00-12267-DPW, 2003 US Dist LEXIS 4974 (D Mass Mar 31, 2003), a Massachusetts federal court held that the reinsurer was only obligated to follow the fortunes of the reinsured's settlement of environmental claims up to the per occurrence limit specified in the facultative certificates. The court refused to allow the reinsured's annualization of the claims, which was not expressly authorized by the certificates, to expand the reinsurer's liability.

The dispute arose from the reinsured's settlement of environmental damages claims at nine sites. The settlement was calculated on an annualized basis with a one-occurrence limit per year. The reinsurer argued that it only had to pay a portion of the settlement because the settlement was calculated on an annualized basis instead of the single per occurrence limits stated in the reinsurance certificates and thereby far exceeded its bargained-for liability. The court agreed with the reinsurer and found that the "follow form" language, which did not provide any limitations on the liability of the reinsurer, did not supersede the limitation on liability contained in the facultative certificates. The court held that even absent the existence of separate endorsements, the certificates unambiguously identified all crucial terms and annualized limits should not be read into multiyear reinsurance policies without an express statement that the policy coverage is to be calculated on an annual basis.

In a subsequent case between the same parties, American Employers' Insurance Co. v Swiss Reinsurance American Corp., 275 F Supp 2d 29 (D Mass Aug 5, 2003), a similar result was reached. The court held that the follow-the-fortunes doctrine could not be used to alter the terms of these facultative certificates, which did not allow for annualization. Again, the court held that the follow-the-fortunes clause could not be used to circumvent the stated limits of the facultative certificates.

Allocation and Follow-the-Fortunes

In a similar vein, a number of courts in the past few years have addressed whether the reinsurer must follow the reinsured's allocation methodology. Some courts have held the reinsurer bound by the reinsured's allocation decisions, stating that to distinguish between settlement and allocation would undermine the follow-the-fortunes doctrine. See Commercial Union Ins. Co. v Seven Provinces Ins. Co., 9 F Supp 2d 49 (D Mass 1998), aff'd on other grounds, 217 F3d 33 (1st Cir 2000); see also The North River Ins. Co. v ACE American Reinsurance Co., 2002 US Dist LEXIS 5536 (SDNY Mar 29, 2002), aff'd, No. 02-7902, 2004 US App LEXIS 4861 (2d Cir Mar 15, 2004).

More recently, a Connecticut federal court held that the follow-the-fortunes doctrine did not obligate the reinsurer to follow the single occurrence allocation method used by the reinsured. In Travelers Casualty & Surety Co. v Gerling Global Reinsurance Corp., No. 3:01cv872, 2003 US Dist 17407 (D Conn Sep 30, 2003), the reinsurer objected to the single occurrence allocation methodology employed by the reinsured in settling asbestos claims that arose out of exposure from various job sites. The reinsurer argued that a multiple occurrence allocation methodology was appropriate because each asbestos job performed by the underlying insured involved different circumstances at over 700 job sites, which constituted over 700 separate occurrences. Under a multiple occurrence theory, the settlement payments would never reach the insured's excess policies and the reinsurer would not be required to indemnify the reinsured.

The reinsured argued that the follow-the-fortune doctrine required the reinsurer to follow the reinsured's allocation of the settlement payments because the settlement was reasonable and in good faith. Agreeing with the reinsurer and rejecting the reinsured's argument, the court held that the doctrine does not obligate reinsurers to indemnify reinsureds for settlement payments that clearly fall outside the scope of the original policy and are in excess of the exposure agreed upon. The court found that the settlement agreement did not specify an allocation of the settlement payment and expressly disclaimed any theory of coverage. Interestingly, the court said that holding the reinsurer to the reinsured's allocation methodology would not promote the purpose of the follow-the-fortunes doctrine—to encourage settlement—because the reinsurer was not contending that the reinsured should not have settled on any basis other than the single occurrence theory.

The Gerling Global decision, however, must be read as limited to its specific facts in light of the Second Circuit's very recent pronouncement in The North River Insurance Co. v Ace American Reinsurance Co., No. 02-7902, 2004 US App LEXIS 4861 (Mar 15, 2004). In North River, the cedent settled its asbestos exposure with its insured after a detailed analysis of its risk of exposure across and through all its policy layers. The settlement reached only the second layer of its excess policies and a reinsurer on the second layer objected to the allocation. In rejecting the reinsurer's arguments, the court held "that the follow-the-settlements doctrine extends to a cedent's post-settlement allocation decisions, regardless of whether an inquiry would reveal an inconsistency between that allocation and the cedent's pre-settlement assessments of risk, as long as the allocation meets the typical follow-the-settlements requirements, i.e., is in good faith, reasonable, and within the applicable policies." Because the allocation was within the definition of loss contemplated by the underlying insurance contracts, there was no breach of the reinsurance contract by allocating the settlement to the second excess layer of policies.

Conclusion

While the basic principles of the follow-the-fortunes doctrine remain steadfast, some courts have limited the use of the doctrine where the reinsured has sought to impose its settlement and allocation methodologies on its reinsurers. Yet other courts view allocation and settlement decisions as the same and have held reinsurers bound to the reinsureds' allocation determinations. The recent cases show, however, that the doctrine cannot be used to expand the reinsurer's liability beyond the stated terms of the reinsurance agreement.

As in most complex contract disputes, the language of the operative contract and the conduct of the parties will affect the ultimate decision on follow-the-fortunes disputes. Ultimately, as more cases are decided where the issue of the reinsured's allocation and settlement methodologies is questioned, a clearer picture will emerge about the scope of the follow-the-fortunes doctrine.

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