When a ceding insurer resolves a long-tail claim or series of long-tail claims (e.g., asbestos) through a settlement, policy buy-back, commutation, or some other mechanism (which could include a judgment after trial), what should it, must it, or can it consider when deciding how to allocate the settlement to multiple policies over multiple years?
At some point during the evolution of a claim, it comes to an end. Either the claim is settled, the claim is dismissed, a judgment is rendered by a court, or an award is issued by an arbitrator. While expenses may have been preliminarily allocated to specific policies and even ceded to specific reinsurers during the life of the claim, once the claim is finalized by settlement or judgment and the checks are cut, the insurer has to make a final determination on how the claim—and its actual expenses and indemnity payments—will be allocated to its insurance policies.
In a normal case where there is a single claim that occurred on a specific date, there typically is only one policy to which the claim can and should be allocated. Allocating a settlement to the only possible responsible policy is generally noncontroversial. That determination is generally made up front (as part of the coverage determination), and, depending on the terms of the reinsurance contract covering that policy, notice of the claim to the reinsurers should not be that difficult to accomplish.
But when the claim is a long-tail claim that spans many years and many possible policies, the allocation decision may become more art than science. This is the case with asbestos and other similar latent bodily injury claims. Decades go by and the vagaries of state law may cause many policies to respond to the claims. Policies may or may not exist, insureds may have gaps in coverage, and carriers may have gone insolvent over time. When claims go back many decades, the ability to locate all responsible policies is a difficult task.
But ultimately, when the claim is resolved, the settling insurance company has to decide how to allocate that settlement to the policies it believes must legitimately respond to the claim. And once the policy allocation decision is made, then the insurer—now the ceding insurer—will also have to determine how to allocate that settlement to its reinsurance contracts and bill its reinsurers for their share of the settlement.
Objectively Reasonable Settlements and Objectively Reasonable Allocations
We know from the case law that the underlying settlement itself must be objectively reasonable and businesslike. Under most notions of proper business behavior and good faith, only settlements that are reasonable and businesslike and that fall within the terms of the insurance policy are settlements that a reinsurer would expect to receive.
The cases teach us that the claims personnel must handle the claim without regard to reinsurance and must act in good faith in resolving the claim. The cases also teach us that when the claim has to be allocated among multiple insurance policies, that allocation also has to be objectively reasonable and made in good faith. So too must the reinsurance allocation be objectively reasonable and made in good faith. In fact, merely following the allocation of the underlying polices is not, in and of itself, sufficient to establish the reasonableness of the reinsurance allocation.
When, in the ceding insurer's mind, all are done in a businesslike manner, are objectively reasonable, and made in good faith, the ceding insurer will expect nothing less than timely payment of a properly presented reinsurance billing.
What's a Reinsurer To Do?
The conundrum for the reinsurer, sometimes being faced with a billing after decades of limited—if any—information about a claim, is how to determine if the reinsurance allocation was done in an objectively reasonable manner and in good faith. Reinsurers know that some courts in the United States imply the follow-the-settlements doctrine even if the applicable reinsurance contracts do not have follow-the-settlements language. They know that under the follow-the-settlements doctrine, reinsurers cannot second-guess the good faith claims determinations of the ceding insurer. They also know that many courts in the United States have applied the follow-the-settlements principle to allocation.
The cases provide words like "objective reasonableness" and "businesslike manner" when discussing these principles in the context of allocation. But each case is fact-specific, and determining the objective reasonableness and good faith of an allocation will depend on the facts. As the New York Court of Appeals said in U.S. Fid. & Guar. Co. v. American Re-Ins. Co., 2013 N.Y. LEXIS 112, 20 N.Y.3d 407 (2013), a ceding insurer's allocation "must be one that the parties to the settlement of the underlying insurance claims might reasonably have arrived at in arm's length negotiations if the reinsurance did not exist."
Most reinsurers want to pay legitimate claims quickly. But to pay quickly, reinsurers need to receive sufficient information to satisfy them that the claim came within the underlying contract, was resolved in good faith, and came within the terms of the reinsurance contract. Sometimes it is hard to get that information even on a single claim paid under a single policy, let alone for 10 or 20 years of policies that are over 30 or even 50 years old, addressing the insured's liability for manufacture or use of asbestos products.
Recent case law provides reinsurers, with the right facts and circumstances, some opportunity to question whether an allocation was made with objective reasonableness and in good faith. But that opportunity cannot be squandered with fishing expeditions; there has to be a legitimate basis for inquiry. And, based on the case law, that opportunity is limited. The mere fact that the allocation decision has resulted in a significant reinsurance recovery claimed by the ceding insurer may not be enough for a court to question the allocation decision.
To Maximize or Minimize Reinsurance
In a recent case, a court did what many courts have done, which is to uphold an allocation of an asbestos settlement under the follow-the-settlements doctrine (Utica Mut. Ins. Co. v. Clearwater Ins. Co., 2016 U.S. Dist. LEXIS 6219 (N.D.N.Y. Jan. 20, 2016)). In upholding the ceding insurer's allocation as a reasonable settlement decision, the court commented that a ceding insurer was not required to pick an allocation that minimized reinsurance recovery.
Fair enough—objective reasonableness and good faith should not weigh in favor of either the ceding insurer or the reinsurer. Thus, in making an allocation determination, the ceding insurer should not be forced to pick one out of a number of reasonable alternatives that minimizes its reinsurance recovery if, in making its settlement and allocation determinations, it must do so with a blind eye toward its reinsurance protections.
This comment is consistent with some other courts' pronouncements when discussing objective reasonableness and good faith. In U.S. Fid. & Guar. Co., the court said that "[r]easonableness does not imply disregard of the cedent's own interests. Cedents are not the fiduciaries of reinsurers, and are not required to put the interests of reinsurers ahead of their own." The court concluded that the ceding insurer's motive "should generally be unimportant. When several reasonable allocations are possible, the law, as several courts have recognized, permits a cedent to choose the one most favorable to itself."
As the courts appear to see it, the ceding insurer must address the claim settlement neutrally, as far as reinsurance is concerned; act in good faith; and proceed in a reasonable manner that would be viewed as objectively reasonable by a third party without consideration of reinsurance. In doing so, the ceding insurer does not have to—and should not have to—pick an allocation methodology that minimizes its reinsurance recovery.
So what happens if the ceding insurer actually picks an allocation method that also happens to maximize its reinsurance recovery? All things being equal, if the theory holds, as long as the allocation was done in an objectively reasonable manner and in good faith, many courts will sustain the allocation determination based on follow-the-settlements principles applied to allocation. Where there are multiple reasonable allocations possible, as the New York Court of Appeals said in U.S. Fid. & Guar. Co., the ceding insurer could choose the one most favorable to itself.
Whether the follow-the-settlements doctrine even applies to allocation is a completely different question, which, in the United States, appears to have been answered by most courts in the affirmative. But assuming that it does apply, the test of objective reasonableness and good faith will depend on the specific facts involved in the settlement and allocation.
Where the evidence shows that the ceding insurer was focused on reinsurance recoveries above all else when settling a long-tail loss and also had the same focus when allocating that loss to its policies and its reinsurance protections, the reinsurer may have a legitimate beef that should be taken up by the courts. But getting that kind proof is no small task. In the more usual case where claims professionals go about their business as they should, an allocation that results in the maximization of reinsurance recoveries may not be so easy to strike down.
Long-tail claims, such as bodily injuries from exposure to asbestos, have run havoc on many in the insurance industry. Policy-issuing companies that issued polices half a century ago have been called on to pay losses for these exposures. The tasks of addressing these exposures and allocating settlements to the proper policies, and then allocating to and billing the correct reinsurers for their share of those exposures, are complicated and complex tasks.
But if a ceding insurer faced with settling these types of exposures allocates its good faith settlements in a businesslike and objectively reasonable manner, the fact that the ceding insurer's allocation results in the maximization of its reinsurance recoveries may provide little support to a reinsurer's challenge to that allocation.
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