Reinsurance, like other specialized industries, has its own unique terms
and phrases that seem foreign to the uninitiated. Over the next several columns,
we will explore some of these reinsurance terms of art and try to make them
One of the bedrock doctrines in reinsurance is the concept of follow-the-fortunes.
This doctrine exemplifies the unique business partnership that exists between
the reinsured and the reinsurer.
The follow-the-fortunes doctrine provides generally that a reinsurer must
follow the underwriting fortunes of its reinsured and, therefore, is bound by
the claims-handling decisions of its reinsured so long as there is no evidence
of fraud, collusion with the insured, or bad faith. It is a burden-shifting
doctrine that allows the reinsured the freedom of making good-faith claims decisions
without the fear of having to relitigate those decisions with its reinsurer.
To confuse things more, there is the similar doctrine of follow-the-settlements.
In the United States, courts and many practitioners use "follow-the-fortunes"
and "follow-the-settlements" interchangeably, and so will we.
Application of the follow-the-fortunes doctrine to reinsurance contracts
in the United States began in as early as the 1800s. These early interpretations
of the doctrine, however, did not originate from English common law, but instead
appear to have evolved from general principles applied to reinsurance contracts
in France. By the 1800s in France, it was customary for reinsurance agreements
to contain an express provision binding the reinsurer to reimburse the reinsured
for payment of loss so long as the reinsured acted in good faith and could produce
evidence of payment of the loss.
This clause obligated the reinsured to exercise sound discretion when deciding
whether to contest or pay a claim presented by the insured. Without this "special
contract," however, reinsurers were entitled to raise every defense that could
have been asserted by the reinsured in a suit upon the underlying insurance
General Applications of the Doctrine
The general rule is that follow-the-fortunes obligates a reinsurer to follow
the underwriting fortunes of its reinsured and bars the reinsurer from relitigating
the good-faith claims-handling decisions of its reinsured. Traditionally, courts
have interpreted this doctrine to apply to the reinsured's decisions regarding
settlement of claims. The doctrine holds that a reinsurer is bound by the reinsured's
decisions regarding payment of settled claims so long as the decision was made
reasonably and in good faith.
This obligation not to relitigate a reinsured's good-faith claims decisions
extends to a reinsured's good-faith decision to waive defenses to which it may
have been entitled. This standard is purposefully low in order to preclude a
completely new review of the reinsured's decision-making process.
Although a reinsurer is entitled to inquire into the dispositions of coverage
disputes between reinsureds and their insureds, a reinsurer may not conduct
a de novo review of these dispositions. Thus, the follow-the-fortunes doctrine
creates an exception to the general rule allowing de novo review of contract interpretation.
By prohibiting a court or arbitration panel from conducting a de novo review of the reinsured's claims
decisions, the follow-the-fortunes doctrine obligates a reinsurer to reimburse
the reinsured unless the reinsurer can demonstrate that the reinsured did not
act in good faith or failed to conduct a reasonable investigation.
An exception to the follow-the-fortunes doctrine exists where the reinsurer
demonstrates that the reinsured's decision-making process was fraudulent, collusive,
made in bad faith, or that the underlying claim was not arguably within the
scope of the reinsurance coverage. The standard for "bad faith" is usually a
high one and generally requires some evidence of gross negligence or recklessness
by the reinsured, or evidence that the settlement is arguably not within the
scope of reinsurance coverage.
For example, courts have stated that the following scenarios do not constitute
a reinsured's bad faith:
- Failing to accurately inform reinsurers of an offer of settlement;
- Failure to inform the reinsurer of the reinsured's decision to forego
an appeal where there was little likelihood of success; and
- Treating a group of similar claims as one occurrence where there was
considerable debate as to whether a large group of claims should be treated
as one occurrence or as multiple occurrences.
In addition, at least one court has allowed the jury to consider the failure
to obtain an opinion from counsel as evidence of bad faith in evaluating a reinsured's
refusal to defend. Evidence of mere negligence, therefore, is likely to be insufficient.
During the past several years, the question of whether the follow-the-fortunes
doctrine may be invoked absent an explicit clause in the reinsurance contract
has been the subject of debate and judicial scrutiny. Early case law indicates
that courts were not willing to read follow-the-fortunes type language into
reinsurance contracts when not expressly stated in the agreement. Reinsurance
contracts were instead viewed within the confines of the general rules applicable
to contract interpretation.
More recent case law suggests a greater tendency to apply the doctrine to
all contracts of reinsurance whether expressly provided for or not. As recently
as 1999, however, an appellate court in Michigan refused to impose liability
on a reinsurer for a settlement contribution absent an express provision in
the contract indicating an agreement between the parties to do so. The court
noted that a reinsurer's liability was determined solely by the terms of the
reinsurance contract. Conclusion The principles embodied in the follow-the-fortunes
doctrine represent one of the hallmarks of the reinsurance relationship. Simply
stated, if the reinsured pays a claim reasonably and in good faith, and the
claim falls within the terms of the underlying contract and the reinsurance
contract, the reinsurer must pay, and the reinsured's claims determination will
not be second-guessed.
The principles embodied in the follow-the-fortunes doctrine represent one
of the hallmarks of the reinsurance relationship. Simply stated, if the reinsured
pays a claim reasonably and in good faith, and the claim falls within the terms
of the underlying contract and the reinsurance contract, the reinsurer must
pay, and the reinsured's claims determination will not be second-guessed.
See the updated (2004) article.