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Follow-the-Fortunes: Reasonableness Is in the Eye of the Beholder

Larry Schiffer | March 2, 2013

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We last updated the law on the bedrock reinsurance concept of follow-the-fortunes (also known as follow-the-settlements) in our April 2004 commentary. We revisit the follow-the-settlements doctrine on the heels of the most recent pronouncement from New York's highest court, the New York Court of Appeals.

Follow-the-fortunes—or more correctly in this context, follow-the-settlements—is a reinsurance doctrine based on the premise that the reinsurer should not be allowed to second-guess the reinsured's good faith claim decisions. This, it is said, is to prevent the entire system of insurance and reinsurance settlements from breaking down while underlying claim and coverage issues are relitigated at the reinsurance level. Our October 2001 commentary goes into the history of the doctrine, including explaining the distinction between follow-the-fortunes and follow-the-settlements. Our April 2004 commentary updates developments in the doctrine based on its expansion into post-settlement allocations to reinsurers of underlying settlements.

What we are talking about is a historical business mechanism, which is based on full disclosure and trust between the reinsured—which typically has the direct relationship with the insured and direct access to all the pertinent information about the risk—and the reinsurer—which typically has to rely on the utmost good faith of the reinsured to underwrite the risk and handle claims properly and reasonably. In some, but not all, reinsurance contracts, an express clause appears that textually addresses the doctrine. Some courts have inferred the doctrine into reinsurance relationships that have no following clause in the written contract, but most courts require the contract to contain a following clause to apply the doctrine.

In the claims context, it is not uncommon to have a clause in the reinsurance contract that states that all claims in which the reinsurance is involved, when allowed by the company, shall be binding on the reinsurers. Some contracts use the term "follow-the-fortunes" or "follow-the-settlements," but whether the contract uses the word "follow" is not determinative of whether the clause is a following clause that binds the reinsurer. As long as the language indicates that the reinsurer is bound by the reinsured's claim determination, the clause is likely to be viewed as a following clause.

The Evolution of Follow-the-Settlements

The initial court cases that construed the doctrine focused on whether the reinsurer could avoid payment of a reinsurance obligation because of the nature of the settlement, the amount of the settlement, or the manner in which the case was settled by the reinsured. This was discussed in our October 2001 commentary. As the asbestos and environmental cases became more complex, and as courts began addressing and settling claims that spanned over many policies issued over many years, issues arose concerning how the reinsured allocated an underlying settlement to its reinsurers. Thus, as discussed in our April 2004 commentary, reinsurance allocation became the subject and is now often the focus of follow-the-settlements disputes.

The Concept of Reasonableness

Courts analogized to the rules requiring a reinsurer to pay when a settlement is made in good faith and reasonably, and applied the test of reasonableness to the reinsured's allocation of that settlement to the reinsurers. The courts did not hold that reinsurers had to follow the reinsured's allocations no matter what, but that the reinsurers had to follow those allocations if they were reasonable, in good faith, and within the applicable policies. A string of cases followed that are fact specific—one might argue limited to their facts—but continued to address the issue of whether the reinsurer is bound by the reinsured's reinsurance allocation of an underlying settlement.

In Travelers Cas. & Sur. Co. v. Gerling Global Reins. Corp., 419 F.3d 181 (2d Cir. 2005), the Second Circuit Court of Appeals granted summary judgment to the reinsured on its reinsurance allocation decision on the settlement of underlying asbestos cases because the reinsurer was unable to raise any genuine issue of material fact as to the reinsured's good faith that might preclude application of the follow-the-settlements doctrine. The court made it clear that it was not bad faith for the reinsured to choose an allocation methodology that did not minimize its reinsurance recovery. In other words, it was reasonable in this case to choose an allocation methodology that provided a greater reinsurance recovery than one of the other reasonable alternatives that would have provided a smaller reinsurance recovery.

The limits of reasonableness were tested in Allstate Ins. Co. v. American Home Assur. Co., 837 N.Y.S.2d (1st Dep't 2007), leave to appeal denied, 860 N.Y.S.2d 483 (2008), where the reinsured allocated a multisite environmental settlement to its reinsurer using a one occurrence methodology when all parties argued for multiple occurrences in the underlying coverage action and after a jury verdict on one of the sites resulted in a judgment based on multiple occurrences. The intermediate appellate court rejected the notion that the follow-the-settlements doctrine required the court to ignore a manipulation of the allocation process. In this fact-specific case, the reinsurer was successful on its defense to payment, further demonstrating the limits to the follow-the-settlements doctrine.

More recently, in Travelers Cas. & Sur. Co. v. Insurance Co. of N. Am., 609 F.3d 143 (3d Cir. 2010), again the challenge was to the reinsurance allocation. In upholding the application of the follow-the-settlements doctrine to post-settlement reinsurance allocation, the appellate court held that the reinsurer was bound to the reinsured's allocation. In doing so, the court stated that a reinsured breaches its duty of good faith when it makes an allocation decision primarily for the purpose of increasing its reinsurance recovery. But, the court limited this breach to situations where there is direct evidence that the reinsured was motivated primarily by reinsurance considerations or that the reinsured's explanation for its reasoning was not credible. Credibility, we will soon see, has been read to mean reasonableness.

The New York Court of Appeals Decision

The latest case to discuss the limits of the follow-the-settlements doctrine in the context of a reinsured's post-settlement allocation to its reinsurers is U.S. Fid. & Guar. Co. v. American Re-Ins. Co., No. 1 (N.Y. App. Feb. 7, 2013). This case involved asbestos claims arising out of policies issued in the 1950s and 1960s to a distributor of asbestos products. The underlying policies were not "occurrence" based policies, but were the old form of "per accident" policies with no aggregate limits. The case is further complicated by corporate acquisitions in the 1960s, which led to questions about whether the cedent's policies covered the successor company. Those and other issues were litigated in California, including whether the successor corporation succeeded to the insurance issued by the cedent to the original insured.

Meanwhile, claims came pouring in, resulting in default judgments after the reinsured and other insurers refused to defend and the insured agreed not to oppose the entry of default judgments. In the coverage litigation, the insured had alleged that the reinsured's refusal to defend breached the implied covenant of good faith and fair dealing (i.e., "bad faith"). The coverage suit settled while the trial was in progress and resulted in the insured's filing for bankruptcy and the creation of an asbestos trust.

After the settlement, the reinsured billed its excess-of-loss reinsurers, which refused to pay. The motion court granted summary judgment to the reinsured directing the reinsurers to pay, and the appellate division affirmed with one judge dissenting. The reinsurers appealed to New York's highest court.

In discussing the reinsurance allocation, the New York Court of Appeals accepted that the follow-the-settlements doctrine raises problems because the interests of the reinsured and the reinsurer may often conflict. The court concluded that this was the case here where an allocation of the settlement to losses less than $100,000 would result in no reinsurance recovery, but allocation to losses of $200,000 would result in the reinsurers paying half the cost. Because of this, the reinsurers argued that the reinsured's allocation decision should not bind reinsurers under the follow-the-settlements clause in the reinsurance contract.

While finding logic to the reinsurers' argument, the court of appeals nevertheless agreed with the majority of courts and held that a follow-the-settlements clause requires a level of deference to a reinsured's allocation decision. The rationale for this deference was described by the court as providing for a more orderly and predictable resolution of claims. But the court made it clear that deference did not mean that the reinsured's allocation decisions were immune from scrutiny.

The allocation decision still must be in good faith and reasonable. The court stated that "[i]n our view, objective reasonableness should ordinarily determine the validity of an allocation. Reasonableness 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 held that a reinsured'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."

The court concluded that the reinsured'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." But, said the court, "the choice must be a reasonable one, and we also conclude that reasonableness cannot be established merely by showing that the cedent's allocation for reinsurance purposes is the same as the allocation that the cedent and the insurance claimants actually adopted in settling the underlying insurance claims." The court rejected the reinsured's argument that if the allocation is the same as the underlying settlement it establishes the validity of the allocation. Instead, the court held that under a follow-the-settlements clause (like the one in this case), a reinsured's reinsurance allocation of a settlement will be binding on a reinsurer if, "but only if, it is a reasonable allocation, and consistency with the allocation used in settling the underlying claim does not by itself establish reasonableness."

In reversing the summary judgment decision, the court of appeals concluded that the reasonableness of the assumptions in the allocation that (1) all of the settlement amount was attributable to claims within the limits of the reinsured's policies and none was attributable to the claims against the reinsured for bad faith in refusing to defend the insured and that (2) all claims for lung cancer had a $200,000 value, while certain other claims had values of $50,000 or less, presented issues of fact that required a trial. The court pointed to evidence in the record to show that a fact finder could conclude that an allocation giving no value to the bad faith claims was unreasonable and that assigning high values to lung cancer claims instead of allocating some of that value to bad faith or other claims was unreasonable. The court identified an underlying settlement demand that included a significant amount for bad faith presented just shortly before settlement and the parties' arguments to the bankruptcy court to approve the plan partly on the basis that the bad faith claims had significant value. The court concluded that it was impossible to find as a matter of law that parties bargaining at arm's length, in a situation where reinsurance was absent, could reasonably have given no value to bad faith claims.


The U.S. Fid. & Guar. case provides the latest and certainly one of the more detailed road maps for addressing reinsurance allocation determinations under a follow-the-settlements clause. What it shows is that even if the reinsurance contract contains a follow-the-settlements clause, the reinsured's post-settlement allocation is subject to scrutiny for reasonableness. These cases are fact intensive. In U.S. Fid. & Guar., an important fact for the court was the existence of bad faith claims as articulated in the related California coverage case and bankruptcy court approval of the plan. It is rare to have underlying court decisions that provide significant support for the unreasonableness of an allocation decision.

Reasonableness is the catchword in analyzing the scrutiny brought to post-settlement reinsurance allocations. But, as articulated by the New York Court of Appeals, it is reasonableness based on the objective standard of what the underlying parties to a settlement would consider reasonable if there were no reinsurance. Allocating all of the settlement to claims covered by the reinsured's policies and nothing to the bad faith claims may or may not be reasonable—only a trial and a decision by a fact finder can decide that issue.

Based on these more recent cases, we can say that the courts will still defer—and reinsurers will be bound—to the reinsured's claim decisions, including settlement allocation decisions, as long as those decisions are reasonable. Reasonableness, however, is in the eye of the beholder.

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