When presented with a large progressive or continuous injury or multiyear claim, one important coverage question is whether the limits of liability on large commercial excess or umbrella multiyear policies should respond to the claim on an annualized basis or as a single occurrence subject to one limit of liability spanning the multiyear period of the contracts. The question is significant because if the limits apply on an annualized basis, more coverage may be available for each occurrence and, presumably, more reinsurance will be available for the reinsured to offset its claim payments.
On the reinsurance side, this issue arose in a number of recent cases where settlements of underlying continuing injury and products claims were allocated by the reinsureds to their policies on an annualized basis, and then ceded to their reinsurers on that same annualized basis. The reinsurance question is whether the reinsurance contract limits should apply on an annual basis when the reinsurance contract was written on a multiyear basis. Among the arguments invoked by reinsureds in favor of annualization is the doctrine of "follow-the-fortunes" (see Expert Commentary April 2004 and October 2001).
As is often the case when these disputes go to court, the question turns on the language of the reinsurance contract and the intent of the parties. If the reinsurance contract is unambiguous, courts generally will not look to extrinsic evidence to discern the parties' intent, but will require compliance with the plain language of the reinsurance agreement. This in spite of underlying contracts that anticipate the annualization of multiyear policy limits.
Large commercial risks are often insured under a series of multiyear primary and excess or umbrella insurance policies spread over various layers of coverage. The policy limits on these large commercial risks are often written as a part of a larger layer of coverage. For example, one policy may express its limits as $4.5 million part of $15 million excess of underlying insurance. That limit may apply on a per occurrence basis, or on an aggregate basis, or both. One insurer may take a portion of a series of layers to spread its risk or it may decide to concentrate in one layer. Other insurers will make up the rest of the support for the insured's insurance program.
These large commercial multiyear policies, in turn, are often reinsured facultatively, with the facultative certificates also written on a multiyear basis. The corresponding facultative reinsurance certificates are also often issued in parts. For example, the reinsurance accepted may be expressed as a percentage of the limit of liability or as a dollar amount, e.g., $1 million part of $4.5 million part of $15 million excess of underlying insurance.
Typically, the underlying policies and reinsurance certificates are on a per occurrence basis. That is, the policy limit, and the reinsurance limit, will apply to each occurrence, subject to any policy aggregate limit.
Large commercial risks face a multitude of multiyear continuous injury-type claims, including old asbestos liabilities, environmental and toxic tort claims, chemical products claims, silicone breast implant claims, and more. Where multiple claims arise out of one occurrence, coverage may be spread over many years and over many policies. Settlement of these claims is complex, costly, and involves difficult allocation decisions by the reinsured.
Where these type of claims are treated as arising out of a single occurrence, the settlement amount needs to be allocated to the reinsured's policies, which then triggers any relevant reinsurance obligations. Some reinsureds have allocated settlements to multiyear policies by annualizing the limit for each policy. For example, if the first multiyear policy had a limit of $4.5 million, the reinsured would allocate $13.5 million ($4.5 million for 3 years) to that policy.
Based on this annualized allocation, the reinsured would then seek reinsurance recoveries on a similar annualized basis. So if we stay with the same example, the facultative certificate's $1 million limit of liability would be annualized so that $3 million is billed to the facultative reinsurer on the $13.5 million of loss allocated to that policy.
The Annualization Dispute
Whether to annualize the limits of an underlying multiyear policy is in dispute, in part, because of inconsistent case law. For example, New Jersey courts have upheld annualization of multiyear policies for progressive injuries that span more than 1 year, holding that the injury is a separate occurrence within each of those years, and applying a full liability limit for each year of the policy. See, e.g., Carter-Wallace, Inc. v Admiral Ins. Co., 712 A2d 116, 1121 (NJ 1998). Other courts, notably the District of Columbia and Fifth Circuits, and Delaware, have refused to read multiyear policies as providing for an occurrence each year. See, e.g., CSX Transportation, Inc. v Commercial Union Ins. Co., 82 F3d 478, 483 (DC Cir 1996); Society of the Roman Catholic Church v Interstate Fire & Cas. Co., 26 F3d 1359, 1366 (5th Cir 1994); Hercules, Inc. v AIU Ins. Co., 784 A2d 481, 495-96 (Del 2001). These cases turn on the specific contracts under review and the view of the specific courts on how to interpret insurance contracts.
The difficulty lies in cases where the potential exists that the court will annualize the underlying limits based on New Jersey or similar law and the reinsured settles on that basis. It then finds itself in the difficult position of trying to convince its reinsurers that the annualized allocation was legitimate based on the applicable law.
Allocation decisions for excess and umbrella policies also are often influenced by the underlying primary policies. If the primary policies have annual limits, it may be appropriate for a following form multiyear excess policy to annualize an occurrence that spreads across the entire policy term of the excess policy. If the excess contracts and the facultative reinsurance of the excess contracts are all written on a following form basis, and they follow primary contracts that have annualized limits of liability, the natural business expectation is that the reinsurance will apply on an annualized basis. The courts, however, do not always see it this way.
The Reinsurance Dispute
The reinsurance dispute is obvious. Does the limit of liability of a multiyear facultative certificate apply on a per occurrence basis each year of the multiyear agreement or does it apply as one single limit per occurrence for the term of the facultative certificate? This issue may arise even if the underlying policy has annualized aggregate limits, but the facultative certificate is silent or unclear on whether that aggregate is extended to the reinsurance.
In recent cases, several courts were faced with facultative certificates with follow-the-form and follow-the-settlements language, but none of the certificates had any explicit language allowing annualization of the reinsurance limits. The courts also were faced with arguments based on the traditional follow-the-fortunes doctrine. See, e.g., Commercial Union Insurance Co. v Swiss Reinsurance American Corp., No. Civ. 00-12267-DPW, 2003 U.S. Dist. LEXIS 4974 (D Mass Mar. 31, 2003); American Employers' Insurance Co. v Swiss Reinsurance American Corp., 275 F Supp 2d 29 (D Mass Aug. 5, 2003); Travelers Cas. & Surety Co. v Constitution Reins. Corp., No. 01-71057 (ED Mich Aug. 2, 2004).
In analyzing these disputes, the courts rejected the follow-the-fortunes argument and looked only to the language of the facultative certificates to determine the scope of the reinsurance obligation. (Our prior columns discussed the follow-the-fortunes issues and that analysis will not be repeated here.)
When reviewing reinsurance contracts, courts first look to the plain and ordinary meaning of the terms of the contracts. Unambiguous contracts are typically enforced according to their terms. The courts will not read terms into the contracts and will not go beyond the express terms of the contracts. These maxims were applied by the courts in the recent annualization cases.
In construing the facultative certificates in the context of annualization claims, the courts rejected the argument that the parties intended a single event spanning multiple years to constitute a separate occurrence in each year. The courts rejected this argument, in part, because the definition of "occurrence" in the underlying policies did not limit an occurrence to a single year and nothing in the facultative certificates did either. Moreover, the facultative certificates did not expressly state that the liability limits would apply annually or each year or for each annual period. Rather, the certificates granted coverage up to the stated limits for each occurrence during the period of the reinsurance coverage.
The basic point of these cases is that the courts tend not to interpret reinsurance contracts to cover losses not expressly provided for in the unambiguous terms of the contracts. What the courts are saying is that if the parties wish to contract for annualized limits, they should do so expressly in the facultative certificate. This brings us back once again to the need for reinsurance contract terms to be carefully and clearly drafted, even if they contain a follow-the-form clause.
The cases, however, present reinsureds with a serious problem. In these cases, it may have been reasonable for the reinsureds to settle and then allocate the settlement to their multiyear policies on an annualized basis given the facts of the cases, the nature of the primary policies, the likelihood of unfavorable state law applying to the claims, and the disposition of the courts to maximize insurance coverage. As these cases point out, the facultative certificates may not explicitly state the extent to which their limits follow those of the underlying reinsured policies. Thus, the reinsured may not be certain of a full annualized recovery from its reinsurers even though the underlying settlement might have been reasonable on an annualized basis. Without express language in the facultative certificates allowing the reinsureds to cede the settlement on an annualized basis, the reasonableness of the original settlement decision may, as these cases suggest, give way to the perceived unambiguous terms of the reinsurance agreements.
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