Insurance companies purchase reinsurance protection for many reasons. But no matter the reason for buying reinsurance, ceding insurers expect their reinsurers to pay when called on to reimburse the ceding insurer's losses. In an active trading relationship, reinsurers are often described as "partners" of their ceding insurers in the risk assumptions undertaken based on the policies issued by the ceding insurers to their policyholders. Both the ceding insurer and the reinsurer share in the ups and downs of the assumed risks, most particularly in a proportional or quota share relationship.
When a reinsurer goes into runoff, however, that feeling of partnership often fades away. The business mindset of a company frequently changes when it is no longer actively trading. The goals in runoff are different than the goals of a company with active business relationships. Unfortunately for ceding insurers, reinsurance recoverables often become more difficult to collect when their reinsurance company goes into runoff.
With the expansion of runoff over the past several years, ceding insurers are attempting to address through the contract drafting process the difficulties of dealing with a reinsurer in runoff. This commentary will briefly explore this new trend of special clauses in reinsurance contracts aimed at issues that arise when a ceding insurer's reinsurer goes into runoff.
A reinsurer goes into runoff when it stops actively trading and ends its underwriting operations. In other words, a runoff reinsurer stops assuming new risks from its ceding insurers and concentrates instead on minimizing its payouts on its existing reinsurance contracts. A runoff may take the form of a court-ordered receivership proceeding (liquidation, rehabilitation, or conservation), a supervised termination of active underwriting by the local regulator, an informal supervision by the local regulator, or merely a business decision to end active underwriting and place all existing contracts into a runoff mode.
A reinsurer in runoff may keep its staff (typically claims, management, and accounting) and manage its own runoff, or it may hire a professional runoff administrator to handle the business. Sometimes, the entire business will be sold to a company that specializes in buying companies or books of business in runoff.
But when a reinsurance company goes into runoff, the reinsurance relationship between the ceding insurer and the reinsurer does not end. To the contrary, the reinsurer still owes to the ceding insurer a contractual duty to perform under the reinsurance contract. Most importantly, the reinsurer's contractual duty includes paying its ceding insurer's losses as they come due under the reinsurance contract.
Even in a receivership, the insolvent reinsurer owes its ceding insurer the duty to perform under the reinsurance contract. Unfortunately for the ceding insurer, however, an insolvent reinsurer will likely be unable to pay 100 percent of its contractual obligations under the reinsurance contract, and it may take many years for its claim to be adjudicated and allowed. Nevertheless, the ceding insurer should file a claim and hope for the best.
Collecting from a Reinsurer in Runoff
When a trade creditor goes into insolvency or ceases doing business, its counterparty often finds it difficult to obtain outstanding payments. Reinsurance is no different. When a ceding insurer's reinsurer goes into runoff, the ceding insurer may find that its reinsurance billings are not paid quite as quickly as they had been paid before. The business incentives to pay reinsurance recoverables timely have less importance when the reinsurer is in runoff and is seeking to maximize its remaining assets for distribution to its shareholders as an exit strategy.
A number of ceding insurers have experienced an increased lag in collection time from runoff reinsurers. Often this lag is accompanied by multiple questions about the billing, requests for documentation on the underlying losses, and lengthy and detailed audit examinations and inquiries. Delays in payments may occur while the ceding company responds to the runoff reinsurer's requests and while the runoff reinsurer examines the responses and reviews the supporting documents provided. These delays and other behaviors by some runoff reinsurers have frustrated some ceding insurers.
Using Contract Wording To Address Runoff Reinsurers
To address these and other concerns that arise when reinsurers go into runoff, some ceding insurers have begun to modify their reinsurance contracts by adding provisions directly addressing their reinsurer's status in runoff. By using these anticipatory clauses, ceding insurers are attempting to avoid or mitigate some of these issues.
For example, some cedents have limited the right of a reinsurer in runoff to deny payment of a claim. Below is an example of a special clause addressing a runoff reinsurer's right to deny payment:
A runoff subscribing Reinsurer will not have the right to deny payment of a claim if the sum of the percentage shares of active subscribing Reinsurers that have paid the claim exceed 50 percent of the sum of the percentage of shares of all active subscribing Reinsurers. However, this provision will not apply if such runoff subscribing Reinsurer has filed a notice requesting arbitration in accordance with the Arbitration Article, or appointed an arbitrator following receipt of such notice from the Company, regarding such claim. "Active subscribing Reinsurer" as used herein will mean a subscribing Reinsurer that is not a runoff subscribing Reinsurer as of the due date of the claim.
This example precludes a reinsurer in runoff from denying payment of a claim where the majority of all the other reinsurers have paid the same claim. To soften the blow of what might be viewed as a harsh result, the clause excludes those claims that the runoff reinsurer has sought to arbitrate. Thus, if the claim is in dispute, and a proceeding has been commenced, the clause will not apply. But if the runoff reinsurer is merely being recalcitrant, then it cannot deny the claim if the majority of the other reinsurers have paid. Of course, to enforce this clause, the ceding insurer will likely have to commence its own arbitration.
Other ceding insurers have been more aggressive and have developed clauses that address a number of issues with runoff reinsurers. For example, if the reinsurer goes into runoff, the ceding insurer may require that runoff reinsurer to enter into a commutation agreement.
In the event a Subscribing Reinsurer is a Runoff Subscribing Reinsurer or meets one or more of the conditions set forth under paragraph B of the Commencement and Termination Article, the Company may require commutation of that portion of any excess loss hereunder represented by any outstanding claim or claims, including any related loss adjustment expense. "Outstanding claim or claims" shall be defined as known or unknown claims, including any billed yet unpaid claims.
This clause helps the ceding insurer avoid having to deal with a runoff reinsurer over the long haul of the reinsurance agreement by requiring an early commutation if it makes economic sense to the ceding insurer. In short-tail lines, it will be easier to commute than in long-tail lines. The ceding insurer will then have to weigh the burden of dealing with a runoff reinsurer against the unforeseen development that might occur on the book for which it will no longer have reinsurance after the commutation.
Where the reinsurance agreement requires the reinsurer to fund outstanding losses, loss adjustment expenses, and incurred but not reported (IBNR) losses, the runoff reinsurer clause might authorize the ceding insurer to go to court to obtain an injunction to compel the runoff reinsurer to comply with its funding obligations even if there is an arbitration clause for most disputes.
Notwithstanding the provisions of the Arbitration Article, if a Runoff Subscribing Insurer fails to fund its share of the Company's ceded outstanding loss and loss adjustment expense reserves (including incurred but not reported loss reserves) under this Contract (the "funding obligation") as set forth above, Company retains its right to apply to a court of competent jurisdiction for equitable or interim relief.
Arbitration clauses may be modified in any reasonable way to suit the needs of the parties. Carve-outs for certain types of issues, often for claims of fraud in the inducement, have been seen in the last few years. The example above carves out the funding obligations of the reinsurer from the arbitration clause for the purpose of allowing the ceding insurer to go to court to obtain an interim order or other equitable relief compelling the runoff reinsurer to comply with its funding obligations, including IBNR losses, pending resolution of any dispute. This avoids the necessity to go to an arbitration panel that might not feel compelled to make the reinsurer fund until the arbitration panel renders an award in the arbitration. Lack of security for the ultimate obligations allegedly owed by a runoff reinsurer is a big issue, and this clause attempts to address that problem by avoiding delays that might occur in selecting the arbitration panel.
The last example is a clause that allows the ceding insurer to forego arbitration against a runoff reinsurer and, instead, go to court.
Notwithstanding the above, in the event that the dispute or difference of opinion involves a Runoff Subscribing Reinsurer, the Company may, at its option, choose to forego arbitration and may bring an action in any court of competent jurisdiction.
This optional clause gives the ceding insurer flexibility to choose its forum depending on the status of the runoff reinsurer and the issues in dispute. By dragging a runoff reinsurer into court, instead of the more genteel surroundings of traditional reinsurance arbitration, the ceding insurer puts much more pressure on a nonpaying runoff reinsurer.
As more and more reinsurers go into runoff, more and more ceding insurers will try to modify their reinsurance contracts to address some of the problems that arise because of runoff. The examples above merely touch the surface of the types of creative solutions being employed by ceding insurers and brokers. The problems ceding insurers face when dealing with runoff reinsurers has prompted the emergence of creative ways to address a common problem faced by many ceding insurers. More developments and refinements should be expected in the future.
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