The legal duty of utmost good faith is an ancient doctrine that continues to evolve. While some have written off the duty in these modern times, most insurance and reinsurance professionals still adhere to its precepts. This article examines this duty that is so fundamental to the reinsurance relationship and how it has changed over the years.
How different or special is the reinsurance relationship compared to other business transactions? Does it rise to the level of trust normally associated with a fiduciary relationship like that of a trustee and beneficiary? Are there special rules of behavior that apply only to the reinsurance relationship?
Over the years, commentators and courts have described the reinsurance relationship in various ways. Among the attributes that stand out when describing the reinsurance relationship is the duty of utmost good faith or uberrimae fidei. This commentary will provide a basic overview of the duty of utmost good faith and will briefly discuss how it has evolved over the years.
What Is the Duty of Utmost Good Faith?
Fundamental to the reinsurance relationship is the duty of utmost good faith. At its core, the duty requires the ceding insurer to disclose to the reinsurer all material facts about the risk being reinsured. It is said that the duty of utmost good faith is implicit in every reinsurance contract and that it supplements all other express and implied contractual obligations. This means that the duty of utmost good faith goes beyond the traditional duty of good faith and fair dealing implicit in every contract.
Some commentators and courts have extended this duty beyond the disclosures at the inception of the reinsurance relationship. The duty of utmost good faith has been applied to the parties' conduct during the life of the reinsurance contract, the underwriting and administration of ongoing business, the obligation to give notice of a claim, and to the duty of the reinsurer to pay under the reinsurance contract.
The duty also has been said to be reciprocal. In other words, the duty runs to both the cedent and the reinsurer. This formulation of the duty of utmost good faith goes to the nature of the reinsurance relationship after the contract has been executed. It is more closely aligned with the notion that the reinsurance relationship is a partnership, where each party to the contract shares in the risk underwritten and reinsured.
Where Did the Duty of Utmost Good Faith Originate?
The duty of utmost good faith has its roots in marine insurance. Marine insurers had little or no information about the risks that they were insuring because the vessels often were in seas far away from the underwriters. To enable marine insurance to develop, a doctrine arose that required the ship owner to disclose every known material fact about the risk, without any inquiry being made by the underwriter, so that the underwriter could proceed with confidence to insure the risk.
Early on, the marine rule was applied equally to marine reinsurance, where the reinsurer had even less information than the insurer. If the ceding company failed to disclose a material fact, whether intentionally or innocently, the reinsurance contract was voidable by the reinsurer. The rationale is that the cedent is in the best position to know of any circumstances material to the risk and, therefore, must disclose that information to the reinsurer. The duty, therefore, requires the cedent to place the reinsurance underwriter in the same position as the cedent and to give the reinsurance underwriter the same means and opportunity of judging the risk.
The Duty of Utmost Good Faith in the Modern Era
Today, courts have extended the rule in marine insurance and reinsurance cases to non-marine reinsurance. Most of the court cases involve claims of rescission for misrepresentation or concealment of material information in the negotiation of the reinsurance contract. The basic rule remains the same—the cedent must disclose all material facts concerning the original risk, and the failure to do so renders the reinsurance contract voidable.
Many courts have stated that the cedent's duty is an affirmative one and that the reinsurer has no duty of inquiry. The burden is on the cedent to disclose all facts that materially affect the risk. Some courts continue to hold the reinsurance contract subject to avoidance even if the cedent innocently failed to disclose a material fact. Other courts, however, have held that under state law, a claim of fraud may not be founded on innocent misrepresentation and concealment in the non-marine context.
What Is Material?
The big question in determining whether there has been a violation of the duty of utmost good faith and whether the reinsurance contract should be rescinded is whether the undisclosed information was material. Some courts have stated that a fact is material if it would have prevented the reinsurer from entering into the reinsurance contract or would have prompted the reinsurer to change the terms of the contract before execution. The test used by some courts is whether a reasonable cedent would have believed the fact to be material to the reinsurer at the time of contracting. This is important because, under this formulation, whether the reinsurer claims the fact was material is irrelevant. It is only what a reasonable cedent believed the reinsurer would consider material that counts.
Some of the facts found material by the courts have been:
- The failure to disclose the cedent's insolvent status
- The undisclosed offer to the underlying insured to extend coverage or provide an unusual policy term
- The failure to disclose recommendations made in a property survey report
In each of these cases, the courts held that these undisclosed facts were known by the cedent to be material to the reinsurer and that disclosure of the facts would have either prevented the reinsurer from entering into the reinsurance contract or would have prompted the reinsurer to change the terms or request a higher reinsurance premium. If, however, the cedent had no reason to believe that the reinsurer would consider a fact material to the nature of the risk, then there is no violation of the duty, and the contract will not be avoided.
The Duty of Utmost Good Faith Post-Contract
Although the duty of utmost good faith originally concerned the information available about the risk at the creation of the reinsurance contract, the duty has been applied to span the entire relationship between the cedent and the reinsurer. Because the cedent remains closest to the risks as the underlying business is written and is most familiar with the underlying claims as they are adjusted, many commentators and courts have stated that the cedent must continue to exercise utmost good faith in its ongoing dealings with the reinsurer. Thus, claims of breach of the duty of utmost good faith have been made concerning a cedent's handling of underlying losses, its attempts to settle those losses through industry mechanisms, and the timing of notice of these efforts to its reinsurers.
The theory behind this expansion has been articulated as an economic one. The duty of utmost good faith allows the reinsurer to avoid having to duplicate the claims, actuarial, and underwriting staffs of the cedent. Under this theory, the continuing duty of the cedent to keep the reinsurer apprised of all information material to the risk, including claims and administrative information, is necessary for the reinsurance market to function efficiently.
Although an ancient doctrine, the duty of utmost good faith continues to evolve. While some commentators and courts have written off the duty in these modern, technological times, most insurance and reinsurance professionals still adhere to its precepts. The lesson taken from the court decisions analyzing the duty of utmost good faith is simple—cedents and reinsurers should continue to act as partners by keeping each other informed and by disclosing all relevant information material to the relationship. If the lines of communication remain open, fewer disputes will occur.