Larry Schiffer explains "follow-the-fortunes," a bedrock doctrine in reinsurance that exemplifies the unique business partnership between the reinsured and reinsurer.
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 more understandable.
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 policy.
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.