After entering into a reinsurance contract, many reinsureds are confident that they know precisely the scope of the reinsurance protection they bargained for. But while the purchase of reinsurance may sound easy, exactly what is covered by the reinsurance contract may not be as clear as the reinsured thought. Particularly in treaty reinsurance on a quota share basis, it is very important to know what risks and what losses are being ceded out of the myriad policies written by the reinsured.

The further away from the original policies the reinsurer is, the more precise the parties need to be in defining exactly what is being reinsured. Unfortunately, what may seem clear may end up being disputed if the parties do not have a definite understanding of the liabilities reinsured under the “business-covered” clause of the reinsurance contract. As in most situations, careful drafting of reinsurance contracts at the outset can save parties the expense and time of an arbitration or litigation over issues of reinsurance coverage.

The Business-Covered Clause

The first place to look to determine what liabilities are covered by the reinsurance contract is the business-covered clause. This clause may be labeled in various ways. Essentially, it is the clause that describes whether the reinsurance contract is covering risks or policies written by the reinsured that attach to the reinsurance contract or whether losses on policies issued by the reinsured occurring during the life of the reinsurance contract are being reinsured. A good “business-covered” clause will state with precision the risks or losses being reinsured and the scope of that coverage. Otherwise, when the losses come in, disputes may arise concerning whether the reinsurer is obligated to cover the losses.

Basically, there are two generic types of reinsurance coverage, with hybrids and customized permutations galore. These are commonly called losses-occurring-during and risks- or policies-attaching. This commentary briefly examines these two reinsurance coverage types.

Losses-Occurring-During or Risks-Attaching Contracts

Losses-occurring-during reinsurance contracts generally require the reinsurer to indemnify the reinsured for all losses incurred during the reinsurance contract period, regardless of when the reinsured issued the loss-generating policies. An example of a losses-occurring-during clause is as follows: “This contract shall apply to losses occurring during the term of this contract and shall remain in force until (month, day, year).”

Imagine that the reinsured issues a policy to its insured for the period May 15, 2003, to May 15, 2004. The reinsured purchases a reinsurance contract covering its book of business running from January 1, 2003, to January 1, 2004. If the reinsurance contract contains a losses-occurring-during clause, a loss occurring on January 2, 2004 would not be covered because it took place outside of the reinsurance contract period.

On the other hand, risks or policies-attaching contracts only cover reinsured losses on policies attaching—i.e., incepting—during the reinsurance contract period. A “business-covered” clause in a risks-attaching reinsurance contract might read: “This contract shall apply to all insurances relating to risks covered hereunder issued or renewed on and after (month, day, year).” Where the reinsurance contract provides that the “company binds itself to cede and the reinsurer agrees to accept a fixed proportion of __ percent of all business falling within the term of this agreement up to a limit of __,” a loss occurring on January 2, 2004, arising out of the reinsured’s policy would be covered despite occurring outside the period of the reinsurance contract because the original policy incepted during the term of the reinsurance contract.

Complicating Factors

Of course, “business-covered” clauses come in more varieties than just these two types. Among other complicating factors, “business-covered” clauses may describe which losses the reinsurance contract covers, but may also spell out which losses on which specific policies are covered. Indeed, losses-occurring-during contracts can apply to new and renewal policies only or the parties may choose to cover policies already in existence when the reinsurance contract is signed i.e., in-force policies, plus new and renewal policies. For example, losses-occurring-during reinsurance coverage for new and renewal policies may be formulated like this:

The Reinsurer will indemnify the Company up to a limit of liability to the Reinsurer of $___ of ultimate net loss each occurrence, for losses occurring with a date of loss during the term of this contract, but only in respect of those policies attaching on or after the inception date of this contract.

A formulation covering in-force business may look like this:

This contract covers any loss or losses occurring during the term of this contract under any and all policies in force at the effective date of this contract, or written or renewed thereafter.

Reinsurance contracts covering in-force business will provide that the reinsurer will receive a share of the unearned premiums for that in-force business, according to common practice.

Termination-Induced Hybrids

Parties may choose to create hybrids of losses-occurring-during and risks-attaching contracts. For example, losses-occurring-during contracts may extend coverage beyond only those losses occurring during the contract period to losses under policies in force when one of the parties terminates the contract. This is termed runoff coverage which, commentators argue, a reinsured might want in order to protect its in-force business when a contract is terminated before the end of its term. See Michael Hollenbach, “Surplus Share,” in Reinsurance Contract Wording 149, 150 (Robert W. Strain, ed., 1996). An example of wording for a runoff clause follows.

The Reinsurer shall remain liable for all cessions in force at termination of this contract; however, the liability of the reinsurer shall cease with respect to losses occurring subsequent to the first anniversary, natural expiration or cancellation of each policy ceded, but not to extend beyond 12 months after such termination.

Conversely, risks-attaching contracts that normally keep the reinsurer on the hook until the covered policies expire may cut coverage short at termination with the help of a cutoff clause. For example, if a reinsurance contract that took effect on October 15, 2003, is suddenly canceled on December 15, 2003, the reinsured that agreed to a cutoff clause would not be covered for any post-December 15 losses. A typical cutoff clause follows: “The Reinsurer shall be relieved of all liability hereunder for losses subsequent to termination of this contract.” The following cutoff clause requires a return of premium to the cedent.

In the event of this treaty being terminated, the Reinsured shall have the option to cancel all reinsurances allotted hereunder and then in force and to debit the reinsurer with __% of the premiums in the accounts for the last four quarters otherwise all reinsurances shall continue in force until the expiry of their current terms.

A reinsured might want a cutoff provision in a contract because at termination it may seek better reinsurance terms for its in-force business. Another reason is that the reinsured may doubt the financial soundness of its reinsurer and may want to contract with a different one, no strings attached. (See Hollenbach at 150.)

Conclusion

This brief excursion into the business-covered clause is meant to demonstrate that it is important to carefully consider what risks are being reinsured and that the contract wording properly reflects the intent of the parties. Reinsureds and reinsurers must carefully examine slips and wordings provided to them by the reinsurance intermediary to make sure that the reinsurance contract accurately captures the intended coverage. Knowing precisely what the reinsurance contract covers will avoid future disputes and will make for a smoother relationship between the reinsured and its reinsurer.

The author gratefully acknowledges the significant assistance of Alice E. Backer, a law clerk in LeBoeuf’s New York office, in the research and drafting of this Commentary.