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.