Reinsurance agreements come in all shapes and sizes. Some are large corporate treaties covering the entire book of business of the ceding insurer. Others are single-minded facultative certificates of reinsurance covering a specific risk of a specific insured. Some are focused on risk transfer and related claims issues, and others are focused on providing financial capital from the reinsurer to the ceding insurer.
Because of the wide variety of reinsurance needs, many reinsurance agreements have customized clauses drafted specifically for that reinsurance relationship. The level of customization or use of manuscript wording in a reinsurance agreement will depend on the relationship of the parties, how generic the reinsurance agreement is, the level of involvement of the reinsurer in the business of the ceding insurer, the sophistication of the ceding insurer, whether the business is fronted, the attachment point where the reinsurance is accessed, the reinsurance intermediary, and myriad other factors.
Underwriting and Claims Clauses Generally
One area of customization that arises with some frequency is where the reinsurance agreement has a specific underwriting and/or claims-related clause. These clauses may be as broad and detailed as the imagination of the reinsurance underwriter. They are used for many purposes but typically to put some guidance into the reinsurance agreement about how the underlying business should be underwritten and/or how the underlying claims should be handled.
Having documentation in a reinsurance agreement on how the underlying business should be written and/or how claims should be addressed is a great idea. The problem is that it is very difficult to anticipate all circumstances. It is also very difficult to predict whether the underwriting and claim guidance will make sense as the business develops over time. As the market changes for the underlying insurance product, rules put in place may need to be changed, and circumstances may dictate that the business has to move forward in a way that technically violates the underwriting and/or claims clauses in the reinsurance agreement. For these and other reasons, special care needs to be taken when developing these clauses and amending them as necessary because of business realities.
One of the biggest problems with underwriting and claims handling clauses is the lack of communication between those negotiating and drafting the reinsurance agreement and those who handle the day-to-day underwriting and claims handling duties. Most line underwriters and claims handlers have little familiarity with the company's reinsurance agreements. When disputes arise, it is not uncommon for underwriting and claims witnesses to testify that they never saw the reinsurance agreement and had only a summary (if lucky) of the requirements that affected their duties. This problem becomes exacerbated when a reinsurance contract is in place for a long time and personnel change with frequency.
Underwriting Clauses—Guidance or Warranties?
Whether a reinsurance agreement includes a clause addressing how the ceding insurer will underwrite the underlying business and the details of that clause depend on many factors. For a broad corporate reinsurance agreement covering multiple lines of business, the business covered clause will describe the risks assumed, and there likely will be very little if anything said about how the ceding insurer should underwrite.
On the other hand, where the reinsurance agreement covers a specific underwriting unit of a company and the reinsurer is assuming a significant portion of the risk, it is more likely that the reinsurance agreement will set out some details on how the reinsurer expects the ceding insurer to underwrite the business.
Underwriting clauses may merely provide guidance and aspirational suggestions or may be drafted as a strict warranty of behavior. Clarity on this point is pretty important to both parties to avoid disputes over whether the ceding insurer followed the underwriting clause in the reinsurance agreement. If the clause makes compliance with underwriting rules a representation and/or warranty, the reinsurer will have an easier time enforcing the rules.
There are many examples of clauses that express the underwriting requirements that the reinsurer seeks to impose on the ceding insurer. Some incorporate underwriting guidelines and manuals into the reinsurance contract. Others lay out the detail of what is an acceptable risk under the reinsurance contract. Some clauses will restrict reinsurance cessions to the size of the underlying premium, the geographic location of the risk, or the requirement that a specifically named underwriter remain in charge of the ceding insurer's underwriting activities for those policies.
One example is requiring the ceding insurer to use certain standard forms for its underlying policies and to place certain exclusions or endorsement on each of those policies. For example:
For every CGL policy issued by the Company, the Company warrants to the reinsurer that it will use ISO CGL Coverage Form (xxx) and shall include ISO Total Pollution Exclusion Endorsement (xxx).
When the underwriting requirement is drafted as a warranty, the reinsurer has the contract right to expect the ceding insurer to comply fully with that warranty. It is critical that requirements like the example above are communicated to the ceding insurer's line underwriters so that they understand that every policy they write for which they intend to seek reinsurance contains the required forms. Where the reinsurance agreement is negotiated and drafted without the input of the ceding insurer's underwriting personnel, the possibility of violations of the warranty are more likely. This only leads to disputes down the road.
A common way of controlling the underwriting of the ceding insurer is to require that all risks of a certain kind or nature be presented to the reinsurer for approval. Essentially, this makes the reinsurance agreement a facultative agreement because each risk must be agreed to by the reinsurer before it is bound by the ceding insurer if the ceding insurer wants to have reinsurance protection for that risk.
When the underlying program is being produced and underwritten by a third-party managing general underwriter or other underwriting manager, it is typical to have a clause in the reinsurance agreement requiring that the business ceded to the reinsurance agreement be written under specific restrictions. For example, reinsurers that support managing general agent programs may require in the reinsurance agreement that the only business that may be ceded to the reinsurance agreement is business underwritten by complying with a specific set of underwriting guidelines formulated by the parties and approved by the reinsurer.
This type of restrictive underwriting clause also requires that the ceding insurer's line underwriters are fully informed about the underwriting guidelines, have the guidelines at their fingertips, and know that compliance with the guidelines is mandatory. The underwriting guidelines should be specific and should be attached to the reinsurance agreement or be identified very specifically so there is no confusion years down the road about what the guidelines consisted of and whether they were agreed to by the reinsurer.
Insurance evolves as the need for coverage changes over time and the industry goes into its various cycles of hard markets and soft markets. When the reinsurance relationship is a long-term relationship, it is critical that both parties expressly adjust any underwriting requirements in the reinsurance agreement as necessary when the market dictates that changes are necessary. If the ceding insurer finds itself in a position where it needs to use a newer or different policy form after a few years and the reinsurance treaty was written with a warranty like the one above requiring a specific form, the ceding insurer cannot just assume that the reinsurer will be ok with the change. This is true even if the form is better for both parties from a risk assumption perspective. The ceding insurer's underwriting management must remain cognizant of the underwriting restrictions in the reinsurance agreement and should seek a formal amendment to the reinsurance agreement to make any necessary adjustments.
Like underwriting clauses, claims clauses also come in many varieties and shapes. Notice clauses are effectively claims clauses, and reporting clauses also often have claims aspects drafted in them. Some claims clauses specify that claims must be handled by a certain third-party administrator. Others restrict the ceding insurer from paying claims over a certain value without obtaining the reinsurer's approval. For example:
The Reinsurer shall be consulted prior to a final determination to pay a claim in excess of the amount shown on Schedule A. In this situation, the Reinsurer shall have three (3) working days to authorize the Company to pay the claim or take appropriate alternative action. In the case where the Company does not take action as agreed upon or authorized by the Reinsurer, then the Reinsurer, may, at its option, deny or accept liability.
This clause is more unique because the ceding insurer can go ahead and pay the claim, but the reinsurer can decide whether to accept the cession of that loss or not if it did not agree with the ceding insurer's original claim determination. Other clauses that require prior written approval before payment of a claim that exceeds a specified monetary amount are in the nature of conditions or warranties depending on how drafted, and noncompliance by the ceding insurer runs the risk of losing any reinsurance recovery for that claim payment.
Also like underwriting clauses, a claims clause may have specific claims handling requirements or refer to and incorporate claims guidelines approved by the reinsurer. These have to be made known to the claims handlers so that full compliance occurs.
Many reinsurance experts have described the process of underwriting a broad reinsurance agreement for the ceding insurer's portfolio of business as underwriting the underwriting and claims departments of the ceding insurer. In other words, the reinsurer does not know when agreeing to the reinsurance agreement the exact risks that it is assuming but must trust the ceding insurer's underwriter and claims manager to underwrite the business as agreed and to handle the claims as agreed in the reinsurance agreement. To make this clear from a claims perspective, some reinsurance agreements contain clauses that allow the reinsurer to either terminate the reinsurance agreement or obtain some monetary (premium or discount on losses) adjustment if the claims handling changes. For example:
If there is any change in the Company's approach, method or guidelines in the processing, settling, administering or paying of claims, the Reinsurer shall be entitled to an adjustment of the portion of the claims which is reimbursable or an adjustment to Premium.
With this kind of clause, the ceding insurer runs the risk of the reinsurer balking at paying claims for full value if, in the reinsurer's opinion, the ceding insurer has changed its claims administration behavior. For example, at the inception of the reinsurance agreement, the reserving philosophy of the ceding insurer is to quickly settle claims and avoid going to trial. But, during the life of the reinsurance agreement, the ceding insurer changes its reserving philosophy to defending each case and fighting everything through trial. One can argue that this change in reserving philosophy is a change in the ceding insurer's claims administration from that originally represented, and under this clause, the reinsurer may be entitled to an adjustment.
Where a reinsurer is likely going to be actively involved in paying losses on the reinsured book of business, the reinsurer will probably want certain understandings put into the reinsurance agreement about how the ceding insurer will be underwriting the business and handling the claims. The examples above demonstrate that it is important for the ceding insurer and the reinsurer to understand the underwriting and/or claims requirements built into the reinsurance agreement. It is even more important that the ceding insurer's line underwriters and claims handlers are made aware of any underwriting and/or claims restrictions, warranties, or requirements set forth in the reinsurance agreement. With everyone on the same page, future disputes should be minimized.
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