Traditionally, a reinsurance transaction is an economic relationship between the ceding insurer and the reinsurer where the reinsurer provides capital to the ceding insurer by agreeing to assume a portion of the ceding insurer's liabilities in exchange for a portion of the ceded premium. It is documented by an arm's-length contract between the ceding insurer and the reinsurer, with the underlying insured not being a party to and generally not privy to the reinsurance contract. Stated differently, with most reinsurance contracts, there is no contractual privity between the underlying insured and the reinsurer.
The lack of contractual privity generally means that the underlying insured cannot sue the reinsurer for breach of contract if, for some reason, the ceding insurer does not pay a claim. The reinsurance contract is considered a separate agreement solely between the ceding insurer and the reinsurer, and no other party—the underlying insured or any other third party—has any rights under the reinsurance contract. Of course, there are some exceptions to this rule, but in general, most reinsurance contracts work this way.
The reason for this is that the reinsurance contract is a separate contract of indemnity between the ceding insurer and the reinsurer that triggers when the ceding insurer pays a ceded claim and bills the reinsurer to collect the reinsurance recoverable due from the reinsurer based on the terms and conditions of the reinsurance contract. In other words, the reinsurance contract is there to reimburse only the ceding insurer for the percentage that the reinsurer agreed to pay and nothing more. The purpose of the reinsurance contract typically is not to pay the insured on its underlying insurance policy but to indemnify the ceding insurer for a specific portion of the loss that the ceding insurer paid.
But there are reinsurance transactions where the reinsurer is either the real party in interest or where the reinsurer purposefully takes responsibility for the ceded policy and controls the relationship with the underlying insured and how claims are handled. This Expert Commentary discusses those types of reinsurance transactions.
Broader Reinsurer Responsibility
There are myriad business reasons why some reinsurance arrangements put the reinsurer in the shoes of the ceding insurer and/or give the reinsurer control over the ceded insurance policy and claims arising out of the ceded policy. Some examples are discussed below.
The Need for Fronting in Insurance and Reinsurance
In the US, insurance and reinsurance companies are licensed to do business by the individual states. If an insurance company wants to write business in State A, but is not licensed in State A, it needs another licensed insurer to write the business on the other insurer's paper on behalf of the unlicensed insurer.
In those circumstances, the unlicensed insurer may enter into a reinsurance contract with the licensed insurer whereby the licensed insurer essentially "fronts" for the unlicensed insurer. What that means is the licensed insurer issues the ceded policy to the insured on the licensed insurer's paper, but the economic responsibility for losses ultimately lies with the unlicensed insurer who assumes the ceded policy under the reinsurance contract.
In the circumstance where the reinsurer assumes 100 percent of the business from the fronting insurer, a fronting fee is usually paid by the reinsurer to the ceding insurer as compensation for lending its license and paper to the reinsurer. But regulators typically do not like 100 percent fronting arrangements, so it may be that the licensed insurer will need to keep 10 percent of the business and cede 90 percent to the unlicensed insurer.
With these fronting deals, the reinsurer may wish to control the underwriting and/or claims depending on who is originating the business and the purpose of the transaction. While the fronting insurer has regulatory risk as the policy issuing company, the reinsurer has the economic risk through the reinsurance contract and is essentially the real party in interest.
In some circumstances, the reinsurance agreement will contain a claims control clause. These clauses allow the reinsurer to control the claims. This is more common in property than liability contracts and the level of information required and control can vary. Below is an example from the London Market.
Notwithstanding anything to the contrary contained in this Reinsurance, it is a condition precedent to Reinsurers' Liability under this Reinsurance that:
(a) The Reinsured shall give to the Reinsurer(s) written notice as soon as reasonably practicable of any claim made against the Reinsured in respect of the business reinsured hereby or of it being notified of any circumstances which could give rise to such a claim.
(b) The Reinsured shall furnish the Reinsurer(s) with all information known to the Reinsured in respect of claims or possible claims notified in accordance with (a) above and shall thereafter keep the Reinsurer(s) fully informed as regards all developments relating thereto as soon as reasonably practicable.
(c) The Reinsurer(s) shall have the right at any time to appoint adjusters and/or representatives to act on their behalf to control all investigations, adjustments and settlements in connection with any claim notified to the Reinsurer(s) as aforesaid.
(d) The Reinsured shall cooperate with the Reinsurer(s) and any other person or persons designated by the Reinsurer(s) in the investigation, adjustment and settlement of such claim.
The Role of Captives in Reinsurance
A similar situation may arise in the context of a captive insurer. The captive may issue a policy on certain business for its affiliated insured but might not have the expertise to underwrite that business and/or handle the claims. A third-party insurer will step in as a reinsurer, but it may be responsible for underwriting the business and issuing it on the captive's paper and for handling the claims. Or, it may be that the reinsurer, assuming 100 percent of the ceded policy, is economically responsible for all claims arising from the ceded policy issued by the captive. Hopefully, the reinsurance contract articulates this relationship clearly. The reinsurance contract also may have a cut-through clause that clearly states that the reinsurer is responsible for claims and that the insured may sue the reinsurer directly if claims are not paid.
Here is an example of some reinsurance contract language that reflects this.
The reinsurance shall inure to the benefit of the Insured, subject to and in accordance with the terms, provisions, conditions and stipulations of the Policy and the provisions of this Contract. As set forth in this Contract, the Insured shall have the right to bring an action against the Reinsurer to recover the loss sustained by the Insured for which the Reinsurer is liable hereunder.
In these cases, the typical insolvency clause that appears in all reinsurance contracts may have a modification that allows the reinsurer to pay claims directly to the underlying insured if the ceding insurer becomes insolvent.
Pursuant to the provisions of the Assumption of Liability Endorsement, the Reinsurer has agreed that, in lieu of payment to the Company or its receiver, rehabilitator, liquidator, conservator, or other statutory successor, it shall pay valid claims under the Policy directly to the Insured, at the Insured's request, if a Cut Through Triggering Event (as that term is defined in the Assumption of Liability Endorsement) occurs.
A cut-through provision may also be contained in a separate cut-through agreement between the parties and not as a clause in the reinsurance contract. Some stand-alone cut-through agreements are limited to the insolvency situation discussed above.
Reinsurer's Business Interests Are Retained by the Reinsurer
Similar and related to fronting is the circumstance where the business originates from the reinsurer and/or the reinsurer wishes to enter into a new market and needs the fronting insurer to issue the underlying insurance policies. In these circumstances, the reinsurer may control the underwriting and claims handling, and it will be clear in the reinsurance contract that the reinsurer is the responsible party.
Often reinsurers develop specific expertise and wish to retain the economic value of the business for themselves. By entering into a reinsurance contract where the reinsurer has control of underwriting and claims, the reinsurer can take advantage of the expertise it has developed and maintain the profitability on the business it wishes to write. The policy-issuing company acts as a conduit for the business, which is passed through to the reinsurer as the real party of interest.
Conclusion
The discussion above is about intentional actions by the parties that give the reinsurer broader responsibility than in a traditional reinsurance contract. In these circumstances, the reinsurer is not concerned whether there is contractual privity with the underlying insured or whether a direct action against it by the ceding insurer is available. Here, the reinsurer purposefully maintains an active role in the underlying business.
The transaction is not merely the traditional reinsurance deal where the reinsurer is simply providing capital and sharing in a percentage of the business; it is a transaction where the reinsurer is the real party in interest and takes responsibility for all or most of the economic risk.
Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.
Traditionally, a reinsurance transaction is an economic relationship between the ceding insurer and the reinsurer where the reinsurer provides capital to the ceding insurer by agreeing to assume a portion of the ceding insurer's liabilities in exchange for a portion of the ceded premium. It is documented by an arm's-length contract between the ceding insurer and the reinsurer, with the underlying insured not being a party to and generally not privy to the reinsurance contract. Stated differently, with most reinsurance contracts, there is no contractual privity between the underlying insured and the reinsurer.
The lack of contractual privity generally means that the underlying insured cannot sue the reinsurer for breach of contract if, for some reason, the ceding insurer does not pay a claim. The reinsurance contract is considered a separate agreement solely between the ceding insurer and the reinsurer, and no other party—the underlying insured or any other third party—has any rights under the reinsurance contract. Of course, there are some exceptions to this rule, but in general, most reinsurance contracts work this way.
The reason for this is that the reinsurance contract is a separate contract of indemnity between the ceding insurer and the reinsurer that triggers when the ceding insurer pays a ceded claim and bills the reinsurer to collect the reinsurance recoverable due from the reinsurer based on the terms and conditions of the reinsurance contract. In other words, the reinsurance contract is there to reimburse only the ceding insurer for the percentage that the reinsurer agreed to pay and nothing more. The purpose of the reinsurance contract typically is not to pay the insured on its underlying insurance policy but to indemnify the ceding insurer for a specific portion of the loss that the ceding insurer paid.
But there are reinsurance transactions where the reinsurer is either the real party in interest or where the reinsurer purposefully takes responsibility for the ceded policy and controls the relationship with the underlying insured and how claims are handled. This Expert Commentary discusses those types of reinsurance transactions.
Broader Reinsurer Responsibility
There are myriad business reasons why some reinsurance arrangements put the reinsurer in the shoes of the ceding insurer and/or give the reinsurer control over the ceded insurance policy and claims arising out of the ceded policy. Some examples are discussed below.
The Need for Fronting in Insurance and Reinsurance
In the US, insurance and reinsurance companies are licensed to do business by the individual states. If an insurance company wants to write business in State A, but is not licensed in State A, it needs another licensed insurer to write the business on the other insurer's paper on behalf of the unlicensed insurer.
In those circumstances, the unlicensed insurer may enter into a reinsurance contract with the licensed insurer whereby the licensed insurer essentially "fronts" for the unlicensed insurer. What that means is the licensed insurer issues the ceded policy to the insured on the licensed insurer's paper, but the economic responsibility for losses ultimately lies with the unlicensed insurer who assumes the ceded policy under the reinsurance contract.
In the circumstance where the reinsurer assumes 100 percent of the business from the fronting insurer, a fronting fee is usually paid by the reinsurer to the ceding insurer as compensation for lending its license and paper to the reinsurer. But regulators typically do not like 100 percent fronting arrangements, so it may be that the licensed insurer will need to keep 10 percent of the business and cede 90 percent to the unlicensed insurer.
With these fronting deals, the reinsurer may wish to control the underwriting and/or claims depending on who is originating the business and the purpose of the transaction. While the fronting insurer has regulatory risk as the policy issuing company, the reinsurer has the economic risk through the reinsurance contract and is essentially the real party in interest.
In some circumstances, the reinsurance agreement will contain a claims control clause. These clauses allow the reinsurer to control the claims. This is more common in property than liability contracts and the level of information required and control can vary. Below is an example from the London Market.
The Role of Captives in Reinsurance
A similar situation may arise in the context of a captive insurer. The captive may issue a policy on certain business for its affiliated insured but might not have the expertise to underwrite that business and/or handle the claims. A third-party insurer will step in as a reinsurer, but it may be responsible for underwriting the business and issuing it on the captive's paper and for handling the claims. Or, it may be that the reinsurer, assuming 100 percent of the ceded policy, is economically responsible for all claims arising from the ceded policy issued by the captive. Hopefully, the reinsurance contract articulates this relationship clearly. The reinsurance contract also may have a cut-through clause that clearly states that the reinsurer is responsible for claims and that the insured may sue the reinsurer directly if claims are not paid.
Here is an example of some reinsurance contract language that reflects this.
In these cases, the typical insolvency clause that appears in all reinsurance contracts may have a modification that allows the reinsurer to pay claims directly to the underlying insured if the ceding insurer becomes insolvent.
A cut-through provision may also be contained in a separate cut-through agreement between the parties and not as a clause in the reinsurance contract. Some stand-alone cut-through agreements are limited to the insolvency situation discussed above.
Reinsurer's Business Interests Are Retained by the Reinsurer
Similar and related to fronting is the circumstance where the business originates from the reinsurer and/or the reinsurer wishes to enter into a new market and needs the fronting insurer to issue the underlying insurance policies. In these circumstances, the reinsurer may control the underwriting and claims handling, and it will be clear in the reinsurance contract that the reinsurer is the responsible party.
Often reinsurers develop specific expertise and wish to retain the economic value of the business for themselves. By entering into a reinsurance contract where the reinsurer has control of underwriting and claims, the reinsurer can take advantage of the expertise it has developed and maintain the profitability on the business it wishes to write. The policy-issuing company acts as a conduit for the business, which is passed through to the reinsurer as the real party of interest.
Conclusion
The discussion above is about intentional actions by the parties that give the reinsurer broader responsibility than in a traditional reinsurance contract. In these circumstances, the reinsurer is not concerned whether there is contractual privity with the underlying insured or whether a direct action against it by the ceding insurer is available. Here, the reinsurer purposefully maintains an active role in the underlying business.
The transaction is not merely the traditional reinsurance deal where the reinsurer is simply providing capital and sharing in a percentage of the business; it is a transaction where the reinsurer is the real party in interest and takes responsibility for all or most of the economic risk.
Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.