In preparing our quarterly reinsurance newsletter, we came across a recent case in which the court was asked to construe a series of reinsurance contracts to determine whether the contracts should be viewed as one big contract or as separate and independent contracts with separate terms and conditions. One party asked the court to apply the so-called interrelated contracts doctrine, which requires separate writings to be read and interpreted together when they form part of the same transaction. In this case, the parties entered into a series of excess-of-loss reinsurance agreements and a series of reinstatement premium protection agreements.
The court ended up rejecting the application of the interrelated contracts doctrine, holding that the excess-of-loss reinsurance agreements and the reinstatement premium protection agreements were different contracts with different language. More importantly for the parties, the court found that what is owed under each of the contracts could differ. Aioi Nissay Dowa Ins. Co. Ltd. v. Prosight Specialty Mgt. Co. Inc., No. 13-2689-cv, 2014 U.S. App. LEXIS 7490 (2d Cir. Apr. 22, 2014) (Summary Order).
This case got us thinking about reinsurance programs and how and whether the different components of a reinsurance program work together. It also got us thinking about whether each component of a reinsurance program should be construed separately or together when a dispute arises.
Reinsurance Programs
Most reinsureds have reinsurance purchasing programs devised by their internal ceded reinsurance buyer or by their reinsurance broker or by both working together. Depending on the state of the reinsurance market, a ceding insurer may have a series of specialized reinsurance contracts for certain lines of business and an overall catastrophe treaty protecting its top line across all classes of business. Others may have a corporate quota share that reduces their exposure across all lines of business, with specific excess-of-loss treaties for specific lines of business. Others may keep their business net but use facultative reinsurance for specific large accounts to militate against a large loss emanating from a large policy.
Some reinsureds have extensive reinsurance programs, and others hardly buy reinsurance. Sometimes, reinsurance programs are devised for purposes other than one ceding insurer's risk profile. Companies often come together to insure or reinsure larger or more complicated risks. Many industries have pools of insurers and reinsurers sharing exposure to these more complex risks.
The Aioi Nissay Dowa v. Prosight case was a pooling situation. A group of reinsurers agreed to pool their underwriting capacity together and participate in reinsuring aviation risks. A pool manager was engaged to manage the pool and to also manage the outgoing reinsurance for the pool and its members. The pool manager obtained excess-of-loss reinsurance protection for the pool members and reinstatement premium protection reinsurance. The latter agreements triggered when reinstatement premiums had to be paid on the excess-of-loss reinsurance contracts because losses exhausted the existing limits (and the limits were allowed to be reinstated by payment of an additional reinsurance premium). In spite of the relationship between the two types of contracts, the court found that each should be construed separately.
Reinsurance contracts also interact with each other because of retention requirements, exhaustion requirements, and other triggering mechanisms. Some reinsurance programs allow the ceding insurer to purchase other reinsurance to reduce the overall risk exposure, which sometimes inures to the benefit of just the ceding insurer and other times inures to the benefit of the ceding insurer and its quota share reinsurers. For example, at one point in the reinsurance market, it was fairly typical for the ceding insurer to purchase common account excess-of-loss reinsurance that would inure to the benefit of the quota share reinsurers on a corporate quota share by reducing the overall cession of loss. The common account excess-of-loss reinsurance contract was an essential part of the deal, but if those reinsurers became insolvent, the ceding insurer and its quota share reinsurers were still on the hook for the full limits.
There are myriad ways of structuring a reinsurance program. The common thread, however, is that the components of the program must work together to provide a coherent plan for the use of reinsurance in the most efficient way to provide the financial relief and the risk-sharing benefits contemplated. Consequently, very often, these various components should be read together so that the proper intent of the reinsured's program is understood. How that bears on a dispute arising between a ceding insurer and one of its reinsurers over the obligations under a specific contract for a specific claim is another question.
Contract Interpretation
When courts or arbitrators are asked to resolve a reinsurance dispute, they are often asked to interpret the terms and conditions of the reinsurance contract forming the basis of the dispute. Reinsurance contracts, just like other commercial contracts (or frankly any contract) are construed by courts by reading the language of the contract and discerning the intent of the parties based on that language. Courts are not permitted to rewrite contracts, insert terms that the court thinks might be helpful, or ignore a term or provision of the contract. The court's job is to ascertain the intent of the parties by reading the "four corners" of the contract and construing the plain meaning of the provisions of the contract. The primary objective of contract interpretation is to give effect to the intent of the parties as set forth by the language they chose to use in the contract.
Where things get dicey is when a provision of a contract is susceptible to more than one reasonable meaning. When faced with a term or provision that has more than one possible meaning, a court may look to extrinsic evidence to ascertain the parties' intent. A contractual provision that has more than one meaning is ambiguous. Evidence of how the provision was negotiated, contemporaneous communications about the contract between the parties and their agents, drafts of the provision, and other evidence outside the "four corners" of the contract will help the court resolve the ambiguity and determine for the parties what they meant when they agreed to that provision.
Sometimes, evidence of how the parties worked together under the contract, or even under similar contracts, provides the court with course of dealing evidence. Course of dealing evidence helps the court ascertain the intent of the parties by showing how the parties construed the ambiguous provision in practical, as opposed to theoretic, terms. Often supplementing course of dealing evidence is industry custom and practice.
In a specialized industry like reinsurance, custom and practice is often relevant to understanding the rationale behind the terms and conditions of a reinsurance contract. Concepts like utmost good faith and follow-the-settlements are unique to the reinsurance industry. How particular contract terms work and their place in the industry are often data points that assist in construing a contract consistently with the parties' intent. Custom and practice plays a larger role in reinsurance arbitrations, where it is common for the arbitration provision in the reinsurance contract to instruct arbitrators to construe the reinsurance contract as an honorable engagement and not as a mere legal obligation.
At the end of the day, if a reinsurance contract has ambiguous terms, courts and arbitrators will use extrinsic evidence and industry custom and practice to do their best to ascertain the intent of the parties.
When Contracts Interact
Reinsurance contracts stand on their own even if they are part of an overall program. If the parties intend that two contracts should be construed together as one overall contractual arrangement, the contracts need to be drafted in such a way that their intent is clear.
A typical way to make this clear is to specifically state the interplay between the two contracts in the contracts themselves. Complex contractual arrangements often incorporate by reference terms and conditions of other contracts. For example, high excess insurance policies often follow the terms and conditions of the underlying first excess policy. Facultative reinsurance contracts often follow the terms and conditions of the underlying policy the facultative certificate is reinsuring. These "following" contracts expressly state that they follow the terms and conditions of the specific underlying contracts. This eliminates any ambiguity, and if a dispute arises, a court or arbitration panel will have no trouble construing the two contracts together.
When a dispute arises and the interplay of multiple contracts is in issue, the true intent of the parties may be lost if the contracts do not expressly state the interrelationship between them. Even though from an industry perspective, the interplay is obvious, if the contracts are unambiguous and do not contain an express provision setting forth the interplay, a court is unlikely to construe the contracts together. Clear and precise contract drafting is the key to preserving the parties' true intentions and avoiding judicial construction that departs from that true intent.
In the case example above, even though the excess-of-loss reinsurance contracts and the reinstatement premium protection contracts related to each other, according to the court, the terms and conditions of each should be construed separately. Thus, the obligations on each contract were separate. If the parties meant for these two types of contracts to be read together, the contracts should have expressly said so, and the court would have construed them together.
Conclusion
Reinsurance programs are often made up of a series of reinsurance contracts providing different reinsurance protection within an overarching reinsurance structure. Whether these contracts must be construed together as one large contract depends on whether that intent is expressly set forth within the contracts. If the parties intend for contracts to interact and be read together as if they were part of a single transaction, the contracts must reflect that intent. Courts will not surmise intent unless it is derived from the plain and unambiguous language of the contract.
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