Expert Commentary

Which Came First, the Insurance Policy or the Reinsurance Contract?

Readers of these Expert Commentaries on reinsurance know that reinsurance is a risk-spreading mechanism. Insurance companies mitigate their risk of loss accumulated from all the insurance policies they have issued to policyholders by ceding or laying off some of that risk to reinsurance companies in exchange for a portion of the premium collected on those underlying insurance policies. The reinsurance contract generally refers to the "business" being reinsured and may limit the reinsurance protection to only certain types of the ceding insurer's policies or may cover all of the ceding insurer's policies.


Reinsurance
December 2014

Part of the reinsurance contract bargain is that, in exchange for a premium, the reinsurer will indemnify the ceding insurer for losses under the ceded insurance policies that qualify for reinsurance protection under the reinsurance contract. There's the rub. Which contract terms control whether the reinsurer must pay the loss?

Follow-the-Settlements Redux

The follow-the-settlements/follow-the-fortunes doctrines have been the subject of several Expert Commentaries (October 2001, April 2004, and March 2013). Under follow-the-settlements principles, a reinsurer must pay a billing if the loss payment by the ceding insurer was made in good faith, was reasonable, and was within the terms of the applicable policy and the reinsurance contract. Assuming the loss payment was reasonable and made in good faith, it still has to be within the terms of both the reinsured insurance policy and the reinsurance contract.

For example, if the underlying insurance policy is a workers compensation insurance policy, the loss has to be a valid workers compensation loss. If the loss is a valid workers compensation loss, it then has to comply with the terms of the reinsurance contract. Assuming that the reinsurance contract covers the ceding insurers' workers compensation policies, the loss should be covered.

The Vagaries of Coverage

Unsurprisingly, the terms in insurance policies and reinsurance contracts vary widely. In personal lines insurance with state insurance department form filing requirements, terms and conditions generally are somewhat uniform. In commercial insurance, however, policy terms and conditions are often customized with state-required endorsements and other add-ons created just for the policyholder. Large commercial risks are often "manuscript" or customized insurance products that vary significantly from the basic forms of insurance.

Reinsurance coverage is even more varied. An insurance company may purchase a reinsurance contract for a specific risk for a specific policyholder (facultative reinsurance) or may purchase a reinsurance contract covering all its workers compensation business (a treaty). A reinsurance contract may only cover certain policies within a portfolio of the ceding insurer's writings. For example, a reinsurer may agree to reinsure general commercial liability policies written by the ceding insurer, but only those policies with limits of liability of $1 million or less. Or a reinsurer may agree to reinsure property insurance policies written by the ceding insurer, but only those issued to cover properties located in Texas and Mississippi.

Some reinsurance contracts will insist on reinsuring policies only if those policies include a specific endorsement or exclusion. For example, if a ceding insurer is issuing policies to banks, its reinsurers may condition their reinsurance coverage on each of those bank policies containing a cyberrisk exclusion.

As you can see, limitations and conditions placed in reinsurance contracts on the types of policies reinsured run the gamut from premium size to location to limits of liability to exclusions. There is no boundary to how a reinsurance contract may limit the ceding insurer's reinsurance coverage.

Reinsurance Claims and Reinsurance Coverage

When a ceding insurer pays a policyholder claim, it does so without consideration of whether it has reinsurance. But that doesn't mean reinsurance is ignored. When a claim is first made to the insurance company, the ceding insurer needs to determine if there is reinsurance potentially covering that claim. If there is potential reinsurance, the ceding insurer must then determine whether the notice provisions of the reinsurance contract require the ceding insurer to notify the reinsurer of the claim.

When the reinsurer receives notice of a claim, it will then review the claim to determine if the claim falls within the reinsurance contract's coverage provisions. If the reinsurer does not believe that the claim is covered by the reinsurance contract, it will likely notify the ceding insurer that the claim is not reinsured. That may spur further dialogue or may eventually end up in dispute when the claim is paid and the loss is billed to the reinsurer.

This, of course, is much easier to address where the details of a claim are reported by the ceding insurer to the reinsurer. In reinsurance contracts where individual case reporting is not required, reinsurance coverage issues may not arise until after the reinsurer audits the ceding insurer's loss cessions, if at all.

After the ceding insurer pays a claim—whether it is a settlement or a judgment—it will bill the reinsurer as allowed under the reinsurance contract. The reinsurer, which may have been on notice about the claim previously, will then make a final determination whether to pay the claim or deny it.

Addressing Complex Claims

With the advent of environmental, asbestos, and other latent disease claims, determining whether there is reinsurance coverage has become much more complex. Ceding insurers and reinsurers have been disputing for years issues like whether the underlying claims are one accident or one occurrence, or whether they are multiple accidents or occurrences. These reinsurance disputes typically follow earlier disputes between the ceding insurer and its policyholder over the very same issues.

For example, in latent environmental damages claims, many years of policies and many claims for damages are involved in determining whether 50 years of dumping chemicals on multiple sites by a policyholder or its predecessor is one or more than one occurrence. Similar issues arise in asbestos claims. Are the thousands of claims brought against a policyholder for bodily injuries alleged to have occurred because of the inhalation of asbestos fibers on the policyholder's work sites or plants one occurrence or one occurrence per site? These disputes are either resolved in a declaratory judgment action or more likely settled between the policyholder and its insurer before trial.

Billing a Complex Claim to Reinsurers

Following settlement of a large-scale environmental or asbestos or other latent exposure dispute, the ceding insurer will likely seek reinsurance coverage for part of that settlement. How the ceding insurer bills the settlement to its reinsurance contracts will determine whether more questions will be raised about number of occurrences and whether the settlement meets the terms and conditions of the reinsurance contract. One question that often arises is whether the terms of the insurance contract or the terms of the reinsurance contract control. The short answer is that it depends. But the terms of both contracts are relevant to the reinsurance billing.

Under the terms of many reinsurance contracts and under follow-the-settlements principles, the loss settlement has to be in good faith, objectively reasonable, and consistent with the terms of both the insurance and reinsurance contracts. Focusing just on the contract issue and assuming good faith and objective reasonableness of the settlement, the first port of call is the insurance contract. If the settlement is for losses that are arguably within the terms and conditions of the insurance policy, the first part of the test is complete. But, just because a settlement comes within the insurance policy does not mean that the reinsurance contract covers the settlement.

Remember, the reinsurance contract may contain a wide variety of limitations and restrictions on what is covered under the reinsurance contract. For example, if the settlement is on environmental property damages claims under a series of commercial property policies, but the reinsurance contract does not cover properties in Texas, to the extent the settlement covers claims arising out of Texas, that part of the settlement is not covered by the reinsurance contract.

Aggregation Provisions

Sometimes, however, the reinsurance contract opens the door for a settlement that otherwise might not be covered. A reinsurance contract may have a provision that allows the ceding insurer to aggregate claims that would otherwise not be covered under the reinsurance contract's standard definition of "loss occurrence." There are a wide variety of aggregation provisions that find their way into reinsurance contracts. These provisions are negotiated to allow the ceding insurer to accumulate or aggregate claims that ordinarily are individual claims and cede them to the reinsurance contract as a single loss occurrence. An aggregation provision may be broad enough to encompass multiple policies over multiple periods, depending on its scope.

Where the ceding insurer settles multiple claims on a multiple occurrence basis under its policy's definition of "loss occurrence," a reinsurance definition of "loss occurrence" that allows for the aggregation of multiple claims as one occurrence may provide the ceding insurer with a contractual right to cede the settlement as one occurrence and obtain reinsurance protection. In this case, even though the insurance policy definition of "loss occurrence" defined each loss as an individual claim, none of which individually would be large enough to be covered by the reinsurance contract, the aggregation provision of the reinsurance contract allows the ceding insurer to treat all the settled claims as a single loss large enough to qualify for coverage under the reinsurance contract.

Conclusion

When an insurance company settles a claim, it does so under the terms and conditions of the insurance policy it issued to its policyholder. Those terms and conditions are directly relevant to whether that settlement is covered under the reinsurance contract. But, where the reinsurance contract's provisions provide for broader or different coverage, those terms and conditions take precedent over those of the underlying insurance policy for reinsurance purposes.


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.

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