Who Knows What Matters When It Comes to Risk Exposures

The Exclusion for Known Exposures

There are many formulations found in reinsurance contracts excluding known exposures. For example, the reinsurance contract likely has a section titled "Exclusions" that may have multiple paragraphs outlining the risks and exposures excluded, including known exposures. These exclusion articles often cover certain general categories (e.g., business from pools and associations), specific types of insurance coverage (e.g., fiduciary liability), and/or business or risks associated with general liability or automobile liability, etc. These exclusions often run for several pages.

One category of exclusions under the exclusions article may be an exclusion for known exposures or risks. Here is a sample of exclusions wording in a reinsurance contract focusing on certain known exposures.

ARTICLE V—Exclusions

THIS AGREEMENT DOES NOT COVER:

A. THE FOLLOWING AS RESPECTS GENERAL LIABILITY

1. Risks involving known exposure to the following substances:
   • a. Dioxin,
   • b. Polychlorinated bisphenols,
   • c. Asbestos.

As can be seen from this example, the reinsurance agreement does not reinsure risks involving known exposure to those three substances. Pretty straightforward, right? If the insured risk has a known exposure to asbestos, the reinsurance contract will not respond to any losses arising from asbestos exposure.

Here is another example from a publicly available reinsurance agreement.

Section B:

1. This Contract excludes business written by the Company for the same perils, which is known at the time to be insured by, or in excess of underlying amounts placed in, any Pool, Association or Syndicate, whether by way of insurance or reinsurance, formed for the purpose of writing any of the following:

   Oil, Gas or Petro-Chemical Plants

   Oil or Gas Drilling Rigs and/or

   Aviation Risks

2. The exclusion under paragraph 1 of this Section B does not apply:
   • a. Where the Total Insured Value over all interests of the risk in question is less than $250,000,000.
   • b. To interests traditionally underwritten as Inland Marine and/or Stock and/or Contents written on a Blanket basis.
   • c. To Contingent Business Interruption, except when the Company is aware that the key location is known at the time to be insured in any Pool, Association or Syndicate named above, other than as provided for under subparagraph (a).

This example is limited to specific risks written by any pools, associations, or syndicates that are also written by the ceding insurer, as opposed to exposure to substances, and is a bit more esoteric, but requires that there be knowledge of business being written by pools, associations, or syndicates.

For either formulation of the known exposure exclusion, the question is, whose knowledge matters here?

Limited Case Law

The issue of known exposures and whose knowledge is required to trigger the exclusion has not come up much in the courts. In Amerisure Mut. Ins. Co. v. Everest Reins. Co., No. 14-cv-13060 (E.D. Mich. Mar. 18, 2015), the court addressed competing motions to vacate and confirm an arbitration award over issues largely irrelevant to this commentary. The reinsurance contract, however, included several enumerated exclusions discussed by the court in its opinion. Among the exclusions was an endorsement that added an exclusion for asbestos-related losses if the insured's operations presented a known risk of asbestos exposure. As quoted by the court, the exclusion read as follows.

SECTION 2—EXCLUSIONS, is amended to include the following:

[….]

9. Bodily injury (including occupational disease) and/or property damage arising from the manufacture, removal, installation, storage, mining, handling or transportation of asbestos if the insured's operations, at the time of the policy issuance, present known and/or generally recognizable asbestos exposures; however, this exclusion shall not apply to the removal, installation, storage, handling or transportation of asbestos if such removal, installation, storage, handling or transportation is incidental to the insured's operations....

The court summarized the exclusion as follows.

The newly-added ninth exclusion precluded indemnification for certain asbestos-related losses if either (1) Amerisure knew that its insured's operations presented a risk of asbestos exposure or (2) the insured's asbestos exposure was generally recognized (the "Asbestos Exclusion").

Note that the court assumed that the party whose knowledge counted was that of the ceding insurer.

In reviewing the facts, the court discussed how the arbitration panel addressed the asbestos exclusion. The court found that "[t]he Panel concluded that [the insured] did not present 'known and/or generally recognizable asbestos exposures' and that the Asbestos Exclusion therefore did not bar [the ceding insurer's] claim for indemnification." In more detail, the arbitration award articulated the following conclusion relevant to this commentary.

In sum, it appears that it was [the ceding insurer's] subjective underwriting judgment, as manifested by the absence of an exclusion in its policies, that the encapsulated asbestos gaskets [Company X] used did not constitute a known exposure.

Among many arguments, the reinsurer challenged this ruling as beyond the panel's authority. In agreeing with that argument (although it did not change the outcome of the court's confirmation of the arbitration award), the court noted that in construing the exclusion, the question was "whether [the ceding insurer] objectively knew about [the insured's] asbestos exposures." The court went on to say that "[i]nstead, [the panel] replaced the contractually mandated inquiry into [the ceding insurer's] knowledge of the exposure with its own inquiry into [the ceding insurer's] subjective assessment about the extent of the exposure."

Was the Court's Question Correct?

The short answer is yes. When addressing a reinsurance contract (and always subject to its terms), the proper question about whose knowledge applies when there is an exclusion based on known exposures is whether the ceding insurer objectively knew about the insured's asbestos exposures.

In a typical reinsurance relationship, it is the ceding insurer's obligation to provide the reinsurer with sufficient information to assess the risks being reinsured. This is part of the ceding insurer's duty of utmost good faith, a traditional doctrine in reinsurance. When an exclusion is based on known exposures or known information, it is the ceding insurer's knowledge that matters. If the ceding insurer objectively does not know about its insured's risk or exposure because it was hidden (intentionally or not) or not yet manifest, then the exclusion for known exposure cannot be triggered.

While it is tempting to assert that the policyholder's knowledge should apply, that cannot work in the reinsurance context. If the underlying policy has an asbestos exclusion that triggers on known exposures, then it is the insured's objective knowledge that counts. But in the reinsurance context, where there is no privity between the reinsurer and the insurer, it is the ceding insurer's knowledge that is the trigger, as it is the ceding insurer's knowledge about the risk that the reinsurer is relying upon.

As always, much depends on the exact language of the reinsurance contract and the exclusion. Some exclusions may expressly state whose knowledge applies. Some exclusions may trigger on general industry knowledge. The type of reinsurance contract may make a difference as well. A facultative reinsurer should have the same underwriting information as the ceding insurer. At the end of the day, examination of the exclusion's exact language is critical to any attempt to interpret the exclusion's triggering mechanism.

Conclusion

Knowledge is power. In reinsurance, the ceding insurer typically holds the knowledge about the risks being reinsured and, therefore, the power. Where an exclusion depends on a known risk or exposure, without more, it is the ceding insurer's objective knowledge that should be the trigger to activate the exclusion.