An insurer and reinsurer litigated their breach of contract actions against each other under two facultative reinsurance certificates in a New York federal court culminating in a 10-day bench trial presenting 10 fact witnesses and five experts. Utica Mutual Insurance Company v. Munich Reinsurance America, Inc. (N.D.N.Y., March 29, 2019). The heart of their dispute was the reinsurer’s liability for additional loss expenses; that is, whether it must pay for expenses the ceding insurer incurred to investigate, adjust and litigate claims supplemental to the liability limits of the certificates. The reinsurer already paid the limits of each certificate. The court’s findings turned on its interpretation of the certificates, and the ceding insurer’s umbrella policies, all which were respectively issued in 1973 and 1977.
The underlying insured defended against over 80,000 claims alleging bodily injury caused by asbestos that was part of a product manufactured by the insured. The insurer issued primary and umbrella policies to the underlying insured, and defended and settled countless of these claims. Under the 1973 certificate, the insurer claims that the reinsurer failed to pay $2,760,533.96 in expenses. Under the 1977 certificate, the reinsurer claims that the insurer improperly billed it for $789,813.47 in expenses for which it demanded reimbursement.
Neither of the certificates contained a “follow-the-fortunes” provision, but as to its claim against the reinsurer under the 1973 certificate, the insurer argued that the court should imply the provision as a matter of law. Although there was testimony that such a provision was not typically written into facultative certificates until the 1980s, the court was guided by precedents of the U.S. Court of Appeals for the Second Circuit and the New York State Court of Appeals that courts should hesitate to read such a provision into a contract without it.
As a consequence, the court held, the reinsurer “must indemnify” the insurer under the 1973 certificate according to the insurer’s “proven liability” on the 1973 umbrella policy. Though, because of an endorsement to the 1973 umbrella policy limiting the insurer’s defense obligations, once the underlying primary policy exhausted, which it did, the insurer had no further obligation to pay supplemental defense expenses under the 1973 umbrella policy. Since these expenses were not part of the risk insured by the 1973 umbrella policy, they were not part of the ceded risk under the 1973 certificate.
Despite this, the insurer argued that the reinsurer had an “independent obligation” to pay expenses supplemental to the insurer’s losses. The insurer relied on the “allocated loss expense” provision in the 1973 certificate to impose this obligation, even if the 1973 umbrella policy did not require the insurer to pay expenses for the underlying insured. The insurer also contended that this provision required the reinsurer to pay a portion of its underlying declaratory judgment expenses. According to the reinsurer, however, the 1973 certificate covers only what is covered under the reinsured policy.
The court found ample authority for the proposition that the nature of facultative insurance is “to reinsure a cedent’s risk,” and that when considered with New York’s interpretation of pertinent language in the certificate, as well as the insurer’s course of conduct, the reinsurer should not be liable to “pay for defense expenses beyond the scope of the coverage under the [1973] umbrella policy.” Further, as to declaratory judgment expenses in connection with the investigation, adjustment, and litigation of an underlying asbestos claim, such expenses were allocated to underlying primary policies, including the primary policy underlying the 1973 umbrella policy, but, significantly, not the 1973 umbrella policy itself and, therefore, not subject to reinsurance.
Under the 1977 certificate, the reinsurer argued that it should not have to pay $789,813.47 in supplemental expenses, in part, because they were not part of the underlying coverage and, therefore, not part of the ceded risk. Facts developed at trial indicated that the reinsurer had “full knowledge that it was being billed for expenses on an expense-supplemental basis,” and that “the documentation [the reinsured] had provided did not support its expense-supplemental position,” but the reinsurer “paid the bill without protest or further inquiry.”
Even though the reinsurer argued a “mistake of fact” whether the expenses billed to it were supplemental, the court was persuaded that the reinsurer should have more diligently determined its contractual obligations and rights, and rejected arguments that the reinsurer’s alleged overpayment was based on a “mistake of fact.” Since the court determined that the reinsurer was not obligated to pay these supplemental expenses, it held that the reinsurer did so on a voluntary basis, thereby defeating its claim for reimbursement.
This case offers some important takeaways. As with any contract, implying unwritten terms is a big lift for the party proposing them, even with respect to reinsurance where courts are particularly deferential to the customs and practices of the cedent-reinsurer relationship. As noted in trial testimony, follow-the-fortunes provisions were less common in certificates in the 1970s, but more so starting in the 1980s. This case, however, serves as reminder that the absence of such a provision more readily infers that its absence was intended. Thus, unless there is a strategic reason to avoid a follow-the-fortunes provision, stating one is the preferred course.
Another important takeaway is the court’s discussion that the reinsurer should have more diligently inquired of its rights and obligations under the 1977 certificate. The trial testimony also revealed that the reinsurer’s decision to pay, despite concerns as to its obligations, was a business decision. The Court did not question the propriety of the reinsurer’s decision to pay, so far as it was a business decision, but clarified that this decision brought irrevocable legal consequences. Thus, where a reinsurer has any doubt as to its obligations when paying, this case clarifies that those doubts may be resolved against the reinsurer and its payments may be deemed voluntary.