The weather in Albany, New York might have been cold on January 2, but the New York Court of Appeals’ bench was scorching during the oral argument for the appeal in United States Fid. & Guaranty v Am. Re-Ins. Co. The five-judge bench fired question after question at counsel concerning important issues concerning the reinsurance industry.
The appeal concerns a reinsurance dispute. More specifically, the appeal concerns whether follow-the-fortunes applies to the post-allocation phase of an insurance payout and whether bad faith serves as an exception to the general rule. Follow-the-fortunes is the basic principle that a reinsurer will follow what an insurance company does and will not second-guess the insurer absent strong evidence of bad faith.
The appeal stems from general liability policies that United States Fidelity & Guaranty Company and St. Paul Fire and Marine Insurance Company (USF&G) issued to Western Asbestos Company. Western distributed asbestos products from 1948 to 1959. Western MacArthur Company took over the in 1967. USF&G refused to defend and indemnify MacArthur when individuals began to it for injuries caused by exposure to Western Asbestos products.
MacArthur sued USF&G in 1993. The insurer settled the suit nine years later by agreeing to pay more than $975 million to satisfy all of the asbestos claims. The settlement required MacArthur to file for bankruptcy.
The appeal stems from the intersection of the settlement and reinsurers of USF&G. USF&G entered into a series of reinsurance treatises with American Re-Insurance Company and Excess Casualty Reinsurance Association beginning in 1945. The treaties are excess-of-loss contracts that require the reinsurers to reimburse a portion of each covered loss above the amount of loss that USF&G retained. The treaty for 1956 to 1962 required USF&G to retain the first $100,000 of covered loss. The retention amounts increased in later treaties. In 1981, the parties agreed to retroactively increase the retention amount to $3 million. One of the issues on appeal is whether the amendment was meant to reach back to the 1956-62 treaty.
After the settlement, USF&G submitted reinsurance claims to American Re and ECRA. They were based on the $100,000 retention amount in the 1956-62 treaty. A point of dispute on the appeal is that USF&G allocated all of the reinsurance claims to 1959. USF&G had allocated all of its losses on the asbestos claims to its 1959 policy. American Re and ECRA refused to pay the reinsurance claims, contending that part of the settlement amount was payment for MacArthur’s bad-faith claims against USF&F for refusing to defend and indemnify it. USF&G had allocated 0 perecent of the settlement to the bad-faith claims. Notably, bad-faith claims are not covered under the reinsurance treaty.
The Appellate Division, First Department affirmed Supreme Court’s grant of summary judgment for USF&G. The First Department stated that Supreme Court correctly held that the follow the fortunes doctrine required American Re and ECRA to accept the reinsurance presentation made by USF&G. It also stated “all of [American Re and ECRA’s] efforts to second guess USF&G’s decisions concerning allocation of the loss . . . are precluded from the court’s review.”
The Court of Appeals judges focused on the allocation issue at the beginning of the oral argument. Chief Judge Lippman asked counsel for ECRA how USF&G’s allocation of 0 dollars to the bad-faith claims impacted her argument. He also asked whether the settlement would still stand if the court upset the allocation. Judge Smith inquired whether there is a difference between allocation and the settlement as a whole.
Judge Smith also prodded ECRA’s counsel as to the outer boundaries of the follow the fortunes doctrine. Was USF&G’s settlement the best-case scenario or did it draw up a settlement to maximize reinsurance coverage and protect its own interests? Judge Smith was searching for the appellants’ counsel to define the line between a prudent settlement and one that demonstrated bad faith. Judges Pigott and Graffeo voiced similar concerns, seeking a recitation from counsel of a rule to guide courts when they should depart from going beyond the follow-the-fortunes doctrine.
The judges seemed to explore the factual issues of possible bad-faith actions with USF&G’s counsel. Judge Smith asked whether it was always the case that an insurer will broker a settlement where most of it falls on the reinsurers shoulders. Chief Judge Lippman asked bluntly at one point,
Do you want us to ignore that the bankruptcy court claimed there was a question of bad faith?
The court’s questions seemed equally critical of all the parties’ arguments. Therefore, the oral argument gave little indication how the court will resolve the appeal. One thing is for certain, though: the court’s decision will have a huge impact on the reinsurance industry.
The court generally hands down decisions approximately one month after oral argument. Therefore, the court will likely release a decision during its February session.