A federal court in Missouri recently addressed two issues of importance to reinsurance practitioners. Employers Reinsurance Corp. v. Massachusetts Mut. Life Insurance Co., Case No. 06-0188-CV-W-FJG (W.D. Mo. Aug. 19, 2008). First, the court addressed whether a cedant’s claim for reimbursement was subject to the follow the settlements doctrine. Second, the court addressed whether a disputed claim could be used to setoff an adverse claim pending the court’s judgment. In both cases, the court decided that the result was implied by the language of the agreements rather than expressly stated.
The case involved a reinsurance treaty covering excess disability insurance. Under the treaty, the cedant retained liability for 100 percent of losses incurred in the first 24 months of a covered claim. The reinsurer became liable for 90 percent of covered losses after the two-year retention period. During the course of the treaty, the reinsurer expressed its concern about the cedant’s investigation of claims, and the cedant subsequently terminated the treaty.
The reinsurer later claimed the cedant had not been entitled to payment for twelve claims and demanded reimbursement. The cedant refused, citing the follow the settlements doctrine. The reinsurer then unilaterally setoff the amount in dispute.
The treaty did not contain an express follow the settlement’s clause, but the cedant argued that such a provision could be inferred from other language in the treaty and that, at any rate, industry custom implied such a provision. Courts have been split on whether follow the settlements is implied in reinsurance treaties. Some courts have held in the affirmative.See ReliaStar Ins. Co. v. IOA Re, Inc., 303 F.3d 874 (8th Cir. 2002); International Surplus Lines Ins. Co. v. Certain Underwriters at Lloyds of London, 868 F. Supp. 917 (S.D. Ohio 1994). Some have held in the negative. See American Motorists Ins. Co. v. American Reinsurance Co., 2007 WL 1557848, *5 (N.D. Cal., May 29, 2007); Employer Reins. Corp. v. Laurier Indemn. Co., 2007 WL 1831775, *4 (M.D. Fla. 2007); Village of Thompsonville v. Fed. Ins. Co., 592 N.W.2d 760, 765 (Mich. App. 1999). Others have categorized the issue as a question of fact for resolution by the jury. See Nat’l Am. Ins. Co. of Cal. v. Certain Underwriters at Lloyd’s of London, 93 F.3d 529, 537 (9th Cir. 1996); North River Ins. Co. v. Employers Reins. Corp., 197 F. Supp. 2d 972, 986 (S.D. Ohio 2002); American Ins. Co. v. American Re-Ins. Co., 2006 WL 3412079 (N.D. Cal. 2006).
In this case, the court did not decide whether follow the settlements should be implied. Rather, the court inferred a follow the settlements clause from the interplay of several other clauses. Specifically, the court cited a provision of the treaty under which the reinsurer was required to reimburse the cedant “promptly for loss against for which indemnity is herein provided ….” Id. at 2. A different article of the treaty provided that the reinsurer “will indemnify the [cedant] against the part of such loss indicated in Schedule Item 6.” Id. at 7
It is debatable whether the foregoing language is equivalent to a follow the settlements clause. An indemnification clause does not imply follow the settlements. The essence of indemnity reinsurance is that that cedant is reimbursed for certain losses. The issue is the extent to which the reinsurer is bound by the cedant’s settlements in measuring the reinsurer’s indemnity obligations.
More troubling is the court’s citation of the absence of an “anti-follow the settlements” clause. “Nowhere in the treaty does it state that [the reinsurer] may question claims once those losses are incurred or paid.” Id. at 7.
Essentially, the court implies a follow the settlement clause while declining to reach the question. This is not to say that such a clause should not be implied in some cases. Indeed, perhaps the Employers Reinsurance case was appropriate for implying the doctrine. But the Court should not obfuscate its reasoning by equating an indemnity obligation with follow the settlements or by shifting the burden to the reinsurer to identify an “anti-follow the settlements” provision.
With respect to the setoff issue, the reinsurer contended that the cedant had erroneously paid claims for which the reinsurer was entitled to reimbursement and unilaterally declared a setoff against reinsurance benefits claimed by the cedant. The court focused on a contractual setoff provision that allowed the reinsurer to setoff “any balance, whether on account of premiums, commissions, loss or claim expenses due to one party to the other….” Id. at 9. The court ruled in favor of the cedant holding that the setoff clause did not allow a setoff for disputed claims. While the setoff provisions provides some support for the court’s decision, parties in litigation often assert claims and counterclaims that are ultimately resolved by the court. If a reinsurer’s refusal to pay lacks a reasonable basis, the court may award attorneys’ fees or, perhaps, penalties.
But the essence of setoff often is that the debts are disputed, and litigation sorts it out. Disallowing a setoff essentially requires a party to pay the disputed amount first, with the adjudication to follow. Of course, the paying party has no guarantee that it will be able to collect the disputed amount if it ultimately prevails.
The court’s decision on setoff may not have substantial practical value. Because the court did not include language confirming its setoff decision as a final judgment, the cedant should not be able to levy or otherwise collect on the amount setoff until the final disposition of the case.
Lew Hassett is co-chairman of the firm’s insurance and reinsurance dispute resolution group. His practice concentrates in the areas of complex civil litigation, including insurance and reinsurance matters, business torts and insurer insolvencies. Lew received his bachelor’s degree from the University of Miami and his law degree from the University of Virginia.
