Morris Manning & Martin, LLP

New York Court Addresses Important Notice, Retention and Allocation Issues in Reinsurance

07.27.2016

A New York trial court recently tackled notice, retention and allocation issues arising from a cedant's settlement of asbestos risks.  Granite State Ins. Co. v. Clearwater Ins. Co., No. 653546/11 (N.Y. Sup. Ct. June 17, 2016).  Granite State and other affiliated AIG companies issued dozens of policies to Kaiser Aluminum and Chemical Corporation between 1970 and 1985, generating approximately $574 million in total exposure.  Granite State, No. 653546/11, slip op. at 1-2.  The policy at issue in this case provided coverage for one year. Id. at 2.  Clearwater Insurance Company (formerly known as Skandia American Reinsurance Corporation and then Odyssey Reinsurance Corporation) had issued a reinsurance certificate to Granite State covering risks under an excess policy issued to Kaiser.  Clearwater had reinsured many AIG policies covering Kaiser, as well as non-AIG policies covering Kaiser.  Id.

Like other asbestos producers, Kaiser was the subject of massive litigation relating to asbestos exposure.  After Kaiser's various insurers disputed coverage, Kaiser filed suit in the California courts in May 2000. Id. The defendants included Granite State and AIG.  Kaiser filed for bankruptcy in 2002, and in 2006 the bankruptcy court approved a settlement between Kaiser and its insurers, including Granite State.  Id. at 3. 

Kaiser's settlements allocated losses to insurers using a "horizontal bathtub methodology," where payments are allocated to the policies with the lowest limits first.  Id.  Because all policies at the same layer pay evenly at the same time, excess policies were not triggered until all lower layer policies were exhausted.  Id

Granite State demanded payment in 2010, and Clearwater refused, arguing that Granite State failed to provide timely notice of the potential claim, breached the reinsurance certificate's unreinsured retention requirement, and unfairly allocated losses.  Granite State then filed suit in New York state court. Id. at 4-5.

The court's choice of law was critical, and, naturally, the parties disputed which states' substantive law should apply.  The court found that the reinsurance certificate was negotiated and issued in California, the coverage litigation was in California, and when the reinsurance certificate was issued, Granite State expected to submit its billings to Clearwater's predecessor in California.  Id. at 11.  Conversely, when the reinsurance certificate was issued, Clearwater's principal place of business was in New York, and Granite State's current principal place of business was in New Hampshire. Id. The trial court held that California law applied as the state where the reinsurance certificate had been issued and the location where the ceding insurer would demand payment.  Id. at 11-12.

Clearwater contended that by 2002 or 2004, Granite State knew that losses would exhaust its layer but did not sufficiently notify Clearwater of the reinsured losses until Granite State billed Clearwater in 2010.  Id. at 3.  Conversely, Granite State contended that Clearwater had been provided constructive notice through periodic reports and that, in any event, Clearwater had not been prejudiced by any delay Id. at 6, 9. 

Unlike New York law, California law recognizes that a reinsurer can be charged with constructive notice of a potential reinsurance claim.  Compare New Hampshire Ins. Co. v. Clearwater Ins. Co., 129 A.D.3d 99, 117 (N.Y. App. Div. 2015) (applying New York law to hold reinsurer’s knowledge of mounting losses obtained through collateral sources did not satisfy insurer’s notice obligations under reinsurance certificate), and Same Day Delivery Serv., Inc. v. Penn Star Ins. Co., --- F. Supp. 3d ---, 2015 WL 9244399, at *5 (S.D.N.Y. 2015) (“[Under New York law,] [t]he fact that an insurer may have actual notice from another source does not relieve the insured of its separate contractual obligation to provide notice.”), with Insurance Co. of Pa. v. Argonaut Ins. Co., 2013 WL 4005109, at *9 (S.D.N.Y. 2013) (“California courts have recognized that constructive notice to a co-insurer satisfies the obligation to give notice under an insurance policy.”).  While the Granite State court applied California law, it held that Granite State's periodic reports to Clearwater did not reach the level of constructive notice.  No. 653546/11, slip op. at 14.  The discussion of other companies' exposure and losses in general was insufficient to trigger constructive notice.  Id.

California law applies the notice prejudice rule to reinsurance.  The rule requires a showing of "actual and substantial prejudice stemming from the late notice" before a reinsurer is discharged.  Id. at 15.  Prejudice may be shown if "there was a substantial likelihood that [the reinsurer] could have either defeated the underlying claim against its insured, or settled the case for a smaller sum" than the ultimate settlement.  Ins. Co. of Pa. v. Associated Int'l. Ins. Co., 922 F.2d 516, 524 (9th Cir. 1991).

Clearwater contended that it sustained prejudice when it commuted its retrocessional cover before being notified of Granite State's potential claims.  However, the court concluded that a disadvantageous commutation was insufficient to show the requisite prejudice.  As in Associated Int'l, 922 F.2d at 525, the Granite State court found that commutation was a "collateral matter" that could not constitute the requisite prejudice.  Compare Associated Int'l. 922 F.2d at 525 (holding that lost reinsurance recoveries are collateral matters which cannot constitute prejudice), with Argonaut, 2013 WL 4005109, at *12 (holding that a disadvantageous commutation may provide the requisite prejudice);andUtica Mut. Ins. Co. v. Fireman's Fund Ins. Co., 2015 WL 521024, at *5 (N.D.N.Y. Feb. 9, 2015) (holding ceding insurer's late notice to reinsurer may cause prejudice if such late notice causes reinsurer to make disadvantageous commutations that result in tangible economic loss).

The application of California law also made a difference with respect to Clearwater's retention argument.  While the reinsurance certificate required Granite State to retain $5 million of risk, subject to treaty reinsurance only, Granite State had entered into a pooling agreement with other AIG companies pursuant to which retained liabilities were pooled.  Id. at 19.  The court noted that, while New York law barred evidence to explain unambiguous contractual terms, California allowed such evidence.  Id. at 20-21.  Accordingly, the court found a question of fact as to whether Granite State had breached its warranty of retention.  Id. at 21.

Finally, the court reached the allocation issue.  The court found that a reinsurer would be bound by a cedant's allocation decisions only if the reinsurance agreement contained a follow-the-forms or follow-the-settlements clause.  Id. at 22.  The clause in this case provided that Clearwater's liability "shall follow [Granite State's] liability in accordance with the terms and conditions of the policy reinsured hereunder." Id. at 23. The court found that the quoted language constituted a follow-the-forms clause and that, therefore, Clearwater was not bound by Granite State's allocations.  Id. at 24.  The court rejected Granite State's argument that a follow-the-settlements clause should be implied from other language in the certificate, as well as from the reinsurance relationship generally.

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