Follow the Settlements — Under English and ... - Sedgwick LLP

Follow the Settlements — Under English and ... - Sedgwick LLP


Follow the SettlementsUnder English and Bermuda Law

Any reinsurance claim involves a certain tension: the cedents want their money without having to prove their losses again; the

reinsurers want to ensure that the underlying claim is one to which both insurance and reinsurance contracts respond.

Importantly, English law generally considers reinsurance

not as a form of liability cover for the

cedents (i.e. to pay them in respect of any liability

they may have in respect of the original risk),

but as a reinsurance of the same subject matter

as the original policy. Accordingly, absent specific

contractual provisions, under English law

the cedent must establish, as a matter of fact

and law, that the loss is covered by the insurance

contract and the reinsurance contract.

In order to ease the tension between the cedent

and reinsurer, and for reasons of commercial

efficacy, it has become usual for the parties to

adopt some form (and there are many) of ‘follow

the settlements’ wording.

Types of Clause

The starting point is the so-called ‘Full Reinsurance’

or ‘Full R/I’ clause which typically

provides that the reinsurance operates as ‘…a

reinsurance of and warranted same gross rate

terms and conditions as and to follow the settlements

of [the reinsured]’. The leading case, ICA

v SCOR [1985] 1 Lloyd’s Rep 312, involved

a facultative arrangement and established that

if (a) the claim falls as a matter of law within

the scope of the reinsurance contract, and (b)

if the cedent acts in good faith and (c) in a

proper and business-like manner, then reinsurers

are bound by the settlement. The clause

also reverses the common law burden of proof,

such that, in case of dispute, it is for the reinsurer

to prove that the cedent has not acted in

good faith or in a proper and business-like way

(Charman v GRE [1992] 2 Lloyd’s Rep 607).

In treaty reinsurance, the formulation is subtly

but significantly altered, a standard clause providing

that: ‘All loss settlements by the reinsured

shall be binding upon reinsurers provided that such

settlements are within the terms and conditions of

the original policies and within the terms and conditions

of this policy’…’. In other words, unlike

with the SCOR-type clause, any settlement by

the cedent must be valid under both the insurance

and reinsurance contracts in order to bind

the reinsurer (see the House of Lords decision in

Hill v M&G Re [1996] 1WLR 1239).

The ‘Back-to-Back’ Presumption

Following the decisions in Vesta v Butcher [1989]

AC 852 and Groupama v Seguros Catatumbo

[2000] 2 Lloyd’s Rep 350, a presumption has

grown up that where there is a ‘follow’ provision

in the reinsurance contract the insurance and

reinsurance must necessarily be ‘back-to-back’.

The recent decision of the House of Lords in

Wasa v Lexington [2009] UKHL 40, while not

on ‘follow the settlements’ per se, deals a blow to

that concept. Wasa makes it plain that ‘follow’

clauses do not operate to bring within the scope

of a reinsurance risk that, on a true interpretation

of the policy, would not otherwise be covered.

In the circumstances, it seems probable

that the somewhat doctrinaire ‘back-to-back’

presumption will revert to its original conception

as a ‘sensible principle of construction’ (see

Mance LJ at paragraph 52 of Wasa).

Compromise Settlements

What if the insurer enters into a ‘commercial’

settlement and then seeks recovery from his reinsurer?

Since it would be unacceptable to litigate

every claim to final award, many—indeed

most—loss settlements involve some element of

compromise. In general, a ‘loss settlement’ that

includes compromises of liability will be recoverable

provided that those compromises are bona

fide and made in a proper and business-like way.

However, there are exceptions to that general

proposition and close attention should be paid

to the words used and the facts involved.

In Faraday v Copenhagen Re [2006] EWHC

1474, the reinsurance contract contained a Full

R/I clause which expressly excluded liability for

‘without prejudice’ and ‘ex gratia’ settlements.

The cedent disputed certain of the underlying

claims but not others, finally effecting a global

settlement on an expressly ‘without prejudice’

basis. The court found that this meant that

there was no admission of liability at all under

the original policy, and therefore nothing to

which the reinsurance could respond.

Lumbermans v Bovis Lend Lease [2004]

EWHC 2197 involved a lump-sum payment

on the underlying claim to settle both

disputed and non-disputed sums, with no

apportionment between the two. Reinsurers

declined cover and the Court held that the

cedent was unable to adduce extrinsic evidence

to prove its loss. On the other hand,

in Enterprise Oil v Strand [2006] EWHC 58

the cedent was allowed to rely on extrinsic

evidence to show which parts of the unapportioned

settlement agreement related to risks

for which reinsurance cover existed. Happily,

English law seems to prefer the more sensible

Enterprise decision, and Lumbermans may be

seen as something of a dead end.

In Commercial Union v NRG [1998] 2 Lloyd’s

Rep 600, Commercial Union (CU) sought

summary judgment against its reinsurers,

NRG, over a claim in respect of the Exxon

Valdez tanker. NRG argued that CU had not

been legally liable to pay Exxon because they

had settled purely on advice from their Texan

lawyer that, although CU had an arguable defence

in law, had the case gone to trial, they

would nevertheless have been unsuccessful.

The Court of Appeal agreed with reinsurers.

It was not enough for CU to establish that

the settlement was businesslike and sensible.

Under the ‘follow the settlements’ clause the

settlement was binding only if it was within

the terms and conditions of both the original

policy and of the reinsurance, and for that purpose

it was not sufficient to rely on the mere

advice of a lawyer. The question of whether it

was arguable that reinsurers might not be liable

to the cedents was rather one for the judge

to decide, based on the proper construction of

the policies according to the applicable law.

The above cited cases are all decisions of the

English courts. There are no reported Bermuda

authorities dealing with a reinsurer’s

obligation to follow a cedent’s settlement. In

large part this is due to the fact that almost all

Bermuda reinsurance contracts contain arbitration

clauses and, unlike the English Arbitration

Act, the Bermuda arbitration statute

does not permit appeals (and thus court review)

on issues of law. It is the general practice

of the Bermuda courts to follow English

case precedent and decisions of the House of

Lords are regarded as de facto binding.


Follow the SettlementsUnder US Law

In the US, where a cedent has made a reasonable settlement in good faith, its reinsurers are often obligated to follow the

settlement and pay their contractual share. This obligation is inherently tied to a reinsurance contract’s loss settlements clause.

It was held long ago that where a reinsurance contract does not contain a loss settlement clause, the cedent must establish coverage

under the reinsurance policy as if the cedent were the original insured. N.Y. State Marine Insurance Company v Protection

Insurance Company. [C.C.D. Mass. 1841] 18 F.Cas. 160. However, where there is a clear settlement clause, the reinsurer is bound to

follow the settlement decisions of its cedent on disputes that arose between the insured and reinsured unless it can demonstrate

that the decisions were fraudulent, collusive, made in bad faith, or resulted in an ex gratia payment. Aetna Casualty and Surety

Company v The Home Insurance Company [S.D.N.Y. 1995] 882 F.Supp 1328.

Where a cedent has litigated coverage, the reinsurer

generally must follow the result. The issue

is when must the reinsurer follow its cedent’s


The leading American case on the follow the

settlements doctrine is Aetna Casualty and

Surety Company v The Home Insurance Company

[S.D.N.Y. 1995] 882 F.Supp 1328. There,

Aetna’s insured was subject to numerous lawsuits

regarding the design of an intrauterine

device. Aetna entered into a settlement that, it

argued, proceeded from its own good faith interpretation

of its obligations under its policies.

Aetna argued that because the scope of coverage

afforded by the Home’s reinsurance policies

was identical to that of its policies, Home was

obligated to indemnify Aetna for its settlement.

The court agreed, and described the purpose for

(and necessity of) the doctrine as follows:

Absent [the follow the settlements doctrine],

an insurance company would be

obliged to litigate coverage disputes with

its insured before paying any claims, lest

it first settle and pay a claim, only to risk

losing the benefit of reinsurance coverage

when the reinsurer raises in court the same

policy defenses that the original insurer

might have raised against its insured.

While the follow the settlements doctrine typically

obligates a reinsurer to follow the coverage

decisions of its cedent, the doctrine is not

without limits. For example, reinsurers are not

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bound by ex gratia payments, or payments outside

the scope of the insurance contract. However,

proving the rule inapplicable is typically

difficult, as illustrated by Christiania General

Insurance Corporation v Great American Insurance

Company [2nd Cir. 1992] 979 F.2d 268.

There, Great American insured Honda Motor

Co. which faced a series of lawsuits related to

the safety of their all-terrain vehicles (ATVs).

Great American settled its claims with Honda

and sought reimbursement from its reinsurer,

Christiania. Christiania disputed that it had an

obligation, arguing, inter alia, that Great American’s

payments to Honda were ex gratia, because

Honda failed to advise the materiality of the

risk of insuring ATVs, entitling Great American

to rescind its insurance policies to Honda.

The court disagreed, stating that the reinsurer

was ‘required to indemnify for payments reasonably

within the terms of the original policy,

even if technically not covered by it.’ The court

elaborated: ‘a reinsurer cannot second guess the

good faith liability determinations made by its

reinsured, or the reinsured’s good faith decision

to waive defenses to which it may be entitled.’

The follow the settlements doctrine is now being

invoked regarding a cedent’s chosen method

of allocating underlying settlements to its reinsurers.

Reinsurers have resisted this, particularly

where the method of allocation was never an

issue between the insured and the reinsured.

However, several decisions support the view

that a cedent is entitled to reasonably allocate

its loss as it sees fit. One of these cases is Travelers

Casualty & Surety Company v Gerling Global

Reinsurance Corporation of America [2d Cir.

2005] 419 F.3d 181, where Travelers sought to

allocate an asbestos loss settlement as though

the loss constituted a single occurrence. A reinsurer

disputed this allocation, arguing that each

site where asbestos contamination was alleged

constituted a separate occurrence. While the

District Court agreed with the reinsurer’s position

on the basis that the question of allocation

was not part of Travelers’ underlying settlement,

the Second Circuit reversed, stating that the follow

the fortunes doctrine extends to a cedent’s

post-settlement allocation decisions as long as

they are made in good faith. (Citing North River

Insurance Company v ACE American Reinsurance

Company [2d. Cir. 2004] 361 F.3d. 134.)

A subsequent decision, Allstate Insurance Company

v American Home Assurance Company

[N.Y.A.D. 2007] 837 N.Y.S.2d 138, came to a

different conclusion. There, the cedent allocated

loss to its reinsurer on a different basis than

it paid the loss to its insured. The court found

such a practice untenable, stating, ‘The follow

the fortunes doctrine was intended to foster

consistency in the treatment of loss at both levels,

insured and reinsured, not allow an insurer

to use a different set of rules at each level.’ The

court refused to apply the follow-the-fortunes

doctrine to the reinsured’s attempt to maximize

the amount of collectible reinsurance.

The follow the settlements doctrine shields cedents

from their reinsurers second-guessing their

good faith claims decisions on matters at issue

between the cedent and the insured. However,

American courts will not countenance its use

by cedents who did not conduct a business-like

investigation or otherwise act in good faith.

Sedgwick UK:

Jolyon Patten

Fitzwilliam House, 10 St Mary Axe

London EC3A 8BF, England

tel: 44.20.7929.1829

Sedgwick Bermuda:

Mark Chudleigh

Mercury House, Fourth Floor

101 Front Street, Hamilton HM12 Bermuda

tel: 441.296.9276

Sedgwick US:

James D. Wangelin

One North Wacker Drive, Suite 4200

Chicago, Illinois 60606

tel: 312.641.9050

Sedgwick US:

W. Neil Rambin

1717 Main Street Suite 5400

Dallas, Texas 75201

tel: 469.277.8200

© 2009 Sedgwick, Detert, Moran & Arnold LLP. This communications is published as an information service for clients and friends of the firm and does not constitute the rendering of legal advice or other professional service.

2 Sedgwick, Detert, Moran & Arnold LLP

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