understanding reinsurance

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Chapter 40 UNDERSTANDING REINSURANCE by David M. Raim and Joy L. Langford * I. OVERVIEW 40.01 Scope 40.02 Key Practice Insights 40.03 Master Checklist II. APPRECIATING PURPOSE OF REINSURANCE 40.04 Types of Reinsurance 40.04[1] Facultative vs. Treaty 40.04[2] Proportional vs. Non-proportional 40.04[3] Catastrophe Reinsurance 40.04[4] Finite Reinsurance 40.04[5] Fronting Arrangements 40.05 Lack of Privity of Contracts 40.05[1] Know General Rule 40.05[2] Consider Cut-Throughs III. CONSIDERING REINSURANCE REGULATION 40.06 Credit for Reinsurance 40.07 Letters of Credit 40.08 Insolvency Clause IV. CONSIDERING INSURER’S OBLIGATIONS TO REINSURERS IN CASE OF CLAIM 40.09 Consider Insurer’s Notice Obligations 40.09[1] Know What Notice Clause Requires

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Page 1: understanding reinsurance

Chapter 40UNDERSTANDING REINSURANCE

by David M. Raim and Joy L. Langford*

I. OVERVIEW

40.01 Scope40.02 Key Practice Insights40.03 Master Checklist

II. APPRECIATING PURPOSE OF REINSURANCE

40.04 Types of Reinsurance40.04[1] Facultative vs. Treaty40.04[2] Proportional vs. Non-proportional40.04[3] Catastrophe Reinsurance40.04[4] Finite Reinsurance40.04[5] Fronting Arrangements

40.05 Lack of Privity of Contracts40.05[1] Know General Rule40.05[2] Consider Cut-Throughs

III. CONSIDERING REINSURANCE REGULATION

40.06 Credit for Reinsurance40.07 Letters of Credit40.08 Insolvency Clause

IV. CONSIDERING INSURER’S OBLIGATIONS TO REINSURERS IN CASEOF CLAIM

40.09 Consider Insurer’s Notice Obligations40.09[1] Know What Notice Clause Requires

Maggal
All rights reserved.
Maggal
New Appleman Insurance Law Practice Guide.
Maggal
Copyright © 2007 Matthew Bender & Company, Inc., a member of the LexisNexis Group. Republished with permission from
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40.09[2] Reinsurer’s Assertion of Late Notice As Defense to Paymentof Its Reinsurance Obligations

40.09[2][a] Jurisdictions Requiring Proof of Prejudice40.09[2][b] Jurisdictions Recognizing Late Notice As Defense

Regardless of Ability to Prove Prejudice40.10 Consider Reinsurer’s Right to Access Insurer’s Records

40.10[1] Consider What Access to Records Clause Requires to BeMade Available to Reinsurer

40.10[2] Consider Whether Insurer’s Disclosure of PrivilegedDocuments to Its Reinsurer Constitutes Waiver As to ThirdParties, Including Its Insureds

40.10[2][a] Common Interest Doctrine40.10[2][b] Disclosure Made Prior To Insurance Coverage

Litigation40.10[2][c] Disclosure Made During Course of Insurance

Coverage Litigation40.10[2][d] Disclosure Made After Resolution of Insurance

Coverage Litigation But Prior to Institution ofArbitration or Litigation Between Cedent And Reinsurer

40.10[2][e] Disclosure Made During Course of ReinsuranceLitigation

40.10[2][f] Use of Confidentiality and Common InterestAgreements

40.10[3] Consider Reinsurer’s Ability to Compel Production ofCedent’s Privileged Documents

40.10[3][a] Consider Whether Inclusion of Access to RecordsClause Constitutes Waiver

40.10[3][b] Know When Privileged Documents Are “In Issue”Therefore Requiring Production by Cedent

40.10[3][c] Consider Application of Common Interest Doctrine toCompel Production of Cedent’s Privileged Documents

40.10[3][c][i] Prior to Dispute Between Cedent and Reinsurer40.10[3][c][ii] During Reinsurance Dispute Between Cedent and

Reinsurer40.10[4] Understand When Insured Is Entitled to Discover Its Insurer’s

Reinsurance Information40.11 Consider Reinsurer’s Rights Under Right to Associate Clause

or Claims Control Clause

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V. CONSIDERING REINSURER’S OBLIGATIONS

40.12 Determine Extent of Coverage40.13 Consider Obligation to Reimburse Insurer for Declaratory

Judgment Expense40.14 Consider Obligation to Reimburse Insurer for Extra-

Contractual Obligations and Excess of Policy Limits (“ECO/XPL”) Damages

VI. CONSIDERING DUTY OF UTMOST GOOD FAITH OR UBERRIMAEFIDEI

40.15 Consider Insurer’s Duty to Disclose to Reinsurer All MaterialFacts About Risk Being Reinsured

40.16 Consider Application of Duty of Utmost Good Faith BeyondDisclosure at Inception of Reinsurance Relationship

40.16[1] Application of Duty of Utmost Good Faith to Parties’Conduct During Life of Reinsurance Contract

40.16[2] Application of Duty of Utmost Good Faith to Underwritingand Administration of Ongoing Business

40.16[3] Application of Duty of Utmost Good Faith to Obligation toGive Notice of Claim

40.16[4] Application of Duty of Utmost Good Faith to Reinsurer toPay Under Reinsurance Agreement

VII. CONSIDERING FOLLOW THE FORTUNES/FOLLOW THESETTLEMENTS

40.17 Understand Distinction Between Follow the Fortunes andFollow the Settlements

40.18 Consider Reinsurer’s Preclusion from Second-GuessingReinsured’s Good Faith Claims Decisions

40.19 Consider Application of Follow the Fortunes/Follow theSettlements to Allocation Decisions

VIII. CONSIDERING BROKERED MARKET

40.20 Brokered vs. Direct Market40.21 Understand Which Entity Broker Represents

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IX. CONSIDERING REINSURANCE ARBITRATION

40.22 Consider Obligation to Arbitrate40.23 Neutral Panel or Party Advocate System40.24 Strict Rule of Law vs. Obligations Pursuant to Honorable

Engagement40.25 Discovery in Arbitration40.26 Summary Disposition in Arbitration40.27 Reasoned Awards40.28 Know When to Move to Vacate or Affirm Arbitration Award40.29 ARIAS Forms

X. FORMS

40.30 BRMA Reinsuring Clause Form 44 C (Quota ShareAgreement)

40.31 BRMA Reinsuring Clause Form 44 B (Surplus ShareAgreement)

40.32 BRMA Reinsuring Clause Form 61 C (Excess of LossAgreement)

40.33 BRMA Unauthorized Reinsurance Clause Form 55 A40.34 BRMA Insolvency Clause Form 19 M40.35 BRMA Offset Clause Form 36 A40.36 BRMA Loss Notice Clause Form 26 B40.37 Notice of Loss Clause Incorporating Right to Associate40.38 BRMA Loss Notice Clause Form 26 A40.39 BRMA Access to Records Clause Form 1 B40.40 BRMA Confidentiality Clause Form 69 D40.41 BRMA Claims Cooperation Clause Form 8 A40.42 BRMA Excess of Original Policy Limits Clause Form 15 A40.43 BRMA Extra Contractual Obligations Clause Form 16 D40.44 BRMA Intermediary Clause Form 23 A40.45 BRMA Arbitration Clause Form 6 A40.46 BRMA Arbitration Clause Form 6 E40.47 ARIAS-U.S. Umpire Questionnaire Sample Form 2.1

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I. OVERVIEW.

40.01 Scope. In essence, reinsurance is insurance for insurance compa-nies. It is a contractual arrangement under which an insurer securescoverage from a reinsurer for a potential loss to which it is exposed underinsurance policies issued to original insureds. The risk indemnifiedagainst is the risk that the insurer will have to pay on the underlyinginsured risk. Because reinsurance is a contract of indemnity, absent specificcash-call provisions, the reinsurer is not required to pay under the contractuntil after the original insurer has paid a loss to its original insured.Reinsurance enhances the fundamental financial risk-spreading functionof insurance and serves at least four basic functions for the directinsurance company: increasing the capacity to write insurance (underprevailing insurance-regulatory law); stabilizing financial results in thesame manner that insurance protects any other purchaser against spikesfrom realized financial losses; protecting against catastrophic losses; andfinancing growth.The reinsurance relationship is structured in the following manner:original insured > insurer > reinsurer. The insurer is called, for reinsurancepurposes, the cedent (or cedant). There is typically no contractual rela-tionship between the reinsurer and the original insured. Reinsurance may,but need not, dovetail with the scope of the original insurance. Basically,all of the risks that are insured can be reinsured, unless contrary to publicpolicy under the relevant governing law for the reinsurance contract.This chapter principally discusses how insurance claims and coveragelitigation can evolve into reinsurance claims and in that context presentsthe most common legal issues that arise from reinsurance relationships.The coverage afforded insurers through the most commonly purchasedtypes of reinsurance is explained to provide a context for most reinsuranceclaims. Certain aspects of reinsurance regulation are set forth to illustratethe role of reinsurance in the entire insurance scheme and the payment ofpolicyholder claims. Also described are the special rights and obligationsof cedents and reinsurers as between them and important aspects ofreinsurance arbitration (the common form of dispute resolution), both ofwhich strongly influence reinsurance recoveries. This chapter provides abackground in reinsurance and explains how an insured’s relationshipwith its insurer fits within the context of the entire reinsurance scheme.Reinsurance, like many areas of business law, has a language of its own.The insurance company purchasing reinsurance is called the “cedingcompany” (or the “cedent” (or “cedant”), “reinsured” or “ceding insurer”)because it “cedes” or transfers part of the risk. The company selling

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reinsurance is called the “reinsurer”. Typically, these are the only parties tothe reinsurance agreement; all rights and obligations run only betweenthem. The reinsurance contract does not change the direct, or original,insurer’s responsibility to its policyholder (the “original insured” or“policyholder”), and the insurer must fulfill the terms of its policy whetheror not it has reinsurance or whether or not the reinsurer is rightly orwrongly refusing to perform. The liability or risk ceded is called a“cession,” and the original policy that the cedent issues to a policyholderis referred to as “direct” insurance. A reinsurer also can purchase its ownreinsurance protection, and such reinsurance of reinsurance is called a“retrocession.” A reinsurer that transfers all or part of its assumedreinsurance is called a “retrocedent,” and the company reinsuring this riskis called the “retrocessionaire.” Retrocessions need not incorporate theoriginal reinsurance and often do not. (Retrocessionaires in turn canpurchase reinsurance again, ad infinitum.)

Reinsurance relationships can be simple or complex. A cedent can cedecertain loss exposures under one contract or purchase several contractscovering different aspects or portions of the same policy to achieve thedesired degree of coverage. A layering process involving two or morereinsurance agreements is commonly employed to obtain sufficient mon-etary limits of reinsurance protection. When a claim is presented, thereinsurers respond in a predetermined order to cover the loss.

The reinsurance relationship is evidenced by a written contract reflectingthe negotiated terms. Although reinsurance contracts between differentcedents and reinsurers can include clauses with similar purposes, thewording of particular provisions varies significantly, depending on theparties’ specific needs, customs and practices. Sample clauses are pro-vided where instructive.

Payments that are due pursuant to a reinsurance agreement are consid-ered an asset of the cedent; in contrast to other types of contingentpayments, the applicable regulatory regime may permit the cedent tocount a reinsurance recoverable as a present asset on its own balancesheet. Reinsurance is payable only after the cedent has paid losses dueunder its own insurance agreements. However, most U.S. reinsurancecontracts include an insolvency clause, which allows the receiver of aninsolvent insurer to collect on reinsurance contracts as if the insolventinsurer had paid the claim in full even if it did not [see § 40.08 belowdiscussing the insolvency clause].

Reinsurance should not be confused with other commercial arrangements.It is not co-insurance, where separate insurers assume shares of the sameinsurance risk. Nor is it a novation as between the original insured and its

40.01 New Appleman Insurance Practice Guide

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insurer or substitution of one insurer for another. A reinsurance agreementdoes not establish a partnership between the insurer and the reinsurer ora separate joint venture as between them, although some pro rata contractsprovide that the parties share proportionally in the premiums collected bythe cedent and in losses paid by it. Reinsurance ordinarily does not conferthird-party beneficiary status on the original insured. Absent a “cut-through” clause or similar modification [see § 40.05 below for discussion ofthese exceptions], there is no privity of contract between the insurancepolicyholder and the reinsurer. In the absence of language in the reinsur-ance agreement granting the original insured rights against the reinsureror unusual factual circumstances, attempts by original insureds to suereinsurers directly generally fail; claimants against the original insuredssimilarly are unsuccessful in bringing suit directly against reinsurers, evenwhere, in direct-action states or in other circumstances, the claimant mightbe able to sustain an action against the original insurer (cedent).

Underlying claims and coverage litigation can trigger reporting and noticeobligations of cedents to reinsurers. Reinsurers that potentially oweindemnity may commence investigations, monitor claims, and establishclaim reserves. Counsel for original insureds in coverage litigation some-times seek production of communications generated between the cedentand reinsurer on the grounds that insurance covering a defendant isgenerally discoverable (even though in the circumstance the “insurance”is reinsurance), or for more narrowly tailored purposes such as to collectevidence that the original insurance policy existed at one time even if it isno longer is available. In some instances, the disclosure of cedent/reinsurer communications can potentially be detrimental to the cedent’scoverage position vis-a-vis its insured.

Typical reinsurance claim issues that are discussed here include: reportingand notice obligations; defenses stemming from interpretation of thereinsurance wording to the indemnity sought; cooperation and claim-handling obligations; and defenses seeking rescission of the reinsurancecontract including nondisclosure and misrepresentation with respect tothe details of risk. The nature of the reinsurance relationship — especiallythe notion of “utmost good faith” or uberimae fidei — may provide a glosson how certain issues get resolved in the reinsurance context that maydiffer from how similar issues are resolved in the ordinary insured-insurercontext. Other common issues addressed here include the reinsurer’sobligations to indemnify the insurer for declaratory judgment expensesincurred in defending or prosecuting coverage litigation against theoriginal insured, and payments by insurers in excess of policy limits orpayments of extracontractual damages.

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Reinsurance claims generate certain legal issues distinct from issues thattypically arise in the context of direct insurance. Rules found in insurancelaw in different arenas may not apply or may apply with different nuancesin the context of reinsurance disputes, and the duties and obligationsbetween a cedent and reinsurer may differ from those between an originalinsurer and policyholder, considering some of the differences in therelative sophistication and bargaining power, custom and practice, ordifferent aspects in which one party is largely dependent upon another.Several important distinctions between the resolution of insurance andreinsurance disputes are examined in this chapter, including the effect ofthe bilateral duty of utmost good faith, which is perhaps unique toreinsurance agreements. Reinsurance disputes also are distinguished bytheir typical resolution through arbitration, rather than courtroom litiga-tion. Among other differences, in typical U.S. arbitrations, the availabilityand weight of legal precedent is less predictable and meaningful than inlitigation in the courts. Arbitrators may not be bound by strict legal rulesand do not always strictly apply contract law and other legal principles toreinsurance agreements; indeed, some reinsurance contracts eschew reli-ance upon legal rules in favor of construing the reinsurance relationshipmemorialized by the reinsurance contract as principally an honorableengagement pursuant to industry custom and practice.

Lexis.com Searches: To find statistics on reinsurance premiums, trythis source: RDS TableBase. Enter this search: PUB(Reinsurance).

To find articles on specific cases involving reinsurance, try this source:Reinsurance: Mealey’s Litigation Report. Enter specific search terms ordate ranges.

40.02 Key Practice Insights. The parties to reinsurance contracts aretypically sophisticated insurers transferring the financial risk assumed ininsuring businesses, homes, cars and individuals. Note that sometimesreinsurers create the instrument that is to be sold to an insured and thenlook for a middleman (cedent) to (i) issue the policy to the insured and (ii)purchase the corresponding reinsurance. Indeed, in such transactions,sometimes the cedent will 100 percent reinsure the risk undertaken to thepolicyholder, in exchange for a ceding commission deducted from thepremium collected from the direct insured, which is ultimately passed onto the reinsurer.

There are no standard reinsurance contracts, although many includecommonly used provisions and clauses sometimes required by state law.Each reinsurance treaty or facultative certificate reflects the special needsof the parties with respect to the type and amount of risk covered, the

40.02 New Appleman Insurance Practice Guide

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calculation of the premium, the role of the reinsurance intermediary, themethod and timing of notice and submission of claims, various reportingobligations, and resolution mechanisms for potential disputes. Reinsur-ance contracts therefore are often complex and unique and must becarefully drafted and, in the event of dispute, carefully interpreted.Lawyers practicing in the reinsurance field must become familiar with thespecialized business of reinsurance, including the purposes and types ofreinsurance and the financial goals and consequences typically involved.Practitioners also must be knowledgeable about the meaning, use andlegal effect of commonly employed reinsurance contract provisions,including insolvency, access to records, claims control, notice, extra-contractual obligations (“ECO”), excess of policy limits (“XPL”), followthe fortunes/settlements, intermediary and arbitration provisions. Attor-neys also should carefully review complete versions of reinsurancewordings, including endorsements and amendments. (Indeed, sorting outwhich is the governing wording particularly when insurers operating indifferent markets or in different countries are involved can prove tediousand time consuming.)

Although regulation of the reinsurance industry in the United States ismore limited than that of the insurance industry in general, lawyersshould be mindful of the insurer’s statutory licensing, solvency andaccounting requirements. Attorneys should understand how insurersmust account for finite risk reinsurance, as this subject recently hasattracted significant regulatory attention. Also of particular concern are“fronting” arrangements and cut-through endorsements, which may notbe allowed or may be subject to special regulations in certain jurisdictions.

Reinsurance disputes are typically resolved through arbitration, andpractitioners should be familiar with arbitration law, particularly theFederal Arbitration Act (“FAA”) and statutory law applicable to non-admitted reinsurers and the availability of pre-answer or pre-judgmentsecurity. Of course, counsel handling a dispute should be familiar withhow reinsurance arbitrations are generally handled. A thorough knowl-edge of the reinsurance industry is needed as many issues are decidedbased upon the custom and practice in the industry (especially where thearbitration panel is comprised of non-lawyers, as is often the case).Lawyers also should know that leading industry and professional orga-nizations offer practice guides, forms, and other resources useful forreinsurance arbitrations (such as lists of professional trained reinsurancearbitrators).

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40.03 Master Checklist.

□ Understand whether the reinsurance contract at issue is a faculta-tive certificate or a treaty.

Discussion: § 40.04[1]

□ Understand whether the reinsurance at issue is proportional ornon-proportional.

Discussion: § 40.04[2]

Forms: §§ 40.30-40.32

□ Become familiar with specific types of reinsurance such as catas-trophe reinsurance, clash cover and finite reinsurance.

Discussion: §§ 40.04[3]-40.04[4]

□ Understand how insurers must account for finite risk reinsuranceunder applicable regulations.

Discussion: § 40.04[4]

□ Determine all of the parties’ responsibilities and liabilities in afronting arrangement, including any obligation to monitor a man-aging general agency.

Discussion: § 40.04[5]

□ Confirm that fronting is permissible in the jurisdiction where thearrangement is executed.

Discussion: § 40.04[5]

□ Determine if special circumstances exist which may providegrounds for a policyholder of the ceding insurer to assert a directaction against the reinsurer.

Discussion: § 40.05[1]

□ Research the legality and enforceability of cut-through clauses (orassumption of liability endorsements) contained in insurance con-tracts covered by reinsurance.

Discussion: § 40.05[2]

□ Understand the credit for reinsurance laws governing your rein-surance transaction.

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Discussion: § 40.06

□ Confirm that a letter of credit obtained by a ceding company thatintends to take financial statement credit for reinsurance placedwith a non-admitted reinsurer complies with statutory require-ments.

Discussion: § 40.07

□ Ensure that an adequate insolvency clause is included in thereinsurance contract if required in your jurisdiction. Most statesrequire that the reinsurance contract include an insolvency clausefor the ceding insurer to take credit for reinsurance on its financialstatement.

Discussion: § 40.08

Form: § 40.34

□ Understand the effect of an offset clause, or any applicable commonlaw or statutory set-off rights, on the rights and obligations underthe reinsurance agreement.

Discussion: § 40.08

Form: § 40.35

□ Understand the requirements of the reinsurance contract’s noticeprovision.

Discussion: § 40.09[1]

Forms: §§ 40.36-40.38

□ Determine whether, in your jurisdiction, the reinsurer must dem-onstrate prejudice in order to successfully assert a late noticedefense.

Discussion: § 40.09[2]

□ Understand the effect of an access to records clause in the reinsur-ance agreement.

Discussion: § 40.10[1]

Form: § 40.39

□ If your client is the ceding insurer, beware the consequences of

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disclosing privileged information to reinsurers pursuant to anaccess to records clause.

Discussion: § 40.10[2]

□ Research the applicability in your jurisdiction of the commoninterest doctrine to a cedent’s disclosure of privileged communi-cations to its reinsurer.

Discussion § 40.10[2]

□ Determine whether the parties to a reinsurance contract shouldexecute a confidentiality or common interest agreement to try topreserve applicable privileges or immunities against disclosure tothird parties.

Discussion: § 40.10[2][f]

□ Understand the circumstances under which a reinsurer can compeldisclosure of its cedent’s privileged communications.

Discussion: § 40.10[3]

□ Understand the circumstances under which an insured will beentitled to discover its insurer’s reinsurance information.

Discussion: § 40.10[4]

□ Become familiar with the rights and obligations presented by rightto associate and claims control clauses in reinsurance contracts.

Discussion: § 40.11

Forms: § 40.41

□ Draft the reinsuring or business covered clause of the reinsuranceagreement carefully to avoid disputes concerning the scope ofcoverage.

Discussion: § 40.12

□ Understand whether the reinsurance contract wording (in manycases the definition of “allocated loss expenses”) obligates thereinsurer to reimburse its cedent for declaratory judgment ex-penses.

Discussion: § 40.13

□ Understand the coverage provided by excess of policy limits

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(“XPL”) and/or extra-contractual obligations (“ECO”) clauses inthe reinsurance contract.

Discussion: § 40.14

Forms: §§ 40.42-40.43

□ Understand the duty of utmost good faith that is central to therelationship between cedent and reinsurer.

Discussion: § 40.15

□ If your client is the cedent, determine the facts that must bedisclosed during the underwriting process.

Discussion: § 40.15

□ If your client is the cedent, ensure that all proper and businesslikesteps are taken in underwriting the underlying business and insettling claims.

Discussion: § 40.16[2]

□ Understand the effect of follow the fortunes or follow the settle-ments wording in the reinsurance contract.

Discussion: § 40.17

� Cross References: §§ 40.18-40.19

□ Determine the extent to which follow the fortunes or follow thesettlements language in the reinsurance contract requires a rein-surer to follow its cedent’s allocation and aggregation decisions asrespects it direct insurance obligations.

Discussion: § 40.19

□ Understand the obligations of the reinsurance intermediary.

Discussion: § 40.20

□ Determine whether, and for what purposes, the reinsurance brokeror intermediary is the agent of the ceding company, the reinsurer,or both parties.

Discussion: § 40.21

Form: § 40.44

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□ Understand what disputes are arbitrable under the reinsurancecontract’s arbitration clause.

Discussion: § 40.22

Forms: §§ 40.45-40.46

□ In drafting reinsurance agreements, counsel should determinewhether the scope of the arbitration clause in the reinsurancecontract is intended to be broad or narrow.

Discussion: § 40.22

Forms: §§ 40.45-40.46

□ Arbitration counsel should consider whether non-signatories to thearbitration agreement may be forced to arbitrate.

Discussion: § 40.22

□ Consider whether or not to include consolidation and joinderprovisions in an arbitration agreement, or whether to requestconsolidation once arbitration has commenced.

Discussion: § 40.22

Form: § 40.45

□ Consider what procedures should be included in the arbitrationprovision concerning the selection of arbitrators and/or umpires,what qualifications the arbiters should have, and whether thearbiters should be neutral or non-neutral.

Discussion: § 40.23

□ Make certain that your client appoints its arbiter on a timely basis.

Discussion: § 40.23

□ Become familiar with the standards and procedures for selectingarbitrators and the lists of qualified individuals published byarbitration and reinsurance organizations.

Discussion: § 40.23

Form: § 40.47

□ Understand the effect of any honorable engagement wording in the

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reinsurance agreement.

Discussion: § 40.24

Form: § 40.46

□ Counsel drafting a reinsurance contract should determine whetherspecific discovery procedures should be included in the reinsur-ance contract’s arbitration provision and, if so, whether theyshould incorporate any procedures published by reinsurance orarbitration organizations.

Discussion: § 40.25

□ Counsel should determine how and whether a reinsurance inter-mediary can be required to participate in the discovery process inthe event of a reinsurance arbitration.

Discussion: § 40.25

□ Arbitration counsel should consider whether to submit a motionfor summary disposition of a reinsurance claim or dispute.

Discussion: § 40.26

□ Arbitration counsel should consider whether to move to confirm afavorable arbitration award in court.

Discussion: § 40.28

□ Arbitration counsel should consider whether grounds exist tomove to vacate an arbitration award in court.

Discussion: § 40.28

□ Arbitration counsel should consider whether there are grounds torequest a court to modify or correct an arbitral award.

Discussion: § 40.28

□ Become familiar with the forms provided by ARIAS.

Discussion: § 40.29

Form: § 40.47

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II. APPRECIATING PURPOSE OF REINSURANCE.

40.04 Types of Reinsurance.

40.04[1] Facultative vs. Treaty. There are two basic types of reinsur-ance: “treaty” and “facultative.” Facultative reinsurance is a contractonly covering all or part of a single specific policy of insurance. Foreach transaction sought to be reinsured, the reinsurer reserves the“faculty” to accept or decline all or part of any insurance policypresented, and the cedent chooses whether to secure reinsurance fora particular policy. The reinsurer and cedent negotiate the terms foreach facultative certificate. Facultative reinsurance is commonlypurchased for large, unusual or catastrophic risks. Reinsurers thusmust have the necessary resources to underwrite individual riskscarefully. (“Treaty” reinsurance, discussed further below, involves apreexisting commitment by the reinsurer to cover a predeterminedclass and amount of coverage that will be sold by the insurer-cedent.)

Other uses of facultative reinsurance include:

1. When an insurer is offered a risk that exceeds its standardunderwriting or reinsurance limits for that class, facultativereinsurance can permit the ceding company to accept the risk.

2. Insurers can fill gaps in coverage caused by reinsurance treatyexclusions by seeking separate facultative coverage for aspecific policy or group of policies.

3. A reinsurer can issue facultative reinsurance to participate in amarket in the short term to minimize risk and take advantageof favorable rates.

4. A treaty reinsurer may purchase facultative reinsurance toprotect itself and its treaty reinsurers.

Insurers sometimes purchase both facultative and treaty reinsuranceto cover the same risk. Unless there are contract terms to the contrary,the facultative reinsurance will perform first and completely beforeany of the treaty reinsurance performs. Sometimes the facultativereinsurance only applies to the ceding company’s net retention; othertimes facultative coverage also inures to the benefit of the treatyreinsurers. Ideally, the wording of the facultative certificate will makethis clear. As a general matter, whether the facultative reinsuranceinures to the benefit of the treaty reinsurers will depend on whetherthe treaty reinsurers paid a portion of the premium for the facultative

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coverage. If not, the facultative reinsurance likely will not inure to thetreaty reinsurers’ benefit.

Facultative certificates are often one or two page documents. Thefront of a typical contract identifies the parties, the underlyingpolicyholder and policy number reinsured, amounts of the policyceded and retained, the type of reinsurance (proportional or non-proportional) and the premium. The back of each certificate usuallycontains the following provisions: notice of loss; net retention;coverage for loss adjustment expenses; claims handling; cancellation;insolvency; tax; offset and intermediaries. Many facultative certifi-cates do not include an arbitration provision [see § 40.22 below for adiscussion of arbitration clauses in reinsurance agreements].

Treaty reinsurance, the most common form of reinsurance, coverssome portion of a defined class of an insurance company’s business(e.g., an insurer’s products liability or property book of business).Reinsurance treaties cover all of the risks written by the cedinginsurer that fall within their terms unless exposures are specificallyexcluded. Thus, in most cases, neither the cedent nor the reinsurerhas the “faculty” to exclude from a treaty a risk that fits within thetreaty terms. Therefore, treaty reinsurers rely heavily on the cedent’sunderwriting. Treaty relationships are often long-term; treaties some-times are renewed automatically unless a change in terms is re-quested. A typical treaty can include thirty or forty articles or clauseswhich describe the class or classes of business covered, the type oftreaty (proportional or non-proportional), the amount of reinsuranceprovided and details about the parties’ obligations with respect totreaty operation.

� Cross Reference: For a thorough discussion of the distinctionbetween facultative and treaty reinsurance, see Compagnie deReassurance D’Ile de France v. New England Reinsurance Corp.,825 F. Supp. 370 (D. Mass. 1993), aff’d in part and rev’d in part, 57F.3d 56 (1st Cir. 1995).

z Strategic Point: Reinsurance treaties that run consecutively formany years can present certain difficulties in terms of claimsprocessing. Contracts are often amended by endorsements whichcan add or delete reinsurers, change premium or ceding commis-sion rates or add, delete or alter important contract terms. Thesechanges may be retroactive to contract inception or have adifferent effective date. Practitioners evaluating indemnity underreinsurance treaties must take care to review complete versions of

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the wordings, including endorsements and amendments.

40.04[2] Proportional vs. Non-proportional. Proportional or pro-ratareinsurance is characterized by a proportional division of liabilityand premium between the ceding company and the reinsurer. Thecedent pays the reinsurer a predetermined share of the premium, andthe reinsurer indemnifies the cedent for a like share of the loss andthe expense incurred by the cedent in its defense and settlement ofclaims (the “allocated loss adjustment expense” or “LAE”). Accord-ing to the percentage agreed, the cedent and reinsurer share thepremium and losses from the business reinsured. Proportional rein-surance spreads the risk of loss and creates a broad identity ofinterests between the cedent and the reinsurer, which effectivelyco-venture in relationship to their relative shares of the risk, eventhough only the cedent has contractual privity with the directinsured.

The two most common types of proportional reinsurance are “quotashare” and “surplus share” reinsurance. Under quota share reinsur-ance, the reinsurer assumes an agreed percentage of each risk fromthe first dollar, up to any limit assigned. For example, if there is a $100loss under a 40 percent quota share reinsurance contract, the cedentwould bear $60 of that loss and the reinsurer concurrently would bear$40 of that loss. The percentage always reflects the percentage of lossborne by the reinsurer. The portion of the risk that the reinsurerassumes is called the “ceded risk,” and the portion that the cedentkeeps is referred to as the reinsurance “retention.” Although it is nota partnership, quota share reinsurance presents a greater identity ofinterests between the ceding insurer and the reinsurer than doesexcess of loss reinsurance (discussed below).

Surplus share is similar to quota share reinsurance in that premiumsand losses are shared on a proportional basis, but differs in that theportion of the reinsured policy the direct insurer retains is expressedas a fixed monetary amount, and the reinsurance may or may notapply from the first dollar (i.e., the reinsurance may apply only inexcess of the fixed dollar amount or the cedent and reinsurer maytogether share losses as they are incurred until the cedent incurs anamount equal to its overall retention). Premium is shared based onthe ratio of retained liability, and the reinsurer agrees to pay the samepro rata portion of any loss and expense incurred by the cedent.

Examples: Where the policy limit is $150,000, and the cedent’sretention is $25,000, the amount ceded to the reinsurer is $125,000

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and the ratio of what is ceded to what is retained is 5:1. Lossestherefore will be shared in that proportion. For a loss of $100,000,the cedent is responsible for $16,667 and the reinsurer pays fivetimes more, or $83,333.

In addition, in surplus share reinsurance contracts, the proportion ofpremium and liability ceded can vary, at the cedent’s option, fromrisk to risk. Although it can be advantageous for the direct insurer tovary the percentage of premium and liability ceded for each risk,these variations make a surplus share contract more difficult toadminister than a simple quota share.Under non-proportional or excess of loss reinsurance (sometimesreferred to as “XL” or “XOL”), the reinsurer’s liability is not triggereduntil the cedent’s losses exceed a specified monetary amount, calledthe “retention.” If losses to the ceding company are less than theretention, the reinsurer owes nothing. The reinsurance agreementwill include a limit of liability for each claim above which thereinsurer is not obligated to pay. Excess of loss reinsurance can beprovided on an individual risk, an occurrence or an aggregate basis,and is typically placed in layers. Non-proportional reinsurance tendsto cost less than does quota share reinsurance because the reinsurerdoes not participate in every loss. However, because the level of riskunder non-proportional reinsurance depends on the nature of thereinsurance undertaking, there is a great deal of uncertainty with thiscoverage. In addition to the underlying risk, reinsurers must considerthe layer of coverage on which it will participate.Whether a potential cedent seeks to obtain or place coverage on a firstdollar basis versus excess of loss reinsurance depends on severalfactors, including the cedent’s anticipated loss profile. For example, ifthe cedent expects to incur frequent losses at low levels, it may makeeconomic sense for the cedent to secure quota share reinsurance, so ithas some protection for even the smallest losses. In contrast, if thecedent expects to have infrequent losses at significant levels or wishesto guard against risk of a significant loss, it may choose to purchaseexcess of loss coverage.

z Strategic Point — Reinsurer: Because non-proportional reinsur-ance is characterized by unpredictability and potentially highlosses, XOL reinsurers may incur a disproportionate share of totallosses. This is especially problematic with respect to “long tail”lines of insurance where the incidence of loss and determinationof damages can extend well beyond the period in which theinsurance or reinsurance is in force. In such cases, premiums may

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be received long before liability is manifested or developed, andliability may be difficult to estimate because it is determined bythe prevailing legal or economic environment in the future. (Onthe other hand, the reinsurer is able to hold on to the premiumpaid by the cedent for a longer period, offering it the opportunityto “earn out” losses through investment return.) Examples oflong-tail lines of insurance include malpractice, products liability,and errors and omissions.

� Cross Reference: For discussion of the advantages and disad-vantages of proportional and non-proportional reinsurance con-tracts, see Eric Mills Holmes, Appleman on Insurance 2d § 102.3.

� Cross References: For an example of a reinsuring clause for aquota share reinsurance agreement, see § 40.30 below. For anexample of a reinsuring clause for a surplus share reinsuranceagreement, see § 40.31 below. For an example of a reinsuringclause for an XOL reinsurance agreement, see § 40.32 below.

40.04[3] Catastrophe Reinsurance. Catastrophe reinsurance is a formof excess of loss reinsurance which, subject to a specific limit,indemnifies the cedent for the amount of loss in excess of its retentionwith respect to an accumulation of individual losses affecting mul-tiple policies resulting from a catastrophic event. Rather than singlelarge losses, even an unexpected number of such losses within thereinsurance policy term, catastrophe coverage principally providesprotection for the cedent against the concentration of several losses,each of which may stem from different direct insureds but whichaltogether arise from a common event (or closely related series ofevents). The reinsurance contract is typically called a “catastrophecover.” Catastrophe reinsurance can be provided on an aggregatebasis with coverage for losses over a certain amount for each loss inexcess of a second amount in the aggregate for all losses in allcatastrophes occurring during a certain time period (often one year).Catastrophe cover is typically secured to protect the cedent against anintolerable accumulation of actual loss and to stabilize its underwrit-ing experience.

Another variant of reinsurance purchased by insurers is “clashcover,” which requires two or more coverages or policies issued bythe reinsured to be involved in a loss, for coverage to apply. Thisreinsurance typically attaches above the limits of any one policy.Clash covers are often catastrophe covers.

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� Cross Reference: For discussion of the typical terms of catastro-phe cover, see Eric Mills Holmes, Appleman on Insurance 2d§ 102.3[B][2].

40.04[4] Finite Reinsurance. There is no generally accepted definitionof finite risk (sometimes called “financial”) reinsurance. Broadlyspeaking, it is a form of reinsurance that carefully controls and limitsthe amount and type of risk transferred to the reinsurer, but ofteninvolves the transfer of money, a return premium from the reinsurer,to the cedent as a result of how losses developed under thereinsurance contract. Finite reinsurance can be distinguished fromother non-finite or “traditional” types of reinsurance based on theextent to which there are limitations on the “underwriting risk,” therisk that the amount of losses will exceed premiums. Participants infinite risk reinsurance transactions tend to focus primarily on finan-cial risks, such as timing risk (the risk that losses will need to be paidsooner than expected), investment risk (the risk that the reinsurer willearn less investment income than expected on the reinsurancepremium) and credit risk (the risk that the cedent will not make therequired premium payments).

Finite risk reinsurance contracts are typically treaties that are closelytailored to meet the particular needs of a cedent. They can be quotashare or excess of loss treaties and may cover losses that have yet tobe quantified or to have occurred at all or losses that have alreadyoccurred in part but where the amount and timing of the loss is stilluncertain. Finite risk reinsurance contracts often include some or allof the following:

1. A ceiling on the amount of underwriting risk assumed by thereinsurer;

2. An explicit recognition of the time value of money through theuse of experience accounts funded by large reinsurance pre-miums, which accumulate investment income over time andfund the loss payments;

3. Inclusion of a commutation clause that allows for profitsharing between the cedent and reinsurer based on the finan-cial results of the reinsurance contract;

4. Multi-year contracts that allow the cedent to mitigate volatilityby recognizing a loss gradually, rather than all at once.

Finite risk transactions are legitimate and widespread, though someforms of transactions have been criticized as being in substance

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distinguished loans but which as something other than a loan obtainsmore favorable tax or accounting treatment (until challenged). Thekey issue is how to account for the transaction. If there has beensufficient risk transfer, the contract can be accounted for as reinsur-ance. If not, then contract deposit accounting is appropriate.

t Warning: Significant regulatory attention has recently beendirected at how insurers account for finite risk reinsurance andwhether the principal objective of these transactions is untetheredfrom an underlying business rationale but instead is designed toimprove the appearance of the balance sheet of the cedent (andthus implicitly, or so the argument goes, to mislead investors andregulators as to the true financial condition of the cedent).Insurers and reinsurers in the United States and elsewhere havebeen investigated by the SEC, state Attorneys General, stateInsurance Departments, and other law-enforcement officials withjurisdiction. A common element in many of the finite riskreinsurance transactions under attack by regulators is an allega-tion that the transactions were presented and accounted for as ifthey genuinely transferred material risk, when in fact the trans-actions did not do so and thus were more in the nature of loansor deposits on account. They were instead allegedly intendedonly to achieve a particular result on a company’s balance sheet— what is sometimes referred to as “financial engineering” ormore commonly “smoothing” of earnings.

Example: Effective in 2006 and 2007, the National Association ofInsurance Commissioners (“NAIC”) amended the disclosure re-quirements for companies that purchase finite risk reinsurance,and the new requirements demand substantial and ongoingmanagement attention. The new requirements include severalnew interrogatories (which are part of the “General Interrogato-ries” section of the Annual Statement) that apply to “ceded”reinsurance and are intended to identify reinsurance agreementsthat have characteristics of contracts which the regulators haveidentified as prone to abuse and which warrant closer review. Forexample, under Interrogatory 9.1, the reporting company is askedto identify any ceded reinsurance which meets three conditions:(1) the agreement alters surplus by more than 3% (positive ornegative) or represents more than 5% of premiums or losses; (2)the contract was accounted for as reinsurance and not as adeposit; and (3) the contract has one or more of the followingfeatures “or other features that would have similar results”:

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• non-cancelable contract terms longer than two years;

• a provision whereby cancellation triggers an obligation bythe ceding company or an affiliate to enter into a newcontract with the reinsurer or an affiliate;

• aggregate stop loss reinsurance coverage;

• an unconditional or unilateral right by either party tocommute, unless triggered by a decline in the counter-party’s credit status;

• a provision permitting reporting or payment of losses lessfrequently than quarterly;

• payment schedule, accumulating retentions from multipleyears or any features inherently designed to delay timingof cedent reimbursement (e.g. experience accounts).

In the event conditions (1), (2) and (3) are satisfied, the reportingcompany must provide certain supplemental information including:(a) a summary of the terms of the responsive contracts; (b) a briefdiscussion of the principal objectives and “economic purpose” forentering into the contract; and (c) the aggregate financial statementimpact of all such contracts on the balance sheet and incomestatement.

A second interrogatory (9.2) is intended to ferret out additionalarguably abusive reinsurance arrangements. Here, the reportingcompany must identify any ceded risks (other than to captives orunder approved pooling arrangements) for which it recorded apositive or negative underwriting result greater than 5% of prioryear-end surplus as regards policyholders or it reported calendaryear written premium ceded or year-end loss and loss expensereserves ceded greater than 5% of prior year-end surplus as regardspolicyholders where: (1) the ceded written premium is 50% or moreof the entire direct and assumed premium written by the assumingreinsurer, based on its most recent financial statement; or (2) twenty-five percent or more of the written ceded premium has beenretroceded back to the ceding company in a separate reinsurancecontract. Cessions by or to affiliates, including multiple contracts withthe same reinsurer or its affiliates, are included in determining if theconditions are met. If either condition 1 or 2 of this interrogatory ismet, the reporting company must provide the same supplementalinformation noted above.

An additional interrogatory (9.4) requires the cedent to identify

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contracts that it has accounted for as reinsurance for statutoryaccounting purposes yet accounted for as a deposit for GAAPpurposes (or vice versa). For any such contract, an explanation for thediffering treatment must be provided in a supplemental filing.

The NAIC also now requires CEOs and CFOs to complete a “Rein-surance Attestation Supplement” that is similar to provisions of theSarbanes-Oxley Act (“SOX”), for “all reinsurance contracts for whichthe reporting entity is taking credit on its current financial state-ment.” The attestation includes the following four parts, which sharein the common objectives to encourage transparency and auditabilityfor reinsurance transactions of certain forms and to memorialize,preferably concurrent to entry into the reinsurance contract inquestion, the underlying business rationale and purpose for thetransaction as a safeguard against market participants coopering uppaper with or without oral side deals that negate the apparentlylegitimate business objective of the paperwork.

Consider: Note that this regulatory purpose is not to precludeparticipants from making ill-considered, underpriced, or evenfoolish deals — shareholders may have other recourse for suchnon- or misfeasance; instead, preservation of the integrity of thelargely self-reported financial and insurance regulatory systems ismeant to be buttressed through these disclosure requirements.

1. No side agreements exist, written or oral, that would “underany circumstances reduce, limit, mitigate or otherwise affectany actual or potential loss to the parties.” This prong of theattestation applies to every reinsurance contract, and not justto those that may be characterized as “finite” in nature orappearance. Verifying the absence of all such oral and writtenarrangements as to all contracts will likely require bothdocumentary review and interviews of underwriting person-nel, perhaps even including prior employees. Companies andtheir auditors should develop a plan for accomplishing thisreview and documenting its methodology and results.

2. For reinsurance contracts entered into, renewed or amendedafter January 1, 1994, for which risk transfer is not reasonablyconsidered to be self-evident, there is documentation evidenc-ing proper accounting treatment under SSAP 62. BecauseStatement of Standard Accounting Practice (“SSAP”) 62 andFinancial Accounting Standards Board (“FASB”) 113 (related toGAAP and statutory reinsurance accounting and risk transfer)did not apply until 1994, the NAIC recognizes that risk transfer

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analysis may not have been memorialized contemporaneously.In terms of which contracts have reasonably self-evident risktransfer, the ceding company may want to look back to theInterrogatories. Certainly, any contract reportable under theconditions delineated will be subject to this prong of theattestation. Companies will want to obtain guidance fromcounsel and auditors as to what constitutes sufficient “risktransfer analysis” in today’s environment.

3. The reporting entity complies with all requirements of SSAP62. This deceptively simple sounding prong will require thecareful exercise of “due diligence.” Each company will deter-mine, perhaps based on consultation with accountants, law-yers and independent auditors, what constitutes sufficient duediligence to establish compliance with all of the risk transferand accounting requirements of SSAP 62.

4. The reporting entity has appropriate controls in place tomonitor the use of reinsurance and adhere to the provisions ofSSAP 62. This prong is the key to the ability to make theCEO/CFO attestations on an ongoing basis. Some companieswill have sufficient controls already in place; others will needto develop such controls and put them in place as soon aspossible.

40.04[5] Fronting Arrangements. There is not a general agreement inthe reinsurance industry as to how fronting is defined, and there arevarying perceptions of whether the general duties and relationshipsbetween cedent and reinsurer change in the context of a “fronting”arrangement. At a minimum, fronting involves the reinsurance of allor substantially all of a book of business. The ceding company retainslittle or no net liability on the ceded business and receives a fee(through the ceding commission and perhaps other forms of com-pensation such as service fees) in exchange for allowing the businessto be written on its paper. Sometimes, the goal of a fronted arrange-ment is to have the insurance that is sought to be brought to themarketplace sold through the auspices of an “admitted” carrier, eventhough the real party in interest — with underwriting expertise andper the reinsurance contract financial exposure vis-a-vis the cedent/front — is the reinsurer. In many fronting arrangements, a managinggeneral agency (“MGA”) underwrites the business and handlesclaims on the reinsured policies. There is disagreement as to whatextent responsibility for monitoring the MGA and responsibility forthe MGA’s misdeeds lies with cedent or reinsurer. It is clear, however,

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that a fronting insurer remains contractually liable to perform withrespect to its insureds under the direct policies, whether or not it isindemnified by its reinsurer [Am. Special Risk Ins. Co. v. Delta Am.Re-Insurance Co., 836 F. Supp. 183, 185 (S.D.N.Y. 1993)]. The rein-surer, lacking privity with the direct insured, may be exposed toclaims of tortious interference with contract or for prospectiveeconomic advantage if it directs the cedent/front not to pay a validclaim. At the same time, the cedent faces the risk that if it pays thedirect claim without the support of its reinsurer a risk that it thoughtit may be only fronting may remain on its doorstep, for the reinsurermay assert that the payment to the direct insured was never owed inthe first place under the direct insurance policy and thus representsan uncovered, ex gratia or gratuitous payment for which indemnifi-cation under the reinsurance arrangement is not owed.

z Strategic Point: The reinsurance contract in a fronting arrange-ment should optimally specify who is responsible for oversight ofthe MGA and who is responsible if the MGA breaches its duties.

Consider: Parties should confirm that fronting is allowed in theirjurisdiction, and that there are no specific regulations that arerelevant to their arrangements.

z Strategic Point: Fronting arrangements enable reinsurers toaccept 100 percent of the liability in states where they are notlicensed to write such business on a direct basis [Reliance Ins. Co.v. Shriver, 224 F.3d 641, 642 (7th Cir. 2000); Union Sav. Am. LifeIns. Co. v. N. Central Life Ins. Co., 813 F. Supp. 481, 484 (S.D. Miss.1993); Equity Diamond Brokers, Inc. v. Transnational Ins. Co., 785N.E.2d 816, 818 (Ohio Ct. App. 2003)]. In some instances, frontingallows alien insurers to accept 100 percent of the exposure onrisks it is prohibited by regulatory restrictions to write directly[Gallinger v. Vaaler Ins., 12 F.3d 127, 128 n.1 (8th Cir. 1994)(applying North Dakota law)]. It should be noted that frontingcan be done as a retrocession also. Fronting allows cedinginsurers to receive reinsurance credit that would not be available,at least without security, if the reinsurance was issued directly byan unauthorized reinsurer [see § 40.06 below for a discussion ofcredit for reinsurance]. A licensed reinsurer can front for anunauthorized reinsurer or a reinsurance syndicate, to permit theceding insurer to take credit for the reinsurance without need forsecurity [Am. Special Risk Ins. Co. v. Delta Am. Re-Insurance Co.,836 F. Supp. 183, 185 (S.D.N.Y. 1993)].

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40.05 Lack of Privity of Contracts.

40.05[1] Know General Rule. A fundamental principle of reinsuranceis that the reinsurer ordinarily is not liable to the original policy-holder of the ceding insurer; it is not a co-signer of the policy issuedto the original policyholder, and it is not jointly and severallyobligated to make good on the benefits the policyholder sought toobtain under the insurance contract sold by the insurer/cedent.Many court decisions have recognized that the reinsurer is incontractual privity only with the ceding company and has nocontractual obligation to the original insured, underlying claimants,or any third parties [Barhan v. Ry-Ron, Inc., 121 F.3d 198 (5th Cir.1997) (applying Texas law); Travelers Cas. & Sur. Co. v. PrudentialReinsurance Corp., 2001 U.S. Dist. LEXIS 10913 (N.D. Ohio 2001),citing Stickel v. Excess Ins. Co. of Am., 23 N.E.2d 839 (Ohio 1939);Prudential Reinsurance Co. v. Superior Court (Garamendi), 842 P.2d48 (Cal. 1992)]. Moreover, most courts have rejected claims broughtby original policyholders against reinsurers based on agency andthird-party beneficiary theories [Aetna Ins. Co. v. Glens Falls Ins. Co.,453 F.2d 687, 690 (5th Cir. 1972) (applying Georgia law); Reid v.Ruffin, 469 A.2d 1030 (Pa. 1983)].

Exception: While the rule of lack of privity is generally respsectedby the courts, there have been some cases, particularly arising outof the insolvency of the direct insurer/cedent, where a court hascharacterized the original policyholder as a third-party benefi-ciary of the reinsurance arrangement, thus possessing the rightsto enforce a contract to which it is not a party in accordance withthe ordinary contract-law rules governing third-party beneficia-ries. Policyholders may seek to skip over the insurer with whichit has privity by arguing that the reinsurer is the alter ego of theinsurer, at least insofar as the particular policy or particularinsurance program is concerned. For example, in the bankruptcycontext, reinsurers were considered to be the true risk bearerswhere the ceding insurer merely acted as the fronting company,bore no underwriting risk, and left responsibility for claimshandling and funding to the reinsurers [Koken v. Legion Ins. Co.,831 A.2d 1196, 1237-38 (Pa. Commw. Ct. 2003)]. In another case,the court found that an insured had third-party beneficiary statuswhere the insurer acted as a fronting company and the reinsurersbore all responsibility for underwriting and claims handling andmanaged the defense of coverage claims [Venetsanos v. Zucker,Facher & Zucker, 638 A.2d 1333, 1339-40 (N.J. Super. Ct. App. Div.

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1994)]. [See § 40.04[5] above for a discussion of fronting arrange-ments]. However a federal district court in Missouri rejected thetheory that a reinsurer’s conduct in paying claims alone can makethe reinsurer liable directly to the original insured [AllendaleMut. Ins. Co. v. Crist, 731 F. Supp. 928, 932-33 (W.D. Mo. 1989)].Similarly, a federal district court in New Jersey rejected thepolicyholders’ assertion that a reinsurer’s involvement in the“adjustment and settlement of claims” (as is common where thereis a claims-control clause) allowed the court to “pierce the allegedreinsurance veil” [G-I Holdings v. Hartford Fire Ins. Co., 2007 U.S.Dist. LEXIS 19060, at *40-41 (D.N.J. 2007)].

Exception: It may be possible for an insured to bring a directaction against a reinsurer if the reinsurer allegedly induced thedirect insurer to breach the underlying policy by denying theclaims in question. For example, a tort claim based on this theoryasserted by policyholders against a reinsurer recently survived amotion to dismiss in a federal district court in Florida [LawOffices of David J. Stern v. SCOR Reinsurance Corp., 354 F. Supp.2d 1338, 1341-42 (S.D. Fla. 2005)].

� Cross Reference: For a general discussion of a reinsurer’spotential liability to the policyholder of the ceding insurer, see EricMills Holmes, Appleman on Insurance 2d § 106.7.

40.05[2] Consider Cut-Throughs. A significant exception to the gen-eral rule that an insured may not seek payment directly from areinsurer is present where a cut-through endorsement is contained inthe original underlying policy. A cut-through provision gives aninsured a contractual right to pursue a direct action against thereinsurer; it can be conceived of as an express grant of third-partybeneficiary status of the putative non-party direct insured. Cut-throughs most often apply only when the direct insurer is insolventand provide that the loss which the reinsurer would have paid to theestate of the insolvent insurer is instead paid directly to the originalpolicyholder [compare Wilcox v. Anchor Wate, 2006 UT 6]. A cut-through is similar to an “assumption reinsurance” arrangement,which effectively is the consensual substitution of the reinsurer forthe cedent as the agent for performance, which in turn typically vestsin the direct insured the right to pursue either the original directinsurer (with which it has contract privity) or the assumer of thedirect insurer’s liability, at the insured’s election. One differencebetween a cut through and an assumption arrangement, is that cut

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throughs more often are agreed ex ante, that is, when the policy isplaced, and assumptions occur when the cedent effects a loss-portfolio transfer to a reinsurer by which the reinsurer steps into itsshoes inter sese. The assumption must be an explicit written assump-tion of liability to the original policyholder who acquires a directright of action against the reinsurer; note that since the assumptiontakes place on only one side of the transaction, it is not a “novation,”freeing the original contracting party from its contractual duties; it isnot fictive, however, which is why the direct insured often will bepermitted to elect to pursue either the original party in privity or theassumption reinsurer. Many state statutes permit reinsurers to enterinto cut-through endorsements. [Cal. Ins. Code § 922.2; N.Y. Ins.Code § 1308(a)(2)(B); Tex. Ins. Code § 493.055]. This right has beenrecognized by many courts as well [Martin Ins. Agency, Inc. v.Prudential Reinsurance Co., 910 F.2d 252-53 (5th Cir. 1990) (interpret-ing Louisiana law); Bruckner-Mitchell, Inc. v. Sun Indem. Co., 82 F.2d434, 444 (D.C. Cir. 1936); Klockner Stadler Hurter, Ltd. v. Ins. Co. ofPennsylvania, 785 F. Supp. 1130, 1134 (S.D.N.Y. 1990)].

Exception: Cut-through endorsements that interfered with admin-istration of an insolvent insurer’s estate were found to beunenforceable [Colonial Penn Ins. Co. v. Am. Centennial Ins. Co.,1992 U.S. Dist. LEXIS 17552, at *15-18 (S.D.N.Y. 1992), discussingFoster v. Mutual Fire, Marine & Inland Ins. Co., 531 Pa. 598, 614(1992)].

t Warning: Cut-through endorsements are unenforceable underBermuda law [Dunlop Pneumatic Tire Company Ltd. v. Selfridge& Co. Ltd. [1915] A.C. 847]. Insurers and reinsurers shouldcarefully research the legality and enforceability of cut-throughclauses before using them.

� Cross Reference: For a discussion of cut-through endorsementsand related contract provisions, see Eric Mills Holmes, Applemanon Insurance 2d § 167.2[B][1].

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III. CONSIDERING REINSURANCE REGULATION.

40.06 Credit for Reinsurance. Credit for reinsurance laws constitute a keycomponent of the regulation of reinsurance in the United States. Theselaws determine the circumstances in which a ceding insurer can takefinancial statement credit for reinsurance recoverables as an asset and as areduction of its unearned premium and loss reserves on account ofreinsurance ceded. Where an insurer can take credit for reinsurance, it canincrease its “surplus” and thus expand its allowed capacity to write newinsurance business. In order to qualify for financial statement credit, moststates require that the reinsurer be licensed or accredited in the same statewhere the direct insurer does business, or that the reinsurer be domiciledand licensed in a state that employs substantially similar credit forreinsurance standards to those imposed by the direct insurer’s state ofdomicile. Most states also allow credit for reinsurance ceded to a non-United States reinsurer that maintains a trust fund in the U.S. for theprotection of its U.S. ceding insurers. In addition, the reinsurance contractmust actually materially transfer risk from the cedent to the reinsurer andinclude an insolvency clause [see § 40.08 below for a discussion of theinsolvency clause]. Some states also require that the reinsurer assume allcredit risks of any intermediary receiving payments [N.Y. Comp. Codes R.& Regs. tit. 11, § 125.6].

Exception: A significant portion of the reinsurance in the U.S. is cededto unlicensed alien reinsurers that are not regulated for solvency in anystate. A ceding insurer can still take credit for reinsurance ceded tounlicensed or unaccredited reinsurers if the recoverables are ad-equately collateralized. This requirement is satisfied if the reinsurermaintains certain trust deposits for the protection of all of its U.S.cedents. Alternatively, the reinsurer can provide individual cedentswith collateral. The ceding company can reduce its balance sheetliabilities by an amount equal to the collateralization. Ceding insurerstypically secure the payment of reserves on reinsured liabilities (i.e.,case reserves, incurred but not reported reserves (“IBNR”), unearnedpremium reserve and reserve for allocated loss adjustment expenses(“LAE”)) by means of a clean letter of credit issued or confirmed by afinancial institution approved by the state insurance commissioner [see§ 40.06 below for a discussion of letters of credit]. In these circum-stances, the reinsurer is the applicant requesting the bank to issue theletter of credit in favor of the beneficiary, the ceding insurer. Trustfunds, reinsurer funds held by the cedent as security (“fundswithheld”) or other approved mechanisms also may be viewed as

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collateral sufficient to permit credit for reinsurance [N.Y. Comp. CodesR. & Regs. tit. 11, § 126.3]. Many of these rules, however, are currentlyunder review by the National Association of Insurance Commissioners(“NAIC”) and the federal government.

Example: The NAIC develops model laws, regulations and financialstatements in order to achieve substantial similarity of state laws andprocedures in key areas of solvency, including credit for reinsurance.The NAIC has issued a recommended credit for reinsurance modellaw and regulation, some variation of which has been promulgated byevery state [Model Law on Credit for Reinsurance (2003) and ModelRegulation on Credit for Reinsurance reprinted in Eric Mills Holmes,Appleman on Insurance 2d].

Example: The State of California recently adopted a comprehensive setof regulations, referred to as the “Reinsurance Oversight Regulations,”which cover the following three general topics: (1) the ceding compa-ny’s accounting for reinsurance on its financial statements; (2) require-ments applicable to the form and content of reinsurance agreements;and (3) oversight of reinsurance transactions and related sanctions.The requirements are intended “to elicit from insurers a true exhibit oftheir financial condition and to safeguard the solvency of licensees”and apply to all insurers licensed or accredited in California, allapproved U.S. trusts of otherwise unauthorized reinsurers and li-censed reinsurance intermediaries. In addition, reinsurers that are notlicensed in California but assume risks from California domestic andforeign insurers may also be affected by changes in the regulationswith respect to approved forms of security securing reinsuranceobligations. The regulations contain detailed requirements for licensedinsurers intending to receive credit for reinsurance on their financialstatements, requirements for risk transfer and requisites for reinsur-ance arrangements, including, specifically:

• Credit for reinsurance ceded to admitted insurers and accred-ited reinsurers;

• Credit for reinsurance secured by an approved U.S. trust;

• Credit for reinsurance required by law;

• Credit for reinsurance secured by a single beneficiary trust, aletter of credit, or funds withheld;

• Credit for reinsurance of foreign insurers;

• Transfer of risk for both life and disability and property andcasualty business;

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• Contract requirements for statement credit; and

• Requirements regarding the form of reinsurance arrangements[Cal. Code Regs. tit. 10, §§ 2303-2303.25].

Example: New York similarly provides credit for reinsurance asfollows:

Ҥ 1301. Admitted assets

(a) In determining the financial condition of a domestic or foreigninsurer or the United States branch of an alien insurer for the purposesof this chapter, there may be allowed as admitted assets of such insurer,unless otherwise specifically provided in this chapter, only the follow-ing assets owned by such insurer:

* * *

(14) Reinsurance recoverable by a ceding insurer: (i) from an insurerauthorized to transact such business in this state, except from a captiveinsurance company licensed pursuant to the provisions of article seventy ofthis chapter, in the full amount thereof; (ii) from an accredited reinsurer . . .to the extent allowed by the superintendent on the basis of the insurer’scompliance with the conditions of any applicable regulation; or (iii) from aninsurer not so authorized or accredited or from a captive insurance companylicensed pursuant to the provisions of article seventy of this chapter, in anamount not exceeding the liabilities carried by the ceding insurer foramounts withheld under a reinsurance treaty with such unauthorized insureror captive insurance company licensed pursuant to the provisions of articleseventy of this chapter as security for the payment of obligations thereunderif such funds are held subject to withdrawal by, and under the control of, theceding insurer” [N.Y. Ins. Law § 1301].

� Cross Reference: For an example of an unauthorized reinsuranceclause applying to reinsurance ceded to an unauthorized reinsurer, see§ 40.33 below.

40.07 Letters of Credit. Sometimes, reinsurance contracts require licensedreinsurers to post letters of credit. However, letters of credit are morecommonly obtained by ceding companies which place reinsurance withnon-admitted reinsurers and wish to take credit for reinsurance on theirfinancial statements [see § 40.06 above for a discussion of letters of creditas security under credit for reinsurance laws]. The “Asset or Reductionfrom Liability” section of the NAIC’s Model Law on Credit for Reinsur-ance, adopted in the same or an equivalent form by most states, sets forththe requirements for collateralization of recoverables from non-admittedreinsurers. The NAIC provision stipulates that letters of credit securing the

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payment of reinsurance obligations must be issued or confirmed by aqualified U.S. financial institution and be clean, irrevocable, unconditionaland “evergreen,” requiring the financial institution to provide notice priorto expiration [Model Law on Credit for Reinsurance, Section 23 (2003)].The NAIC Model Letter of Credit regulations further provide that lettersof credit must not be subject to side agreements and must stipulate that thebeneficiary need only draw a sight draft under the letter of credit andpresent it to obtain funds and need not present any other document[Credit for Reinsurance Model Regulation, Section 11A (July 2003)].

z Strategic Point — Cedent: Ceding insurers should make sure thatletters of credit comply with statutory requirements so they canproperly take credit for reinsurance.

Example: Regulation 133 issued by the New York State InsuranceDepartment sets forth conditions for letters of credit which may betreated as an asset by a ceding insurer. Among other things, anacceptable letter of credit must: be irrevocable; be clean and uncondi-tional; be issued, presentable and payable at an office of the qualifiedbank in the U.S.; contain a statement that identifies the beneficiary;contain a statement that it is not subject to any agreement, condition orqualification outside of the letter of credit; contain a statement to theeffect that the obligation of the issuing bank under the letter of creditis an individual obligation of such bank and is in no way contingentupon reimbursement with respect thereto; contain an issue date and adate of expiration; have a term of at least one year and contain anevergreen clause which provides at least 30 days’ written notice to thebeneficiary prior to expiry date for nonrenewal; and state that it issubject to and governed by New York law [N.Y. Comp. Codes R. &Regs. tit. 11, § 79.2].

40.08 Insolvency Clause. In most states, a rehabilitator or liquidator underthe direction of the domiciliary state’s insurance department takes controlof an insurance company that is determined to be insolvent. Althoughreinsurance agreements are indemnity contracts, they usually include aninsolvency clause which alters the indemnity nature of the contract whenthe ceding insurer becomes insolvent. The insolvency clause permits aliquidator to collect from the reinsurer the amount of reinsurance proceedsthat would have become due if the ceding insurer had not becomeinsolvent, even if the cedent has not paid its original policyholders. Theliquidator of the estate assumes the insurer’s rights and obligations underthe reinsurance agreement, including the reporting, settlement and de-

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fense of claims, and can promptly discharge the insolvent insurer’sobligations to claimants.

Most states have encouraged the inclusion of insolvency clauses byenacting legislation providing that the original insurer may not take creditfor reinsurance on its financial statement unless the reinsurance contractcontains an insolvency provision [Cal. Ins. Code § 922.2; N.Y. Ins. Law§ 1308[a][2]; Mass. Ann. Laws ch. 175, § 20A]. This is a significantincentive, as one of the primary reasons for obtaining reinsurance isdefeated if the cedent is forced to maintain reserves for the full amount ofreinsurance ceded [see § 40.06 above which discusses the advantages ofobtaining credit for reinsurance]. As a result, these statutes have had theeffect of ensuring that virtually all reinsurance agreements issued to U.S.cedents include an insolvency clause.

z Strategic Point — Cedents: Cedents should ensure that the insol-vency clause meets the requirements of the insurance department oftheir domiciliary state. There are generally five key provisions in-cluded in the insolvency clause: (1) there is no diminution of the claimspaid by virtue of the cedent’s insolvency; (2) the liquidator mustprovide notice of the pendency of a claim; (3) the reinsurer has theright to investigate and defend claims; (4) the expenses incurred by thereinsurer in defense of claims may be reimbursable; and (5) thereinsurance proceeds are payable to the liquidator with statutoryexceptions (i.e. cut-throughs) [Robert C. Reinarz, et al., ReinsurancePractices, Vol. I, 67-68 (1st ed. 1990)].

� Cross Reference: For an example of a standard insolvency clause, seeBusiness Insurance Law and Practice Guide § 14.08[3]; see also § 40.34below.

z Strategic Point — Reinsurer: There can be a tension between theliquidator’s interests and those of the insolvent company’s reinsurers;if the liquidator agrees to pay a direct insurance claim, it can collectreinsurance on the claim even if the estate does not have sufficientassets to pay the claim, in whole or in part [see Robert W. Hammesfahrand Scott W. Wright, The Law of Reinsurance Claims 254 (1992)].Therefore, reinsurers often monitor liquidators to ensure that theyhandle claims properly until a full settlement is concluded. Many statestatutes provide that the insolvency clause may permit the reinsurer toinvestigate claims against the insolvent ceding company and interposeany defense or defenses which it may deem to be available to theceding company or its liquidator, receiver or statutory successor in theproceeding where the claim is adjudicated [N.Y. Ins. Law § 1308(a)(3);

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Cal. Ins. Code § 922.2(a)(2)]. Reinsurers should ensure that theirinsolvency clauses include this wording.

z Strategic Point — Reinsurer: Many reinsurance contracts include anoffset clause providing for net accounting between the parties [see§ 40.35 for an example of a typical offset clause]. In addition, areinsurer may have a statutory or common law right of set-off (oroffset) against amounts owed to an insolvent insurer’s estate for anyamounts that the insolvent insurer owed to the reinsurer. In the eventof the cedent’s insolvency, an offset clause protects the reinsurer byallowing it to reduce the sum that would otherwise be payable to theinsolvent estate by the amount it is owed. In the absence of a right ofoffset, the reinsurer would be forced to pay claims in full, and it wouldpossess an independent claim for any premiums or other sums owedby the cedent (which might be paid at only a fraction of the amountdue given that the cedent is insolvent). Several state insurance statutesexpressly permit set-offs when the insolvent insurer owed the debtbefore the date of liquidation and the debts and credits are consideredmutual [Cal. Ins. Code § 1031; Fla. Stat. Ann. § 631.281; N.Y. Ins. Law§ 7427]. Several courts have held that inclusion of a statutory insol-vency clause in the reinsurance contract does not destroy the reinsur-er’s right to set-off [Comm’r of Ins. v. Munich Am. Reinsurance Co.,706 N.E.2d 694, 697 (Mass. 1999); Prudential Reinsurance Co. v.Superior Court, 842 P.2d 48, 63-64 (Cal. 1992); In re Midland InsuranceCo., 590 N.E.2d 1186, 1192 (N.Y. 1992)]. However, at least one court hasfound that the insolvency clause’s directive that reinsurance bepayable without “diminution due to the insolvency of the cedinginsurer” abrogates the reinsurer’s right to offset unpaid premiumsfrom sums due under the insurer’s policies [Bluewater Ins., Ltd. v.Balzano, 823 P.2d 1365, 1371-74 (Colo. 1992)]. Another court hasdetermined that allowing a reinsurer to set-off unpaid premiumsagainst sums owed the insolvent insurer under the reinsuranceagreement would conflict with the priority of claims established bystate statute and thus, in effect, is a disguished preference in favor ofone creditor (the reinsurer) [Allendale Mut. Ins. Co. v. Melahn, 773 F.Supp. 1283, 1287-88 (W.D. Mo. 1991) (applying Missouri law)].

t Warning: Reinsurers of insolvent companies must take care to payclaims to the appropriate party; they are generally obligated to pay theliquidator administering the insolvent company’s estate, who isdeemed the “statutory successor” to the insolvent insurer [Martin Ins.Agency, Inc. v. Prudential Reinsurance Co., 910 F.2d 249 (5th Cir. 1990)(applying Missouri law); Excess & Cas. Reinsurance Ass’n v. Ins.

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Comm’r of Cal., 656 F.2d 491 (9th Cir. 1982) (applying California law);Skandia Am. Reinsurance Corp. v. Schneck, 441 F. Supp. 715 (S.D.N.Y.1977) (applying New York law)].

Exception: A significant exception to the general rule that the reinsurermust pay an insolvent cedent’s liquidator occurs when the reinsurancecontract contains a cut-through endorsement, [see § 40.05[2] above fora discussion of the operation of cut-throughs].

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IV. CONSIDERING INSURER’S OBLIGATIONS TO REINSURERS INCASE OF CLAIM.

40.09 Consider Insurer’s Notice Obligations.

40.09[1] Know What Notice Clause Requires. Most reinsurance con-tracts include a provision requiring the ceding insurer to notify thereinsurer of losses or claims that may require the reinsurer toindemnify the cedent. Notice provisions typically include informa-tion sufficient to:

1. Apprise the reinsurer of potential liabilities to enable it to setreserves;

2. Enable the reinsurer to associate in the defense and control ofunderlying claims; and

3. Assist the reinsurer in determining whether and at what priceto renew reinsurance coverage [Unigard Sec. Ins. Co. v. N.River Ins. Co., 4 F.3d 1049, 1065 (2d Cir. 1993), reh’g denied, 4Mealey’s Reins. Rep., No. 15, at 7 (1993), aff’d in part and rev’din part, 762 F. Supp. 566 (S.D.N.Y. 1991)].

Consider: As a practical matter, the cedent should be mindful ofthe need of the reinsurer to provide notice in turn to its retroces-sionaires.

Notice requirements may differ with respect to proportional andnon-proportional reinsurance. Proportional contracts sometimes donot require individual notice of losses, but instead obligate the cedinginsurer to report losses paid and premiums received on a quarterly ormonthly basis, so that accounts between the parties can be settled.Non-proportional contracts generally include wording requiringtimely notice of individual claims. The wording used to convey thisrequirement varies but usually conveys the need to give noticepromptly, immediately or as soon as reasonably possible or practi-cable. In many reinsurance disputes, industry custom and practiceare often reviewed to determine whether notice was timely. Cedinginsurers should establish standards and procedures to ensure thatnotice is given to reinsurers in a timely fashion.

Notice clauses also incorporate varying standards for the event oroccurrence which triggers the requirement to give notice of a loss orclaim. Some of the wording frequently used is as follows:

• any event or development which, in the judgment of the

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reinsured, might result in a claim . . . hereunder

• any occurrence or accident which appears likely to involvethis reinsurance

• any accident in which the reinsurance is or may probably beinvolved

• all losses which, in the opinion of the Company, may result ina claim hereunder

• any occurrence likely to give rise to a claim hereunder; and

• in the event of an accident, disaster, casualty or occurrenceoccurring which either results in or appears to be of a seriousnature as probably to result in a loss involving this Agreement.

Other notice clauses include specific or objective standards mandat-ing notice, such as when the cedent’s reserve exceeds a certainpercentage or when particular types of injuries occur. Some noticeclauses require the cedent to inform the reinsurer of significantdevelopments that arise after initial notice of a claim has beenprovided. [For an example of a notice clause requiring notice ofsubsequent developments, see § 40.36 below.]The notice clause sometimes is part of a reports and remittancesclause or is included in the “conditions” section of the reinsurancecontract (though the obligation to provide notice may be consideredto be a covenant rather than a genuine condition of the reinsurer’sperformance).

� Cross Reference: One of the primary purposes of the noticeclause is to permit reinsurers to determine whether it is necessaryto take action to protect their interests. Many reinsurance con-tracts include wording permitting the reinsurer to associate in thedefense of a claim. The claims cooperation wording can beincluded in the notice clause or as a separate provision [see § 40.11below for a discussion of claims control and right to associateclauses; see § 40.37 below for an example of a notice clauseincorporating the right to associate with the ceding insurer in thedefense of claims].

� Cross Reference: For a discussion of the notice requirement inreinsurance agreements covering environmental business, seeMitchell L. Lathrop, Insurance Coverage for EnvironmentalClaims, § 10.06[1].

40.09[2] Reinsurer’s Assertion of Late Notice As Defense to Paymentof Its Reinsurance Obligations.

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40.09[2][a] Jurisdictions Requiring Proof of Prejudice. Most courtshave held that a reinsurer may refuse to perform on the basis of“late” notice only if it shows that it was prejudiced by late noticeof a claim [British Ins. Co. of Cayman v. Safety Nat’l Cas., 335 F.3d205, 207 (3d Cir. 2003) (interpreting New Jersey law); Zenith Ins.Co. v. Employers Ins. Co. of Wausau, 141 F.3d 300, 307 (7th Cir.1998) (applying Wisconsin law); Ins. Co. of Pa. v. Associated Int’lIns. Co., 922 F.2d 516, 523-24 (9th Cir. 1991) (applying Californialaw)]. The particular nuances of late-notice law varies from state tostate. In North Carolina, for example, the reinsurer is required toprove prejudice only if the cedent first has demonstrated that itsfailure to give notice was in good faith [Fortress Re, Inc. v. CentralNat’l Ins. Co. of Omaha, 766 F.2d 163, 165-67 (4th Cir. 1985)(applying North Carolina law)]. In Pennsylvania, the reinsurermust show that it was “unduly” prejudiced by untimely notice ofloss [Life & Health Ins. Co. of Am. v. Fed. Ins. Co. & Great Nat’l Ins.Co., 1993 U.S. Dist. LEXIS 12165, at *4 (E.D. Pa. 1993) (applyingPennsylvania law)]. In Connecticut, the cedent has the burden ofshowing that the reinsurer suffered no prejudice [Travelers Ins. v.Central Nat’l Ins. Co. of Omaha, 733 F. Supp. 522, 528 (D. Conn.1990) (applying Connecticut law)].

Exception: In some jurisdictions, late notice may entitle thereinsurer to relief without a showing of prejudice if the cedentacted in bad faith, i.e., was grossly negligent or reckless infailing to provide notice [Unigard Sec. Ins. Co. v. North RiverIns. Co., 4 F.3d 1049, 1069-70 (2d Cir. 1993) (applying New Yorklaw); Fortress Re Inc. v. Central Nat’l Ins. Co., 766 F.2d 163,165-66 (4th Cir. 1985) (applying North Carolina law); CertainUnderwriters at Lloyd’s London v. Home Ins. Co., 783 A.2d238, 240 (N.H. 2001)].

z Strategic Point — Cedent: In some jurisdictions, a reinsurermay waive its defense of late notice if it fails to object promptlyand specifically [Cal. Ins. Code § 554; Nat’l Am. Ins. Co. v.Certain Underwriters at Lloyd’s London, 93 F.3d 529, 538 (9thCir. 1996); Michigan Twp. Participating Plan v. Fed. Ins. Co.,292 N.W.2d 760, 767 (Mich. Ct. App. 1999)].

40.09[2][b] Jurisdictions Recognizing Late Notice As Defense Re-gardless of Ability to Prove Prejudice. Some courts have determinedthat breach of a notice provision is a complete bar to recovery,without a showing of prejudice [Liberty Mut. Ins. Co. v. Gibbs, 773

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F.2d 15, 18-19 (1st Cir. 1985) (applying Massachusetts law); AllstateIns. Co. v. Employers Reinsurance Corp., 441 F. Supp. 2d 865, 875(N.D. Ill. 2005), citing INA Ins. Co. of Ill. v. City of Chi., 379 N.E.2d34, 36 (Ill. App. Ct. 1978) (applying Illinois law); Highlands Ins. Co.v. Employers’ Surplus Lines Ins. Co., 497 F. Supp. 169, 171-73 (E.D.La. 1980) (applying Texas law)]. These cases thus construe thenotice provision as a condition precedent to performance.

Exception: The Ninth Circuit has stated that, even where noticeis denominated a condition precedent, the reinsurer still mustdemonstrate prejudice to be relieved of liability [Nat’l Am. Ins.Co. v. Certain Underwriters at Lloyd’s London, 93 F.3d 529, 539(9th Cir. 1996) (applying California law)].

� Cross Reference: For a discussion of reinsurance cases con-sidering late notice defenses and what constitutes prejudice toa reinsurer from late notice, see Eric Mills Holmes, Applemanon Insurance 2d § 105.7.

40.10 Consider Reinsurer’s Right to Access Insurer’s Records.

40.10[1] Consider What Access to Records Clause Requires to Be MadeAvailable to Reinsurer. Most reinsurance contracts include a provisiongranting the reinsurer the right to inspect or audit the cedinginsurer’s books and records. This clause might be called “Access toRecords,” “Inspection of Records” or simply “Audit.” The right toaudit or inspect is important to the reinsurer, as the nature ofreinsurance dictates that the cedent maintain all of the informationabout the business written and the claims made. The inspectionclause allows the reinsurer to evaluate the performance of thereinsurance contract, specifically, what business the reinsured isunderwriting, how it is handling claims and whether they arecovered by the reinsurance agreement. Access to documents enablesthe reinsurer to determine whether the cedent acted reasonably andin good faith in handling underlying claims and in settling andceding claims to the reinsurer. Some inspection clauses provideaccess to claims files only.

Reinsurers may choose to inspect cedents’ records on a regular basis.Requests for inspections or audits also may arise in the followingcircumstances: in preparation for the annual renewal of a reinsurancecontract; when there is a change in the loss reporting pattern; whenthe cedent has not provided sufficient information in presentinglosses; when there is a marked change in premium volume; or when

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there is another unusual event regarding either the claims orunderwriting/premium activity. Reinsurers also often seek audits orinspection when cedents enter run-off or exit certain business sectors.

The right of inspection is as broad or narrow as the particular contractwording provides. A typical inspection or audit clause definesbroadly the records to which the reinsurer is entitled; clausesenabling the reinsurer to review “all documents referring to thebusiness” under the reinsurance agreement or “any records relatingto this reinsurance or claims in connection therewith” are common.Access often is provided to the reinsurer and its authorized repre-sentatives, allowing the use of consultants to conduct inspections.Use of consultants to assist in audits has become increasinglycommon as the magnitude and complexity of claims, especially inlong-tail casualty lines, have caused reinsurers to engage indepen-dent auditors or consultants to perform records inspections. Accessusually is permitted at all reasonable times and is typically providedwhere the records are normally kept.

Documents typically requested by reinsurers during claims inspec-tions include the following:

1. The claims register;

2. Claims bordereaux (i.e., summaries);

3. Selected underlying claims files; and

4. Inspection reports on claims handling facilities.

Documents typically sought during underwriting and financial au-dits or inspections include the following:

1. Basic underwriting information for the direct insurance, in-cluding the name of the insured, insured’s location, policynumber and period, limits of liability, name of underwriterand underwriting analysis, broker, type of coverage and policyprovisions;

2. Premium information;

3. Documentation regarding brokers, third-party administratorsand delegations of underwriting authority;

4. Reinsurance contract wording, underwriting guidelines,evaluation of risks, negotiation files; and

5. Accounting files showing cessions of premiums and losses.

A frequent inspection-related issue is the impasse that occurs when a

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reinsurer’s claim payments are delinquent and it has demanded anaudit to verify the claims’ validity. The cedent may then refuse toallow the audit until the claims are paid; as a result, each party claimsthe other has breached the contract and thus the obligation toperform is suspended until the prior breach is remedied. Arbitrationpanels usually elide this dilemma by ordering an inspection or auditas a part of discovery. In one case, a court ordered a reinsurer to makeits payments current, despite the reinsurer’s complaint that thecedent had refused it access to records regarding one of the treaties atissue. The court found the cedent’s insistence that payment becurrent before access to records was permitted to be “commerciallyreasonable” given the reinsurer’s failure to object to the cedent’sstatement of account or pay them. The reinsurer was ordered “toprove the sort of mistakes cognizable in law to support an adjustmentof the stated account” or to pay the claim [Am. Home Assurance Co.v. Instituto Nacional de Reaseguros, 1991 U.S. Dist. LEXIS 501, at *11(S.D.N.Y. 1991)]. This decision may be limited by the specific facts ofthis reinsurance relationship.

� Cross Reference: For an example of a typical access to recordsclause in a reinsurance agreement, see § 40.39 below.

� Cross Reference: For additional examples of inspection clauses,see Eric Mills Holmes, Appleman on Insurance 2d § 106.4[A].

z Strategic Point — Reinsurer: Reinsurance agreements should bedrafted with an Access to Records clause allowing the reinsurerthe right to examine the books and records of the ceding insurerthat relate to the reinsurance. The clause should include thefollowing provisions:

1. The reinsurer has the right to inspect all books anddocuments relating to business ceded to the reinsurerunder the reinsurance agreement;

2. The right of inspection survives contract termination;

3. The inspection right vests in the reinsurer or in any of itsauthorized representatives; and

4. Access for inspection will be allowed at all reasonabletimes.

Exception: A federal court affirmed an arbitration panel’s findingthat, even in the absence of an audit or inspection clause, thecedent is obligated to furnish information reasonably requested

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by the reinsurer. The panel had denied recovery to the cedentafter it failed to support its reinsurance claim with sufficientinformation [Mich. Mut. Ins. Co. v. Unigard Sec. Ins. Co., 44 F.3d826, 832 (9th Cir. 1995)]. At least one commentator has expressedthe view that access to records is so vital to the reinsurancerelationship that it constitutes an implied right of the reinsurer inthe absence of express wording [Robert W. Hammesfahr & ScottW. Wright, The Law of Reinsurance Claims 6.4 (1994)].

t Warning: A reinsurer’s failure to exercise the right of inspectionmay have a negative impact in a later dispute with its cedent. Onecourt found a reinsurer’s fraudulent concealment claim “unten-able” in the light of the reinsurance contract’s inclusion of atypical access to records clause. The court explained that theabsence of any indication that the cedent failed to honor theaccess to records provision defeated the fraudulent concealmentclaim [Gerling Global Reinsurance Corp. v. Safety Mut. Cas.Corp., 1981 U.S. Dist. LEXIS 13864, at * 7 (S.D.N.Y. Aug. 7, 1981)].

z Strategic Point — Cedent: To the extent possible, cedents shoulddevelop a policy regarding the privileged information they willor will not disclose to their reinsurers. Some courts have foundthat coverage opinions prepared by cedent’s counsel and otherprivileged materials that are shared with reinsurers lose theirprivileged status and therefore must be disclosed to policyholdersin direct insurance coverage litigation (at least where there is aconflict between the cedent and the reinsurer) [see § 40.10[2]below discussing the cedent’s dilemma in providing privilegeddocuments to its reinsurer].

Consider: While reinsurers can enforce the right to inspectionthrough arbitration or, if the contract does not include an arbitra-tion clause, through a lawsuit, at least one court has held thatallowing the reinsurer to inspect is not a condition precedent tothe right to arbitrate. The court granted the cedent’s petition tocompel arbitration despite its refusal to allow the reinsurer accessto its records [Phila. Reinsurance Corp. v. Universale Ruckver-sicherungs A.G., 1994 U.S. Dist. LEXIS 56, at *1 (S.D.N.Y. Jan. 5,1994)].

� Cross Reference: The inspection and audit provision is oftenincluded within the claims cooperation clause of the reinsurancecontract. For a discussion of claims cooperation or control (and

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right to associate) clauses in reinsurance contracts, see § 40.11below.

Consider: Cedents often ask reinsurers to sign confidentialityagreements before permitting access to records. While there donot appear to be any published decisions on this issue, it is likelythat courts or arbitration panels would permit cedents to condi-tion inspections in this manner. Arbitrators have demonstrated ageneral trend towards imposing confidentiality on the partiesbeyond that strictly provided in the reinsurance contract. Forexample, arbitrators may order the parties to treat the entirearbitration process, not just the outcome, as confidential. Areinsurer that objects to executing a reasonable confidentialityagreement pertaining to the inspection of records may riskalienating the adjudicators.

� Cross Reference: See § 40.10[2][f] below for a discussion of theuse of confidentiality agreements to protect a cedent’s privilegeddocuments.

� Cross Reference: For an example of a clause requiring confiden-tiality that can be added to or used in conjunction with an accessto records provision, see § 40.40 below.

40.10[2] Consider Whether Insurer’s Disclosure of PrivilegedDocuments to Its Reinsurer Constitutes Waiver As to ThirdParties, Including Its Insureds.

40.10[2][a] Common Interest Doctrine. There is no cedent-reinsurerprivilege, so whether the disclosure of otherwise privileged mate-rials from one party to the other waives the privilege is determinedby ordinary principles of privilege law, considered in the light ofthe nature of the relationship between the parties and the circum-stances that exist at the time of disclosure. Thus, a cedent will beable to disclose its privileged communications to a reinsurerwithout waiving the right to assert its privilege as to other parties(including its insureds), depending on the nature of the cedent/reinsurer relationship, specifically, whether the cedent and rein-surer had a “common interest” when the disclosure was made.(The question of nonwaiver of privilege is separate from thequestion whether the cedent is required to share privileged com-munications with the reinsurer.) The “common interest” doctrine isan exception to the general rule that disclosure of a privilegedcommunication to a third party who is not an agent or employee of

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counsel waives any privilege that otherwise would apply to thecommunication. It is most often used as a “shield,” enablingparties with a common interest to share privileged informationwithout waiving privilege against a third party. The commoninterest doctrine is most commonly recognized when multipleparties are represented by the same attorney. Communicationsmade to the shared attorney to establish a litigation strategy areprivileged as against all others, although not privileged inter sese[N. River Ins. Co. v. Phila. Reinsurance Corp., 797 F. Supp. 363, 366(D.N.J. 1992), aff’d in part and rev’d in part on other grounds, N. RiverIns. Co. v. CIGNA Reinsurance Co., 52 F.3d 1194 (3d Cir. 1995)]. Thedoctrine has been extended to situations where the parties arerepresented by separate counsel but are engaged in a commonlegal enterprise or share an identical legal interest with respect tothe subject matter of a communication between an attorney andclient pertaining to legal advice. The doctrine is not applicable,however, when the parties’ shared interests are only commercial[Blanchard v. Edgemark Fin. Corp., 192 F.R.D. 233, 237 (N.D. Ill.2000); Aetna Cas. & Sur. Co. v. Certain Underwriters at Lloyd’sLondon, 676 N.Y.S.2d 727, 731-34 (N.Y. Sup. Ct. 1998)].

40.10[2][b] Disclosure Made Prior To Insurance Coverage Litigation.Cedents and reinsurers that have shared privileged materialssometimes argue that their “common interest” in the outcome of acoverage claim should avoid a waiver of the privilege as againstthe insured. Where coverage opinions and other privileged mate-rials are generated prior to a reservation of rights or denial of claimby the insurer or in the absence of the anticipation of a directcoverage dispute, courts often reject assertion of the commoninterest doctrine and find a waiver of privilege when the cedenthas disclosed the materials to its reinsurer. The rationale for thisresult is in part that the motivation of the cedent to provide thecoverage opinion is to induce the reinsurer to perform under itscontract rather than to coordinate common legal strategy.

Example: A court found that coverage opinions disclosed by acedent to its reinsurer were not protected by the attorney-clientprivilege or the work product doctrine but that even if they hadbeen privileged, the common interest doctrine did not applybecause: (i) there was no evidence that the documents weredisclosed in anticipation of litigation; (ii) any common interestwas commercial and not legal; and (iii) the disclosures weremade in the ordinary course of business [Allendale Mut. Ins.

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Co. v. Bull Data Sys., Inc., 152 F.R.D. 132, 141 (N.D. Ill. 1993)].

Example: In a case involving a cedent’s demand for discoveryfrom a group of reinsurers, a court refused to find a commonlegal interest among the reinsurers sufficient to avoid waiver ofattorney-client privilege, where the parties were not in litiga-tion and the reinsurers’ common interests were purely com-mercial [Aetna Cas. & Sur. Co. v. Certain Underwriters atLloyd’s London, 676 N.Y.S.2d 727, 731-34 (N.Y. Sup. Ct. 1998)].

Example: Even where a reinsurer had anticipated that coveragelitigation would arise from a large policyholder claim, the courtrefused to recognize a common interest between the cedinginsurer and the reinsurer and found that the attorney-clientprivilege had been waived by the disclosure of documents[Am. Prot. Ins. Co. v. MGM Grand Hotel — Las Vegas, 1983U.S. Dist. LEXIS 16423, at *15 (D. Nev. June 9, 1983)].

Example: A cedent’s production of documents to its reinsurerwaived any applicable privileges as “the relationship betweeninsurer and reinsurer is simply not sufficient” to invoke thecommon interest doctrine [McLean v. Cont’l Cas. Co., 1996 U.S.Dist. LEXIS 17503, at *2 (S.D.N.Y. 1996)].

Exception: A court refused to find waiver of privilege based onthe reinsurer’s need to review the cedent’s documents todetermine the extent of its reinsurance exposure [Great Am.Surplus Lines Ins. Co. v. Ace Oil Co., 120 F.R.D. 533, 538-39(E.D. Cal. 1988)].

z Strategic Point — Reinsurer: It is in both the cedent’s and thereinsurer’s best interests to minimize the risk that a policy-holder might gain access to privileged information, especiallythat which reveals the strategies and thought processes of thecedent and its counsel in evaluating and litigating a policy-holder’s claim. Thus, the reinsurer’s requests for privilegedinformation from a cedent should be made carefully, regardlessof whether the reinsurer believes it is entitled to the informa-tion or whether the cedent has customarily provided it.

z Strategic Point — Cedent: Given the inconsistent views ofcourts considering the applicability of the common interestdoctrine, a cedent that discloses privileged communications toa reinsurer risks a later finding that it has waived its privileges.

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The outcome of a privilege dispute also may depend on theparticular jurisdiction or the forum within the jurisdiction atthe time of disclosure. Cedents that wish to avoid waiver ofprivilege as against their policyholders by disclosing privi-leged materials to their reinsurers may consider taking thefollowing measures (which may or may not be successful):

1. Try to establish the foundation for assertion of thecommon interest doctrine by expressly stating in thereinsurance contract that the parties share a commoninterest and do not intend the sharing of privilegeddocuments to waive any applicable privileges or protec-tions.

2. Consider whether disclosure of privileged informationto the reinsurer is really necessary. For example, the factsnecessary for a reinsurer to evaluate a settlement can beprovided through means other than the disclosure ofprivileged materials;

3. If disclosure must occur, enter into a confidentiality orcommon interest agreement that acknowledges a com-mon interest between the cedent and reinsurer, restrictsfurther disclosure of the material and endeavors topreserve all applicable privileges or immunities againstdisclosure [see § 40.10[2][f] for a discussion of the useand efficacy of confidentiality and common interestagreements];

4. If litigation or arbitration between the cedent and thereinsurer is already in progress, obtain a protective orderthat seeks to preserve privileges and immunities againstwaiver and includes a ruling that the parties have acommon interest requiring the cedent to produce thedocuments. An order finding common interest mightbolster the assertion of privilege against a claim ofwaiver in a subsequent dispute between the cedent anda policyholder.

� Cross Reference: For a discussion of cases considering theavailability of protection for privileged or confidential infor-mation provided by a cedent to its reinsurer, see Mitchell LLathrop, Insurance Coverage for Environmental Claims§ 10.06[4][c].

z Strategic Point: Cedents and reinsurers invoking the com-

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mon interest doctrine to avoid waiver of privilege as against apolicyholder cannot later assert the privilege against each otherif their interests become adverse [N. River Ins. Co. v. Phila.Reinsurance Corp., 797 F. Supp. 363, 366 (D.N.J. 1992)]. This canbe an advantage or a disadvantage in a subsequent disputeover reinsurance payment, depending on the content of theprivileged material.

40.10[2][c] Disclosure Made During Course of Insurance CoverageLitigation. The majority of courts that have addressed the issuehave determined that a cedent’s disclosure of privileged docu-ments and communications to a reinsurer during the course ofinsurance coverage litigation does not constitute a waiver of theattorney-client privilege. This determination is based on the theorythat the cedent and its reinsurer share a “common interest” in theoutcome of the coverage litigation [Minn. Sch. Bds. Ass’n Trust v.Employers Ins. Co. of Wausau, 183 F.R.D. 627, 632 (N.D. Ill. 1999);U.S. Fire Ins. Co. v. Gen. Reinsurance Corp., 1989 U.S. Dist. LEXIS8280, at *6-7 (S.D.N.Y. 1989); Great Am. Surplus Lines Ins. Co. v.Ace Oil Co., 120 F.R.D. 533, 537-38 (E.D. Cal. 1988)]. The fact thatthe reinsurer is not a party defendant is of little significance. Somecourts have emphasized the cedent’s obligation to keep its rein-surer apprised of the status of the coverage dispute and thenecessity of disclosure — particularly where such disclosure ismade pursuant to an inspection or cooperation clause. The doc-trine was similarly applied to preclude waiver of privilege asagainst an excess insurer overlying the cedent, where the cedenthad disclosed a memorandum to its reinsurer [U.S. Fire Ins. Co. v.Gen. Reinsurance Corp., 1989 U.S. Dist. LEXIS 8280, at *6-8(S.D.N.Y. 1989)] and as against a reinsurer, where the insurer haddisclosed privileged material to another reinsurer [Employer Re-insurance Corp. v. Laurier Indem. Co., 2006 U.S. Dist. LEXIS 10943,at *6 (M.D. Fla. 2006)]. In most circumstances, the involvement ofa broker as a conduit for disclosure of privileged information doesnot by itself effect a waiver [see Minn. Sch. Bds. Ass’n Ins. Trust v.Employers Ins. Co. of Wausau, 183 F.R.D. 627, 631 (N.D. Ill. 1999);U.S. Fire Insurance Co. v. Gen. Reinsurance Corp., 1989 U.S. Dist.LEXIS 8280, at *4-7 (S.D.N.Y. July 19, 1989); but see U.S. v. Pepper’sSteel & Alloys, Inc., 1991 U.S. Dist. LEXIS 21563, at *8-10 (S.D. Fla.1991)].

Exception: A court found that there was no “unity of interest”protecting from disclosure correspondence between an insurer

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and reinsurer regarding an insured’s claim that had ripenedinto litigation. Although their commercial interests coincidedto some extent, the insurer failed to establish that it coordinatedlegal strategy with its reinsurer [Reliance Ins. Co. v. Am. LintexCorp., 2001 U.S. Dist. LEXIS 7140, at *10-11 (S.D.N.Y. 2001)].

40.10[2][d] Disclosure Made After Resolution of Insurance CoverageLitigation But Prior to Institution of Arbitration or Litigation BetweenCedent And Reinsurer. When a cedent wishes to disclose privilegedinformation to its reinsurer after settlement or adjudication of anunderlying coverage action, but prior to the institution of arbitra-tion or litigation against the reinsurer (perhaps in an effort topersuade the reinsurer of the legitimacy of the ceded losses and toavoid a reinsurance dispute), it is unclear whether the commoninterest doctrine will apply. At least one court has declared that acedent’s disclosure to its reinsurer is not in furtherance of a“common interest” where disclosed after settlement with theinsured but prior to litigation/arbitration between the cedent andreinsurer. As the court explained:

North River and CIGNA had no common legal interest. On thecontrary, their interests . . . were antagonistic. In the process of seekingpayment from CIGNA under their reinsurance contract, North Riverprovided the [privileged memos], apparently hoping that CIGNAwould be persuaded to pay. It was not, and litigation ensued. At nopoint did North River and CIGNA engage in a common legal enter-prise, and the common interest doctrine therefore does not apply”[North River Ins. Co. v. Columbia Cas. Co., 1995 U.S. Dist. LEXIS 53, at*22-23 (S.D.N.Y. 1995)].

40.10[2][e] Disclosure Made During Course of Reinsurance Litigation.When a cedent voluntarily discloses privileged communications toa reinsurer during the course of a dispute involving a claim forreinsurance, it may not have the ability to assert the commoninterest doctrine to protect against the assertion that the privilegehas been waived. A case where a reinsurer attempted to compelproduction of its cedent’s privileged documents by arguing thatthe parties had a common interest sheds some light on the issue. Inthat case, the court rejected the common interest argument, findingthat “[t]he interests of the ceding insurer and the reinsurer may beantagonistic in some respects and compatible in others. Thus, acommon interest cannot be assumed merely on the basis of thestatus of the parties” [N. River Ins. Co. v. Columbia Cas. Co., No.90 Civ. 2518 (MLJ), 1995 U.S. Dist. LEXIS 53, at *12 (S.D.N.Y. Jan. 5,1995)]. The court added: “[w]hile their commercial interests coin-

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cided to some extent, their legal interests sometimes diverge, asdemonstrated by the instant litigation. In short [the reinsurer’s]only argument for finding a common interest is that the two partiesstand in the relation of reinsurer to ceding insurer, and that isinsufficient” [id. at 15].

40.10[2][f] Use of Confidentiality and Common Interest Agreements.A cedent that discloses privileged materials to its reinsurer riskswaiving the privilege as against its policyholders, unless it candemonstrate a common interest between the cedent and reinsurerthat avoids the waiver [see § 40.10[2][b] above discussing applica-tion of the common interest doctrine to the reinsurance relation-ship]. Courts have inconsistently recognized a common interestbetween cedents and reinsurers, and the outcome of a waiverdispute may depend on the reinsurer/cedent relationship at thetime of disclosure. Cedents and reinsurers that wish to avoid awaiver of privilege can execute confidentiality or common interestagreements to try to preserve applicable privileges or immunitiesagainst disclosure or, more precisely, to indicate the factual circum-stances and understandings that exist at the time of disclosure.A demonstration through an agreement that the cedent andreinsurer mutually intended to respect and maintain the confiden-tiality of privileged documents may persuade a court that theprivilege and work product protection should be maintained asagainst a policyholder who is using the fact of disclosure to gainaccess to documents to which it ordinarily would not be entitled.A confidentiality agreement may not, however, provide full pro-tection against a claim for disclosure. Put differently, a confidenti-ality or common interest agreement does not create a privilege;rather, it confirms the underlying circumstances at the time ofdisclosure so as to confirm the lack of any intention to effect awaiver as against third parties.Thus, a common interest (or joint defense) agreement may providewaiver protection by laying out the bases for the existence of acommon interest between the cedent and its reinsurer. This maybetter the parties’ position if a waiver claim is later asserted. Awell-drafted common interest agreement may convince a courtthat the parties have carefully considered the waiver issue andintended to protect against further disclosure.

Examples — Waiver: A court allowing disclosure despite theexistence of a confidentiality agreement reasoned that: “[t]heagreement does not alter the objective fact that the confidenti-

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ality has been breached voluntarily . . . The agreement ismerely a contract between two parties to refrain from raisingthe issue of waiver or from otherwise utilizing the informationdisclosed. Plaintiff has no genuine claim of confidentiality tothe documents it produced . . . .” [Chubb Integrated Sys. Ltd.v. Nat’l Bank of Wash., 103 F.R.D. 52, 67-68 (D.D.C. 1984)].Another court, refusing to find a common interest precludingwaiver, explained that: “[a] private agreement by the parties toprotect communications cannot create a privilege” [Aetna Cas.& Sur. Co. v. Certain Underwriters at Lloyd’s London, 676N.Y.S.2d 727, 733 (N.Y. Sup. Ct. 1998)].

Examples — No waiver: One court found that disclosure to aparty pursuant to a confidentiality agreement did not substan-tially increase the opportunity for an adversary to obtain thedocument and therefore did not constitute waiver of workproduct protection, although the court did not determinewhether the common interest doctrine actually applied [BASFAktiengesellschaft v. Reilly Indus., 2004 U.S. Dist. LEXIS 21969,at *13 (S.D. Ind. Oct. 19, 2004)]. Another court similarly foundthat, “while not dispositive,” disclosure pursuant to a confi-dentiality agreement militated against a finding of waiver ofwork product protection [SmithKline Beecham Corp. v. Pen-tech Pharm., Inc., 2001 U.S. Dist. LEXIS 18281, at *15-16 (N.D.Ill. 2001)]. A court considering the confidential exchange oflegal advice and information pursuant to a cross-consultationagreement among insurance companies and Lloyd’s syndicatesdetermined that the parties shared a common interest sufficientto preclude waiver of attorney-client privilege and that it wasclear they shared the expectation that their communicationswould remain confidential [Travelers Cas. & Sur. Co. v. ExcessIns. Co., Ltd., 197 F.R.D. 601, 607 (S.D. Ohio 2000)].

z Strategic Point — Cedent: A confidentiality or common inter-est agreement may be particularly helpful in maintainingprotection under the work product doctrine, which couldapply to many of the disclosed documents. While courts haveoften taken a stricter view of the attorney-client privilege andhave been quick to find a waiver where the confidentiality thatthe privilege protects has been breached, courts applying thework product immunity generally have been more tolerant ofdisclosure to third parties. The work product immunity willnot be deemed waived “unless the disclosure is inconsistent

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with maintaining secrecy from possible adversaries” [U.S. FireIns. Co. v. Gen. Reinsurance Corp., 1989 U.S. Dist. LEXIS 8280,at *7 (S.D.N.Y. July 20, 1989) (citation omitted); Mitchell L.Lathrop, Insurance Coverage for Environmental Claims§ 25.04]. The analysis should “focus on whether the disclosuresin issue increased the likelihood that a current or potentialopponent in litigation would gain access to the disputeddocuments” [In re Imperial Corp. of Am. v. Shields, 167 F.R.D.447, 454 (S.D. Cal. 1995), aff’d on subsequent appeal, 92 F.3d 1503(9th Cir. 1996)]. In some circumstances, a cedent should be ableto argue that disclosure of work product material to a reinsurerunder the auspices of a confidentiality agreement has notincreased the likelihood that a current or potential opponent inlitigation (i.e., a policyholder) would gain access to the dis-puted documents.

40.10[3] Consider Reinsurer’s Ability to Compel Production of Cedent’sPrivileged Documents.

40.10[3][a] Consider Whether Inclusion of Access to Records ClauseConstitutes Waiver. In some circumstances, a ceding insurer maywish to withhold privileged documents from a reinsurer, perhapsto avoid a potential waiver of privilege which would obligate thecedent to provide the documents to its insured. A frequently raisedissue is the extent to which access-to-records clauses allow rein-surers to compel production of documents contained in thecedent’s files that are subject to attorney-client privilege or workproduct protection. Several types of documents in a ceding insur-er’s files could be subject to privilege or immunity as against thereinsurer, including:

1. Claims counsel reports regarding the defense of policyhold-ers;

2. Expert reports or analyses of a claim by the insurer’s orinsured’s personnel concerning the defense of a claim;

3. Coverage analyses by the cedent’s in-house or outsidecounsel; and

4. Draft pleadings and communications with counsel regard-ing those pleadings.

Nevertheless, reinsurers may have a legitimate interest in review-ing such documents. However, the courts that have addressed theinterplay between the contractual obligation to permit inspection

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and claims of privilege or work product protection have found thatthe mere inclusion of “access to records” and “cooperation”clauses in reinsurance contracts do waive the cedent’s privilege asagainst the reinsurer [N. River Ins. Co. v. Phila. Reinsurance Corp.,797 F. Supp. 363, 369 (D.N.J. 1992), aff’d in part and rev’d in part onother grounds, N. River Ins. Co. v. CIGNA Reinsurance Co., 52 F.3d1194 (3d Cir. 1995); Gulf Ins. Co. v. Transatlantic Reinsurance Co.,788 N.Y.S.2d 44, 45-46 (N.Y. App. Div. 2004)]. As one courtexplained: “Although a reinsured may contractually be bound toprovide its reinsurer with all documents or information in itspossession that may be relevant to the underlying claim adjust-ment and coverage determination, absent more explicit language,it does not through a cooperation [or inspection] clause give upwholesale its right to preserve the confidentiality of any consulta-tion it may have with its attorney concerning the underlying claimand its coverage determination” [N. River Ins. Co. v. Phila.Reinsurance Corp., 797 F. Supp. at 369]. Another court reasonedthat the access to records and cooperation clauses do not waiveprivilege because the cedent’s obligations under these provisionsend when the cedent and reinsurer become adversaries [U.S. FireIns. Co. v. Phoenix Assurance Co., No. 7712/91 (N.Y. Sup. Ct. Aug.7, 1992), reported in Mealey’s Litigation Reports: Reinsurance, Vol.4, No. 4 at F-2].

40.10[3][b] Know When Privileged Documents Are “In Issue” There-fore Requiring Production by Cedent. Some reinsurers seeking accessto privileged documents under an inspection clause have arguedthat the cedent waived any applicable privileges by putting thesubject matter of the documents in issue in the dispute between theparties. The “in issue” or “at issue” exception to the attorney-clientprivilege applies when a party asserts a claim or defense that heintends to prove by use of the privileged materials [N. River Ins.Co. v. Columbia Cas. Co., 1995 U.S. Dist. LEXIS 53, at *17 (S.D.N.Y.1995)]. Often, the “in issue” exception is an application of waiverprinciples, where the courts find that the party intending to rely onprivileged materials to prove its claim or defense implicitly waivesthe privilege. (The question of the scope of that waiver is tetheredto the offer of proof the party relying on the privileged materialsintends to make.) In the majority of the reported decisions consid-ering the “in issue” exception in the context of a reinsurancedispute, courts have determined that the “in issue” exception hasnot applied. [N. River Ins. Co. v. Columbia Cas. Co., 1995 U.S. Dist.LEXIS 53, at *16-17 (S.D.N.Y. 1995); N. River Ins. Co. v. Phila.

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Reinsurance Corp., 797 F. Supp. at 370-71; U.S. Fire Ins. Co. v.Phoenix Assurance Co., No. 7712/91 (N.Y. Sup. Ct. Aug. 7, 1992),reported in Mealey’s Litigation Reports: Reinsurance, Vol. 4, No. 4 atF-2]. Several courts have reasoned that merely placing the broadquestion of coverage in issue is insufficient to constitute a waiver ofthe privilege [N. River Ins. Co. v. Columbia Cas. Co., 1995 U.S.Dist. LEXIS 53, at *17; N. River Ins. Co. v. Phila. Reinsurance Corp.,797 F. Supp. at 370-71].

It should be noted, however, that in a recent decision a court didfind a limited waiver based on the “in issue” doctrine. In AmericanRe-Insurance Co. v. United States Fid. & Guar. Co. [No. 604517/02(N.Y. Sup., App. Div., 1st Dept. May 29, 2007), reported in Mealey’sLitigation Reports: Reinsurance, Vol. 18, No. 3 at B-1], the courtruled that a cedent waived attorney-client privilege when itsreinsurance director responsible for preparing the bill to thereinsurers testified during a deposition that in preparing the bill hesought guidance from an in-house attorney who explained to himthat the settlement of the insured’s claim was based on California’s“all sums” and “non-accumulation” rules. The court ruled that thereinsurers were entitled to seek further testimony and the produc-tion of documents regarding the presentation of the reinsuranceclaim to the extent that such discovery related to the disclosuresmade by the reinsurance director during his deposition.

Example: A cedent refused to produce privileged documentsthat revealed its internal legal assessments of the claims forwhich it was requesting reinsurance payment in a reinsurancearbitration. Although the arbitration panel ordered the cedentto produce the documents and warned that it would drawwhatever negative inference it deemed appropriate from afailure to produce, after the cedent refused to produce thematerial (on the basis that it wished to avoid waiver ofprivilege in future dealings with its insureds) the panel orderedthe reinsurer to pay the balance owed. The reinsurer’s motionto vacate the panel’s order was denied [Nat’l Cas. Co. v. FirstState Ins. Group, 430 F.3d 492, 494-97 (1st Cir. 2005)].

Exception — Notice Condition Precedent to Coverage: In a directinsurance coverage dispute where timely notice was a condi-tion precedent to coverage, a court found that, by seekingcoverage, the insured put “in issue” its knowledge regardingits potential liability to the claimant and regarding its notice

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obligations. The court emphasized that the insured had theburden to prove that notice was timely, and therefore it hadimpliedly waived the attorney-client privilege as to communi-cations with its attorney relevant to knowledge of its potentialliability [Century 21, Inc. v. Diamond State Ins. Co., 2006 U.S.Dist. LEXIS 56733, at *5-10 (S.D.N.Y. 2006)].

40.10[3][c] Consider Application of Common Interest Doctrine toCompel Production of Cedent’s Privileged Documents.

40.10[3][c][i] Prior to Dispute Between Cedent and Reinsurer. Re-insurers have tried to use the common interest doctrine as a“sword” — to gain access to a privileged materials over itscedent’s objection. It is unclear whether courts will find that acommon interest exists if the parties are not involved in a legaldispute. In many of the cases finding common interest protec-tion as against the policyholder [see § 40.10[2][c] above], thecedents and reinsurers were found to be united in interest due tothe cedent’s involvement in coverage litigation at the time ofdisclosure. In contrast, in the few reported cases rejectingcommon interest claims by reinsurers, the interests betweencedents and reinsurers were already adverse [see § 40.10[3][c][ii]below]. The absence of an adversarial relationship betweencedent and reinsurer may not guarantee a common interestforcing disclosure, however. At least one court has advised thata cedent’s disclosure to its reinsurer was not in furtherance of a“common interest” at the time the cedent sought payment underthe reinsurance contract and before there was a legal dispute [N.River Ins. Co. v. Columbia Cas. Co., 1995 U.S. Dist. LEXIS 53, at*15 (S.D.N.Y. 1995)]. In another case, the court ordered disclo-sure of allegedly privileged documents to a policyholder basedon the cedent’s disclosure to a reinsurer, when there was noindication as to whether the reinsurer/cedent relationship wasadversarial at the time of disclosure [McLean v. Cont’l Cas. Co.,1996 U.S. Dist. LEXIS 17503, at *2 (S.D.N.Y. 1996)]. In addition,one court has gone so far as to reject the theory that a commoninterest ever exists between cedent and reinsurer, even at thepre-dispute stage, stating that “the common interest doctrine iscompletely unlashed from its moorings in traditional privilegelaw when it is held broadly to apply in contexts other than whenthere is dual representation” [N. River Ins. Co. v. Phila. Reinsur-ance Corp., 797 F. Supp. 363, 367 (D.N.J. 1992) aff’d in part andrev’d in part on other grounds, N. River Ins. Co. v. CIGNA

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Reinsurance Co., 52 F.3d 1194 (3d Cir. 1995)].

40.10[3][c][ii] During Reinsurance Dispute Between Cedent andReinsurer. In general, reliance on the purported “common inter-est” between parties at odds with each other is not a sound basisto predicate the compelled disclosure of privileged communica-tions. In the courts, reinsurers seeking privileged documentsunder the common interest doctrine have been unsuccessfulwhen the parties are already embroiled in a reinsurance dispute[N. River Ins. Co. v. Columbia Cas. Co., 1995 U.S. Dist. LEXIS 53,at *5-15 (S.D.N.Y. 1995); N. River Ins. Co. v. Phila. ReinsuranceCorp., 797 F. Supp. 363, 366-68 (D.N.J. 1992) aff’d in part and rev’din part on other grounds, N. River Ins. Co. v. CIGNA ReinsuranceCo., 52 F.3d 1194 (3d Cir. 1995); U.S. Fire Ins. Co. v. PhoenixAssurance Co., No. 7712/91 (N.Y. Sup. Ct. Aug. 7, 1992), reportedin Mealey’s Litigation Reports: Reinsurance, Vol. 4 No. 4 at F-2].

Reinsurers may be less likely to obtain a cedent’s privilegeddocuments during reinsurance litigation because the reinsurer’salleged breach of the reinsurance agreement suspends thecedent’s disclosure obligations pursuant to the inspection clause[U.S. Fire Ins. Co. v. Phoenix Assurance Co., No. 7712/91 (N.Y.Sup. Ct. Aug. 7, 1992), reported in Mealey’s Litigation Reports:Reinsurance, Vol. 4 No. 4 at F-1].

Reinsurers are more likely to obtain a cedent’s privilegeddocuments regarding the underlying claim in arbitrations, how-ever, where arbitrators can more easily impose confidentialityrestrictions and are not bound to follow strict rules of law orevidence. In all likelihood, if the Panel orders disclosure in aconfidential proceeding over the cedent’s objection, that shouldnot waive privilege vis-a-vis others.

40.10[4] Understand When Insured Is Entitled to Discover Its Insurer’sReinsurance Information. Policyholders often seek access to correspon-dence, reports, agreements and other materials exchanged betweenthe cedent and its reinsurer which may or may not otherwise besubject to protection by the attorney-client privilege or the workproduct doctrine. In some instances, policyholders hope tostrengthen coverage claims by finding admissions or inconsistenciesin these materials. Ceding insurers typically oppose requests forreinsurance information by arguing that it is not relevant to theunderlying coverage dispute or that the information is confidentialand proprietary.

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A majority of courts have held that the existence of reinsuranceagreements and the terms of coverage are relevant to insurancecoverage disputes and therefore discoverable. Many of these deci-sions are premised on the disclosure mandated by Rule 26(a)(1)(D) ofthe Federal Rules of Civil Procedure, which states that “a party shall,without awaiting a discovery request, provide to other parties . . .any insurance agreement under which any person carrying on aninsurance business may be liable to satisfy part or all of a judgmentwhich may be entered in the action or to indemnify or reimburse forpayments made to satisfy the judgment” [Country Life Ins. Co. v. St.Paul Surplus Lines Ins. Co., 2005 U.S. Dist. LEXIS 39691, at *28-29(C.D. Ill. 2005); Medmarc Cas. Ins. Co. v. Arrow Int’l, Inc., 2002 U.S.Dist. LEXIS 15082, at * 9 (E.D. Pa. 2002); Mo. Pac. R.R. Co. v. AetnaCas. & Sur. Co., 1995 U.S. Dist. LEXIS 22157, at *6-7 (N.D. Tex. 1995);Nat’l Union Fire Ins. Co. of Pittsburgh, Pa. v. Cont’l Ill. Corp., 116F.R.D. 78, 83-84 (N.D. Ill. 1987)]. In some instances, courts haveacknowledged that reinsurance agreements contain proprietary orconfidential information and ordered production of the contractspursuant to a protective order, or have simply noted the existence ofa confidentiality agreement precluding wider dissemination of thematerial [Ohio Mgmt., LLC v. James River Ins. Co., , 2006 U.S. Dist.LEXIS 47516, at *6 (E.D. La. 2006); Peco Energy Co. v. Ins. Co. of N.Am., 852 A.2d 1230, 1234 (Pa. Super. Ct. 2004)].

Ceding insurers’ attempts to block access to other types of reinsur-ance information, including reports and other correspondence be-tween cedents and reinsurers, have yielded mixed results. Efforts toavoid discovery are most successful when the policyholder fails toindicate how the reinsurance information is relevant to the coveragedispute or might lead to the discovery of admissible evidence. Forexample, access to communications between cedents and reinsurershas been denied where the policyholder has argued that it hoped togather evidence showing that the policy language at issue wasambiguous [Zurich Am. Ins. Co. v. Keating Bldg. Corp., No. 04-1490(D.N.J. Dec. 29, 2006), reported in Mealey’s Litigation Reports: Insur-ance, Vol. 21, No. 16, at 7; Country Life Ins. Co. v. St. Paul SurplusLines Ins. Co., 2005 U.S. Dist. LEXIS 39691, at *30-32 (C.D. Ill. 2005);Medmarc Cas. Ins. Co. v. Arrow Int’l, Inc., 2002 U.S. Dist. LEXIS15082, at * 13 (E.D. Pa. 2002); Rhone-Poulenc Rorer, Inc. v. HomeIndem. Co., 139 F.R.D. 609, 612 (E.D. Pa. 1991)].

Reinsurance communications have been found relevant and discov-erable typically when there is a defense raised by the ceding insurerin a direct coverage dispute, such as misrepresentation/

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nondisclosure or lack of late notice, which puts the reinsuranceinformation at issue, or to reconstruct a lost policy or provideextrinsic evidence of an ambiguous policy provision.

Example — Reinsurance Communications Relevant: Insurers’ com-munications with reinsurers were found relevant to a claim forrescission of the policies based on the policyholder’s allegedmisrepresentations as to its financial condition. The court rea-soned that pre-policy-issuance communications with reinsurerscould reveal what financial information the insurers relied uponwhen deciding to issue the policies [Nat’l Union Fire Ins. Co. ofPittsburgh, Pa. v. Cont’l Ill. Corp., 116 F.R.D. 78, 82 (N.D. Ill.1987)]. In addition, post-issuance communications with reinsur-ers were relevant to the insurers’ allegation that the policyholderbreached its duty to cooperate with insurers [id. at 82-83].Similarly, communications between an insurer and its reinsurerwere relevant to an insurer’s claim for rescission based on thepolicyholder’s alleged misrepresentation concerning his health[Sotelo v. Old Republic Life Ins., 2006 U.S. Dist. LEXIS 68387, at *8 (N.D. Cal. 2006)].

Example — Reinsurance Communications Relevant: Reinsuranceinformation was directly relevant to rebutting the insurer’saffirmative defense of late notice because evidence that reinsurerswere given timely notice would tend to establish that the insurersthemselves had notice [Rhone-Poulenc Rorer, Inc. v. Home In-dem. Co., 1991 U.S. Dist. LEXIS 16336, at *6-7 (E.D. Pa. 1991); PecoEnergy Co. v. Ins. Co. of N. Am., 852 A.2d 1230, 1233-34 (Pa.Super. Ct. 2004)].

Example — Reinsurance Communications Relevant: Notes andmemoranda prepared by reinsurers’ claim representatives con-cerning information relayed by the cedent’s claims personnelconcerning a policyholder’s claim were relevant to a directcoverage dispute. The court reasoned that the materials werelikely to elucidate conflicts between the cedent and its reinsurerswhich might explain why the ceding insurer had refused to paythe claim [Allendale Mut. Ins. Co. v. Bull Data Sys., Inc., 152 F.R.D.132, 139 (N.D. Ill. 1993)].

Example — Reinsurance Communications Irrelevant: A federal dis-trict court for the District of Columbia ordering discovery of theexistence and contents of the ceding insurer’s reinsurance agree-

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ments denied discovery of other reinsurance communications onrelevance grounds, also noting that “the correspondence maywell constitute proprietary information” [Potomac Elec. PowerCo. v. Cal. Union Ins. Co., 136 F.R.D. 1, 3 (D.D.C. 1990)].

t Warning: If a cedent summarizes advice given by coveragecounsel in correspondence with its reinsurer, the summary infor-mation may be deemed to constitute ordinary business commu-nications and will therefore not be protected from disclosureunder the attorney-client privilege or work product immunity [seeAm. Cas. Co. of Reading Pa. v. Gen. Metals of Tacoma, No. C92-5192B (W.D. Wash. April 13, 1994), reported in Mealey’s Litiga-tion Reports: Reinsurance, Vol. 4, No. 23, at B-1].

� Cross Reference: For a discussion of additional cases consider-ing the discovery of reinsurance information in coverage actionsbetween a ceding insurer and its insured, see Eric Mills Holmes,Appleman on Insurance 2d § 107.3; Mitchell L. Lathrop, Insur-ance Coverage for Environmental Claims § 25.05[2][c].

40.11 Consider Reinsurer’s Rights Under Right to Associate Clause or ClaimsControl Clause. Related to the right to inspect the cedent’s records is thereinsurer’s right to associate in, or to control, the defense of claims. Theserights are embodied in “right to associate” or “claims control” clauses.

Under a right to associate (sometimes called a “claims cooperation”)clause, the reinsurer’s exercise of the right is discretionary, but the cedentis required to make prompt disclosure of information that the reinsurerneeds to decide whether to associate with the cedent in defense of a claim.A right to associate clause typically gives the reinsurer the right toparticipate “in the defense and control of any claim, suit or proceedingwhich may involve [the] reinsurance with the full cooperation of [thecedent]” [Unigard Sec. Ins. Co., Inc. v. N. River Ins. Co., 4 F.3d 1049, 1055(2d Cir. 1993)]. A court considering this language declared that the phrase“which may involve [the] reinsurance” does not mean “which mayinvolve insurance underlying this reinsurance” [Unigard Sec. Ins. Co. Inc.v. N. River Ins. Co., 762 F. Supp. 566, 587 (S.D.N.Y. 1991), aff’d in part, rev’din part, 4 F.3d 1049, 1055 (2d Cir. 1993)]; therefore, there is no right toassociate if there is no direct impact on the reinsurance coverage [id.].

Claims control clauses are not typical. They go further than right toassociate clauses in giving the reinsurer control over claims settlements.These provisions, sometimes termed “counsel and concurrence” or “con-cur and consent” clauses,” not only give the reinsurer the right to be

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involved in the adjustment of a claim but also obligate the cedent to conferwith and secure the agreement of the reinsurer to settle claims of certaintypes or amounts in order to be indemnified. In the U.S. market, counseland concur provisions are usually found in clauses that provide excesslimits and extra-contractual (“ECO”) coverage [see § 40.14 below for ageneral discussion of the reinsurer’s obligation to reimburse the cedent forthese types of losses]. Some clauses go further still and give the reinsurerbroad authority over claims handling.

A cedent’s failure to provide the notice required by a claims cooperationclause can arguably provide a defense to coverage [Liberty Mut. v. Gibbs,773 F.2d 15, 17-18 (1st Cir. 1985); see § 40.09 above for a completediscussion of the cedent’s notice obligations and the consequences of abreach of this obligation]. Similarly, a cedent’s failure to comply with theterms of a claims control clause may provide an affirmative defense to aclaim for payment [Certain Underwriters at Lloyd’s London v. Home Ins.Co., 783 A.2d 238, 239-242 (N.H. 2001); Argonaut Ins. Co. v. CertainLondon Mkt. Reinsurers, No. 03-317805 (Cal. Super. Ct. Nov. 13, 2006),reported in Mealey’s Litigation Report: Reinsurance, Vol. 17, No. 15 at A-4].However, denial of coverage for a violation of the right to associate maynot succeed if the reinsurer cannot show that it was prejudiced and thecedent did not act in bad faith [see N. River Ins. Co. v. Cigna ReinsuranceCo., 52 F.3d 1194, 1216 (3d Cir. 1995); Unigard Sec. Ins. Co. v. N. River Ins.Co., 4 F.3d 1049, 1068-70 (2d Cir. 1993)].

Example: Reinsurers were required to indemnify a cedent for expensesincurred after instructing the cedent how to handle a claim pursuant toa claims control clause providing for indemnification “for any and allloss or expense which the Reinsured may sustain by reason of havingfulfilled [Reinsurers’] instruction” [La Reunion Francaise v. Martin,1996 U.S. App. LEXIS 9578, at *3-4 (2d Cir. 1996) (unpublishedopinion)].

t Warning: Reinsurers that choose to associate in the handling of aclaim should do so cautiously, in order to preserve the legal positionthat there is no privity of contract between an insured or a third-partyclaimant in an action against an insured and the reinsurer [see§ 40.05[1] above discussing the general lack of privity of contract inreinsurance arrangements]. Reinsurers that are intimately involved inthe claims-handling process run the risk of being held directly liable topolicyholders or third parties for the cedent’s insurance obligations orits settlement actions [see Slotkin v. Citizens Cas. Co. of New York, 614F.2d 301, 316-17 (2d Cir. 1979), adhered to on rehearing, 614 F.2d 301, 323;

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O’Hare v. Pursell, 329 S.W.2d 614, 621 (Mo. 1959)]. At a minimum, areinsurer increases the likelihood that a court will order discoveryagainst it in a coverage case so as to enable the policyholder to testwhether the reinsurer should be found to be an alter ego or the realparty in interest; this is especially a risk where the cedent is a frontinginsurer or where the reinsurer is exposed to paying the bulk of thepolicyholder’s claim. In one case where the reinsurance contract wasviewed by the court as not otherwise covering punitive damages, areinsurer was obligated to pay its proportionate share of liability for itscedent’s bad faith failure to settle a third-party claim against itsinsured, where the reinsurer was engaged in a joint enterprise with thecedent in defending and settling the third-party action [Peerless Ins.Co. v. Inland Mut. Ins. Co., 251 F.2d 696, 703-04 (4th Cir. 1958); but seeReid v. Ruffin and Granite Mut. Ins. Co., 469 A.2d 1030, 1033 (Pa.1983)]. To avoid potential liability for claims handling and settlement,reinsurers should carefully consider whether or not to incorporate aclaims control or counsel and concurrence clause in their reinsuranceagreements and the appropriate degree of participation in the claimsprocess.

Consider: A clause requiring the reinsurer’s consent to settlements maybe in conflict with a “follow the settlements” provision, whichobligates the reinsurer to indemnify its cedent for any losses within theterms of the original policy, as long as the cedent has acted in goodfaith.

� Cross Reference: For a discussion of follow the settlements clauses inreinsurance agreements, see § 40.17 below.

� Cross References: For an example of a claims cooperation clause, see§ 40.41 below.

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V. CONSIDERING REINSURER’S OBLIGATIONS.

40.12 Determine Extent of Coverage. The “reinsuring” or “business cov-ered” clause of a reinsurance treaty typically determines the extent of thereinsurer’s liability to the cedent [see §§ 40.30, 40.31 and 40.32 below forexamples of reinsuring clauses]. This clause specifies the types of risksincluded in the agreement and the percentage of business covered (for aquota share contract) or the attachment point and limits of the agreement(for an excess of loss contract). Facultative certificates, in turn, typicallyinclude a “liability” clause, which specifies the liability of the reinsurerand provides that the reinsurance certificate will cover only the kinds ofliability covered in the original policy. Facultative certificates often include“follow the form” clauses, which provide that the reinsurance coveragedovetails with or adopts as its own the terms of the coverage of theunderlying policy. This presumption is not absolute, however, and can beoverridden by express wording in the certificate creating a non-concurrency as to liability. As a general rule, in both treaties andfacultative certificates, the extent of the reinsurer’s liability is determinedby the express wording of the reinsurance agreement.

A reinsurer will not be held liable beyond the terms of the reinsurancecontract merely because the ceding insurer has sustained a loss. The factthat the direct insurer has paid a claim does not establish that it is entitledto indemnity from the reinsurer because the claim might have been one forwhich the insurer was not bound to make payment [Mich. Millers Mut.Ins. Co. v. N. Am. Reinsurance Corp., 452 N.W.2d 841, 842-43 (Mich. Ct.App. 1990); Independence Ins. Co. v. Republic Nat’l Life Ins. Co., 447S.W.2d 462, 467-69 (Tex. Civ. App. 1969)]. For example, cedents that makeex gratia or “voluntary” payments (payments made in the absence of anylegal obligation to pay) are not entitled to indemnity from their reinsurersunless the reinsurance contract provides to the contrary [Am. Ins. Co. v. N.Am. Co. for Prop. & Cas. Ins., 697 F.2d 79, 81 (2d Cir. 1982); Lexington Ins.Co. v. Prudential Reinsurance Co. of Am., 1997 Mass. Super. Lexis 593, at* 10-19 (Mass. Super. Ct. 1997)].

Reinsuring clauses should be drafted carefully to avoid disputes concern-ing the scope of coverage [N. River Ins. Co. v. Cigna Reinsurance Co., 52F.3d 1194, 1206-07 (3d Cir. 1995)].

Example: A reinsurer was not liable to cover a payment for lost cargounder a facultative certificate where the loss was due to a “shore risk”because “the defendant never consented to reinsure this loss notcovered in the original insurance policy” [Ins. Co. of N. Am. v. U.S. Fire

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Ins. Co., 322 N.Y.S.2d 520, 524 (N.Y. Sup. Ct. 1971)].

Example: A reinsurance certificate referring to the direct policy’s termsas the limitations on liability could not be construed to providecoverage for claims that were expressly excluded by the underlyingpolicy [Ambassador Ins. Co., Inc. v. Fortress Re, Inc., 1983 U.S. Dist.LEXIS 14685, at *31 (M.D.N.C. Aug. 12, 1983)].

Example: A cedent’s motion for summary judgment on its indemnityclaim against its reinsurer was denied where a substantial portion ofthe settlement paid to the insured was attributable to legal expenses, aloss not reinsured under the facultative certificate [Affiliated FM Ins.Co. v. Employers Reinsurance Corp., 2004 U.S. Dist. LEXIS 27961, at*43 (D.R.I. 2004)]. The cedent also had failed to demonstrate that thelosses actually occurred during the coverage period of the certificate[id. at 46].

Example: Indemnity under facultative certificates was limited to theamounts expressly stated in the certificates and was not coextensivewith the underlying policies: “if [the ceding insurer] were allowed torecover its full liability to [the insured] simply because it held someamount of reinsurance, the negotiated coverage limits of the reinsur-ance certificates would be rendered meaningless” [Travelers Cas. andSur. Co. v. Constitution Reinsurance Corp., 2004 U.S. Dist. LEXIS21829, at *13 (E.D. Mich. 2004)].

Cedent’s Perspective: Many reinsurance contracts include “follow thefortunes” or “follow the settlements” clauses, which have been inter-preted to embody the principle that a reinsurer will indemnify itscedent for any losses arguably within the terms of the original policyso long as the cedent has acted in good faith. These clauses operateprimarily for the benefit of cedents, allowing them some measure ofcertainty in calculating expected reinsurance recoveries and discour-aging reinsurers from challenging a cedent’s coverage decisions [See§§ 40.17, 40.18 and 40.19 for a complete discussion of follow thefortunes and follow the settlements clauses]. Occasionally disputesarise in which cedents assert that “follow the fortunes” or “follow thesettlements” clauses obligate a reinsurer to provide indemnity despitereinsurance contract wording excluding the particular loss fromcoverage or for other ex gratia payments. This argument is usuallyunsuccessful because the general doctrine of follow the fortunes/settlements must yield to the express terms of the reinsurance agree-ment, requiring only that the cedent make the underlying payment in

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good faith and exercise ordinary prudence. [Bellefonte ReinsuranceCo. v. Aetna Cas. & Sur. Co., 903 F.2d 910, 913 (2d Cir. 1990); Am. Ins.Co. v. N. Am. Co. for Prop. & Cas. Ins., 697 F.2d 79, 80-81 (2d Cir. 1982);Commercial Union Ins. Co. v. Swiss Re Am. Corp., 2003 U.S. Dist.LEXIS 4974, at *32-48 (D. Mass. 2003)]. Even in the absence of a followthe settlements provision, many cedents argue that they are investedwith a zone of discretion to make loss payments in good faith;otherwise, public policies fostering settlements would be underminedinasmuch as the cedent might choose to litigate claims with itspolicyholder so as to avoid creating an unintended gap with itsreinsurance recovery.

Consider: Some reinsurance agreements include “cash call” provisions.Cash call clauses can provide for reinsurance payment to be madebefore, or at the same time, the ceding company makes a payment toits insured.

40.13 Consider Obligation to Reimburse Insurer for Declaratory JudgmentExpense. Declaratory judgment expenses are the expenses an insurancecompany incurs in seeking a judicial determination of its obligation toprovide insurance coverage to its policyholder and pay claims under aninsurance policy. These legal expenses can arise when either the insured orthe insurer initiates a lawsuit to determine whether a claim is covered.Ceding insurers often seek indemnity from their reinsurers for declaratoryjudgment expenses. A reinsurer’s obligation to reimburse its cedent fordeclaratory judgment depends on the wording of the reinsurance contract,often its definition of “allocated loss expenses” to be paid by the reinsurer.The most recent reported decisions evidence a trend toward allowingcedents to recover declaratory judgment expenses; importantly, however,the reinsurance contract wording controls in all circumstances, so counselmust evaluate the language of the particular reinsurance agreementcarefully.

Example — Declaratory Judgment Expenses Recoverable: Reinsurancecertificates providing for coverage of “expenses” incurred in the“investigation and settlement of claims or suits” was ambiguous; afterconsideration of evidence of custom and usage, the court found thatthe disputed language covered the declaratory judgment expensessought by the cedent [Fireman’s Fund Ins. Co. v. Gen. ReinsuranceCorp., 2005 U.S. Dist. LEXIS 43650, at *31-33 (N.D. Cal. 2005)].

Example — Declaratory Judgment Expenses Recoverable: There was “noquestion” that the allocated loss expense provision requiring payment

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for “all expenses incurred in the investigation and settlement of claimsor suits” included the declaratory judgment expenses incurred by areinsured attempting to avoid coverage for a claim [Employers Ins. Co.of Wausau v. Am. Reinsurance Co., 256 F. Supp. 2d 923, 925 (W.D. Wis.2003)]. A sentence in the provision stating that “allocated loss expensesshall not include expenses incurred by [the cedent] in regard to anyactual or alleged liability that is not within the circumscribed provi-sions of the policy reinsured” was an exclusion of expenses relating tothe cedent’s extracontractual or tortious (i.e., bad faith) conduct andwas not an exclusion of declaratory judgment expenses [id.].

Example — Declaratory Judgment Expenses Recoverable: A reinsuranceprovision requiring reimbursement of “claim expenses,” defined as“all payments under the supplementary payments provision of [theceding insurer’s] policy, including court costs, interest upon judg-ments, and allocated investigation, adjustment and legal expenses,”required payment of fees and expenses incurred in a declaratoryjudgment action [Employers Reinsurance Corp. v. Mid-Continent Cas.Co., 202 F. Supp. 2d 1221, 1235-36 (D. Kan. 2002), aff’d, 358 F.3d 757, 768(10th Cir. 2004)].

Example — Declaratory Judgment Expenses Recoverable: A facultativecertificate stating that “the Reinsurer shall pay its proportion ofexpenses (other than office expenses and payments to any salariedemployee) incurred by the [cedent] in the investigation and settlementof claims or suits” was ambiguous with respect to the payment ofdeclaratory judgment expenses, so evidence of industry standards andcustoms was reviewed to determine contractual intent [Affiliated FMIns. Co. v. Constitution Reinsurance Corp., 626 N.E.2d 878, 881-82(Mass. 1994). A jury reviewing evidence of reinsurance custom andpractice determined that a “common understanding” existed betweenthe parties requiring the reinsurer to indemnify the cedent for declara-tory judgment expenses [see Affiliated FM Ins. Co. v. ConstitutionReinsurance Corp., No. 89-2411 (Mass. Super. Ct. Sept. 24, 1998),reported in Mealey’s Litigation Reports: Reinsurance, Vol. 9, No. 10, at1].

Example — Declaratory Judgment Expenses Not Recoverable: Recoveryof declaratory judgment expenses was denied where the reinsurancecertificates included a clause stating: “[t]his Certificate of Reinsuranceis subject to the same risks, valuations, conditions, endorsement(except change of location), assignments and adjustments as are ormay be assumed, made or adopted by the reinsured, and loss, if any,

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hereunder is payable pro rata with the reinsured and at the same timeand place” [British Int’l Ins. Co. v. Seguros La Republica, S.A., 2001U.S. Dist. LEXIS 11453, at *2 (S.D.N.Y. 2001)]. On appeal, the courtrejected the reinsured’s argument that the certificates were ambiguouswith respect to recovery of declaratory judgment expenses because theword “expenses” did not appear anywhere in the certificates [BritishInt’l Ins. Co. v. Seguros La Republica, S.A., 342 F.3d 78, 82-83 (2d Cir.2003)].

� Cross References: For a discussion of the equitable and policyarguments advanced by cedents and reinsurers in disputes overreimbursement of declaratory judgment expenses, see Mitchell L.Lathrop, Insurance Coverage for Environmental Claims § 10.06[6]; EricMills Holmes, Appleman on Insurance 2d § 106.6.

40.14 Consider Obligation to Reimburse Insurer for Extra-Contractual Obli-gations and Excess of Policy Limits (“ECO/XPL”) Damages.

9 Bad Faith: As a general rule, reinsurers are required to indemnifyceding insurers only to the extent that the ceding insurer’s paymentsor losses are within the scope of the original policy’s terms [Am. Ins.Co. v. N. Am. Co. for Prop. & Cas. Ins., 697 F.2d 79, 81 (2d Cir. 1982)].A reinsurer will not be held liable for payments in excess of policylimits (“XPL”), that is, payment for what is sometimes called “third-party” bad faith, or for the extra-contractual obligations (“ECO”) of thecedent, that is, payment for “first-party” bad faith, unless the reinsur-ance contract is interpreted as covering that exposure [see Reliance Ins.Co. v. Gen. Reinsurance Corp., 506 F. Supp. 1042, 1050 (E.D. Pa. 1980)].There are differing opinions as to whether the reinsurance contractmust cover such exposures expressly in order for the reinsurer to beheld liable for them.

An exception to the general rule that arises on rare occasions is when thereinsurer actively participates in the defense or settlement of a claim underthe direct insurance policy. In those circumstances, a court may concludethat the reinsurer has acted as a “co-insurer” or joint venture, therebysubjecting itself to liability for losses in excess of the stated policy limits[see Peerless Ins. Co. v. Inland Mut. Ins. Co., 251 F.2d 696, 703-04 (4th Cir.1958); but see Employers Reinsurance Corp. v. Am. Fid. & Cas. Co., 196 F.Supp. 553, 560-61 (W.D. Mo. 1959)].

Cedents can secure XPL or ECO coverage by including clauses in theirreinsurance contracts that specifically address these obligations. Mostcedents request these provisions to address the risk that tort claims against

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their insureds will not be resolved within applicable policy limits follow-ing the cedent’s unreasonable failure to effect a settlement or that bad faithclaims will be directed at the cedent’s conduct in handling the insured’sclaim for coverage. Inclusion of XPL and ECO clauses removes theuncertainty as to whether such losses will be covered under the reinsur-ance contract.

An XPL clause specifically provides coverage for losses in excess of thepolicy limits in the insurance policy issued by the cedent to its policy-holder and typically appears in reinsurance treaties covering liabilitybusiness. An XPL clause covers payment by a cedent arising from ajudgment against its insured in excess of the reinsured’s policy limits, butotherwise covered, where the size of the judgment was affected by thecedent’s negligence, fraud or bad faith in handling the claim or in thesettlement or defense of the lawsuit against the insured. The reinsurancecontract usually limits the amount paid by a reinsurer on an XPL claim toan amount within the overall reinsurance limit. An XPL clause is notintended to cover amounts the cedent is found liable to pay directly to itsinsured as compensation or punitive damages due to its own misconductto its insured, rather than indirectly on account of its failure to resolve thepolicyholder’s liability to others. [See § 40.44 for an example of an XPLclause included in a reinsurance treaty.]

An ECO clause is similar to an XPL clause in that it covers the liability ofthe cedent due to mishandling or defense of claims but it focuses on thecedent-insurer’s obligation to act in good faith relative to its own insured.By definition, extra-contractual obligations incurred by the cedent are“extra” or outside the coverage provided by the policy. For example, ECOclauses can provide for indemnification of payments to an insured forpunitive damages and emotional distress caused by the cedent’s tortiousconduct or failing to treat the insured fairly and in good faith. [See § 40.43for an example of an ECO clause.] In addition, an ECO clause may bedrafted to cover a ceding insurer’s exposure when its insured is foundliable to a third party for punitive damages, though this may be moreprobably understood as an XPL exposure.

t Warning: In some states, public policy concerns preclude insuranceindemnification for punitive damages awards [see Home Ins. Co. v.Am. Home Prod. Corp., 550 N.E.2d 930, 932 (N.Y. 1990)]. A reinsurancecontract including an ECO clause covering liability for bad faithjudgments may be interpreted not to cover punitive damages in stateswhere insurance for punitive damages awards is prohibited. A rein-surer could assert that, because the state’s public policy prohibitsinsurance for punitive damages, reinsurance for punitive damage

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awards also should be prohibited. However, a federal district court inConnecticut refused to vacate an arbitration award directing a rein-surer to reimburse its cedent for punitive damages where the reinsur-ance contracts included ECO clauses, despite Connecticut’s publicpolicy against insurance for such awards. The court ruled that theConvention on the Recognition and Enforcement of Foreign ArbitralAwards, which governed the international arbitration, preemptedConnecticut law, that the Convention looked to the public policy of thecountry in which enforcement of the arbitral award is sought and thatthe United States does not have a public policy against contractualindemnification of punitive damages [Hartford Fire Ins. Co. v. Lloyd’sSyndicate, 1997 U.S. Dist. LEXIS 10858, at *14-18 (D. Conn. 1997)].Further, if a ceding insurer pays punitive damages in circumstanceswhere the legality of indemnification is unsettled, a reinsurer may beobligated to follow the fortunes of its cedent and provide reimburse-ment.

z Strategic Point: The specific language of ECO or XPL clauses canvary and make a significant difference in the coverage afforded. Partiesto the reinsurance agreement should draft these provisions carefully toensure appropriate coverage and to avoid disputes.

� Cross References: For discussions of circumstances under whichreinsurance potentially covers punitive damages, see Eric MillsHolmes, Appleman on Insurance 2d § 127.5; Mitchell L. Lathrop,Insurance Coverage for Environmental Claims, § 10.06[3].

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VI. CONSIDERING DUTY OF UTMOST GOOD FAITH OR UBERRIMAEFIDEI.

40.15 Consider Insurer’s Duty to Disclose to Reinsurer All Material FactsAbout Risk Being Reinsured. The law and practice of the reinsuranceindustry recognize that the relationship between parties to a reinsuranceagreement is characterized by “uberrimae fidei” or “utmost good faith,”which entails mutual trust and regard for the interest of the other party.Both parties to a reinsurance contract must treat each other with theutmost good faith in terms of disclosing all facts that are material to therisk reinsured and in conducting themselves in business dealings that mayaffect the other’s legal liability under the contract. Specifically, utmostgood faith means that the maxim caveat emptor does not apply to thereinsurance relationship [Barry R. Ostrager and Mary Kay Vyskocil,Modern Reinsurance Law and Practice (2d ed. 2000) § 3.01[a], citingBlack’s Law Dictionary 1520 (6th ed. 1990)].

The duty of utmost good faith arises from the recognition that thereinsurer does not perform all the actions that would be taken if it wasplacing original coverage, but has to rely on the cedent to do so. Areinsurer is not intimately involved in underwriting the ceded business orin handling claims subject to the reinsurance agreement; instead, thereinsurer is dependent upon and must be able to rely on the cedent toperform these functions. Although cases regarding the doctrine of utmostgood faith focus primarily on the cedent’s duties to the reinsurer,particularly in terms of affirmatively disclosing material facts about theceded business during the reinsurance placement process, it is a mutualobligation [Mich. Mut. Ins. Co. v. Unigard Sec. Ins. Co., 44 F.3d 826, 829 n.3(9th Cir. 1995); United Fire & Cas. Co. v. Arkwright Mut. Ins. Co., 53 F.Supp. 2d 632, 642 (S.D.N.Y. 1999)]. The facts and circumstances of thereinsurance relationship are important in determining the existence andscope of the duty.

The doctrine is most often referenced in terms of the cedent’s duty todisclose material facts about the risk that the reinsurer is reinsuring [A/SIvarans Rederei v. Puerto Rico Ports Auth., 617 F.2d 903, 905 (1st Cir.1980)]. A ceding company that conducts an investigation and is inpossession of all of the details relating to the risk must exercise the utmostgood faith in revealing all facts that materially affect the risk of which it isaware and of which the reinsurer has no reason to know [Christiania Gen.Ins. Corp. v. Great Am. Ins. Co., 979 F.2d 268, 278 (2d Cir. 1992)]. A cedentis required “to place the [reinsurance] underwriter in the same position ashimself [and] to give to him the same means and opportunity of judging

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the value of the risks” [Sun Mut. Ins. Co. v. Ocean Ins. Co., 107 U.S. 485,510 (1883)].

A fact will be deemed “material” if it “would have either prevented areinsurer from issuing a policy or prompted a reinsurer to issue it at ahigher premium” had it been disclosed before the reinsurance contractwas executed [Christiania Gen. Ins. Corp. v. Great Am. Ins. Co., 979 F.2d.at 279; In re Liquidation of Union Indem. Ins. Co. of N.Y., 674 N.E.2d 313,320 (N.Y. 1996)]. Disclosure is required, for example, “[w]here the rein-sured has offered extended coverage or an unusual term” [SumitomoMarine & Fire Ins. Co. v. Cologne Reinsurance Co., 552 N.E.2d 139, 143(N.Y. 1990)].

The following are additional types of information that have been found tobe material to the underwriting process:

• The premium rate, volume or sufficiency;

• Prior significant losses or legal actions against the insured;

• The underwriting agent’s role;

• The geographical spread of the underlying risks; and

• The type of business ceded.

The duty of utmost good faith also applies to the relationship between aretrocedent and its retrocessionaire [Compagnie de Reassurance D’Ile deFrance v. New England Reinsurance Corp., 57 F.3d 56, 66-70 (1st Cir.1995)].

Whether the reinsurance intermediary is an agent of the cedent or thereinsurer is a fact based inquiry. Under typical circumstances, the inter-mediary is the agent of the ceding company. Hence, a reinsuranceintermediary may be held to be the agent of the ceding company in termsof the representations made to the reinsurer during the reinsuranceplacement process [see Old Reliable Fire Ins. Co. v. Castle Reinsurance Co.,Ltd., 665 F.2d 239 (8th Cir. 1981); Calvert Fire Ins. Co. v. Unigard Mut. Ins.Co., 526 F. Supp. 623 (D. Neb. 1980)].

Example: The reinsurers’ defense of fraud in the inducement andavoidance of the reinsurance treaties was upheld where the cedinginsurer failed to disclose its insolvency [In re the Liquidation of UnionIndem. Ins. Co. of N.Y., 674 N.E.2d 313, 320 (N.Y. 1996)].

Example: Reinsurers were entitled to rescission of a reinsurancecontract where the cedent failed to disclose the existence of unimple-mented recommendations made as part of a survey report prepared in

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connection with the underwriting of an earlier insurance policy, andthe reinsurers had previously informed the cedent that they consid-ered compliance with the survey report recommendations to bematerial [Allendale Mut. Ins. Co. v. Excess Ins. Co., 992 F. Supp. 278,282-83 (S.D.N.Y. 1998)].

Example: Substantial evidence of material misrepresentations sup-ported a jury verdict where the cedent hid from its reinsurer thedangerous nature of the insured’s business, misstated the insured’sprevious loss record and did not reveal the nature of the underlyinginsurance [Sec. Mut. Cas. Co. v. Affiliated FM Ins. Co., 471 F.2d 238,241, 245-46 (8th Cir. 1972)].

Example: Where the ceding insurer had no reason to believe that itsreinsurer would consider the direct insured’s distribution of ATV’smaterial to the nature of the risk because the insurer itself did not viewit as such when the reinsurance contract incepted, the failure todisclose this information did not deprive the reinsurer of the sameopportunity the cedent had to assess the risk, and the reinsurer’smisrepresentation claim was properly dismissed [Christiania Gen. Ins.Corp. v. Great Am. Ins. Co., 979 F.2d 268, 280 (2d Cir. 1992)].

Examples: Some courts have found that reinsurers have a duty toinvestigate the reinsurance transaction, and a failure to do so mayprovide a defense to a claim for rescission based on an omission wherethe cedent lacked the intent to deceive. For example, in rejectingcertain claims of fraudulent inducement, the First Circuit Court ofAppeals stated: “[w]ithout first being asked by the other party, onewould not expect [the cedents] to volunteer a plethora of details ontheir proposed underwriting practices. Matters would have beendifferent had [the cedents] affirmatively misrepresented their intendedunderwriting practices or given incomplete, evasive or incorrectanswers to questions asked . . . .” [Compagnie De Reassurance D’llede France v. New England Reinsurance Corp., 57 F.3d 56, 80 (1st Cir.1995); see also Old Reliable Fire Ins. Co. v. Castle Reinsurance Co., Ltd.,665 F.2d 239, 244 (8th Cir. 1981); Unigard Sec. Ins. Co. v. Kansa Gen.Ins. Co., Ltd., 1992 U.S. Dist. LEXIS 20677, at *22 (W.D. Wash. Nov. 9,1992), aff’d 1994 U.S. App. LEXIS 35914 (9th Cir. 1994)].

Consider: In some states, the duty to disclose all material facts to thereinsurer is required by statute [see Cal. Ins. Code § 622].

Consider: It has been argued that a cedent’s duty to disclose informa-

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tion to its reinsurer is broader in treaty relationships as compared tofacultative relationships. Cedents must arguably be more detailed intheir disclosures because treaty reinsurers are unable to reject indi-vidual risks that fall within the class of risk covered by the treaty [seeBarry R. Ostrager and Mary Kay Vyskocil, Modern Reinsurance Lawand Practice § 3.03[a] (2d ed. 2000); Steven W. Thomas, Utmost GoodFaith in Reinsurance: A Tradition in Need of Adjustment, 41 Duke L.J. 1548,1571 (June 1992)].

� Cross References: For discussions of the doctrine of utmost goodfaith and cases considering its application, see Mitchell L. Lathrop,Insurance Coverage for Environmental Claims §§ 10.01[4], 10.05; EricMills Holmes, Appleman on Insurance 2d § 105.5.

40.16 Consider Application of Duty of Utmost Good Faith Beyond Disclosureat Inception of Reinsurance Relationship.

40.16[1] Application of Duty of Utmost Good Faith to Parties’ ConductDuring Life of Reinsurance Contract. The mutual duty of utmost goodfaith extends to the parties’ actions during the entire course of thereinsurance relationship. For example, the cedent’s duty to discloseall material facts is not just relevant in the contract formation stage ofthe reinsurance relationship: “[i]n fact, because the reinsurer placescomplete trust in the underwriting capability, claims-handling abilityand general integrity of the reinsured, the reinsured owes thereinsurer the highest duty of fair dealing and utmost good faiththroughout the reinsurance relationship” [New York Insurance Law§ 15.02 (Walcott B. Dunham, Jr., ed.).

40.16[2] Application of Duty of Utmost Good Faith to Underwriting andAdministration of Ongoing Business. The duty of utmost good faithrequires the cedent to act honestly and to follow all proper andbusinesslike steps in underwriting reinsured business and in settlingclaims [Am. Marine Ins. Group v. Neptunia Ins. Co., 775 F. Supp. 703,705 (S.D.N.Y. 1991)]. Moreover, a cedent’s failure to act in good faithin handling or resolving claims may excuse the reinsurer fromfollowing the fortunes or settlements of the cedent [for a discussionof the follow the fortunes doctrine and the reinsurer’s preclusionfrom second-guessing the reinsured’s good faith claims decisions, see§ 40.18 below]. Many courts considering what constitutes good faithin the context of a ceding insurer’s payment or settlement of claimshave concluded that negligence alone cannot establish bad faith [Am.Bankers Ins. v. Nw. Nat’l Ins., 198 F.3d 1332, 1336 (11th Cir. 1999);Unigard Sec. Ins. Co., Inc. v. N. River Ins. Co., 4 F.3d 1049, 1069 (2d

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Cir. 1993)]. Instead, the appropriate standard for bad faith in thesecircumstances is deliberate deception, gross negligence or reckless-ness [Unigard Sec. Ins. Co., Inc. v. N. River Ins. Co., 4 F.3d at 1069].

Example: A federal district court found that application of thefollow the settlements doctrine is subject to the requirement thatthe cedent conduct a reasonable, businesslike investigation beforepaying a claim. The cedent’s superficial investigation of claimsstemming from implantation of a heart valve, failure to obtaintechnical advice as to whether injury occurred during the policyperiod, and failure to secure a legal opinion as to the appropriatetrigger of coverage were grossly negligent and relieved thereinsurer of the duty to follow the settlements of the cedent [Suterv. Gen. Accident Ins. Co., 2006 U.S. Dist. LEXIS 48209, at *84-86(D.N.J. 2006)].

Example: The Third Circuit Court of Appeals reversed the DistrictCourt’s finding that a ceding insurer breached its duty of goodfaith by agreeing to participate in the Wellington Agreement,which established an orderly mechanism for the application ofinsurance policies to underling asbestos-related bodily injuryclaims, and by failing to schedule the underlying policies accord-ing to the Agreement in order to avoid paying defense costs. Theappellate court found that mere negligence could not support aviolation of the duty, that none of the cedent’s actions amountedto gross negligence or recklessness and that the reinsurer did notprove that it had suffered the requisite separate economic injury(apart from its obligation to make payment under the reinsurancecertificate) [N. River Ins. Co. v. CIGNA Reinsurance Co., 52 F.3d1194, 1212-17 (3d Cir. 1995)].

Example: An appellate court directed the trial court on remand toconsider whether a cedent violated its duty to act in good faith byfailing to disclose its increased use of intermediaries to produce“non-system” business that was ceded under the reinsurancetreaties and by abandoning plans set forth in the placing docu-ments to establish direct relationships with insurers [Compagniede Reassurance D’Ile de France v. New England ReinsuranceCorp., 57 F.3d 56, 79-82 (1st Cir. 1995)].

Example: Reinsurers sufficiently alleged claims for breach ofreinsurance contracts based on proven “irregularities” in thecedent’s underwriting [Int’l Ins. Co. v. Certain Underwriters at

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Lloyd’s London, 1991 U.S. Dist. LEXIS 12948, at * 18, 36 (N.D. Ill.1991)].

Example: An arbitration panel acknowledged that a cedent couldhave handled claims better but concluded that “the estimatedsavings that might have resulted from improved claims handlingwas relatively modest and well within the amount of slippagethat would be expected under industry standards for averageclaims handling of a large book of workers’ compensation claims”and ordered the reinsurer to pay the claims [Superior Nat’l Ins.Co. v. U.S. Life Ins. Co., No. 07-01458 (C.D. Cal. Feb. 18, 2007),reported in Mealey’s Litigation Reports: Reinsurance, Vol. 17, No.21 at 4].

Example: A federal District Court confirmed two arbitrationawards reducing the amount of reinsurers’ participations intreaties, where the cedent had made cessions to the treaties thatwere not of the type of business that it represented would beproduced [Mut. Fire, Marine & Inland Ins. Co. v. Norad Reinsur-ance Co., Ltd., 1988 U.S. Dist. LEXIS 6277, at *3-7 (E.D. Pa. June 28,1988)].

40.16[3] Application of Duty of Utmost Good Faith to Obligation to GiveNotice of Claim. Reinsurers rely on their cedents for the informationnecessary to properly assess risks. Therefore, the duty of utmost goodfaith applies to the obligation of cedents to notify reinsurers ofpotential claims where the reinsurance contract so requires [CertainUnderwriters at Lloyd’s London v. Home Ins. Co., 783 A.2d 238, 240(N.H. 2001)]. In most states, a cedent’s failure to provide promptnotice of a claim entitles the reinsurer to refuse to perform only if thereinsurer was prejudiced by the untimely notice or where the cedentacted in bad faith [Unigard Sec. Ins. Co., Inc. v. N. River Ins. Co., 4F.3d 1049, 1069 (2d Cir. 1993); Certain Underwriters at Lloyd’sLondon v. Home Ins. Co., 783 A.2d at 240-41; for a discussion of theceding insurer’s notice obligations and late notice as a defense topayment of reinsurance obligations, see § 40.09 above].

9 Bad Faith: Bad faith can be established by proof that thereinsured acted in a grossly negligent or reckless manner infailing to implement practices and controls to ensure proper andtimely notice of claims to the reinsurer [see Unigard Sec. Ins. Co.,Inc. v. N. River Ins. Co., 4 F.3d at 1069]. “[I]f a ceding insurer hasimplemented routine practices and controls to ensure notification

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to reinsurers but inadvertence causes a lapse, the insurer has notacted in bad faith. But if a ceding insurer does not implementsuch practices and controls, then it has willfully disregarded therisk to reinsurers and is guilty of gross negligence. A reinsurer,dependent on its ceding insurer for information, should be able toexpect at least this level of protection” [id. at 1069-70].

Example: A reinsurer was relieved of its obligation to indemnifyits reinsured where the reinsured failed to implement notificationpractices, procedures and controls, made no effort to determinewhat its duties were under the reinsurance agreement and failedto give timely notice of a significant claim in violation of theagreement’s claims control clause [Certain Underwriters atLloyd’s London v. Home Ins. Co., 783 A.2d at 240-42].

Example: A cedent’s untimely notice of loss to its facultativereinsurers did not amount to bad faith where it had established a“coordinated and coherent policy of dealing with [asbestos]claims,” and the failure to provide notice to the facultativereinsurers was merely negligent [Unigard Sec. Ins. Co., Inc. v. N.River Ins. Co., 4 F.3d at 1070].

40.16[4] Application of Duty of Utmost Good Faith to Reinsurer to PayUnder Reinsurance Agreement. Most of the cases dealing with thereinsurer’s duty of utmost good faith to its reinsured involveobligations to make payments under reinsurance agreements [Ark-wright Mut. Ins. Co. v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa.,1995 U.S. Dist. LEXIS 11, at *14-15 (S.D.N.Y. 1995); Commercial UnionIns. Co. v. Seven Provinces Ins. Co., 9 F. Supp. 2d 49, 69-70 (D. Mass.1998), aff’d, 217 F.3d 33 (1st Cir. 2000)]. “Utmost good faith . . .requires a reinsurer to indemnify its cedent for losses that are evenarguably within the scope of the coverage reinsured, and not torefuse to pay merely because there may be another reasonableinterpretation of the parties’ obligations under which the reinsurercould avoid payment” [United Fire & Cas. Co. v. Arkwright Mut. Ins.Co., 53 F. Supp. 2d 632, 642 (S.D.N.Y. 1999)].

Example: A reinsurer violated the duty of utmost good faith andunfair claims practices law by adopting a “moving target”strategy of seeking to achieve a commutation of all of itsobligations to the cedent by engaging in protracted delays inpayment of the cedent’s claim. Among other things, the reinsurerraised constantly shifting defenses and objections to payment and

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unreasonably questioned the cedent’s settlement allocation[Commercial Union Ins. Co. v. Seven Provinces Ins. Co., 9 F. Supp.2d at 64-65].

Example: A reinsurer may have acted in bad faith by exercising itscontractual right to determine the amount of incurred loss in amanner designed to evade the spirit of the reinsurance contractand deny the cedent the benefit of its bargain. Denial of thecedent’s bad faith claim was reversed, as the appellate courtfound that if the reinsurer’s selection of a particular method forcalculating the amount of incurred loss was specifically designedto trigger a contractual provision enabling the reinsurer to avoidits payment obligation it would have acted in bad faith [BJCHealth Sys. v. Columbia Cas. Co., 478 F.3d 908, 914-16 (8th Cir.2007)].

t Warning — Reinsurers: Reinsurers may violate the duty ofutmost good faith in other circumstances. In one case, a reinsurermay have breached an implied term of the reinsurance contractwhen its attorneys disclosed confidential information obtainedfrom the ceding insurer by filing it in a court file accessible to thepublic without first attempting to file it under seal. A federaldistrict court refused to dismiss the cedent’s claim for breach ofcontract, stating that it may be able to prove that the “customsand practices of the reinsurance industry include preservation ofconfidences” [Int’l Ins. Co. v. Certain Underwriters at Lloyd’sLondon, 1991 U.S. Dist. LEXIS 12911, at *5-12 (N.D. Ill. 1991)].

Consider: One reason for the reinsurer’s duty to exercise utmostgood faith in its relationship with a cedent is the permission toexamine the cedent’s records that is granted by the access torecords provision of the reinsurance contract. The reinsurer isoften granted intimate access to the inner workings of the cedentand accordingly has a higher duty to exercise good faith in itsdealings with the reinsured.

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VII. CONSIDERING FOLLOW THE FORTUNES/FOLLOW THESETTLEMENTS.

40.17 Understand Distinction Between Follow the Fortunes and Follow theSettlements. The duty of utmost good faith inherent in all reinsurancerelationships extends beyond contract placement and includes the claims-handling process [for a discussion of the duty of utmost good faith, see§§ 40.15 and 40.16 above]. The parties’ continued good faith is manifestedin the “follow the fortunes” and “follow the settlements” doctrines.“Follow the fortunes” and “follow the settlements” clauses have beeninterpreted to embody the principle that a reinsurer will indemnify itscedent for any losses arguably within the terms of the underlying policy,as long as the cedent has not acted in bad faith. The provisions operateprimarily for the benefit of cedents, allowing them some measure ofcertainty in calculating expected reinsurance recoveries and discouragingreinsurers from challenging a cedent’s coverage decisions and the amountof any settlement. If the follow the fortunes/settlements doctrine did notapply, there would be no reinsurance liability unless a claim was expresslycovered under the direct policy. If the ceding insurer settled a coveragedispute and the reinsurer denied liability, the coverage case likely wouldhave to be tried again.

Although many U.S. court decisions fail to distinguish between followingfortunes and following settlements [see, e.g., Nat’l Am. Ins. Co. of Cal. v.Certain Underwriters at Lloyd’s, London, 93 F.3d 529, 535 n.15 (9th Cir.1996); N. River Ins. Co. v. CIGNA Reinsurance Co., 52 F.3d 1194, 1199, 1205(3d Cir. 1995); Houston Cas. Co. v. Lexington Ins. Co., 2006 U.S. Dist.LEXIS 45027, at *9 n.8 (S.D. Tex. June 15, 2006)], there is a meaningfuldistinction between the two concepts. As one court explained: “[t]he’follow the fortunes’ doctrine requires reinsurers to accept a reinsured’sgood faith decision that a particular loss is covered by the terms of theunderlying policy, while the ’follow the settlements’ doctrine requiresreinsurers to abide by a reinsured’s good faith decision to settle, ratherthan litigate, claims on that policy” [Commercial Union Ins. Co. v. SevenProvinces Ins. Co., Ltd., 9 F. Supp. 2d 49, 66 (D. Mass. 1998)]. The phrasesare often used interchangeably, but “the term ’follow the fortunes’ moreaccurately describes the reinsurer’s obligation to follow the reinsured’sunderwriting fortunes, whereas ’follow the settlements’ refers to the dutyto follow the actions of the reinsured in adjusting and settling claims” [N.River Ins. Co. v. Employers Reinsurance Corp., 197 F. Supp. 2d 972, 978 n.1(S.D. Ohio 2002)].

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t Warning: Although U.S. practice and case law tends to conflatefollow the fortunes and follow the settlements clauses, counsel shouldnot expect that other jurisdictions do not draw sharper distinctionsbetween the two, especially English precedent which may governreinsurance contracts or inform the thinking or approach of reinsur-ance arbitrators.

The “follow the fortunes” doctrine requires the reinsurer to indemnify thecedent for all claims paid in good faith and reasonably within the coverageprovided under the direct policy. The “follow the fortunes” obligation isbroad, but a reinsurer’s liability is still limited to losses covered by thedirect policy and not excluded by the reinsurance agreement. “Follow thefortunes” clauses do not override or alter express coverage limits in areinsurance certificate, i.e., a follow the settlements provision does notrequire the reinsurer to indemnify for ex gratia payments.

Under the “follow the settlements” doctrine, a reinsurer will be obligatedto reimburse a cedent for a settlement or judgment paid by the cedent ingood faith. The purpose of the “follow the settlements” doctrine is toprevent the reinsurer from second guessing the settlement decisions of theceding company and from obtaining de novo review of judgments of thereinsured’s liability to its insured [N. River Ins. Co. v. CIGNA ReinsuranceCo., 52 F.3d 1194, 1199 (3d Cir. 1995); Aetna Cas. & Sur. Co. v. Home Ins.Co., 882 F. Supp. 1328, 1346 (S.D.N.Y. 1995)]. Absent exceptional circum-stances, the ceding insurer’s interpretation and application of its policy tothe underlying claim cannot be revisited by reinsurers or the courts.Ceding insurers that know their settlement decisions cannot be freelychallenged have more incentive to settle with their insureds and avoidcostly litigation.

Some courts have found that the duty to follow the fortunes or settlementsof a cedent can be implied in a reinsurance contract where a “follow thefortunes” or “follows the settlements” clause is not expressly included,based on the custom and practice of the reinsurance industry [see AetnaCas. & Sur. Co. v. Home Ins. Co., 882 F. Supp. 1328, 1349 (S.D.N.Y. 1995);Int’l Surplus Lines Ins. Co. v. Certain Underwriters at Lloyd’s, London,868 F. Supp. 917, 920 (S.D. Ohio 1994)]. Other courts, however, haverefused to imply such a duty [see Am. Ins. Co. v. Am. Re-Insurance Co.,2006 U.S. Dist. LEXIS 95801, at *16-17 (N.D. Cal. 2006); N. River Ins. Co. v.Employers Reinsurance Corp., 197 F. Supp. 2d 972, 986 (S.D. Ohio 2002)(applying New Jersey law); cf. Affiliated F.M. Ins. Co. v. EmployersReinsurance Corp., 369 F. Supp. 2d 217, 227 (D.R.I. 2005)]. This issue hasbeen hotly contested in recent litigation [see Am. Motorists Ins. Co. v. Am.Re-Insurance Co., 2007 U.S. Dist. LEXIS 41257 (N.D. Cal. 2007) (where

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cedent failed to produce evidence to support its claim that custom andpractice in the reinsurance industry dictates that “follow the settlements”is implied in a reinsurance contract even absent an express provision tothat effect, “follow the settlements” provision cannot be read into acertificate of facultative reinsurance contract as a matter of law)].Follow the fortunes and settlement obligations also apply to a retroces-sionaire in its agreements with a retrocedent [Am. Bankers Ins. Co. of Fla.v. Nw. Nat’l Ins. Co., 198 F.3d 1332 (11th Cir. 1999)].Disputes frequently arise regarding the scope of the obligations of areinsurer who has agreed to “follow the fortunes” or “follow the settle-ments” of a cedent. Although most disputes are resolved in reinsurancearbitrations, where the opinions are typically confidential, several courtshave published decisions considering this issue. [For examples of deci-sions involving reinsurer’s obligations under “follow the fortunes” or“follow the settlement” provisions, see §§ 40.18 and 40.19 below].

Distinguish: Many facultative certificates include a “follow the form”provision, under which the reinsurer agrees to indemnify the cedent asif the reinsurance certificate adopted or incorporated the terms andconditions of the reinsured policy [for a discussion of “follow theform” clauses, see § 40.12 above]. “Follow the fortunes” and “followthe settlements” clauses help define the scope of the reinsurer’sindemnification obligation in terms of a specific loss, while a “followthe form” provision confirms that the reinsurer’s undertaking is instep with that of the cedent. As one court explained:

“Following form simply obliges the reinsurer to indemnify the cedingcompany fully within the scope of the reinsured risk when the claim fallswithin the scope of that risk as a matter of law (subject to exclusionsexplicitly delineated within the certificate of reinsurance); the follow thefortunes/settlements doctrine vests in the ceding company the right todecide what the scope of coverage actually is when the cedent’s policy issubject to more than one reasonable interpretation, and to make adjust-ments and settlements in conformity with its interpretation” [Aetna Cas.& Sur. Co. v. Home Ins. Co., 882 F. Supp. 1328, 1349 (S.D.N.Y. 1995)].

� Cross References: For discussions of the “follow the fortunes” and“follow the settlements” doctrines and examples of typical clauses thatembody these principles in reinsurance agreements, see Eric MillsHolmes, Appleman on Insurance 2d §§ 106.2 and 102.5[D]; BusinessInsurance Law and Practice Guide § 14.08[5]].

40.18 Consider Reinsurer’s Preclusion from Second-Guessing Reinsured’sGood Faith Claims Decisions. The “follow the fortunes” and “follow the

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settlements” doctrines preclude reinsurers from challenging cedents’payments of claims and settlements that are reasonable and made in goodfaith.

9 Bad Faith: The burden of demonstrating bad faith is high. Thereinsurer must show that the cedent acted with gross negligence,recklessness or evident bad faith or demonstrate that the payment orsettlement was not even arguably within the scope of the reinsurancecoverage [Am. Bankers Ins. Co. of Fla. v. Nw. Nat’l Ins. Co., 198 F.3d1332, 1335-36 (11th Cir. 1999); Mentor Ins. Co. (U.K.) v. NorgesBrannkasse, 996 F.2d 506, 517 (2d Cir. 1993)]. Some courts havedetermined that the duty to act in good faith obligates cedents to be“honest and businesslike” in the claims settlement process [Am.Marine Ins. Group v. Neptunia Ins. Co., 775 F. Supp. 703, 709 (S.D.N.Y.1991), aff’d, 961 F.2d 372 (2d Cir. 1992); Aetna Cas. & Sur. Co. v. HomeIns. Co., 882 F. Supp. 1328, 1347 (S.D.N.Y. 1995)]. It is difficult forreinsurers to avoid following cedents’ fortunes or settlements byproving their decisions were not made in good faith. Courts andarbitrators typically require some element of intentional misconductrather than inadvertent error.

Example: A reinsurer was found not liable to its reinsured for paymentof its share of a settled claim, even though the reinsurance agreementcontained a “follow the settlements” clause. The court concluded thatthe settled claims were not even arguably covered by the underlyingpolicies and that the cedent had not conducted a reasonable, business-like investigation before paying the claims [Karen L. Suter v. Gen.Accident Ins. Co. of Am., 2006 U.S. Dist. LEXIS 48209, at *82, 84-86(D.N.J. 2006)].

Example: The Court of Appeals for the Eleventh Circuit found that areinsurer was obligated to follow the fortunes of a ceding insurer thatmade a good faith determination of coverage based on existing law,regardless of whether its decision was ultimately correct [Am. BankersIns. Co. of Fla. v. Nw. Nat’l Ins. Co., 198 F.3d 1332, 1336-37 (11th Cir.1999)]. Because there was legitimate debate at the time of paymentabout whether a large group of similar claims constituted a singleoccurrence, the ceding insurer’s decision to pay those claims on anaggregate basis was not grossly negligent or reckless [id.].

Consider: Although courts have recognized limits on the scope of the“follow the fortunes” and “follow the settlements” doctrines, thereinsurance industry largely measure their mutual relationships as if a

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particular contract included a broad follow the settlements clause.Most arbitration panels, heeding provisions in reinsurance contractsdirecting them to consider reinsurance agreements as “honorableengagements,” and not merely legal obligations, uphold these prin-ciples in reinsurance payment disputes. [For a discussion of honorableengagement language in reinsurance contracts, see § 40.24 below].

40.19 Consider Application of Follow the Fortunes/Follow the Settlements toAllocation Decisions. One of the more common issues in reinsurancecoverage disputes is the extent to which the follow the fortunes/settlements doctrine requires reinsurers to follow the cedent’s allocationand aggregation decisions in the case of settlements of its direct insuranceobligations, viz., the allocation of loss to particular policy years and theaggregation of losses to satisfy minimum per-occurrence retentions or todisaggregate losses to multiply the available reinsurance policy limits.Allocation issues typically arise when insureds seek coverage for injuriesto multiple parties or multiple properties under several policies spanningmany years and the case is settled without a judicial determination as tohow the losses should be allocated to particular policies. Cedents mustdetermine how to allocate these losses among their underlying policies,which allocation in turn affects their reinsurers. This tension has arisenlargely in the context of asbestos, product liability and environmentalcoverage cases. Reinsurers have often challenged cedents’ allocationdecisions on the grounds they were incorrect or made only to maximizereinsurance recovery. Many courts have held that the follow the fortunes/settlements doctrine applies to preclude reinsurers from avoiding liability,where the allocation decisions are made reasonably and in good faith aspart of the settlement with the insured. In addition, some courts haveregularly found that the “follow the settlements” doctrine extends to acedent’s post-settlement allocation decisions, even if there is an inconsis-tency between the cedent’s allocation and its pre-settlement assessment ofrisk as long as the allocation was made in good faith and was reasonable[Travelers Cas. & Sur. Co. v. Gerling Global Reinsurance Corp. of Am., 419F.3d 181, 188-91 (2d Cir. 2005); N. River Ins. Co. v. ACE Am. ReinsuranceCo., 361 F.3d 134, 140-41 (2d Cir. 2004)].

Reinsurers will still be relieved from following cedents’ settlements if theallocation at the direct insurance level is trumped by the specific terms ofthe reinsurance contracts.

Example: A facultative reinsurer was bound to pay its share of thedirect insurer’s settlement of certain products liability claims underthe certificate’s “follow the fortunes” clause. The court interpreted the

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“follow the fortunes” clause as having the same effect in the settlementcontext as would a “follow the settlements” clause. The court deter-mined that the cedent’s allocation of the settled claims to the reinsuredpolicy was “at least arguably correct, and therefore . . . could not havebeen unreasonable” [Nat’l Union Fire Ins. Co. v. Am. Re-Insurance Co.,441 F. Supp. 2d 646, 652 (S.D.N.Y. 2006)]. The court stated that thereinsurer’s challenges to the ceding company’s allocation decisionsinvite “exactly the type of inquiry [by the reinsurer and the court] thatthe follow-the-fortunes doctrine is intended to prevent,” and thatpermitting reinsurers to “second guess [the propriety of the cedent’sallocation] ’would . . .make settlement impossible and reinsurance initself problematic”’ [id., citing Travelers Cas. & Sur. Co. v. GerlingGlobal Reinsurance Corp., 419 F.3d 181, 189 (2d Cir. 2005)].

Example: The Second Circuit Court of Appeals held that “a cedent’spost-settlement allocation must be deferred to under a follow-the-fortunes clause, regardless of any pre-settlement position taken by thecedent, whether that position is articulated in a pre-settlement riskanalysis or is implicit in the settlement with the underlying insured”[Travelers Cas. & Sur. Co. v. Gerling Global Reinsurance Corp. ofAmerica, 419 F.3d 181, 188 (2d Cir. 2005)]. Granting summary judg-ment to the cedent on its claim for reinsurance payment, the courtexplained that a reinsurer seeking to avoid application of follow thefortunes must make an “extraordinary showing of a disingenuous ordishonest failure” [id. at 191] and that “a cedent choosing amongseveral reasonable allocation possibilities is surely not required tochoose the allocation that minimizes its reinsurance recovery to avoida finding of bad faith” [id. at 193].

Example: A reinsurer disputed its cedent’s allocation of non-productsasbestos claims that differed from its pre-settlement analysis. TheSecond Circuit Court of Appeals upheld the allocation, ruling that the“follow the settlements” doctrine obligated the reinsurer to indemnifythe cedent for its share of the settlement as allocated by the cedent,regardless of whether there was an inconsistency between the alloca-tion and the reinsured’s pre-settlement assessment of risk, as long asthe allocation met the typical “follow the settlements” requirements,i.e., was in good faith, reasonable and within the applicable policies [N.River Ins. Co. v. Ace Am. Reinsurance Co., 361 F.3d 134, 141 (2d Cir.2004)]. The court explained that “[r]equiring post-settlement allocationto match pre-settlement analyses would permit a reinsurer, andrequire the courts, to intensely scrutinize the specific factual informa-tion informing settlement negotiations and would undermine the

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certainty that the general application of the doctrine to settlementdecisions creates” [id.].

Example: The New York Court of Appeals rejected a cedent’s argumentthat “follow the fortunes” clauses in reinsurance treaties permitted itto recover under a single occurrence theory, where the language of thetreaties did not support such allocation [Travelers Cas. and Sur. Co. v.Certain Underwriters at Lloyd’s of London, 760 N.E.2d 319, 327-29(N.Y. 2001)]. The court determined that the treaties’ definition of“disaster and/or casualty” as “resulting from a series of accidents,occurrences and/or causative incidents” incorporated spatial bound-aries and precluded aggregation of environmental losses that occurredat various sites across the country [id. at 326-27]. The court emphasizedthat the “follow the fortunes” clause could not override the specificlanguage of the reinsurance contracts [id. at 328].

Example: A federal district court denied a cedent’s motion for sum-mary judgment on its claim for indemnity from its reinsurer premisedon a “follow the settlements” provision in facultative certificates,where there were facts that could support the inference that thecedent’s conduct in allocating environmental liability to only one sitewas grossly negligent or reckless. The cedent’s classification of thesettlement as a single occurrence, where there were claims from over50 different sites, may have been motivated by its desire to maximizereinsurance recovery and was done without following the customarypractice of consulting an environmental expert [Hartford Accident &Indem. Co. v. Columbia Cas. Co., 98 F. Supp. 2d 251, 258-60 (D. Conn.2000)].

Example: The Appellate Division of the New York Supreme Courtreversed the trial court’s grant of summary judgment to the cedent,which was premised on the “follow the fortunes” doctrine. During aninsurance coverage dispute, the cedent took the position with itsinsured that damage allegedly sustained due to environmental pollu-tion at various sites constituted multiple occurrences at each indi-vidual site. In a trial of one site at issue, the court found that one of theindividual sites constituted seven occurrences. In the subsequentsettlement of 16 additional sites, the cedent took the position that therewere 95 occurrences in all; however, when it came time to cede itslosses under facultative reinsurance agreements, the cedent took theposition that each site constituted a single occurrence. Had the cedentbilled the losses based on the same number of occurrences determinedin the underlying coverage action, there would have been no reinsur-

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ance recovery because no single occurrence would have breached thereinsurance retention. The trial court granted the cedent summaryjudgment regardless of the inconsistency between the pre and postsettlement allocation positions declaring that to do otherwise wouldrequire it to engage in an “intrusive factual inquiry” into the cedent’ssettlement process. The Appellate Division reversed this decisionfinding that “[a] reinsurer is not bound by the follow-the-fortunesdoctrine where the reinsured’s settlement allocation, at odds with itsallocation of the loss with its insured, designed to minimize its loss,reflects an effort to maximize unreasonably the amount of collectiblereinsurance.” Allstate Ins. Co. v. Am. Home Assurance Co., N.Y. SlipOp. 05170 (N.Y. App. Div., 1st Dept., June 12, 2007).

Consider: Most allocation disputes are decided in arbitration, ratherthan litigation, and it is uncertain whether or to what extent courtdecisions on this issue are truly representative of industry practice orwill be followed and applied in the arbitral arena.

z Strategic Point — Cedents: The following factors may influence whatallocation position a cedent should take in seeking indemnificationfrom reinsurers:

1. Whether the positions taken by the cedent when negotiating orlitigating with the insured are consistent with positions ad-vanced by the company in the past;

2. Whether an underlying allocation is consistent with applicablestate law;

3. If there is an environmental cession, whether the liability hasbeen apportioned to the various underlying sites in proportionto estimates developed by environmental consultants withrespect to damages attributable to the individual sites;

4. Whether there are annualization of limits issues;

5. Whether more than a single occurrence limit has been paid tothe insured to settle the liability;

6. Whether the settlement is a policy buy-back, and if so whetherany of the settlement amount should be allocated to knownand/or unknown future claims (or to bad faith).

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VIII. CONSIDERING BROKERED MARKET.

40.20 Brokered vs. Direct Market. Reinsurance companies are generallyknown as either direct markets or brokered markets, depending onwhether the reinsurers deal directly with their cedents or deal with themthrough an intermediary. Direct markets operate through salaried employ-ees of ceding insurers and reinsurers who negotiate and bind reinsurancecontracts. In brokered markets, reinsurers assume business by dealingwith brokers or intermediaries. Whether the intermediary is the agent ofthe cedent or the reinsurer or is a dual agent is determined by anapplication of the facts to standard agency principles. Under typical factpatterns, although the intermediary commission is generally paid by thereinsurer, the intermediary is held to be the agent of the cedent [In rePritchard & Baird, Inc., 8 B.R. 265 (D.N.J. 1980)].

Reinsurance brokers perform many of the same functions as brokers in thedirect insurance market. Reinsurance brokers try to secure the mostadvantageous terms for ceding insurers from the reinsurance marketplace.A reinsurance broker or intermediary also may perform administrativefunctions during the operation of the reinsurance agreement. Reinsuranceintermediaries often serve as a conduits for communications betweencedents and reinsurers, transmit payments, collect sums due, settle lossesand prepare periodic statements of account. Reinsurance brokers mayhave functions akin to claim handlers in the gathering of information,conveyance of attorney advice and the like concerning the submission ofclaims for indemnification. Additional responsibilities may include draft-ing reinsurance contract wording and creating complex reinsuranceprograms tailored to the ceding insurer’s specific needs.

z Strategic Point — Cedent: Although a reinsurance intermediary’sduties may be limited by specific instructions from the ceding insurer,it is generally required to fulfill its client’s reinsurance needs withreasonable care. For example, there is case law which suggests that areinsurance broker has a duty to determine whether the reinsurancecompany the broker is recommending is financially solvent [MasterPlumbers Ltd. Mut. Liab. Co. v. Cormany & Bird, Inc., 255 N.W.2d 533,535-36 (Wis. 1977)]. This requirement exists as of the time the brokerissues the policy [see Cherokee Ins. Co. v. E.W. Blanch Co., 66 F.3d 117,123 (6th Cir. 1995)]. In analyzing potential liability, courts have statedthat the broker must conduct a diligent inquiry that is consistent withindustry standards [id.]. In addition, many states have enacted statu-tory schemes similar to the National Association of Insurance Com-missioners (NAIC) Reinsurance Intermediary Model Act (“NAIC

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Model Act”), requiring special licensing for reinsurance intermediaries[see Cal. Ins. Code §§ 1781.1 to 1781.13; 215 Ill. Comp. Stat. 100/1 to100/60; N.Y. Ins. Law § 2100 et seq.]. The NAIC Model Act is repub-lished in full at Eric Mills Holmes, Appleman on Insurance 2d § 104.3.In New York, regulations require intermediaries to inquire into thefinancial status of unauthorized reinsurers, disclose any findings to thecedent and provide a copy of the reinsurer’s most recent financialstatement [N.Y. Comp. Codes R. & Regs. tit. 11, § 32.1(c); for adiscussion of the regulation of reinsurance intermediaries in NewYork, see New York Insurance Law § 15.04[3] (Walcott B. Dunham, Jr.,ed.)].

z Strategic Point — Cedents: A broker also can be liable for breach of anobligation to procure reinsurance for an insurer [see Nw. Nat’l Ins. Co.v. Marsh & McLennan, 817 F. Supp. 1424, 1430-34 (E.D. Wis. 1993)].Similarly, a reinsurance intermediary may be liable for failure toinform the cedent that reinsurance coverage was not obtained in full orin part or is inferior to that which was expected [see CommonwealthIns. Co. v. Thomas A. Greene & Co., Inc., 709 F. Supp. 86, 88 (S.D.N.Y.1989); La. Home Builders Ass’n Self-Insurers’ Fund v. Adjustco, Inc.,633 So. 2d 630, 635-36 (La. Ct. App. 1993)].

� Cross Reference: For a discussion of direct and brokered reinsurancemarkets, see California Insurance Law & Practice § 11.01.

40.21 Understand Which Entity Broker Represents. The issue often arises asto whose agent the reinsurance broker or intermediary is with respect toa specific transaction. The general rule is that the broker or intermediaryis the agent of the ceding company, unless there are facts demonstratingotherwise [Houston Cas. Co. v. Certain Underwriters at Lloyd’s London,51 F. Supp. 2d 789, 799-800 (S.D. Tex. 1999); Banco Ficohsa v. AseguradoraHondurena, S.A., 937 So. 2d 161, 165 (Fla. Dist. Ct. App. 2006)]. Underapplicable state law principles of agency law, the specific conduct andrelationship of the parties determines the nature and extent of agencystatus, and the most critical factor is control [St. Paul Fire and Marine Ins.Co. v. Eliahu Ins. Co., 1997 U.S. Dist. LEXIS 8916, at *18-19 (S.D.N.Y. 1997)].Where the broker or intermediary is found to be an agent of the cedent, thecedent may be responsible for the agent’s actions, including misrepresen-tations [see Houston Cas. Co. v. Certain Underwriters at Lloyd’s London,51 F. Supp. 2d 789, 802-05 (S.D. Tex. 1999); Reliance Ins. Co. v. CertainMember Companies, 886 F. Supp. 1147, 1152-55 (S.D.N.Y. 1995); CalvertFire Ins. Co. v. Unigard Mut. Ins. Co., 526 F. Supp. 623, 638-39 (D. Neb.1980)].

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It is also possible for a reinsurance intermediary to be a dual agent [seeCapitol Indem. Corp. v. Smith Intermediaries, Inc. 593 N.E.2d 872, 876 (Ill.App. Ct. 1992); Paul M. Hummer, Reinsurance Intermediaries: When Are TheyLiable and To Whom?, Mealey’s Litigation Reports § Commentary; Vol. 7,No. 10 (Sept. 25, 1996)].

Example: A reinsurance broker or intermediary may serve as the agentfor the reinsurer in order to receive or transmit money. In that case,payment of a premium to the ceding insurer’s agent is likely toconstitute a valid premium payment on the reinsurance contract,whether or not the reinsurer knows of the payment [see Arkwright-Boston Mfrs. Mut. Ins. Co. v. Calvert Fire Ins. Co., 887 F.2d 437, 440 (2dCir. 1989)].

That an intermediary functions as an agent for one party for part of thetransaction, and the other party for a different part, does not mean that theintermediary is the agent of both for all purposes.

Most reinsurance agreements include an intermediary clause that setsforth the intermediary’s role in communications and its agency status interms of receiving monies due between the parties. In most jurisdictions,a reinsurer will receive statutory credit for reinsurance only if thereinsurance agreement provides for the reinsurer to assume the credit riskof the intermediary (i.e., the reinsurer is not permitted to refuse to performsimply because the intermediary failed to transmit premium paymentsfrom the cedent). Therefore, reinsurance agreements involving intermedi-aries include an intermediary clause providing that the intermediary actsas the agent of the reinsurer, and not as the agent of the cedent, withrespect to transmission of payments. [For a sample intermediary clausetransferring the credit risk to the reinsurer, see § 40.44 below.]

On rare occasions, a non-signatory to the arbitration agreement such as areinsurance intermediary may become a party to a reinsurance arbitration.[For a discussion of the inclusion of non-signatories in reinsurancearbitrations, see § 40.22 below.] There are conflicting decisions on whetherpre-hearing discovery can be compelled from an intermediary that is nota party to a reinsurance arbitration, especially whether pre-hearingdeposition examination is available. [For a discussion of discovery inreinsurance arbitrations, see § 40.25 below.]

Example: Court found that there was no agency relationship betweena broker and a ceding insurer where the broker was not acting with theknowledge and consent or under the control of the ceding insurer [St.Paul Fire and Marine Ins. Co. v. Eliahu Ins. Co., 1997 U.S. Dist. LEXIS8916, at *14 (S.D.N.Y. 997)]. The court stated “[a]lthough in most cases

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the primary insurer is the principal and the reinsurance broker itsagent, the cases do not establish this relationship as a matter of law”[id. at *5].

Example: An employee of the cedent who erroneously ceded a risk toa treaty was acting as an agent of the ceding company and not of thereinsurers. The fact that the reinsurers knew of and were satisfied withhis underwriting did not establish the element of control necessary tothe agency relationship [Aetna v. Glens Falls, 453 F.2d 687, 690-91 (5thCir. 1972)].

Example: A reinsurance treaty was rescinded because of misrepresen-tations by the intermediary, who was found to have been acting as theagent of the cedent [Calvert Fire Ins. Co. v. Unigard Mut. Ins. Co., 526F. Supp. 623, 633 (D. Neb. 1980)].

Example: A reinsurance broker was the ceding insurer’s agent, and itsmisrepresentation of the underlying policy’s terms was made withinthe scope of its actual authority and voided the reinsurance policy[Houston Cas. Co. v. Certain Underwriters at Lloyd’s London, 51 F.Supp. 2d 789, 799-805 (S.D. Tex. 1999)].

Example: The insurer entered into a general agency agreement with acompany which was also “an intermediary with Lloyd’s” [BrougherAgency, Inc. v. United Home Life Ins. Co., 622 N.E.2d 1013, 1015 (Ind.Ct. App. 1993)]. This agent negotiated the purchase of reinsurancefrom Underwriters at Lloyd’s, London. In a reinsurance coveragedispute between the insurer and the Lloyd’s Underwriters, the insurerargued that the underwriters were bound by the agent’s statementsabout coverage during the placement process. An arbitration panelrejected this claim, determining that the agent had only “ministerial”authority relating to the reinsurance and no binding authority onbehalf of Lloyd’s Underwriters. Because the agent was not authorizedto act as the agent for Lloyd’s Underwriters, they could not be liablefor any alleged fraud by the intermediary [id. at 1016-17].

� Cross Reference: For a discussion of cases considering the agencystatus of reinsurance brokers and intermediaries, see Bertram Harnett,Responsibilities of Insurance Agents and Brokers § 2.10[7].

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IX. CONSIDERING REINSURANCE ARBITRATION.

40.22 Consider Obligation to Arbitrate. Most reinsurance treaties include aclause providing for resolution of disputes through arbitration, and U.S.courts strongly favor the enforcement of arbitration provisions. Even inthe absence of an arbitration provision, the parties to a reinsurancecontract may agree after the fact to arbitrate a particular dispute. Oneadvantage of arbitration is that it enables parties to a reinsuranceagreement to have their disputes adjudicated by a tribunal that isknowledgeable about the reinsurance industry; arbitrators may also befree to eschew fidelity to strict rules of law pursuant to “honorableengagement” clauses.

The Federal Arbitration Act (“FAA”) [9 U.S.C. §§ 1 et seq.], which appliesto arbitrations arising from transactions that affect interstate or interna-tional commerce, is the primary source of arbitration law in the U.S. and“enunciates a liberal policy in favor of arbitration” [Argonaut Ins. Co. v.Travelers Ins. Co., 744 N.Y.S.2d 24, 25 (N.Y. App. Div. 2002); see alsoProgressive Cas. Ins. Co. v. C.A. Reaseguradora Nacional de Venez., 991F.2d 42, 45 (2d Cir. 1993)]. The FAA includes provisions concerning thefollowing: compelling a party to arbitrate; staying litigation pendingarbitration; appointing an arbitrator if the agreement does not so provide;submitting motions before courts; subpoenaing arbitration witnesses; andlisting grounds and procedures for confirmation, vacatur, and modifica-tion of arbitral awards [9 U.S.C. §§ 3-16].

Another body of law governing and favoring commercial arbitration inthe U.S. is the Convention on the Recognition and Enforcement of ForeignArbitral Awards (the “New York Convention”) [9 U.S.C. §§ 201-208],which applies to arbitrations arising from commercial transactions whereat least one party is not a U.S. citizen or where the arbitration has some“reasonable relation with one or more foreign states,” even if all parties areU.S. citizens [9 U.S.C. § 202]. State arbitration statutes, many of which aremodeled after the Uniform Arbitration Act, generally apply to disputesthat do not affect interstate or international commerce.

When one party tries to avoid arbitrating a dispute, the other party mayfile a motion to compel arbitration (which is in its nature a request forspecific performance of the arbitration clause). Whether a claim is arbi-trable is a legal question for a court to decide, unless there is “clear andunmistakable” evidence that the parties have agreed to arbitrate arbitra-bility [First Options of Chi., Inc. v. Kaplan, 514 U.S. 938, 944(1995), citingAT&T Techs., Inc. v. Communications Workers of Am., 475 U.S. 643, 649(1986); see also Contec Corp. v. Remote Solution Co., 398 F.3d 205, 208 (2d

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Cir. 2005) (citation omitted)]. Although arbitration is favored by the courts,it will not be ordered unless the parties have agreed to arbitrate theirdispute [Ace Capital Re: Overseas Ltd v. Central United Life Ins. Co., 307F.3d 24, 29 (2d Cir. 2002)]. There must be “clear and unmistakable”evidence of an agreement to arbitrate [First Options of Chi., Inc. v. Kaplan,514 U.S. 938, 947 (1995)], although most courts seem, as a practical matter,to rule in favor of arbitrability or to remand the question of arbitrability toarbitrators — either way referring a particular matter to arbitration. Inaddition, the duty to arbitrate is limited by “the scope of the particulararbitration clause to which the parties have agreed,” so certain types ofdisputes, such as tortious interference or bad faith, might be found to beoutside the scope of an arbitration clause governing contractual perfor-mance [Argonaut Ins. Co. v. Travelers Ins. Co., 744 N.Y.S.2d 24, 25 (N.Y.App. Div. 2002)].

The arbitration clause in a reinsurance contract typically sets forth thefollowing: the types of disputes subject to arbitration; the initiation of thearbitration process; the process of selecting the arbitration panel and thequalifications of arbitrators; the place and time of the arbitration hearing;the governing law; the procedures and timeframes to be followed in thearbitral process; and enforcement of the arbitration award. Arbitrationscan be conducted under many different rules and in various fora. Somereinsurance arbitrations are conducted pursuant to procedures set forth bythe following organizations:

• The American Arbitration Organization;

• The International Chamber of Commerce;

• The Reinsurance Association of America;

• ARIAS-U.S.;

• The Insurance and Reinsurance Dispute Resolution Task Force; and

• The International Institute for Conflict Prevention and Resolution.

The presumption favoring arbitrability of a particular dispute is strength-ened when the language in the arbitration clause defining arbitrabledisputes is “broad” [Leadertex, Inc. v. Morganton Dyeing & FinishingCorp., 67 F.3d 20, 27 (2d Cir. 1995)]. The following are examples oflanguage included in arbitration clauses that have been viewed as broadand encompassing a variety of disputes beyond interpretation of thecontract:

• Any dispute, controversy or claim arising in connection with theperformance or breach of the agreement;

• Any controversy, claim or dispute between the parties arising out

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of or relating in any way to the agreement;

• Any dispute arising from the making, performance or terminationof the contract;

• All claims and disputes of whatever nature arising under thecontract; and

• Any dispute between the parties to the agreement over the terms ofthe agreement or any claim of breach by either of the parties.

� Cross Reference: For an example of a broad arbitration clause in areinsurance agreement, see § 40.45 below.

In contrast, included below are examples of language in arbitrationclauses that have been viewed as narrow, limiting arbitration to particulartypes of disputes:

• All disputes or differences arising out of the interpretation of theagreement;

• Any matter involving the interpretation or application of theagreement;

• An irreconcilable difference of opinion as to the interpretation ofthe contract.

Parties are free to limit by agreement the claims they wish to arbitrate,requiring the “federal policy favoring arbitration [to] yield” to the parties’agreement [Hartford Accident and Indem. Co. v. Swiss Reinsurance Am.Corp., 246 F.3d 219, 223 (2d Cir. 2001) (citation omitted); see also AceCapital Re: Overseas Ltd v. Central United Life Ins. Co., 307 F.3d 24, 29 (2dCir. 2002)].

In determining whether a particular dispute is arbitrable, courts typicallyengage in a two-part inquiry: whether there is an agreement to arbitrateand, if so, whether the scope of the agreement encompasses the assertedclaims [Hartford Accident and Indem. Co. v. Swiss Reinsurance AmericaCorp., 246 F.3d 219, 226 (2d Cir. 2001) (citation omitted)]. “[A]ny doubtsconcerning the scope of arbitrable issues should be resolved in favor ofarbitration” [Moses H. Cone Mem’l Hosp. v. Mercury Constr. Corp., 460U.S. 1, 24-25 (1983)]. Therefore, a court should compel arbitration “unlessit may be said with positive assurance that the arbitration clause is notsusceptible of an interpretation that covers the asserted dispute” [David L.Threlkeld & Co., Inc. v. Metallgesellschaft Ltd., 923 F.2d 245, 250 (2d Cir.1991) (citations omitted)]. In determining whether a particular claim fallswithin the scope of an arbitration agreement, courts focus on the factualallegations rather than the legal claims asserted. If the allegations under-

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lying the claims “touch matters” covered by the parties’ contract, thenthose claims are arbitrable [see Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth Inc., 473 U.S. 614, 625 n.13 (1985); Genesco, Inc. v. Kakiuchi &Co., Ltd., 815 F.2d 840 (2d Cir. 1987)]. Appellate courts review decisions tocompel arbitration de novo [Sphere Drake Ins. Ltd. v. Clarendon Nat’l Ins.Co., 263 F.3d 26, 29 (2d Cir. 2001)], but such review may not be availableon an interlocutory basis.

Courts can sever arbitrable claims from nonarbitrable claims. When acourt determines that only some claims are arbitrable, it must decidewhether to stay litigation of the remaining claims pending arbitration or tolet them proceed concurrently [JLM Industries, Inc. v. Stolt-Nielsen SA,387 F.3d 163, 169 (2d Cir. 2004) (citation omitted); Benson v. Lehman Bros.,Inc., 2005 U.S. Dist. LEXIS 8542, at *4-5 (S.D.N.Y. May 9, 2005) (citationomitted)]. [For a discussion of when courts stay litigation pendingarbitration, see New York Insurance Law, § 15.08[2] (Walcott B. Dunham,Jr., ed.).] If factual questions on which the non-arbitrable claim turns maybe resolved in the arbitration, courts typically stay the non-arbitrableclaim.Absent a contract provision to the contrary, questions of mere delay, lachesand untimeliness raised to defeat arbitration are generally issues ofprocedural arbitrability reserved for resolution by the arbitrator [Glass v.Kidder, Peabody & Co., Inc., 114 F.3d 446, 454-56 (4th Cir. 1997); All Am.Termite & Pest Control, Inc. v. Albert Bedford Walker, 830 So. 2d 736, 739(Ala. 2002); Amtower v. William C. Roney & Co., 590 N.W.2d 580, 583(Mich. Ct. App. 1998); but see In the Manner of Donaldson Acoustics, Inc.v. N.Y. Inst. of Tech., 671 N.Y.S.2d 114, 115 (N.Y. Sup. Ct. 1998)].Another issue that most courts have found to be within the purview of thearbitration panel, unless the parties’ agreement provides otherwise, iswhether or not arbitrable disputes can be consolidated, that is, whetherarbitration under separate contracts can be resolved in a single proceeding[Employers Ins. Co. of Wausau v. Century Indem. Co., 443 F.3d 573, 581(7th Cir. 2006); Shaw’s Supermarkets, Inc. v. United Food & CommercialWorkers Union, 321 F.3d 251, 254-55 (1st Cir. 2003); Markel Int’l Ins. Co. v.Westchester Fire Ins. Co., 442 F. Supp. 2d 200, 203-05 (D.N.J. 2006), aff’dCertain Underwriters at Lloyd’s London. v. Westchester Fire Ins. Co., 2007U.S. App. LEXIS 13714 (3d Cir. 2007)].

z Strategic Point — Consolidation of Arbitrations: There are potentialadvantages and disadvantages posed by the consolidation of arbitra-tion proceedings. On the one hand, consolidation may prevent incon-sistent and conflicting decisions, provide arbitrators with a morecomplete understanding of the issues involved in the disputes and

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promote more efficient and cost-effective dispute resolution. On theother hand, consolidation may be more costly for a party onlyperipherally involved in a series of complex disputes, may create a riskthat the panel’s decision will be tainted by facts irrelevant to aparticular dispute and may raise additional confidentiality concerns. Italso may be difficult to restructure an arbitration proceeding toaccommodate the rights of additional parties or related disputes. Thus,contracting parties should carefully consider whether or not to includeconsolidation and joinder provisions in their arbitration agreements orto request consolidation once arbitration has commenced. Partiesseeking consolidation should approach their arbitration panel quicklyto ensure that the decision regarding consolidation will be made by thepanel they chose, and not a panel adjudicating another dispute.

Some parties have argued that inclusion of a service of suit clause in areinsurance agreement conflicts with an arbitration clause in the sameagreement and indicates that the parties did not intend all issues to bearbitrable. Most courts have harmonized these clauses, however, byassuming that the parties did not intend to eviscerate the arbitrationclause through the service of suit clause [see Montauk Oil Transp. Corp. v.Steamship Mut. Underwriting Ass’n (Bermuda), 79 F.3d 295, 298 (2d Cir.1996); Ochsner/Sisters of Charity Health Plan, Inc. v. Certain Underwrit-ers at Lloyd’s, London, 1996 U.S. Dist. LEXIS 12561, at *5-7 (E.D. La. Aug.30, 1996); W. Shore Pipe Line Co. v. Associated Elec & Gas Ins. Servs., Ltd.,791 F. Supp. 200, 204 (N.D. Ill. 1992)]. Courts have found that the serviceof suit clause is intended to provide jurisdiction over a foreign party, andwhere it co-exists with an arbitration clause, its purpose is to permitenforcement of an arbitration decision or to allow a petition to compelarbitration to be adjudicated in a particular court [W. Shore Pipe Line Co.v. Associated Elec. & Gas Ins. Servs., Ltd., 791 F. Supp. 200, 204 (N.D. Ill.1992)].

The arbitration clause is also the starting point for a determination of theremedies that can be imposed by an arbitral panel. “[S]ubject to the termsof the empowering clause, arbitrators possess latitude in crafting remediesas wide as that which they possess in deciding cases” [Advest, Inc. v.McCarthy, 914 F.2d 6, 10-11 (1st Cir. 1990)], including equitable remediessuch as pre-judgment attachment or security. Consistent with the federalpolicy favoring arbitration, courts have been reluctant to find that anarbitrator exceeded his authority in ordering relief, where the arbitrationagreement does not specifically restrict the arbitrator’s authority [Mich.Mut. Ins. Co. v. Unigard Sec. Ins. Co., 44 F.3d 826, 831 (9th Cir. 1995);Rhone-Poulenc, Inc. v. Gould Elecs., Inc., 1998 U.S. Dist. LEXIS 15848, at *7(N.D. Cal. Oct. 6, 1998)]. For example, under a broadly worded arbitration

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clause, arbitrators are empowered to reform a contract [Mut. Fire, Marine& Inland Ins. Co. v. Norad Reinsurance Co., 868 F.2d 52, 56 (3d Cir. 1989);Mich. Mut. Ins. Co. v. Unigard Sec. Ins. Co., 44 F.3d 826, 832-33 (9th Cir.1995)]. Assuming the arbitration clause is broad enough, arbitrators alsocan grant rescission of a reinsurance contract (in part because arbitrationclauses are generally thought to be separable from the underlyingcontract) [Ace Capital Re Overseas Ltd. v. Central United Life Ins. Co., 307F.3d 24, 26, 33 (2d Cir. 2002)]. In some circumstances, arbitrators can awardtemporary equitable relief where necessary to ensure that the final awardis meaningful [Pac. Reinsurance Mgmt. Corp. v. Ohio Reinsurance Corp.,935 F.2d 1019, 1022-23, 1026 (9th Cir. 1991); British Ins. Co. of Cayman v.Water St. Ins. Co., 93 F. Supp. 2d 506, 516 (S.D.N.Y. 2000); but see RecyclersIns. Group v. Ins. Co. of N. Am., 1992 U.S. Dist. LEXIS 8731, at *14 (E.D. Pa.1992]. Arbitrators also generally are empowered to award prejudgmentinterest [Rhone-Poulenc, Inc. v. Gould Elecs., Inc., 1998 U.S. Dist. LEXIS15848, at *7-8 (N.D. Cal. 1998); J.A. Jones Constr. Co. v. Flakt, Inc., 731 F.Supp. 1061, 1064 (N.D. Ga. 1990)].

Courts also may look to the parties’ submissions of the issues to thearbitrators to determine the scope of the arbitrators’ power to grant relief[Trade & Transp., Inc. v. Natural Petroleum Charterers, Inc., 931 F.2d 191,195 (2d Cir. 1991); Mut. Fire, Marine & Inland Ins. Co. v. Norad Reinsur-ance Co., 868 F.2d 52, 56 (3d Cir. 1989)]. Further, the power to grant reliefmay not be limited by the scope of the parties’ agreement, if thebackground rules governing the arbitration provide broad equity powers[see Gilmer v. Interstate/Johnson Lane Corp., 500 U.S. 20, 32 (1991); Brownv. Coleman Co., 220 F.3d 1180, 1183 (10th Cir. 2000)].

The attempted inclusion of non-signatories to the arbitration agreement inan arbitration proceeding is frequently a subject of dispute. Becausearbitration is a contractual right, non-signatories to an arbitration agree-ment generally may not be bound to, nor able to, enforce an agreement toarbitrate [Mut. Benefit Life Ins. Co. v. Zimmerman, 783 F. Supp. 853, 865-67(D.N.J. 1992)]. However, in certain circumstances, a non-signatory mayforce a signatory to an arbitration agreement to submit to an arbitrationwith the non-signatory under principles of contract, agency and estoppel[see Hughes Masonry Co. v. Greater Clark County Sch. Bldg. Corp., 659F.2d 836, 838-41 (7th Cir. 1981); Gulf Guar. Life Ins. Co. v. Conn. Gen. LifeIns. Co., 957 F. Supp. 839, 841-42 (S.D. Miss. 1997); Cont’l Cas. Co. v.Certain Underwriters at Lloyd’s London, 2004 U.S. Dist. LEXIS 4060, at*13-14 (S.D.N.Y. 2004)]. In addition, non-signatories to an arbitrationagreement may be bound to arbitrate pursuant to several legal doctrines,including: assumption; agency; estoppel; veil piercing; and incorporationby reference [Int’l Paper Co. v. Schwabedissen Maschinen & Anlagen

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GMBH, 206 F.2d 411, 416-18 (4th Cir. 2000); Thomson-CSF, S.A. v. Am.Arbitration Ass’n, 64 F.3d 773, 776 (2d Cir. 1995); but see Grundstad v. Ritt,106 F.3d 201, 204-05 (7th Cir. 1997)].

The right to arbitrate a dispute may be waived if a party fails to complywith the terms of the arbitration agreement, excessively delays commenc-ing arbitration or takes action that is inconsistent with the arbitral process[see Gen. Star Nat’l Ins. Co. v. Administratia Asigurarilor De Stat, 289 F.3d434, 438 (6th Cir. 2002); Menorah Ins. Co. v. INX Reinsurance Corp., 72 F.3d218, 221-22 (1st Cir. 1995); Kramer v. Hammond, 943 F.2d 176, 179-80 (2dCir. 1991)]. If a party waits while a matter is being litigated to assert a rightto arbitrate, the court may find it to be estopped from asserting thearbitration clause if the litigation has proceeded substantially.

Example: Some courts have found that inclusion of the phrase “arbi-tration clause” in an executed placement slip or cover note constitutesevidence of a binding agreement to arbitrate [Zurich Am. Ins. Co. v.Cebcor Serv. Corp., 2003 U.S. Dist. LEXIS 10346, at *6-11 (N.D. Ill.2003); Guarantee Trust Life Ins. Co. v. Am. United Life Ins. Co., 2003U.S. Dist. LEXIS 22777, at *7-8 (N.D. Ill. Dec. 18, 2003) (applyingPennsylvania law); but see Frank B. Hall Co. of Colo. v. Colo. Sch. Dists.Self-Insurance Pool, No. 92 CV 225 (Colo. Dist. Ct., City and Co. ofDenver Mar. 26, 1997), reported in Mealey’s Litigation Reports: Rein-surance, Vol. 3, No. 24 at D].

Example: A narrow arbitration clause applying only to “irreconcilabledifferences of opinion” that concern “the interpretation” of facultativecertificates did not encompass a claim that the certificates were void abinitio because of the cedent’s failure to disclose asbestos litigation[Gerling Global Reinsurance Co. v. Ace Prop. & Cas. Ins. Co., 2002 U.S.App. LEXIS 15571, at *5-7 (2d Cir. Aug. 1, 2002) (unpublishedopinion)].

Example: A reinsurer sued to rescind a reinsurance contract based onnon-disclosures in the underwriting process. The federal district courtfound that the arbitration clause covering “[a]ll disputes or differencesarising out of the interpretation of this Agreement” was too narrow toencompass claims for rescission based on misrepresentation andrefused to stay those claims in favor of arbitration [Farm Bureau Mut.Ins. Co. v. Am. Int’l Group, Inc., 2003 U.S. Dist. LEXIS 14463, at *11-12(S.D. Iowa 2004)].

Example: Under an arbitration clause providing that “any dispute ordifference of opinion hereafter arising with respect to this Contract . . .

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shall be submitted to arbitration,” the issue of a mutually agreeablelocation for the underlying dispute is arbitrable [Trustmark Ins. Co. v.Fire & Cas. Ins. Co. of Conn., 2002 U.S. Dist. LEXIS 7923, at *6-7 (N.D.Ill. 2002)].

t Warning: A Missouri arbitration statute has been interpreted by afederal district court to preclude the enforcement of arbitration clausesin insurance and reinsurance agreements [Transit Cas. Co. v. CertainUnderwriters at Lloyd’s of London, 1996 U.S. Dist. LEXIS 22710, at *5-8(W.D. Mo. 1996), citing Mo. Rev. Stat. § 435.350 (as then existing)].

Examples — Non-signatories: A non-signatory to arbitration agreementswas compelled to arbitrate disputes with a signatory of the agreementsbecause the guaranty signed by the non-signatory incorporated theagreements and the arbitration provisions of the agreements weresufficiently broad to bind non-signatories [Clarendon Nat’l Ins. Co. v.Lan, 152 F. Supp. 2d 506, 519-521 (S.D.N.Y. 2001)]. A reinsured partynot specifically named in an excess of loss reinsurance agreement waspermitted to compel arbitration against the signatory reinsurer underthe agreement’s arbitration clause as a third-party beneficiary of theagreement [Cont’l Cas. Co. v. Certain Underwriters at Lloyd’s London,2004 U.S. Dist. LEXIS 4060, at *13-14 (S.D.N.Y. 2004)]. A reinsuranceintermediary that was not a signatory to reinsurance and retrocessionagreements containing arbitration clauses was nonetheless compelledto arbitrate a dispute concerning a reinsurer’s obligations under thoseagreements. The court found that the intermediary was estopped fromrefusing to arbitration because of its allegations that it suffered harmdue to the reinsurer’s repudiation of the contracts and because theintermediary received a direct benefit from the agreements [Int’l Ins.Agency Services, LLC v. Revios Reinsurance U.S., Inc., 2007 U.S. Dist.LEXIS 22229, at *14-19 (N.D. Ill. 2007)].

� Cross References: For discussions of whether an insolvent company’sliquidator or receiver is bound by an agreement to arbitrate, see NewYork Insurance Law § 15.08[4] (Walcott B. Dunham, Jr., ed.); Eric MillsHolmes, Appleman on Insurance 2d § 107.2[F].

Lexis.com Search: To find a general discussion of arbitration in thereinsurance law context, try this source: Reinsurance Law. Using theTable of Contents, navigate to Chapter 6 Arbitration.

40.23 Neutral Panel or Party Advocate System. Arbitration agreementstypically include provisions stipulating the number of arbitrators andtheir qualifications, the timing and method by which the panel is to be

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selected and whether one arbitrator is to act as an umpire or chairman ofthe panel. Some agreements do not specifically list these procedures, butinstead incorporate the rules of an arbitration organization containingsuch procedures. If the agreement is completely silent on the method forselecting arbitrators, or if the parties “fail to avail” themselves of theprocedures agreed upon for selecting arbitrators, a court is authorizedunder the Federal Arbitration Act (“FAA”) to appoint any one or all of thearbitrators upon application of a party [9 U.S.C. § 5; see also Pac. Reinsur-ance Mgmt. Corp. v. Ohio Reinsurance Corp., 814 F.2d 1324, 1327-29 (9thCir. 1987); AIG Global Trade and Political Risk Ins. Co. v. Odyssey Am.Reinsurance Corp., 2006 U.S. Dist. LEXIS 73258, at *15-17 (S.D.N.Y. 2006)].In arbitrations conducted pursuant to reinsurance agreements, the tribu-nal is usually composed of three arbitrators.

Reinsurance arbitration agreements typically provide that each side is todesignate its own “party” arbitrator, and then the two designated “party”arbitrators are to appoint a third “neutral” arbitrator, usually called an“umpire.” Some agreements also include a default mechanism for selec-tion of the neutral arbitrator that operates when the parties or partyarbitrators (where vested with the decision to elect a third, neutral umpire)cannot agree on umpire selection. In some instances, parties request theorganization administering the arbitration to appoint the umpire.

Unless set forth in the contract, the arbitrators need not meet anyparticular requirements beyond capably performing their task. Arbitrationclauses in reinsurance agreements, however, usually set forth objectivequalifications for arbitrators and umpires. Most arbitrators are required tohave some level of expertise in the reinsurance or insurance industry or tobe a present or former officer or director of an insurance or reinsurancecompany. In the United States, party-appointed arbitrators may be non-neutral and predisposed towards the party that appointed them, unlessthe parties or the contract specifies otherwise [Lozano v. Md. Cas. Co., 850F.2d 1470, 1472 (11th Cir. 1988); Merit Ins. Co. v. Leatherby Ins. Co., 714F.2d 673, 679 (7th Cir. 1983); Astoria Med. Group v. Health Ins. Plan ofGreater N.Y., 182 N.E.2d 85, 87-89 (N.Y. 1962)]. Although party-appointedarbitrators may have a general predisposition or sympathy with a party orits position, this is more in the nature of a duty to give the partyappointing them a fair hearing; party-appointed arbitrators are notsurrogates for the party and still must make independent judgments andact fairly [Universal Reinsurance Corp. v. Allstate Ins. Co., 16 F.3d 125, 129n.2 (7th Cir. 1994); Metro. Prop. & Cas. Ins. Co. v. J.C. Penney Cas. Ins. Co.,780 F. Supp. 885, 892 (D. Conn. 1991)]. (There also may be more latitude indiscussing the merits of the dispute with a party-appointed arbitrator untilthe umpire is selected.) In contrast, umpires are expected to remain

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completely neutral. Both neutral and non-neutral members of the panelmust participate in the arbitration process in a fair, honest and good faithmanner and may not exhibit “evident partiality or corruption” [9 U.S.C.§ 10(a)(2); Nationwide Mut. Ins. Co. v. Home Ins. Co., 429 F.3d 640, 644-49(6th Cir. 2005); Scott v. Prudential Sec., 141 F.3d 1007, 1015 (11th Cir. 1998)].

Arbitrators must disclose to the parties any potentially disqualifyinginterests or relationships [Commonwealth Coatings Corp. v. Cont’l Cas.Co., 393 U.S. 145, 147-49 (1968); see also U.S. Wrestling Fed’n v. WrestlingDiv. of AAU, Inc., 605 F.2d 313, 319 (7th Cir. 1979)]. Failure to disclosebusiness or financial relationships that would create an objectively rea-sonable impression of bias could result in vacation of the award [Nation-wide Mut. Ins. Co. v. Home Ins. Co., 278 F.3d 621, 626 (6th Cir. 2002); Nw.Nat’l Ins. Co. v. Allstate Ins. Co., 832 F. Supp. 1280, 1286-87 (E.D. Wis.1993); Barcon Assocs., Inc. v. Tri-County Asphalt Corp., 430 A.2d 214,218-21 (N.J. 1981); for a discussion of the circumstances under whicharbitral awards may be vacated, see § 40.28 below].

Court challenges to an arbitrator’s qualifications to serve can only beraised after issuance of the award, except in limited circumstances [GulfGuar. Life Ins. Co. v. Conn. Gen. Life Ins. Co., 304 F.3d 476, 489-90 (5th Cir.2002); Aviall, Inc. v. Ryder Sys., Inc., 110 F.3d 892, 895-96 (2d Cir. 1997); Ins.Co. of N. Am. v. Pennant Ins. Co., Ltd., 1998 U.S. Dist. Lexis 2466, at *5-7(E.D. Pa. 1998)]. Some courts have recognized that arbitrators can bedisqualified prior to rendition of an award, based on courts’ “inherentpowers” or on general contract principles [see Aviall, Inc. v. Ryder Sys.,Inc., 110 F.3d 892, 895-96 (2d Cir. 1997); First State Ins. Co. v. Employers Ins.of Wausau, No. 99-12478-RWZ (D. Mass. Feb. 23, 2000), reported inMealey’s Litig. Report: Reinsurance, Vol. 10, No. 21 (Mar. 9, 2000) at C-1;Evanston Ins. Co. v. Kansa Gen. Int’l Ins. Co., Ltd., No. 94 C 4957 (N.D. Ill.Oct. 17, 1994), reported in Mealey’s Litig. Report: Reinsurance, Vol. 5, No.14 (Nov. 23, 1994) at A-1].

t Warning: Many arbitration agreements include a provision, some-times called an “adverse selection clause,” stating that if a party failsto appoint an arbitrator within a specified time following receipt of awritten request to designate an arbitrator, the other party may appointboth “party-appointed” arbitrators. Section 5 of the FAA requires thatthe parties follow the contractually specified method for appointingarbitrators [9 U.S.C. § 5]. Parties should carefully observe any time-table or procedures set forth in their contracts for selecting arbitratorsto avoid forfeiting the right to appointment [see Universal ReinsuranceCorp. v. Allstate Ins. Co., 16 F.3d 125, 128-29 (7th Cir. 1994); EvanstonIns. Co. v. Gerling Global Reinsurance Corp., 1990 U.S. Dist. LEXIS

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12521, at *7-8 (N.D. Ill. 1990); Employers Ins. of Wausau v. Jackson, 527N.W.2d 681, 688-89 (Wis. 1995)]. Some courts have been reluctant,however, to find that a party making an untimely selection forfeited itsappointment right, unless the parties expressly made time of theessence in the contract’s arbitration provision [see Ancon Ins. Co.(U.K.) v. GE Reinsurance Corp., 2007 U.S. Dist. LEXIS 24822, at *23-24(D. Kan. 2007); RLI Ins. Co. v. Kansa Reinsurance Co., 1991 U.S. Dist.LEXIS 16388, at *9 (S.D.N.Y. 1991); New England Reinsurance Corp. v.Tenn. Ins. Co., 780 F. Supp. 73, 77-78 (D. Mass. 1991)].

� Cross Reference: For an example of an adverse selection clause in afacultative certificate, see California Insurance Law and Practice§ 11.07[2][c].

� Cross Reference: For a survey and discussion of the standards forselection of party-appointed arbitrators that are set forth in the majorprivate international arbitration rules, see Doak Bishop and Lucy Reed,Practical Guidelines for Interviewing, Selecting and Challenging Party-Appointed Arbitrators in International Commercial Arbitration, in Arbitra-tion International, Vol. 14, No. 4 (LCIA 1998) at 395.

� Cross References: Many arbitration agencies maintain lists of quali-fied individuals from which parties can select arbitrators. For example,ARIAS-U.S. publishes a list of certified reinsurance arbitrators andumpires [see www.arias-us.org]. The American Arbitration Associationalso maintains a roster of prospective arbitrators and mediatorsexperienced in various industries [see www.adr.org].

z Strategic Point: Considerable care should be taken in appointing aparty arbitrator who is fair and knowledgeable. The party arbitratorshould understand the issues well and be able to articulate a coherentview of the case. It is helpful if the arbitrator has sufficient standing inthe industry to influence other panel members or at least not to beintimidated by other arbitrators with more experience or “better”credentials Umpires ideally should have industry knowledge as wellarbitration experience.

z Strategic Point: The parties can dispense with some of the back andforth in the appointment of arbitrators and umpires by agreeing to aprocess — or a joint list of candidates — at the time their disputeripens.

� Cross Reference: The “Code of Ethics for Arbitrators in CommercialDisputes,” prepared by a joint committee of the American Arbitration

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Association (“AAA”) and the American Bar Association (“ABA”), setsforth generally accepted standards of ethical conduct for the guidanceof arbitrators and parties. The current (2004) version is available on theAmerican Bar Association website, at ww.abanet.org/dispute/commercial_disputes.pdf.

� Cross Reference: For a sample questionnaire for prospective umpires,see § 40.47 below.

� Cross Reference: The ARIAS-U.S. Umpire Appointment Procedure isavailable on its website at www.arias-us.org. In addition, the “Proce-dures for the Resolution of U.S. Insurance and Reinsurance Disputes,”drafted by the Insurance and Reinsurance Dispute Resolution TaskForce, include a procedure for the selection of an all-neutral arbitrationpanel [see Procedures at www.ArbitrationTaskForce.org].

40.24 Strict Rule of Law vs. Obligations Pursuant to Honorable Engagement.Most reinsurance agreements include an honorable engagement clausewhich typically instructs arbitrators to interpret the contract “as anhonorable engagement and not merely as a legal obligation,” and relievesarbitrators from following the strict rules of law [for a sample arbitrationprovision containing typical honorable engagement language, see § 40.46below]. This language reflects the overriding commercial practicalityinherent in reinsurance relationships and embodies the mutual duty ofutmost good faith. [For a discussion of the duty of utmost good faith inreinsurance relationships, see §§ 40.15 and 40.16 above]. Honorable en-gagement clauses can allow arbitrators to find a resolution that bestreflects the purpose and intent behind the transaction at issue. Anhonorable engagement clause, however, does not necessarily supplant theobligation of the panel formally to issue a statement of reasons for thedecision they reach, which is a separate issue.

Language relieving arbitrators from following strict rules of law permitsarbitrators to apply principles of fairness, equity and commercial practicein resolving reinsurance disputes. “Courts have read honorable engage-ment clauses generously, consistently finding that arbitrators have widediscretion to order remedies they deem appropriate” [Banco de Segurosdel Estado v. Mut. Marine Office, Inc., 344 F.3d 255, 261 (2d Cir. 2003); seealso Pac. Reinsurance Mgmt. Corp. v. Ohio Reinsurance Corp., 935 F.2d1019, 1025 (9th Cir. 1991); Certain Underwriters at Lloyd’s v. Argonaut Ins.Co., 264 F. Supp. 2d 926, 939 (N.D. Cal. 2003)]. Arbitrators may bepersuaded by relevant case law, but, as a general matter, are not requiredto resolve matters based on how they believe a court would decide theissue, which also reflects that the qualifications clause in the arbitration

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agreement often does not require that the arbitrators be trained in the law[see U.S. Life Ins. Co. v. Ins. Comm’r of the State of Cal., 2005 U.S. App.LEXIS 25763, at *7-8 (9th Cir. 2005) (unpublished decision); Nw. Nat’l Ins.Co. v. Generali Mex. Compania De Seguros, S.A., 2000 U.S. Dist. LEXIS7348, at *4 (S.D.N.Y. 2000); Employers Ins. of Wausau v. Certain Under-writers at Lloyd’s London, 552 N.W.2d 420, 427 n.8 (Wis. Ct. App. 1996);for a discussion of the rare circumstances under which arbitral awardsmay be vacated under the “manifest disregard of the law” standard, see§ 40.28 below]. Instead, they may, and often do, apply industry customand practice as well as equitable principles to reach their decisions. Unlessthe contract provides otherwise, arbitrators in U.S. arbitrations are notobligated to issue a reasoned decision explaining the award. [For adiscussion of reasoned awards in reinsurance arbitrations, see § 40.27below].

Example: Contract language permitting the arbitrators to “considerthis contract an honorable engagement rather than merely a legalobligation” and absolving the arbitrators from “following the strictrules of law” was broad enough to give the arbitrators the power todetermine the preclusive effect of a prior arbitration award [N. RiverIns. Co. v. Allstate Ins. Co., 866 F. Supp. 123, 129 (S.D.N.Y. 1994)].

Example: The court determined that a reinsurance treaty relievingarbitrators of all judicial formalities and providing that they mayabstain from following strict rules of law empowered the arbitrators toaward relief in “any reasonable form or at any stage in the proceed-ing,” including ordering a party to post additional pre-hearing secu-rity [Meadows Indem. Co., Ltd. v. Arkwright Mut. Ins. Co., 1996 U.S.Dist. LEXIS 14318, at *12-13 (E.D. Pa. 1996)].

40.25 Discovery in Arbitration. The broad and liberal rules governingpretrial discovery in state and federal civil cases generally do not apply inarbitrations, unless the parties so agree or the panel so orders. The natureand extent of discovery available in reinsurance arbitrations varies widely,depending upon the nature of the case, the arbiters’ views on the issue,and the particular rules governing the arbitration. Document discovery isalmost universally permitted in arbitration; however, the amount ofdocument discovery can differ significantly. Some arbiters will allowdiscovery only on the specific claims and reinsurance contracts at issue inthe arbitration, while others essentially will permit the parties to requestany documents they wish. In addition, some arbiters will allow deposi-tions, while others will not (especially from third parties).

Although arbitration clauses often do not address the arbitrators’ author-

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ity to resolve discovery disputes, it is commonly recognized that arbitra-tors have the authority to resolve procedural disputes, including the scopeand nature of permissible discovery. As can be expected, the parties oftenraise privilege and other production disputes during the discoveryprocess. These disputes typically are resolved by means of letter briefs tothe panel or a conference call with the umpire. Occasionally, the panel willhold a hearing with counsel to resolve a discovery dispute.

Under Section 7 of the Federal Arbitration Act (“FAA”) [9 U.S.C. § 7], andthe laws of most states, arbitrators have broad power to issue subpoenasand subpoenas duces tecum, if the evidence sought for the hearing ismaterial to the proceedings. The FAA does not, however, specificallyaddress the arbitrators’ power to require non-parties to submit to pre-hearing discovery. As a result, case law is split as to whether arbitratorshave the authority to order pre-hearing discovery of non-parties, particu-lary pre-hearing deposition discovery. The Fourth Circuit Court of Ap-peals has held that arbitrators’ powers should be limited to thosespecifically set forth in the FAA; therefore, pre-hearing discovery ofnon-parties is prohibited unless a party demonstrates a “special need” [seeComsat Corp. v. Nat’l Science Found., 190 F.3d 269, 274-76 (4th Cir. 1999);Application of Deiulemar Compagnia Di Navigazione S.P.A. v. M/VAllegra, 198 F.3d 473, 480-81 (4th Cir. 1999)]. In contrast, the Eighth CircuitCourt of Appeals and several federal district courts have held that implicitin an arbitration panel’s power to subpoena relevant documents forproduction at a hearing is the power to order the production of documentsprior to the hearing [see In re Sec. Life Ins. Co. of Am., 228 F.3d 865, 870-71(8th Cir. 2000); In re Arbitration between Douglas Brazell v. Am. ColorGraphics, Inc., 2000 U.S. Dist. LEXIS 4482, at *4-9 (S.D.N.Y. 2000); AmgenInc. v. Kidney Ctr. of Delaware County, Ltd., 879 F. Supp. 878, 880 (N.D. Ill.1995)]. The Third Circuit Court of Appeals has determined that the text ofthe FAA limits the subpoena power of arbitrators to compelling produc-tion of documents by non-parties only at an actual arbitration hearing[Hay Group, Inc. v. E.B.S. Acquisition Corp., 360 F.3d 404, 407 (3d Cir.2004)]. In one case, the court approved a “special purpose hearing” fornon-parties to respond to arbitral subpoenas, reasoning that “[n]othing inthe language of the FAA limits the point in time in the arbitration processwhen [the subpoena] power can be invoked or says that the arbitratorsmay only invoke this power under section 7 at the time of the trial-likefinal hearing” [Stolt-Nielsen SA v. Celanese AG, 430 F.3d 567, 577 (2d Cir.2005), quoting Odfjell ASA v. Celanese AG, 348 F. Supp. 2d 283, 287(S.D.N.Y. 2004); see also Hay Group v. E.B.S. Acquisition Corp., 360 F.3d404, 413-14 (3d Cir. 2004) (Chertoff, J., concurring)].

Some courts have approved pre-hearing subpoenas for production of

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documents, but not for depositions [see SchlumbergerSema, Inc. v. XcelEnergy, Inc., No. 02-4304, 2004 U.S. Dist. LEXIS 389, at *7 (D. Minn. Jan. 9,2004); Atmel Corp. v. LM Ericsson Telefon, AB, 371 F. Supp. 2d 402, 403-04(S.D.N.Y. 2005); Integrity Ins. Co. v. Am. Centennial Ins. Co., 885 F. Supp.69, 71 (S.D.N.Y. 1995)]. Other courts have acknowledged broad arbitralpower to order both documentary and testimonial discovery of non-parties before a final hearing, a result that can be justified especially wheresuch discovery may facilitate speedier resolution of the principal dispute[see Stanton v. Paine Webber Jackson & Curtis, Inc., 685 F. Supp. 1241,1242-43 (S.D. Fla. 1988)]. Several courts weighing the question of arbitralpower to summon pre-hearing evidence from non-parties have taken intoaccount the non-parties’ relationships to the parties and to the disputedmatters [see In re Sec. Life Ins. Co. of Am., 228 F.3d at 871; In re Arbitrationbetween Douglas Brazell v. Am. Color Graphics, Inc. 2000 U.S. Dist. LEXIS4482, at *9; Meadows Indemnity Co., Ltd. v. Nutmeg Ins. Co., 157 F.R.D.42, 45 (M.D. Tenn. 1994)].

� Cross Reference: Several arbitration organizations have publisheddiscovery procedures that can be incorporated in arbitration agree-ments or otherwise adopted by parties for use in reinsurance arbitra-tions. ARIAS-U.S., for example, includes discovery procedures in its“Practical Guide to Reinsurance Arbitration Procedure” [see ARIAS-U.S. Practical Guide at www.arias-us.org]. Discovery also is includedin the “Procedures for the Resolution of U.S. Insurance and Reinsur-ance Disputes” published by the Insurance and Reinsurance DisputeResolution Task Force [see Procedures at www.arbitrationtaskforce-.org]. In addition, “The CPR International Reinsurance Industry Dis-pute Resolution Protocol,” published by the International Institute forConflict Prevention & Resolution, includes procedures for the parties’exchange of information [see Protocol at www.insurancemediation-.org].

z Strategic Point: Given the conflicting case law interpreting arbitra-tors’ subpoena power under Section 7 of the FAA, it is unclear whethera pre-hearing arbitral subpoena issued to a non-party will be enforcedby a court. Reinsurance intermediaries are typically not parties toarbitrations between ceding insurers and reinsurers but often possesscritical information relevant to reinsurance agreements. Parties whowish to ensure that intermediaries will be required to provide pre-hearing testimonial and documentary evidence in the event a reinsur-ance dispute reaches arbitration have several options:

1. The intermediary can be made a party to the reinsurance

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contract, making it a three-way agreement among the cedent,reinsurer and intermediary;

2. The intermediary can be made a party only to the intermediaryand arbitration clauses of the reinsurance agreement (in eithercase, the arbitration clause could provide that the intermediarysubmit to pre-hearing discovery in disputes arising out of theagreement); and

3. A provision in the agreement between the ceding insurer and itsintermediary can require the intermediary to cooperate with thearbitration panel in pre-hearing discovery in any dispute arisingunder an reinsurance contract placed by the intermediary.

Of course, intermediaries may resist such approaches. As a practicalmatter, at the time of a dispute, both parties to the reinsurance contractmay wish to have access to the intermediary’s documents and witnesses,and either or both may have ongoing commercial relations with theintermediary, both of which counsel that the parties may be able to reacha practical accommodation of the intermediary’s interest (including per-haps agreeing to defray part of the intermediary’s cost of compliance).

Consider: Nevertheless, the federal District Court for the District ofMassachusetts, following the Third Circuit’s decision in Hay GroupInc., dismissed a petition to enforce a subpoena that had been issuedby an arbitration panel to a non-party [Liberty Mut. Ins. Co. v. WhiteMountains Ins. Group Ltd., No. 06-11901 (D. Mass. 2007), reprinted inMealey’s Litig. Rep. Reinsurance, Vol. 17, No. 22 (Mar. 22, 2007) at 4].

40.26 Summary Disposition in Arbitration. Dispositive motions have tradi-tionally been granted sparingly in reinsurance arbitrations; however, thereappears to be a growing understanding that such motions should begranted in arbitrations where the facts and circumstances so warrant.There is ample authority supporting an arbitration panel’s granting of amotion for summary disposition without live testimony or a full eviden-tiary hearing, if the evidence omitted is not legally relevant or iscumulative.

Although there is no express statutory authority under the FederalArbitration Act (“FAA”) [9 U.S.C. § 1, et seq.] for an arbitrator to respondto a dispositive motion, arbitrators are generally assumed to have alldiscretionary authority necessary to conduct the proceedings in a mannerthat is not expressly prohibited by the arbitration agreement between theparties or the FAA [Terry L. Trantina, “An Attorney’s Guide to AlternativeDispute Resolution (ADR): ’ADR 1.01,”’ 1 A.B.A. Sec. Bus. L. 8 (Jan. 2003),

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available at http://www.abanet.org/buslaw/newsletter/0008/adr/adr101.pdf; see also John Wiley & Sons, Inc. v. Livingston, 376 U.S. 543, 557(1964)]. The revised Uniform Arbitration Act (the “UAA”) expresslypermits arbitrators to decide a request for summary disposition basedsolely on documentation, after a party submitting the request gives noticeand opposing parties have a reasonable time to respond [see UAA § 15(b)(2000), available at http://www.nccusl.org]. The Procedures for the Reso-lution of U.S. Insurance and Reinsurance Disputes issued by the Insuranceand Reinsurance Dispute Resolution Task Force also specifically authorizeconsideration of summary disposition motions by reinsurance arbitrationpanels [Reinsurance Ass’n of America, Procedures for the Resolution ofU.S. Insurance and Reinsurance Disputes § 13.1 (2004)]. In addition, theAmerican Arbitration Association (“AAA”) Commercial Arbitration Rulesgive arbitrators wide latitude to conduct the proceedings and do notprohibit the use of dispositive motions. The AAA Procedures for Large,Complex Commercial Disputes also appear to permit summary adjudica-tion by allowing arbitrators to “take such steps as they may deemnecessary or desirable to avoid delay and to achieve a just, speedy andcost-effective resolution” of the cases [American Arbitration Ass’n, Com-mercial Arbitration Rules and Mediation Procedures R-30(b) (2005);American Arbitration Ass’n, Procedures for Large, Complex CommercialDisputes L-4(a) (2005)].

Parties may agree upon appropriate procedures by contract, but wherethey do not, arbitrators have wide discretion to decide procedural mattersand determine the meaning of procedural rules [see Bell Atlantic-Pennsylvania, Inc. v. Communications Workers of Am., Local 13000, 164F.3d 197, 201-02 (3d Cir. 1999); Raytheon Co. v. Computer Distrib., Inc., 632F. Supp. 553, 557-58 (D. Mass. 1986); for a discussion of arbitrators’freedom to dispense with judicial formalities and determine arbitrationprocedures, see § 40.23 above]. Consistent with the goals of speed andefficiency in arbitration, arbitrators are encouraged to take appropriateaction to simplify and expedite proceedings [see PaineWebber Group, Inc.v. Zinsmeyer Trusts P’ship, 187 F.3d 988, 995 (8th Cir. 1999); CearfossConstr. Corp. v. Sabre Constr. Corp., 1989 U.S. Dist. LEXIS 9639, at *12-13(D.D.C. Aug. 10, 1989)]. Unless otherwise restricted, this mandate leavesarbitrators free to consider and grant motions for summary adjudicationof issues or summary judgment

The power of arbitrators to grant summary disposition may be restricted,however, by arbitration agreements that expressly limit such authority.The FAA requires courts to enforce privately negotiated agreements toarbitrate, like other contracts, in accordance with their terms, and partiesmay stipulate by contract the rules under which their arbitration will be

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conducted [see Mastrobuono v. Shearson Lehman Hutton, Inc., 514 U.S. 52,57 (1995); Baravati v. Josephthal, Lyon & Ross, Inc. 28 F.3d 704, 709 (7th Cir.1994)]. Arbitrators generally are required to follow any procedures setforth in the parties’ agreement [W. Employers Ins. Co. v. Jeffries & Co., 958F.2d 258, 262 (9th Cir. 1992)]. Therefore, a contract provision prohibitingsummary adjudication in the arbitration proceeding most likely precludessuch action.

The authority of arbitrators to decide motions for summary disposition isusually litigated in court proceedings to vacate or confirm the award.Generally, there are very limited grounds for courts to vacate arbitralawards under the FAA, the Convention on the Recognition and Enforce-ment of Foreign Arbitral Awards (the “New York Convention”) and statearbitration acts. [For a discussion of the circumstances under which courtsvacate arbitral awards, see § 40.28 below]. Challenges to an arbitrationpanel’s decision to grant a motion for summary disposition typically fallinto two categories. Parties contend that the arbitrators lacked theauthority to grant the dismissal motion (exceeded their powers) or assertthat the panel engaged in misconduct by improperly refusing to hearevidence. Courts have made clear that misbehavior cognizable underSection 10(a)(3) of the FAA “must amount to a denial of fundamentalfairness of the arbitration proceeding” in order to justify overturning anaward” [Max Marx Color & Chem. Co. Employees’ Profit Sharing Plan v.Barnes, 37 F. Supp. 2d 248, 252 (S.D.N.Y. 1999)]. In the cases confirmingsummary decisions, courts agreed with the arbitrators that an evidentiaryhearing was not necessary because any excluded evidence either wasduplicative or not material to the issues in dispute [see Hudson v. ConAgraPoultry Co., 2007 U.S. App. LEXIS 7681, at *19-20 (8th Cir. 2007); Sheldonv. Vermonty, 269 F.3d 1202, 1207 (10th Cir. 2001); Pegasus Constr. Corp. v.Turner Constr. Co., 929 P.2d 1200, 1201-03 (Wash. Ct. App. 1997)].Alternatively, courts vacating summary awards determined that summaryadjudication was inappropriate because the arbitrators’ failure to receivepertinent evidence resulted in palpable prejudice to a party [see Int’lUnion, United Mine Workers of Am. v. Marrowbone Dev. Co., 232 F.3d383, 387-90 (4th Cir. 2000); Prudential Sec., Inc. v. Dalton, 929 F. Supp. 1411,1417-18 (N.D. Okla. 1996)]. Vacatur will not be granted simply because thecourt might have come to a different result.

Examples: Several courts have found that the “hearing” mandated bySection 10 of the FAA does not necessarily require oral presentation orlive witness testimony [see, e.g., Fed. Deposit Ins. Corp. v. Air Fla. Sys.,Inc., 822 F.2d 833, 842-43 (9th Cir. 1987); Griffen Indus. v. Petrojam,Ltd., 58 F. Supp. 2d 212, 219-21 (S.D.N.Y. 1999); but see British Ins. Co.

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of Cayman v. Water St. Ins. Co., 93 F. Supp. 2d 506, 517-19 (S.D.N.Y.2000)].

Examples: Courts have confirmed summary awards in arbitral pro-ceedings despite the absence of explicit authorization for the proce-dure in the governing rules or statutes [see Melchers v. Corbin Assocs.,LLC, 2006 U.S. Dist. LEXIS 18049, at *19-26 (E.D. Tenn. 2006); PegasusConstr. Corp. v. Turner Constr. Co., 929 P.2d 1200, 1203 (Wash. Ct. App.1997); Schlessinger v. Rosenfeld, Meyer & Susman, 40 Cal. App. 4th1096, 1104 (1995)].

Example: A federal district court confirmed an arbitration panel’ssummary award where a party, All American Life Insurance Co. (“AllAmerican”), “admitted” in its position statement that a broker did nothave the authority to bind All American to the contracts at issue in thedispute. The panel found that the position statement constituted apleading and that All American had made an irrevocable admissionthat the broker did not have binding authority; therefore the contractswere not valid [Sphere Drake Ins. Ltd. v. All Am. Life Ins. Co., 2004U.S. Dist. LEXIS 3494, at *8-10 (N.D. Ill. 2004)]. In a motion to vacatethe award, All American argued that it had been denied a fundamen-tally fair hearing because the panel gave undue weight to the alleged“admission,” exceeded its authority by deciding a legal issue reservedfor the courts and a factual issue not before it, and exhibited a manifestdisregard for the law by misinterpreting state contract law [id. at*33-42]. In affirming the panel’s award, the court did not specificallyaddress whether or not the panel had the authority to decide thematter by ruling on the motion for judgment on the pleadings.However, the court’s opinion clearly assumes that the panel had thispower and rejects each of All American’s purported grounds forvacatur [id.].

z Strategic Point: Dispositive motions can streamline the arbitralprocess by eliminating specious claims and defenses. Although arbi-trators are sometimes wary of the practice and courts will carefullyscrutinize summary rulings, submission of dispositive motions can bea successful and appropriate tactic in arbitration where there is norelevant or material evidence necessary for resolution of a particularclaim, or of the entire dispute.

40.27 Reasoned Awards. Reinsurance arbitration panels typically issue asigned written decision articulating the award. If the decision is notunanimous, a written dissent also may be issued. In the United States, an

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arbitration panel need not set forth the rationale supporting its award,unless the parties’ arbitration agreement requires it to do so [N.Y. StockExch. Arbitration between Fahnestock & Co., Inc. v. Waltman, 935 F.2d 512,516 (2d Cir. 1991); Koch Oil, S.A. v. Transocean Gulf Oil Co., 751 F.2d 551,554 (2d Cir. 1985)]. Thus, many arbitral decisions are presented in a briefstatement outlining the nature of the dispute, stating the prevailing partyand describing any relief awarded. The parties may, however, require thereinsurance arbitration panel to explain the reasoning for an award as apre-requisite for being appointed to the panel.

z Strategic Point: Although arbitration is sometimes derided as un-duly allowing arbitrators to reach compromise awards, that also is onevirtue of the process, so parties should consider their philosophicaltolerance for one approach or the other when drafting an arbitrationclause. Note also that the absence of reasoned awards, especially whenhonorable engagement clauses apply, may increase differences inoutcomes from one arbitration to the next; whether differences in theoutcomes in a portfolio of similar disputes is acceptable or not issomething parties should consider at the time they draft their arbitra-tion agreements.

40.28 Know When to Move to Vacate or Affirm Arbitration Award. After areinsurance arbitration panel renders its award, the prevailing party maysubmit a motion in court to confirm the award or the losing party maymove to have the award vacated, or both. These steps are not necessary ifthe parties simply act in accordance with the award but are often taken toconclude or challenge the process.

z Strategic Point: On balance, it is probably a good practice for theprevailing party to have the award confirmed even if the losing partyintends to comply with the award. A confirmation action need not becontentious, but it allows the prevailing party to have an executablejudgment.

s Timing: If the arbitration agreement specifies a particular court forconfirmation, the party seeking to confirm the award may request aconfirmation order from the specified court any time within one yearof the award [9 U.S.C. § 9].

Consider: If the arbitration agreement does not specify a confirmationcourt, application for confirmation “may be made to the United Statescourt in and for the district within which [the] award was made” [id.].An arbitration award will be summarily confirmed upon motion by aparty, absent grounds for vacatur, modification or correction [id.]. It

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should be noted that moving to confirm or vacate an award under theFederal Arbitration Act does not in and of itself constitute a basis forfederal court jurisdiction (so independent subject matter jurisdiction isneeded though the fact of an arbitration alone is sufficient to show an“actual controversy”), although moving to confirm or vacate under theNew York Convention does provide an independent fount of jurisdic-tion in the appropriate court.

The grounds upon which an arbitration award can be vacated areextremely narrow under the Federal Arbitration Act (“FAA”) [9 U.S.C.§ 10], state statutes and the New York Convention. The “[e]xceptions toconfirmation are strictly limited so as not to frustrate the basic purpose ofarbitration to dispose of disputes quickly and to avoid the expense anddelay of protracted court proceedings” [Transit Cas. Co. v. TrenwickReinsurance Co., 659 F. Supp. 1346, 1351 (S.D.N.Y. 1987)]. While decadesago courts were more receptive to challenges to arbitration awards, that isnot true today. Under Section 10 of the FAA, awards typically are vacatedonly where arbitrators exhibited bias or procedural unfairness (as opposedto procedural error). The district courts are not to function as an appellateforum to second-guess what happened in the arbitration, and the standardof review they apply is much narrower than the federal appellate courtsapply to decisions of the district courts. The following are the specificstatutory circumstances justifying vacatur of an arbitral award:

• “Where the award was procured by corruption, fraud, or unduemeans” [9 U.S.C. § 10(a)(1)]. A party who alleges that an arbitrationaward was procured through fraud or undue means must demon-strate that the improper behavior was: (1) not discoverable by duediligence before or during the arbitration hearing; (2) materiallyrelated to an issue in the arbitration; and (3) established by clearand convincing evidence [Houston Gen. Ins. Co. v. Certain Under-writers at Lloyd’s London, 2003 U.S. Dist. LEXIS 19516, at *3-4(S.D.N.Y. 2003); Trans Chem. Ltd. v. China Nat’l Mach. Import &Export Corp., 978 F. Supp. 266, 304 (S.D. Tex. 1997)]. Fraud typicallyrequires a showing of bad faith and may be evidenced by briberyor by willful destruction or withholding of evidence [id.; In-docomex Fibres Pte., Ltd. v. Cotton Co. Int’l, Inc., 916 F. Supp. 721,728 (W.D. Tenn. 1996)].

• “Where there was evident partiality or corruption in the arbitrators,or either of them” [9 U.S.C. § 10(a)(2)]. Although there is disagree-ment among courts as to precisely what an arbitrator must discloseto avoid a claim of “evident partiality,” courts typically look for areal and direct financial interest in the result of the arbitration or a

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direct business relationship with one of the parties that calls intoquestion his or her neutrality [see Commonwealth Coatings Corp. v.Cont’l Cas. Co., 393 U.S. 145, 146-48 (1968); Sphere Drake Ins. Ltd.v. All Am. Life Ins. Co., 307 F.3d 617, 621-23 (7th Cir. 2002); HobetMining, Inc. v. Int’l Union, United Mine Workers, 877 F. Supp. 1011,1021 (S.D. W. Va. 1994)]. Nondisclosure sufficient to vacate anaward usually creates a concrete, and not merely speculative,impression of bias [see Positive Software Solutions, Inc. v. NewCentury Mortgage Corp., 476 F.3d 278, 286 (5th Cir. 2007); Nation-wide Mut. Ins. Co. v. Home Ins. Co., 278 F.3d 621, 626 (6th Cir.2002); Gianelli Money Purchase Plan and Trust v. ADM InvestorServs., Inc., 146 F.3d 1309, 1312-13 (11th Cir. 1998)]. Some courtshave stated that “evident partiality” is present when a reasonableperson would conclude that the arbitrator acted with partiality (butmere unhappiness in or disagreement with the outcome is notequated with the arbitrator’s having acted in a partial manner)[Kaplan v. First Options of Chi., Inc., 19 F.3d 1503, 1523 n.30 (3d Cir.1994), (citations omitted); Lourdes Med. Ctr. of Burlington Countyv. Jnesco, 2007 U.S. Dist. LEXIS 25458, at *24-25 (D.N.J. 2007);Vigorito v. UBS Painewebber, Inc., 477 F. Supp. 2d 481, 486-87 (D.Conn. 2007)].

• “Where the arbitrators were guilty of misconduct in refusing topostpone the hearing, upon sufficient cause shown, or in refusing tohear evidence pertinent and material to the controversy; or of anyother misbehavior by which the rights of any party have beenprejudiced” [9 U.S.C. § 10(a)(3)]. Arbitrators are accorded widelatitude in conducting hearings and are not constrained by formalrules of procedure or evidence [Robbins v. Day, 954 F.2d 679, 685(11th Cir. 1991); for discussions of arbitrators’ broad powers toconduct proceedings, see §§ 40.24, 40.25 and 40.26 above]. Theymay simplify and expedite proceedings, and they are not bound tohear all of the evidence tendered by the parties [PaineWebberGroup, Inc. v. Zinsmeyer Trusts P’ship, 187 F.3d 988, 995 (8th Cir.1999); Robbins v. Day, 954 F.2d 679, 685 (11th Cir. 1992)]. Therefore,an arbitral award will not be vacated unless an error in the arbitralmisconduct deprived a party of a fundamentally fair hearing [ElDorado Sch. Dist. #15 v. Cont’l Cas. Co., 247 F.3d 843, 847-48 (8thCir. 2001); Tempo Shain Corp. v. Bertek, Inc., 120 F.3d 16, 20 (2d Cir.1997)].

• “Where the arbitrators exceeded their powers, or so imperfectlyexecuted them that a mutual, final and definite award upon thesubject matter submitted was not made” [9 U.S.C. § 10(a)(4)]. The

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question whether arbitrators have exceeded their powers focuseson whether the arbitration agreement, or the parties’ submissionsto the panel, gave the arbitrators the power to reach a particularissue [Reliastar Life Ins. Co. of N.Y. v. EMC Nat’l Life Ins. Co., 2007U.S. Dist. LEXIS 9861, at *3-4 (S.D.N.Y. 2007)]. An award will not bevacated for indefiniteness unless it is not sufficiently clear orspecific enough to be enforced if judicially confirmed [IDS Life Ins.Co. v. Royal Alliance Assocs, 266 F.3d 645, 650 (7th Cir. 2001);Certain Underwriters at Lloyd’s v. BCS Ins. Co., 239 F. Supp. 2d 812,816 (N.D. Ill. 2003)].

The burden of proof rests on the party seeking to vacate an arbitral award[Transit Cas. Co. v. Trenwick Reinsurance Co., 659 F. Supp. 1346, 1351(S.D.N.Y. 1987)].

Some courts have determined that an award also may be vacated when anarbitrator exhibits a “manifest disregard of the law” [see Westerbeke Corp.v. Daihatsu Motor Co., Ltd., 304 F.3d 200, 208-09 (2d Cir. 2002); Mich. Mut.Ins. Co. v. Unigard Sec. Ins. Co., 44 F.3d 826, 832 (9th Cir. 1995)], a rule thatcannot be vigorously applied in the teeth of an honorable engagementclause. Courts recognizing this doctrine will not disturb an arbitrator’sinterpretation of the law unless it is clear that the arbitrator “appreciat-ed[d] the existence of a clearly governing legal principle but decided[d] toignore or pay no attention to it” [Merrill Lynch, Pierce, Fenner, & Smith,Inc. v. Bobker, 808 F.2d 930, 933 (2d Cir. 1986). “The error must have beenobvious and capable of being readily and instantly perceived by theaverage person qualified to serve as an arbitrator” [id.]. Other courts haverejected the “manifest disregard of the law” standard as “reflect[ing]precisely that mistrust of arbitration . . . which the [United StatesSupreme] Court [has] criticized” [Baravati v. Josephthal, Lyon & Ross, Inc.,28 F.3d 704, 706 (7th Cir. 1994); see also Robbins v. Day, 954 F.2d 679, 684(11th Cir. 1992)]. The “manifest disregard of the law” standard has notbeen applied so as to vacate a reinsurance arbitration award in anyreported court decision; recent reported cases in both reinsurance andnon-insurance arbitrations should not provide confidence that this veinwill prove to be a particularly promising angle to mine.

Another potential challenge to an arbitral award is the assertion that theaward is contrary to public policy [see United Paperworkers Int’l Union v.Misco, Inc., 484 U.S. 29, 43 (1987); Milwaukee Bd. of Sch. Dirs. v.Milwaukee Teachers’ Educ. Ass’n, 287 N.W.2d 131, 135 (Wis. 1980)]. Moreaction has occurred in the non-insurance context on this argument,especially concerning relationships between employers and employees,health care providers and their members, and other relationships marked

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by imbalances of power such as consumer contracts. This exception to thegeneral deference granted arbitrators is very limited and can succeed onlyif the decision clearly violates explicit, well-defined and dominant publicpolicy that can be easily seen in laws or judicial precedent [CommercialUnion Ins. Co. v. Lines, 378 F.3d 204, 208-09 (2d Cir. 2004); Painewebber,Inc. v. Agron, 49 F.3d 347, 350 (8th Cir. 1995); Seymour v. Blue Cross/BlueShield, 988 F.2d 1020, 1024 (10th Cir. 1993)]. With sophisticated commercialentities on both sides of a reinsurance contract, this style of argument toois unlikely to gain much traction in the absence of some well-ensconcedpublic policy in the state (set forth in statute or prior high court decision).

In the following limited circumstances, a United States court may issue anorder modifying or correcting an arbitral award in order to “effect theintent thereof and promote justice between the parties:”

• “Where there was an evident material miscalculation of figures oran evident material mistake in the description of any person, thingor property referred to in the award;”

• “Where the arbitrators have awarded upon a matter not submittedto them, unless it is a matter not affecting the merits of the decisionupon the matter submitted;” and

• “Where the award is imperfect in matter of form not affecting themerits of the controversy” [9 U.S.C. § 11].

Consider: If the arbitration is conducted under the auspices of anarbitration organization, then the rules of that agency concerningappeals of arbitral awards may apply.

Example: The federal District Court for the District of the Virgin Islandsaffirmed vacatur of an arbitral award where the arbitrator failed topostpone the hearing after a party submitted an amended arbitrationclaim and voluminous supporting documentation 24 hours before thescheduled hearing and denied the opposing party a continuance toinvestigate the amended claim [Coastal Gen. Constr. Servs., Inc. v.Virgin Islands Hous. Auth., 238 F. Supp. 2d 707, 708-10 (D.V.I. 2002)].

Example: The Tennessee Court of Appeals affirmed the trial court’srefusal to vacate an arbitral award on the basis of evident partiality,where the party did not object to or seek clarification of the arbitrator’sdisclosed conflict of interest until after an unfavorable award wasissued [Bailey v. Am. Gen. Life and Accident Ins. Co., 2005 Tenn. App.LEXIS 838, at *27-30 (Tenn. Ct. App. 2005)].

Examples: A federal district court ordered correction of an arbitral

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award to conform the amount of the written award to the amount thepanel had verbally announced [Nationwide Mut. Ins. Co. v. First StateIns. Co., 213 F. Supp. 2d 10, 14-16 (D. Mass. 2002)]. A federal districtcourt remanded the case to the arbitrators with directions to reopenthe proceedings and correct an acknowledged material miscalculation[Laurin Tankers Am., Inc. v. Stolt Tankers, Inc., 36 F. Supp. 2d 645,652-53 (S.D.N.Y. 1999)]. All of these decisions are motivated by adecision to correct an obvious clerical error, rather than to change therelationship between the arbitrating parties following the arbitrationaward.

40.29 ARIAS Forms. The AIDA Reinsurance and Insurance ArbitrationSociety, ARIAS-U.S., is a not-for-profit corporation that promotes theimprovement of the insurance and reinsurance arbitration process for theinternational and domestic markets. ARIAS-U.S. provides training, con-ferences and workshops to educate prospective arbitrators. ARIAS-U.S.also provides a variety of forms related to specific stages of the arbitrationprocess that are referenced in its “Practical Guide to Reinsurance Arbitra-tion Procedure.”

ARIAS-U.S. provides the following forms:

• Application for Certification as an Arbitrator;

• Application for Qualification as Mediator;

• Hold Harmless Stipulation;

• Confidentiality Agreement;

• Confidentiality Affidavit;

• Discovery & Briefing Schedule;

• Order Requiring Respondent to Post Security;

• Umpire Questionnaire [see § 40.47 below];

• Umpire Selection Procedure Request Letter;

• Neutral Selection Questionnaire;

• Neutral Selection Procedure Request Letter;

• Membership Application; and

• Practical Guide to Reinsurance Arbitration Procedure — Complete2004 Revised Edition.

These forms are available on the ARIAS-U.S. website at www.arias-us.org.

Lexis.com Search: For information on international reinsurance issues,

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try this source: Global Reinsurance. Enter specific search terms or dateranges.

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X. FORMS.

40.30 BRMA Reinsuring Clause Form 44 C (Quota Share Agreement).

Use of Form: The wording stipulating the quota share terms is typicallyset forth in the contract’s “Reinsuring Clause,” “Limit and Retention”or “Limit of Liability” clause. Several forms are reprinted from theBrokers and Reinsurance Markets Association (“BRMA”) ContractReference Book, available at http://www.brma.org/frommembers/frommemcontractwd01.htm.

Lexis.com Search: For further jurisdiction-specific forms, please see:ISO Policy Forms. Enter this search request: reinsurance AND [state].

REINSURING CLAUSE

By this Contract the Company obligates itself to cede to the Reinsurer andthe Reinsurer obligates itself to accept % quota share rein-surance of the Company’s net liability under policies, contracts andbinders of insurance or reinsurance (hereinafter called “policies”) in forceat and becoming effective at and after (hour) (date) (year), includingrenewals, and classified by the Company as .

“Net liability” as used herein is defined as the Company’s gross liabilityremaining after cessions, if any, to .

The liability of the Reinsurer with respect to each cession hereunder shallcommence obligatorily and simultaneously with that of the Company,subject to the terms, conditions and limitations hereinafter set forth.

40.31 BRMA Reinsuring Clause Form 44 B (Surplus Share Agreement).

Use of Form: The details of a surplus share agreement are usuallycontained in the “Reinsuring Clause,” the “Cessions and Limits” or the“Business Covered” clause of the contract.

REINSURING CLAUSE

The Company shall cede to the Reinsurer and the Reinsurer shall acceptfrom the Company 100% of the first surplus liability, as hereinafterdefined, of the Company on risks insured under policies in force at orbecoming effective or renewed at and after hour (date) (year), covering thelines of business set forth below, subject to the terms, conditions andlimitations hereinafter set forth:

LINES OF BUSINESS

A.

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B

C

A policy written on an installment premium, report from or continuousbasis shall be considered renewed as of the end of each annual periodcommencing with the caption date of the policy.

The term “policies” as used herein means the Company’s binders, policiesand contracts providing insurance and reinsurance on the lines of businesscovered under this Contract.

40.32 BRMA Reinsuring Clause Form 61 C (Excess of Loss Agreement).

Use of Form: The clause defining an excess of loss agreement can becalled the “Reinsuring Clause,” “Cover Clause,” “Business ReinsuredClause” or “Application of Agreement Clause,” and it sets forth thetype of business covered and the method of determining whether aloss falls within the scope of the agreement. “Excess liability” shouldbe defined in the contract.

REINSURING CLAUSE

“By this Contract the Reinsurer agrees to reinsure the excess liability thatmay accrue to the Company under its policies, contracts and binders ofinsurance or reinsurance (referred to herein as “policies”) in force at theeffective date hereof or issued or renewed on or after that date, andclassified by the Company as , subject to the terms, condi-tions an limitations hereafter set forth.”

40.33 BRMA Unauthorized Reinsurance Clause Form 55 A.

Use of Form: This form applies only to a reinsurer that does not qualifyfor full credit with any insurance regulatory authority having jurisdic-tion over the company’s reserves. The form covers unearned premium,outstanding losses and incurred but not reported reserves (“IBNR”).

UNAUTHORIZED REINSURANCE

As regards policies or bonds issued by the Company coming within thescope of this Contract, the Company agrees that when it shall file with theinsurance regulatory authority or set up on its books reserves forunearned premium and losses covered hereunder which it shall berequired by law to set up, it will forward to the Reinsurer a statementshowing the proportion of such reserves applicable to the Reinsurer. TheReinsurer hereby agrees to fund such reserves in respect of unearnedpremium, known outstanding losses that have been reported to the

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Reinsurer and allocated loss adjustment expense relating thereto, lossesand allocated loss adjustment expense paid by the Company but notrecovered from the Reinsurer, plus reserves for losses incurred but notreported, as shown in the statement prepared by the Company (hereinaf-ter referred to as “Reinsurer’s Obligations”) by funds withheld, cashadvances or a Letter of Credit. The Reinsurer shall have the option ofdetermining the method of funding provided it is acceptable to theinsurance regulatory authorities having jurisdiction over the Company’sreserves.

When funding by a Letter of Credit, the Reinsurer agrees to apply for andsecure timely delivery to the Company of a clean, irrevocable andunconditional Letter of Credit issued by a bank and containing provisionsacceptable to the insurance regulatory authorities having jurisdiction overthe Company’s reserves in an amount equal to the Reinsurer’s proportionof said reserves. Such Letter of Credit shall be issued for a period of notless than one year and shall be automatically extended for one year fromits date of expiration or any future expiration date unless thirty (30) days(sixty (60) days where required by insurance regulatory authorities) priorto any expiration date the issuing bank shall notify the Company bycertified or registered mail that the issuing bank elects not to consider theLetter of Credit extended for any additional period.

The Reinsurer and Company agree that the Letters of Credit provided bythe Reinsurer pursuant to the provisions of this Contract may be drawnupon at any time, notwithstanding any other provision of this Contract,and be utilized by the Company or any successor, by operation of law, ofthe Company including, without limitation, any liquidator, rehabilitator,receiver or conservator of the Company for the following purposes, unlessotherwise provided for in a separate Trust Agreement:

(a) to reimburse the Company for the Reinsurer’s Obligations, thepayment of which is due under the terms of this Contract and which hasnot been otherwise paid;

(b) to make refund of any sum which is in excess of the actual amountrequired to pay the Reinsurer’s Obligations under this Contract;

(c) to fund an account with the Company for the Reinsurer’s Obligations.Such cash deposit shall be held in an interest bearing account separatefrom the Company’s other assets, and interest thereon not in excess of theprime rate shall accrue to the benefit of the Reinsurer; and

(d) to pay the Reinsurer’s share of any other amounts the Company claimsare due under this Contract.

In the event the amount drawn by the Company on any Letter of Credit

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is in excess of the actual amount required for (a) or (c), or in the case of (d),the actual amount determined to be due, the Company shall promptlyreturn to the Reinsurer the excess amount so drawn. All of the foregoingshall be applied without diminution because of insolvency on the part ofthe Company or the Reinsurer.

The issuing bank shall have no responsibility whatsoever in connectionwith the propriety of withdrawals made by the Company or the disposi-tion of funds withdrawn, except to ensure that withdrawals are made onlyupon the order of properly authorized representatives of the Company.

At annual intervals, or more frequently as agreed but never morefrequently than quarterly, the Company shall prepare a specific statementof the Reinsurer’s Obligations, for the sole purpose of amending the Letterof Credit, in the following manner:

(a) If the statement shows that the Reinsurer’s Obligations exceed thebalance of credit as of the statement date, the Reinsurer shall, within thirty(30) days after receipt of notice of such excess, secure delivery to theCompany of an amendment to the Letter of Credit increasing the amountof credit by the amount of such difference.

(b) If, however, the statement shows that the Reinsurer’s Obligations areless than the balance of credit as of the statement date, the Company shall,within thirty (30) days after receipt of written request from the Reinsurer,release such excess credit by agreeing to secure an amendment to theLetter of Credit reducing the amount of credit available by the amount ofsuch excess credit.

40.34 BRMA Insolvency Clause Form 19 M.

Use of Form: This Article contains “payable on demand” language inthe first sentence. Note that it also contains the word “or” rather than“and” in the second sentence after “New York Insurance Law,” thusmaking the exceptions to the direct payments to the Company (or itsliquidator, receiver, conservator or statutory successor) independent ofeach other. The Offset provision in the final paragraph is for thisContract only.

INSOLVENCY

In the event of the insolvency of the Company, reinsurance under thisContract shall be payable on demand, with reasonable provision forverification, on the basis of claims allowed against the insolvent Companyby any court of competent jurisdiction or by any liquidator, receiver,conservator or statutory successor of the Company having authority to

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allow such claims, without diminution because of such insolvency orbecause such liquidator, receiver, conservator or statutory successor hasfailed to pay all or a portion of any claims. Such payments by theReinsurer shall be made directly to the Company or its liquidator, receiver,conservator or statutory successor, except as provided by Section 4118(a)of the New York Insurance Law or except (a) where the Contractspecifically provides another payee of such reinsurance in the event of theinsolvency of the Company, or (b) where the Reinsurer with the consent ofthe direct insured or insureds has assumed such policy obligations of theCompany as direct obligations of the Reinsurer to the payees under suchpolicies and in substitution for the obligations of the Company to suchpayees.It is agreed, however, that the liquidator, receiver, conservator or statutorysuccessor of the insolvent Company shall give written notice to theReinsurer of the pendency of a claim against the insolvent Company onthe policy or policies reinsured within a reasonable time after such claimis filed in the insolvency proceeding and that during the pendency of suchclaim the Reinsurer may investigate such claim and interpose, at its ownexpense, in the proceeding where such claim is to be adjudicated, anydefense or defenses which it may deem available to the Company or itsliquidator, receiver, conservator or statutory successor. The expense thusincurred by the Reinsurer shall be chargeable, subject to court approval,against the insolvent Company as part of the expense of liquidation to theextent of a proportionate share of the benefit which may accrue to theCompany solely as a result of the defense undertaken by the Reinsurer.Where two or more reinsurers are involved in the same claim and amajority in interest elect to interpose defense to such claim, the expenseshall be apportioned in accordance with the terms of this Contract asthough such expense had been incurred by the insolvent Company.Should the Company go into liquidation or should a receiver or conser-vator be appointed, all amounts due either Company or Reinsurer,whether by reason of premium, losses or otherwise under this Contract,shall be subject to the right of offset at any time and from time to time, andupon the exercise of the same, only the net balance shall be due.

40.35 BRMA Offset Clause Form 36 A.

Use of Form: This is a broad offset clause which permits offset ofmutual debits and credits across all existing and future reinsuranceagreements.

OFFSETThe Company and the Reinsurer may offset any balance or amount due

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from one party to the other under this Contract or any other contractheretofore or hereafter entered into between the Company and theReinsurer, whether acting as assuming reinsurer or ceding company. Thisprovision shall not be affected by the insolvency of either party to thisContract.

40.36 BRMA Loss Notice Clause Form 26 B.

Use of Form: This clause requires the ceding company to provideprompt notice of losses and of all subsequent developments.

LOSS NOTICE

The Company shall advise the Reinsurer promptly of all losses which, inthe opinion of the Company, may result in a claim hereunder and ofsubsequent developments thereto which, in the opinion of the Company,may materially affect the position of the Reinsurer.

40.37 Notice of Loss Clause Incorporating Right to Associate.

Use of Form: This notice of loss clause incorporates the reinsurer’s rightto associate in the defense of any claim.

Source of Form: This wording is provided in the Business InsuranceLaw and Practice Guide § 14.08[7] (LexisNexis).

NOTICE OF LOSS

Prompt notice shall be given to the Reinsurer by the Company of anyoccurrence or accident which appears likely to involve this reinsuranceand, while the Reinsurer does not undertake to investigate or defendclaims or suits, it shall nevertheless have the right and be given theopportunity to associate with the company and its representatives at theReinsurer’s expense in the defense and control of any claim, suit orproceeding involving this reinsurance, with the full cooperation of theCompany.

40.38 BRMA Loss Notice Clause Form 26 A.

Use of Form: This clause specifies that prompt notice to the reinsurer isa condition precedent to recovery.

LOSS NOTICE

As a condition precedent to recovery hereunder, the Company shall advisethe Reinsurer promptly of all losses which, in the opinion of the Company,may result in a claim hereunder and of all subsequent developmentsthereto which, in the opinion of the Company, may materially affect the

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position of the Reinsurer.

40.39 BRMA Access to Records Clause Form 1 B.

Use of Form: This clause allows the reinsurer or its representative broadaccess to all matters relating to the reinsurance at all reasonable times.

ACCESS TO RECORDS

The Reinsurer or its designated representatives shall have free access tothe books and records of the Company on matters relating to thisreinsurance at all reasonable times for the purpose of obtaining informa-tion concerning this Contract or the subject matter hereof.

40.40 BRMA Confidentiality Clause Form 69 D.

Use of Form: This clause can be used in conjunction with or added asa paragraph of an access to records clause. It allows informationsharing with other entities if prior consent is obtained.

CONFIDENTIALITY

The Reinsurer, except with the express prior written consent of theCompany, shall not directly or indirectly communicate, disclose or divulgeto any third party any knowledge or information that may be acquiredeither directly or indirectly as a result of the inspection of the Company’sbooks, records and papers. The restrictions as outlined in this Article shallnot apply to communications or disclosures that the Reinsurer is requiredto make to its statutory auditors, retrocessionaires, legal counsel orarbitrators involved in any arbitration procedures under this Contract, orto disclosures required under subpoena or other duly-issued order of acourt or other governmental agency or regulatory authority.

40.41 BRMA Claims Cooperation Clause Form 8 A.

Use of Form: This is a stand-alone claims cooperation clause. Otherclauses, in conjunction with the notice of loss provision or separately,include an admonition that the reinsured (not the reinsurer) has a dutyto investigate and defend a claim.

CLAIMS COOPERATION

When so requested in writing, the Company shall afford the Reinsurer orits representatives an opportunity to be associated with the Company, atthe expense of the Reinsurer, in the defense of any claim, suit orproceeding involving this reinsurance, and the Company and the Rein-surer shall cooperate in every respect in the defense of such claim, suit or

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proceeding.

40.42 BRMA Excess of Original Policy Limits Clause Form 15 A.

Use of Form: This clause is for use in excess of loss contracts where thepercentage of coverage provided for XPL is specified in the UltimateNet Loss article of the contract.

EXCESS OF ORIGINAL POLICY LIMITS

This Contract shall protect the Company, within the limits hereof, inconnection with ultimate net loss in excess of the limit of its original policy,such loss in excess of the limit having been incurred because of failure byit to settle within the policy limit or by reason of alleged or actualnegligence, fraud or bad faith in rejecting an offer of settlement or in thepreparation of the defense or in the trial of any action against its insuredor reinsured or in the preparation or prosecution of an appeal consequentupon such action.

However, this Article shall not apply where the loss has been incurred dueto fraud by a member of the Board of Directors or a corporate officer of theCompany acting individually or collectively or in collusion with anyindividual or corporation or any other organization or party involved inthe presentation, defense or settlement of any claim covered hereunder.

For the purpose of this Article, the word “loss” shall mean any amountsfor which the Company would have been contractually liable to pay hadit not been for the limit of the original policy.

40.43 BRMA Extra Contractual Obligations Clause Form 16 D.

Use of Form: This clause is for use in a reinsurance contract where thepercentage of coverage provided for ECO is specified elsewhere in thecontract. Insurance or other reinsurance recoveries, which protect theCompany for ECO, shall be deducted when determining the total ECOloss under this reinsurance contract.

EXTRA CONTRACTUAL OBLIGATIONS

A. “Extra Contractual Obligations” are defined as those liabilities notcovered under any other provision of this Contract and whicharise from the handling of any claim on business covered here-under, such liabilities arising because of, but not limited to, thefollowing: failure by the Company to settle within the policylimit, or by reason of alleged or actual negligence, fraud or badfaith in rejecting an offer of settlement or in the preparation of thedefense or in the trial of any action against its insured or

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reinsured or in the preparation or prosecution of an appealconsequent upon such action.

B. The date on which an Extra Contractual Obligation is incurred bythe Company shall be deemed, in all circumstances, to be the dateof the original accident, casualty, disaster or loss occurrence.

C. However, coverage hereunder as respects Extra Contractual Ob-ligations shall not apply where the loss has been incurred due tothe fraud of a member of the Board of Directors or a corporateofficer of the Company acting individually or collectively or incollusion with any individual or corporation or any other orga-nization or party involved in the presentation, defense or settle-ment of any claim covered hereunder.

D. Recoveries from any other form of insurance or reinsurance,which protects the company against claims the subject matter ofthis Article, shall inure to the benefit of the Reinsurer.

40.44 BRMA Intermediary Clause Form 23 A.

Use of Form: This typical intermediary clause creates an exception tothe usual agency relationship between an intermediary and thereinsured and places the credit risk of the intermediary on thereinsurer.

INTERMEDIARY

(Intermediary Name) is hereby recognized as the Intermediary negotiatingthis Contract for all business hereunder. All communications (includingbut not limited to notices, statements, premium, return premium, com-missions, taxes, losses, loss adjustment expense, salvages and losssettlements) relating thereto shall be transmitted to the Company or theReinsurer through (Intermediary Name and Address). Payments by thecompany to the Intermediary shall be deemed to constitute payment to theReinsurer. Payments by the Reinsurer to the Intermediary shall be deemedto constitute payment to the Company only to the extent that suchpayments are actually received by the Company.

40.45 BRMA Arbitration Clause Form 6 A.

Use of Form: This clause defines arbitrable matters as “any dispute orother matter in question between the Company and the Reinsurerarising out of, or relating to, the formation, interpretation, perfor-mance, or breach of this Contract.” This language is intended to grantarbitrators broad authority to hear disputes that could arise under or

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with respect to the contract, including disputes relating to the forma-tion and validity of the arbitration clause. The second paragraphaddresses the situation where more than one reinsurer has taken thesame position with respect to a dispute with the cedent. Under thiswording, the reinsurers must consolidate and act jointly for thepurposes of the arbitration. Parties seeking to avoid mandatoryconsolidation in the event of a dispute can substitute the phrase “mayconsolidate” for “shall consolidate.” This clause also expressly permitsthe parties to agree upon a different location for the hearing from thatwhich is specified. In addition, it provides that “[j]udgment on theaward may be entered in any court having jurisdiction thereof,” whichparaphrases the language of the FAA, 9 U.S.C § 9, authorizing certaincourts to confirm an award.

ARBITRATION

Any dispute or other matter in question between the Company and theReinsurer arising out of, or relating to, the formation, interpretation,performance or breach of this Contract, whether such dispute arises beforeor after termination of this Contract, shall be settled by arbitration.Arbitration shall be initiated by the delivery of a written notice of demandfor arbitration by one party to the other within a reasonable time after thedispute has arisen.

If more than one reinsurer is involved in the same dispute, all suchreinsurers shall constitute and act as one party for the purposes of thisArticle, provided, however, that nothing herein shall impair the rights ofsuch reinsurers to assert several, rather than joint, defenses or claims, norbe construed as changing the liability of the Reinsurer under the terms ofthis Contract from several to joint.

Each party shall appoint an individual as arbitrator and the two soappointed shall then appoint a third arbitrator. If either party refuses orneglects to appoint an arbitrator within sixty (60) days, the other partymay appoint the second arbitrator. If the two arbitrators do not agree ona third arbitrator within sixty (60) days, of their appointment, each of thearbitrators shall nominate three individuals. Each arbitrator shall thendecline two of the nominations presented by the other arbitrator. The thirdarbitrator shall then be chosen from the remaining two nominations bydrawing lots. The arbitrators shall be active or retired officers of insuranceor reinsurance companies or Lloyd’s London Underwriters; the arbitratorsshall not have a personal or financial interest in the result of thearbitration.

The arbitration hearings shall be held in (City, State), or such other place

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as may be mutually agreed. Each party shall submit its case to thearbitrators within sixty (60) days of the selection of the third arbitrator orwithin such longer period as may be agreed by the arbitrators. Thearbitrators shall not be obliged to follow judicial formalities or the rules ofevidence except to the extent required by governing law, that is, the stateof the situs of the arbitration as herein agreed; they shall make theirdecisions according to the practice of the reinsurance business. Thedecision rendered by a majority of the arbitrators shall be final andbinding on both parties. Such decision shall be a condition precedent toany right of legal action arising out of the arbitrated dispute which eitherparty may have against the other. Judgment upon the award renderedmay be entered in any court having jurisdiction thereof.

40.46 BRMA Arbitration Clause Form 6 E.

Use of Form: The third paragraph includes the phrase “[a]ll arbitratorsshall interpret this Contract as an honorable engagement rather than asmerely a legal obligation,” which has been included in arbitrationclauses for decades and is sometimes a subject of debate among partiesto reinsurance agreements [for a discussion of the meaning and importof “honorable engagement” language, see § 40.24].

ARBITRATION

As a precedent to any right of action hereunder, if any differences shallarise between the contracting parties with reference to the interpretation ofthis Contract or their rights with respect to any transaction involved,whether arising before or after termination of this Contract, such differ-ences shall be submitted to arbitration upon the written request of one ofthe contracting parties.

Each party shall appoint an arbitrator within thirty (30) days of beingrequested to do so, and the two named shall select a third arbitrator beforeentering upon the arbitration. If either party refuses or neglects to appointan arbitrator within the time specified, the other party may appoint thesecond arbitrator. If the two arbitrators fail to agree on a third arbitratorwithin thirty (30) days of their appointment, each of them shall name threeindividuals, of whom the other shall decline two, and the choice shall bemade by drawing lots. All arbitrators shall be active or retired disinter-ested officers of insurance or reinsurance companies or Underwriters atLloyd’s London, not under the control of either party to this Contract.

Each party shall submit its case to its arbitrator within thirty (30) days ofthe appointment of the third arbitrator or within such period as may beagreed by the arbitrators. All arbitrators shall interpret this Contract as an

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honorable engagement rather than as merely a legal obligation. They arerelieved of all judicial formalities and may abstain from following thestrict rules of law. They shall make their award with a view to effecting thegeneral purpose of this Contract in a reasonable manner rather than inaccordance with a literal interpretation of the language.

The decision in writing of any two arbitrators, when filed with thecontracting parties, shall be final and binding on both parties. Judgmentupon the award rendered may be entered in any court having jurisdictionthereof. Each party shall bear the expense of its own arbitrator and shalljointly and equally bear with the other party the expense of the thirdarbitrator and of the arbitration. In the event that two arbitrators arechosen by one party as above provided, the expense of the arbitrators andthe arbitration shall be equally divided between the two parties. Anyarbitration shall take place in the city in which the Company’s Head Officeis located unless some other place is mutually agreed upon by thecontracting parties.

40.47 ARIAS-U.S. Umpire Questionnaire Sample Form 2.1.

Use of Form: The AIDA Reinsurance and Insurance Arbitration Society,ARIAS-U.S., certifies a pool of qualified arbitrators and serves as aresource for parties involved in a dispute to find the appropriatepersons to resolve the matter in a professional, knowledgeable andcost-effective manner. It is common practice for nominated panelmembers to disclose their contacts with the parties (and their counseland any known witnesses) in the business world and in priorarbitrations, and with the particular contracts involved in the dispute.This proposed disclosure form designed for umpire candidates in-cludes a variety of questions that may or may not serve as a basis todisqualify a panel member. This form can be tailored for party-arbitrators if the parties so desire.

UMPIRE QUESTIONNAIRE

In the Matter of the Arbitration Between

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,

Petitioner,

- and -

,Respondent

⎫⎪⎪⎬⎪⎪⎭

UMPIRE QUESTIONNAIRE

To help the parties evaluate the qualifications of umpire nominees in theabove-captioned arbitration, and to identify any potential conflict ofinterest, please supply the following information:

1.Name:Company:Address:Telephone:Fax:Cell Phone:Email:Home Address:Telephone:

2. EMPLOYMENT HISTORY (please attach a current résumé or CV).

A. Current Employment (if not apparent from the attached résumé or CV)

Position Title:

Length of Employment:

Principal Duties:

B. PAST QUALIFYING EMPLOYMENT (if not currently an officer of aninsurance or reinsurance company [or an Underwriter at Lloyd’s ofLondon] and if not apparent from the attached résumé or CV)._____________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

3. Please provide a copy of your current fee schedule, including anyrefundable or non-refundable retainer.

4. INSURANCE ARBITRATION EXPERIENCE

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Have you previously participated as an arbitrator or umpire in connectionwith insurance disputes?

[ ] Yes [ ] No

If yes, please set forth:

Number of appearances as an umpire:__________________________________________________________________________________________________________________________________

Number of appearances as an arbitrator:__________________________________________________________________________________________________________________________________

5. REINSURANCE ARBITRATION EXPERIENCE

Have you previously participated as an arbitrator or umpire in connectionwith reinsurance disputes?

[ ] Yes [ ] No

If yes, please set forth:

Number of appearances as an umpire:__________________________________________________________________________________________________________________________________

Number of appearances as an arbitrator:__________________________________________________________________________________________________________________________________

6. POTENTIAL CONFLICTS

A. Are you presently or have you ever been an employee, officer, director,shareholder, agent or consultant of any of the parties listed below, or of theparties’ subsidiaries, affiliates or parent companies? [List of all applicableparties, subsidiaries, affiliates and parent companies]

[ ] Yes [ ] No

If yes, please explain.____________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

B. Have you ever served as an arbitrator, umpire, attorney or expertwitness in a matter involving any of the parties listed above or anysubsidiaries, affiliates or parent companies of such parties?

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[ ] Yes [ ] No

If yes, please explain.____________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

C. Have you ever had any involvement in an insurance or reinsurancetransaction or dispute involving any of the parties, or involving suchparties’ subsidiaries, affiliates or parent companies?

[ ] Yes [ ] NoIf yes, please explain.____________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________D. Have you ever had any involvement in an insurance or reinsurancetransaction or dispute involving any of the specific claims, policies and/ortreaties at issue in this matter as described in Question 8 below?[ ] Yes [ ] No__________________________________________________________________________________________________________________________________If yes, please explain.____________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________E. To your knowledge, do any companies with which you are presentlyaffiliated or in which you presently have a financial interest have anongoing business relationship with any of the parties and/or affiliateslisted above?[ ] Yes [ ] NoIf yes, please explain.____________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

EXPERIENCE WITH OTHER PANEL MEMBERS AND PARTIES’COUNSEL

A. Have you ever served on an arbitration panel with

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?Name of Arbitrator

[ ] Yes [ ] No

If yes, for each such arbitration, state the approximate date of commence-ment and termination (or whether still pending) and the respectivecapacities in which you and acted, i.e., asarbitrator or umpire.___________________________________________________________________________________________________________________________________________________________________________________________________

B. Have you ever served on an arbitration panel with?

Name of Arbitrator

[ ] Yes [ ] No

If yes, for each such arbitration, state the approximate date of commence-ment and termination (or whether still pending) and the respectivecapacities in which you and acted, i.e., asarbitrator or umpire.___________________________________________________________________________________________________________________________________________________________________________________________________

C. Have you ever served as an arbitrator, umpire, expert witness orconsultant in an arbitration or litigation at the request of any counselinvolved in this arbitration? [List counsel for all parties]

[ ] Yes [ ] No

If yes, identify counsel and disclose type of service and approximate dateso engaged.___________________________________________________________________________________________________________________________________________________________________________________________________

D. Have you ever served as an arbitrator, umpire, expert witness orconsultant in an arbitration or litigation in which any of the above-listedcounsel represented a party?

[ ] Yes [ ] No

If yes, identify counsel and disclose type of service and approximate dateso engaged._________________________________________________________________

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__________________________________________________________________________________________________________________________________

8. SUBJECT MATTER OF THE ARBITRATION

This arbitration involves [insert a neutral description of the disputebetween the parties]___________________________________________________________________________________________________________________________________________________________________________________________________

Might these facts or circumstances prevent you from rendering anunbiased decision in this arbitration?

[ ] Yes [ ] No

If yes, please explain.___________________________________________________________________________________________________________________________________________________________________________________________________

9. OTHER CONSIDERATIONS

Are you aware of any facts or circumstances which (1) might impair yourability to serve (including schedule availability) or (2) might create anappearance of partiality on your part in the above-captioned arbitration?

[ ] Yes [ ] No

If yes, please explain.___________________________________________________________________________________________________________________________________________________________________________________________________

Signature:Date:

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