9/11 Highlights Need To Improve Conduct Of Reinsurance Business

The Sept. 11 tragedies touched virtually every fabric of our society, and the world of reinsurance is no exception. Relationships between cedent and reinsurer appear to be strained and worsening, and each player is focusing on its own respective liabilities associated with those unanticipated and tragic events.

In times such as these, reinsurance professionals ought to realize the need to pay closer attention to the way our industry conducts its business. Unexpected losses of huge magnitude can send normally amicable business partners running to attorneys to find ways to avoid liabilities that threaten to alter the fortunes of even well-established, risk-bearing entities.

Even in the world of reinsurance, where parties recognize duties of utmost good faith to one another, those who face the threat of financial ruin sometimes allow their parochial interests to overtake the spirit of the contract they struck.

In the ordinary course of the business of reinsurance, the risk of multi-millions of dollars of loss is routinely spread among insurers, reinsurers and retrocessionaires throughout the world, pursuant to documentation that is at times surprisingly vague, incomplete and uncertain in common understanding.

The principals, their managing agents, consultants, intermediaries and brokers, with varying degrees of competence, play roles in effecting and administering these contracts and overseeing these relationships. Expectations that parties to the transactions will honor their obligations are based upon the premise that all parties mutually understand and accept the terms of the deal.

Unless a major loss hits, those expectations and that premise may never be tested. Sept. 11 ensured that tests would occur.

Reinsurers and retrocessionaires routinely follow the fortunes of their cedents whose decisions as to claims adjudication have been made in good faith and pursuant to reasonable investigations.

However, a retrocessionaire faced with a request to reimburse its retrocedent for $135 million may apply a different degree of scrutiny than one asked to pay $2 million. The relatively larger claim may give rise to an inquiry as to the appropriate documentation traced all the way back to the claim payment under the policies originally insured where the risk transfer process started.

If the documentation is not clear and consistent, parties in the midst of the risk transfer process may find themselves obligated to reimburse claims payments, but held at the mercy of their own protecting reinsurers' conditions for reimbursement.

An example of this dilemma may be helpful. Imagine a reinsurance agreement under which the reinsurer has agreed to fund claims payments of its cedent in advance, upon simple notification of the fact of a claim. Such provisions are not uncommon. While the reinsurer certainly will have audit rights to confirm the appropriateness of the cedent's claims action, the reinsurance agreement may require immediate payment and permit limited recourse to challenge the cedent's actions.

The reinsurer's protecting retrocessional agreements may not always provide “back to back” terms and conditions as to the policies they protect.

If the retrocessionaire is entitled to require sufficient information to verify the appropriateness of payment under the “original policy,” or under similar wording, the retrocessionaire may be entitled to hold up its reimbursement until its retrocedent (i.e., the reinsurer with respect to the underlying policy) submits documentation to support the underlying claims action. That information may not have even been required to be submitted to the retrocedent under the underlying reinsurance agreement.

Reinsurers and retrocessionaires that suddenly wake up to unexpected large loss reimbursement requests may seek detailed substantiation of the claim, whether or not such documentary support had been intended by the parties or practiced in the past.

If the parties have not incorporated a clear claims adjudication protocol as part of the understanding of the conditions of reinsurance, there may be uncertainty as to the circumstances when the retrocessionaire's payment is required to be forthcoming.

Retrocessionaires may prepare laundry lists of documentation requirements to be satisfied prior to honoring claims payment requests. While cedents may object to those documentation requests, especially if similar requests had not been part of the prior course of conduct of the parties, the likely result would be, at a minimum, delay in realizing retrocessional recoveries.

The consequences may even be more troublesome: the documentation, once supplied, may indicate serious defects in the primary carrier's claims adjudication that may justify the retrocessionaire's avoidance of liability.

A solution to this problem–and a way to avoid unnecessary disagreements between parties to reinsurance agreements–is for each party to pay more attention to the documentation of the reinsurance transaction from the outset, and to its own operating procedures.

Cedents ought to take care to ensure that the package presented to reinsurers when reinsurance protection is initially sought is complete and sets forth all the important terms of the intended transaction. Ideally, that complete package would include a claims adjudication protocol that would specify the steps followed in determining when a claim payment under a reinsured contract is cleared for payment.

That protocol should reflect the actual practices of the cedent, and it ought not to be inconsistent with the prior dealings between the parties. A properly drafted protocol would articulate the claim adjuster's professional discretion in making the claims adjudication decision and specifically permit the claims handler to select from the itemized list of protocol procedures for use in individual claims.

The prospective reinsurer would be asked to accept that protocol as part of the documentation underlying the reinsurance agreement. The reinsurer would have the opportunity to determine whether the protocol is satisfactory before signing off. Then both parties should ensure that their claims and reimbursement procedures are carefully followed.

Additionally, all the reinsurance documentation should be consistent with the parties' understanding of the transaction. Often placement slips and contract wordings are created by brokers and intermediaries that use form documents not tailored to the specific transaction or the understandings of the contracting parties.

The documents can create gaps in coverage and misunderstandings and ambiguities where they may not otherwise exist or could easily be avoided. For example, a “boilerplate” integration clause should not be used if the parties intend to incorporate their underwriting guidelines, claims protocol, or any other such procedure as part of the reinsurance agreement.

If the understanding of the parties to a retrocessional agreement is that the retrocedent's disclosure obligation is limited to supporting the claim reimbursement made under the contract retroceded (and not also supporting the underlying policy action), then the documents ought to reflect that intent.

Managers, brokers and intermediaries often handle not only communications between the principals but also the flow of funds exchanged pursuant to reinsurance agreements. Such critical events as timely payment of premiums, prompt notice of claims, reimbursement of claims, application of setoffs, and notice of corporate rating changes or insolvency are frequently in the hands of these third parties.

The responsiveness and quality of service of these entities vary considerably throughout the industry. Typically, the intermediary or manager's pockets are far shallower than those of its principals, and errors and omissions insurance coverage is rarely sufficient to cover the liability that may arise where multi-millions of dollars change hands.

For example, a reinsurer may have a defense to its $100 million obligation to protect its cedent under an excess-of-loss treaty by reason of late claim notice or non-payment of premiums for which the broker is responsible. The exposure assumed by the parties may not match their respective protections.

Perhaps the reinsurance community should view Sept. 11 as a wakeup call to get its house in order. Our industry has been steadily becoming less and less a world of handshake agreements and more and more one in which the letter of the law governs.

If greater attention–prior to reinsurance contract formation–were placed on comprehensive underwriting audits, agreement as to administration, intermediary responsibility, claims adjudication process, and proper documentation of the parties' intentions, there may be less of a need for dispute resolution after the losses hit.

Jack R. Scott is counsel for White and Williams LLP in Philadelphia and a member of the firm's Reinsurance Practice Group. The views expressed in this article are not necessarily those of the firm or any of its clients.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, September 16, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.

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9/11 Highlights Need To Improve Conduct Of Reinsurance Business

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