October 21st, 2013

When Contract Certainty Isn’t So Certain

Posted at 1:00 AM ET

Richard Banyard, Senior Vice President, Lance Finley, Managing Director, Jane Furnas, Senior Vice President and Scott VanKoughnett, Senior Vice President

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Insurance policies are carefully drafted to outline coverage that is needed by policyholders while also specifying those areas where coverage is not expected to apply - the goal is to provide contract certainty, not in the usual sense of timeliness of contract signing, but from the perspective of specific policy language.  Sometimes, however, contract certainty is not so certain.  Recent examples have shown that insurers are increasingly facing reinterpretations of their policies by the judicial system, regulators, politicians and even the public via social media, all exerting pressure on insurers to provide coverage not previously anticipated by the drafters and underwriters of those policies.  As these claims are presented to the reinsurance market, pressure is also put on reinsurers to provide coverage that they may not have originally contemplated.  Insurers need to know that their reinsurers partner with them in such situations, and that reinsurance contracts provide appropriate flexibility to help ensure the reinsurers’ promise to pay.  The comments made in this article are intended solely to foster discussion on this topic.

Let’s examine some recent situations where contract certainty has proved to be not so certain:

  • Sandy

While hurricane deductibles were not triggered based on strict interpretation of policy language, political leaders in the states impacted by this storm sought to pre-empt any potential application of these deductibles through the issuance of “no-hurricane-deductibles-for-Sandy” decrees.

The issue of storm surge, and whether this fell within policy exclusions for flood, caused a huge public outcry and in response the Mississippi Attorney General sued several insurance companies to force them to pay for storm surge damage.

  • Queensland Floods

A number of Australian homeowners felt they were subject to the fine print of the policy on whether coverage was excluded as a result of flood.  Political leaders expected insurance companies to act with compassion in settling claims, despite any policy exclusions.  Social media was also used to identify insurers who were perceived to be not properly paying claims.

  • Thailand Floods

The impact of the floods on manufacturing and retail throughout the world as a result of contingent business interruption was enormous.  The judicial reinterpretation of policies with regard to suppliers has brought unexpected outcomes as courts wrestle with exclusions and sublimits when any part of the causal chain involves an excluded or limited peril.

How Reinsurance Can Help In Times of Contract Uncertainty

While reinsurance contracts, like insurance policies, contain specific provisions intended to outline both the coverage being provided as well as those areas where coverage is specifically excluded, reinsurance is like a partnership. Reinsurance has a degree of flexibility built into many reinsurance contracts to provide coverage when the ceding insurer is faced with situations such as those noted above.  Some of these contract provisions include:

“Follow The Fortunes”

Reinsurance contracts will often include language that underscores the principle that the reinsurance contract is to follow the terms, and often the interpretations, of the insurance policies that are subject to coverage.  Still other versions include language specifically stating that the reinsurer is to “follow the fortunes” of the ceding insurer, intertwining the fate of the reinsurer with that of the ceding insurer in the event of loss.  Some courts have even implied this concept when it is not specifically included in the contract, as part of industry custom and practice.  These provisions are commonly looked to when insurance coverage is extended to situations not originally foreseen.

Indemnification

Some contracts will include what are known as indemnification provisions.  These provisions reinforce that the ceding insurer is the sole judge as to its liability under each claim, and the amount to be paid for that claim, and that the reinsurer is bound by the judgment of the ceding insurer.  Such provisions help clarify that the ceding insurer is the best judge as to its liabilities, even in situations where coverage may not be absolutely clear.

Loss Settlements

While some reinsurance contracts provide coverage only for those settlements made in accordance with the conditions outlined in the policy, still other reinsurance contracts include more flexible provisions stating that the ceding insurer has full discretion in settling its claims, and that settlements made by the insurer whether under strict policy terms and conditions or by way of compromise, are binding on the reinsurer.

In the wake of Sandy, the high-profile nature of the event produced both commercial and regulatory pressure for prompt claim settlements, which in turn created liquidity concerns for ceding insurers.  Reinsurers often went beyond their strict contractual obligations in order to pay loss recoveries to their ceding insurers, in many cases paying claims in advance of original settlements based on estimates of losses that would be paid in the near future.  Similarly, reinsurers will sometimes agree to partner with ceding insurers and cover ex gratia settlements for the good of the insurer, with the additional impact of enhancing the image of the industry.

While each reinsurance contract stands on its own, and will respond uniquely to the claims that are presented to it based on the facts of the particular claim, provisions such as those discussed above help to solidify the relationship between the ceding insurer and its reinsurers and facilitate reinsurance recoveries in those situations where the insurer finds that contract certainty is not so certain.

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The information contained herein is based on sources we believe reliable, but we do not guarantee its accuracy, and it should be understood to be general insurance/reinsurance information only. Guy Carpenter & Company, LLC makes no representations or warranties, express or implied. The information is not intended to be taken as advice with respect to any individual situation and cannot be relied upon as such.

Statements concerning tax, accounting, legal or regulatory matters should be understood to be general observations based solely on our experience as reinsurance brokers and risk consultants, and may not be relied upon as tax, accounting, legal or regulatory advice, which we are not authorized to provide. All such matters should be reviewed with your own qualified advisors in these areas.

Readers are cautioned not to place undue reliance on any historical, current or forward-looking statements. Guy Carpenter & Company, LLC undertakes no obligation to update or revise publicly any historical, current or forward-looking statements, whether as a result of new information, research, future events or otherwise.

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