Sedgwick Summary: Follow the Settlements
Follow the Settlements — Under English and Bermuda Law
Any reinsurance claim involves a certain tension: the cedents want their money without having to prove their losses again; the reinsurers want to ensure that the underlying claim is one to which both insurance and reinsurance contracts respond.
Importantly, English law generally considers reinsurance not as a form of liability cover for the cedents (i.e. to pay them in respect of any liability they may have in respect of the original risk), but as a reinsurance of the same subject matter as the original policy. Accordingly, absent specific contractual provisions, under English law the cedent must establish, as a matter of fact and law, that the loss is covered by the insurance contract and the reinsurance contract.
In order to ease the tension between the cedent and reinsurer, and for reasons of commercial efficacy, it has become usual for the parties to adopt some form (and there are many) of ‘follow the settlements’ wording.
Types of Clause
The starting point is the so-called ‘Full Reinsurance’ or ‘Full R/I’ clause which typically provides that the reinsurance operates as ‘…a reinsurance of and warranted same gross rate terms and conditions as and to follow the settlements of [the reinsured]’. The leading case, ICA v SCOR  1 Lloyd’s Rep 312, involved a facultative arrangement and established that if (a) the claim falls as a matter of law within the scope of the reinsurance contract, and (b) if the cedent acts in good faith and (c) in a proper and business-like manner, then reinsurers are bound by the settlement. The clause also reverses the common law burden of proof, such that, in case of dispute, it is for the reinsurer to prove that the cedent has not acted in good faith or in a proper and business-like way (Charman v GRE  2 Lloyd’s Rep 607).
In treaty reinsurance, the formulation is subtly but significantly altered, a standard clause providing that: ‘All loss settlements by the reinsured shall be binding upon reinsurers provided that such settlements are within the terms and conditions of the original policies and within the terms and conditions of this policy’…’. In other words, unlike with the SCOR-type clause, any settlement by the cedent must be valid under both the insurance and reinsurance contracts in order to bind the reinsurer (see the House of Lords decision in Hill v M&G Re  1WLR 1239).
The ‘Back-to-Back’ Presumption
Following the decisions in Vesta v Butcher  AC 852 and Groupama v Seguros Catatumbo  2 Lloyd’s Rep 350, a presumption has grown up that where there is a ‘follow’ provision in the reinsurance contract the insurance and reinsurance must necessarily be ‘back-to-back’. The recent decision of the House of Lords in Wasa v Lexington  UKHL 40, while not on ‘follow the settlements’ per se, deals a blow to that concept. Wasa makes it plain that ‘follow’ clauses do not operate to bring within the scope of a reinsurance risk that, on a true interpretation of the policy, would not otherwise be covered. In the circumstances, it seems probable that the somewhat doctrinaire ‘back-to-back’ presumption will revert to its original conception as a ‘sensible principle of construction’ (see Mance LJ at paragraph 52 of Wasa).
What if the insurer enters into a ‘commercial’ settlement and then seeks recovery from his reinsurer? Since it would be unacceptable to litigate every claim to final award, many—indeed most—loss settlements involve some element of compromise. In general, a ‘loss settlement’ that includes compromises of liability will be recoverable provided that those compromises are bona fide and made in a proper and business-like way. However, there are exceptions to that general proposition and close attention should be paid to the words used and the facts involved.
In Faraday v Copenhagen Re  EWHC 1474, the reinsurance contract contained a Full R/I clause which expressly excluded liability for ‘without prejudice’ and ‘ex gratia’ settlements. The cedent disputed certain of the underlying claims but not others, finally effecting a global settlement on an expressly ‘without prejudice’ basis. The court found that this meant that there was no admission of liability at all under the original policy, and therefore nothing to which the reinsurance could respond.
Lumbermans v Bovis Lend Lease  EWHC 2197 involved a lump-sum payment on the underlying claim to settle both disputed and non-disputed sums, with no apportionment between the two. Reinsurers declined cover and the Court held that the cedent was unable to adduce extrinsic evidence to prove its loss. On the other hand, in Enterprise Oil v Strand  EWHC 58 the cedent was allowed to rely on extrinsic evidence to show which parts of the unapportioned settlement agreement related to risks for which reinsurance cover existed. Happily, English law seems to prefer the more sensible Enterprise decision, and Lumbermans may be seen as something of a dead end.
In Commercial Union v NRG  2 Lloyd’s Rep 600, Commercial Union (CU) sought summary judgment against its reinsurers, NRG, over a claim in respect of the Exxon Valdez tanker. NRG argued that CU had not been legally liable to pay Exxon because they had settled purely on advice from their Texan lawyer that, although CU had an arguable defence in law, had the case gone to trial, they would nevertheless have been unsuccessful. The Court of Appeal agreed with reinsurers. It was not enough for CU to establish that the settlement was businesslike and sensible. Under the ‘follow the settlements’ clause the settlement was binding only if it was within the terms and conditions of both the original policy and of the reinsurance, and for that purpose it was not sufficient to rely on the mere advice of a lawyer. The question of whether it was arguable that reinsurers might not be liable to the cedents was rather one for the judge to decide, based on the proper construction of the policies according to the applicable law.
The above cited cases are all decisions of the English courts. There are no reported Bermuda authorities dealing with a reinsurer’s obligation to follow a cedent’s settlement. In large part this is due to the fact that almost all Bermuda reinsurance contracts contain arbitration clauses and, unlike the English Arbitration Act, the Bermuda arbitration statute does not permit appeals (and thus court review) on issues of law. It is the general practice of the Bermuda courts to follow English case precedent and decisions of the House of Lords are regarded as de facto binding.
Follow the Settlements — Under US Law
In the US, where a cedent has made a reasonable settlement in good faith, its reinsurers are often obligated to follow the settlement and pay their contractual share. This obligation is inherently tied to a reinsurance contract’s loss settlements clause. It was held long ago that where a reinsurance contract does not contain a loss settlement clause, the cedent must establish coverage under the reinsurance policy as if the cedent were the original insured. N.Y. State Marine Insurance Company v Protection Insurance Company. [C.C.D. Mass. 1841] 18 F.Cas. 160. However, where there is a clear settlement clause, the reinsurer is bound to follow the settlement decisions of its cedent on disputes that arose between the insured and reinsured unless it can demonstrate that the decisions were fraudulent, collusive, made in bad faith, or resulted in an ex gratia payment. Aetna Casualty and Surety Company v The Home Insurance Company [S.D.N.Y. 1995] 882 F.Supp 1328.
Where a cedent has litigated coverage, the reinsurer generally must follow the result. The issue is when must the reinsurer follow its cedent’s settlements.
The leading American case on the follow the settlements doctrine is Aetna Casualty and Surety Company v The Home Insurance Company [S.D.N.Y. 1995] 882 F.Supp 1328. There, Aetna’s insured was subject to numerous lawsuits regarding the design of an intrauterine device. Aetna entered into a settlement that, it argued, proceeded from its own good faith interpretation of its obligations under its policies. Aetna argued that because the scope of coverage afforded by the Home’s reinsurance policies was identical to that of its policies, Home was obligated to indemnify Aetna for its settlement. The court agreed, and described the purpose for (and necessity of) the doctrine as follows:
Absent [the follow the settlements doctrine], an insurance company would be obliged to litigate coverage disputes with its insured before paying any claims, lest it first settle and pay a claim, only to risk losing the benefit of reinsurance coverage when the reinsurer raises in court the same policy defenses that the original insurer might have raised against its insured.
While the follow the settlements doctrine typically obligates a reinsurer to follow the coverage decisions of its cedent, the doctrine is not without limits. For example, reinsurers are not bound by ex gratia payments, or payments outside the scope of the insurance contract. However, proving the rule inapplicable is typically difficult, as illustrated by Christiania General Insurance Corporation v Great American Insurance Company [2nd Cir. 1992] 979 F.2d 268. There, Great American insured Honda Motor Co. which faced a series of lawsuits related to the safety of their all-terrain vehicles (ATVs). Great American settled its claims with Honda and sought reimbursement from its reinsurer, Christiania. Christiania disputed that it had an obligation, arguing, inter alia, that Great American’s payments to Honda were ex gratia, because Honda failed to advise the materiality of the risk of insuring ATVs, entitling Great American to rescind its insurance policies to Honda. The court disagreed, stating that the reinsurer was ‘required to indemnify for payments reasonably within the terms of the original policy, even if technically not covered by it.’ The court elaborated: ‘a reinsurer cannot second guess the good faith liability determinations made by its reinsured, or the reinsured’s good faith decision to waive defenses to which it may be entitled.’
The follow the settlements doctrine is now being invoked regarding a cedent’s chosen method of allocating underlying settlements to its reinsurers. Reinsurers have resisted this, particularly where the method of allocation was never an issue between the insured and the reinsured. However, several decisions support the view that a cedent is entitled to reasonably allocate its loss as it sees fit. One of these cases is Travelers Casualty & Surety Company v Gerling Global Reinsurance Corporation of America [2d Cir. 2005] 419 F.3d 181, where Travelers sought to allocate an asbestos loss settlement as though the loss constituted a single occurrence. A reinsurer disputed this allocation, arguing that each site where asbestos contamination was alleged constituted a separate occurrence. While the District Court agreed with the reinsurer’s position on the basis that the question of allocation was not part of Travelers’ underlying settlement, the Second Circuit reversed, stating that the follow the fortunes doctrine extends to a cedent’s post-settlement allocation decisions as long as they are made in good faith. (Citing North River Insurance Company v ACE American Reinsurance Company [2d. Cir. 2004] 361 F.3d. 134.)
A subsequent decision, Allstate Insurance Company v American Home Assurance Company [N.Y.A.D. 2007] 837 N.Y.S.2d 138, came to a different conclusion. There, the cedent allocated loss to its reinsurer on a different basis than it paid the loss to its insured. The court found such a practice untenable, stating, ‘The follow the fortunes doctrine was intended to foster consistency in the treatment of loss at both levels, insured and reinsured, not allow an insurer to use a different set of rules at each level.’ The court refused to apply the follow-the-fortunes doctrine to the reinsured’s attempt to maximize the amount of collectible reinsurance.
The follow the settlements doctrine shields cedents from their reinsurers second-guessing their good faith claims decisions on matters at issue between the cedent and the insured. However, American courts will not countenance its use by cedents who did not conduct a business-like investigation or otherwise act in good faith.