1. Scope of the duty
C1 The duty of utmost good faith requires a prospective reinsured to provide full disclosure of information. Full disclosure means a prospective reinsured must disclose to the prospective reinsurer all information material to the risk that is known or ought to be known by the prospective reinsured. The focus in determining materiality is that of a reasonable party to the transaction. Information is material if it would affect a reasonable party’s decisions regarding the contract. Material information must be disclosed irrespective of whether the prospective reinsurer has requested it.
C2 This duty applies irrespective of any fault on the part of the prospective reinsured. So, failure to disclose is not excused by negligence on the part of the prospective reinsured.
C3 If a contract is subject to renewal, the duties set forth in this Section regarding initial contracting continue to apply during the renewal process. These duties also apply if the reinsured and the reinsurer enter into discussions regarding commutation of the agreement.
C4 The process of renewal of an insurance policy or contract of reinsurance is generally more informal and streamlined than the initial process of entering into the agreement. However, the same duties of utmost good faith apply. For example, a reinsured cannot fail to disclose material information in order to obtain a renewal that would not have taken place if the information had been disclosed.
Illustrations
I1. Prospective Reinsured A and prospective Reinsurer B are approaching the renewal date of the contract. Reinsured A becomes aware that a recently developed product of its policyholder that has just entered the market has been discovered to have a deadly defect that was not known at the time of the placement of reinsurance. The policyholder has shipped roughly 10,000 of these products to retailers or consumers. Although there is concern, the product is not subject to government or manufacturer recall. The information is material and should be disclosed by Reinsured A to Reinsurer B prior to renewal of the contract.
I2. Prospective Reinsured A has an extensive portfolio of homeowner policies in Canada. Meteorologists predict a particularly cold winter for the region. Reinsured A becomes aware of this in September, just before the 1 October renewal of the contract. This prediction of a colder winter in the area does not impose a duty of disclosure upon Reinsured A, even though it might mean more claims for losses due to frozen pipes during the ensuing period after renewal. Although a colder winter may significantly affect claims, relatively colder or warmer weather occurs in the normal course of business and does not constitute the sort of material development that must be disclosed to the reinsurer. It would not substantially increase the risk that the reinsurer has already accepted. Prospective Reinsurer B already knows that Reinsured A sells property insurance in a cold weather climate where frozen pipes and similar losses are normal. Reinsurer B is also aware that some winters are harsher than others and that Canadian winters are on average harsher than those in most other countries. Further, the predicted colder winter may not come to pass. Even if it does, this is not certain to lead to substantially more frequent or severe claims. This distinguishes information of this type from information such as an anticipated surge in claims due to design defect in a product.
C5 Similarly, when a reinsured and a reinsurer decide to commute the contract of reinsurance, the reinsured must satisfy the standard of utmost good faith in its disclosures. It violates this Article, for example, if a reinsured incorrectly represents that there is a pipeline of serious claims that have not yet been reported. This in turn induces the reinsurer to make a commutation it would otherwise have resisted or induces commutation on terms more favorable to the reinsured.
2. Materiality of information
C6 The touchstone of materiality is whether the undisclosed information, if known, would have affected the underwriting decision of a reasonable, prudent reinsurer. For example, a reinsurer, had it known all the facts, may have refused to accept the risk. Or the reinsurer may have been willing to accept the risk only if it received a larger premium or modified the contract in other ways, such as with a specific exclusion or limitation upon certain risks.
C7 What constitutes material information may vary according to the type of risk reinsured. For example, a life reinsurer will be concerned about the quality of the reinsured’s underlying policies and its underwriting guidelines and procedures. By contrast, a property or casualty reinsurer will be more concerned about the location of the reinsured’s risk and the magnitude of the exposure created by the policyholder’s activities.
C8 The following cases provide useful examples of omitted material information that should have been disclosed to the reinsurer during the contracting process (see, e.g., Sun Mutual Ins Co v Ocean Ins Co, 107 US 485 (1883); M’Lanahan v Universal Ins Co, 26 US 170 (1928); Carlingford Australia Gen Ins Ltd v St Paul Fire & Marine Ins Co, 722 F Supp 48 (SDNY 1989)).
Illustrations
I3. Prospective Reinsured A, which has a portfolio of commercial liability policies covering a chain of storage facilities, contracts with prospective Reinsurer B but fails to inform Reinsurer B that the facilities contain large quantities of propane gas. One of the tanks explodes, setting off a chain reaction that engulfs the local area in fire, causing extensive damage. Reinsured A’s failure to disclose the dangerous contents is a material omission that violates the duty of disclosure.
I4. Prospective Reinsured A provides liability insurance to a major manufacturer of automobiles. Reinsured A informs prospective Reinsurer B of the identity of the manufacturer and the policies but does not specifically inform Reinsurer B that the automaker also manufactures ATVs (All-Terrain Vehicles) that are used for recreational riding off-road and therefore present a heightened liability risk as compared to other vehicles. ATVs constitute one percent of the manufacturer’s business. The non-disclosed information regarding ATVs is not material (facts based on Christiania Gen Ins Corp v Great American Ins Co, 979 F2d 268, 279–80 (2d Cir 1992) (applying New York law), affirming 745 F Supp 150 (SDNY 1990)).
I5. Same facts as in the previous Illustration, but ATVs constitute 10 percent of the manufacturer’s vehicles insured by prospective Reinsured A. The information that 10 percent of the insured vehicles are ATVs bearing a higher risk of liability is material. Therefore, Reinsured A must disclose this information to prospective Reinsurer B.
I6. Same facts as in the previous Illustration, but prospective Reinsurer B asks prospective Reinsured A about the number of automobiles, trucks, and motorcycles sold each year without specifically asking about ATVs or off-road vehicles generally. Reinsured A answers truthfully but makes no disclosure about ATVs. Because Reinsurer B has indicated interest in the composition of the fleet of vehicles insured by Reinsured A, Reinsurer B has shown that it considers the type of vehicles sold an important fact (and this creates a presumption of materiality, see Comment 13). Reinsured A’s failure to mention ATVs when providing other specific details of the fleet is in violation of Article 2.2.1.
I7. Prospective Reinsured A is a small local insurance company operating exclusively in a confined region. It lacks the resources and expertise of a large international insurance group. A large percentage of Reinsured A’s business is crop insurance. Reinsured A is aware that a devastating disease is affecting local farmers and is likely to cause large crop losses. As this information is material, Reinsured A must disclose it to prospective Reinsurer B and is not excused from fulfilling this duty due to its small size and limited resources.
a. Determining materiality
C9 In determining whether information is material and must be disclosed, an objective standard applies. At that stage, it remains irrelevant whether the prospective reinsurer subjectively considers the information to be material. However, the subjective understanding of a particular reinsurer may affect the remedy available to the reinsurer as set forth in Chapter 3. For instance, if the reinsurer wants to avoid the contract in accordance with Article 3.2(3)(b), it will not be sufficient to demonstrate that a reasonable and prudent reinsurer would not have accepted the risk at all (objective standard), but additionally that the reinsurer itself would not have accepted the risk at all (subjective standard).
C10 An objective approach to determining materiality is superior to a subjective approach in that it provides better and fairer notice to insurers seeking to purchase reinsurance. Applicants must consider whether a reasonably prudent insurer would want to be informed of certain facts known to the applicant. Prospective reinsureds are, of course, insurers that are in the business of risk management. They can fairly be charged with knowing what information would impact the decisions of a reasonable reinsurer. But it is unfair to ask prospective reinsureds to read the subjective mind of the reinsurer and calculate what information it might consider material beyond that which would be material to an ordinary reasonable reinsurer. Adopting an objective approach that examines the views of reasonable reinsurers as a whole provides clearer guidance to the parties considering entering into a contract of reinsurance and prevents a reinsured from losing cover based on the idiosyncratic views of the reinsurer in question.
C11 Objective consideration also improves resolution of reinsurance disputes. Under a purely subjective approach, the particular mindset of a particular insurer is a question of fact that logically requires fact finding through trial, which in the US means impaneling a jury of laypersons unfamiliar with the insurance/reinsurance business which is governed by restrictive rules of evidence. This makes for a cumbersome, time-consuming, and costly process that may easily result in error if jurors are swayed by false testimony (e.g. a reinsurer that asserts that it would not have entered into the contract if it had known that the reinsured’s claims personnel wore uniforms while on the job) or wrongly disbelieve reasonable testimony (e.g. the reinsurer that asserts it would not have made the agreement if it had known that the reinsured issued its large life insurance policies without requiring a physical examination). In contrast, under an objective standard, a tribunal will often be able to apply the objective standard of materiality as a matter of law. In many cases, there will be no dispute regarding whether a reasonable and prudent reinsurer would find an omitted fact sufficiently important to affect underwriting decisions.
C12 It should be recognized that the market for certain insurance products, such as coverage for emerging or very particular risks, may be relatively small, making it more difficult to ascertain the behavior of a reasonable and prudent reinsurer in such thin markets. As a practical matter, the evidentiary submissions and testimony of the actual reinsurer involved – and the particular reinsurer’s rationale for regarding certain information as material – take on greater importance than it would in disputes involving reinsurance of common insurance risks.
Illustrations
I8. Prospective Reinsured A, a general liability insurer, is aware that a customer has brought suit against a policyholder, alleging the manufacture of a dangerous product that injured the claimant. Reinsured A is aware that the policyholder has manufactured and distributed tens of thousands of these products during the first year of its product’s availability. As a reasonable and prudent reinsurer would want to know this information, it is material, and Reinsured A is under a duty to disclose it.
I9. Same facts as in the previous Illustration, except there is only one lawsuit and prospective Reinsured A’s claims professionals regard the suit as clearly unfounded. In addition, the claim is one of isolated defective manufacture and not one alleging systemic defective design. This information is not material.
I10. Prospective Reinsured A, an insurer of commercial marine vessels, negotiates with prospective Reinsurer B for reinsurance. Reinsured A fails to disclose instances where two insured vessels were damaged while using their home port where a defect in the port’s docking system caused damage. The facts and circumstances of the injuries to the two vessels are material to the risk because it is the home port of all insured vessels and there is a heightened risk of such accidents at this port (facts based on A/S Ivarans Rederei v Puerto Rico Ports Authority, 617 F2d 903 (1st Cir 1980) (applying maritime law)).
I11. Prospective Reinsured A, a property insurer, enters into a contract with prospective Reinsurer B covering Reinsured A’s exposure to loss of a shipment of 500 “clocks” from Spain to Chile. The “clocks” are in fact expensive Rolex watches. Reinsured A’s usage of the term “clocks” is due to the fact that the Spanish word “reloj” describes both clocks and watches and depends on context to clarify meaning. Reinsured A’s disclosure is imprecise and incomplete since the extraordinary value of the watches would have required mention. Reinsured A has violated Article 2.2.1 (facts based on Wise Underwriting Agency v Grupo Nacional Provincial SA [2003] EWHC 3038, [2004] 1 All ER (Comm), rev’d on other grounds [2004] EWCA Civ 962, [2004] Lloyd’s Rep IR 764).
I12. Reinsurer B is considering renewal of a contract with Reinsured A, a US liability insurer. During the term of the contract, the US Supreme Court issues a decision overruling a precedent that had made it more difficult for foreigners to sue in the United States for injuries suffered abroad. The effect of the new decision is to make it somewhat more likely that US-based plaintiffs’ counsel will be able to file suit in the US, which has a more plaintiff-friendly legal regime, rather than in their home countries or the country in which injury took place. Reinsured A need not disclose this development to Reinsurer B. This involves only a small number of potential claims. A reasonable and prudent reinsurer would not be deterred from accepting the risk or would not charge a higher premium solely because of this change in US law. Failing to inform Reinsurer B is not a breach of the duty of disclosure.
I13. Same facts as in the previous Illustration, but Reinsured A is a leading liability insurer whose sole market is insurance of state and local governments which insures thousands of governments across the US. During the term of the contract, five small US States with relatively few governments have increased their cap on tort damages against the state from USD 50,000 to USD 100,000. Provided that this increase in tort damage caps represents only a small portion of the insured potential liabilities, its disclosure is not required by Article 2.2.1.
I14. Same facts as in the previous Illustration, but during the term of the contract, 30 US States, including the 12 largest States, have doubled the size of their caps on tort damages against the state, raising the average cap on damages from USD 150,000 to USD 300,000. There are tens of thousands of such suits brought against state and local governments each year, with approximately ten percent of them reaching the USD 150,000 cap due to payment of settlements or judgments. Reinsured A has breached its duty of disclosure by not informing Reinsurer B of these developments during renewal negotiations.
Note: Illustrations 12–14 assume a situation where the reinsurer neither knows nor ought to know about the legal changes. This may particularly apply to foreign reinsurers not established in the country where the risk is located.
b. Inquiries propounded by the reinsurer
C13 Where a reinsurer propounds a question to the reinsured, this creates a rebuttable presumption that the information sought is material to the risk. However, to obtain the benefit of this presumption, a reinsurer’s question must be reasonable. The reinsured may rebut the presumption of materiality if the facts of the situation demonstrate that the inquiry did not seek material information. For example, if a reinsurer during the underwriting process propounds a question seeking information that no reasonable reinsurer would regard as material, an absent or incorrect answer to such a question may not affect coverage if the reinsured can demonstrate the lack of materiality and if the deficiencies of the response to the question did not involve fraud or deceit.
Illustrations
I15. Prospective Reinsurer B asks prospective Reinsured A, which issues kidnap and ransom insurance, to list the countries subject to travel alerts to which the policyholders’ executives travel. Reinsured A must answer the question truthfully.
I16. Same facts as in the previous Illustration, but instead of asking about travel, prospective Reinsurer B asks whether the policyholders have a crisis management system in place for their top managers. Prospective Reinsured A erroneously answers in the affirmative. This violates Reinsured A’s duty to answer Reinsurer B’s question truthfully.
I17. Late in the underwriting process, prospective Reinsurer B asks prospective Reinsured A: “Is there anything else we should know?” This question is too vague and does not relate to any specific information. It only reminds A to satisfy its duty of disclosure. As such, the question has no immediate impact on the duty of disclosure. In particular, it does not create a presumption of materiality of any information to be disclosed.
c. Impact of type of reinsurance on materiality
C14 The question as to whether information is considered material may depend on the type of contract. Where a reinsurer negotiates a contract in view of a specified risk only, elements of this specific risk will be considered material. This is usually the case with facultative reinsurance. In contrast, where the reinsurer negotiates a contract in view of a group of risks, relevant details of the underwriting policy of the reinsured but not the elements of each individual risk submitted later on will be considered material. This is usually the case with treaty reinsurance. However, where the reinsurer has a discretion to accept or refuse individual risks when tendered by the reinsured, elements of each individual risk will become material to the extent that they differ from the grouping criteria. Such discretion is granted to the reinsurer in certain reinsurance treaties.
d. Further examples
C15 The reinsured’s duty of disclosure ordinarily requires the reinsured to: (a) provide accurate information on claims history that presents a fair picture of the risk to be assumed by the reinsurer; (b) identify significant risk exposures; (c) respond frankly to the reinsurer’s inquiries; (d) raise potential issues affecting the risk that are material even if not raised by the reinsurer; (e) identify any other applicable reinsurance that may cover the risks in question; and (f) update all information in the event of significant changes during the negotiations. Additional examples of information material to reinsurance underwriting may include information concerning the capital and surplus of reinsured, including any significant regulatory matters affecting it.
Illustrations
I18. Prospective Reinsured A is negotiating with prospective Reinsurer B to form a contract. Reinsured A informs Reinsurer B of several lawsuits alleging harm from the over-the-counter, non-prescription drugs made by a large policyholder. Reinsured A fails to inform Reinsurer B that the policyholder has been told by a regulatory agency that the policyholder’s drug will soon be labeled “unsafe” and that the policyholder will be required to cease selling the drug and pull it from the shelves. The contract is formed. A month later, the regulatory agency action is announced. A spate of lawsuits against the policyholder follows, forcing Reinsured A to defend and pay many claims for which it seeks payment from Reinsurer B. The information regarding regulatory action is not public and would affect a reasonable reinsurer’s decision as to whether to accept the risk or charge a higher premium. The undisclosed information is material.
I19. Same facts as in the previous Illustration, except that when negotiations begin there is no indication that the regulatory agency is considering banning the sale of the drug. Prospective Reinsured A becomes aware of this during the contract negotiation process. This information is material and must now be disclosed.
I20. Prospective Reinsurer B does not ask about environmental risks in prospective Reinsured A’s portfolio. Although primarily a seller of general liability policies that include a pollution exclusion, Reinsured A also sells a significant number of environmental impairment policies. This information is material. Even though not specifically asked about this by Reinsurer B, Reinsured A must disclose this aspect of its business.
I21. Same facts as in the previous Illustration, but prospective Reinsured A has only a small number of environmental impairment policies. Unless Reinsured A is aware of particular claims that are significant in number or amount that are highly likely to be made pursuant to these policies, Reinsured A is not obligated to disclose this information.
I22. Prospective Reinsured A is seeking facultative reinsurance from prospective Reinsurer B for a particular risk. Although not certain, losses under this facultative contract may also be covered under treaty reinsurance that Reinsured A already has in place for much of its business. Reinsured A is required to disclose this material information.
I23. Same facts as in the previous Illustration, but it is clear that prospective Reinsured A’s treaty reinsurance does not cover the risk to be placed under the facultative contract of reinsurance. Reinsured A need not disclose information about its treaty reinsurance to prospective Reinsurer B.
I24. Prospective Reinsured A, the Canadian Homeowners Protective Society, headquartered in Boston, MA, is a commercial property insurer that has an unusually high concentration of its policies along the US Gulf Coast, which is prone to hurricanes. Reinsured A fails to inform prospective Reinsurer B of the geographic concentration of its business and risks. There is no reason for prospective Reinsurer B to assume that Reinsured A’s risk pool includes such a significant concentration of Gulf Coast property. But the opposite is true in view of the concentrated nature of Reinsured A’s risk pool. This information is material and must be disclosed.
I25. Prospective Reinsured A writes residential property insurance and has ninety percent of its business in Alabama, Florida, Louisiana Mississippi, North Carolina and South Carolina – all of which is disclosed to prospective Reinsurer B. However, Reinsured A does not inform Reinsurer B that Reinsured A’s property loss policies do not contain exclusions for flooding or other water damage such as hurricane storm surge. Even if Reinsurer B does not ask about policy content as part of its underwriting process, Reinsurer B is entitled to know that Reinsured A is issuing policies with much broader water damage coverage than is normal in the US. This information is material and must be disclosed.
3. Knowledge and constructive knowledge of the reinsured
C16 In assessing knowledge, the reinsured is viewed as an entity. The entity must have actual or constructive knowledge of the information in question. In accordance with the applicable rules for representation of legal entities, it is deemed to have knowledge of what its relevant employees and agents know. For example, if claims personnel or legal personnel of the reinsured know that a product previously considered safe has been found to be defective and dangerous, that knowledge is imputed to the reinsured entity.
C17 The reinsured will be deemed to have knowledge of material information readily available to it and which it has reason to investigate when fulfilling the disclosure duty (constructive knowledge). Information stored, e.g., in documents and computer systems of the reinsured shall be considered readily available.
4. Knowledge and constructive knowledge of the reinsurer
C18 A prospective reinsured is not required to disclose information of which the prospective reinsurer is already aware or which is readily available to it and which it has reason to investigate when negotiating the contract. As with the reinsured, the reinsurer is treated as an entity and knowledge of employees and agents will be imputed to the reinsurer in the same manner.
5. Reinsurer’s duty of inquiry
C19 Reinsurers have a duty to conduct further examination of the information provided by a reinsured in cases where that information would be viewed as obviously incomplete or unclear to a reasonable reinsurer. Without inquiry, the reinsured’s disclosure will ordinarily be deemed to comply with Article 2.2.1.
Illustration
I26. Prospective Reinsured A negotiates with prospective Reinsurer B regarding liability insurance for a policyholder with the nondescript name of “Generation X,” which is described as a “manufacturer.” Generation X operates electric power generation plants. The information provided by Reinsured A is obviously vague and thus insufficient. However, if the specific activity of the policyholder is relevant to Reinsurer B’s underwriting decision, it should make further inquiry. Otherwise, the information provided by Reinsured A is deemed to comply with Article 2.2.1.
6. Appropriateness of the reinsured’s disclosure
C20 The reinsured is required to comply with its duty of disclosure in an honest and complete manner. Providing technically correct but misleading information is inconsistent with the duty of disclosure (see Illustration 3 to Article 2.1.2).
C21 Where the prospective reinsurer has asked questions, the completeness of the answer will often depend on the specificity of the question and the amount of information available. For example, if a reinsurer asks whether a reinsured has a “good” loss ratio, such a question permits a general answer. In contrast, a request for detailed information should ordinarily result in the provision of detailed information. So, if the reinsurer asks the reinsured for its precise loss ratio, the reinsured must answer accurately and truthfully.
7. Disclosure duties outside Article 2.2.1
C22 Article 2.2.1 only establishes a duty to disclose material information and does not oblige the prospective reinsured to disclose any other information. However, a prospective reinsurer may ask for additional information. If such request is reasonable, the general duty of utmost good faith as set out in Article 2.1.2 requires the prospective reinsured to provide an appropriate answer. The same will apply where the parties have stipulated that the prospective reinsured must truthfully answer inquiries propounded by the reinsurer.
C23 The reinsurer also has a duty to adequately respond to a reasonable request for information. Again, this demonstrates that the duty of utmost good faith is reciprocal (see Article 2.1.2 Comment 10 et seq.).
Illustrations
I27. Reinsured A and Reinsurer B have stipulated that “in seeking reinsurance, Reinsured A will truthfully answer all inquiries propounded by Reinsurer B, whether or not material.” Reinsurer B asks whether Reinsured A’s top managers play handball. Reinsured A erroneously answers in the negative. Even though this information is not material, Reinsured A’s misstatement is a breach of its duty to accurately answer questions. Remedies, if any, are governed by Article 3.1.
I28. Prospective Reinsurer B asks prospective Reinsured A to furnish copies of all policies and endorsements subject to the reinsurance. This request is overbroad and unduly burdensome. Reinsured A should request that Reinsurer B narrow the information request and be more specific. Unless Reinsurer B complies, Reinsured A may refuse to answer the unreasonable request.
I29. Prospective Reinsurer B asks for detailed numbers from prospective Reinsured A, an automobile liability insurer, regarding the percentage of its policies sold to residents of a particular jurisdiction known for large awards to bodily injury plaintiffs and the total policy limits in force in this jurisdiction. Reinsured A must provide the information. The duty to answer will follow from Article 2.2.1 if the information is material. Otherwise, Reinsured A must disclose the information in accordance with the general duty of good faith (Article 2.1.2).
I30. Prospective Reinsured A asks questions about the financial stability of prospective Reinsurer B. Although Reinsurer B is not required to answer any of these questions and may decline on proprietary grounds (just as it may decline to enter into an agreement with a prospective contracting party), Reinsurer B is obligated to provide sufficiently complete and truthful answers if it responds to the questions.
I31. Prospective Reinsured A asks about prospective Reinsurer B’s investment in equity stocks. If Reinsurer B, which has twenty-five percent of its investment portfolio in equities responds that the amount of its investment in equities is “very low”, this is a breach of the duty to disclose if this degree of concentration creates more than an incidental risk exposure for Reinsurer B.
I32. Late in the underwriting process, prospective Reinsurer B asks prospective Reinsured A: “Is there anything else we should know?” This question can do no more than make prospective A think about what it must disclose and therefore does not itself have to be answered.