1.          The dependence of the reinsurer upon the reinsured’s claims handling

C1        Due to the nature of reinsurance, the reinsurer is to a degree dependent on the reinsured regarding claims handling and resolution. Even if the contract of reinsurance has a claims handling provision giving rights to the reinsurer or provides for reports to the reinsurer or even the consent of the reinsurer to any settlements, the fact remains that it is the reinsured that is the primary respondent to the claims and has effective control over the defense of claims. Consequently, the duty of utmost good faith requires that the reinsured conduct itself reasonably in the defense and analysis of claims as well as in the settlement of claims.

2.          The standard for assessing the reinsured’s claims handling

C2        The principle of utmost good faith requires that the reinsured behaves in the same manner as it would if there were no reinsurance in place and all defense expenditures or claims payments were made from the reinsured’s own funds. The phrase is not meant literally in that the reinsured is, of course, aware that it has purchased reinsurance and may legitimately consider the existence of reinsurance in structuring its business operations. However, with regard to an individual claim or loss, the reinsured should administer the matter as if any payments for defense costs, settlements, or judgments would be made from the reinsured’s own funds. Under this standard, the reinsured is not only incentivized to defend claims vigorously if justified, but also to resolve matters economically when compromise is justified by the merits of the claim.

C3        In this context, unreasonable claims behavior requires something more than mere adverse results or claims decisions that may appear unwise in retrospect. A reinsured is permitted to make arguable mistakes while addressing claims. But if a reinsured’s claims behavior is fraudulent, deceptive, grossly negligent, reckless, self-serving, or intended to unfairly impose liability upon the reinsurer, the reinsured has not lived up to the standard of utmost good faith and, thus, violated Article 2.4.2.

C4        Requiring the reinsured to respond to claims as if it had no reinsurance aligns the reinsured’s duties to the reinsurer with a liability insurer’s duty to its policyholders. In cases where a liability insurer fails to make reasonable settlement decisions and resolve a claim within policy limits, the insurer is typically responsible for paying not only its policy limits but the amount of any judgment against the policyholder in excess of policy limits. The rationale for this remedy is to make the insurer approach settlement opportunities as if any resulting judgment would be paid solely by the insured without regard to policy limits. This encourages the insurer to accept reasonable settlement demands at or below the policy limits.

Illustrations

I1.         A prominent movie director is sued for alleged sexual harassment and provides notice to Reinsured A, the director’s EPL (employment practices liability) insurer. Reinsured A investigates and finds the claim appears to be meritless. The plaintiff’s account of two of the incidents is contradicted by security camera footage. A third alleged incident supposedly took place at a time when the plaintiff and defendant were in different cities, which can be documented by airline tickets, hotel receipts, and security camera footage. The fourth incident of purported harassment allegedly took place at a company retreat. All eyewitness testimony supports the defendant but most of the witnesses are company employees. However, two of the witnesses present at the retreat are not company employees. The policyholder demands a confidential multi-million-dollar policy limits settlement to keep the matter from attracting media coverage. If Reinsured A pays policy limits in settlement, Reinsurer B may correctly contend that Reinsured A has acted unreasonably. To settle an objectively meritless or overstated claim without significant resistance would be a breach of the duty to handle claims reasonably under Article 2.4.2 where a claim appears objectively meritless.

I2.         Reinsured A, a general liability insurer, has a large corporate policyholder who has been sued for defamation by a competitor that claims its product was disparaged by the policyholder. The defamatory conduct alleged did take place but despite the negative statements, the plaintiff’s product sales have skyrocketed, making it difficult to determine the amount of damage, if any, suffered by the plaintiff. In the absence of facts counseling to the contrary, Reinsured A would be acting unreasonably to pay policy limits in settlement of the claim without first testing the bona fides of the plaintiff’s damages. If Reinsured A makes an immediate policy limits settlement without engaging in adequate investigation, discovery, and defense of the damages portion of the plaintiffs’ claim, Reinsured A is in breach of its duty to handle claims reasonably under Article 2.4.2.

I3.         Same facts as in the previous Illustration, except that Reinsured A not only contests damages but also disputes the allegations of product disparagement defamation, even though the policyholder has admitted the misconduct and the evidence clearly established that Reinsured A’s policyholder made untrue, disparaging statements about the plaintiff’s product that do not fall within any immunity provided by the applicable law. Reinsured A incurs substantial defense costs, which are within the scope of the contract of reinsurance, on the liability question and is sanctioned by the presiding court for making a frivolous defense. Reinsured A pays these sanctions. The matter is eventually settled for a relatively small amount of damages paid to the plaintiff. Reinsured A breached its duty to handle claims reasonably under Article 2.4.2.

I4.         Reinsured A, an automobile insurer, has a policyholder who has been sued by an injured pedestrian. The liability of Reinsured A’s policyholder is clear, but Reinsured A determines that the plaintiff is not badly injured and offers only a small settlement, assuming that the plaintiff will become weary of pressing the claim and eventually accept the small settlement offer. Instead, the plaintiff files suit. By the time trial takes place two years later, doctors have discovered that plaintiff’s injuries are much worse than initially thought, including cognitive degeneration from a concussion incurred in the collision. Reinsured A increases its settlement offer, but it is still objectively low in relation to plaintiff’s injuries and well below the policyholder’s automobile and umbrella liability policy, which was also issued by Reinsured A. Trial results in a multi-million judgment against Reinsured A’s policyholder that is well in excess of the combined policy limits. Reinsured A pays policy limits and the excess judgment and then seeks payment from Reinsurer B. Reinsured A is in violation of its duty under Article 2.4.2 to handle claims reasonably.

I5.         Same facts as in the previous Illustration, except that Reinsured A makes a fair settlement offer at the outset and then defends the policyholder aggressively after the offer is refused. When doctors find out that plaintiff’s injuries are more serious than expected, Reinsured A increases its settlement offer to the combined policy limits, but the plaintiff rejects the offer. Trial results in the same multi-million judgment in excess of policy limits. Pursuant to the law of most US states, Reinsured A’s offer of policy limits will, absent extenuating circumstances, be regarded as reasonable and Reinsured A will not be responsible for the amount of any judgment in excess of its policy limits. Reinsured A pays the limits and then seeks payment from Reinsurer B. Reinsured A has behaved reasonably as if it had no reinsurance in place.

3.          The duty to seek funds from third parties

C5        As part of its obligation to process claims prudently, the reinsured should make reasonable efforts to obtain indemnity, contribution, salvage or recovery from third parties who have contributed to creating the reinsured’s liability.

Illustrations

I6.         Reinsured A, a commercial property insurer, pays USD 10 million in connection with a large fire in a newly completed warehouse. Investigation reveals that the fire was caused by faulty wiring attributable to an electrical subcontractor that wired the warehouse. The subcontractor is solvent and has a large amount of liability insurance. Reinsured A declines to pursue a subrogation action on behalf of itself and the warehouse owner, but does seek payment from Reinsurer B for the loss. Reinsured A has breached its duty to handle claims reasonably under Article 2.4.2 by failing to take reasonable measures to recoup the loss from the tortfeasor electrical subcontractor.

I7.         Same facts as in the previous Illustration, except that the liability case against the electrical subcontractor is estimated to have less than a fifty percent chance of success and will cost at least USD 1 million to litigate to conclusion because of the need for expert witnesses and a considerable investment of time by Reinsured A’s lawyers in pursuing the potential subrogation claim. Although Reinsured A perhaps should at least make the claim or file suit in order to seek a settlement from the electrician’s liability insurer, Reinsured A can colorably claim that it has not acted unreasonably and that it would make the same decision in the absence of available reinsurance. Reinsured A is in compliance with its duty to handle claims reasonably under Article 2.4.2.

I8.         Same facts as in Illustration 6, except that the estimated chance of success in a suit against the electrical subcontractor is less than twenty percent. Reinsured A’s decision not to invest resources in pursuit of a subrogation claim that is so uncertain to succeed is reasonable under the circumstances. Reinsured A is in compliance with its duty to handle claims reasonably under Article 2.4.2.

I9.         Similar facts as in Illustration 6, except that Reinsured A is a homeowner’s insurer, the amount of loss was USD 100,000 and the alleged tortfeasor electrician is a small business with no liability insurance. Reinsured A decides not to pursue subrogation. Reinsured A’s decision appears reasonable in light of the relatively low possibility of recovery in relation to investment of resources by Reinsured A. Reinsured A is in compliance with its duty to handle claims reasonably under Article 2.4.2.

4.          Limitations on claims resolution authority

C6        A reinsured shall observe any claim authority limit established by the contract of reinsurance or other agreement or course of dealing established between the reinsured and the reinsurer. Where the contract of reinsurance contains a claims control or claims co-operation clause, both reinsured and reinsurer shall conform to the terms of the clause in utmost good faith.

C7        The reinsured should also reasonably comply with the claims handling requirements of the relevant jurisdiction in order to avoid or minimize extra-contractual obligations. This includes, as necessary, shouldering defense obligations to the policyholder, complying with the fair claims handling laws of the relevant jurisdiction, and complying with any general consumer protection or fair dealing law of the relevant jurisdiction.

5.          Sharing of information

C8        As a general matter, the reinsured is required to share information sought by the reinsurer if it is relevant to the claims at issue or the construction of the contract of reinsurance. The information to be shared includes: (a) amounts claimed; (b) the amounts reserved; (c) amounts of loss adjustment expenses; (d) claims personnel with decision-making authority; (e) expert reports; (f) policy wording and other relevant documents; (g) explanation of the reinsured’s coverage position and assessment of exposure; (h) claims handling activities and decisions; (i) discharge of the reinsured’s duty of good faith owed to insureds; (j) recoveries obtained or pursued; (k) litigation documents and settlement agreements; and (l) proof of loss or claim and payment.

6.          Reasonable allocation of claims

C9        Reasonable allocation of claims requires the reinsured to allocate claims to particular policies or time periods according to an objective principle apt for the claims in question. As a practical matter, reinsureds will often be aware that particular allocation decisions may affect reinsurance coverage. If a reinsured selects one of two or more allocation methods that increases available reinsurance, this does not, standing alone, violate the reinsured’s duties or constitute improper claims processing. However, if the allocation method chosen is not colorable or is shown to have been chosen primarily to maximize reinsurance, the reinsured is in breach of its duties to the reinsurer.