Reinsurance and Insurance Arbitrator and Umpire Ronald S. Gass
ARIAS-U.S. Certified Arbitrator and Umpire
AAA Roster of Neutrals
Reinsurance and Insurance Dispute Resolution Services Consultant

New York Appellate Division Rejects Cedent’s Post-Settlement Reinsurance Allocation as Unreasonable and Inconsistent with Its Pre-Settlement Allocation Positions

Follow-the-settlements (loosely referred to by some courts as follow-the-fortunes) is a critical element of every reinsurance relationship and a doctrine that the courts rarely fail to enforce to avoid disruptive second-guessing by reinsurers of reasonable, good faith settlements. However, the doctrine does have its limits as aptly demonstrated in a recent unanimous Supreme Court of New York, Appellate Division decision. The court rejected, as a matter of law, the cession of certain multi-site, multi-occurrence environmental losses to a facultative reinsurer primarily because the cedent’s number of occurrences analysis underlying a global settlement with its insured was inconsistent with its post-settlement reinsurance allocation and would have required that “courts turn a blind eye to such manifest manipulation of the allocation process in total disregard of the reinsured’s obligation to act in good faith.”

The cedent in this case insured United Technologies Corp. (“UTC”) under two three-year property insurance policies, one with $6 million limits for the 1975-1978 period and the other with $10 million limits for the 1978-1981 period. UTC’s self-insured retention under both policies was $200,000 for “any one occurrence.” The cedent facultatively reinsured these two policies, with the reinsurer’s participation being 22% of $5 million excess $1 million on the 1975 cert and 25% of the same layer on the 1978 cert. Both certs had typical follow-the-settlements wordings. The 1975 cert provided, “This Certificate . . . is subject to the same . . . mode of settlement, as are, or were, or may be assumed or adopted by the Reinsured,” and the 1978 cert provided, “The liability of Allstate shall follow that of the Company . . . .”

In 1992, UTC filed a federal district court action against its insurer seeking indemnification under the two policies for physical loss and damage allegedly sustained due to environmental pollution at 17 sites. Throughout the litigation, both UTC and the insurer “consistently argued” that there were multiple occurrences at each of these sites, and neither ever took the position that each site constituted just one occurrence. The trial proceeded in two phases, with one of the several UTC plants being the subject of the first jury trial. The jury verdict was that there were 7 separate areas at which loss or damage occurred during the relevant policy periods. The trial court subsequently found 7 occurrences at this site for the purpose of calculating the number of UTC’s SIRs (UTC had claimed 7 occurrences and the insurer claimed at least 18). Although the insurer sought a new trial and petitioned for an interlocutory appeal, the case was settled with neither party conceding its position on the number of occurrences at the first site.

During the second phase of the trial involving the remaining 16 sites, the insurer’s exposure analysis found multiple occurrences at each site and assigned an estimated cost of each occurrence. Two months prior to the scheduled 2002 trial, the parties settled, with the insurer agreeing to pay a lump sum of $112 million for all the remaining sites. During their settlement negotiations, the insurer claimed 95 occurrences at the 16 sites, and UTC claimed only 44.

Following the UTC global settlement, the cedent’s lead counsel in the underlying UTC litigation prepared a complex reinsurance allocation analysis that was, according to the Appellate Division, “in stark contrast” to the cedent’s position throughout the UTC litigation regarding the number of occurrences. It essentially resulted in a post-settlement one-occurrence-per-site-per-year allocation that enabled the cedent to pierce the fac certs’ $1 million retentions and to bill the reinsurer $2,578,638 for its participations.

The reinsurer objected to this post-settlement allocation because it disregarded the cedent’s multiple occurrence positions taken during the UTC litigation as well as its settlement allocation analysis, which had identified and allocated 21 occurrences for all the second phase sites. It also ignored the federal court’s binding 7 occurrences ruling in the first phase trial by assigning a single occurrence to that site. If this multiple occurrences per site analysis had been carried through to the reinsurance allocation, no single occurrence would have breached the cedent’s $1 million retention per cert. Even if UTC’s more conservative number of occurrences position had been adopted, there would still be no loss in excess of the retention.

The reinsurer subsequently filed a declaratory judgment action in the Supreme Court, New York County, and on cross-motions for partial summary judgment, that court declared that the cedent’s post-settlement allocation did not violate the terms of the parties’ fac certs, was reasonable, and was made in good faith. It relied on two U.S. Court of Appeals for the Second Circuit decisions, North River Insurance Co. v. ACE American Reinsurance Co., 361 F.3d 134 (2d Cir. 2004), and Travelers Casualty & Surety Co. v. Gerling Global Reinsurance Corp., 419 F.3d 181 (2d Cir. 2005), for the proposition that the follow-the-settlements doctrine was applicable regardless of any inconsistency between the reinsured’s pre-settlement and post-settlement allocation positions.

Flatly rejecting the lower court’s summary judgment ruling in favor of the cedent, the Appellate Division reversed, holding as a matter of law that the cedent was “playing by two sets of rules”: one at the claim level to minimize the amount of the insured’s exposure and loss, and another post-settlement to maximize its recovery against the reinsurer. In denying the cedent's reinsurance claim, it held:

“The follow-the-fortunes doctrine was intended to foster consistency in the treatment of losses at both levels, insured and reinsured, not to allow an insurer to use a different set of rules at each level. We soundly reject the notion that the follow-the-fortunes doctrine requires that courts turn a blind eye to such manifest manipulation of the allocation process in total disregard of the reinsured’s obligation to act in good faith.” [Emphasis added.]

The Travelers and North River decisions, according to the Appellate Division, do not require a reinsurer to accept its cedent’s post-settlement loss allocation even if that allocation is contrary to its pre-allocation position and treatment of the loss allocation issue with its own insured. While the follow-the-settlements doctrine generally applies, it does so only as long as the allocation meets the usual follow-the-settlements requirements, i.e., it must be in good faith, reasonable, and within the applicable policies.

“For [the cedent] to assert aggressively the maximum number of occurrences at each site to minimize its liability to its insured in the UTC litigation, and then completely change its position in allocating its loss to [the reinsurer] under the reinsurance certificates, is neither reasonable nor reflective of good faith. It is disingenuous.”

The reinsurer was not bound by the cedent’s post-settlement allocation of the $112 million lump sum payment, “where the reinsured’s settlement allocation, at odds with its allocation of the loss with its insured, designed to minimize its loss, reflects an effort to maximize unreasonably the amount of collectible reinsurance.” Moreover, its single occurrence allocation of the first phase site was clearly at odds with the trial court’s binding determination that there were 7 occurrences. The Appellate Division found that the cedent had used a one-occurrence-per-site calculation in its post-settlement reinsurance allocation “to exaggerate its reinsurance claim against Allstate” as to that site.

As this rare follow-the-settlements decision favoring a reinsurer demonstrates, this doctrine definitely has its limits, particularly when there is such a stark difference between the cedent’s pre-allocation positions and post-settlement reinsurance allocations. Such troubling allocation discrepancies will be thoroughly scrutinized by the court and subjected to the reasonableness and good faith tests. Any failing post-settlement allocations may be struck down by the court as a matter of law.

Allstate Insurance Co. v. American Home Assurance Co., No. 9335, 2007 NY Slip Op. 5170, 2007 N.Y. App. Div. LEXIS 7284 (N.Y. App. Div. June 12, 2007).

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