Discovery of Reinsurance Information in Insurance Coverage Litigation
Hummer, Paul M., Defense Counsel Journal
Insurers are in a dilemma: Should they should make full disclosure of communications, but will that undermine their coverage position?
THE REINSURANCE relationship is premised on the free flow of information. Recently, however, communications between cedents and reinsurers, or reinsurers and their retrocessionares, have become the target of discovery requests in coverage litigation between policyholders and their insurers or between insurers and their reinsurers. What are the circumstances in which reinsurance information or communications between insurers and their reinsurers may become discoverable? What is the quandary this new trend creates for insurers?
IMPORTANCE OF COMMUNICATIONS
In Unigard Security Insurance Co. v. North River Insurance Co., the Second Circuit discussed the importance of communications and the free flow of information in the reinsurance relationship:
To enable them to set premiums ... and to determine whether to "associate" in the defense of a claim, reinsurers are dependent on their ceding insurers for prompt and full disclosure of information concerning pertinent risks. The reinsurance relationship is often characterized as one of "utmost good faith." This utmost good faith may be viewed as a legal rule but also as a tradition honored by ceding insurers and reinsurers in their ongoing commercial relationships. Historically, the reinsurance market has relied on a practice of the exercise of utmost good faith to decrease monitoring costs and ex ante contracting costs. Reinsurance works only if the sums of reinsurance premiums are less than the original insurance premium. Otherwise, the ceding insurers will not reinsure. For the reinsurance premiums to be less, reinsurers cannot duplicate the costly but necessary efforts of the primary insurer in evaluating risks and handling claims. Reinsurers may thus not have actuarial expertise or actively participate in defending ordinary claims. They are protected, however, by a large area of common interest with ceding insurers and by the tradition of utmost good faith, particularly in the sharing of information.(1)
In addition to facilitating the economic relationship between insurers and their reinsurers, communications have significant implications for their legal rights. Courts have held that a ceding insurer's duty of "utmost good faith" imposes an affirmative obligation on it to disclose all material facts to its reinsurers during the placement of the reinsurance and that the cedent's duty of utmost good faith imposes on the cedent a duty to "exercise good faith and to disclose all material facts" in the underwriting process.(2)
According to the Second Circuit, the cedent's duty is "to place the underwriter in the same position as himself [and] to give to him the same means and opportunity of judging of the value of the risks. ... The relationship between a reinsurer and a reinsured is one of utmost good faith, requiring the reinsured to disclose to the reinsurer all facts that materially affect the risk of which it is aware and of which the reinsurer itself has no reason to be aware.(3)
A cedent that fails to make full disclosure runs the risk that a reinsurance agreement will be rescinded.(4)
Communications also play an important role in the claims process. Many reinsurance agreements contain provisions requiring cedents to give "immediate notice" or notice "as soon as practicable" upon knowledge of an occurrence "likely to give rise to a claim" under the reinsurance agreement.(5) In Unigard, the Second Circuit grounded the notice obligations of cedents in the duty of utmost good faith:
[B]ecause information regarding risks lies with the ceding insurer, the reinsurance market depends upon a high level of good faith to ensure prompt and full disclosure. Absent such disclosure, reinsurers would have to duplicate actuarial and claims-handling efforts of ceding insurers, and reinsurance would become unavailable. …