Academic journal article Defense Counsel Journal

Common Reinsurance Issues: Follow the Fortunes, Late Notice and Rescission

Academic journal article Defense Counsel Journal

Common Reinsurance Issues: Follow the Fortunes, Late Notice and Rescission

Article excerpt

Law is evolving in each of these areas, while courts seek to balance cedents' expectations with reinsurers' contract rights

THERE are three legal issues that are common to many reinsurance disputes--follow the fortunes, late notice, and rescission. The law in each of these areas, while still evolving, attempts to balance the cedent's expectation that it will be reimbursed with the reinsurer's right to rely on the terms of the reinsurance agreement and on the good faith and diligence of the cedent in both the underwriting and claims handling process.

FOLLOW THE FORTUNES

A. Use

Many reinsurance agreements contain a follow the fortunes clause, which provides that all settlements pursuant to the underlying insurance are binding on the reinsurer.(1) Even when a follow the fortunes provision is not expressly included in the agreement, courts have implied such a condition.(2) Courts also have applied the doctrine to both facultative and treaty reinsurance.(3)

Notwithstanding this widespread recognition of the doctrine, decisional law on its parameters is still developing. A federal district court in New York refused to vacate an opinion on the issue, even though requested by the parties who had reached a settlement following the decision, noting "that the important public interest in the development of decisional law definitively outweighs the settlement interests of the parties here."(4)

B. Purpose

The follow the fortunes doctrine is generally understood to mean, as stated in National American Insurance Co. v. Certaint Underwriters at Lloyd's London, that a reinsurer "may not challenge the reinsured's good faith and studied decision to pay on a claim that is arguably subject to the coverage of a valid insurance policy."(5) The Third Circuit declared in North River Insurance Co. v. Cigna Reinsurane Co. that the doctrine prevents "reinsurers from second guessing good-faith settlements and obtaining de novo review of judgments of the reinsured's liability to its insured."(6) The North River court also stated that the follow the fortunes doctrines is broader than the obligations imposed by a "following forms" clause, which obligates the reinsurer only to cover risks insured under the reinsured policy, adding that it obligates a reinsurer to indemnify "all payments made in good faith that are reasonably within the scope of the policy's coverage."

The decision whether a payment is reasonably within the scope of coverage is made by the cedent. In discussing the scope of a cedent's obligation to its reinsurer, the federal district court in Aetna Casualty & Surety Co. v. Home Insurance Co. stated:

      The reasoning that undergirds the "follow the settlements" doctrine does
   not require that a ceding company pursue every defense in litigation
   against the insured, however close a call the particular policy defense
   might be. Quite the contrary: subject to the ceding company's duty of
   utmost good faith, and the requirement that investigations such as the one
   conducted by [the cedent] be reasonable and businesslike, the doctrine
   leaves it to the ceding company to make the settlement decision in the
   first instance, which settlement is then binding upon the reinsurers.(7)

The rationale for the doctrine is that allowing reinsurers to relitigate coverage issues would put cedents in the untenable position of having coverage defenses that they might initially have advanced in defense of an insured's claim used against them by reinsurers seeking to disclaim liability for a subsequent settlement of the claim. The North River court observed, "Without 'follow the fortunes' doctrine, reinsureds would be in the impossible position of advancing defenses in coverage contests that could be used against them by reinsurers seeking to deny liability."(8)

C. Limits

Notwithstanding the broad scope of the doctrine, courts generally have been careful not to allow the doctrine to overwhelm the remainder of the reinsurance agreement. …

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