A Fortunes Cookie For The U.S. Reinsurance Industry

InsureReinsure Blog
December 31, 2020

Much of American law is derivative of British law, and this is particularly true in the realm of reinsurance law.  In the UK, courts distinguish between ‘follow the fortunes clauses’ and ‘follow the settlements clauses’ and attribute different meanings to each, which is often a significant factor in the determining claims and coverage related issues.  Unlike the UK, courts in the US appear not to distinguish between the two clauses, and often refer to them interchangeably, as was the case in Fireman’s Fund Ins. Co. v. OneBeacon Ins. Co., No. 14 CIV. 4718, 2020 WL 6135101 (S.D.N.Y. Oct. 19, 2020).

In October of 2020, a federal court in New York held that a follow the settlements clause in a reinsurance contract required a reinsurer to reimburse its cedent under a facultative reinsurance certificate because the exhaustion language in the reinsurance contract had not been satisfied.  Notably, the court did not distinguish the follow the settlements clause from a follow the fortunes clause.

Fireman’s Fund Insurance Company (FFIC) issued three excess liability insurance policies to Asarco.  The FFIC policies contained a Limit of Liability provision, which stated, in part: “in the event of reduction o[r] exhaustion of the applicable aggregate limit or limits of liability under said underlying policy or policies solely by reason of losses paid thereunder on account of occurrences during this policy period, this policy shall in the event of reduction, apply as excess of the reduced limit of liability thereunder.” FFIC’s third excess policy also stated that it was “a condition of [the policy] that the insurance afforded under [the policy] shall apply only after all the underlying insurance has been exhausted.”

FFIC’s third excess policy was reinsured by General Accident Insurance Company (predecessor-in-interest to OneBeacon Insurance Company) under a Facultative Certificate, which covered a 15% share of the risk assumed in the third excess policy and contained a follow-the-settlement provision.

Asarco brought an action against FFIC seeking coverage for asbestos claims.  In 2009, Fireman’s estimated the potential exposure to be $50 million.  Asarco and Fireman’s eventually settled in 2011 for $35 million and FFIC then allocated a portion of that settlement to the FFIC third excess policy in proportion to its 2009 exposure analysis.

OneBeacon denied FFIC reinsurance claim, arguing that FFIC did not comply with the exhaustion requirements in the underling policies.  OneBeacon also argued that the Facultative Certificate, which incorporated the Limit of Liability provision in the FFIC excess policy, did not attach below $78 million.

In the ensuing action, FFIC relied on the Second Circuit’s seminal decision in Zeig v. Massachusetts Bonding Co., 23 F.2d 665, 666 (2d Cir. 1928), to argue that the underlying excess policies were exhausted by settlement, which is permissible “unless ‎an excess policy unambiguously provides that underlying policies can be exhausted only by the ‎carrier’s payment of the full limit ….”  FFIC also argued that more recent cases have held that, where “underlying coverage was not exhausted by settlements[,] … the language of the relevant excess policy was arguably unambiguous in requiring exhaustion by payment rather than settlement.”

OneBeacon, however, argued that the Second Circuit’s more recent decision in Ali v. Fed. Ins. Co., 719 F.3d 83, 91 (2d Cir. 2013) overruled Zeig with respect to below limits settlements in the context of liability insurance.  In Ali, the Second Circuit found exhaustion language in three excess liability policies unambiguous, concluding that the “coverage obligation is not triggered until payments reach the respective attachment points.”  719 F.3d at 91.  OneBeacon argued that that “Zeig only applies in the presence of ambiguous exhaustion language” and that “[c]ourts following Zeig have uniformly confirmed that below limits settlements apply to functionally exhaust an underlying policy only if the excess policy does not clearly and unambiguously require payment of the underlying limits by the underlying carrier.”  2020 WL 6135101, at *10.

Noting that the term “exhaustion” was not defined by the FFIC third excess policy, the court rejected OneBeacon’s argument that the phrase “solely by reason of losses paid” in the FFIC excess policies required actual payment under the underlying insurance policies, because the language “only clarifies what happens ‘in the event of reduction … by reason of losses paid thereunder’.”  Id. at *11.

The court concluded that the FFIC third excess policy was ambiguous as to the meaning of “exhaustion.”  The court distinguished the holding in Ali based on the language of the policy and instead followed the Zeig holding that claims have been “paid to the full amount of the policies[] if they are settled and discharged.”  Id.  The court also held that none of the grounds on which Ali distinguished Zeig were present to preclude the application of Zeig.  Turning to the “follow-the-fortunes” doctrine (which was in fact a follow the settlements clause), the court held that the reinsurer was bound to accept Fireman’s settlement and allocation.

This case presents a reminder for both reinsurers and cedents to: 1) review the exhaustion language of underlying policies and reinsurance contracts, and 2) always include a fortune cookie!

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