EVOLVING CONTOURS OF THE FOLLOW THE FORTUNES/SETTLEMENTS DOCTRINE

1. EVOLVING CONTOURS OFTHE FOLLOW THE FORTUNES/SETTLEMENTS DOCTRINE

2. U.S. Case Law Regarding The Evolving Contours Of The Follow The Fortunes Doctrine As Applied To Post-Settlement Allocations Wm. Gerald McElroy, Jr.Zelle Hofmann Voelbel & Mason LLPwmcelroy@zelle.com

3. Issues Influencing Post-Settlement Allocations • Trigger of coverage • Allocation methodology • Annualization of policy limits • Per occurrence policy limits • Number of occurrences • Allocation to particular hazardous waste sites

4. The Follow The Fortunes Doctrine And Its Rationale

5. Sample Clause All loss settlements made by the Reinsured, including compromise settlements, shall be binding upon the reinsurer, provided that the loss underlying the settlement is within the terms of the original policy and is within the terms of the Reinsurance.

6. Fundamentals Of Doctrine • Reinsurer obligated to indemnify reinsured for any good faith payment • No second-guessing of good faith liability determinations

7. Rationale For Follow The Fortunes Doctrine • Forecloses relitigation of coverage disputes • Mutuality of interest between insurers and reinsurers • Furthers goals of “maximizing coverage and settlements”

8. Limitations on the Doctrine • Reinsurer not liable for risks beyond what was covered by the underlying policy. No requirement to reimburse cedent for exgratia payments. • Reinsurer not liable for risks which are not covered by the reinsurance certificate • Does not apply to settlements made by the cedent which are fraudulent, collusive, or made in bad faith

9. Does The Doctrine Apply To Post-Settlement Allocations As Well as Coverage Decisions?

10. Decisions Construing The Follow The Fortunes Doctrine Broadly To Post-Settlement Allocations

11. Seven Provinces Doctrine applies to good faith and reasonable allocation of settlement dollars

12. North River Insurance Co. v. ACE American Reinsurance Co. • Doctrine applied to cedent’s post-settlement allocation based on “rising bathtub” methodology • Inconsistency between cedent’s post-settlement allocation and its own pre-settlement analysis of risk • Main rationale for follow the fortunes doctrine is to foster the goals of “maximum coverage and settlement” and avoid undermining the foundation of the cedent-reinsurer relationship

13. Travelers v. Gerling • Post-settlement allocation subject to follow the fortunes doctrine regardless of whether allocation is inconsistent with cedent’s pre- settlement risk analysis or the settlement with the underlying insured • Not easy to establish bad faith in the context of post-settlement allocations

14. Cases Construing the Doctrine More Narrowly To Post-Settlement Allocations

15. Allstate Ins. v. American Home Assurance • Cedent’s post-settlement allocation unreasonable as a matter of law where it was inconsistent with position taken by cedent and insured and with court ruling in underlying litigation • Attempt to distinguish North River and Gerling • Cedent cannot play by two sets of rules

16. American Employers Ins. v. Swiss Reinsurance America • Not “presently prepared to adopt” the cedent’s argument that the follow the settlements clause required acceptance of the cedent’s unilateral post-settlement decision as to allocation among reinsurance policies “regardless of what the settlement embodies.” • Description of remand on good faith issue

17. Practical Observations Based on U.S. Case Law

18. The English Revolution:“Follow the Fortunes” after Lexington v. Wasa and AGF John T. HardingMorrison Mahoney LLPjharding@morrisonmahoney.com

20. Your Host for the Revolution

21. The Revolution is On!

22. A Tale of Two Cedents

23. ICA v. SCOR • Fraudulent Claim (Maybe? Probably?) • Honestly settled by direct company after liability determined • Reinsurer bound to follow settlement even if claim was not within the scope of the insurance because claim was fraudulent

24. Lexington v. Wasa • Direct company liable per Washington Supreme Court • Liability estimated to be greater than $180 million • Settled for $103 million

25. The Cedent’s Position • Written as “back-to-back” reinsurance—same terms and conditions as direct insurance • “Full Reinsurance Clause” • Reinsurer agreed to “follow the settlements” of the direct company

26. Let’s Hear from the Reinsurer

27. You want me to follow what??? • Reinsurance certificate governed by “purely English law” • Reinsures the original “risk,” not the direct company’s liability • Period of cover fundamental; does not cover damage outside the policy period

28. No Bloody English Court Would Ever Rule That Way

29. The Envelope Please • Settlement was reasonable and business-like • Presumption that insurance is back to back • BUT Reinsurer does not pay under “purely English law” governing the reinsurance certificate as no English court would ever reach the same result as Washington Supreme Court

30. What Does It All Mean? • London reinsurers rebelling from the vagaries of the US civil system • Contract clauses must be viewed through “purely English law eyes” • “Follow the settlements” is just one clause

31. Fundamental Principles

32. FULL REINSURANCE CLAUSE NO. 1 (3 June 1943)

33. The Critical Wording “Being a reinsurance of and warranted same gross rate, terms and conditions as and to follow the settlements of the Company. . .”

34. Back-to-Back • Language creates the presumption that the insurance and the reinsurance are “back-to-back” • Written on same terms, conditions and limitations and to have the same scope • Terms of two contracts mean the same thing (but just a presumption per Wasa)

35. INSURANCE COMPANY OF AFRICA v. SCOR(1985)

37. They Call Me Mr. Ali!

38. ICA v. Scor • Warehouse fire at Africa Trading Co. • ATC operated by a questionable dude, Mr. Ali • Building insured for $500K and contents for $3 million

39. Was it Fraud? • ICA suspected fraud, but couldn’t prove it • ICA refused to pay • ATC sues in Liberian court • Judgment for $4 million

40. Who is the Cedent?

41. The Reinsurance Claim • ICA tenders to Scor • Scor defends on grounds that it was a fraudulent claim and therefore not within scope of the direct insurance nor of the reinsurance • If “back-to-back” and was never covered, reinsurer should not have to pay

42. Don’t Score Another One for Scor • Scor loses at trial • Absence of proof of fraud • Seeks appeal claiming new evidence from the mystery witnesses

43. Appeal Rejected • “The reinsurer, when called upon to perform his promise, is entitled to require the reassured first to shew that a loss of the kind reinsured has in fact happened; and, secondly, that the reassured has taken all proper and businesslike steps to have the amount of it fairly and carefully ascertained. That is all. He must then pay.” --- Poole’scase [1903]

44. The Touchstone:Lord Justice Robert Goff “In my judgment, the effect of a clause binding reinsurers to follow settlements of the insurers, is that the reinsurers agree to indemnify insurers in the event that they settle a claim by their assured. . .provided that:

45. Proviso One • “The claim so recognized by them falls within the risks covered by the policy of reinsurance as a matter of law”; and

46. Proviso Two • “That in settling the claim the insurers have acted honestly and have taken all proper and businesslike steps in making the settlement.”

47. The Conclusion “If insurers have settled a claim, acting honestly and in a proper and businesslike manner, then the fact that reinsurers may thereafter be able to prove that the claim of the assured was fraudulent does not of itself entitle reinsurers not to follow the settlement of the insurers. In my judgment they must follow the settlement, as they have contracted to do.”

48. Post-Scor Developments • Hill v. General Reinsurance • CU v. NRG • Generali v. CGU • Aegis v. Continental Casualty All Reaffirm Basic Principles of Scor

49. Out of Africa