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Reinsurance

Presented by
Dan Labrie, Vice President Underwriting
Housing Authority Risk Retention Group, Cheshire, Connecticut

Part I: The Reinsurance Environment

Good afternoon. Today we are going to talk about reinsurance contract wording. My presentation is divided into three major parts: One, the reinsurance environment: the function and goals of a contract. Two, clauses used in most reinsurance contracts. And three, some clauses used in excess liability coverage.

This is a topic that brings confusion and has a great amount of complexity. How can we tell, as reinsurance buyers, whether or not we have a solid contract when the issue of contract wording is so nebulous? How do we know how far we can go in negotiating a contract?

The intent of this session is to highlight important points that will enhance your position as a buyer of reinsurance.

Before I get into the meat of my presentation, I would like to say a few words about facultative and Treaty Reinsurance.

Reinsurance treaty is defined as ìa standard agreement for the cession and assumption of riskî as defined in the treaty. Most treaties provide automatic assumption of risk. The obligations are expressed in a contract. Facultative Reinsurance deals with a single risk with separate negotiations for each placement. The document used is a reinsurance certificate. The focus of the presentation is to discuss treaty contract wording, NOT facultative certificates.

The reinsurance environment has changed significantly during the last 10 to 15 years. Back in the old days, we had a small community of reinsurers that acted like a gentlemen's club. They knew each other, and followed pretty much the same code of conduct. Disputes were few and were often informally resolved.

Today, the environment is more like a business than a gentlemen's club. You have more players, more deals, and contracts can vary greatly between reinsurers. Disputes are no longer resolved by a handshake. They are more frequent and more difficult to resolve.

A reinsurance agreement has three major functions:

1. It's a Map -- It provides direction to the parties in order to fulfill the obligations of the contract;
2. It's a Shield -- It protects the reinsurer from obligations with no intent;
3. It's a Sword -- It enforces the obligation of the contract;
4. It's a Knight in Shining Armor

There are three important goals of contract wording which we need to keep in mind:

1. A contract should be short, concise and easy to understand;
2. The contract should contain terms and provisions that lend themselves to ready and uniform interpretation;
3. The focus of the contract should imply the utmost good faith principle. This principle assumes that both parties are so knowledgeable on the subject matter to be dealt with and possess such a degree of sophistication as to preclude the necessity for long complex declarations of intent and implementation.

Part II: Common Clauses Used in Reinsurance Contracts

The second part of this presentation deals with common clauses that are used in a contract.

The first one is the reinsurance clause:

This is the clause where you get your contractual obligation. The clauses should contain the type of reinsurance and what the obligation of the parties are. (See attachment 3)

Here is an example of a clause that is worded properly:

Another common clause is the list of exclusions:

The purpose of an exclusion is to spell out the classes of business' or exposures not intended to be protected or reinsured. The exclusion is usually a matter of negotiations.

There are three types of categories:

1. Classes such as Aviation or Boiler & Machinery;
2. Difficult exposures, such as underground coal mining;
3. Perils such as flood or hail.

Here is one example of a long list of exclusions from one reinsurer. I think we have to be very careful when we make the contract subject to a list of exclusions. Why?

1. Non-concurrent forms/policy says one thing and then the reinsurance contract says another.
2. You open the door for differences of opinion or misinterpretations.

Example: Law Enforcement Liability -- We have housing authorities that employ non-armed security guards which are covered under the General Liability policy. The policy includes personal injury which provides coverage for false arrest and defamation of character. This exclusion could take away the personal injury protection.

I think one way to avoid these situations is to have a reinsurance contract following the underlying policy. The reinsurer should rely on the policy wording to exclude a specific exposure. I think it is cleaner and provides better protection to the ceding company.

What about incidental exposures that are not covered by the exclusions of the reinsurance contract?

Example: On this list we have the herbicide exclusion. A PHA performs this operation (which is incidental) and is covered under our primary policy.

Would this reinsurer be obligated to pay for the loss? According to past industry practices, the answer is yes. If it is incidental and the primary policy provides coverage. However, you cannot always rely on past industry practices because it changes over time. It is not anchored under court law. Your reinsurer has the option to stick to the contract terms. Industry practices do not always override the terms of a contract.

Arbitration -- I think the industry placed too much confidence in the arbitration process.

Here are some of the problems we may face when arbitration is triggered:

1. The process is very slow;
2. There are many bottlenecks in picking arbitrators;
3. It is difficult to get active people to be arbitrators;
4. The number of arbitration cases are increasing faster than the availability of people;
   Example: A couple of years ago, we had 2,000 to 3,000 cases per year; today, the estimated number is 5,000 to 7,000 cases per year.
5. The cost of arbitration is going up.

Because of the vital significance of this clause, it should receive the closest scrutiny in order to make sure it clearly expresses the intent and wishes of the parties. The clause is designed to avoid taking disputes to a court of law. Virtually all states now recognize the enforcement of the arbitration clauses, except Missouri.

Here is a list of what an arbitration clause should include:

1. Qualified arbitrators;
2. Arbitrators are not under the control of either of the parties;
3. If arbitrators are unable to agree upon an umpire, there should be a process to select the umpire;
4. Payment of the cost of the arbitrator;
5. Stated time limit for the appointment of an arbitrator;
6. Site of the arbitration;
7. The decision rendered by the majority of arbitrators should be final and binding on both parties.

Ways of Improving the Arbitration Process

1. The clause should clearly state that any dispute will be settled by arbitration;
2. Because the buyer is at a disadvantage in appointing an arbitrator, you need more time to select. Usually, the standard 30 day period is not enough time. A recommendation is a minimum of 60 days.
3. Most clauses require an arbitrator or umpire to be an active or a retired executive officer of an insurance or reinsurance company. Because there is a lack of qualified insurance executives to perform arbitrational duties, you could add ìqualified representatives.î This would give you the flexibility in picking someone who you feel can understand and appreciate you position.
4. Adding a meditation clause to the contract. (See attachment 6a)
5. The purpose of this clause is to reduce the possibility of arbitration and resolve the problem quickly and effectively, without jeopardizing the relationship.

e. Errors and Omissions

The errors and omissions clause is a standard provision in reinsurance contracts. It illustrates the utmost good faith that underlies the agreement between the parties. Basically, what the clause says is that errors may be made by either party but it provides that such an error does not relieve the parties of liability so long as the errors are corrected as soon as possible. However, the clause does have limitations and is not intended for Errors and Omissions resulting from business shortcomings or from a deficient system is the business' organization.

One quick comment regarding the cancellation clause

Pay special attention to the advance notice requirement. The more common custom is to require either party to give to the other 90 days notice in writing. That may be enough time. To relace your reinsurance, you can negotiate for a longer term.

The last item is a suggested provision that will help reduce your business cost when reinsurers delay payments of claims. ( See attachment 7)

Part III: Important Clauses in Excess Treaties

The third section of my presentation is discussing clauses that are common to liability excess treaties.

The ìultimate net loss clauseî in an excess contract states how allocated adjustment expenses are to be handled in determining recovery under the contract. The clause also deals with salvage recoveries and recoveries from other reinsurance. There are two types of clauses.

1. The first states that the reinsurer will pay the loss within its layer and a proportional amount of the allocated loss adjustment expense.
2. The second method adds the loss and allocated loss adjustment expense together and are considered to be the total loss for the reinsurer.

In the first two examples, the reinsurer may pay less dollars on a specific claim by paying the loss plus a share of defense costs. The reinsurer is more comfortable in doing this because the "attachment point" to loss is higher.

When the contract includes allocated loss adjustment expenses in the retention of the ceding company, the benefit to the ceding company is to move the reinsurer closer to loss. Usually the reinsurer cost is more than the pro rata method.

Judgment in Excess of Policy Limits

Such situations arise when a company fails to accept a settlement offer within its original policy limits or commits some act of alleged or actual negligence in handling the claims. the court may award a judgment against the insured which is in excess of the company policy limits and the insured, in turn, sues the company on the ground that the company did not handle the claim settlement properly.

Up to now, it is not uncommon for an insurance company to be held liable in third party claims for a judgment in excess of its policy.

There are two ways in which to handle this:

1. If the reinsurer ìfollows the fortuneî of the company, then the company may be covered under the contract; the reasoning being that the company is assured that all losses over and above the attachment point will be accepted by the reinsurer and within the reinsurance contract limit.
2. The recommended option is to specifically add the coverage to the contract.

Extra Contractual Obligations

This occurs when punitive damages are assessed against the insurance company because the company acted in an outrageous or malicious manner in the handling of a claim. Such cases arise when a policyholder can prove he/she suffered harm or financial loss as a consequence of the manner in which a claim was handled.

Two Schools of Thought

1. Some reinsurers maintain that punitive awards against a client company is a business risk and therefore not covered by the reinsurance contract.
2. The other approach is to add the coverage to your reinsurance contract. This
3. coverage can be negotiated with the reinsurer and is worth pursuing because of the exposure to loss.

Closing Comments

Now that I have completed my presentation, I would like to conclude by going back to the questions I had raised at the beginning.

1. How can we, as reinsurance buyers, tell whether or not we have a solid contract?
   If your contract has achieved the goal of being short, concise and easy to understand, then you are on the right track. Also, you want to make sure that your contract protects your interests.
   For Example: Your reinsurance contract may follow the coverage of your underlying policy and doesn't have a long list of exclusions. Or perhaps, your cancellation notice is 120 days rather than 90 days. Another possibility is the arbitration clause that you negotiated with the reinsurer gives you more time to select an arbitrator.
2. As reinsurance buyers, what are the conditions that would produce a contract that would give you broader coverage?

My response is "Never Say Never" and all items of the contract are negotiable.

For example: The Mediation clause can be discussed with your reinsurer. Also when you negotiate your contract, you may want to review which ultimate net loss provision best fits your need. Or you may want to include or demand the penalty for late payment claims by the reinsurer.

Knowing more about reinsurance contract wording will help you become much more sophisticated reinsurance buyer and gives added value to your reinsurance agreements.

Major Functions of a Reinsurance Contract

1. A MAP
2. A SHIELD
3. A SWORD
4. A KNIGHT

Three Important Goals In Contract Wording

1. Short, concise and easy to understand.
2. Uniform interpretation of clauses.
3. Utmost good faith.

In consideration of the payment of the premium as provided herein, the Reinsurers agree to indemnity the Company in respect of the net excess liability which may accrue to the Company as a result of loss occurrences arising during the term of this Contract under any of its policies, binders, contracts of insurance or reinsurance (all hereinafter called ìpoliciesî) or other evidence of liability (whether written or oral) heretofore issued or which may hereafter be issued by or on behalf of the Company, subject to the following conditions.

Exclusions

1. All business other than liability coverages indicated in the Business Covered Section
2. Law Enforcement Liability, Public Officials Errors and Omissions, Lead-based Paint Liability, Employee Benefit Liability
3. Worker's Compensation
4. Seepage and Pollution
5. Asbestos exposure
6. Extra-contractual obligations (ECO)
7. Pools, Syndicates and Associations
8. Fairs, carnivals, and the operation of amusement devices
9. Explosive substances
10. Professional Liability except for incidental (non-physician) health care
11. Kidnap, ransom and extortion
12. Fiduciary liability from ERISA
13. Sexual molestation
14. Use/storage of insecticides, pesticides, and herbicides
15. All public livery vehicles including buses and emergency vehicles
16. Trucks hauling or operating regularly beyond 200 mile radius
17. Vehicles transporting gas, fuses, fireworks, hazardous materials or hazardous waste.
18. Nuclear incident

Provisions of Arbitration

If an irreconcilable difference of opinion should arise between the parties as to the interpretation of this Reinsurance Agreement, the ceding Insurer shall have the option of submitting the matter to arbitration and the Assuming Insurer shall be bound by such election. One arbitrator shall be chosen by the ceding Insurer, one by the Assuming Insurer, and an umpire shall be chosen by the arbitrators. If the Assuming Insurer fails to name its arbitrator within thirty (30) days after receiving the written request of the other party to do so, the latter shall name both arbitrators and they shall select an umpire.

Ways to Improve the Arbitration Process

1. Any Dispute
2. Stated Time Limit
3. Qualified Professional
4. Mediation

Mediation - If the parties fail to resolve a dispute either party may request Mediation. The sole purpose of Mediation is to assist the parties in reconciling their dispute. Mediation shall not be binding in any way on either party. Mediation shall not be binding in any way on either party. Mediation shall not cause the forfeiture of any future defenses. A Mediator shall be appointed by the parties but shall have no binding authority, and his/her judgment, opinions or assistance does not have to be accepted by either party, his/her only function is to assist the parties in reaching a successful and satisfactory conclusion to their dispute.

PAYMENT OF CLAIMS

The reinsurer when presented with proper documentation from the Reinsured shall pay claims promptly. This shall be defined as within ten (10) business days from the receipt of the claim.

If a promptly documented claim is not paid within fifteen (15) days an interest charge of ?7 percent per day will be applied against the amount past due by the Reinsurer until the total amount is paid. This interest charge shall not be applied against the total limits payable by the Reinsurer under this agreement.

Two Methods to Handle Allocated Loss Adjustment Expense

1. Pro-Rata
2. Cost Inclusive

First Method

Proportional (Pro-Rata) in addition to reinsurer's limit.

Treaty: 1,500,000 x 500,000 (for all examples)

Example 1:

                          Indemnity            ALAE           Total 
Cost

GROSS LOSS                 1,000,000          250,000                  
--

Reinsurer's Share            500,000          125,000 (50%)       
625,000

                  (50% of Gross Loss)

Ceding Company's Share        500,000 (50%)    125,000 (50%)       
625,000

                                  *********

Example 2:

GROSS LOSS                   650,000          100,000                  
--

Reinsurer's Share            150,000           23,000 (23%)        
173,000

                  (23% of Gross Loss)

Ceding Company's Share       500,000 (77%)     77,000 (77%)        
577,000

                                   *********

Example 3:

GROSS LOSS                 2,000,000          300,000                  
--

Reinsurer's Share          1,500,000          225,500 (75%)      
1,725,000

                  (75% of Gross Loss)

Ceding Company's Share       500,000 (25%)     75,000 (25%)        
575,000

Second Method

The Second Method is to make the allocated loss adjustment expense and indemnity as part of the loss.

Example 1:

Gross Loss:               $1,000,000

ALAE:                        250,000

Total Loss:                1,250,000

Reinsurance Treaty: $1,500,000 x $500,000

Reinsurer Pays:             $750,000

Ceding Company Pays:        $500,000

                                   ************

Example 2:

Gross Loss:                 $650,000

ALAE:                        100,000

Total Loss:                  750,000

Reinsurance treaty: $1,500,000 x $500,000

Reinsurer Pays:             $250,000 

Ceding Company Pays:        $500,000

                                   *************

Example 3:

Gross Loss:               $2,000,000

ALAE:	                     300,000

Total Loss:                2,300,000

Reinsurance treaty: $1,500,000 x $500,000

Reinsurer Pays:           $1,500,000

Ceding Company Pays:        $800,000

Comparison

                                               Cost

                            Prorata         Included

Example 1

($1,250,000 loss)

Reinsurer                    625,000          750,000

Ceding Company               625,000          500,000

Example 2

($750,000 loss)			

Reinsurer                    173,000          250,000

Ceding Company               577,000          500,000

Example 3

($2,300,000 loss)

Reinsurer                  1,725,000        1,500,000

Ceding Company               575,000          800,000

ARTICLE XVIII

LOSS IN EXCESS OF POLICY LIMITS/
EXTRA CONTRACTUAL OBLIGATIONS

1. In the event the Reinsured pays or is held liable to pay an amount of loss in excess of its policy limit, but otherwise within the terms of its policy, (herein after called ìloss in excess of policy limitsî) or any punitive, exemplary, compensatory, or consequential damages, other than loss in excess of policy limits (hereinafter called ìextra contractual obligationsî) because of alleged or actual bad faith or negligence on its part in rejecting a settlement within policy limits, or in discharging its duty to defend or prepare the defense in the trial of an action against its policyholder, or in discharging its duty to prepare or prosecute an appeal consequent upon such an action, or in otherwise handling a claim under a policy subject to this Agreement, 90% of the loss in excess of policy limits and/or 90% of the extra contractual obligations shall be added to the Reinsured's loss, if any, under the policy involved, and the sum thereof shall be subject to the provisions of Article VI.
2. An extra contractual obligation shall be deemed to have occurred on the same date as the loss covered or alleged to be covered under the policy.
3. Notwithstanding anything stated herein, this Agreement shall not apply to any loss in excess of policy limits or any extra contractual obligations incurred by the Reinsured as a result of any fraudulent and/or criminal act by any officer or director of the Reinsured acting individually or collectively or in collusion with any individual or corporation or any other organization or party involved in the presentation, defense or settlement of any claim covered hereunder.
4. Recoveries from any form of insurance or reinsurance which protects the reinsured against claims the subject matter of this Article shall inure to the benefit of this Agreement.

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