“FOLLOW THE LEADER” A BRIEF HISTORY OF “FOLLOW THE SETTLEMENTS” CLAUSES – THE U.S. VIEW Prepared for: AIDA Word Congress September 30, 2014 Prepared By: Richard K. Traub Traub Lieberman Straus & Shrewsberry LLP

INTRODUCTION  Designed to prevent reinsurers from second guessing the good faith claims handling decisions of cedents.  Without such a clause, the reinsured would bear the onus of proving that the reinsurer is liable to it.  This would required strict proof of both legal liability and evaluation of amount of payment.  Difficult enough with facultative reinsurance, in the treaty context, impossible.  Thus the reinsurer agrees not to dispute the settlement made.  Leaves claims handling to the reinsured – which is most often the one that wrote the risk and most familiar with it.

EVOLUTION OF THE CLAUSE Historical business process where reinsured has direct relationship with insured and direct access to pertinent information about the risk – And the reinsurer usually must rely on the utmost good faith of the reinsured to: ▫Underwrite the risk and ▫Handle claims properly and reasonably In fact, some courts imply the doctrine of “Follow the Settlements” even when it is not present – most do not. 3

EVOLUTION OF THE CLAUSE While most courts do not imply the language, the word “Follow” is not determinative of the issue. As long as the language indicates that reinsurer is bound by the reinsured’s determination, the clause is likely to be considered following. 4

EVOLUTION OF THE CLAUSE Early cases looked to see if reinsurer could avoid payment because of: ▫The nature of the settlement; ▫The amount of the settlement, or; ▫The manner in which the case was settled. Reinsurance allocations in the context of asbestos and environmental claims lead the charge on this front. 5

EVOLUTION OF THE CLAUSE Context of reasonableness does apply Early courts applied test of reasonableness to reinsured’s allocation of good faith settlement to the reinsurers. Did not have to be followed “no matter what” but the reinsurer id have to follow those allocations if they were reasonable, in good faith, and within the applicable policies 6

EVOLUTION OF THE CLAUSE At one point of time or another, reinsurers were: Bound to pay any claim honestly paid by the reinsured; Bound to pay only if the reinsured could prove that it was strictly liable under the original policy for the precise amount of the loss; Bound to pay so long as the reinsured could show that an insured loss had taken place. An honest mistake was not a reason to avoid the contract. Bound to pay so long as the reinsured could provide that the the loss was covered under the original policy; Bound to pay provided the reinsured’s settlement was not dishonest or careless.

EVOLUTION OF THE CLAUSE Finally resolved in Insurance Company of Africa v. Scor (1985) 1 Lloyd’s Rep 312. ▫Warehouse fire which was held to be covered under the ICA policy which was reinsured in part by Scor. ▫Scor refused to settle arguing that the claim was fraudulent. ▫Insured sued ICA, ICA had no evidence of fraud, lost the case, and settled underlying case. 8

Insurance Company of Africa v. Scor Lord Justice Goff held that the reinsurer binds itself to pay a claim settled by the reinsured with two exceptions: ▫Where the reinsured did not take a proper or business like steps in making the settlement, or ▫Where the claim does not fall within the risk covered by the reinsurance contract. ▫Thus, obligation to follow the settlements extends to fraudulent claims if the reinsured, acting in a businesslike manner cannot prove the fraud – even if the reinsurer is later able to do so. 9

Evolution of the Clause Thus it does not matter whether the claim falls within the direct policy, it matters only that it falls within the reinsurance policy There are other limitations 10

BURDEN OF PROOF and “PROPER BUSINESS LIKE STEPS” So long as cedent can show it paid underlying insured and that claim falls within reinsurance contract – The burden of proving the ABSENCE of good faith or the fact that the settlement was not made in a business like manner, falls to the reinsurer. 11

Burden of Proof Its significant. For example, proper and business like steps is more than merely having he matter handled by a competent loss adjuster. That loss adjuster must adjust the claims in a businesslike manner and settle the claim in a businesslike manner. But, it is the reinsurer that most show that this did NOT happen. Very difficult to prove. 12

OTHER LIMITATIONS Ex Gratia payments ▫Made when no obligation to do so, perhaps for commercial reason ▫Coverage will depend on precise language of the reinsurance contract. ▫Unless clause refers to “ex gratia” payments, the reinsurer will NOT be liable to follow the settlements regardless of how businesslike or reasonable the payment may have been. Gross negligence in claims handling 13

OTHER LIMITATIONS Without Prejudice Settlements ▫Settlement made where there is no admission of the existence of a any liability under the terms and conditions of the underlying policy. ▫Distinguished from “ex gratia” whereas here it means only that there is no admission of liability and the settlement is of a disputed amount. ▫Certain, albeit few, courts have held that this compromise falls OUTSIDE the reinsurer’s obligation to pay – usually were reinsurance contract requires that the settlements must fall within the terms and conditions of the reinsured contract. 14

FOLLOW THE FORTUNES Sometimes used interchangeably especially in the U.S. “Follow the Fortunes” reminded the reinsurer of obligation to provide indemnification to reinsured even when mistakes were made in the bordereaux or general administration Not subject of many court decisions. 15

CONCLUSION Case law suggests that multiple different words can be used to describe follow the settlements or to describe obligation of reinsurer. Scope and effect will depend on specific construction within context of particular reinsurance. Cases prefer language that identifies real intention of the parties Beware of inconsistencies 16

CONCLUSION Case law useful of course, in demonstrating situations where exceptions apply – BUT Case law is not definitive in demonstrating the practical differences between the two ways in which the exception is articulated i.e. a “reasonable, business like investigation” or the “absence of gross negligence or recklessness” Why burden of proof is so important. Either way, closer scrutiny of how claims are handled can be expected. 17

CONCLUSION So long as case law limits exceptions to truly incompetent and/or dishonest claims adjusting and settlement, it should not undercut, but place only reasonable limits on the cedent’s judgment calls which are protected by the “follow the settlements” clause. 18