1. EVOLVING CONTOURS OF THE 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 LLP wmcelroy@zelle.com wmcelroy@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 ex gratia 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. Harding Morrison Mahoney LLP jharding@morrisonmahoney.com jharding@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’s case [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

51. And Now a Word from Our Sponsor...

53. A Series of Unfortunate Events

54. The Lexington Policy Lexington DIC Policy: 1 July ’77 to ’80 “Gap” coverage / Difference in Conditions $20 million per occurrence All risks of direct physical loss as well as business interruption, etc.

55. Alcoa’s Claim Indemnification for environmental contamination 75 sites / 2 cases 150 policies Contamination from 1940’s to 1980’s

56. The Trial Court Rulings Pennsylvania law applies (Alcoa HQ) Suit limitation period bars coverage More than one occurrence at each site Jury determines damage occurred over long period of time Trial judge rules that damage from continuous process of injury can be apportioned

57. Washington Supreme Court Mass. law applies to Lexington policy (no enforceable suit limitation provision) J.H. France = “All Sums” / No Allocation As long as “some” property damage occurred during policy period the insurer is on the hook for everything

58. The Fun Begins Lexington calculates liability > $180M Lexington settles for $103M Lexington tenders to Wasa and AGF (2.5% of the reinsurance slip) They way “No thanks, indeed.”

59. There Will Always Be An England

60. Common Ground “This was an honest and business-like settlement” Contract contains Full Reinsurance Clause No. 1 “...and to follow the settlements of the Company” English law governs the reinsurance

61. Lexington’s Position Scope of direct insurance determined by court of competent jurisdiction Presumed intent is that same meaning and effect given to reinsurance Otherwise what is point of “back-to-back”

62. The Reinsurers’ Position We insured three years, not 50 Period of cover fundamental “Follow the settlements” does not mean that agreed to indemnify for any “liability” Lexington might incur Not within the reinsurance as a matter of law

63. The Court of Appeal Frames the Issue Q:“It is no doubt true that the stated period of time is fundamental; the question is, however, whether that fundamental provision is, if it is the same in both the contracts, to receive the same interpretation or a different interpretation.”

64. The Court of Appeal Answers the Inquiry No evidence that the parties intended the contracts to operate other than according to the usual presumption Same or equivalent wordings should be given the same meaning in the reinsurance and the direct insurance (See Vesta and Catatumbo) Imagined “intent” of underwriters in 1977 not a basis to depart from these rules

65. The Modern Commercial Reality “The need for the fiction that the reinsurance covered the primary risk and not the insurer’s own potential liability is thus long spent. The practice and vocabulary of reinsurance law have for a long time now reflected the reality that what is reinsured is the insurer’s own liability”

66. An Epistle from Lord Justice Longmore “No one can pretend that the decisions of the United States courts in relation to asbestosis and pollution claims are remotely satisfactory from the point of view of insurers let alone reinsurers....

67. The Lord Justice Speaks “Reinsurers’ arguments in the present case had a whiff of an assertion (although they were careful not to say so expressly) that Lexington were an American Corporation and therefore had to take unsatisfactory American decisions on the chin, while reinsurers were English... and could not be expected to do so. That of course, will not do.”

68. The Revolution is Over “The appellant’s very name is apt to remind one of the opening shots of the War of Independence but that conflict has long since receded into history and must remain there”

69. Reaction to the Court of Appeal’s Decision Was Swift

70. The Queen Was Not Amused

71. “You Say You Want a Revolution”

72. These are so not the Fab Four

73. The Decision: Warts and All

74. Rule Brittania When the chips are down, English law controls “ ‘Physical loss or damage’ under a policy providing cover for three years simply cannot be construed under English law to include pre-existing damage”—Lord Justice Brown

75. Whatever Happened to “Back-to-Back” No dispute that insurance and reinsurance were “back-to-back” Presumption that terms mean the same thing But, overcome in this case by...

76. When English Law Eyes are Smiling Reinsurance is a separate contract Reinsurance is not an insurance against liability Rejects idea that reinsuring the original risk (rather than liability) is “long spent”

77. Consider the Scope Scor—claim so recognized falls within risk covered by the reinsurance Construing period of cover according to English law principles cannot possibly have the meaning given to it by the Washington Supreme Court “Follow the settlements” does not change the scope

78. But Lexington Didn’t Think it was Covered Either “The consideration that Lexington probably did not reckon on the liability which it was held to have in America is not by itself a conclusive reason for passing that liability to reinsurers who were, on the face of it, also entitled to be confident that no such liability could arise under the clear and basic terms of the English law contract into which they entered.”

79. Lord Justice Collins “At the beginning and end of these appeals remains the question whether the provision for the policy period in the reinsurance is to be given the effect it has under English law, or whether the parties must be taken to have meant that the reinsurance was to respond to all claims irrespective of when the damage occurred and irrespective of the period to which the losses related...

80. And so it goes... “There is, in my judgment, no principled basis for a conclusion in the latter sense.”

81. Wake Me Up When the Revolution is Over

82. Thoughts and Recommendations: How broadly will it be applied? What arguments will reinsurers craft? Drafting considerations—choice of law? Involvement of Reinsurers?

83. Questions: How About a Shave?