A key feature of facultative reinsurance is the back-to-back nature of the coverage. While not all facultative placements are meant to be back-to-back, most are and as shown by the case discussed below, that is a strong presumption under English law.
In The Insurance Co. of the State of Pennsylvania v. Equitas Insurance Ltd., No. 17 CV 6850-LTS-SLC (S.D.N.Y. Jul. 16, 2020), the parties cross-moved for summary judgment on a dispute over a large environmental pollution claim paid by the cedent under an umbrella policy. The underlying policy was governed by Hawaii law and the settlement was allocated by the cedent under the “all sums” approach. The cedent reinsured the umbrella policy under two facultative certificates. The certificates were governed by English law and contained follow-the-settlements language.
In granting summary judgment in favor of the cedent and denying summary judgment to the reinsurer, the court focused on the strong presumption of back-to-back coverage for facultative reinsurance. The court provided a neat summary of English reinsurance law as it pertains to follow-the-settlements and back-to-back coverage. Under English law, said the court, there is a presumption as a matter of law that the cedent’s settlements are covered if the cedent can prove that it paid the settlement and the claims arguably fall within the insurance and reinsurance contracts. A reinsurer can refuse to follow the settlement if it falls outside the legal scope of cover.
The court noted that in determining the legal scope of cover under a reinsurance contract, English law provides a strong presumption of back-to-back coverage. In other words, said the court, liability under a proportional facultative certificate is co-extensive with the reinsured policy (citations omitted).
The main dispute here was whether the all-sums approach under Hawaii law flowed through to the facultative certificates or whether the exception to the back-to-back presumption under English law applied. The reinsurer argued that under English law, the “all-sums” approach violated the temporal term of the contract and the back-to-back presumption could not expand coverage beyond what the parties intended. The court rejected the reinsurer’s argument finding, instead, that English law did not require an exception to the back-to-back presumption. The exception arose in a case where the parties were unclear on the governing law. In this case, the parties knew that Hawaii law would apply and that Hawaii law concerning allocation could change.
The mere fact that English law governs the Reinsurance Policies, including their stated policy periods of three years, is not sufficient to overcome the presumption English law applies in favor of back-to-back coverage and does not excuse [the reinsurer’s] obligation to indemnify [the cedent] under the law governing the … Policy. For these reasons, [the cedent] is entitled to indemnification from [the reinsurer] for its reinsured share of the settlement paid under the … Policy.
Finally, the court rejected the reinsurer’s late notice defense, holding that the reinsurer did not meet its burden of presenting evidence that the cedent acted with extreme dishonesty resulting in the reinsurer being extremely prejudiced by the notice.
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