Second Circuit Rules Facultative Certificates Respond On a Cost-Inclusive Basis in Asbestos Dispute

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Insurance coverage and reinsurance disputes over asbestos settlements continue to occupy the courts. Many of the reinsurance disputes revolve around how facultative certificates of reinsurance must respond to underlying asbestos settlements involving umbrella policies. The issue typically involves whether the expenses associated with the defense of the underlying claims is recoverable in excess of the underlying policy limits. In a recent case, the Second Circuit issued a fairly long decision on this issue.

In Utica Mutual Insurance Co. v. Munich Reinsurance America, Inc., Nos. 19-1241; 19-4335 (2d Cir. Jul. 29, 2021), the Second Circuit was faced with two appeals of two district court judgments that went in opposite directions. The cases primarily concern whether the reinsurers must reimburse the cedent for defense costs in addition to limits of the cedent’s umbrella policies. In one case, the court, after a bench trial, held that the reinsurer did not have to reimburse defense costs in addition to the limits. In the other case, after a jury trial, the court held that the cedent was entitled to reimbursement for defense costs in addition to the limits. Obviously, the opposite results could not stand.

The case involved two facultative certificates and two different reinsurers. In one case, there was a further dispute about whether the reinsurer was, in fact, the successor-in-interest to the original reinsurer. A side issue for this discussion, but not for the parties. The opinion was written by former Chief Judge Dennis Jacobs, who in his earlier career was an insurance and reinsurance lawyer so he knows a thing or two about the subject (and has written several important insurance and reinsurance opinions).

The circuit court affirmed the bench trial judgment (no reimbursement on a costs-in-addition basis – victory to the reinsurer) and reversed and remanded, in part, the jury trial judgment (the side issue had to be decided with the reinsurer allowed to bring in evidence excluded from the jury on whether it was the successor-in-interest but the decision on cost-in-addition to the limits was reversed). In making its decision, the court provided a clear roadmap to contract construction and a mini-treatise on excess and umbrella policies and facultative certificates of reinsurance.

One of the issues in dispute is whether an amendment to the umbrella policy changed the policy from cost-inclusive to cost-in-addition. The amendment addressed the umbrella policy’s drop-down coverage for losses outside of the coverage of the primary policy, while the asbestos losses came under the umbrella policy’s excess coverage. The court found that the amendment only affected the drop-down coverage, not the excess coverage, and changed the how expenses would be reimbursed only for the drop-down coverage. Accordingly, the cedent was not entitled to reimbursement for expenses in addition to the limit.

Nevertheless, the cedent argued that the follow-the-settlements doctrine required the reinsurer to pay the settlement anyway. The court rejected this argument.

True, when a reinsurance certificate contains a follow-the-settlements clause,[4] the reinsurer cannot question allocation decisions made after a settlement between the cedent and policyholder if the settlement “is in good faith, reasonable, and within the applicable policies.” Travelers Cas. & Sur. Co. v. Gerling Glob. Reinsurance Corp. of Am., 419 F.3d 181, 190 (2d Cir. 2005) (citing N. River Ins. Co. v. Ace Am. Reinsurance Co., 361 F.3d 134, 140 (2d Cir. 2004)). But this assumes that the cedent’s billing to its reinsurers is at least consistent with, and does not contradict, its performance of the settlement. Not so with Utica’s performance.

Because the underlying settlement treated the umbrella policy as cost-inclusive, it contradicted the cedent’s position in this case that the reinsurer must pay on a cost-in-addition basis. Accordingly, the cedent’s allocation was invalid.

Additionally, the court found that the follow-form facultative certificates linked the reinsurer’s liability to that of the cedent and under the umbrella policies, expenses were cost-inclusive. As the court noted, with citations, a follow-the-settlements clause does not alter the terms or override the language of the reinsurance contracts. Accordingly, the court held that the underlying settlement agreement did not independently require the reinsurers to pay defense costs in addition to the limits.

The court also rejected the cedent’s argument that the facultative certificates’ provision that requires reinsurers to pay all “expenses incurred” by the cedent meant that costs-in-addition to the limits have to be paid. The court found that the cedent’s position violated the contractual intent of the facultative certificates. The court also held that the cedent’s construction would impermissibly impose liability on the reinsurers for risks beyond the scope of the facultative certificates.