Cedent Prevails on Back-to-Back Reinsurance Recovery

Settlement allocations of long-tail losses like pollution claims have long been a source of disputes between cedents and reinsurers. Often the allocation of the underlying settlement depends on the allocation methodology used based on the law of the relevant jurisdiction. The issue becomes more complicated where the reinsurance contract is governed by the law of a different jurisdiction that may not use the same allocation methodology. In a recent case, the United States Circuit Court for the Second Circuit addressed this issue where the cedent claimed back-to-back reinsurance and the reinsurer rejected the allocation methodology.

In The Insurance Company of the State of Pennsylvania v. Equitas Insurance Limited, No. 20-3559-cv (2d Cir. May 22, 2023), the cedent settled pollution claims and allocated the settlement based on the “all-sums” methodology used in California. The reinsurer rejected this approach, contending that because the all-sums approach is not used under English law and the reinsurance contract was governed by English law, the allocation was improper and did not have to be followed by the reinsurer. Instead, the reinsurer argued that time on the risk allocation was appropriate. Additionally, the reinsurer argued late notice.

The district court, on completing motions for summary judgment, granted the cedent’s motion holding that the reinsurer was bound by the cedent’s use of the all-sums allocation methodology. On appeal, the Second Circuit affirmed.

The opinion provides an extremely detailed analysis of the various allocation methodologies and how the UK Supreme Court might consider this issue. It is worth the read.

The Second Circuit’s holding is worth a careful review. The court held as follows:

Although the question is not without doubt, we conclude that under the better reading of English law, [the reinsurer’s] obligations under the reinsurance policy are co-extensive with [the cedent’s] obligations under the [ ] policy. The question is not whether English law would have allocated [the cedent’s] liability on an all sums basis; English law does not govern [the cedent’s] liability. Instead, the question is whether, once [the cedent’s] liability was properly allocated, as [the reinsurer] concedes that it was, English law would then interpret the reinsurance policy as providing co-extensive coverage. Under English law, there is a strong presumption that facultative reinsurance policies provide back-to-back coverage, meaning that the liability of the insured is generally equivalent to the liability of the reinsured.

Unpacking the holding, the court acknowledges that its interpretation may not be right, but that it was the better reading of English law in its opinion. Will the UK Supreme Court weigh in on this issue? Second, the court made it clear that the real question was whether, based on the cedent’s allocation, English law would interpret the reinsurance contract to provide back-to-back reinsurance coverage. The circuit court held that it would based on the strong presumption of back-to-back reinsurance coverage under English law.

On the late notice point, the court held as follows:

English law has never recognized the defense of full repudiation based on late notice of claim where, as here, timely notice is not a condition precedent to coverage. While [the reinsurer] urges that English law would recognize such a defense on extreme facts, no such facts are present here.

This holding is somewhat analogous to US caselaw where the reinsurer has to show actual prejudice to prevail on a late notice defense.

This decision provides an interesting look into how an appellate court will interpret the laws of another jurisdiction to reach a result it thinks would be consistent with the high court in that other jurisdiction. It also points out the important presumption under English law that in most circumstances, a facultative certificate will provide back-to-back or coextensive reinsurance coverage to the cedent.