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Reinsurers face variety of litigation in early absence of Katrina suits

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Reinsurers face variety of litigation in early absence of Katrina suits

Few reinsurance disputes are emerging over Hurricane Katrina losses only a year after the storm came ashore, but cedents and their reinsurers are engaged in a variety of other legal battles—some new and others a reprise of longstanding disagreements, legal experts say.

Among the relatively new issues being arbitrated is the enforceability of allegedly improper side agreements in finite reinsurance contracts, lawyers say.

Recent months have also seen a surge of late-notice claims by reinsurers after several years in which they had largely forgone such claims.

Insurers and reinsurers continue to complain, meanwhile, about the growing cost and slow pace of arbitration—originally envisioned as a faster, cheaper alternative to litigation—though arbitration proponents are making efforts to streamline the process, legal sources report.

Interest also is growing in mediation, a simpler alternative to arbitration, particularly for smaller disputes, some say.

Reinsurance coverage battles may yet develop over Katrina claims, though most of the legal fights so far have been between policyholders and insurers, primarily over the issue of coverage for flood damage, lawyers say.

A small regional insurer under political pressure to pay claims, for example, could run afoul of a reinsurer that contends the insurer's payments were "ex gratia" and not actually covered by the underlying policies, noted Dean Hansell, a lawyer with LeBoeuf, Lamb, Greene & MacRae L.L.P. in Los Angeles.

Nationwide Mutual Insurance Co. won a court ruling in August that water damage from Katrina's storm surge is not covered by an insured's homeowners policy; more such rulings could limit any subsequent disputes between insurers and their reinsurers, noted Lawrence I. Brandes, a lawyer with Cadwalader, Wickersham & Taft L.L.P. in New York.

"To the extent insurers reduce their liabilities, it's less likely they will be in fights with their reinsurers," Mr. Brandes said.

Most legal observers agree that it's too early to know the size and extent of Katrina-related reinsurance litigation.

"Even when there is no tail on losses, it's going to take some time before there's any litigation," said David Raim, a lawyer with Chadbourne & Parke L.L.P. in Washington.

Meanwhile, another issue produced a key federal court decision this summer on the extent of a reinsurer's right to challenge a ceding company's claims settlements, including allocation of losses to different policy years.

A U.S. District Court judge in New York granted summary judgment in July to National Union Fire Insurance Co. of Pittsburgh, Pa., against American Re-Insurance Co., which had challenged National Union's settlement of a group of personal injury claims under policies covering a manufacturer. National Union, a unit of American International Group Inc., had accepted the policyholder's allocation of losses between two policies, one of which was reinsured by American Re, which has since been renamed Munich Reinsurance America Inc. The court ruled that the reinsurer failed to show that National Union had acted with the "extraordinary" level of bad faith required to overcome American Re's duty to follow the fortunes of its ceding company. Even if National Union had agreed to the allocation to maximize its reinsurance recoveries, it was under no duty to American Re to minimize those recoveries, the court found.

The ruling, which followed similar decisions in two other cases by the 2nd U.S. Circuit Court of Appeals in 2005 and 2004, was "probably the most significant reinsurance decision of the past 12 to 18 months," said Mr. Raim, noting that the burden it places on reinsurers to prove that a settlement is in bad faith "is certainly a high threshold."

Some insurers and reinsurers, meanwhile, have launched arbitrations over a new issue: the enforceability of side agreements in finite risk reinsurance deals.

Several insurers and reinsurers have faced legal action by regulators or have been forced to restate their financial results in the past year because of undisclosed side agreements that allegedly eliminated risk from finite contracts, making reinsurance accounting treatment of the contracts inappropriate.

Some companies have commenced arbitration to enforce the side agreements despite regulators' objections to the deals, said Lawrence S. Greengrass, a lawyer with Mound Cotton Wollan & Greengrass in New York.

Mr. Greengrass and other lawyers familiar with such cases declined to identify companies involved in these arbitrations.

An older issue that has resurfaced in recent months is late-notice disputes, in which reinsurers deny recoveries on the grounds that they were not properly notified of pending claims, Mr. Greengrass and other lawyers report.

These disputes are growing more common, especially in cases where reinsurance contracts include a clause giving reinsurers the "right to associate" in the defense of claims, he said. When reinsurers have not been given this right, they may invoke a late-notice defense, he said.

Mr. Greengrass expressed surprise over the increase in late-notice cases, since the tactic had largely died out over the past decade. He speculated that reinsurers that have commuted retrocessional protections may be more inclined to try the defense when they are suddenly facing claims that they will have to pay without retrocessionaires' contributions.

The arbitration process itself, meanwhile, remains a focus of ceding insurer and reinsurer frustration, though some observers say its shortcomings are being addressed. Intended as an alternative to lengthy and expensive litigation, many arbitrations have become as costly and protracted as court cases, with voluminous discovery and proceedings that can extend for years, lawyers say.

"I think it's gotten worse," Mr. Brandes said. "My experience has been (that there is) more and more discovery, more and more irrelevant discovery, lots and lots of motion practice."

"Because arbitration has become so litigation-like...it is no longer a cheaper and more efficient avenue for resolving disputes," said Matthew Wulf, assistant vp and assistant general counsel with the Reinsurance Assn. of America in Washington.

One disturbing development, Mr. Brandes said, is consolidation of arbitration cases, in which—for example—a ceding insurer begins proceedings against one reinsurer and, after a panel is selected, moves to consolidate other reinsurers involved in that loss.

The practice is "fundamentally unfair," since parties consolidated into an existing arbitration get no opportunity to select panel members, he noted.

Courts hearing challenges to the practice have decided in some cases against consolidation but in other cases have let the arbitration panel decide the matter for itself, Mr. Brandes said.

Not everyone agrees that arbitration has lost its advantages, though.

Vincent J. Vitkowsky, a lawyer with Edwards Angell Palmer & Dodge L.L.P. in New York, said arbitration still strikes a fair balance between speed and the need to provide both sides with due process.

Insurers and reinsurers are also taking steps to streamline the process, said Mary A. Lopatto, a lawyer with Chadbourne and current chairman of the AIDA Reinsurance and Insurance Arbitration Society, based in Mount Vernon, N.Y.

While conceding that arbitration can be as expensive as litigation, Ms. Lopatto noted that companies are adding language to arbitration clauses allowing for summary adjudication of claims in lieu of presentation of a full case; allowing for the random selection of an umpire through ARIAS when the parties can't agree on a selection; and providing that smaller disputes be heard by a single arbitrator rather than a panel.

Still, frustration with arbitration is leading some insurers and reinsurers to consider another alternative: mediation.

Mediation, though nonbinding, is an abbreviated process in which the parties file limited submissions to a single mediator who may hear the dispute in a single day, said Joseph G. Grasso, a lawyer with Thacher Profitt & Wood L.L.P. in New York.

While it could theoretically be used in disputes of any size, mediation is more common in smaller disputes, said Mr. Greengrass.

While, most insurers and reinsurers believe in arbitration's benefits, the growth of mediation "obviously stems from dissatisfaction and frustration with the process," said Mr. Greengrass, whose firm launched a reinsurance mediation group in 2000.