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Several courts have applied an “all sums” allocation methodology to continuous losses, that is losses triggering multiple years of a policyholder’s insurance coverage. Those decisions were rendered in cases arising from disputes involving solvent insurers. When an all sums allocation methodology is applied to insolvent insurers, it can have unintended side effects.
In the aftermath of the explosion of asbestos cases in the last two decades of the 20th century, courts had to develop methods of allocating continuous losses over policyholder coverage blocks extending many years. This was necessary because asbestos losses develop over many years and the policy wordings did not specify an allocation methodology for such losses. Those same methodologies have been applied to environmental and other losses occurring over a period of years.
The two main allocation methods are pro rata and all sums. A pro rata method apportions the loss to each insurer in the coverage block severally, usually as a percentage of time on risk. In contrast, an all sums method permits an insured to select a particular year in the coverage block and collect all its losses from the insurers in that policy year up to the limits of each insurer’s policy. The insurers affected are then entitled to seek contribution from the other insurers in the coverage block to pay their fair share of the loss.
Generally, policyholders prefer an all sums allocation methodology and insurers prefer a pro rata methodology. An all sums allocation permits the policyholder to recover, up to the policy limits of triggered policies, without apportioning any of the loss to uninsured time periods; without diminution for unrecoverable insurance; and without having to pursue each insurer in the coverage block separately. An insurer tagged for more than its pro rata share then has the right — and the burden — of pursuing contributions from other insurers in the coverage block.
There are pros and cons to each methodology and policyholders and insurers have battled them out in state after state, with some states choosing one method, other states choosing the other. One thing all states have in common, however, is that whichever method they chose, they did so in the context of evaluating claims presented to solvent insurers.
That matters because insolvency upends the balance of benefits and costs. An all sums methodology applied to an insolvent insurer provides fewer benefits to the policyholder and greater costs to the insurer than would be the case with a solvent insurer. From the policyholder’s perspective, the main problem is that the insolvent insurer will not be paying the full amount allowed, but only some percentage of it. That means the policyholder will have to pursue other insurers in the coverage block to make up the deficiency.
From the insolvent insurer’s perspective, an all sums allocation greatly multiplies its costs. Instead of being able to resolve a policyholder’s claim in a single suit in the liquidation court, the insurer will be saddled with the prospect of needing to initiate contribution actions in other courts to recover the excess of its pro rata share. Arguably, it also provides a preference to such policyholders as opposed to policyholders paid on a pro rata basis. Either way, whether by the extra payment to all sums policyholders or the extra expenses incurred by the liquidator in seeking contribution from other insurers, an all sums allocation reduces the funds available to the liquidator to pay claims.
Few courts have considered whether an all sums allocation should be permitted against an insolvent insurer. The Supreme Court of Missouri applied Pennsylvania law and permitted an all sums recovery against the Transit Insurance Co. receivership for claims submitted under insurance policies that Transit issued to a Pennsylvanian policyholder. In doing so, the court noted that if Missouri law applied, Transit would have been permitted to “allocate the claims based on a pro rata, time-on-the-risk method.” The court considered whether its determination that Pennsylvania law applied should be affected by Transit’s insolvency. Ruling that it should not, the court held that “[t]he most ratable distribution of Transit’s assets requires that the receivership only pay claims that would be valid if the company had remained solvent.” The court did not address any of the practical problems involved in allowing all sums claims against an insolvent insurer. Similarly, in New York an all sums recovery was permitted against the liquidator of Midland Insurance Co., although the court’s analysis did not include any discussion of the effect, if any, of Midland’s insolvency.
In contrast, New Jersey courts supervising the liquidation of Integrity Insurance Co. came to the opposite conclusion, denying all sums recoveries against Integrity’s liquidator. As in the Transit case, the insurer issued policies to out-of-state policyholders from all sums jurisdictions. Unlike Transit, however, the Integrity court found that the insurer’s insolvency made all the difference in what law applied.
The court found that New Jersey had a “compelling interest in applying a pro-rata allocation methodology to insolvent insurance companies being wound up under its jurisdiction [in order to protect its] paramount interest in treating Integrity’s creditors equitably and prohibiting the waste of resources entailed by paying certain of its policyholders amounts due from the policyholders’ other insurers.”
The court did not set down a blanket prohibition on the use of an all sums methodology against an insolvent insurer, but it did find, under the circumstances presented in that case, that an all sums allocation “would seriously violate New Jersey’s policy of equitable distribution of the assets marshalled through the liquidation proceedings.” In part, the court based its decision on the practical consideration that the insurer’s liquidation closing plan had been largely implemented, leaving the liquidator “without the realistic probability of recoupment.”
The practical problems noted by the Integrity court are greatly magnified if the liquidator has reinsurance for all sums claims being allowed in the insolvency proceeding. Although reinsurance contracts are contracts of indemnity, the insolvency clause typically included provides that the reinsurer shall pay the liquidator in accordance with the cedent’s liability, not the smaller amount actually paid to its policyholders.
This can exacerbate the difficulty of resolving claims in the liquidation court. The insolvency clause gives the reinsurers a right to interpose their own defenses to claims asserted against the liquidator that implicate the reinsurance. Just as the use of an all sums allocation methodology can greatly increase the claim amount allowed by the liquidator, so, too, it increases the reinsurers’ incentive to assert their right to contest claims in the liquidation court.
The result is that an all sums recovery against an insolvent insurer provides the policyholder little benefit, but it has the prospect of increasing the litigation costs of policyholders, insolvent insurers and reinsurers alike, thus making all sums a losing proposition in liquidation proceedings.
Andrew Costigan is a partner in Freeborn & Peters LLP’s litigation practice group and a member of the firm’s insurance/reinsurance industry group. He can be reached at firstname.lastname@example.org.