Reinsurance: New York Revisits Follow the Fortunes and Its Bad Faith and Ex Gratia Exceptions
January 3, 2008
In its recent decision in Granite State Insurance Company v. ACE American Reinsurance Company,[1] the New York Supreme Court's Appellate Division, First Department, reviewed the scope of the "follow the fortunes doctrine" under New York reinsurance law. As explained by the First Department, where the cedent's policy and the reinsurer's policy provide a "concurrency of coverage," there generally exists a contractual obligation upon the reinsurer to indemnify the cedent insurance company for claim payments made by the cedent to its insured under the cedent's policy.
The court found that the general "follow the fortunes" obligation comes with exceptions for claim payments that are "fraudulent, collusive or otherwise made in bad faith" or are "ex gratia." Ex gratia payments are payments made by a cedent insurer "that recognizes no legal obligation to pay, but makes payment to avoid greater expense, as in the case of a settlement by an insurance company to avoid the cost of a suit."
As the court noted in Granite State,
the ‘follow the fortunes' doctrine requires payment where the cedent's good faith payment is at least arguably within the scope of the insurance coverage that was reinsured, and a reinsurer cannot second-guess the good faith liability decisions made by its reinsured or the reinsured's good faith decision to waive defenses to which it may be entitled.
Some commentators have suggested that, where it applies, the follow the fortunes doctrine may serve to encourage the timely payment of reinsurance proceeds by avoiding the creation of a second layer of coverage dispute at the reinsurance level. Some have even suggested that follow the fortunes is intended to make reinsurance more "automatic" and thus more reliable, so as to aid the orderly underwriting of risks and disposition of claims by cedent insurers.
As reinsurance markets have tightened in recent years, litigation and arbitration activity involving the applicability of follow the fortunes and its exceptions has increased. The Granite State case itself involved a dispute over the exceptions for bad faith or ex gratia settlements. ACE American contended that, years after making settlements in thousands of DBCP pesticide poisoning cases, Granite State's parent company had reallocated some of its many settlement payments from sister companies to Granite State just to obtain the benefit of ACE American's reinsurance coverage. ACE American charged that the cedent insurance company's conduct constituted bad faith or at least an ex gratia payment that should relieve ACE American of any obligation as a matter of law on summary judgment. The First Department disagreed, finding that issues as to the intent and circumstances of the underlying settlements remained unresolved, requiring a trial.
Disputes between reinsurers and their cedents have become more common in recent years. Granite State is a good example of the issues that commonly arise in reinsurance disputes and how important evidence of intent and the circumstances of underlying settlements can be to parties seeking to avoid the expense of a full-blown trial or arbitration of a matter involving issues of bad faith payment, ex gratia payment, or allocation.
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