DLA Piper's Practical Guide for Claims Managers in 2022 - Part 10

Introduction

In the latest edition of our Practical Guides for Claims Managers, we take a look at claims handling considerations which are relevant to claims under reinsurance contracts. In particular, we take a look at important points to bear in mind regarding:

1. "Follow the settlements" clauses;
2. Claims control and claims co-operation clauses; and
3. Ex-gratia payments and without prejudice settlements.

This article considers the position under English law. If you would like to better understand the position under a different system of governing law, please contact us and we will be able to connect you with a member of our extensive international Insurance and Reinsurance practice.

“Follow the settlements” clauses

Introduction

A "follow the settlements" clause is a provision in a reinsurance contract intended to clarify that the reinsurer is obliged to follow the liabilities (judgments, awards and, specifically, settlements) of the reinsured.

In an early case, Excess Liability Insurance Co Ltd -v- Matthews (1925) 31 Com Cas 43, the reinsurance contract included an obligation on the defendant reinsurer "to pay as may be paid thereon and to follow their settlements". The latter part of this provision (“and to follow their settlements") was additional to the language adopted in the reinsurance contracts that had been the subject of earlier judicial scrutiny.

Having been decided that the "to pay as may be paid thereon" language required a reinsurer to follow payments by a reinsured founded upon a legal liability (such as those imposed by a court judgment), the question before the court was whether the "and to follow their settlements" formulation also meant that the reinsurer was obliged to indemnify the reinsured for settlements agreed with the underlying insureds. Branson J. decided that this was indeed the case.

In the years since Matthews, "follow the settlements" has become the formulation adopted in the vast majority of facultative reinsurance agreements and in many treaty reinsurances.

Today, there are typically two main types of "follow the settlements" clause in use in the marketplace:

1. a 'full follow' type clause (often referred to as a Scor type clause, following the case of Insurance Co of Africa -v- SCOR (UK) Reinsurance Co Ltd [1985] 1 Lloyd's Rep 312, CA); and
2. a 'qualified follow' type clause (often referred to as a Hill -v- M&G clause, following the case of Hill -v- Mercantile & General Reinsurance Co [1996] 3 All ER 865).

We consider these two types of "follow the settlements" clauses below and identify the requirements that a Claims Manager must bear in mind when considering whether an indemnity is owed under a reinsurance contract.

The limbs / provisos of each type of "follow the settlements" clause

For a reinsured to recover from its reinsurer in accordance with a "follow the settlements" clause:

1. A 'full follow' / Scor type clause requires that:
   
   • the reinsured must act in a business-like manner when settling the claim; and
   • the claim must fall within the risks covered by the reinsurance contract.
2. A 'qualified follow' / Hill -v- M&G type clause requires that:
   
   • the loss falls within the terms of the underlying policy; and
   • the loss falls within the terms of the reinsurance contract.

At first blush, it is evident that a 'full follow' / Scor type clause is typically more favourable to a reinsured than a 'qualified follow' / Hill -v- M&G type clause. Conversely, a reinsurer may be more comfortable with a ‘qualified follow’ / Hill -v- M&G type clause in its contracts. This is because, under a ‘full follow’ / Scor type clause, the reinsured need not evidence that the loss falls within the terms of the underlying policy – it need merely establish that it has taken business-like steps in its decision to settle the underlying claim.

It should be noted that, in the absence of an express "follow the settlements" clause in a reinsurance contract, the law will interpret the reinsurance contract as if a 'qualified follow' / Hill -v- M&G type clause had been included.

What is required by way of compliance with a "follow the settlements" clause?

'Full follow' / Scor type clauses

Limb I – Acting in a business-like manner

To satisfy the requirement that it must act in a business-like manner when settling a claim, a reinsured generally needs to:

1. consider the wording of the underlying policy giving rise to a liability;
2. determine the facts and apply them to the wording of the underlying policy; and
3. consider possible defences.

So, what does this mean in practice?

First, when considering the wording of the underlying policy, a reinsured is not obliged to refer to a lawyer for legal advice. However, it is recommended that legal assistance be sought in circumstances where there is uncertainty as to the scope of cover, or the matter is complex.

Second, to determine the facts so they can be applied to the wording (and an assessment of the amount of loss made), a reinsured may look to appoint a loss adjuster to investigate the loss. However, merely appointing a loss adjuster and placing their report on file – somewhat as a 'tick box' exercise - is not enough to establish business-like steps. A Claims Manager must give appropriate consideration to the appointment, and the work product, of the loss adjuster. As explained in Charman -v- Guardian Royal Exchange Assurance Plc [1992] 2 Lloyd’s Rep. 607, a reinsured must:

1. when appointing a loss adjuster: act in a business-like manner and ensure the loss adjuster is reasonably competent;
2. when receiving a loss adjuster's report: ensure any adjustment has been made in a business-like fashion before it is accepted; and
3. when a loss adjuster's report has been provided: negotiate with the insured in a business-like manner in light of the loss adjuster's report.

Third, when it comes to giving thought to possible defences, if a defence does not have an automatic discharging effect (and most defences will not have this effect), it needs to be determined whether, on balance, any particular defence is likely to succeed. If the assessment is that the defence would likely fail, then the reinsured will have acted in a business-like fashion in not pursuing it. However, if the reinsured considers a defence and concludes that it is likely to succeed, but then does not pursue that defence and instead settles the insured's claim, it opens itself up to the challenge that it has not conducted itself in a business-like manner.

The burden is on the reinsured to prove that it has acted in a business-like manner. However, to discharge this burden, reinsureds need not furnish the reinsurer with reams of information and detail – providing information adequate for reinsurers to check and verify the accuracy of the claims presented under the underlying insurance, and how they were dealt with, and responding to relevant questions that the reinsurer may have, will be sufficient.

Limb II - The claim falls within the risks covered by the reinsurance

First of all, a claim must of course fall within the scope of cover / class of business of the reinsurance contract - so an underlying marine loss cannot on the face of it be presented to a property treaty. In addressing this issue, a reinsurer should also consider whether any exclusions or limitations of cover are relevant. This can be a complex issue where a different governing law applies to the underlying insurance than to the reinsurance contract.

Connected to this, when it comes to considering whether the loss, as a matter of law, falls within the risks covered by the reinsurance contract, thought needs to be given to whether the underlying insurance policy and the reinsurance contract are written on the same terms. Where they are, it should be more straightforward for a reinsured (having satisfied the first limb) to satisfy this second limb.

This does not necessarily mean that everything is plain sailing for the reinsured though – not having a court judgment establish a reinsured's liability means that a reinsurer may be minded to question the reinsured’s liability under the policy.

That said, in the case of Assicurazioni Generali SpA v CGU General Insurance plc [2003] Lloyd’s Rep. I.R. 737, it was established that a reinsured need only evidence that the claim as recognised arguably falls within the terms of the reinsurance. This is a low threshold.

Given the low threshold attaching to the second limb, it could be said that the second limb adds little to the overall test relating to 'full follow' / Scor type clauses: the main requirement is for the reinsured to act in a business-like manner.

A reinsurer that wishes to 'protect' itself more (i.e. require that the reinsured do more than show that it has acted in a business-like manner to be able to require the reinsurer to follow its settlements) may want to either:

1. refuse to accept a "follow the settlements" clause when agreeing the reinsurance contract; or
2. expressly adopt a 'qualified follow' / Hill -v- M&G type clause.

'Qualified follow' / Hill -v- M&G type clauses

As noted above, these clauses are qualified by two provisos, which must both be satisfied before a reinsurer is obliged to follow the reinsured’s settlements.

The provisos are that the reinsured’s settlement with an underlying insured must be within the terms and conditions of both:

1. the underlying policy; and
2. the reinsurance contract.

Both provisos must be established by the reinsured as a matter of law.

In relation to the second proviso, it is not enough to demonstrate that the settled claim arguably fell within the terms and conditions of the reinsurance contract. Whether a settled claim falls within the scope of the reinsurance contract is a question for the court to decide: Commercial Union Assurance Company Plc -v- NRG Victory Reinsurance Ltd [1998] 2 Lloyd’s Rep. 600. It is not enough simply to rely on the advice of a lawyer.

In light of the above, it is much more open (than if there was a 'full follow' / Scor type clause) for a reinsurer to challenge that it has a legal liability to follow the reinsured's settlement.

A reinsurer is not bound by a settlement agreed by a reinsured simply because it has been settled in a business-like manner – even if it can be demonstrated that the settlement has removed the risk of a greater liability being passed to the reinsurer.

Fraud by an underlying insured

Although reinsureds will obviously want to ensure no fraud is perpetrated by the underlying insured, should a fraud on the part of the underlying insured be discovered by the reinsurer after the reinsured has entered into a settlement with an insured, the reinsurer is still obliged to follow the settlement and indemnify the reinsured (subject to the relevant conditions discussed above being satisfied).

Where a reinsurer has identified a fraud, the remedy for the reinsurer will be – unless agreed otherwise – to use their rights of subrogation to pursue an action against the underlying insured.

Claims control and claims co-operation clauses

Introduction

With the growth and global nature of the insurance and reinsurance industry, it is not now always possible for a reinsurer to satisfy itself that a reinsured has acted in a business-like manner – the main protection afforded to reinsurers by 'full follow' / Scor type "follow the settlements" clauses.

Accordingly, in recent times, the practice of reinsurers including claims control or claims co-operation clauses in their reinsurance contracts has also increased.

Should a reinsurer wish to have oversight or involvement in the claims process, then a claims control or claims co-operation clause is required; an obligation on the reinsured to involve the reinsurer in negotiation of the underlying insured's claim will not be implied into a reinsurance contract.

Both types of clause are now commonplace, with the difference between the two being as follows:

1. pursuant to a claims control clause, a reinsurer can require a reinsured to pass responsibility for handling a claim to the reinsurer; whereas
2. pursuant to a claims co-operation clause, a reinsured is only required to notify the reinsurer of a claim and seek their consent before settling a claim.

Conditions precedent

Compliance with a claims control or claims co-operation clause is frequently framed as a condition precedent to cover under the reinsurance contract.

As well as concerning a "follow the settlements" clause, the Scor case referenced above also involved a claims co-operation clause and, amongst other considerations, the court focussed on the extent to which obligations imposed by a claims co-operation clause are to be construed as conditions precedent. The claims co-operation clause concerned in Scor – set out below – was highlighted in the case as having a serious fault:

"It is a condition precedent to liability under this insurance that all claims be notified immediately to the underwriters subscribing to this policy and the reinsured hereby undertake in arriving at the settlement of any claim that they will co-operate with the reinsurer underwriters and that no settlement shall be made without the approval of the underwriters subscribing to this policy."

So what was the fault? Well, the clause imposes two obligations on the reinsured, and it could be suggested that in drafting the clause, the reinsured intended for both obligations to be conditions precedent to cover:

1. the reinsured must notify reinsurers of all claims immediately; and
2. the reinsured must co-operate with reinsurers in negotiating a settlement and must not agree a settlement without reinsurers' approval.

However, because of how the clause was drafted, it was ultimately interpreted in Scor as only imposing a condition precedent on the first of the two obligations above.

Scor, then, serves as a warning to reinsurers to pay close attention to the drafting of their claims co-operation clauses, and highlights to reinsureds the need to consider their obligations closely to appreciate which of the obligations upon them are actually conditions precedent.

Unlike the clause in Scor, the claims co-operation clause that was the subject of discussion in Gan Insurance Co -v- Tai Ping Insurance Co (No.2) [2001] Lloyd’s Rep. I.R. 682 is an example of a claims co-operation clause in which each of the obligations therein was held to be a condition precedent to the reinsurers' liability – i.e. it successfully performed the role intended of it by the reinsurers, unlike the clause in Scor. The clause is set out below, and illustrates how the use of sub-clauses can help clarify to which obligations conditions precedent attach:

"Notwithstanding anything contained in the reinsurance agreement and/or policy wording to the contrary, it is a condition precedent to any liability under this policy that

a) the reinsured shall, upon knowledge of any circumstances which may give rise to a claim against them, advise the reinsurers immediately, and in any event not later than 30 days,

b) the reinsured shall co-operate with reinsurers and/or their appointed representatives subscribing to this policy in the investigation and assessment of any loss and/or circumstances giving rise to a loss,

c) No settlement and/or compromise shall be made and liability admitted without the prior approval of reinsurers."

When faced with such a clause, Claims Managers must therefore appreciate that each obligation listed is a condition precedent to cover under the reinsurance contract.

The relationship between "follow the settlements" clauses and claims control / claims co-operation clauses

On their face, "follow the settlements" clauses are at odds with claims control and claims co-operation clauses. The former requires reinsurers to follow settlements reached in a business-like manner, whereas the latter requires that reinsureds not enter into settlements without the reinsurer's prior approval.

The Court of Appeal considered this conundrum in Scor and determined that the wording in that policy required that the claims control / claims co-operation clause take priority over the "follow the settlements" clause.

This highlights that Claims Managers must pay close attention to claims co-operation or claims control clauses, and not assume that they will be able to recover under a reinsurance contract simply because the contract includes a "follow the settlements" clause.

Indeed, if a reinsured settles a claim without first obtaining the approval of the reinsurer, then they must prove their loss as a matter of law.

The burden of proof

The burden of proving a breach of a claims control clause or a claims co-operation clause rests with reinsurers. In considering issues around potential breach, it is helpful to consider the requirements on a reinsured pursuant to a clause such as that in the Gan Insurance Co Ltd -v- Tai Ping Insurance Co Ltd case, as set out above.

Claims Managers need to consider these requirements closely, because (as touched upon above) if a claims control or claims co-operation clause is expressed to be a condition precedent, any breach by the reinsured will prevent it from being able to recover from the reinsurer – even if liability under the underlying insurance policy can be proved. This is different to the position with claims control and claims co-operation clauses which are not stated as being a condition precedent, as in such circumstances, breach will not prevent the reinsured from recovering from the reinsurer if it can indeed demonstrate its loss (as held in Scor).

Advising reinsurers of circumstances which may give rise to a claim

This is a straightforward obligation, which is determined as a question of fact.

Of course, Claims Managers must be mindful of any time limits that may be imposed by a claims control or claims co-operation clause. As illustrated in Lexington Insurance Co -v- Multinacional De Seguros SA [2008] EWHC 1170 (Comm); [2009] 1 All E.R. (Comm) 35, in the absence of an express time limit, a reinsured must act within a reasonable time – which is a question of fact determined on a case-by-case basis.

Investigating the loss

It is a continuing duty of the reinsured to co-operate with the reinsurer in investigating the loss. As the duty is on-going, co-operation provisions (cf. notification provisions) do not impose time limits, but there is an implied obligation on the reinsured to co-operate within a reasonable time.

Although they may generally be aware of negotiations, reinsurers may make a specific request for the provision of information, and reinsureds will need to comply with such a request.

The reinsured's duty is not absolute however, and as demonstrated by Welch -v- Royal Exchange Assurance [1939] 1 KB 294, there are reasonableness limitations to what a reinsurer can demand. As such, whilst ensuring they are helpful to a reinsurer, a reinsured may wish to reflect on whether what is being asked of them is needed to be able to discharge the burden upon them.

Approval of settlements

Pursuant to a claims co-operation clause in the form as set out above from Gan Insurance Co Ltd -v- Tai Ping Insurance Co Ltd, a reinsured must obtain its reinsurer’s approval before either settling a claim or admitting liability. A reinsured cannot proceed with a settlement without obtaining the reinsurer's prior approval simply because the reinsured does not admit liability in the settlement.

It is worth noting though that a reinsured need only obtain the approval of the reinsurers whose liability will be affected by the settlement. This means that if the reinsured settles at an amount below the layer on which a reinsurer is concerned, that reinsurer's approval of the settlement need not be obtained.

Ex-gratia payments and without prejudice settlements

Introduction

An ex-gratia payment is a payment made outside the terms and conditions of the policy – it is made voluntarily in order to settle a claim. Ex-gratia payments are often made for commercial or reputational reasons.

Settlements made on a "without prejudice" basis are settlements reached on the basis that liability is not being admitted. This is common practice in England and Wales.

Do ex-gratia payments fall within the scope of reinsurance contracts?

Of course, each reinsurance contract and factual scenario is different, and the parties are free to agree different terms. However, in general, reinsurance contracts exclude ex-gratia payments since they fall outside the scope of cover upon which the reinsurer priced the risk and agreed to provide reinsurance. Reinsurers are also unlikely to be concerned by the same commercial or reputational considerations influencing the reinsured to agree to making an ex-gratia payment.

Cover (or not) for settlements agreed on a without prejudice basis

In Faraday Capital Ltd -v- Copenhagen Reinsurance Co Ltd [2006] EWHC 1474 (Comm), the reinsurance contract included a "follow the settlements" clause in the following terms:

"This reinsurance is subject to all terms, clauses and conditions as original except as provided for herein, and to follow in all respects the settlements or other payments of whatsoever nature excluding Without Prejudice and Ex-Gratia Settlements made by the Original Underwriters arising out of and in connection with the Original Insurance."

The payment made in Faraday -v- Copenhagen Re was not asserted as having been ex-gratia, so the court's focus was on the "without prejudice" language.

The court held that the reference in the clause to excluding Without Prejudice settlements applied to any settlement in which liability is not admitted – including binding settlements. Indeed, the court rejected the reinsured's argument that the terms of the "follow the settlements" clause were limited to non-binding or provisional settlements, or settlements which were subject to being re-opened. This conclusion was reached on the basis that non-binding settlements are not settlements for the purposes of a "follow the settlements" clause.

This means that a clause such as that in Faraday -v- Copenhagen Re is unfavourable to a reinsured – losses incurred pursuant to a settlement that is objectively sensible in the circumstances may not be recoverable from a reinsurer simply because it is agreed on a without prejudice basis. Accordingly, when agreeing settlements, reinsureds will need to weigh the pros and cons of settling a claim on a without prejudice basis against the prospect of being unable to make a recovery under their reinsurance contracts.

Important takeaways

"Follow the settlements" clauses

1. A reinsured will typically prefer for their reinsurance contract to include a 'full follow' / Scor type clause, rather than a 'qualified follow' / Hill -v- M&G type clause. The converse will typically be the case for a reinsurer.
2. Appointing lawyers and loss adjusters and keeping their advice in mind can help a reinsured evidence that they have acted in a business-like manner when settling claims.

Claims control and claims co-operation clauses

1. Claims Managers must pay close attention to claims control and claims co-operation clauses to understand which obligations upon the reinsured are conditions precedent to the reinsurer’s obligation to indemnify under the reinsurance contract.
2. Where the reinsured is under an obligation to notify a reinsurer of circumstances giving rise to a claim, the reinsured must comply with any express time limits, and in the absence of such time limits, act within a reasonable time.
3. A reinsured's duty to co-operate with the reinsurer in investigating the loss is a continuing duty.
4. Where it is a condition precedent that a reinsured will obtain the reinsurer's approval before entering into a settlement, a reinsured cannot fail to seek such approval and still recover under the reinsurance contract simply because it has not admitted liability when settling the claim.

Ex-gratia payments and without prejudice settlements

1. More often than not, reinsurers will stipulate that ex-gratia payments are not recoverable under a reinsurance contract.
2. Exclusions of cover for without prejudice settlements apply to binding settlements, meaning that reinsureds may need to consider whether, on balance, it is preferable for them to agree a settlement on a non-admission of liability basis, or for them to be able to recover under their reinsurance.