Am. Employers’ Ins. Co. v. Swiss Reinsurance Am. Corp.

Issue Discussed: Follow the Fortunes / Settlements

Submitted by Cecilia Froelich Moss, David Byowitz

Date Promulgated: June 27, 2005

Am. Employers’ Ins. Co. v. Swiss Reinsurance Am. Corp., 413 F.3d 129 (1st Cir. 2005)

Court: United States Court of Appeals for the First Circuit

Issues Decided:

  1. Whether, under a multi-year facultative certificate with a follow-the-fortunes clause, a reinsurer is bound by its cedent’s settlement based on annualization of the underlying policy limits, when the certificate is silent as to annualization?
  2. Whether a settlement of claims relating to hazardous waste at multiple sites is inherently made “in bad faith” (thus relieving the reinsurer from its obligations under the follow-the-fortunes doctrine) if the cedent did not make individualized remediation-cost assessments for each site in determining its settlement value?

Factual Background:

American Employers’ Insurance Company (“American”) provided excess insurance coverage to the predecessor of Elf Atochem North America (“Elf”) pursuant to three multiple-year umbrella policies.  The American policies provided coverage for “each occurrence” and defined “occurrence” to include:

[A]ll personal injury and property damage . . . arising out of one event or continuous or repeated exposure to substantially the same general conditions existing or emanating from one premises location shall be deemed to be one occurrence.

Swiss Re reinsured American under three multi-year facultative certificates.  Each certificate provided limits for “each occurrence and in the aggregate,” and each contained both follow-the-form and follow-the-fortunes clauses.

When Elf notified American of potential hazardous waste losses at 37 sites and demanded indemnification, American sued for declaratory judgment in New Jersey state court.

Elf made several settlement demands  which assumed high remediation costs and that each per-occurrence limit in the American policies applied once per policy period (i.e. no annualization of American’s policy limits).

American’s coverage counsel also prepared an exposure analysis based on its lower estimates of remediation costs of the top 10 hazardous waste sites  but which assumed annualization of limits.  That analysis estimated American’s exposure for the top 10 sites at $44.8 million, and valued the remaining 27 sites, for which American had no detailed information, at an additional $2.8 million (by applying an 80% reduction to the estimated liability proposed by Elf for the secondary sites).

Eventually, the parties settled for $44 million, pursuant to an agreement that did not mention annualization and explicitly stated that neither party made any admissions regarding the interpretation or application of the policies.  American billed Swiss Re for its share of the settlement, based on American’s allocation which was premised on annualized per-occurrence limits.

Swiss Re challenged American’s use of annualization, and also claimed that it was not liable for any portion of the payments made on the 27 secondary sites.  American sued Swiss Re to recover the full amount of its reinsurance billings.  The district court granted Swiss Re’s motion for summary judgment, finding that the certificates’ per-occurrence language precluded annualization, and that a settlement made without investigating the secondary sites was not in good faith.  American appealed.

Key Holding:

Follow the Fortunes

The First Circuit vacated and remanded, finding against Swiss Re on both counts.  With regard to annualization, American argued that it made a good faith, reasonable settlement based on annualization of its limits, and that Swiss Re was bound by the follow-the-settlement provisions of the certificates.  The First Circuit held that, while the definition of occurrence in the American policies may have seemed to weigh against annualization, American was entitled to consider the risk that annualization would apply.  Further, the Court noted that the settlement amount paid by American was based on American’s calculation of liability assuming annualization, and therefore held that American had supported its characterization of the settlement.  However, the Court left open the possibility for Swiss Re to argue on remand that the settlement was unreasonable because the risk of annualization was small, or that the settlement based on annualization was not made in good faith because American had additional liability to Elf under other, higher layer, excess policies.

The First Circuit also held that there was no clear anti-annualization language in the reinsurance certificates that would serve to overcome the follow-the-settlements clause; the certificates simply used the term “per occurrence,” which neither adopts nor refutes annualization.

Lack of Individual Site Assessment

Regarding the 27 secondary sites, the First Circuit found that American provided a colorable explanation for its decision to settle those sites based on an across the board 80% discount as opposed to conducting a site-by-site investigation.  The Court noted that “settling numerous claims based on detailed information about only a subset of those claims is consistent with modern practice . . . .” and held that it was not unreasonable for American to use the top ten sites as a crude proxy for the remaining 27 sites.

Key Takeaways: 

Absent specific language in a multi-year reinsurance certificate precluding annualization of policy limits, the follow-the-fortunes doctrine will bind a reinsurer to its cedent’s settlement based on annualization, so long as the settlement was reasonable, made in good faith, and not clearly excluded by the underlying policy.

A cedent’s settlement of multiple claims based on a detailed analysis of a subset of those claims is not per se “bad faith,” and will not excuse a reinsurer from its liability under follow-the-fortunes, as long as the cedent provides a colorable explanation for its settlement decision.



* Cecilia Froelich Moss is a founding partner of Chaffetz Lindsey LLP, where her practice focuses on representing major insurance companies in reinsurance disputes and in coverage litigation.  Ms. Moss also handles large scale commercial disputes in court and in international arbitration.

** David Byowitz is an associate of Chaffetz Lindsey LLP, and has experience representing clients in reinsurance disputes and commercial litigation.