Houston Casualty Company v. Lexington Insurance Company

Issue Discussed: Follow the Fortunes / Settlements

Submitted by Tracey Laws

Date Promulgated: June 15, 2006

Issues Addressed: Validity of “Follow the Settlements” Provision

In Houston Casualty Company v. Lexington Insurance Company, the United States District Court Southern District of Texas ruled on summary judgment that a reinsurer was bound by the “follow the settlements” provision of a reinsurance contract where there was no bad faith and the claim was reasonably within the terms of the original insurance policy.

Pursuant to an executive order from Florida Governor Jeb Bush, Universal Studios Theme Park in Orlando (“Universal Studios”) closed in anticipation of Hurricane Floyd. Hurricane Floyd did not make landfall in Florida. Universal Studios had an “all risks” policy with Gulfstream Insurance (“Gulfstream”). Gulfstream is managed by AIG Insurance Management Services, which is an affiliate of Lexington Insurance Company. After the closure, Gulfstream paid Universal Studios’s claim for property damage and additional expenditures.

Gulfstream reinsured part of the risk, 40% of which was reinsured through Plaintiff Houston Casualty Company (“HCC”). The HCC reinsurance policy incorporated the policy terms, conditions and exclusions of the original Gulfstream policy and required HCC to “follow the settlements” of the original underwriters. HCC reinsured 75% of its risk through Defendant, Lexington Insurance Company (“Lexington”). The Lexington reinsurance policy also incorporated the original Gulfstream policy and required Lexington to “follow the settlements” of HCC. Lexington did not pay the claim submitted by HCC.

HCC filed suit to enforce payment of its claim to Lexington. Lexington filed a motion for summary judgment, arguing that it was not obligated to pay under the reinsurance agreement because the claim paid by Gulfstream was not covered by its policy to Universal Studios. Lexington asserted that there was no coverage under the Gulfstream policy because: (1) Universal Studios did not suffer physical damage to its property resulting in business interruption; and (2) the deductible applicable to the Gulfstream policy was not satisfied because business interruption damages are limited to the period the park was actually closed (Lexington contended the park was closed for 1.5 days; the claim submitted by Universal Studios included business interruption losses for 7 days). HCC filed a cross-motion for summary judgment asserting that Lexington’s defenses for non-payment were barred by the “follow the settlements” doctrine.

The District Court held the follow the settlements doctrine “prevents facultative reinsurers from second guessing good-faith settlements and obtainingde novo review of judgments of the reinsured’s liability to its insured… even if technically not covered by it.” National Am. Ins. Co. of Cal. v. Certain Underwriters at Lloyd’s London, 93 F.3d 529, 535 (9th Cir. 1996) (quoting North River Ins. Co. v. Cigna Reinsurance Co., 52 F.3d 1194, 1199). Consequently, the District Court did not make a de novo determination whether Universal Studio’s claim was actually covered under the Gulfstream policy. Instead, it looked only at whether the claim was paid in good faith and whether the claim was reasonably within the terms of the original policy.North River, 52 F.3d at 1204. The District Court noted that other courts addressing good faith in the reinsurance context had not developed a uniform approach to determining the meaning of good faith. The District Court noted that the Second Circuit had previously held that the reinsurer must show bad faith, not mere negligence, and that the minimum standard for bad faith is gross negligence or recklessness. North River, 52 F.3d at 1212-13.

In granting HCC’s cross-motion for summary judgment, the District Court found that HCC’s actions, even with potential overpayment (as characterized by Lexington), did not rise to the level of bad faith and that the claim was reasonably within the terms of the policy.

* Tracey Laws is currently the Senior Vice President and General Counsel of the Reinsurance Association of America. She is responsible for establishing and advocating the RAA’s public policy positions. Previously, she was a partner at Chadbourne & Parke, focusing her practice on reinsurance issues.