North River Ins. Co. v. ACE American Reins. Co.

Issue Discussed: Follow the Fortunes / Settlements

Submitted by Cecilia Froelich Moss, Justinian Doreste

Date Promulgated: March 15, 2004

North River Ins. Co. v. ACE American Reins. Co., 361 F.3d 134 (2d Cir. 2004)

Court: United States Court of Appeals for the Second Circuit

Issues Decided: Whether the “follow-the-settlements” doctrine applies to a cedent’s post-settlement allocation decisions.

Factual Background

North River participated in the second through fifth excess layers of insurance issued to Owens-Corning. ACE provided North River with facultative reinsurance on portions of its second layer excess policies. For the period at issue, North River’s second layer policies provided combined, per-occurrence limits of $345 million.

Owens-Corning sued North River for indemnification of “non-product” asbestos-related losses. Ultimately, North River settled with Owens-Corning for $335 million ($10 million below its second layer’s limits). Prior to the settlement, North River conducted various analyses which, under some scenarios, predicted losses beyond the second excess layer. Using the “rising bathtub” method, whereby the lowest lawyers of coverage are exhausted before moving on to higher layers, North River allocated virtually all the settlement cost to its second layer policies. When North River sought indemnification from its reinsurers, ACE argued that it should not have to contribute to that portion of the settlement that, under North River’s pre-settlement analysis, reflected risk to layers above ACE’s.

The district court granted summary judgment to North River, holding that the follow-the settlements doctrine prevents a reinsurer from challenging a post-settlement allocation so long as that allocation was made in good faith and covered by the policy. ACE appealed.

Key Holding

Follow the settlements

ACE argued that follow the settlements does not bind a reinsurer to anything other than the cedent’s settlement decisions, and therefore it does not require a reinsurer to follow a post-settlement allocation arguably inconsistent with the cedent’s own pre-settlement analysis.

The court determined that the follow the settlements doctrine’s “main rationale” was to “foster the goals of maximum coverage and settlement” and to prevent courts from undermining the cedent-reinsurer relationship “through de novo review of the cedent’s decisions-making process.” 361 F.3d at 140-41. And, it found that those goals were served by upholding North River’s allocation. Therefore, it held, “the follow-the settlements doctrine extends to a cedent’s post-settlement allocation decisions, regardless of whether an inquiry would reveal an inconsistency between that allocation and the cedent’s pre-settlement assessments of risk, as long as the allocation meets the typical follow-the-settlements requirements, i.e., it is in good faith, reasonable, and within the applicable policies.”

ACE also argued that, even if follow the settlements applied, the amounts billed to it by North River were outside the terms of the reinsurance contracts. ACE again based this argument on the fact that North River’s pre-settlement analysis did not line up with its post-settlement allocation. Specifically, it argued that because North River considered the risk of loss in layers above ACE’s in its pre-settlement analysis, ACE was not liable for the portion of the settlement paid to release risks attributable to those higher layers because that payment was outside of the policy limits. The court disagreed, concluding that ACE was conflating “loss” under the policies with “risk of loss.” The court concluded that because the $335 million settlement payment fell within the $345 million limit for the second excess layer, the loss reinsured did not exceed the limits of that layer, thereby falling “within the definition of ‘loss’ contemplated by the insurance contracts.” 361 F.3d at 143.

Key Takeaways

The court held that the follow-the-settlements doctrine applies not only to the settlement itself, but also to a cedent’s post-settlement allocation, even if it is inconsistent with the cedent’s pre-settlement analyses, so long as the allocation was reasonable, made in good faith, and within the policy.

The court also held that in evaluating what “loss” is covered by the policy limits, the court must look to the actual loss paid by the reinsured, not the risk of loss considered pre-settlement.
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.

Justinian Doreste is an associate of Chaffetz Lindsey LLP, and has experience representing clients in insurance and reinsurance dispute resolutions, international arbitration, commercial litigation, and class actions.