United States Fid. & Guar. Co. v. American Re-Insurance Co. (N.Y. 2013)

Issue Discussed: Follow the Fortunes/Settlements

Submitted by Amy S. Kline

Date Promulgated: February 7, 2013

Issues Decided: Follow the settlements applies to allocation; reinsurer to follow “objectively reasonable” allocations of cedents’ settlement of underlying lawsuit. Factual disputes existed as to whether cedent, in allocating settlement amount, reasonably attributed nothing to “bad faith” claims, and as to whether certain claims were given unreasonable value for settlement purposes.

In United States Fidelity & Guaranty Company v. American Re-Insurance Company, the New York Court of Appeals modified the decisions of the Supreme Court, New York County and the Appellate Division on two issues and otherwise affirmed. The Appellate Division had affirmed summary judgment in the amount of $262 million (plus statutory interest) for cedents United States Fidelity and Guaranty Company and St. Paul Fire and Marine Insurance Company (collectively “USF&G”) against reinsurers American Re-Insurance Company (“American Re”) and Excess and Casualty Reinsurance Association and its pool members (“ECRA” and together with American Re, the “Reinsurers”). From 1948 until 1960, USF&G insured Western Asbestos Company (“Western Asbestos”), a distributor of asbestos products. The business of Western Asbestos was taken over in the 1960s by Western MacArthur Company (“MacArthur”). In 1993, MacArthur initiated underlying coverage litigation against USF&G in California state court seeking damages and a declaration that USF&G had a duty to defend and indemnify MacArthur against asbestos-related personal injury claims. In 2002, USF&G settled the underlying coverage litigation for approximately $987 million. As part of the settlement, MacArthur was to file for bankruptcy, and a trust was to be created to assume MacArthur’s asbestos-related liabilities. Upon settlement of the underlying coverage litigation, USF&G billed the Reinsurers for a portion of the settlement. USF&G calculated the Reinsurers’ share of the settlement at approximately $391 million. The Reinsurers declined to pay and this litigation followed (some Reinsurers settled with USF&G, leaving approximately $262 million, not including interest, in dispute). The Supreme Court granted summary judgment to USF&G, and the Appellate Division affirmed. The courts held that the Reinsurers were obligated to follow the fortunes of USF&G’s settlement of the underlying coverage litigation. The Court of Appeals modified the Appellate Division’s order on two issues and otherwise affirmed. The Court reaffirmed the principle that follow the fortunes clauses “require deference to a cedent’s decisions on allocation,” and affirmed several aspects of the allocation as a matter of law under an “objective reasonableness” test. The Court continued, however, by noting that “to say a cedent’s allocation decisions are entitled to deference is not to say that they are immune from scrutiny.” Rather, an allocation is subject to an objective reasonableness standard such that the “reinsured’s allocation must be one that the parties to the settlement of the underlying insurance claims might reasonably have arrived at in arm’s length negotiations if the reinsurance did not exist.” Furthermore, the Court rejected USF&G’s argument that the validity of the allocation was established simply by virtue of the fact that the allocation used in billing the Reinsurers was the one that USF&G agreed upon with the underlying insurance claimants. Therefore, the Court held that, under a follow the settlements clause such as presented here, “a cedent’s allocation of a settlement for reinsurance purposes will be binding on a reinsurer if, but only if, it is a reasonable allocation, and consistency with the allocation used in settling the underlying claims does not by itself establish reasonableness.” The Court then applied these principles to three assumptions underlying USF&G’s settlement allocation that were subject to challenge by the Reinsurers: • First, the USF&G allocation attributed all of the settlement amount to claims within the limits of the underlying policies, and none of the settlement amount to the claims that USF&G acted in bad faith during the course of the underlying asbestos litigation. The Court held that “while the people who negotiated the settlement of the coverage litigation all agreed that the settlement gave no value to the bad faith claims,” there was evidence in the record from which a fact finder could conclude that an allocation giving no value to the bad faith claims was unreasonable. The evidence included: (a) “a significant risk of an adverse verdict on the bad faith claims,” (b) the potential finding that USF&G “assigned inflated values to claims other than the bad faith claims,” (c) that the demand immediately before settlement included value for bad faith claims, and (d) the Bankruptcy Court’s finding that bad faith claims against USF&G (and other insurers) had “great settlement value” such that their surrender in the settlement was part of the “benefits provided.” On this record, the Court found that it was “impossible to conclude, as a matter of law, that parties bargaining at arm’s length, in a situation where reinsurance was absent, could reasonably have given no value to the bad faith claims.” Rather, the Court found that this issue must be decided at trial. • Second, the USF&G allocation assigned the maximum value per claim ($200,000) to pending and future claimants with lung cancer, which USF&G asserted to be in accord with claim values agreed by the parties to the underlying coverage litigation. The Court, however, distinguished between the valuation of mesothelioma claims, which it found to have been “reasonably valued” at higher than the $200,000 limit in the policies, and lung cancer claims. Evidence in the record, including evidence that “at an earlier stage of the coverage litigation” the asbestos claimants’ expert valued lung cancer claims at less than half of $200,000, was sufficient to support the inference that the value assigned to lung cancer claims was “unreasonably high.” The Court found “[w]hether the values assigned to lung cancer claims could reasonably have been agreed on in an arm’s length bargaining in the absence of reinsurance presents an issue of fact.” • Third, the USF&G allocation attributed all of the losses to a single insurance policy, rather than prorating them over the many policy years in which claimants were exposed to asbestos. On this point, the Court found no evidence from which a fact finder could infer that the allocation was unreasonable. The Court rejected the Reinsurers’ arguments that USF&G improperly adopted the rules of “continuous trigger,” “all sums” and “no stacking,” and that the “Other Reinsurance” clause of the USF&G policies forbade the allocation of all losses to one policy year. Finally, the Court rejected the Reinsurer’s contention that the reinsurance treaty was retroactively amended to increase the retention per loss to $3 million, an amount far in excess of any loss for which USF&G could have been liable. The Court also held that the courts below correctly rejected the reinsurers’ other defenses.

* Ms. Kline is a partner at Saul Ewing LLP.