The Continuing Evolution of the ‘Follow the Fortunes’?

With a proliferation of long-tail claims, the reinsurance industry has been confronted with a multitude of questions involving the application of the “follow the fortunes.”

As is commonly understood, the purpose of the “follow the fortunes” or “follow the settlements” doctrine is in its simplest form intended to prevent the reinsurer from “second guessing” the settlement decisions of the ceding company.

In the most recent significant case to address the issue, the Second Circuit Court of Appeals recently ruled that a cedent is required to follow a cedent’s post-settlement allocation (even if it is not a position that the cedent has always advocated) as long as the settlement was in good faith, reasonable, and within the terms of the policies. Travelers Cas. & Surety Co. v. Gerling Global Reinsurance Corp. of America, 419 F.3d 181 (2d Cir. 2005).

The facts of Travelers are relatively straight-forward. Following a settlement with its insured, Owens-Corning Fiberglass Corporation (“Owens-Corning”), Travelers allocated the settlement among the Owens-Corning policies in such a manner as to allow Travelers to pursue reinsurance recovery from Gerling Global. The reinsurance contracts at issue contained provisions under which Gerling Global agreed to be bound by any loss settlements entered between Travelers and the underlying insured, provided the loss settlements fell within the terms and conditions of the original policy and the reinsurance contracts.

The underlying coverage dispute between Owens-Corning and Travelers involved the availability of coverage for products and non-products asbestos claims under the polices at issue. Travelers took the position with Owens-Corning that all of its asbestos claims, whether products or non-products, arose from a single occurrence. Prior to the time that an arbitration panel had the opportunity to render a decision on the occurrence issue, Owens-Corning and Travelers settled their coverage dispute.

Although the settlement with Owens-Corning did not resolve the occurrence issue, Travelers had to choose a post-settlement methodology in order to allocate the settlement among the primary and excess policies issued to Owens-Corning. Travelers elected to allocate most of the settlement as a single, additional non-products occurrence in what Travelers viewed as an allocation most closely resembling the compromises reached as part of the settlement with Owens-Corning.

Following Gerling Global’s refusal to indemnify Travelers for its purported share of the Owens-Corning settlement, Travelers filed a breach of contract action. The district court granted Gerling Global’s motion for summary judgment, finding that the follow the fortunes doctrine did not apply. Thus, Gerling Global was not required to follow Travelers’ post-settlement, single occurrence allocation. The district court essentially found that by not challenging the settlement on the basis of a “second-guess” that the doctrine was inapplicable. Instead, the district court accepted Gerling Global’s position that by refusing to indemnify Travelers it was not challenging the terms of underlying settlement, but rather seeking to enforce them. Under Gerling Global’s approach, Travelers should have allocated the settlement according to the multiple-occurrence position that Gerling Global believed had been implicitly accepted in order to complete the underlying settlement.

The Second Circuit Court of Appeals reversed the lower court’s ruling and entered summary judgment for Travelers. Gerling Global was obligated, pursuant to the follow the fortunes provisions in the reinsurance contracts, to indemnify Travelers for losses arising out of Owens-Corning non-products asbestos claims that were ceded as a single occurrence.

In finding for Travelers, the Second Circuit relied on the North River Insurance Co. v. ACE American Reinsurance Co., 351 F.3d 134, 139 (2d Cir. 2004) (“North River II”), wherein the court rejected the reinsurer’s assertion that the settlement process can be distinguished from a cedent’s allocation to reinsurers, and ruled that the follow the fortunes doctrine applies to allocation decisions. Of importance, the Second Circuit also distanced itself from the Travelers Cas. & Sur. Co. v. Certain Underwriters at Lloyd’s of London, 96 N.Y.S.2d 583 (2001) decision which Gerling maintained stood for the proposition that the follow-the-fortunes doctrine does not apply to post-settlement decisions.

The Second Circuit reasoned that the holding of Lloyd’s was inapplicable because it involved treaties, rather than facultative certificates, providing individual definitions of “loss” and “disaster.” Finally, of particular importance, the court ruled that Gerling Global had failed to present evidence to support the argument that Travelers allocated the losses in “bad faith” in order to maximize reinsurance recovery. The court reasoned that an allocation that increases reinsurance recovery – when made in the aftermath of a legitimate settlement and when chosen from multiple possible allocations – would rarely demonstrate bad faith in and of itself.

This is a significant reinsurance decision as reinsurers and ceding insurers consistently battle over allocation issues. Undoubtedly, ceding insurers will aggressively argue that the case limits a reinsurer’s ability to question allocation issues.

In turn, reinsurers will seek to limit the application of the decision given the Second Circuit’s specific distinction between treaties and facultative certificates.

Andrew S. Boris is a partner in the Chicago office of Tressler Soderstrom Maloney & Priess. His practice is focused on litigation and arbitration of insurance coverage and reinsurance matters throughout the country, including general coverage, directors and officers liability, professional liability, environmental, and asbestos cases. Questions and responses to this article are welcome at aboris@tsmp.com.