For centuries the venerable duty of utmost good faith has served as a bedrock principle of the reinsurance industry: a standard that has set reinsurance contractual relationships apart from other commercial transactions governed by “caveat emptor.”
However, a number of commentators in the industry have questioned whether the duty of utmost good faith has been in decline in our modern era. Is a reinsurer still entitled to rely in blind faith on a cedent’s representations? Does a cedent still have an affirmative duty to volunteer all material facts to its reinsurer during placement? And after the contract is signed? Or must a reinsurer spend time and money investigating its cedent’s representations as well as its underwriting, accounting and claims practices to verify compliance with the treaty’s terms?
This article examines how today’s courts and arbitration panels are interpreting and applying the duty of utmost good faith. There are relatively few court decisions examining the duty of utmost good faith, primarily because the vast majority of reinsurance contracts require the parties to resolve their differences in private arbitration. And because arbitration awards are rarely made public, and most are in any event not reasoned awards, there are few published awards that specifically address the duty’s modern day application. We examine below several court decisions in recent years that have addressed the duty of utmost good faith as well as two reasoned, unanimous arbitration awards (made public in court proceedings) that examined the duty’s requirements. To paraphrase Mark Twain, reports of the demise of the duty of utmost good faith are greatly exaggerated.
Court Decisions in Recent Years
As of the publication of this article, the most recent reported court opinion referencing the duty of utmost good faith is Associated Industries Insurance Company v. Excalibur Reinsurance Corp., 13 Civ. 8239, 2014 U.S. Dist. LEXIS 169163 (S.D.N.Y. Nov. 26, 2014). In this dispute, the cedent sought to confirm in part and vacate in part an arbitration award. For the portion it sought to vacate, the cedent alleged that the arbitration panel exceeded its authority in granting the reinsurer 10-15% discounts on some of the claims at issue. The cedent contended that the follow the fortunes doctrine obligated the panel to award 100% of each claim. Essentially, according to the cedent, if a claim was valid, the arbitrators did not possess any discretion to partially discount the amounts the cedent was entitled to receive.
In the arbitration, the reinsurer argued that deficiencies in the cedent’s claims handling constituted a violation of the duty of utmost good faith. While the panel did not find those deficiencies sufficient to relieve the reinsurer of most of its liability for the claims in question, the court ruled that the panel could award a discount because the cedent “did less than it should have to meet its good faith obligation to its reinsurer.” Id. at *20.
In response to the cedent’s argument that its reinsurer was obliged to fully follow the fortunes of the cedent’s deficient claims handling, the court specifically referenced the duty of utmost good faith, writing that the follow the fortunes doctrine is not “applicable where the cedent fails in its duty of good faith, which requires it to protect its reinsurer’s interests as if they were the cedent’s own. Reinsurers ‘are protected by a large area of common interest with ceding insurers and by the tradition of utmost good faith, particularly in the sharing of information.’” Id. at *14 (quoting Unigard Sec. Ins. Co., Inc. v. North River Ins. Co., 4 F.3d 1049, 1054 (2d.Cir. 1993)).
For the full article, refer to page 12 in the Spring 2015 issue. https://www.airroc.org/assets/docs/matters/airroc%20matters.%20vol%2011%20no%201%20spring%202015.pdf