Stamp v. Insurance Co. of North America

• Decision Date: 23 July 1990
• Docket Number: No. 89-1168,89-1168
• Citation: 908 F.2d 1375
• Parties: Zack STAMP, Director of Insurance for the State of Illinois, as Liquidator of Reserve Insurance Company, Plaintiff-Appellant, v. INSURANCE COMPANY OF NORTH AMERICA, et al., Defendants-Appellees.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 1375

908 F.2d 1375

59 USLW 2090

Zack STAMP, Director of Insurance for the State of Illinois as Liquidator of Reserve Insurance Company Plaintiff-Appellant, v. INSURANCE COMPANY OF NORTH AMERICA, et al., Defendants-Appellees.

No. 89-1168.

United States Court of Appeals Seventh Circuit.

Argued Oct. 30, 1989.

Decided July 23, 1990.

Jeremiah Marsh, John N. Gavin, Albert C. Maule, David B. Goroff, Hopkins & Sutter, Chicago, Ill., for plaintiff-appellant.

Andrew M. Staub, Ross & Hardies, David M. Spector, Ronald A. Jacks, Thomas S. Kiriakos, Ira J. Belcove, Mayer, Brown & Platt, Peter M. Sfikas, Clay H. Phillips, Peterson, Ross, Schloerb & Seidel, Chicago, Ill., Alan J. Rein, John Mezza Cappa, Mound, Cotton & Wollan, New York City, for defendants-appellees.

John W. Dondanville, Francis D. Morrissey, Thomas A. Doyle, William M. Sneed, John M. Murphy, Baker & McKenzie, Chicago, Ill., for North American Reinsurance Corp., General Reinsurance Corp.

Carole J. Olson, Kansas City, Mo., for amicus curiae Nat. Ass'n of Ins. Com'rs.

John W. Morrison, Charles A. Valente, Altheimer & Gray, Chicago, Ill., Daniel J. Conway, Washington, D.C., for amicus curiae Reinsurance Ass'n of America.

Jonathan F. Bank, Lorraine B. Moura, Buchalter, Nemer, Fields & Younger, San Francisco, Cal., for amicus curiae American Ins. Ass'n, American Council of Life Ins., Nat. Ass'n of Independent Insurers, and Alliance of American Insurers.

Before CUDAHY, EASTERBROOK and MANION, Circuit Judges.

EASTERBROOK, Circuit Judge.

Bankruptcy in the insurance business has brought us two difficult questions. First is whether amounts the insolvent insurer owes to a reinsurance pool for net losses before the bankruptcy may be set off against amounts the pool owes to the insolvent firm. Second is whether the unearned premiums credited to customers on the cancellation of policies placed with the insolvent firm are voidable preferences and, if they are, who is liable.

I

The Bankruptcy Code does not apply to insurance companies. 11 U.S.C. Sec. 109(b)(2), (d). Like most other states, Illinois handles the failure of insurers in state court under the supervision of the state's chief regulator, who takes title to the firm's assets as trustee and liquidator. In 1979 the Director of Insurance applied to a state court (the "liquidation court") for an order declaring Reserve Insurance Company insolvent and authorizing him to wind up the firm's business. That order issued on May 29, 1979, and ever since the director as Liquidator has been collecting and paying outstanding claims under the supervision of the state court.

Reserve participated in several reinsurance "treaties". See 622 F.Supp. 611, 613-15 (N.D.Ill.1985). When it wrote a policy covered by one of the treaties (the three in this case concerned petroleum and petrochemical properties), Reserve notified another firm (the Manager) that coordinated the reinsurance pool. The Manager allocated the risk among Reserve and other members of the pool, making entries on the books to indicate percentage ownership of each risk. Similarly, when other firms wrote policies, Reserve would be assigned some of the risk. Each treaty specified the allocation of risks among insurers. The Manager collected the premiums on behalf of the insurers and paid the salesmen or agencies their commissions. The Manager retained the rest of the money to pay claims. Each quarter the Manager would send every member of the pool a statement of accounts: income received from premiums (plus the salvage value of assets the pool acquired when it paid claims), less the amounts disbursed to policyholders. If the pool had net earnings in any quarter, the balance would be distributed to the insurers in proportion to their shares of the risks underwritten. If the pool suffered net losses, the Manager would bill the insurers for the shortfall, again according to their stakes.

The treaties allowed the Manager to place insurance with firms it designated. In early 1979 the Manager concluded that Reserve was in financial difficulty. It cancelled 107 policies written by Reserve and replaced them with policies issued by other members of the pool. A sequence of bookkeeping entries made the transfers.

1. The Manager cancels Reserve's policies and debits Reserve's account for the "unearned premiums"--that is, the amounts customers have prepaid for coverage in days and months ahead. The Manager also cancels the reinsurance of these policies and debits the accounts of the reinsurers for unearned premiums.

2. The unearned premiums are credited to the policyholders' accounts.

3. The Manager uses the credits in the policyholders' accounts to buy new policies from firms other than Reserve.

4. Having purchased new policies for the customers, the Manager reinsures them, usually with the same reinsurers. This reverses the debits in step one for all firms other than Reserve. To the extent that Reserve reinsured policies newly issued by the other firms, it reverses a portion of the debits for Reserve as well.

At the conclusion of the transaction, every customer has the same insurance as before, now from solvent insurers. Most members of the pool carry the same risk, for the same premium, as before, with a slight increase to the extent other insurers absorb Reserve's share. Reserve owes the pool the total of the unearned premiums, less the credits it received as reinsurer of other firms' policies. If the price for the insurance was actuarially correct, Reserve's savings on the reduction in its exposure will approximate the debits for unearned premiums, so there is a wash from its perspective as well as the policyholders' and the other insurers'. ("Approximate" rather than "equal", because Reserve might have made a profit on the business.)

Reserve incurred debts to the pool for 1979 not only because of the cancellation and re-placement of policies but also because the pool suffered net losses on its insurance business for these months. The Manager billed Reserve for the difference.

After the liquidation court declared Reserve insolvent in May 1979, the firm stopped paying its share of losses. Claimants insured under policies that the Manager had not cancelled needed to go to the liquidation court for approval and (part) payment of their losses. Amounts paid directly to the insureds on approval of the court generated debts by the pool to Reserve for the portion of each policy that had been reinsured. The liquidation court also cancelled all of Reserve's remaining policies, generating "unearned premiums" from the reinsurers credited to Reserve's account. (Reserve incurred a corresponding debt to its insureds.) The Manager contended that the pool could set off against these debts to Reserve the amount Reserve owed for net underwriting losses and unearned premiums before it was declared insolvent.

The Liquidator filed this diversity action against the Manager and the other members of the pool. He asked the court to declare that amounts owed to the pool for net losses before May 29 could not be set off against the amount the pool owes for claims that Reserve paid directly after May 29. He also asked the court to direct the Manager to restore to Reserve the unearned premiums on the cancelled policies. Judge Plunkett granted partial summary judgment for the pool on the question of setoff, ruling that the debts were "mutual", and so could be offset, because both debts represented sums due on casualties policyholders suffered before May 29. That some of the claims had been liquidated before May 29, while others were paid later, did not destroy the contemporaneous nature of the debts. 622 F.Supp. at 618-19.

With respect to the cancellation of the policies, Judge Plunkett first concluded that the Manager had authority under the treaties to proceed as it did. 622 F.Supp. at 620. Then the court concluded that the cancellation was not a voidable preference, because it was not a payment of an antecedent debt. Id. at 620-22. The Liquidator asked Judge Duff, to whom the case was transferred, to reconsider. Judge Duff disagreed with Judge Plunkett's reasoning in some particulars but concluded that his disposition of the Liquidator's claims is correct. 668 F.Supp. 1183 (N.D.Ill.1987). The principal difference between the opinions is that Judge Duff concluded that the unearned premiums were a debt, but that the debits were not preferences because Reserve got a contemporaneous exchange of equal value--release from its obligation to pay in the event a policyholder suffered a casualty. The parties then stipulated to the size of their claims and to a complex judgment effecting the netting. In the end, the court directed the pool to pay the Liquidator $201,677.

II

We begin with the question whether the district court had subject-matter jurisdiction to determine and set off the amount that Reserve owed to the pool for net losses before May 29, 1979. According to the Liquidator, a setoff is just like ordering Reserve to pay a claim. Only the liquidation court may do that. The upshot, the Liquidator believes, is that the district judge may (and must) require the pool to pay Reserve, but may not require Reserve to pay the pool even indirectly by recognizing a setoff. For this proposition the Liquidator relies on Thacher v. H.C. Baldwin Agency, Inc., 283 F.2d 857 (7th Cir.1960).

We may assume that the district judge could not have directed the Liquidator to pay anything to the reinsurers. That is not, however, what happened. The net judgment runs in favor of the Liquidator. The only question is whether, in determining how much the pool owes the Liquidator, the district court may consider how much Reserve owed the pool. Thacher affirms the decision of a district court not to recognize a setoff against an insurer in liquidation. Although the Liquidator says that Thacher held that a federal court lacks jurisdiction to recognize a setoff, the case does not use the language of...