Bluewater Ins. Ltd. by Tennessee Ins. Co. v. Balzano by Colaiannia, 90SC417

• Decision Date: 13 January 1992
• Docket Number: No. 90SC417,90SC417
• Citation: 823 P.2d 1365
• Parties: BLUEWATER INSURANCE LIMITED (by TENNESSEE INSURANCE COMPANY, as its successor in interest); Camelback Reinsurance Underwriter, Inc., on behalf of Imperial Casualty and Indemnity Company; First Horizon Insurance Co. and American Centennial Insurance Company, Petitioners, v. Robert D. BALZANO (by Daniel J. COLAIANNIA, as his successor in interest), Special Deputy Commissioner of Insurance of Colorado and Receiver in Liquidation of Aspen Indemnity Corporation and A.I.C., Agency, Inc., Respondent.
• Court: Colorado Supreme Court

Page 1365

823 P.2d 1365

BLUEWATER INSURANCE LIMITED (by TENNESSEE INSURANCE COMPANY as its successor in interest); Camelback Reinsurance Underwriter, Inc., on behalf of Imperial Casualty and Indemnity Company; First Horizon Insurance Co. and American Centennial Insurance Company, Petitioners, v. Robert D. BALZANO (by Daniel J. COLAIANNIA, as his successor in interest), Special Deputy Commissioner of Insurance of Colorado and Receiver in Liquidation of Aspen Indemnity Corporation and A.I.C., Agency, Inc., Respondent.

No. 90SC417.

Supreme Court of Colorado,

En Banc.

Jan. 13, 1992.

As Modified on Denial of Rehearing Feb. 24, 1992.

Joseph J. Bronesky, F. Brittin Clayton, III, Sherman & Howard, Denver, for petitioners.

Thomas Frank, Frank & Finger, Evergreen, for respondent.

Alan Epstein, Hall & Evans, Denver, for amici curiae.

Richard E. Barnsback, Phillip E. Stano, David M. Leifer, Washington, D.C., for American Council of Life Ins.

Jack Blaine, Robert Sarber, Washington D.C., for Reinsurance Ass'n of America.

Craig A. Berrington, Ronald S. Gass, Washington, D.C., for American Ins. Ass'n.

Richard E. Goodman, Schaumburg, Ill., for Alliance of American Insurers.

John J. Nangle, Des Plaines, Ill., for National Ass'n of Independent Insurers.

Justice MULLARKEY delivered the Opinion of the Court.

We granted certiorari to review the decision of the court of appeals in Balzano v. Bluewater Ins. Ltd., 801 P.2d 1 (Colo.App.1990). The court of appeals affirmed summary judgment and held that the relevant Colorado statutes require a reinsurer to pay in full the policy liabilities of an insolvent ceding insurer without diminution, thus abrogating any right of the reinsurer to offset unpaid premiums from the reinsurance proceeds due. We affirm.

I.

To properly approach this case, a basic understanding of the business of reinsurance is required. Before introducing the parties and presenting the factual background of this case, we first summarize the relevant general features of reinsurance. In addition, we remark on whether the business of reinsurance in Colorado adheres to or departs from these general features.

A.

Obviously, reinsurance is predicated on the existence of insurance, which "serves to protect individuals against financial calamity." ¹ With insurance purchased from a primary insurer, individuals and businesses (the "policyholders" or "insureds") receive compensation for losses incurred. Basically, reinsurance is a contract between a primary insurer and another insurance company where the former is indemnified by the latter for losses on paid claims to policyholders. The indemnitor is called the reinsurer. With such a contract, the primary insurer is reinsured.

The contract is formed when the primary insurer "cedes" a portion of the premiums for its policies and the losses on those policies to the reinsurer. Policyholders pay premiums to their primary insurer, and that insurer, as the reinsured, in turn pays to the reinsurer a certain percentage of those premiums as consideration. Since the reinsurer does not incur the normal costs of writing primary insurance, such as administrative expenses and commissions paid to agents, the reinsurer can profitably reinsure the risks for only a percentage of the premiums paid to the primary insurer. If the primary insurer has to compensate its policyholders for losses, the reinsurer in turn indemnifies the primary insurer. ² The advantage of this general feature of reinsurance is to secure to the primary insurer "adequate risk distribution by transferring part of the risk to another insurer or group of insurers." ³

A second advantage of reinsurance is that it enables a primary insurer to reduce the amount of reserves usually required by law for the protection of the policyholding public. ⁴ The advantage to the insurer is an increased ability to underwrite additional policies and/or to make other types of investments. From the perspective of the insurance industry, contracting for reinsurance permits an insurer, typically a small insurer, simultaneously to lessen its exposure to catastrophic loss and to increase its capital available for investment.

In Colorado and in most if not all states, the insurance business is regulated by fairly comprehensive insurance codes. The Colorado insurance code, Title 10, 4A C.R.S. (1987), which is enforced by the state insurance commissioner (the "commissioner"), reflects more or less the general features and attendant advantages of reinsurance summarized above. Thus, under the specific statute regulating the reinsurance business, a qualified primary insurer may "reinsure all or part of an insurance risk in any other insurer" and "take credit for reserves on risks ceded to a reinsurer." § 10-3-118(1) and (3)(a), 4A C.R.S. (1987).

Reinsurance has certain advantages which accrue to the insured public as well, at least under the Colorado insurance code as enforced by the commissioner. As supervised by the commissioner, reinsurance coverage represents an added shield protecting a policyholder against uncompensated loss. This advantage to the insureds is realized most obviously in the event of the primary insurer's insolvency, an event which precipitated the dispute in this case. Thus, from the perspective of an insured or policyholder, the insolvency of the primary insurer may make any reinsurance the only or de facto source of at least partial compensation for losses incurred. Since the Colorado insurance code allows the reinsured primary insurer to take credit for statutory reserves, which reserves are required for the protection of the public, it is not surprising that reinsurance contracts are treated and regulated by the commissioner with a view to the public interest.

As noted, reinsurance generally is considered an indemnity contract between the primary insurer and the reinsurer. This means that the "reinsurer does not assume the liability of the ceding company" and that the insured or policyholder is not a third-party beneficiary of a reinsurance contract with the right to sue. ⁵ However, because the public interest is implicated in reinsurance contracts, in Colorado such contracts may not be considered pure indemnity contracts, as we shall see in part II.

There is a third general feature of reinsurance, the presence or absence of which does affect the public interest in cases of the insolvency of the primary insurer. This feature is the practice of "offsetting" balances due between the primary insurer and the reinsurer and is at the center of the dispute in this case. Apparently, "[m]ost reinsurance agreements contain an offset clause which allows either party to the agreement to net credits against debits and pay only the balance." ⁶ Under an offset clause, reinsurers and ceding insurers maintain a periodic account which involves numerous credits and debits reflecting various payables and recoverables. The advantage of an offset clause to a primary insurer is that the primary insurer "can obtain the reinsurance recoverables immediately (and improve its liquidity) by netting them against premiums otherwise due the reinsurer." ⁷ As we shall discuss in part II of this opinion, the manner in which the reinsurance business as regulated in Colorado either adheres to, or departs from, this practice of netting debits against credits even after the insolvency of the primary insurer presents the broad problem in this case.

B.

Petitioners, including the Tennessee Insurance Company, the successor in interest to Bluewater Insurance Ltd. (the "reinsurers"), are a group of insurance companies in the business of providing reinsurance coverage. The reinsurers, in a series of contracts which included the so-called Non-Caterpillar Dealer Business Reinsurance Treaty and the Master Excess of Loss Reinsurance Agreements (the "contracts"), provided reinsurance coverage to the Aspen Indemnity Corporation ("Aspen"), a primary insurer licensed in Colorado. As consideration, Aspen agreed to pay a certain percentage of its premiums to the reinsurers in quarterly installments which were payable in advance.

Initially, Aspen issued primary coverage to independent franchised Caterpillar dealerships, including their workers' compensation plans. Aspen expanded in 1979 and began to write primary fire, property and casualty coverage. According to the reinsurance contracts, the reinsurers were committed to indemnify Aspen for claims or losses incurred by those holding policies written by Aspen. The contracts also provided that, in the event of insolvency, the reinsurance would be payable to the receiver on the basis of the liability of Aspen without diminution because of the insolvency of Aspen. As required by statute, these contracts were submitted to the commissioner for his approval.

Evidently, even in the absence of a contractual offset clause of the type described above, the reinsurers and Aspen nevertheless maintained an account which netted credits and debits reflecting various payables and recoverables. As noted, the contracts provided that the premiums were to be paid to the reinsurers in advance. The accounts between the reinsurers and Aspen were not prudently managed because Aspen failed to pay, for at least five consecutive quarters, premiums ceded to the reinsurers under the reinsurance contracts. It was established at oral argument that upon Aspen's failure to pay the premiums, the reinsurers could have terminated the contracts after due notice to the commissioner. The reinsurers did not give notice to the commissioner of Aspen's nonpayment of premiums for five quarters and/or of an intent to terminate the reinsurance contracts with Aspen.

In 1984, the commissioner determined that Aspen was insolvent and liquidation proceedings were initiated under the Uniform Insurers Liquidation Act, § 10-3-501, et seq., 4A C.R.S. (1987) (the "liquidation act"). Respondent in this case, the deputy commissioner of insurance and Aspen's...