Unigard Sec. Ins. Co., Inc. v. North River Ins. Co., 197

CourtUnited States Courts of Appeals. United States Court of Appeals (2nd Circuit)
Citation4 F.3d 1049
Docket NumberD,No. 197,197
PartiesUNIGARD SECURITY INSURANCE COMPANY, INC., successor to Unigard Mutual Insurance Company, Inc., Plaintiff-Appellant, v. NORTH RIVER INSURANCE COMPANY, Defendant-Appellee. ocket 91-7534.
Decision Date09 September 1993

Eugene Wollan, New York City (Michael H. Goldstein, Robert A. Stern, Mound, Cotton & Wollan, New York City, of counsel), for plaintiff-appellant.

Dennis G. Jacobs, New York City (Andrew S. Amer, Mary Beth Forshaw, Simpson, Thacher & Bartlett, New York City, of counsel), for defendant-appellee.

Before: WINTER and ALTIMARI, Circuit Judges, and POLLACK, Senior District Judge. *

WINTER, Circuit Judge:

Unigard Security Insurance Company, Inc., appeals from Judge Sweet's decision after a bench trial rejecting its late loss notice defense under a facultative reinsurance certificate with North River Insurance Company. 1 See Unigard Sec. Ins. Co. v. North River Ins. Co., 762 F.Supp. 566 (S.D.N.Y.1991).

Judge Sweet held that, although North River's notice under the certificate was five months late, Unigard could not prevail on its late loss notice defense because it had failed to prove prejudice. He also held that Unigard was liable for expense costs that exceeded the policy liability limits. After oral argument, we certified to the New York Court of Appeals the question whether a reinsurer must prove prejudice to prevail on a late loss notice defense. The Court of Appeals held that prejudice must be shown. See Unigard Sec. Ins. Co. v. North River Ins. Co., 79 N.Y.2d 576, 584 N.Y.S.2d 290, 594 N.E.2d 571 (1992). We affirm in part because, although Unigard was not given notice of the signing of the so-called Wellington Agreement, it has not shown prejudice resulting from this lack of notice. We reverse in part because Unigard is not liable for expenses that exceed the reinsurance certificate's policy limits.


We will briefly discuss the business of reinsurance and then turn to the facts of the instant case.


Reinsurance occurs when one insurer (the "ceding insurer" or "reinsured") "cedes" all or part of the risk it underwrites, pursuant to a policy or group of policies, to another insurer. See 13A John A. Appleman & Jean Appleman, Insurance Law and Practice Sec. 7681, at 480 (1976); 19 George J. Couch, Cyclopedia of Insurance Law Sec. 80:1, at 624 (2d ed. 1983). The reinsurer agrees to indemnify the ceding insurer on the risk transferred.

The purpose of reinsurance is to diversify the risk of loss, see Delta Holdings v. National Distillers, 945 F.2d 1226, 1229 (2d Cir.1991), and to reduce required capital reserves. See Colonial Am. Life Ins. Co. v. Comm'r, 491 U.S. 244, 246, 109 S.Ct. 2408, 2410, 105 L.Ed.2d 199 (1989). Spreading the risk prevents a catastrophic loss from falling upon one insurer. By reducing the legal reserve requirement, the ceding insurer then possesses more capital to invest or to use to insure more risks. See Bart C. Sullivan, Reinsurance in the Age of Crisis, 38 Fed'n Ins. & Corp. Couns. Q. 3, 4 (1987).

There are two basic types of reinsurance policies--facultative and treaty. See generally 1 Klaus Gerathewohl, Reinsurance Principles and Practice 64-128 (1980) (discussing The reinsurer is not directly liable to the original insured. See Unigard, 79 N.Y.2d at 582, 584 N.Y.S.2d 290, 594 N.E.2d 571. Reinsurance involves contracts of indemnity, not liability. Id. at 582-83, 584 N.Y.S.2d 290, 594 N.E.2d 571. Reinsurers do not examine risks, receive notice of loss from the original insured, or investigate claims. Id. at 583, 584 N.Y.S.2d 290, 594 N.E.2d 571. In practice, the reinsurer has no contact with the insured.

various types of reinsurance coverage). In facultative reinsurance, a ceding insurer purchases reinsurance for a part, or all, of a single insurance policy. Treaty reinsurance covers specified classes of a ceding insurer's policies. As the district court explained, a "typical treaty reinsurance agreement might reinsure losses incurred on all policies issued by the ceding insurer to a particular insured, while facultative reinsurance would be limited to the insured's losses under a policy or policies specifically identified in the reinsurance agreement." Unigard, 762 F.Supp. at 572 n. 2.

To enable them to set premiums and adequate reserves, see Delta Holdings, 945 F.2d at 1229, and to determine whether to "associate" in the defense of a claim, reinsurers are dependent on their ceding insurers for prompt and full disclosure of information concerning pertinent risks. The reinsurance relationship is often characterized as one of "utmost good faith." This utmost good faith may be viewed as a legal rule but also as a tradition honored by ceding insurers and reinsurers in their ongoing commercial relationships. Historically, the reinsurance market has relied on a practice of the exercise of utmost good faith to decrease monitoring costs and ex ante contracting costs. Reinsurance works only if the sums of reinsurance premiums are less than the original insurance premium. Otherwise, the ceding insurers will not reinsure. For the reinsurance premiums to be less, reinsurers cannot duplicate the costly but necessary efforts of the primary insurer in evaluating risks and handling claims. Reinsurers may thus not have actuarial expertise, see Delta Holdings, 945 F.2d at 1241, or actively participate in defending ordinary claims. They are protected, however, by a large area of common interest with ceding insurers and by the tradition of utmost good faith, particularly in the sharing of information. Because repeat transactions are the norm, reputation is thus important to commercial success and the loss of repeat business is a penalty that usually outweighs the short-term gains of misrepresentations or stonewalling contractual obligations. The New York Court of Appeals thus recently commented: "This appeal calls upon us to resolve a question of reinsurance law--a field in which differences have often been settled by handshakes and umpires, and pertinent precedents of this court are few in number." Sumitomo Marine & Fire Ins. Co. v. Cologne Reins. Co. of Am., 75 N.Y.2d 295, 298, 552 N.Y.S.2d 891, 552 N.E.2d 139 (1990).

However, in recent years, the reinsurance market has witnessed an increase in participants and a decline in profitability due to huge environmental losses. This has led some commentators to question the continued vitality of utmost good faith as a description of the current practices in the reinsurance market, see Eugene Jericho, Insurance and Reinsurance Disputes, 55 Def. Couns. J. 289, 289 (1988), and argue that the market is now one of caveat emptor. John Milligan-Whyte & Mary Cannon Veed, Bermudian, English and American Reinsurance Arbitration Law and Practice and Alternative Dispute Resolution Methods, 25 Tort & Ins. L.J. 120, 124 (1989). See also Unigard, 762 F.Supp. at 591 (noting that the customs and practices of reinsurance had changed due to the "overwhelming pressures" of huge environmental losses like asbestos); Steven W. Thomas, Note, Utmost Good Faith in Reinsurance: A Tradition in Need of Adjustment, 41 Duke L.J. 1548, 1558-61 (1992).

If these commentators are correct, the reinsurance industry may encounter severe difficulties. It involves a market that has relied upon informal understandings and practices that cause participants to act toward each other with the good faith expected of joint venturers. Whether the industry can thrive if these understandings and practices are eroded and replaced by litigation is an open question.

1. The Insurance Policies

The reinsurance contract at issue in the instant case is facultative. North River, through its agent L.W. Biegler, Inc., also a subsidiary of Crum & Forster, issued two excess insurance policies to Owens-Corning Fiberglass Corporation in July 1974--XS-3619, a second-layer excess policy, and XS-3672, a third-layer excess policy. Both policies provided coverage for, inter alia, claims for asbestos-related bodily injuries. North River purchased reinsurance to cover 100 percent of its liability risk under XS-3672.

Unigard was one of the reinsurers under XS-3672. North River issued XS-3672 to Owens-Corning for coverage of $30 million, payable if losses exceeded the $76 million in underlying excess and primary coverage. XS-3672 covers three policy periods: (A) July 9, 1974 to October 22, 1974; (B) October 22, 1974 to October 22, 1975; and (C) October 22, 1975 to October 22, 1976.

Unigard, through its managing general agent Allen Miller and Associates, Inc. ("AMAI"), issued to North River Certificate of Facultative Reinsurance No. 1-5143 (the "Certificate") to reinsure one-sixth of the risk of XS-3672. The reinsurance for policy period (C) was cancelled by endorsement effective October 22, 1975.

The relevant terms of the coverage under the Certificate are as follows:

[Follow the Form Clause ]

A. ... [T]he liability of [Unigard] shall follow that of [North River] and, except as otherwise provided by this Certificate, shall be subject in all respects to all the terms and conditions of [North River's] policy except such as may purport to create a direct obligation of [Unigard] to the original insured or anyone other than [North River].


[Notice of Loss Clause and Claims Association Clause ]

C. Prompt notice shall be given by [North River] to the Underwriting Managers on behalf of [Unigard] of any occurrence or accident which appears likely to involve this reinsurance and while the Underwriting Managers or [Unigard] do not undertake to investigate or defend claims or suits, the Underwriting Managers, directly or through its representatives and/or counsel, shall nevertheless have the right and be given the opportunity to associate with [North River] and its representatives at [Unigard's] expense in the defense and control of any claim, suit or...

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