Confronting reinsurers' rescission claims: some suggestions for cedents.

• Author: Sneed, William M.

In recent years, cedents attempting to enforce reinsurance contracts have encountered rescission claims based on allegations of misrepresentation or non-disclosure(1) - claims that can raise the stakes of litigation or arbitration considerably. For instance, the federal district court in Compagnie de Reassurance D'Ile v. New, England Reinsurance Corp.(2)! rescinded retrocession treaties and ordered the retrocedent to pay to its retrocessionaires the difference between all claims previously paid by the retrocessionaires less all premiums received by them, resulting in a total award in excess of $37.5 million. In this climate, cedents and retrocedents are well-advised to mount an aggressive defense to rescission claims.

There are several strategies for defending reinsurance rescission claims based on allegations of misrepresentation or non-disclosure. The suggestions that follow are not intended to be exhaustive but only to provide a focal point for analyzing and then rebutting these claims. Also, there is no substitute for researching and determining the applicable law in any given situation. Different jurisdictions have different requirements for rescission claims, with variations in presumptions, evidentiary standards, elements and burden of proof.

Elements of Rescission Claim

Generally, the elements of a rescission claim based on misrepresentation are (1) a false representation of material fact, (2) made with knowledge of its falsity, (3) for the purpose of inducing the receiving party to act, and (4) the receiving party's reliance on the misrepresentation to its detriment.(3) Reliance on the misrepresentation should be reasonable or "justified" under the circumstances.(4)

A rescission claim based on non-disclosure includes nearly identical elements, with the touchstone being an omission of material fact, rather than a misrepresentation. Courts generally hold that a cedent owes a duty to disclose to its reinsurers all material facts pertaining to the risk being reinsured.(5)

Defending Against Claims

1. Isolate Alleged Misresentations or

   Non-disclosures

   The cedent should begin its defense by forcing the reinsurer to delineate the misrepresentations and non-disclosures giving rise to the claim. Two benefits result from this approach.

   First, the cedent can determine where to focus its discovery efforts. For instance, the rescission claim will likely stem from what was said or unsaid during placement and renewal of the reinsurance treaty because most claims involve allegations of misrepresentation or non-disclosure at the time of placement. The most common complaints focus on representations concerning the way in which the primary business would be underwritten (whether through a managing agent or not), how a treaty would be operated (whether automatic or discretionary), type of business to be ceded, and so forth.(6) If the alleged misrepresentations or non-disclosures occurred during placement, the cedent should obtain the broker's placing file, depose the parties who made and received the misrepresentations, and follow similar leads.

   The second benefit of this procedure is that it enables defense counsel to determine whether the actual representations or omissions complained of are in fact actionable, given their nature, industry custom and practice, or other circumstances.

   1. Industry Custom and Practice

      Evidence of industry custom and practice can demonstrate that alleged misrepresentations or non-disclosures are not actionable. Old Reliable Fire Insurance Co. v. Castle Reinsurance Co.(7) rejected a reinsurer's rescission claim on this basis.

      The reinsurer, which sought rescission of a quota share treaty covering both property and casualty business, complained that automobile business was ceded and that automobile physical damage risks were improperly classified as property, rather than casualty, for purposes of representing the respective shares of property and casualty business to be ceded when the treaty was placed. After a bench trial, the district court found that the information admittedly disclosed to the reinsurer's underwriter plainly indicated that automobile risks would be ceded and that under industry custom and practice automobile physical damages risks were properly classified as property.

      The Eighth Circuit affirmed, holding that there was no fraudulent misrepresentation of the portfolio to be ceded because documents disclosed to the reinsurer at placement indicated that automobiles were included in the treaty and "appropriately characterized automobile physical damage risk as property business, therefore stating that the portfolio to be reinsured was approximately 65 percent property and 35 percent casualty."(8)

      Old Reliable turned in part on whether a particular representation comported with custom and practice. The district court in American Home Assurance Co. v. Fremont Idemnity Co.(9) considered industry custom and practice in evaluating whether a non-disclosure was material. The cedent (AIG) sought to enforce two reinsurance treaties, and the reinsurer (Fremont) argued for rescission. With respect to one of the treaties, the intermediary, an AIG affiliate, had submitted a study to AIG that analyzed various features of the treaty and projected the aggregate losses that would pierce the treaty in future years. These projections were based on underlying data, including loss history and loss ratios from past years.

      Fremont argued that AIG's failure to disclose these projections at the time of placement constituted a material non-disclosure that warranted rescission of the treaty. AIG countered that the projections were not material because they represented a non-actuary's personal and subjective views and failed to observe certain basic actuarial techniques. In addition, AIG contended that Fremont was provided with the same underlying data as that relied on by the author of the projection, and therefore Fremont's actuaries were in as good a position as AIG to calculate predicted losses.

      The district court found that a question of fact precluded Fremont's motion for summary judgment on its rescission claim, stating: "It remains to be seen whether under the standard by which materiality is judged, an objective one, industry practice would consider [the AIG affiliate's! loss projections as material to a reinsurer's decision to participate" in the treaty.

      The lesson of American Home is that evidence of industry custom and practice can stymie what otherwise appears to be a solid non-disclosure claim.

   2. Challenge Allegations Relating to

      Future Expectations

      The cedent should consider whether the alleged representations or omissions relate to future expectations, rather than to existing facts. Generally speaking, statements amounting to projections or promises of future conduct are not actionable, absent proof of a present intent not to honor them.(10)

      This general principle can protect cedents accused of misrepresentions during placement because, by its very nature, the placement of a reinsurance treaty necessarily involves statements regarding future expectations, particularly with respect to premium volume. For instance, in CNA Reinsurance of London Ltd. v. Home Insurance Co. (footnote 6) the reinsurers sought to rescind on a number of grounds, including alleged misrepresentations regarding estimated premium income to the treaty. The district court granted the cedent's summary judgment motion with respect to the premium volume representations because the reinsurers could not show that the cedent actually believed its prognostic statements were false when made.(11)

      Claims of misrepresentation based on nonspecific utterances of future intent by the cedent also should be challenged. The court in Old Reliable (footnote 7) held that a cedent's expressed policy goals to tighten its underwriting procedures, require policyholders to insure to value and force policyholders to increase the value of their policies by 30 percent on renewal did not amount to promises actionable under a contract theory. In similar fashion, the court in CNA Reinsurance of London held that the following statements regarding the business to be ceded were not actionable - "it is highly unlikely that [the cedent] will be insuring any organizations with total staffs in excess of say 100 persons" and lawyers involved in SEC work "will be avoided."(12)

2. Focus on Reinsurer's Knowledge and

   Means of Knowledge

   After scrutinizing the actual representations or non-disclosures at issue, the cedent should turn the focus to the reinsurer - its actual knowledge, its actual opportunities to obtain knowledge, and its general means of knowledge. The more the cedent can establish as to what the reinsurer knew or should have known, the less likely the reinsurer's reliance on the alleged misrepresentations for...