Vol. 10, No. 2, Pg. 40. A Brief Introduction to Reinsurance.

• Author: By Thomas S. White

South Carolina Lawyer

1998.

Vol. 10, No. 2, Pg. 40.

A Brief Introduction to Reinsurance

40A Brief Introduction to ReinsuranceBy Thomas S. WhiteWhat is reinsurance? Stated most simply, it is the insur- ance of insurance. It is an extension of the risk spreading mechanism that allows insurance coverage limits to be procured for a comparatively small premium. North River Ins. Co. v. CIGNA Reins. Co., 52 F.3d 1194, 1198-99 (3d Cir. 1995).

When an insurer--or excess insurer--writes a policy for an insured, it accepts an obligation to pay the limits specified in the contract. These may be large while the premium, where the risk of loss is small, may be little.

For example, communication satellites are insured routinely. The risk of failure is statistically low. When a launch is aborted, however, the loss can be staggering. The premium charged by the insurer for that and other coverages would not ordinarily begin to approach the dollars required to meet even a single such claim.

How does the insurer reasonably accept this risk? It does so by procuring a commitment from a reinsurer, or several reinsurers, to take a percentage of the loss exposure for a percentage of the premium the insurer receives. Therefore, the risk of loss is spread in a manner that avoids catastrophic impact on any single party. Delta Holdings v. Nat'l. Distillers Chem. Corp., 945 F.2d 1226, 1229 (2d Cir. 1991).

At first glance, it may appear that this extended arena of insurance coverage is of little relevance to the lawyer practicing in South Carolina. Litigators are called on routinely to address insurance questions in the cases they handle. Litigated cases involving reinsurance are rarer. Such disputes are generally managed in the commercial centers where reinsurance contracts are written.

Moreover, because arbitration is frequently stipulated as the vehicle for resolving disagreements between insurers and reinsurers, many controversies are resolved informally. Given this and the paucity of reported reinsurance decisions in South Carolina, the occasions for handling such cases here appear to be few.

So, why bother with this seemingly esoteric subject?

There are at least two reasons. First, representation of insurers should include sensitivity to their rights and responsibilities to reinsurers. Issues like notice and periodic reporting often involve lawyers managing litigated claims. Sometimes reserving recommendations do as well. Considerations of policy interpretation can also bear importantly on allocation and trigger determinations in the settlement context. Protecting the position of the insurer means not only limiting exposure potential but also being sensitive to the bases for claims for indemnification after the underlying dispute is resolved.

Second, there is underway in this country an explosion of reinsurance litigation. As the stakes in coverage disputes growing out of environmental and mass tort claims have become higher, insurers and reinsurers have been increasingly inclined to contest their coverage obligations. While historically this has been done in arbitration, this process has become expensive and

42unpredictable at the same time that the continuity of commercial relationships providing incentive for arbitration has dissolved.

As a result, these problems are finding their way into the courts, and it can be expected that reinsurance controversies will be litigated in our courts more frequently than in the past. For these reasons, South Carolina lawyers who represent insurers or encounter insurance issues in the cases they handle should have at least a general familiarity with the fundamental concepts that underlie the rich history of reinsurance practice.

THE MECHANICS OF REINSURANCE CONTRACTS

How, then, does it work? Reinsurance takes many forms. The two most conventional are "treaty" and "facultative" reinsurance. These classes of reinsurance are, in turn, divided into "proportional" and "excess of loss" reinsurances.

Treaty reinsurance involves the acceptance by the reinsurer of a percentage of all of the risks underwritten by an insurer. In such circumstances, the reinsurer has no...