Reinsurance Focus

New reinsurance-related and arbitration developments from Carlton Fields

FSOC Rescinds Prudential’s Designation as Systemically Important Financial Institution

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The Financial Stability Oversight Council (“FSOC”) announced on October 17, 2018 that it has voted unanimously to rescind the designation of Prudential Financial Inc. (“Prudential”) as a systemically important financial institution (“SIFI”). Prudential is currently the largest life insurance company and the seventh largest insurer and bank holding company in the United States.  Due to the size, scope and complexity of its business, it was labeled a SIFI in 2013 and added to the list of nonbanks considered “too big to fail” – those whose collapse the Treasury Department believed could threaten the stability of U.S. financial markets.  SIFIs are subject to strict supervision and oversight by the Federal Reserve.  Pursuant to the Dodd-Frank Act, the FSOC must annually reevaluate the continued necessity of a SIFI-designation.

The FSOC previously identified three channels through which the negative effects of a SIFI’s distressed finances could be transmitted to the market, including exposure to the SIFI by market participants, asset liquidation, and the inability or unwillingness of the SIFI to carry out critical functions or services. In 2013, the FSOC found the threat posed by Prudential arose primarily from exposure and asset liquidation channels.  According to the FSOC’s most recent evaluation, although certain aspects of Prudential’s business and activities have not materially changed since 2013, several factors have significantly affected its previous conclusion that Prudential could cause financial instability if it experienced material financial distress.  The factors include actions taken directly by Prudential, such as creating and dissolving captive reinsurance companies and restructuring debt, as well as certain critical regulatory developments and related initiatives by the National Association of Insurance Commissioners.

Notwithstanding the FSOC’s determination, Prudential and eight other insurance companies remain designated as globally significant SIFIs by the International Association of Insurance Supervisors and the Financial Stability Board. Two of these insurers had also been designated as SIFIs under the Dodd-Frank Act, but the labels were since rescinded or otherwise removed.

This post written by Alex Silverman.
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European Reinsurers Question Whether Proposed Changes to the Credit for Reinsurance Models Would Ensure Compliance with the Covered Agreement

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We have posted a number of times on the Covered Agreement between the U.S. and the E.U. concerning the reduction of collateral requirements for reinsurance provided by reinsurers domiciled in the E.U. The approach of the National Association of Insurance Commissioners (“NAIC”) to the implementation of the Covered Agreement, through its Reinsurance Task Force, has been based upon proposed amendments to the Credit for Reinsurance Model Act and Credit for Reinsurance Model Regulation, with the assumption being that the adoption of the revised Models by the individual states would ensure compliance with the Covered Agreement. Drafts of the revised Models have been under consideration, and are scheduled to be presented for a vote at the NAIC’s Fall National Meeting in approximately two weeks. The Reinsurance Advisory Board (“RAB”), which is a trade association composed of European domiciled reinsurers that purport to account for “approximately 60% of worldwide reinsurance business,” has submitted a comment letter to the chair of the NAIC’s Reinsurance Task Force expressing doubts over whether the proposed revisions to the Models would appropriately implement the Covered Agreement. This is potentially a serious issue, because if the revised Models do not appropriately implement the requirements of the Covered Agreement, the adoption of the revised Models by the states might not save state credit for reinsurance laws from preemption by the Covered Agreement. The RAB is represented at the CEO level by Gen Re, Hannover Re, Lloyd’s of London, Munich Re, Partner Re, Scor, and Swiss Re.

While many of the comments in the RAB’s letter concern fairly modest wording issues, one of the concerns expressed by the RAB is that “some of the language in the exposure drafts [of the proposed Model revisions] deviates significantly from the language of the bilateral agreement [i.e., the Covered Agreement] and thereby provides extensive discretion to state regulators in their compliance with the terms of the bilateral agreement.” We raised this issue as a possible concern in our last post on the Covered Agreement. One of the criticisms of the Covered Agreement in the Congressional hearing on the agreement shortly after it was announced was that it was too rigid, and took away the discretion and flexibility that individual state insurance commissioners have in our state-based structure of insurance regulation. The focus of the letter on the ability of individual state insurance commissioners to exercise some discretion in the implementation of the Models raises an issue that may be problematic. It will be interesting to see if and how the NAIC responds to this letter.

On a related note, the U.S. Department of the Treasury has announced plans to engage in discussions with the United Kingdom aimed at agreeing to a Covered Agreement with the U.K. that would be similar to that in place with the E.U. The NAIC has stated its position on that announcement.

This post written by Rollie Goss.
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Southern District of New York Confirms Arbitration Award Despite Allegation of Undisclosed Real Party in Interest

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After Hurricane Sandy hit the east coast in 2012, the Army Corps of Engineers contracted with Environmental Chemical Corp. (ECC) to conduct clean up on Fire Island, New York. ECC subcontracted most of the work to Coastal Environmental Group, Inc. (Coastal). Both entities incurred unexpected costs, which ECC blamed on Coastal and Coastal blamed on factors outside of its control. ECC then refused to pay Coastal a portion of the money it was otherwise due under the contract, and Coastal commenced an arbitration that ended with an award in Coastal’s favor.

ECC moved to vacate the award, focusing on two main issues: (1) Coastal’s failure to disclose the interest of its creditor Signature Bank in the matter; and (2) the arbitrator’s decision that ECC was estopped from challenging certain calculations of costs that Coastal had provided during the litigation because ECC has used those same calculations in submissions to the Army Corps of Engineers.

Documents filed after the award was issued showed that all of Coastal’s rights to payment under its agreement with ECC had been assigned to Signature Bank, which had agreed to take over all efforts to collect amounts due under the contract. ECC argued that Signature Bank was thus the real party in interest, and that Coastal’s failure to disclose this assignment of claims tainted the entire proceeding, including because this prevented the arbitrator from performing a proper conflict check. However, the court found that ECC had presented no evidence that Coastal or its attorneys ever made any affirmative misrepresentations on the question of Signature Bank’s role in the matter and that Coastal had informed ECC prior to the arbitration that one of its attorneys was also an attorney for Signature Bank. The court also found that ECC presented no evidence that a conflict check that included Signature Bank would have led the arbitrator to be conflicted out of the matter, and that “raising only the specter of potential but totally unknown conflicts” was not enough to show objective facts inconsistent with impartiality, as is needed to vacate an award on the basis of “evident partiality.”

Regarding the arbitrator’s invocation of equitable estoppel, ECC argued that, by raising the issue sua sponte and without briefing from the parties, the arbitrator exceeded his authority. The court disagreed, finding that the relevant portion of the contract specifically said that Coastal’s rights to certain compensation should be based on what “is equitable under all of the circumstances,” thus inviting the arbitrator to consider the equitable doctrine of estoppel. The court also noted that ECC had provided no authority suggesting that an arbitrator cannot consider an issue that was not briefed by the parties. Thus, the court confirmed the award.

Environmental Chemical Corp. v. Coastal Environmental Group, Inc., 18 Civ. 3082 (S.D.N.Y. Sept. 14, 2018).

This post written by Jason Brost.

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Illinois Appellate Court Holds Nebraska Arbitration Act Reverse Preempts Federal Arbitration Act and Renders Arbitration Clause in Reinsurance Agreement Unenforceable

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An Illinois appellate court recently affirmed a lower court decision granting summary judgment and denying defendant insurers’ motion to compel arbitration where Nebraska law governed, reverse preempted the Federal Arbitration Act (FAA), and rendered a mandatory arbitration provision in a reinsurance agreement unenforceable. Plaintiffs were required to enter reinsurance agreements to obtain workers’ compensation insurance and the agreement at issue contained provisions requiring mandatory arbitration of disputes and the application of Nebraska law. A dispute arose over the cost of the insurance policies and plaintiffs filed suit for various unfair and deceptive business practices violations. Defendants served an arbitration demand on plaintiffs, who refused to arbitrate. The lower court accepted plaintiffs’ argument that the arbitration clause was invalid under the Nebraska Arbitration Act (NAA) and therefore denied defendants’ motion to compel arbitration and granted summary judgment to plaintiffs.

On appeal, the appellate court affirmed. First, the court rejected defendants’ argument that plaintiffs were required to arbitrate because they failed to “specifically and directly” challenge delegation clauses in the reinsurance agreement. In defendants’ view, the delegation clauses precluded judicial determination of arbitrability based in part on the Supreme Court’s decision in Rent-A-Center, West, Inc. v. Jackson. The court ultimately concluded that the plaintiffs had challenged the delegation clauses specifically enough via their arguments on the arbitration provision, and therefore the lower court was entitled to consider the arbitrability challenge rather than compel arbitration on that issue.

Second, the court found the NAA applied and invalidated the arbitration clause of the reinsurance agreement. The court applied the three-part test to determine whether the McCarran-Ferguson Act allows a state law to reverse preempt a federal statute and concluded that: (1) the FAA does not specifically relate to the business of insurance, (2) the relevant provision of the NAA was enacted to regulate the business of insurance, and (3) the NAA applied in this case; thus the NAA reverse preempted the FAA. Because the NAA prohibits arbitration of agreements concerning or relating to insurance, the court held the arbitration clause was unenforceable and the lower court did not err in denying defendants’ motion to compel arbitration.

Onken’s Am. Recyclers, Inc. v. Cal. Ins. Co., Case No. 4-18-0240 (Ill. App. Ct. Sept. 10, 2018).

This post written by Thaddeus Ewald .

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UK Court Considers Whether Payment of Insurance Claim Violates Iran Sanctions

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A court in the United Kingdom has issued a ruling considering the intersection of a clause in an insurance agreement meant to protect the insurer from obligations that would violate international sanctions regimes and the rapidly changing realities of US sanctions against Iran.

At the heart of the case was an insurance agreement providing coverage for cargo carried on two ships that transported goods to Iran in August 2012. Upon arrival in Iran, certain cargo covered by the insurance agreement was put into storage, from which it was stolen in September or October 2012. The insured made a claim based on this loss in March 2013, but the insurer denied coverage on the basis of clause in the agreement providing that “no (re)insurer shall be liable to pay any claim . . . to the extent that the . . . payment of such claim . . . would expose that (re)insurer to any sanction, prohibition or restriction under . . . the trade or economic sanctions, laws, or regulations of . . . the United States of America.”

The insurer argued that paying this claim would expose it to sanctions based on US sanctions barring the provision of services to Iran. The parties agreed that insurance is a covered service and that the insurer was prohibited by these sanctions from paying this claim when it was made in March 2013. The insurer argued that its obligations were extinguished at that time, but the insured argued that later developments allowed the insurer to pay the claim. Specifically, in 2015, the US entered in an agreement with Iran called the Joint Comprehensive Plan of Action (JCPOA) under which the sanctions were relaxed. Under provisions of the JCPOA that went into effect in January 2016, the insurer could have paid the claim but delayed doing so while awaiting confirmation from the US and UK governments that this was allowed. Then, in May 2018, President Trump announced that the US was withdrawing from the JCPOA effective June 27, 2018, with a wind down provision allowing certain transactions to take place through November 4, 2018, and the parties disagreed regarding whether paying this claim was among the permitted transactions.

The court made several significant findings. First, it found that the fact that payment was prohibited at the time the claim was made in 2013 did not extinguish the insurer’s obligation to pay the claim, but instead only suspended that obligation until such time as the law changed to allow such payment to be made, as happened in 2016. Second, it found that payment of the claim was a permitted transaction under the wind down provision of the US withdrawal from the JCPOA. Finally, it interpreted the provision excusing the payment of the claim to the extent it “would expose” the insurer to sanctions to mean that the insurer had the burden to show that the payment was prohibited under the sanctions law, and not merely that there was a risk that a relevant government entity would interpret the payment to be prohibited. The court therefore decided that the insured was entitled to payment of the claim.

Mamancochet Mining Ltd. v. Aegis Managing Agency Ltd., [2018] EWHC 2643 (Comm)

This post written by Jason Brost.

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