Reinsurance Focus

New reinsurance-related and arbitration developments from Carlton Fields

SECURITIES LAWSUIT ALLEGING REINSURANCE STEERING PRACTICES WILL PROCEED

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An insurance broker’s bid to dismiss a federal securities lawsuit failed when a federal district court in Illinois denied its motion to reconsider its earlier motion to dismiss. The lawsuit arose out of the New York Attorney General’s investigation into the insurance brokerage industry’s use of so-called “contingent commission” practices, wherein brokers would allegedly direct or steer business to insurers willing to use their services when buying reinsurance in order to generate revenues in the form of commission payments. The broker, Aon, originally sought dismissal of the case in 2005, which the district court denied in 2006, relying on the pleading requirements set forth in the Seventh Circuit’s decision in Makor Issues & Rights, Ltd. v. Tellabs, Inc., 437 F.3d 588 (7th Cir. 2006). After the United States Supreme Court vacated the Seventh Circuit’s decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S. Ct. 2499 (2007), articulating the standard courts must apply in determining whether a securities plaintiff has pled a “strong inference of scienter” as required by the Private Securities Litigation Reform Act of 1995, the broker reasserted its argument that the plaintiffs had not adequately pled scienter.

The district court disagreed with the broker once again, however, and denied the motion to reconsider. The court found that, even under the new Tellabs decision, the complaint supported an inference of the defendants’ knowledge, awareness and involvement in the alleged steering scheme. It also found that the complaint adequately alleged that the defendants either knew, or would have realized under the circumstances, that a failure to reveal potentially material facts would likely mislead investors. Among other things, the court found a financial motive to conceal the contingent commission practices, that it had been alleged that defendants failed to comply with GAAP and substantially inflated their reported earnings, and that company executives had admitted violating the internal code of ethics. Thus, the court found that a “strong inference of scienter” had been pled. Roth v. Aon Corp., Case No. 04-C-6835 (USDC N.D. Ill. Mar. 7, 2008).

This post written by Brian Perryman.

COURT VACATES ARBITRATION AWARDS AGAINST FEDERAL CROP INSURANCE CORPORATION

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The plaintiff farmers brought an action in federal district court to enforce two arbitration awards against the Federal Crop Insurance Corporation (“FCIC”), a division of the United States Department of Agriculture. FCIC is a reinsurer of crop insurance policies issued by private insurance companies. It issues cooperative financial agreements with the private insurers that are referred to as “standard reinsurance agreements.” Plaintiffs purchased policies with American Growers Insurance Company (“AGIC”). In turn, AGIC entered into standard reinsurance agreements with FCIC. Plaintiffs filed arbitration demands against AGIC, but in 2005, the State of Nebraska liquidated AGIC. On the order of liquidation, FCIC notified plaintiffs that it would review their claims. The arbitration proceeded, however, over FCIC’s objections that it was not a party to the arbitration agreement, and that it would not submit to the arbitrator’s jurisdiction. Eventually, the arbitrator granted awards against FCIC.

When plaintiffs sought to enforce the awards in the United States District Court for the Eastern District of Washington, the court ruled against them on cross-motions for summary judgment. The court found that FCIC had not agreed to submit to arbitration, being neither a party to the crop insurance policies at issue nor otherwise in privity of contract with plaintiffs. Among other things, FCIC was found to be a reinsurer, not a “substituted insurer,” i.e., an entity that assumes direct liability to the policyholder. Accordingly, the arbitrator lacked jurisdiction to preside over any dispute between FCIC and plaintiffs. The district court, therefore, vacated the awards. Olsen v. United States, Case No. CV-06-5020-FVS (USDC E.D. Wash. Mar. 8, 2008).

This post written by Brian Perryman.

COURT AFFIRMS SUMMARY JUDGMENT IN FAVOR OF BROKER ON STATUTE OF LIMITATION GROUND, REFUSING TO APPLY THE DISCOVERY RULE

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The US Court of Appeals for the Fifth Circuit has affirmed a summary judgment in favor of Aon, ruling that claims asserted against it by TIG arising out of the placement of reinsurance were barred by the statute of limitation. Aon acted as reinsurance intermediary and broker for TIG with respect to workers’ compensation risks that TIG ceded to U.S. Life. Aon failed to pass to U.S. Life historical loss information regarding the ceded risks that TIG had provided to Aon, and U.S. Life succeeded in rescinding that portion of the reinsurance in an arbitration due to the failure to provide known historical loss information. TIG then sued Aon for damages for breach of fiduciary duty. The district court held, and the Fifth Circuit affirmed, that the cause of action arose under Texas law when TIG and U.S. Life entered into an “impaired reinsurance agreement,” rather than when U.S. Life succeeded in rescinding the reinsurance (or even when U.S. Life first contended that it had the right to rescind). The courts refused to apply the discovery rule to delay the accrual of the cause of action because: (1) TIG only used Aon to solicit bids, dealing directly with bidders to negotiate reinsurance agreements and confirm the information that had been provided to the bidders; and (2) at the time that it received U.S. Life’s reinsurance proposal, TIG suspected that the loss information had not been passed to U.S. Life due to the fact that the proposal was much lower than other proposals it had received. The courts essentially imposed a duty to inquire upon TIG at that time, a duty which it had not satisfied. The Fifth Circuit concluded that “[i]nquiry could have been made to determine or confirm the facts and assumptions on which the bargain was to be based,” and that the “injury was not inherently undiscoverable” when the reinsurance agreement was executed. This seems like a harsh result, since neither party to the reinsurance agreement knew it was potentially voidable until the arbitration. There may have been a number of reasons why US Life's proposal was so low, some of which might not make the reinsurance agreement “impaired” from its inception. The effect of this decision, however, at least in the Fifth Circuit, is that cedents cannot rely upon brokers to do their jobs and pass on historical loss information that the cedent has provided to the broker if there is a reasonable doubt that the loss information may have been passed on to a prospective reinsurer. TIG Ins. Co. v. Aon Re Inc., No. 05-11450 (USCA 5th Cir. Mar. 13, 2008).

This post written by Rollie Goss.

SUPREME COURT RULES THAT PARTIES MAY NOT CONTRACT FOR BASES FOR JUDICIAL REVIEW OF ARBITRATION AWARDS

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The United States Supreme Court has held that the grounds for vacating or modifying arbitration awards set out in the Federal Arbitration Act are the exclusive grounds for such action, and can not be “supplemented” by contractual agreement. This ruling will end the practice of contracting for the judicial review of arbitration awards on grounds similar to those for the appeal of final judgments of courts after trials, in order to avoid the restrictive judicial review provisions of the FAA. In discussing the FAA’s judicial review provisions, the Court mentioned the manifest disregard of law basis for reviewing awards, noting that this theory is not explicitly mentioned in the FAA, but is implied from the FAA’s provisions. Some courts may take this mention as a criticism of the legitimacy of the manifest disregard of law theory, and it will be interesting to see how courts respond to this portion of the opinion. Given the clear trend in court opinions over the past 16 months or so of substantially restricting the scope of the manifest disregard theory, however, this portion of the opinion may have limited impact, no matter how it is interpreted. Hall Street Assoc. LLC v. Mattel, Inc., No. 06-989 (US Mar. 25, 2008).

This post written by Rollie Goss.

COURT RESOLVES DISAGREEMENT OVER PROTECTIVE ORDER PROVISIONS IN INSURANCE DISPUTE

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The National Council on Compensation Insurance, as attorney-in-fact for participating companies of the National Workers Compensation Reinsurance Pool, filed a complaint against AIG alleging that AIG engaged in a fraudulent scheme to avoid paying their proportional share of the insurance costs in the residual market for workers compensation insurance. The parties, unable to agree on several terms of a protective order to govern the exchange of confidential information, turned to the district court to resolve their differences on numerous provisions.

The Court made the following key determinations: First, the ‘inadvertent production’ provision would require the receiving party to ‘return, sequester, or destroy’ the information that the producing party claimed had been inadvertently produced. The Court explained that the 2006 Amendments to Rule 26 added the option of sequestration. Second, the Court acknowledged the need for a two-tier definition of confidentiality (“confidential” and “highly confidential – outside counsel’s eyes only”) but limited “highly confidential” documents to those that “(a) must have current applicability to defendant’s business operations, and (b) more likely than not would cause competitive harm to the business operations of the disclosing party.” Lastly, the court rejected defendants’ request to include a provision in the protective order that would require the Court to award damages for any breach of the protective order. National Council on Compensation Ins., Inc. v. American International Group, Case No. 07 C 2898 (USDC N.D.Ill. Dec. 11, 2007).

This post written by Lynn Hawkins.