Reinsurance Recovery: Proportionality and the Survey Clause
A hull claim of USD 2,400,000 is settled by the primary insurer. The primary has a quota-share facultative arrangement ceding 40% of the risk to a reinsurer, and a surplus treaty above that. The reinsurance slip contains a 'follow the settlements' clause and a survey clause requiring a condition survey before attachment for vessels over 15 years. The vessel was 17 years old at attachment and no survey was done; the primary's underwriter had noted 'survey waived - long-standing account'. The loss arose from a latent defect in the propeller shaft, discovered during a routine dry-docking unrelated to any casualty. The reinsurer disputes the cession, arguing (i) breach of the survey clause and (ii) that a latent-defect loss discovered at dry-docking is not a casualty and therefore outside the reinsured scope.
1. Assess the reinsurer's two grounds of dispute and state which is stronger and why.
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Ground (i) - survey clause breach: the clause is a condition precedent to attachment. The primary waived it internally ('long-standing account') without the reinsurer's consent. A reinsurer is not bound by the cedant's unilateral waiver of a reinsurance condition; the cedant cannot enlarge the reinsurer's exposure by waiving a protective term. This ground is strong if the clause is drafted as a condition precedent and the reinsurer can show it would have declined or rated differently had the survey been done. If the clause is merely a warranty of information, the remedy may be limited.
Ground (ii) - latent defect not a casualty: weaker. Hull policies on ITC(H) expressly cover loss of or damage to the subject matter caused by latent defects (with a proviso excluding the cost of repairing/replacing the defective part itself). A latent defect discovered at dry-docking is still 'damage caused by a latent defect' - the absence of a casualty is not a bar. The reinsurer's argument confuses 'fortuity' with 'casualty'; a latent defect is a covered peril even without an external event.
Conclusion: ground (i) is the stronger and should be pursued; ground (ii) is likely to fail on the ITC(H) wording. The follow-the-settlements clause does not cure a breach of a condition precedent to attachment, because FTS governs the cedant's settlement of claims, not the formation of the reinsurance.
2. The primary settled the claim without consulting the reinsurer. How does 'follow the settlements' affect the dispute, and what should the primary have done?
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Effect of FTS: FTS obliges the reinsurer to follow the cedant's settlements, but only where the cedant has acted honestly, in good faith, and in a businesslike manner, and where the claim falls within the reinsured scope. FTS does not require the reinsurer to accept a settlement that is outside the reinsurance contract or that results from the cedant's breach of a condition precedent. So FTS does not rescue the primary here on ground (i).
On ground (ii), if the loss is within the reinsured scope, FTS would ordinarily bind the reinsurer to the cedant's settlement figure even if the reinsurer would have fought it - provided the cedant acted properly. The cedant's failure to consult is not itself a breach unless the slip contains a claims-control or consultation clause.
What the primary should have done: (a) obtained the reinsurer's agreement to waive the survey condition before attachment, or arranged a survey; (b) notified the reinsurer of the large loss and consulted before settlement if the slip contains a claims-cooperation clause; (c) documented the basis of settlement so that FTS could be relied on. The lesson is that FTS protects the cedant's settlement judgement, not its underwriting shortcuts.