Follow the settlement, or follow the claims control clause?
A Lloyd's syndicate writes a £10m excess-of-£5m facultative reinsurance layer for a Caribbean hurricane-exposed resort portfolio. The reinsurance contains a 'follow the settlements' clause and a claims control clause requiring the reinsurer's prior written approval for any settlement above £2m. In September a hurricane causes damage. The cedent's insured claims £18m. The cedent's loss adjuster reports that £4m of the claim relates to a marina building that may be excluded because the damage was caused by storm surge rather than wind. The cedent's claims committee, without consulting the reinsurer, settles the entire claim for £13m, allocating £2.5m to the disputed marina as a goodwill payment to preserve the relationship. The cedent then bills the reinsurer for the full £10m layer and sends the file. The reinsurer's underwriter notes that the claims control clause was not followed and that the marina loss is arguably excluded. The cedent argues that the follow clause obliges the reinsurer to pay.
1. Is the reinsurer bound by the cedent's settlement under the follow-the-settlements clause? Explain the interaction with the claims control clause.
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Not automatically. A follow-the-settlements clause is a significant protection for the cedent, but it is not a blank cheque. It binds the reinsurer to a settlement that is honest, businesslike and within the terms of the underlying policy and the reinsurance. It does not require the reinsurer to pay a settlement that is outside the reinsurance contract or made without the required control.
Here the reinsurance also contains a claims control clause requiring the reinsurer's prior written approval for any settlement above £2m. Claims control clauses are commonly treated as conditions precedent. The cedent settled for £13m without consulting the reinsurer. That is a breach of the clause. The reinsurer is therefore not bound by the settlement in the ordinary way, and the follow clause does not cure the breach. The two clauses operate together: follow applies to settlements the cedent is entitled to make; control removes that entitlement where approval is required and not obtained.
The reinsurer should not simply refuse the whole claim, because the underlying loss may still be covered. It should reserve rights and investigate what it would have done had it been consulted.
2. How should the reinsurer treat the £2.5m goodwill allocation, and what is its likely response on the figures?
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The £2.5m 'goodwill' allocation is the second problem. A reinsurer is not bound to ex gratia or goodwill payments unless the reinsurance expressly covers them. A payment made to preserve a commercial relationship, rather than to discharge a legal liability under the policy, is not a loss under the underlying insurance.
The reinsurer should look behind the allocation. The cedent's insured claimed £18m. The adjuster identified £4m as marina damage potentially excluded as storm surge. If the exclusion applies, the covered loss is £14m. The cedent settled for £13m, which is less than the covered loss, but the allocation says £2.5m of the £13m is for the excluded marina. If that allocation is genuine, the covered settlement is £10.5m. The layer is £10m excess of £5m, so the reinsurer's liability on £10.5m is £5.5m. If the whole £13m is treated as covered, the liability is £8m. The £2.5m difference is the amount in dispute.
The reinsurer should not accept the cedent's allocation uncritically, but nor should it ignore the possibility that the settlement was a sensible global compromise. It should require the adjuster's full report and the coverage analysis.
3. What should the reinsurer do now to protect its position?
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The reinsurer should:
- acknowledge the claim without prejudice and reserve all rights under the claims control clause and in respect of the ex gratia element;
- request the complete claims file, the underlying policy, the adjuster's reports, the settlement agreement and the cedent's coverage advice;
- obtain its own coverage view on the marina/storm surge exclusion;
- ask the cedent to explain why it did not seek approval and whether there is any standing agreement or delegated authority that permitted the settlement;
- consider whether the cedent's breach has caused prejudice; if the reinsurer would have defended or settled on different terms, it can rely on that;
- pay the undisputed covered amount promptly, to avoid a dispute about delay, while withholding the disputed £2.5m;
- check whether the cedent has recovered anything from other reinsurers or from the insured, and apply any reinsurance recoveries properly.
If the cedent refuses to cooperate, the reinsurer should consider its rights under the access-to-records and claims control provisions, and take legal advice before any final denial. A blanket refusal to pay anything risks losing the covered part of a valid claim.