Follow-the-settlements versus an ex gratia payment with consent withheld
A ceding company wrote a professional indemnity risk with a limit of Rs 10 crore and ceded 60% of it to a facultative reinsurer. The underlying claim by the insured's client was for Rs 9.2 crore. The insured notified the ceding company eleven months after receiving the client's legal notice, although the policy requires immediate notice and makes breach of that condition a bar to liability. After mediation, the ceding company settled at Rs 6.0 crore. Its own panel counsel had assessed probable liability at Rs 3.5 crore and advised that the late-notice defence was strong. The decision to settle was driven by the insured's threat of a market-conduct complaint and by a request from the broker who controls the ceding company's largest account.
The facultative certificate is full follow form, with a follow-the-settlements clause covering settlements made in good faith, an ex gratia exclusion, and a claims-cooperation clause requiring the reinsurer's consent before any settlement above Rs 2 crore. The reinsurer learned of the settlement only after payment was made.
1. Advise the reinsurer whether it is bound to pay its 60% share of the Rs 6.0 crore settlement, giving reasons.
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Follow-the-settlements binds the reinsurer to an honest, business-like settlement that falls within the scope of the original policy. It is not a licence to pay money the reinsurer was never liable for, and it does not survive the three defects here.
First, the settlement conceded a policy defence. Late notice of eleven months was available as a complete answer under the original policy, and counsel assessed liability at Rs 3.5 crore taking that into account. A settlement that abandons a policy defence the reinsurer never agreed to abandon is outside the clause - the reinsurer is bound by the settlement of a covered claim, not by the creation of a covered claim.
Second, the ex gratia element. The stated drivers - avoiding a market-conduct complaint and protecting the broker relationship - are commercial considerations of the ceding company, not legal liability of the insured. Payment on those grounds is ex gratia, which the certificate expressly excludes.
Third, breach of the claims-cooperation clause. Consent was required above Rs 2 crore and was not even sought. That is an independent bar, whatever the merits of the settlement.
Conclusion: the reinsurer is not bound to the full Rs 3.6 crore.
2. Quantify the likely exposure and explain how a tribunal would probably approach the dispute.
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The numbers. Reinsurer's share of the settlement: 60% of 6.0 = Rs 3.60 crore. If the late-notice defence had been run and counsel's assessment held, liability would have been Rs 3.5 crore, of which the reinsurer's share is 60% = Rs 2.10 crore. The disputed amount is therefore Rs 1.50 crore, plus interest and costs.
How a tribunal is likely to reason. It will not simply ask whether the ceding company acted in good faith in a subjective sense; it will ask whether the ceding company acted as a prudent insurer would have acted had it been entirely uninsured, and whether it gave proper weight to the reinsurer's interest. Settling at Rs 6.0 crore when counsel advised Rs 3.5 crore, without consulting the party bearing 60% of the cost, fails that test.
Equally, a tribunal dislikes reinsurers who sit back and complain after the event. If the reinsurer was notified of the mediation and stayed silent, it may be taken to have acquiesced. Here it was told only after payment, so that argument is unavailable to the ceding company.
The realistic outcome is an award around the Rs 2.10 crore that would have been payable on a properly defended claim, with the Rs 1.50 crore differential and the costs of the mediation borne by the ceding company. The ceding company may also have a professional-negligence claim against the broker who pressed for the accommodation.
3. Set out the drafting and process changes that would have prevented this outcome.
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Drafting. The consultation trigger of Rs 2 crore was too high for a Rs 10 crore limit; a trigger at 20-25% of the reinsurer's share, or "any claim where a policy defence is to be waived", would have caught this. Add express language that the reinsurer is not bound by any settlement to the extent that it exceeds what would have been payable had the defence been run, and that waiver of a policy condition requires prior written consent.
Process on the ceding side. Any file where counsel has advised a strong coverage defence should require sign-off above the underwriter who owns the broker relationship. The reason for settlement must be minuted: "protecting the account" is not a coverage rationale, and if it is the real reason, the amount should be funded from the ceding company's own account and described as ex gratia.
Process on the reinsurance side. Do not wait to be told. Where a large facultative claim is in mediation, ask for the panel counsel opinion, attend the mediation, and either consent or reserve rights in writing before payment. A timely reservation is cheap; an arbitration after payment is not.