Run-Up to Renewals - Follow the Fortunes

Does it mean what you think it means?

When placing and renewing reinsurance contracts, Follow the Fortunes and Follow the Settlements are often viewed as interchangeable phrases, meaning the same thing. But that is not necessarily the case. 

Why are these clauses used?

In the absence of this type of clause, and subject always to the other terms and conditions of the reinsurance contract, the default position under English law is generally that a reinsured must prove that the reinsurer is liable because the reinsured was legally liable to pay the amount paid to the original insured, and that that payment also fell within scope of the reinsurance contract. That can be a time-consuming or onerous process.  Accordingly, some standard clauses have evolved to reach a more commercial resolution which allows the reinsured to settle an underlying claim with confidence, but without the reinsurer effectively giving the reinsured a blank cheque.

A “Follow the Settlements” clause properly drafted will require settlement by the reinsurer unless it can show that the reinsured has not acted in good faith or in a proper and business-like manner when settling a claim. There have been a number of English law cases examining how the clause works. 

Follow the Fortunes

Surprisingly for some, although it has received judicial treatment in the US and is commonly found in reinsurance contracts subject to a wide range of governing law provisions, a “Follow the Fortunes” clause (and the differences between such a clause and a Follow the Settlements clause) has not been considered in any great detail by the English courts.

In the US, “Follow the Fortunes” binds the reinsurer to the underwriting fortunes of its cedant so that reinsurance liability is concurrent with the underlying insurance liability. US courts generally treat this clause as meaning that the reinsurer is obligated to follow the reinsured’s liability (or its “fortunes”) both as determined by courts and as compromised by the cedant – unless the settlement is proven unreasonable, ex gratia, or in bad faith. This indemnification obligation even includes, as one federal court of appeals put it, “payments reasonably within the terms of the original policy, even if technically not covered by it”. (See British Int’l Ins. Co. v. Seguros La Republica S.A., 342 F.3d 78, 85 (2d Cir. 2003) (quoting Christiania Gen. Ins. Corp. v. Great Am. Ins. Co.), 979 F.2d 268, 280 (2d Cir. 1992)). In the US “Follow the Settlements” may confer an additional benefit to the reinsured in respect of compromised claims not determined by a Court. When explicitly stated in the contract, a “Follow the Settlements” provision generally binds a reinsurer to the cedant’s liability, no questions asked. 

The position under English law

As noted above, very few English reinsurance law cases have considered the difference between a Follow the Settlements and a Follow the Fortunes clause.

In Hayter v. Nelson  [1990] 2 Lloyd’s Rep 265, the judge noted that “there is no authority on the meaning of a ‘follow the fortunes’ clause of this or indeed any other kind, though the use of such clauses in commonplace in the business of reinsurance and retrocession” and “it is clear from the textbook writers that there is, or appears to be, very considerable uncertainty (not to say confusion) as to what is intended to be meant and agreed by the use of the phrase "follow the fortunes".

In the more recent reinsurance case of CGU International Insurance plc v AstraZeneca Insurance Co Ltd [2005] EWHC 2755 (Comm), it was common ground between the parties that the “follow the fortunes” clause in question was not the same as a “follow the settlements” clause, but the judge was not required to determine the exact scope and effect of the former. 

When the same case went on to appeal, it was noted that the contract contained a “follow the fortunes” clause, but no “follow the settlements” clause. The Court of Appeal referred to an argument that the “follow the fortunes” would bind reinsurers in the event of a foreign judgment, even if local law found the underlying claim was covered in circumstances where there would have been no cover under English law. However, it was argued that there would not be cover under the reinsurance contract if the reinsured settled the claim in anticipation of such liability. The point was ultimately not decided by the Court, so this judgment did not advance the general understanding of theses clauses as a matter of English common law.

Comment

The phrases “follow the fortunes” and “follow the settlements” are often used as shorthand and interchangeably in the reinsurance market, but may have unintended effects or lead to a lack of clarity about reinsurers’ obligation to indemnify, depending on the governing law of the contract in question. The key takeaway from the case law is that it is best to spell out exactly what the reinsurer is agreeing to be bound to, and what the reinsured will have to prove. 

It is possible to amend standard clauses to better reflect the true intention of the parties. For example, a clause could specify that the reinsured need only show it was arguable that a claim presented by an insured is covered as a matter of law and fact, or could set out whether a higher test is required. Alternatively, a lower requirement – for example, that only a bad faith settlement will afford reinsurers a defence - might be adopted.