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USF&G v. Am Re: An End Or A New Beginning?

by ~ Michael F. Aylward (Email) (Web Site)

In the latest chapter of an asbestos coverage dispute that began over twenty years ago, the New York Court of Appeals has issued a provocative and interesting analysis of the interplay between a reinsurer’s duty to “follow the settlement,” and its right to challenge the cedent’s allocation methodology where the settled claims have significant components that seemingly fall outside the scope of the reinsurance agreements at issue. Massachusetts practitioners will want to take note of the decision, because the complex issues addressed by the court are ones that tend to recur in reinsurance disputes.

In United States Fidelity & Guaranty Co. v. American Re-Insurance Co., No. 1 (N.Y. Feb. 7, 2013), the Court of Appeals ruled that while reinsurers could not dispute the trigger and allocation methodology used to settle the underlying claims, summary judgment should not have been granted to the cedent due to substantial evidence that called into question the values that the cedent had assigned to certain types of claims and the failure to assign any value at all to the insured’s bad faith claims.


During the early 1990s, MacArthur Company asked USF&G to accept the defense of various asbestos bodily injury suits arising out of the operation of its former subsidiary, Western McArthur. Although McArthur alleged that USF&G had issued several primary GL policies to Western McArthur during the 1950s, USF&G could find no evidence to confirm that it had ever issued these policies. In any event, USF&G disputed that it would have owed a defense to McArthur as its insured’s corporate successor.

In 1993, McArthur sued USF&G in California, seeking a declaration of coverage. In 1997, the California Court of Appeal validated USF&G’s back-up defense, ruling in General Accident Ins. Co. v Superior Court of Cal., 55 Cal. App. 4th 1444, 64 Cal. Rptr. 2d 781 (1997), that a successor corporation does not obtain coverage “by operation of law.” However, McArthur circumvented the effect of this precedent by obtaining an assignment of Western McArthur’s coverage position. USF&G’s position was further weakened when secondary evidence emerged that seemed to confirm that it had, in fact, insured Western McArthur during the period in question.

Meanwhile, McArthur ratcheted up the pressure on its insurers by allowing many of the underlying asbestos cases to go into default with the complicit agreement of the plaintiffs’ lawyers not to collect on their judgments while the insurance issues played out. By 2002, when McArthur’s suit against USF&G was finally called for trial, these judgments totaled over $1.4 billion plus interest. That sum posed a significant peril to USF&G because the evidence indicated that, while its policies had low limits of liability (ie. $200,000 per claim), they did not contain any aggregate limits.

Mid-way through the trial, USF&G settled with McArthur for $975 million. USF&G then ceded $391 million of the settlement to the participants in a 1956-62 “excess of loss” treaty that reinsured it for individual loss payments over $100,000. The reinsurers disputed this cession, and litigation followed in New York. By the time the case went to trial, USF&G had settled about a third of this claim. $262 million remained at issue, most of which was claimed to be owed by American Reinsurance Company.

New York Court Proceedings

Supreme Court granted summary judgment to USF&G, a ruling that was affirmed by the Appellate Division in January 2012. The First Department declared that the reinsurers had no right to second-guess USF&G’s decision to settle, much less its decision to assign the entire loss to a single policy instead of spreading it among its thirteen years of coverage. As to the latter point, the court noted that applying thirteen retentions would have deprived USF&G of any reinsurance for this settlement, and that the decision to select the 1959 policy, whether or not beneficial to the cedent’s reinsurance rights, was permitted under California’s “all sums” law and benefitted the underlying claimants, since the 1959 policy was the only one that was triggered by all their claims and had a higher policy limit that some of the other years.

Writing in dissent, Justice Abdus-Salaam argued that there were disputed issues of fact with respect to whether the settlement was for bad faith. Justice Abdus-Salaam noted that Western McArthur had not only made such claims in the original coverage litigation (USF&G had first denied that it ever insured Western McArthur and then asserted that any policies would necessarily have contained aggregates when, in fact, documents that USF&G had donated to a Baltimore museum proved the opposite) but that the Bankruptcy Court, in approving the settlement, had assigned value to these claims.

Court of Appeals Issues Decision

The New York Court of Appeals observed that, in most cases, “follow the settlements” clauses pose little risk of unfairness to reinsurers, as their interests are aligned with those of the cedent in seeking the cheapest settlement possible. However, those interests diverge where allocation issues predominate. In this case, for example, USF&G was responsible for the first $100,000 of each loss, with the reinsurers thereafter assuming responsibility for the next $100,000. If the settlement were allocated entirely to losses amounting to $100,000 or less, the whole cost would be borne by USF&G and the reinsurers would pay nothing; but if it were allocated entirely to losses of $200,000 each, the reinsurers would bear half the cost.

Notwithstanding this conflict, the Court of Appeals declined to find that a cedent’s allocation decisions should not bind reinsurers under a follow the settlements clause. Rather, it agreed with the Second Circuit that the cedent’s allocation determinations are due a certain amount of deference, if only because the court could not think of a good alternative that would not open the door to “long litigation over complex issues that courts may not be well equipped to resolve.” Rather, the court opined that “deference to a cedent's decisions makes for a more orderly and predictable resolution of claims.”

The Court of Appeals emphasized, however, that there were limits to this deference. In particular, a reinsurer is only bound by allocation decisions that are made in good faith and are objectively reasonable. While an allocation is not unreasonable merely because it furthers the self-interest of the cedent (by increasing the reinsured recovery), “the reinsured's allocation must be one that the parties to the settlement of the underlying insurance claims might reasonably have arrived at in arm's length negotiations if the reinsurance did not exist.”

Importantly, the Court of Appeals also ruled that reasonableness does not exist just because the cedent’s reinsurance allocation methodology mirrors the assumptions used in settling with the policyholder. The court archly noted that “in many cases claimants and insureds[,] far from being indifferent, will enthusiastically support insurers' efforts to fund a settlement at reinsurers' expense.”

Summing up the first phase of its opinion, the court declared:

In sum, under a follow the settlements clause like the one we have here, a cedent's allocation of a settlement for reinsurance purposes will be binding on a reinsurer if, but only if, it is a reasonable allocation, and consistency with the allocation used in settling the underlying claim does not by itself establish reasonableness.

In the second phase of its opinion, the court proceeded to consider whether USF&G's allocation decisions in this case were reasonable as a matter of law in ceding this loss to its reinsurers based on the assumptions: (1) that all of the settlement amount was attributable to claims within the limits of USF&G's policies, and none of it to the claims that USF&G acted in bad faith when it refused to defend MacArthur in asbestos litigation; (2) that claims by claimants suffering from lung cancer had a value of $200,000 each, while certain other claims had values of $50,000 or less; and (3) that USF&G's entire payment should be attributed to the policy in force in 1959 – the last full year in which USF&G was Western Asbestos's liability insurer. Could these assumptions “reasonably have been the basis for an arm's length settlement among the asbestos claimants, MacArthur and USF&G if reinsurance were not in the picture?”

1. The Bad Faith Claims

In this case, it was clearly to USF&G’s advantage not to attribute any portion of its settlement to the bad faith claims, as bad faith damages were not a reinsured “loss in connection with each policy.” However, the court found that there was significant evidence that USF&G might have faced a bad faith verdict had it not settled. In particular, the court observed that a jury could have found that USF&G “knew, well before it admitted, that it did indeed provide such coverage, and that its litigation position was an irresponsible attempt to exploit the fact that, with the passage of time, the policies it issued had disappeared.” The court suggested that even though USF&G’s alternative argument that it did not owe coverage by “operation of law” to the corporate successor of its named insured might have been plausible, one reasonable basis for avoiding coverage did not nullify the bad faith denial on the basis of missing policies. The court took note of the fact that the California Superior Court had found questions of fact concerning USF&G’s possible bad faith and had not only denied its motion for summary judgment on these grounds before trial, but had also denied, at the outset of the coverage trial, a motion in limine to exclude some evidence thought to be relevant to those claims.

In light of these facts, the Court of Appeals concluded that “it was therefore arguably not reasonable, at the time the coverage litigation was settled, to say that the bad faith claims had no value.” Further, it found that USF&G might have assigned inflated values to non-meso claims to offset the lack of any valuation for bad faith. The court also took note of the fact that McArthur had included a bad faith dollar demand in earlier negotiations with USF&G and that bad faith claims had been discussed with the Bankruptcy Court in approving a plan of reorganization for McArthur. The court concluded, therefore, that:

In short, we find it impossible to conclude, as a matter of law, that parties bargaining at arm's length, in a situation where reinsurance was absent, could reasonably have given no value to the bad faith claims. This issue must be decided at trial.

2. Valuation of Non-Meso Claims

In its settlement and cession to reinsurers, USF&G had assigned a value of $200,000 to each of the underlying asbestos claims, even though an expert for the underlying claimants had estimated the value of the non-meso claims as only being worth $91,174. Under the circumstances, the Court of Appeals found a second issue of fact with respect to “whether the values assigned to lung cancer, asbestosis, pleural thickening and other cancer claims could reasonably have been agreed on in arm's length bargaining in the absence of reinsurance.”

3. Allocation to the 1959 Policy

On the other hand, the Court of Appeals validated USF&G’s right to allocate the entire settlement to its 1959 policy year, even though pro-ration to the entire insured period would have placed most of the loss within the $100,000 deductible and largely eliminated any cession to reinsurers. The court found that this allocation fairly reflected California’s law with respect to the trigger of coverage, allocation and stacking as regards long-tail claims and that it was undisputed that, if forced to spike its claims in a single policy year, McArthur would have chosen 1959 as it had the highest limits and the broadest number of claimants. The court acknowledged that the California Supreme Court’s adoption of a continuous trigger in Montrose was specific to the wording of “occurrence” forms, whereas these old USF&G policies were written on an “accident” basis; but the New York high court also found that it was not unreasonable for USF&G to conclude that this distinction would not ultimately be persuasive to a California court. The court ruled, therefore, that summary judgment had properly been granted to USF&G on this aspect of the allocation.

The Court of Appeals therefore ordered that the case be remanded for further factual determinations as to whether some portion of the ceded loss should be reduced or revised to reflect an allocation to the insured’s bad faith claims or was distorted due to the internal allocation among different claimants’ non-meso claims.

Mr. Aylward is a partner in the Boston office of Morrison Mahoney LLP. He may be reached at

© 2013 Morrison Mahoney LLP. All rights reserved.

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