Reinsurance and follow the settlements clauses: What you need to know


By Jacob Foster

The Ontario Superior Court of Justice (Commercial List) recently released a decision regarding a “follow the settlements” clause in a reinsurance agreement. While follow the settlements clauses are common in reinsurance, this was the first time that a Canadian court has addressed the interpretation and application of such clauses.

Follow the settlements clauses are one of several types of loss settlement clauses that are used in reinsurance agreements. Reinsurance agreements are agreements between insurers where one insurer (the reinsured) transfers some part of a risk insured to another insurer (the reinsurer). Generally, the purpose of loss settlement clauses is to avoid the expense and burden on a reinsured of proving that a settled claim under the reinsured policy was actually covered under that policy. In the absence of a loss settlement clause, the reinsured must prove that they were liable for the underlying claim, and the reinsurer is entitled to raise any defence that would have been available to the reinsured, as well as any defence available under the reinsurance policy.

Although wordings vary, there are two general types of follow the settlements clauses: unqualified and qualified. A qualified or “double proviso” follow the settlements clause places a heavier burden on the reinsured to prove that the settled claim was covered by the underlying policy.

In Wiener Städtische Versicherung AG v Infrassure Ltd., 2023 ONSC 5256, the plaintiff (“VIG”) was the fronting reinsurer and had accepted and paid the claim of the reinsured, Zurich, which had entered into a settlement with its insured. Infrassure, the defendant, had entered into a retrocession agreement with VIG whereby, if the loss or settlement exceeded a threshold amount, Infrassure took on most of VIG’s risk under the reinsurance policy.

The loss settlement clause in the retrocession agreement provided as follows:

This reinsurance will follow the terms and conditions of the Original polic(ies) in all respects and will follow the settlements of the Original policy(ies), in each case save insofar as any express term on this reinsurance provides otherwise.  [Bolded emphasis added, underlined emphasis in Wiener]

The “Original policy” was the policy issued by Zurich to its insured. There was no term in the retrocession agreement that set conditions on when Infrassure could avoid following Zurich’s settlement with its insured. Therefore, the loss settlement clause was unqualified and VIG argued that there was no ability of Infrassure to challenge VIG’s settlement with Zurich. The Court rejected that argument, citing Assicurazioni Generali SPA v CGU International Insurance Plc, [2004] EWCA Civ 429, which contained a similar unqualified follow the settlements clause. The Court held that Infrassure was required to follow the settlements under the terms of that clause, provided that:

(i) the claim settled by the insurer must fall within coverage “as a matter of law”; and,

(ii) the settlement must have been entered into in good faith and through proper and businesslike steps.

The Court in Wiener held that a claim falls within coverage as a matter of law if it is covered or is “arguably” covered by the original policy. The settling insurer does not have to prove that if the insured’s claim was decided by a court, the insured would have succeeded.

In determining whether an insurer took proper and businesslike steps in entering into a settlement, the court will look to the steps taken by the insurer to consider and evaluate the claim and the insured’s losses before making a settlement. The analysis is contextual and depends on the facts of the case.

The underlying claim in Wiener was for first party coverage for business interruption losses incurred by a smelting operation resulting from damage to a furnace. There were two potentially applicable exclusion clauses in the underlying policy. The Court held, based on the evidence, that there was uncertainty as to the cause of the loss and where it occurred, and that therefore the exception to the first exclusion arguably applied. With respect to the second exclusion, the Court held that it arguably did not apply. Therefore, the Court held that the underlying claim fell within coverage “as a matter of law”.

The steps taken by Zurich and the steering group (of which Infrassure was a member) to consider and evaluate the claim included the following:

(i) investigating and analyzing the insured’s business interruption claim over a period of over three and a half years, through an experienced adjuster;

(ii) retaining numerous forensic and technical experts to ascertain the basis for the insured’s claim and determine whether its business interruption losses could be substantiated;

(iii) seeking legal counsel on the terms of the policy and whether any exclusions applied;

(iv) arranging for their experts to participate in “hot tub sessions” with the insured’s experts;

(v) responding as new issues arose and investigating further, including by retaining experts;

(vi) having their experts present their forensic calculations to the reinsurers, before the settlement negotiations were scheduled to begin;

(vii) assessing and recalculating the insured’s losses prior to and throughout the settlement negotiations.

The Court found that Zurich took proper and businesslike steps in entering into the settlement. The Court held that the proper question was whether Zurich took proper and businesslike steps, not whether VIG did. However, in the event that VIG was also required to take proper and businesslike steps in paying the reinsurance claim, the Court found that it had.

However, the Court in Wiesel appears to have misstated the first part of the test it adopted from Assicurazioni. The English Court of Appeal in Assicurazioni held as follows:

[17]        The proviso to which Evans J refers is that reinsurers are bound by reasonable compromises on liability and quantum between the insurers and their assured under the terms of the original policy… No investigation as to whether [the claim] was arguably within the terms of the original policy is required

[18]        … insurers do not have to show that the claim they have settled in fact fell within the risks covered by the reinsurance, but that the claim which they recognized did or arguably did… [The test requires the insurer] to show that the basis on which he settled [the claim] was one which fell within the terms of the reinsurance as a matter of law or arguably did so. This and the need for the insurer to have acted honestly and taken all reasonable and proper steps in settling the claim provide adequate protection for the reinsurer.

[Emphasis added]

The lower court in Assicurazioni explained the distinction and how to apply the test in practice, which the Court of Appeal agreed with. However, the Court in Wiener does not appear to have recognized that distinction. Instead, the Court appears to have examined whether it was arguable that the underlying claim in fact fell within the original policy, as opposed to whether the claim as recognized arguably fell within the retrocession agreement.

Interestingly, unlike the unqualified follow the settlements clause in the retrocession agreement, the clause in the reinsurance agreement was a double proviso clause:

5.2 – Subject to the exceptions in clauses 2 and 3, all loss settlements made by Zurich, provided they are within the terms, conditions and limits of the Original Policies, and within the terms, conditions and limits of this Agreement, shall be binding on [VIG]. [Emphasis added]

Since the loss settlements clause in the retrocession agreement created a duty to follow the settlements under the original policy (ie. Zurich’s settlement with the insured, not VIG’s payment to Zurich under the reinsurance), subject to the above noted test, the Court did not address the effect of the double proviso clause in the reinsurance agreement.

Given that most reinsurance disputes are resolved through arbitration, it may be quite some time before a Canadian court has another opportunity to address the interpretation and application of loss settlements clauses. However, Wiener may influence how arbitrators apply unqualified follow the settlements clauses in reinsurance disputes governed by Canadian law. Further, as there are relatively few cases on the subject, Wiener might be cited by a foreign court.