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Appellate Court Applies Follow-the-Fortunes to Post-Settlement Reinsurance Allocation

Reinsurance Alert | February 8, 2012
By: Michael Olsan and Timothy Stapleton

A recent decision from a New York State appellate court concluded the latest chapter in a long running reinsurance dispute over the asbestos liabilities of Western MacArthur Company. The opinion in USF & G v. American Reinsurance Co., --- N.Y.S.2d, ---, 2012 WL 178229 (N.Y. App. Div. Jan. 24, 2012), addresses several complex issues relating to USF & G’s reinsurance presentation, including allocation, bad faith, treaty modification, asbestos bankruptcy, and collateral estoppel. The court ultimately concluded that the reinsurers were bound to follow USF & G’s fortunes, and bear their portion of the substantial settlement amount.

The case concerned the liabilities of Western Asbestos Company, which dissolved in 1967. Its business was taken over by Western MacArthur Company (MacArthur), which became the target for lawsuits based on asbestos-related injuries caused by products manufactured by Western Asbestos Co. In 1993, MacArthur sued USF & G, seeking insurance coverage under the policies that USF & G had issued to Western Asbestos Co. The court found that MacArthur was not a successor in interest to the Western Asbestos policies, and ruled in favor of USF & G. Undaunted, MacArthur “resurrected” Western Asbestos, and located a former officer of the defunct company, who agreed to assign Western Asbestos’ rights to MacArthur. The litigation resumed with Western Asbestos joined as a co-plaintiff. 

A settlement was reached that required MacArthur to declare bankruptcy. As part of the bankruptcy proceedings, MacArthur sought a channeling injunction under 11 U.S.C. § 524(g). USF & G and one other insurer contributed $975 million to a trust established for the compensation of existing and future asbestos claimants. In order to qualify for 524(g) protection, MacArthur also was required to contribute something of value. The bankruptcy court found that MacArthur had done so by releasing “business loss claims,” including “potential bad faith claims” arising from USF & G’s longstanding denial of coverage. On that basis, the bankruptcy court approved the settlement and entered the injunction.

USF & G then presented the settlement to its reinsurers—American Reinsurance Company and a reinsurance pool known as the Excess Casualty Reinsurance Association (ECRA). The reinsurers rejected the billings and sought a declaration that there was no reinsurance coverage for the claims. The trial court entered summary judgment in favor of USF & G. On appeal, the reinsurers raised several objections to the billing, including that USF & G’s decision to allocate the entire settlement to a single policy year was improper, that USF & G’s presentation failed to account for a significant modification to its reinsurance retention, and that at least some amount of USF & G’s settlement reflected liability for its own bad faith and was not reinsured.

In making its allocation, USF & G, in consultation with MacArthur and counsel for the underlying claimants, had allocated the entire settlement to the 1959 policy year. This allocation had the effect of maximizing the available insurance. The 1959 policy year had the highest per-person limits ($200,000) and was the only year that covered all potential claimants. USF & G likewise made its reinsurance presentation entirely under the 1959 treaty year. For purposes of its reinsurance billing, USF & G treated each claimant’s injury as a separate occurrence and applied a single retention of $100,000 (as required by the 1959 treaty) to each one. For past injuries, USF & G’s liability was capped at $200,000 per claimant, and only the portion of each injury that exceeded the retention was billed. Only two types of anticipated future claims were valued above $100,000—lung cancer and mesothelioma. To calculate the amount of these claims for inclusion in the reinsurance bill, USF & G took the number of claimants with these injuries, multiplied it by $200,000 and divided that number in half (thus accounting for the $100,000 per claimant retention). The reinsurers objected to this allocation, arguing, inter alia, that the losses should have been spread across multiple policies and treaty years.

The court upheld USF & G’s allocation, finding that follow-the-fortunes precluded the reinsurers from second guessing it. The court noted that requiring USF & G to spread each loss across multiple treaty years, thereby triggering multiple retentions, would effectively wipe out its reinsurance cover. 

The reinsurers also argued that summary judgment in favor of USF & G was inappropriate on the grounds that there was an issue regarding whether the settlement included amounts for USF & G’s bad faith liability, and, therefore, not covered by reinsurance. MacArthur had alleged bad faith in the underlying litigation, but the settlement agreement stipulated that the settlement amount was calculated only to address the cost of compensating asbestos claimants and to reimburse MacArthur for its litigation costs. However, this stipulation was contrary to the findings of the bankruptcy court, which found that the value MacArthur contributed to the trust was its release of bad faith claims against USF & G. The bankruptcy court explicitly stated that it was not deciding the merits of the bad faith claims nor assigning a definite value to them. However, it did conclude that the value of the bad faith claims was at least in excess of MacArthur’s $17 million net liquidation value. 

The reinsurers argued that USF & G was collaterally estopped from denying that bad faith liability comprised some portion of the settlement. The New York appellate court rejected this argument, stating that the issue “only arose tangentially” and was never “actually litigated” by the parties before the bankruptcy court. On this point, a single judge dissented from the opinion, arguing strenuously that the bankruptcy court’s findings at least raised a triable issue of fact.

Finally, the reinsurers argued that a 1981 agreement between themselves and USF & G raised the applicable annual retention from $100,000 to $3 million. The treaty program was in place from 1945 to 1980 with different retentions and limits applying to different periods. The parties had agreed to raise the retention amount on the “old First Excess of Loss reinsurance layer” for any claim reported on or after July 1, 1981. The parties adduced conflicting evidence as to whether the modification applied to all treaty years or only to those incepting in or after 1962, the first year in which USF & G’s first and second layers of reinsurance were split into separate treaties. Although credible evidence was submitted by both sides, the appellate court,  persuaded by the fact that USF & G’s reinsurance would effectively be eliminated if the retention in 1959 was $3 million, applied the lower $100,000 retention. 

Based on the foregoing, the court upheld the reinsurance presentation and affirmed an award in favor of USF & G  for $420,425,536. 

For more information regarding this alert, please contact Michael Olsan (215.864.6278/olsanm@whiteandwilliams.com) or Tim Stapleton (215.864.6342/stapletont@whiteandwilliams.com).

This correspondence should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult a lawyer concerning your own situation and legal questions.
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