The word "reasonable" and its derivations appear in many reinsurance contracts. Sometimes, the word is used to inform the ceding insurer how it should act in the underwriting process. Other times, it is used in the context of claim reporting or in providing temporal criteria as to when something should happen. Rarely, however, is "reasonable" or "reasonableness" defined in a reinsurance contract. Is this another case of "We know it when we see it?"
How "Reasonable" Is Used in a Reinsurance Contract
"Reasonable" shows up in various sections of reinsurance contracts. For example, the word "reasonable" often shows up in the inspection clause.
The
Reinsured shall,
subject to
the protections extended by ARTICLE XIX (Confidentiality), place at the disposal of
the Reinsurer at all reasonable times during
regular business hours, and the Reinsurer shall have the right to inspect (at the
office of the Reinsured) or the Reinsured's authorized representative, through the
Reinsurer's authorized representatives, all books, records and papers of the
Reinsured ("Records") in connection with any reinsurance hereunder, or claims in
connection herewith.
It
may appear in the confidentiality
clause, allowing disclosure to specified third parties "with a reasonable need to know" the information. It also
appears in arbitration or dispute resolution clauses ("reasonable attorney fees" or "[t]he arbitration panel will render its award
with a view towards effectuating the general purpose of this Agreement in a reasonable manner") and in salvage and
subrogation clauses ("if economically reasonable"). You can find "reasonable" in the reports clause ("reasonable evidence of the amounts due) and in
the credit for reinsurance provision
("the
Reinsurer will take any other reasonable steps
that may be required for the Company to take full credit on its statutory financial
statements").
A
more important usage of "reasonable"
appears in some property reinsurance contracts, such as in the event clause giving
the ceding insurer the ability to choose what is an "event" for reinsurance purposes
("The Company shall use its reasonable discretion
in determining what constitutes an Event."). Additionally, in the
claims/follow-the-settlements clause, the ceding insurer may be given the right to
determine if the reinsurer's payment is in default ("in the reasonable and good faith judgment of the Company
should have been settled by the Reinsurer").
How Is Reasonable Used by the Courts in the Reinsurance Context?
"Reasonable" shows up in quite a few judicial opinions concerning
reinsurance issues. For example, where the ceding insurer is allocating multiple
losses to its policies and then its reinsurance contracts, whether the ceding
insurer acted reasonably in its allocation methodology is an issue discussed by the
courts. In Utica
Mut. Ins. Co. v. Clearwater
Ins. Co., No. 6-13-cv-1178 (GLS/TWD) (N.D.N.Y. Jan. 20,
2016), the court held that under the follow-the-settlements doctrine, the court must
determine if the ceding insurer settled the underlying claims in good faith, which
essentially meant "reasonable." The court found the settlements reasonable because
sufficient evidence was submitted to support the ceding insurer's position.
Utica Mutual follows the Second Circuit Court of Appeals' opinion in Travelers Cas. & Sur. Co. v. Gerling Glob. Reinsurance Corp. of Am.,
419 F.3d 181 (2d Cir. 2005), in which the appeals court held that it would not "authorize an inquiry into the propriety of a cedent's method of allocating a settlement if the settlement itself was in good faith, reasonable, and within the terms of the policies" (citing N. River Ins. Co. v. ACE Am. Reins. Co.,
361 F.3d 134 [2d Cir. 2004]).
In Travelers, the Second Circuit relied on fact-specific details to determine reasonability. For example, it found that the ceding insurer accepted the claims from the insured on a single-occurrence basis, and the insured did not object until its product liability coverage was exhausted, so it was reasonable for the ceding insurer to allocate the losses on a single-occurrence basis. The court also found that the ceding insurer's allocation was consistent with prevailing case law. As usual, facts matter and provide the basis for determining reasonability.
What Does Reasonable Mean?
The Law Dictionary, powered by Black's Law Dictionary, defines "reasonable" as "[a]greeable to reason; just; proper. Ordinary or usual." Cornell's Legal Information Institute defines "reasonable" as "[j]ust, rational, appropriate, ordinary, or usual in the circumstances." The Cambridge Dictionary defines "reasonable" as "based on or using good judgment and therefore fair and practical."
Why is the definition of "reasonable" relevant? In most jurisdictions, courts construe undefined terms in contracts, including reinsurance contracts, based on their ordinary meaning.
Reasonable or reasonableness has been viewed by courts as an objective standard. Many courts have held that what is reasonable is a factual question for the jury. The objective standard is most evident in United States Fid. & Guar. Co. v. Am. Re-Ins. Co.,
2013 NY Slip Op 784, 20 N.Y.3d 407, 962 N.Y.S.2d 566, 985 N.E.2d 876, where the New York Court of Appeals (New York's high court) used the phrase "objective reasonableness" in determining whether a ceding insurer's allocation decisions were valid.
But to say that a cedent's allocation decisions are entitled to deference is not to say that they are immune from scrutiny. Recognizing that the cedent's and the reinsurer's interests will often conflict, courts generally hold that a reinsurer is bound only by a cedent's "good faith" decisions. While that expression might seem to suggest that the cedent's subjective intentions are critical, most decisions also consider reasonableness or some other objective element. [Citations omitted.]
* * *
In our view, objective reasonableness should ordinarily determine the validity of an allocation. Reasonableness does not imply disregard of a cedent's own interests. Cedents are not the fiduciaries of reinsurers, and are not required to put the interests of reinsurers ahead of their own.
* * *
We mean by "reasonable" essentially what we take the Third Circuit to mean by "legitimate": 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.
Source:
United States Fid. & Guar. Co.
In another example, a New York intermediate appellate court articulated why a ceding insurer's allocation was unreasonable as a matter of law based on the facts of the case.
Defendant's postsettlement allocation was unreasonable because the one-occurrence-per-site allocation of the Windsor Locks site directly contradicts the District Court ruling as to the number of occurrences at that site. Moreover, the reinsurance allocation is internally inconsistent, as reflected by defendant's highly selective use of the District Court ruling.
* * *
For defendant to assert aggressively the maximum number of occurrences at each site to minimize its liability to its insured in the UTC litigation, and then completely change its position in allocating its loss to plaintiff under the reinsurance certificates, is neither reasonable nor reflective of good faith. It is disingenuous.
There are many examples of what courts have found reasonable or unreasonable in various contexts. As you can see from the examples above, in the reinsurance context, what is "reasonable" is fact-specific and fact-dependent. In court, it is often left to a jury to determine what is reasonable.
Conclusion
Because courts construe reinsurance contracts the same way they construe any commercial contract, courts will apply the ordinary meaning of undefined terms like "reasonable." What is reasonable is often in the eye of the beholder. Importantly, as in any dispute, what is reasonable will depend on the specific facts and circumstances of the case. If the parties mean something more than the ordinary meaning of "reasonable," it is incumbent on them to define the term specifically to avoid any ambiguity.
Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.
The word "reasonable" and its derivations appear in many reinsurance contracts. Sometimes, the word is used to inform the ceding insurer how it should act in the underwriting process. Other times, it is used in the context of claim reporting or in providing temporal criteria as to when something should happen. Rarely, however, is "reasonable" or "reasonableness" defined in a reinsurance contract. Is this another case of "We know it when we see it?"
How "Reasonable" Is Used in a Reinsurance Contract
"Reasonable" shows up in various sections of reinsurance contracts. For example, the word "reasonable" often shows up in the inspection clause.
It may appear in the confidentiality clause, allowing disclosure to specified third parties "with a reasonable need to know" the information. It also appears in arbitration or dispute resolution clauses ("reasonable attorney fees" or "[t]he arbitration panel will render its award with a view towards effectuating the general purpose of this Agreement in a reasonable manner") and in salvage and subrogation clauses ("if economically reasonable"). You can find "reasonable" in the reports clause ("reasonable evidence of the amounts due) and in the credit for reinsurance provision ("the Reinsurer will take any other reasonable steps that may be required for the Company to take full credit on its statutory financial statements").
A more important usage of "reasonable" appears in some property reinsurance contracts, such as in the event clause giving the ceding insurer the ability to choose what is an "event" for reinsurance purposes ("The Company shall use its reasonable discretion in determining what constitutes an Event."). Additionally, in the claims/follow-the-settlements clause, the ceding insurer may be given the right to determine if the reinsurer's payment is in default ("in the reasonable and good faith judgment of the Company should have been settled by the Reinsurer").
How Is Reasonable Used by the Courts in the Reinsurance Context?
"Reasonable" shows up in quite a few judicial opinions concerning reinsurance issues. For example, where the ceding insurer is allocating multiple losses to its policies and then its reinsurance contracts, whether the ceding insurer acted reasonably in its allocation methodology is an issue discussed by the courts. In Utica Mut. Ins. Co. v. Clearwater Ins. Co., No. 6-13-cv-1178 (GLS/TWD) (N.D.N.Y. Jan. 20, 2016), the court held that under the follow-the-settlements doctrine, the court must determine if the ceding insurer settled the underlying claims in good faith, which essentially meant "reasonable." The court found the settlements reasonable because sufficient evidence was submitted to support the ceding insurer's position.
Utica Mutual follows the Second Circuit Court of Appeals' opinion in Travelers Cas. & Sur. Co. v. Gerling Glob. Reinsurance Corp. of Am., 419 F.3d 181 (2d Cir. 2005), in which the appeals court held that it would not "authorize an inquiry into the propriety of a cedent's method of allocating a settlement if the settlement itself was in good faith, reasonable, and within the terms of the policies" (citing N. River Ins. Co. v. ACE Am. Reins. Co., 361 F.3d 134 [2d Cir. 2004]).
In Travelers, the Second Circuit relied on fact-specific details to determine reasonability. For example, it found that the ceding insurer accepted the claims from the insured on a single-occurrence basis, and the insured did not object until its product liability coverage was exhausted, so it was reasonable for the ceding insurer to allocate the losses on a single-occurrence basis. The court also found that the ceding insurer's allocation was consistent with prevailing case law. As usual, facts matter and provide the basis for determining reasonability.
What Does Reasonable Mean?
The Law Dictionary, powered by Black's Law Dictionary, defines "reasonable" as "[a]greeable to reason; just; proper. Ordinary or usual." Cornell's Legal Information Institute defines "reasonable" as "[j]ust, rational, appropriate, ordinary, or usual in the circumstances." The Cambridge Dictionary defines "reasonable" as "based on or using good judgment and therefore fair and practical."
Why is the definition of "reasonable" relevant? In most jurisdictions, courts construe undefined terms in contracts, including reinsurance contracts, based on their ordinary meaning.
Reasonable or reasonableness has been viewed by courts as an objective standard. Many courts have held that what is reasonable is a factual question for the jury. The objective standard is most evident in United States Fid. & Guar. Co. v. Am. Re-Ins. Co., 2013 NY Slip Op 784, 20 N.Y.3d 407, 962 N.Y.S.2d 566, 985 N.E.2d 876, where the New York Court of Appeals (New York's high court) used the phrase "objective reasonableness" in determining whether a ceding insurer's allocation decisions were valid.
In another example, a New York intermediate appellate court articulated why a ceding insurer's allocation was unreasonable as a matter of law based on the facts of the case.
There are many examples of what courts have found reasonable or unreasonable in various contexts. As you can see from the examples above, in the reinsurance context, what is "reasonable" is fact-specific and fact-dependent. In court, it is often left to a jury to determine what is reasonable.
Conclusion
Because courts construe reinsurance contracts the same way they construe any commercial contract, courts will apply the ordinary meaning of undefined terms like "reasonable." What is reasonable is often in the eye of the beholder. Importantly, as in any dispute, what is reasonable will depend on the specific facts and circumstances of the case. If the parties mean something more than the ordinary meaning of "reasonable," it is incumbent on them to define the term specifically to avoid any ambiguity.
Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.