Continental Cas. Co. v. Stronghold: Did the Court Correctly Apply New York Law?
Welcome to Part III.B of our multi-part reinsurance statute of limitations feature. (Links to previous installments are listed at the end of this post.)
If you’ve been following this series, then you already know that under New York law, the six-year statute of limitations begins to run on a reinsurance claim once it is settled and the cedent has the right to demand payment. This is the general rule that applies to other contracts of indemnity, including insurance contracts, but it is subject to an exception: when an insurance or reinsurance contract expressly conditions the reinsurer’s duty to perform its obligations on the presentation of a claim, the statute of limitations generally does not begin to run any earlier than the date the cedent presents the claim.
In Part III.A we summarized the facts and holding of the United States Court of Appeals for the Second Circuit’s decision in Continental Cas. Co. v. Stronghold Ins. Co., 77 F.3d 16 (2d Cir. 1996), which concluded that a garden-variety notice of loss provision in a reinsurance contact was an express condition to the extent that it required notice of paid loss, which the Court seemed to think was more important to reinsurers than prompt notice of the original insureds’ reported losses losses and their development over time. Stronghold essentially created an express condition out of whole cloth by placing a strained interpretation on a timely notice provision identical in all material respects to one that New York’s highest court, in North River Ins. Co. v. Unigard Sec. Ins. Co., 79 N.Y.2d 576 (1992) (“Unigard I”), had held was not an express condition. And it relied on that interpretation to justify delaying the accrual of the statute of limitations on claims that were settled more than six-years before the Cedent commenced its action against the Reinsurers.
This Part III.B explains why we believe Stronghold misconstrued the notice provision, misapprehended its purpose and misapplied New York law on express conditions.
Stronghold Misinterpreted the Notice-of-Loss Provision and Misapprehended its Purpose
The Second Circuit interpreted the notice provision—which required the Cedent to notify the London Reinsurers of “loss, under” the policies “as soon as practicable”—as requiring the Cedent to report only, as the Court put it, “actual loss”—or in more accurate insurance or reinsurance parlance, “paid loss.” As used in the notice provision the term “loss” was unqualified and referred to “loss under” the reinsured policies. (emphasis added)
“Loss,” as used in the insurance and reinsurance industry is a broad one that does not turn on whether the loss was paid by an insurer or its insured. For example, one definition of “loss” is “(1) The basis of a claim for damages under the terms of a policy. (2) Loss of assets resulting from a pure risk. Broadly categorized, the types of losses of concern to risk managers include personnel loss, property loss, time element loss, and legal liability loss.” International Risk Management Institute, Inc. (IRMI) website, Glossary of Insurance and Risk Management Terms, definition of “loss,” here.
That definition is as workable as the next and comports with New York law. New York’s Insurance Law defines “insurance contract” to “mean any agreement or other transaction whereby one party, the ‘insurer’, is obligated to confer benefit of pecuniary value upon another party, the ‘insured’ or ‘beneficiary’, dependent upon the happening of a fortuitous event in which the insured or beneficiary has, or is expected to have at the time of such happening, a material interest which will be adversely affected by the happening of such event.” N.Y. Ins. L. § 1101(a)(1) (To access New York’s Consolidated Laws online, including the New York Insurance Law, go here). “Fortuitous event” is defined as “any occurrence or failure to occur which is, or is assumed by the parties to be, to a substantial extent beyond the control of either party.” N.Y. Ins. L. § 1101(a)(2).
The “loss” under an insurance contract is thus the adverse effect on the insured’s “material interest” in the occurrence or nonoccurrence of the “fortuitous event” that triggers the insurer’s obligation “to confer benefit of pecuniary value” on the insured. It is the “loss” to the insured that is the subject of the cedent’s policy, not the cedent’s payment of its share of that loss to the insured or the loss of income or assets the cedent may suffer as a result. Thus, for example, under a property insurance policy, the loss would be the damage to the insured property caused by the happening of a fortuitous event, e.g., the insured’s property catching fire. That loss occurs when the fire takes place. Cf. Steen v. Niagara Fire Ins. Co., 89 N.Y. 315, 325 (1882) (generally, the statute of limitations “begin[s] to run upon a contract of indemnity from the time at which the plaintiff is actually damaged”). No doubt the insured would agree, and would vehemently disagree with the suggestion that her loss was, to use Stronghold’s terminology, “potential” once the fire destroyed her property and became “actual” only when the insurer paid its share of the loss.
That loss under an insurance or reinsurance contract is understood to mean the original insured’s loss is evidenced by the various terms insurance and reinsurance industry participants commonly use to describe different types of loss or losses. For example, “outstanding loss” is reported loss that has not been adjusted and settled. “Paid loss” is loss that has been paid by the insurer or reinsurer. “Incurred loss” means outstanding and paid loss (and sometimes also includes incurred but not reported loss). Incurred but not reported loss (“IBNR”) is loss that has occurred but has not yet been reported to the insurer, and thus must be estimated using one or more actuarial methods, which take into account, among other things, unpaid reported loss.
Rather than interpret the term to mean what insurers and reinsurers ordinarily understand it to mean, the Court conflated the question of what the term “loss” means with the analytically distinct question of when a contractual obligation to indemnify another for loss matures. Insurance and reinsurance contracts are, indeed, contracts of indemnity, but not all contracts of indemnity are insurance or reinsurance contracts. Insurance and reinsurance contracts are unique in that they transfer insurance risk from one entity to another, and if they transfer sufficient insurance risk, then they may, for accounting and regulatory purposes, be treated as bona fide insurance or reinsurance contracts.
That accounting and regulatory treatment is critical to both reinsurers and insurers. Insurers and reinsurers must meet certain minimum capital and surplus requirements, which determine whether they may continue to write new business. For purposes of meeting these requirements, and those of GAAP and statutory insurance and reinsurance accounting (“SAP”), outward (i.e., ceded) reinsurance is an asset that offsets corresponding inward (i.e., assumed) insurance and reinsurance claim liabilities and unearned premium liability, provided it qualifies for reinsurance accounting treatment and satisfies other requirements. That, in turn, affects regulatory, internal, investor and creditor evaluation of insurer and reinsurer financial performance, including solvency.
The risk transferred by reinsurance is not the risk that cedents will pay claims too quickly or pay more than they should; were that the case, then the date of loss for a reinsurance claim would be the date the cedent paid it, which would cause an accounting mismatch between reporting periods for premium and losses and a concomitant distortion of financial performance, not only in general, but as respects particular books of business (something that is critical for underwriting reinsurance). The risk transferred is a portion of the risk of loss under the original policies, which means that the date of loss is the date the insured’s loss occurs, that is, the date the insured’s interests are adversely affected by a fortuitous event covered by the policy.
The financial performance of an insurer’s or reinsurer’s book of business or any part of it, and the overall financial performance of the insurer or reinsurer, is determined in large part by the tracking and reporting of the losses under the original policies. The development of those losses over time is reflected in the loss reserves insurers and reinsurers are required to post to estimate the amount of reported and unreported losses that the insurer or reinsurer will, at some point in the future, likely have to pay. In Delta Holdings, Inc. v. National Distillers and Chem. Corp., 945 F.2d 1226, 1229-33 (2d Cir. 1991), Circuit Judge Ralph K. Winter (who was not a member of the Stronghold panel) did an excellent job of clearly explaining the basics of how and why insurers and reinsurers post reserves for reported and unreported losses.
The purpose of notice provisions in reinsurance contracts, and of the reasons that loss reporting, an integral part of any reinsurance relationship, is part and parcel of a cedent’s duty of good faith, was discussed in the Second Circuit’s Unigard opinion (“Unigard II”), which the Court issued roughly four-years before Stronghold, and several months after the New York Court of Appeals answered in Unigard I the question the question the Second Circuit had certified to it.
Unigard II was authored by Judge Winter who had decided the Delta Holdings case discussing loss reserving. Judge Winter explained that reinsurance-contract notice provisions “are designed to: (i) apprise the reinsurer of potential liabilities to enable it to set reserves; (ii) enable the reinsurer to associate in the defense and control of underlying claims; and (iii) assist the reinsurer in determining whether and at what price to renew reinsurance coverage.” See Unigard Sec. Ins. Co. v. North River Ins. Co., 4 F.3d 1049, 1065 (1993).
But a notice of loss provision could not serve any of those purposes if, as Stronghold suggested, it required the Cedent to report only paid loss, for that would not serve any of the three purposes discussed in Unigard II. Stronghold’s interpretation of the notice of loss provision as something that simply amounted to a claim presentation requirement was thus far off the mark, and its corresponding conclusion that the notice provision was materially different than the notice provision in Unigard, were both based on false premises. And since the notice provision in Unigard was not an express condition under New York law, so too was not the notice provision in Stronghold.
Stronghold Erred by Concluding that the Notice of Loss Provision was an Express Condition
Even assuming that the Second Circuit correctly concluded that the Stronghold notice provision required only the reporting of paid loss and the demanding of payment for it, its conclusion that the notice condition was an express condition would fare no better. The notice clause in Stonghold simply imposes an obligation on the cedent to provide prompt notice of loss and nothing in it even remotely suggests that any of the London Reinsurers’ obligations were conditioned on the cedent providing the required notice. It is bereft of any of the “unmistakable language of condition,” e.g., “if,” “upon,” “in the event,” “provided,” or like terms. See, e.g., Oppenheimer & Co. v. Oppenheim, Appel, Dixon & Co., 86 N.Y.2d 685, 691 (1995).
The Second Circuit based its conclusion about the alleged express-condition status of the notice provision using the distinction Unigard drew between the relative importance of late notice provisions in the direct insurance versus reinsurance contexts. By remarking that “[i]t would distort Unigard to read it as meaning that the reinsurers had a duty to indemnify [the Cedent] even before [the Cedent] gave notice of the payments it had made to the hospitals[,]” the Court suggested that the cedent’s demand for payment is of greater importance to the reinsurer than the cedent’s notice of its insured’s loss. That suggestion seems doubtful at best, given how important loss reporting is to the insurance and reinsurance business. But even if valid, it says nothing about whether the notice provision was an express condition under New York law.
As discussed in Part II (here), express-condition status begins and ends with a determination of whether the provision unambiguously conditions performance on the occurrence of the condition. Because clearly expressed intent controls, a judicial evaluation of the relative importance of the provision: (a) in one versus another type of contract; or (b) as applied to different types of factual scenarios presented under the same contract, is simply beside the point.
In basing its express condition finding on an apparent misunderstanding of the relative importance of notice provisions in the paid versus outstanding loss context, Stronghold used the analytical framework that Unigard I employed to answer a different question: whether a limited, direct-insurance-notice-provision exception to the rule that express conditions must be clearly stated should be extended to notice provisions in reinsurance contracts. That issue was relevant in Unigard I only because the Court concluded that the notice provision before it was not an express condition. Stronghold strayed from the Unigard I interpretive path by using “relative importance” considerations as a substitute for the plain-meaning contract interpretation rule that New York’s highest court used to determine whether the notice provision in Unigard I was an express condition or simply a promise.
In defense of the Second Circuit, it may be that the question it answered was not whether the notice provision was an express condition, but whether it was an implied or constructive condition. The direct-insurance-notice-provision exception referred to in Unigard I is an example of an implied or constructive condition, and something akin to the “relative importance” analysis Unigard I used to determine whether implied or-constructive condition status should be conferred on reinsurance notice provisions would be relevant to whether implied or constructive condition status should be conferred on a reinsurance notice provision that could be interpreted to require a cedent to demand payment of a reinsurance claim.
Nevertheless, construing Stronghold as having found that the notice of loss provision was an implied or constructive condition would not justify the Court’s conclusion. In Part III.C, we’ll explain why.
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Tags: .Accounting, Accrual of Statute of Limitations, Circuit Judge Ralph K. Winter, Condition, Condition Precedent, Constructive Conditions, Continental Cas. Co. v. Stronghold Ins. Co., Contract of Indemnity, Definition of Insurance, Definition of Insurance Contract, Definition of Loss, Delta Holdings v. National Distillers, Due and Payable Rule, Express Condition, Fortuitous Event, Hahn Automotive Warehouse v. American Zurich Ins. Co., IBNR, Implied Conditions, Incurred but not Reported Loss, Incurred Loss, Insurance and Reinsurance Regulation, IRMI Glossary, Judge Winter, Late Notice, Loss, Loss Reporting, Loss Reserves, Minimum Capital and Surplus, N.Y. Ins. Law § 1101(a), New York Court of Appeals Unigard, Notice Clause, Notice of Loss, Notice Provision, Oppenheimer & Co. v. Oppenheim, Outstanding Loss, Paid Loss, Purpose of Notice of Loss Provision, Regulatory Requirements, risk transfer, Second Circuit Unigard, Statute of Limitations, Time Bar, Timely Notice, Unearned Premium, Unigard Sec. Ins. Co. v. North River Ins. Co., United States Court of Appeals for the Second Circuit, Unmistakable Language of Condition, Unpaid Reported Losses