Opinion ID: 697655
Heading Depth: 2
Heading Rank: 2

Heading: Performance of the Treaties

Text: 15 Once the Treaties were fully placed for the 1980 treaty year, NERCO began retroceding to the plaintiffs portions of the risks it was reinsuring. Central to the plaintiffs' present complaint, and to the district court's finding of liability, are the source and nature of NERCO's business as ceded to them. In the first year, over 95 percent of the business so ceded was system business. However, few, if any, of the risks reinsured were from Hartford companies other than First State. In the ensuing three years, the proportion of system business declined in favor of non-system business to less than 50 percent. There was evidence that defendants had hoped that system business would grow and that NERCO and its retrocessionaires would obtain more reinsurance business directly from the other Hartford companies, in addition to First State, but that these hopes were not realized. 16 The proportion of non-system business rose steadily after the first year, but the non-system business was of a kind which plaintiffs contend, and the district court found, was different from that represented in the Placing Information. The court construed the Placing Information as representing that Graham Watson would produce 'non-system' reinsurance business directly from primary insurance companies without the use of intermediaries. In support of the court's construction, plaintiffs point to representations in the Placing Information that Graham Watson did not intend to seek reinsurance on a wholesale basis from all and sundry but rather to develop a close working relationship with selected primary companies. The Placing Information stated that non-brokered business placed significantly with the direct professional reinsurance market characterized over 80 percent of United States facultative reinsurance. The Placing Information also stated that Graham Watson was charged with the responsibility of penetrating this business. Notwithstanding these announced intentions in the Placing Information, most of defendants' growing non-system business after the end of 1980 was, in fact, obtained from intermediaries--to wit, brokers and Managing General Agents (MGAs). MGAs serve as agents of primary insurance carriers with authority to underwrite and place certain business on the insurers' behalf. Defendants received the majority of their non-system business, portions of which were then ceded to the plaintiffs under the SANS Treaties, from Baccala & Shoop Insurance Services, an MGA representing a variety of primary insurance companies. Baccala & Shoop worked closely with the broker, G.L. Hodson; in fact, they were owned by the same entity.
17 Another key issue in the present litigation stems from the fact that, during the annual periods covered by the Treaties, almost all of the non-system business that defendants produced, and shared with the plaintiffs, was underwritten using what are called semi-automatic facilities. (A facility is an agreement setting out, among other things, the rules under which a reinsurer will reinsure risks ceded by the other party.) Defendants insist that semi-automatic facilities were perfectly consistent with the representations in the slips and Treaties that the reinsurance to be ceded to plaintiffs would be business classified by the Reassured [NERCO] as Property and Casualty Facultative Assumed business. (Emphasis supplied.) Plaintiffs sharply dispute this. Calling facultative underwriting the fundamental material term in the SANS Treaties, the district court agreed with plaintiffs that the term facultative included only reinsurance that a reinsurer underwrites and negotiates with the primary insurer on a risk-by-risk individual certificate basis in advance, i.e., a certificate of reinsurance is issued for each risk after the reinsurer has first looked into and approved reinsuring that particular risk. 18 Under the semi-automatic method that defendants mostly used in underwriting non-system risks, defendants' underwriters did not evaluate risks one at a time in advance of the issuance of a policy of reinsurance on each risk. Instead, in contracts called Master Facultative Certificates (MFCs), NERCO agreed with an MGA, broker, or primary insurer that the latter entity could issue reinsurance upon risks of described types, and upon certain conditions and with certain limits, prior to defendants' underwriters' scrutiny and approval of the risk. After the reinsurance attached to each risk, however, the agent or ceding company would send to Graham Watson a risk bordereau--a document identifying and providing a summary of information as to that, and any other, risks reinsured within the reporting period. Graham Watson then had a brief period after receipt of the bordereau, for example 72 hours, within which to cancel the reinsurance on a particular risk if it so desired, cancellation to take effect within a specified period, say, 14 days. 19 Defendants contend, and presented evidence at trial, that the semi-automatic facility is commonly classified in the industry today as a form of facultative reinsurance. They concede that, in an earlier era, facultative was a term applied only to reinsurance individually underwritten on a risk-by-risk basis in advance of binding. But while accepting that the reinsurer's right to reject individual risks remains a general feature of facultative reinsurance, defendants contend that this feature is adequately preserved in the more economical and streamlined semi-automatic facility. 11 20 Defendants also used, in a few instances, a variation known as an automatic facility. Under this type of facility, rather than having the right to cancel an individual risk, the reinsurer has the right to cancel the entire facility on very short notice. Even without the right to cancel a particular risk, defendants argue that this was facultative, since the reinsured would, as a practical matter, agree to cancel individual risks rather than face cancellation of the entire facility. Moreover, the reinsured retained the freedom to cede or not to cede a particular risk, which is not the case in treaty reinsurance. Automatics comprised only a small portion of the non-system business, most of which was underwritten using semi-automatics.
21 With regard to system business (which was almost exclusively with First State), the defendants did not use a risk bordereau, nor did they ever enter into a formal contractual arrangement spelling out First State's and NERCO's relationship in respect to the latter's reinsuring of risks later assigned under the SANS Treaties. There was evidence, however, indicating how matters worked in practice. In practice, First State's underwriters had the power initially to commit NERCO and the SANS Treaty signatories to the reinsuring of individual risks primarily insured by First State. The reinsurance was evidenced by a layoff sheet that First State prepared; each layoff sheet identified a First State risk that NERCO and the Treaty signatories were to reinsure, and provided a brief summary of information about that risk. A packet containing many of these layoff sheets was periodically provided by First State to Graham Watson, whose underwriter could study the risks and would have the right to cancel the reinsurance at will. 22 Defendants contend that this method was facultative because each risk was individually evaluated in due course by a Graham Watson underwriter based on the information provided on the layoff sheets--and by follow-up phone and face-to-face inquiries, as well as by means of microfiches which reproduced First State's entire underwriting file for a risk, and were available upon request--and it was understood that the reinsurance was subject to cancellation at will by Graham Watson. They point out that because First State's and Graham Watson's employees were under the same roof and answerable to the same bosses, the latter's underwriters could informally influence First State not to cede business the latter did not wish, as further evidence of their facultative control. Notwithstanding the absence of a written understanding between Graham Watson and First State, the district court found, after hearing the evidence, that, Graham Watson underwrote all 'system business' ... by the 'automatic' and/or 'semi-automatic' method of underwriting. Since practically all system business was with First State, this finding grouped that underwriting with the explicit semi-automatic and automatic facilities used in non-system business.
23 At trial, plaintiffs made much of the absence of proof of particular occasions when defendants had ever actually rejected a risk listed in a bordereau or layoff sheet. Plaintiffs also sharply questioned whether the information in the bordereaux and layoff sheets was sufficient to allow for adequate underwriting (evaluation) of individual risks. Defendants responded by emphasizing that, whether or not used, the right to reject at all times existed, and by pointing to evidence that its underwriters adequately reviewed the risks and had other means--personal inquiries, telephone calls, inspection of First State files, and so on--to make inquiry in doubtful cases. Defendants' evidence also indicated that Graham Watson conducted periodic audits of the underwriting practices of MGAs and others in order to assess compliance with the terms of the various facilities. The district court found no evidence that defendants had rejected any risks and found that Graham Watson's underwriting of individual risks was inadequate. 24 In any case, while defendants wrote some small percentage of reinsurance under the SANS Treaties that was facultative in the traditional sense of advance risk-by-risk underwriting, most of the reinsurance produced under the SANS Treaties was underwritten either under some variety of the semi-automatic facility or, in the case of First State system business, under the informal in-house procedures previously described. And, as mentioned above, over the four years of the SANS Treaties, one MGA, Baccala & Shoop, furnished almost all of the non-system business to defendants. Non-system business was found by the court to constitute approximately one-half of the treaty business during the four year period. 25 The agreement with Ralph Bailey to avoid non-system business for the first year was not to the liking of Graham Watson, whose employees felt that non-system business would be a steadier source of income for the Treaties. Bailey also made known his dislike of MGAs and his reluctance to allow MGA business to be ceded to the SANS Treaties. Bailey testified that, because MGAs did not themselves bear any risk, they did not underwrite as carefully as did underwriters on the payrolls of the primary companies, and hence the business produced through them was of a lower quality. 12 Again, this was not to the liking of Graham Watson; one internal memorandum, dated December 11, 1980, stated that Ralph Bailey has an aversion to MGAs and he will have to be approached rather delicately because a good deal of the business going into this facility will be on business which is designed to provide a real flow of business from a single source. This memorandum also noted that Tom Hearn, of Hodson, would travel to London on December 15, 1980 to attempt to overcome this aversion. Responding to repeated requests from Graham Watson employees, Bailey agreed at some time during the first year to begin allowing non-system business to be ceded to the Treaties. While he expressly agreed to the cession of certain MGA business during the first year (from an MGA known as the London Agency), he did so only with great reluctance. However, he did not request or insert an exclusion for MGA business in the slips or Treaty Wordings for subsequent years, as he could have done. No such express exclusion was ever inserted.
26 The SANS Treaties were continuous contracts subject to cancellation upon 120 days prior written notice at December 31, 1980 or any subsequent December 31st. This allowed any desired adjustments to be made in the terms of the Treaties on a yearly basis. In practice, all of the retrocessionaires cancelled during the 120-day period preceding December 31, 1980 and then initialled new slips for the next calendar year. In order to induce renewal, Graham Watson, again through Hodson and the European sub-brokers, disseminated a document referred to as the 1981 Anniversary Information. In addition to listing losses in excess of $50,000 reported through September 30, 1980, and providing a summary of the business ceded thus far, the Anniversary Information included the following statements: 27 To date, the preponderance of the business has been assumed from First State Insurance Company and written on a pro rata basis. Non-System business represents a relatively small proportion of the total and what has been written is limited to Casualty business on an excess of loss basis emanating from Baccala and Shoop Insurance Services. 28 Because of the competitive climate in the United States, Non-System business will develop more slowly than originally anticipated. It continues to be the posture of Graham-Watson not to seek business on a wholesale basis but rather to develop close working relationship [sic] with selected primary sources. 29 On March 23, 1981, a meeting was held in Boston to discuss the performance of the SANS Treaties. In attendance were Ralph Bailey and several employees of Hodson and Graham Watson. One major topic of conversation was the inclusion of MGA business. Bailey asked the Graham Watson underwriters for their opinion of Baccala & Shoop, and was told by Bob Wright, the property underwriter, that Wright knew most of Baccala & Shoop's home office people and was comfortable with them. Later in the meeting, however, Bailey stated that he would not consider any new MGA business for the facility. He did not, however, make this a contractual requirement by inserting an exclusion for MGA business in the slip at the next renewal. 30 At the close of the second year, a 1982 Anniversary Information was disseminated, which again provided a list of losses and a summary of the business. This document also included figures as to overall loss experience through September 30, 1981, which disclosed that the SANS Treaties were losing money. Indeed, the loss ratio for the 1980 Treaties was an alarming 248.65 percent. 13 In addition, the 1982 Anniversary Information included the following statements: 31 The rating basis of these treaties is being amended with effect from 1st January 1982 to more accurately reflect the basis used by Graham-Watson. All business other than that assumed from the First State which is a system company is being written on a net rated basis in that Graham-Watson is quoting their price and if a ceding commission is required by the original company, this is then added to the premium required by Graham-Watson 32 ...The current sources of business is [sic] as follows:-- 33 FIRST STATE INS. CO. 34 TWIN CITY per Baccala and Shoop Insurance Services ST. PAUL FIRE & MARINE NORTHBROOK CRUM & FORSTER CNA 35 ROYAL INS. CO. CHUBB AND SON AETNA CASUALTY & SURETY 36 Plaintiffs point out defendants' failure to mention, other than in the case of Twin City, that certain of the listed primary insurers acted through Baccala & Shoop or other intermediary. 37 It appears that no formal anniversary information was prepared for 1983, the last year of the SANS Treaties, although letters were sent to the retrocessionaires containing a list of losses, a summary of the business, and notification of various changes that had been made over the past year, none of which are material here. However, the retrocessionaires were told that the treaties were continuing for 1983 basically as before. 38 Following the placing of the SANS Treaties, the plaintiffs at first accepted their shares of the premiums and paid their shares of corresponding losses incurred by NERCO. The losses were considerable, as they were throughout the insurance industry at this time. Beginning as early as the fourth quarter of 1982, however, certain of the plaintiffs ceased paying losses. 14 There was evidence that some of the plaintiffs (in addition to Terra Nova, through Bailey, as related above) began to inquire as early as 1982 about the use of MGAs to obtain business (rather than through the formation of direct relationships with primary insurers), and about the underwriting methods used by the defendants.