Is Big Brother Becoming a Reality?
Reinsurance and Retrocession
THE RHA REVIEW
Volume 3, No. 1, Fourth Quarter 1996
By Robert N. Hughes, CPCU, ARM
Germans have a very useful work, doppelganger, which refers to a "ghostly counterpart of a living person" supposedly hanging around and participating in sub rosa decisions. George Orwell, in his 1949 novel 1984, described a terrifying society where constant supervision was maintained by "Big Brother." Is it possible that, quietly but inexorably, such a presence is developing in the insurance industry and, if so, do we care? At the risk of appearing slightly paranoid, I believe the answer to the first question is "yes" and the answer to the second is "We had better."
First let’s take a peek into the back rooms of insurance for the benefit of the educated but uninitiated. You may or may not be surprised to learn that insurance companies themselves buy insurance in order to limit their exposure in a single occurrence or in the aggregate. If the policy-issuing company buys insurance, it is called "reinsurance." If a reinsurance company buys reinsurance, it is still reinsurance but is referred to as a "retrocession." Using these vehicles, the insurance industry is able to effectively spread risk worldwide and maintain a relatively stable insurance environment.
Reinsurance has traditionally been considered an arm’s-length transaction "between knowledgeable parties" and, as such, not highly regulated. That being the case, the industry has established some rules (through tradition and practice as well as contractually) which govern the business of reinsurance. There are two such rules that over the years have come to be seen as significantly more important than any other. The first is "Uberrima Fides" (usually seen in the plural Uberrimæ Fidæ), which, for you non-Latin speakers, means "the most abundant good faith." The second abiding rule which has governed reinsurance transactions for centuries is the concept of "follow the fortunes." This means that the reinsurer will "follow the fortunes" of the reinsured company, paying claims which are paid in good faith by the ceding company without "re-arguing" the coverage in the underlying policy.
I have already probably bored you all to tears talking about "Uberrima Fides" in previous writings, so I’m not going to say much more about that. I am going to talk about "follow the fortunes," however, and link that to another recent headline which, when considered together with "follow the fortunes," greatly stimulates my paranoid side.
First, let me cite a recent British House of Lords decision. (Now I know you usually don’t hang on every work that comes out of the House of Lords, but trust me on this one.) In a case titled Hill and Others vs. Mercantile & General Reinsurance Co. P.L.C., the House of Lords ruled that reinsurers no longer must simply "follow the fortune" of their reinsured but may instead strongly question claims and refuse to pay on any number of bases, including their interpretation of the underlying coverage. Put simply, this means that your insurance carrier may no longer be able to pay your claim with the confidence that — because they believe it is covered or, more critically, a U.S. court believes it is covered — their reinsurers will automatically pay. Charles Gordon and Chris Jones, partners in the London law firm of Manches & Co., state, "The reinsurer is now free to impose his own definition of the terms of the direct insurance policy and his reinsurance policy without being bound by any decision reached by his reinsured."1
Now put that in your pipe for a moment, but don’t smoke it just yet. Instead, let’s turn the page of this mythical morning newspaper we are perusing. Here we see the headline "Reinsurance Consolidation Continues as Munich Re Acquires American Re."2 In this report we learn that Munich Re, already the world’s largest reinsurance company, is acquiring American Re, the combination of which will result in a company with "net premiums written" of almost $14 billion, "policyholder surplus" of almost $6 billion and "net income" of $290 billion. Similar consolidations have occurred in other areas, and virtually all knowledgeable observers of the marketplace predict that the world’s reinsurance market is in the process of concentrating itself into a small number of gigantic corporations.
OK, now add the second poke to your pipe, light up and take a puff. Notice the bitter taste? In case you don’t catch my drift, let me explain. What we apparently should anticipate is the consolidation of insurance power into a relatively few hands, the vast majority of which are non-U.S. entities, coupled with an erosion of the ability of policy-issuing insurers to make their own coverage decisions. What that seems to me to guarantee is a situation in which the settlement of large claims becomes even more complicated and drawn out than it is now (heaven forbid!). Even worse, if you put on your really black hat, the ultimate interpretation of policy language drawn by U.S. drafters, issued by U.S. companies to U.S. Policyholders, will be vested in "star chamber" in some faraway land … cloaked in anonymity and insulated from U.S. securities and anti-trust laws.
Regular readers will realize I usually close with a remedy for the ills I discuss. Not this time, however. I have no idea what you or I or anyone else can do about this. All I can suggest is that we hope for the best and keep faith in the American judicial system, because that’s where the problem, if it does develop, will ultimately be settled. When I was in the insurance agency business twenty-five years ago, our motto was "Insure Today – Be Sure Tomorrow." I’m not sure it works like that anymore, all the pity.
1Business Insurance, August 5, 1996, p. 39.
2BestWeek, August 19, 1996, Release 34.