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Symposium 2016

Panelists Offer Differing Viewpoints on Reinsurance Audits

by ~ Christine Phan (Email)

Andrew Costa of Devonshire Group, Alexandra Furth of Liberty Mutual, and Mitchell Gibson of Swiss Re broadly commented on the respective perspectives of an auditor, a cedent, and a reinsurer relating to reinsurance audits at the Fourth Annual MReBA Symposium. Jerry McElroy of Zelle Hofmann Voelbel & Mason moderated the panel.

MReBA member John Matosky of Prince Lobel Tye set the stage for the panel dialogue by discussing the purpose and scope of reinsurance audits. Reinsurers audit or examine the books and records of cedents for many reasons, including to set reserves and to obtain information about the underlying claim. One fundamental point of contention between reinsurers and cedents is whether an audit is a contractual right to be exercised by the reinsurer, or an obligation that the cedent must comply with. A reinsurer, it was remarked, often feels that an audit is a right stemming from the “access to records” clause contained in reinsurance certificates, while a cedent typically takes the view that an audit is an obligation.

On this point, Mr. Matosky noted that audits for payment disputes, while not always contentious, often include an adversarial aspect. It is this “natural tension, given the roles of the respective parties” that causes cedents and reinsurers to stake their differing positions about the scope and necessity of reinsurance audits. Mr. Matosky further noted that it is often in the context of complex cases – toxic torts, long tail claims, multiple site environmental pollution, and asbestos, for example – that the audits can become freighted, particularly with respect to allocation issues and questions about the number of occurrences.

Mr. Costa then spoke, noting that privilege issues arise often in reinsurance audits. Because it is such a common issue, he noted that the participants in an audit tend prophylactically to enter into a confidentiality agreement before the start of the audit. Indeed, all three panelists stressed the importance of clarifying audit rights at the outset of an audit.

Mr. Costa emphasized: “There’s a lot of work up front, and you don’t want to be surprised when you walk in the first day.” He pointed out that the ceding company will sometimes present records to an auditor in a form that is not readily “auditable” – that is, the records may meet the requirements of the confidentiality agreement, but are not necessarily useful from a reinsurer perspective. For example, an auditor may request the claim file on the assumption that some ceding companies include accounting records and litigation management records within the claim file. However, the auditor may not receive those additional records simply because the ceding company labels its files differently. Mr. Costa used the example to illustrate the point that auditors must familiarize themselves with how both cedents and reinsurers handle claims so that the auditor may request the appropriate records for review.

Mr. Costa further observed that, with complex claims, the ceding company may sometimes produce a vast volume of files for the auditor to inspect. In such a case, requesting an index may be helpful to get an idea of how the ceding company maintains its records. Further, Mr. Costa mentioned that auditors may request access to the individuals most closely involved in the underlying claim, such as the claims handlers or counsel at the ceding company, to gather information about how the claim was handled. This source of information may be important to elucidate details about the claim – such as why a certain reserve was established, or observations about the general direction of the underlying litigation – that are not always clear from a review of the claim file. Mr. Costa emphasized that it is always important to identify why the audit is taking place, and to be clear about what records are needed.

Mr. Gibson then gave some remarks about what reinsurers might perceive to be the most challenging part of a reinsurance audit. Mindful that reinsurers are at least one level removed from the actual handling of the claim, they must often place complete faith in the cedent, and assume that the cedent has handled the claim reasonably and in a business-like manner. With that in mind, a reinsurance audit tends to focus upon 1) whether the claim is covered under the underlying policy; 2) whether the claim is covered under the reinsurance contract; 3) whether the claim settled in a reasonable, business-like manner; and 4) whether the ceded claim is something the reinsurer would agree with, particularly in cases where the reinsurer must cede the claim to its retrocessionaire. Even if a cedent is hesitant to share information because of privilege and confidentiality issues, it was observed in a discussion with the audience, cedents still must share enough information to support their presentation of the loss to get reimbursed.

A question was put to the panel about whether the audit process differs materially if the reinsurer is in runoff. When a company is in runoff, the company is faced with limited finances and is not constrained by considerations of a continuing business relationship. A reinsurer in runoff, then, would likely be more inclined to ask more questions – essentially, dotting every “i” and crossing every “t.” In those circumstances, a reinsurer generally is not under any pressure to turn payments around quickly. The result may well be that such a reinsurer will generally present more questions, and require more documentation, before issuing payments. In contrast, in the case of a solvent reinsurer, the reinsurer is more likely to make decisions based on the claim itself, and must also simultaneously consider preserving the ongoing business relationship with the cedent.

In points of discussion then moderated by Ms. Furth, there was general consensus that solvent insurers and runoff insurers approach reinsurance audits differently. In particular, there may be a tendency among runoff reinsurers to view “access to records” clauses as an obstacle to payment. Rather than using a reinsurance audit to understand a claim, for example, reinsurers in runoff could attempt to use audits as a tool to avoid payment – essentially treating an audit as a condition to payment.

In addition, it was observed that the access-to-records clause is regularly conflated with the cedent’s duty to cooperate. Ms. Furth emphasized, however, that whether access to records or cooperation are actually conditions to payment depends entirely on the language of the particular reinsurance contract at issue. Ms. Furth added that many of the contracts she has dealt with do not contain a condition to cooperate in order for the reinsurer to have a payment obligation, and reminded the attendees and panel that the concepts are distinct.

There then followed a general discussion about how cedents and reinsurers could better manage audits. In addition to the suggestions about indices of documents or discussing a claim with the responsible handlers that were shared earlier, one point that was raised was that the reinsurer could exercise its right to associate with the cedent at an early stage, and monitor the claim over its lifecycle. Such early association could potentially reduce the reinsurer’s learning curve, and the volume of information that the auditor would have to digest in a compressed timeframe. Universally, however, reinsurers tend to be reluctant to associate with the ceding company for fear of a potential cut-through vis-à-vis the underlying claim.

Finally, to close the panel, there was a general discussion of reserves. The panelists generally noted that the litigation environment of the past few decades has altered the amount of reserve information that a cedent may be willing to share. In particular, it was pointed out that there seems to be a growing perception among cedents that reserve information might be used in litigation to argue that the cedent conceded coverage. But reinsurers, it was observed, may take the view that reserve information serves as the best indicator of where the cedent believes the claim to be going, as well as the cedent’s potential exposure. The result of the standoff is that, either out of necessity or as a matter of good practice, reinsurers themselves may be forced to make their own estimates of potential ultimate exposure, and thereby set their own reserve levels.

Ms. Phan was an associate in Zelle Hoffman’s Boston office at the time of the symposium and at the time of reporting. She is currently Assistant Litigation Counsel at Jenzabar, Inc. She may be reached at christine.phan@jenzabar.com.

© 2012 Zelle Hoffman Voelbel & Mason, LLP. All rights reserved.

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