A Little Neglect May Breed Great Mischief

A Little Neglect May Breed Great Mischief

For want of a nail, the shoe was lost. For want of a shoe, the horse was lost. For want of a horse, the rider was lost. For want of a rider, the battle was lost. For want of a battle, the kingdom was lost, and all for the want of a horseshoe nail.”?  Ben Franklin put it more pithily in this 14th-century Poor Richard’s Almanac proverb: “A little neglect may breed great mischief.

You have probably heard these aphorisms before, but what you did not know is that they were explicitly conjured up to give guidance to reinsurance professionals.  Not really, but still, Franklin’s saying should be tattooed on the arms of every reinsurance buyer, reinsurer, broker, contract drafter, lawyer, claims professional, and legacy manager.  After all, unless the reinsurance contract is well drafted, all the excellent work done in researching, designing, pricing, placing, and finalizing a reinsurance treaty or program may be for naught.

The old cut-and-paste approach (or its electronic equivalent) to drafting reinsurance contracts has long been and continues to be the source of numerous problems. Yes, good reinsurance contract lawyers are worth their weight in gold, but so, too, are good reinsurance brokers and astute reinsurance consultants with lengthy and varied experience and expertise in structuring and designing reinsurance products and ensuring that those contracts are consistent with insurer’s objectives. Reinsurance contracts need to be reviewed continuously, and insurers, despite all the available help, retain the responsibility to ensure their reinsurance contracts are fit for purpose. Insurers must also study how reinsurance contracts and specific clauses respond during arbitration and litigation.

Often, expertise in structuring and designing reinsurance products is not adequate.  It is also critical to have lived through numerous reinsurance contract interpretation disputes, i.e., to be on intimate terms with the skeletons in the closet.  Even those reinsurance professionals who review and analyze reinsurance contracts for a living (buyers, brokers, underwriters, lawyers, regulators, claims professionals, policyholders’ lawyers, arbitrators, and legacy managers) often overlook subtle ambiguities in reinsurance contracts or the omission of a phrase which, if present, could save the parties to the contract vast sums they would otherwise be forced to spend to resolve an ensuing dispute.

Part of an effective risk management program is a comprehensive open-source intelligence program that focuses, not only on existing risks, but emerging ones.  Among them are legal and regulatory risks.  Unless underwriters and reinsurance contract drafters keep abreast of such risks, the results could be disastrous. For example, the exposure of liability insurers and reinsurers could have expanded exponentially if they failed soon enough to note, and appropriately price and address in their reinsurance contracts, the newfound strict liability for defective products, which was first envisioned in the 1965 Restatement (Second) of Torts (Products), with the introduction of Section 402A.  This Restatement was a seminal event in casualty insurance and reinsurance history. Today, artificial intelligence and cloud computing, like electricity before them, are transformative technologies that generate new types of individual policy and aggregate losses in a tightly coupled and networked world. Again, underwriters and contract drafters must pay heed.

Too often, inertia sets in, and the terms and conditions of contracts that have long been used are reflexively maintained. It is essential to review each clause annually to identify the ideal terms, conditions, and coverage grants that provide the insurer with the best possible terms, in light of legal and regulatory developments and emerging risks. This review process means working with reinsurance consultants, brokers, coverage lawyers, litigators with breach of contract experience, or corporate lawyers with contract drafting experience.

Reinsurance relationships are akin to romantic relationships, which can involve three different phases:  the “wine and dine” courtship phase, the “marriage phase,” and the “divorce or break-up phase.” While it is often prudent in a marriage to have a pre-nuptial agreement, it is critical in the courtship phase of a reinsurance relationship to contemplate and prepare for its termination.  If you have ever had trouble collecting losses from legacy reinsurers, you understand the importance of carefully defining the rights and obligations of the parties upon termination without ambiguity or vagueness.

Reinsurance textbooks give the impression that there are standard reinsurance contracts and clauses that are universally adopted.  Not so. Lloyds, the direct reinsurers, some insurance companies, and each reinsurance intermediary have their own recommended clauses.  But no matter whose “standard” clauses are at issue, it is important to take a step back and evaluate whether a given clause satisfies the ends you are seeking to achieve.  Not doing so can be an expensive oversight when subsequently attempting to collect claims or during a reinsurance relationship’s “divorce or break-up” phase.

Every bored 1990s business air traveler who skimmed the airline magazines behind the airsick bags saw Chester Karrass’ print ads for his negotiation seminars with the tagline, “You don’t get what’s fair, you get what you negotiate.” That’s true in spades for reinsurance contracts. The ability to successfully negotiate reinsurance agreements begins with a comprehensive risk management program. Such a program involves a multi-disciplinary process to research, anticipate, and manage the existing and emerging risks that impact the risk assumer and the specific risks associated with the reinsurance contract creation and documentation.

Let me end where I began with a proverb: don’t be “penny-wise and pound foolish.” Don’t hesitate to contact us if you want to explore creating robust contract management procedures and processes or need help drafting reinsurance contracts. 

One Comment

  1. Richard Jones

    Amen to this, brother … this coming from a “cut and paster” who lived to regret this approach during several depositions!

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