Reinsurance Law and Practice

Contract certainty enforced in reinsurance

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Individuals and companies who have sold and purchased reinsurance had always been very relaxed when getting actual contracts drafted, negotiated and signed. In 1994, the Plenary Committee of the National Association of Insurance Commissioners adopted amendments that are now known as the “Nine Month Rule.” Prior to the rule, there was concern regarding parties to reinsurance agreements were reconstructing the coverage terms of a deal that was previously negotiated. This was done after the losses so they could take reinsurance credit for transactions that involved little or no risk. Now with the new rule, these transactions are governed and the transactions will be accounted for in all financial statements. The Nine Month Rule states that a contract must be signed within nine months or the transaction will receive retrospective accounting treatment. This could impact the financial statement of the insurer.
In the Silverstein case in 2001, the parties involved did not agree upon a contract before losses had occurred. These types of issues have been arising for years. This was a prime example of an insurance binder. The case attracted the attention of the public and regulators and they quickly realized how the insurance and reinsurance industry was practicing a less than sophisticated business. The result of the Silverstein case was an investigation by Eliot Spitzer, the Attorney General of New York. Spitzer found that most companies in the industry would not sign a contract until almost 9 months after the inception date. This caused the push to regulate when contracts were required to be signed.
The same issues were arising in London. In 2002, the Financial Services Authority posed a challenge to the UK insurance industry. The industry was to achieve contract certainty by the end of 2006. If this challenge was not met, there would be intervention which may result in operational risk charges and other capital charges. Contract certainty is needed because it will minimize any risks. Without the certainty, the underwriters would have uncertainty in regards to their exposure. If the contract certainty was not achieved, there would be a need for regulatory interest. As of now, the market in London is well on their way to meeting the goal.
This contract certainty must apply to the US Reinsurance market as well. An example of the need for certainty is apparent when an individual accepted a job with a reinsurance company. On the first day he was told to work on a pile of contracts. While reviewing the contracts, the employee came across a contracted dated September 1988. That same contract had an inception date of January, 1977! As his career progressed, the company began to use placement slips. These were written contracts, though not complete, that were legally binding. The complete contract would be drafted at a later date. While this may not constitute as a contract, it in fact is. Anything that is put in writing that shows the intentions of the involved parties is deemed a contract. Slips were the easy way to avoid completing a true contract. Even though the slips were legally binding, they often do not include all the information.
There are many problems that arise when trying to obtain contract certainty. The negotiation and placement process is lengthened when there is a need to negotiate provisions other that the financial terms of the contract. If things take longer, it may cause some brokers to disservice their clients by failing to place coverage by the inception date. It is not uncommon for discussions to last right up to the inception date.
It has been suggested that the use of standardized wording be implemented. This would allow for a faster review of the wording of the contract. While it sounds acceptable, there may be problems because each cover is different so standardized wording would not be effective in every situation. The question of how the reinsurance industry could accommodate the changes remained. The industry is already heavily regulated. The change needed is one that would affect how the companies do their business. This change would only come about through the leadership of senior management.
When the Nine Month Rule was introduced, there was a lot of resistance. Contractors and underwriters said it was impossible to do. Despite the resistance, it was achieved. Currently, all documentation is negotiated, drafted and signed within the nine month time period. The only reason this change was accomplished was because it had to be. There was no way the industry could continue doing things the old way.
Category: Insurance, Law

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