Are They In or Out? ECO/XPL

by Frank DeMento of Crowell & Moring

On September 19, 2013, Andrew Costa of DEVONSHIRE, Michael Frantz of Munich Re, and Frank DeMento of Crowell & Moring, spoke at the AIRROC West Coast Insurance and Reinsurance Regional Education Conference in Orange County, California. Andy, Mike and Frank discussed claims for ECO / XPL and the (re)insurability of punitive damages. Extra contractual obligations (“ECO”) claims are brought by the underlying insured against its insurance carrier, seeking damages arising out of the insurer’s alleged faulty handling or defense of a claim. A distinguishing characteristic of an ECO claim is that it falls outside of the coverage provided by the underlying insurance policy. Excess of a policy’s limit (“XPL”) claims are brought against the insured by a third party that would be covered by the underlying policy but for the policy limits.

The question for reinsurers and cedents alike is whether reinsurance is available to cover ECO or XPL claims. The answer depends on a number of factors, including but not limited to, whether the reinsurance contract contains specific clauses providing for such coverage, if a separate E&O policy exists that provides similar coverage, to what extent the reinsurer was involved in the claims handling and/or is required to follow the cedent’s fortunes, and whether state laws on the insurability of punitive damages are applicable. Generally speaking, a reinsurer’s liability to its cedent is determined by the parameters of the reinsurance contract entered into by the parties. The more specific and accurate parties can be in drafting language for the ECO/XPL clause, the greater guidance they will have when an ECO/XPL situation arises.

Parties to a reinsurance contract may also need to address whether state law has any bearing on the reinsurance recoverability of ECO claims. In particular, parties to a reinsurance contract may dispute the applicability of state laws on the insurability of punitive damage awards, as a number of states prohibit insurance of punitive damage awards as a matter of public policy. At minimum, when faced with a claim for reinsurance coverage for a punitive damages award, the parties must address: (1) which state law applies; (2) whether that state prohibits the insurability of punitive damages as a matter of public policy and under what circumstances; (3) whether that state public policy would apply in the reinsurance context; (4) whether any specific contract language exists that explicitly provides for such coverage; and, (5) whether other language in the contract – such as a follow the fortunes or honorable engagements clause – bears on the issue.

Recent decisions have demonstrated that punitive damage awards remain an issue for insurers and reinsurers and illustrate the potential importance of determining what portions of a cedent’s settlement with its insured is related to ECO or XPL claims when the contract either limits or prohibits reinsurance of such liabilities.