Facultative reinsurance is the oldest form of reinsurance and refers to the temporary entry by the original insurer into a reinsurance contract with another insurer regarding a specific item of insurance business (e.g. a very large risk or an item of insurance business that exceeds a certain limit). Reinsurance usually involves an insured subject matter and settlement risk of a large amount, and constitutes one of the important steps taken by insurance companies to control risks.
However, in actual reinsurance practice in China at present, the importance of compliance requirements in the course of the contract process is commonly overlooked. After being brought together through the offices of an insurance broker, the cedant and reinsurer are deemed to have concluded an agreement after simple communication by e-mail, fax, etc. Not only do they not execute a written contract, but they do not reconfirm changes in key conditions.
Such non-compliant operations conceal huge commercial risks as, if a large insurance settlement is triggered by the occurrence of an insured event, the reinsurer may strictly cite contract law rules and deny the existence of a reinsurance relationship, thus evading its liability to pay indemnities. Based on our lawyers’ experience in handling a number of reinsurance commercial disputes recently, we have seen that the key point of disagreement in reinsurance contract disputes comes down to whether a reinsurance contract is formed. The above-mentioned carelessness and points of non-compliance can result in the court denying that a contract has been formed, thereby greatly increasing the cedant’s risk of losing.
Problems of non-compliance
The non-compliant operation practices that have arisen over many years in the reinsurance business have resulted in numerous non-compliant operations existing in the industry. The most typical are the failure to execute formal reinsurance contracts after reaching agreement, neglecting the acceptance of new offers.
No written contracts. One of the biggest problems in the operations of the reinsurance industry is the failure to sign formal written contracts after an agreement is reached. The agreement of the reinsurance parties is recorded in scattered e-mails, faxes, letters, etc. In practice, repeated consultations over key conditions will often occur, readily giving rise to disputes over the issue of determining the legal nature of the pieces of correspondence containing the different conditions. In cases where we acted as counsel we have encountered situations where key e-mails have been lost due to the passage of a significant amount of time, departure of the handling person, replacement of computers, clearing of a mail box and so on, greatly increasing the difficulty of collecting evidence for
the case hearing.
Having undergone hundreds of years of development, reinsurance contracts have also given rise to a unique system of rules, e.g. utmost good faith clauses, following the fortunes, cut-through clauses, subrogation clauses, etc. These rules were created to specifically address matters that readily give rise to disagreements in reinsurance transaction disputes. The author argues that the execution of a standard reinsurance contract after an agreement has been successfully reached not only reflects the professional particularities of the reinsurance business, but can also avert the occurrence of disputes.
Neglecting the reconfirmation of new offers. Article 30 of the Contract Law specifies that if an offeree makes substantive changes to the content of an offer, such offer constitutes a new offer. The author argues that changes in the reinsurer’s share, premium rate, the insured, and type of risk constitute substantive changes. In practice, the reason a reinsurance contract is not formed can often be traced back to the fact that no acceptance was given for a new offer. Taking the nationally influential SK Hynix reinsurance dispute as an example, the key here was that six remarks added by the reinsurer to the acceptance given by the cedant could be deemed substantive revisions to the original conditions, thus constituting a new offer. If the cedant cannot show that it reconfirmed the new offer, it is quite likely that the court will find that the contract was not formed.
From the author’s practice of handling reinsurance contract disputes, the author has become aware of one common phenomenon: after formation of the reinsurance contract, the cedant will sometimes reduce its ceded share, within the specified share limit, and pay the premiums based on the actual share performed. The reinsurer rarely comments on the change, and does not reconfirm it. For example, in one dispute, the acceptance of the offer specified that the “acceptable share is 30%”, whereas, in fact, performance was done based on a share of 20%.
During the hearing, Wintell represented the cedant in giving the following explanation: (1) the original specified share was up to 30%, so that the actually performed 20% did not breach the provision; (2) the counterparty did not raise any objections to accepting the premiums for the 20%; and (3) the reason that the cedant revised the ceding percentage downwards was for the purpose of strictly performing the regulatory requirement of the China Insurance Regulatory Commission (CIRC) of not exceeding a ratio of 80%.
Notwithstanding the fact that the firm successfully convinced the judge to find that the reinsurance relationship was formed, if the parties had reconfirmed the change and executed a formal reinsurance contract, it is likely that it would have been possible to cause the counterparty to duly perform the contract and to avoid the occurrence of a dispute.
Compliant contract procedure
Curing the various problems that plague the reinsurance industry will not happen overnight, but one can start from what is most basic, i.e. observing the rules for entering into contracts, and completing the procedures for the invitation of an offer, an offer, acceptance, new offer, acceptance anew, contract execution, recordal, etc. in strict accordance with the rules in the Contract Law and the Insurance Law.
The reinsurance business also needs to enhance the legal awareness of reinsurance practitioners and brokers, and the requirements for their skills and, when necessary, invite legal professionals to participate in the contract process. Ensuring compliance in the contract process is not only consistent with the interests of the insurer and insured, but is also of great significance to the compliant and orderly development of the reinsurance business.
Harry Wu is an associate at Wintell & Co. in Shanghai
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