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In Travelers Casualty and Surety Company v. Insurance Company of North America, Travelers Casualty and Surety Co. (“Travelers”) had settled a coverage dispute with Acme Corporation for $137 million, and it allocated that money among three tiers of insurance coverage.  The highest tier, entitled “excess policies”, included products and non-products claims that were in excess of Acme’s insurance coverage.  This tier of insurance was the one reinsured by Insurance Company of North America (“INA”).  INA, as a reinsurer, insured the risk of Travelers, the original insurer, by assuming a portion of Travelers’ potential financial exposure in exchange for premiums.

Under the “follow-the-fortunes doctrine,” the reinsurer has almost no ability to challenge the coverage decisions that lead to its liability to the insurer.  It insulates a reinsured’s liability determination from challenge by a reinsurer unless they are in bad faith or the payments are clearly beyond the scope of the original policy.

When Travelers settled its coverage dispute with Acme, it insisted that a term be written into the contract stating that it could allocate any or all of the settlement amount to any policy.  It decided to allocate $15 million to the “excess policies” tier.  Travelers billed INA over $13.7 million based on its allocation, and INA refused to pay.  Travelers agreed that five decisions it made during the settlement negotiations likely increased the amount of its coverage it was able to allocate to INA, but INA claimed that Travelers acted in bad faith making these decisions and made them for the express purpose of increasing its reinsurance recovery.

The District Court found that Travelers did not act in bad faith when allocating money.  The Third Circuit affirmed this ruling, holding that “the insurer’s negative duty not to make allocation decisions primarily in order to increase reinsurance recovery does not translate into a positive duty on the part of the insurer to minimize its reinsurance recovery.”

For bad faith, the reinsurer must “provide direct evidence that the insurer was motivated primarily by reinsurance considerations, or show that the after-the-fact rationales offered by the insurer are not credible,” and INA did neither in this case.  It asserted that a memo from a vice-president of Travelers that outlined the insurance implications of different coverage scenarios exhibited bad faith, but the courts disagreed, holding that the memo’s purpose was to “provide . . . a general estimate of Travelers’ potential net exposure on the breast implant claims.”

Date of Decision:  June 9, 2010

Travelers Cas. & Sur. Co. v. Ins. Co. of N. Am., Nos. 06-4100, 06-4101, 07-4690 and 08-1032, United States Court of Appeals for the Third Circuit, 2010 U.S. App. LEXIS 11689, 609 F.3d 143 (3d Cir. June 9, 2010) (Ambro, J.)