Limitations of Reinsurance Contracts

In the previous few articles, we have studied how reinsurance contracts work. We now have a deep understanding of the type of relationship between the ceding insurance company as well as the reinsurer.

We now know about the various types of clauses which are commonly included in the reinsurance contract as well as the financial losses that a reinsurance contract must provide the ceding insurer cover against.

However, it is important to note that the reinsurer is not always liable for the losses which are incurred by the ceding insurance company. There are some very clear exclusions to any reinsurance contract which limit the liability of the reinsurance company.

This article provides details about these limits which commonly apply to reinsurance contracts.

• Negligence: The reinsurance company expects the ceding insurance company to do any underwriting only after conducting their due diligence. If it is proved that the ceding insurance company has not conducted its due diligence, then it is possible for the reinsurer to deny paying the claim to the ceding insurer.

  Reinsurance companies underwrite the policies issued by the ceding insurer on a good faith basis. However, most reinsurance contracts ensure that the reinsurance service provider has the right to demand the relevant documentation and check whether the policies were issued after due diligence. This is important to ensure that the ceding insurance company does not indulge in reckless underwriting since they know that they will not be bearing all or most of the losses which result from it.

• Ex-Gratia Payments: An ex-gratia payment is a payment made by a ceding insurance company that they are not legally required to make.

  Ceding insurance companies generally make these payments in order to protect their reputation or to ensure the loyalty and repeat business of a client.

  Since the ceding insurance company is not liable to make such payments as a part of their policy terms and conditions, these are generally not covered under the terms of the reinsurance policy. However, many times customized reinsurance policies are drawn up in order to ensure that a portion of the ex-gratia payment is covered.

• Errors and Omissions: Insurance companies are expected to make full and complete disclosures while obtaining a reinsurance policy. Any failure to submit the required information, whether intentionally or unintentionally makes the reinsurance policy voidable.

  Since ceding insurance companies aggregate a large number of policies simultaneously, the reinsurance company generally provides them some time to ensure that all the relevant information has been furnished to the reinsurance company. While accepting the business, reinsurance companies take all the information at face value because of the good faith principle. However, while actually paying out the claims, the information is extensively verified to unearth any error or omission which may have happened.

• Extraordinary Risks: There are certain extraordinary risks that are specifically excluded by reinsurance policies. For instance, in many parts of the world, terrorism risks are specifically excluded from general reinsurance coverage.

  There are special covers that ceding insurance companies need to purchase in order to cover the risk of terrorism. Unforeseen events such as pandemics are also not covered under many reinsurance policies! This clause caused a lot of ceding insurance companies to lose money during the pandemic. It also led to a lot of regulatory as well as legal battles. As a result, now pandemics are not considered to be extraordinary risks and are included in most reinsurance policies.

  Generally, the reinsurance company will specify the exact nature of extraordinary risks that they plan to exclude from the policy. For example, most reinsurance policies will explicitly specify that losses arising from nuclear risks are not included in their policy.

• Lack of Timeliness: Ceding insurance companies are expected to cooperate with the reinsurance company when making reinsurance claims. This means that the ceding insurance company is supposed to be aware of the procedures which have been set by the reinsurer to make the claim. Also, they must be aware of the documents which need to be submitted and must do so in a timely manner.

  The reinsurance company also has a responsibility to send reminders to the ceding insurance company. However, if the ceding insurer does not make a timely claim or is unable to provide the required documents to substantiate their claim, then the reinsurance company has the right to reject the claim.

The fact of the matter is that there are several exclusions that can absolve the reinsurance company of any liability when it comes to making reinsurance payments. The above list is only indicative in nature.

It is possible for the reinsurer or the reinsured to add or remove any exclusion to the list at their convenience. It is important for the ceding insurance company to be completely aware of such exclusions since the lack of awareness can threaten the very existence of the ceding insurance company!