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CHRISTIANA GEN. INS. v. GREAT AM. INS.

August 9, 1990

CHRISTIANA GENERAL INSURANCE CORPORATION OF NEW YORK, PLAINTIFF,
v.
GREAT AMERICAN INSURANCE COMPANY, DEFENDANT.



The opinion of the court was delivered by: Leisure, District Judge.

OPINION AND ORDER

This is a declaratory judgment action, filed pursuant to 28 U.S.C. § 2201. The jurisdiction of this Court is based on diversity of citizenship. Plaintiff seeks a declaration from this Court stating that, inter alia, plaintiff is not obligated to indemnify defendant for losses incurred under certain reinsurance policies between the parties. Extensive discovery has taken place in this action, and the parties have now cross-moved for summary judgment, and plaintiff has moved for attorneys' fees. Additionally, plaintiff has moved to amend its complaint, should its summary judgment motion be denied.

BACKGROUND

The essential facts of this action are not in dispute. The disputed issues will be discussed below in the body of this opinion. This case arises out of reinsurance contracts between the parties. For four policy years stretching from 1980 to 1984*fn1, plaintiff Christiana General Insurance Company of New York ("Christiana") agreed by contract to reinsure certain risks insured by defendant Great American Insurance Company ("GAIC"). In the instant action, Great American was an excess insurer on a policy issued to American Honda Motor Company, Inc. ("American Honda"), and to various American Honda subsidiaries and affiliates. For the 1980 and 1981 policy years, GAIC's contract with American Honda stated that GAIC would provide $10 million in coverage in excess of $15 million dollars in losses. Thus, should American Honda's insured losses for one of those years exceed $15 million, GAIC would be obligated to cover those losses, up to $10 million. For the 1982 policy year, GAIC provided $10 million in coverage in excess of $17 million, and for the 1983 policy year, GAIC provided $7 million in coverage in excess of $18 million.

In each of the policy years 1980 through 1983, Christiana reinsured a portion of GAIC's liability obligation to American Honda.*fn2 Reinsurance is a contract between two insurance companies designed to spread the risks associated with insuring large accounts. Under a reinsurance contract, one insurer, known as the ceding insurer, transfers all or a portion of the risk it has underwritten to another insurer, known as the reinsurer, for a portion of the premium paid by the insured to the ceding insurer. See Colonial American Life Ins. Co. v. Commissioner, ___ U.S. ___, 109 S.Ct. 2408, 2411, 105 L.Ed.2d 199 (1989). As Judge Kevin Duffy of this Court has succinctly put it, "Reinsurance is simply an insurance policy issued to insurers." Employers Ins. of Wausau v. American Centennial Ins. Co., No. 86 Civ. 8576 (KTD), slip op. at 2, 1989 WL 6631 (S.D.N.Y. Jan. 24, 1989).

Reinsurance is a means for insurance companies to spread the risks they assume from insured, and to lessen the impact any individual company will suffer in the event of a catastrophic loss. Reinsurance comes in two basic forms: "treaty" reinsurance, and "facultative" reinsurance. Treaty reinsurance "involves an ongoing agreement between two insurance companies binding one in advance to cede and the other to accept certain reinsurance business pursuant to its provisions." Sumitomo Marine & Fire Ins. Co. v. Cologne Reinsurance Co., 75 N.Y.2d 295, 301, 552 N.Y.S.2d 891, 894, 552 N.E.2d 139, 142 (1990). Facultative reinsurance, on the other hand, "involves the offer of a portion of a particular risk to one or more potential reinsurers, who are then free to accept or reject the risk in whole or in part." Id. (footnote omitted) (citing Thompson, Reinsurance, at 75 (4th ed. 1966)). A separate reinsurance certificate is typically issued for each risk assumed by the facultative reinsurer. The reinsurance is often placed through a broker employed by the ceding insurer, and, in the case of facultative reinsurance, a single risk is often placed with a number of reinsurers, each assuming a portion of the ceding insurer's risk. The case at bar involves facultative reinsurance.

In the instant case, GAIC, after entering into its insurance agreement with American Honda, utilized a licensed New York reinsurance intermediary, Willcox, Barringer & Co. ("Willcox"), who brokered GAIC's American Honda liability to a number of reinsurance companies, including Christiana.*fn3 Provision 7 of each of the facultative reinsurance certificates provides:

  Prompt notice shall be given by the Company [GAIC]
  to the Reinsurer of any occurrence or accident
  which appears likely to involve this reinsurance
  and, while the Reinsurer does not undertake to
  investigate or defend claims or suits, the
  Reinsurer through its representative and/or
  counsel, shall nevertheless have the right and be
  given the opportunity to associate with the
  Company and its representatives at the Reinsurer's
  expense in the defense and control of any claim,
  suit or proceeding which may involve this
  reinsurance, with the full cooperation of the
  Company.

It is this provision that underlies much of plaintiff's allegations in this action. Plaintiff asserts that defendant failed to give adequate notice to its reinsurers that defendant's excess insurance layer was likely to be pierced for most or all of the policy years reinsured in part by defendant. Plaintiff further alleges that failure to provide prompt notice to plaintiff and other reinsurers constituted a breach of a fiduciary duty of good faith owed to the reinsurers by GAIC. Finally, plaintiff contends that GAIC misrepresented the products and risks being reinsured, thus misleading plaintiff and other reinsurers into accepting risks they otherwise would have rejected.

American Honda is the wholly-owned United States subsidiary of the well-known Japanese manufacturer of automobiles, motorcycles, power equipment and related products. American Honda is the exclusive distributor of Honda products in the United States. See Cabriolet Porsche Audi, Inc. v. American Honda Motor Co., 773 F.2d 1193, 1198 (11th Cir. 1985), cert. denied, 475 U.S. 1122, 106 S.Ct. 1641, 90 L.Ed.2d 186 (1986). Among the Honda products distributed by American Honda are all-terrain vehicles ("ATVs"). ATVs are three- or four-wheeled motorized vehicles capable of operating off-road. They come in a number of models designed for a variety of purposes. Some of the more powerful models, particularly in a four-wheel configuration, can be used as a small tractor. During the late 1970s and early 1980s, however, ATVs were principally marketed as recreational vehicles. Apparently, many users treated ATVs in a manner previously reserved for "dirt bikes" — racing them off-road or attempting to traverse difficult terrain at relatively high speeds. Most states did not require a driver's license or any other type of permit to operate an ATV, and only a few states required riders to wear a helmet or other protective gear. Accordingly, it was not uncommon for children under the age of sixteen to operate ATVs with little or no training or protective clothing.

ATVs, it turns out, were not well designed for the activities for which many Americans purchased them. The three-wheeled versions, which look similar to large, motorized tricycles with oversized, deep-tread tires, were particularly popular with off-road enthusiasts. The smaller, less-powerful three-wheel ATVs were popular amongst teenagers and children both as recreational vehicles and, in some cases, as a form of transportation. ATVs, particularly the three-wheeled models, turned out to be unstable and deceptively difficult to operate. In the early 1980s, as the popularity of ATVs began to increase, the number of accidents resulting from ATV use increased dramatically. The injuries suffered in ATV accidents were often severe. By mid-1985, there were 161 ATV-related deaths reported nationwide for the period from 1982 to 1985. Of those victims, 73 were under the age of sixteen, and 39 were under the age of twelve. There were also numerous reports of accident victims with severe brain and spinal cord injuries.

In the spring of 1985 the Federal Consumer Product Safety Commission ("CPSC") released a report, indicating that ATVs might pose an unreasonable risk of injury. Two months after its first announcement, the CPSC issued a proposed rule, designed to reduce the risks associated with ATVs, and initiated judicial action to ban the products as unduly hazardous. The CPSC action spurred journalistic interest in the ATVs. Between the two CPSC announcements in the spring of 1985, the ABC television news show 20/20 aired a segment which focused on the risks associated with ATVs, and on some of the accidents which had resulted from ATV use. Despite this publicity, American Honda continued to market and sell ATVs.*fn4 Finally, in 1988, with injuries and deaths from ATV use continuing to mount, American Honda and its parent entered into a consent decree with the CPSC to reduce the harm associated with ATVs. Specifically, American Honda agreed to cease selling all three-wheel ATVs, to limit sales of the remaining models to buyers of an appropriate age, and to undertake an extensive program to promote safe ATV use. This consent decree has, apparently, resulted in a significant reduction in ATV-related injuries.

The legacy of the ATVs is obvious in the instant action. As early as 1985, it was clear to at least some of American Honda's primary and excess insurers that the ATVs posed a serious liability problem. The number of lawsuits arising from ATV accidents was rising rapidly, and many of those claims were for substantial injuries which would likely result in large awards or settlements. By the fall of 1987, led by the ATV cases, liability claims against American Honda had pierced, or were on the verge of piercing, GAIC's layer of excess insurance for the 1980 through 1983 policy years. By 1988, ATV losses exceed those for all other Honda products combined. See Plaintiff's Memorandum of Law, Exh. A. These losses have resulted in a significant drain on GAIC's layer of insurance, and thus has resulted in GAIC calling on its reinsurers, including Christiana, for indemnification under the facultative certificates.

Christiana has refused to indemnify GAIC for losses on the American Honda account. Christiana alleges that it was not notified of its potential liability in a timely fashion, and that GAIC misrepresented to Christiana at the time of the reinsurance contracts which products were being insured. Additionally, Christiana alleges that by not giving earlier notice of potential liability to it reinsurers, GAIC breached a duty of good faith to those reinsurers. In order to explore fully Christiana's allegations, it is necessary to review the events leading up to GAIC's notification to its reinsurers that their policies would be affected by the ATV losses.

As noted above, the extent of the potential liability problems arising from ATV use began to surface in 1985, with the action by the CPSC and the resulting media attention. Just as the public awareness of the ATV problem was growing, there apparently was knowledge among American Honda's insurers that the ATV losses, along with the expected losses from other Honda products, could well result in major liability for the insurers. In April 1985, Johnson & Higgins, who acted as American Honda's insurance broker, informed GAIC that, given the current rate of loss for the 1979 and 1980 policy years, it was possible that GAIC's layer of insurance could become involved in covering the claimed losses. Plaintiff's Exh. 2. A month later, Johnson & Higgins notified GAIC that existing claims might also involve the 1982 policy year. Plaintiff's Exh. 53. Within GAIC, some concern was expressed during 1985 about the extent of GAIC's possible exposure on it American Honda policies. See, e.g., Plaintiff's Exh. 105i. Johnson & Higgins forwarded at least some case files to GAIC for their review.

Throughout 1986, there was continuous activity within GAIC regarding the American Honda account. See Plaintiff's Exh. 115a-115m. Officials within GAIC were aware of the company's potential exposure for one or more policy years. However, it is clear that no one at GAIC knew which policy year would definitely be affected, or when GAIC's insurance layer for any one of those policy years would actually be pierced and GAIC would be required to take over management of any claims. GAIC was receiving updates from Johnson & Higgins, as well as computer runs of claims from the Insurance Company of North America ("INA"), which was the carrier for the excess layer directly below that carried by GAIC. Representatives of American Honda offered to assist GAIC in any review or claims management that GAIC felt would be necessary. Plaintiff's Exh. 115p. It appears, however, that because it was not certain which of GAIC's layers and policy years would be penetrated and which claims, if any, of the ones then existing would be involved in this penetration, GAIC declined American Honda' offer of help at that time.

In November 1986, GAIC was informed by INA that it was possible that INA's layer of insurance for the 1983 policy year would be expended during the following 12 months. Plaintiff's Exh. 115t. That same month, American Honda indicated to GAIC that it was likely that GAIC's layer for at least some years would be penetrated within the next six months. Plaintiff's Exh. 1151. This information apparently led Jerry Runnels ("Runnels"), a vice-president of GAIC in the claims department wrote to a colleague, Robert Adams ("Adams"), a vice-president in the accounting department, that it appeared that GAIC's layer would be penetrated soon for at least two policy years. Plaintiff's Exh. 115u. It is clear from this memo that GAIC did not have a complete picture of their potential liability, or the time-frame in which it would arise. Runnels stated that he was going to "get a more accurate assessment as soon as possible [so that GAIC can] begin to plan how we are going to handle these cases when the necessity to do so arises." Id.

From the documentation before the Court, it is clear that in December 1986 and January 1987, GAIC began to pay significant attention to its American Honda account. In late January 1987, Runnels again wrote to Adams, attaching an internal GAIC report which indicated that, on an incurred basis, GAIC's insurance layer had been pierced for at least three policy years. Plaintiff's Exh. 42. Because of this apparent piercing on an incurred basis, Runnels explained that the claims department was taking a number of steps to prepare to handle claims when they became GAIC's responsibility. The first of those tasks was to conduct an audit of the American Honda claim files to "get a better feel for past and current handling, reserve accuracy, etc." Id. Further, Runnels indicated that his department need to "[d]ecide which years we should become actively involved in. . . ." Id.

Plaintiff has made much of the fact that GAIC knew, through Runnels, that by early 1987 GAIC's layer of insurance had been penetrated on an incurred basis. There are two ways of calculating losses on an insurance policy: on an incurred basis, and on a paid basis. Incurred losses are losses actually paid plus reserves put in place to cover what are expected losses based on pending claims. Paid losses are just that: losses actually paid. An excess insurer, and thus its reinsurers, are not actually called upon to participate in claims handling and coverage until the underlying levels of insurance have been exceeded on a paid basis. Thus, the fact that INA's and American Honda's figures in 1986 and early 1987 indicated that GAIC's layer was penetrated on an incurred basis did not mean that GAIC at that point was required to participate in any existing claims. It simply indicated a strong possibility that, should INA's reserve figures prove to be correct, GAIC's layer would eventually be involved. However, it remained at least theoretically possible that GAIC's layer would never actually be called upon to make payments, and it was certainly true that there would be a gap in time between when GAIC's layer was penetrated on an incurred basis and when it would be penetrated on a paid basis.

As 1987 progressed, however, events moved inexorably toward the eventual penetration of GAIC's layer of insurance for at least some policy years. In the spring of 1987, as Runnels had indicated, GAIC undertook an audit of the American Honda account. This review was apparently completed in April 1987, and indicated that GAIC should establish some reserves for at least the 1983 year and notify its reinsurers. Defendant's Memorandum of Law at 19. Soon thereafter, in early May, representatives of GAIC contacted Willcox, the reinsurance intermediary to explain the situation with the American Honda account, and discuss notification of the reinsurers.*fn5 GAIC's representatives apparently supplied Willcox with the results of the audit, and also discussed the provision of notice to the reinsurers about the imminent exposure for the 1983 policy year. See Deposition of Merrick McCarthy ("McCarthy Dep.") at 61-66; Deposition of Peter Hildebrand ("Hildebrand Dep.") at 28-31.

By the time GAIC met with Willcox, Willcox was in the process of winding down its facultative reinsurance operation.*fn6 Thus, there was a question whether Willcox would be capable of providing initial and on-going notice to GAIC's reinsurers of the activity in the American Honda account. GAIC apparently agreed to provide the reinsurers with information regarding the American Honda account. It is not clear, however, whether GAIC entirely absolved Willcox of its contractual obligation to provide notice to ...


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