Punitive Damage Awards |Are these recoverable under Reinsurance Agreement?

What are punitive damage awards?

Like having been spanked for something you thought was correct in the eyes of the law

In the context of this posting, punitive damages or what is usually termed as exemplary damages are damages intended to deter the defendant and others from engaging in conduct similar to that which formed the basis of the lawsuit. Although the purpose of punitive damages is not to compensate the plaintiff, the plaintiff will in fact receive all or some portion of the punitive damage award. Punitive damages are also often awarded where compensatory damages are deemed an inadequate remedy.

Back to the question of….

When an Insured’s bad faith claim against the Insurer is successful and the court for whatever reason awards punitive damages in this regards, would your Reinsurer reimburse the Insurer for the punitive damages judgment?

In simple terms, you as a professional of an insurance company have to decide if there are questionable issues on the Insured’s part when making the claim – you would need to take abit more time to respond to the claim, and during the handling processes failed to specify the reasons for a reservation of rights, ignores settlement opportunities, disclaims all defense or coverage obligations, or may in certain circumstances construed having mishandled the claim in BAD FAITH. Somehow or rather the claimant decides to take your company to court, alleging the claim was handled in bad faith, and the claimant won the court decision. The claimant when pursuing the claim would have also seek punitive damages in respect of the insurer’s poor responsiveness and bad faith – in most cases the courts are willing to consider those damages.

Will your reinsurer(s) reimburse such punitive damage judgment that your company has paid?

The answer to this question depends on whether the coverage provisions of the reinsurance contract are broad enough to include punitive damages awarded against the cedant and whether such punitive damages are reinsurable under the public policy of the relevant jurisdiction.

It is a norm in Malaysia that standard reinsurance contract provides that the reinsurer will reimburse the cedant for a certain portion or quantum of the settlements and judgments actually paid by the cedant on claims arising under the policies of insurance that it issued.Generally, punitive damages awarded on bad faith claims are precisely the type of claim that falls outside the underlying insurance contract, thus unlikely to be reimbursed by the reinsurers.

In recent soft-markets it is not abnormal to find insurers squeezing out off their treaty reinsurer some form of enhancement to those standard contracts. Although Extra-Contractual Obligations (ECO) add-on clause or enhancement is not becoming a norm but is picking up steam in recent years….

ECO clause can be unpredictable

A typical Extra-Contractual Obligation (ECO) clause

The Typical Extra-Contractual Obligation (ECO) generally provides that the reinsurer will reimburse the cedant for the payments made by the cedant on a claim that goes beyond the standard coverage provisions of the underlying insurance contract.

The ECO clause, to a large extent obliged then reinsurer to pay for those punitive damage awards.

Typically, the ECO clause would have a limit of liability or a percentage recovery provision on standalone basis – more of a sublimit within the reinsurance contract’s general limit of liability.

Recent practices. In recent days, reinsurers have been inserting sub-clause within the ECO clause limiting the validity of the clause to jurisdictions where the insurability of punitive damages is not prohibited, or against public policy. This sub-clause if inserted can be a headache to the cedant.

In Malaysia it is generally accepted that punitive damages exist to punish a wrongdoer for aggravated, intentional, or willful acts against the public.Typically, that punishment is meted out because of the direct acts of the insurer in handling the underlying claim or because of the acts of its employees and agents, which subject the insurer to vicarious liability for those wrongful acts. “Would our courts not seek to impose the public policy rules where an ECO clause specifically provides for indemnification….”

Whether one may insure against punitive damages is a question of public policy… so far, no test case in respect of ECO clause related dispute. By the acts of reinsurers inserting the public policy ‘exemption’ they are preempting possible dispute that may leads to them compensating cedants beyond the realm of the Malaysian jurisdiction.

“Conversely, if our laws did not forbid a wrongdoer to insure itself for punitive damages, then reinsurance coverage for punitive damages assessed against a cedant should then be permitted”

If Malaysian jurisdiction allows parties to insure against punitive damage awards, reinsurability of such damages is no longer an issue as long as the reinsurance contract has an ECO clause or other provisions broad enough to encompass punitive damages. Main issue is some of the reinsurers on the treaty list may decide to challenge that assumption…. What would that turn out to be? This makes the reinsurability of punitive damages abit more tricky – to manage cedants’ expectation, perhaps it is best if the ECO clause is qualified with the public policy ‘exception’.

What do you think as an Underwriter?

Then… as an underwriter of a cedant company, I would still adapt to the fact that the ECO clause was supposed to eliminate the possibilities of such punitive damage awards, whether public policy eventually stands in the way or otherwise, the original ECO recipe should remain in their original self.

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2 comments for “Punitive Damage Awards |Are these recoverable under Reinsurance Agreement?

  1. Jap-pan
    February 18, 2013 at 08:43

    I supposed you are talking about property based contracts as most liability based contracts in Malaysia exclude punitive damages.

  2. October 24, 2010 at 12:57

    [New Post] Punitive Damage Awards |Are these recoverable under Reinsurance Agreement? – via #twitoaster http://www.malaysiainsurance.info/reinsu

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