The Office of General Counsel issued the following informal opinion on June 14, 2000 representing the position of the New York State Department of Insurance.
Re.: Cut-Through Endorsements and Insolvency
Question Presented
Will a "cut-through" endorsement be effective in the event of the insolvency of the ceding insurer?
Conclusion:
As a general rule, a cut-through endorsement will be effective notwithstanding the insolvency of the ceding insurer. However, the provision of a cut-through that constitutes an improper preference in the event of an insolvency will be voidable.
Facts
You are an agent of Orange Insurance Company ("Orange") and have stated that as a result of that companys rating downgrade, Orange obtained reinsurance and has issued their insureds a cut-through endorsement with Blue Company. You have expressed concern as to whether, in the event of Oranges insolvency, any reinsurance proceeds will be payable to the insured as opposed to the ceding insurers estate.
Analysis:
Authorized insurers are generally permitted to reinsure its risks and policy liabilities in any other insurer, and none of the prohibitions or limitations of the Insurance Law will invalidate any reinsurance agreement as between the parties thereto. See, N.Y. Ins. Law § 1308 (McKinney 1985 & Supp. 2000). When the ceding insurer obtains reinsurance with respect to a risk, the insured has no privity of contract with the reinsurer. Thus, in the event of the insolvency of the ceding insurer, the obligation of the reinsurer for payment on a loss is to the ceding insurer or the liquidator thereof. However, in the event of the insolvency of the ceding insurer, the right of an insured to collect from the reinsurer can be preserved by the provisions of the reinsurance contract. See, Squibb-Mathieson Intl Corp. v. St. Paul Mercury Ins. Co., 44 Misc. 2d. 835, 254 N.Y.S.2d 586 (Sup. Ct. 1964). The cut-through endorsement at issue herein is just such a provision, and, as such, will be effective in preserving the insureds right to coverage by the reinsurer.
Although the cut-through will protect the insured in the event of the insolvency of the ceding insurer, the arrangement is nevertheless subject to the rules governing voidable transfers. In particular, N.Y. Ins. Law § 7425(a) (McKinney 1985 & Supp. 2000) provides as follows:
(a) Any transfer of, or lien created upon, the property of an insurer within twelve months prior to the granting of an order to show cause under this article with the intent of giving to any creditor or enabling him to obtain a greater percentage of his debt than any other creditor of the same class and which is accepted by such creditor having reasonable cause to believe that such a preference will occur, shall be voidable.
Thus, if the cut-through arrangement were entered into within the twelve-month period prior to the ceding insurers liquidation or rehabilitation and with the intent that an insured receive preferential treatment as against other creditors or insureds of the ceding insurer, the cut-through could be set aside.
For further information contact Senior Attorney Michael Campanelli at the Departments New York Office.