The office of General Counsel issued the following informal opinion on February 26, 2002, representing the position of the New York State Insurance Department.

Re: Reinsurance Agreements That Cover Extra Contractual Obligations.

Question

1. Does a New York domestic reinsurer who enters into a reinsurance agreement with a ceding insurer for coverage of a risk located outside New York State that may include indemnification for the ceding insurer’s extra contractual obligations for fraud or bad faith need to include a savings clause in such reinsurance agreement?

2. Would the requirement that such a reinsurance agreement contain a savings clause depend on the domiciliary of the ceding insurer?

Conclusion

1. Yes. N.Y. Ins. Law § 1102(b) (McKinney 2000) bars a New York domestic reinsurer from issuing a reinsurance agreement that may include indemnification of a ceding insurer’s extra contractual obligations, whether the risk insured against is located within New York State or outside New York, unless the reinsurance agreement contains a savings clause.

2. No. The requirement is based on the New York licensing status of the reinsurer.

Facts

No specific facts were provided. The questions were general in nature.

Analysis

1. A New York domestic reinsurer may not enter into a reinsurance agreement that includes the ceding insurer’s extra contractual obligations to its insured, which could require indemnification for coverage not permitted in New York such as fraud, bad faith and/or punitive damages, whether the agreement is issued for a risk located in New York or elsewhere, unless the agreement contains a savings clause that states, "in no event shall coverage be provided to the extent that such coverage is not permitted under New York law."

The Insurance Law does not have a definition for extra contractual obligation. Some reinsurance agreements define it as those liabilities not covered under any other provision of the insurance agreement between the insurer and its insured and which arise from the handling of any claim by the insurer on the policy, such as liabilities arising because of, but not limited to, the following: the failure by the insurer to settle within the policy limit, or by reason of alleged or actual negligence, fraud or bad faith in rejecting an offer of settlement or in the preparation of the defense or in the trial of any action.

The extra contractual obligation is not a kind of insurance, it is merely the extra liability of the ceding company as a result of its claim handling for those kinds of business that it is authorized to write.

The Department has previously opined that under N.Y. Ins. Law § 1102(b) (McKinney 2000), a New York domestic insurer (including a reinsurer) is barred from doing an insurance business outside New York State which it is not permitted to do in New York State.

Specifically, New York domestic insurers may not provide coverage for fraud, bad faith and punitive damages as it is against public policy. Numerous New York courts have ruled that such insurance coverage would defeat the purpose of an award of punitive damages, which is to punish and deter unacceptable behavior ¹.

Likewise, a New York domestic reinsurer may not provide coverage for an insurer’s fraud and/or bad faith in handling claims. Thus, a New York domestic reinsurer² that enters into a reinsurance agreement, that covers a ceding insurer’s extra contractual obligations that may involve indemnification to the ceding insurer for fraud, bad faith and/or punitive damages must modify the reinsurance agreement by the inclusion of a savings clause.

2. The fact that the ceding insurer is not a New York domestic insurer does not change the above analysis. The requirement is based on the New York licensing status of the reinsurer and not the ceding insurer.

Therefore, a New York domestic reinsurer may not enter into a reinsurance agreement that covers a ceding insurer’s extra contractual obligations, whether the agreement is issued for a risk located in New York or elsewhere, unless the agreement contains a savings clause.

For further information you may contact Senior Attorney Adiza Mohammed at the New York City Office.

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¹The New York Court of Appeals stated, in Zurich Insurance Company v. Shearson Lehman Hutton, Inc. 84 N.Y.2d 309, 618 N.Y.S.2d 609 (1994), that a necessary threshold determination is whether the tortious conduct in the underlying personal injury action would support an award of punitive damages in New York. If the damages awarded would not be punitive under New York law, indemnification would not be precluded by New York public policy.

²Although the New York court mentioned above discussed the issue of indemnification for punitive damages awards within the context of an insurance agreement (as opposed to a reinsurance agreement), the Department’s position for purposes of the public policy enunciated by the New York courts and its application of N. Y. Ins. Law § 1102(b) (McKinney 2000) makes no distinction between an insurance agreement and a reinsurance agreement.