Lack of precision in reinsurance contract wording has been known to engender anomalous results. Often a single word or phrase can cause a court or arbitrator to construe an agreement in ways unintended. In reinsurance arbitrations, when the panel majority decides how a contract operates based on its construction of a word or phrase, the losing party is likely stuck with that result even if a court might have construed the contract differently.
Recently, a New York federal court had occasion to construe a decades old third umbrella liability excess of loss reinsurance contract, and specifically its exclusion article, after an arbitration panel, by majority, had issued an award in favor of the reinsurer. Yosemite Ins. Co. v. Nationwide Mut. Ins. Co., No. 16 Civ. 5290 (PAE), 2016 U.S. Dist. LEXIS 157061 (S.D.N.Y. Nov. 10, 2016). The result may have been correct for a variety of reasons, but the arbitration panel’s construction of what I will call the write-back provision of the exclusion article is what makes this interesting.
Many reinsurance contracts have long lists of exclusions, but often contain a subsequent paragraph to the effect that the exclusions set forth in the preceding paragraph do not apply if the main operations of the underlying insured are not excluded and the operations or perils excluded are merely incidental to the insured’s main operation. The general view of these types of clauses is that the loss is not excluded and the reinsurer has to perform so long as the excluded activity is incidental to the insured’s main operations and the insured’s main operations are not otherwise excluded.
Here, the write-back provision was phrased as follows:
If the insured’s main operations are not excluded hereunder, exclusions listed in paragraph B above shall not apply, provided such operations or perils are incidental to the insured’s main operations. The reinsured shall be the sole judge of the meaning of the word “incidental.”
The umpire in the underlying arbitration saw the word “hereunder,” along with the word “above” in this paragraph and determined that “hereunder” had to refer to the two next paragraphs below (which dealt with special acceptances and head office knowledge issues) otherwise, to the umpire, the word “above” made no sense. Because of that construction, the panel majority found that the relevant exclusion applied regardless of whether the operations or perils were incidental to the insured’s main operations because the insured’s main operations were not excluded under the next two paragraphs.
Other iterations of this write-back clause in other example treaties are not burdened by the word “hereunder.” There generally is no ambiguity that the write-back clause is referring to the exclusions listed in the preceding paragraph. The purpose of the clause is to determine whether the incidental activity applies to except the loss from the exclusions listed or whether the operations were not incidental, but central to the main operations of the insured (and therefore excluded).
Under the Federal Arbitration Act, courts cannot second-guess the arbitration panel’s interpretation of the contract so long as the arbitration panel’s decision was derived from, and drew its essence from, the text of the contract. My point in raising this issue is that legalese and unnecessary words can cause a trier of fact to interpret a clause in a way that is unexpected. If the parties in Yosemite intended the write-back clause to reference the next two paragraphs and not the list of exclusions, then those paragraphs should have been expressly stated in the write-back provision. That would have resolved any ambiguity or question about how to interpret the clause.