International Reinsurance Newsletter - 4th Edition: Middle East Update

Our recent 3-part series focusing on issues that arise for cedants and reinsurers involved in cross-border reinsurance arrangements reviewed two recent English judgments which highlighted the inherent risks where fronted risks are placed 'back to back', and reinsurers exercise 'claims control'. The full 3-part series can be accessed here.

In this final article we identified the following potential pitfalls and how to avoid them:

1. Fronting issues

   Local cedants commonly 'front' for foreign reinsurers by substantially reinsuring the risk (sometimes up to 100%). Significant risks arise for both local cedant, who is responsible for 100% of the risk whether or not the reinsurance cover responds, and reinsurers, who are reliant on the cedant's underwriting and claims handling in the local jurisdiction.

   In the Princess of the Stars, the cedant faced the invidious position of being left without any reinsurance cover for a major loss which was still to be adjudicated by the local courts. In Beazley v Al Ahleia, following market reinsurers were bound by the cedant's and lead reinsurer's actions in compromising the claim, without their knowledge or involvement, notwithstanding the reinsurance including a claims control clause.

   Additional fronting risks arise for reinsurers where:

   The cedant has a wider relationship with the underlying insured Cedants are substantially owned by the underlying insured The same broker is involved at underlying and reinsurance level In order to mitigate these risks cedants and reinsurers need:

   To recognise and identify the risks Ensure the reinsurance documents deal with inherent conflicts of interest Deal with brokers' inherent conflict of interest Cedants ought to include provisions dealing with any failure of reinsurance security (eg non-vitiation provisions). Ensuring that underlying and reinsurance wordings will be interpreted identically is vital.

   Reinsurers need to be aware that cedants retain negligible risk; understand underlying relationships; and ensure adequate controls in the reinsurance contract to permit control over claims settlement.

2. Different legal systems applying to the direct and reinsurance placements

   Middle East risks are almost always subject to local law and jurisdiction, no matter what the policy wording might say. Policies governed by foreign law will inevitably be interpreted in accordance with local law.

   Local courts may well interpret policy wordings differently to international practice...