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Ario v. Reliance Insurance Co.

September 4, 2009


The opinion of the court was delivered by: Judge Leavitt

Argued: June 11, 2009



Before the Court are motions for summary judgment filed by Palm Springs General Hospital and Baptist Health South Florida, Inc., (collectively, Hospitals).*fn1 Hospitals assert that they are entitled to have their medical malpractice claims paid by American Healthcare Indemnity Company (AHIC), which reinsured the policies issued to them by an affiliate of Reliance Insurance Company (In Liquidation). Hospitals claim that AHIC functioned as their malpractice insurer and, accordingly, request this Court to authorize AHIC's payment of their claims. In support, Hospitals assert that their request satisfies the standards established in Koken v. Legion Insurance Company, 831 A.2d 1196 (Pa. Cmwlth. 2003) (single judge decision), aff'd sub nom. Koken v. Villanova Insurance Company, 583 Pa. 400, 878 A.2d 51 (2005).*fn2


In the 1960s, Sullivan, Kelly & Associates, Inc., a California-based broker, developed a program of medical malpractice and general liability insurance for its hospital clients. As manager of the program, Sullivan Kelly located the insurers to write the medical malpractice coverage. It placed the primary layer with Farmers Insurance Group and the excess coverage with Lloyd's of London. In addition, Sullivan Kelly did the underwriting and pricing of the primary and excess policies; placed the reinsurance for the primary and excess insurers; and chose the company that handled the malpractice claims brought against the hospitals participating in the program.

In 1995, Sullivan Kelly began discussions with Southern California Physician's Insurance Exchange Holdings, Inc. (SCPIE) to have a SCPIE carrier replace Farmers on the primary layer of coverage.*fn3 Palm Springs General Hospital's Motion for Summary Judgment (Palm Springs), Exhibit 5. SCPIE agreed to establish a new company, American Healthcare Insurance Company (AHIC) to write the Sullivan Kelly hospital business. Because of the time needed to get AHIC licensed in all the states where Sullivan Kelly had introduced the program, it was decided to find an insurer that had the requisite insurance company licenses or authorizations to front for AHIC while it underwent the licensing process.*fn4 It was contemplated that once AHIC became licensed in a particular state, it would replace the fronting company in that state.

Reliance Insurance Company of Illinois, an affiliate of Reliance Insurance Company, was chosen to be the fronting company for SCPIE.*fn5 In accordance with the fronting arrangement, Reliance Illinois issued the policies providing the primary layer of coverage for claims under $500,000. These policies, created by SCPIE, were assigned Reliance and SCPIE policy identification numbers. AHIC accepted "100% of [Reliance's] 'ultimate net loss' [on] each and every loss, each and every subject policy" in accordance with an "Automatic Facultative Quota Share Reinsurance Agreement" (Reinsurance Agreement). Palm Springs, Exhibit 17 at 5. The Reinsurance Agreement defines ultimate net loss at "100% of the amounts paid or payable in defense and/or settlement of loss or liability under [the Reliance] policies." Id. Reliance paid AHIC a "Reinsurance Premium" of 100% of the "Gross Net Written Premium actually received by [Reliance] on Business Covered." Id. at 6. AHIC allowed Reliance "five percent (5%) of the Reinsurance Premium payable under this Agreement .." Id.

The Reinsurance Agreement contains provisions that are standard for reinsurance contracts. Of significance to this case are two clauses highlighted by the Liquidator in support of his argument that Hospitals should be denied direct access.

The first clause highlighted by the Liquidator is a clause (Privity Clause) that prevents either policyholders or claimants from sidestepping the ceding company and presenting their claims directly to the reinsurer. This Privity Clause states:

Except as expressly provided for in the Article entitled Insolvency, the provisions of this Agreement are intended solely for the benefit of [Reliance] and Reinsurer. Nothing in the Agreement shall in any manner create or be construed to create any obligations to or establish any rights against any party to this Agreement in favor of any other persons not party to this Agreement.

Palm Springs, Exhibit 17, art. XV. Notably, this clause ceased to be effective after insolvency.

The second clause highlighted by the Liquidator is the Insolvency Clause. It states, in pertinent part, as follows:

In the event of the insolvency of one (or more) of the reinsured companies, this reinsurance shall be payable immediately upon demand directly to the insolvent Company, or to its liquidator, receiver, conservator or statutory successor on the basis of the liability of that Company without diminution because of the insolvency of that Company or because the liquidator, receiver, conservator or statutory successor of that Company has failed to pay all or a portion of any claim.

The reinsurance shall be payable by the Reinsurer to that Company or to its liquidator, receiver, conservator or statutory successor, except as provided by applicable Insurance Law, or except (a) where the Agreement specifically provides another payee of such reinsurance in the event of the insolvency of that Company, and (b) where the Reinsurer with the consent of the direct insured or insureds have assumed such policy obligations of that Company as direct obligations of the Reinsurer to the payees under such policies and in substitution for the obligations of that Company to such payees.

Id., art. XVIII (emphasis added).

In accordance with a "Program Manager's Agreement," SCPIE Management Services, Inc., an affiliate of AHIC, underwrote the Reliance fronting policies issued to Hospitals, using the underwriting guidelines developed by Southern California Physician Insurance Exchange, another SCPIE insurance company. Palm Springs, Exhibit 18, Exh. A. SCPIE Management also priced the policies issued to Hospitals and collected the premium from them. SCPIE Management wired the premium it collected to Reliance, which, in turn, remitted the premium, less its 5% ceding commission, to SCPIE Management. Reliance demanded that the premium flow through Reliance in this manner because of certain "tax and accounting rules." Palm Springs, Exhibit 35 at 1. SCPIE Management provided monthly premium reports to Reliance. The costs of the services provided by SCPIE Management were paid by AHIC. Palm Springs, Exhibit 18, art. V.

Pursuant to a separate "Claims Services Agreement," SCPIE Management investigated, defended and adjusted the malpractice claims covered by the program. Palm Springs, Exhibit 19. It gave SCPIE Management total settlement authority, i.e., $500,000 per claimant and per occurrence. Id. at 19. The Claim Services Agreement allowed Reliance "the right to assume the control and handling of any Claim at any time." Id. at 4.However, Reliance did not exercise this right. SCPIE Management agreed to provide the services until "each claim shall have been paid.." Id. at 4. The services included "all payments with respect to Claims and to pay all Allocated Loss Expenses . from funds provided in accordance with the procedures set forth in Exhibit D." Id. at 5. Exhibit D provided that SCPIE Management would establish a regular bank checking account . [called] the Disbursement Account . [to] be used solely to make payments of Claims or to pay Allocated Loss Expenses or to receive recoveries in accordance with the terms of this Exhibit and the Agreement." Id. at 26. In consideration for SCPIE Management's "Basic Services for all Claims," including the funding of the Disbursement Account, Reliance agreed to pay SCPIE Management "fees and charges set forth in Exhibit C." Id. at 5. The fees and charges in Exhibit C are stated to be "None." Id. at 25.

The 5% fronting fee, or ceding commission, paid to Reliance under the Reinsurance Agreement, was lower than the 10% suggested by the Reliance corporate guidelines for fronting arrangements. However, Reliance deemed the 5% fee an "adequate front fee considering Reliance's limited administrative involvement." Palm Springs, Exhibit 36, August 1, 1997, internal Reliance memorandum.

In 1996, when Farmers was dropped from the program, Sullivan Kelly offered "the SCPIE Program" to its hospital clients as Farmers' replacement. In its marketing materials, Sullivan Kelly identified the malpractice program as the "SCPIE Program," Palm Springs, Exhibit 30, and explained, in a form letter to clients, that "SCPIE policy coverage will be much like the Farmers Insurance Group policy." Palm Springs, Exhibit 28 (emphasis added). These marketing materials trumpeted SCPIE's qualifications to provide claims management and risk management services to participating hospitals. These materials were silent on Reliance's qualifications in any regard; indeed, they did not make any reference to Reliance.

In 1996, Reliance began fronting for SCPIE, thereby replacing Farmers on the policies issued to Hospitals. At that time, Palm Springs had been involved with the Sullivan Kelly program for three years and Baptist Health for four years. On October 1, 1998, after SCPIE was licensed, the fronting arrangement with Reliance ended. Thereafter, AHIC issued the policies directly to Hospitals.

The Reliance Liquidation

On October 3, 2001, Reliance was placed into liquidation, a proceeding governed by Article V of The Insurance Department Act of 1921, Act of May 17, 1921, P.L. 789, added by Section 2 of the Act of December 14, 1977, P.L. 280, as amended, 40 P.S. §§221.1 -- 221.63 (Article V). As a result of this liquidation order, SCPIE Management ceased paying on claims presented by Hospitals because the Liquidator asserted a right to these payments under the Reinsurance Agreement. Accordingly, since 2001, Hospitals have been funding the claims arising from the 1996-1998 policy periods; those claims are not covered by state guaranty funds.

In connection with the Reliance liquidation, this Court approved the Liquidator's proposed guidelines for evaluating a Reliance policyholder's request for direct access to reinsurance.*fn6 The Reliance Guidelines provide that a policyholder seeking direct access to reinsurance proceeds must present a cut-through endorsement. In pertinent part, the Reliance Guidelines state:

3. Where a binding written contract document creating the reinsurance relationship between Reliance and a reinsurer contains a provision relating to the direct payment of the claims of an insured by the reinsurer, and the reinsurer or insured desires that such direct payment be made by the reinsurer, the reinsurer or insured must first submit a written request to the Liquidator seeking approval of direct payment by the reinsurer.

4. In reviewing the written request [for approval of direct payment by the reinsurer], the Liquidator, or her designee, shall determine whether the following requirements are satisfied before approving the request:

a. The reinsurance contract must specifically provide for payment to an individual named insured and that insured must be identified with particularity either by name or policy number in the reinsurance contract;

b. The reinsurance contract must provide for a direct coverage obligation by the reinsurer to the insured and the payment must be made in satisfaction of that coverage obligation. The term "direct coverage" in § 221.34 refers to the creation of rights in the insured to look to the reinsurer directly to satisfy coverage obligations in place of and in substitution for any obligations of Reliance to the insured and on such terms as are set forth in the policy of insurance between Reliance and the insured.

Order of April 26, 2002, Exhibit A (emphasis added). Following the Liquidator's refusal to permit Hospitals' direct access to the AHIC reinsurance, the Hospitals filed objections.

This Court assigned Hospitals' objections to a Referee, who used the documentary evidence submitted by the parties to establish the record. Hospitals objected, citing a need for more discovery. Based on the legal arguments of the Liquidator and of Hospitals, the Referee recommended that (1) Hospitals' request for discovery be denied and (2) Hospitals' objections be denied. This Court accepted the Referee's findings of fact, but it did not adopt his recommendation. Instead, the Court granted Hospitals' objections, thereby allowing them to present their claims to AHIC for payment.

At the time Reliance was placed into liquidation in 2001, the management of Reliance and SCPIE had been negotiating a novation to have a SCPIE insurance company replace Reliance retroactively on the 1996-1998 fronting policies. Negotiations continued after Reliance was placed into liquidation, but the Liquidator refused to agree to a novation. However, this Court ruled that the parties, by their actions, had "caused a novation of the reinsurance contract," thereby authorizing Hospitals to present their claims to AHIC for payment. Koken v. Reliance Insurance Company, 846 A.2d 167, 172 (Pa. Cmwlth. 2004). On appeal, our Supreme Court, in a per curiam order, vacated and remanded "for discovery relating to the issue of whether Palm Springs General Hospital and Baptist Health South Florida Hospital are entitled ...

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