Pennsylvania Court Gives Policyholders Direct Access To Reinsurance Of Insolvent Insurer
2003 Winter - Insurance Newsletter
January 1, 2003

While in most instances there are barriers to policyholders having rights directly against the reinsurer of an insolvent insurer, in a ground-breaking decision, Judge M. Hannah Leavitt of the Pennsylvania Commonwealth Court recently concluded that several policyholders were the intended third-party beneficiaries to certain reinsurance agreements and were thus entitled to the agreements' proceeds. Koken, Ins. Comm'r of the Commonwealth of Pennsylvania v. Legion Ins. Co., 831 A.2d 1196 (2003).

The Psychiatrists' Purchasing Group ("PPG") was one of the policyholders who benefited from the decision. PPG is an insurance purchasing group that was established by the American Psychiatric Association as a vehicle for its member-psychiatrists to obtain professional liability insurance benefits tailor-made to the practice of psychiatry. Legion Insurance Company became the principal front company for PPG's insurance program in 1988, meaning that it bore very little risk, passing most of the potential risk onto reinsurers. In 1991, the program obtained reinsurance from Transatlantic Reinsurance Company ("TRC") for a portion of the program's losses. Over a period of years, TRC took on larger and larger shares of the program's risk, and by April 2002, reinsured approximately 95% of the program's risk. At the time Legion was deemed insolvent, approximately 7,000 psychiatrists and other mental health professionals insured through the program.

In April 2002, the Commonwealth Court of Pennsylvania placed Legion into rehabilitation. The state's insurance commissioner subsequently filed petitions seeking to place Legion in statutory liquidation. Shortly afterwards, several Legion policyholders, including PPG, petitioned to intervene in the action. The Commonwealth Court granted these petitions and re-opened the record to allow policyholders such as PPG to present evidence in support of their request for access to the reinsurance proceeds in order to satisfy outstanding claims, such as professional liability malpractice claims.

In her opinion and order on the insurance commissioner's liquidation petition, in addition to ruling that Legion was insolvent, Judge Leavitt granted the policyholders' petitions for direct access to the reinsurance agreements. In reaching its conclusion, the court found that the TRC reinsurance was negotiated for the benefit of the program participants; that during the history of the program, the program administrator worked closely with TRC with regard to premium rate setting, underwriting and claims decisions, while Legion had minimal involvement with regard to program issues; that TRC, in effect, functioned as the direct insurer for PPG and the program's participants; that the program's participants were the intended beneficiaries of the TRC reinsurance; and that, for various reasons, the state guaranty funds might be inadequate or unavailable to pay all future claims for the program's participants.

The court explained that "Legion has no right to the proceeds of the reinsurance agreements that cover the liability claims of … PPG" and that "[d]irect access to reinsurance . . . will give effect to the reasonable expectations of policyholders" and "will not adversely affect the Legion estate." Relying on case law as well as various provisions of Pennsylvania's Insurance Department Act, the Commonwealth Court's decision recognized policyholder's rights to obtain the intended benefits of the coverage they paid for: "The general rule makes little sense . . . where following it will turn upside down the contractual arrangements established by the [policyholders] for providing for their liability risks."

The decision is currently the subject of an appeal before the Supreme Court of Pennsylvania.

PPG was represented by Terence Cummings of Ohrenstein & Brown, LLP. Readers interested in obtaining a copy of the court's decision may contact him.