Best’s News & Research Service - May 17, 2004 09:36 AM (EDT)
WTC Binder Execution Fell Short, Experts Say
NEW YORK //BestWire// - The kernel of the dispute settled in the just-completed World Trade Center trial-which of two competing forms the insurers agreed to bind to-lies in the ability of the parties involved in putting together the complex property insurance program to negotiate coverage in an accurate and timely manner.
Insurance and legal experts mostly agree that the methods employed by brokers, insurers and reinsurers to get insurance deals together in the months before the Sept. 11, 2001, terrorist attack were-and still are-sound. But the execution of those methods, influenced by deadline pressure from leaseholder Larry Silverstein and by competing policy forms, left a lot to be desired.
"Large, complex property accounts require a lot of attention," said Sherryl Pierre, a partner with property/casualty brokerage and consultancy Travers O'keefe. Two major elements in getting such a program together-agreement on a policy form and a consistent, well-documented effort to reach that agreement-were lacking in the months leading up to Sept. 11, she said.
When approaching large-scale placements like the World Trade Center, a broker must first determine what carriers they will use, then try to decide how much each carrier is willing to take on. "The third step is to decide how much is going to go out to the reinsurers," said Pierre. "Once those things are determined, the next part is determining the form to be used, and the coordination here is critical."
Much has been made about the fact that there was no final insurance policy in place for the World Trade Center when the terrorists struck. A 99-year lease had been signed by the leaseholders-Silverstein Properties and Westfield Properties-with the Port Authority of New York and New Jersey, the twin towers' owner, less than two months before Sept. 11. More than 20 insurers and reinsurers were negotiating final coverage terms with the leaseholders through Silverstein's broker, Willis Group Holdings, using temporary binders and slips to commit to coverage until a final policy could be issued.
In the 13-week trial in federal court in Manhattan, the leaseholders attempted to prove that most of the insurers involved bound to a form submitted by Travelers Insurance Co., rather than a rival form issued by Willis. A federal court ruled earlier that the Willis form's definition of "occurrence" defines the destruction of the World Trade Center as a single event. The definition of occurrence in the Travelers form has yet to be determined. As a single occurrence, the event would cost the insurers a combined $3.55 billion. Two occurrences would have doubled that.
A lingering post-trial question is whether the temporary binders and slips used by the insurers and brokers were inadequate for legal purposes.
Kenneth W. Erickson, a partner in the law firm Ropes & Gray LLP and one of the attorneys representing the London insurers in the trial, said the industry's use of binders and slips to get coverage into place temporarily was not the source of failure in the World Trade Center's case. An opinion on some of the insurers involved in the twin towers' coverage delivered by the 2nd Circuit Court of Appeals in New York last September included a lengthy review of the history of binders and binder law, demonstrating the value of binders, he said.
"There was an appeal earlier in this case, which set some of the parameters of law that were relevant to this trial," said Erickson. "They pointed out that having these binder contracts is very important to the way that life is conducted in the commercial world. It is commonplace that binders are in effect for a period of time, until the final policy is issued. That serves an important purpose, because it allows closings of transactions and other things to take place."
The 2nd Circuit court recognized that binders are important in the commercial world, serving a useful purpose, and that the law should recognize that there are some unique features to them. "You will not always have a fully-agreed policy in place at the date of coverage inception," said Erickson. "Obviously, you want the final wording in place as soon as possible, but you can't always do that."
The 2nd Circuit's opinion, which upheld St. Paul Fire & Marine Insurance Co.'s argument that it had bound to WilProp, reinforced the insurers' argument that the dispute was about basic contract fundamentals, said Lon A. Berk, a founding partner of law firm Shaw Pittman LLP's insurance coverage litigation group. Berk, who represented St. Paul before the 2nd Circuit court, said that court had upheld a long-standing tradition in New York law that binders serve well as "a present contract" while negotiations continue on a final form.
"It's like when you add a car to your auto insurance policy," he said. "You call your insurance broker and tell them to put the new car on the policy. It won't be on your original policy, but the coverage is added."
Complex commercial programs such as that for the World Trade Center also require the smoothing out of differences in practices between players coming from different markets. With reinsurers from Switzerland and Germany, insurers and reinsurers from Lloyd's and the London market and players from North America, Bermuda and Japan all involved, coordination on the twin towers project was a challenge, and the use of binders and slips a necessity.
"In London, the broker's the one who generates the policy documentation," said Erickson. "The underwriters themselves don't issue the policies. The broker negotiates what the terms and conditions are going to be, then prepares the policy wording and clears it through the system in place in the London market. So there is going to be some lag time, where binders provide the structure. But according to the courts, it is a necessary and useful structure. In my opinion, binders are an important structure, and they are here to stay."
Temporary insurance arrangements can work well, but two factors must be present for them to hold up under scrutiny-everything that's agreed to must be well documented, and the drive to finalize negotiations must be kept up. Grant Hanessian, a partner in the New York office of the international law firm Baker & McKenzie who represented QBE International Insurance Ltd. during the trial, said the key to winning in any commercial dispute is having everything clearly and consistently documented.
"It usually takes several years for a dispute of this size to reach trial, and as you go about your everyday business, you never know which of the things you do will end up in court," he said. "In any commercial dispute, whoever has the best paper records usually wins."
Hanessian said his client and most of the other insurers had their documentation in better order than some of the witnesses for the leaseholders, including Willis brokers who worked on the program. The trial's pivotal witness, Willis broker Timothy Boyd, who spent far more time testifying than any other witness (10 days), did not present a convincing account of what happened and when, Hanessian said. "The way to avoid 10 days on the witness stand is to have a clear paper record," he said. "He did not."
Well-documented negotiations would have been particularly useful in the World Trade Center case, where Silverstein was coming into an arrangement as a new leaseholder on a big, complex piece of property, said Hanessian. Adding to Silverstein's problems was the short time he had in which to put insurance coverage in place, so that he could line up the financing that would allow him to sign the lease with the port authority.
In the end, the paper trail is key. "Boyd said he had a series of telephone conversations with insurers about switching from one form to another, but he had no clear paper record," said Hanessian. "You need to get the policy finished, rather than relying on coverage being bound on a series of short forms and slips."
A Willis spokesman said the company did not wish to comment on the trial or its outcome.
Willis Chief Executive Officer Joe Plumeri commented at several recent industry events, including the Risk and Insurance Management Society's annual conference in San Diego, that insurance participants from risk managers to brokers to insurers need to "embrace technology" in such as way as to get around what he sees as inherent flaws in traditional paper filings linked to contract negotiations. "We all need to move away from shaking hands on deals and later figuring out what we agreed to," he said at RIMS. "Employing that technology will enable that much-needed change."
According to Berk, St. Paul's success in the 2nd Circuit ruling had a lot to do with the straightforward, documented way in which the insurer dealt with the buyer and broker. "You have to make sure there are written records of what you want to agree to," he said.
Jay M. Levin, leader of Cozen O'Connor's insurance coverage practice group, which represented Chubb Corp.'s Federal Insurance Co. in the trial, pointed out that two big insurers in the World Trade Center program-Ace Ltd. and XL Capital Group-settled with the leaseholders in 2002 and avoided the lengthy and costly trial because they put language into their binder referring specifically to the WilProp form. The documentation left no doubt about where they stood. "They referenced it by name," he said.
"It seems to me that a lot of this could have been avoided if the binder the brokers sent out to the market had just specified the form instead of just saying 'manuscript form'," said Levin. "The real problem, in my view, is that the broker's desire to change forms from WilProp to Travelers was never properly communicated to the carriers."
Hanessian acknowledged the complexity introduced by having two competing policy forms in the mix. Usually, on a large commercial property program, the parties involved try to finalize their positions on one, properly amended form. In the World Trade Center case, Silverstein's need for speed-he had to get the insurance in place to get the financing that would allow him to sign the lease-along with the number of insurers and reinsurers involved (more than 20), provided plenty of headaches for the brokers.
Kevin Brawley, president of Savannah Reinsurance Underwriting Management, a Palmer & Cay subsidiary, said participants in large commercial property placements such as the World Trade Center must work hard to avoid ambiguity of terms at all stages of the negotiating process.
"Many potential participants may get involved in the early stages of the structuring and placement of a large account, even some reinsurers," he said. "To get a very large placement completed, there is a need to understand both insurance company and reinsurance company risk appetites for the account. If not, some potential capacity may not be utilized because they were only offered a part of the account that was outside their underwriting parameters."
Some potential markets prefer pro rata participations, others high excess points of attachment, said Brawley. "Others have available earthquake capacity but no coastal wind capacity, or vice-a-versa. All these preferences need to be taken into account when designing the account placement structure in order to maximize total capacity. It is often like putting together a thousand-piece puzzle," he said.
Brawley, who has been in the insurance business since the late 1970s, said his impression is that not much has changed in the placement of large risks. Sorting out all the different quotes and counter-quotes is still difficult and still requires great attention to detail. "If anything, placing a large account is more complex now, because forms are less standardized, coverages broader and exposures to loss harder to gauge," he said.
Most markets also use catastrophe modeling software, and need to perform a new analysis every time a change in terms, pricing, or layer structure occurs. Every time a change in account specifications are communicated to every potential participant, a whole new set of comments, questions, counter-quotes or quotes with coverage exceptions are received. "Further, a reinsurer may see this same account from several potential cede company clients, each quoting slightly different terms, prices or forwarding slightly different sets of information," said Brawley.
Andrew J. Barile, president and chief executive officer of insurance and reinsurance consultancy Andrew Barile Consulting Corp. Inc., said the reinsurer's role in complex programs has changed over the years. Describing himself as a "traditionalist," Barile expresses discomfort as the idea of the reinsurer getting more heavily involved in the front end of negotiations.
"In the traditional distribution system, the broker works with the primary insurer, then the insurer works with the reinsurer-at each stage everyone is on the same page, talking at the same level of expertise," he said. "When you start getting the risk manager and the broker jumping into talks with the reinsurer, you run the risk of people having to make decisions without understanding the definitions, the contract language."
Given the pressure on both Silverstein and Westfield, the brokers needed to drive all parties toward a final policy form as quickly as possible after the initial binders were gathered, said Hanessian. But there was a period of about 60 days between the signing of binders in July and Sept. 11, where the negotiating process bogged down as Willis brokers examined the alternate form presented by Travelers.
Since the broker represents the buyer, they want to get the best price and terms for their client. At a certain price and set of terms and conditions, the process is relatively straightforward as plenty of capacity is offered and most everyone is comfortable with the risk/reward balance. "As the pricing gets lower, and the terms and conditions get broader, potential participants begin to decline the account or reduce capacity," Brawley said. "They also begin counter-quoting changes in the offered terms to make it work for them. It's not just price. It could be lowering a sub limit, excluding certain difficult exposures, raising deductibles or requiring policy language changes. Multiply all the different prices and subjectivities times the number of participants and the complexity of the placement dramatically increases."
Pierre said that whether the broker and all the carriers involved settle on a manuscript form, and ISO form or a proprietary company form, it is critical that an agreement is reached on a form to be used throughout each layer of coverage. "That was one of the big problems that we've seen in the World Trade Center case," she said.
"It's very important for a broker to stay involved all the way around," said Pierre. "And if there is a risk manager involved on the insured side, it's important that the lines of communication are open, and everyone is on the same page at the same time."
With the World Trade Center trial as background, it is likely brokers will engage more in the negotiating process from the beginning in complex commercial programs, paying much more attention to contract language and moving in a step-by-step fashion, said Pierre. "As you work through the layers of the program, you will have to be sure everyone is in agreement as to what will be used in the first layer, and take that agreement into the second layer, and so on," she said.
(By David Pilla, senior associate editor, BestWeek: David.Pilla@ambest.com)