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A 5-2 majority of the Pennsylvania Supreme Court last week affirmed the 2003 order of a Commonwealth Court judge, who ruled that policyholders who can demonstrate third-party beneficiary rights may cut through the line of creditors awaiting payment from an insolvent insurer and directly access their reinsurance funds. A reinsurer is generally liable only to the primary insurer, but the Commonwealth Court had applied a common law exception to this rule, allowing a policyholder to bring a direct action against a reinsurer when the policyholder is deemed a third-party beneficiary of a reinsurance contract. But in a brisk dissent, Supreme Court Justice Sandra Schultz Newman argued that if a reinsurance contract doesn’t expressly give third-party beneficiaries direct access to reinsurance proceeds when the main insurer becomes liquidated, state law requires the direct payment of all reinsurance proceeds to the estate of the insolvent insurer “for the benefit of all policyholders.” Newman said she believed the Commonwealth Court had erred in granting four corporate policyholders “direct, preferential access to reinsurance proceeds at the expense of other policyholders and claimants.” The Commonwealth Court concluded two insurers that were to be liquidated by state Insurance Commissioner M. Diane Koken mainly sold “fronting” policies that were primarily reinsured by other insurers. Therefore, the risk of loss was passed almost entirely onto the reinsurers. For example, policyholder Pulte Homes Inc. purchased reinsurance and used Legion Insurance Co. as a licensed “fronting” or “pass-through” insurance company to issue certificates of insurance that enabled Pulte to satisfy state and regulatory financial responsibility requirements, said Pulte’s lawyers. Commonwealth Court Judge Mary Hannah Leavitt found that the policyholders — not Legion — “placed the reinsurance; Legion neither adjusted nor funded claims; and Legion did not seek to expand its underwriting capacity through reinsurance,” Leavitt wrote in her 2003 opinion. The insurers, Legion and Villanova Insurance Co., had avoided underwriting because their business plans called for generation of fees, Leavitt explained. She ultimately refused to allow any reinsurance proceeds to become general assets of the estates of the insolvent Legion or Villanova Insurance companies. Koken appealed Leavitt’s ruling to the Supreme Court. She argued that the four policyholder intervenors — Pulte, Psychiatrists’ Purchasing Group, Rural/Metro Corp. and American Airlines — should not have been granted exclusive rights to the insolvent insurers’ reinsurance funds because they never provided for such direct access in their reinsurance contracts, according to Newman’s opinion. The Supreme Court majority’s July 19 per curiam order affirmed Leavitt’s Koken v. Villanova Insurance Co. decision. Newman’s 13-page dissent was joined by Justice Ronald Castille. It largely adopted Koken’s argument. “Here, none of the reinsurance contracts at issue contain an express provision conferring third-party beneficiary status on any of the corporate policyholder intervenors seeking direct access to reinsurance funds,” Newman wrote. She noted that the corporate policyholders who intervened in Koken’s petition for liquidation are “sophisticated business entities who are familiar with the language contained in typical reinsurance agreements.” These “knowledgeable” policyholders “could have contracted for the inclusion of a ‘cut-through’ provision in the language of the reinsurance agreement, which would have eliminated payments to the primary insurer and, instead, provided direct payments from the reinsurer to the insured.” They had not, Newman observed. She and Koken highlighted a provision of Section 534 of the state Insurance Department Act detailing a reinsurer’s liability to an insolvent insurer in liquidation. Section 534 allows for the payment of reinsurance proceeds directly to the policyholder where “the reinsurance contract provided for direct coverage of an individual named insured.” Only when such express language is included in the reinsurance contract can there be payment of reinsurance proceeds directly to the insured, Newman contended. “Absent such unambiguous contractual language, the insureds in this matter should not have been permitted to circumvent the statutory mandate of Section 534 by simply declaring, via parol evidence, that they were third-party beneficiaries of the reinsurance contracts,” she wrote. “Instead, the corporate policyholder intervenors should have been directed to do what is required of all other insureds, namely to pursue collection of the reinsurance proceeds by filing a claim with the liquidator in accordance with the liquidation provisions of the Insurance Department Act.” In a statement, Koken said her department was assessing the impact of the Supreme Court’s order and would “continue our efforts to marshal the assets into the estate for the benefit of all policyholders.” Pulte Homes Inc. was represented by John Ellison, Timothy Law and Kevin Dreher of Anderson Kill & Olick. In a statement, Ellison said the majority recognized the “commercial realities of Pulte’s and the other policyholder intervenors’ insurance arrangements.” The ruling “is founded on common sense,” Ellison said. “A party that arranges for, negotiates and pays for a contract has the right to enforce and obtain the benefits of that contract. Whether it is called reinsurance or something else, that is and always has been a fundamental tenet of contract law.”

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