Cut through
Meora Teitler, ADV.
What is a cut through clause?
• A cut- through clause allows a party not in
privity with the reinsurer to have rights
against the reinsurer under the reinsurance
agreement.
• The clause’s purpose is to confer upon the
original insured a right to claim directly from
the reinsurer.
When is it being used?
• A cut- through clause is a method by which
an insured or reinsured may wish to secure
its position should there be an insolvency of
the ceding company.
• It allows the original insured to take direct
action against the reinsurer .
Who needs it?
• A ceding company with insufficient financial
rating to
attract
large
commercial
policyholders.
• When the potential risk, like e.q. is huge.
• In fronting arrangement, where the reinsurer
is not licensed in a particular jurisdiction and
intends to retain all of the risk from the
original policy.
Reinsurers concerns:
• A reinsurer's main concern is that it may be subjected
to duplicate liability.
• A reinsurer usually will draft the cut- through provision
so that when the reinsurer makes payments to a thirdparty, it will not be required to make payments to the
reinsured.
• Sometimes the clause will contain indemnity provision
from the third party, should there be a double payment
situation.
Main use in Israel
• In Israel, Cut through clauses are largely
used in connection with mortgage banks due
to the huge accumulation of earth quake
exposure regarding the pledged/mortgaged
assets.
• Most banks require from the local insurers to
purchase proportional facultative reinsurance
with a "cut through" agreement attached
thereto.
Form of use in Israel
• An explicit irrevocable assignment of rights.
• An irrevocable payment instruction from the
local insurer to the reinsurer.
• A cut through agreement given by the
reinsurer to the bank and signed by the
parties.
Legal risks involved
• Does this conditioned assignment of rights
constitute:
– an assignment by way of sale.
or
– An assignment by way of pledge .
• Case law in Israel had not yet addressed this
issue.
A contract in favor of a Third party
under Israeli law
• The right of the third party is enshrined in the
contract law articles 34- 38:
• The third party- the beneficiary’s right is
created upon the formation of the contract,
and its irrevocability requires notification.
• It implies that the parties thereto intend to
grant the third party both the benefit as well
as the right to claim it.
Assignment of debts
• An assignment of debt may be subject to two laws:
– The Assignment Of Debts Law - 1969 , deals with the
relationship between the debtor and the assignee.
– The Pledge Law 1967 - deals with the relationship
between the secured creditor and the debtor.
Both laws complement one another.
• There are principally two forms of assignment:
– An assignment by way of a sale.
– An assignment by way of a pledge.
How Do Courts in the US regard the
cut through clauses?
• An interesting development seems to be taking place- the
argumentation involving attempts to assert implied cut
through provisions and attempts to impose upon
reinsurers tortuous liability.
• - In Jurupa Valley Spectrum, LLC v. National Ind: "In the
case of assumption reinsurance, the reinsurer steps into
the shoes of the [original insurer] with respect to the
reinsured policy, assuming all its liabilities and its
responsibility. “
• -In CANAL INSURANCE COMPANY v. MONTELLO, INC –
”even in the absence of an express provision, such a right
may be implied through the conduct of the reinsurer. “
To sum it up
•
Rights of the original insured (policyholder) against the reinsurer may be
triggered through cut through provisions, provided they are drafted in the right
form.
•
An explicit irrevocable assignment of rights must be given by the ceding company
and a specific cut through wording naming the policyholder as the beneficiary
must be made. The more the wording of this contract are clear and explicit, the
better are the chances of it being acknowledged by courts.
•
The parties intent and the language of the assignment contract determines the
nature of the assignment.
•
Cut through clauses may trigger actions for preferences in insolvency procedures
in order to set aside such transactions. Also the timing of their granting is an
important factor in how courts will relate to them.
•
It seems that in most jurisdictions courts require express contractual language in
accepting cut through rights of the original insured. However, recent US court
decisions open a possibility for implied cut through clauses, mainly when a
reinsurer behaves as the ceding company in its relationship with the insured.