Follow the Settlements

Follow the Settlements

Investopedia / Jessica Olah

What Is Follow the Settlements?

In the insurance industry, the phrase “follow the settlements” refers to a legal provision that is often included in reinsurance contracts. The purpose of the provision is to clarify that, if the reinsured party decides to settle a claim with one or more policyholders, the reinsurer will honor those settlements. The phrase is similar to the related term, “follow the fortunes.”

Key Takeaways

  • "Follow the settlements" is a phrase used in reinsurance contracts.
  • It clarifies that a reinsurer will accept and honor the settlements made by the ceding party.
  • These provisions are an important way for insurance companies to manage their risks.

Understanding Follow the Settlements

The reinsurance market is a large and important part of the insurance industry. Through it, insurance companies can manage their risk by offloading a portion of their liability to other insurance companies.

In that scenario, the party purchasing reinsurance cedes part of their liability to another insurer, and is therefore known as the “ceding party.” In exchange, the ceding party agrees to give a percentage of the insurance premiums they collect on those policies. The party selling the reinsurance is known as the reinsurer.

From time to time, insurance companies will contest the claims made by their policyholders, arguing that the claim is illegitimate due to reasons such as improper documentation or suspected fraud. These disputes can lead to lengthy legal battles. To help avoid delays and costly legal fees, insurance companies sometimes choose to settle these disputes by agreeing to pay the policyholder a portion of the contested claim.

If the insurance company making the settlement was also party to a reinsurance contract, then the reinsurer might not agree with the decision to settle the claim. For example, the ceding party and the reinsurer might disagree about the merits of the insurance claim or the likely time and expense of litigation. To avoid additional conflict between the ceding party and reinsurer, many reinsurance contracts include a “follow the settlements” clause that clearly states the reinsurer will accept any settlement decisions made by the ceding party.

In practice, this means that the ceding party would settle the claim and submit a reimbursement request to the reinsurer. The reinsurer would then be expected to pay the reimbursement, unless they can demonstrate that the ceding party committed fraud or failed to exercise reasonable due process before deciding to settle the claim.

Real-World Example of Follow the Settlements

Michaela is the owner of an insurance company specializing in real estate development and rental properties. Recently, she agreed to underwrite insurance policies for a real estate development project in which the policyholder built and rented out an apartment building.

Under the terms of the insurance contract, Michaela’s firm would be liable for claims relating to the physical condition of the building as well as any landlord-tenant disputes. Because the project was relatively large compared to her previous insurance deals, Michaela decided to obtain reinsurance to help her manage her insurance liability. 

Unfortunately, the apartment building showed signs of physical deterioration shortly after it was constructed. Tenants complained about leaking roofs and other expensive problems, forcing the landlord to incur significant repair and restoration costs. Because these costs were covered under their insurance contract, the landlord filed several large claims with Michaela’s insurance company. Michaela suspected that the problems with the building may be due to errors made by the developer during construction, in which case she would not be responsible for covering these costs. 

After a lengthy dispute with the developer, she decided to reach a settlement and filed a request for reimbursement with her reinsurer. Although the reinsurer was initially skeptical about Michaela’s decision to settle, the follow the settlements clause in their contract made it impractical for the reinsurer to dispute this decision. To do so, they would have had to demonstrate the Michaela failed to make reasonable efforts in disputing the claim, which would be difficult to prove in practice.