We have spoken about “contract certainty” before. In the rush to have contract certainty, auditors and regulators have insisted that insurers and reinsurers have documents that contain more language than the “slips” or what might be considered shorthand contracts. While as an attorney, I applaud the intent of contract certainty. Contract certainty requires more than just more words. A poorly drafted contract will not meet the aims of contract certainty.

In a recent case In Re Acceptance Ins. Co. Inc. that was reported in Reinsurance Focus, www.reinsurancefocus.com/, the parties had contracts. While there were a number of issues under consideration by the courts, due to the failure to define all the relevant terms a significant amount of time and money was spent arguing before the courts. Even terms that many in the industry would consider to be almost boilerplate need to be defined. Let us face it, when things are going well, no one will need to look at the thirty or more pages of a reinsurance contract. All the important parts can be written on the “back of a napkin.” It is when a claim is a little outside the norm or a company has run into some financial difficulty that all the pages are looked at with great scrutiny. We should work to ensure that all pages get that scrutiny and are understood by all.

I was happy to see that the Obama Administration has sent a letter to the Chairman of the House Financial Services Committee opposing the inclusion of wind coverage in the National Flood Insurance Program. There was recognition for the need for the rates charged for the coverage to be “actuarially sound.” When this was factored into whether there was a need for a federal program, the determination was that there were sufficient private market resources available to provide the coverage.

As I’ve said before, what will help to keep the catastrophe rates down, is if the tax code is changed to allow for the deductibility of reserves established for future catastrophes. Before my friends in the reinsurance world get all excited that I am advocating a reduction in rates, please note that, at present, any premiums (less expenses) that are not used to pay current year catastrophes are considered to be profit and subject to corporate income tax.

What is the problem with the arbitration clause? In theory, there is nothing wrong with arbitration. Instead of using the courts with a jurist or jury who knows nothing about your business, you enlist people for the arbitration panel who are well versed in the norms of the business. They will apply the procedural rules of law in a less rigid manner than the courts. It is supposed to be faster.

While there has been a good deal of litigation concerning arbitration, most litigation has been whether the controversy is subject to arbitration or were the arbitrators so far off base as to the law or facts that the arbitration decision should be thrown out. The problem is that, since almost all reinsurance agreements have an arbitration clause in them and the rationale for the arbitration decisions are not published, the body of reinsurance law is growing much more slowly than for insurance law.

Since many of the clauses the businesses to which they relate are similar, a party could arbitrate the same issues more than once and come out with both positive and negative results even when the same law is being applied. While this can also happen at a trial court level if the agreement were to lack an arbitration clause, the parties would at least have ability to appeal the decision. The results of the appeal would at least provide some certainty for that jurisdiction and maybe guidance in others.

There has been a move in the reinsurance business towards what has been called “contract certainty.” As an attorney, I’m all for contract certainty, whatever that is. The reinsurance world has long been more casual and fluid with respect to contracts than on the insurance side. Evidence of a reinsurance agreement may have been as informal as the legendary cocktail napkin agreements, although there was usually a document that is called a “slip.” The slip usually had all of the important elements of the contract spelled out followed by a listing of clauses that were considered to be standard. Since relationships were frequently long lasting and between parties that knew each other well, if there were problems they would be worked out between the parties and terms would be adjusted. There were times that the term of the agreement would have ended before it was reduced to a complete signed document with all of details spelled out.

The reinsurance world moved on and relationships became more distant. Parties began insisting on something more than just a handshake or a slip, particularly after the events of September 11th. Although the disputes involved an insurance agreement, the point of not having agreement to all of the terms is equally applicable to the reinsurance contract.

Auditors and regulators were rightfully concerned that, without all of the terms spelled out, how could they be sure that the reinsurance recoverables or payables that companies would show on their balance sheets were correct. I submit that there is one clause that appears in almost every reinsurance contract which actually contributes to contract uncertainty, the arbitration clause.