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Arbitration provision considered by New York court.

Can a reinsurer compel arbitration with the liquidator of an insolvent ceding company? That question, which has been repeatedly considered in court, is important because arbitration, especially regarding an insolvency, may provide a faster and more economical and intelligent way to settle this issue.

Generally, the issue has been decided on the basis of whether the Federal Arbitration Act takes precedence over state law, notwithstanding the McCarran-Ferguson Act. Most courts favor compelling arbitration under those circumstances, although New York holds that arbitration cannot be compelled.

However, the U.S. Court of Appeals in New York considered the issue in a slightly different context last year in Corcoran v. Ardra Insurance Co., Ltd. In the case, a Bermuda-based reinsurer sought to compel arbitration in a dispute with the insolvent Nassau Insurance Co. While the issue did not involve the Federal Arbitration Act, it did involve the U.N. Convention on the Recognition and Enforcement of Foreign Arbitral Awards, a treaty to which the United States is a party.

Although the court held that the treaty pre-empts federal and state laws, including McCarran-Ferguson, and that reinsurance agreements are commercial contracts Within the general scope of the treaty, its application may depend on domestic law, including whether the disputed arbitration clauses are "capable of being performed" and whether the claims asserted are "capable of settlement by arbitration." As a result of McCarran-Ferguson, the Court of Appeals found that the applicable domestic statute was Article 74 of the New York Insurance Law, which mandates that disputes with insolvent insurers be litigated in the New York Supreme Court. The court found that the arbitration clauses were incapable of being performed and the claims were not "capable of settlement by arbitration" under applicable domestic law. As such, the liquidator could not be compelled to arbitrate.

IRS Eases Discounting Rules

When the Internal Revenue Code (IRC) was amended in 1986, a particularly controversial provision affecting the property/casualty industry was the requirement that loss reserves be discounted in calculating taxable income for federal income tax purposes. IRC Section 846(a) required that discounted unpaid losses be computed separately for each accident year of each "line of business," which was defined as a category for reporting loss payment patterns on the National Association of Insurance Commissioners' blank for property/casualty companies.

Accordingly, the Internal Revenue Service has computed loss payment patterns for medical malpractice business attributable to accident years through the 1991 accident year and for the combined losses for several lines of business (Composite Schedule P).

Discount factors for the medical malpractice line of business are usually calculated on the basis of an occurrence book of business, which results in greater discount factors for longer occurrence policy payout patterns.

IRC Section 846(e) permitted certain insurers to use their own historical experience to determine loss payment patterns for each accident year line of business. IRS Notice 88100 provides the requirements for this election, which include taxpayers having written premiums in the line of business for at least the number of years that unpaid losses are required to be reported for that line of business on the annual statement. In addition, taxpayers must have written a statistically significant" amount of that line of business, or in other words, an amount that is at least in the 10th percentile of industry-wide reserves for the year in which the election is made.

Thus, several smaller commercial carriers, risk retention groups and captives writing this business on a claims-made basis were precluded from using their own experience. Instead, they had to use factors based on an occurrence form payment pattern, causing taxable income to be artificially increased.

Under Revenue Procedure 91-21, taxpayers that were unable to use their own historical loss payment patterns may use Composite Schedule P factors for any "qualified line of business," including medical malpractice or a similar line of professional liability, if at least 70 percent of the gross premiums written by the taxpayer in that accident year for the line represent claims-made coverage. The election will usually apply to Composite Schedule P and to a timely filed return for the first tax year beginning after Dec. 31, 1989. Election should thus result in reduced future tax liabilities.
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Title Annotation:Legal Considerations
Author:Wright, P. Bruce
Publication:Risk Management
Date:Jun 1, 1991
Words:701
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