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Missouri court denies right to offset.

Originally recognized in most jurisdictions as a common law right, offset is currently recognized by many states in their insurance laws. Offset is the mechanism by which two contracting parties, a ceding company and a reinsurer, reduce mutual debits and credits to arrive at a net balance. In the event of insolvency of the ceding company, the reinsurer relies on its statutory or common law right of offset to reduce the losses payable to the ceding company by premium amounts owed by the ceding insurer. Without this right, the reinsurer would stand in line with other general creditors waiting to collect its premiums and still pay losses in full (even if premiums relating to those losses were never received).

In general, offset requires the reduction of mutual debts to a net balance. Mutuality in this context has two essential elements: capacity and time. The capacity in which each party asserts its claim must be the same; for instance, if a reinsurer has several contracts with the ceding company, the outstanding balances of each contract may be offset against each other. In many cases, offset will be permitted when there is a series of contracts between two companies even if each acts as both a reinsurer and a cedant under separate contracts.

Mutuality in capacity does not exist among affiliate reinsurers and the insolvent cedant or when one of the parties is acting in a representative capacity, such as a trustee. Mutuality in time requires that preliquidation obligations only be offset against other preliquidation obligations, and postliquidation obligations be offset against postliquidation obligations.

Although the right to offset usually arises in claims between commercial insurers and reinsurers when, for example, the insurer has become insolvent, it is an issue for captives and risk retention groups which have reinsured a program written by an admitted carrier. Examples of this include workers' compensation reinsured by a captive or fleet automobile reinsured by an RRG. Thus, captives or RRGs acting as reinsurers must be sensitive to offset rules to ameliorate the effect of the insolvency of a ceding company.

Some states, however, restrict the right to offset. Recently, in Allendale Mutual Insurance Co., et al. v. Melahan, a Mississippi court granted Melahan's motion to dismiss the first amended complaint of one plaintiff because it failed to state a cause of action. In the complaint, the plaintiff had claimed the right to offset any reinsurance balances owed to Melahan as reinsurer of Transit Casualty Co. against the amount of reinsurance premiums that Transit owed. The plaintiff argued that a right to offset is allowed under Missouri common law. The court, however, disagreed and stated that even if it did, it would not apply if it were in conflict with the Missouri liquidation statute. The court stated that a right of offset would provide the plaintiff with a priority which would conflict with the statutory priority. The court also rejected the argument that a recently adopted statute authorizing offset merely codifies common law.

The plaintff also argued that offsets are not within the definition of "general assets" in the statutue. The court ruled, however, that because a creditor with a claim subject to offset is not defined as a "creditor with a secured claim" as to such claim, the creditor must look to general assets.

Finally, the plaintiff contended that the right to offset is an express contractual provision in the reinsurance contract. The court ruled that the provision differs from public policy because it conflicts with the Missouri liquidation statute. How this will affect the status of offset in other states remains to be seen.

P. Bruce Wright is a member of the law firm LeBoeuf, Lamb, Leiby and MacRae in New York.
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Title Annotation:Legal Considerations
Author:Wright, P. Bruce
Publication:Risk Management
Date:Dec 1, 1991
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