By SERGIO BARROSO DE MELLO sergiom@pellon-associados.com.br

1. AIDA INTERNATIONAL WORKGROUP ON REINSURANCE PARTY By SERGIO BARROSO DE MELLO sergiom@pellon-associados.com.br Brief notes on fronting, in accordance with Brazilian provisions on reinsurance www.pellon-associados.com.br

2. FRONTING IN BRAZIL During the first two years of opened reinsurance market in Brazil, some characteristic features of the contract had to be adjusted, in order to meet the requirements of the local provisions. A typical example was observed in the field of reinsurance under the fronting model. In this sense, it is worthy to note that, among other reasons, fronting purports to allow the parties to comply with the national legislation that contemplates the insurance of their risks in the country. Therefore, a local insurance company undertakes the coverage of the risk, issues the policy, receives the corresponding premium, and then cedes it to the reinsurer, in its whole or in great part.

3. FRONTING IN BRAZIL In our country, the matter is clearly ruled by the explicit provision of article 19 of the Complementary Law no. 126/2007, according to which, for the purpose of guaranteeing risks situated in the Brazil, compulsory insurances may be necessarily contracted in Brazil, as well as facultative ones with natural persons living in the country or with legal entities domiciled in the national territory, regardless of their form of constitution. Consequently, only national insurance companies duly authorized by the Private Insurance Superintendence – SUSEP to operate can undertake such risks, thus jeopardizing the feasibility of a classical fronting.

4. FRONTING IN BRAZIL Therefore, making use of this alternative to comply with the legal system, big insured companies, while contracting insurance with a local insurer, seek coverage and guarantees with reliable international reinsurers, such operation being only possible under the fronting model. We may bear in mind an important detail referring to situations where the parties decide to contract a reinsurance fronting. In these cases, despite the relevance of a previous commercial relationship in the international reinsurance activity, the insurer is usually led to contract with the reinsurer proposed by the insured, but which is not used to operate with it, keeping no prior business relationship with the insurance company.

5. FRONTING IN BRAZIL That is the precise reason why the simultaneous payment clause becomes every day more usual in this kind of business. Then, in view of the facts and legal issues referred to as examples, it is possible to repute the reinsurance fronting as a perfectly licit alternative, that allows a big insured company to comply with Brazilian legal provisions and, in parallel, to obtain an insurance coverage under the conditions it understands to be compatible with its professional activity in the country and abroad.

6. CONSEQUENCES FOR THE PARTIES’ RIGHTS AND OBLIGATIONS A better understanding of the phenomenon involving reinsurance under the fronting model requires the study, even though a superficial one, of the rights and obligations for the parties to this kind of business, namely, the insured, the insurer, the reinsurer and the reinsurance broker.

7. THE INSURED Whenever the insured itself requires the insurer to reinsure the risks as fronting, it may play a crucial role for the execution of this kind of contract. Nevertheless, in many instances involving both facultative reinsurances (individual risks) and the automatic ones (treaties), the insured may not influence the business, as it may not even be aware of this contractual form. In situations where the insured does not influence at all the way of reinsuring risks, more particularly under the fronting model, the insurer will not be entitled to raise a further exceptio against it. As it did not take part at the reinsurance operation, the insured keeps all its original rights and obligations.

8. THE INSURED Contrarily, whenever the insured appears as an active agent for the execution of a reinsurance and even nominates the reinsurer, expressing its consent to the contract and indicating a company to reinsure its policies, as may often happen in businesses involving big-size companies in Brazil, a situation of that kind raises a crucial issue to be examined: Does such a behavior alter the mutual obligations undertaken both by the insured and by the insurer? In this case, should the insurer be released from certain fundamental obligations towards this insured?

9. THE INSURED In what concerns contractual obligations, there is no doubt that the insured is still required to perform its main duty, or, in other words, to pay the premium. This fundamental obligation arising from the contract is not affected at all. However, as it deprived the insurer from its natural right of choice of its reinsurer, the insured undertakes to accept some exceptions imposed by the reinsurer. It still faces the risk of insurer’s credit, so that the insurance company may raise a condition – such as, for instance, the need of receiving anticipated payments from the reinsurer - to withhold the payment of insurance indemnifications.

10. THE INSURED This reasoning is exactly grounded on the alteration that resulted from the insured’s influence on the original reinsurance relationship. Some of the well-reputed authors as, for instance, ÁlvaroMuñoz[1], who are very concerned about the marked intervention of insured companies and reinsurers to the detriment of insurers themselves, do not hesitate to ascertain that: “Con este sistema, el asegurador queda reducido a la condición de frontingcompany, siendo un mero instrumento o testaferro del asegurado. Los peligros de esta situación son evidentes ya que el asegurador directo debe hacer frente a la mayor parte o a la totalidad del riesgo sin tener relación alguna y, muchas veces, sin siquiera conocer los auténticos reaseguradores.”(“Byadoptingthissystem, theinsurerisreducedtothecondition of a frontingcompany, being a meretoolorrepresentative of theinsured. The risks arising from this situation are evident, since the direct insurer must undertake the most part of the whole risk, without keeping a business relationship with the real reinsurers and, many times, without even knowing them.”) [1] MUÑOZ, Álvaro. La desnaturalización del contrato de reaseguro, in Estúdios sobre el contrato de reaseguro. Madri: SEAIDA and MUSINI, 1997, pp. 203/204

11. THE INSURED Said alterations give rise to a similarity between reinsurance and insurance, and, in view of this, the insured undergoes some circumstances resulting from this kind of contractual relationship. As a concrete example, we may note that, sometimes, the insured must wait for the reinsurer’s acceptance of the proposed risk (influence at the risk’s underwriting) or even for its explicit position as to the payment of the claim. In these cases, where the contract with the insurer contemplates a control or a claims cooperation clause, the reinsurer effectively takes part at the adjustment.

12. THE INSURED If, on the one hand, the insured may accomplish some obligations towards the reinsurer, as the contractual duties from the original insurance relationship become relative, on the other hand, the insured is entitled to enforce a number of rights arising from this contractual sphere. By the way, it is possible to mention the legitimacy to directly sue the reinsurer aiming at the recovery of the insurance indemnification, even with no direct payment clause, provided that the reinsurance contract foresees a control clause, thus allowing a direct relationship between reinsurer and insured. This contractual provision minimizes the risk of insurer’s credit, being even likely to extinguish it.

13. THE INSURED The right of keeping a direct relationship with the reinsurer during the claim’s adjustment also arises from this contractual legitimacy, so that the insured is entitled to oppose the reinsurer’s decisions, as if they had been taken by the insurer. Another situation of direct contact between the insured and the reinsurer refers to the case of reinsurance encompassing a commission between insurer and reinsurer that, in fact, corresponds to the reinsurance under total fronting model (100% of the original obligation).

14. THE INSURED The insured’s initiative in requiring the reinsurance of its risks as fronting plays a relevant role at the sphere of the insurer’s rights and obligations, being crucial to mitigate and pulverize the insurance company’s liabilities. In fact, the insurer benefits from the following rights: its liability may start only upon the reinsurer’s decision as to the underwriting (such right being already provided for by article 3[1] of the Act no. 251/2004, issued by SUSEP); it may safeguard its position by using the anticipated funds to pay the claim; it is allowed to impose to the insured the need of waiting for the simultaneous payment of indemnification. [1]Art. 3o Should the acceptance of the proposal depend on contracting or altering the coverage of a facultative reinsurance, the deadlines provided for by article 2nd. of this Act will remain suspended until the reinsurer issues a formal declaration.

15. THE INSURED The situations referred to at the paragraph above would only arise in case of a direct influence from the insured at the choice of its reinsurer. The aforesaid comments would not apply to fronting if the insured had not taken knowledge of the reinsurer’s nomination or if it had not taken part at its choice. In these cases where the insurer’s contractual liability remains unaltered, the insurance company appears to be the sole and exclusive liable towards the legitimate insured for all the obligations arising from insurance contracts, including the most relevant ones such as, for instance, the compliance with the guarantee and, more particularly, the payment of indemnifications resulting from further claims.

16. THE REINSURER As regards the reinsurer, whenever fronting is contracted without the insured’s interference, this latter is entitled to keep its contractual liability solely towards the insurer. As a matter of fact, this is the original obligation, which naturally resulted from the reinsurance relationship, even because reinsurance, although being dependent from insurance, produces its autonomous effects, as had been previously pointed out. For this same reason, whenever appointed without direct influence from the insured, the reinsurer keeps all the contractual rights that had been negotiated with the reinsured insurer. Then, the reinsurer may enforce these rights towards the insurers, which are expected to comply with the original obligations provided for by the reinsurance contract.

17. THE INSURED On the contrary, should the insured influence the reinsurance relationship in whatever concrete way, such an interference alters the context of obligations, giving rise to a broader list of persons involved in the reinsurance legal relationship. Using other words to describe this new business sphere, the reinsurer, instead of being exclusively obliged towards the insurer – as happened in relation to the original contract -, is led to admit and incorporate contractual obligations towards the insured as well.

18. THE REINSURANCE BROKER Within these contractual situations of fronting, the reinsurance broker plays a crucial role for the precise definition and knowledge of the sphere of the parties’ rights and obligations. As a matter of fact, he acts essentially on behalf of the reinsurer, yet being strongly influenced by big insured companies. This can make a significant difference at the moment of checking under which model the fronting was negotiated.

19. THE INSURED Contrarily to what happens to the other parties to the reinsurance contract, the legal relationship with the reinsurance broker is not frequently affected by the fronting. In fact, his brokerage fees are still expected to be paid by the reinsurer. As the insured, as well as the insurer, may be aware of the reinsurance clauses referring to the intermediary, we observe a higher degree of transparency at the relationships.

20. CONCLUSION The purpose of this short study was to provide an overview on the current situation of reinsurance fronting in Brazil, after two years from the opening of a market that had undergone a state monopole for more than seven decades. We strongly believe that, within the next years, several divergences may still arise between insurers, reinsurers and insured companies, particularly referring to the claims; nevertheless, we also understand that many of these disputes shall be certainly settled thanks to a higher level of maturity shown by the market, to the extent that time goes by and that the accumulated experiences teach us how to deal with these new challenges.