Publications
Reinsurance Bulletin Service: Back-to-Back Reinsurance
March 2008
Wasa International Insurance Company Limited & AGF Insurance Limited v Lexington (Court of Appeal, 29 February 2008)
This is a key decision concerning English law reinsurances of original policies governed by a foreign law. It reaffirms the principle that, in general, reinsurers will be brought into line with the position of the reinsured, as determined by a foreign tribunal, to ensure “back-to-back” cover. It also calls into question a longstanding analysis of reinsurance which regards it as insuring the underlying risk, not the liability of the reinsured.
Background
This was an appeal by Lexington from a decision of the Commercial Court concerning Lexington’s right to reinsurance recoveries for its share of American manufacturer, Alcoa’s, clean-up costs. The reinsurance was governed by English law. Pennsylvanian law governed the original policy.
In underlying proceedings, the Washington Supreme Court accumulated several decades’ worth of Alcoa’s pollution-related clean-up costs into one three-year policy provided by Lexington dating from 1977. The decision jarred with the English law approach, and potentially that of many US jurisdictions, which is to apportion divisible long-term loss such as clean-up costs among policy years. The decision left Lexington facing a claim for $180 million, which it settled for $103 million. Importantly, the decision interpreted a period clause in the policy in a manner that accorded it no practical significance.
The Commercial Court Decision
Sedgwick reported the first instance decision in its May 2007 Reinsurance Bulletin Service.
In essence, the Commercial Court agreed with reinsurers that they should not be liable for 50 years’ worth of Alcoa’s clean-up costs. It found the presence of a “period” clause in the reinsurance (albeit in materially identical terms to the period clause in the original) evidenced an intention that reinsurers’ exposure should not be on all fours with Lexington’s.
The Court also held that Pennsylvanian law should not influence the interpretation of the reinsurance period clause unless there was a settled meaning at Pennsylvanian law when the reinsurance was entered into in 1977. In fact, at that time, probably no one would have accepted or foreseen that the period clause in the insurance could have been read in that way. The commencement of the policy in 1977 antedated much of the US asbestos-related coverage litigation that caused a sea change in insurers’ exposure. And even with the benefit of hindsight following that saga, few would have foreseen the spin on the period clause that the Washington Court was prepared to give. If neither reinsured nor reinsurer could have ascertained at inception, thirty years ago, the interpretation a foreign court places on the policy today, then you cannot impose that interpretation on the reinsurance.
The Court also took a steer from a line of authority suggesting that reinsurance is in a sense a fresh insurance of the original risk, not a liability insurance for insurers. Coverage under the reinsurance has to be decided on its own terms, and independently of the governing law of the “original” policy. If English law were applied to the period provision, it would require apportionment of the loss.
The Reversal by the Court of Appeal
A unanimous Court of Appeal swept the first instance decision aside. The separate period clause in the reinsurance was not enough to disturb the normal back-to-back presumption. It had to be given effect consistently with the underlying judgment, in the usual way.
Further, it cannot be right that there has to be a “legal dictionary” available at the time the contract was entered into that exhaustively and unequivocally demarcates the scope of the reinsurance. Although Pennsylvanian lawyers in 1977 may not have predicted the lengths courts would go to in “finding coverage” for long-term damage. But the intention of reinsurance is that the reinsurer will take the risk in such legal developments.
Finally, one Lord Justice took the opportunity to debunk the analysis of reinsurance as a quasi-insurance of the underlying risk, rather than the liability of the insurer. The origin of the theory dates back to a quirk of legislative history, which outlawed, for a time, the reinsurance of marine insurances. There was no longer a reasoned basis for the analysis and it should be discarded.
Conclusions
The decision brings the relation between English law reinsurance and foreign law underlying policy back on an even keel. In a sense, the extreme scenario presented by the underlying decision has usefully stress-tested the back-to-back presumption. As ever, parties to a reinsurance may elect to displace these principles, but they must do so clearly.
This Reinsurance Bulletin provides a summary only and is not intended to be a comprehensive statement of the law. Any opinions expressed should not be construed as those of any client, the firm or author; they are for illustrative purposes only. You should not act on this information without taking relevant professional advice.
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