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Publications
Reinsurance Bulletin
August 2009
Lexington Insurance Co v AGF Insurance Ltd; Lexington Insurance Co v Wasa International Insurance Company Ltd (House of Lords, 30 July 2009)
There is hardly a more fundamental issue in facultative reinsurance than the nature of "back-to-back" cover. This issue has been explored in depth in the case of Lexington v Wasa, which has run the gamut of the English courts. The House of Lords has now rendered its decision, reiterating the primacy of the terms of the reinsurance and reinstating the judgment at first instance.
We have previously reported on the earlier decisions in this litigation (May 2007 and March 2008), but a brief reminder of the facts may be in order.
Background
Lexington was one of many insurers sued by Alcoa in the 1990s for indemnity in respect of cleanup costs for contamination of some 58 sites across the United States and outside it. The various insurance policies covered periods between 1956 and 1985, that of Lexington being 1977 to 1980. The litigation took place in Washington state and Pennsylvania law was held to apply to the dispute. In light of limitation issues presented by the different policy wordings, all insurers but Lexington were eventually dismissed from the action. In an interplay of policy wording and Pennsylvania law, Lexington was held liable by the state supreme court for all the losses incurred by Alcoa at the various sites and over the entire period in question. Lexington settled a potential $180 million liability for $103 million and sought indemnity from its reinsurers.
The insurance and reinsurance contracts were effectively back-to-back, having the same policy period, perils covered and general terminology; however, the reinsurance contract was governed by English law, whereas the insurance policy contained only a "service of suit" clause.
The Decision
Two reinsurers, Wasa International Insurance Company Limited (Wasa) and AGF Insurance Ltd, resisted Lexington's claim. The court at first instance held that reinsurers could only be liable for the costs incurred in remedying the damage that occurred during the policy period. The Court of Appeal reversed that decision in light of the precedent in Vesta v Butcher, finding that the parties intended the cover to be back-to-back, such that the period clause in the reinsurance agreement should be given the same meaning as that in the insurance policy (as interpreted by the foreign court). In essence, the Court of Appeal considered that the subject matter of a reinsurance policy was the liability of the insurer under its contract of insurance. The House of Lords disagreed, affirming the time-honoured view under English law that the subject matter of both policies was the same, i.e., the underlying risk. To be indemnified under the reinsurance contract, the insurer first needed to establish (a) that it was liable to the insured under the terms of the insurance contract; and (b) that it was entitled to indemnity under the terms of the reinsurance contract. Although there is a presumption that liability under facultative reinsurance is co-extensive with the insurance, that presumption can be rebutted.
The House of Lords was unanimous in holding that application to the present facts of its 1989 decision in Vesta v Butcher was misconceived and that the principle established by Vesta "cannot be made into an inflexible rule of law, which would impose on reinsurers a liability for which, under the law applicable to the reinsurance, they did not bargain". Unlike the situation in Vesta (where the effect of a warranty clause under Norwegian law (which governed the insurance policy) "trumped" that of English law (which governed the reinsurance)), the parties in Wasa would have been unable to ascertain in advance the construction of the policy wording under any US law, as it was only at trial and in the particular circumstances of the Alcoa litigation that Pennsylvania law was held to govern the contract. Furthermore, the underlying coverage litigation had dealt with issues and circumstances that were outside the Lexington policy, hence not within the contemplation of the parties to the reinsurance agreement.
The House of Lords confirmed the principle that the period clause in a reinsurance contract is fundamental to coverage. Although Lexington argued that the Washington court had assigned a specific meaning to the period clause, their Lordships noted that the decision of the Washington court was not "that losses occurring during the policy period encompassed liability or losses flowing from damage which occurred during that period. It was a decision that, provided that there was some damage in the policy period, the insured had a right to indemnity for liability flowing from damage whenever it occurred." The choice of Pennsylvania law and the vagaries of the US tort system could not have been anticipated by the parties and could not override the clear terms of the reinsurance.
While providing comfort to reinsurers as to the limits to which back-to-back cover can be stretched, this decision also begs the rhetorical question for reinsureds of how to ensure that the contracts remain back-to-back. Lexington's cover contained a full reinsurance clause, "as original" wording, a "follow the settlements" clause and a pro rata premium. Short of, e.g., express wording in both policies as to the governing law, the reinsurance agreement will remain a separately enforceable contract, rather than an extension of the primary insurance.
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