Reinsurance - "back to back" cover?

In the early 1990s, the US Environmental Protection Agency, amongst others, required a company based in Pennsylvania, Aluminium Company of America (Alcoa), to clean up scores of polluted manufacturing sites across the US and beyond. The environmental damage stemmed from Alcoa’s continuing failures to address the escape of waste products and failure of manufacturing units to contain pollutants. These failures first began causing damage as long ago as 1942, and continued until at least 1986.

In 1992, Alcoa commenced proceedings in the US against numerous insurers, including Lexington, which had insured it against property damage for the three-year period 1 July 1977 to 1 July 1980.

Ultimately, in 2000, the Washington Supreme Court held that, under Pennsylvanian law, Lexington’s insurance was to be construed as rendering it liable for the full costs of remediation at any site provided only that some damage occurred there during the years Lexington was at risk - making it liable for the damage sustained over almost half a century. This was recognition of Pennsylvanian law’s adoption of the so-called “triple trigger” approach to insurers’ liability under “occurrence” policies (which had its genesis in a 1982 decision of the Court of Appeal of the District of Columbia).

Lexington went on to settle Alcoa’s claim, for more than US$103 million, and sought to recover from its facultative reinsurers, including Wasa, which had a one percent line on a London market slip reinsuring Lexington for the three-year period.

Wasa declined to pay, on the basis the reinsurance policy was governed by English law, under which reinsurers could only be liable for the costs of remedying property damage which actually occurred between 1977 and 1980, not what occurred before or after. Wasa sought declarations that it was not liable to indemnify Lexington, which then counterclaimed for an indemnity or damages in respect of its settlement with Alcoa, plus its costs of defending Alcoa’s claim.

First instance

The Commercial Court held that the loss claimed by Lexington did not fall within the reinsurance contract as a matter of English law and Wasa was entitled to the declarations sought. It also rejected Lexington’s claim for defence costs. Lexington appealed.

Court of Appeal

Adopting a fundamentally different approach, the Court of Appeal allowed the appeal, holding that:

• As the insurance and reinsurance provided back-to-back cover for the same period, it was natural to infer the parties intended the wording should have the same meaning in each contract.
• The same or equivalent wording should generally be given the same construction in the reinsurance and insurance, unless there were clear indications to the contrary.

Rejecting a submission by Wasa that reinsurers had not assumed the risk of a change of law in any of many American jurisdictions, Lord Justice Longmore observed: “…reinsurers must themselves take that risk if they reinsure an American Insurance Company just as the insurers take the risk.”


Also rejecting the submission that reinsurance was an insurance on the subject-matter of the primary insurance, Lord Justice Sedley commented, “The need for the fiction that reinsurance covered the primary risk and not the insurer’s own potential liability is … long spent.”


In reaching that conclusion, the Court of Appeal endorsed the line of authority from Vesta & Butcher [1989] and Groupama v Catatumbo [2000], that there was a presumption of “back to back” cover in facultative reinsurance placements, even where the insurance and reinsurance were governed by different choices of law.

House of Lords

Wasa appealed to the House of Lords, which yesterday handed down a unanimous judgment in its favour. For watching insurers and reinsurers, however, who hoped for meaningful comment on the “back to back” question, the judgment is likely to be a disappointment, as the Lords broadly endorsed the “back to back” presumption as a matter of commercial intention, but distinguished Vesta & Butcher and Groupama v Catatumbo on grounds which suggest the opinions were “result”, rather than “principle”, driven. The consequence is that there is likely to be more, rather than less, uncertainty.

Lord Collins, with whom all the other law lords agreed, held that the solution to this dispute was to be found in the following steps:

1. To establish liability against a reinsurer, the reinsured has to establish that the loss is within the risk assumed under the underlying insurance and that the relevant risk has been assumed under the reinsurance contract.
2. Whether the relevant risk has been assumed under the reinsurance is a question of construction of that contract.
3. In principle, the relevant terms in a proportional facultative reinsurance, especially those regarding the risk, should be construed to be consistent with the terms of the insurance, on the basis the normal commercial intention is they should be back-to-back.
4. Where the insurance and reinsurance are governed by different laws, it remains a question of construction of each contract, under its applicable law, as to what risk is assumed. (Notably, in this instance, the insurance did not contain an express choice of law. The reinsurance was to be governed by English law.)
5. Both the insurance and reinsurance contract were “losses occurring during” policies, which in English law means an insurer/reinsurer is liable to indemnify the insured/reinsured for loss/damage that occurs during the policy period.
6. In 1977, when these contracts were concluded, in the absence of an express choice of law in the insurance, there was no identifiable system of law applicable to the insurance that could have provided a basis for construing the reinsurance in a manner different from its ordinary meaning in the London insurance market.
7. The Washington Supreme Court’s decision imposed liability on Lexington under the insurance for loss/damage that occurred before, during and after the policy period in the reinsurance.
8. It is common ground that, under English law, an insurer/reinsurer would only be liable for losses occurring during the policy period.
9. Although normally any loss within the coverage of the insurance will be within the coverage of the reinsurance, there is no rule of construction or law that a reinsurer must respond to every valid claim under the insurance, irrespective of the terms of the reinsurance.
10. The reinsurance cannot reasonably be construed to mean it would respond to any liability that “any court of competent jurisdiction within the United States” would impose on Lexington, regardless of its period of cover.

Lord Collins concluded by stating, “At the beginning and end of these appeals remains the question whether the provision for the policy period in the reinsurance is to be given the effect it has under English law, or whether the parties must be taken to have meant that the reinsurance was to respond to all claims irrespective of when the damage occurred and irrespective of the period to which the losses related. There is, in my judgment, no principled basis for a conclusion in the latter sense.”

Comment

Insofar as the “back to back” debate is concerned, the Lords’ recognition of the “normal commercial intention” of facultative reinsurance ((3) above) is confirmation that Vesta & Butcher and Groupama v Catatumbo remain in favour with this constitution of the House of Lords. It is suggested from the opinions of their Lordships, albeit not explicit, that Vesta and Groupama were distinguished in this instance because, in the absence of an express choice of law in the insurance (or anything in the insurance policy to suggest that Pennsylvanian law would apply to the insurance), there was no reason to depart from English law principals in construing the reinsurance.

It is equally implicit that, had there been a clearly defined choice of law in the insurance, reinsurers could be deemed to have agreed that the law of the insurance may affect the interpretation of terms of the reinsurance.

In part endorsing Lord Collins (with whom he claimed to agree), Lord Mance concluded his opinion by stating:
“… I find it impossible to adopt [the decision given in the Court of Appeal] in circumstances where Lexington’s liability has been held to arise under a system of law which was applied to the insurance not by reason of the terms of the insurance or their operation, but in the context of a choice of law on a blanket basis to cover also a large number of other independent insurances and claims.”

It might be thought that these distinctions seem a torturous method of reconciling this decision with the presumption of “back to back” cover which was strongly expressed by the House of Lords in Vesta and the Court of Appeal in Groupama.

Perhaps a clearer explanation of their Lordships’ decision can been gleaned by contrasting Lord Collins’ description of the reinsurers in Vesta & Butcher and Groupama v Catatumbo as: “… taking the wholly unmeritorious point that they were relieved from liability because the original insured (and not the reinsured) had been guilty of a breach of a warranty . . . [where] in each case the breach was not, or was assumed not to have been, causative of the loss”, with his conclusion that, “… this is an unusual case in which the express (and entirely usual) terms of the reinsurance are clear. This is not a case where the reinsurers are relying on a technicality to avoid payment.”

It is unlikely the Lords would want to allow, by any means, US theories of triple trigger liability to define the scope of time limited occurrence based reinsurances expressed to be governed by English law.

In summary, despite the House of Lords upholding the reinsurers’ appeal, the presumption of “back to back” cover between insurance and facultative reinsurance has been approved and only appears likely to be distinguished:

1. Where there is no clear or express choice of law in the insurance.
2. Or perhaps, where the terms of the reinsurance are so clear in defining the scope of reinsurers’ risk that English courts will not allow “the merits” to be obfuscated by unusual applications of foreign law.