The limitations of "back to back" as a concept in reinsurance in English law following Lexington v. AGF (and Lexington v. Wasa).

AuthorPerry, Bill
  1. Background

    WRITING TOWARDS the end of the 18th Century, at a time when reinsurance contracts were prohibited in England by statute, (1) Park J. said "Reassurance, as understood by the law of England, (2) may be said to be a contract which the first insurer enters into, in order to relieve himself from those risks which he has incautiously undertaken, by throwing them upon other underwriters, who are called re-assurers." (3) Historically there has been some discussion on whether reinsurance actually constitutes a form of liability insurance contract whereby the re-insurance insures the liability of the cedant or is indeed a different specific type of contract that is properly called "reinsurance", the distinguishing feature of which is that the subject matter of the reinsurance is treated as being the same as that of the original insurance.

    In England, Lord Mansfield answered that question 200 years ago: "... a reinsurance, ... consists of a new assurance, effected by a new policy, on the same risk which was before insured, in order to indemnify the underwriters from their previous subscription and both policies are in existence at the same time." (4) Lord Hoffman affirmed this recently in Charter Reinsurance Co Ltd v. Fagan: (5) "... Contracts of reinsurance were unlawful until 1864. Such contract [of reinsurance] is not an insurance of the primary insurer's potential liability or disbursement. It is an independent contract between reinsured and reinsurer in which the subject matter of the insurance is the same as that of the primary insurance, that is to say, the risk to the ship or goods or whatever might be insured. The difference lies in the nature of the insurable interest, which in the case of the primary insurer arises from his liability under the original policy...."

    In other words, even a perfectly proportional facultative reinsurance is not an insurance against liability, and ipso facto not one against any liability which the reinsured may incur under his own insurance. Accordingly, one of the perennially vexed questions which arises in reinsurance is the extent to which a reinsurer is liable to pay the losses suffered by the reinsured.

    "In proportional reinsurance the reinsurer or reinsurers accept a specified percentage of the risk and receive the same percentage of the gross premium or 'gross/net premium' as it is quaintly called--the premium to the reinsured net of commission paid by him. The fortunes of the reinsured and the reinsurer, on the business written should, proportionately, be the same." (6)

    In order to ensure that their fortunes are indeed the same, in other words that reinsurances do respond properly to losses properly paid by reinsureds, English law has developed a substantial body of case law.

  2. Follow the Fortunes

    In Insurance Company of Africa v. Scor (UK) Reinsurance Co. Limited, (7) the Court of Appeal laid down that where a reinsurance contract contains a "follow the settlements" clause, in any case in which the cedant insurers can establish that: (1) the claim falls as a matter of law within the risks covered by the reinsurance policy; (8) (2) they have acted in good faith and without fraud or collusion; and (3) they have acted "in a proper and businesslike manner", reinsurers must pay their proportion of the claim.

    Such a clause is frequently, indeed usually, to be found in London market facultative reinsurance contracts. It is often incorporated within what is called a "full reinsurance clause" (or "full R/I clause"). (9) Such a clause tends to be regarded as "an essential part of the facultative reinsurance policy." (10)

    The use of such shorthand is part and parcel of normal London market practice. Although as time has gone by the law has developed, brokers have become more cautious. Lloyd's and the company market have also become more demanding, so although the length of placement slips in the London market has expanded, they remain succinct, using market shorthand. Certainly in the 1970s, even the largest reinsurance contracts might be written on slips of 100 or 200 words.

    Of course the intention is usually that such slips eventually be expanded into full policy wordings (and English law provides that if and when that happens, the full policy wording normally displaces the slip ab initio). (11) However, in many cases that was/is never actually done. In such cases the slip is, and remains, a binding contract once signed/subscribed. (12) Hence it is important that such "shorthand" is well understood in the market, and it has frequently had to be interpreted by the courts. (13)

  3. Foreign Law and "Back to Back"

    The general idea of facultative reinsurance contracts is usually that they should be "back to back", in other words that they should exactly parallel the underlying insurance so that the cedant may be relaxed in the knowledge that provided he meets the tests laid down in ICA v. Scor, any payments he makes will be recoverable under his reinsurances. Questions inevitably arise, however, when the English market has reinsured a foreign insurance contract. Experience has shown that the same words and phrases used in contacts governed by different law can have different effects, with the result that the contracts are not "back to back" and the cedant/reinsured may not be paid.

    Thus for example, in Forsikringsaktieselskapet Vesta v. Butcher, (14) the reinsurance was on the Lloyd's J1 form. This form provides: "being reinsurance of and warranted at the same gross rate, terms and conditions as and to follow the settlements of the company"--the classic words of a full reinsurance clause and containing a "follow the settlements" clause. In that case the cedant Norwegian Insurance Company had insured a fish farm in Norway. The fish farm subsequently suffered serious storm damage. It was a condition of the insurance contract that "A 24 hour watch be kept over the site." No such 24 hour watch was kept, but the existence of such twenty-four hour watch would not have affected the damage inflicted by the storm.

    The insurance contract was governed by Norwegian law. Under Norwegian law, the fact that the twenty-four hour watch had not been kept, and that there was accordingly a breach of condition, was not a defense for insurers because the breach had nothing to do with the loss. Accordingly, the insured was able to succeed in a claim against the insurer.

    The J1 form, as stated, incorporated the same terms and conditions into the reinsurance policy. The reinsurance was almost entirely with Lloyd's underwriters. A reinsurance policy placed in London with Lloyd's underwriters or London companies is governed by English law as a result of the implied choice of the parties. (15) Under English law, a breach of warranty entitles an insurer (in this case reinsurer) to repudiate liability even if the breach is irrelevant to the loss suffered. Accordingly, although (in fact, because) the wording of the policies was the same, the insurers were compelled to pay the insured but prima facie were not entitled to recover from their reinsurers.

    The Judge in the Commercial Court, Hobhouse J., held that "As a matter of English law ... the proper law of the reinsurance contact is English law subject to the construction and effect of the clauses of the [brokers'] wording being determined in accordance with Norwegian law in the same manner as they are as part of the contract of original insurance." (16) In other words, as a matter of English law, the English law reinsurance must be interpreted to match properly the effect of Norwegian insurance, despite any normal English law to the contrary. So reinsurers had to pay.

    This decision was unanimously upheld in the Court of Appeal. (17) It was also upheld in the House of Lords. (18) Although the speeches in the House of Lords were in differing terms, for present purposes the important quotation is probably from Lord Lowry, who said that "Like every Judge who has considered the case ... [he considered that] ... the real intention ... [of the parties was that the policy should be] ... "back to back" ... [and that] ... effect should, if legally possible, be given to it." (19)

    A similar dispute was resolved by the Court of Appeal in Groupama Navigation v. Catatumbo CA Seguros. (20) The insurance policy covered two vessels which were damaged. They had never been in class. There was a warranty of class in both the insurance and, separately, in the reinsurance. Further, the reinsurance, like the J1 slip, said that "All term clauses, conditions, warranties ... as original". Venezuelan law, like Norwegian law, provides that a breach of warranty does not give insurers a defense unless it is material to the loss. English law, as explained above, does. Once again, therefore, the Court held that under English law the reinsurance was to be construed in line with the (Venezuelan law) effect of the underlying contract, so as to deprive reinsurers of their defense and ensure that the reinsurance responded.

    The effect of Vesta and Catatumbo has been that London underwriters have understood for the last 20 years (but probably did not before about 1986) that where they write "back to back" facultative reinsurance, itself governed by English law but of a foreign law underlying insurance, the English Courts will interpret their reinsurance to match the effect of the underlying insurance.

    That has not, however, derogated from the fact that the reinsurance contract is not a contract of liability insurance of the cedant but, as held by Lords Mansfield and Hoffman nearly 200 years apart, a separate contract on the same risk that the cedant insured.

  4. The Facts in Lexington v. AGF

    In this particular case, the original insured was Alcoa. Alcoa had been forced by the United States Environmental Protection Agency to pay to clean up a large number of sites which had been polluted by its aluminum smelting activities between 1942 and 1986. The costs were considerable: Alcoa...

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT