This year, the courts have provided clarity in relation to various issues in the context of reinsurance, such as challenging an arbitral award and claiming litigation privilege over documents. However, equally, certain questions have been left open for future consideration. The most interesting of these is whether an insured or reinsured may present losses in a way that maximises the available cover under an insurance programme, which is likely to be the subject of further debate in the future.
CAN AN INSURED MANIPULATE THE ORDER IN WHICH IT PRESENTS LOSSES TO MAXIMISE THE AVAILABLITY COVER?
In December 2011, the England and Wales Court of Appeal delivered its decision in Teal Assurance Company Ltd v WR Berkley (Europe) Insurance Ltd & Anor  EWCA CIV 1570. The case related to the allocation of liability claims against a "tower" of underlying insurance policies and an excess "top and drop" policy. The issue was whether the losses to the insured could be ordered in a way that maximised the cover available to the insured. The reinsurers were successful at first instance and on appeal.
Teal Assurance Company Ltd (Teal) was the captive insurer of Black & Veatch Corporation (BV). Teal and another insurer provided US$60 million of cover (tower), subject to a self-insured retention by BV of US$10 million on any one claim (with an annual aggregate of US$20 million). On top of the tower, Teal issued a further "top and drop" policy to BV with a limit of US$10 million on each and every claim (with no aggregate limit) for liability in excess of the tower (the top layer), which it reinsured with WR Berkley and Aspen (reinsurers). The tower covered both US and non-US claims, but the top layer covered only non-US claims. Liability to pay under the top layer only attached once the insurers of the tower had paid, admitted liability or been held liable to pay the full amount of their indemnity.
A difficulty arose because of the fact that the tower provided worldwide cover, but the top layer excluded US claims. Four large claims were made against BV in the relevant policy period: two in the US and two outside the US. All four claims fell within the scope of the tower, but the US claims were not covered by the top layer. If the US claims (which were large enough to exhaust the tower) were presented first, BV would have a smaller uninsured loss. Teal argued that BV can choose the order in which it presents claims to Teal and that Teal can choose the order in which the claims are settled. Reinsurers argued that once the tower is exhausted, the top layer "drops down" to become the primary layer and Teal is liable once a claim against BV is established (by settlement, judgment or award). Therefore, claims must be met in the order in which they are established against BV.
At first instance, the Commercial Court found in favour of reinsurers. This was upheld on appeal. The Court of Appeal preferred reinsurers' construction and pointed out that it was the commercially sensible construction. The court held that it was clear from the wording that once the indemnity provided by the underlying policies is exhausted, the top layer will "drop down" and become the underlying policy. The insurer under the original underlying policy is liable once claims are established against BV by settlement, judgment or arbitration, and this will continue up the tower. As liability arises when losses are established (not when claims are paid), an insured or reinsured has no ability to manipulate liabilities, except insofar as it is able to hasten or delay settlement of claims or the litigation process, subject of course to the duty of utmost good faith.
CHALLENGING AN ARBITRAL AWARD
In the recent decision of Westport Insurance Corporation v Gordian Runoff Ltd  281 ALR 593, the High Court overturned the NSW Court of Appeal's decision in relation to what constitutes a "manifest error of law" in an arbitral award. The High Court also considered the application of s18(1) of the Insurance Act 1902 (NSW) (Insurance Act).
The dispute arose out of a reinsurance contracts between Westport Insurance Corporation (reinsurers) and Gordian Runoff Ltd (Gordian), which reinsured Directors and Officers (D&O) liability policies written by Gordian for FAI Insurance Ltd, including a seven-year D&O runoff policy. Under the reinsurance contract, cover was limited to underlying policies with a term not exceeding three years. A number of claims had been made and notified to Gordian within the seven-year period under the D&O runoff policy. All but one of those claims were made and notified within three years.
Reinsurers argued that the reinsurance contract did not respond to the claims made on Gordian under the D&O runoff policy because it covered claims made and notified within an extended period of seven years, rather than three years, and the risk reinsurers had agreed to cover was limited to underlying policies with a term not exceeding three years. Gordian disputed this and relied upon section 18B of the Insurance Act, which limits the application of exclusion clauses in contracts of insurance.
The dispute was referred to arbitration and the arbitrators found in favour of Gordian on the basis that section 18B of the Insurance Act would apply to the claims made within three years and would thereby preclude reinsurers from denying indemnity to Gordian. Reinsurers successfully appealed to the Supreme Court of New South Wales, but subsequently lost in the Court of Appeal.
Reinsurers were granted leave to appeal to the High Court. Reinsurers submitted to the High Court that there had been a manifest error in law in the failure of the arbitrators to give adequate reasons for their decision regarding section 18B(1) of the Insurance Act and that as such reinsurers should have been given leave to appeal the arbitrators' award. The majority of the High Court agreed.
The High Court held that as the arbitrators had treated section 18B of the Insurance Act as a critical element in reaching their award, they were obliged to succinctly explain their reasons in relation to the interpretation and application of that complex statutory provision, but failed to do so. It was held that because the arbitrators failed to succinctly explain the reasons for their decision, there was a manifest error of law on the face of the arbitral award, as required by the Commercial Arbitration Act 1984 (NSW).
The court also held that s18B did not apply because the treaties did not exclude or limit the reinsurers' liability to indemnify Gordian, because the FAI policy was for seven years, not three.
This decision provides guidance as to what will be considered a manifest error of law, as well as confirming the importance of arbitrators giving adequate reasons in relation to all aspects of an arbitral award.
LITIGATION PRIVILEGE IN THE CONTEXT OF REINSURANCE
In Axa Seguros SA de CV v Allianz Insurance Plc & Ors  EWHC 268 (Comm), the High Court of England and Wales considered the issue of litigation privilege in the context of reinsurance.
The claimant (Axa) wrote an insurance policy that covered risks of physical damage to certain roads in Mexico. That risk was reinsured with the defendant reinsurers.
In early October 2001, a highway in Mexico was damaged by torrential rainfall caused by a hurricane. The insured notified a claim to Axa under the policy. A loss adjuster was appointed on behalf of Axa and the reinsurers to investigate the loss. In addition, the insured appointed an engineering firm and reinsurers appointed their own engineering firm (Halcrow).
In September 2002, the claim was referred to arbitration and the arbitral award required Axa to pay approximately US$14.8 million to the insured. Axa claimed an indemnity from reinsurers, who denied that they were liable to indemnify Axa. The primary ground for denying indemnity was that it was a condition precedent to coverage under the reinsurance contract that the roads were to be constructed to internationally acceptable standards, and that some or all of the relevant sections of the highway were not constructed to those standards.
Axa then applied to the court for inspection of the Halcrow reports. Reinsurers claimed litigation privilege over the reports. In order for each of Halcrow's reports to be protected by litigation privilege, reinsurers needed to establish two conditions:
- At the time the document was created, litigation was reasonably in prospect and was not a mere possibility; and
- The document must have been made with either the sole purpose or the dominant purpose of using it for obtaining legal advice about actual or anticipated litigation.
The court considered that there was a reasonable prospect in January 2002 that the Halcrow reports would reveal that the roads were not constructed to an acceptable standard, with the result that reinsurers would reject the claim and litigation would ensue. The court was therefore persuaded that there was a reasonable expectation in January 2002 of litigation between Axa and reinsurers. Importantly, the court stated that the perception of the reinsurer or its lawyers at the time was some guide as to whether there was a reasonable prospect of litigation.
However, the court held that reinsurers had not established that the Halcrow reports were made for the dominant purpose of anticipated litigation between Axa and reinsurers. Rather, Halcrow was instructed for the dual purposes of:
- Assessing whether the highway had been constructed to internationally acceptable standards
- Determining the extent to which any damage had been caused by the hurricane and verifying the correctness of the quantum figures for remedial work.
The court considered that neither of those issues was dominant and that the Halcrow reports were not privileged. This decision shows that it is important for insurers/ reinsurers to be aware that where there might be an issue in relation to policy coverage and they wish to obtain their own report that is subject to privilege, they should be careful to avoid obtaining a report for dual purposes rather than only the dominant purpose of obtaining legal advice.
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