In the recent UK decision of Aegis Electrical & Gas v Continental Casualty  EWHC 1762, the Commercial Court considered how the reference to underlying policy terms in a reinsurance slip affects the scope of reinsurance cover, and whether follow the settlement provisions bind a reinsurer to a settlement where the cover is not back-to-back.
The reinsured (the Syndicate), sought to recover from the defendant reinsurer, Continental Casualty Company (CCC), for settled claims arising from incidents at an oil refinery in the South Caribbean. The incidents involved damage to certain components of the insured's (Aegis) oil refinery including the 'Visbreaker unit' and the 'D1A reactor'.
The reinsurance contract was stated 'to follow the terms, clauses, conditions, exception and settlements of the original policy wording as far as applicable hereto'. However at the time CCC's underwriter (Ms Dennis) initialled the slip, she also wrote the words 'Subject to B[oiler] & M[achinery] terms & conditions attached pages 1-3' (B&M Conditions). Ms Dennis did not however see the wording of the direct cover referred to in the slip at the time she initialled it.
The B&M Conditions contained definitions of 'Accident' and 'Object'. The definition of 'Accident' excluded loss or damage resulting from 'Explosion'.
CCC argued that those conditions were effective to restrict the reinsurance cover to losses involving 'Accidents' and 'Objects', and because the Visbreaker unit was not in fact an 'Object', CCC could deny liability for the loss associated with the Visbreaker unit. CCC also argued that the reactor loss fell within the exclusion of loss or damage from explosion and therefore was not covered because it did not arise from an 'Accident'.
In relation to the Visbreaker loss, the Syndicate's response was that the reinsurance slip did not use the words 'Accident' or 'Object', and those definitions did not impinge upon the general provisions of the reinsurance contract. Further, the reinsurance slip provided that the cover would 'follow terms, clauses, conditions, exceptions ... of the original policy as far as applicable', so that the additional B&M Conditions were to be understood to relate to the incorporated terms of the direct policy (whose terms did not refer to 'accident' or 'object' in any relevant sense).
In relation to the reactor loss, the Syndicate contested that the loss was caused by an explosion, but in any event, CCC was precluded by the follow the settlements clause from relying upon that exclusion by reason of the back-to-back nature of the insurance and reinsurance.
Justice Smith of the Commercial Court held that the Syndicate failed on the Visbreaker loss but succeeded on the reactor loss.
In relation to the Visbreaker loss, Justice Smith noted that the underlying cover did not use the terms 'Accident' or 'Object' in the insuring clause (although it did use them in other clauses that were irrelevant for current purposes). Justice Smith thought that although it was surprising that the parties should decide to tinker with the effect of the 'follow the terms' provision and to have done this 'so obliquely', the parties had chosen to reduce the effect of the follow the terms provision by referring to the terms 'Accidents' and 'Objects'.
While Justice Smith refused to take into account the parties' negotiations and subsequent conduct, he did take into account the fact that the reinsurer (Ms Dennis) had not seen the terms of the underlying cover. In this regard, Justice Smith stated:
'The fact that Ms Dennis did not know the terms of the underlying cover, and therefore did not know whether and if so in what context the terms "Accident" and "Object" were there used supports the conclusion that the purpose of the Additional Conditions was not to define those terms wherever they happened to be used in the wording that was adopted for the relevant section of the direct cover. It is unrealistic to suppose that Ms Dennis would have introduced these definitions into the reinsurance contract without having any idea about where they would apply, and unrealistic to suppose that...[the reinsured] understood her to be doing so.'
The result was that the Visbreaker loss was excluded from the scope of the reinsurance.
In relation to the reactor loss, the Court found that there was no evidence of any 'manifest violence', blast damage, dramatic noise or relevant puncture which would have supported the proposition that an 'explosion' caused the relevant damage, and in any event, such an explosion would not have been the proximate cause of loss. As a result, the relevant exclusion did not apply and CCC was liable for the reactor loss. Despite this finding, the Court noted that had there been a finding that there was an explosion, then the exclusion would have applied and CCC would not have been required to follow the reinsured's settlements.
Justice Smith noted that by agreeing to the follow the settlements provision, the reinsurer agreed that if the reinsured settled a claim by their insured, the reinsurer would not dispute the settlement. This was provided the settlement was made honestly and in a proper businesslike manner. However Justice Smith accepted the reinsurer's argument that this obligation only arose where the underlying claim was covered by both the direct insurance and reinsurance, in other words the cover was back-to-back.
The current follow the settlements provision was stated 'to follow...the settlement of the original policy wording as far as applicable hereto', and Justice Smith found that the qualification 'as far as applicable' meant that the provision only applies when the risk is one covered by the reinsurance. Accordingly, in the current context, had the loss been caused by explosion, then CCC could have relied upon the exclusion in the reinsurance and avoided liability - even though it had agreed to follow the reinsured's settlements.
This last aspect of the decision highlights the need for insurers and reinsurers to be vigilant in assessing whether or not a reinsurance wording actually achieves back-to-back cover with the direct insurance.
Phillips Fox has changed its name to DLA Phillips Fox because the firm entered into an exclusive alliance with DLA Piper, one of the largest legal services organisations in the world. We will retain our offices in every major commercial centre in Australia and New Zealand, with no operational change to your relationship with the firm. DLA Phillips Fox can now take your business one step further − by connecting you to a global network of legal experience, talent and knowledge.
This publication is intended as a first point of reference and should not be relied on as a substitute for professional advice. Specialist legal advice should always be sought in relation to any particular circumstances and no liability will be accepted for any losses incurred by those relying solely on this publication.