Australia: Reinsureds Beware

Last Updated: 15 September 2009
Article by Rohan Bennett

Lexington Insurance Company v AGF Insurance Limited; Lexington Insurance Company v Wasa International Insurance Company Limited [2009] UKHL 40 confirms that where the laws of the insurance and reinsurance contract differ, it is no longer safe to assume that cover under a facultative reinsurance contract incorporating the terms of the underlying insurance contract will be 'back-to-back'. The decision has implications for Australian reinsureds who reinsure in the London market.

Key Points:

  • A reinsured must establish its liability under the insurance contract and also that the loss is within the risk assumed under the reinsurance contract.
  • One interpretation of Lexington v Wasa is that where insurance and reinsurance contracts differ in terms of governing law, and the legal position on a term in an underlying contract is unascertainable in the jurisdiction governing the underlying contract, then that term is not incorporated into the reinsurance contract.
  • A more restrictive interpretation is that the back-to-back principle which applies to warranties in facultative proportional contracts does not extend to coverage clauses.
  • One way to ensure that a reinsurance policy is fully back-to-back is to make both insurance and reinsurance contracts subject to one governing law.


Lexington Insurance Company (Lexington) insured Aluminium Company of America (Alcoa) for loss and damage to Alcoa's property worldwide for the period 1 July 1977 until 12pm on 1 July 1980 (the policy). The policy contained a US Service of Suit clause requiring Lexington to submit to the jurisdiction of certain courts within the US.

Lexington obtained reinsurance under a proportional facultative reinsurance contract with AGF Insurance Limited (AGF) and WASA International Insurance Company Limited (WASA). The period of cover and terms of the reinsurance contract mirrored those of the insurance contract, except in relation to the applicable laws – the reinsurance contract was subject to English law.

In the early 1990s, Alcoa was ordered by the US Environmental Protection Agency to clean up contamination at 35 of its United States sites. The damage had been ongoing for about 50 years. Alcoa sought to recover the cleanup costs from its insurers, including Lexington.

Insurance Claim

Alcoa commenced proceedings in Washington against its insurers seeking declarations as to which of its insurers was required to indemnify it for contamination arising between 1965 and 1980. The trial court, in applying the laws of Pennsylvania, held that the damage for which Alcoa sought an indemnity had occurred over many years, including between 1977 and 1980. The trial court allocated the losses proportionately to each year in which damage had occurred. As a result, insurers were held to be liable for their relevant proportion of the total loss. For Lexington, this meant its liability was limited to relatively small sums which represented the loss in the years 1977 to 1980.

The trial judge's decision was overturned on appeal with the Supreme Court of Washington deciding that the policy covered losses arising from damage that had occurred before, during and after the policy period, provided that the loss was 'manifest' during the policy period. The Supreme Court found that the underlying policy was broadly drafted and that there was no exclusion for damage occurring outside the period of cover. On this interpretation of the policy, the Supreme Court found the insurers, including Lexington, were to be jointly and severally liable for the total loss suffered by Alcoa. Facing a claim of about US$180 million, Lexington settled for just over US$103 million payable over a two year period and sought to recover from its reinsurers.

Reinsurance Claim

WASA and AGF, who were notified of the settlement, denied liability and commenced proceedings in London seeking declaratory relief that they were not liable to indemnify Lexington under the reinsurance contract. Under English principles of construction, the reinsurance covered only damage to property caused during the period of cover. In the Commercial Court, Justice Simon held that the loss claimed by Lexington did not fall within the reinsurance contract as a matter of English law and WASA was granted the declarations sought.

The Court of Appeal took a fundamentally different approach, holding that as the insurance and reinsurance contract provided cover for the same period, it could be inferred that the parties intended the wording should have the same meaning in each contract. WASA and AGF appealed the Court of Appeal's decision.

House Of Lords Decision

The House of Lords unanimously upheld the appeal and restored the decision of Justice Simon. The Law Lords agreed that an insurer seeking indemnity under reinsurance must establish its liability under the terms of the underlying insurance contract and that the loss is within the risk assumed under the reinsurance contract – which is a separate contract with its own independent terms.

The Court noted that in this case the vital issue was whether the parties to the reinsurance implicitly agreed to be subject to whatever law might be applied to interpretation of the primary cover. It concluded there was no such agreement by the reinsurers.

The Court distinguished this case from, and arguably limited the principles espoused in, Forsikringsaktieselskapet Vesta v Butcher [1989] AC 852 and Groupama v Catatumbo [2000] 2 Lloyd's Rep 350. These earlier cases have been regarded as authorities for the principle that if a reinsurance contract and underlying insurance contract are governed by different laws, the terms of the underlying contract are incorporated into the reinsurance contract and have the same meaning and effect as in the insurance contract.

Lexington v Wasa was distinguished from these cases on the basis that in the earlier cases the law by which each insurance contract was governed was readily ascertainable and would have been in the contemplation of the parties. However, in this case the underlying policy was not subject to an express choice of law, but rather subject to a US Service of Suit clause and the property insured was located in various locations around the United States and beyond.

The Court did not consider that the parties at the time the reinsurance contract was entered into could have ascertained under which law coverage the policy would be determined. As a consequence the 'period clause' was not incorporated into the reinsurance policy. The inference to be drawn is that if the meaning of a clause in the direct policy is unclear, reinsurers cannot be expected to have agreed to follow the interpretation which may be placed on it by a court in proceedings between the insured and the reinsured.

Interestingly, a number of the Law Lords, in determining whether the term in the underlying policy was incorporated into the reinsurance contract, emphasised that in this instance their decision was arrived at by examining the surrounding circumstances of the reinsurance contract rather than a rejection of the back-to-back presumption.

© DLA Phillips Fox

DLA Phillips Fox is one of the largest legal firms in Australasia and a member of DLA Piper Group, an alliance of independent legal practices. It is a separate and distinct legal entity. For more information visit

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.

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