UK: A Pizza Slice That’s Hard To Swallow

Last Updated: 28 June 2013
Article by Nick Miles

Claims Control Clauses (CCCs) with multiple reinsurers who don't speak with one voice can leave the reinsured little option but to put itself in breach with some reinsurers, jeopardising part of its security. A recent decision1 about a London market reinsurance of a Kuwaiti policy has been portrayed as allowing reinsureds in this predicament freedom to refuse control with impunity. For the following reasons, reinsurers should not allow it to influence their claims practices.

Which negotiations must a reinsurer be allowed to control?

The CCC required that each reinsurer control negotiations "in connection with . . . loss or losses . . . which may give rise to a claim" against it. All reinsurers bar one wished the reinsured to raise an exclusion-based defence to a claim for costs of repair of a storage tank. One reinsurer and the reinsured wanted the claim to be part-paid, to be funded between them according to their respective interests (the reinsured had a proportionate retention). The reinsured communicated with the insured about this. The Judge had to decide if the communications were negotiations other reinsurers should have controlled.

Having found that they weren't in fact negotiations at all, he went on to find that, even if they had been, they couldn't have been eligible for control by the other reinsurers. In reaching this conclusion, he theorised that a loss may be divided into slices, like a pizza, for which a reinsurer, or the reinsured (for its proportionate retention), can be made exclusively liable.

There could therefore be negotiations in connection with a loss (or slice of it) for which only one reinsurer (or only the reinsured) is liable. Other reinsurers can't be liable for that (slice of) loss, so they needn't control negotiations in connection with it. Negotiations by the reinsured towards a settlement funded by it and the settling reinsurer alone would have concerned a loss that the other reinsurers couldn't be liable for, and so wouldn't have been entitled to control.

Are losses sliceable?

But this theory ignores the fact that any covered settlement breaching a reinsurance will, of itself, cause several liability on the part of each reinsurer according to its proportionate share. You can't stop reinsurers becoming liable. The theory treats proportionate subscriptions and a proportionate retention as a series of excess of loss layers.

Another reading is that the Judge accepted that settlement causes liability for each reinsurer but found that, if the reinsured proposes not to collect from a reinsurer, the settlement is not one that "may give rise to a claim" against the reinsurer, who therefore needn't control.

But it is very unsatisfactory that a reinsurer subscribing a contract with a CCC should have no rights in relation to negotiations the culmination of which render it liable.

It also leaves too much to chance: the reinsured might change its mind about not collecting; the settling reinsurer might pull out. Moreover, if the settling reinsurer pays 100% of the reinsurance's share of a partial covered settlement, it may have discharged the liability of its co-reinsurers. Their resulting unjust enrichment may entitle it to a contribution. What stops it claiming the contribution?

Which settlements and admissions must be approved?

The CCC required the approval of each reinsurer to settlements and admissions that may give rise to a claim against the reinsurer. Surprisingly, the Judge considered it made manifestly more commercial sense for the reinsured to have a completely free hand in settling its proportionate retention and the settling reinsurer's interest, than for it to require approval by other reinsurers. Applying the pizza theory, other reinsurers couldn't be liable for the settlement, so the reinsured hadn't failed to obtain approval from any reinsurer whose approval was needed. But, as the foregoing suggests, there are reasons for doubting that the theory is right.

Practical consequences

Reinsurers interested in exercising rights under CCCs should not allow this decision to change their practices. In fact, if the case teaches any practical lesson, it is that assertive attempts to exercise rights of control serve a reinsurer better than dignified resignation in the fact of unilateral negotiations.

Thus, on being notified of the onset of dialogue between insured and reinsured, other reinsurers expressed surprise but took no action. They felt (rightly or wrongly) that they couldn't stop the settling reinsurer "going its own way". In ensuing months, the reinsured sent unapproved communications to the insured attaching draft settlement terms. This development was only checked months later when other reinsurers were notified of it. These communications looked much more like negotiations than the onset of dialogue, but reinsurers evidently felt, in the litigation, that they couldn't rely on them as evidence of breach, presumably because they considered that their earlier acquiescence would stand against them.

Postscript: settlements and admissions

His decision on the pizza theory relieved the Judge of the need to consider if there had been settlement or admission in fact. But in case the theory was wrong, he made the following interesting findings about settlements and admissions.

  • Settlements must be legally binding or involve actual transfer of consideration (communications about the draft settlement terms were neither). Interestingly, the Judge observed that an ex gratia payment would be a settlement by involving transfer of consideration. This is an odd finding, because a genuinely ex gratia payment is not consideration for anything. It may be that he had in mind payments that reflect some (albeit minimal) potential liability.
  • An admission requires unequivocal acceptance of the validity of a claim. A mere offer to pay is not an admission. The draft settlement terms proposed discharge of the reinsured in return for payment of: its retained interest in the loss; the settling reinsurer's interest, when received; and such other reinsurance proceeds that happen to be received. The Judge found that this was not an offer to pay, but an offer to vary the policy by replacing liability for loss with liability to pay such reinsurance proceeds as happen to be received. This was a slightly odd finding, given that the offer to pay the retention was not conditional on receipt of reinsurance. But the pizza theory – according to which an offer to pay retention couldn't be eligible for approval by a reinsurer - may have been unconsciously at work in this reasoning.

Footnotes

1.Beazley Underwriting Limited and others v Al Ahleia Insurance Company and others [2013] EWHC 677 (Comm).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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