UK: Writing Against: The Law After Bonner v Cox

Last Updated: 17 April 2006
Article by Jeffrey Gruder QC

This article was previously published in Issue 114 April 2006 of Sweet & Maxwell’s Insurance and Reinsurance Law Briefing.

Does a reassured owe to his reinsurer any duty in selecting the risks to be written and reinsured? Is there an implied term in a reinsurance contract which prohibits "writing against reinsurers"? Is there any limitation on the risks which can be ceded under a reinsurance based on their quality?

These important questions were considered by the Court of Appeal in Bonner v Cox [2005] EWCA Civ 1512, on appeal from Morison J. in the Commercial Court [2005] Lloyd’s I.R.R. 569. The answers provided were broadly negative.

In Phoenix v Halvanon [1985] 2 Lloyd’s 599, 613, Hobhouse J. endorsed an agreement between the parties that, at least, in the context of a facultative obligatory treaty, the reinsured should accept the obligation to conduct the business involved in the cession prudently, reasonably carefully and in accordance with the ordinary practice of the market. The judge stated that:

"… the duty to act prudently as if not reinsured is not an alternative but it is really a restatement of the same obligation, provided it is realized that the obligation does not preclude the plaintiffs from taking into account the added capacity to write business that the availability of the reinsurances give them. Such is, after all, one of the important purposes of any reinsurance."

A number of subsequent authorities accepted the analysis of the position in Phoenix v Halvanon but did not subject it to close and rigorous scrutiny. In Toomey v Eagle Star [1994] 1 Lloyd’s Rep. 516 at 523, Hobhouse L.J. approved his previous judgment. He said that Phoenix v Halvanon:

"deal[s] with the terms to be implied into such, and similar, types of contract in order to ensure that the interests of the reinsurers or those to whom risks are ceded, are sufficiently protected."

Tuckey J. followed Phoenix in Economic v Le Assicurazioni d’Italia (unreported, November 27, 1996).

There was also some support in the textbooks for the duty enunciated in Phoenix, although there was a difference between authors as to whether the Phoenix duty applied to all reinsurances or only to facultative/obligatory contracts where the reinsured has a right to select the risks to be reinsured (see MacGillivray on Insurance Law (10th Ed. 2003) paras 33–69; Arnould on Marine Insurance (paras 397–404, note 97); O’Neill & Wolonieki, The Law of Reinsurance (2004) 2nd Ed. para.7–08; Barlow, Lyde & Gilbert on Reinsurance Practice and the Law at para.15.3.1).

It has often been suggested that Phoenix v Halvanon was an authority for the proposition that a reinsured owes his reinsurer a duty of care. That is a misunderstanding. Phoenix grappled with a problem which has troubled subsequent judges (in particular, in Bonner v Cox and Sphere Drake), namely the extent to which it is permissible for the conduct of a reassured to be influenced by the fact that he has reinsurance and is, wholly or partially, insulated from the adverse financial consequences of risks written by him. Hobhouse J.’s answer appeared to suggest that a reinsured was obliged to act prudently as if not reinsured, provided it is realised that that obligation does not preclude reassureds from taking into account the added capacity to write business that the availability of reinsurance gives them. Phoenix appeared to suggest that it would be wrong for a reassured to write a bad quality risk because he had reinsurance if he would not have written that risk without reinsurance.

Similar issues were revisited by Thomas J. (as he then was) in Sphere Drake v Euro International Underwriting and others [2003] 1 Lloyd’s I.R.L.R. 525, albeit in the context of extreme facts. In this notorious case arising from the workmen’s compensation spiral, inevitably loss-making business was knowingly written by reinsurers on the basis that they would make a "turn" by passing the risk on at a lower premium to their retrocessionaires. The reinsurers/retrocedants did not assess the risk and the premium in the manner of conventional insurance. This process continued down the chain of retrocessions so that the reinsurer at each tier was in effect passing the bulk of the losses on to the reinsurer at the next tier for progressively less premium. Thomas J. said:

"... some called it ‘arbitrage’ or ‘net underwriting’. It would more accurately be described as deliberately accepting business known to produce losses in excess of the premium charged on the backs of reinsurers who would be expected to pay the losses for even less premium …"

The facts of Sphere Drake were striking and Thomas J. held that:

"There was obviously a duty to disclose to any reinsurer, the fact that the business to be reinsured with him was being written deliberately on the basis that the business would make a gross loss, with a loss ratio in some cases of many hundreds of per cent (or more than 1,000 per cent); the reinsurer would be expected to pay for those losses but receive a premium that was far less than the premium that had been received by the reinsured …"

Even if there had not been a breach of the duty of disclosure, because the decision to write gross loss-making business was first made after the contract of reinsurance was concluded, the logical consequence of Thomas J.’s decision would be that the reassured would not be entitled to cede gross loss-making business without the express consent of the reinsurer. This conclusion is confirmed by the decision of the Court of Appeal in Bonner v Cox.

Thomas J. stated (para.145) that:

"A feature of the insurance market has always included arbitrage—an underwriter insuring business he thinks will be profitable and increasing the potential for profit by favourable reinsurance …"

This he considered to be unobjectionable. He continued (para.146):

"In a soft market, as existed in the late 1980s and 1990s, it was possible for underwriters to obtain reinsurance at such favourable terms that they could write insurance at rates where the premium would not cover the losses—or using a market phrase, they were writing ‘below the burn’; the losses would be paid by reinsurers who were prepared to write at a loss. The decision of the reinsurer to write below cost is an ordinary incident of such market conditions resulting from overcapacity; as long as proper disclosure was made, there could be no complaint."

There are also comments by Thomas J. which appear to accept that a reassured can take full advantage of a favourable reinsurance (paras 284–285):

"If a participant enters the market when he does not understand those risks or miscalculates what those risks are, he has no one but himself to blame if he makes significant losses; he is presumed to know about the trade of the market in which he writes … The capital provider or the senior management of a company should not entrust such business to someone who does not understand it.

No other participant in a market owes a duty to protect those who knowingly enter a market but who do not understand it, are imprudent, or who miscalculate; indeed, it is likely that a person who is imprudent or foolish or who miscalculates in any market will be ruthlessly exploited by those who understand the market; he is at risk of having dumped on him risks which no one else wants …"

Thomas J. seemed to accept that "arbitrage underwriting" was acceptable in cases where loss was not certain. He said (para.258):

"An underwriter would often take on the risk of a catastrophe in the expectation that it might not happen and that he would therein make a profit, but if it did happen, he had so arranged his outwards reinsurance that he would not have to bear any of the loss. There have been a number of distinguished underwriters who have written with the expectation of making an underwriting profit but who, through skilful use of outwards reinsurance, have ensured a profit even if there was no underwriting profit …"

However, these dicta were strictly obiter. Thomas J. was not considering what, if any, duties a reassured owed his reinsurer other than in the case of the cession of business which was certain to cause loss.

Bonner v Cox directly raised the question of what if any duties a reassured owed to his reinsurer in the selection and cession of risks beyond the very limited duties established in Sphere Drake. It was also the first time the Court of Appeal directly considered Phoenix v Halvanon.

Bonner v Cox involved a reinsurance by Cox and syndicate 1243 of the 1999 underwriting year of the Aon 77 Energy cover. The reinsurance paid the first US$10,000,000 of losses on each risk accepted to the cover after the exhaustion of an aggregate deductible of US$5,000,000. The premium agreed was 35 per cent of ONP. The reinsurers suffered disastrous losses. Numerous defences were raised, but relevant to the present article is the allegation that the reassureds "wrote against" the reinsurance. This allegation required a detailed examination of the quality of the risks which were accepted to the cover and consequently reinsured under the cover reinsurance. This most significant risk was Oceaneering.

None of the risks accepted by the Aon 77 cover underwriters involved certainty of loss in the sense discussed by Thomas J. in Sphere Drake. There might not have been any claims on any of them in the relevant period.

The reinsurers sought to rely upon Phoenix v Halvanon, but they also argued that there was an implied term that the cover underwriters would not accept a risk to the cover if the cover underwriters were indifferent as to whether a gross underwriting profit would be made by reason of the existence and terms of the cover reinsurance, i.e. reinsurers argued that a risk should not be accepted to the cover unless the cover underwriters believed that it would make a gross underwriting profit and not just a net underwriting profit after taking account of the cover reinsurance. There was some support in the evidence for this formulation of the implied term Mr Seymour, who wrote most of the risks for syndicate 535, said:

"On no occasion did I decide to accept a declaration simply because of the existence of the reinsurance; either not caring whether a loss might or might not occur or in the certain knowledge that I would make a profit on that risk even if losses were sustained (because those losses would be met by reinsurers)."

In cross-examination, Mr Watters of syndicate 62 (another cover underwriter) set out his understanding of "writing against":

"Writing against a reinsurer, I would suggest, is where you analyse the risk, work out that you probably would not write it, but with the benefit of a reinsurance, you would write it anyway. I think you would be not doing your underwriting on a normal basis because you had reinsurance to protect you.

MR GRUDER: Would you accept that it would be wrong to do that?

Absolutely, yes."

This formulation provided some support for the duty set out in Phoenix v Halvanon, i.e. it would be wrong for a reassured to write a risk of doubtful quality because he had reinsurance if he would not have written that risk without reinsurance.

Morison J.’s decision on the question of duty is set out at para.255 of his judgment. The first significant proposition was: "Reinsurance enables an underwriter to write business which he would not otherwise have written: that is one of the purposes of reinsurance. It enables the reassured to write larger lines or more of the smaller lines than he could or would have done without the reinsurance. It can never be wrong for a reinsured to take account of his reinsurance when deciding whether or not to write business, otherwise the reinsurance market would collapse …"

Morison J. rejected the proposition that a reassured owed his reinsurer a duty to take reasonable care in the selection of risks to be reinsured. But he did decide that:

"There is also room for another implied term: that the policies to be accepted to the Cover will be those which in the ordinary course of business the lead underwriter would write, taking account of the reinsurance …"

This appeared to be a refinement of the Phoenix v Halvanon duty to act "prudently, reasonably carefully and in accordance with the ordinary practice of the market".

The judge then applied the duty which he found to exist to the facts of the Oceaneering risk. He found that the declaration was written at a time when the cover underwriters knew that the aggregate deductible in the reinsurances had been exhausted. He also accepted the submission that the risk was only written to ensure that Aon could grab Oceaneering’s business from another broker. The insurers of the Oceaneering package policy were unwilling to write it unless the first and most exposed US$15,000,000 of cover was reinsured by the cover underwriters on the basis that the first and most exposed US$10,000,000 would be automatically reinsured by the cover reinsurance. Cox and syndicate 1243 argued that the risk was artificially structured so that it could be reinsured under the cover reinsurance and that any unreinsured exposure of the cover underwriters was more theoretical rather than real. As the judge said:

"I have to say that I think that many of Mr Gruder Q.C.’s points are valid, but crucially, I reject his suggested inference that a partial retention of risk by the Cover Underwriters was theoretical rather than real. In the other respects I draw the adverse inferences which I am invited to draw. It seems to me quite plausible that this risk was written substantially in advance because it was desired that the risk should have the benefit of the reinsurance. I also infer that it was no coincidence that inquiries were made, as they appear to have been, as to whether the aggregate deductible had been exhausted, so that Mr Brown would be able to assess the potential liabilities to the Cover Underwriters if the risk were accepted to the Cover.

It follows, therefore, that I must approach the issue relating to this declaration on the basis that the Cover Underwriters accepted the risk to the Cover because it would have the benefit of the reinsurance and because they knew that the reinsurance would cover the first $10 million in the event of a loss; and I infer that without this reinsurance the contract would never have been written."

However, the judge still found that the policy was written in the ordinary course of the underwriter’s business even though he said that the declaration was "near the knuckle" and:

"If a reinsured treated his reinsurer in this way on a regular basis I doubt whether his shelf life at Lloyd’s would be a long one. It is one thing to act lawfully; quite another to act decently …"

The crucial consideration, as far as the judge was concerned, was that:

"… the Cover Underwriters accepted part of the risk: this was not an arbitrage situation. Had they not retained any part of the risk I would have decided this point differently because I would have taken the view that the risk should not have been accepted to the Cover without express approval."

In this respect, Morison J. accepted the view of Mr Holmes that "writing against the reinsurer":

"reflects the situation where an underwriter has decided to write a risk because he had the benefit of a reinsurance that would allow him to make a profit, irrespective of what loss was sustained on that risk."

Although the reinsurers were unsuccessful at trial, the decision of Morison J. appeared to establish that reassureds owed a duty to their reinsurers, which was more extensive than a duty not to knowingly write gross loss-making business without express disclosure and consent. Morison J. held that it was a breach of duty if a reassured so structured an acceptance of risk so that he would inevitably make a profit whatever happened. This formulation of "writing against" looks at the certainty of profit to the reassured rather than the certainty of loss to the reinsurer which was the distinguishing feature in Sphere Drake. In addition, Morison J. accepted that reassureds owed a duty to accept risks in the ordinary course of business taking account of the reinsurance, although it seemed strange that a risk which he considered "near the knuckle" and not decent was still written in the ordinary course of business.

The Court of Appeal curtailed drastically the limited duties which Morison J. held to exist. It is noteworthy that it was fundamental to the Court of Appeal judgment that it believed that there was no market consensus as to the duties owed by a reassured to a reinsurer (para.85):

"A number of market witnesses gave evidence of what they understood this to mean, but it is clear that there was no consensus between them. An analysis in legal terms is therefore required …"

Any duty which might arise by way of construction or an implied term could only be imposed on the grounds of necessity and would have minimal content. The Court of Appeal saw nothing wrong in the reassured taking full advantage of an advantageous contract, especially since they viewed the interests of reassured and reinsurer as adverse and antagonistic, a proposition that the appellants’ counsel criticised as "the law of the jungle". The Court of Appeal was of the view that the reinsurer should look after himself and said (para.106):

"But the reinsurer is not defenceless or at the mercy of his reinsured. As a market professional he is able to protect himself by way of pre-contract disclosure. Before he writes the reinsurance or on renewal he is entitled to a fair presentation of the risk which includes the type of business his reinsured proposes to write or has written and its history. The wordings should clearly define the nature of the risks reinsured and could permit the reinsurer to monitor the progress of the business if necessary. If he fails to protect himself in this way he should not be able to blame his reinsured."

The Court of Appeal rejected any notion that the reassured owed the reinsurer a duty of care. They also disagreed with the judge’s proposition that the reassured was under an obligation to write business "in accordance with the ordinary practice of the market". The limited duties which the Court of Appeal were prepared to imply were set out in the following passage (para.110):

"‘Dishonesty’, ‘wilful misconduct’ or ‘recklessness’ might provide a basis on which a reinsurer could refuse to accept a risk, for example, if the underwriter exercises no underwriting judgment at all in accepting a risk, not caring whether it was good or bad, or deliberately took a risk knowing of a loss which would only fall on his reinsurers, or took a bribe to write the risk, a remedy might well be available. But if this is to be so we would think it likely to be on the basis that on the proper construction of the policy such a risk would not be covered at all. But whether that is via pure construction or an implied term, or indeed whether it is right at all, is not fruitful to explore further in this case because we are simply not concerned with conduct of that kind."

Where does this leave the law? Although the Court of Appeal left open the question whether Phoenix remained good law in the case of proportional reinsurance, the whole thrust of the logic of the judgment is that Phoenix is no longer good law in the case of either proportional and non-proportional reinsurance. In the absence of specific provisions in the reinsurance (which would be rare indeed), it is only extreme conduct which would breach an implied term. Such conduct would include the knowing acceptance of lossmaking business without disclosure, or if the underwriter exercises no underwriting judgment at all in accepting a risk, not caring whether it was good or bad, or deliberately took a risk knowing of a loss which would only fall on his reinsurers, or took a bribe to write the risk. It does not appear to be wrongful for a reassured to structure his acceptance of risks so that, with the aid of reinsurance, he cannot lose and will inevitably make a profit, so long as it is not inevitable that the reinsurer will lose. This was merely taking full advantage of an advantageous contract.

The Court of Appeal decision has caused some concern in the market. If this is so, the remedy lies in the hands of the market. The foundation of the Court of Appeal judgment is their perception that there was no consensus in the market. It is suggested that Bonner v Cox is not necessarily the final word on the subject of "writing against". However, change cannot come from the courts in the absence of the market. If a consensus emerges in the market as to the duties which a reassured should owe a reinsurer, based on the fact that the modern view of the insurer/reinsurer relationship is one of co-operation rather than antagonism, that consensus can potentially overturn Bonner v Cox. If a court is presented with strong unanimous expert evidence or considers, on appeal, an award of distinguished arbitrators, disagreeing with Bonner v Cox, the law might yet move on.

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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