UK: LMX Spiral Claims - The End Of The Beginning Or The Beginning Of The End?

Last Updated: 16 November 2009
Article by Andrew Bandurka

Equitas v R&Q [2009] EWHC2787 (Comm)

The latest instalment in the series of cases arising out of the LMX spiral has produced a finding which is as unexpected and unwelcome in some quarters as it is celebrated in others.

For many years the LMX market spiral has been in "lock-down", with no claims being paid because, as the Court of Appeal has confirmed in two judgments, Scott v Copenhagen Re [2003] and King v Brandywine [2005], "bad" claims had been mixed in and collected along with "good" claims in the Ultimate Net Loss calculations of the writers of LMX business. In the former case, the bad claims arose from the destruction of the BA plane in the first Gulf War. This was a separate event to that which produced the good claims, namely the loss of the KAC fleet and spare parts when Iraq invaded Kuwait in 1990. In the latter case the good and bad claims arose from settlements under different sections of Exxon Corporation's insurance, following the grounding of the Exxon Valdez and the subsequent oil spill. The value of claims thus blocked in the market (taking into account the magnifying effect of the LMX spiral) ran to several $billions.

In both Scott v Copenhagen Re and King v Brandywine, Equitas, assignee of the reassureds, was on the losing side. The barriers preventing collection of the good claims, tainted as they were with the bad, were manifold and apparently insuperable, since no-one had sufficiently reliable data to re-start the LMX spiral claims process from the ground up, using only the good claims.

In Equitas v R&Q it was R&Q's case that Equitas must re-present its claims, correctly aggregated upwards through the spiral, appropriately stripped of the irrecoverable losses and, in the LMX Spiral Claims - the end of the beginning or the beginning of the end? Equitas v R&Q [2009] EWHC2787 (Comm) case of Kuwait, adjusted to take into account the effect of UNCC refunds. R&Q argued that unless Equitas could prove that sums claimed were due on a contract by contract basis, Equitas was not entitled to recover anything at all. In fact, Equitas did not attempt to reconstruct the spiral from the ground up in this way, but spent years developing an actuarial model which uses discounts to effectively strip out the bad claims, so leaving a minimum recoverable amount properly due under certain of its ceded reinsurance contracts.

In Equitas v R&Q, R&Q questioned the appropriateness of the model. Mr Justice Gross said that actuarial modelling is complex, expensive imperfect and not ideal. However, Equitas' model produced an acceptable, soundly-based route to establishing the properly recoverable minimum losses, having regard to the burden and standard of proof. This ruling was based upon a novel interpretation of the cases (principally Hill v Mercantile & General) on "follow the settlements" clauses and the manner in which the reassured, i.e. Equitas, is bound, or is able to prove its loss. The judge highlighted the fact that there is no rule of law as to how proof of loss must be performed and that the content of the evidence required must vary from case to case.

The actuarial modelling involved inputting voluminous actual data extracted from market databases into computer programs which generate reasonably realistic salient features which were representative of the LMX spiral in showing the passage of the Kuwait Airways and Exxon losses through the spiral. The model took into account the effects of leakages in the spiral, vertical and horizontal exhaustion of reinsurances, reinsurers' insolvencies, and commutations.

The Judge held that on a balance of probabilities the model showed that Equitas' existing (good and bad) UNL was at least 86.5% recoverable for Kuwait (subject to UNCC refunds) and 75% recoverable for Exxon. The most significant participants in the LMX market may recall early attempts at a market compromise were along discounted lines on similar principles.

There may be an appeal, and a further hearing to determine the quantum of Equitas' claims. R&Q is contemplating a counter-claim in the next stage of the litigation, which relates to substantial undiscounted claims previously paid to Equitas.

The ruling, if it withstands possible appeal, poses a number of questions. Although the acceptance of actuarial modelling as a method to prove reinsurance loss is novel, economic modelling and proving loss by experts is commonly used in international arbitration and commercial litigation in general. The ruling may not herald a new way of approaching proof of reinsurance claims since the facts of this case are so unusual, if not unique.

Will the ruling unwind the spiral? There must be doubts about this since Equitas is in a unique position to model the whole of the Lloyd's market, which accounted for roughly 40% of the LMX market. Whether company participants will have the means and the will to undertake a similar exercise for their own retrocessions remains to be seen. The case involved only 26 reinsurance contracts although there may be more in the wings. Whether modelling is capable of producing a workable solution for all reinsurance contracts and "players" remains to be seen.

However, it is undoubtedly the case that obstacles which were once thought to be insuperable may now be a step closer to being resolved.

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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