UK: What Challenges Lie In Store For The Reinsurance Market In 2010?

Last Updated: 15 December 2009
Article by Barlow Lyde & Gilbert LLP

Foreseeing the future direction of the market is never a simple exercise.  In the current climate it is a genuine challenge.  Nevertheless, a number of events and recent judicial developments can act as useful signposts.  We consider some of the most significant of these below.

Predictions made earlier in the year of a hardening market have only proved correct in respect of the classes of business which have seen markedly increased claims - aviation, trade credit and US cat amongst them. However, estimates suggest that such areas represent a relatively small percentage of globally ceded reinsurance premium over the last year. Other classes including, most notably, US casualty business, remain flat or are softening. In the final quarter of this year and looking forward to the next 12 months, rates have been and will continue to be at the heart of negotiations between reinsurers and their cedants. The former will be pushing for increases to bolster disappointing investment income and to counter the impact of detrimental and unpredictable retroactive legislation and court authorities; the latter looking for reductions to counterbalance the negative impact of the recession, increased claims and stiff competition. 

Focus should not, and perhaps will not, be on rates alone. We may also see the softening of contract terms. The repercussions could prove detrimental to both reinsurers and cedants, who are not selling/purchasing the cover which they expect or for which they have priced. When the parties' intentions are not accurately spelt out in the wording, there may be disagreements further down the line, leading to damaged commercial relationships, delay in claims settlement and, potentially, recourse to court or arbitration proceedings. Wordings should be carefully reviewed. Simply removing the words 'condition precedent' for example, does not necessarily mean the clause ceases to be such.

Key considerations for the production of reinsurance wordings in the forthcoming year, where underwriting integrity is not diluted, should remain the inclusion of appropriate proper law, jurisdiction and arbitration provisions, review of special termination clauses (in particular more heavily scrutinised downgrade and insolvency provisions), claims/settlement claims control clauses and the inclusion of warranties plus reliance upon them (an issue currently under review by the Law Commissions and touched upon in the Wasa v Lexington judgment referred to below). 

The question of whether notification requirements in contracts amount to conditions precedent or mere conditions (entitling the reinsurer only to damages for their breach) has been an issue in three noteworthy judgments handed down in the last 12 months namely, HLB Kidsons v Lloyd's Underwriters, Laker Vent v Templeton and Aspen v Pectel. Ensuring that such clauses reflect what the contracting parties want them to achieve in this regard is vital.  Renewals and reviews which take place over the next 12 months will serve as an ideal opportunity for parties to make any adjustments required.

The House of Lords' ruling in Wasa v Lexington, handed down on 30 July 2009, was probably the most significant judgment for the reinsurance market this year. Its import will resonate throughout the next 12 months as contracts come up for renewal. At the heart of the dispute lay the debate about application of the presumption that proportionate facultative reinsurance should be back-to-back and respond to claims payable under the primary policy, irrespective of differences in coverage resulting from the application of different governing laws in the primary and reinsurance contracts. The decision is important for a number of reasons, not least because of the certainty it gives to reinsurers who write overseas business, specify the application of English law to their contract, and expect it to be applied. 

The House of Lords upheld this expectation and could find no rule of construction and no rule of law that a reinsurer must respond to every valid claim under an insurance policy, irrespective of the actual terms and conditions of the reinsurance contract. The impact of a contrary decision would have had serious consequences for the market, leading to a possible rise in rates to reflect the uncertainty around such business and damaging reinsurers' confidence in their ability to recover on their own outward protections. 

Cedants of such business who had previously relied upon the presumption of back-to-back cover will, on the other hand, be reviewing their contracts with a mind to how such cover can now be achieved. They can, at least, draw comfort from the Lords' comments to the effect that they are unlikely to tolerate reinsurers trying to rely upon 'technicalities' to avoid making payments to their cedants. The Lords agreed with the judgments in Vesta v Butcher and Groupama v Catatumbo, where reinsurers unsuccessfully argued that they should be relieved from liability because the original insured (rather than the reinsured) had been guilty of a breach of warranty. Such breaches had not been causative of the loss in question. 

In addition, over the next 12 months the issues arising out of the California wildfires will, no doubt, continue to exercise the market. Insurers and reinsurers on the Sempra Energy slip are in dispute over whether the cause of the fires, which occurred in October 2007, in Witch Creek, Guejito and Rice Canyon, were elemental (natural perils) or non-elemental. Further, the expectation is that wildfire losses will continue to increase because the wildfire season has extended by two or more months each year. Given the massive scale of these fires and consequent losses, future claims may result in further disputes. Parties entering into reinsurance contracts to cover these type of risk will therefore make use of the knowledge which they gain from the events which have occurred to date to develop their wordings for the future. Care, for instance, should be taken to ensure that the aggregation provisions in these contracts respond as anticipated.

The financial crisis has yet to hit the reinsurance market. It should not be a market threatening loss, but is still developing in the US in particular. Reinsurers will be paying express attention to issues such as notification and aggregation.

The year ahead could well be a testing one, but provide reinsurers with an opportunity to, once more, be the best regarded performer of the financial sector.

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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