Aggregation In Reinsurance: What Does It Add Up To ?

This article will focus particularly on the different meanings attributed by the Courts recently to the "cause" language typically used in direct policies and the "event" or "occurrence" terminology commonly used in reinsurance. An awareness of this crucial distinction is essential for any reinsured concerned to ensure that his reinsurance cover will fully indemnify him in respect of losses.

Most readers will be aware that aggregation is the process whereby several losses which would otherwise be characterised as separate losses may be grouped together and treated as a single loss, for the purpose of making recoveries under insurance or reinsurance contracts, or in the application of limits and deductibles.

Very significant sums of money can ride upon the interpretation of aggregation clauses, as the long list of legal decisions in this area illustrates only too clearly. A difference in interpretation can lead to a decision that either a relevant loss is not covered at all under the policy, or that the indemnity available is significantly less than the amount of the actual loss.

In one recent case, a clearing bank's ability to recover from its professional indemnity insurers in respect of losses totalling hundreds of millions of pounds arising from pensions mis-selling, was wholly dependant upon its entitlement to aggregate all the claims together. Otherwise all the individual claims would have fallen below the level of the applicable deductibles.

The aggregation of losses can be achieved by a variety of terms. The cases show a broad distinction between clauses in which aggregation is based on an originating "event" or "occurrence" (considered to be broadly synonymous ¹ ), and those based on "cause". It is worth mentioning that the Courts will not consider such terms in isolation when interpreting aggregation clauses.

The terms must take colour from the contractual context, including the object of the contract and the perils insured against, and must if the language so demands be causally relevant to the losses in question. Also relevant is the presumption of back to back cover which will be applicable in the case of proportional (but not for example excess of loss) reinsurance. It will then be assumed, in the absence of very clear words to the contrary, that the aggregation regime in the direct policy was intended to be mirrored in the reinsurance.

What do we mean by "event" in a reinsurance contract? A good starting point is Lord Mustill's definition in Axa v Field ² ,contrasting "event" with "cause":

Axa v Field concerned the interpretation of typically inconsistent aggregation provisions in a reinsurance contract and in the original E&O cover. The original cover included a separate limit in respect of "any one occurrence or series of occurrences arising from one originating cause", whereas the reinsurance contract created a separate limit in respect of losses "arising out of one event." It was held that because of the difference between "event" and "cause" there was a dislocation between the aggregation regimes in the reinsurance and in the original E&O cover, such that the reinsurers were not necessarily bound to provide the reinsured with a full indemnity.

This relatively narrow interpretation of "event" followed the Court of Appeal's decision in Caudle v Sharp ³ to the effect that the writing of each of a series of 32 run-off contracts pursuant to a consistent underwriting policy was in each case a separate event. Evans LJ held that the underwriter's underlying "blind spot"(his continuing failure to research the risks inherent in asbestos related business) could not be a relevant event because it did not fall within the commonly accepted definition of "event" (being more akin to a continuing state of affairs), and it was causally irrelevant to the losses until the contracts were actually written.

One of the more recent authorities on the meaning of "occurrence" is the decision of Rix J in Kuwait Airways Corporation v Kuwait Insurance Company ⁴ ,which is broadly consistent with Lord Mustill's definition of "event" in Axa v Field as quoted above. This concerned the application of primary insurance limits to the seizure by Iraqi forces of 15 aircraft all at Kuwait Airport on 2nd August 1990. The planes were flown to Baghdad in the course of the next few days. At least $242 million rested on the issue of whether the losses constituted one or more occurrence(s) for the purposes of a maximum ground limit in the contract.

Whilst Rix J acknowledged that an occurrence could embrace multiple losses, he held that:

Rix J found that all the planes were effectively lost for the purposes of the policy at the point when the airport was captured by the Iraqi forces. Applying the test quoted above, he held that the seizure of the aircraft constituted one occurrence because there was unity of time, location and purpose. However, he held that there would have been multiple occurrences if the aircraft had been lost only when they were each flown out on successive days after the invasion. This emphasised the importance of unity of time in the analysis of "occurrence" because all the other required unities would still have been present on that alternative analysis.

In American Centennial Insurance Co v INSCO Ltd ⁵ ,it was held that "event" or "occurrence" could mean something other than a physical occurrence and that the collapse of a financial institution could also naturally be described as an event. However, the excess of loss reinsurances under review were concerned only with events which "affected" underlying policies. Because the liabilities under the relevant underlying D&O policy derived from individual acts or omissions, and were not caused directly by the collapse of the financial institution in question, this could not be a relevant event and hence there was no entitlement to aggregate.

The distinction between "event"/ "occurrence" and "cause" was given further emphasis more recently in Municipal Mutual Insurance Ltd v Sea Insurance Ltd ⁶ . Damage to machinery at the Port of Sunderland occurred over a period of about 18 months as a result of a whole succession of individual acts of pilferage and vandalism. Hobhouse LJ held that these acts amounted to a series of occurrences "consequent on or attributable to one source or original cause" for the purposes of the limit of indemnity, the cause being the absence of an adequate security system at the Port. Importantly, however, the Judge noted expressly that had this been an "any one event" clause then there would have been a powerful argument to the effect that each act of pilferage or vandalism was a distinct event.

The recent decision in Lloyds TSB General Insurance Holdings Ltd v Lloyds Bank Group Insurance Co ⁷ shows how wide the interpretation of "cause" may be compared with "event"/"occurrence." A substantial number of pension purchasers brought claims against financial service consultants (employed by the claimant companies in the proceedings) on the basis that they were not given comprehensive and objective advice. The question was whether the losses had resulted from a single act or omission (or related series of acts or omissions), giving the insured claimant companies the right to aggregate and bear only one deductible. In determining the preliminary issues, it was assumed that the claims arose from a central management failure properly to train the financial service consultants. Moore-Bick J found that, applying conventional causation principles, it was common sense that all claims resulted from this failure. He rejected the argument that each loss was only caused when the investor in question entered into a pension contract relying upon the advice provided, highlighting the distinction between "event" as in Caudle v Sharp, and "cause."

The leading Court of Appeal authority on the meaning of "occurrence" is the recent decision in D P Mann v Lexington Insurance Company ⁸ .This expressly affirmed that multiple losses which are separate in time and space will not be converted into a single occurrence or event simply because they may have a common underlying cause or arise as a result of a common intention or purpose. The relatively restricted interpretation of "event"/"occurrence" as compared with "cause" was thus given renewed emphasis.

The case concerned attacks on 21 supermarkets at various times over at least two days in the course of Indonesian rioting in May 1998, the supermarkets being up to 80 km apart. The Sum Insured clause in the retrocessions read: "USD 5,000,000 per occurrence but in the annual aggregate separately for Flood and Earthquake." By contrast, the equivalent limit in the reinsurance was IDR 30 billion "each and every loss, each and every location." The reinsurers argued that each attack constituted a separate occurrence; the retrocessionaires contended that all the attacks amounted to only one occurrence because the rioting was allegedly orchestrated by the government. That issue determined the amount of cover available under the retrocessions.

Having reviewed the authorities, and based upon a construction of the retrocessions having regard to the terms of the underlying reinsurance, Waller LJ concluded that: "the occurrence has to occur at the particular locations, and cause loss and damage at the same to be an occurrence within the contemplation of this policy." He acknowledged that many of the insured perils (for example, volcanic eruptions or hurricanes) might loosely be characterised as single "occurrences", in the sense in which the term is used in property catastrophe excess of loss covers, even though they affect numerous locations. However he held that in this contractual context, "occurrence" was location specific. Indeed he endorsed the reinsurers' submission that even if a typhoon simultaneously damaged several supermarkets at different locations, there would be multiple occurrences because of the absence of unity of location.

In any event, even if he was incorrect and "occurrence" was not in fact location specific, Waller LJ still rejected the retrocessionaire's argument that the alleged orchestration of the riots by the government was in itself sufficient to aggregate what would otherwise be losses separate in time and space into one occurrence.

Great care needs to be taken to ensure that there is no dislocation between the aggregation regimes in direct policies and in the corresponding reinsurances or retrocessions, especially in the case of non-proportional reinsurance, or reinsurance recoveries will be jeopardised. It is important to note that the use of general incorporation language such as "As Original" will by no means necessarily achieve that objective. In particular an awareness of the distinctly different ways in which the Courts are likely to interpret "cause" based provisions and "event"/"occurrence" based clauses is essential if reinsurance failures and disputes are to be avoided. The recommended approach is to spell out the intentions of the parties with respect to aggregation in the clearest possible terms. Hours clauses or locality clauses will help to achieve this purpose. Alternatively, if commercially feasible, it may be possible to negotiate a sole judge clause giving the reinsured the right to determine what constitutes an "event"or an "occurrence" for aggregation purposes - these are likely to be upheld by the Courts ⁹ in the absence of perversity, bad faith or manifest unreasonableness in the exercise of such discretion.

1 See for example Axa v Field, Kuwait Airways Corporation v Kuwait Insurance Co, American Centennial Insurance Co v INSCO Ltd

2 [1996] 2 Lloyd's Rep 233

3 [1995] LRLR 433

4 [1996] 1 Lloyd's Rep 664

5 [1996] LRLR 407

6 [1998] Lloyd's Rep IR 421

7 [2001] Lloyd's Rep PN 28

8 [2001] 1 Lloyd's Rep 1

9 Brown v GIO [1998] Lloyd's Rep IR 201

RPC acted for the successful London market reinsurers in D P Mann v Lexington.