In Part 2 of this 3-part series we look at further challenges which arise from typical reinsurance arrangements in the Middle East involving cross-border transactions, with the cedant based locally, and the reinsurer located in one of the traditional reinsurance centres of London, Munich, Zurich or Paris.
Our focus in this article is on the problems that have recently been considered by the English Courts in relation to the operation of a claims control clause in a Kuwaiti energy reinsurance risk. The manner in which the risk was placed and underwritten will be familiar to anyone involved with Middle East business, and the decision provides a stark warning as to what can go wrong with reinsurance placements of this nature.
Compliance with Claims Control Clauses: the 'reinsurance pizza'
In March 2013, the English Commercial Court handed down a judgment on a case involving the reinsurance of a risk in Kuwait, which is typical of the type of re/insurance arrangements that are put in place on a daily basis in the region. The Court's decision in Beazley and others v Al Ahleia and others is a fascinating read for anyone involved in reinsurance business in the region.
The original policy involved a Construction All Risks and Third Party Liability policy issued to Kuwait Oil Company (incorporating Kuwait Petroleum Company) to cover risks associated with the construction of 15 new crude oil storage tanks as part of an onshore crude export facility.
The original risk was underwritten by a consortium of Kuwaiti insurers, led by Al Ahleia with a 35% share. Facultative insurance to the order of 89.5% was placed with the London market on a subscription basis, led by AIG (20%) and Beazley, pursuant to the usual General Underwriting Agreement for subscription risks. Of special note was that AON were brokers on the direct and reinsurance policies. The reinsurance policy contained a Claims Control Clause that required compliance with the clause as a condition precedent to liability. The reinsurance policy also contained a follow settlements clause.
Partial settlement of the re/insurance claim
Notice of alleged damage to Tank 84 was given under the re/insurance policies in March 2007. The loss was quantified at US$28m. Adjusters were appointed and cover for the claim was initially declined on grounds of a design defect that was excluded under the London Engineering Group Exclusion 2 (LEG2). Reinsurers were at first united in this stance until, in May 2009 when the KOC account came up for tender, AON contacted AIG to see whether AIG would be prepared to take a fresh look at the claim. Unbeknown to the rest of the market, and as part of a bid to secure renewal of the KOC insurance tender, AON and AIG arranged for a further engineering report to be undertaken. In December 2009, AON and AIG agreed with KPC that AIG would settle its 20% share of the loss based on a reduced 100% loss figure of US$19m. Al Ahleia were informed of this development, and duly produced release and discharge forms for AIG's share, along with the local Kuwaiti insurers' share of the loss. It was only after these developments that Beazley and the following reinsurers were informed of the deal that had been struck.
Beazley and the following market notified Al Ahleia that the arrangements that had taken place without their involvement were in breach of the Claims Control Clause and therefore declined cover for the loss. In the meantime, KPC commenced proceedings against Al Ahleia in Kuwait, relying on documents (a number of which were marked 'without prejudice') for the remainder of the claim. Beazley and the following market initiated proceedings in London seeking a declaration they were not liable as a result of the breach, by Al Ahleia of the Claims Control Clause in the reinsurance contract.
Decision of the English Commercial Court
Various representatives of Al Ahleia and the London market reinsurers gave evidence at trial, with the notable exception of AON, who the judge remarked, based on their dual role of being the original and reinsurance brokers on the risk, were "placed in a difficult if not impossible position". Some evidence of the Kuwait proceedings was put before the court, although the judge remarked that "the precise nature of these proceedings remains somewhat unclear", and confessed that "I have found the debate in relation to the [underlying claim in the Kuwait proceedings] confusing partly because I am not sure whether the documents I have been shown in relation to the Kuwaiti proceedings are complete and partly because I am not sure that the translations are accurate".
In proceeding to hold that the Claims Control Clause had not been breached, Mr Justice Eder referred to the following factors as the basis for his decision:
- Discussions and without prejudice documentation produced between KPC and Al Ahleia, including documentation forwarded to AON confirming Al Ahleia's agreement to the proposed settlement of AIG's and the Kuwaiti insurers' shares did not breach the rights of reinsurers to "control all negotiations, adjustments, and settlements" pursuant to the Claims Control Clause;
- The settlement that was reached did not constitute a 'settlement' under the reinsurance to which the terms of the Claims Control Clause, because "in accordance with business common sense … [Al Ahleia] should, if they so wish, be entitled to settle, compromise or admit liability under the Insurance Policy at least if such settlement, compromise or admission is not in respect of or in connection with any loss or losses that might give rise to a claim under the Reinsurance Contract …". The judge held that settlement of AIG's 20% share was also not such a settlement.
- The settlement was made "without prejudice" in circumstances where "the effect of a without prejudice settlement as a matter of Kuwaiti law would be far from certain".
- There was no admission of liability by Al Ahleia, because the documentation produced amounted to "at best simply an offer to pay money".
The decision has not been appealed and is thus final. The English Court's decision, in our view, represents a significant setback to following market reinsurers seeking to rely on the cedant's responsibility to involve its reinsurer in the negotiation of a loss. Although no ruling was made on Al Ahleia's arguments that the settlement agreed by AIG was akin to comparing its settlement to a slice of a pizza, with the rest of 'the pizza' continuing to remain open for individual negotiation, the judge's ruling has in effect confirmed this view of the basis on which individual 'slices' of a reinsurance contract might be negotiated and settled, independent of the rest of the contract.
Implications for the Middle East market
The decision in the case leaves following market reinsurers in a very difficult position where one of their number breaks ranks and seeks to cut a deal with the underlying insured in order to settle its liability.
The problems that arose in this case could conceivably have been avoided by:
- Avoiding the position where the broker is involved in placing both the direct insurance policy and the reinsurance placement, which of itself gives rise to a significant conflict of interest that became readily apparent in this matter as the adjustment of the claim progressed.
- More attention being paid to producing contractual documentation which properly delineates and scopes out the role of the local insurer/s in risks which are heavily reinsured by the international reinsurance markets.
- Those advising the local insurer and the reinsurance market being able to show that a settlement of any part of the loss by the local insurer would be regarded under local law as an admission of liability, and that the risk could never be 'sliced up' under local law.
- The duties and responsibilities required of the leaders (AIG and Beazley) on the reinsurance risk be further clarified and scoped out, which may be a reason to review the basis on which the General Underwriting Agreement is used in the London Market.
As we have indicated above, the circumstances which gave rise to the issues which fell to be considered by the English Court are by no means abnormal: reinsurance placements are effected in this manner in the Middle East region on a regular basis. The participants in these placements (brokers, local insurers and reinsurers) need to recognise the nature of the contractual arrangements that are put in place, in order to appreciate their particular position (and possibly exposure) as a result of their participation, and then take steps to safeguard themselves effectively against the types of problems that arose in the Tank 84 case.