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 in relation to the operation of a claims control  clause in a Kuwaiti energy reinsurance risk.

Compliance with Claims Control Clauses: the ‘reinsurance pizza’

In March 2013, the English Commercial Court handed down a judgment in Beazley and others v Al  Ahleia and others. It involved 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 original policy involved a Construction All Risks policy issued to Kuwait Oil Company (“KOC”)  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.  Facultative reinsurance was placed with the London market on a subscription basis, led by AIG (20%)  and Beazley. AON were brokers on the direct and reinsurance policies. The reinsurance policy  contained a Claims Control Clause (giving reinsurers the right to control all settlements) which  was a condition precedent to liability.

Partial settlement

Notice of alleged damage was given under the re/insurance policies in March 2007.Cover for the  claim was initially declined on grounds of a design defect. Reinsurers were at first united in this stance until May 2009 when the KOC account came up for tender, and 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, 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 USD 19 million. It  was only after these developments that Beazley and the following reinsurers were informed of the  deal.

Beazley and the following market notified Al Ahleia that they were declining cover because of a  breach of the Claims Control Clause. They then initiated proceedings in London seeking a  declaration that they were not liable.

Decision of the English Commercial Court

In finding that the Claims Control Clause had not been breached, Mr Justice Eder referred to the  following factors as the basis for his decision:

  1. The settlement that was reached did not constitute a ‘settlement’, because “in accordance with  business common sense … [Al Ahleia] should, if they so wish, be entitled to settle, ..at least if such  settlement… is not  in respect … any loss … that might give rise to a claim under the Reinsurance  Contract …”. (AIG’s 20% share was also not such a settlement)
  2. 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”
  3. There was no admission of liability by Al Ahleia; instead, it was “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. The judge’s ruling also effectively confirms Al Ahleia’s arguments that the settlement was akin to a slice of a pizza, with the rest of  ‘the pizza’ continuing to remain open for individual negotiation.

Implications

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.

The problems that arose in this case could conceivably have been avoided by:

  1. Avoiding having the broker involved in placing both the direct insurance policy and the  reinsurance placement, which can give rise to a significant conflict of interest
  2. Prroperly delineating the role of the local insurer/s in risks which are heavily reinsured by  the international reinsurance markets
  3. 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
  4. The duties and responsibilities required of the leaders (AIG and Beazley) on the reinsurance  risk being further clarified As we have indicated above, reinsurance placements are effected in this manner in the Middle East region on a regular basis. The participants in these  placements need to recognise the nature of the contractual arrangements that are put in place and  to take steps to safeguard themselves effectively against the types of problems that arose here.