In a decision that brings “back-to-back” back to basics, the House of Lords has held that no amount of follow the settlements language in a reinsurance contract will make reinsurers liable for risks that, on the true construction of the reinsurance policy, would not otherwise be covered by it.  

The dispute in Wasa v Lexington began with an order to US aluminium manufacturer, Alcoa, to clean up over 40 years’ worth of pollution waste in various sites across America. Despite being on risk for a three-year period only, property damage insurer Lexington was held by the Supreme Court of Washington, applying Pennsylvanian law, to be liable for the full extent of Alcoa’s clean-up costs at any particular site so long as at least some of the damage had occurred at that site during the period of cover. Lexington sought to recover from its reinsurers, including Wasa, in England, under a reinsurance contract which to all intents and purposes was back-to-back with the underlying policy, containing a full reinsurance clause, follow the settlements language and a 36-month period clause spanning the same term as the three-year period clause in the underlying contract. The only crucial difference between the policies was that the insurance was held to be governed by Pennsylvanian law, while the reinsurance was governed by English law.  

At first instance, it was held that Wasa was not liable for damage which had occurred outside the 36-month period that it was on risk. The Court of Appeal disagreed, and ruled that the parties must have intended the cover to be back-to-back, so that the period clause in the reinsurance contract should be construed in the same way as the period clause in the underlying policy.  

Unanimously overturning the Court of Appeal decision, the House of Lords held that a reinsurance policy is a separate contract, and that what falls within its cover is a question of construction of that contract, applying the law governing it. In this case the 36-month period clause in the reinsurance contract meant what it said under English law, and could not be construed to mean over 40 years in the same way as the three-year period clause in the underlying contract had been interpreted under Pennsylvanian law.

In order, therefore, for reinsureds to ensure that their reinsurance cover is fully back-to-back with the underlying contract, the insurance and reinsurance policies should either be made subject to one and the same governing law, or agreement should be reached that reinsurers will indemnify their reinsureds in respect of any liability sustained under the primary cover - regardless of the terms of the reinsurance contract. A word of caution, however, for reinsurers: where the governing law of the insurance is expressly set out in the underlying policy (unlike in this case), so that it would in theory be possible for reinsurers, taking appropriate foreign legal advice, to determine their potential exposure under back-to-back reinsurance contracts from the outset, then (in the absence of express words to the contrary) the greater the possibility of the meaning of the underlying policy being translated into the reinsurance contract.