In Teal Assurance Co Ltd v W R Berkley Insurance (Europe) Ltd and Aspen Insurance UK Ltd  EWHC 91 (Comm), the Commercial Court confirmed the general approach that losses trigger cover not when presented or paid, but in the order of date of loss for property insurance and in the order in which they are ascertained by judgment, arbitral award or settlement in the context of liability insurance. The key question in Teal was whether that approach would be varied by wording in excess layer liability insurance providing that excess liability insurers would only be liable when the primary layer insurer had either paid, admitted liability or been found liable to pay the insured on the primary insurance. The Commercial Court adopted a purposive rather than literal construction of that wording and found that it operated simply as a pre-condition to the policies responding, rather than affecting the order in which the policy indemnity was eroded.
Teal is the captive insurer of companies in the Black & Veatch group ("BV") which includes the Black & Veatch Corporation, an engineering company based in the US.
The insurance programme
BV's professional indemnity programme for the 2007-2008 policy year was generally subject to an each and every claim deductible. Above the deductible, BV's cover was structured as follows:
- BV had a "self-insured retention" ("SIR") of $10 million for any one claim, subject to an annual aggregate of $20 million.
- Of the SIR, Teal insured the upper $5 million per claim.
- Excess of the SIR, there was a primary layer of $5 million per claim and in the aggregate, underwritten by Lexington Insurance Company.
- Thereafter, BV had three successive excess layers of cover underwritten by Teal, totalling $55 million per claim and in the aggregate.
- The various layers therefore provided $60 million of cover in excess of the deductibles and a SIR of $10 million for any one claim or $20 million in the annual aggregate. This was known as the "p.i. tower". The p.i. tower covered worldwide claims.
- In addition, Teal underwrote a further, "top and drop" layer in excess of the p.i. tower with cover limited to £10 million per claim, but excluding claims emanating from or brought in America. In common with "top and drop" cover generally, this layer was intended to drop down to provide cover in the event the underlying layers were exhausted. This top and drop layer was reinsured by W R Berkley and Aspen ("the Reinsurers").
Each of the excess layer policies, as well as the top and drop layer policy, incorporated the primary policy. This provided cover in respect of BV's liabilities to third parties ("liability cover") and, by way of an endorsement, for costs and expenses incurred by BV in rectifying a design defect ("mitigation cover"). In addition, these policies contained the following provision, referred to as "Clause 1":
"Liability to pay under this policy shall not attach unless and until the underwriters of the underlying policy/ies shall have paid or admitted liability or have been held liable to pay, the full amount of their indemnity inclusive of costs and expenses…"
The reinsurance included provisions similar to those in the excess layer policies, as well as a claims cooperation clause.
Claims against BV
A number of claims were made against BV, in America and elsewhere, with the result that it incurred significant costs and expenses rectifying design defects. As at the date of the hearing, therefore, the claims position for the 2007-2008 policy period was as follows:
- BV had paid out its SIR in respect of one of the American claims, and used up $500,000 of the $5 million cover available under the primary policy.
- BV had, however, notified a further American claim, the value of which it was expected would substantially exceed the limit of cover available under the p.i. tower.
- BV had also notified a claim for (at least) $20.5 million in respect of a construction project in the United Arab Emirates, and further claims (excess of deductibles) for approximately $9.5 million of costs it had incurred in remedying defectively designed piping at a gas plant in Trinidad.
The issue between Teal and its reinsurers on the top and drop layer was the order in which these claims should be brought into account for the purposes of determining whether the layers of the primary and excess layers had been exhausted. This was of consequence to Teal and its reinsurers because, if the American losses were attributed to the primary and excess layers, Teal would become liable under the top and drop layer policy for the two non-American claims. In this case, Teal would be entitled to recover under the reinsurance, up to a limit of £10 million. If, on the other hand, the losses relating to the non-American claims were covered by the primary and excess layers, it was common ground that the reinsurance would not respond, on the basis it excluded American claims. This issue as to the order in which BV's losses attached to its insurance programme was tried as a preliminary issue of the construction of the reinsurance.
Andrew Smith J began by noting a number of what he stated were established legal principles on the nature and timing of a reinsured's right to an indemnity which he considered relevant to the Reinsurers' liability. These were that:
- Reinsurance is not a type of liability insurance of the reinsured, but an insurance of the underlying risk;
- The right of an insured to an indemnity arises when an insured loss is suffered (which, in the case of liability cover, is when liability is established and the amount of liability is ascertained); and
- The right of a reinsured to an indemnity does not depend (absent contrary agreement) on the reinsured paying the underlying insured; rather, the right arises once the reinsured's own liability has been ascertained and quantified.
The general rule
Andrew Smith J then considered the parties' arguments on the point at which BV's insurers became liable in respect of its mitigation costs. Applying these principles, the judge had little difficulty accepting the Reinsurers' submission that the question of whether a loss had been suffered by BV depended (in the case of liability cover) upon whether BV's liability had been established and ascertained in amount and (in the case of mitigation cover) upon when BV incurred the costs and expenses.
In reaching this conclusion, the judge rejected Teal's contention that BV's insurers (and therefore the Reinsurers) only became liable when a claim was presented for payment. This was premised on the argument that, because the policies provided liability cover on a claims made basis, the general rule should be displaced with regard to mitigation costs.
The Clause 1 submission
Andrew Smith J then proceeded to consider what he termed Teal's "Clause 1 submission" that the inclusion of Clause 1 in the top and drop layer policy meant it did not become liable to pay BV until the underlying layers had paid out in full (or been held liable to do so). On this basis, because BV had not yet sought payment for the non-American losses, Teal claimed it could present the American losses for payment first, and so attribute the non-American losses to the top and drop layer.
The judge concluded that Clause 1 did not operate in the way suggested by Teal but was simply intended to impose a further pre-condition to cover. This pre-condition was not intended to override the general rule that losses attached to the layers in the order in which they were ascertained. Rather, it was a necessary part of the machinery of a top and drop (or other excess) policy which enables an excess insurer to ensure that the underlying layers are exhausted by prior claims, before it accepts liability for a subsequent claim.
Andrew Smith J would not, however, be drawn on whether Reinsurers were correct that a reinsured may not deal with claims in whatever order it wishes so as to maximise its reinsurance recoveries, whether by virtue of its obligations under a claims cooperation clause, or because it is generally prohibited from acting arbitrarily. The judge did, however, comment that such argument "illustrates the uncertainty that would be introduced into the reinsurance arrangements if the clause 1 submission were correct, and makes it the less likely that the parties intended clause 1 to affect the question of which losses go to erode the p.i .tower".
The annual aggregate and notification submissions
Teal also put forward the further argument that it was the level of aggregate losses in the relevant period which determines how the layers of insurance are eroded. On this basis, if the total aggregate losses exceeded the limit of the p.i. tower, the top and drop layer (and so the reinsurance) would respond to the extent the excess aggregate included losses in respect of non-American claims. In the alternative, Teal argued that the claims should be ordered with reference to the order in which they were notified, on the basis this reflected market practice.
These arguments were dealt with briefly by the judge, who held that it would be contrary to the operation of top and drop policies generally if, at the end of the period of insurance, the insured were able to aggregate its losses and attribute losses to the various layers without regard to when they were incurred. In addition, the practical difficulty would arise that where (as here) cover was provided on a claims made basis, a lengthy period may follow the initial notification of circumstances before a claim is made. As to the notification submission, this was rejected after no evidence of market practice was adduced.
The Commercial Court's decision confirms the general rule that, for the purposes of calculating the order in which claims erode the layers of insurance cover, losses will be brought into account in the order in which they are ascertained. In the case of liability cover, this will usually be when the insured's liability is established and the amount of liability is ascertained. In the case of first party loss cover this will usually be when the loss is incurred. What Teal demonstrates is that the courts will be reluctant to alter that approach absent very clear wording intended to have such effect. Readers may be aware of similar reluctance on the part of the House of Lords in the context of reinsurance in Charter Reinsurance Co Ltd v Fagan  AC 313 to adopt a different approach.
Also of interest were the judge's comments on the nature of reinsurance. Far from being established, the nature of reinsurance is very much open to debate – albeit the pendulum seems to have swung in favour of the "insurance of the underlying risk" analysis in more recent authorities. That issue is not just of academic interest but should also have practical consequences on issues such as limitation. The approach now adopted appears to be in effect that reinsurance is treated as a type of liability insurance of the reinsured, albeit just for the purposes of the timing of when a cause of action arises. While that approach may be commercially and practically sensible (as pointed out by Mance LJ in Gan Insurance Co Ltd v Tai Ping Insurance Co Ltd (No 2)  Lloyd's Rep IR 677), it is very difficult to square with the reinsurance of the underlying risk analysis. Comments in the authorities are (as here) generally obiter, and it is inevitable that at some stage the issue will need to be directly addressed by the courts.