In this post in the Blog’s Bermuda Form Insurance Arbitration Series, we discuss additional features of the Bermuda Form that policyholders should take into consideration.
As shown by the history of the Form and the method of acquiring capital for creation of Bermuda Form insurers, the Bermuda Form, as originally drafted and issued by ACE and XL, took into account the interests of the investing policyholders that provided capital necessary to the founding of this new excess liability insurance market. The policy form that the founders and investors sought to draft to help stem the liability insurance crisis in the 1980s has the following distinctive features:
Expected or Intended Injury and the “Maintenance Deductible”
The Bermuda Form contains a clause known in Bermuda insurance industry custom and practice as the “maintenance deductible.” Bermuda Form policies do not actually use that term. In fact, the relevant clause is part of the definition of “occurrence” that addresses injury or damage “expected” or “intended” by the policyholder. The concept of excluding injury or damage that the policyholder expected or intended is, of course, a well-known feature of traditional CGL insurance policies used for decades in worldwide commercial insurance markets by United States, London, and other insurers. Bermuda Form insurers carried that concept over into the Bermuda Form, with revisions to address concerns of both the policyholder market in the United States and the insurance industry and specifically the fledgling Bermuda insurers. It remains in the current Bermuda Form,1 with revisions made over time to address the ambiguities and complexities in application of these concepts that became obvious as policyholders presented batch claims for payment under the Bermuda Form. Although the concept in general terms is well understood, the complexities of the Bermuda Form’s definition of occurrence, and the difficulty of applying it in specific factual circumstances or industries, often results in controversy – and arbitration of disputes over coverage.
A classic example, used at the time the Bermuda Form was introduced, involves the manufacture of a vaccine. Although beneficial to huge numbers of people, many vaccines also may seriously harm a very small number of people who react adversely to the product. Thus, while millions of people use the vaccine safely and successfully each year, it also is known to harm a small number of people each year, most or all of whom are seriously injured and can be expected to sue. The Bermuda Form responded to this known incidence of loss by seeking to preclude coverage for the expected, “noise-level” claims each year, but to preserve coverage if, for some reason, the nature or level of claims changed significantly and unexpectedly from that experienced in the expected noise level of claims.
In very broad terms, the “maintenance deductible” concept in the Bermuda Form was an innovative solution to this recognized problem.2 The Bermuda Form sought to strike a balance between the legitimate interests of policyholder and insurer. Absent the revised “expected or intended” language and the “maintenance deductible” concept, which originally operated as a proviso to the classic “expected/ intended” language of the policy, the insurer might have said to the policyholder that the marketing of a product with a proven history of losses meant that the policyholder expected or intended all the damage alleged, whether or not a later unanticipated “spike” in claims took place. Accordingly, this concept sought to preserve the existence of coverage for a product with a known incidence of losses while, at the same time, keeping responsibility for paying “noise-level” claims on the shoulders of the policyholder. The language used is not found in traditional policy forms drafted by the Insurance Services Office, Inc. or its predecessors (“ISO”), the London Market, or other insurance markets and used prior to the advent of the Bermuda Form; and was designed to address the specific concern discussed above. However, the language used is complex and leads to disputes. The language – seeking to preserve coverage for the claims that are “fundamentally different in nature or order of magnitude” – raises ambiguities which insurers in more recent years have sought to exploit in addressing coverage for batch claims. For example, insurers in recent claims, and unlike their positions in earlier similar claims, have argued that “order of magnitude” must mean at least a 10 times increase in claims, a point that is not specified anywhere in the policy language (or marketing materials). Policyholders in earlier claims did not confront that argument.
As discussed in an earlier post, these evolving arguments by insurers about how claims may be aggregated into a batch and how the maintenance deductible should be calculated put a premium on claims presentation and development of sophisticated strategies for rebutting those arguments—strategies that similarly put a premium on experience in handling Bermuda Form claims and arbitrations.
Dispute Resolution Provision
The Bermuda Form includes an arbitration clause seeking to move the decision-making process on disputes with policyholders from the United States court system to London arbitration under the English Arbitration Act. The current version, the English Arbitration Act 1996, applies to ad hoc arbitrations conducted in the United Kingdom. While it may appear odd to require parties to a contract governed by New York law to arbitrate their disputes in London, there are historical reasons for this procedure. Insurance companies have historically favored New York law, perceiving it to be more insurer-friendly than other laws and recognizing that companies based in the United States likely would find application of the law of a jurisdiction in the United States more acceptable and familiar than the law of a country outside of the country. They also have favored English barristers or retired judges as arbitrators, believing them to be less influenced by what the insurers perceived as undesirable outcomes in insurance disputes in the United States. London-based arbitrations also lessened the chances of the Bermuda Form being interpreted in courts in the United States in connection with any confirmation or vacatur proceedings.
For policyholders, an important consequence of this scheme of dispute resolution is that little binding precedent has developed—or will, outside of the occasional litigation in the United States against ACE or XL that is not dismissed, develop—regarding interpretation of the Bermuda Form. Although English law does permit appeals of arbitration awards in limited circumstances, these circumstances are confined to awards involving an error of English law.3 While some United States courts have addressed questions relating to the Bermuda Form (e.g., as a result of a contribution claim by another insurer against XL or ACE), no United States decision has addressed or resolved substantive issues under the Form. This may change to some extent as Bermuda Form policy provisions are increasingly incorporated in policy forms used by other insurance companies and Bermuda insurers and other insurance companies using the Form do business in the United States to a greater extent and thus are subject to the jurisdiction of United States courts.4 However, the lack of precedent on key provisions in the Bermuda Form, and the provisions of the English Arbitration Act specifying that arbitrations remain confidential, disadvantage policyholders and also provide a key benefit to the insurer which, unlike the policyholder, obviously will be aware of its own previous wins and losses in earlier proceedings with respect to certain provisions of the Bermuda Form.
Choice of Law
In addition to the arbitration clause, the Bermuda Form includes a unique choice-of-law provision which selects as the governing law the law of the State of New York on substantive issues of law, and the law of the United Kingdom on procedural issues. With regard to the substantive law, one of the reasons that insurers have long favored New York substantive law is because, as home historically to many insurers, New York has a well-developed body of law applicable to insurance policies of all kinds and many believe that New York law tends to favor the rights and interests of insurers. For example, New York law traditionally, with some important exceptions, applied the old “per se” rule on notice, which voided coverage if the policyholder’s notice was found to be “late.” That rationale may be changing now that New York, by statute, has adopted the modern rule on notice, requiring the insurer to show prejudice before coverage is voided due to the timing of notice of claim. In addition, certain other provisions of New York law are helpful to policyholders. For example, the New York Insurance Law specifically provides that evidence relating to other “similarly situated” policyholders is relevant to the issue of the materiality of an alleged misrepresentation in the policy application.5 As exemplified by the New York Court of Appeals in Belt Painting v. TIG Insurance Co.6, New York courts are inclined to interpret “pollution exclusions” narrowly to exclude coverage only for environmental pollution, as opposed to any type of fume or contaminant.
The Bermuda Form also modifies New York substantive law in certain key respects. For example, it explicitly allows for recovery of punitive damages. The Bermuda Form also seeks to negate the effects of contra proferentem and select other doctrines that are perceived to favor policyholders. The relevant choice-of-law provision is located at Article VI(O) of Form 004:
This Policy, and any dispute, controversy or claim arising out of or relating to this Policy, shall be governed by and construed in accordance with the internal laws of the State of New York, except insofar as such laws:
(1) may prohibit payment in respect of punitive damages hereunder;
(2) pertain to regulation under the New York Insurance Law or regulations issued by the Insurance Department of the State of New York pursuant thereto, applying to insurers doing insurance business, or issuance, delivery or procurement of policies of insurance, within the State of New York or as respects risks or insureds situated in the State of New York; or
(3) are inconsistent with any provision of this Policy;
provided, however, that the provisions, stipulations, exclusions and conditions of the Policy are to be construed in an even-handed fashion as between the Insured and the Company; without limitation, where the language of this Policy is deemed to be ambiguous or otherwise unclear, the issue shall be resolved in the manner most consistent with the relevant provisions, stipulations, exclusions and conditions without regard to authorship of the language, without any presumption or arbitrary interpretation or construction in favor of either the Insured or the Company or reference to the ‘reasonable expectation’ of either thereof or to contra proferentem and without reference to parol or other extrinsic evidence). To the extent that New York law is inapplicable by virtue of any exception or proviso enumerated above or otherwise . . ., the internal laws of England and Wales shall apply.
For strictly procedural matters, English law, in the form of the English Arbitration Act 1996, governs, though the distinction between substantive and procedural law is not always clear. Generally, London arbitrators adopt procedures influenced by English civil procedure. For example, the parties typically first exchange statements of the case and documentary discovery, followed by an exchange of fact and expert-witness statements. The tribunal may also appoint its own expert.
In addition, there can be differences in what is or is not considered privileged under English law in a London arbitration. The most common question is whether the policyholder can withhold as privileged documents generated by lawyers in the underlying proceedings. An insurer in a London arbitration may seek to compel disclosure of communications with counsel from the underlying proceedings based on a “common interest” between the policyholder and the insurer recognized under English law. However, a London arbitral tribunal is unlikely to allow such disclosure absent a clear agreement or strong implication that the policyholder agreed to share such information.7 In any event, it is generally accepted that an arbitral tribunal in London has broad discretion to determine whether documents should be disclosed, and is not bound to follow the practices customary in English litigation.8