The Court of Appeal has ruled in Ace European Group & Ors v Standard Life Assurance Ltd9 that extending the principle of apportionment to recoveries under a liability policy between insured and uninsured losses was “irrational and unprincipled”. Accordingly, only careful and precise drafting will permit an insurer to ensure the indemnity is apportioned.

Background to the decision

This dispute arose out of the operation of Standard Life’s Pension Sterling Fund (the Fund), which by 2007 included a substantial proportion of asset backed securities. Much of the literature marketing the Fund implied that this was a cash fund in the narrow sense with its capital value protected. Asset backed securities are, however, less liquid and their value subject to market movement. Following the collapse of Lehman Brothers and the onset of the credit crunch in 2008, which rendered the Fund increasingly difficult to value, Standard Life took the decision to switch to a different source of pricing data, and therefore valuation. The result was a fall in value of units in the Fund of around 4.8%, equivalent to a shortfall of approximately £100 million. Standard Life was concerned that it was vulnerable to mis-selling complaints on the basis that the customer facing literature had failed to make it clear that the capital value of the Fund was not protected.

Standard Life considered setting up a claims process and inviting any claims to be met on a case by case basis. However, it subsequently decided that a better option was to restore the shortfall by taking steps to inject c.£102 million into the Fund (the Cash Injection) to restore the shortfall. The decision to make the Cash Injection was also motivated by Standard Life’s estimate that not doing so would cost it c.£300 million as a result of consequential brand damage.

Standard Life then sought to recover the Cash Injection under its professional indemnity policy which, as drafted, provided an indemnity in respect of third party claims. The policy contained a limit of £100 million and included cover in respect of “Mitigation Costs.” “Mitigation Costs” were defined as “any payment of loss, costs or expenses reasonably and necessarily incurred by the Assured in taking action to avoid a third party claim or to reduce a third party claim... of a type which would have been covered under this Policy...”.

Insurers denied liability on the basis that the Cash Injection did not fall within the definition of “Mitigation Costs”. They also argued that some or all of it should properly be regarded not as made for the purpose of avoiding or reducing claims, but rather for the dominant purpose of avoiding or reducing potential brand damage which was not covered under the policy.

Insurers sought to assert that, unless the policy provides otherwise, a rule of law requires the apportionment of mitigation costs between the respective insured and uninsured interests at risk. Standard Life had used the £100 million to mitigate its losses in respect of potential claims against it and this was an insured risk. It had also estimated the brand damage if it did not make the Cash Injection at £300 million (which loss was not insured under the policy). As a result, the total amount of damage that Standard Life had avoided as a result of the Cash Injection was £400 million. In broad terms, therefore, the proportion of the total potential loss saved by the Cash Injection that came within the “Mitigation Costs” definition was 25% (i.e. the cash loss of £100 million as compared with a total saving to Standard Life of £400 million). Insurers argued that the recovery under the policy ought to be apportioned on that basis. This rule of law was said to emerge by analogy from the well-established principle of apportionment under ‘sue and labour’ clauses in marine insurance.

The first instance decision

The judge, Mr Justice Eder, found that the Cash Injection was reasonably and necessarily incurred by Standard Life in taking action to avoid or reduce third party claims of a type which would have been covered under the policy. It therefore came within the definition of “Mitigation Costs” under the policy. However, he also found that another, equally efficacious, intended objective was to avoid brand damage.

Eder J rejected the insurers’ argument that, given the injections had the dual effect of avoiding/reducing claims and protecting Standard Life’s reputation, any indemnity to which Standard Life was entitled should be reduced in accordance with principles of apportionment. Insurers appealed on the issue of apportionment.

The Court of Appeal decision

Insurers’ appeal was rejected. The Court of Appeal held, first, that this approach was untenable as a matter of construction of the policy wording. Under the policy the insurers had undertaken to indemnify Standard Life for “Mitigation Costs” and Eder J had found at first instance that the Cash Injection met all of the criteria required to satisfy the definition in the policy wording. This part of his decision was uncontested on appeal.

Secondly, Lord Justice Tomlinson, who gave the reasoned judgment in the Court of Appeal, made a helpful analogy with the well-established principle that, where a loss is caused by an insured peril, the fact that there is another, equally effective, uninsured cause will not affect recovery under the policy (see the Miss Jay Jay10). The position is of course different if the second cause is the subject of an exclusion under the policy. In such a situation, the policy will not respond at all (see Wayne Tank and Pump Co v Employers Liability Insurance Corporation Ltd11).

Although the appeal could have been disposed of on this short point of construction, Tomlinson LJ went on to explain why, in his view, there is no place in liability insurance for the principle argued for by insurers.

Insurers’ primary argument that cover for mitigation costs is analogous to a ‘sue and labour’ provision in a marine policy, such that the principle of apportionment should be implied into liability policies as it is for marine policies, was rejected. Tomlinson LJ held that marine policies are different from liability policies in that the adjustment of losses under marine policies proceeds on the assumption that the subject matter is fully covered by insurance. Where there is under-insurance (and so the insured is “his own insurer” for the uninsured balance) apportionment is required in order to ensure that insurers only contribute to the extent of their interest in the property. Tomlinson LJ stated that the extension of the apportionment principle to liability insurance, where the extent of the liabilities to be incurred is unknown when the policy is agreed, would be “irrational and unprincipled”.

The Court of Appeal went on to cast doubt on the view of Mr Justice Rix in an aviation insurance case, Kuwait Airways Corporation v Kuwait Insurance Company12, that apportionment could apply in a non-marine context. Tomlinson LJ noted, “It may be that aviation property losses are traditionally adjusted in the same manner as marine property losses, but there is no finding to that effect in the Kuwait Airways case, and thus no immediately discernible rationale for the extension of the rule from marine property insurance to aviation property insurance”.

The implications

It is inevitable that insurers of Financial Institutions policies (and other liability policies) will seek to tighten their wordings in light of this decision to ensure that they are not providing cover unintentionally for actions designed to protect an insured’s reputation.