On 31 July 2013 the Supreme Court handed down judgment in Teal Assurance Company Ltd v WR Berkley Insurance (Europe) Ltd [2013] UKSC 57

What the judgment means?

The Supreme Court has endorsed the Court of Appeal’s judgment that losses erode a programme of insurance as and when they are ascertained. The erosion of the policy’s indemnity limit is automatic and simultaneous with the ascertainment of the loss.

This means an insurer is obligated to pay an insured’s losses in the order in which they are ascertained (in the case of third party liability, when the liability is established by a settlement, judgment or arbitral award, and in the case of defence costs, when they are incurred). An insured cannot demand that the insurer pays the losses in a different order.

The Supreme Court’s judgment also considers the interplay between layers of insurance and the trigger point for coverage under an excess policy.

Background

Black and Veatch Group (BV) had a programme of professional indemnity (PI) insurance providing it with worldwide cover of $60m any one claim and in the aggregate. The first layer of the programme ($5m) was underwritten by Lexington and above that there were three excess layers ($55m) underwritten by BV’s captive, Teal.

Sitting above the PI programme was a further excess policy, known as the ‘top and drop’ policy, with a limit of $10m per claim, also underwritten by Teal, and reinsured by WR Berkley and Aspen (reinsurers). Crucially, the top and drop policy was not on identical terms since it excluded US claims.

The excess layers comprising the PI programme and the top and drop policy incorporated the terms and conditions of the primary and (by clause 3) ‘dropped down’ to continue as the primary once the layer below was exhausted.

Each excess policy also provided (by clause 1) that liability to pay under it “shall not attach unless and until the Insurers of the Underlying Policy(ies) shall have paid or have admitted liability or have been held liable to pay, the full amount of their indemnity inclusive of costs and expenses”. Clause 1 is a fairly standard clause in excess wordings, and is derived from the widely used LSW 55 form.

BV received and notified two US claims and two non US claims, with an expected total aggregate liability for BV of over $200m and $50m respectively.

The arguments

The ultimate issue before the Supreme Court was whether BV or Teal were entitled to allocate all of the losses arising from the US claims to the PI programme, and all of the losses arising from the non US claims to the top and drop policy (irrespective of the precise chronological order in which the losses were ascertained), so as to maximise the coverage available under the top and drop policy (which would not cover the US losses).

BV said it could control this allocation, by waiting until all of the losses had been ascertained, before presenting the US losses for payment under the PI programme. Once those losses were paid by Teal, the PI programme would be exhausted, and the top and drop policy would ‘drop down’ to meet the non-US losses. Teal argued that the PI programme would only be eroded once it had paid the full limits, and that it could choose which losses to pay and when.

Reinsurers on the other hand, relying on Cox v Bankside1, argued that BV’s losses would erode the PI programme as and when they were ascertained (ie in the case of a third party liability, once established by a settlement, judgment or arbitral award, and in the case of costs and expenses, once actually incurred2), and Teal was obligated to pay them in that order under the PI programme. It was irrelevant when BV presented the losses for payment to Teal, or when Teal actually paid them, as the erosion was automatic and occurred simultaneously with the ascertainment of the loss. There was nothing BV or Teal could do to hold back the non US losses for the top and drop policy, once ascertained.

Supreme Court decision

The Supreme Court had little hesitation in agreeing with the reinsurers (as the Court of Appeal had done, upholding Andrew Smith J at first instance), thereby approving Cox v Bankside. Lord Mance (with whom Lord Neuberger, Lord Clarke, Lord Sumption and Lord Toulson agreed) held that the purpose of an insurance policy (especially liability insurance) is to meet “each ascertained loss when and in the order in which it occurs”.

Lord Mance held that the effect of clause 1 was to make clear that “the obligation to pay under each excess layer is deferred until the resolution of any uncertainty or dispute as to the liability of the underlying insurers”. Once clause 1 is satisfied, the excess policy drops down (under clause 3) to become the primary insurance, and it will then respond to the losses in the order in which they have been ascertained, and so on up the programme.

The effect of the result for BV was that it no longer had the absolute certainty that Teal (and reinsurers) would be liable for the full limit(s) of the top and drop policy, as Teal’s liability under the policy will depend on the order in which the non US and US losses are ascertained through the PI programme.

Comment

The Supreme Court’s judgment is founded on the fundamental principle that an insured’s claim for indemnity under a liability insurance crystallises at the point when the loss is ascertained (by a settlement agreement, court judgment or arbitral award in the case of third party liability; and when incurred in the case of defence costs). At that point the policy’s indemnity limit is treated as being immediately eroded.

The timing of indemnity payments to an insured does not therefore disturb the order in which the losses have been ascertained and the consequent erosion of the policy.

An insured or insurer cannot therefore manipulate the order in which the insured’s ascertained losses attach under an insurance programme by the timing of the indemnity payments to the insured.

The Supreme Court’s reasoning took account, amongst other things, of the fact that to permit an insured to manipulate the order in which losses were presented for indemnity was not reconcilable with the principle that insurance covers risks which lie outside of the insured’s control.

The practical result of the judgment is that an insured or insurer is not able to determine the order of the presentation or payment of ascertained losses to maximise its cover under a direct insurance or reinsurance programme or otherwise to suit its interests.

The judgment also endorsed the proposition in Cox v Bankside that where there are competing claims for indemnity by multiple insureds or, where the insured is insolvent, third party claimants, the insurer is obligated to pay out in the precise order that the losses were ascertained.