In the last edition of Edwards Wildman’s Insurance and Reinsurance Review, we reported on the recent decision of Tokio Marine Europe Insurance Ltd v Novae Corporate Underwriting Ltd (Tokio Marine) (Commercial Court, 6th November 2013) (see here). This decision and the later case of AstraZeneca Insurance Company Limited v XL Insurance (Bermuda) Limited & Ace Bermuda Insurance Limited (AstraZeneca) (Court of Appeal, 20th December 2013), have brought back under the spotlight the important matter of the threshold of proof to be met so as to enable settlements (including compromise settlements), effected in relation to claims on insurance policies, to form the subject matter of recoverable reinsurance claims under facultative reinsurance contracts.
The AstraZeneca decision concerned liability insurance, while theTokio Marine decision concerned property damage and business interruption insurance. Both entailed “back to back”, facultative reinsurance, (including, in Tokio Marine, a “back to back” facultative retrocession placement). Both highlight the scrupulous attention paid by the English courts to the precise contract wording used, with a view to discerning and applying the intentions of the contracting parties.
In AstraZeneca, it fell to be decided whether, for AstraZeneca (AZ) to recover from its captive insurer, AstraZeneca Insurance Company Limited (AZICO), it was necessary for AZ to establish, on a balance of probabilities, that it would have been liable to those who made claims against it in respect of damage resulting from the drug “Seroquel” (claims which were later settled), or whether it was sufficient that AZ settled an arguable liability with the consent of AZICO. The settlements approved by AZICO were commercial settlements representing a settlement of modest per claim amounts reflecting the risks of litigation. The settlements were not reached on the footing they represented reasonable amounts in respect of what were actual liabilities.
The reinsurance contracts between AZICO and its reinsurers, XL Insurance (Bermuda) Ltd and ACE Bermuda Insurance Ltd, were on the same terms as the underlying (Bermuda Form liability) insurance, so that if AZ had to establish actual liability in order to be able to claim successfully against AZICO, the same applied to any claim by AZICO under the reinsurances.
The English Court of Appeal affirmed that under English law, a liability insurance policy is, generally speaking and in the absence of wording to the contrary, a policy which indemnifies the insured in respect of actual liability. This means that in order to recover under the insurance, the insured must show the existence of liability to the person who made a claim against the insured (assuming a correct application of the law governing the claim to the facts properly found).
In the event of dispute, the existence of liability has to be established to the satisfaction of the insurer, or failing that, by the judge or arbitrator having jurisdiction to decide such a dispute. According to the Court of Appeal, it is not, therefore, necessarily sufficient for the insured to show that he has been held liable to a claimant by some court or tribunal, or that a settlement of the claim has been agreed. In practice, the fact that this has occurred may cause or persuade an insurer to pay but if it does not, the insured must “prove that he was actually liable". As the Court of Appeal has stated, “under English law, the ultimate arbiter of whether someone is liable, if insured and insurer cannot agree, is the tribunal which has to resolve their disputes...It may hold that there was in fact no actual liability and that an insured who thought, or another tribunal which decided, that there was liability, was in error on the facts or the law or both.” “Liability” means “the state of being liable and not alleged liability.” In this regard, the Court of Appeal cited, with approval, Mr Justice Aikens in Enterprise Oil v Strand Insurance Co Ltd Lloyd’s Rep IR 186, who said “[o]ne cannot be obligated to pay sums by law if there is only an alleged liability.”
According to the Court of Appeal, the terms of the insurance in question (which expressly indemnified the insured for “Ultimate Net Loss the Insured pays by reason of liability imposed by law for Damages on account of Personal Injury”), gave “...every indication that the policy provides an indemnity against actual liability.” The Court of Appeal refused to accept that when the insurance refers to amounts paid "by reason of liability imposed by law", it means “liability, whether actual or alleged, of a type which the law imposes, whether or not it actually does so.” There has to be a “causal link between what is paid and an actual legal liability.” Since most of the claims settlements in question did not contain an admission of liability and many had been made with an express non admission, or a denial, of liability, the Court of Appeal noted that “it is difficult to see how a settlement that in terms did not admit, or denied, liability could be taken as establishing that liability existed.”
The Court of Appeal drew attention to the existence of various ways in which the insurance could have been made more favourable from the standpoint of the insured: “The policy does not have to be a liability policy. The insured can seek...cover which insures him against claims made, or judgments given, or against occurrences. The policy may contain a follow the settlements clause whereby the insurer is bound to follow the settlements of the insured, in which case the reinsurer will be bound if the insured has made a settlement in a reasonable and business-like manner. The policy may contain a QC clause or a clause similar thereto. The policy may contain provisions whereby actual liability is, as between the insurer and the insured, taken to have been established if certain conditions are met.” However, in the absence of any such mechanisms and on the basis of the contractual terms as they stood, “liability imposed by law” meant an actual legal liability. In other words, where the peril insured against (and in turn, reinsured) was a legal liability, cover would only exist where an actual legal liability could be established on a balance of probabilities.
Under a facultative excess of loss retrocession contract, Novae Corporate Underwriting Ltd (Novae) agreed to reinsure Tokio Marine Europe Insurance Ltd (Tokio Marine) for a percentage of property damage and business interruption losses sustained by the original insured during the period 1 October 2011 to 28 February 2013 in excess of £53m each and every “Loss Occurrence” subject to a limit of £25m each and every “Loss Occurrence”.
The retrocession contained a follow the settlements clause which provided that:
“This Contract is subject in all respects (excluding the rate and/or premium hereon and subject always to the Limits Reinsured hereon and except as otherwise provided herein) to the same terms, clauses and conditions as original and without prejudice to the generality of the foregoing, Reinsurers agree to follow all settlements (excluding without prejudice and ex-gratia payments) made by original Insurers arising out of and in connection with the original insurance and to bear their proportion of any expenses incurred whether legal or otherwise in the investigation and defence of any claim hereunder in addition to limits hereunder.”
The follow the settlements clause, in essence, (notwithstanding certain amplifications), was of the so-called “Scor” type, thereby having the effect summarized by Lord Justice Robert Goff in Insurance Company of Africa v Scor (UK) Reinsurance (Scor)  1 Lloyd’s Rep 312, as follows:
“In my judgment, the effect of a clause binding reinsurers to follow settlements of the insurers, is that the reinsurers agree to indemnify insurers in the event that they settle a claim by their assured, ie when they dispose, or bind themselves to dispose, of a claim, whether by reason of admission or compromise, provided that the claim so recognised by them falls within the risks covered by the policy of reinsurance as a matter of law, and provided also that in settling the claim the insurers have acted honestly and have taken all proper and businesslike steps in making the settlements.”
Alongside other issues, the Commercial Court in Tokio Marineconsidered:
(1) whether on a true and proper construction of the follow the settlements clause in the retrocession, the burden fell on Tokio Marine to show that the relevant recognised claim fell within the terms of the retrocession as a matter of law, on a balance of probabilities, or (2) whether it was sufficient for Tokio Marine to show that such claim arguably did so.
The Commercial Court cited Mr Justice Evans in Hiscox v Outhwaite(No 3)  2 Lloyd’s Rep 524 to the effect that where a follow the settlements clause of the kind in question existed, “the reinsurer may well be bound to follow the insurer's settlement of a claim which arguably, as a matter of law, is within the scope of the original insurance, regardless of whether the Court might hold, if the issue was fully argued before it, that as a matter of law the claim would have failed.”
The Commercial Court also cited and followed Assicurazioni Generali SpA v CGU International Insurance plc (Generali)  EWCA Civ 429, in which the Court of Appeal affirmed that a reinsured does not have to show that the claim settled in fact falls within the risks covered by the reinsurance but that the claim which the reinsured has recognised did, “or arguably did” (Lord Justice Tuckey). On this footing, the reinsurer is unable to require the reinsured to prove that the insured's claim was, in fact, covered by the original insurance policy but, according to Lord Justice Tuckey, requires the reinsured “to show that the basis on which he settled it was one which fell within the terms of the reinsurance as a matter of law or arguably did so.” This and the need for the insurer to have acted honestly and taken all reasonable and proper steps in settling the claim “provide adequate protection for the reinsurer. ”
Accordingly and following the decision of the Court of Appeal inGenerali, the Commercial Court held that the standard of proof by reference to which Tokio Marine had to show that the recognised claim fell within the retrocession, as a matter of law, was arguability, and not a balance of probabilities, although the court expressed the view that“in principle it is difficult to see why a lesser standard of proof than the usual civil standard should govern the application of the first Scor proviso to the reinsurance.”
Addressing materially different contractual provisions, the AstraZenecaand Tokio Marine decisions affirm English law principles enunciated in earlier authorities relating to the standard of proof required for claims recoverability, depending on the precise contractual framework:
- The words “liability imposed by law” mean just that, whether appearing in a liability insurance contract, or incorporated into a facultative reinsurance. In the absence of any qualifying provisions, references to "liability" mean "actual liability", not "alleged" or "arguable" liability.
- Establishing actual liability, on a balance of probabilities, is therefore required and judicial findings of liability adverse to an original insured, do not, unless there is provision to the contrary, preclude an insurer (or reinsurer, where the need for "liability" flows through into the reinsurance) from insisting on proof of "actual" liability.
- As the Court of Appeal in AstraZeneca noted could be done (and as had occurred in Tokio Marine) insurers and reinsurers naturally remain free to agree that proof of “actual liability” is not required, or is replaced by the need to fulfill less demanding conditions, such as those considered in Tokio Marine.
- In the context of facultative reinsurance (and retrocession) contracts, various forms of follow the settlements clauses have come into existence which bind reinsurers (or retrocessionaires) to the claims settlements effected by the reinsured or retrocedant without requiring proof of “actual liability” for such settlements under the terms of the original insurance.
- Where a reinsurance contract (and not necessarily just of the facultative kind) contains a clause which renders settlements binding subject to compliance with the so-called "double proviso" (namely that all settlements must fall “within the terms and conditions of” the insurance, as well as “within the terms and conditions of” the reinsurance), reinsurers are free to question whether the claim is, in law, covered by both the insurance and the reinsurance. This has been established as the position since the decision of the House of Lords in Hill v Mercantile & General Reinsurance Co Plc (Hill)  1 WLR 1239 (HL), the effect of which is that a distinction must be drawn between the facts from which claims arise and the proper interpretation of the relevant insurance and reinsurance (or retrocession) contracts. According to the House of Lords in Hill, the “double proviso” clause’s repeated use of the words “within the terms and conditions of”prevented “an honest and conscientious appraisal of the legal implications of the facts embodied in an agreement between the parties down the chain”, from imposing on reinsurers “risks beyond those which they have undertaken and those which the reinsured have undertaken”. In other words, the “double proviso”clause enables reinsurers to assess whether, as a matter of law (focusing on “the legal implications of the facts”), any given settlement falls within the contractually defined scope of both the (underlying) insurance and the reinsurance, without a re-opening of factual matters upon which the claim is based.
- Where a facultative reinsurance (or retrocession) contains a follow the settlements clause of the kind considered by the Commercial Court in Tokio Marine, then aside from the requirements to effect settlements honestly and in a proper and business-like manner, a reinsured need merely show that the claim it has recognised under the original insurance contract is (1) “arguably” covered, as a matter of law, under the insurance contract and (2) where the coverage provided under the reinsurance contract is identical to that of the insurance contract, “arguably” covered as a matter of law under the reinsurance contract.
However, the decision of the Commercial Court in Tokio Marinehighlights the need for a higher court to revisit the standard of proof required under a facultative reinsurance (or retrocession) contract and in particular, to clarify whether “arguability”, as opposed to the balance of probabilities, is the relevant standard of proof under a facultative reinsurance contract in circumstances where the relevant terms of cover provided under the insurance and reinsurance are materially identical, or “back to back”. There is strong suggestion in Tokio Marinethat a reinsurer should be able to insist upon proof on a balance of probabilities under a reinsurance, even where such reinsurance is not materially different from the underlying insurance. After all, according to the Court of Appeal in Scor, it was a requirement of the follow the settlements clause that the claim “recognised” and settled by the reinsured “falls within the risks covered by the policy of reinsurance as a matter of law” (emphasis added), suggesting that the claim must, on a balance of probabilities, fall within the scope of the reinsurance as a matter of law.
It is also important to recall that in Lexington Insurance Company v Wasa International Insurance Company Limited , UK 40 HL Lord Mance noted that the Generali case was concerned with how Scorprinciples might apply when the relevant terms of the insurance and reinsurance are identical and that Tuckey LJ’s reference to an“arguability” standard ( “arguably did so”) must be read in context, the relevant context being the existence in both the insurance and the reinsurance of “materially identical terms with materially identical effect”. However, he then questioned whether “arguability” could be the applicable standard where “the like terms in the insurance and reinsurance have different effects due to the application of different governing laws”.However, the decision of the Commercial Court in Tokio Marinehighlights the need for a higher court to revisit the standard of proof required under a facultative reinsurance (or retrocession) contract and in particular, to clarify whether “arguability”, as opposed to the balance of probabilities, is the relevant standard of proof under a facultative reinsurance contract in circumstances where the relevant terms of cover provided under the insurance and reinsurance are materially identical, or “back to back”. There is strong suggestion in Tokio Marinethat a reinsurer should be able to insist upon proof on a balance of probabilities under a reinsurance, even where such reinsurance is not materially different from the underlying insurance. After all, according to the Court of Appeal in Scor, it was a requirement of the follow the settlements clause that the claim “recognised” and settled by the reinsured “falls within the risks covered by the policy of reinsurance as a matter of law” (emphasis added), suggesting that the claim must, on a balance of probabilities, fall within the scope of the reinsurance as a matter of law.
It is highly likely that the Tokio Marine case will be going to the Court of Appeal. At the time of writing, this appeal had yet to be heard.