In Teal Assurance Co Ltd v W R Berkley Insurance (Europe) Ltd and Aspen Insurance UK Ltd  UKSC 57, the Supreme Court upheld the decisions of the Court of Appeal and Commercial Court that a tower of liability insurance contracts was eroded when and in the order in which the insured's liability giving rise to a claim under the insurance was ascertained by agreement, judgment or award. Accordingly the insured and its captive insurer could not vary the order in which insurance claims were paid under the tower so as to adjust the priority of claims and ensure that specific claims were paid by the "top and drop" policy which sat above the tower. The decision reiterates that very clear wording will be needed if policy liability is to be triggered other than in the order in which the underlying claims are ascertained.
As outlined in our e-bulletin on the Court of Appeal decision, the Black and Veatch Group (“BV”) is an engineering firm incorporated in Delaware. BV’s professional indemnity insurance programme for the 2007-2008 year was structured as a “tower” of insurance contracts which provided it with total cover for any one claim (and in an annual aggregate) of US$60 million in excess of the deductible and self-insured retention (“the PI tower”). The primary layer of US$5million (“the primary policy”) was underwritten by Lexington Insurance Co Ltd (“Lexington”). Above this, there were three excess layers of cover totalling US$55 million underwritten by BV’s captive insurer, Teal Assurance Co Ltd (“Teal”). Teal also underwrote an additional “top and drop” layer which provided cover of up to £10 million in excess of the PI tower. This was reinsured by W R Berkley and Aspen (“the Reinsurers”). In contrast to the worldwide coverage provided by the PI tower, however, the top and drop policy excluded claims emanating from or brought in the USA and Canada.
The excess and top and drop policies incorporated the primary policy. This provided liability cover in respect of BV’s liability to third parties, and mitigation cover for costs and expenses incurred by BV in rectifying design defects. The primary policy provided in the Definitions section that:
"E. Deductible and/or Self-Insured Retention means the amount stated in Item 5. of the Declarations that the Insured will pay, as set forth in the Declarations, for Claim Expenses and Damages with respect to every Claim made during the Policy Period. This amount must be paid prior to the Company indemnifying the Insured under the terms and conditions of this Policy."
The excess and top and drop policies also contained the following conditions, being standard excess layer wording reference LSW055:
“1. Liability to pay under this policy shall not attach unless and until the Insurers 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.
3. If by reason of the payment of any claim or claims or legal costs and expenses by the insurers of the underlying policy(ies) during the period of this insurance, the amount of indemnity provided by such underlying policy(ies) is:-
a) Partially reduced, then this policy shall apply in excess of the reduced amount of the underlying policy(ies) for the remainder of the period of insurance;
b) Totally exhausted, then this policy shall continue in force as underlying policy until expiry hereof.
5. All recoveries or payments recovered or received subsequent to a loss settlement under this Policy shall be applied as if recovered or received prior to such settlement and all necessary adjustments shall then be made between the Assured and the Underwriters provided always that nothing in this Policy shall be construed to mean that loss settlements under this Policy are not payable until the assured's ultimate net loss has been finally ascertained.
6. Except as otherwise provided herein this Policy is subject to the same terms, exclusions, conditions and definitions as the Policy of the Primary Insurers…." [sic]
The reinsurance contract in respect of the top and drop layer provided that “the reinsurer’s liability under this agreement shall follow that of the reinsured for losses under all terms, conditions and limits to the reinsured original policy or policies specified therein”.
BV notified a number of claims made against it in the USA, Canada and elsewhere, with a total value which was expected to exceed the cover available under the PI tower. The issue between Teal and the Reinsurers was the order in which these claims should be brought into account for the purposes of determining whether the primary and excess layers had been exhausted. This issue took on significance due to the differing geographical scope of cover provided by the PI tower (which applied worldwide) and the top and drop policy (which excluded US and Canadian claims). As a result of this discrepancy, if the US/Canadian claims were attributed to the excess layers, Teal (and thus its reinsurers) would become liable under the top and drop policy. If, however, the losses relating to the non-US/Canadian claims fell for coverage under the excess layers, the reinsurance would not respond, on the basis that the top and drop policy excluded US/Canadian claims.
Decision of the Commercial Court
Andrew Smith J in the Commercial Court considered the order in which BV's losses attached as a preliminary issue on construction of the reinsurance contract. Finding for Reinsurers, he took as a starting point the established approach that losses trigger coverage 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 (Post Office v Norwich Union Insurance Co Ltd  2 QB 363 applied). Construing LSW055 Clause 1 of the excess and top and drop policies commercially, the judge concluded that it operated as a pre-condition to the policies responding where there was a dispute on the underlying cover but did not affect the order in which the policy indemnity was eroded, as had been suggested by Teal.
Decision of the Court of Appeal
The Court of Appeal upheld the decision of Andrew Smith J and rejected Teal's submissions as to the effect of Clause 1. The court held that the key provision was Clause 3 of the top and drop policy, which provided that once the underlying policies had been exhausted, “this policy shall continue in force as Underlying policy". It followed that upon the exhaustion of the PI tower, the top and drop policy was intended to drop down and become (or at least provide the same cover as) the primary policy.
Thus, once the first excess layer dropped down and effectively became the underlying policy, the insurer (Teal) was liable (as Lexington had been) once BV’s liability had been established by admission, judgment or award; and so on up the PI tower. The primary policy had no equivalent to the provisions of Clause 1, and so that provision was displaced by the terms of the underlying policy as each excess layer dropped down upon the exhaustion of the previous layer. The purpose of Clause 1 was to make clear (as a condition precedent to payment under the layer in question) that the obligation to pay under the excess layers was to be deferred until the resolution of any uncertainty as to the liability of the underlying insurer. The clause was not therefore apt to affect the order in which the policy indemnity was eroded. Furthermore, the construction for which Teal contended did not produce a commercially sensible result and would have permitted Teal to manipulate the lower excess layers to pay US/Canadian claims, leaving reinsurers to face non-US/Canadian claims – an outcome which was unlikely to have been the intention of the parties.
Decision of the Supreme Court
Before the Supreme Court, Teal challenged the proposition that the ascertainment of a claim against the insured exhausted the insured's cover to the extent of that claim. Teal accepted that under a liability policy the insurer's liability typically arose at the time that loss within the scope of the policy was ascertained against the insured, but submitted that it was only when that claim was met by the insurer that policy cover was exhausted. On that basis, if a second claim was notified and ascertained against the insured, BV was free to claim and the insurer was free to make payment in respect of the latter first, in exercise of its contractual rights.
Teal also sought to rely upon LSW055 Clauses 1 to 3 as providing that liability arose under each excess layer only once the underlying insurers "shall have paid or have admitted liability or have been held liable to pay, the full amount of their indemnity". On this basis Teal submitted that its liability under the top and drop policy depended on the order in which the underlying insurers chose to settle insurance claims. Teal in its separate capacity as underlying excess layer insurer could therefore shape its own liability as top and drop insurer.
The Supreme Court did not accept Teal's submissions and unanimously upheld the decision of the Court of Appeal. Lord Mance, giving the leading judgment, rejected Teal's suggestion that policy cover was exhausted only when a claim was actually met by the insurer. He held that:
- Where an insurance had a limit, it made no sense to speak of the insured as having causes of action or recoverable claims which together would exceed that limit. The ascertainment by agreement, judgment or award of the insured's liability gave rise to the claim under the insurance, which was exhausted to the extent of the claim at that time. The same applied to ascertained expenses incurred by BV, which were set against first the policy retention and deductible but thereafter against the insurance provided as and when the expenses were incurred. The policy thus met each ascertained loss when and in the order in which it occurred. The insured could of course forbear from notifying or could withdraw or abandon a claim, in which case the insurance would not be exhausted by that claim. That was not, however, what was envisaged by Teal who instead sought the continued pursuit of a claim, coupled with adjustment of its priority as against the programme of insurances.
- The terms of the relevant policies did not alter this position. Whilst the Definition in the Lexington primary policy required BV to have 'paid' the amount of the deductible and self-insured retention prior to the insurer indemnifying BV, this simply underlined that the deductible and retention must be used up before Lexington could be called upon. It was not a clause which would be expected to affect the nature or subject-matter of the indemnity. Nor was it certain that the word 'paid' meant disbursed – as was held in Charter Reinsurance Co Ltd v Fagin  AC 313, it ought probably to be understood here as being used only as a measure of liability incurred and not as insisting on monetary disbursement. Finally, even if it meant disbursed, such a pre-condition to recovery from insurers did not say anything about the order in which expenses and third party liability were ascertained or mean that the insured could, by delaying payment, alter the order in which expenses or liability would attach.
- Accordingly, as and when expense or third party liability was incurred and ascertained, it was to be taken into account against the primary policy. That policy would respond up to its limit, at which point the next layer was engaged. This was what was envisaged by LSW055 Clause 6 of the PI tower and top and drop policies which provided that each were subject to the same terms as the primary layer policy. Teal's submissions as to the effect of LSW055 Clause 1 were rejected as they treated a clause intended to define when liability arose as affecting the claims in respect of which liability arose. Clause 1 was intended to make clear that the obligation to pay of each excess layer was deferred until the resolution of any uncertainty or dispute as to the liability of underlying insurers. It was not intended to alter the identity of the claims which fell to be met by that underlying insurance. Clause 1 merely provided that liability under the first excess layer only attached as and when Lexington paid or admitted or was held liable in respect of BV's ascertained expenses or third party liability.
- This position was confirmed by the terms of LSW055 Clause 3(b), which provided that on exhaustion of the Lexington policy, the first excess layer dropped down to continue in force as the Lexington primary policy i.e. on the same terms as the Lexington policy. The Lexington policy had no equivalent of Clause 1 and liability under the first excess policy in its new role as the primary policy would therefore necessarily be determined by the timing of the ascertainment of BV's third party liability and expenses. The same position would apply successively under each excess layer, including the top and drop, as each was exhausted in turn.
- Looking to the commercial common sense of the policies (and citing the Supreme Court in Rainy Sky SA v Kookmin Bank  UKSC 50) Lord Mance agreed that it was true that such a position might lead to some degree of control by the insured or primary insurer in the timing of the ascertainment of BV's third party liability. This was less remarkable, however, than the degree of adjustment of the order of claims which Teal maintained it could achieve and which only arose because Teal was BV's captive and party to BV's insurance programme. This produced the unfamiliar phenomenon of an insurer seeking to maximise its own insurance liabilities. It could not readily be reconciled with the basic philosophy that insurance covers risks lying outside an insured's own deliberate control. Lord Mance would not, therefore, have any difficulty agreeing with the Court of Appeal's views on commerciality, but considered it unnecessary to do so as the terms and scheme of the relevant policies provided the answer without more.
As was the case in the Court of Appeal, there was no issue before the Supreme Court as to the general application of the rule that (in the case of liability cover) the liability of insurers typically arises as and when loss is ascertained as against the insured by judgment, arbitral award or settlement. Unlike before the Court of Appeal, however, Teal sought also to argue that as a general principle cover under such policy was only actually exhausted on payment by the insurer. There is no indication as to the basis for such submission, and the suggestion was given short shrift by Lord Mance. Teal's better submissions concerned the question whether the general approach was varied by particular wording in the top and drop policy which provided that Teal only became liable as top and drop insurer once BV's insurers on the layers below had admitted liability or been held liable to pay. If the general approach was so varied, it would have permitted Teal to order the claims so as to maximise its reinsurance recoveries. Whilst the comments of the Supreme Court were less obviously critical of Teal's submissions on this issue than those of the Court of Appeal, it is notable that the Supreme Court did not (unlike the Court of Appeal) feel it necessary to consider the commercial sense of those arguments in rebutting them. Rather, the analysis of the terms and scheme of the relevant policies was sufficient to answer the question. This reiterates in stronger terms the need for very clear wording to be used if the general rule on the attachment of losses is to be disapplied.
Lord Mance also noted that Teal's application for permission had suggested that the case might raise the question of the formulation of insurers' liability to indemnify, namely whether a claim under liability insurance is one for damages for the insurer's failure to hold the insured harmless, or is a debt claim based upon the insurer's undertaking to pay valid claims on the occurrence of particular events. The latter formulation would have the potential effect that insurers could become liable in damages for non- or late payment, contrary to the current position established by cases such as Sprung v Royal Insurance (UK) Ltd  1 Lloyd's Rep IR 111. In the event it was not considered as it would make no difference to the outcome of the appeal, but it is clear that this is an issue that the Courts are eager to address should the opportunity arise. The English and Scottish Law Commissions are already reviewing the position (see their consultation paper Insurance Contract Law: Post Contract Duties and Other Issues) and the outcome of that process is eagerly awaited. It is difficult not to suspect that the Supreme Court granted leave to appeal originally in the mistaken expectation that this controversial issue could be looked at again at the highest level.
Finally, the Supreme Court (as with the Court of Appeal) made no comment on one aspect of Andrew Smith J's underlying Commercial Court judgment of importance to reinsurance, namely his finding that reinsurance was properly analysed as an insurance of the underlying risk rather than a liability insurance of the reinsured. Despite that finding, Andrew Smith J held that a cause of action under the reinsurance would only be established once the reinsured's own liability for the reinsured was ascertained by settlement, judgment or arbitral award. Such an approach is illogical, but does reflect the Commercial Court's reluctance to create limitation difficulties on reinsurances.