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What, if any, duties are owed to non-proportional reinsurers by their reinsureds?
In its recent judgment in Bonner & Others -v- Cox & Others ("Aon 77") the Court of Appeal held that a reinsured does not owe his non-proportional reinsurer a duty to write business with the care and skill of a reasonably prudent underwriter or in accordance with market practices. It was felt that the reinsurer was adequately protected by his entitlement to a fair presentation of the risk and the need of the reinsured to maintain his reputation in the market.
Introduction
The case concerned a renowned energy broker's open cover known in the market as "Aon 77", by which cover underwriters committed to be bound by risks accepted by the leader within the terms of the cover. Until the 1998 year the cover underwriters obtained reinsurance protections under various arrangements, a detailed understanding of which is not necessary for an appreciation of the legal issues involved in the case. From 1999, Aon wished to procure reinsurance for the cover as a whole and to offer the benefit of this to the cover underwriters as part of their renewal broke.
The cover had a reasonably good track record but inevitably was hit by heavy losses. Reinsurers sought to avoid their contracts on various grounds. In due course, the resultant dispute came before Morison J, who dismissed the reinsurers' arguments. Three issues arising out of his judgment came before the Court of Appeal:
- Whether reinsurers were entitled to avoid the reinsurance for misrepresentation ("the misrepresentation issue");
- Whether reinsurers were entitled to avoid the reinsurance for non-disclosure ("the Elk Point issue"); and
- Whether the cover leaders owed implied duties to their reinsurers when accepting declarations to the cover ("the implied duties issue").
Misrepresentation Issue
The misrepresentation issue, in which the Court of Appeal upheld the judgment of Morison J, really raises no new issues of law or principle. Detailed consideration of the Court of Appeal's judgment in this Bulletin is therefore confined to the Elk Point and the implied duties issues.
"Elk Point" Issue
In order to offer cover underwriters the benefit of the reinsurance at the 1999 renewal, Aon adopted a familiar practice at Lloyd's of first obtaining a (binding) promise from syndicate 1688 to provide reinsurance for whichever insurers may in due course renew the cover. For the present purposes it is sufficient to note that four cover underwriters, syndicates 62, 187, 228 and Euclidian, were proposing to take a 50% line (in total) on the cover with the benefit of this reinsurance protection.
Under the procedure adopted by Aon, 1688's promise was recorded by their underwriter initialling a percentage line on the slip. This was at a time when he could not have known with certainty the identity of the renewing cover underwriters. Adopting the Court of Appeal's analysis in The "Zephyr" [1985] 2 Lloyd's Rep 529, Morison J found that the reinsurers' promise was an open offer capable of acceptance by a renewing underwriter committing to the cover for the 1999 year on the basis of that offer of reinsurance.
A question arose, however, as to the point in time at which the reinsured's duty of disclosure comes to an end. The expert witnesses were in agreement that the market regarded the duty as running until the reinsured accepts the offer by becoming a party to the cover. However, they recognised the potential for difficulties to arise if material information became known to the broker when the cover was only partly subscribed, such that the reinsurer might withdraw or vary his offer in relation to other underwriters who had not by then renewed.
The sequence of events in the present case was, in summary, as follows. 1688 scratched the slip on 23rd November 1998. On 1st December, Aon became aware of press reports of a blow-out at a well operated by Elk Point resources. Although it was apparent that it was a major incident, it was not known for certain whether it would impact the cover. Some time between 3rd and 7th December, syndicates 62 and 187 (but not 228 nor Euclidian) agreed to renew their lines. On 8th December, the brokers received a preliminary report from loss adjusters indicating that the incident was likely to impact the cover to a significant extent. This was followed two days later by an upward threefold revision by the adjusters of the anticipated impact on the cover.
The judge found that the information possessed by the brokers on 1st December was not material to be disclosed as it was insufficiently concrete and did not establish that the cover was going to be hit. Thus, it was only when Aon came into possession of the adjusters' report on 8th December that the duty of disclosure arose. However, by that time contracts had already been concluded with syndicates 62 and 187. Although it might theoretically have been possible for the reinsurers to withdraw or amend their offer of reinsurance to 228 and Euclidian , the judge nevertheless concluded (without the benefit of any relevant evidence from the underwriter involved) that the broke had proceeded too far by 8th December to make that commercially sensible. Thus, although 228 and Euclidian had breached their duty of disclosure, that failure had not induced 1688's underwriter to enter into the contract on the terms he did.
On appeal, the Court of Appeal refused to interfere with Morison J's conclusion that the information held by Aon on 1st December was not material. In any event, even if that conclusion were wrong, the reinsurer would still have had to show that the failure to divulge information which might or might not have lead to a further claim on the 1998 year (but, in any event, not on the 1999 year which was what he was being asked to reinsure) had induced him not to withdraw the offer or vary its terms. In the absence of any evidence from the reinsuring underwriter as to what he would have done in these circumstances, the court would not infer what he would have done.
The Court of Appeal also dismissed reinsurers' arguments that, as a matter of construction, no binding contracts had come into existence at all by 8th December. More significantly, in so doing the Court endorsed the trial judge's finding (which was essentially one of fact) that it was far-fetched to suggest that the reinsurer would have altered or withdrawn his offer even if the information in the adjusters' reports had been made known to him. Accordingly, the appeal on the Elk Point issue failed.
Implied Duties Issue
This was the single most important issue in the appeal. In summary, the reinsurers objected to a small handful of declarations accepted to the cover in circumstances where it was suggested that the cover leaders were indifferent as to whether they would make a gross underwriting profit, knowing that they could avail themselves of their reinsurance protections.
One particular declaration was singled out where the risk was accepted to the cover at a time when the aggregate excess on the reinsurance had been exhausted, such that the first US$10 million of any loss would inevitably and immediately impact the reinsurance, while only $5 million of any loss excess of US$10 million was retained by the cover.
The reinsurers argued before Morison J that cover underwriters had breached terms to be implied into their reinsurance that (i) they would not accept a risk to the cover if they were indifferent as to whether a gross underwriting profit would be made by reason of the existence and terms of the reinsurance; and (ii) risks written to the cover would be written with the ordinary skill and care of a reasonable underwriter.
The judge did not agree with the reinsurers' formulation of the implied duties. However, he did find that there were two limited duties to be implied into reinsurances of this nature. The first was that a policy will only be declared to the cover if it has been the subject of an underwriting judgement by the leading underwriter. The second was that policies to be accepted to the cover would be only those which in the ordinary course of business the lead underwriter would write, taking account of his reinsurance.
However, the judge went on to find that none of the declarations complained of was accepted to the cover in breach of these implied duties. In reaching that conclusion, he placed emphasis on the absence of dishonesty, as reflected in the retention of part of the risk by the reinsured, albeit contingently. Although the premium split as between reinsurers and cover underwriters did not fairly reflect their respective exposure to the risk, the judge accepted that having agreed to write the reinsurance for a specified proportion of the premium in relation to such risks as were declared to the cover, the reinsurer would "win some, lose some". He had merely lost on this occasion.
Before the Court of Appeal, as before Morison J, much of the argument centred around the application and extent of the decision of Hobhouse J, as he then was, in Phoenix -v- Halvanon [1985] 2 Lloyd's Rep 599. That was a case involving facultative obligatory reinsurances of a variety of business. As such, the reassured had an unfettered right to choose whether to cede or not, whilst the reinsurer had no equivalent right to reject any cessions he found unpalatable. In the circumstances of that case, the judge accepted that the reinsured was under an implied duty to conduct his business prudently, reasonably carefully and in accordance with the ordinary practice of the market.
The Court of Appeal decided, however, that there was no room for the implication of Phoenix -v- Halvanon type duties into non-proportional reinsurance. They also shied away from a finding that the duties were universally applicable in all cases of proportional reinsurance.
In reaching its conclusions the Court of Appeal emphasised that, in the case of non-proportional reinsurance, the reinsured and the reinsurer generally have adverse and competing interests, whereas in proportional reinsurance the reinsured and reinsurer are effectively joint venturers. Non-proportional insurance is an arm's length transaction and each party will attempt to secure the best deal it can for itself. The Court of Appeal rejected the notion that one of the counterparties might owe to the other a duty to safeguard the other's interest, not least because he cannot be taken to know what the interests of that other are. If an underwriter in such a situation is presented with what he perceives to be an excellent risk, he cannot be expected to decline it on the basis that it might adversely impact on his reinsurers. The Court of Appeal thought that it would be quite nonsensical were an underwriter unable to take full account of his reinsurance when deciding whether or not to accept a particular risk.
Against this, the Court of Appeal felt that a reinsurer has perfectly adequate remedies available to him, without the need to imply duties of this kind. In particular, he is entitled to receive a fair presentation of the risk, including details of the type of business the reinsured proposes to write, or has written, and its history. The reinsurer can also protect himself from exploitation through the express words of the reinsurance contract. In addition, there is to some extent an element of self-regulation within the market as the reinsured will need to maintain his reputation. Any insurer who consistently fails to act professionally or competently will soon find that he is un(re)insurable. It is trite law that the touchstones for the implication of terms into a contract are necessity and certainty. In the case of non-proportional reinsurance, at least, the Court of Appeal saw no necessity for a reinsured to take on additional duties to his reinsurer. The Court also considered that an implied term requiring one party to act in accordance with "the ordinary practice of the market" (or to some similar standard) would be too uncertain in application. While such concepts may be easy to state they are not at all easy to ascertain.
The Court of Appeal accepted that in an extreme case, such as where an underwriter exercised no underwriting judgment at all in accepting a risk, not caring whether it was good or bad, or where he deliberately took a risk knowing of a loss which would only fall on his reinsurers, or where he accepted a bribe to write the risk, a remedy might well be available. However, that would most likely be on the basis that, on a proper construction of the policy, such a risk would not be covered at all. In any event, the facts of this case fell far short of conduct of this type.
The Court of Appeal finally concluded that, even if they were wrong and Phoenix -v- Halvanon type duties were owed, such duties had not been breached on the facts of this case.
Conclusion
In summary, the Court of Appeal found that it would never be appropriate to imply duties of the kind under consideration into non-proportional reinsurance. To do so would open up the spectre of "retrospective" underwriting in arbitration or litigation and would spawn a mass of claims, seeking to undo what with hindsight turned out to be bad bargains. However, the question of whether all proportional reinsurance would be subject to such duties was left open.
If you have any queries concerning the above, please do not hesitate to contact Andrew Purssell.
January 2006
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