Court of Appeal to rule on standard of proof in 'follow the settlement' clause dispute

Out-Law Analysis | 30 Jan 2014 | 3:33 pm | 4 min. read

FOCUS: The Court of Appeal is to consider the standard of proof to be applied in unqualified 'follow the settlement' clauses in deciding whether a claim falls within the risks covered by the reinsurance policy following a recent High Court judgment.

The case in the High Court was between Tokio Marine Europe Insurance Ltd and Novae Corporate Underwriting Ltd and considered a number of issues arising from losses caused by floods in Thailand in 2011.

ACE provided insurance to Tesco, which claimed for losses arising from the floods.  ACE was reinsured under a facultative reinsurance by, amongst others, Tokio Marine Europe Insurance Limited. Tokio in turn purchased facultative excess of loss reinsurance (the retrocession) from Novae Corporate Underwriting Limited. The retrocession contained an unqualified follow the settlement clause.

A key issue considered by the High Court was: "To what standard of proof does Tokio have to show that the claim so recognised by ACE falls within the Retrocession as a matter of law: balance of probabilities or arguability?"

The High Court found, in following earlier authorities, that arguability was the standard that applied. But Mr Justice Hamblen indicated that this is not necessarily desirable.  He said that "in principle it is difficult to see why a lesser standard of proof than the usual civil standard should govern" the issue. 'Balance of probability' is the standard usually used in civil cases.

Mr Justice Hamblen considered previous Court of Appeal Judgments that had addressed the issue.

In a case between Insurance Company of Africa (ICA) and Scor Reinsurance it was held that the effect of an unqualified follow the settlements clause was that reinsurers agree to indemnify insurers in the event that they settle a claim provided that, first, the claim so recognised by them falls within the risks covered by the policy of reinsurance as a matter of law, and, second, in settling the claim the insurer has acted honestly and has taken all proper and businesslike steps in making the settlement.

As a result of the so-called first proviso it is necessary for "the claim so recognised by the reinsured" to fall with the terms of the reinsurance contract.  On this basis, the reinsurer is not allowed to reopen the settlement of the original insured's claim. However, the reinsurer is not precluded from arguing that the reinsurance contract does not cover the underlying loss.

The first proviso was initially considered in Hiscox and Outhwaite (No.3) and then in Generali and CGU International Insurance at first instance and later in the Court of Appeal.  In the Hiscox case, Mr Justice Evans stated that there may be issues as to the scope of the reinsurance cover even where it was on the same terms as the original insurance. 

"The reinsurer is always entitled to raise issues as to the scope of the reinsurance contract, and where the risks are co-extensive with those of the underlying insurance he is not precluded from raising such issues, even when there is a 'follow the settlement' term of the reinsurance contract," he said.

"Ultimately, this is the only sure protection which the reinsurer has against being called upon to indemnify the reinsured against payments which were not legally due from him to the original insured, however reasonable and businesslike the payments may have been," said the judgment. "But this is subject to one proviso…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."

In the case involving Generali and CGU International Insurance, the Court of Appeal considered the meaning of the words "the claim so recognised" where the reinsurance provided back-to-back cover:

"By reference to the words 'the claim so recognised'…the insurers do not have to show that the claim they have settled in fact fell within the risks covered by the reinsurance, but that the claim which they recognised did or arguably did," said that judgment.

"It gives substance to the fact that the reinsurer cannot require the insurer to prove that the assured's claim was in fact covered by the original policy, but requires him 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," the judgment said.

Meaning of 'arguably'

The present case considered the standard of proof that Tokio needed to show that the claim so recognised by ACE fell within the retrocession as a matter of law: balance of probabilities or arguability. 

Tokio argued that the test is whether the basis on which the claim is settled arguably falls within the terms of the reinsurance.  Novae, on the other hand, said that the Hiscox and Generali judgments use the word 'arguably' to refer to the settlement of the claim under "the original insurance". 

Mr Justice Hamblen said that he was bound by the decision of the Court of Appeal in Generali and thereby found that "the claim so recognised by ACE falls within the Retrocession as a matter of law is arguability". 

However, he said that he found it difficult to see why a lesser standard of proof than the usual civil standard, balance of probabilities, should govern the application of the first proviso to the reinsurance.  Novae has been given leave to appeal on this issue.

Stephen Kilner is an insurance and reinsurance litigation specialist at Pinsent Masons, the law firm behind Out-Law.com