Lexington Insurance Company v AGF Insurance Limited; Lexington Insurance Company v Wasa International Insurance Company Limited
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Lexington insured the Aluminium Company of America (Alcoa) against property damage at Alcoa's sites all over the world. Lexington reinsured the risk with (among others) Wasa and AGF under a proportional facultative contract.
The policy periods of both the insurance and reinsurance ran from 1st July 1977 to 1st July 1980.
During those three years, Alcoa sites in different US states suffered environmental damage because of Alcoa's continuing failures over a 40-year period to control the escape of waste products. Alcoa began proceedings in Washington State to recover clean-up costs from its insurers, including Lexington.
The insurance policy did not specify what law governed its terms. But a US service of suit clause provided that Lexington was bound to submit to the jurisdiction of any court of competent jurisdiction in the US chosen by Alcoa, and that the dispute would be determined in accordance with the law and practice of that court.
In May 2000, the Washington Supreme Court, applying Pennsylvanian law, found that, in the absence of any relevant policy limitation or exclusion, Lexington was liable with other insurers to pay the full cost of cleaning up the environmental damage, whether or not the damage occurred before, during or after the three-year insurance policy period.
Lexington settled Alcoa's claims for US$103million and claimed from its reinsurers. Wasa and AGF started an action in the English court seeking declarations that they were not liable.
The reinsurance contract
The reinsurance contract was governed by English law and incorporated a standard London market full reinsurance clause: "Being a reinsurance of and warranted same gross rate, terms and conditions as and to follow the settlements of the Company…"
Where a reinsurance contract contains a "follow settlements" provision, reinsurers will be bound by the settlement of the underlying insurance claim, provided the reinsured (a) acted honestly and took all proper and businesslike steps in making the settlement; and (b) the claim so recognised by the reinsured falls within the risks covered by the policy of reinsurance (Insurance Co of Africa v Scor ).
This applies even in cases where the reinsurance and insurance cover are on the same terms ("back-to-back"), (Assicurazioni Generali v CGU ).
It was not suggested that Lexington had not acted honestly and in a businesslike manner in reaching settlement with Alcoa. The question was whether the claim fell within the risks covered by the reinsurance.
Lexington argued that the full reinsurance clause showed the reinsurance and insurance contracts were intended to be co-extensive. The fact that the reinsurance was governed by English law and the insurance was not was not enough to disturb the back-to-back nature of the cover. Its terms should be given the same effect as the terms of the underlying insurance, as established by the US court.
Reinsurers, however, argued that the reinsurance contract was governed by English law and that, under English law, the period of cover is fundamental. Reinsurers could only be liable for physical damage occurring within the reinsurance policy period.
The High Court agreed with the reinsurers. Neither the back-to-back nature of the reinsurance nor the presence of a follow settlements clause was enough to displace the importance of the stated period of cover. Lexington appealed.
Court of Appeal judgment
The Court of Appeal found the reinsurers were liable. It said the real question was whether the parties intended that terms that were effectively identical in both contracts should be given the same effect.
In this case, the policy period (although expressed slightly differently) was the same in the insurance and the reinsurance contract. In the absence of any clear indication to the contrary, it could be presumed that the parties intended the same term would be given the same meaning – whatever that meaning might be. In this case, that meant the interpretation applied by the US court.
The House of Lords judgment
The Law Lords unanimously overturned the Court of Appeal's decision.
Although there is normally a strong presumption that, when insurance and reinsurance are written back-to-back, any loss under the insurance will fall within the reinsurance, there is no rule of law that states the reinsurance contract must respond to every claim irrespective of its own terms.
Reinsurance is a separate contract which may contain its own independent terms. Since this reinsurance contract was governed by English law, it was a question of construction under English law as to what risks were covered.
Both insurance and reinsurance contract were written on a "losses occurring" or "occurrence" basis. Under English law, such a policy only covers physical loss and damage occurring during the policy period. As a result, reinsurers could not be held liable for losses occurring before or after that period.
When these insurance and reinsurance contracts were concluded, it could not have been predicted what law would govern the insurance contract. The service of suit clause left the question open. Reinsurers could not have had any particular governing law in mind other than English law, or have anticipated that the terms of the reinsurance would be given any meaning other than that normally applied in the London market.
The decision confirms that full reinsurance clauses and follow settlements cannot extend the scope of the cover beyond the terms of the reinsurance contract.
Underlying the decision is a fundamental question: what does reinsurance actually reinsure?
The House of Lords has upheld the traditional view that it covers the same underlying risk as the insurance. In other words, it is not a form of liability insurance, where the insurer would have to show its liability to the insured had been established and quantified. Even where there is a follow the settlements clause, the original loss must fall within the risks covered by the reinsurance.
The Law Lords distinguished the circumstances from those in Vesta v Butcher  and Groupama Navigation v Catatumbo , where a warranty in the reinsurance (governed by English law) was given the same effect as a warranty in the insurance (governed by Norwegian and Venezuelan law respectively).
In those cases, the applicable law of the underlying insurance was clearly identifiable from the outset. Reinsurers would have known, or could easily have found out, the effect that law would have on a breach of warranty.
In this case, there was no clear choice of law in the insurance, only a service of suit clause that effectively meant proceedings could be brought in (and determined according to the law of) any US state.
This was one of the last decisions of the House of Lords, which ended its judicial work on 30th July 2009. Its role will now be taken up by the new United Kingdom Supreme Court.