Andrew Rose and David McCarthy review some of the legal developments in the run-off market in 2002.
There have been a number of interesting case law and legislative developments affecting the run-off market in 2002, and this article summarises those that may affect market practitioners.
In our article in Global Reinsurance last year, we discussed the proposal to allow administration orders to be made for financially troubled insurers. The UK Treasury has now allowed this development through the Financial Services and Markets Act (Administration Orders Relating to Insurers) Order 2002 which came into force on 31 May 2002.
Previously, financially troubled English insurance companies could not be placed into administration and had to either go into liquidation or provisional liquidation, often followed by a scheme of arrangement under the Companies Act. Administration had been thought inappropriate for insurance companies given the long-tail nature of the business. However, the UK Financial Services and Markets Act 2000 represented a change in the traditional view. This Act introduced the power to enable financially troubled English insurance companies to be placed into administration. The London operation of Folksam was the first company to use the new procedure, but companies already in provisional liquidation are likely to form part of the run-off market for many years to come.
Under the Insolvency Act 1986, the court is empowered to appoint an administrator when it is satisfied that the company is insolvent or is likely to become insolvent, and where at least one of the four statutory purposes would be fulfilled by administration. The four purposes are: the survival of the company as a going concern; the approval of a voluntary arrangement; the sanctioning of a compromise or scheme of arrangement; or a more advantageous realisation of the company's assets than would be effected on a winding up. It is the sanctioning of a scheme of arrangement that is the purpose most likely to be relevant to reinsurance. The statutory definitions of the purpose of an administration are to be changed under the Enterprise Act 2002 so as to provide for the survival of the company as a principal purpose. Implementation of such an aim, although laudable, seems even less likely in the case of an insurer than for a conventional trading company.
Apart from cost, another perceived advantage offered by an administration is that an administrator is permitted to investigate and, when appropriate, seek to set aside any qualifying prior transactions without the company being placed in liquidation. Another significant difference between administration and liquidation for reinsurers is that time will continue to run in an administration so allowing claims to be become time-barred. All parties will need to be diligent to protect their position in relation to prospective time-bar issues, and there may be a greater use of standstill agreements. The position may be affected if the low commission proposals for reform of the law of limitation are implemented, but there is no current legislation timetable.
EC Insolvency Directive
This directive is not due for implementation by European Union member states until April 2003. Although introduced by the European Commission in April 2001, the directive has only attracted wider publicity in the insurance and reinsurance market during 2002.
Under the terms of the directive, creditors with insurance claims against companies that become insolvent will be paid before the company's reinsurance creditors. Implementation of the directive will create a two-tier payment system for unsecured creditors of failed reinsurers.
In Wasa International (UK) Insurance Company Ltd v Wasa International Insurance Company Ltd the court approved the transfer of outward reinsurance in a portfolio transfer under the new regime established by section 112 (2) (B) of the FSMA 2000. The court determined that the benefit of a reinsurance contract could be transferred under this section by the reinsured whether or not the consent of the reinsurer had been given. The new regime has considerably eased the process of making portfolio transfers by removing the need to seek formal consent from the reinsurer.
Aggregation - event
The Commercial Court gave judgment on 11 July 2002 in the Kuwait test case on `event', Scott v Copenhagen Re.
The Scott syndicates argued that all the British Airways (BA) and Kuwait Aircraft Corporation (KAC) aircraft and spares losses after the Iraqi invasion of Kuwait in 1990 arose from one event while Copenhagen Re argued that they arose out of two or more events. The court decided in favour of Copenhagen Re, finding that while the loss of the 15 KAC aircraft and spares arose out of one event, namely the invasion and capture of Kuwait airport, the loss of the BA aircraft did not.
The court accepted Copenhagen Re's submission for three principal reasons. Firstly, the timing and secondly, the causes of the loss were different: the KAC losses were caused by the capture of the airport but the BA aircraft was not lost at the point of capture. The cause of the BA loss was the destruction of the aircraft or when war later broke out or became inevitable. Thirdly, while the Iraqi plunder of KAC property was economically motivated, there were no similar designs on BA property.
Following the well-known Dawson's Field arbitration award, the judge held that, although there was unity of locality, the required unity of time, cause and intent were not present and the losses could not be aggregated as an `event'. Despite the sophistication of the argument, the court noted that the matter was largely "one of impression". It is understood that an application for permission to appeal has been made to the Court of Appeal. A final decision should enable a number of outstanding claims to be resolved, although there remains the problem of how to deal with claims already settled on the basis of one event.
One source or original cause
Countrywide Assurance Group v AIG Europe (UK) Ltd is another case on the aggregation and deductible consequences of the pensions mis-selling issue. The policy provided for a limit of indemnity of £1m, although the words "each and every claim" were inadvertently omitted. Under the definitions, any "claim or any loss" was defined as "one occurrence or all occurrences of a series consequent upon or attributable to one source or original cause". Given that by the date of inception the mis-selling issue was well known, the policy also provided that "in respect of claims arising out of pension transfer activities the excess will apply on an each and every claimant basis". For the purposes of the preliminary issue, it was accepted that the lack of proper training of the selling agents and employees was the underlying issue, and was a consistent necessary factor that allowed the mis-selling to occur.
It was submitted by both the claimants (and their excess layer insurers) that the specific reference to a deductible per claimant meant that pensions mis-selling claims were not to be aggregated under the series provisions. However, the court held that given that the words "per claimant" were only added to the excess clause, and not the aggregation provision which referred to a cause, the primary layer insurers were entitled to treat the pensions mis-selling claims as all arising from "one source or original cause", namely the failure to train advisers properly.
The Lloyds TSB case which relates to "a series of claims arising from one original cause" is currently awaiting hearing before the House of Lords.
The House of Lords reversed the decision of the Court of Appeal in Fairchild v Glenhaven, thus allowing a claimant to recover even though they could not prove which of various employers had caused exposure to the fibres that caused mesothelioma. Any employer who contributed to the risk can now be found responsible for the entirety of the damage, even if others were also at fault, and even if it cannot be established that the injury was caused by that or any particular defendant.
Whilst undoubtedly fair to the former employee, this decision is likely to have far-reaching implications for the UK reinsurance industry and, particularly, the run-off market. In the UK there are presently around 1,500 claims a year for asbestos-related injury. This figure could be set to rise in view of this decision from the House of Lords. The House of Lords' judgment does not attempt to deal with apportionment issues between various employers, an area which may be suitable for a protocol between participating insurers.
Feasey v Sun Life Insurance Co of Canada concerned the placement of reinsurance with syndicate 957 by a P&I Club of the liability of members for damages for death or personal injury to employees. For the 1995 year of account, Lloyd's reclassified certain risk codes, which meant that risks of this nature were to be classified as long- tail liability rather than personal accident cover. This required the retention of greater reserves. A scheme was designed by syndicate 957 and the brokers whereby the insured was to receive fixed payments, which it was assumed would more or less relate to the actual liabilities over a lengthy period, thus enabling the business to continue to be classified as personal accident cover. The trigger for payment was simply the death or disablement of an original person. No other claims figures were required. A retrocession was agreed by syndicate 957 with Sun Life and Phoenix, but issues arose as to whether misrepresentations had been made in connection with the renewals of that retrocession and/or to the extent of the authority of Phoenix's underwriting agent.
The Life Assurance Act 1774, which still remains in force, imposes an insurable interest requirement and prevents recovery of more than the amount of such interest. The Commercial Court held (recognising the difficulties of applying such an act to modern insurance practice) that the insurance was not unlawful for the absence of any insurable interest and that the parties had agreed genuine pre-estimates of the likely loss. This scheme was not a mere wager as the insurer was not seeking to make a profit, but merely to cover its own liabilities to members, and had an insurable interest in the lives of persons on its members' vessels. The court ruled that the policy was of a hybrid nature, being part personal accident and part liability, but this did not adversely affect the validity of the coverage.
The judgment is of interest to the run-off market because reinsurers were held liable, despite the `reclassification' of liability business as personal accident business. Such `reclassification' was central to the problems that arose from the PA spiral in the personal accident market in the 1990s.