UK: The scope of a reinsured’s duties to its reinsurers: important Court of Appeal decision

Yesterday’s decision by the Court of Appeal in Bonner v Cox & Others, provides guidance to the reinsurance market as to whether a reinsured owes a duty to its reinsurers in respect of its own underwriting.

The Court determined that the reinsurance in issue was not subject to any implied terms by which a duty was sought to be imposed. The Court indicated that it would have reached the same conclusion in respect of any non-proportional reinsurance.

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Yesterday's decision by the Court of Appeal in Bonner v Cox & Others provides guidance to the reinsurance market as to whether a reinsured owes a duty to its reinsurers in respect of its own underwriting.

The Court determined that the reinsurance in issue was not subject to any implied terms by which a duty was sought to be imposed. The Court indicated that it would have reached the same conclusion in respect of any non-proportional reinsurance.

Reinsurers agreed to reinsure the Cover underwriters in respect of risks attaching to business known as the '77 Energy Cover.

Having unsuccessfully argued various defences at first instance, the reinsurers asked the Court of Appeal to reconsider whether the Cover underwriters were in breach of duty when writing risks a particular loss making risk referred to as the Oceaneering risk.

At first instance, the trial judge had found that there were implied terms in the reinsurance that:

Despite commenting that the writing of Oceaneering was "near the knuckle" and that it had not been written "decently", the trial judge held that upon the facts, neither of the terms had been breached.

The reinsurers contended that the judge should have found that in writing the Oceaneering risk, the Cover underwriters had breached these two implied terms. Alternatively, the reinsurers contended that there was also an implied term that the Cover underwriters "had an obligation to conduct the business involved in the cession prudently, reasonably carefully and in accordance with the ordinary practice of the market", in accordance with the decision of Hobhouse J in Phoenix-v-Halvanon [1985] 2 Lloyds Rep. 599.

The Court of Appeal concluded that the reinsurance was not subject to any of the implied terms contended for "and would reach the same conclusion in respect of any non-proportional reinsurance."

In reaching its decision, the Court attached significance to the fact that in proportional reinsurance, the risk is shared between reinsured and resinsurer where their interests might be expected to coincide. In non-proportional reinsurance, commercial interests of a reinsured and reinsurer may and often will conflict in the sense that one might profit at the expense of the other. The disparity in interests was itself enough to preclude the existence of any duty.

The Phoenix case, upon which the reinsurers relied, appeared to concern a quota share reinsurance. The Court considered that Hobhouse J in Phoenix could not possibly have intended this implied term to be applied to all forms of reinsurance. The Court did note, however, that some leading textbooks regard the implied term of Phoenix as applicable to instances of selective cession by a reinsured, whereas other textbooks regard it as being more widely applicable to treaty business.

The Court next considered whether the incorporation of implied terms was a necessity in the context of non-proportional reinsurance and whether they could be defined with any certainty (necessity and certainty being the touchstones of any implication of terms).

The Court found that there was no necessity for an implied duty of care. Since the reinsured and reinsurer have competing interests to make money for their respective capital providers, there was no scope, still less a necessity, for implying a term that the reinsured owes some sort of duty to protect the interests of the reinsurer. This is the more so when neither side could be expected to know what the other's interests might be.

A reinsured could not be expected to decline an excellent risk simply because it might be a bad one from the point of view of its reinsurer.

The Court ruled that it would be impossible to determine with any certainty what could be written in either "the ordinary course of business" or "in accordance with the ordinary practice of the market" (as per Phoenix). There may be countless different views and it would simply be unworkable.

The Court also anticipated difficulties in calculating the measure of damages in the event that such implied terms were breached.

The Court stopped short of considering whether an implied term might be appropriate in circumstances of recklessness or dishonesty by the reinsured because such conduct was not in issue.

When considering whether terms should be implied, the Court noted that reinsurers were already able to protect themselves through:

• appropriate pre-contract disclosure showing the history of the risks written and/or the nature of those proposed to be written;

• agreeing contract wording which would allow the reinsurer to monitor the business;

• exercising (better) judgment as to which underwriter to reinsure and upon what terms.

The Court noted that if a reinsurer established an implied term with his reinsured, he might be subject to similar terms down the chain with his retrocessionaires.

The Court was careful not to penalise Cover underwriters for their commercial opportunism. The Oceaneering risk had been written in the knowledge that the aggregate deductible had already been exhausted, meaning an almost exclusive exposure to the reinsurers. The fact that the (fixed) premium to be earned by the reinsurers did not fairly reflect their exposure to the risk could not be judged retrospectively. As the trial judge put it, when running a book of business, a reinsurer will "win some and lose some".

The Court echoed similar sentiments expressed by Thomas J in the Sphere Drake case when commenting "there is nothing wrong in taking advantage of an advantageous contract". Taking this one step further, the Court questioned why should there be an implied duty of prudence upon the reinsured to protect the reinsurers against their own imprudence. The Court concluded that if the implied term in Phoenix were to apply to all types of reinsurance, it would open up the spectre of "retrospective" underwriting, whereby every unprofitable treaty would be subject to challenge. The Court did, however, acknowledge that market reputation inevitably plays a part in tempering abuse by a reinsured.

This decision reiterates that the Courts are unwilling to rescue negligent reinsurers who have effectively been taken advantage of by clever reinsureds. Indeed, there are only two English cases, Phoenix and Economic v Le Assicurazioni d'Italia, that provide any support for the proposition that there is any implied duty of care that is owed by a reinsured to its reinsurer. Those two cases, which deal with proportional reinsurance, survive. The Court of Appeal had no need to overrule them, restricting itself as it did to clarifying the position in respect of non-proportional reinsurance.

CMS Cameron McKenna acted for the broker Aon Limited who were entirely vindicated by the Court's decision.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

The original publication date for this article was 09/12/2005.