Supreme Court rules on the allocation of an insured’s losses

On 31 July 2013, in Teal Assurance Company Limited v W R Berkley Insurance (Europe) Limited and Aspen, the Supreme Court dismissed Teal’s appeal, confirming the rule that an insurer becomes liable as soon as the insured’s liability is established. Unless the policy expressly permits, an insured is not entitled to choose the order in which it presents claims to its insurer and the insurer cannot choose the order in which the claims are settled.

Facts

A tower of insurance contracts provided Black & Veatch (“B&V”) with worldwide cover of US$60 million in excess of the deductible and self-insured retention. Lexington wrote the primary layer, whilst B&V’s captive insurer, Teal, wrote the next three layers of the tower. A “top and drop” insurance provided further cover of £10 million upon the exhaustion of the tower. This insurance was also written by Teal but excluded US claims. Teal’s participation in the “top and drop” insurance was reinsured by WR Berkley and Aspen.

B&V notified a number of US and non-US claims, which included a large US claim in excess of US$200 million. B&V also faced two significant non-US claims involving losses of approximately US$10 million and USD$35 million.

If the non-US claims were settled first, there would be limited funds available to meet the US claim that was excluded by the “top and drop” insurance. This was clearly not an attractive prospect to B&V. B&V argued that if it was entitled to hold back incurred losses on the non-US claims until the primary layer and excess layers were exhausted the US claim, so that the “top and drop” insurance would then be available to cover the non-US claims, maximizing Teal’s recovery. WR Berkley and Aspen disagreed.

The various insurance policies contained different terms and conditions. However, each of the excess layer policies and the “top and drop” insurance contained the following standard wording (“Clause 1”): “Liability to pay under this Policy shall not attach unless and until the Underwriters of the Underlying Policy/ies shall have paid, or have admitted liability to have been held liable to pay, the full amount of their indemnity inclusive of costs and expenses.”

The Court at first instance and the Court of Appeal

The Court at first instance found for WR Berkley and Aspen, finding that an insured’s losses should exhaust the primary and excess layers in the chronological order in which they were ascertained.

The Court of Appeal dismissed Teal’s appeal. It construed Clause 1 as meaning Lexington became liable whenever claims were established against B&V by admission, judgment or award. Once Lexington’s layer had been exhausted, the next policy became the underlying policy. Longmore LJ said that this was the “commercial common sense” of the “top and drop” insurance.

To access our Law-Now on the Court of Appeal judgment, please click here.

The Supreme Court’s decision

The Supreme Court unanimously upheld the Court of Appeal’s decision. In doing so, they made the following points:

• Lord Mance concluded: “It suits Teal in the present case to claim that BV or it itself can adjust the order in which claims impact the different programme layers, in order to assist Teal’s associate BV. This produces the unfamiliar phenomenon of an insurer seeking to maximise its own insurance liabilities. Teal can afford to try to do this on the back of its reinsurance in respect of the top and drop layer by the respondents. Had Teal been an independent rather than captive insurer and determined to avoid as much liability to BV as possible, BV would no doubt vigorously have objected to the legitimacy of Teal as its excess layer insurer under the PI tower policies adjusting the order of payment of claims ascertained as against BV, with the aim of ensuring that it was only US and Canadian claims that reached the top and drop policy. Its objection would in my view have been well-founded. The freedom of choice which Mr Butcher advocates on behalf of Teal and in the interests of BV cannot in the present context readily be reconciled with the basic philosophy that insurance covers risks lying outside an insured’s own deliberate control.”
• The main problem with Teal’s submission as to the operation of Clause 1 was that “it treats a clause intended to define when liability arises as affecting the claims in respect of which liability arises”. The readily understandable function of Clause 1 is to clarify that the obligation to pay under each excess layer is deferred until the resolution of any uncertainty or dispute as to the liability of underlying insurers. It is not intended to alter the identity of the claims that fall to be met by that insurance.
• Teal looked at the picture incorrectly from the top downwards, instead of looking at claims as they impact the programme, from the bottom upwards. The Supreme Court noted that this was reflected by the clauses in the insurance policies. Upon payment by Lexington (which the Supreme Court stated could mean “established” or “ascertained”), the first excess layer policy had to “drop down” to become the underlying policy (i.e. on the same terms as the Lexington policy). The same position would apply successively under each excess layer, as each is exhausted in turn.

Teal also questioned a number of fundamental insurance law principles. In particular, it challenged the decision in Cox v Bankside (1995) that liability insurance is activated when the liability of the insured is established and instead argued that it was when insurers agree to pay a claim. The Supreme Court did not agree with Teal’s interpretation of Cox v Bankside (1995) and agreed with the decision that the ascertainment by agreement, judgment or award of the insured’s liability gives rise to a claim under the insurance. Teal also stated that it is a “legal fiction” that a claim under a liability insurance is for damages for the insurer’s failure to hold the insured harmless (the ‘hold harmless principle’) but the Supreme Court concluded that this issue was not relevant to the timing of accrual of the cause of action in liability insurance.

Conclusion

The Supreme Court’s decision provides reassurance and certainty to insurers and reinsurers that an insured or insurer below them in any tower of insurance cannot adjust the order in which the claims impact the layers for their own convenience. It reaffirms the principle that an insured’s claims exhaust the primary and successive excess layers in the chronological order in which the losses are ascertained. The decision will provide comfort to insurers and reinsurers on the degree of control that can be exercised by an insured, particularly a captive insurer’s associate.

For a full copy of the judgment, click here.