A GUIDE TO REINSURANCE LAW CHAPTER 7 CLAIMS

1st Edition, 2007

Chapter 7

CLAIMS
GROUNDS FOR DENYING LIABILITY
Good faith
In reinsurance law there is a strict duty of disclosure imposed upon the parties by virtue of the duty of utmost good faith.
The duty of utmost good faith was established in the common law in the case of Carter v. Boehm (1776) 3 Burr 1905. This case
involved insurance in respect of Fort Marlborough in Sumatra for property loss that would occur if the Fort was attacked and taken by
a foreign country. During the cover period the fort was attacked and taken by the French. Liability was denied by the underwriter on
the grounds that the fort was poorly defended and was sure to fall if it was attacked by a European power and that the insured was
aware that the fort may be attacked. Lord Mansfield made it clear that the underwriter depended upon what the insured told him and
therefore it is imperative that the insured holds nothing back and supplies the underwriter with all of the information he should know
about the risk and the holding back of information will be a fraud and will render the policy void. The general principle was stated
thus, Good faith forbids either party by concealing what he privately knows, to draw the other into a bargain, from his ignorance of
that fact, and his believing the contrary (at p. 1910) but Lord Mansfield took the view that the principle applies to all contracts.
The Marine Insurance Act 1906, s. 17, also deals with the duty of utmost good faith and says that a contract of marine insurance is
a contract based upon the utmost good faith, and, if the utmost good faith is not observed by either party, the contract may be avoided
by the other party.

Container Transport International Inc and Reliance Group v. Oceanus Mutual Underwriting Association (Bermuda)
Limited [1984] 1 Lloyds Rep. 476
Oceanus argued that CTI had put forward an inaccurate and misleading claims record and that they had failed to disclose the refusal by Lloyds
underwriters to renew the cover, and also that they had failed to make a full disclosure when obtaining the insurance with Lloyds. The Court of
Appeal held that an insurer could avoid a contract under section 18(1) of the Marine Insurance Act 1906 if there was a failure to disclose any
circumstance which a prudent insurer would take into account when deciding whether or not to accept the risk before the contract was finalised.
Furthermore, there would be no waiver of material information unless it should have been disclosed by an inquiry by the underwriter, which common
prudence demanded, and the contract would not be affirmed unless the underwriter had full knowledge of the information before he entered into the
contract. According to Kerr L.J., the reinsured is required to make a fair presentation of the risk but above that there is a threshold limit at which the
emphasis shifts to the reinsurer, and it is up to the reinsurer to ask for more information if he so wishes.

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The insured is under a duty of good faith not to misrepresent material facts before the underwriter actually accepts the risk, and the
case of Orakpo v. Barclays Insurance Services [1995] L.R.L.R. 443 makes it clear that this duty continues when the claim is put
forward so that the insured must forward the claim honestly. In Orakpo the insured stated on his proposal form that the property was
in a good state of repair, which it was not, the claims for lost rent of the bedsitting rooms was grossly exaggerated by Mr Orakpo. The
first instance judge held that Mr Orakpos claim was clearly fraudulent and must therefore fail. The Court of Appeal agreed with the
first instance decision but the judges had different interpretations of the duty of utmost good faith. Hoffmann L.J. believed that the
policy was broken from the date of breach of the contract. Sir Roger Parker took the view that Mr Orakpos fraud rendered the policy
void ab initio, while Staughton L.J. was of the opinion that the insured could only recover the amount of his genuine loss and nothing
more.

Direct Line Insurance Plc v. Khan and Others [2002] Lloyds Rep. IR 634
A husband and wife made a claim on a policy in joint names in respect of damage to a property, which they jointly owned, including a claim for the
rental of alternative accommodation. The claim proved to be fraudulently exaggerated. The claim form had been filed by Mr Khan. His wife, Mrs
Khan, subsequently alleged that she was not tainted by her husbands fraudulent exaggeration of the claim and she had no knowledge of it. A separate
issue also arose as to whether or not the fact that there had been exaggeration of a substantial part of the claim was sufficient to make the entire claim
void. The Court of Appeal held that the exaggeration of a substantial part of the claim entitled the insurer to avoid the whole claim. The Court of
Appeal also found that Mrs Khan had granted actual or apparent authority to Mr Khan to pursue her claim on her behalf and accordingly she was

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A GUIDE TO REINSURANCE LAW CHAPTER 7 CLAIMS

1st Edition, 2007

bound by his fraud, as she could not demonstrate that it was outside the scope of his agency.

Konstantinos Agapitos and Another v. Ian Charles Agnew and Others [2002] 3 W.L.R. 616
In this case, the insured had not been fraudulent in making the claim, in that he had not made up the loss or exaggerated it, but he had lied about the
surrounding circumstances in order to bolster the strength of his claim for the purpose of recovery in litigation. The Court of Appeal held that if a
claim is made up or deliberately exaggerated, then it is irrelevant as to whether insurers are actually misled or not, if part of the claim is not itself
immaterial or unsubstantial.

Svenska Kreditfursakrings AB v. Munchener Ruckversicherungs-Gesselschaft, Schweizeriche

Ruckversicherungs-Gesellschaft and other Reinsurers (Swedish Arbitration, Stockholm, 11 November 1998)
In this case the duty of utmost good faith and misrepresentation were considered closely. Svenska Kredit was a Swedish Insurance and reinsurance
company, which embarked upon an ambitious plan to increase its market share in the financial guarantee business. From late 1989 to the end of 1991
Svenska Kredit suffered heavy losses, by 1992 it was in crisis and in October 1992 bankruptcy proceedings were adjudicated on Svenska Kredit. In
December 1992 and January 1993 several reinsurers tried to avoid the reinsurance treaties and refused to make payments under the treaties. The estate
of Svenska Kredit filed claims for payment against the reinsurers under the treaties and the reinsurers filed claims for a declaration that they could
avoid the treaties and that they could avoid liability for certain individual risks for the underwriting years 1988 to 1991. With regard to applicable law,
the Tribunal decided that the treaties were governed by Swedish substantive law and that although the Swedish Contracts Act 1927 did not specifically
apply to reinsurance it would apply by analogy. The honourable engagement clause in the reinsurance treaties enabled the Tribunal to decide the
disputes in a way that they considered fair and equitable having regard to the customs and practices of the insurance industry. The Tribunal was
chaired by Kenneth Rokison, a former UK judge, together with a well-known Danish attorney and a Swedish University professor.
The Tribunal decided that insurance and reinsurance contracts are ruled by the principle of utmost good faith which carries with it the duty of
disclosure of material facts by the insured or the reinsured.
For treaty reinsurance and especially obligatory proportional reinsurance treaties where the reinsured effectively underwrites on behalf of the reinsurer
the reinsured has a duty to disclose to reinsurers facts which may influence the reinsurers decision as to whether or not to continue with the business
relationship with the reinsured. The Tribunal had to decide if there was a duty on the reinsured to disclose the increase in its financial guarantee
business. There is no such duty in Swedish law or in international reinsurance market practice. The tribunal decided that the reinsured is under a duty
to disclose all facts and circumstances which would be material for any decision to be taken by the reinsurer in relation to the formation and continuing
existence of the treaty and its terms. Since the reinsurer and reinsured decided whether or not they wished to continue the business relationship on 30
September each year, Svenska Kredit were required to disclose all material facts and circumstances to the reinsurer on 30 September each year. There
was a non-disclosure by Svenska Kredit in relation to the increased volume of financial guarantee business and Svenska Kredit also failed to report a
large loss to reinsurers but these did not allow the reinsurers to avoid the treaties.
The Tribunal looked at the attitude of the reinsurers and since all reinsurers were keen to develop good relations with Svenska Kredit and obtain their
business they were prepared to rely upon Svenska Kredits reputation and business sense. The Tribunal believed that even if the material facts had
been disclosed to reinsurers they would still have continued to participate in the treaties but would have insisted that guidelines were imposed and

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followed in relation to the borrowers creditworthiness.

Svenska Kredit was found guilty of failing to comply with reasonable underwriting standards but under Swedish law the termination of a contract for
breach did not operate with retroactive effect and the reinsurers only gave notice of supposed termination after the bankruptcy proceedings had begun,
which was too late.
The Tribunal made it clear that the reinsured owes a duty to the reinsurer not to write business to be ceded to the treaties recklessly or irresponsibly
and not to cede risks which exceed treaty limits. There was evidence that Svenska Kredit had accepted some very poor risks where the borrowers
ability to pay the loans was doubtful, such risks were not underwritten in strict adherence to accepted insurance and reinsurance market underwriting
practice, and were not in accordance with Svenska Kredits own underwriting guidelines. Accordingly, the Tribunal held that the reinsurers were able

Robert Merkin

A GUIDE TO REINSURANCE LAW CHAPTER 7 CLAIMS

1st Edition, 2007

to avoid liability in respect of these risks and were not liable to Svenska Kredit for these risks.

Since the reinsurer is far removed from the original insured it depends heavily on the insurer to make detailed investigations of the
original claim to ensure that it is legitimate and covered under the terms of the original insurance policy. The Court of Appeal in the
recent case of Brotherton and Others v. Aseguradora Colseguros SA and Another (2003) EWCA Civ 705 held that where a reinsured
has knowledge of allegations of misconduct on the part of the original insured, and of official investigations into such misconduct, the
question of whether such allegations are well founded is irrelevant to the reinsurers determination of the reinsurers case of
non-disclosure of such allegations and investigations.

When does the duty of good faith come to an end?

It appears that the duty of good faith terminates when the insurer rejects the claim. This was established in Manifest Shipping
Company Limited v. Uni-Polaris Insurance Company Limited (The Star Sea) [1995] 1 Lloyds Rep. 65. This involved a ship which
had caught fire. The Court of Appeal held that once the claim has been rejected the parties are adversaries, which makes sense, since
otherwise the insured would be obliged to disclose information to assist his opponents.

DISCHARGING THE REINSURANCE CONTRACT

Non-performance
If one of the parties clearly refuses to perform his obligations under the contract then this will amount to a repudiation of the contract.
Sometimes, the party will not perform his duties under the contract without expressly stating his intention in this regard and in this
situation it will be up to the court to determine the intentions of that party by examining its conduct to see if it really does not wish to
be bound by the contract. The case of Universal Cargo Carriers v. Citati [1957] 1 Lloyds Rep. 174 involved a voyage by ship of
6,000 tons of scrap iron from Basrah to Buenos Aires. Delays occurred by the charterer in nominating the shipper, nominating the
berth, and in providing the cargo. The owners claimed for damages and argued that they were entitled to rescind the contract because
the charter party had breached fundamental terms of the contract. Devlin MJ held that the charterers had breached the warranty but
that such breaches did not ipso facto entitle the owners to rescind the contract. He pointed out that the aggrieved party could rescind
the contract if the delay was so long as to go to the root of the contract, and what constituted a reasonable time would very much
depend upon the facts of each particular case. In order to rely upon an anticipatory breach the owners had to show that the charterer
had renounced his liabilities, which they were unable to do in this case. The matter was referred back to the arbitrator to see if
performance of the contract was in fact impossible.
If one of the parties behaves in such a way as to make it impossible for the other party to perform his obligations under the contract
then that party may regard itself as being discharged from the contract.
If one of the parties fails to perform a major part of the contract then the other party will be discharged from the contract.
The innocent party will normally be awarded damages for breach of contract. However, to be successful in this regard, there must
be a causal link between the breach of contract and the loss, the damages suffered must not be too remote and the innocent party will
be expected to mitigate his losses. In practice it will be very rare for courts to insist upon specific performance of the contract.

Fenton Insurance Company Limited v. Gothaer Versicherungsbank WaG [1991] 1 Lloyds Rep. 172
The reinsured did not provide quarterly statement accounts to the reinsurer or statements of premiums or claims or any other documentation
concerning balances. The question for the court to consider was whether this failure on the part of the reinsured amounted to a discharge of the
reinsurance contract, breach of the contract or abandonment. Potter J. explained in some detail how reinsurance and insurance works in practice and he
emphasised that communication between the two parties is often poor and delays in payment are frequent. He concluded that the non-payment was not
an agreement to abandon, there being no evidence that the statements had not been sent to the reinsurer nor was the contract discharged. In his view it
would be very rare for the courts to regard a delay in payment in a reinsurance case to be a repudiatory breach and for it to consider doing so there
would have to be formal written demands from the reinsurer and then the reinsured would have to fail to pay for a reasonable time afterwards. He

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examined what the likely remedy would be for such a breach and believed that it would only enable the reinsurer to terminate the contract from the
date of the non-payment but the reinsurer would still be liable to pay all of the claims covered by the contract until that point.

Misrepresentation
If a party makes a misrepresentation or non-disclosure to the other party in relation to the contract then the other party will be able to
terminate the contract ab initio. This requirement is especially strong in the insurance and reinsurance fields because of the
application of the duty of utmost good faith.

Robert Merkin

A GUIDE TO REINSURANCE LAW CHAPTER 7 CLAIMS

1st Edition, 2007

Black Sea Shipping Corporation v. Massie (The Litsion Pride) [1985] 1 Lloyds Rep. 437
The plaintiffs were owners of the ship which was insured against war risks with the defendant underwriters. The policy contained a condition that if
the ship sailed into hazardous waters, an additional premium should be paid to the underwriters. During the Iran/Iraq war the ship entered the danger
zone and was destroyed by missile fire. The court held that the shipowners and the brokers acted fraudulently and that the duty imposed upon the
insured to disclose circumstances which will affect the premium charged does continue after the risk has been accepted on cover.

Continental Illinois Bank Trust Company of Chicago v. Alliance Assurance Company Limited (The Captain
Panagos) [1986] 2 Lloyds Rep. 470
In Continental Illinois Bank Trust Company of Chicago v. Alliance Assurance Company Limited (The Captain Panagos) [1986] 2 Lloyds Rep. 470
the insured made a fraudulent claim. The insured who owned the ship grounded the ship and set it alight and then sought to recover the cost of a
constructive total loss under the terms of the insurance policy. The court held that the insured had been fraudulent and by virtue of section 17 of the
Marine Insurance Act 1906 the insurers were able to terminate the contract ab initio.

Orakpo v. Barclays Insurance Services and Another [1995] L.R.L.R. 443

The plaintiff made misrepresentations to Commercial Union regarding the condition of his property in London. He was aware that there had been dry
rot problems with the property for some time and he exaggerated the claims for loss of rent from the bedsitting rooms in the property. The Commercial
Union insurance policy had recently been revised to make it conform to plain English, and as a result the section (relating to the fact that the
submission of a fraudulent claim would remove all benefits under the insurance policy) had been removed. Nevertheless, the Court of Appeal held that
this made no difference. The fact of the matter was that as part of the duty of utmost good faith the insured is obliged to put forward honest claims, and
if a fraudulent claim is made then this will mean that the insurer can be discharged from liability.

Insurance Corporation of the Channel Islands and Royal Insurance Company Limited v. McHugh and Royal Hotel
Limited [1997] L.R.L.R. 94
In Insurance Corporation of the Channel Islands and Royal Insurance Company Limited v. McHugh and Royal Hotel Limited [1997] L.R.L.R. 94 the
insured inflated the claim by exaggerating the room occupancy at the hotel. This case was unusual in that the contract contained special conditions
regarding the options available to the insurer in the event that the insured presented a fraudulent claim, and the case very much focused upon the
interpretation of the terms. However, the court still mentioned the continuing duty of utmost good faith.

In Direct Line Insurance plc v. Khan and Others [2002] Lloyds Rep. IR 634 (see earlier in the chapter for details) the Court of
Appeal held that exaggeration of a substantial part of the claim was sufficient for the Insurer to avoid the whole claim.

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Instead of making a fraudulent claim the insured or reinsured may misrepresent the facts of the claim. For example, in Manifest
Shipping Company Limited v. Uni-Polaris Insurance Company Limited (The Star Sea) [1997] 1 Lloyds Rep. 360 (see earlier) a ship
was lost at sea by fire. The insured did not disclose relevant experts reports to the insurer. The Court of Appeal held that this was
culpable conduct and the duty not to make fraudulent claims included this culpability.

Toomey v. Banco Vitalicio de Espana SA de Seguros y Reaseguros [2003] EWHC 1102 (Comm)
In this case a Spanish insurer issued a policy, which provided for payment of Pts 2.9 billion in the event that the insured, a Spanish football club
suffered relegation from the Spanish first division. The policy was reinsured facultatively on the basis of a slip policy containing the terms as
original and full reinsurance clause. The judge held that the reinsurers were entitled to reject the reinsureds claim because on the proper
construction of the reinsurance contract the reinsured had given an undertaking by way of a warranty that the original insurance was properly
described in the statement of interest. The statement actually contained a fundamental misdescription of the reinsured interest. It stated that the policy
was one of indemnity against actual loss, subject to a maximum of Pts 2.9 billion when in reality it was a valued policy, which meant that the insured

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A GUIDE TO REINSURANCE LAW CHAPTER 7 CLAIMS

1st Edition, 2007

sum became payable upon relegation of the club whether or not it could show that it had actually suffered measurable financial loss.

In the recent case of Wise v. Grupo Nacional Provincial SA [2004] 2 Lloyds Rep. 483 the Court of Appeal heard an appeal by the
respondent insurer against a decision that the reinsurer of the cargo cover could avoid the reinsurance on the grounds of
non-disclosure. The non-disclosure in this case was that a certain cargo included Rolex and other expensive watches. As a result of a
mistranslation the slip referred to the cargo as clocks. The Court of Appeal agreed with the first instance judge that the
mis-description was material and had not alerted the reinsurer of the high value of the watches. When the reinsurer became aware of
the non-disclosure they gave notice of cancellation of the policy instead of immediately seeking to avoid the policy. The Court of
Appeal held that that was an affirmation of the contract and as a result the reinsurer had waived its right to avoid the policy.
The case makes it very clear that insurers and reinsurers should seek to avoid the contract as soon as they are made aware of
misrepresentation or nondisclosure and not risk affirming the contract and thereby waiving their rights.

Remedies available
In the event of a non-disclosure by the insured the insurer will rescind the contract.
This will be a satisfactory result for the reinsurer but it will not be sufficient for the reinsured because if the claim is not covered
then all he will receive will be the return of his premium, which in most circumstances will not cover the loss.

Banque Keyser Ullman SA v. Skandia (UK) Insurance Company Limited [1987] 1 Lloyds Rep. 69
In the Commercial Court, Steyn J. in Banque Keyser Ullman SA v. Skandia (UK) Insurance Company Limited emphasised that the contract of
insurance is reciprocal and it requires both sides to disclose material circumstances which may influence the insurance, and he expressed the fact that
avoidance of the policy will be an ineffective remedy for the insured in such a situation. Nevertheless, the House of Lords ([1990] 2 Lloyds Rep. 377)
decided that the only remedy available to the insured in the event of breach of the duty of utmost good faith is avoidance of the policy and the recovery
of the premium. The circumstances of this case were that Mr Ballestero persuaded syndicates of banks to enter into separate loan agreements with four
companies which he owned and the securities offered in support were a pledge of gemstones and a credit insurance policy. The value of the pledges of
gemstones were confirmed by the Gemmologisch Instituut Antwerpen and verified by a Zurich jeweller. Each policy contained a fraud exclusion
clause. The banks advanced the monies. The borrowing companies defaulted on the loans and it was discovered that the value of the gemstones was
negligible and that Mr Ballestero had executed a large fraud on the banks. The banks sought reimbursement under the insurance policies but the
insurers denied liability because the loss was caused by Mr Ballesteros fraud and the fraud exclusion clause applied. The House of Lords made it clear
that the money advanced would have been lost whether it had been insured or not because the banks had accepted and paid a premium for insurance
which contained a fraud exclusion clause.

According to section 2(1) of the Misrepresentation Act 1967, if a person makes a misrepresentation to another party in respect of a
contract then he will be liable in damages, unless he can prove that he believed until the point when the contract was made that the
facts were true. This point was considered in Banque Financiere De La Cite v. Westgate Insurance Company Limited [1989] 2 All
E.R. 952, and the Court of Appeal decided that for damages to be payable the misrepresentation had to be fraudulent, with the party
making the misrepresentation aware that it would be acted upon by the other party, and the party who received the misrepresentation
must have acted upon it to his detriment and suffered a loss.

Morrison v. Universal Insurance Company (1873) L.R. 8 Ex. 197

Before executing the insurance policy Universal became aware of information which had not been disclosed to it by the brokers. They proceeded to
issue the policy until a loss was reported four days after the policy was issued and then Universal sought to avoid the policy. The court held that
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Universal had not elected to abide by the insurance contract by not raising the non-disclosure when it became aware of it. The court did, however,
make it clear that the decision may have been different if Universal had induced Morrison to believe that they would not raise the non-disclosure point
and in doing so prevent Morrison from obtaining alternative insurance.

CTI v. Oceanus [1984] 1 Lloyds Rep. 476 makes it clear that the contract would not be deemed to be affirmed by the underwriter
unless the underwriter had full knowledge of the information and then entered into the contract.
It seems obvious that in order for an underwriter to affirm the contract he must have knowledge of the issue. The matter of
knowledge was discussed in the following case:

Robert Merkin

A GUIDE TO REINSURANCE LAW CHAPTER 7 CLAIMS

1st Edition, 2007

Mahli v. Abbey Life Assurance Company Limited [1996] L.R.L.R. 237

Abbey Life tried to avoid a joint life policy upon the death of Mr Mahli. The insurers argued that there had been a non-disclosure of Mr Mahlis
alcoholism and malaria. Mrs Mahli argued that Abbey Life were aware of these medical conditions because they had been disclosed in a joint
application they had made in 1986. The problem was that the application for a further policy had not been cross-referred with the original proposal and
reinstatement request. The Court of Appeal held that the insurance company could not have imputed knowledge of all documents in its records, the
information would have been forwarded to different departments. The Court of Appeal recognised that communication within insurance and
reinsurance companies is often poor, and it outlined the circumstances in which providing information would be sufficient for the company to have
knowledge and concluded that the information must be given to an authorised person within the company who appreciates the significance of the
information in order for knowledge to be passed to the insurance company, and on this occasion knowledge had not passed to the insurer and
presumably the same would apply in the reinsurance context.

Pan Atlantic Insurance Company v. Pine Top Insurance [1992] 1 Lloyds Rep. 101
Pine Top reinsured Pan Atlantic under an excess of loss treaty for casualty risks for 1982. At renewal in 1982 the brokers only showed the reinsurers
underwriter a short report of the risks which did not show all of the losses, yet a longer report was available. The reinsurer argued that there had been
non-disclosure and misrepresentation in failing to produce the longer report. Walker J. held that the losses missed off the short report did amount to
non-disclosure, but the failure to advise the underwriter of the existence of the longer report did not amount to a non-disclosure. He also set down
some guidelines on affirmation of contracts. The contract would be affirmed if the reinsurer being aware of the misrepresentation and non-disclosure
treated the contract as continuing. Simple delay would not in itself amount to affirmation of the contract.

Sirius International Insurance Corporation v. Oriental [1999] Lloyds Rep. 343

Oriental insured a number of warehouses in the Philippines. Sirius, who were one of Orientals three reinsurers, claimed to be able to avoid the
reinsurance when a fire occurred at one of the warehouses in 1995 because of misrepresentation.
Sirius requested further details regarding fire-extinguishing equipment at each of the warehouses. On 23 February 1995 the producing broker sent a fax
confirming that there were portable fire extinguishers, security guards, fire alarms and hydrants at each of the locations. The placing broker took the
slip around the market and it was subscribed by the Sirius underwriter who also signed and scratched the fax.
Sirius argued that they could avoid the reinsurance since there were no hydrants at the warehouse, only dry risers, and that the sprinkler system did not
work because the pump had never been supplied. The court considered the meaning of hydrants and decided that a hydrant had to be connected to a
mains water supply, so clearly there were no hydrants within this definition at the warehouse.
Longmore MJ concluded that a misrepresentation in relation to the hydrants had been made to Sirius because they had signed and scratched the fax,
but there was no evidence that a misrepresentation had been made to the other two reinsurers. However, the problem for the reinsurers was that by the

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time they had seen the fax they were already on risk and could not have relied upon the misrepresentation to reinsure the risk.

As discussed earlier, Iron Trades Insurance v. Companhia de Seguros Imperio [1991] 1 Re L.R. 213 confirms that if the reinsurer
is aware of misrepresentation but inspects the reinsureds records without a reservation of rights then that contract will be treated as
affirmed.

THE LEADING UNDERWRITER AND THE FOLLOW MARKET

The leading underwriter has a powerful role. He can agree policy wordings and agree amendments to cover and settle claims on
behalf of the follow market. The extent of the leads authority is determined by the wording of the leading underwriter clause.
You would think that if the following reinsurers are prepared to be bound by the lead reinsurers decision that the reinsurer should
be clearly identified. Normally the lead reinsurer will be clearly identified in the slip and in the case of claims processed on the
London Processing Centres claims system CLASS, the lead reinsurer is normally clearly identified since the leads response needs to
be given before the follow market can view the claims detail and respond to it. However, the identity of the leading underwriter is not

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A GUIDE TO REINSURANCE LAW CHAPTER 7 CLAIMS

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always clear.

ROAR Marine Limited v. Bimeh Iran Insurance Company [1998] 1 Lloyds Rep. 423
In this case, the following market agreed to follow the leading underwriter in relation to the settlement of claims. The leading underwriter settled a
claim and one of the defences raised was to dispute the identity of the leading underwriter. The judge decided that since the purported leading
underwriter:

-- appeared first in the list of market participants

-- appeared first in the brokers list of underwriters
-- scratched an endorsement in the box reserved for the leading underwriter, and
-- scratched the claims endorsement in its capacity as leading underwriter
that he was the leading underwriter. Therefore, if the leading underwriter looks and behaves like the leading underwriter then he will be the leading
underwriter. The court stressed that it did not matter that the leading underwriter did not have the largest participation in the risk because when the
leader first scratched the risk he did not know if subsequent underwriters would take more of a share than he himself took.
It was argued in ROAR that the follow the leader clause was subject to a condition that the settlement must have been concluded in a proper and
businesslike manner. This was rejected by the court since it would undermine the purpose and operation of the clause, and that following underwriters
have to accept the advantages and risks of the leading underwriters handling of settlements.

It should be borne in mind when agreeing to giving the leading underwriter authority to settle claims that the leading underwriter
has very wide powers to bind the following market to settlements.
In order for there to be certainty in the disposal of claims the courts have consistently favoured following the leader, regardless of
whether or not he actually intended to bind the market and whether or not he acted in accordance with market practice.
Unfortunately, the actual scope of the responsibilities of the leading under-writer to the following market is unclear. In Barlee
Marine Corporation v. Trevor Rex Mountain (The Leegas) [1987] 1 Lloyds Rep. 471 the judge expressed the opinion that underlying
the entire relationship between the leading under-writer and the following underwriters was the leading underwriters manifest duty
of care.
In Mander v. Commercial Union [1998] Lloyds Rep. IR 93 the court rejected the idea that the leading underwriter was the agent
of the following market. Instead the court construed the agreement as a trigger to bind the following market and refused to impose the
unrealistic fiduciary duties of an agent. However, the judge did say that if a leading underwriter does owe a duty of care then it is to
the following market rather than to the insured.
From a practice perspective there seems to be an increase in the leaders authority to bind the following market. This is especially
so in relation to the wide use of the LMP slip wording, which effectively means that the follow market give claims handling authority
to the lead reinsurer on their behalf to such an extent that requests for information by the follow reinsurers cannot delay settlement of
the claim once it has been agreed by the lead reinsurer. This can create problems where the following reinsurers have little faith in the
decisions taken by the lead. In this situation of course the following market can still examine the claims documentation and form their
own view on the matter but it is likely that the wording of the leading underwriter clause will prevent the follow market from taking a
different view to that of the lead, although naturally they can air their views with the leading reinsurer. The actual rights of the
following market are currently underdeveloped and it is not clear what recourse might be available to the followers against the lead
for abuse by the leader. It is therefore very important that the leaders and followers pay close attention to the wording of the leading
underwriter clause to avoid problems at a later stage.

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ISSUES RELATING TO RUN-OFF

The expression run-off has become very fashionable in recent years but it can actually have a number of different meanings. It may
mean that a particular contract is in run-off because the cover period has expired and the contract has not been renewed. It may relate
to a number of old contracts, which are no longer current but the account is still active. It may also relate to the entire business of a
reinsurance company, which has stopped underwriting new business. For example, when Mercantile and General was acquired by the
Swiss Re its general business went into run-off while its life business continued under the Swiss Re banner.
In view of the fact that run-off companies will not receive new income they will be paying claims out of an ever-decreasing pool of
money. It is therefore very common for run-off companies to take a more bullish stance in relation to claims handling, to exercise
legal rights to raise coverage issues and to delay paying claims for as long as possible.
One of the most expensive costs in relation to run-off will be the claims handling fees and these can be reduced by commuting as
much of the business as possible.

Robert Merkin

A GUIDE TO REINSURANCE LAW CHAPTER 7 CLAIMS

1st Edition, 2007

Commutation
A commutation agreement is an understanding between the reinsurer and the reinsured whereby in consideration of a payment by the
reinsurer to the reinsured the reinsured releases the reinsurer from future liabilities under the reinsurance contract.
It is difficult to determine the correct price for a commutation but in considering the value the reinsurer will look at the claims
history of the contract or contracts and project into the future what claims are likely to be made and the likely cost of those claims,
and what payments are likely to be made in the future in respect of existing claims. The reinsurer will normally carry out a
without-prejudice inspection of the reinsureds records prior to a commutation to give it a better understanding of the reinsureds
claims statistics and to assist with calculating the incurred but not reported (IBNR) figures. The reinsurer will project the claims
figures into the future and then make a deduction to take account of the fact that the reinsured is in receipt of the payment earlier than
he would have been if the claims had been paid when they were presented in the future and will thus be able to invest this money.
Reinsurers should liaise closely with their retrocessionaires when they are considering commuting business in order to avoid any
difficulties which may arise when the reinsurer tries to recover the commutation deal payment from its own reinsurers.
When the commutation terms have been agreed between the parties they will be confirmed in a release agreement. The release
agreement will clearly identify the contracts which have been commuted, specify the payment details and outline where and when the
payment should be made. It will contain a confidentiality clause preventing the parties from disclosing the details of their agreement
to other parties, a clause stating which law will govern the agreement and the jurisdiction within which any disputes regarding the
agreement will be determined. It is also common for the agreement to contain an arbitration clause to ensure that any disputes
regarding the parties agreement are determined by the arbitration process rather than by litigation.
A typical commutation agreement would look like this:
COMMUTATION AND RELEASE AGREEMENT
(hereinafter referred to as the Agreement)
THIS Agreement is entered into by and between [insert name of Reinsurer], domiciled in (hereinafter referred to as the
REINSURER) and [insert name of the Company], domiciled in (hereinafter referred to as the COMPANY), and made
effective [insert effective date].
WHEREAS, the REINSURER and the COMPANY entered into a reinsurance contract, Number [insert policy number], effective
[insert date], and executed by the REINSURER on [insert date], and by the COMPANY on [insert date] (the Contract). The term
Contract shall include all other arrangements, representations and agreements (whether written or not), which the REINSURER and
the COMPANY may have made with respect to the reinsurance obligations which are the subject of the Contract;
WHEREAS, the REINSURER and the COMPANY desire fully and finally to settle and commute all past, present and future
obligations and liabilities known and unknown of the REINSURER and the COMPANY arising under or in any way connected with
the Contract;

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NOW, THEREFORE, for good and valuable consideration the receipt of which is hereby acknowledged, IT IS AGREED BY AND
BETWEEN THE REINSURER AND THE COMPANY THAT:
1. The REINSURER shall pay to the COMPANY the sum of , detailed in Schedule A, attached hereto/ within days after
the signing the Agreement by both parties.
2. Subject to the receipt of the sum of described in Paragraph 1. above herein the COMPANY hereby releases and fully
discharges the REINSURER, its predecessors, parents, affiliates, subsidiaries, agents, officers, directors and shareholders
and assigns from any and all past, present and future payment obligations, adjustments, executions, offsets, actions, causes
of action, suits, debts, sums of money, accounts, reckonings, bonds, bills, covenants, contracts, controversies, agreements,
promises, damages, judgments, claims, demands, liabilities and/or losses whatsoever, all whether known or unknown,
which the COMPANY, and their successors and assigns ever had, now have, or hereinafter may have, whether grounded in
law or equity, in contract or in tort, against the REINSURER or any of them by reason of any matter whatsoever arising
out of or under or relating, directly or indirectly, to the terms and conditions of the Contract, it being the intention of the
parties that this release operate as a full and final settlement of the REINSURERs past, present and future liabilities to the
COMPANY under said Contract.
3. Subject to the release by the COMPANY of the REINSURER as provided for in Paragraph 2, herein above, the
REINSURER hereby releases and fully discharges the COMPANY, its predecessors, parents, affiliates, subsidiaries,
agents, officers, directors and shareholders and assigns from any and all past, present and future payment obligations,
adjustments, executions, offsets, actions, causes of action, suits, debts, sums of money, accounts, reckonings, bonds, bills,
covenants, contracts, controversies, agreements, promises, damages, judgments, claims, demands, liabilities and/or losses
whatsoever, all whether known or unknown, which the REINSURER, and their successors and assigns ever had, now have,
or hereinafter may have, whether grounded in law or equity, in contract or in tort, against the COMPANY or any of them
by reason of any matter whatsoever arising out of or under or relating, directly or indirectly, to the terms and conditions
of the Contract, it being the intention of the parties that this release operate as a full and final settlement of the
COMPANYs past, present and future liabilities to the REINSURER under said Contract.
4. The rights, duties and obligations set forth herein shall inure to the benefit of and be binding upon any and all

Robert Merkin

A GUIDE TO REINSURANCE LAW CHAPTER 7 CLAIMS

1st Edition, 2007

predecessors, successors, affiliates, officers, directors, employees, parents, subsidiaries, stockholders, liquidators,
receivers and assigns of the parties hereto.
5. The parties hereto expressly warrant and represent that they are entities in good standing in their respective places of
domicile; that the conclusion and the execution of this Agreement is fully authorized by each of them; that the person or
persons concluding and executing this Agreement have the necessary and appropriate authority to do so; that there are no
pending agreements, transactions, or negotiations to which any of them are a party that would render this Agreement or
any part thereof void, voidable, or unenforceable; and that no authorization, consent or approval of any government entity
is required to make this Agreement valid and binding upon them.
6. This Agreement contains the entire agreement between the parties as respects its subject matter. All discussions and
agreements previously entertained between the parties concerning the subject matter of the commutation are merged into
this Agreement. This Agreement may not be modified or amended, nor any of its provisions waived, except by an
instrument in writing, signed by the parties hereunder.
7. The parties hereto and each of them do hereby covenant and agree to do such things and execute such further documents,
agreements and assurances as may be necessary or advisable from time to time in order to carry out the terms and
conditions of this Agreement in accordance with their true intent.
8. This Agreement shall be governed by and construed in accordance with the laws of and the parties hereto hereby
irrevocably submit to the nonexclusive jurisdiction of the Courts in , and to the extent permitted by law expressly
waive all rights to challenge or otherwise limit such jurisdiction.
9. This Agreement shall be read and be considered as an integral part of the Contract and in the case of any conflict with
any part of said Contract the provisions of this Agreement shall prevail.
10. This Agreement may be executed and delivered in one or more counterparts, each of which shall together constitute one
and the same instrument.
11. Neither party shall disclose the details of this Agreement to any third party other than with the prior consent of the other
party except where otherwise required by law or authority of a court or arbitration panels in which event disclosure shall,
insofar as is practicable, be made only after consultation with the party taking into account the reasonable requirements of
the other party.
IN WITNESS WHEREOF, this Agreement has been executed this ________ day of ________ by
For and on Behalf of ________________ [insert name of Company]
Name: Title: Date:
For and on Behalf of ________________ [insert name of Reinsurer]
Name: Title: Date:
Schedule A
Contract description

Contract number

Reinsurers reference

Cedants reference

Underwriting year

The tendency is for the industry to think of commutation as a way to dispose of dead business but commutations can also be
attractive to the reinsurer to get them off risk on a line of business, which is no longer profitable with an existing client so that they
can focus on more profitable business lines going forward.

The commutation protocol

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On 25 June 2003 the Association of Run-Off Companies launched a Commutations Protocol aimed at making it easier for reinsureds
to conclude commutations. It was issued initially as a consultation document with a target effective date of 1 October 2003.
Unfortunately the plan of having a commutation protocol which all companies would sign up to has proved to be too ambitious.
However, the Protocol may be used by any parties if both parties agree to it. (Further information about the Protocol may be found at
www.arcrunoff.com)
The Protocol addresses a longstanding difficulty over recognition of outstanding loss reserves and Incurred But Not Reported
claims (IBNR). This arises when a reinsured commutes a book of business and then seeks to make a recovery from its reinsurers. If
reinsurers have not previously agreed to recognise the commutation, they may refuse to indemnify the reinsured for anything other
than accounted balances (i.e., paid claims). This is a disincentive to reinsureds wishing to commute. It makes it more difficult for
companies no longer trading to run-off their business.
The aim of the Protocol is to provide, on a reciprocal basis, predetermined limits for recognition of reserves and IBNR in
commutations.
Four classes of business have been identifiedLife and Health, Liability, Property, and Pecuniary Lossand for each class
different percentages are recoverable from reinsurers for loss reserves or IBNR. The percentages vary according to the underwriting
year in which the business being commuted falls: current and up to two years old, 35 years, 69 years, 1020 years, 20 years plus.
The maximum recoverable amounts for each period are set out in a schedule to the Protocol. There is nothing to prevent separate
arrangements being agreed with reinsured for higher amounts but in the absence of any separate agreement these proportions of loss
reserves and IBNR are binding.

Robert Merkin

A GUIDE TO REINSURANCE LAW CHAPTER 7 CLAIMS

1st Edition, 2007

DISPUTE RESOLUTION
Arbitration and dispute resolution are dealt with in greater detail in Chapter 10. However, dispute resolution is very relevant to claims
since often any difficult issues and tensions between the reinsurer and cedant will arise in relation to non-disclosures,
misrepresentations or the non-payment of claims.
The parties will normally incorporate an honourable engagement clause or an arbitration clause into their reinsurance contract to
ensure that disputes between the parties in relation to the contract will be determined by arbitration rather than litigation.
An honourable engagement clause indicates the parties wish not to fetter the decision-making process of the arbitrators with the
application of strict legal principles if they consider that the dispute should be resolved on an equitable basis.
A standard Honourable Engagement Clause would read like this:
shall interpret this treaty as an honourable engagement, and shall determine any reference in accordance with current reinsurance market practice
pertaining during the currency of this Agreement, with a view to effecting the general purpose of this reinsurance in a reasonable manner rather than in
accordance with the strict rules of law and literal interpretation of the language.

The parties often prefer to have their dispute decided by arbitration because it is perceived to be quicker, cheaper and less public
than court proceedings. They also are keen to have their dispute resolved by someone who is familiar with insurance and reinsurance
market practice and who will be familiar with their problems. Arbitration is seen to be more informal than court proceedings,
certainly arbitrators are less restricted by the doctrines of precedent and the law but the style of the arbitration is very much dependent
upon the view of the arbitrators appointed by the parties and in some situations the arbitration can mirror court proceedings in relation
to evidence, disclosure and exchange of documents. In relation to speed, arbitrations can be quicker but the speed depends upon the
attitudes of the parties and the issues in dispute. In many respects, arbitration may not be a cheaper alternative to litigation because
the cost of expert arbitrators can be substantial and the parties will also be required to pay the cost of the venue where the arbitration
is held.
The ARIAS (The Reinsurance and Insurance Arbitration Society of the International Association For Insurance Law (AIDA))
arbitration clause and rules are frequently used in reinsurance contracts and the rules can be added to a contract by simply including
the words ARIAS Arbitration Clause. The rules lay down guidelines regarding the appointment of arbitrators, the composition of
the Tribunal, the communication of the decision, the position in relation to fees and so on. The general rule is that there will be three
arbitrators, one appointed by each of the parties and the third to be appointed by the two arbitrators. With regard to the qualification
of the arbitrators, according to ARIAS they should be people with at least 10 years experience in the insurance or reinsurance
industries or have 10 years experience as a lawyer or other professional adviser of serving the industry. (The ARIAS Rules are
dealt with more specifically in Chapter 10.)
The case of Orion Compagnia Espanola de Seguros v. Belfort Maatschappij voor Algemene Verzekgringeen [1962] 2 Lloyds Rep.
257 makes it clear that arbitration clauses will not be permitted where they seek to oust the jurisdiction of the courts.

Home Insurance Company Limited v. Administratia Asigurailor de Stat [1983] 2 Lloyds Rep. 674
A dispute arose regarding the validity of the reinsurance contract. The honourable engagement clause said This treaty shall be interpreted as an
honourable engagement rather than a legal obligation and the award shall be made with a view to effecting the general purpose of this treaty rather
than in accordance with a literal interpretation of its language. The reinsurers argued that the agreement was not binding in law only in honour. The
court disagreed and decided that the parties had a clear intention to arbitrate and to abide by that award.

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Home and Overseas Insurance Company Limited v. Mentor Insurance Company (UK) Limited [1989] 1 Lloyds Rep.
473
In Home and Overseas Insurance Company Limited v. Mentor Insurance Company (UK) Limited [1989] 1 Lloyds Rep. 473 the arbitration clause said
The arbitrators and the umpire shall interpret this reinsurance as an honourable engagement and they shall make their award with a view to effecting
the general purpose of this reinsurance in a reasonable manner rather than in accordance with a literal interpretation of the language. At first instance
Hirst J. held that the arbitration clause was valid, and this was endorsed by the Court of Appeal with the proviso that the arbitrators should have regard
to the law and the clause must not try to oust the applicability of general law.

The case law makes it plain that the courts are not prepared to incorporate an arbitration clause from the original insurance contract
into the reinsurance contract simply because the reinsurance contract contains the words as original.

Robert Merkin

A GUIDE TO REINSURANCE LAW CHAPTER 7 CLAIMS

1st Edition, 2007

Trygg Hansa Insurance Company Limited v. Equitas and Butcher [1998] 2 Lloyds Rep. 439 (Comm)
Trygg Hansa reinsured certain Lloyds syndicates in respect of professional indemnity excess of loss contracts. Trygg Hansa attempted to avoid the
reinsurance contracts on the basis of misrepresentation and non-disclosure. Equitas as the assignee of the Lloyds syndicates commenced proceedings
against Trygg Hansa to recover the reinsurance monies owed. Trygg Hansa argued that since the original policy contained an arbitration clause and the
reinsurance was as original that the dispute between the reinsurer and reinsured should be determined by arbitration and that accordingly the court
proceedings should be stayed in accordance with section 9 of the Arbitration Act 1996. Judge Jack QC held that since an arbitration clause is a special
clause, which does not relate to the actual performance of the contract, in the absence of special circumstances something more than general words
of incorporation would be required to incorporate the arbitration clause into the reinsurance contract. Unfortunately, it is not specified in the judgment
what is meant by special circumstances, but it appears that for an arbitration clause to be successfully incorporated into a reinsurance agreement the
slip must either contain a specific arbitration clause or state something like as original, including any arbitration clause contained or incorporated
into the original contract.

There will be certain situations in which the parties will wish to dispense with the arbitration clause and instead have the dispute
determined by the litigation process. This will be common for example where there has been negligence on the part of the brokers and
the parties wish to join the brokers to the action in order to make a recovery from them.

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In order for a matter to be referred to arbitration it is necessary for there to be a dispute between the parties. In Hayter v. Nelson
[1990] 2 Lloyds Rep. 265 Saville J. said that the words dispute and difference should be given their usual meaning according to
the English language. He made it clear that just because one party was clearly correct and the other party was obviously wrong and
that this could easily be proven did not mean that there was not a dispute.

Robert Merkin