Whether Defence Costs Contribute To Reinsurance Excess

ROYAL & SUN ALLIANCE (“RSA”) V EQUITAS  INSURANCE LIMITED  

London Circuit Commercial Court (KBD) HHJ Keyser KC, [2025] EWHC 2704

The insurance – For many years, BOC, a British multinational manufacturing group, took out general liability insurance which included cover for products liability.  For one particular period (referred to in this note as the ‘Four Year Period’) BOC purchased cover from a member of the group that became RSA and whose liabilities RSA took over. This provided cover of £20m in respect of any claim, or number of claims, arising out of an occurrence during the policy period, and in the annual aggregate.  

In addition, the insurance provided that RSA would indemnify BOC against costs and expenses (i) recoverable from BOC by any third party claimant and/or (ii) incurred by BOC itself with the consent of the insurers.

The reinsurance – RSA partly laid off this exposure by purchasing facultative excess of loss reinsurance from various Lloyd’s syndicates whose relevant years of account were later transferred into Equitas.  This reinsurance was stated “to follow original terms, conditions and settlements” and recorded that the original policy had been seen.  

This reinsurance provided cover of £16m, excess of £4m, for any one loss or series of losses arising out of one occurrence and in the annual aggregate.  

The claims – BOC became subject to bodily injury claims in the USA, in which third parties pursued ‘toxic tort’ claims.  The claimants alleged that they had been exposed to welding fumes or asbestos-containing products manufactured, designed or distributed by BOC.  As a result, BOC incurred extensive defence costs and paid substantial damages, for which BOC sought and obtained insurance recoveries.  One of the most substantial claims made by BOC against its insurers was in respect of BOC’s contribution to the Toxic Torts Settlement Agreement (‘TTSA’), in which damages agreed with a large number of claimants were allocated across the insurers who had participated in BOC’s insurance program over the years. 

RSA sought to recover from Equitas in respect of those claims occurrences which it calculated exceeded £4m, including the share of the TTSA that had been allocated to the Four Year Period.  Equitas denied liability.  In the subsequent proceedings, the court had to decide the following issues.

1. Defence Costs Erosion Issue

The issue – The question here was whether, as the reinsurers asserted, the £4m excess in the reinsurance was eroded only by indemnity payments or, as RSA asserted, it was eroded also by defence costs.

In the court proceedings to determine this issue, it was common ground between the parties that the liability to indemnify BOC in respect of defence costs was not subject to any financial limit but that it was the subject of a temporal limit, in that the obligation continued only while the £20m indemnity limit in respect of third party claims had not been exhausted.

The decision – The court held that the excess was not eroded by RSA’s contribution to BOC’s defence costs.  The court’s reasoning was that the reinsurance was a facultative excess of loss policy, ‘back to back’ with the underlying insurance and stated to ‘follow original terms’. In the original insurance, the obligation to indemnify defence costs sat alongside the obligation to indemnify BOC for the compensation paid to third parties.   The natural understanding of the ‘limit’ provisions would be that the £16m for cover and the £4m of excess reflected and related to the indemnity cover and not defence costs.  

The court held that this view was supported by the wording of the reinsurance contract and further that the result was not uncommercial.  This was so even though, pursuant to the Claims Co-operation Clause (for which, see Issue 2 below), reinsurers had to be consulted about the defence of claims for less than £4m.

2. How the reinsurance was to operate, containing as it did both a Claims Co-operation Clause and a Follow Settlements Clause

As indicated above, the reinsurance provided that reinsurers were to follow claims settlements entered into by RSA with BOC or third party claimants (as far as applicable to the layer of coverage).  However, the reinsurance also contained the Claims Co-operation Clause referred to in the preceding paragraph.  To paraphrase, the latter clause required RSA to notify reinsurers in the event of an occurrence which might be the subject of a claim under the reinsurance; in that event, the course to be adopted by RSA was to be agreed with the reinsurers and RSA was not to litigate without the consent of the reinsurers.

In these circumstances, the second issue before the court was whether the Claims Co-operation Clause annulled, modified or circumscribed the operation and effect of the Follow the Settlements Clause.

The decision -The court held that the two clauses could be read consistently because the Claims Co-operation Clause was to be read as not prohibiting the reinsured from settling claims without the reinsurers’ consent:  the prohibition was against the reinsured litigating without consent.  Therefore, the Claims Co-operation Clause did not modify the obligation upon the reinsurers to follow RSA’s settlements.

3. The proper and business-like steps issue

The effect of a clause binding reinsurers to follow the settlements of the insurers is that reinsurers agree to indemnify insurers in the event that they settle a claim by their insured, provided that the claim so recognised by them falls within the risks covered by the reinsurance as a matter of law and provided also that in settling the claim the insurers have acted honestly and have taken all proper and businesslike steps in making the settlement (ICA V Scor, 1985).

RSA’s participation in the TTSA had proceeded on the basis that under the relevant legal system, that of New Jersey, the courts would treat progressive injury, such as that which follows exposure to welding fumes or asbestos, as an occurrence within each of the years of the injuring company’s liability insurance following the exposure.  Moreover, in such cases, losses should be allocated among the various triggered years of coverage with reference to the degree of risk transferred, i.e. with reference to how much insurance the injuring company purchased in the year in question.  The precise way in which this process of allocation would work had not been fully clarified in the case law of New Jersey, but it could be that insurers on upper layers of cover would be counted in the allocation process even though actual losses to the year in question were not in the circumstances likely to exhaust lower layers of cover.

It so happened that, in the Four Year Period, the relevant BOC company purchased much higher levels of cover than in previous years because it participated for the first time in BOC’s global excess policies. Accordingly, RSA’s lawyers advised that, if the matter went to court, there was the potential for allocation of a disproportionately high percentage of the TTSA settlement to the Four Year Period, even though this would arguably create an inequitable result, and particularly as there had been no spike of claims in the Four Year Period.  RSA’s contribution to the TTSA settlement reflected this potential exposure, in that the allocated share ultimately agreed by RSA for the Four Year Period amounted to some 47% of the total amount paid out via the TTSA, even though the total period covered by the TTSA was some 70 years. 

In these circumstances, the third issue before the court was Equitas’ contention that, in entering the TTSA, RSA had failed to take all proper and business-like steps because they had adopted an unreasonable interpretation of New Jersey law and failed to obtain information relevant to decisions regarding settlement, with the result that RSA had agreed to bear an unreasonably high proportion of BOC’s losses.

The decision – The court proceeded on the basis that an allegation of failure to take proper and businesslike steps is tantamount to an allegation of professional negligence. The court then reviewed the relevant case law of New Jersey and the legal advice on which RSA acted. The court concluded that Equitas had not proved that there had been any failure to take proper and businesslike steps and that Equitas was therefore bound by the follow settlements clause.

4. Interest

Date from which interest should run – The first notice of potential loss under the reinsurance policies had been given in 1986 and a standstill agreement had been in place for some 20 years until 2017,  Nevertheless, the court in its discretion did not restrict the time for which interest should run and ordered it to run from the date of each respective loss. 

Compound or simple interest – RSA claimed compound interest.  Having analysed the case law, the court concluded that there was no default rule that, in a commercial case, compensation for being kept out of one’s money will be awarded on the basis of the cost of commercial borrowing, i.e. by way of compound interest. The legal position is simply that compensation on that basis will be awarded if the facts pleaded and proved are sufficient to justify the inference that such an award reflects the claimant’s actual loss.  In the present case, the court had been referred to no evidence to justify departure from the general practice of awarding simple interest, which it set at 2% above the Bank of England’s base rate, as varied from time to time.

For further information, please contact Wendy Miles, Chris Earl-Anderson or William Sturge at Lovetts.For further information, please contact Wendy Miles, Chris Earl-Anderson or William Sturge at Lovetts.