1. Paragraph (1): No defence based on interpretation of incorporated matching terms
C1 The effect of paragraph (1) is that a reinsurer is prevented from raising interpretation-based defences in relation to the contract of reinsurance where the reinsured has settled a claim without judicial or arbitral proceedings but in accordance with Article 2.4.3 (follow-the-settlement and follow-the-fortunes). In the event that the contract of reinsurance excludes the application of Article 2.4.3, the rule in paragraph (1) only applies if the reinsured has complied with Article 2.4.2 (Claims handling by the reinsured) and the settlement is binding on the reinsurer under the applicable rules of law.
C2 Paragraph (1) does not distinguish between proportional and non-proportional reinsurance – it applies to all types of contracts of reinsurance within the scope of the Principles (see Chapter 6, Section 1), unless the parties otherwise agree.
C3 From a legal certainty perspective, it is preferable that it is not open to the reinsurers to argue that the interpretation of incorporated matching terms varies from that of the equivalent term in the underlying insurance contract, provided that a claim has been settled by the reinsured based on the terms of the insurance policy, and that settlement is binding for the purposes of establishing the liability of the reinsured under the underlying insurance contract. Issues as to the basis on which the claim was recognized by the reinsured are thus removed by paragraph (1).
C4 Paragraph (1) addresses three points of uncertainty arising from English case law regarding the circumstances in which incorporated matching terms in a contract of reinsurance should be construed so as to be consistent with the terms of the underlying insurance contract.
C5 The first point of uncertainty is whether there is a rule of construction that incorporated matching terms must be interpreted consistently with their equivalent terms in the underlying insurance contract. In the context of proportional reinsurance in which the reinsured cedes a share of the risk to the reinsurer, it will frequently be inferred that it is the intent of the parties that the insurance contract and the contract of reinsurance are to be back-to-back and that, accordingly, incorporated matching terms should be given the same interpretation. As noted in Comment 31 to Article 6.1.1, in the US, the presumption is that a follow-form clause in a contract of reinsurance is to be construed as meaning that reinsurance coverage is concurrent with that in the underlying insurance contract.
C6 The common law rule on back-to-back interpretation is based upon Forsikringsaktieselskapet Vesta v Butcher [1989] 1 All ER 402, in which a fish farm in Norway was insured under a contract governed by Norwegian law and was reinsured on identical terms in London under a policy governed by English law. The assured was guilty of breach of a warranty – effectively operating as a limitation on cover – which required a 24-hour watch to be maintained over the fish farm, but the assured was nevertheless able to recover for storm damage because Norwegian law provided a defence in warranty cases only where there was a causal link between the breach and the loss. English law at the time did not require any causal link between breach of warranty and loss to provide a defence to underwriters, and the reinsurers relied upon the reinsurance warranty. The House of Lords held that they were not entitled to do so: while the contract of reinsurance was governed by English law, the presumption of back-to-back cover required the English court to construe the contract consistently with the construction that the direct policy would receive in Norway, and on that basis the English warranty was to be treated as effective only if there was a causal relationship between breach and loss.
C7 In contrast, in Wasa International Ins Co Ltd v Lexington Ins Co [2009] Lloyd’s Rep IR 675, the House of Lords held that, where at the time the contracts were formed, there was no identifiable system of law applicable to the underlying insurance contract which could have provided a basis for construing the contract of reinsurance in a manner different from its ordinary meaning, the contract of reinsurance is construed on its own terms without reference to the meaning given to term or terms in judicial or arbitration proceedings in relation to the insurance contract. Under paragraph (1), the English law rule on back-to-back construction (discussed in Comments 5 and 6 above) is not needed and does not apply as the reinsurer may not raise any defence based upon the interpretation of any incorporated matching terms in the contract of reinsurance if the reinsured has settled a claim by its insured in accordance with Article 2.4.3 or in any other manner which is binding on the reinsurer.
C8 The second point of uncertainty is to what extent a back-to-back approach to construction applies in the context of non-proportional reinsurance. In Axa Reins (UK) Ltd v Field [1996] CLC 1169, the House of Lords said that in the case of non-proportional reinsurance equivalent clauses in the contract of reinsurance and the underlying insurance contract need not be construed consistently because the contracts are not in any real sense back-to-back: the interests of a reinsurer with a horizontal layer may be different to those of the reinsured in respect of claims, depending on whether or not its layer is engaged. Yet, in Tokio Marine Europe Ins Ltd v Novae Corporate Underwriting Ltd [2013] EWHC 3362 (Comm), a first instance court applied a back-to-back construction approach to an aggregation clause in a non-proportional retrocession agreement. Paragraph (1) does not distinguish between proportional and non-proportional reinsurance – the interpretation rule applies to all types of contracts of reinsurance within its scope.
C9 The third point of uncertainty under English law is the test to be applied to the burden of proof that the reinsured has to discharge in establishing that a claim under the underlying insurance contract falls within the scope of the contract of reinsurance. While this is primarily a question how the applicable follow-the-settlement clause is to be construed, the approach taken can have implications on the construction of an incorporated matching term. The question arises as to whether the reinsured has to prove that (1) a loss is arguably within the cover of the underlying insurance contract (the approach taken by Evans J in Hiscox v Outhwaite (No 3) [1991] 2 Lloyd’s Rep 524 and the first instance judge Gavin Kealey QC (sitting as a Deputy High Court Judge) in Assicurazioni Generali SpA v CGU International Ins Plc [2004] Lloyd’s Rep IR 457), or that (2) a loss is arguably within the cover of the contract of reinsurance (as held by the Court of Appeal in Assicurazioni Generali SpA v CGU International Ins Plc [2004] EWCA Civ 429 and followed by Hamblen J in Tokio Marine Europe Ins Ltd v Novae Corporate Underwriting Ltd [2013] EWHC 3362 (Comm). If the test of arguability relates to the contract of reinsurance, questions of construction that have already been settled in respect of the underlying insurance contract cannot be reopened in relation to an identical clause in the contract of reinsurance. In contrast, if the test of arguability applies to the insurance level, an interpretation of a term in the underlying insurance contract adopted by the reinsured which is not ‘arguable’ could take the settlement outside the scope of the follow-the-settlement clause. The approach of the Principles (Article 2.4.3(a)) is that the test of arguability applies at the insurance level, so that interpretation points cannot be reopened under Article 6.1.3(1).
2. Paragraph (2): Interpretation to be applied
C10 For the purposes of interpretation, the Principles operate as if the law applicable to the contract of reinsurance is the same as the law applicable to the underlying insurance contract in relation to terms that are subject to matching cover. It is therefore not possible for reinsurers to argue that the meaning of a particular insured peril or exclusion as determined by a judgment or arbitration award against the reinsured at the insurance level does not have the same meaning in the contract of reinsurance.
C11 This is a narrower version of the common law rule that operates where the insurance contract and contract of reinsurance have different applicable laws and those laws confer different meanings on the same words: that rule is that the provision for matching cover requires the reinsurance to be construed in the same way as the insurance. The common law rule on back-to-back interpretation is based upon Vesta v Butcher [1989] 1 All ER 402, discussed in Comment 6 above. The principle has been applied on several occasions to secure matching cover: Mann v Lexington Ins Co [2001] Lloyd’s Rep IR 179; Ace Ins SA-NV v Zurich Ins Co [2001] Lloyd’s Rep IR 504; HIH Cas & Gen Ins Ltd v New Hampshire Ins Co [2001] Lloyd’s Rep IR 596. In an early contrasting decision, St Paul Fire & Marine Ins Co v Morice (1906) 22 TLR 449, which is out of line with the modern approach, it was held that the word “mortality” in respect of a horse was to be given different meanings under English and New York law, with the outcome that insurers were liable whereas the reinsurers were not. St Paul Fire was held to be unsupportable by Lord Collins in Wasa International Ins Co Ltd v Lexington Ins Co [2009] Lloyd’s Rep IR 675. The principle has even been extended so as to allow an express warranty contained in a reinsurance agreement governed by English law to be overridden by an equivalent warranty incorporated from the direct policy governed by Venezuelan law in circumstances where Venezuelan law allowed recovery despite breach but English law did not: Groupama Navigation et Transports v Catatumbo CA Seguros [2001] Lloyd’s Rep IR 141. The Court of Appeal in that case unconvincingly disposed of the reinsurance warranty by suggesting that it was provisional and had been inserted only to protect the reinsurers in the event that no such warranty had been included in the direct policy.
C12 The common law rule was applied by United States Court of Appeals for the Second Circuit in Ins Co of the State of Pa v Equitas Ins Ltd, 68 F4th 774 (2d Cir 2023). In Equitas, the underlying insurance contract provided liability cover and was governed by the laws of Hawaii. Hawaiian law applies the “all sums” doctrine to environmental pollution liability: the insurer is liable to indemnify up to its policy limits for all the damage, regardless of whether it can be conclusively determined that all the pollution occurred during the policy period, as some of it occurred while the policy was in effect, on the basis that the insuring clause provides that the insurer is liable to indemnify for “all sums” for which the insured is itself liable. The contract of reinsurance was on “as original” terms and governed by English law. The reinsurer argued that they were not liable to indemnify for liabilities outside the reinsurance policy period. The court said that the question to be decided was whether the English courts would interpret the reinsurance policy as entitling the reinsured to indemnity for its properly allocated liability. The “properly allocated liability” under Hawaiian law was “all sums” and, following the UK House of Lords decision in Vesta v Butcher [1989] 1 All ER 402 (see Comment 6 above), the presumption of back-to-back cover required the contract of reinsurance to be construed consistently with the construction that had been given to the direct policy. For further discussion of the Equitas case, see also Comment 32 to Article 6.1.1.
C13 Paragraph (2) is narrower than the common law rule because it only applies the “same interpretation” to incorporated matching terms – i.e. those terms that are subject to matching cover (as determined by Article 6.1.1(2)). Paragraph (2) does not deem the “same interpretation” to be applicable to the terms in the contract of reinsurance that are not subject to matching cover, and instead, the construction of those terms would be a matter of interpretation of the contract of reinsurance. Reference is made to Article 4.1(1) PICC which requires contracts to be interpreted according to the common intention of the parties.
C14 The issue is not as acute under the Principles where they are the “governing law” of the contract of reinsurance (see Comments to Article 1.1.1), because the contract of reinsurance is governed by the Principles and there are no potentially conflicting meanings of individual words of coverage or exclusion laid down by the Principles, and the potential conflict of diverging interpretations of the insurance contract and the contract of reinsurance governed by different national laws does not arise. However, the application of rules of interpretation under the Principles might still give rise to a different result at the reinsurance level. Paragraph (2) operates to apply the same interpretation given to a term in the underlying insurance contract as determined in judicial or arbitration proceedings to the incorporated matching term in the contract of reinsurance. Where a choice of the Principles by the parties merely represents an incorporation of the PRICL provisions into the contract of reinsurance, the operation of paragraph (2) has the same effect – i.e. the same interpretation applies to the incorporated matching term – even if the law applicable to the contract of reinsurance would otherwise have given it a different interpretation.
C15 The “same interpretation” rule in paragraph (2) does not adopt the “Wasa exception”: in Wasa International Ins Co Ltd v Lexington Ins Co [2009] Lloyd’s Rep IR 675, no system of law applicable to the underlying insurance contract was identifiable at the time the underlying insurance contract and the contract of reinsurance were formed, and the applicable law of the underlying insurance contract was only judicially determined many years later. The House of Lords in Wasa held that, where at the time the contracts were formed, there was no identifiable system of law applicable to the underlying insurance contract which could have provided a basis for construing the contract of reinsurance in a manner different from its ordinary meaning, the contract of reinsurance is construed on its own terms, without reference to meaning given to a term or terms in judicial or arbitration proceedings in relation to the insurance contract. This exception is not replicated in the Principles, and the rules in Article 6.1.3 are a reminder to reinsurance underwriters to ascertain the governing law of the underlying insurance contract. As noted above, the rules in Article 6.1.3 only apply to incorporated matching terms. The rules do not apply in respect of any other terms that are not subject to matching cover. Accordingly, any terms in the contract of reinsurance that are not incorporated matching terms are interpreted in accordance with the rules of construction of the applicable law of the contract of reinsurance (i.e. the Principles, another governing law chosen by the parties, or the applicable law as determined by private international law rules).
Illustrations
I1. Reinsured A and Reinsurer B enter into a facultative contract of reinsurance on terms “as original”. The underlying insurance contract is a construction all-risks policy covering an infrastructure project from 1 January 2019 to 31 December 2023. Environmental liabilities are excluded, and on-site movable machinery is not covered. The underlying insurance contract is governed by French law. The terms relating to the insured perils and risks (infrastructure CAR cover), exclusions (environmental liabilities), terms rendering certain losses ineligible to be indemnified (on-site machinery), geographical (the building site) and temporal scope of the cover (1 January 2019 to 31 December 2023) are material to the scope of cover and will become incorporated matching terms in the contract of reinsurance (Article 6.1.1(2), subject to Article 6.1.1(3)). The governing law clause from the insurance contract will not travel across into the contract of reinsurance.
I2. Same facts as in the previous Illustration. After the formation of the contract of reinsurance on 1 January 2021, Reinsured A agrees to a modification of the underlying insurance contract so that cover extends to another building site in Spain. Article 6.1.2(1) provides that this modification will not become incorporated into the contract of reinsurance and will not be binding on Reinsurer B. However, if Reinsurer B gives its consent for the modified term to become incorporated into the contract of reinsurance (under paragraph (2)(b)), the modification of the contract of reinsurance will be effective as of 1 January 2021 (Article 6.1.2(3)).
I3. Reinsured A has subscribed 10 percent of the risk insured by several insurers, including Insurer L who is the leading underwriter. The insurance contract contains a leading underwriter clause which authorizes Insurer L to extend the policy period by six months. Reinsured A reinsures its share of the risk with Reinsurer B on terms “as original”. Toward the end of the policy period of the underlying insurance contract, Insurer L extends the policy period by six months. Article 6.1.2(1) provides that this modification will not become incorporated into the contract of reinsurance and will not be binding on Reinsurer B. Article 6.1.2(2)(b) does not apply because the contract of reinsurance does not expressly provide that any modification to a term in the underlying insurance contract that has become an incorporated matching term shall be automatically incorporated into the contract of reinsurance.
I4. A contract of reinsurance is written on an “as original” basis and contains an express term requiring Reinsurer B’s consent “to all material amendments and alterations to the terms, clauses and conditions of the Original Policy”. By requiring consent only for material amendments in respect of the underlying insurance contract, Reinsurer B indicates that no such consent is required for modifications that are immaterial or, put differently, that it gives its tacit prior consent to immaterial modifications to terms incorporated into the contract of reinsurance. In these circumstances, Article 6.1.2(2)(a) applies. For example, Reinsured A may update the underlying policy of insurance to reflect a change in name of Reinsured A. The name change is incorporated into the contract of reinsurance.
I5. The territorial application of cover under an underlying insurance contract is limited to Italy. On 1 February 2024, Reinsured A agrees with its insured to extend the cover of the underlying insurance contract to apply also to France with immediate effect. Reinsured A has reinsurance cover on an “as original” basis. Reinsured A then contacts its reinsurer (Reinsurer B), and for an additional premium, Reinsurer B agrees the territorial extension on 7 February 2024. Under Article 6.1.2(2)(b), Reinsurer B has given its consent to a modification and, according to Article 6.1.2(3), the modification of the contract of reinsurance is backdated to 1 February 2024. However, had Reinsurer B given its consent on the basis that the modification of the contract of reinsurance would only take effect as of 1 March 2024 (for example, to allow time for internal administrative adjustments and to arrange corresponding modifications to is retrocession arrangements), the special agreement of the parties as to the effective date would displace the rule in Article 6.1.2(3) and the modification of the terms of the contract of reinsurance would take effect on 1 March 2024.
I6. Under the underlying insurance contract, Reinsured A (as the insurer) provides business interruption cover for twenty restaurants at different locations in Turkey. The insurance contract is governed by Turkish law and contains an aggregation clause. Reinsured A reinsures with Reinsurer B. The contract of reinsurance applies the Principles and incorporates the terms of the underlying insurance contract by reference. Ten of the restaurants are flooded after several days of heavy rain and bursting riverbanks. A Turkish court decides that under Turkish law, the aggregation clause is interpreted so that the losses are to be treated as ten different “occurrences”. According to Article 6.1.3(2), this interpretation would also apply to the aggregation clause incorporated into the contract of reinsurance.