Lexington v. Wasa: The House of Lords Redefines Concurrent Reinsurance Coverage

On July 30, 2009, the House of Lords issued the much anticipated judgment in Lexington Insurance Company v. Wasa International Insurance Company Limited. This judgment is certain to have an immediate and significant impact on the world-wide reinsurance community given the ultimate holding that two London reinsurers, Wasa International Insurance Company and AGF Insurance Company, are not bound by a US court's interpretation of the ceded policy even though they had issued follow form facultative reinsurance that included an express follow the settlements clause.

The underlying dispute focused on the scope of coverage provided by a first-party difference in conditions property policy issued by Lexington to Alcoa for a three-year period between July 1, 1977 to July 1, 1980. Lexington and Alcoa were parties to an insurance coverage dispute pending in Washington state court based on Alcoa's coverage demand under that policy for alleged losses caused by environmental damage at 58 separate sites occurring over a 44-year period between 1942-1986.

Applying Pennsylvania law, the Washington Supreme Court held that, given the broad language in Lexington's policy obligating it to indemnify the insured for "all physical loss of, or damage to, the insured property as well as the interruption of business, except as hereinafter excluded or amended," the policy obligated Lexington to cover "any physical loss or damage manifesting itself during the time [the policy] was in effect . . . including pollution damage starting before the policy inception." In reaching this result, the Washington Supreme Court drew heavily on trigger and allocation theories applied to asbestos claims under Pennsylvania law. In light of that ruling, Lexington settled Alcoa's claims for $103 million.

Lexington then turned to its London reinsurers seeking coverage for a portion of the $103 million settlement with Alcoa. These reinsurers had issued facultative coverage to Lexington for the same three-year period between July 1, 1977 and July 1, 1980. The facultative coverage was expressly warranted to be on the "same gross rate, terms and conditions as and to follow the settlements of the Company . . . on the identical subject matter and risk and in identically the same proportion on each separate part thereof. . ." The reinsurers did not challenge either the Washington court's interpretation of the ceded policy or the propriety of Lexington's claims handling, which are often viewed as the most viable types of challenges available to reinsurers, particularly under contracts that include follow form and follow the settlements clauses. Rather, the reinsurers asserted that the reinsurance agreements were not concurrent with respect to governing law - the ceded policy was subject to Pennsylvania law and the reinsurance agreement was subject to English law. The parties did not dispute that under English law a reinsurer is only liable for property damage occurring during the reinsurance coverage period. Accordingly, the reinsurers argued that they were not bound to pay for their portion of the entire $103 million settlement, but only for that portion of the settlement that Lexington could demonstrate tied to property damage occurring during the three-year reinsurance period.

The House of Lords unanimously agreed with the reinsurers. First, the Law Lords reasoned that "reinsurance is a separate contract, which may contain its own independent terms," that must be satisfied before a ceding company may claim indemnity under it. Second, they agreed that the facultative certificate was not concurrent with respect to governing law. Finally, they agreed that under English law, the reinsurers could not be held responsible for all of the contamination at Alcoa's sites, whenever occurring, as long as part of the contamination manifested itself during the reinsurance period. As the House of Lords held:

the reinsurance is an independent contract, with its own terms which fall to be construed under English law, and I see no basis for interpreting it as covering any liability which might subsequently be held to arise under the insurance in any State whose law might, after disputes had arisen under it and other separate insurances, be applied by reference to factors extraneous to the particular insurance to which alone the reinsurance related. . . Although normally any loss within the coverage of the insurance will be within the coverage of the reinsurance, there is no rule of construction, and no rule of law, that a reinsurer must respond to every valid claim under the insurance irrespective of the terms of the reinsurance.

Accordingly, the Law Lords agreed that the reinsurers were not bound to indemnify Lexington for their portion of the entire $103 million underlying settlement.

This judgment is likely to cause substantial concern to cedents and retrocedents that deal with the London reinsurance market. Cedents and retrocedents likely did not anticipate that the absence of a choice of law clause in a reinsurance agreement could create such a disconnect between the scope of coverage provided by a ceded policy and a reinsurance agreement, particularly under facultative reinsurance coverage that is expressly back-to-back with the ceded policy. In order to avoid this result, cedents and retrocedents may wish to consider including provisions in their reinsurance agreements specifically providing that the reinsurance coverage is to be governed by the same law as the ceded coverage.