The peculiar features of mesothelioma have led the English courts and Parliament to create special rules of causation enabling employees to claim in full against a single employer who had exposed them to asbestos. In a series of cases, the English courts have had to grapple with the consequences of that special regime for employers’ liability (EL) insurance claims, concluding that employers could “spike” their claims 100% into a single policy year and the insurer would then have to pursue recoveries through contribution and recoupment.
In the recent case of Equitas Insurance Limited v Municipal Mutual Insurance Limited  EWCA Civ 718, the English courts for the first time considered the implications at the reinsurance level. In a rare example of the Court of Appeal overturning an arbitrator’s decision, it concluded that it was an implied term of the reinsurance contracts that reinsurance claims could not be “spiked” and must instead ordinarily be presented pro rata to the period of exposure. This decision is likely to be of great interest to the reinsurance industry, and gives rise to important questions which may ultimately have to be addressed by the Supreme Court.
Municipal Mutual Insurance (MMI) provided Employer’s Liability policies to numerous local authorities and public bodies during the period between 1950 and 1981. MMI reinsured its liabilities under these policies with Lloyd’s syndicates, whose liabilities have since been transferred to Equitas Insurance Limited (Equitas). There were unequal excess of loss insurance policies. MMI’s employer insureds have faced a large number of claims from employees who were exposed to asbestos during their periods of employment and have contracted mesothelioma. MMI paid claims by its insureds without attempting to apportion the claims to individual policies or periods. An issue arose as to the proper basis upon which MMI was entitled to present its claim to Equitas.
To understand the issue in dispute it is necessary to briefly recap the legal developments that led to this case.
Mesothelioma is a fatal lung disease caused by asbestos. Exposure to a single strand of asbestos can cause mesothelioma, and mesothelioma sufferers have often been exposed to asbestos over a period of time spanning multiple employers. This led to difficulties of causation: how could an employee victim prove on the balance of probability which of two or more employers who had exposed them to asbestos had caused the disease?
To avoid the potential unfairness of an employee victim being unable to recover against any employers who had exposed them to asbestos, the House of Lords in Fairchild v Glenhaven Funeral Services Ltd  UKHL 22 and subsequently Parliament in the Compensation Act 2006 created a special rule of causation in the law of tort. A modified (“weak” or “broad”) rule of causation would be applied so that any employer who made a material contribution to the risk of mesothelioma was treated as having caused the disease. This special regime for mesothelioma – known as “the Fairchild enclave” – enables an employee victim to recover in full from a single employer who had exposed them to asbestos. That employer would then be entitled to seek contribution from other employers under the Civil Liability (Contribution) Act 1978, with contribution levels calculated based on the relative lengths of the period for which each employer exposed the employee to asbestos (unless other factors made an alternative allocation more appropriate).
Neither Fairchild nor the Compensation Act 2006 addressed the potential consequences for EL insurance or reinsurance claims. The position at employer-insurer level has been addressed in a number of subsequent decisions, most notably by the Supreme Court in International Energy Group Ltd v Zurich Insurance Plc UK Branch  UKSC 33. The debate in that case was whether an employer could “spike” its insurance claims to a single policy year, so that an EL insurer who provided cover for only part of the period of exposure to asbestos was required to bear the whole of the employer’s liability? If so, was it entitled to a proportionate contribution from other insurers who provided cover for other years and/or the insured (for periods of exposure that it did not purchase insurance). The case was complicated by the fact that it was decided in accordance with Guernsey law, and the Compensation Act 2006 did not apply in Guernsey. The parties (including the EL insurers and Association of British Insurers (ABI) as intervenor) accepted – and the majority of the Court agreed – that spiking was permitted, notwithstanding concerns about whether this was a proper reflection of the intention of the parties at the time of the contract. In doing so, they recognised the strong policy arguments for ensuring that an employee victim has recourse to a single insurer in the event a claim against the employer is impossible (e.g. due to insolvency). However Lord Sumption, in his minority judgment, took the view that as a matter of construction of the insurance policy, the insurer’s liability must be pro rated.
Arbitration between Equitas and MMI
Prior to the current case, spiking had not been considered in a judicial context at the reinsurance level. That is in part because the underlying issues at employee/employer level and employer/insurer level took time to work through the courts, but also because the prevalence of arbitration clauses in reinsurance contracts meant these issues were addressed in confidential proceedings.
The dispute between Equitas and MMI was initially referred to arbitration before Lord Justice Flaux, sitting as judge-arbitrator. In an award handed down in 2017, Flaux LJ found in favour of MMI:
- MMI was entitled to “spike” its whole claim to any year’s reinsurance contract. There was no basis on which to conclude that liability should be apportioned pro rata at the reinsurance level, although equitable contributions and recoupment should be used to sort out any anomalies or unfairness thereafter.
- The reinsured’s duty of utmost good faith was limited only to the duty not to act dishonestly in making a claim, and had no bearing on its ability to “spike” its reinsurance claims.
- MMI need only give credit for one retention, being that applicable in the year into which the claim was spiked. Equitas had no right of recoupment from MMI as regards to the retentions before or after the year to which the whole claim was presented. Rights of contribution against any other reinsurers who were also on risk for the claim still have to be calculated using the “independent liability” method; the top down approach to contribution, by which the higher layers of reinsurance get the first benefit of contribution and recoupment by analogy with the principles of subrogation, had no place in the apportionment exercise.
Equitas sought leave to appeal, which was granted by Lady Justice Gloster and Sir Jack Beatson in 2018 ( EWCA Civ 991, as reported in our Insurance and Reinsurance Annual Review 2018).
Court of Appeal decision
The Court of Appeal was asked to answer two questions:
- Was an EL insurer obliged to present reinsurance claims on a pro rata, time on risk basis either because:
- by necessary implication the settlement of each underlying EL insurance claim must be treated as having been on that basis; or
- the doctrine of good faith requires the claim to be presented on that basis?
- If the EL insurer was not so obliged and was entitled to “spike” its reinsurance claims, how are the reinsurer’s rights of recoupment and contribution to be calculated?
Lord Justice Males, giving the leading judgment, began his analysis by stating that his preferred outcome was that reinsurance claims could not be spiked, but should instead be pro rated to time on risk, and that he would work backwards to find a legal justification for that approach. He acknowledged that it was “unusual explicitly” to begin at the end in this way, but said that this was a legitimate approach in the “unprecedented and unique” situation which the courts have created within the Fairchild enclave. He preferred the pro rata approach because (amongst other things):
- The policy reasons for the anomalous approach taken at employee/ employer level and employer/ insurer level had been satisfied: a victim of mesothelioma will have recourse to a remedy, either against a solvent employer, a solvent insurer or (if the insurer is insolvent) a statutory or industry compensation scheme. It was not necessary or desirable to perpetuate those legal anomalies at reinsurance level.
- It had the practical benefit of avoiding the significantly greater complexity and expense which would result if it was for the reinsurer (rather than EL insurer, who is generally better-informed about available avenues of recovery) to pay in full then seek to regularise the position by seeking equitable contribution and recoupment.
Males LJ then considered the different legal analyses which had been advanced by Equitas as justifying a pro rata apportionment:
- Deemed allocation / implied term – Although it would be more consistent with fairness and the annual nature of EL insurance and reinsurance to treat the inward EL insurance claims as if they had been on a pro rata time on risk basis, it would be contrary to the evidence of what in fact happened. It would also be inconsistent with the decision in IEG that spiking at employer/insurer level was permitted and would introduce a further anomaly which may not easily be confined to the Fairchild enclave. A deemed allocation analysis was therefore rejected.
- Post-contractual duty of good faith – Males LJ rejected Equitas’ suggestion that the (currently limited) post-contractual duty of good faith in insurance contracts should be extended to require the reinsured to present its reinsurance claims on a pro rata basis. To broaden the English law concept in this way would go beyond the current law and may be difficult to confine to the Fairchild enclave.
- Implied good faith requirement – Males LJ considered the recent line of cases which imposed a constraint of good faith on the exercise of contractual choices (notably Braganza v BP Shipping Ltd  UKSC 17). He concluded that there were “powerful” reasons to support the implication of a term in the specific reinsurance context of the Fairchild enclave that:
“the insurer’s right to present its reinsurance claims must be exercised in a manner which is not arbitrary, irrational or capricious, and that in that context rationality requires that they be presented by reference to each year’s contribution to the risk, which will normally be measured by reference to time on risk unless in the particular circumstances there is a good reason (such as differing intensity of exposure) for some other basis of presentation.”
The opportunity for an EL insurer to choose to which year a claim should be presented was a fortuitous consequence of the Fairchild jurisprudence and not something the parties could have contemplated at the time of contracting or setting the premium. It was inconsistent with the annual nature of insurance and reinsurance, and contrary to fairness. Further, it creates a significant imbalance of power between the reinsured and reinsurer; the reinsured has control in how to allocate its inward claims and exclusive knowledge of its own reinsurance programme. The implied term is therefore as close as possible to what the parties can be taken to have intended.
Males LJ went on to consider how, if he was wrong and spiking was permitted, contribution and recoupment should operate at the reinsurance level. In the absence of direct authority, the objective was “to achieve a just solution”. Flaux LJ had held, by analogy with principles of double insurance, that only one retention (in the year that the claim was spiked) need to be applied, and Equitas could only recoup from MMI in respect of that “self-insured” retention in the spiked year, but not in previous years. However Males LJ concluded that Flaux LJ applied too closely the concept of double insurance and incorrectly disregarded the doctrine of subrogation as providing guidance. Equitas’ view was to be preferred, hence:
- MMI had to give credit in full for its retentions in each year of reinsurance even though the claim was “spiked” into one year; and
- by analogy with principles of subrogation, the higher layers of reinsurance in subsequent years should be made good first in any contribution and recoupment process.
Lord Justice Patten and Lord Justice Leggatt agreed with Males LJ’s analysis. Leggatt LJ added further commentary on the desirability of an implied term in this case, and also sought to distinguish IEG, noting in particular that the good faith arguments were not advanced in IEG. His formulation of the implied term was slightly different from that of Males LJ:
“MMI may claim under reinsurance policies covering a particular year only such share of its ultimate net loss as reflects the extent to which exposure to asbestos in that year contributed to the risk which arose during periods covered by MMI’s policies of the victim contracting mesothelioma as a result of the insured employer’s wrongdoing.”
The Court of Appeal did not provide much analysis in this case of the terms of the reinsurance contracts in implying a good faith requirement. However at the heart of the dilemma faced by Flaux LJ and the Court of Appeal was the tension between the contract language on the one hand (which suggests cover is available for all sums paid by EL insurers and, hence, permits spiking) and the undesirability on the other hand of perpetuating the legal anomalies of the Fairchild enclave at the reinsurance level.
Males LJ was startlingly frank about the fact that he regarded pro rating as the fairest solution at the reinsurance level and was then working backwards to find a legal analysis to justify this result. The Court of Appeal clearly believed that the policy arguments at employee/ employer level and employer/ insurer level did not apply at the reinsurance level. Further the Court of Appeal was obviously also concerned that, as a practical matter, reinsurers would find it much more difficult to exercise rights of recoupment and contribution. In reaching its conclusion, the Court of Appeal appears to have been influenced to some degree by the arguments against spiking at the insurance level advanced by Lord Sumption in IEG.
The Court of Appeal’s unusual approach will undoubtedly come under scrutiny. The judgment gives rise to number of questions:
- Did the Court of Appeal give sufficient weight to the express terms of the reinsurance?
- Did it consider adequately the counter policy arguments for permitting spiking at the reinsurance level?
- Is the implied term appropriate in this context and should it apply to all reinsurances of EL policies in respect of mesothelioma claims, regardless of their terms and purpose?
- Notwithstanding the Court of Appeal’s concern to confine the implied term specifically to the EL mesothelioma reinsurance claims context, is there scope for (re)insurers to argue in other contexts that their (re)insureds must present claims in “good faith”?
- And was the Court of Appeal correct to conclude that Flaux LJ had given too much weight to the double insurance analogy when considering the question of contribution and recoupment?
On 8 May 2019 the Court of Appeal granted MMI permission to appeal to the Supreme Court, with the hearing expected in the first half of 2020. We await with interest to see if these questions will be addressed.