ICIL Section A

International
commercial insurance
law
Module A: The contract of reinsurance
2012
R. Merkin
This Study Guide was prepared for the University of London International Programmes by:
̆ Professor Rob Merkin, School of Law, University of Southampton and consultant to the
Norton Rose Group.
This is one of a series of Study Guides published by the University. We regret that owing to
pressure of work the author is unable to enter into any correspondence relating to, or arising
from, the Guide.
If you have any comments on this Study Guide, favourable or unfavourable, please use the
form at the back of this Guide.
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Contents
Contents
Chapter 1 Introduction ........................................................................................... 1

1.1 Introduction to the course........................................................................................ 1
1.1.1 Structure of the course.................................................................................... 1
1.1.2 Detailed programme of study .......................................................................... 1
1.2 Introduction to Module A: The contract of reinsurance .............................................. 3
1.3 How to use this Study Guide .................................................................................... 3
1.4 Other study resources .............................................................................................. 4
1.5 Keeping up to date .................................................................................................. 5
1.6 Allocating your time................................................................................................. 6
1.7 Preparing for the examination.................................................................................. 6
Chapter 2 The definition of reinsurance................................................................. 7
Introduction ................................................................................................................. 7
2.1 General definition .................................................................................................... 7
2.2 Facultative reinsurance ............................................................................................ 9
2.3 Treaty reinsurance .................................................................................................. 10
2.4 Relationship between assured, insurer and reinsurers ............................................. 13
Chapter 3 Regulation of reinsurance business ..................................................... 15
Introduction ............................................................................................................... 15
3.1 Reinsurance as insurance ....................................................................................... 15
3.2 The Reinsurance Directive ...................................................................................... 16
3.3 Reinsurance intermediaries .................................................................................... 18
Chapter 4 Formation and insurable interest ........................................................ 21
Introduction ............................................................................................................... 21
4.1 Formation procedures ............................................................................................ 21
4.1.1 Slip procedure .............................................................................................. 21
4.1.2 London Market principles.............................................................................. 23
4.1.3 Market Reform Contract ............................................................................... 23
4.2 Reinsurance in advance of insurance ..................................................................... 25
4.3 Rules relating to insurable interest ......................................................................... 26
4.4 Application of insurable interest rules to reinsurance .............................................. 28
Chapter 5 Utmost good faith ............................................................................... 31
Introduction ............................................................................................................... 31
5.1 The principle of utmost good faith .......................................................................... 32
5.1.1 Definitions of non-disclosure and misrepresentation ...................................... 32
5.1.2 Materiality and inducement .......................................................................... 34
5.2 Material facts in reinsurance cases ......................................................................... 35
5.3 Post-contractual obligations ................................................................................... 39
5.4 The remedies of the parties .................................................................................... 41
Chapter 6 The terms of reinsurance contracts ..................................................... 45
Introduction ............................................................................................................... 45
6.1 Construction of policy terms .................................................................................. 46
6.2 Express terms ........................................................................................................ 48
6.3 Implied terms ........................................................................................................ 49
6.4 Incorporated terms ................................................................................................ 51
Appendix 1: The examination ............................................................................... 55
Sample examination questions ..................................................................................... 55
i
International commercial insurance law: Module A
Notes
ii
Chapter 1 Introduction
1.1 Introduction to the course

Welcome to International commercial insurance law. This is a course
on the Postgraduate Laws Programme of the University of London
International Programmes. It is aimed at students at a postgraduate
level. You may be studying this course as part of a Postgraduate
Certificate in Laws, Postgraduate Diploma in Laws or Master of Laws
(LLM), or you may be studying it as a single course. Whatever your
purpose in studying the course, I hope that you find it a rewarding
experience.
Insurance is an essential element of nearly all commercial transactions
and of many situations that private individuals encounter. The United
Kingdom insurance industry, with its centre at Lloyds of London, has
an international, indeed worldwide, importance. It is a subject with
long historical roots, but is also going through a period of change and
reform, making this an interesting time to study the subject. To date
much of the literature on insurance law has been at a practitioner level,
but it is a growing area of academic study. This course will enable you
to study the development of commercial insurance law and to engage
with the cases and problems that will give you an understanding of the
reality of decision-making and problem-solving in this field of law.
1.1.1 Structure of the course

The course is divided into four modules. These must be studied
consecutively (Modules A, B, C then D), and are assessed separately:
• Module A: The contract of reinsurance
• Module B: Reinsurance losses and claims
• Module C: Liability insurance
• Module D: Conflict of laws in insurance.
1.1.2 Detailed programme of study

• Module A: The contract of reinsurance introduces you to the key
concept of reinsurance, which allows insurance risk to be spread
thereby enabling insurers to accept risks that would otherwise be
beyond their capacity. We begin, in Chapter 2, by outlining the
definition of reinsurance and the difference between the main
forms of reinsurance, before discussing the relationship between
assured, insurer and reinsurer. In Chapter 3 we consider regulation
of reinsurance both within and UK and in the wider context of the
EU. Chapter 4 discusses the formation procedure for a contract of
reinsurance and the documents used in that procedure. Chapter 5
examines the concept of ‘utmost good faith’ , the information that
must be disclosed by the reinsured prior to a contract, the post-
contractual duties of the parties and the remedies for a breach of
those duties. Lastly, Chapter 6 considers the terms of reinsurance
contracts and the interpretations that courts have placed on these.
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• In Module B: Reinsurance losses and claims, we explore in more

detail the construction placed on reinsurance contracts. Chapter
2 looks at the concept of back to back cover, whereby agreements
often provide for the coverage provided by reinsurers to match that
provided by the reinsured. In Chapter 3: ‘Follow the settlements
and follow the fortunes’, we discuss the obligation of reinsurers to
indemnify the reinsured where the latter has suffered a loss. Chapter
4 considers the obligations of the reinsured when making claims
against reinsurers. In Chapter 5 we look at the issues that can arise
regarding assessment of the amount recoverable under a contract of
reinsurance.
• In Module C: Liability insurance, we consider this form of insurance,
the purpose of which is to give protection against claims by third
parties. Chapter 2 outlines the nature of liability insurance, its main
forms and the principles of law that apply to it. Then, in Chapter 3,
we examine the compulsory insurance regimes, in particular marine
policies and employers’ liability insurance. In Chapter 4 we discuss
another area affected by a compulsory insurance requirement: motor
vehicle insurance, including the problems of dealing with uninsured
and untraced drivers. Chapter 5 focuses on other specific forms of
liability insurance: professional indemnity insurance, product liability
insurance and diretors’ and officers’ insurance. Chapter 6 addresses
the question of defence costs in liability insurance cases, and this
module concludes in Chapter 7 with a discussion of third party rights
against insurers, with particular focus on the 2010 Third Parties
(Rights against Insurers) Act 2010.
• Module D: Conflict of laws in insurance covers the rules
concerning which legal system and jurisdictions apply to particular
disputes. Chapters 2 and 3 consider the jurisdiction of the English
Courts for European and non-European cases respectively. In
Chapter 4 we examine the law as it applies to insurance and
reinsurance contracts, in particular the Rome I Regulation. We
conclude in Chapter 5 by discussing how the applicable law rules
operate in practice.
Aims of the course

The aims of the course are to provide you with an understanding of and ability to
analyse issues relating to:
• reinsurance and the key aspects of contracts of reinsurance
• the construction placed by the courts on reinsurance contracts
• third parties and liability insurance
• jurisdiction and conflicts of laws as they affect insurance.
Course learning outcomes

By the end of the course you should be able to:
• outline the nature of reinsurance, its main forms and terms
• analyse issues relating to insurance losses and claims
• discuss insurance issues as they affect third parties
• identify and explain where jurisdiction should lie in international commercial
insurance cases.
2
1.2 Introduction to Module A: The contract of reinsurance

• In this module we focus on the contract of reinsurance, which allows
insurance risk to be spread, thereby enabling insurers to accept risks
that would otherwise be beyond their capacity.
• After this introduction, Chapter 2 outlines the definition of
reinsurance and the differences between its main forms, before
discussing the relationship between assured, insurer and reinsurer.
• Chapter 3 looks at regulation of reinsurance, both in the within the
United Kingdom and in the wider context of the European Union.
• In Chapter 4 we consider the formation procedure for a contract of
reinsurance and the documents used in that procedure.
• Chapter 5 examines the concept of ‘utmost good faith’ , the
information that must be disclosed by the reinsured prior to a
contract, the post-contractual duties of the parties and the remedies
for a breach of those duties.
• Chapter 6 discusses the terms of reinsurance contracts and the
interpretations that courts have placed on these.
Aims for Module A

Module A is designed to develop your skills and ability to explain the nature of a
contract of reinsurance and to analyse the rights and liabilities of the parties to
the contract.
Objectives
Our objectives in module A of this course are to explain:
• the nature of a contract of reinsurance
• the regulation of reinsurance business
• the various parties involved in the process of creating reinsurance contracts
• the application of ordinary principles of insurance in reinsurance law
• the contents of the contract.
Learning outcomes for Module A

By the end of this module and the relevant readings you should be able to:
• define the various types of reinsurance agreements
• explain the regulatory rules relating to reinsurance
• describe the process of formation of a contract of a reinsurance
• recognise the terms of the reinsurance contracts
• explain the respective obligations of the parties.
1.3 How to use this Study Guide

The extent to which you follow the detail of this Study Guide will vary
depending on your style of studying, your previous experience and
your existing knowledge. It is intended to be as informative, but also as
flexible as possible.
There is a separate Study Guide for each of the four modules of the
course. Each module includes a number of chapters. (See Structure of
the course and Detailed programme of study.)
3
The Study Guides provide a general framework for your study of the
course. They are not intended to replace the study of relevant primary
sources (legislation and case reports), textbooks and other academic
literature. For the purposes of the examinations, it is assumed that
you will make full use of the other materials made available via the
Online Library. More will be said about those materials later in this
introduction.
Modules: At the beginning of each module is a list of:
• Aims − that is, things that you will achieve while completing that
module and
• Learning outcomes − that is, things that you should be able to do
after completing the module.
Each chapter within the module is then presented in turn. At the
beginning of each new chapter you will find a list of educational aims,
intended Learning outcomes and Essential reading (see below). You
will also find some Self-assessment questions − that is, questions to
address while and after you do the reading. At the end of each module,
you will find Sample examination questions.
The modules of the course are designed to be roughly equal in length.
Advice on answering sample examination questions: Feedback
is provided for sample examination questions, suggesting possible
approaches to answering the questions. Do make sure that you
attempt each question yourself before you read the feedback.
1.4 Other study resources

Essential reading
This Guide is only the starting point for your study of the course. It is
not a substitute for the other resources that you will need to use in
order to gain an adequate understanding of the subject. The textbooks
on International commercial insurance law are mainly designed for
practitioners rather than academic courses. As a result, the majority of
our essential reading consists of case law reports rather than textbooks.
Cases cited as essential reading will be available via the databases
on the Online Library. In addition many cases are now available free
online through BAILII, which you can access without having to log in.
Decisions before 1865 are to be found in the English Reports, which
can be accessed on www.bailii.org/form/search_ers.html, searchable by
name and date. Other cases are available on www.bailii.org/. The most
important cases are identified at the start of each section, and these are
essential reading, but those cases refer to others that you might want
to look at by way of background.
There are also chapters on reinsurance in the leading insurance texts,
which are available on the Online Library:
Legh-Jones, N., J. Birds and D. Owen MacGillivray on insurance law. (London:
Sweet & Maxwell, 2008) eleventh edition [ISBN 9781847030535].
Merkin, R. Colinvaux’s law of insurance. (London: Sweet & Maxwell, 2010)
ninth edition [ISBN 9780414042339].
4
The material in Colinvaux, Chapter 17, is essential reading for this course.
Useful further reading

The textbooks on reinsurance law are primarily designed for
practitioners. The leading texts are:
Butler, J. and R. Merkin Butler and Merkin’s reinsurance law. (London, Sweet
& Maxwell, 1986] looseleaf [ISBN 1870080076].
Barlow, Lyde and Gilbert Reinsurance practice and the law. (London:
Informa, 2009) looseleaf [ISBN 9781843117964].
Carter, R. Reinsurance. (London: Reactions Publishing Group/Guy Carpenter
& Company, 2000) fourth edition [ISBN 1855647923].
Edelman, C. The law of reinsurance. (Oxford: Oxford University Press, 2005)
[ISBN 0199268932].
Kiln, S. Reinsurance in practice. (London: Witherby, 2001) fourth edition
[ISBN 1856091791].
Merkin, R. (ed.) A guide to reinsurance law. (London: Informa, 2007)
[ISBN 9781843116783].
O’Neill, T. and J. Wolonecki The law of reinsurance. (London: Sweet &
Maxwell, 2010) third edition [ISBN 9781847035554].
You do not need to read every item of Useful further reading, but you
should try to read at least some of it in order to broaden and deepen
your understanding of the subject. Experience from other Postgraduate
Laws courses shows that those students who do best in the final
examinations are usually those who have made an effort to do further
reading on, and research into, their subject. The University does not
undertake to provide you with Useful further reading items.
Using online resources

You can access the Online Library via the Student Portal. The Library
consists of several different databases containing an enormous
collection of case reports, journals and practitioner texts. Through
the Portal, you can also access the Postgraduate Laws eCampus (also
known as the virtual learning environment, or VLE). Here you can
download the Study Guides and, as the course becomes established,
past examination papers, Examiners’ reports and updates to the study
materials. You can also contact fellow students on the course via a
dedicated discussion forum. Notices concerning changes to course
materials or administrative arrangements may be posted on the
eCampus, so you should check it regularly. For more information on the
Student Portal, Online Library and eCampus, see the Postgraduate Laws
Student handbook.
There are many other web sites that you may find useful. You should
certainly search online for relevant material, but bear in mind the usual
‘health warnings’ that apply to all information, and perhaps particularly
some internet sources: be aware of possible inaccuracy and bias.
1.5 Keeping up to date

You do need to keep your knowledge up to date. If you are studying
the course after 2012, be sure to look out for the latest edition of
the annual update supplement, Recent developments. This should
5
be published on the eCampus in February or March each year. It will

outline any major changes in relevant law and direct you to related
readings, if available.
1.6 Allocating your time

It is impossible to say with great precision how much time you
should set aside for studying International commercial insurance
law because you will each have individual learning rates depending
on your circumstances, fluency in English and the extent of your
prior study of law. Furthermore some topics of the syllabus require
considerably more time than others.
However, as an International Programmes student you are expected
to spend approximately 115 hours studying and preparing for the
examination for each module of this course. It is advisable to set aside a
specific amount of time each week to study each course, increasing the
amount in the six weeks before the examination.
Some topics of the syllabus will require considerably more time than
others. My best advice is that you should allocate a specific amount of
time for the study of International commercial insurance law each
week with a view to completing your study of all topics in the syllabus
so as to leave ample time for revision before the examination.
1.7 Preparing for the examination

Important: The information and advice given in the following section
is based on the examination structure used at the time this Guide
was written. However, the University can alter the format, style or
requirements of an examination paper without notice. Because of this,
we strongly advise you to check the instructions on the paper you
actually sit.
Your understanding of the material covered by the syllabus for this
module will be assessed by an unseen written examination of 45
minutes’ length, with reading time. To the extent that there are any
prerequisites for this module, knowledge of the materials covered in
those prerequisites may be necessary to answer the questions on the
examination of this module.
We intend in the future to publish past examination papers for
this course, which you can use those to practise your examination
technique. There will also be Examiners’ reports for these past papers –
commentaries by the Examiners who marked the papers giving advice
on the kind of points that they were looking for in a good answer to
each question.
6
Chapter 2 The definition of reinsurance
Chapter 2 The definition of reinsurance
Introduction
This chapter analyses the nature of a contract of reinsurance and
provides a definition of the contract. Reinsurance contracts are
necessarily commercial arrangements and are subject to the general
rules of the law of contract. They are also governed by the special legal
provisions which apply to insurance contracts, notably the duty of
utmost good faith.
Learning outcomes
By the end of this chapter and relevant readings you should be able to:
• define a contract of reinsurance
• explain the difference between the main forms of reinsurance
• identify the features of the various types of reinsurance
• discuss the relationship between the assured, the reinsured and the reinsurers.
Essential reading
• Caudle v Sharp [1995] LRLR 433.
• Cox v Bankside Members Agency [1995] 2 Lloyd’s Rep 437.
• Delver v Barnes (1807) 1 Taunt 48.
• Feasey v Sun Life Assurance Co of Canada [2002] Lloyd’s Rep IR 807.
• Grecoair Ltd v Tilling [2005] Lloyd’s Rep IR 151.
• Hanwha Non-Life Insurance Co Ltd v Alba Pte Ltd [2011] SGHC 271.
• Re Norwich Equitable Fire Assurance Society (1887) 57 LT 241.
• Wasa International Insurance Co v Lexington Insurance Co [2009] UKHL 40.
Further reading
• Kuwait Airways Corporation v Kuwait Insurance Co SAK [1996] 1 Lloyd’s
Rep 664.
• Travellers Casualty & Surety Co of Europe Ltd v Commissioners of Customs and
Excise [2006] Lloyd’s Rep IR 63.
2.1 General definition

A contract of reinsurance is one whereby an insurer obtains its own
insurance to cover some or all of the sums which it has to pay to its
own assureds. The contract is often referred to as an ‘outwards’ contract,
by way of contrast to the insurance contract written by the insurer
which is often referred to as an ‘inwards’ contract. An insurer who
obtains reinsurance is known as the ‘reinsured’, the ‘ceding company’ or
the ‘cedant’, and the other party is known as the ‘reinsurer’. Very often
the plural is used, and in this Study Guide the terms ‘reinsured’ and
reinsurers will be adopted. The reinsurance itself is variously referred
to as the ‘contract’, ‘agreement’ or ‘policy’. The insurance to which the
reinsurance relates is referred to as the ‘underlying’, ‘original’ or ‘direct’
policy. Reinsurance may be provided by insurance companies or
Lloyd’s Syndicates, but there are also some companies which write
only reinsurance business (pure reinsurers). Reinsurers may reinsure
7
themselves, under contracts known as ‘retrocessions’ (reinsurance of

reinsurance), and the parties are referred to as the ‘retrocedant’ and the
‘retrocessionaires’. Most reinsurance contracts are placed by brokers.
The role of brokers is discussed in Chapter 3.
Reinsurance has a number of purposes. First, it allows an insurer to
accept risks that would otherwise be beyond its financial underwriting
capacity. Secondly, it protects the insurer’s solvency in the event that
it is faced with a large number of unexpected losses. Thirdly, risks
which would otherwise be uninsurable because of the potential losses
flowing from them become insurable where the insurers are backed by
reinsurance. Fourthly, and related to the last point, reinsurance is a truly
international business, so that risks faced in one country (e.g. those
arising from adverse weather conditions such as hurricanes) can be
spread amongst the international underwriting community. Many large
commercial organisations have their own ‘captive’ insurance companies
which accept risks from group members and then seek reinsurance in
the ordinary market. The use of captives and reinsurance is a method of
keeping down insurance costs for such organisations.
Reinsurance agreements are very commonly ‘composite’, in that the risk
is generally placed with two or more reinsurers (the number depending
upon the size of the risk). A typical reinsurance portfolio held by an
insurer will consist of a number of different arrangements: the various
types of reinsurance are considered below.
Reinsurance has a relatively modern history. Marine reinsurance
was outlawed by section 4 of the Marine Insurance Act 1745, on the
basis that it constituted a form of gambling and the prohibition was
not lifted until the passing of the Revenue (No 2) Act 1864. Marine
reinsurances had in that period to be framed as if they were insurance
contracts. This is reflected in the early definition of reinsurance in Delver
v Barnes (1807) 1 Taunt 48 as:
… a new assurance effected by a new policy on the same
risk which was before insured in order to indemnify the
underwriters from their previous subscriptions …
That definition needs to be treated with some care for two reasons.
First, modern market practice is to arrange reinsurance either
beforehand or at the same time as the insurance protected by it,
so the notion that insurance is placed first does not reflect how the
market works. This is discussed in Chapter 4. Secondly, the suggestion
that reinsurance consists of a further policy on the original risk
is not a definitive statement. In Wasa International Insurance Co v
Lexington Insurance Co [2009] UKHL 40 the House of Lords ruled that a
reinsurance contract was generally construed to be in this fashion, but
it was recognised that if the contract was appropriately drafted it could
take effect as a policy which protected the reinsured against liability
for claims. For example, in Travellers Casualty & Surety Co of Europe Ltd v
Commissioners of Customs and Excise [2006] Lloyd’s Rep IR 63 it was held
by a Value Added Tax Tribunal that a contract under which reinsurers
agreed to indemnify an insurer against claims under performance
bonds issued by it was one of reinsurance: the Tribunal accepted the
wider definition of reinsurance as being insurance of an insurer, even in
respect of contracts which were not themselves contracts of insurance.
8
The nature of the reinsurance thus depends upon how it is defined in

the contract. For an illustration, see Feasey v Sun Life Assurance Co of
Canada [2002] Lloyd’s Rep IR 807, discussed in the Insurable Interest
section of Chapter 4.
Reinsurance contracts can be issued on a proportional or non-
proportional basis. A proportional contract is one under which the
reinsurers accept a proportion of the risk written by the reinsured for
an equivalent proportion of the premium (although generally the
reinsured retains an additional percentage of the premium by way of
‘finder’s fee’ or ‘ceding commission’). A non-proportional contract is
one under which the reinsurers do not accept a proportion of the risk
as such, but one under which their liability is expressed in monetary
terms and their cover attaches when the reinsured’s loss exceeds the
amount retained by the reinsured for its own account. This is exactly
the same structure as is found in any domestic policy (e.g. a motor
policy where the assured has to pay the first £50 of any loss). The self
insured sum is known as an excess or deductible, but in this Study
Guide the term ‘deductible’ is preferred, as the terms ‘excess’ is often
used in other senses. The purposes of a deductible are: (a) to impose
some form of control on the reinsured’s underwriting behaviour, in
that if the reinsured has to bear the first amount of any loss itself
then it will potentially exercise care in deciding which risks to accept;
and (b) to remove the reinsurers’ liability for small losses, thereby
keeping premiums down. If the reinsurers insist upon a high retention,
the reinsured is – unless the contract otherwise provides – free to
seek reinsurance for some or all of the deductible. The premium will
necessarily be higher, given that the number of reinsured losses at that
lower level will inevitably be greater.
Illustrations of proportional and non-proportional contracts will be
given below. The reader should be aware that reinsurance may be
arranged in non-traditional forms, under a variety of arrangements
collectively known as ‘alternative risk transfer’. These contracts, which
include securitisation of debt (by the use of bonds administered by
‘special purpose vehicles’ established for the purpose) and derivatives
(in the form of credit default swaps), have much the same effect as
reinsurance, in that they transfer the risk of loss, albeit by different
means. As is seen in Chapter 3, some alternative risk transfer
arrangements are regulated by the financial regulatory authorities as if
they were pure reinsurance agreements.
2.2 Facultative reinsurance

The word ‘facultative’ is derived from Latin facultas, and means ‘one-
off ’. A facultative contract is, therefore, one under which the reinsured
reinsures a single risk with reinsurers. The reinsured will enter into
a contract of insurance with the original assured, and an agreed
proportion of the risk will be ceded to reinsurers. It is generally the case
that the arrangements for reinsurance have been agreed in advance
of the insurance having been put into place, so that the reinsured
has the security of reinsurance when negotiating with the assured. In
a number of jurisdictions the law requires all risks to be placed with
a local insurer. If there is no local insurer with the relevant capacity
9
or expertise, the risk may be brokered in the London market as a

reinsurance risk, and once reinsurance has been agreed, a local insurer
may then be ‘inserted’ into the arrangement but on terms that 100
per cent of the risk is then ceded to the reinsurers. This arrangement
is known as ‘fronting’, with the reinsured simply acting as a nominal
insurer in return for a small premium commission. Where there is a
claim against the insurers, it will be negotiated and controlled by the
reinsurers.
Most facultative contracts are in proportional form, so that the
reinsurers accept an agreed proportion of the risk for an equivalent
proportion of the premium (minus ceding commission payable to the
reinsured and brokerage paid to the broker). The amount of the risk to
be ceded depends upon the circumstances, but can range from a very
small percentage to – in fronting cases – 100 per cent. In the event of
a claim against the reinsured, the reinsurers are required to indemnify
the reinsured for the agreed proportion of its payment to the assured.
In those rare cases where the contract is written on a non-proportional
basis, the cover is arranged in layers. Thus the reinsured will be liable
for the first £x of any claim by the assured, and the reinsurers will be
liable for any loss in excess of £x up to the maximum financial limits laid
down by the reinsurance agreement.
It is usual for a facultative reinsurance contract to be written on
the same terms as the direct policy, so that the cover under the
two contracts is exactly matching. However, there may be agreed
variations. A facultative policy will also provide for the intervention of
the reinsurers in settling any claim made by the assured against the
reinsured, in the form of an obligation on the reinsured to co-operate
with the reinsurers or – in some cases, particularly where the reinsurers
have accepted a substantial proportion of the risk – in the form of
authorising the reinsurers to take over any negotiations with the
assured.
2.3 Treaty reinsurance

Treaties may be proportional or non-proportional, and they may also
be obligatory or non-obligatory. The essence of a treaty is that the
reinsured obtains cover for all losses or policies of a given class (e.g.
product liability or marine losses) or even for its ‘whole account’ (i.e. all
losses whatever their source).
There are two important types of proportional treaty:
• quota share
• surplus.
Under a quota share treaty the reinsured cedes to the reinsurers a fixed
percentage of every risk falling within the scope of the treaty.
The percentage agreed will depend upon the amount of risk that the
reinsured wishes to retain for its own account. There will be financial
limits on the reinsurance, so that the reinsurers’ losses may be capped
at a given figure. By way of example, the treaty may specify that in
the event of any loss, the reinsured and the reinsurers will bear the
loss in the proportions 40 per cent to the reinsured and 60 per cent to
10
the quota share reinsurers, but the reinsurers’ liability is not to exceed
£200,000 in respect of any one risk. The premium is allocated between
the parties in accordance with their agreed proportions of the risk
(minus ceding commission and brokerage). Under a surplus treaty,
a deductible expressed in monetary terms is fixed and the reinsured
bears 100 per cent of the losses falling within the deductible. Any loss
exceeding the deductible is then divided between the reinsured and
the reinsurers in an agreed percentage proportion. The deductible is
generally calculated as a percentage of the total sum reinsured
There are two important types of non-proportional treaty:
• excess of loss
• stop loss.
An excess of loss treaty operates in much the same way as an insurance
contract. The reinsured is required to bear a deductible in respect
of any loss, and the reinsurers are liable for sums exceeding the
deductible up to the limits covered by the policy. Thus the reinsured
may bear the first £1,000,000 and the reinsurers are then liable for any
loss over £1,000,000 up to a maximum limit of £10,000,000. An excess
of loss treaty covers ‘loss’, and there is generally a definition of loss as
meaning all losses arising from ‘any one event’ or ‘any one occurrence’.
This wording allows the reinsured to add together a large number of
individual losses which individually are not large enough to exceed the
deductible but in the aggregate do exceed the deductible. The words
‘event’ and ‘occurrence’ are generally regarded as interchangeable, and
refer to something which happens at a particular time, at a particular
place and in a particular way as opposed to a state of affairs. Thus,
if an underwriter at Lloyd’s has a ‘blind spot’ in respect of writing
business, and enters into a series of contracts which prove disastrous
to the investors in the underwriter’s syndicate and actions are brought
against him for negligence, his blind spot is a state of affairs rather than
an ‘event’ and accordingly, each contract negligently underwritten
by him is to be treated as the event. That means that the underwriter
cannot add together the claims made against him and treat them as
a single event for the purpose of showing that he has suffered a loss
in excess of the deductible (see Caudle v Sharp [1995] LRLR 433). By
contrast, it is possible to regard the seizure of an airfield as a single
‘event’ so that all of the aircraft on the ground at the time are to be
treated as lost by means of that seizure (Kuwait Airways Corporation v
Kuwait Insurance Co SAK [1996] 1 Lloyd’s Rep 664). By contrast, if the
treaty allows the aggregation of losses arising from a single ‘cause’
or ‘originating cause’, that wording is appropriate to cover all losses
arising from a state of affairs such as a propensity of an assured to
act negligently (Cox v Bankside Members Agency [1995] 2 Lloyd’s Rep
437). A stop-loss treaty is designed to protect the reinsured against
insolvency, and provides cover for the reinsured’s losses when they
reach a given figure.
There is an important distinction between obligatory and non-
obligatory treaties. Under an obligatory treaty, any risks accepted
by the reinsured are automatically ceded to the reinsurance, and
the reinsurers are simply told of cessions by means of period reports
(known as ‘bordereaux’). No discretion is involved on either side. If the
11
reinsured has failed to inform the reinsurers of a cession, that default

does not prevent the risk attaching, and reinsurers cannot rely upon
breach of the notification provision as a defence to a claim involving
that risk (see Glencore International AG v Ryan, The Beursgracht [2002]
Lloyd’s Rep IR 574, where the point arose under an insurance policy in
similar ‘declaration’ form). Under a non-obligatory treaty, the reinsured
does not have to cede any accepted risk but may simply offer it to
the reinsurers, and the reinsurers for their part may refuse any risk
proffered to them: in this situation the treaty operates more as a
facility or machinery for channelling risks to the reinsurers, and each
risk accepted is treated as a separate contract of reinsurance. The vast
majority of treaties are obligatory. There is an intermediate possibility
of a ‘facultative-obligatory’ treaty under which the reinsured is free to
choose which risks to declare to the reinsurers but once the reinsured
has chosen to declare a risk it will automatically attach to the treaty.
This type of arrangement allows ‘cherry-picking’ by the reinsured, and
means that the reinsurers do not receive a balanced portfolio of good
and bad risks: for the latter reason, facultative-obligatory treaties are
rarely written these days.
Although the distinction between obligatory, non-obligatory and
facultative-obligatory treaties is crucial, the parties do not always
themselves make it clear what type of contract is involved and the
court has to ascertain what is intended from the surrounding terms
and conditions. In Hanwha Non-Life Insurance Co Ltd v Alba Pte Ltd
[2011] SGHC 271 the claimant insurers agreed to insure a series of
construction risks and obtained reinsurance from the defendants.
The reinsurance was stated to be ‘facultative’ and provided that
construction projects would be declared monthly for a premium of
13% of the value. It was the practice of the parties that risks would be
declared monthly in arrears and that the premium would be payable
at the same time. A dispute arose as to an extension of a risk accepted
by the insurers on 19 November 2007, and this was declared to the
reinsurers on 14 December 2007. Unknown to the parties, a fire had
occurred a few hours before the declaration. The reinsurers did not
initially deny liability but appointed their own loss adjusters on
28 January 2008, and on 1 February 2008 accepted the reinsurance
premium for the extended cover. At that point the reinsurers argued
that the treaty was facultative and that they had a right to decline the
declaration. The High Court of Singapore, dismissing this defence ruled
that the contract was an obligatory open cover under which any risk
accepted by the insurers was automatically ceded to the reinsurance,
so that the risk attached to the reinsurance irrespective of the making
of a declaration or the payment of any premium. Although the contract
was stated to be ‘facultative’, its true nature – given the declarations
in arrears and the fixed premium – was obligatory, and no further
underwriting was required at declaration stage. The court further ruled
that the risk fell within the scope of the reinsurance treaty and that,
even if the treaty was facultative, the reinsurers had by their post-loss
conduct in appointing adjusters and accepting the premium, accepted
the declaration.
12
2.4 Relationship between assured, insurer and reinsurers

The relationship between the reinsured and the reinsurers varies as
between the different forms of reinsurance contract. Where the policy
is proportional, there is plainly a close relationship between the parties,
the cover is co-extensive and it is in their interests to act together. By
contrast, if the contract is non-proportional, the parties are at arm’s-
length and there is no necessary relationship between the terms of the
insurance and of the reinsurance.
English law treats the contract of insurance between the assured and
the insurer, and the contract of reinsurance between the insurer and the
reinsurers, as entirely separate. There is no privity of contract between
the assured and the reinsurers, so that if the reinsured becomes
insolvent the assured cannot bring a direct action against the reinsurers.
It was held in Re Norwich Equitable Fire Assurance Society (1887) 57 LT
241 that a quota share treaty did not create a partnership between the
reinsured and the reinsurers even though they shared the risk in agreed
proportions. Similarly, a fronting arrangement cannot be regarded as a
direct contract between the assured and the reinsurers even though the
reinsured’s role is purely nominal: in Grecoair Ltd v Tilling [2005] Lloyd’s
Rep IR 151 the court rejected the suggestion that the reinsured acted
as the agent of the assured in this form of arrangement. A reinsurance
agreement is not expressed as for the benefit of the assured, so that the
assured cannot argue that it has a direct claim against the reinsurers
under the Contracts (Rights of Third Parties) Act 1999 (which abolished
the doctrine of privity in England). There may be some situations in
which the reinsurers, following a loss, undertake direct negotiations
with the assured, possibly to the exclusion of the reinsured: in Grecoair
Ltd v Tilling [2005] Lloyd’s Rep IR 151 it was held that the reinsurers did
not expose themselves to personal liability by acting in this way.
The most important situation in which this question will arise is
where the reinsured has become insolvent and cannot pay claims.
The insolvency of a reinsured does not as a matter of English law give
the assured a direct claim against the reinsurers: the legislation which
allows the victim of an insolvent assured to bring a claim against the
assured’s liability insurers – the Third Parties (Rights Against Insurers)
Act 1930 (to be replaced by a more modern version passed in 2010
but which is not yet in force), does not extend to reinsurance. Some
contracts, particularly those written in the US, contain ‘cut-through’
clauses which allow the assured to sue the reinsurers in the event of
the reinsured’s insolvency. Such a clause would in principle allow the
assured to sue the reinsurers despite the absence of privity of contract,
under the Contracts (Rights of Third Parties) Act 1999, which is triggered
where a contract term is stated to be for the third party’s (assured’s)
benefit. However, it is unlikely that English insolvency law would
allow a claim to be made: giving the assured what is in effect a priority
claim against the reinsured’s assets (its reinsurance recovery) is almost
certainly an infringement of the pari passu rule which requires the equal
treatment of unsecured creditors; and it may also be that a cut-through
clause represents a charge on the reinsured’s assets which requires
registration as a company charge under the Companies Act 2006 (which
in practice never happens).
13
Reminder of learning outcomes

• define a contract of reinsurance
• explain the difference between the main forms of reinsurance
• identify the features of the various types of reinsurance
• discuss the relationship between the assured, the reinsured and the reinsurers.
Chapter 2 Self-assessment questions

1. What are the main classes of reinsurance agreements?
2. What are the differences between treaty reinsurance and facultative
reinsurance?
3. In what circumstances can a direct assured bring proceedings against the
reinsurers for direct payment?
14
Chapter 3 Regulation of reinsurance business
Introduction
This chapter analyses the way in which reinsurance contracts are
regulated. There is now a European Union-wide regime for the
regulation of reinsurers, concerned primarily with their solvency rather
than with the terms into which their contracts are entered upon.
Learning outcomes
• describe how reinsurers are regulated within the European Union
• identify the most significant regulatory matters in the UK system
• discuss the rules relating to insurable interest and how they relate to
reinsurance contracts.
Essential reading
• European Parliament and Council Directive 2002/92/EC, the Insurance
Mediation Directive.
• European Parliament and Council Directive 2005/68/EC, the Reinsurance
Directive.
• Attorney General v Forsikringsaktieselskabet National [1925] AC 639.
• Dunlop Haywards (DHL) Ltd v Barbon Insurance Group Ltd [2009] EWHC 2900
(Comm).
• Re NRG Victory Insurance [1995] 1 All ER 533.
• Sphere Drake Insurance Ltd v Euro International Underwriting Ltd [2003]
Lloyd’s Rep IR 525.
3.1 Reinsurance as insurance

A working definition of insurance is:
an agreement to confer upon the insured a contractual right
which, prima facie, comes into existence immediately when loss
is suffered by the happening of an event insured against, to be
put by the insurer into the same position in which the insured
would have been had the event not occurred …
(Callaghan v Dominion Insurance [1997] 2 Lloyd’s Rep 541). Reinsurance
is clearly within this definition, and it is now accepted without
argument that reinsurance is a form of insurance. Many of the decided
cases which apply insurance principles are in fact decisions on
reinsurance agreements, and no distinction has been made. Many of
the leading authorities on insurance law are reinsurance cases. These
include:
• Feasey v Sun Life Assurance Co of Canada [2002] Lloyd’s Rep IR 807
(insurable interest)
• Pan Atlantic Insurance Co v Pine Top Insurance Co [1995] 1 AC 501
(utmost good faith)
• BP Ltd v Aon [2006] Lloyd’s Rep IR 577 (duties of brokers).
15
There is, however, a technical distinction between facultative contracts

and reinsurance treaties. A facultative contract plainly resembles an
ordinary contract of insurance, in that it is a single cover in respect of
a single risk. A treaty, by contrast, covers a series of risks, which are
sometimes related and sometimes unrelated, and under an obligatory
treaty the insurers have no right to refuse any risks which are accepted
by the reinsured and thereby declared to the treaty. In the case of an
obligatory treaty, therefore, the risk is in effect accepted when the
reinsurers agree to be bound by the treaty, even though at that time
there may be no underlying policies in existence. For that reason it is
perhaps more accurate to describe an obligatory treaty as a contract
for insurance rather than a contract of insurance. In the case of a
non-obligatory treaty the same terminology is preferable, because the
treaty itself does not of itself offer reinsurance but merely provides a
mechanism under which applications for reinsurance can be made
by the reinsured and considered by the reinsurers: each individual
accepted declaration is a contract of insurance in its own right.
Reinsurance treaties are not, therefore, strictly speaking, contracts
of insurance at all, but nevertheless the ordinary rules applicable to
insurance contracts extend to treaties (with minor modifications on the
question of disclosure, discussed in Chapter 5).
3.2 The Reinsurance Directive

The regulation of insurance business in the United Kingdom can be
traced back to the Life Assurance Act 1870, which introduced a deposit
system under which insurers guaranteed their solvency by depositing
sums of money with the Board of Trade. The next century or so saw
increasing regulation of insurers, often immediately following a high-
profile insolvency, and by the time the Insurance Companies Act 1982
was passed there was a complex legislative structure which applied
to all insurers. That Act required an insurer to seek authorisation to
carry on insurance business: insurance was divided into a number of
general classes (e.g. motor, marine, property) and long-term classes
(e.g. life, pensions) and authorisation had to be sought by an insurer
for each class of business to be written. Starting in 1973, the European
Community began to develop its own programme for the regulation of
insurers, in the form of a series of non-life and life directives and as that
programme developed over the following two decades English law was
adapted to take account of the requirements of the various European
Community Directives. In 2000, the earlier English legislation was
repealed and replaced by the Financial Services and Markets Act 2000,
which both consolidated and expanded the earlier law. In general
terms, the 2000 Act:
• requires class by class authorisation of any insurance company
• requires insurers to adhere to minimum standards of marketing and
disclosure when selling insurance; and
• regulates mergers between insurance companies.
An insurer which is established and authorised in its home state is
thereby given a single licence to establish branches, or sell insurance
directly, in all other Member States with minimal regulatory control
16
from the host. The 2000 Act is administered by the Financial

Services Authority (FSA), and the general provisions of the Act are
supplemented by a detailed set of rules contained in the Handbook
published by the FSA, published online at:
www.fsa.gov.uk/pages/handbook/.
While there was an accepted need to protect policyholders against
the insolvency of insurers, the early regulators did not regard
control of the solvency of reinsurers as a matter of concern, because
reinsurers did not deal with the public. However, in Attorney General
v Forsikringsaktieselskabet National [1925] AC 639 the House of Lords
held that reinsurance business constituted insurance business for
regulatory purposes, so that the reinsurance activities of insurers did
fall to be regulated in the same was as their insurance activities. What
was unclear was exactly what sort of authorisation was required: was
reinsurance a form of liability cover which simply required the reinsurer
to be authorised to carry on liability insurance, or was reinsurance a
further contract on the original subject matter so that the reinsurer
had to be authorised to carry on insurance business of every class
reinsured? After earlier conflicting authority, the point was clarified
in Re NRG Victory Insurance [1995] 1 All ER 533, where it was held (in a
decision under the Insurance Companies Act 1982) that the transfer of
a life reinsurance portfolio from one reinsurer to another fell within the
controls for the transfer of insurance business, and that the legislation
applied to the reinsurance as if it was direct insurance. It followed that
the rules regulating the transfer of life insurance business, which were
more stringent than the rules applicable to the transfer of general
business, governed the case. The outcome was that the UK regulatory
authorities treated companies carrying on reinsurance business
in much the same way as companies carrying on direct insurance
business. Moreover, as reinsurance became increasingly important,
it became apparent that an insurer whose reinsurance arrangements
were inadequate was at risk of financial failure. For that reason, the
regulatory structure was modified to require an insurer to prove, as
part of its submission for authorisation and in respect of its continuing
solvency, that it had sufficient reinsurance in place. So, by the time of
the passing of 2000 Act, reinsurance business was regulated in the
same way as insurance business, and an insurer’s reinsurance formed
a significant part of its own assets for the purpose of assessing its
solvency.
The position in the UK was not, however, replicated throughout the
European Community. The Directives applied to companies which
carried on both insurance and reinsurance businesses, but they did
not apply to ‘pure’ reinsurers (i.e. those companies who carried on
reinsurance business only). As a result, the law varied as between
Member States of the European Commission: some, such as the UK,
regulated both mixed companies and pure reinsurers in much the
same way as insurance companies; some regulated pure reinsurers in
a modified and lighter way and some did not regulate pure reinsurers
at all. The position in the European Community was ultimately
harmonised by the Reinsurance Directive, European Parliament and
Council Directive 2005/68/EC, which extended regulation to pure
reinsurers: this was regarded as of great benefit to the UK, as it required
17
other Member States to regulate their pure reinsurers up to UK

standards.
The Reinsurance Directive, which is available online at
http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2005:323
:0001:0001:EN:PDF, is a long and complex document. The Reinsurance
Directive, as implemented in the UK, requires any reinsurer with
its head office in the UK to be authorised by the Financial Services
Authority to carry on reinsurance business. An authorised reinsurer
is given the right to carry on its business in every other EC Member
State, and is subject only to home state control rather than control
by the state in which it is carrying on business. The most important
elements of the Directive relate to solvency, and require a reinsurer
to establish and maintain a solvency margin under which assets
exceed liabilities (each of these terms being defined by reference to
detailed accounting criteria). A reinsurer’s home state regulatory is
empowered to intervene in the operations of a reinsurer if it fails to
meet its solvency obligations, either by instructing it to put in place a
three-year plan to restore the position or, ultimately to withdraw the
reinsurer’s authorisation. A key feature of the Reinsurance Directive is
its extension to two particular forms of alternative risk transfer, namely,
‘finite reinsurance’ and ‘special purpose vehicles’. Finite reinsurance is
a mechanism under which the reinsured’s losses are spread over the
period of reinsurance, and there may be little or no underwriting risk
transferred to the reinsurers: a good explanation of the operation of
finite reinsurance is to be found at www.investopedia.com/terms/f/
finitereinsurance.asp. Special purpose vehicles are used to effect
the securitisation of debt by the use of catastrophe bonds: for an
explanation, see www.investopedia.com/terms/c/catastrophebond.asp.
The Reinsurance Directive authorises Member States to regulate finite
reinsurance and requires them to authorise special purpose vehicles as
if they were reinsurance companies,
The Reinsurance Directive has not had a great effect on the UK
position, as pure reinsurers were regulated beforehand. Minor changes
were made to English law as a result. These included minor changes
to the rules on the transfer of insurance business so as to encompass
reinsurance, the extension of regulation to reinsurance special purpose
vehicles and the addition of reporting controls on finite reinsurance.
It should be noted that the current regulatory regime for insurance and
reinsurance will be replaced with effect from October 2012 by what has
become known as the ‘Solvency 2’ Directive, European Parliament and
Council Directive 2009/138/EC, available online at
http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2009:335:0
001:01:EN:HTML
3.3 Reinsurance intermediaries

Various classes of insurance intermediary are involved in the
reinsurance market. A reinsured who wishes to place an outwards
reinsurance risk will approach a broker (known as a ‘producing broker’,
because he produces the risk) to act for him in that regard. The broker
is the agent of the reinsured for this purpose, and it is his role to seek
18
reinsurance cover from one or more reinsurance underwriters. Very

often the producing broker is unable to carry out these instructions
himself for example because he is operating outside the UK and does
not have direct access to the London market, and the producing broker
will appoint a sub-broker to carry out the task for him (known as a
‘placing broker’, because he actually places the risk). Once the risk has
been placed, the broker owes duties to the reinsured to give advice
when requested and to provide assistance in the event that a claim
arises under the reinsurance agreement. A placing broker does not
usually have any contractual arrangement with the reinsured, and does
not owe any duty of care to the reinsured: if, therefore, the reinsured’s
instructions are not adhered to by reason of the default of either or
both of the producing and placing brokers, so that the reinsured does
not have the cover which it had sought, the reinsured will have a
remedy against the producing broker for breach of contract or in tort,
and the producing broker is then entitled to contribution or indemnity
from the placing broker based upon their respective degrees of fault
for the reinsured’s loss (Dunlop Haywards (DHL) Ltd v Barbon Insurance
Group Ltd [2009] EWHC 2900 (Comm)).
Although brokers are the most important class of intermediary
operating in the reinsurance market, reinsurers may themselves
appoint agents to assist with the underwriting process. Reinsurers
may form themselves into ‘pools’, formed for the purpose of offering
reinsurance of specified classes of risks on a collective basis. Pools are
managed by underwriting agents, appointed by the pool members
to: (a) accept risks presented by brokers; and (b) arrange outwards
retrocession. There has been much litigation involving pools in recent
years, in virtually every case stemming from fraudulent conduct on
the part of the underwriting agent. The cases make it clear that an
underwriting agent owes fiduciary duties to the pool members as well
as duties of care in deciding which risks should be accepted by it on
behalf of the pool (see, for example, Sphere Drake Insurance Ltd v Euro
International Underwriting Ltd [2003] Lloyd’s Rep IR 525).
The regulation of intermediaries in the United Kingdom is a recent
development. Until 1977 there was no regulation at all. The Insurance
Brokers (Registration) Act 1977 introduced a self-regulatory structure
under which any intermediary who described himself as a broker was
required to register with the Insurance Brokers Registration Council
and to adhere to its various codes of conduct. This was very much a
consumer protection measure which did not extend to reinsurance,
and was repealed in 2000 and replaced with voluntary self-regulation.
This was destined to be short-lived: not only was it a failure but in
2002 the European Community adopted the Insurance Mediation
Directive, European Parliament and Council Directive 2002/92/EC,
which required Member States to introduce measures laying down
minimum qualifications, experience and compulsory insurance
requirements for insurance intermediaries. Any intermediary must be
authorised to carry on intermediary business by its home Member
State regulator and, in accordance with European Community single
market principles, an intermediary so authorised has the right to
form branches and otherwise to carry on its activities anywhere in
the European Community with little or no control by host Member
19
States. The Directive applies to reinsurance intermediaries, although

the obligations on them are less onerous, reflecting the fact that their
clients are more sophisticated than those of insurance brokers.
The Mediation Directive has been implemented in the UK by
modifications to the FSA Handbook, and there is a special section of
the Handbook devoted to brokers: http://fsahandbook.info/FSA/html/
tailored-GIBRKR. The activities regulated by the FSA include arranging
and concluding insurance contracts, providing advice on insurance
contracts, assisting in the performance of insurance contracts,
and claims handling. The controls extend both to reinsurance
intermediaries, and also to underwriting agents, who carry on business
in the United Kingdom.
Learning outcomes
• describe how reinsurers are regulated within the European Union
• identify the most significant regulatory matters in the UK system
• discuss the rules relating to insurable interest and how they relate to
reinsurance contracts.

1. How are reinsurers regulated in the European Union?
2. How are reinsurance intermediaries regulated in the European Union?
20
Chapter 4 Formation and insurable interest
Introduction
This chapter analyses the essential elements of the formation of a
contract of reinsurance. It considers the special procedures which are
adopted in the market, the role of brokers and slips, and also looks at
the legal requirement for insurable interest.
Learning outcomes
• describe the formation procedure for a contract of reinsurance
• describe the various documents that are used in that procedure, in particular,
slips and slip policies
• outline the features of the various types of reinsurance.
Essential reading
• Allianz Insurance Co Egypt v Aigaion Insurance Co SA (No 2) [2008] EWCA Civ
1455.
• Crane v Hannover Ruckversicherungs AG [2008] EWHC 3165 (Comm).
• Dalby v India & London Life Assurance (1854) 15 CB 364.
• Feasey v Sun Life Assurance of Canada [2002] EWCA Civ 885.
• General Accident Fire and Life Assurance v Tanter, The Zephyr [1985] 2 Lloyd’s
Rep 529.
• General Reinsurance Corporation v Forsikringstiebolaget Fennia Patria [1983]
2 Lloyd’s Rep 287.
• HIH Casualty and General Insurance Co v New Hampshire Insurance Co [2001]
• Roar Marine v Bimeh Iran Insurance [1998] 1 Lloyd’s Rep 423.
• Wasa International Insurance Co v Lexington Insurance Co [2009] UKHL 40
www.lawcom.gov.uk/docs/issues4_paper.pdf.
Further reading
• Brotherton v Aseguradora Colseguros (No 2) [2003] Lloyd’s Rep IR 762.
• Unum Life Insurance Co of America v Israel Phoenix Assurance Co Ltd [2002]
4.1 Formation procedures

Insurance contracts, as with all other contracts, are completed by
means of offer and acceptance. It is not always easy, however, to
identify the point at which offer and acceptance coincide in the
reinsurance context.
4.1.1 Slip procedure

Reinsurance contracts are generally subscribed to by a number of
different reinsurers (often a combination of insurance companies and
Lloyd’s Syndicates), each accepting liability for an agreed percentage
of the risk. The London Market has developed and for centuries used
a mechanism for risk placement which facilitates this form of multiple
21
subscription. The standard procedure for placing reinsurance risks in the

London market has, until recently, been by means of a ‘slip’, although in
July 2007 a gradual phasing out of the slip procedure has been put in
place, and the slip has for the most part disappeared from the London
market. The slip procedure is nevertheless described in what follows,
both compare it with the new procedure and also because disputes will
arise under the old procedure for some years to come.
The slip is a document prepared by the broker (who is, for this purpose,
the agent of the reinsured) setting out the risk for which reinsurance is
being sought and the basic terms of the contract. The slip is in the form
of an offer. The broker presents the slip to underwriters in the market,
and any underwriter who wishes to accept a part of the risk stamps and
signs the slip on behalf of his syndicate or company, a process known
as ‘scratching’. The effect of a scratch to the slip is to create a binding
contract between the reinsured and the reinsurer for the agreed
proportion of the risk. The broker will (in London, physically) take the
slip to potential participants until the necessary level of participation
has been agreed. Thereafter formal policy wording will be issued. More
is said about the content of a reinsurance contract in Chapter 6.
Once a slip has been scratched, a formal policy wording will be issued.
The policy wording was at one time prepared by the Lloyd’s Policy
Signing Office, but since 2001 the function has been outsourced
to Xchanging (see www.lloyds.com/The-Market/I-am-a/Other/
Committees-,-a-,-associations/XISXCS). There is nevertheless a risk that
the policy wording ultimately issued and the content of the slip are
at variance. At one time there was a view in the cases that the policy
superseded the slip and that the latter ceased to have any function.
However, the judgment of Rix LJ in HIH Casualty and General Insurance
Co v New Hampshire Insurance Co [2001] Lloyd’s Rep IR 596 rejected
that analysis. This case concerned the reinsurance of a ‘film finance’
risk. The reinsured issued insurance cover to various investors in a film
production company, the policy indemnifying the investors for any
shortfall between the amount of the loan and the amount of revenues
derived from the films made by the production company. Reinsurance
was issued on the same terms. The question in this case was whether
a provision in the reinsurance slip under which the investors had
stated that a specified number of films would be made was a part of
the policy when the policy itself made no reference to the number of
films. The statement ultimately proved to be over-optimistic thereby
leading to a significant shortfall in revenue. The reinsured asserted
that the policy had superseded the slip so that there was nothing
in the agreement between the parties that required the stated
number of films to be made. Rix LJ, giving the leading judgment in
the Court of Appeal, held that there was no hard and fast rule on the
relationship between the slip and the policy, and that all depended
upon the intentions of the parties. If the parties intended the slip to
be superseded, then that was the case and it could be disregarded.
By contrast, if the parties intended the two documents to be read
together, then the slip could be used to fill gaps in the policy and also
act as an aid to the interpretation of the policy. On the facts it was held
that the parties intended the two documents to be read together,
given that there were several terms in the slip which had not been
22
incorporated into the policy, so that the reinsurance did impose a

condition that the specified number of films would be made.
4.1.2 London Market principles

The main problem with the slip procedure was that it provided no
incentive for policy wordings to be issued at all. The production
of a policy wording was frequently delayed, and in many cases no
policy wording was ever issued at all. Facultative reinsurances were
commonly made only by slips, designated a slips policy which stated
that no further wording was to be issued. This gave rise to a great
deal of uncertainty as to the terms of contracting. In 2002 a voluntary
scheme, London Market Principles, was put into place, the purpose of
which was to ensure that proper wordings were issued. LMP was not,
however, a success, and was largely disregarded. In 2006 the regulator
of the industry, the Financial Services Authority, stated that unless
the market adopted binding reforms then steps would be taken by
the FSA itself to impose them. That threat had the desired effect and,
with effect from June 2007, the Market Reform Contract came into
existence. The nature and content of the Market Reform Contract can
be found on at www.londonmarketgroup.co.uk/.
4.1.3 Market Reform Contract

Under the MRC procedure, the word ‘slip’ is no longer used, although
in practice a document looking suspiciously like a slip is still used.
In outline, the broker now presents a summary of a proposal for
insurance, with draft wording appended to it. Those documents are
then taken round the market by the broker in exactly the same way
as used to occur with the slip, and those willing to subscribe to the
risk scratch the documents as before. Subsequently, a formal policy
wording will be issued. All of this is done face to face, although it may
be that this may change in the future, with reports that brokers are
trialling the use of iPads: www.guardian.co.uk/business/2010/sep/28/
lloyds-london-insurers-trial-ipad.
The creation of a contract of reinsurance by scratching of the
documents presented to the underwriter is the general rule, but there
may be exceptions. The test in every case is whether the reinsured
and the reinsurers have reached agreement. A slip or other document
may be expressed in a manner which makes it clear that it is not an
offer but has the more limited function of obtaining quotations from
underwriters (a quotation), and equally a document which is expressed
to be an offer may be scratched provisionally or with qualifications. It is
equally possible that the parties have reached agreement in advance
of the presentation, so that the documents scratched merely confirm
that agreement. This was found to be the case in Allianz Insurance Co
Egypt v Aigaion Insurance Co SA (No 2) [2008] EWCA Civ 1455, in which
the reinsured’s broker forwarded a marine reinsurance slip to the
reinsurers at their request. The slip by oversight omitted a classification
warranty which the parties had intended to include. The reinsurers did
not notice the omission and replied ‘Cover is bound with effect from
31.03.05 as we had quoted …’ The Court of Appeal held that a binding
agreement had been reached when the reinsurers chose to respond
accepting the terms of the slip, and there was no need for formal
23
scratching. Accordingly, there was a binding contract on the terms

stated in the slip. A very similar situation arose in Crane v Hannover
Ruckversicherungs AG [2008] EWHC 3165 (Comm).
One of the characteristics of the London Market Procedure is the
manner in which the slip, and now the MRC, process leads to a series
of individual contracts being formed when the offer is scratched by
individual underwriters. This means that each subscribing underwriter
is owed a separate duty of disclosure (see Chapter 5). Further, if there
is an amendment to the documents on their journey round the
market, those who have subscribed before amendment are bound on
the original terms whereas subsequent subscribers have the benefit
of the amendment. This is demonstrated by General Reinsurance
Corporation v Forsikringstiebolaget Fennia Patria [1983] 2 Lloyd’s Rep
287. Here, the defendant reinsurer reinsured a marine risk under two
separate policies, a whole account cover and a specific risks cover.
The reinsured was dissatisfied with the financial allocation between
the two policies, and instructed its brokers to amend the specific risks
cover by allocating a greater proportion of loss to the whole account
reinsurers. The brokers prepared an amendment slip for scratching by
the 28 reinsurers who had subscribed to the original slip. Two of them
scratched the amendment slip, but at that point there was a loss and
the reinsured instructed the broker to withdraw the amendment slip.
The Court of Appeal held that the two reinsurers who had scratched
the amendment slip were entitled to rely upon the new terms even
though the remaining 28 underwriters remained bound by the old
terms. The case thus shows that it is not open to the reinsured to
withdraw or modify a slip so as to alter the rights of underwriters who
have already subscribed to it. There is only one situation in which a
subscription to a slip can be altered unilaterally, and that is where
the broker has obtained more than 100 per cent subscription: the
custom and practice of the market allows the broker to reduce the
subscriptions proportionately so that the amount of cover is no more
than that required by the reinsured. Indeed, it is common for a broker
to seek oversubscription and then to ‘write down’ proportionately the
contributions of subscribers. As is shown by General Accident Fire and
Life Assurance v Tanter, The Zephyr [1985] 2 Lloyd’s Rep 529, the facts
of which are given below, insurers may be given a ‘signing indication’
by the broker, informing them of the likely level of oversubscription
so that they are able to base their own scratching decision on the
possibility of later reduction.
The multiple subscription procedure has two procedural drawbacks.
The first is that there may be some delay in the broker obtaining the
necessary amount of subscriptions from the market. The second is that,
once the risk is fully subscribed, each reinsurer has a separate contract
with the reinsured, and any issues that arise post-contractually have to
be negotiated with each of them. Each of these drawbacks is addressed
by market arrangements. As to placement, there are various agency
arrangements in place in the market (including reinsurance pools)
whereby one underwriter is authorised by others to write risks on their
behalf under a facility known as a ‘line slip’. The Wikipedia definition of
‘line slip’, in http://actuarialwiki.org/index.php?title=Line_slip, is:
24
A facility under which the underwriters delegate authority to

accept a pre-determined share of certain coinsured risks on
their behalf. The authority may be exercised by the leading
underwriter on behalf of the following underwriters; or it may
extend to the broker or some other agent being authorised to
act for all the underwriters.
This system is still in use despite the introduction of the MRC. As to
post-contractual issues, the modern practice of the London market
is for various functions to be delegated to a ‘leading underwriter’.
The introduction of the MRC has enhanced the role of the leading
underwriter. Exactly what is delegated depends upon the wording
adopted, but it is common to authorise the leading underwriter to act
on behalf of the entire market in respect of agreeing to modifications
to the risk and receiving notification of losses. Some clauses empower
the leading underwriter to settle claims on behalf all subscribers, in
which case any settlement agreed by the leader is binding as long as
it was made in good faith (Roar Marine v Bimeh Iran Insurance [1998] 1
Lloyd’s Rep 423). Although the point is not finally resolved, it is thought
that the leading underwriter acts as the agent of the following market,
which means that there is a duty of care owed by him to the others. The
ability of the leading underwriter is revoked if the policy is avoided, and
it was thus held in Unum Life Insurance Co of America v Israel Phoenix
Assurance Co Ltd [2002] Lloyd’s Rep IR 374 that the leading underwriter
could not, after avoidance, bind the rest of the underwriters to an
agreement with the reinsured to arbitrate their outstanding disputes.
4.2 Reinsurance in advance of insurance

It was commented in Chapter 2 that the definition of reinsurance in
Delver v Barnes (1807) 1 Taunt 48 as ‘… a new assurance effected by
a new policy on the same risk which was before insured …’ does not
reflect market practice. Insurers insist upon the security of reinsurance
as a condition for accepting an underlying risk. Much insurance
business will be automatically reinsured under treaties when it is
accepted. Larger risks and risks falling outside treaty protection will be
reinsured under facultative arrangements. A broker who is requested
to place a direct risk is likely to look for reinsurance at the same time
as insurance: underwriters who are approached to write the direct
risk may request reinsurance, and others may agree to act only as
reinsurers and not insurers. In fronting arrangements, the identity of
the fronting insurer may be the last thing to be put into place. The
broker may choose to arrange for a reinsurance slip to be scratched
by willing reinsurers, and the broker is then able to present both the
risk and also reinsurance coverage relating to it to potential direct
underwriters. The cases show that the correct legal analysis is that a
reinsurance slip scratched in advance of the insurance slip to which
it relates amounts to a standing offer to potential insurers, and that
any insurer who scratches the insurance slip thereby automatically
accepts the offer of reinsurance cover. A scratching to a reinsurance slip
cannot, therefore, be withdrawn by a reinsurer once the direct slip has
itself been fully subscribed. The leading authority on this point, which
has been followed on a number of occasions, is The Zephyr [1985]
25
2 Lloyd’s Rep 529. Here, a broker was instructed to place insurance

on a vessel, and prepare a reinsurance slip which was submitted to
three reinsurers. It was scratched by the first of them on the basis of
an express undertaking, in the form of a signing indication by the
broker, that it was likely to be oversubscribed and that the percentage
accepted by the reinsurer was likely to be reduced by a significant
proportion. Two other reinsurers scratched the slip on the assumption
that a signing indication had been given, although nothing was said
them about the possibility of their agreed proportions being written
down. Following the scratching of the reinsurance slip, an insurance
slip was submitted to the market and was fully subscribed. In the event
the broker reinsurance slip was not fully subscribed, with the result that
the reinsurers found themselves facing a greater percentage of liability
than they had intended. It was held by the Court of Appeal that:
(1) the reinsurance slip was a standing offer by the reinsurers
to the insurers, and this had been accepted when they
scratched the insurance slip
(2) the broker was liable to the first reinsurer for breach of
an implied contractual promise that he would use best
endeavours to meet the promise made in the signing
indication; and
(3) the broker was not liable to the second and third reinsurers,
because he had not made any express promise to them.
The Court of Appeal did not address the thorny problem of the broker’s
position as agent when seeking reinsurance: plainly he could not have
been acting as agent for the assured, because the assured’s instructions
were to obtain insurance, not reinsurance; and he could not have been
acting as agent for the insurers because they had not been identified at
the date the reinsurance slip was scratched. Nevertheless, the general
assumption is that the broker acts as agent for the insurers, so that
any false statement by him which is material to the risk itself will give
the reinsurers the right to avoid the slip as against the reinsured (see
Chapter 5 for the duty of utmost good faith).
4.3 Rules relating to insurable interest

One of the characterising features of a contract of insurance is the
requirement that the assured possesses some form – usually pecuniary
– of insurable interest in the subject matter insured. One reason for
this is to distinguish insurance from gambling: if the policyholder has
no interest in the insured subject matter, then he is clearly gambling
when he pays a premium in return for the possibility of a claim if the
subject matter is destroyed. A further reason is the risk of deliberate
destruction of the subject matter by a person who has no interest in
the subject matter, as the assured’s desire is to ensure that there is
indeed a loss in respect of which a claim can be made. It may be that
these justifications are overstated. Gambling by insurance is not an
everyday occurrence but requires some degree of sophistication, and
England has in any event relaxed its gambling laws in recent years
by the Gambling Act 2005 (which has important, albeit unintended,
effects on insurance). Deliberate destruction is not rational behaviour
by a person who has no insurable interest but who shortly thereafter
26
makes a claim under a policy, and – that point aside – instances

of deliberate destruction by persons with insurable interest are
commonplace.
The general law on insurable interest is complex, and it suffices here
to summarise the principles. The Marine Insurance Act 1906 contains
special rules which require the assured to possess insurable interest at
the date of the policy and at the date of the loss. The Life Assurance Act
1774, as construed by the courts (Dalby v India & London Life Assurance
(1854) 15 CB 364 – see below) requires the assured to have insurable
interest when the policy is taken out, but not at the date of the death of
the life insured. Other policies have no formal requirements at all, but
interest is required by ordinary principles of indemnity. The position is
as follows:
1. As regards marine insurance, under section 4 of the Marine
Insurance Act 1906, if the insured does not possess an insurable
interest, and has no reasonable expectation of acquiring such an
interest, at the date of the policy, then the policy is void as being
one made by way of gaming or wagering. Further, the assured must
be interested in the subject matter at the date of the loss, failing
which he cannot prove his loss and he is debarred from recovery by
the principle of indemnity (section 6 of the 1906 Act).
2. As regards life insurance, under section 1 of the Life Assurance Act
1774, the policyholder must have an insurable interest in the life
insured at the date the policy is taken out, although there is no
need for the policyholder to retain his interest – the person who
owns the policy is entitled to recover on the life insured’s death
whether or not that person has insurable interest. Any policy made
without interest is illegal, so that premiums paid under it cannot be
recovered by the assured even though no claim is possible.
3. Other policies (e.g. buildings, goods, financial loss) are not governed
by legislation but by common law principles. There is no statutory
requirement for the assured to possess insurable interest at the date
the policy is taken out. At one time there was such a requirement,
imposed by section 18 of the Gambling Act 1845, which rendered
void all contracts made by way of gaming and wagering. However,
that section was repealed by the Gambling Act 2005, which allows
gambling contracts to be enforced. The only remaining requirement
is that imposed by the indemnity principle, namely that the assured
must prove his loss once an insured peril has occurred. The assured
must possess an insurable interest in order to prove that loss.
There is no single definition of ‘insurable interest’ in English law. Section
5(2) of the Marine Insurance Act 1906 provides a non-exhaustive
definition, based on nineteenth century authority, which refers to:
any legal or equitable relation to … any insurable property at
risk … in consequence of which [the assured] may benefit by
the safety or due arrival of the insurable property, or may be
prejudiced by its loss, or damage thereto, or by the detention
thereof, or may incur liability in respect thereof.
Although this definition is the starting point, later cases have expanded
upon it and it has been applied in a variety of different situations.
27
The underlying theme is nevertheless a pecuniary interest. The main

exception is life insurance: the cases recognise that a person has an
insurable interest in their own life and that of their spouse, but in other
family relationships there is a need to prove some form of financial
reliance. The courts have nevertheless in recent times sought to expand
the definition, and in particular they have recognised insurable interest
in order to give effect to commercial relationships and understandings.
By way of example, every sub-contractor working on a site has a
‘pervasive’ insurable interest in the whole works, so that a policy taken
out for the benefit of all sub-contractors covers each of them for the
entire project so that in the event that a sub-contractor negligently
causes a loss the insurers must pay and cannot seek recourse against
him to recover their payment (Deekpak Fertilisers & Petrochemical
Corporation v Davy McKee (London) Ltd [1999] 1 Lloyd’s Rep 387.
The English and Scottish Law Commissions, as a part of their review
of insurance law, published an Issues Paper on insurable interest in
January 2008. This can be found at www.lawcom.gov.uk/docs/issues4_
paper.pdf. The Law Commissions were of the view that, with minor
modifications, the law operates satisfactorily.
Following consultation, the Law Commissions published a Consultation
Paper in December 2011, to be found at http://lawcommission.
justice.gov.uk/docs/cp201_ICL_post_contract_duties.pdf. The Law
Commissions laid down detailed proposals for life and indemnity
insurance. The life proposals were that: the test of insurable interest
should be that of real economic benefit; parents should be entitled
to insure the lives of their children although the amount of any
policy should be capped at, say, £30,000; persons co-habiting should
be recognised as having insurable interest as long as a long-term
relationship can be shown; the formal requirement in s.2 of the Life
Assurance Act 1774 that the names of all interested parties are to
be inserted in the policy should be repealed; and a policy taken
out without interest should be void but no longer illegal. The Law
Commissions have withdrawn their earlier suggestion that a policy
should be valid as long as the life assured consented to it. The non-life
proposals were that: there should be general requirement for insurable
interest at the date of the policy, or at least a real probability that an
interest would be acquired during the currency of the policy; insurable
interest should be required at the date of loss; a policy taken out
without interest should be void; and the definition of insurable interest
should be extended to any property contractual right, possession or a
real probability of benefit from preservation or loss from destruction of
the insured subject matter.
4.4 Application of insurable interest rules to reinsurance

Facultative contracts, being contracts of insurance, have to be
supported by insurable interest. As seen in Chapter 2, some treaties
cannot be classified as contracts of insurance at all, but are contracts
for insurance. Nevertheless, no one suggests that treaties are not
subject to the ordinary insurable interest rules, and every case in which
insurable interest points have arisen has proceeded on the basis that
every form of reinsurance agreement requires insurable interest.
28
There is some difficulty in ascertaining exactly how the insurable

interest requirement applies to reinsurance contracts, because there
is some ambiguity in the cases as to whether a reinsurance contract
is one on the reinsured’s liability to the assured or whether it takes
effect as a further policy on the insured subject matter. The difference
is crucial. If the former view is correct, then a reinsured automatically
has insurable interest by reason of its liability to the assured, and the
only requirement that has to be fulfilled is that the interest remains
in existence at the date of the loss. If the latter view is correct, the
reinsured’s interest must satisfy the insurable interest rules which apply
to the underlying policy.
The latter view has prevailed. It was noted in Chapter 2 that, in the
absence of specific wording, a reinsurance contract takes effect as a
further policy on the original subject matter. The leading authority is
indeed the most important case on the operation of the Life Assurance
Act 1774, Dalby v India & London Life Assurance (1854) 15 CB 364. In
Dalby a policy was taken out on the life of the Duke of Cambridge
by one Wright, and the insurers took out their own policy. Wright
surrendered his policy, but the insurers maintained their policy and,
following the death of the Duke of Cambridge, made a claim against
the reinsurers. The claim was contested on the ground that the Life
Assurance Act 1774 required the insurers to possess insurable interest
at the date of the death of the Duke of Cambridge, but they had no
such interest because they faced no liability. The court ruled that the
Life Assurance Act 1774 did not impose any requirement for insurable
interest beyond the date of inception, so that as long as the policy
was supported by insurable interest when it was taken out there was
no need for the insurers to prove any interest at the date of Duke of
Cambridge’s death. That decision in effect opened the door to the use
of life insurance as a means of investment, in that it authorises the
trading of life policies, but what is relevant here is that the court treated
the reinsurance as one on the life of the Duke of Cambridge so that the
1774 Act was in principle applicable to the reinsurance.
If the policy is silent, then Dalby represents the default position.
However, if the reinsurance is expressed as being one which is on
the liability of the reinsured, then the reinsured is able to recover
simply by showing that it faced liability to the original policyholder.
The importance of drafting is shown by Feasey v Sun Life Assurance
of Canada [2002] EWCA Civ 885. Here, a P&I Club (a mutual liability
insurance company providing cover for shipowners’ liabilities) was the
insurer of its member shipowners against their liability to indemnify
them for any personal injury claims brought by crew members. The
Club reinsured under an excess of loss treaty with a Lloyd’s Syndicate
represented by the claimant, and the Syndicate entered into a
retrocession with the defendants. The reinsurance was framed in terms
that it covered the Club’s liability when losses reached a given level.
However, as a result of changes to Lloyd’s rules affecting the reserves to
be held by syndicates, it became impractical for the Syndicate to offer
reinsurance in that form. An alternative scheme was devised, under
which the reinsurance was expressed to be a personal accident cover,
so that when an employee was injured the Syndicate was obliged to
make a payment to the Club based on the nature and extent of the
29
injury. Inevitably, not all injuries led to claims, so the sums payable in
respect of an injury were based on statistical evidence as to the sums
likely to be necessary to indemnify the Club in full for any payments
that it might n due course be called upon to make to the Club. Under
these arrangements, the Club did not make any profit, and there was
indeed a shortfall between the amount of reinsurance receipts from
the reinsurers and the amount payable to shipowners. Dispute arose
between the Lloyd’s Syndicate and its retrocessionaires, and one of the
grounds used by the retrocessionaires to deny liability to the Syndicate
was that the reinsurance taken out by the Club with the Syndicate
was void because the Club did not possess insurable interest. The case
proceeded on the assumption that the reinsurance was a life policy
which fell within the scope of the Life Assurance Act 1774, rather than
a policy covering the Syndicate’s liability which was subject only to
common law indemnity rules. The question thus became what the
policy actually covered. The Court of Appeal, by a majority, adopted
an expansive view of insurable interest and held that although the
treaty was expressed to be a life insurance policy it was worded in a
manner which covered the interests of the Club even though, strictly
speaking, the Club did not possess an insurable interest in the lives
of shipowners’ employees. The point, therefore, is that the insurable
interest rules applicable to the underlying policy will also apply to the
reinsurance. The Feasey case is a controversial one, as is shown by the
powerful dissent of Ward LJ, but it does herald a more modern and
commercial approach to the issue of insurable interest.

• describe the formation procedure for a contract of reinsurance
• describe the various documents that are used in that procedure, in particular,
slips and slip policies
• outline the features of the various types of reinsurance.

After reading this chapter, you should be able to answer the following questions.
1. Describe the current method for the placing of reinsurance risks in London?
2. What are the legal issues that arise where reinsurance is placed in advance of
insurance?
3. How do the rules on insurable interest apply to reinsurance agreements?
30
Chapter 5 Utmost good faith
Introduction
This chapter analyses the mutual obligation of the parties to a contact
of insurance to act with utmost good faith. The obligation is at its most
significant in the lead-up to the making of the contract, the reinsured
being under a duty to disclose material facts to the reinsurers, although
the duty does have some impact upon reinsurers and also upon the
post-contractual dealings between the parties.
Learning outcomes
• define the scope of the duty of utmost good faith
• describe the facts that have to be disclosed by the reinsured prior to the
making of the contract
• outline and discuss the post-contractual duties of the parties
• discuss the available remedies for breach of duty.
Essential reading
• Marine Insurance Act 1906, sections 18, 19, 20 and 84.
• Assicurazioni Generali v Arab Insurance Group [2003] Lloyd’s Rep IR 131.
• Axa Insurance Co v Gottleib [2005] Lloyd’s Rep IR 369.
• Brotherton v Aseguradora Colseguros (No 3) [2003] Lloyd’s Rep IR 774.
• Drake Insurance v Provident Insurance [2004] Lloyd’s Rep IR 277.
• ERC Frankona Reinsurance v American National Insurance Co [2006] Lloyd’s
Rep IR 157.
• Glencore International AG v Ryan, The Beursgracht [2002] 1 Lloyd’s Rep 574.
• Group Josi Re v Walbrook Insurance Co [1996] 1 All ER 791.
• La Banque Financière de la Cité v Westgate Insurance Co Ltd [1990]
2 All ER 947.
• Limit No 2 v Axa Versicherung AG [2007] EWHC 2321 (Comm), reversed in
part [2009] Lloyd’s Rep IR 396.
• PCW Syndicates v PCW Insurers [1996] 1 All ER 774.
• Pan Atlantic Insurance Co v Pine Top Insurance Co [1994] 3 All ER 581.
• SAIL v Farex Gie [1995] LRLR 116.
• WISE Underwriting Agency Ltd v Grupo Nacional Provincial SA [2004] Lloyd’s
Rep IR 764.
Further reading
• Friends Provident Life & Pensions Ltd v Sirius International Insurance
Corporation [2006] Lloyd’s Rep IR 45.
• Glencore International AG v Alpina Insurance Co Ltd [2004] Lloyd’s Rep IR 111.
• HIH Casualty and General Insurance v Chase Manhattan Bank [2001] Lloyd’s
Rep IR 702, [2003] Lloyd’s Rep IR 230.
• K/S Merc-Skandia XXXXII v Certain Lloyd’s Underwriters [2001] Lloyd’s
Rep IR 802.
• Sirius International Insurance Corporation v Oriental Assurance Corporation
[1999] Lloyd’s Rep IR 345.
31
5.1 The principle of utmost good faith

Under section 17 of the Marine Insurance Act 1906 (which codifies the
common law and which has been held to apply to reinsurance as well
as to all forms of insurance), a contact of insurance is one based on
the utmost good faith, and if either party fails to observe the duty the
contract may be avoided by the other. The duty of utmost good faith
has four separate strands:
• the pre-contractual obligation of the policyholder to disclose, and
not to misrepresent, facts material to the risk
• the pre-contractual obligation of the underwriter to disclose, and
not to misrepresent, facts material to the risk
• the post-contractual duty of the policyholder to observe utmost
good faith
• the post-contractual duty of the underwriter to observe utmost
good faith.
Although section 17 encompasses each of these matters, the Act itself
expands on only the first of these: section 18 governs disclosure by
the policyholder; section 19 governs disclosure by the policyholder’s
broker; and section 20 governs misrepresentation by the policyholder.
In this section the most important rules on pre-contractual utmost
good faith will be set out. The operation of the duty in reinsurance
cases, and post-contractual matters, are considered in subsequent
sections.
The reinsured’s pre-contractual duty in sections 18 and 20 is to disclose
and not misrepresent all ‘material’ facts. The duty of disclosure is all
but unique to insurance contracts, although the obligation not to
misrepresent is a matter of general law.
5.1.1 Definitions of non-disclosure and misrepresentation

The definitions of non-disclosure and misrepresentation are both
important.
As to the definition of non-disclosure, the duty of disclosure requires
the reinsured to make a ‘fair presentation’ to the reinsurers. It suffices if
the reinsured makes the relevant information available to the reinsurers
and it is no part of the reinsured’s duty to draw the reinsurers’ attention
to particular matters or to advise the reinsurers on their underwriting
decisions: this was made clear by the House of Lords in Pan Atlantic
Insurance Co v Pine Top Insurance Co [1994] 3 All ER 581, in which the
reinsured’s broker made all of the relevant information available to the
reinsurers but gave an oral presentation which focused on the most
favourable aspects of the risk. The House of Lords held by a 4:1 majority
that the broker had made full disclosure; Lord Mustill felt that there
had not been full disclosure but concurred in the result on the ground
that the reinsurers had waived further disclosure by failing to ask follow
up questions when it was clear that further information was available.
Three classes of facts have to be disclosed:
a. facts which the reinsured actually knows (section 18(2))
32
b. facts which the reinsured ought to be aware of in the ordinary

course of its business (section 18(2))
c. facts known to the reinsured’s ‘agent to insure’ (section 19).
Category (a) requires actual knowledge. Category (b) encompasses
facts known to the reinsured’s employees and agents, but only those
agents whose duties include reporting the facts in question to the
reinsured. In ERC Frankona Reinsurance v American National Insurance
Co [2006] Lloyd’s Rep IR 157 it was held that the reinsured was under
an obligation to disclose to reinsurers the fact that the chief executive
of the underwriting agency which was authorised to write risks on
its behalf, had a criminal conviction for dishonesty, but that was only
because the reinsured was actually aware of that conviction: had
the reinsured not been aware of the information, there would have
been no duty to disclose it because the underwriting agent was not
a person whose knowledge was to be imputed to the reinsured for
disclosure purposes. Category (c) applies only to the knowledge of
the reinsured’s placing broker, although the section is an important
one because the broker is placed under a duty to disclose facts which
are not, and could not possibly be, known to the reinsured itself (e.g.
previous unsuccessful attempts by the broker to place similar risks
for other reinsureds). In each of cases (b) and (c), where the agent has
been guilty of fraud against the reinsured (e.g. where an underwriting
agent has been misappropriating insurance premiums belonging to
the reinsured) and that fraud is a material fact for reinsurers, disclosure
is not required. The reason is that it is not realistic to expect the
reinsured to be aware of fraud against it or to expect the agent to
disclose its own fraud. These points were decided in PCW Syndicates v
PCW Insurers [1996] 1 All ER 774 and Group Josi Re v Walbrook Insurance
Co [1996] 1 All ER 791, in each of which there had been fraud against
the reinsured by its underwriting agent: the Court of Appeal ruled that
the underwriting agent was not an agent to insure within section 19
so that there was no duty of disclosure under that provision, and that
in any event there was no duty of disclosure under section 18 because
the assured was not deemed to be aware of the agent’s fraud against
the reinsured.
As to misrepresentation, the elements are that the reinsured (or his
broker) has made a representation which is false. Not every statement
made in pre-contractual negotiations is a representation, in that
what is said must be specific and capable of being relied upon by
the reinsurers. In Limit No 2 v Axa Versicherung AG [2007] EWHC
2321 (Comm) (reversed in part on another point, [2009] Lloyd’s Rep
IR 396) the broker seeking reinsurance of a construction risk for
the reinsured stated that the reinsured ‘as a matter of principle …
retained high standards’ and that the reinsured ‘would not normally
write construction risks unless the original deductible was at least
£500,000 and preferably £1,000,000’. The former was held to be too
vague to amount to a representation, but the latter was regarded
as sufficiently specific despite the use of the word ‘normally’. A
representation is regarded as true ‘if it is substantially correct, that
is to say, if the difference between what is represented and what is
actually correct would not be considered material by a prudent insurer’
33
(Marine Insurance Act 1906, section 20(4)). Statements of fact must

also be distinguished from statements of opinion or intention: such
statements are only untrue if the reinsured does not hold the stated
opinion or intention, so that the test is honesty (Marine Insurance Act
1906, sections 20(3) and 20(5), and see Rendall v Combined Insurance
Co of America [2005] EWHC 678 (Comm) in which an estimated figure
given to the reinsurers of days of travel by the assured’s employees was
held not to be a misrepresentation because the reinsured genuinely
believed that the figure was correct.
5.1.2 Materiality and inducement

Assuming that there has been a false statement or a failure to disclose,
the reinsurers will have a right to avoid the policy only if the fact is
‘material’. A ‘material’ fact is defined for this purpose as one which
would influence the judgment of a prudent underwriter in fixing
the premium or in determining whether he will take the risk (Marine
Insurance Act 1906, sections 18(2) and 20(2)). For some years it was
believed that the statutory test was exhaustive, and that reinsurers
would be able to avoid simply by proving, by means of expert
evidence, that a prudent underwriter in the market at the time would
have been interested in the facts withheld or misstated. However, the
law underwent a substantial change in Pan Atlantic Insurance Co v Pine
Top Insurance Co [1994] 3 All ER 581, where the House of Lords held that
the objective test was simply the first of two barriers to be surmounted
by the reinsurers, the second being proof that the underwriter who
wrote the risk was himself induced by the reinsured’s presentation to
enter into the contract on the terms which were ultimately agreed.
Cases decided after Pan Atlantic have made it clear that there is no
connection between the materiality and inducement tests, and that
suggestions in Pan Atlantic that if objective materiality could be proved
then subjective inducement could be presumed, were wrong (see
Assicurazioni Generali v Arab Insurance Group [2003] Lloyd’s Rep IR 131).
The effect of the authorities is that the reinsurers have to prove:
a. by expert evidence, that the fact was one which would have been of
interest to a prudent underwriter working in the relevant market at
the time and
b. by their own evidence, that the underwriter who wrote the risk was
induced to reach his conclusion on the risk by the facts misstated or
withheld.
In practice, inducement has proved to be the key issue in most disputes
which have arisen after the ruling in Pan Atlantic, in that proof of
materiality is in most cases relatively straightforward and obvious
whereas proof of inducement requires internal evidence from the
reinsurers which, in the event of a dispute, is capable of being tested
by cross-examination on the part of the reinsured. A particular problem
arises with inducement in market placements, in that in practice the
most important and most detailed presentation will be made to the
leading underwriter, and other underwriters may be prepared to follow
the example of that underwriter and to scratch the slip for that reason.
The cases indicate that in such circumstances the following market is
entitled to rely upon the judgment of the leading underwriter, so that if
34
there has been an unfair presentation to the leader, which has induced
his participation on the agreed terms, those in the following market
are themselves to be regarded as having been induced. An alternative
analysis which reaches the same result is that if there has been an
unfair presentation to the leader, that is a material fact which has to be
disclosed to the following market, and if it is not disclosed then those
reinsurers can treat themselves as having been induced. In Brotherton v
Aseguradora Colseguros (No 3) [2003] Lloyd’s Rep IR 774 the court ruled
that the failure of the reinsured to disclose to the leading underwriter
the existence of rumours was of itself a material fact which had to be
disclosed to the following market, a decision based on the undoubted
fact that the following market did rely heavily on the presentation made
to the leading underwriter.
The discussion so far has focused on the reinsured’s duty of utmost good
faith. As has been noted above, section 17 imposes a similar duty on
the reinsurers. In practice, the duty is likely to be of limited importance.
There is no definition of materiality in respect of the reinsurers’ duty of
disclosure, and in any event the only remedy is avoidance: in general,
if the reinsured has suffered a loss, the last thing that the reinsured will
wish to do is to avoid the policy, as that removes any right of recovery
other than the premium. If, therefore, the reinsurers’ duty is to be
meaningful, it will have to relate to facts which in some way diminish
the risk and, therefore, the premium that the reinsured is willing to pay.
The duty was discussed by the Court of Appeal and House of Lords in
La Banque Financière de la Cité v Westgate Insurance Co Ltd [1990] 2 All
ER 947, in which the assured bank sought to recover damages from
its insurers either for breach of the duty of utmost good faith or in
negligence, in that the insurers had failed to warn the assured that its
broker had been guilty of fraud in earlier transactions by leaving the
bank underinsured. The fraud was repeated and, facing a shortfall on its
insurance claim, the bank sought to recover its loss by way of damages.
The claim was dismissed in the House of Lords on causation grounds so
that the good faith issues were not discussed, but in the Court of Appeal
it was held that: (a) the duty of disclosure owed by an underwriter
extended to the scope of the insured peril and recoverability under the
policy; and (b) the only remedy is avoidance. So although it may be that
reinsurers are in possession of, and have to disclose to the reinsured,
facts which may affect the reinsured’s prospects of recovery under the
policy, if they fail to do so and the reinsured suffers a loss which it is
unable to recover from the reinsurers, the reinsured’s only remedy is to
recover its premium. It is apparent, therefore, that the duty of utmost
good faith owed by the reinsurers is of little significance unless the
reinsured discovers the problem before a loss has occurred and wishes to
withdraw from the policy.
5.2 Material facts in reinsurance cases

In ordinary insurance cases, material facts fall into the categories of
physical hazard and moral hazard. Physical hazard covers anything
which relates to the insured subject matter and affects the likelihood or
degree of any loss, and moral hazard relates to the policyholder and his
previous history, including his honesty.
35
The general principles constituting the duty of utmost good

faith which apply to insurance contracts are equally applicable to
reinsurance contracts, with three modifications. First, it is commonly
the case in the formation of facultative reinsurance contracts that the
information provided by the assured to the reinsured is forwarded
by the reinsured to the reinsurers: if, unknown to the reinsured, there
are material false statements, then the reinsurers may have the right
to avoid the contract (Sirius International Insurance Corporation v
Oriental Assurance Corporation [1999] Lloyd’s Rep IR 345, where it
was held that false statements made by the assured to the reinsured
about fire precautions in the insured building, which were passed to
the reinsurers, constituted representations made on the part of the
reinsured which, if false, would justify avoidance).
Secondly, the duration of the duty of utmost good faith with respect
to reinsurance treaties depends upon the nature of the treaty. Under
an obligatory treaty all utmost good faith duties are to be carried
out on the placement of the treaty, because each individual risk
which attaches to the treaty does so automatically and without any
presentation by the reinsured to the reinsurers: the most that reinsurers
will receive is a bordereau or other schedule of risks accepted by the
reinsured and which fall within treaty limits. That document is a mere
formality, so that failure to present it does not have any impact upon
the earlier automatic prior attachment of the risk, and the reinsurers
have no remedy (Glencore International AG v Ryan, The Beursgracht
[2002] 1 Lloyd’s Rep 574, a direct open cover case). If the reinsured
has failed to disclose material facts prior to the inception of the treaty,
then the entire treaty can be avoided and all risks ceded under it cease
to be binding on the reinsurers. Strictly speaking, a treaty of this type
is a contract for reinsurance and not a contract of reinsurance, but
the general assumption is that disclosure is required (see Glencore
International AG v Alpina Insurance Co Ltd [2004] Lloyd’s Rep IR 111 and
Limit No 2 v Axa Versicherung AG [2009] Lloyd’s Rep IR 396). By contrast,
if the treaty is non-obligatory, it is no more than a mechanism for
channelling individual reinsurance applications to the reinsurers. That
means that the treaty itself is probably not a contract of utmost good
faith at all, but each individual declaration is a reinsurance contract in
its own right and thus the duty of utmost good faith must be complied
with for every declaration. That said, failure by the reinsured to comply
with the duty for any one declaration will only affect that declaration:
reinsurers cannot avoid all declarations under a non-obligatory
treaty simply because one of them is tainted by non-disclosure or
misrepresentation (SAIL v Farex Gie [1995] LRLR 116). A facultative-
obligatory treaty is more problematic, because any risk accepted by
the reinsured is not automatically ceded to the treaty but requires
a decision by the reinsured to make a declaration, following which
the reinsurers are bound by the declaration. So the issue here is not
whether there is a duty of utmost good faith in respect of a declaration,
which is plainly not the case, but rather whether a reinsured who has
failed to notify the reinsurers of a declaration is nevertheless able to
prove that he intended to make a declaration.
Thirdly, the facts which may be material to a prudent reinsurer may be
more extensive than those material to a prudent direct insurer. Facts
36
which are material to the direct risk are also material at the reinsurance
level but, in addition, facts which relate to the reinsured and its
business are themselves material, particularly where the reinsurance
is in the form of a treaty and the reinsurers are reliant upon the
underwriting judgment and practices of the reinsured as exemplified
by its portfolio and claims record. The first category encompasses
all facts which have to be disclosed for the purposes of the direct
insurance. Reinsurers are thus entitled to be informed of facts which
relate to the nature of the subject matter, such as the quality and value
of goods to be insured (WISE Underwriting Agency Ltd v Grupo Nacional
Provincial [2004] Lloyd’s Rep IR 764 – Rolex watches and not clocks)
and the risk of damage to the subject matter (Prifti v Musini Sociedad
Anonima de Seguros y Reaseguros [2004] Lloyd’s Rep IR 528 – sportsman
suffering pre-existing injury), and they are entitled to be informed
of facts which go to the ‘moral hazard’ (Brotherton v Aseguradora
Colseguros SA (No 3) [2003] Lloyd’s Rep IR 774 – president of the insured
bank under investigation for fraud). The second category consists of all
matters which may affect the reinsurers’ exposure to liability in the light
of the reinsured’s own practices. Material facts thus include:
• any terms in the direct policy which impose upon the reinsured a
form of liability which is unusual or which otherwise could not have
been anticipated by the reinsurers (Property Insurance v National
Protector Insurance (1913) 108 LT 104)
• whether the reinsured requires its policyholders to retain any part
of the insured risk for themselves (Limit No 2 v Axa Versicherung AG
[2009] Lloyd’s Rep IR 396)
• in the case of a proportional treaty, the premium actually received
by the reinsured because the reinsurers are entitled to a proportion
of that premium (Mander v Commercial Union Assurance Co plc
[1998] Lloyd’s Rep IR 93)
• the fact that the reinsured was willing to pay a higher premium to
the reinsured than was actually demanded (Markel International
Insurance Company Ltd and Another v La República Compañia
Argentina de Seguros Generales SA [2005] Lloyd’s Rep IR 90)
• that the reinsured has entered into facultative obligatory
arrangements with the assured, so that the assured can choose
which risks are declared to the reinsured but the reinsured has no
power to reject them (Aneco Reinsurance Underwriting Ltd v Johnson
& Higgins [2002] Lloyd’s Rep IR 91)
• that the underlying policy is a valued one so that the assured does
not have to prove the amount of its loss in order to recover the
full sum insured (Toomey v Banco Vitalico de España de Seguros y
Reaseguros [2005] Lloyd’s Rep IR 423)
• the reinsured’s loss experience on the business in question (Limit No
2 v Axa Versicherung AG [2009] Lloyd’s Rep IR 396)
• the reinsured’s approach to calculating the losses likely to arise
from outstanding claims, including the reinsured’s approach to
setting aside reserves for potential claims – if the reinsured has a
policy of not setting aside a reserve until a claim is all but certain,
then reserving figures given to the reinsurers are almost certain
37
to understate future claims (Assicurazioni Generali v Arab Insurance

Group [2003] Lloyd’s Rep IR 131)
• anticipated claims against the reinsured involving losses which have
incurred but not yet reported (‘IBNR’ – Aiken v Stewart Wrightson
[1995] 3 All ER 449).
Facts which have been held not to be material include: whether the
reinsured has obtained additional reinsurance from other sources, in
particular whether the amount of the reinsured’s self-insured retention
under the reinsurance has been the subject of other reinsurance (the
fact that the reinsured has chosen not to bear any of the loss for itself
is only material if the reinsurers ask an express question about it – SAIL
v Farex Gie [1995] LRLR 116); and facts which, through its broker, the
reinsured may possess about the quality and effectiveness of any
retrocession cover obtained by the reinsurers in respect of the risk to
be reinsured (SAIL v Farex Gie [1995] LRLR 116).
Section 18(3) of the Marine Insurance Act 1906 lists the facts which are
deemed to be immaterial, namely:
a. circumstances which diminish the risk
b. circumstances known or presumed to be known by the
underwriters, including matters of common knowledge and matters
which the underwriters ought to know in the ordinary course of
their business
c. any circumstance whose disclosure is waived by the underwriters
d. any circumstance covered by express policy terms. The most
significant of these in the context of reinsurance are (b) and (c).
As to (b), the cases show that reinsurers are not required to make
investigations, so that if material facts exist and they are not obvious
to the reinsurers, they have to be disclosed. Thus, in Brotherton v
Aseguradora Colseguros (No 3) [2003] Lloyd’s Rep IR 774, the reinsurers
agreed to reinsure a fidelity cover on a bank in Colombia. Prior to the
placement of the reinsurance, there were reports in the Colombian
media that the bank’s president was undergoing fraud investigations.
It was held that the reinsurers could not be expected to be aware of
those reports in the absence of disclosure by the reinsured, and that
conclusion was unaffected by the presence of a representative of the
reinsurers in Colombia at the time, as he was not a Spanish speaker.
As to (c), waiver, reinsurers will be taken to have waived disclosure
where: they expressly agree that there is to be no duty of disclosure;
limited questions are asked, so that disclosure of related information
is regarded as unnecessary; and disclosure is made by the reinsured
and the reinsurers choose not to seek follow-up information. The
leading authority is WISE Underwriting Agency Ltd v Grupo Nacional
Provincial SA [2004] Lloyd’s Rep IR 764. In this case the reinsured, a
Mexican insurance company, insured a shop in Cancún against loss of
goods. The insurance slip was in Spanish and referred to various items,
including Rolex watches. The risk was reinsured in London, and the
slip was translated into English: in the course of translation, ‘watches’
became ‘clocks’. The reinsurers sought to avoid the reinsurance for non-
disclosure of the true nature of the insured subject matter. The Court
of Appeal by a majority held that the reinsurers were entitled to treat
38
the reinsurance slip as a proper statement of the risk insured, and that
they had no reason to believe that Rolex watches were included in the
insured subject matter. Accordingly, there was no waiver. There was a
strong dissent on this point by Rix LJ, who took the view that reinsurers
should have realised, from the facts that the slip had been translated
and that Cancún was known to be an expensive tourist location, that
there was further information to be elicited and accordingly there was
waiver of that further information.
5.3 Post-contractual obligations

The duty of utmost good faith, insofar as it relates to the presentation of
the risk, comes to an end as soon as the contract is made. In reinsurance
terms, that means that there is no further disclosure obligation once
the reinsurer has scratched the slip and, equally, if the reinsured makes
a false statement after the slip has been scratched then that can have
no effect on the contract itself (as in Sirius International Insurance
Corporation v Oriental Assurance Corporation [1999] Lloyd’s Rep IR 345,
where a false statement was made after the risk incepted and thus
had no effect on the validity of the contract). A renewal is, however, a
fresh contract, so that the duty of utmost good faith reattaches at that
point. Equally, any endorsement to the policy during its currency, and
any extension of the cover before renewal, amounts to a new contract
and thus attracts a duty of utmost good faith. See Limit No 2 v Axa
Versicherung AG [2008] EWCA Civ 1231, where a reinsurance contract
was extended for seven months, and then renewed, and it was held that
the duty of utmost good faith attached at both points. The case also
makes the important point that information given by the reinsured to
the reinsurers when the contract is first entered into cannot necessarily
be treated as repeated on renewal. In Limit the reinsured stated at
the outset that it normally demanded a retention from its underlying
policyholders, and reinsurers sought to avoid the renewal some 19
months later by arguing that the original statement had impliedly
been repeated at renewal. The Court of Appeal held that statements
of opinion or intention had a limited life, and it may be that the same
principle applies also to some statements of fact, depending upon their
nature.
Those specific cases aside, there is some debate among the authorities
as to whether either party to an insurance or reinsurance contract owes
any form of continuing duty of utmost good faith. In principle this must
be doubtful, because the remedy for breach of the duty of utmost good
faith, as set out in section 17, is that the innocent party has the right to
avoid the policy ab initio, thereby treating it as if it never existed. The
concept that a contract can be avoided for something which occurs
after it has started to be performed is not one which conforms with
either legal principle or logic, and it has for the most part been rejected.
Turning first to the assured’s possible continuing duty of utmost good
faith, the most recent authorities appear to deny that any general duty
exists. After some uncertainty, the leading authority is now K/S Merc-
Skandia XXXXII v Certain Lloyd’s Underwriters [2001] Lloyd’s Rep IR 802. This
was a direct marine liability claim, but the judgment of Longmore LJ lays
down definitive guidelines on post-contractual duties. In his view, there
39
is a potential continuing duty where the reinsured is under a contractual

obligation to provide information to the reinsurers during the currency
of the policy, and has in bad faith (which will mean either fraudulently or
at least recklessly) failed to do so. If the reinsurers have the right to treat
the reinsured’s failure as conduct which amounts to repudiation of the
policy as a whole, then the reinsurers have the alternative rights either to
terminate the policy for breach or to avoid the policy ab initio for breach
of the continuing duty. It would seem, however, that this is no more
than a theoretical possibility, because it is all but inconceivable that the
reinsured’s failure to provide information under a contractual provision
would be treated as a repudiatory breach which justifies termination: the
courts treat such terms as innominate, so that unless the reinsured is in
effect refusing all future performance under the policy then his conduct
cannot be treated as repudiatory (Friends Provident Life & Pensions Ltd v
Sirius International Insurance Corporation [2006] Lloyd’s Rep IR 45). The
context in which the policyholder’s continuing duty of utmost good
faith has most widely been discussed is that of fraudulent claims, the
suggestion being that a fraudulent claim entitles the underwriters to
avoid the policy ab initio and to demand repayment of all sums paid in
respect of earlier and valid claims. The English courts appear to have
rejected this approach, and have preferred the view that a fraudulent
claim is a breach of contract which entitles the underwriters to refuse
to pay the claim and (although this is not yet clear) to treat the contract
as terminated as from the date of the fraud (Axa Insurance Co v Gottleib
[2005] Lloyd’s Rep IR 369). The English and Scottish Law Commissions
have reviewed the law on the policyholder’s post-contractual duty, and
their document contains a very useful discussion of the development of
the law: See:
• www.lawcom.gov.uk/docs/issues7_duty-of-good-faith.pdf.
Paper in December 2011, to be found at http://lawcommission.justice.
gov.uk/docs/cp201_ICL_post_contract_duties.pdf. The document is
largely confined to the issue of fraudulent claims, and recommends
little change to existing law.
There is little authority on the scope of the reinsurers’ continuing duty
of utmost good faith. Apart from the general statement in section 17 of
the Marine Insurance Act 1906 that such a duty exists, there is nothing
in the Act to indicate what the reinsurers are required to do. The duty
is necessarily constrained by the fact that the only possible remedy
is avoidance by the reinsured, which is likely to be of little or no use
to the reinsured once a loss has occurred and the reinsurers’ breach
of duty has been identified. There are three possible strands to the
duty, as indicated by the cases. The first is that the reinsurers may be
under a duty to act in good faith when exercising a decision whether
or not to avoid the policy for the reinsured’s own breach of duty of
disclosure or for the reinsured’s misrepresentation. This is suggested by
the decision in Drake Insurance v Provident Insurance [2004] Lloyd’s Rep
IR 277, discussed below in section 5.4. The second is that the need for
the reinsurers to act with the utmost good faith may be regarded as a
factor which determines whether or not a term is to be implied into the
agreement, and how express terms are to be construed. The operation
40
of this possibility may be seen in cases in which the courts have ruled
that reinsurers do not have an absolute right to demand information
from the reinsured following a loss, or to withhold their consent to
a settlement with, or to a decision to defend a claim brought by, the
reinsured: those cases are discussed in Module B: Reinsurance losses
and claims of this Study Guide (see, for example, Eagle Star Insurance
Co Ltd v Cresswell [2004] EWCA Civ 602). The third is the possible duty
of the reinsurers to pay claims within a reasonable time. The law to date
has rejected the suggestion that underwriters are under any form of
duty to make a timely payment, and in Sprung v Royal Insurance [1999]
Lloyd’s Rep IR 111 the Court of Appeal refused to award damages to an
assured who had lost his business as the result of the insurers’ wrongful
delay in making payment to allow the reinstatement of his damaged
premises. However, the matter has been considered in detail by the
English and Scottish Law Commissions in their July 2010 Issues Paper
on Late Payment, and the document suggests that underwriters should
be under a duty to make timely payment:
• www.lawcom.gov.uk/docs/late_payment_issues.pdf.
The Issues Paper also discusses other possible applications of the
underwriters’ continuing duty of utmost good faith.
Paper in December 2011, to be found at http://lawcommission.justice.
gov.uk/docs/cp201_ICL_post_contract_duties.pdf. The Consultation
Paper showed a general consensus in favour of damages for late
payment, subject to safeguards to ensure that any liability should
not be disproportionate to the sum insured. The Law Commissions
recommended that: insurers should be under a contractual obligation
to pay valid claims within a reasonable time, breach of which would
give rise to damages for foreseeable losses; in assessing what is a
reasonable time, the conduct of both parties in respect of the claim
should be taken into account, subject to the consideration that insurers
should have full opportunity to carry out a proper investigation; and
it should be open to the parties to exclude the right to damages in
non-consumer cases as long as the insurers have acted in good faith in
handling the claim.
5.4 The remedies of the parties

As is stated by section 17 of the Marine Insurance Act 1906, the remedy
for breach of the duty of utmost good faith is that the innocent party
is entitled to treat the contract as void. There is no question of an
action for breach of contract, because utmost good faith does not
give rise to contractual duties. Misrepresentation may well amount
to a tort where there is either deliberate fraud (the tort of deceit) or
carelessness (the tort of negligence), but there is rarely if ever any
need for the reinsurers to rely upon a claim for damages: the solution
always adopted by reinsurers is to avoid the policy. Section 2(2) of the
Misrepresentation Act 1967 allows the court to refuse avoidance and
to award damages in its place, a measure which is designed to protect
the guilty party against the possibly draconian and disproportionate
remedy of avoidance of the entire contract. This measure applies
41
only to misrepresentation and not to non-disclosure, but even in the

context of misrepresentation the English courts have ruled that it
is not appropriate to exercise its discretion in favour of a reinsured,
because the parties to a reinsurance agreement are assumed to
know the importance of the duty of utmost good faith and the legal
consequences of a breach (HIH Casualty and General Insurance v Chase
Manhattan Bank [2001] Lloyd’s Rep IR 702, appealed on other grounds
[2003] Lloyd’s Rep IR 230).
The remedy of avoidance is open to the reinsurers irrespective of the
reinsured’s state of mind: a misrepresentation, whether fraudulent,
innocent or negligent, permits avoidance, whether or not the reinsured
was aware of the facts and of their materiality; and a failure by the
reinsured to disclose material facts of which he was aware gives rise
to the right of avoidance irrespective of the reinsured’s appreciation
or non-appreciation of that materiality. As was discussed earlier, a
reinsured who is unaware of the existence of material facts is (subject
to agency rules) not under any duty of disclosure in respect of those
facts.
Avoidance is a self-help remedy, so that the assistance of the court is
not required. However, very often the reinsurers will seek a declaration
as to their right to avoid, as wrongful avoidance amounts to a breach
of contract. Avoidance can be effected simply by the reinsurers
giving notice to the reinsured that they have exercised their right
of avoidance. The right of the reinsurers’ to avoid has to be assessed
at the date at which the decision to avoid is taken. In Brotherton v
Aseguradora Colseguros (No 2) [2003] Lloyd’s Rep IR 762 reinsurers
avoided the reinsurance contract on discovering that, at the time of
placement, there had been reports in the press that the president of
the assured bank was under investigation for fraud, but those reports
had not been disclosed to the reinsurers. The reinsured asserted that
the president was entirely innocent and sought to have the avoidance
set aside on the ground that by the time of the trial there was
evidence that the president was innocent and that although the media
reports were material facts which had to be disclosed, the court was
entitled to revoke the avoidance on proof that those facts had been
undermined. The Court of Appeal disagreed and held that there was a
valid avoidance at the time and that the court could not overturn that
avoidance on the strength of later evidence. However, subsequently,
in Drake Insurance v Provident Insurance [2004] Lloyd’s Rep IR 277, the
Court of Appeal held that underwriters owed a duty not to avoid if
they had become aware of evidence which indicated that facts which
appeared to be material when the policy was written had proved
to be immaterial. As a result of these cases, if material facts, such
as allegations of dishonesty against the assured, are withheld from
reinsurers, then the reinsurers may not avoid the policy if, at the time of
purported avoidance, they have become aware that the allegations are
untrue.
The effect of avoidance is to treat the policy as if it never existed. That
means that the reinsured is entitled to recover any premiums paid
under the policy, although section 84 of the Marine Insurance Act
1906 states that the premium is irrecoverable in the event that there
42
has been fraud. It is nevertheless the practice of reinsurers simply

to return the premium. It is less clear whether sums paid in respect
of prior claims have to be repaid by the reinsured. That may depend
upon the manner in which a claim has been paid: if there has been
a formal settlement agreement which states that the settlement is
full and final, it is likely that the avoidance of the policy will not affect
such a settlement unless the settlement has itself been obtained by
misrepresentation; by contrast, if there has simply been a payment to
the reinsured without the formality of a settlement agreement, it may
be that the sum is recoverable on the ground that it was paid under a
mistake. The law remains unclear on these points.
The right of the reinsurers to avoid the policy may be lost by waiver
or estoppel. Waiver may be express or implied. Express waiver arises
where the reinsurers have agreed that they will not exercise their right
of avoidance. This may be an absolute statement, or it may be more
limited (e.g. it may relate only to innocent misrepresentation). The
validity of waiver clauses was discussed by the House of Lords in HIH
Casualty and General Insurance v Chase Manhattan Bank [2003] Lloyd’s
Rep IR 230, and their Lordships decided that the only limit on a waiver
clause is the public policy rule that the parties may not agree to oust
the reinsurers’ remedies where the reinsured has been guilty of fraud.
Their Lordships were divided on the further question of whether the
reinsurers could agree to oust their rights where there had been fraud
on the part of the reinsured’s broker. Implied waiver arises where the
reinsurers, with knowledge of the reinsured’s breach of the duty of
utmost good faith, have indicated that they do not intend to rely upon
their right of avoidance. The rules on implied waiver were laid down by
the Court of Appeal in WISE Underwriting Agency Ltd v Grupo Nacional
Provincial SA [2004] Lloyd’s Rep IR 764, a case in which reinsurers,
having become aware of their right to avoid, chose not to exercise
it but instead they gave notice to the reinsured of their intention to
cancel the policy under an express cancellation clause. The Court of
Appeal, by a majority, held that this act amounted to a waiver of the
right to avoid, in that it was inconsistent for the reinsurers at the same
time to rely upon a contractual provision for cancellation and at the
same time to argue that there was no contract. Implied waiver will be
made out, according to the judgment of Simon J which was approved
on appeal by the Court of Appeal, if: (a) the reinsurers have actual
knowledge of the reinsured’s breach of duty and of their right to avoid;
and (b) the reinsurers have made an unequivocal statement to the
reinsured that they do not intend to avoid. There is an independent
estoppel principle, which precludes avoidance if the reinsurers have
unequivocally represented that they do not intend to avoid and it has
become inequitable for the reinsurers to rely upon that statement, but
estoppel will rarely be available independently of implied waiver.
The English and Scottish Law Commissions have considered at length
the future of the duty of utmost good faith. Issues Paper 1, published in
2006 expressed some dissatisfaction with the law:
• www.lawcom.gov.uk/docs/insurance_contact_law_issues_paper_1.pdf.
In December 2009 the Law Commissions published a Consultation
Paper on utmost good faith in consumer cases, available at
43
http://lawcommission.justice.gov.uk/docs/lc319_Consumer_
Insurance_Law.pdf. The proposals were adopted by the government
and were enacted in March 2012 as the Consumer Insurance
(Disclosure and Representations) Act 2012, due to come into force
in March 2013. Under the Act, the duty of disclosure is completely
abolished, and the remedies of insurers for misrepresentation rest upon
the assured’s state of mind: if the assured is fraudulent, the insurers can
avoid the policy; if the assured has acted honestly and reasonably, the
insurers have no remedy; and if the assured has been negligent then
the insurers are entitled to be put into the contractual position they
would have insisted on but for the misrepresentation. These proposals
do not extend to reinsurance or other commercial insurance, although
proposals on those areas are due to be published in June 2012.

• define the scope of the duty of utmost good faith
• describe the facts that have to be disclosed by the reinsured prior to the
making of the contract
• outline and discuss the post-contractual duties of the parties
• discuss the available remedies for breach of duty.

1. What modifications are made to the duty of utmost good faith when it is
applied to reinsurance treaties?
2. What facts are material for reinsurance agreements?
3. Does the duty of utmost good faith affect the operation of the reinsurance
contract itself?
44
Chapter 6 The terms of reinsurance contracts
Introduction
This chapter analyses the terms of a contract of reinsurance. It looks at
typical express terms, considers when the courts will imply terms and
then concludes with a discussion of the practice of incorporation of
terms from the direct policy into the reinsurance.
Learning outcomes
• identify and outline the most important principles adopted by the courts in
construing a contract of reinsurance
• identify and outline the most important express terms of a contract of
reinsurance
• explain the circumstances in which the courts will imply a term into a contract
of reinsurance
• discuss the effectiveness of attempts to incorporate terms from a direct policy
into the reinsurance.
Essential reading
• Aegis Electrical and Gas International Services Ltd v Continental Casualty Co
[2008] Lloyd’s Rep IR 17.
• Attorney General of Belize v Belize Telecom Ltd [2009] UKPC 10.
• Baker v Black Sea [1998] Lloyd’s Rep IR 327.
• Bonner v Cox Dedicated Corporate Member Ltd [2006] Lloyd’s Rep IR 385.
• Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38.
• Charter Reinsurance Co v Fagan [1997] AC 313.
• Forsikrings Vesta v Butcher [1989] 1 All ER 402.
• Gan Insurance Co Ltd v Tai Ping Insurance Co Ltd [1999] Lloyd’s Rep IR 229
[1999] 2 All ER (Comm) 54.
• Hanwha Non-Life Insurance Co Ltd v Alba Pte Ltd [2011] SGHC 271.
• HIH Casualty and General Insurance v New Hampshire Insurance [2001]
• Home Insurance of New York v Victoria-Montreal Fire [1907] AC 59.
• Investors Compensation Scheme v West Bromwich Building Society [1998]
1 All ER 98.
• Phoenix General Insurance of Greece v Halvanon Insurance [1985] 2 Lloyd’s
Rep599 [1986] 1 All ER 908.
• Rainy Sky SA v Kookmin Bank [2011] UKSC 50.
• Toomey v Banco Vitalico de España de Seguros y Reaseguros [2004] Lloyd’s
Rep IR 354, [2005] Lloyd’s Rep IR 423.
Further reading
• Carvill America Inc v Camperdown UK Ltd [2005] Lloyd’s Rep IR 55, [2006]
Lloyd’s Rep IR 1.
• Commercial Union Assurance Co plc v Sun Alliance Insurance Group plc [1992]
1 Lloyd’s Rep 475.
• Tryg-Hansa v Equitas [1998] 2 Lloyd’s Rep 439.
• Youell v Bland Welch [1992] 2 Lloyd’s Rep 127.
45
6.1 Construction of policy terms

The English courts have developed a series of principles to be applied
in the construction of commercial contracts, and many of the leading
authorities are insurance and reinsurance cases. The law has been set
out by Lord Hoffmann in two leading cases, Investors Compensation
Scheme v West Bromwich Building Society [1998] 1 All ER 98 and
Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38. The Investors
Compensation Scheme guidelines are as follows:
1. Interpretation is the ascertainment of the meaning which the
document would convey to a reasonable person having all the
background knowledge which would reasonably have been
available to the parties in the situation in which they were at the
time of the contract.
2. The background was famously referred to by Lord Wilberforce as
the ’matrix of fact’, but this phrase is, if anything, an understated
description of what the background may include. Subject to the
requirement that it should have been reasonably available to the
parties and to the exception to be mentioned next, it includes
absolutely anything which would have affected the way in which
the language of the document would have been understood by a
reasonable man.
3. The law excludes from the admissible background the previous
negotiations of the parties and their declarations of subjective
intent. They are admissible only in an action for rectification. The
law makes this distinction for reasons of practical policy and, in
this respect only, legal interpretation differs from the way we
would interpret utterances in ordinary life. The boundaries of this
exception are in some respects unclear. But this is not the occasion
on which to explore them.
4. The meaning which a document (or any other utterance) would
convey to a reasonable man is not the same thing as the meaning
of its words. The meaning of words is a matter of dictionaries and
grammars; the meaning of the document is what the parties using
those words against the relevant background would reasonably
have been understood to mean. The background may not merely
enable the reasonable man to choose between the possible
meanings of words which are ambiguous but even (as occasionally
happens in ordinary life) to conclude that the parties must, for
whatever reason, have used the wrong words or syntax.
5. The ’rule‘ that words should be given their ‘natural and ordinary
meaning’ reflects the common sense proposition that we do not
easily accept that people have made linguistic mistakes, particularly
in formal documents. On the other hand, if one would nevertheless
conclude from the background that something must have gone
wrong with the language, the law does not require judges to
attribute to the parties an intention which they plainly could not
have had.
These guidelines allow the courts to consider virtually all relevant
background material, including previous contracts between the parties
46
and market understandings of particular words and phrases. However,

the test is objective and not subjective and, as was emphasised in
the Persimmon case, the courts are not entitled, in ascertaining what
a contract means, to pay any attention to: the parties’ declarations of
subjective intention or internal documents setting out their views;
the negotiations between the parties; and the manner in which the
contract was actually operated by the parties. As is clear from guideline
(3), negotiations are relevant only if it can be shown that the parties
had reached agreement on a particular point but that did not find its
way into the contract: the earlier agreement can then be used to rectify
the concluded agreement accordingly.
A number of other points emerge from the cases. First, if a form of
wording has been used for many years and has received judicial
interpretation, the courts will be slow to depart from it. Secondly, if a
word has a technical meaning, whether legal or scientific, that meaning
is to be applied to the policy. An insurance illustration of the former is
Grundy (Teddington) v Fulton [1983] 1 Lloyd’s Rep 16 (Theft Act 1968
definition of ‘theft’ applied). A reinsurance illustration of the latter is
Aegis Electrical and Gas International Services Ltd v Continental Casualty
Co [2008] Lloyd’s Rep IR 17 (the scientific meaning of ‘explosion’ was
adopted). Thirdly, it is always necessary to look at the contract as a
whole rather than attempt to construe words and phrases in isolation.
It was on that principle that the House of Lords held, in Charter
Reinsurance Co v Fagan [1997] AC 313 that the requirement imposed on
the reinsured that it must ‘actually have paid’ the assured as a condition
of recovery from the reinsurers was held not to require physical
payment but merely that the reinsured’s liability to pay the reinsured
had been established, because the entire policy was framed on the
basis that prepayment was not contemplated.
Fourthly, where the parties have reached express agreement on a point
and have included it in the document which has been scratched by the
reinsurers, any attached standard form wording which is inconsistent
with the express agreement is to be regarded as overridden. Priority is
thus to be given to typed or added words over printed words. Thus in
Commercial Union Assurance Co plc v Sun Alliance Insurance Group plc
[1992] 1 Lloyd’s Rep 475 a reinsurance contract was written as being
of 12 months’ duration, but the parties had expressly inserted the
words ‘120 days’ Notice of Cancellation at Anniversary Date’. This was
held to qualify the period clause and to mean that the policy was to
be automatically renewed unless either party gave 120 days’ notice of
termination before the last day of the policy.
Lastly, the contra proferentem rule, which allows ambiguous words
in a contract to be read against the person who proposed them, is of
limited significance in the reinsurance context, given that some terms
are proposed by the reinsured through its brokers, some terms are
standard market terms which require a consistent interpretation and
other terms are generally freely negotiated between the parties. In
Youell v Bland Welch [1992] 2 Lloyd’s Rep 127, the Court of Appeal held
that there was no justification in applying the contra proferentem rule
to the duration clause of a reinsurance agreement which limited cover
to 48 months when the underlying cover was unlimited in duration.
47
The Court of Appeal ruled that the wording was that of the broker,
which meant that it had to be construed in favour of the reinsurers,
while the wording amounted to an exclusion clause which meant that
it had to be construed in favour of the reinsured: the effect was that
these two considerations cancelled each other out and that the clause
was to be construed in accordance with its strict wording.
It may be, however, that the use of contra proferentem will diminish
in time, following the decision of the Supreme Court in Rainy Sky SA
v Kookmin Bank [2011] UKSC 50, where it was held that if the court is
faced with wording which can be interpreted in one of two ways, the
court is entitled to prefer the construction which is consistent with
business common sense and to reject the alternative construction.
In the case of facultative proportional reinsurance agreements, one of
the most significant rules of construction is that of back to back cover.
Because the reinsurers accept an agreed proportion of the risk for an
equivalent proportion of the premium (minus brokerage and ceding
commission), and because the reinsurance is stated to be on the same
terms and conditions as the direct policy (with the provisions of the
latter normally incorporated into the former – see below), there is a
presumption that the two contracts are to be construed in the same
manner. This is of particular significance where each contract has a
different governing law and those laws construe the same words in
different ways: in that situation, unless there are clear indications to
the contrary, it is to presumed that the meaning of the reinsurance
follows that of the direct policy (see WASA International Insurance
Co v Lexington Insurance Co [2009] UKHL 40, discussed in Module B:
Reinsurance losses and claims of this course.
6.2 Express terms

Reinsurance contracts of all types contain four main heads of terms:
the reinsuring clause, which sets out the temporal, geographical and
financial limits of cover; exclusions from cover; the obligations of the
parties (e.g. in writing business and settling claims); and choice of law
and jurisdiction or arbitration clauses.
The precise express terms of reinsurance contracts depend upon
the nature of the contract. In the case of facultative reinsurance, the
traditional approach was for the parties to agree that the slip presented
to the reinsurers was itself to constitute the entire agreement, and
such facultative slips were often referred to as ‘slip policies’. Since
June 2007, however, slips are being replaced by the Market Reform
Contract, which sets out in standard form the cover provided by the
reinsurance. The essential terms of a facultative reinsurance are: the
identities of the parties; duration; the nature of the underlying risk;
the terms and conditions of the reinsurance; and the premium to be
paid. When slip policies were used, it was almost standard practice to
incorporate the terms of the direct policy into the reinsurance, or at the
very least to say that the reinsurance was subject to the same terms
and conditions as the original policy the object in either case being to
ensure that the cover provided by the insurance and the reinsurance is
matching. Reference to the direct policy by the reinsurance continues
48
to be the practice even under the MRC. More will be said of this below.
A facultative policy will generally contain a ‘follow the settlements’
clause under which the reinsurers agree to be bound by any settlement
reached by the reinsured with the assured, although that obligation
may be limited by a claims clause under which the reinsurers are
entitled to be involved to a greater or lesser extent in the settlement
process failing which they are not bound by the settlement. All of this is
discussed in Module B: Reinsurance losses and claims of this course.
Treaty wordings, by contrast, have always been regarded as essential
because the relationships involved are much more complex and
detailed. A treaty will identify the parties, the risk to be covered, the
extent of the reinsurers’ liability and the premium payable, but there
will be additional terms for the protection of the reinsurers (e.g. the
right to inspect the reinsured’s books and records on reasonable
notice). Much of the detail is accounting in nature.
6.3 Implied terms

The English courts will not imply terms into commercial contracts
lightly. There are three situations in which terms are potentially to be
implied.
The first arises where the parties have failed to provide for a particular
set of circumstances and that, unless some term is added to deal with
those circumstances, the contract cannot operate properly. The way
in which the test is to be described has varied over the years, but it is
these days accepted that the correct formulation is that of ‘business
efficacy’. The leading authority is now the Privy Council decision
in Attorney General of Belize v Belize Telecom Ltd [2009] UKPC 10, in
which Lord Hoffmann has emphasised that implication is a matter of
ascertaining the intentions of the parties and then adding a term which
gives effect to those intentions. The term implied must be essential to
the operation of the contract. Terms implied in this way are said to be
‘terms implied in fact’, as they meet the facts of the special case before
the court.
Secondly, the courts may imply terms into contracts of a specific
class so that the contracts all comply with minimum standards. In
a contract for the sale of goods, for example, there are statutory
implied terms in the Sale of Goods Act 1979 which apply to all
contracts of sale governed by English law and which are designed
to protect the purchaser against being supplied with goods which
are of unsatisfactory quality or not fit for their agreed purpose. Other
standard form contracts which may be affected by implied terms are
leases and mortgages. Terms of this sort are said to be terms implied by
law, in that they rest not so much on the intentions of the parties but
on the nature of the contract.
Thirdly, the custom and practice of the trade or industry in which the
contract operates may itself justify the implication of a term based
on usage. For any such implication to be made, the term must be
one which is both universally recognised and reasonable. Implication
may fail on either ground. An illustration of the former, universality,
is Baker v Black Sea [1998] Lloyd’s Rep IR 327, in which it was argued
49
before the House of Lords that the market recognised a custom under
which reinsurers would indemnify the reinsured for costs incurred
in defending claims under the direct policy. The House of Lords held
that such a custom could be established by market evidence showing
that this was the universal practice of the market, and the case was
remitted to the trial judge so that such evidence could be produced:
unsurprisingly, the invitation was not taken up by the reinsured.
An illustration of the latter, reasonableness, is Carvill America Inc v
Camperdown UK Ltd [2005] Lloyd’s Rep IR 55, affirmed [2006] Lloyd’s
Rep IR 1. At first instance the judge refused to recognise, on the
grounds of unreasonableness, an alleged custom that the brokerage
payable to a reinsurance broker was payable by the reinsurers and not
by the reinsured, as an implied term to that effect would have been
inconsistent with the rule that the broker is the agent of the reinsured.
The point did not arise on appeal.
In each of these cases, an implied term cannot contradict anything
which has expressly been agreed by the parties (leaving aside the
special case of statutory implied terms, which statute itself may render
incapable of exclusion for consumer protection purposes). Equally, a
term cannot be implied if it would affect the operation of expressly
agreed terms or if the term cannot be formulated with sufficient
precision to allow it to be enforced.
There is no authority on the possibility of implying terms into
facultative contracts: as will be seen, most of the disputes relating to
facultative contracts relate to incorporation. There is some authority
in respect of treaties, although this seems to represent a shift from
an early interventionist approach to the subsequent adoption of the
idea that the parties to a reinsurance agreement can look after their
own interests and that there is rarely justification for attempting to
mend the parties’ bargain. In Phoenix General Insurance of Greece
v Halvanon Insurance [1986] 1 All ER 908 Hobhouse J, obiter, listed
the terms which in his view were to be implied into a facultative-
obligatory proportional treaty (i.e. one under which the reinsurers
were bound to accept any risk which the reinsured, in its discretion,
chose to cede). Those terms were concerned to protect the reinsurers
against negligent underwriting and negligent claims handling on the
part of the reinsured. The reinsured was, therefore, under an implied
obligation to:
a. keep full and proper records of all risks accepted, all premiums
received and receivable, and all claims made or notified
b. investigate all claims made to confirm that they fell within the terms
of the contract and were properly payable before accepting them
c. properly investigate risks offered to them and closings relating
thereto
d. keep full, proper and accurate accounts showing at all times the
amounts due and payable by the [reinsured] to the [reinsurers] and
by the reinsurers to the [reinsured] under the contract
e. ensure that all amounts owing to them were collected promptly
when due, entered forthwith in their accounts and all balances
owing to the [reinsurers were likewise paid in promptly when due
50
f. obtain, file or otherwise keep in a proper manner all accounting

claims and other documents and records and make these available
on request to the [reinsurers].
In Baker v Black Sea [1995] LRLR 287, a case involving a proportional
obligatory surplus treaty, Potter J extended the last of these implied
terms to encompass a duty on the reinsured to allow the reinsurers to
inspect its books and documents at all reasonable times.
However, it is unlikely that these decisions have survived. The House of
Lords on appeal in Baker v Black Sea [1998] Lloyd’s Rep IR 327 rejected
the implication into the treaty of any obligation on the reinsurers to
indemnify the reinsured for costs incurred in defending the claim
brought by the assured under the direct policy, holding that that was a
matter for which the parties could have made express provision if they
had so wished. In Bonner v Cox Dedicated Corporate Member Ltd [2006]
Lloyd’s Rep IR 385, a case involving a non-proportional obligatory treaty,
reinsurers sought to avoid liability on the ground that the reinsured
had been engaged in ‘writing against’ the reinsurance, by accepting
risks that could never be profitable in their own right and which were
viable only because of reinsurance recoveries. In other words, losses
which were all but certain were being imposed upon the reinsurers. The
reinsurers relied upon the Halvanon implied term that the reinsured
would properly investigate risks: the essence of the reinsurers’ case
was that the reinsured owed a duty to the reinsurers not to underwrite
negligently. The Court of Appeal rejected their argument and held
that it was for the reinsurers themselves to assess whether the risk
being presented to them was one which they should properly accept,
and that the highest at which the reinsured’s duty could be put was
to avoid recklessness. The Court of Appeal chose not to comment on
the correctness of Halvanon, and instead distinguished it on the basis
that the treaty in Halvanon was proportional, As explained earlier, the
relationship between a proportional reinsurer and its reinsured is quite
different to that between a non-proportional reinsurer and its reinsured,
in that the former accepts a proportion of the risk based upon the
underlying premium whereas the latter fixes its own premium. That
means that a proportional reinsurer is more reliant on the underwriting
judgment of its reinsured than is the case in a non-proportional treaty.
But, that said, it is far from obvious that Halvanon remains good law.
6.4 Incorporated terms

It has been the practice, almost since the inception of facultative
reinsurance, for the reinsurers to write the reinsurance on the same
terms and conditions as the direct policy. Although doubts have been
expressed on occasion, the generally accepted view is that reinsuring
phrases such as ‘as original’, ‘all terms and conditions as original’ and
‘warranted same gross rate, terms and conditions as the original’
operate to incorporate into the reinsurance the terms of the direct
policy. Typically, a facultative reinsurance consists only of a cover sheet,
with the terms of the direct policy appended to it.
Experience has shown that incorporation is a practice fraught with
difficulty, for two reasons. First, terms which are devised for direct
51
policies may have no relevance at the reinsurance level. Secondly,

the reinsurance may contain its own provisions on specific matters,
and these may be inconsistent with those in the direct policy.
These difficulties have given rise to the doubts referred to above. In
Forsikrings Vesta v Butcher [1989] 1 All ER 402 Lord Griffiths commented
that incorporation is a most unsatisfactory method of doing business
and that a better view of the phrase ‘warranted same gross rate, terms
and conditions as the original’ was that it was some form of warranty
that the terms of the direct policy matched those presented to the
reinsurers. That suggestion was rejected in Toomey v Banco Vitalico
de España de Seguros y Reaseguros [2004] Lloyd’s Rep IR 354, where it
was held that a warranty in the direct policy was incorporated into the
reinsurance. The Court of Appeal on appeal, [2005] Lloyd’s Rep IR 423,
did not comment on the point and instead held that there had been
an express warranty in the reinsurance so the point did not arise. In the
most recent case, WASA International Insurance Co v Lexington Insurance
Co [2009] UKHL 40, it was conceded before the House of Lords that the
terms of the direct policy had been incorporated into the reinsurance.
In HIH Casualty and General Insurance v New Hampshire Insurance
[2001] Lloyd’s Rep IR 161 David Steel J set out the conditions for the
incorporation of a term. Incorporation is possible if: (a) the term was
germane to the reinsurance; (b) the term made sense in the context
of the reinsurance; (c) the term was consistent with the express terms
of the reinsurance; and (d) the term was apposite for inclusion in the
reinsurance. In applying these principles, it is necessary to distinguish
between: dispute resolution terms; coverage terms; and terms setting
out the duties of the parties.
It is now clear that dispute resolution terms – choice of law, choice
of jurisdiction and arbitration – found in the direct policy will not be
regarded as incorporated into the reinsurance unless the words of
incorporation expressly refer to the term in question. This is not a rule
confined to reinsurance, and stems from the principle that any term
which removes from a person the right to go to his home court must
be agreed to expressly. See, on this point:
• Pine Top Insurance v Unione Italiana [1987] 1 Lloyd’s Rep 476
• Excess Insurance v Mander [1995] LRLR 358
• Tryg-Hansa v Equitas [1998] 2 Lloyd’s Rep 439 (arbitration clauses)
• AIG Group UK Ltd v The Ethniki [1998] 4 All ER 301
• Gan Insurance Co Ltd v Tai Ping Insurance Co Ltd [1999] 2 All ER
(Comm) 54 (choice of law and jurisdiction clauses).
Terms of coverage and also exclusions are generally appropriate for
incorporation. This ensures that the scope of the insurance and the
reinsurance are back to back. There will not be incorporation, however,
if the reinsurance contains its own differently worded coverage
provision, as in Aegis Electrical and Gas International Services Ltd v
Continental Casualty Co [2008] Lloyd’s Rep IR 17 where the reinsurance
agreement contained a definition of the term ‘accident’ which
specifically excluded ‘explosion’ whereas that risk was covered by the
direct policy.
52
The most difficulty arises in relation to obligations imposed upon

the parties. There are two issues here. The first is that the obligation
may be one which is inappropriate at the reinsurance level. In Home
Insurance of New York v Victoria-Montreal Fire [1907] AC 59 the direct
policy required any claim to be brought against the insurers within
12 months of the occurrence of an insured peril. This provision was
held by the Privy Council not to have been incorporated into the
reinsurance because it potentially put the reinsured in difficulty (e.g.
where a claim was made against it at the very end of the 12 month
period so that a timely claim could not be made against the reinsurers).
The second issue is that the wording of the direct policy may be
framed so as to refer to ‘insurer’ and ‘assured’ and not ‘reinsurer’ and
‘reinsured’. That raises the question of whether it is possible, in order
to achieve incorporation, to ‘manipulate’ the words of the insurance
term so as it make it fit the reinsurance context. The point is well
illustrated by HIH Casualty and Genreal Insurance v New Hampshire
Insurance [2001] Lloyd’s Rep IR 702. The direct policy contained a
waiver of defences provision under which the insurers agreed that
they would not rely upon failure to disclose material facts as a ground
for avoiding the policy. The reinsured asserted that this provision had
been incorporated into the reinsurance so that the reinsurance was
relieved from any duty of disclosure. The Court of Appeal distinguished
between the fact of incorporation and the effect of the term as
incorporated. The Court of Appeal was satisfied that the term had
been incorporated, but further held that it had been incorporated in
an unmanipulated form, so that it took effect in the reinsurance as a
statement that the reinsured had waived its disclosure defences against
the assured. The result was that the incorporated term did not relieve
the reinsured of its own duty to disclose, but operated as a statement
that the reinsured had waived the assured’s duty of disclosure and
that the reinsurers agreed to indemnify the reinsured if payment was
required despite non-disclosure by the assured. See also Hanwha Non-
Life Insurance Co Ltd v Alba Pte Ltd [2011] SGHC 271, where the court
ruled that a provision in the direct policy under which the consent of
the insurers was required for the extension of any accepted risk was
held not to be incorporated into the reinsurance, so that the reinsurers
themselves did not have the right to refuse to accept a risk which had
been extended by the insurers as long as it otherwise fell within the
scope of the reinsurance. The point here is that incorporation has an
uncertain effect.

• identify and outline the most important principles adopted by the courts in
construing a contract of reinsurance
• identify and outline the most important express terms of a contract of
reinsurance
• explain the circumstances in which the courts will imply a term into a contract
of reinsurance
• discuss the effectiveness of attempts to incorporate terms from a direct policy
into the reinsurance.
53

1. What are the sources of the terms of reinsurance contracts?
2. When will the courts imply a term on business efficacy grounds?
3. When will the courts imply a term on customary grounds?
4. What problems are raised by incorporation from the direct policy into the
reinsurance?
54
Appendix 1: The examination
Appendix 1: The examination
Examination questions may be either essays or problems. An essay

question will ask you to discuss a particular aspect of the syllabus. It
may be a general question or it may focus on a specific aspect of the
course. A problem question will provide you with a factual scenario
and ask you to give advice to one or more of the parties. Examination
questions tend to direct attention to areas which are controversial or
not fully resolved. In all cases it is important to keep to the point. The
Examiner does not want to read information which is unrelated to the
question and you will not receive any credit for it; that is important,
because you only have a limited time for each answer. It is often useful
to make a brief plan of the points that you intend to cover in your
answer, and to make sure that you allocate sufficient time to each of
them. You can put a line through the plan so that the Examiner does
not mark it.
Sample examination questions

Sample essay 1
What features of a contract of reinsurance distinguish it from a contract of
insurance?
Advice on answering the question

You might here look at matters such as:
• the way in which insurance contracts are formed
• the special rules relating to insurable interest
• the use of incorporation
• the particular issues that arise for non-disclosure and misrepresentation,
particularly with regard to treaties.
Sample essay 2
What legal issues arise from the formation of a contract of reinsurance in advance
of the contract of insurance to which it relates?

You might here look at matters such as:
• the procedure that is used
• the status of the reinsurance pending the making of the insurance
• the standing offer concept
• the duties of the broker.
Sample problem
White Hart Insurance issued a property and business interruption risks policy
to Harry. This was stated to be governed by the law of Bermuda and subject to
arbitration in Bermuda. The policy required Harry to notify all claims within 14
days, and it also stated that White Hart would not terminate cover if Harry was in
55
arrears with premium payments. White Hart reinsured under a facultative policy
issued by Tottenham Reinsurance under a contract which stated ‘all terms and
conditions as original’.
Harry’s premises suffered a disastrous fire on 1 May 2012, and Harry gave notice of
loss to White Hart on 13 May 2012. White Hart informed Tottenham Reinsurance
of the loss on 20 May 2012. White Hart agreed to settle Harry’s claim, and
demanded payment from Tottenham Reinsurance. Cover was denied on the
grounds that White Hart had not paid any premiums under the policy and also
that the claim had been made by White Hart later than the 14 days allowed. White
Hart then served a notice of arbitration in Bermuda on Tottenham Reinsurance.
Tottenham Reinsurance have asked for your advice on their legal position.

This problem is asking for discussion of the following matters:
• the principles which govern incorporation
• whether the arbitration clause has been incorporated
• whether the notice of loss clause has been incorporated
• whether the premium payment clause has been incorporated.
56
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International

Module A: The contract of reinsurance

University of London International Programmes

Published by the University of London Press

Chapter 1 Introduction ........................................................................................... 1

1.1 Introduction to the course

1.1.1 Structure of the course

1.1.2 Detailed programme of study

• In Module B: Reinsurance losses and claims, we explore in more

Aims of the course

Course learning outcomes

1.2 Introduction to Module A: The contract of reinsurance

Aims for Module A

Learning outcomes for Module A

1.3 How to use this Study Guide

1.4 Other study resources

Useful further reading

Using online resources

1.5 Keeping up to date

be published on the eCampus in February or March each year. It will

1.6 Allocating your time

1.7 Preparing for the examination

Chapter 2 The definition of reinsurance

2.1 General definition

themselves, under contracts known as ‘retrocessions’ (reinsurance of

The nature of the reinsurance thus depends upon how it is defined in

2.2 Facultative reinsurance

or expertise, the risk may be brokered in the London market as a

2.3 Treaty reinsurance

reinsured has failed to inform the reinsurers of a cession, that default

2.4 Relationship between assured, insurer and reinsurers

Reminder of learning outcomes

Chapter 2 Self-assessment questions

Chapter 3 Regulation of reinsurance business

3.1 Reinsurance as insurance

There is, however, a technical distinction between facultative contracts

3.2 The Reinsurance Directive

from the host. The 2000 Act is administered by the Financial

other Member States to regulate their pure reinsurers up to UK

3.3 Reinsurance intermediaries

reinsurance cover from one or more reinsurance underwriters. Very

States. The Directive applies to reinsurance intermediaries, although

Chapter 3 Self-assessment questions

Chapter 4 Formation and insurable interest

4.1 Formation procedures

4.1.1 Slip procedure

subscription. The standard procedure for placing reinsurance risks in the

incorporated into the policy, so that the reinsurance did impose a

4.1.2 London Market principles

4.1.3 Market Reform Contract

scratching. Accordingly, there was a binding contract on the terms

A facility under which the underwriters delegate authority to

4.2 Reinsurance in advance of insurance

2 Lloyd’s Rep 529. Here, a broker was instructed to place insurance

4.3 Rules relating to insurable interest

makes a claim under a policy, and – that point aside – instances

The underlying theme is nevertheless a pecuniary interest. The main

4.4 Application of insurable interest rules to reinsurance

There is some difficulty in ascertaining exactly how the insurable

Reminder of learning outcomes

Chapter 4 Self-assessment questions

Chapter 5 Utmost good faith