UK Court Opinions

A London Court of Appeal recently vacated and remanded a High Court’s decision precluding the approval of a deal to transfer approximately 370,000 annuities after concluding that the High Court made several errors in its analysis of the relevant factors in play.

Prudential Assurance Co. (PAC) and Rothesay Life PLC entered into a reinsurance agreement “to transfer the majority of the economic risk and reward of the annuity business covered by the agreement from PAC to Rothesay.” The “assets backing the annuity policies were transferred by PAC to Rothesay as part of the premium for the reinsurance.”

A separate business transfer agreement “contemplated that the parties would cooperate to achieve the actual transfer of th[e] business through” regulatory and court approval.

As part of the approval process, the parties asked the High Court of Justice of the Business and Property Courts in London “to sanction a scheme … providing for the transfer from PAC to Rothesay of some 370,000 annuity policies written by PAC” under the United Kingdom’s Financial Services and Markets Act 2000, which permits discretionary court approval of such schemes if “in all the circumstances of the case, it is appropriate to sanction the scheme.”

The High Court declined to approve the scheme. In short, the court did so because, among other things, (1) “Rothesay did not have the same capital management policies or the backing of a large well-resourced group” (in other words, PAC, which was part of the Prudential family, had much more support from its parent in the event of a financial crisis) and (2) “it had been reasonable, in the light of PAC’s sales materials, age and reputation, for policyholders to have chosen PAC on the basis of an assumption that it would not seek to transfer their policies” (in other words, policyholders selected PAC for its financial strength and reputation and reasonably believed that they would be dealing with PAC for the life of their annuities, which could be decades).

PAC and Rothesay appealed, and the Court of Appeal vacated and remanded.

In sum, the Court of Appeal held, among other things, that the High Court “ought not to have concluded that there was a material disparity between the non-contractual external support potentially available for each of PAC and Rothesay” (put differently, the court wrongly believed Rothesay had less support from its parent than PAC had from its parent) because the High Court “disregarded the opinion of [an independent] expert and the [Prudential Regulation Authority] as to [PAC’s and Rothesay’s] future financial resilience on the false basis that those opinions were themselves founded upon only a snapshot of the current year” when they were not.

Even putting that aside, the Court of Appeal explained that the theoretical availability of “non-contractual parental support” that the High Court felt would be provided by PAC’s parent (Prudential) to protect its reputation in the event of a financial crisis at PAC was irrelevant because it was not proper to “assume that any non-contractual parental support will be available in the future” because, among other things, “[p]arents can never be required to support their subsidiaries” and “parents of insurers are always at liberty to sell their regulated subsidiaries.” The independent expert had, in any event, concluded that the risk of either “PAC or Rothesay needing external support in the future was remote,” and the High Court failed to give that opinion proper weight.

Turning to the High Court’s analysis concerning the policyholders’ decisions and expectations, the Court of Appeal concluded that the High Court “ought not to have accorded any weight to the fact that the objecting policyholders chose PAC on the basis of its age, venerability and established reputation, and reasonably assumed that PAC would always provide their annuities” because such subjective considerations were irrelevant and the “only correct question was whether the transfer would have a material adverse effect on the security of their benefits.”

In re Prudential Assurance Co., No. [2020] EWCA Civ 1626 (Feb. 12, 2020).

In a closely watched case, the Court of Appeal of England and Wales has given reinsurers a win with respect to reinsurance claims related to mesothelioma and other asbestos-related diseases. The decision bars insurers from engaging in “spiking.” Under that practice, insurers were making a single reinsurance claim for the entire loss to an injured employee under a single reinsurance policy of their choosing rather than allocating the loss on a pro rata basis between the various policy years in which the employee was exposed to asbestos. Prohibiting “spiking” is a significant win for reinsurers.

The decision stemmed from a dispute between insurer Municipal Mutual Insurance Limited (MMI) and reinsurer Equitas Insurance Limited.

For decades, MMI has issued employers’ liability (EL) policies to insured entities on an annual basis. Many of the entities insured by MMI faced claims from their employees for mesothelioma and other diseases related to exposure to asbestos in the workplace. Because of unique developments in the law of the United Kingdom regarding asbestos litigation, employees who made such claims did not need to prove which employer caused the critical exposure or the year in which the critical exposure occurred. (Under the Fairchild jurisprudence, all employers who made a material contribution to the risk of mesothelioma are jointly and severally liable for the employee’s injury. Pursuant to an act of Parliament that reversed a Barker decision, an employee can recover their entire damages from any employer during the years in question.) As a result, MMI did not need to, nor did it, identify which policy provided coverage for a particular claim when it paid claims. Nor did MMI apportion the claims among policy years.

MMI reinsured its liability under its EL policies with Lloyd’s syndicates whose liabilities are currently held by Equitas. Unsurprisingly, MMI presented its claims for asbestos-related losses to Equitas initially on a pro rata basis whereby the loss was divided over the years the claimant was exposed to asbestos. However, after several years, MMI began presenting each claim under a single year of reinsurance. MMI claimed that, because each underlying insurance policy was liable in full for the loss, each claim could be presented to a single annual reinsurance policy of its choice, i.e., “spiking.” Spiking benefited MMI because it maximized its recovery. By spiking, MMI avoided multiple retentions, submitting claims to reinsurers who were insolvent and reducing paperwork and potential disputes. Spiking was detrimental to Equitas because, by MMI’s spiking, MMI had fewer retentions and was able to submit more to reinsurance, and Equitas could find itself paying for years it had not provided reinsurance.

Equitas and MMI arbitrated whether MMI could engage in “spiking.” A judge-arbitrator ruled in favor of MMI, agreeing that, because developments in the law made each annual EL policy liable for all of an insured’s loss, MMI had a contractual right to present its claim for reinsurance under any reinsurance policy year that corresponded to an EL policy year that was liable for the individual claimant’s loss. The judge-arbitrator further concluded, among other things, that even if MMI had a duty of good faith with respect to how it presented its reinsurance claims, MMI did not breach that duty because it had “expressly acknowledged that there was a need for equitable recoupment and contribution to redress any anomalies.”

Equitas obtained leave to appeal the judge-arbitrator’s decision.

The Court of Appeal reversed. The court rested its decision on the duty of good faith. (Notably, the court (and the judge-arbitrator) explained that the duty of good faith in New York differs significantly from the duty of good faith under the law of the United Kingdom.) Lord Justice Males, whose decision was joined by Lord Justice Leggatt (who also wrote a concurrence) and Lord Justice Patten, summarized his reasoning regarding the duty as follows:

In my judgment there are powerful reasons to support the implication of a term in the very specific reinsurance context existing within the Fairchild enclave that the insurer’s right to present its reinsurance claims must be exercised in a manner which is not arbitrary, irrational or capricious, and that in that context rationality requires that they be presented by reference to each year’s contribution to the risk, which will normally be measured by reference to time on risk unless in the particular circumstances there is a good reason (such as differing intensity of exposure) for some other basis of presentation.

The reasons supporting applying the duty of good faith in that manner included the fact that “spiking is inconsistent with the presumed intentions and reasonable expectations of the parties at the time when the contracts were concluded,” which was long before the unique Fairchild jurisprudence that allowed MMI to choose between numerous policies existed.

The Court of Appeal therefore adopted the method proposed by Equitas: Reinsurance claims based on exposure in multiple policy years for which the insurer has not allocated its loss among the various policy years at issue must nevertheless be presented to the reinsurer on a pro rata basis for purposes of calculating the applicable reinsurance payment.

MMI will likely appeal the decision to the Supreme Court of the United Kingdom.

Assuming it stands, the Court of Appeal’s decision constitutes a significant win for reinsurers exposed to asbestos-related claims in the United Kingdom. Spreading reinsurance claims regarding asbestos injuries across multiple policy years will require compliance with multiple retentions and potentially mean that more than one reinsurer is involved in each claim.

Equitas Ins. Ltd. v. Municipal Mut. Ins. Ltd., [2019] EWCA Civ 718 (Apr. 17, 2019).