In the first judgment to provide guidance on the allocation of mesothelioma liabilities at a reinsurance level, the Court of Appeal in Equitas Insurance Limited v Municipal Mutual Insurance Limited  EWCA Civ 718 has ruled that insurers cannot choose to allocate their full loss to whichever reinsurance policy would produce the maximum recovery, ie so-called “spiking” or “pick-and-choose” is not permitted. Rather, losses must be presented to reinsurers on the basis of a pro rata allocation by reference to time on risk.
1. Background to Mesothelioma Claims
The epic struggles of the English Courts in grapplling with the unique problems presented by mesothelioma claims are well-known. One of the outcomes was the development of a common law rule allowing an employee who has been exposed to asbestos over a number of years (and a number of employers) to recover the full amount damages from any single employer, even where it is not possible to prove on the balance of probabilities which employer was responsible for the critical exposure which caused the disease (Fairchild v Glenhaven Funeral Services  UKHL 22; Compensation Act 2006, s.3). Employers can then pursue other employers for contribution (apportioned on basis on the period of employment).
Similarly, any Employers’ Liability insurer on risk during the period of wrongful exposure is liable to indemnify the employer in full, regardless of the period for which it provided cover (Zurich Insurance plc UK Branch v International Energy Group Ltd  UKSC). Insurers can then pursue other insurers on risk for contribution (apportioned on a time on risk basis) or even the employer itself for periods during which it was uninsured.
Until the decision of the Court of Appeal in Equitas, there had been no guidance as to whether an insurer who has indemnified an employer in full can “spike” its full loss to a single policy year of reinsurance.
2. The Facts
Municipal Mutual Insurance Ltd (“MMI”) had a number of insureds who had tortiously exposed employees to asbestos. MMI had indemnified employers (under policies that had no limits and no deductibles) in respect of claims from those employees, but did not apportion such claims to individual policies or years on the basis that each of its policies was liable in full.
Initially, MMI presented claims to its reinsurers – which included Equitas – on a pro rata basis (divided between the years of reinsurance in which the employee claimant was exposed to asbestos). However, later, it began presenting the entire loss to one single policy year of reinsurance to mitigate the impact of the insolvency of one of the reinsurers on its programme. This was on the basis that MMI had settled inward claims without apportionment to particular years, and if each insurance policy was liable in full, so too was each reinsurance policy. This is known as “spiking”.
Sitting as a judge-arbitrator, Flaux LJ (a pre-eminent reinsurance expert) decided that MMI was entitled to present its reinsurance claim to any given year of reinsurance (on the basis that every annual insurance policy issued by MMI was liable in full). He found that this was not a breach of any duty of good faith (which was limited to the duty not to act dishonestly in connection with making a claim.) When analysing Equitas’ right to claim a contribution from other reinsurers, Flaux LJ held that the contributions should be apportioned using the independent liability method (ignoring the existence of any other (re)insurers when allocating the independent amount each (re)insurer would be liable for.) Equitas appealed this decision.
3. The Court of Appeal Decision
The Court of Appeal unanimously allowed Equitas’ appeal, holding that spiking at a reinsurance level is not permissible, instead losses must be presented to reinsurers on a pro rata basis, based on the time spent on risk.
The Court of Appeal noted that Fairchild, whilst intended to ensure remedies for victims of asbestos exposure, had created necessary anomalies from conventional principles of liability and should be confined to the “Fairchild enclave”. In the present case it was desirable to return to the common law apportionment of liability by reference to contribution to the risk (as per Barker v Corus UK Ltd  UKHL 20) in order to achieve certainty and predictability.
In terms of the best way to achieve certainty and predictability the Court considered three methods proposed by Equitas:
- Deemed Allocation: Males LJ rejected a “deemed allocation” approach (whereby insurers would be deemed to have allocated liability for inward risks proportionately to each insurance policy year by reference to the time spent on risk). It was held that spiking is permissible at an insurance level, and since there is no valid basis for distinguishing between insurance and reinsurance contracts as a matter of construction, if each policy year was 100% liable at an insurance level, then insurers have a contractual right to present a reinsurance claim to the policy year of its choice. The question is then whether the contractual right of insurers to present a reinsurance claim to any policy year is absolute, or constrained by any duties of good faith.
- Implied Duty of Good Faith: Males LJ rejected the applicability of the post-contractual duty of good faith applicable to insurance contracts, and also rejected any influence from the wider concept of good faith in New York case law. However, he looked to a line of case law suggesting that in exercising contractual choices, there should be an implied term that the decision maker’s discretion will not be arbitrary, irrational or capricious:
“…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 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.” (Emphasis added.)
- Contribution and Recoupment: If, for any reason, there is no good faith reason why claims should be presented on a pro rata basis and spiking is in fact permissible, the Court of Appeal adopted Equitas’ proposed approach which would allow a reinsurer that is liable in the spiked year to seek contribution from reinsurers in the equivalent layer in other years, achieving a similar result as a pro rata contribution. Leggatt LJ found that although determining contribution between insurers at an insurance level was relatively straightforward, at the reinsurance level “an insurer has multiple layers of excess of loss reinsurance in each relevant year [and] there may be no direct correspondence between the limits of layers of reinsurance placed in different years.” The Court of Appeal found no need to impose a complex and burdensome approach on the reinsurance market when a more practical and principled approach is at hand (ie pro rata apportionment following the principle set out in Barker).
In many ways this case marks the final frontier for insurers and reinsurers in responding to the extraordinary legal complexities presented by asbestos related losses; spiking of reinsurance recoveries is one of the few major issues of principle that had remained to be resolved. This is in stark contrast to the U.S. where this issue has been the subject litigation for decades, including the well-known 1993 decision in JH France v Allstate which permitted a “pick-and-choose all-sums” reinsurance allocation.
The Court of Appeal has chosen to draw an important distinction between insurance and reinsurance, finding no sufficient public policy reason to depart from the common law notions of fairness at a reinsurance level. While Males LJ had no issue with an implied duty of “good faith” being non-existent at an insurance level (where such a term would risk jeopardising a victim’s ability to recover in full), he was prepared for one to be implied (in a limited way) at a reinsurance level where the public policy risk is minimal.
The Court of Appeal reaching a different result from an authority as distinguished as Flaux LJ speaks volumes for the complexities of the problem and suggests that this is an issue that will need finally to be resolved by the Supreme Court.