Lexington Insurance Company (Respondents) v AGF Insurance Limited (Appellants) and one other action Lexington Insurance Company (Respondent) v Wasa International Insurance Company Limited (Appellants) and one other action

A proportional facultative reinsurance is ordinarily intended to be back-to-back with the underlying insurance. That presumption remains a principle of contractual construction, not an inflexible rule requiring the reinsurance to meet every valid claim under the insurance.

The reinsured must establish both that the loss falls within the underlying insurance and that the reinsurance covers the relevant risk. A follow-the-settlements clause does not extend the risks covered by the reinsurance. Under English law, property reinsurance written on a losses-occurring basis covers damage occurring during the stated period, not damage occurring before or after it.

Where the contracts have different governing laws, their respective scope remains a question of construction under each applicable law. Foreign-law treatment of the insurance cannot override a clear temporal limitation in an English-law reinsurance, particularly where that foreign law was not identifiable or reasonably predictable when the contracts were made.

Lexington insured Alcoa and a subsidiary under a three-year property policy covering all risks of physical loss or damage. Wasa and AGF proportionately reinsured that policy for the same period under an English-law facultative reinsurance.

The Supreme Court of Washington, applying Pennsylvania law, held Lexington liable for environmental contamination occurring over several decades, provided some damage manifested during the policy period. Lexington settled the insureds' claims for about US$103 million and sought the reinsurers' corresponding shares.

Simon J held that the reinsurance covered only damage occurring within its three-year period. The Court of Appeal, in [2008] EWCA Civ 150, reversed that decision because it considered the insurance and reinsurance should be construed as back-to-back. The central issue before the House was whether the back-to-back presumption or follow-the-settlements clause required the English-law reinsurance to respond to loss outside its temporal cover.

1. Appeals allowed unanimously. Lord Mance and Lord Collins delivered the principal opinions and agreed with one another. Lord Phillips agreed with both; Lord Walker and Lord Brown agreed with Lord Collins. The judgment of Simon J was restored.

2. Per Lord Mance and Lord Collins, a reinsurance is an independent contract. The reinsured must show both liability under the underlying insurance and entitlement under the reinsurance. The subject matter of conventional property reinsurance is the original property risk, while the insurer's exposure supplies its insurable interest. The reinsurance is not simply an indemnity against every liability which a court may impose under the underlying policy.

3. A follow-the-settlements or full-reinsurance clause binds the reinsurer to an honest, proper and business-like settlement only where the recognised claim falls within the risks covered by the reinsurance. It cannot bring within the contract a risk excluded by its proper construction. Lexington's settlement established its underlying liability but did not answer whether the loss was within the temporal scope of the reinsurance.

4. Per Lord Collins, proportional facultative reinsurance is normally intended to be back-to-back with the insurance. The scope and nature of its cover should therefore begin with a strong presumption of co-extensiveness. Lord Mance likewise treated the principle as commercially sensible. The presumption remains a principle of construction and cannot become an inflexible rule imposing liability for which reinsurers did not bargain.

5. The reinsurance was governed by English law and covered physical loss or damage occurring during the stated three-year period. Under English law that period was fundamental. It did not cover damage occurring before inception or after expiry. The Washington decision imposed liability on Lexington for contamination outside that period, provided some damage existed during it.

6. The insurance and reinsurance had different governing laws. There was no special conflict-of-laws rule curing the resulting inconsistency. Unlike the circumstances in Vesta and Groupama, no identifiable foreign legal system or legal meaning applicable to the underlying insurance could reasonably have been contemplated when the contracts were made. Pennsylvania law was selected later through a blanket choice-of-law decision involving many policies, insurers and sites.

7. Accordingly, neither the back-to-back presumption nor the wording incorporating the original risk displaced the clear English-law temporal limitation. Lord Brown emphasised that even a powerful presumption of co-extensiveness could not override that fundamental limitation.

8. On the subsidiary retention issue, Lord Mance considered the stated US$1.675 million retention to be one aggregate sum for the whole three-year period, not a retention per occurrence. Lord Collins would have dismissed the reinsurers' appeals on that issue, but it did not affect the disposition.

1. House of Lords: The reinsurers' appeals were allowed unanimously and the judgment of Simon J was restored: [2009] UKHL 40.

2. Court of Appeal: Pill, Sedley and Longmore LJJ allowed Lexington's appeal, holding that the reinsurance should respond on a back-to-back basis: [2008] EWCA Civ 150.

3. High Court: Simon J held that the English-law reinsurance covered only property damage occurring during its three-year period. No citation is stated in the judgment.