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Lloyd's Maritime and Commercial Law Quarterly

Facultative reinsurance and the full reinsurance clause

Özlem Gürses * Rob Merkin

This article discusses the decision of the Court of Appeal in WASA International Insurance Co Ltd v. Lexington Insurance Co. Although the judgments are relatively short, the case raises fundamental questions about the very nature of reinsurance, with the so-called “orthodox” view, that reinsurance is a further policy on the original subject-matter, being seriously questioned. The Court of Appeal has further decided: that the “back-to-back” principle which applies to facultative proportional contracts is not confined to warranties but extends also to coverage clauses; that there is no magic in a “Period Clause” which requires the reinsurance wording to be given a meaning different to that of a virtually identical provision in the direct policy; and that the unpredictability as to how the wording of the direct policy might be construed in the future does not excuse the reinsurers from their obligation to follow settlements entered into by the reinsured based on that wording.

I. THE SCENARIO

Reinsurance is the most important mechanism by which insurers may lay off the risks accepted by them. Risk-spreading by way of reinsurance is essential to protect the underwriter against catastrophic losses, to allow the underwriter to extend capacity to risks which but for the security of reinsurance would not be written, and to allow the underwriter indirect access to a foreign market which requires all risks to be insured locally.1 London plays a central role in the worldwide market for reinsurance, and is essential for those jurisdictions which possess insurance but not reinsurance industries: all manner of international risks are ultimately partially or completely reinsured in London. Reinsurance services remain the United Kingdom’s largest invisible export earner, and now form a part of the EC’s single market programme.2
There are various forms of reinsurance contract. Underwriters can protect classes of policy, losses from particular sources or indeed some or all of their whole account, by treaty reinsurances under which classes of risks are ceded to reinsurers. Alternatively, if an underwriter is looking for reinsurance for a single risk to be accepted by him, and there is no available treaty covering that risk, then reinsurance by the facultative method is appropriate. By this means, the underwriter offers the risk to one or more reinsurers, each of whom will subscribe to a proportion of it. The underwriter will generally retain a proportion of the risk for its own account, the size of that proportion varying from case to case, and the reinsurers will be paid the relevant proportion of the original premium received by the underwriter.3 Some, although relatively few, facultative reinsurances are written on a non-proportional basis, so that the underwriter bears the first part of any loss by means of the traditional excess (or deductible) with the surplus being shared between the reinsurers in their respective proportions.

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