In Or Out, Incorporation Of Direct Policy Terms In Reinsurance Contracts

Article by Edward Mann and George Mortimer

First published November 2001

The commercial nature of proportional facultative reinsurance raises a strong presumption that the original cover and the reinsurance will be "back to back"; the reinsurance will respond when the direct policy does, unless there has been a separate or adopted non-disclosure, misrepresentation or breach of warranty by the reinsured, or a breach of claims control or other failure to comply with conditions specific to the reinsurance.

Conventionally, reinsurance contracts seek to ensure that they are "back to back" with the direct policy by including in the slip "subject to the same terms and conditions as original", or a similar provision, which the courts have interpreted as incorporating the direct policy terms as conditions of the reinsurance.

Professor Robert Merkin has argued that incorporation is an archaic concept which fails to recognise the modern understanding of reinsurance, which is that a reinsurer covers not the underlying risk, but the reinsured's liability to his insured. However, the courts have continued to decide cases on the basis that direct policy terms were incorporated. A number of difficulties arise

1. What happens where the original policy and the reinsurance are subject to different systems of law?

This will often be the case where a foreign insurer reinsures business into the London market, as happened in Vesta v Butcher 1 , the first modern English court decision on incorporation. In that case, it was conceded that a warranty in the Norwegian direct policy (that a 24 hour watch be kept over the insured fish farm) was incorporated as a term of the reinsurance (which was subject to English law), because the reinsurance was "warranted same terms and conditions". The original insured's breach of this warranty had not caused the loss, and under Norwegian law, unlike English law, a breach of warranty could only bar a claim if it was causative. The warranty, as incorporated in the reinsurance and if interpreted in accordance with English law, would therefore bar a claim under the reinsurance, but the reinsureds remained liable under the direct policy.

The House of Lords' reluctant solution was to accept incorporation of the warranty, but to hold that the back to back nature of the two contracts dictated that it had to be construed by reference to the intent of the parties that it should bear the same meaning in both contracts; the words of...