Reinsurance: Broker negligent for failing to make fair presentation of risk

The Plaintiff cedant participated in a treaty which was a reinsurance of the marine excess of loss account of a number of Lloyd's syndicates.

The Plaintiff cedant instructed the Defendant brokers to obtain retrocession cover. The Defendant brokers arranged retrocession agreements with various insurers from both the Lloyd's and the London companies' market and the overseas market.

Subsequently, the Plaintiff cedant suffered extremely heavy losses which it sought to recover from its retrocessionaires. The retrocessionaires avoided the cover on the basis of material misrepresentation and non-disclosure, in particular, as to the nature of the underlying reinsurance treaty subscribed by the Plaintiff cedant.

Subsequently, an arbitration took place between the Plaintiff cedant and the retrocessionaires at which it was held that the retrocessionaires were entitled to avoid the cover.

Following the arbitration, the Plaintiff cedant commenced proceedings against its brokers alleging negligence in the placing of the retrocession agreements. The brokers denied liability.

Held:

The brokers were negligent in that they had failed to make a fair presentation of the risk to the retrocessionaires.

The Defendant brokers had placed the cover on the basis that the Plaintiff's treaty was a quota share, whereas it was, in fact, a facultative/obligatory treaty.

Under a quota share treaty, the cedant is obliged to cede and the reinsurer is obliged to accept, a fixed proportion of all business protected by the treaty.

Under a facultative/obligatory treaty, the cedant may select either those risks which it wants to cede, or what proportion of its participation in each risk it wishes to cede, or a combination of the two. This is the "facultative" element. The reinsurer is obliged to accept the risks ceded and this is the "obligatory" element.

The Judge accepted that facultative/obligatory treaties were generally regarded in the London market as less attractive than quota share treaties. This was mainly because of the risk of "anti-selection" by the cedant and, indeed, there was some tendency for cedants to use facultative/obligatory contracts as a "dumping ground" for high risk or other poor quality business.

On that basis, the nature of the Plaintiff's treaty was material information according to the test in Pan Atlantic Insurance Co Limited -v- Pinetop Insurance Co Limited (1994).

As regards the following market, the Judge held that, the fact that the brokers had made a misrepresentation to the Leading Underwriter regarding the nature of the Plaintiff's treaty was, in itself, a material fact which the brokers were required to disclose in order to make a fair presentation of the risk to each of the following insurers.

Overall, the Judge was satisfied that the brokers had made an unfair presentation of the risk and that they were therefore in breach of duty.

The Judge then considered the issue of quantum.

The Plaintiff's primary case was that the brokers should meet the total loss it had suffered on the treaty on the basis that it would not have participated unless the brokers had advised that retrocession protection was available.

The Plaintiff's alternative case was that the brokers were liable for the amount which the Plaintiff had not been able to recover under the actual retrocession agreements.

The Judge found that, if there had been a fair presentation of the risk, alternative retrocession cover would have been available at a broadly similar price. Accordingly, the Plaintiff's primary case was too generous, because it would involve the brokers paying more than the Plaintiff would have been able to recover from the retrocessionaires had the retrocession agreements not been validly avoided. The Plaintiff's alternative case was therefore the correct way to assess damages.

In that regard, the Judge referred to the SAAMCO case, where the House of Lords held that the liability of a professional Defendant is limited to that part of the Plaintiff's loss which falls within the scope of the Defendant's duty of care. On the present facts, the Plaintiff's participation in the treaty resulted in extremely heavy losses because of, for example, Hurricane Hugo and Exxon Valdez. The brokers did not, however, assume a duty to advise the Plaintiff as to whether to enter the marine market and, in particular, whether to participate in the treaty. Accordingly, the Judge held that the Defendant brokers should only be liable for the amount which the Plaintiff could not recover from the retrocessionaires. The other losses suffered by the Plaintiff were not attributable to the broker's breach of duty.

Note:

The Judge commented that it is highly desirable in the interests of justice (and of avoiding unnecessary cost and delay) that, whenever practicable, claims against brokers should be heard at the same time, and by the same tribunal, as that which decides whether underwriters have validly avoided. Reinsurance disputes are, of course, often resolved by means of an arbitration. The arbitration award will not be binding on the broker and, in the absence of any issue estoppel, there is a danger that the issues will have to be re-litigated in subsequent proceedings between the cedant and the broker. One answer to this problem is for the broker to participate as a party in the arbitration. However, depending upon the facts, it may be better for the broker to keep a low profile in the hope that either the arbitrators will find the reinsurance to be valid, or the cedant and reinsurers will reach a commercial compromise of their dispute without any contribution or, alternatively, only a modest contribution being sought from the brokers.

The Judge also commented that it is highly desirable that a means be found of recording (in a form which precludes later dispute) what was said between brokers and underwriters at the time of the presentation of a risk. Clearly, disputes would be minimised if brokers made and retained contemporaneous notes.

Cameron McKenna acted for the Plaintiff cedant (Aneco Reinsurance Underwriting Limited (in liquidation) - v - Johnson & Higgins, QBD: Judgment 1st August 1997).