Authored by Donald Dinnie.
This Kings Bench judgment dealt with an interesting insured defence costs erosion issue. The question was whether the £4 million excess applicable under the reinsurance policies, prior to accessing the reinsurance cover of £16 million, eroded by both indemnity payments and defence costs, or by indemnity payments only. The court held that the defence costs incurred by the claimants did not erode the £4 million excess under the reinsurance.
The court held that the UK basic principles of construction of contracts applied to insurance and reinsurance contracts.
The reinsurance policies were facultative back-to-back policies which followed “original terms”.
The natural understanding of the “Limit” provisions in the policies would be that the £16 million of cover and the £4 million for excess reflected the £20 million in the Royal Master Policies and were related to indemnity cover and not defence costs.
The court said that that understanding was confirmed by the structure of the policies, the natural interpretation of which was that it referred to the insured group’s liability for damages or compensation to third-party claimants. The duty to pay defence costs was additional. The “Limit” provisions for the £16 million related only to indemnity and not defence costs and it would be surprising if the £4 million excess related any differently. The court held that there was nothing uncommercial in that interpretation. It was correct that the result might be that the insurers would expend large amounts of money on defence costs without the excess ever being exhausted but their own obligation under the policies was to pay defence costs within the financial limit. It was only when the indemnity limit had been reached would the obligation to pay defence costs end.
Equally so, on the other hand, once the £4 million excess under the reinsurance policies was exhausted, the reinsurers would be similarly exposed to an obligation to pay defence costs without financial limit until the £16 million of the indemnity cover was exhausted.
The court acknowledged that things could turn out disadvantageously for either party.
Reinsurance policies are seldom litigated or arbitrated in South Africa.
On the application of general principles the outcome would likely be the same in South African law. Insurance and reinsurance parties who do not have appetite for the risks and exposures identified by the judgment should consider appropriate amendments to their relevant wordings.