15 Apr 2009

What's covered, and what's excluded? Contracts of reinsurance and section 18B

The NSW Supreme Court has confirmed that contracts of reinsurance are subject to the beneficial operation of section 18B of the NSW Insurance Act 1902 - and that exclusions and limitations have a precise meaning separate to the scope of cover (Westport Insurance Corporation v Gordian Runoff Limited [2009] NSWSC 245)

The policy, the reinsurance treaties, and the arbitrators

Gordian Runoff wrote a Directors & Officers (D&O) liability run off policy for FAI. Westport then wrote excess of loss reinsurance treaties over three layers for Gordian Runoff. Gordian Runoff asked Westport to expand the reinsurance cover to include D&O policies written for up to three years.

So far, so good.

A dispute then arose, so the reinsured and reinsurer went to arbitration. A key issue in the arbitration was the effect of section 18B of the Insurance Act.

According to the NSW Government when it was introduced, section 18B was intended to allow a court to permit an insured person to remain indemnified in the face of clause in an insurance contract that specifically excludes or limits the liability of the insurer, where there is no connection between the loss and the event or circumstances triggering an exclusion or limitation.

The arbitrators considered that the agreement made at Gordian Runoff’s request to extend cover for D&O policies to include those issued for up to three years was a "limitation" or "exclusion" of others, and that triggered section 18B.

And why the arbitrators were wrong

In effect, the arbitrators' view meant that the three-year time period in the reinsurance treaties was irrelevant - the reinsurers were bound to provide cover to Gordian for any D&O policy, of any length, so long as the claim for which Gordian Runoff sought indemnity was made and notified in the first three years of the policy.

This would have the effect of making policies outside the agreed class of business covered by the reinsurance treaties, said the NSW Supreme Court, and that could not be right.

The fundamental error made by the arbitrators was that they conflated the scope of cover with the exclusions or limitations.

The parties defined the agreed scope of cover - D&O policies with periods of insurance up to three years. As the Court said, "The definition of cover was an exercise in inclusion… A scope of cover for a reinsurance treaty, defined by reference to the period of underlying policies to be issued by the reinsured, is no different to a scope of cover defined by any other criterion."

An exclusion or limitation is something that only becomes an issue once the class of business has been determined. It explains "the circumstances where, although a policy issued by the insurer is within the class of business of the reinsurance treaty, the happening of a particular events or the existence of a particular circumstance has the effect of excluding or limiting the reinsurer’s obligation to indemnify the insurer for any claims arising under that policy."

Implications for insureds and reinsurers

This is the latest case tackling the application of the NSW Insurance Act to reinsurance and arbitration agreements (starting with the decision in HIH v Wallace.

It's clear that reinsurers and reinsured alike will need to take the Insurance Act into consideration in their dealings in New South Wales.

The decision is also a timely reminder of the distinction between the scope of cover on the one hand and exclusions and limitations on the other, and that courts will apply that distinction.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.