Royal & Sun Alliance v Equitas: High Court clarifies reinsurance excess erosion and settlement obligations

His Honour Judge Keyser KC's recent judgement in Royal & Sun Alliance Insurance Limited v Equitas Insurance Limited provides important guidance on several contentious reinsurance issues, particularly the erosion of excess layers and the interplay between claims co-operation and follow settlements clauses.

The dispute arose from facultative excess of loss reinsurance policies covering the period 1981-1985, under which RSA sought recovery of approximately £3.76 million for liabilities incurred through toxic tort settlements relating to BOC Group's asbestos and welding product exposures. Equitas, as successor to Lloyd's syndicates' liabilities, disputed both liability and quantum.

The court addressed four principal issues, each carrying significance for reinsurance practice. On the defence costs erosion question, Judge Keyser held that the £4 million excess in the reinsurance policies was eroded solely by indemnity payments, not defence costs. This interpretation aligned with the structure of the underlying Royal Master Policies, where defence costs sat alongside but separate from the indemnity cover. The judgement emphasised that in back-to-back reinsurance, the natural reading of limit provisions correlates to the underlying policy structure. The £16 million reinsurance cover and £4 million excess reflected the £20 million indemnity limit, with defence costs remaining additional rather than erosive.

Regarding the claims co-operation clause, the court rejected Equitas's argument that it circumscribed RSA's power to make binding settlements. Unlike the position in Insurance Co. of Africa v Scor, where an express prohibition on settlement without approval effectively emasculated the follow settlements provision, the clause here merely restricted litigation without consent. Judge Keyser distinguished between requiring agreement on settlement strategy versus settlement terms, finding the clause compatible with the follow settlements provision's underlying philosophy of trusting insurers' settlement decisions.

The judgement comprehensively addressed whether Newark Insurers failed to take proper and businesslike steps in entering the Toxic Torts Settlement Agreement. Equitas challenged the inclusion of Global Excess Policies' limits in allocation calculations, arguing this created an inequitable spike in coverage for 1981-1985. The court heard extensive expert evidence on New Jersey allocation law under Owens-Illinois and Carter-Wallace. Judge Keyser concluded that whilst reasonable opinions could differ on the allocation methodology, Mr Charles Miller's advice that the Global Excess Policies would likely be included was not negligent. The settlement at 47% allocation represented a reasonable commercial decision given the risk of a 72% allocation if the matter proceeded to judgement.

The court's analysis highlighted that New Jersey's presumptive allocation method intentionally assigns greater losses to years with higher insurance purchases, reflecting economic realities of risk transfer. The substantial coverage spike in 1981-1985 didn't constitute exceptional circumstances warranting departure from this method.

On interest, whilst RSA claimed compound interest following Sempra Metals principles, the court awarded simple interest at 2% above base rate. Judge Keyser found insufficient evidence that compound interest reflected actual losses, distinguishing this case from Equitas Ltd v Walsham Brothers where specific market evidence justified compound interest.

This judgement reinforces that reinsurers challenging settlements face a high burden when alleging failure to take proper business steps. It clarifies that defence costs provisions in facultative reinsurance require careful analysis against underlying policy structures, and confirms that claims co-operation clauses must be construed consistently with follow settlements provisions where possible.