Run-Up to Renewals: What is ‘back-to-back’ cover in a reinsurance contract and how can parties achieve certainty?

In the last article in our series, we mentioned that one of the advantages of choosing English law as the governing law of a proportional reinsurance contract is the general presumption that cover is “back-to-back”.

In other words, reinsureds can take comfort from the fact that their liability to the underlying insured will be matched by their reinsurer. In this article, we set out the basic principles of how this works as a matter of English law and provide a refresher on when problems can still arise.

What does back-to-back mean in practice?

Although the terms of the insurance contract can be incorporated into the reinsurance contract by specific clauses (such as “As original” or “Subject to the same terms and conditions as original”) the starting point under English law is that there is a presumption of back-to-back cover anyway.

The practical effect of that is that if non-English law governs the insurance contract, English law will adopt the same meaning of terms in the reinsurance contract as that non-English law, notwithstanding that English law governs the reinsurance contract.

So, for example, in Vesta v Butcher [1989] 1 Lloyd’s Rep. 331, the legal effect of the insured breaching a warranty contained in both contracts was construed in accordance with Norwegian law (which governed the direct policy), even though the reinsurance was governed by English law. 

Accordingly, a defence which would have been available to reinsurers under English law in that case was not available because Norwegian law did not provide the same defence. It was held that that was not unfair to English reinsurers because they were said to have access “to a common legal dictionary”. In other words, reinsurers could have found out what effect a breach of warranty would have under Norwegian law when they entered into the reinsurance contract, in the knowledge that the underlying contract was subject to Norwegian law.

However, there are limits to what can be incorporated into the reinsurance. Even where express incorporation wording is used, that wording will not incorporate terms from the direct insurance contract which would expressly contradict a term in the reinsurance contract, or which would make no sense in the reinsurance contract context (but there can be some “manipulation” to make a term in the insurance contract work in the reinsurance once).

When does the presumption not work?

The presumption only applies to proportional reinsurance. As Lord Muskill put it in Axa Reinsurance v Field [1996] 1 WLR 1026, that type of reinsurance presumes that “the reinsurer is sharing the risk assumed by the direct insurer”. But there is no such presumption for excess of loss or other non-proportional reinsurance and so, if that is what the parties want, it needs to be spelled out in the reinsurance contract. 

Furthermore, even in a proportional reinsurance contract, “back-to-back” is not a rule of law and the precise meaning of the reinsurance contract’s terms will be interpreted by the English Court (or arbitration Tribunal).

In extreme situations, the back-to-back argument will fail. An example of that happened in the House of Lords decision in Wasa v Lexington [2009] UKHL 40. There, a “fundamental” term of the reinsurance contract (the definition of the policy period) could not be overridden by changes in the underlying foreign law which effectively changed and lengthened that period. 

In Wasa, it had not been clear at the time that the reinsurance contract had been entered into what law would govern the direct policy. But the same principles might possibly apply even if it is possible to identify the governing law of the direct policy from the outset, especially where the result of applying a back-to-back presumption would be “wholly uncommercial and outside any reasonable expectations of either party”.

How can parties to a reinsurance contract achieve certainty?  

The decision in Wasa has left some uncertainty. For example, what exactly is a “fundamental term” of a reinsurance contract? Will reinsurers be required to provide cover in every circumstance where it is possible to determine the local law position before the reinsurance was written? Does the back-to-back presumption apply to procedural terms, such as a claims control clause?

For those reasons, it is best to avoid over-reliance on the back-to-back presumption when writing proportional reinsurance and to spell out where the underlying wording is to be incorporated, and where there are differences between the two contracts. 

Reinsurers also need to be confident that they understand what impact local law will have on coverage issues and it should not be assumed that that local insurance law will mirror the English law position.