Equitas v R&Q – a kickstart for the LMX spiral?

The recent decision of Mr Justice Gross in Equitas v R&Q [2009] EWHC 2787 (Comm) addressed specific aspects of two original LMX market catastrophe losses, Kuwait and Exxon Valdez, and the effect of those losses on the LMX spiral. The losses entered the spiral in 1990 and 1989 respectively but had since been judged to be "tainted" because they contained incorrectly aggregated (Kuwait) and irrecoverable (Exxon) elements. The market was acknowledged by Mr Justice Gross as being in "lockdown" with the LMX spiral magnifying those "tainted" elements – the direct Kuwait claim of under $350 million in 1991 was magnified by the LMX spiral to create an aggregate market UNL in excess of $6 billion by 2000.

Equitas, as reinsured, argued that its claims on the contracts in dispute were capable of being proved through the use of actuarial modelling and that its models did prove the claims to the requisite standard of proof ie on the balance of probabilities.

R&Q, the reinsurer, objected, both as a matter of principle and as a matter of fact. It stated that the losses could not be proved by a generalised actuarial model which does not replicate the LMX spiral, and that the claims should lie where they fell – unless Equitas could prove that each sum was properly due on a contract by contract basis. Further, it stated that, even if Equitas could overcome this objection of principle, the model utilised by Equitas was flawed. R&Q did not propose an alternative model itself but relied on criticism of the Equitas model.

The question for Mr Justice Gross was whether Equitas could establish that its claims fell within the scope of cover of the contracts. This involved a two stage analysis: first (i) whether the actuarial modelling approach was permissible as a matter of law and, if so, (ii) whether the Equitas models provided evidence of the claims such as to satisfy the burden of proof – a question of fact.

The contracts contained the same "double proviso" loss settlement provision addressed by the House of Lords in Hill v M&G [1996] 1 WLR 1239 HL (and/or the JELC equivalent):
 
“All loss settlements by the Reassured including compromise settlements...shall be binding upon the Reinsurers, providing such settlements are within the terms and conditions of the original policies and/or contracts … and within the terms and conditions of this Reinsurance”.

As a matter of law, the reinsured was required to prove that the settlements were within the terms of the insurance, and the reinsurance, to a standard of the balance of probabilities. However, Hill v M&G did not prescribe how the reinsured could, or should, prove its claims.

Mr Justice Gross therefore decided that a reinsured could, as a matter of principle, choose appropriate evidence to seek to prove its claims, which in his view could include an actuarial model. The reinsured was not required to prove liability under each and every underlying contract. Consequently, the inability of Equitas to reconstruct the LMX spiral and to provide evidence of the untainted Exxon and Kuwait claims through it, on a contract by contract basis, was not fatal to its claim.

On the question of fact, Mr Justice Gross decided that the Equitas models were capable of proving the claims on the balance of probabilities. The potential weaknesses of actuarial models were addressed both in abstract (the comparison of this approach with direct evidence) and in the specific, through dealing with the various detailed objections of R&Q. In short, it was acknowledged by Mr Justice Gross that actuarial modelling was "complex, expensive, imperfect and… not ideal in the context of this litigation".

However, Mr Justice Gross concluded that the models were "both capable of making the transition from the general to the particular and [did] go on to provide a reasonable representation of reality". The models assisted "in doing practical justice in this case", producing "a solution emphatically preferable to leaving the losses to lie crudely where they fall.". He hoped that the LMX spiral would be "kickstarted" by his judgment. In the coming months we will see whether that is the outcome.

Contacts

The information in this article is for general guidance only and is not intended to be a substitute for specific legal advice. If you would like any further information please contact:




Mark Everiss
Partner, Insurance & Reinsurance Group (London)
t: +44 (0) 20 7556 4523
e: MEveriss@eapdlaw.com