Subrogation – top down recoveries

Summary

In Royal & Sun Alliance Insurance PLC v Textainer Group Holdings Ltd the Court of Appeal held that an insured's recoveries were to be applied first to uninsured losses, followed by the insured portion of any losses, applying the "top down" approach adopted by the House of Lords in Lord Napier and Ettrick v Hunter [1993].

Background

Textainer is a large container lessor. One of Textainer's large lessees (Hanjin) entered receivership while in possession of approximately 113,000 containers, held on a mixture of operating leases and finance leases. Textainer claimed against its insurance policies.

Textainer's lessee default insurance programme comprised:

• US$5m retention

• primary policy of US$5m (in excess the US$5m retention)

• five excess of loss policies providing cover up to US$80m in excess of the US$5m retention:

  • 1st excess policy of US$5m excess US$10m;
  • 2nd excess policy of US$5m excess US$15m;
  • 3rd excess policy of US$25m excess US$20m;
  • 4th excess policy of US$10m excess US$45m; and
  • 5th excess policy of US$30m excess US$55m.

• Losses over US$85m were uninsured

Please see here for an illustration of Textainer’s lessee default insurance programme.

Each of the excess policies included a "no drop down" clause, providing that the policy would only ever provide cover for the identified tranche of excess loss, and would not provide cover for the layers below in any circumstances.

Textainer's total losses were agreed in the sum of $101,856,624. Hanjin's default was an event entitling Textainer to an indemnity under the policies, and in total the insurers paid US$75.1m to Textainer. This was made up of payment of policy limits through the first five policies, and a discounted settlement on the 5^th^ excess layer of $25.1m (negotiated in return for the 5th excess layer insurers' subrogation rights being transferred back to Textainer). This left uninsured losses in the region of US$21m (in addition to the retention of US$5m) plus Textainer's rights to recover under the 5th excess policy.

Hanjin then agreed to pay US$25,886,647.60 to Textainer in settlement of Textainer's claim relating to operating leases only.

Subrogation - rights of recovery

On appeal, the principal issue was whether insurers were entitled to a proportionate share of the Hanjin settlement monies, or whether those recoveries should first be applied to Textainer's uninsured losses, applying the "top down" approach adopted by the House of Lords in Lord Napier and Ettrick v Hunter [1993]. The Court concluded that this "top down" allocation of recoveries was the correct approach. This meant that recoveries are allocated to pay off uninsured losses first, above the paid insurance cover, then paid down from the highest layer to the lowest layer of cover, before finally being allocated to reimburse the Insured's retention.

In reaching this conclusion, the Court rejected the argument that recoveries should be pro-rated between the insured and uninsured amounts. It also rejected the suggestion that the recoveries could be allocated to individual containers or sets of containers.

The Policy contained a "Recoveries" clause which stated, amongst other things, that "any sums recovered from any other source whatsoever as or towards payment of the amount indemnified shall be shared between the Insurers and the Assured as follows... all sums shall be allocated to the Insurers until such amount paid under this policy (including costs) has been recovered... all further sums shall inure to the benefit of the Assured...". The Court did not appear to consider that this altered the general legal principle that recoveries are paid "top down".

The crucial basis of the decision was encapsulated in the following statement from the Court:

"In the present case, recoveries from the Hanjin Settlement had the effect of reducing Textainer's total losses, but those losses nevertheless remained well above the upper limit of the cover provided by the Insurers. On the face of matters, those recoveries did not therefore engage the Insurers' undoubted right to be subrogated to recoveries to be made in respect of insured losses. This mirrors the position as it would have been if the recoveries had been made before Textainer had claimed under the Policies: the recoveries would have reduced Textainer's losses, but however those recoveries were allocated, losses would still have exceeded the cover under the Policies when a claim was made."

Under-insurance

The Court of Appeal also rejected insurers' arguments that Textainer had been under-insured, and that average should apply pursuant to s.81 of the Marine Insurance Act. 

S.81 provides that:

"Effect of under insurance
Where the assured is insured for an amount less than the insurable value or, in the case of a valued policy, for an amount less than the policy valuation, he is deemed to be his own insurer in respect of the uninsured balance."

Acknowledging the distinction between marine (here) and non-marine (in Napier) cover, the Court of Appeal held that the concept of undervaluation is "simply not engaged in relation to layers of insurance", where cover relates to a defined portion of loss. In the present case, Textainer's risk, including as it did cover for the costs of recovery and repair of containers for example, was undefined and indefinite (unlike, say, cover for a specific asset with a quantifiable value), and not suitable for the application of average.

Commentary

The judgment above builds on existing case law in Napier and also Kuwait Airways Corporation v Kuwait Insurance Co SAK [2000] to reiterate the application of the top down recovery principle. The Court saw no reason top down recovery should not apply to aggregate and excess layer placements in the same way as it does to unitary losses, by which is meant a single or unified loss arising simultaneously (in the Kuwait Airways case, that being the seizure of various aircrafts by the Iraqi forces in Kuwait).

However, it is worth noting that the Court gave very little consideration to the policy terms. It is open to the parties to agree a different allocation of recoveries than the top down approach. There are also situations where recovery might not be top down. Top down recovery has no application as between insurers on the same layer of cover or where an insured bears a proportionate exposure to a loss. These two points come together on political risks or credit policies, where the insured bears a proportionate share of an insured loan exposure or prepayment exposure. In that case, the Insured is treated as a co-insurer and will retain a pro rata share of any recoveries obtained.

It seems to us helpful to ask, as the Court did in this case, what would the impact have been if payment had been made prior to a claim being paid? The effect should broadly be the same whether or not he monies are secured by the Insured prior to or post-payment.