Allocation and the ‘LMX spiral‘

Equitas Ltd v R&Q Reinsurance Company (UK) Ltd [2009] EWHC 2787 (Comm), a decision of Gross J, is a crucial test case on the operation of the ‘LMX spiral’ and in particular the obligation of reinsurers (or, more strictly, retrocessionaires) to accept claims which had been incorrectly aggregated and which otherwise encompassed uninsured losses at a lower level in the chain of placements. Gross J applied the accepted principle that there can be liability only for losses falling within the scope of both the direct policy and the reinsurance, but confined it to the immediate inwards and outwards contracts between the parties so that it remained possible for a reinsured to establish that it had suffered losses which led to excess of loss trigger figures being reached even though some of those losses were tainted by improper underlying claims.

The London Market Excess spiral

The disputes between the parties arose out of the LMX (London Market Excess) spiral. In essence, as described by Phillips J in Deeny v Gooda Walker Ltd [1994] CLC 1224, the market had developed a complex structure of reinsurance and retrocession. Insurers obtained excess of loss reinsurance cover, and themselves procured similar outwards protection from retrocessionaires. The process continued, so that when claims came in the result was, in the graphic description of Phillips J, ‘rather like a multiple game of pass the parcel.’ Some of the business was written on the reinsured’s whole account, while other of the business was confined to specific risks. As layers of retrocession cover increased, the amount of cover diminished, by reason of the outwards reinsurer’s retention or by reinsurance from outside the spiral, so that as the claims progressed up the spiral the amount of cover diminished. It is also important to note that much of the premium income which was generated by the reinsurance and retrocession placements was absorbed by brokerage earned by successive placements at the rate of around 10%.