"All Sums" Impact on Reinsurers ARC Congress: 24 – 25 February 2009 Nicholas Bradley Lawrence Graham LLP

1. "All Sums" Impact on Reinsurers ARC Congress: 24 – 25 February 2009 Nicholas Bradley Lawrence Graham LLP

2. All Sums - Impact on ReinsurersWasa vLexington (AC – 29/2/08) • Structure: ALCOA Pennsylvania Law (Washington Court) Insurance: Loss or damage to property 1/7/77 to 1/7/80 Lexington • FAC R/I: • All risks of physical loss or damage to the reinsured occurring during the period 36m from 1/7/77 • Full R/I and FTS English law WASA AGF

3. All Sums - Impact on ReinsurersWasa vLexington (AC – 29/2/08) What happened? • Alcoa wrongfully caused pollution 44 yrs to mid 80's • Washington State Supreme Court held Lexington jointly and severally liable to indemnify Alcoa for all property damage, including damage occurring pre 1/7/77 • Referred back to State Court • Against a claim for US$180m Lexington settled with Alcoa for US$103m • English Comm Ct held: under Eng law reinsurers only liable for costs of remedying damage which actually occurred during reinsurance policy period • Lexington appealed

4. All Sums - Impact on ReinsurersWasa vLexington (AC – 29/2/08) Court of Appeal held: • Real question: Where parties used same wording in reinsurance as in the underlying, did they intend the wording to have the same meaning in both contracts? • Answer: Where an insurer sought and obtained fac r/i in the manner Lexington had here, the policy period must bear same construction in both policies (even though the Washington Ct focussed on ins wording in "not quite the way an English Court would do") House of Lords?

5. All Sums - Impact on Reinsurers Captives?Fronting?Period mismatch? X/LLoss settlementsDouble proviso Quota Share FTS Fac R/I B2BFull R/I • Lexington v WASA • Stronghold v Bulstrad • Toomey v Eagle Star • MMI v Sea • Hiscox v Outhwaite (No 3) • Hill v M&G

6. All Sums, Contribution and Settlement CreditsARC Congress February 25 2009London, EnglandBenedict M. Lenhart, Esq.Covington & Burling

7. How To Divide Up LiabilityWhen More Than One Policy PeriodIs Triggered By a Loss Allocation – The Question Is Straightforward … Covington & Burling

8. All sums or pro rata Straight or weighted pro rata Start date/end date Treatment of deductibles/SIRs Treatment of stub polices Treatment of multi-year polices Contribution, reallocation and settlement credits Horizontal exhaustion Number of occurrences Stacking Claims made/occurrence coverage Others . . . But The Issues Are Dizzying Covington & Burling

9. All Sums Approach • Also known as “pick and choose,” “vertical spike,” or (incorrectly) as “joint and several” • No allocation of long-term loss to uninsured periods • Insured may allocate some or all of the liability into a policy period of its choosing • Insured may also select other policy periods into which to allocate additional liability Covington & Burling

10. All Sums Approach Bases • Policy language -- “The company will pay on behalf of the insured all sums which the insured shall become legally obligated to pay . . .” • There is no policy language requiring pro-ration to insured • All sums effectuates insurance contracts’ dominant purpose of indemnity and avoiding forfeitures • Contra proferentem – policies at best for insurers are ambiguous, therefore should be construed in favor of coverage Covington & Burling

11. Pro Rata Approach Insurer arguments for pro rata: • Policy language – “The company will pay on behalf of the insured all sums which the insured shall become legally obligated to pay as damages because of bodily injury or property damage to which this insurance applies, caused by an occurrence. . . . This insurance applies only to bodily injury or property damage which occurs during the policy period[.]” (Emphasis added.) • butwhat if insured is jointly and severally liable because of the partial BI or PD during policy period • Appeals to equity – why should one insurer pay all of the loss? • but see contribution, settlement credits law • Appeals to public policy – efficiency • should efficiency trump contract rights • not efficient if discourages settlement Covington & Burling

12. Pro Rata Allocation -- Methodologies • Time On The Risk (Forty-Eight Insulations (6th Cir.); Stonewall (NY); Consolidated Edison (NY); Northern States Power (Minn.); Public Service of Colorado (Colo.)) • Time On The Risk And Limits(Owens-Illinois (NJ); Carter-Wallace (NJ)) Covington & Burling

13. Alls Sums vs. Pro Rata – Results By State After 20 Years of Litigation • “All Sums” States include: • Pennsylvania • Ohio • Indiana • California • Massachusetts • Rhode Island • Wisconsin • Others • Pro Rata States include: • Minnesota • New York (not certain – see Con Ed) • New Jersey • Alabama, Utah (in some cases) • Others Covington & Burling

14. Alls Sums and Contribution • All Sums “spiked” carrier entitled to contribution • contribution results in partial reallocation away from spiked carrier • contribution avoids the situation where the “spiked” carrier pays more than its “fair share” • broad agreement (between policyholders and insurers) on basic principle of contribution • Two fundamental limitations on contribution • It is the insurer’s burden to pursue it (not the policyholder’s) • See JH France, Goodyear • Contribution can be obtained only from available coverage • coverage is available only if triggered, solvent, found, not excluded and not settled • coverage is not available if it is not triggered, insolvent, missing, excluded orsettled • SIRs are not coverage for purposes of contribution Covington & Burling

15. Alls Sums and Contribution • “All Sums Net of Contribution” (“ASNC”) • Common methodology in many solvent schemes when policyholder otherwise qualifies for “all sums” • ASNC violates both of the fundamental limitations on contribution • First, it shifts the burden to the policyholder • the effect is to strip away the policyholder’s hard fought court victories • better solution -- solvent scheme carrier can pursue contribution during period of scheme operations (equal treatment of scheme and non-scheme insurers) • Second, some schemes assume that contribution can be obtained from all coverage • this violates rule that -- for contribution purposes -- coverage is available only if it is triggered, solvent, found, not excluded and not settled • converts “all sums” into simple pro rata Covington & Burling

16. Settlement Credits in Place of Contribution • Arises in states that follow an “all sums” allocation approach • generally not present in pro rata allocation schemes • “All sums” allows policyholder to pick and choose the triggered policy or policies that will respond to the claim in the first instance • The chosen or “spiked” insurer will argue that it has paid more than its fair share, and that it should be allowed to spread or reallocate some or all of its liability to other triggered carriers • Nonsettled carriers: the spiked carrier can generally sue other non-settled, triggered carriers for contribution • Settled carriers: for public policy reasons, many states bar contribution claims against settled carries. • Instead, settlement credits are seen as a substitute for contribution rights Covington & Burling

17. Settlement Credit Rationale • Public policy favors settlement • Courts favor contribution protection because it encourages settlement and helps to reduce the court’s case load • Settling parties – insurers and policyholders – favor contribution protection because they want their “peace” and finality • if not, why settle? • Policyholder indemnity issues • suits against settled carriers can trigger policyholder indemnity obligations, negating advantages of settlement • again, this outcome may run counter to public policy Covington & Burling

18. Types of Settlement Credits • Settlement credits differ in the amount subtracted from the total loss, not from the excess insurer’s limit: • No credit: -- unless insurer can prove duplication of other payments (double recovery) (Weyerhaeuser) • Pro Tanto: credit for the amount actually paid by the settling insurer (Eli Lilly; Rubenstein; Mass. Electric; Kayser Roth; Black & Decker) • both “no credit” and pro tanto protect insurer against duplicative payment • both preserve policyholder’s right to full recovery • Pro Rata: credit for the portion of liability allocable to, but not necessarily paid by, the settling insurer (Koppers) • protects insurer from paying other insurers’ “shares” • Policy Limit: credit for the policy limits of settling insurers, regardless of settlement amount (GenCorp) Covington & Burling

19. Pro Tanto Settlement Credits – Dominant Trend • Reduce the judgment against the non-settling insurer by the actual amount of the settlements with triggered insurers • Applies only to settlements for the same liability (see Goodrich) • Endorsed by a number of states in recent years • Pro tanto cases • Eli Lilly v. Aetna Cas. & Sur. Co. (Ind. Super. Ct. 2002), involving primary insurers, noted that the pro rata settlement credit deprives a policyholder of the full payment of its loss because if it settles for less than 100% of its loss, then it loses coverage for the gap between the settlement amount and its “rightful claim.” Instead, the court applied a pro tanto approach which favored settlement and was consistent with the “all sums” regime. • Massachusetts Electric Co. v. Commercial Union Ins. (Mass. Super. 2005) applied a pro tanto credit to an excess insurer in the environmental context. • See also: Liberty Mutual Ins. Co. v. Black & Decker Corp., 2004 U.S. Dist. LEXIS 1744 (D. Mass. Aug. 25, 2004); Rubenstein v. Royal Ins. Co. of Am., 694 N.E.2d 381 (Mass. App. Ct. 1998); Insurance Co. of N. Am. v. Kayser-Roth Corp., 770 A.2d 403 (R.I. 2001). Covington & Burling

20. Timing of “Pick Year” and Protection Against Double Recovery • In “all sums” litigation, policyholder not required to select the year or years for the vertical spike until all coverage defenses are resolved in the coverage case • See Goodrich appellate rulings (Ohio) • This rule encourages settlement – contrary rule would “take the heat” off most carriers and discourage settlement • Insurers protected against double recovery • settlement credits rules (see above) • Zeig rule (excess carrier gets full benefit of directly underlying limits absent unusual factors) • rep/warranty (in appropriate circumstances) Covington & Burling

21. Conclusion • Watch Ohio courts for pending cases, which may bring greater clarity to the law of contribution (Goodrich, Park-Ohio) • Questions? Covington & Burling

22. All Sums – Mark Allen, PwC ARC Congress February 2009

23. Pro-Rata Allocation Pro-Rata Allocation • Consider a $15m claim for clean-up of a polluted site. The claim is allocated uniformly across all triggered policies. • The insured is liable for paying the SIR in each year over which the losses are spread • The insured is responsible for paying for gaps in cover and insolvencies • Many small claims will often not exceed the SIR on the later policy years. • Total recoveries are $2.5m. 15m 1m 1980 1966 Recovery = 2.5m ARC Congress

24. All Sums Allocation – Pure All Sums All Sums Allocation • Claim is spiked onto an All Sums year selected by the insured. • This will normally be a later underwriting year where more vertical cover is available (but will depend on operation of pollution exclusions). • Will sometimes be possible to pick a second (and a third) All Sums year. • SIRs will be borne by the insured on each spiked year. • Total recoveries are $12.5m, i.e 5 times Pro-Rata recovery. 15m 2.5m 1980 1966 Recovery = 12.5m ARC Congress

25. All Sums Allocation : All Sums Net of Contributions All Sums Net of Contributions • Other insurers on the coverage block have to contribute to the costs borne by the insurers on the spiked year. • Calculated using a Rising “bath-tub” that allocates increased liabilities equitably across policy years and insurers. The bath-tub fills up around gaps in cover and insolvencies. • The total amount recovered is $12.5m, the same as for Pure All Sums. • In this example, nothing is paid by the insurers on the spiked year. 15m 2.4m 1980 1966 Recovery = 12.5m ARC Congress

26. All Sums : Other issues and Commutations / Schemes • In some cases, all primary policies on the coverage block must be exhausted before the claim can spike a single year. • In other situations, All Sums is only allowed to spike a single policy year. After cover on that year is exceeded, liability returns to the insured. • Principle in commutations is to estimate the amount payable by the insurer to the insured on settlement. • Which All Sums year? The insured should always pick their best year, not the year on which the insured has a policy with a particular insurer. • Who recovers the contributions? Assignment of contribution rights leaves insured in same position as if claim was being settled today. • Policy exclusions and win factors. ARC Congress

27. All Sums – The Insurers’ Response Helen A. Franzese Riker Danzig London, LLP 33 Cornhill – Fourth Floor London EC3V 3ND hfranzese@riker.com

28. All Sums – The Policyholders’ Perspective Why All Sums? • Maximizes insurance recoveries • Minimizes policyholder costs • Increases settlement leverage • Greater benefit than the original bargain

29. All Sums: The Insurers’ Perspective • Policy Language – “The company will pay on behalf of the insured all sums which the insured shall become legally obligated to pay as damages because of personal injury or property damage…to which this policy applies, caused by anOccurrence…” Occurrence - “an accident, happening, event…that causes injury to a person or property during the policy period.” • Violates fundamental rule of contract interpretation • “Ultimate Net Loss”/ “Other Insurance” • Contra Proferentem – manuscript v. negotiated language • Inconsistent with Continuous Trigger • Assumes all damage has true connection to spiked policy year • Reasonable expectations – fails to reflect reality

30. All Sums: The Insurers’ Perspective • Public Policy – • Policyholder should bear consequences of its decisions • Lack of incentive to acquire insurance • Policyholder knows its coverage universe • Hinders settlement of complex coverage matters • Spawns additional burdensome and expensive litigation (Contribution/Settlement Credits) • Detrimental to policyholder and insurer in long haul • Schemes – • Right of Contribution severely impaired/eliminated • Prior precedent – hinges on equity of contribution

31. Pro Rata - A More Equitable Solution • Insurers’ liability is “individual and proportionate” • Share assigned to policyholder corresponding with periods of self-insurance, under-insurance or no insurance • Generally, policyholder not penalized where insurance was unavailable • Various permutations of methodology • Time on Risk (Straight Pro Rata) • Time on Risk and Limits (Weighted Approach, O-I/Carter-Wallace) • Example to follow…

32. Pro Rata - A More Equitable Solution • “Principles of simple justice” • Balances the equities – reflects the realities • Supported by policy language • Provides incentive for • more meaningful settlement negotiations • responsible conduct by insured • procurement of insurance

33. Pro Rata - A More Equitable Solution In summary – • Definitive methodology remains to be determined in many states • Trend for change (Massachusetts) • Pro Rata: • Fundamentally fair • Predictable • Provides incentives to insure or rationally self-insure • Decreases litigation and transaction costs • Reflects realities (economic and reasonable expectations) • Consistent with policy language and rules of K interpretation