The Court of Appeal has confirmed that the wording of a “top and drop” excess insurance policy did not affect the order in which liability attaches under a tower of insurance.

In Teal Assurance v WR Berkley Insurance (Europe) and Aspen Insurance UK Ltd [2011] EWCA Civ 1570, it was held that the commercial common sense of a top and drop policy was for policies within the tower to be exhausted in an orderly manner depending on when liability was established against the insured. It did not make commercial sense to allow the excess of loss insurer on different layers within the tower to pick and choose which claims were paid first in order to maximise its reinsurance recoveries.

The facts of the case are explained in our blog on the first instance decision (please click here). The top and drop policy written by Teal provided $10m of excess cover and sat on top of several layers of underlying policies which gave $60m of cover. It contained Clause 1 which provided that liability “shall not attach unless and until the Underwriters of the Underlying Policy/ies shall have paid or admitted liability or have been held liable to pay, the full amount of their indemnity inclusive of costs and expenses.”

The Court of Appeal acknowledged that in isolation this could be construed as meaning that Teal was not liable under the top and drop policy until liability on the part of the underlying policies had been established by admission, agreement or judgment. However, the clause had to be read in the context of the various excess layer policies, and particularly Clause 3, which provided that once the underlying policy had been exhausted “this policy shall continue in force as underlying policy.” This clause made clear the way each excess policy dropped down to become the underlying policy. Liability of the higher layer insurers therefore arose whenever the insured’s claims were established to their level of attachment. Clause 1, however, merely determined the relationship between the different layers by stating that no insurer would be liable to make payment until underlying insurers had paid. It had no impact on attachment.

Longmore LJ said that Teal’s construction would enable them to “manipulate liabilities” which was unlikely to have been the intention of the parties and “does not lead to a sensible commercial result.” On the other hand, the reinsurers’ construction that the policies would be exhausted in order “does produce a commercially sensible outcome … [and] in these circumstances it is the more sensible commercial construction which is to be preferred.”

This decision is in accordance with the general rule that for the purposes of exhausting underlying policies, losses are to be accounted for chronologically as they are ascertained by judgment, award or settlement. It appears that very clear wording would be needed to vary this principle and allow an insurer to order the claims as it saw fit.