What degree of connection is required between a notified circumstance and a subsequently notified claim in a later policy period?
As any financial lines underwriter or claims adjuster knows, cover under a claims-made policy is not only triggered by the insured receiving actual notification from a third party alleging the insured is legally liable (Actual Claim), but also by the insured becoming aware of a circumstance that may lead to this.
Connection between notified circumstance and Actual Claim
Under traditionally drafted claims-made policies, only Actual Claims trigger the standard cover. The insured must notify Actual Claims during the policy period and any days of grace after this allowed for in the policy. (In New Zealand, section 9 of the Insurance Law Reform Act 1977 tempers the finality of this.)
However, an exception to this applies to Actual Claims notified after the policy period expires if they are connected with a circumstance notified during the policy period. In other words, the circumstance notified during the policy period ‘anchors’ the cover in the policy period for any subsequent Actual Claim so long as there is sufficient connection between the two. The policy only covers Actual Claims ‘arising from’ that notified circumstance. A typical clause says:
… any claim arising from the circumstances notified which is subsequently made after the end of the period of insurance shall be deemed to have been made during the period of insurance.
How connected do the circumstance notified and the subsequent Actual Claim have to be? This was the issue in a recent decision of the High Court of England and Wales in Euro Pools Plc v Royal and Sun Alliance Insurance Plc  EWHC 46 (Comm).
Before addressing that case, we summarise the recent English cases addressing this issue, and in particular Kajima UK Engineering Limited v The Underwriter Insurance Company Limited  EWHC 83 (TCC).
Summary of recent English case law
Up until recently, the leading English authority has been J Rothschild Assurance Plc v Collyear  Lloyd’s Rep I.R. 6. This held that the connection between the circumstance notified and the subsequently notified Actual Claim in a later policy year can be relatively weak. In McManus v European Risk Insurance Co  EWHC 18 (Ch) a blanket notification of circumstances in relation to about 5,000 files a law firm had acquired was upheld as valid. Based on a sample of 32 files, there was a consistent pattern of negligence involving the same legal error. (Contrast this with Walters v AIG Insurance NZ Ltd  NZHC 2701 in New Zealand where a spreadsheet of all of a law firm’s files relating to transactions with Blue Chip companies, and nothing further, was notified to the insurer as a circumstance. This was held not to be a valid notification.)
The link between the notified circumstance and the subsequently notified Actual Claim came under scrutiny in the Kajima case. Kajima notified its insurer of circumstance in relation to the ‘ponding’ of walkways at a housing estate it had designed. During the course of the investigation of this problem over subsequent years, other serious and extensive design defects unconnected with the ‘ponding’ problem were discovered. The High Court held that the notification of the circumstance in relation to the ‘ponding’ problem was limited to that defect. The notification was not effective in relation to the subsequent unconnected defects. The High Court summarised the principles that apply to the scope of a circumstance notified as follows:
- It is only circumstances of which the insured is actually aware which can be the subject matter of a notification …. The claim which is later pursued must arise not only from the notified circumstances but also from the circumstances of which the insured was aware.
- There must be some causal, as opposed to some coincidental, link between the notified circumstance and the later claim.
The insured had two fundamental problems in the case:
- There was no connection between the ‘ponding’ defect and the other defects other than they involved the same housing estate and the same insured, and critically,
- A circumstance by definition must be something the insured is aware of, and at the date of the notification of the ‘ponding’ problem, the insured was not aware of the other defects.
Euro Pools case
We now turn to the Euro Pools case. Euro Pools specialised in the installation of swimming pools. The pool in question had an ‘air drive’ system that consisted of steel tanks, which, when filled with air, would raise partitions within the pool in order to divide the pool into different swimming areas. The partitions could be lowered by releasing the air from the steel tanks and allowing them to fill with water.
Euro Pools discovered a problem with the partitions; they were not raising and lowering correctly. It investigated and found the original bracing at the bottom of the steel tanks was failing. This allowed air out and water in, so the partitions would not stay in a raised position.
Details of this problem were provided to the insurer as a circumstance. However, Euro Pools added that it thought it could fix the problem by adding balloons into the tanks and filling them instead. It anticipated that no claim would eventuate.
In the following policy year, Euro Pools discovered problems with the balloon solution too and notified the insurer that this was not the answer and it now needed to change to a hydraulic system for raising and lowering the partitions. The policy covered mitigation costs and it claimed for these in the following policy year.
A dispute then arose as to whether these mitigation costs fell to be covered under the first policy year as part of the circumstance notified, or in the following policy year as an Actual Claim. In other words, did they arise from the circumstance notified in the first policy year or not?
In a surprising decision, the High Court held that they did not arise from the circumstance notified in the first policy year and they fell to be covered in the following policy year. The court said that Euro Pools:
… was not aware [during the first policy year] of problems with the air drive system such that it could not notify the circumstances which led to a claim for the expenses of the move to a hydraulic system.
The court’s reasoning seems to be based on Euro Pools not correctly identifying the exact nature of the problem with the air drive system at the time of the notification of the circumstance during the first policy period. However, commentators have pointed out that this seems to confuse the nature of the circumstance itself (the failure of the air drive system) with the cause of it.
The court seems to have narrowed the Kajima approach even further. In the Kajima case, the facts involved wholly unconnected defects. In this case, the defect is the same, but the cause of the defect (and the remedy required) changed.
Perhaps unsurprisingly, the insurer is seeking to appeal the decision to the Court of Appeal.
What this means in the real world
Insurance brokers should take note of both the Kajima and the Euro Pools decisions.
Where a circumstance that has already been notified involves a developing situation in relation to either the cause of the defect or the finding of further unconnected defects, the safest course of action for a broker is to notify a further circumstance immediately to the insurer in relation to that development.
This will avoid the arguments that occurred in these two decisions.