A leading City of London law firm

Article

Weighing Up The Options At Lloyd's

By Timothy Brentnall of Elborne Mitchell
First published: The Insurance Insider [1st September 2004]

The long-established practice of issuing "Tonners" - policies that can pay out even though there is no insurable interest - was banned by legislation nearly 100 years ago. Now that the Lloyd's market is more familiar with Alternative Risk Transfer techniques the time has come to consider their reinstatement, argues Tim Brentnall of Elborne Mitchell.

Mention the word "tonner" in the market and, as likely as not, at least one member of the audience will make the sign of the cross.

However, tonners, or "PPI" policies (Policy Proof of Interest) have not always been viewed thus. The Marine Insurance Act 1906 declared marine tonners void as a matter of civil law: the Marine Insurance Act 1909 made anyone engaging in such contracts guilty of a criminal offence. This notwithstanding, tonners were not officially banned in Lloyd's until June 1981. The then Chairman, Peter Green, later Sir Peter Green (quondam holder of Lloyd's Gold Medal) wrote on 8 June 1981:

"The Committee has decided that from today's date no Lloyd's underwriter will be allowed to place or write a "Tonner" or similar policy relating to any class of business".

On 8 June 1993, the Manager of the Solvency Department at Lloyd's wrote:

"Subject: Tonner Policies

Action Points: Ensure immediate compliance

Deadline: Effective immediately

The above subject was last addressed in the Chairman of Lloyd's letter dated 8 June 1981, a copy of which is attached for your ease of reference.

It has been brought to Lloyd's attention that despite the content of the Chairman's letter, tonner or similar type policies are once more being offered to Lloyd's syndicates ... This bulletin is being issued as a reminder that policies lacking insurable interest are prohibited within the Lloyd's market".

Was this just a case of Lloyd's being slightly behind the times, or was it more in tune with commercial reality? What in fact lay behind the Chairman's proclamation in 1981 were the activities of Christopher Moran, who was then expelled from Lloyd's.

Until then, tonners and PPI policies seem to have enjoyed, if not a recognised place in the market, at least a tolerated one. So named because the risk was frequently defined by the tonnage of shipping disasters in any particular year, the practice later spread to the aviation market. There, they were (and are) sometimes referred to macabrely as "blood tonners" in that the risk can be defined by the number of lives lost in any particular year in air disasters.

It would be a misrepresentation to say that all PPI policies were out-and-out tonners, red in tooth and claw. There were frequently perfectly understandable reasons why a policy should be marked "Policy Proof of Interest", where the precise insurable interest of the Assured, or the market value of cargo at the time of loss was uncertain. The example always given is of cargo being bought and sold while still on the high seas. The market value of such may have changed very dramatically from the day on which it was shipped. Another example given is the uncertainty surrounding the loss of anticipated freight on a vessel that becomes a total loss, which may be difficult to prove and ascertain.

When the Marine Insurance Act 1909 was introduced in the House of Commons by the President of the Board of Trade, a certain Mr Winston Churchill,

Mr W W Rutherford MP made an impassioned speech against the Bill:

"A very large number of policies of insurance are taken out in respect both of vessels and cargoes that are for various reasons "interest admitted" policies ... in order to prevent any possible questions being raised as to the exact nature and exact extent of the [insurable] interest.

I entirely deny on behalf of the Commercial Community ... that there is any great practice of simply gambling in policies of marine insurance.

I very strongly deprecate those attempts to set up and impose moral standards, so- to-speak, upon other people, which have the effect of interfering in any way with legitimate business".

Clearly, this was a sentiment that was shared by the insurance market at large because PPI policies continued to be written after the Marine Insurance Acts 1906 and 1909 were enacted, although it was a truth that dared not speak its name. Insurers developed the practice of pinning the PPI clause to the front of the policy so that it could be removed in the event that the policy had to be produced in court in connection with some other dispute between the parties. The Commercial Judges could frequently be seen running their fingers over the policy document to see if there were pinholes in it! If it became apparent that a policy was a PPI policy, the court would take the point of its own motion and declare the policy void.

But, provided it wasn't obvious, insurers rarely resorted to defending a claim on the basis that it was a PPI policy and therefore void. I recall a case where brokers were sued in connection with a PPI policy. The brokers' legal representatives kept saying orally that they would tell the judge that the policy was a tonner. In the event, they didn't and paid up like lambs. The potential loss of reputation of taking the point that it was a tonner was too great.

However, the purpose of this article is not just to give an historical perspective to tonner policies, but to ask whether the reasons that lay behind the Marine Insurance Acts 1906 and 1909 remain relevant and compelling today. As we have seen, there was doubt even when the Acts were passed as to their commercial validity.

Two discernable reasons can be seen behind the Marine Insurance Acts. First, a wish to outlaw insurance contracts which were in effect purely gambling. Second, to avoid situations where an insurer might profit from a loss. Churchill, when introducing the Marine Insurance Act 1909, commented on the mysterious loss of the "SS Firth of Forth" and quoted from an article published in the "Shipping Gazette":

"It must be obvious to all that to stand to make a large sum by the wreck of a ship or the loss of her cargo is not a contingency which makes for the greater safety of ships or the lives on board them".

Much the same point can be seen in the press commentary in the UK on the recent scandal in the horseracing world of alleged race-fixing. Previously, anyone who was not a licensed bookmaker could only guarantee a profit from betting that a particular horse will not win by placing a bet on all the other horses in the race. However, with the advent of spread- betting indices and vehicles such as betfair.com, anyone can now bet on a particular horse losing. Further, there is not the same transparency as when, for example, someone destroys insured property and then makes a fraudulent claim under a policy. It is nigh on impossible to ascertain with any certainty who is the real counter-party to all the spread bets placed and who therefore has benefited from the race being lost. However, nobody suggests that the sensible way of tackling this potential problem in the racing world is to legislate to banish spread-betting. There comes a stage when it is futile to try and push back the boundaries of financial and technological sophistication.

In the insurance and reinsurance markets, it is now possible, perfectly legitimately, for an insurer or reinsurer to profit from a loss without recourse to tonner contracts. Derivative contracts (swaps, options, caps, floors) are traded on the Chicago Board of Trade and CATEX in New York. Positions can be taken whereby the purchaser of an option stands to make a large profit from a natural catastrophe, notwithstanding that he may have no insurable interest in the underlying loss. That position might become murkier if such contracts were available by reference to specific property or specific lives. Then, as now in the racing world, there may be the faint whiff of suspicion of those with control over the insured property taking an understandable adverse position in the sure and certain knowledge that there will be a loss.

Banning pure tonners where the Assured or Reassured has absolutely no insurable interest may still not be anachronistic. But insurable interest can be an elusive concept in law. In a loose sense, the aviation market is always likely to have an insurable interest in the crash of western airlines, although it may take a while to establish how much of that interest is direct or indirect, immediately quantifiable or only quantifiable over a very much longer period.

Is it really morally or commercially repugnant for an aviation underwriter to take out a tonner which pays a quantifiable amount in the event of a major loss without regard to what the Reassured's actual insurable interests or his actual ultimate loss? Is it morally or commercially repugnant for a catastrophe reinsurer to take out a similar policy to pay in the event that there is a hurricane or earthquake of a certain magnitude? How do you distinguish in any real sense a contract of that nature with buying or selling options on the Chicago Board of Trade?

To a certain extent, there are signs that the English courts are beginning to relax the legal requirements of insurable interest - see the recent case of Feasey v - Sun Life. But there remains a weight of complicated case law on what is needed to ascertain insurable interest in relation to particular classes of business. And of course there remain the absolute prohibitions on tonners and PPI policies contained in the Marine Insurance Acts, 1906 and 1909. Perhaps it is time to ask Parliament to revisit these questions and pay closer regard to what Mr Rutherford MP said in reply to Winston Churchill in 1909.

Tim Brentnall is senior partner at the specialist London insurance and reinsurance law firm Elborne Mitchell.