Introduction
I remember when I first heard the term “aggregate extension clause.” I was a couple of years out of law school and just getting my feet wet in reinsurance law and practice. Naturally, I had no idea of what an aggregate extension clause was or, for that matter, why someone would want to call something an “aggregate extension clause” in the first place, unless the principal objective was to confuse the reader. I envisioned some densely worded, obtuse, complex and hopelessly confusing provision designed to accomplish some obscure yet important purpose, the relevance of which was surely beyond my ken. I decided that I could read up on the clause, or ask a colleague about it, but I feared that the explanation – written or oral – would be at least as difficult to decipher as the clause itself, and probably more so. So I did my best to avoid even having to think about aggregate extension clauses — let alone deal with them — for as long as possible.
Eventually, of course, I had to face my fears and grapple with the seemingly elusive concept of “aggregate extension.” I quickly learned that my initial assessment was only partly correct: aggregate extension clauses are indeed densely worded, but the purpose of the clause is far more straightforward than I once assumed. Once I learned a little bit about the clause, I realized (or at least thought) that I could impress – or perhaps awe – my less experienced colleagues with it, and might even be able to use it to show my more experienced colleagues that I knew something about reinsurance. While I can’t say I obtained as much mileage out of my newfound knowledge as I expected, I am nevertheless glad that I invested a little time into learning about aggregate extension clauses.
In this Reinsurance Nuts & Bolts post we briefly discuss in very simple and basic terms what an aggregate extension clause is, and what it does. We also provide the reader with an example of some of the operative wording of an aggregate extension clause. Our discussion is not intended to be comprehensive; if anything, it is oversimplified. But it should give the reader a basic understanding of the topic.
Aggregate Extension Clauses: Extending the Concept of Aggregate Cover into the Excess of Loss Treaty
Excess of loss reinsurance agreements typically provide cover on an each and every loss or each and every occurrence basis. They provide reinsurance for each loss or occurrence in an amount in excess of a specified retention per loss or occurrence up to a specified limit per loss or occurrence. Excess of loss treaties often cover a wide range of the cedent’s underlying policies, and their retentions and limits are frequently set to respond to losses of moderate to high severity (of course, some are specifically designed to address catastrophic losses or low severity losses). Losses or occurrences that do not meet the retention (sometimes referred to as the attachment point) are not covered.
All of this works quite well when the underlying insurance contract provides insurance on an each and every loss or each and every occurrence basis for losses of moderate to high severity. But it does not work well when the underlying insurance is written on an aggregate basis.
Aggregate cover is generally designed to insure against the risk that there will be a higher frequency of low severity losses than the insured expects. The dollar amount of an individual loss or occurrence does not determine whether the contract provides cover or the dollar amount of the cover. The existence and amount of cover is determined by aggregating together all losses occurring within a specified period, irrespective of their severity. The aggregate amount is subject to an aggregate deductible and frequently an aggregate limit. The risk insured is that the frequency of relatively small losses will exceed an expected level during the period, although larger losses may also fall within the scope of the cover.
Reinsuring aggregate cover on an excess of loss basis presents problems because the amount of each loss or occurrence is generally not high enough to exceed the retention of the excess of loss treaty. Over a period, however, the aggregate amount of loss covered by the policy may well exceed the retention of the excess of loss treaty if the aggregate amount of loss were deemed a single loss or occurrence for the purposes of the treaty.
The aggregate extension clause effectively extends the aggregate cover of the underlying policy into the excess of loss treaty. Instead of subjecting each individual loss or occurrence to a separate retention and limit, it allows the aggregation of losses or occurrences when the underlying cover is written on an aggregate basis.
Aggregate extension clauses come in various forms and may be interpreted in various ways. Here is the relevant portion of an aggregate extension clause used in the London Market, which was construed by the English Court of Appeal (Civil Division) in Yasuda Fire & Marine Co of Europe Ltd v. Lloyd’s Underwriting Syndicates No. 209, 356 & Ors., [1998] Lloyd’s Rep. LR. 343 (C.A.) (available here):
As regards liability incurred by the reinsured for losses on risks covering on an aggregate basis, this agreement shall protect the reinsured excess of the amounts as provided for herein in the aggregate any one such aggregate loss up to the limit of indemnity as provided for herein in all any one such aggregate loss.
Notwithstanding that this agreement is effected on a losses occurring during the period basis, all aggregate original policies coming within the scope of this agreement shall be covered on a risks incepting during the period basis. Furthermore, where an original aggregate policy is issued for limits relevant to an overall period greater than 12 months with an inception date during the period of this agreement then such original policy shall be covered hereunder for the whole of its period notwithstanding any annual resignature. Long term policy periods with annual limits are to be treated as each annual period being a separate policy with the anniversary date being regarded as the inception date. . . .
In Yasuda the English Court of Appeal (Civil Division) explained the purpose and intent behind aggregate extension clauses. Yasuda illustrates that the key purpose of an aggregate extension clause is “to provide effective reinsurance where the reinsured is covering aggregated losses exceeding certain limits” by “carr[ying] through into the reinsurance policy the same principle of aggregation as exists in the original policy which has been written ‘on an aggregate basis:'”
The aggregate extension clause has been in existence in one form or another for some 60 years. It is a standard clause in the sense that it is one of the clauses with a more or less standard wording which is then incorporated into reinsurance contracts. The … [most] important [purpose of the aggregate extension clause] is to provide effective reinsurance where the reinsured is covering aggregated losses exceeding certain limits. The classic example used to illustrate this is drawn from the products liability field and what are called ‘Coca Cola losses’. A producer such as Coca Cola sells large numbers of articles each of which involves a small product liability risk, as for example from the bursting of a defective bottle. Statistically in any given year there will be an anticipated number of claims which the producer has to pay. The producer is concerned not only that any one of these claims may substantially exceed the norm but also the number of claims that have to be paid in any given period may exceed the norm. Therefore the producer may take out products liability insurance which covers him against the risk of having to payout more than a certain sum in the aggregate in respect of such claims. This is a simple and uncontroversial example of an insurance covering the assured ‘on an aggregate basis’. Similarly, it provides an uncontroversial illustration of the operation of the aggregate extension clause in a reinsurance policy. Under the ‘Coca Cola’ type of cover, once the aggregate excess has been reached, the original insurer becomes liable to pay every claim that comes in during the relevant period (possibly subject to an overall policy limit). The aggregate extension clause enables the original insurer to pass on those liabilities, in the aggregate, to the reinsurer. It carries through into the reinsurance policy the same principle of aggregation as exists in the original policy which has been written ‘on an aggregate basis’.
Id. (emphasis added; citations omitted)
Aggregate Limits and an Aggregate Retention Do not Necessarily Mean Underlying Cover
Was Written on an Aggregate Basis for Aggregate Extension Purposes
One important thing to keep in mind about aggregate extension clauses is that they come into play only when the underlying insurance is written on an aggregate basis. That the underlying policy has aggregate limits and even an aggregate deductible does not necessarily mean that the cover is written on an aggregate basis. As the English Court of Appeal in Yasuda pointed out, the underlying cover is not written on an aggregate basis where the insured’s right to recover is predicated on each individual loss or occurrence satisfying a deductible or retention, even where the underlying cover also contains an aggregate deductible and an aggregate limit:
In the present cases the question arising under the aggregate extension clause has to be considered in relation to the original policies issued by the reinsured all of which included terms imposing an each and every claim excess and limit. Thus, as part of the establishment of the original assured’s right to recover from the reinsured, the original assured had to demonstrate that each individual claim exceeded the excess or ‘retention’ figure stipulated. If it did not, then no claim could be made under the original cover against the reinsured. If it did, the right of recovery of the original assured was then confined to the amount of the excess but was subject also to a per claim limit. It is thus an essential feature of the cover provided by the reinsured to those it was insuring that each claim satisfy an each and every loss criterion. Whatever else one may think, this is the antithesis of providing cover on an aggregate basis. . . .
. . . .
The argument of Yasuda and the other reinsureds is that notwithstanding the each and every loss clauses in the original cover, there were other features of the cover provided by one or more of the original insurance policies, which nevertheless justified the conclusion that the original cover was provided on an aggregate basis. Thus, consistently with their arguments to which I have earlier referred, Yasuda rely upon the fact that the original cover was in all cases subject to an overall limit, maybe with a right of reinstatement and was in most cases also subject to an aggregate retention which had to be exceeded before any claim could be made under that cover. They rightly point out that such provisions would be expected to be features of cover on an aggregate basis. Thus, in the Coca Cola type policy to which I have referred earlier, the claims qualify for recovery under the policy because they in the aggregate exceed a certain level. It is a feature of that type of policy that the risk which is being insured is one which deals with the aggregation of claims and is not concerned with their individual size. But this serves to demonstrate that the feature upon which the reinsured seek to rely in the present cases does not suffice to demonstrate that the cover was ‘on an aggregate basis’. It leaves unanswered the question whether it is then necessary to look at each individual claim and ask whether it individually exceeds a certain limit. If it is necessary to do this, then it no longer remains possible to say that the cover is on an aggregate basis: it is on an each and every claim basis.
. . . .
In the relevant policies of original insurance, once the aggregate retention has been exceeded, the claim still has to be looked at on an individual basis to see whether it individually exceeds a certain sum and, if it does, the right to recover from the original insurer is defined by reference to a per claim excess and limit. Where that is the case, the basis of cover is not on an aggregate basis: it is upon an each and every loss basis. I do not accept the argument of the reinsureds that any element of aggregation trumps the other features of the cover. It is the basis of the cover which has to be looked at. This may involve an evaluation of the features or characteristics of the cover but it does not permit one element of aggregation to be pointed out and the remainder of the features of the cover to be ignored. I accept the submission of the reinsurers that cover which requires criteria to be applied to each and every loss and imposes an each and every loss excess and limit cannot be said to be cover provided on an aggregated basis.
Id.
If you, the reader, have gotten this far, then perhaps you would like to delve into a discussion of “Aggregate Extraction Clauses.” But these clauses – which conjure up some of the more frightening scenes from Marathon Man (1976) – are better left for another day. . . .
