B E T W E E N:

IAN McINTOSH HENDERSON

(and other Names listed in

the Schedule to the Writ of Summons)

- and -

MERRETT SYNDICATES LIMITED

(and the other Agencies listed in

the Schedule to the Writ of Summons)

ERNST & WHINNEY

(a firm)

Defendants

AND BETWEEN Names and similar parties in Actions 1992

Folios 1652 and 1834

B E T W E E N:

WILLIAM HALLAM-EAMES

(and other Names listed in

the Schedule to the Writ of Summons

- and -

MERRETT SYNDICATES LIMITED

(and the other Agencies listed in

the Schedule to the Writ of Summons)

ERNST & WHINNEY

(a firm)

AND BETWEEN Names and similar parties in Actions 1993

Folios 137, 144, 163, 164, 175, 203, 247,

290, 320, 511, 724 and 817

AND BETWEEN 1993 Folio 545

ELISE HECKMAN HUGHES

(and other Names listed in

the Schedule to the Writ of Summons)

- and -

MERRETT SYNDICATES LIMITED

(and the other Agencies listed in

the Schedule to the Writ of Summons)

STEPHEN ROY MERRETT

ERNST & WHINNEY

(a firm)

AND BETWEEN Names and similar parties in Actions 1993

Folios 546 and 592

Appearances

MR. A. BOSWOOD QC, MR. B. DOCTOR, MR. A. WALES, and MR. T. MACEY-DARE appeared on behalf of the Names, instructed by More Fisher Brown.

MR. A. TEMPLE, QC, MR. J. ROWLAND and MR. A. CHRISTIE appeared on behalf of Merretts, instructed by Reynolds Porter Chamberlain.

MR. ROGER TOULSON, QC and MR. C. EDELMAN QC appeared on behalf of the Members' Agents instructed by Oswald Hickson Collier.

MR. C. CLARKE, QC, MR. M. HOWARD and MS. H. DAVIES appeared on behalf of Ernst & Whinney instructed by McKenna & Co.

CONTENTS

2. THE SCHEME OF THE JUDGMENT

3. THE ROLE OF MEMBERS' AGENTS AND MANAGING AGENTS AT LLOYD'S

This section of the judgment is drawn from an agreed statement of facts.

At all material times, the manner in which underwriting business at Lloyd's was carried on was as follows.

There were 2 types of underwriting agents, namely members' agents and managing agents. Combined agents perform both the role of members' agents and the role of managing agents.

The main duties of managing agents were to manage the syndicate or syndicates of which they were managing agents and to conduct the underwriting on behalf of those names who were members of the syndicates. The management of the syndicate and the conduct of the underwriting on behalf of the names was controlled and carried on exclusively by the managing agents of the syndicate. The managing agents employed the "active underwriter" being the person with principal authority to accept risks on behalf of the syndicate or syndicates managed by the managing agents of which he or she was designated as the active underwriter.

The main duties of members' agents were to assist candidates for membership of Lloyd's in the making of their application for membership, to discuss and agree with each of the names for whom they acted the syndicates on which the name should be placed and the allocation of the name's premium limit as between syndicates, to seek to arrange the participation of their names in syndicates as so discussed and agreed and generally to look after the interests of their names and act as a channel between managing agents and their names. Save when acting as managing agents, members' agents played no part in managing or controlling syndicates or in the conduct of the underwriting on behalf of names.

At all material times underwriting agents were only entitled to carry on business as such at Lloyd's if they were approved by Lloyd's to act as underwriting agents at Lloyd's and in order to be so approved, each underwriting agent would be required to undertake, inter alia, to conform to any requirements which might from time to time be introduced by Lloyd's. Such requirements were set out, inter alia, in the Lloyd's Manual for Underwriting Agents which provided as follows :

CONDUCT OF UNDERWRITING AGENCIES.

1. GENERAL

3. DUTIES OF AN AGENT.

(ii) Service to Names

Further by Lloyd's Byelaw No. 4 of 1984 "Underwriting Agents" made on 14th May 1984, provision was made for a system of registration specifying those underwriting agents at Lloyd's permitted to act solely as members' agents, those underwriting agents at Lloyd's permitted to act solely as managing agents and those underwriting agents at Lloyd's permitted to act as both members' agents and managing agents. The Byelaw defined a members' agent as being an underwriting agent which acted on behalf of a name but did not perform any of the functions of a managing agent and defined a managing agent as being an underwriting agent which performed for the name one or more of the following functions :

(iii) paying claims on such contracts.

At all material times the respective roles of members' agents and managing agents with regard to syndicate accounts were as follows.

The managing agent was responsible for keeping accounting records and for the production of annual audited accounts for the syndicates which it managed and the members' agent played no part in the preparation of such accounts or any of the work required therefor.

On the basis of the annual audited syndicate accounts and solvency reports provided by managing agents, auditors appointed by the members' agents prepared and submitted solvency reports to Lloyd's in respect of each of their names.

The respective functions of members' agents and managing agents were set out, inter alia, in the Lloyd's Manual for Underwriting Agents which provided, inter alia, as follows:

"10. ACCOUNTS.

The respective functions of members' agents and managing agents were further set out in Byelaws made under the Lloyd's Act 1982.

(2) The Syndicate Accounting Byelaw (No. 7 of 1984)

MSL and/or MUAM had sole control and management of 418/417 and sole conduct of its underwriting and the defendant members' agents did not take any part in the management or control of 418/417 or the conduct of its underwriting and were not authorised by Lloyd's so to do but merely were authorised to perform and performed the duties of members' agents in relation to the participation of their names on 418/417.

Lord Goff in Henderson v Merrett Syndicates Ltd [1995] 2 AC 145

summarized the contractual structure as follows:-

As regards the indirect names the position was as follows.

Each of the plaintiffs entered into an Underwriting Agency Agreement in relation to his or her participation in 418/417. Prior to the coming into effect of the Agency Agreements Byelaw (No. 1 of 1985) on 1.1.87, the form of Underwriting Agency Agreement between the defendant members' agents and those of the plaintiffs for whom they acted as members' agents in relation to participation in 418/417 was prescribed by MSL and/or MUAM. A specimen agreement is at Appendix 3 to this judgment. After the coming into effect of the Byelaw, the form of Underwriting Agency Agreement between the defendant members' agents and those of the plaintiffs for whom they acted as members' agents in relation to participation 418/417 was as required by the Byelaw.

To the extent that the defendant members' agents were the members' agents in relation to the participation of any of the plaintiffs in 418/417, that participation was pursuant to a Sub-Agency Agreement made between the plaintiffs' respective members' agent and MSL and/or MUAM. Prior to the coming into effect of the Byelaw, each such Sub-Agency Agreement was in the form prescribed by MSL and/or MUAM. A specimen agreement is at Appendix 3. After the coming into effect of the Byelaw, each such Sub-Agency Agreement was in the form required by the Byelaw.

By the form of Underwriting Agency Agreement prescribed by MSL and/or MUAM, it was provided, inter alia, as follows :

By the form of Sub-Agency Agreement prescribed by MSL and/or MUAM it was provided, inter alia, as follows :

The form of Underwriting Agency Agreement required by the Byelaw, provided, inter alia, as follows :

The form of Sub-Agency Agreement required by the Byelaw provided, inter alia, as follows :

TABLE 2

Policies written to Syndicates 418 and 417

U/L = unlimited

xs = excess

apr = and prior years

Footnotes -

1. Outhwaite 317 50%

2. 317 50%

3. Merrett 421 20%

5. 421 12.5%; 317 50%

6. 421 10%; 317 50%

7. 421 15%

8. 421 25%

10. 421 20%

11. 421 16.7% 317 33.3%

"Reinsurance to close" ("RITC") means an agreement under which underwriting members who are members of a syndicate for a year of account agree with underwriting members who comprise that or another syndicate for a later year of account that the reinsuring members will indemnify the reinsured members against all known and unknown liabilities of the reinsured members arising out of the insurance business underwritten through that syndicate and allocated to the closed year, in consideration of a premium and the assignment to the reinsuring members of all the rights of the reinsured members arising out of or in connection with that insurance business. In computing a reinsurance to close the premium arrived at will take account of two elements : known outstanding claims and claims incurred but not reported ("IBNR"). The amount charged by way of premium in respect of reinsurance to close should, where the reinsuring members and the reinsured members were members of the same syndicate for different years of account, be equitable between them, having regard to the nature and amount of the liabilities reinsured.

Between 1982 and 1987, 418/417's 1979 year of account, and each subsequent year until its 1984 year of account, was closed by way of an RITC into the following year of account. The effect of the succession of RITCs is that the underwriting members of 418/417's 1980, 1981, 1982, 1983, 1984 and 1985 years of account have successively agreed to indemnify the names on the immediately preceding year of account against all known and unknown liabilities of the reinsured members arising out of the insurance business written or reinsured into the reinsured year of account.

The succession of RITCs is shown in Table 3 below.

TABLE 3

THE CLOSURE OF YEARS - RITC

The direct names claim against the combined agents in contract and tort (and against Mr. Merrett in tort only).

The indirect names claim against the managing agents in tort (and certain of the indirect names claim against Mr. Merrett in tort). The indirect names claim against the members' agents in contract and tort.

The plaintiffs claim against the auditors in contract and tort.

Before considering these causes of action it is convenient to refer to a further cause of action in misrepresentation/failure to report or disclose.

The plaintiffs allege that in its conduct and management of the underwriting as managing agents of 418/417, and/or as the active underwriter of 418/417, Merretts and/or Mr. Merrett respectively misrepresented, or at least failed adequately to report or disclose to the plaintiffs, information in their possession which was evidently material to the plaintiffs' assessment of their underwriting as members of 418/417 for years of account between 1980 and 1985 (inclusive), and/or to the conduct of that underwriting.

Paragraph 11 (3) of the Amended Points of Claim in the Hallam-Eames actions states that "if and insofar as any defendant seeks to rely upon a defence of limitation... and succeeds in establishing that defence, each affected name will claim damages against Merretts, Mr. Merrett and his or her relevant members' agent, for the loss arising by reason of (the alleged misrepresentation/failure to report or disclose)".

This alternative plea calls for further evidence beyond that adduced to date. I will if necessary give further directions in this connection after delivery of this judgment.

7. THE SPEECHES OF THE HOUSE OF LORDS IN HENDERSON V MERRETT SYNDICATES LTD.

I refer to the full report of the speeches of the House of Lords in Henderson v Merrett Syndicates Ltd. [1995] 2 AC 145. This decision determined a number of preliminary issues in these actions. The effect of the decision of the House of Lords is summarised in sections 8 to 11 to below. This summary is not however a substitute for reference to the full report.

8. THE 1985 NAMES

When names on the 1985 underwriting year reinsured names on the 1984 year, although the 1984 names were running off their business, the 1985 names were writing new insurance business which could only be done pursuant to the 1985 Byelaw form of agreement in force as from 1.1.87.

9. DIRECT NAMES/COMBINED AGENTS : CONTRACT AND TORT

MSL ceased to be a combined agent on 1.1.86. There is a contract between the direct names and the combined agent, in the terms of the pre-1985 Byelaw form of agency agreement, in which a term is to be implied that the agents will exercise reasonable skill and care in the exercise of their functions as managing agents under the agreement. That duty of care is no different from the duty of care owed by the combined agents to the direct names in tort on the Hedley Byrne principle.

10. INDIRECT NAMES/MANAGING AGENTS : TORT

The claims of the indirect names arise in the context of the pre and post 1985 Byelaw forms of agency agreements. There is to be implied into the sub-agency agreements a duty upon the managing agents to exercise reasonable skill and care. There is no material difference between the relevant contractual duty and the duty of care owed by the managing agents to the indirect names in tort on the Hedley Byrne principle.

11. INDIRECT NAMES/MEMBERS' AGENTS : CONTRACT

Under an implied term in the pre-1985 Byelaw forms of agency agreements and under the form prescribed by the 1985 Byelaw, members' agents are responsible to indirect names for any failure to exercise reasonable skill and care on the part of the managing agents to whom underwriting was delegated by the members' agents. For these purposes underwriting includes the assessment and effecting of any RITC and the fixing of the premium therefor.

12. INDIRECT NAMES/MEMBERS' AGENTS : TORT

In P.J. Aitken v Stewart Wrightson Members Agency Limited (Pulbrook 334) Potter J. held on agreed facts that the members' agents did not owe a non-delegable duty of care to the indirect names in tort. Pending appeal the plaintiffs reserve their position on this. The point was not argued before me.

13. E & W's DUTIES

The plaintiffs contend that E&W were engaged by them contractually and that, as syndicate auditors, had the responsibility to ensure:

The plaintiffs contend that there was an implied term of reasonable skill and care and/or a duty of care in tort to like effect, and in particular a duty of care and skill in assessing whether the RITC premium was equitable in the terms set out above. This duty was owed to all names on the year into which the previous year was closed.

The plaintiffs further contend that at all material times such implied term and/or duty imposed at least the following specific obligations on the syndicate auditors:

The names contend that the assessment and/or effecting of the RITC and the decision to close the year was made by Mr. Merrett and/or Merretts and participated in and/or approved by E&W.

E&W submit that the names had no contract with and have no contractual claim against E&W. As to tort E&W's submissions are as follows. The only duty in tort owed by E&W to the names on the succeeding year (when there is a RITC) was to act with such reasonable care and skill as was to be expected of a Lloyd's Panel Auditor in carrying out the work necessary to give, and in giving, the form of opinion or report in fact given. In respect of the years 1981, 1982 and 1983 E&W did not provide (and were not engaged to provide) a qualitative opinion on the syndicate accounts. In respect of the years 1984, 1985 and 1986 E&W did express a qualitative opinion that the Annual Report gave a true and fair view of the closed year of account profit.

In respect of all of the years 1981-1986 E&W compiled a Syndicate Solvency Report.

Accordingly E&W's duty (so far as presently relevant) was to take reasonable care in taking the steps necessary to give and in giving:

In respect of (a), the duty was, in essence, to take care to see that the agent had discharged his responsibilities for establishing reserves in a reasonable manner, so as to be in a position to give the opinion in the Syndicate Solvency Report. This did not involve the auditor in approving or expressing an opinion on the RITC. It required the auditor to ensure that the managing agent had used the highest of the two or three alternative tests. In the case of a non-marine syndicate the first (Lloyd's percentages) and third (RITC) tests were "given" figures. By virtue of the second test (total of estimated outstanding liabilities including an element to take care of unnoted and unknown liabilities) the auditor had to ensure that the agent had discharged his responsibility in a reasonable manner consistent with available information.

In respect of (b) no serious question arises. Merretts' books were properly kept and the accounts were in agreement with them.

In respect of (c) the critical feature for present purposes is the reinsurance to close. The duty is not accurately expressed, whether in relation to the period before or after "true and fair view" reporting, as a duty to make, participate in, or approve the decision to close or leave open the year of account. It was a duty to form (and express) an opinion, or decline to do so, on a decision made by the underwriter.

In view of my findings as to years 1,2 and 3 below it is unnecessary to express an opinion as to the extent of E&W's duties in years 1 to 3, save to say (a) that having regard to E&W's functions in respect of the syndicate accounts and syndicate solvency report the duties were wider than those contended for by E&W but (b) weight has to be given to the fact that the opinion required was not a true and fair view opinion. Even if the plaintiffs' submissions were accepted in full, I do not consider that E&W were negligent in years 1, 2 and 3.

As to years 4, 5 and 6 E&W accept that they owed a duty of care in tort to the reinsuring names to act with such reasonable care and skill as was to be expected of a Lloyd's panel/recognised auditor in carrying out the work necessary to give, and in giving, the true and fair opinion. It was, as E&W point out, a duty to form and express an opinion, or decline to do so, on a decision made by the managing agent/underwriter.

In view of the fact that E&W accept that they owed a duty of care in tort as set out above, the question whether the contract of engagement was with the managing agents (as E&W contend) or with the names (as the plaintiffs contend) is academic and it is unnecessary to express an opinion on this point.

14. STANDARD OF CARE

I turn to consider the standard of care required of Merretts and

E&W.

In Bolam v Friern Hospital Management Committee [1957]1 WLR 582 at p 587 McNair J. said that a professional:-

In Saif Ali v Sydney Mitchell & Co [1980] AC 198 at 220D Lord Diplock said:-

In Maynard v West Midlands Regional Health Authority [1984] 1 WLR 634, Lord Scarman at page 638 H said:-

In Wilsher v Essex AHA [1987] 1 QB 730 at 747 A-C Mustill LJ said:-

In Eckersley v Binnie [1988] 18 Con.LR 1 at p.79 Bingham LJ said:-

Bingham LJ then quoted the passage from Saif Ali set out above and continued:-

In The Lloyd's Litigation : The Merrett, Gooda Walker and Feltrim Cases [1994] 2 Lloyd's Rep 468 at 474 Bingham MR said:-

I set out below propositions relevant to the present case derived from the above authorities:-

As to MSL (to the extent that they acted as managing agents), MUAM and E&W:-

15. LIMITATION

Save in all cases for the plea in paragraph 11 (3) of the Amended Points of Claim (misrepresentation/non-disclosure):-

Subject to S14A (tort) and S32 (contract and tort) of the Limitation Act 1980 claims by direct names against combined agents in contract and tort by the pre-1984 joiners in the Hallam-Eames actions are statute-barred.

Subject to S14A and S32 claims by indirect names against managing agents in tort by the pre-1984 and the 1984 joiners in the Hallam-Eames actions (but not the 1984 joiners in the Henderson actions) are statute-barred.

Subject to S32 claims by indirect names against members' agents in contract by the pre-1984 and the 1984 joiners in the Hallam-Eames actions (but not the 1984 joiners in the Henderson actions) are statute-barred.

The Names assert claims in contract and tort against E&W. E&W assert that the only duty arises in tort. Subject to S14A (tort) claims by names against E&W by the pre-1984 and the 1984 joiners in the Hallam-Eames actions (but not the 1984 joiners in the Henderson actions) are statute-barred.

The limitation position and issues are set out in Table 4 below.

I return to the subject of limitation in section 39 below.

TABLE 4

Footnote ² Subject to the plea in para 11(3) of the Amended Points of Claim of misrepresentation, non- disclosure.

16. THE WITNESSES

I turn to consider the witnesses in the order in which they gave

evidence.

Mr. Ayliffe joined MSL as Non-Marine Claims Manager in 1977. He was appointed a director of MSL in 1978 and was a director of MUAM from January 1986. He became a name on Syndicate 418/417 in 1978.

Mr. Ayliffe served on a number of Lloyd's Market Committees including the Management Board of LUNCO and the Non-Marine Association Claims Committee of which he was Chairman from 1965 to 1978.

Mr. Ayliffe was a founder member of the Asbestos Working Party ("AWP") (which was set up in 1980). He was one of the two London Market representatives instructed to work with the US insurance industry and asbestos producers on the Asbestos Claims Council. In 1985 he was appointed as the London Director to the Board of the Asbestos Claims Facility ("ACF") which was established that year. He retired from that post in May 1988. Mr. Ayliffe served on the AWP Claims Committee for the years 1983 to 1988 and the AWP Reinsurance Claims Committee from 1983 to 1988. He was also a member of the Special LMX Committee dealing with problems associated with delayed response of certain outward reinsurers to asbestos-related claims.

Mr. Ayliffe was also a founder member and the initial chairman of the London Market Environmental Claims Group set up in 1984 and served on the Environmental Claims Reinsurance Group for the years 1985 to 1988.

Mr. Ayliffe was appointed a director of Toplis & Harding (Asbestos Services) Limited in 1984 and continued to serve as a director of its successor company, Toplis & Harding (Market Services) Limited until early 1989. He retired from Merretts in 1988. On his retirement he was awarded the Freedom of the City of London for services to the Lloyd's Insurance Market.

Mr. Ayliffe said that he had no involvement in the assessment of strict IBNR as that was the responsibility of the underwriter Mr. Merrett, though he said that with his fellow directors he approved the relevant accounts.

He said that it never crossed his mind that the nature of the problems of asbestos and pollution were such as to make it impossible for the underwriter to reach a responsible and fair IBNR or to make it unfair to close any of the relevant years of account.

Mr. Ayliffe plainly had very considerable specialist knowledge as to the problems of asbestos and pollution. His witness statement contained a number of passages dealing with the perception of the market as to the problems of asbestos and pollution claims at different periods in time. While in no way doubting Mr. Ayliffe's considerable experience and expertise I consider that it is far safer to base my analysis of the perception of these problems at the material times on the contemporary documents. By way of example what Mr. Ayliffe said in October 1985 (see section 36 below) should be compared with the relevant passages in his witness statement.

Mr. Ayliffe was not concerned with the claims handling of the run-off contracts and said that he first heard about these in about 1984. A striking feature of Mr. Ayliffe's evidence was that he was very reluctant even to comment on the run-off contracts.

Mr. Hart has been a Fellow of the Institute of Actuaries since 1970 and a member of the Institute's General Insurance Study Group from 1974. He was a founder member of the London Market Actuaries Group in 1982 and was Chairman in 1990/91. He was a member of the Institute's General Insurance Joint Committee from 1989 to 1992.

Mr. Hart joined MSL in August 1982. He was responsible to the underwriter of Syndicate 799, Mr. Jackson. His role at 799 was to assist Mr. Jackson on the RITC and to deal with whatever statistical or actuarial tasks were allocated to him. Mr. Hart regarded himself as working full time for Mr. Jackson and was only seconded to special projects for 418/417.

Mr. Hart was the first actuary to be employed by a Lloyd's underwriting agency.

Mr. Hart edited a monograph entitled "Lloyd's and the London Market" by London Market Actuaries Group (two editions in 1989). Chapter 6 is entitled Claims and Estimating Reserves. Paragraph 6.18 et.seq deals with Asbestos and Latent Disease Claims.

In paragraphs 4 to 6 of his witness statement Mr. Hart explains why traditional actuarial or statistical approaches were not applicable to reserving for asbestos and other latent disease claims. In the result Mr. Hart acknowledged that his actuarial qualification was of marginal relevance to the assessment of an IBNR. It was not Mr. Hart's function to form a view as to the likely future development of asbestos and pollution claims. As he said "I was not in a position to suggest that asbestos would run-off over another 3,5 or 7 years. I did not know." In this connection he was dependent on what he was told by other personnel at Merretts.

Mr. Hart said that the decision whether or not to close a year or to leave it open was not one in which he would be involved, save to the extent that he would provide some figures to the underwriter, whose decision it was.

Mr. Hart did not know that 417/418 had written any of the run-off contracts until about late March 1985. When shortly thereafter he conducted a review with Mr. Randall, they found it was a struggle to get even the most basic data.

Mr. Merrett started work in the London Insurance Market in 1962 as a marine broker. In 1964 he joined the marine box of Merretts as a trainee underwriter, covering all classes of business handled by the marine syndicate at that time. In 1971 he became joint active underwriter of 418/417 with Mr. Richard Outhwaite. He became sole active underwriter in 1974 on Mr. Outhwaite's departure. During the course of more than 20 years underwriting experience Mr. Merrett has been involved in the underwriting and leading of risks across many classes of business. Most of these classes have included both direct insurance and reinsurance or retrocession business. Mr. Merrett has been a name on 418/417 since 1968.

During the course of his underwriting career Mr. Merrett has been involved with Lloyd's governance and with market issues, technical, regulatory and structural. He was elected to the Committee of Lloyd's to serve from 1981 to 1984 inclusive, and therefore became a member of the Council of Lloyd's after the passage of the 1982 Lloyd's Act. He was re-elected for a second term on the Council from 1987 to 1991, and a third in 1993. He served as a Deputy Chairman in 1993. Mr. Merrett has served on many of the committees and sub-committees of the Council and Committee of Lloyd's, including Finance and General Purposes, Membership, Audit (subsequently Members Solvency), Accounting and Auditing Standards and Financial Guarantee. Mr. Merrett was a member of the Higgins Working Party which reviewed the relationship between names, managing agents and members' agents after the passage of the 1982 Act, and the Rowland Task Force, whose report encompassed the radical change in the structure of the Market since 1990. Mr. Merrett served on the Committee of the Lloyd's Marine Underwriters Association from 1974 to 1993 and for two years he was Chairman. In 1978 at the request of Lloyd's he undertook the management of the Sasse Agency and Syndicates after the Agency had been suspended from trading following substantial losses.

Mr. Merrett has provided expert evidence for Lloyd's in a number of contexts including testimony at the Committee Stages in both Houses on the Lloyd's Bill in 1981. Mr. Merrett is currently Chairman of the Lloyd's "Superfund" Working Party.

Mr. Merrett had a distinguished father who provided very valuable services to the market.

Mr. Merrett is a highly intelligent man who has extremely wide experience of the market as appears from the above. Mr. Holland of E&W described him as having a forceful personality.

I regret to say that I have serious reservations about many aspects of Mr. Merrett's evidence and serious reservations about his approach as underwriter to 418/417.

Mr Merrett said that Mr. Emney was at the outset responsible for the management of the run-off contracts including the underwriting, the recording and the handling and management of claims. In 1985 it was the Board's view that Mr. Emney had not fulfilled his duties properly and that was why, when he withdrew his resignation, he was dismissed.

As to the writing of the run-off contracts the minutes of the meeting of the Audit Committee held on 2.3.82 (H1/471A) attended by Mr. Merrett recorded:-

I do not accept Mr. Merrett's explanation of this passage in the minutes (Day 15/141-144). It is in my view plain that the reference to "telling its own Names" is in the context of a syndicate which had written run-off contracts. The point of concern was that such liabilities could fall on comparatively few syndicates. In fact Merretts did not tell E&W about the writing of the run-off contracts until year 3 (when reference was made to only 6 out of 11). I reject Mr. Merrett's evidence that E&W were told about the writing of the run-off contracts prior to year 3. The first the plaintiffs heard about the writing of the run-off contracts was on 18.4.85.

On 4.5.82 Mr. Merrett signed a letter in response to E&W's Latent Disease Questionnaire for year 1 (D1/146) which failed to mention the run-off contracts. When asked about this letter Mr. Merrett said that it was wholly consistent with his having informed E&W of the existence of the run-off contracts. The letter of 4.5.82 was seriously misleading and I reject Mr. Merrett's explanation (Day 15/138-9). Mr. Merrett was in no doubt as to the importance of informing E&W about the run-off contracts (see the meeting on 2.3.82 above). The Latent Disease Questionnaire in year 2 (D2/174) asked a specific question about "OTHER EXPOSURE TO LATENT DISEASES. Evidence that syndicates have taken steps to identify, quantify and record as above any other known or potential liabilities in respect of writing of ... (c) Run-off Account containing latent disease liability". Mr. Merrett replied in a letter dated 28.4.83 (D2/170) "Other exposures to latent Disease. This syndicate (417) does not as a matter of policy write these classes of business, other than on a very incidental basis, very seldom". On the same date Mr. Merrett wrote in respect of 418 "Latent Diseases. The reports have been obtained, and records retained in accordance with the reinsurance to close claims analysis exercise: we have no knowledge of any other reinsurance contract which might become involved. We have no other known or known potential liabilities and no material recoveries". Neither of these letter referred to the fact that by 28.4.83 all 11 run-off contracts had been written. When asked about the letters dated 28.4.83 Mr. Merrett said "Had I been in any doubt as to (E&W's) knowledge of those contracts and had I wished to make certain that they had a record in writing of our having written them then I suppose I would have written in those terms; but given that, to my belief, they were already aware of the contracts then the necessity to make specific reference fell away." (Day 17/12-13). Again I reject Mr. Merrett's attempted explanation of these very serious failures.

In his witness statement Mr. Merrett said:-

Mr. Merrett's oral evidence was to very different effect (Day 16/9/9-/14/11) and his explanation for the inconsistency unconvincing (Day 15/118/9-122/17).

Merretts did not call Mr. Emney to give evidence. As a result I consider that I have been inhibited in getting to the truth about the writing of the run-off contracts. The probability is that Mr. Merrett knew more about the writing of the run-off contracts than he accepted in his statement or in his evidence.

As to the 6 RITCs Mr. Merrett correctly accepted that his duties in this connection were the most important function that he fulfilled each year as underwriter of 418/417. The amount charged by way of premium in respect of reinsurance to close had to be equitable as between the reinsuring members and the reinsured members, having regard to the nature and amount of the liabilities reinsured. Compliance with "equity between Names" had to be demonstrated by the underwriter and the managing agent in determining the RITC. I find that Mr. Merrett gave inadequate time and attention to the RITCs particularly in years 4, 5 and 6, and this must have been apparent to E&W. It was not enough to rely on Mr. Ayliffe, Mr. Hart and Mr. Randall. Mr. Ayliffe had no involvement in the assessment of strict IBNR as that was the responsibility of Mr. Merrett. It was not Mr. Hart's function to form a view as to the likely future development of asbestos and pollution claims. Further the decision whether or not to close a year was not one in which Mr. Hart would be involved, save to the extent that he would provide figures to Mr. Merrett, whose decision it was. Mr. Randall said that in 1985 and subsequent years he was in no position to form an opinion as to the likely development of asbestos-related claims or pollution claims and was totally dependent on the advice received from others.

Mr. Merrett's evidence in relation to Mr. Rokeby-Johnson's letter of 16.7.82 (D6/444, quoted below) was unconvincing (see Day 16/63/23-67/5).

In relation to the RITCs particularly in years 4, 5 and 6 Mr. Merrett was subject to conflicts of interest inherent in the system. Significant commercial disadvantages would flow from leaving the year open. The letter dated 18.4.85 and the reports in the year 4 accounts contain a mixture of truth, half-truth and falsehood. But the letter dated 18.4.85 stated "in the current underwriting climate, it is our intention significantly to expand... 418...".

Mr. Merrett knew from his very considerable experience that 418/417 in year 4 was subject to deep-rooted problems and uncertainties as to the future development of (i) asbestos bodily injury claims (ii) asbestos property damage claims and (iii) pollution claims not only in respect of 418/417's own book going back to 1953, but also in respect of the books of the ten cedants. Further the information as to the run-off contracts was wholly inadequate. I find that Mr. Merrett knew that a reinsurance to close figure could not be arrived at in year 4 with a reasonable degree of accuracy and yet he was determined to close the account. Similar considerations applied in years 5 and 6.

Mr. Randall first became involved in the insurance industry in 1974 when he joined the Corporation of Lloyd's as Deputy Corporation Accountant. He had previously qualified as a certified accountant. In 1979 he became responsible for the Lloyd's Audit Department which dealt, inter alia, with the review of the solvency of Lloyd's Members and security behind the Lloyd's Policy of Insurance. In 1982 he additionally became head of the Special Investigation Department at Lloyd's looking into various Market problems such as Alexander Howden, PCW and Brooks & Dooley amongst others. In 1983 he became the Head of Regulatory Services and as such was the principal point of contact between the Lloyd's Market and the Corporation of Lloyd's and between the Corporation of Lloyd's and the Department of Trade and Industry in respect of, inter alia, solvency. He was also the principal point of contact between the Corporation of Lloyd's and the panel auditors. He was a member of the Lloyd's Audit Committee and Chairman and/or a member of several of the Fisher Task Groups set up in 1980 to follow up the various suggestions made in the Fisher Report.

Mr. Randall joined Merretts at the beginning of 1985. His initial appointment was as Managing Director of MSL. He was also appointed a director of Merrett Holdings PLC. He was subsequently appointed Managing Director of MUAM when that company assumed the managing agency function from MSL as at 1.1.86. In 1987 Mr. Randall was appointed Group Chief Executive and Managing Director of the Merrett Group. He left the Merrett Group in August 1991 and set up an independent insurance consultancy, Randall Insurance Services Ltd, of which he is Chief Executive.

Mr. Randall said that after he left Merretts his office was cleared "and no-one seems to be sure what happened to all the papers in it - there was an entire series of cupboards and filing cabinets stacked full of files and reports of various sorts and they have all disappeared".

In fairness to Mr. Randall he had only been with Merretts a very short time when the problems in relation to the run-off contracts came to light. Mr. Randall said that in 1985 and subsequent years he was in no position to form an opinion as to the likely development of asbestos-related claims or pollution claims and was in this connection totally dependent on the advice received from others.

After making full allowance for the difficulties that Mr. Randall faced including those referred to above, I have a number of reservations about his evidence. In particular I consider that Mr. Randall was at times inclined to go further than was justified in seeking to defend the approach of the Merrett defendants.

Two United States Attorneys were called to give evidence. Mr. Newman gave evidence on behalf of the plaintiffs and Mr. Ringer gave evidence on behalf of the Merrett defendants. Mr. Ringer's evidence was also relied upon by E&W. Mr. Newman and Mr. Ringer prepared and agreed Appendix 2 to this judgment and I am grateful to them for this assistance.

Mr. Newman's and Mr. Ringer's experience and qualifications are set out in their statements.

Mr. Ringer's witness statement extended to 134 pages (his statement in reply to 29 pages). Mr. Ringer frankly accepted that the opinions set out in his statements were largely based upon the research he had conducted. He said he did have some anecdotal evidence learnt contemporaneously but would not consider that to have been sufficient to base an opinion on. He relied upon the documents and various other materials that his research had located. I have marked reservations about Mr. Ringer's witness statement, save where the statement contains matters that are agreed between the parties. The statement contains numerous assertions which should have been qualified so as to make it clear that the opinions expressed were based upon research and not on any contemporary experience. Mr. Ringer confirmed that the two attorneys between them had collected a good representative sample of the material available in the United States at the material times. In my view the most accurate reflection of perception in the United States in the 1980s is found in the contemporary materials and particularly the attorneys' reports.

In paragraph 53 of his statement Mr. Ringer said that based on the 10-k and Annual Reports of the 9 US insurers he had reviewed all 9 believed that their reserves were adequate to cover current and future asbestos bodily injury (and environmental liability) claims up to and including 1988 and that only at the 1989 year end did the first qualifications appear. I refer below in connection with Mr. Knowlton's evidence to the fundamental distinctions between the considerations applicable to and circumstances of a US insurance company and a Lloyd's syndicate such as 418/417. For the purposes of any comparison between a US insurance company and 418/417 it is necessary to compare net assets, exposure to asbestos-related claims (direct, reinsurance and retrocession), the extent of any reinsurance protections, the proportion of the reserves for asbestos-related claims to the total reserves and the fact that a US insurance company is not concerned with equity between names. Further 418/417 wrote 11 run-off contracts with a resultant funnelling of asbestos and pollution risks into the syndicate.

In paragraph 105 of his statement Mr. Ringer said "the unanticipated surge of claims by workers in trades other than shipbuilding and insulation goes a long way to explain why the Conning & Co. 1982 predictions became obsolete by the late 1980s". The extent to which at any moment in time there were claims by workers in trades other than shipbuilding and insulation is shown by the contemporary documents and particularly the attorneys' reports. I have to consider the perception of asbestos-related claims (and pollution claims) at 17 different points in time (11 run-off contracts and 6 RITCs). The best guide is found in the contemporary documents and particularly the attorneys' reports. It is possible to point to "surges" but what matters for present purposes is the state of perception at the 17 different points in time.

Mr. Knowlton was called to give evidence on behalf of Merretts. He commenced employment with Travelers Insurance Company Inc in 1960. He remained with Travelers until 1989 when he moved to ITT Hartford Insurance Group. In 1979 Mr. Knowlton transferred to the strategic claims operations of Travelers. In April 1979 he was asked to oversee Travelers' recently established department set up to deal exclusively with asbestos claims. In 1981 he was appointed Vice-President. In late 1984 he was placed in charge of the Strategic Claim Division which included large liability claims as well as the Environmental Unit. He remained in that position with Travelers until 1989 when he transferred to ITT Hartford to take up the position of Director of Environmental Claims and Litigation. He is presently a Vice-President with ITT Hartford. Mr. Knowlton, in preparing his statement, did not have access to contemporary materials at Travelers.

In my view the most reliable indications of Mr. Knowlton's perception in the 1980's are to be found in the contemporary documents. As at April 1983 (H4/294C) Mr. Knowlton is reported as saying "Asbestos is the single biggest problem we find in the industry. But the numbers aren't anywhere near the numbers that the Chicken Littles are saying."

In an article in 'The Brief' in August 1983 (H4/296C) Mr. Knowlton wrote:-

Mr. Knowlton's perception as at January 1985 is referred to below.

As at May 1987 (Mr. Ringer's file 4/27) Mr. Knowlton is recorded as saying:-

The fact that it is far safer to rely on Mr. Knowlton's perception as reflected in contemporary documents as opposed to some passages in his witness statement is illustrated by the following example.

Paragraph 32 of Mr. Knowlton's witness statement ("I recollect that in the early 1980's there were some pessimists who predicted that property damage claims would present a bigger problem for insurers than bodily injury claims. However, neither I nor others at Travelers nor, to my knowledge, my associates at other insurance companies, shared that view at the time.") should be contrasted with Mrs. Rowe's contemporary record of a conversation with Mr. Knowlton on 31.1.85 "Knowlton said the asbestos BI problem may be more or less under control, but he feels the P.D. will be at least as large - and may in turn spark more B.I. claims..." (I2/478).

Mr. Knowlton refers in his witness statement to changes in the type of claimant (paragraph 23 (2)), changes in the number of defendants (paragraph 27) and the development of class actions (paragraph 26). The nature and extent of these changes and developments are most accurately reflected in the attorneys' reports from time to time. Mr. Knowlton says in paragraph 30 of his statement "In my own case, and I believe that to be reasonable and typical in the industry, the perception that reserving "to ultimate" was no longer possible developed during 1989 and 1990. By that time I had taken the view that reserving for these types of claims would have to be done on a simple projection of future payment streams covering a limited period of time."

There are fundamental distinctions between the considerations applicable to and the circumstances of a US insurance company such as Travelers (not concerned with equity between two sets of names, able to adjust reserves from year to year, net assets amounting to billions of dollars, primary layers/excess layers with extensive reinsurance protections, very little reinsurance exposure) and a Lloyd's syndicate such as 418/417. When asked whether he was able to provide any indication as to the proportion that asbestos reserves bore to total reserves at Travelers, Mr. Knowlton said that at the Hartford asbestos is probably 1% or 2% of the total reserves of some $9 billion and that Travelers and Hartford are about the same size.

Mr. Knowlton provided a valuable description of the extremely detailed approach adopted by Travelers in relation to reserving asbestos-related claims.

Mrs. Rowe was called, as an expert witness on claims handling and managing, by the plaintiffs. After graduating in 1974 in Economics from Cambridge she spent 15 years in Lloyd's employed by R.J. Kiln. In 1981 she qualified as a Fellow of the Chartered Insurance Institute by examination. She is a Chartered Insurance Practitioner. Her time at R.J. Kiln was spent almost entirely in the Claims Department where for most of her career she was Claims Manager. She was responsible to the extent shown by the contemprorary documents for the calculation of the RITC figures, including estimates for IBNR. Since 1989 she has been practising independently as senior partner in her own firm. Mrs. Rowe was expert in claims handling and managing but made no claim to have any expertise in underwriting decisions.

Mrs. Rowe based her report on a reading of limited materials. In paragraph 4 of her report she said she had studied the various copy RITC files, in particular the "pruned" RITC files. Thus by way of example Mrs. Rowe did not read the E&W audit files (D1-13).

Mrs. Rowe was cross-examined at length as to the approach adopted by the Kiln Syndicate 510/511. The defendants rely on a number of points derived from this cross-examination. I will consider the position of the Kiln Syndicate below.

Mrs. Rowe said she became aware that 418/417 had written some of the same run-off contracts as the Outhwaite syndicate, once the Outhwaite run-off contracts became a subject of general discussion. She was asked whether it occurred to her at that stage that 418/417 would have an insoluble reserving and closing problem. She said that she believed it did and that at some of the reserving discussion meetings between the underwriter of Kiln 510/511 the conversation went along the following lines - "If our figures are this big, and still developing, how on earth do people with bigger portfolios, let alone run-off contracts, manage?".

The essence of Mrs. Rowe's criticism of Merretts was as follows. She said that in her opinion they did not do as much analysis of their account as was possible. She said that the principal heads of analysis that she conducted, but Merretts did not conduct, comprised statistical triangulations of all sections of the account (including eventually separate triangulations for asbestos-related claims), graphical projections of those triangulations and close analysis of the direct casualty account from virtually complete records. Mrs. Rowe said that Merretts did not do as much analysis of their accounts as possible; had they done that analysis, coupled with the much greater knowledge that people like Mr. Ayliffe had of the underlying nature of the asbestos problems in the market, they would have come to the conclusion earlier that they should not close. Mrs. Rowe added that the larger the impact of asbestos-related claims (including in particular asbestos-related claims deriving from the run-off contracts which were even harder to estimate) the more any uncertainty was likely to damage the syndicate. Kiln was in the fortunate position that it could close in the years in question. She did not believe that 418/417 was in the same position. She was asked what approach she would have adopted if Kiln had written run-off contracts. She said that for each run-off contract she would want to be able to do the same exercise as she did for Kiln's own book of business, if she were to have any comfort at all in closing a syndicate with a run-off contract in it.

Although Mrs. Rowe's evidence must be approached with care having regard in particular to the extent of her expertise and her limited consideration of the materials in the case, I formed the impression that she was a sincere and generally a reliable witness. For the reasons set out below I consider that there are marked distinctions between the position of the Kiln syndicate and 418/417.

I should record that the materials before the court in relation to the Kiln syndicate were not complete. I accept Mrs. Rowe's evidence that there are a number of relevant materials missing from the files relating to the Kiln Syndicate. I was left with the impression that Mrs. Rowe was thorough in her statistical analysis of Kiln's own book of business. It should not be assumed that she would have reached the same conclusions as those arrived at in relation to Kiln if she had been concerned with 418/417's own book of business plus the eleven run-off contracts.

There were marked differences between 418/417's own book of business and the book of business written by Kiln 510/511. Further Kiln did not write any run-off contracts.

From 1963 to approximately 1968 the Kiln Syndicate wrote a small book of direct US casualty insurance. Nearly all of this was written under market line slips and in particular the Price Forbes line slip. Nearly all of it was high level excess umbrella business and none of it was primary business. That book ceased in 1968 or 1969. The Kiln Syndicate was mostly a reinsurance syndicate, and had always written some reinsurance of US casualty business. In the 1970's that was predominantly either the casualty element of global or package reinsurances or the reinsurance of claims made and medical malpractice business. From the 1980's onwards, the element of global business disappeared, and from then on virtually all of the syndicate's US casualty business was on a claims made or a high level clash basis. There was a specific programme of outward insurance to protect the direct book, which consisted of an excess cession treaty protecting each year of account, covering each line written. It varied from between 75 and 80% of the syndicate's line, in excess of 25 or 20% of the line, with unlimited reinstatements as to the original business and that in turn enured to the benefit of an excess of loss protection, with a very low deductible, about $10,000 each and every loss, also with unlimited reinstatements. Thus the per loss retention of the syndicate was approximately $5,000 or $10,000 any one casualty loss. The syndicate's total casualty book was never more than about 10% of the book at its maximum.

Mrs. Rowe said "we did not have the sort of book that would inevitably respond to every casualty problem that surfaced" (Day 26/123) and "we were known in the market as almost entirely a short tail syndicate" (Day 27/93). For other points of distinction between 418/417 and 510/511 see the plaintiffs' closing submissions 21/15.

A chart prepared on behalf of the plaintiffs contrasted the stamp capacity and RITC gross of credit for T&D in the case of 418/417 and Kiln 510/511.

In the Chairman's report dated 3.5.95 Mr. C.K. Murray, Chairman of R.J. Kiln & Co Ltd wrote:-

Mrs. Rowe described 510/511's general approach to reserves as follows. "We started with noted outstandings received from professionals, lawyers, adjusters, and the like... We made no attempt... to interfere with those figures... Before applying any projections to our total figures, we then put in our own specific IBNR, or supplementary reserves, which was the syndicate's own judgment of where those specific claims should be reserved... We then did a statistical projection on the total figures..." (Day 26/22).

The defendants rely on a number of contemporary documents from Kiln's files including inter alia the following which relate to the years ended 31.12.84-6:-

(i) The 510/511 RITC as at 31.12.84 Supplementary Reserves

(a) Asbestos - bodily injury claims

N1/358 ("Last year we loaded our noted asbestos figures by 100%... This year ...I... suggest a 50% IBNR. In addition I am not removing our old 'expense' reserves...");

(b) Asbestos - property damage

N1/359 ("To date, one reinsured ... and one insured ... have advised potential P.D. claims. We have no reserves ... We know that several other reinsurers ... anticipate P.D. claims... At the moment we have no way of predicting what our involvement will be and I therefore am making no suggestions for supplementary reserves ...")

(c) Pollution/Toxic Waste/Clean-Up Costs

N1/361 ("American insurers forecast that this class of claims will be the "next asbestosis" - and possibly bigger ... Some claims have already been made on the Lloyd's market ... Shell ... reserving this in (our attorneys) most pessimistic assumptions ... produces NIL to ... 510/511 ... For neither of these claims do I think we need any extra reserves added to our noted outstandings... Nor, at this stage, am I suggesting any other supplementary reserves - we have far too little information to make a sensible suggestion").

A chart prepared on behalf of the Merrett defendants compares the position as at 31.12.84 and 31.12.89 in relation to asbestos, pollution and property damage.

(ii) The 510/511 RITC as at 31.12.85 Supplementary/Specific IBNRs

(a) Asbestos - bodily injury claims

N2/41 ("Claims are also being made against insurers from some new sources ... Claims from various American railroad companies ... last year's 50% load on noted outstandings as an asbestosis IBNR is still reasonable and should be continued but now applied to all years...")

but see N2/100 ("Moreover our history of asbestos "specific IBNRs" has been a load of 100% for 1983 when reserve information was rudimentary and a load of 50% for (1984) when we thought nearly all exposures were reserved. A load of 50% again when reserves have increased again and the "Facility" has taken effect is not therefore justifiable");

(b) Asbestos - property damage

N2/44 ("We have received new advices this year on account of US Gypsum ... These reserves are precautionary only ... We know that several other reinsureds ... anticipate P.D. claims ... though few have formally been made ... We should begin establishing IBNRs for expenses, but we are still not in a position to forecast our loss IBNR which is still 'unknowable'").

(c) Pollution/Toxic Waste/Clean-up Costs

N2/45 ("We have several more advices since last year end, both directly and by way of reinsurance ... I therefore think it appropriate ... to begin setting up 'expense' IBNRs although it is still impossible to predict the outcome of the claims themselves").

See further the document at page 102 of bundle N3 which summarises the syndicate's RITC as at 31.12.85.

(iii) The 510/511 RITC as at 31.12.86

(a) Asbestos - bodily injury claims

N2/147 ("... plaintiffs' attorneys are actively seeking both new claimants and new target defendants ... The IBNR for claims is now included in our graphs and estimated ultimate losses for all long tail business ... It would ... be illogical to include a further specific amount");

(b) Asbestos-propery damage

N2/149 ("We continue to receive new advices ... I think we should begin establishing IBNRs for expenses, but we are still not in a position to forecast our loss IBNR which is still 'unknowable'");

(c) Pollution/Toxic Waste/Clean-up Costs

N2/149 ("We continue to receive new advices, but largely without reserves - at least for our years of involvement ... I think it is appropriate to continue setting up 'expense' IBNRs").

According to the figures at N2 pages 282 to 284 as at 31.12.87 the cumulative total of asbestos bodily injury claims amounted to 471 (a claim being defined as the total claim for one insured for one policy year or for one reinsured in respect of one insured for one policy year). As to asbestos property damage the total number was 41 and as to pollution - EPA the total number was 182.

I have carefully considered the contemporary documents relating to 510/511 and with these in mind I have given appropriate weight to Mrs. Rowe's evidence in relation to each of the six 418/417 RITCs. As Mr. Ayliffe said attempts to compare one syndicate with another in terms of the impact of asbestos etc. are liable to be a trap for the unwary because no syndicate is the same as another. Every syndicate has a different historical background.

There are numerous points of distinction between 418/417 and 510/511 including the fact that 418/417's own book of US casualty business was far greater than 510/511's own book and the fact that 510/511 did not write any run-off contracts. I should not be taken to accept that the approach adopted by 510/511 in respect of its own particular book of business was necessarily appropriate in every respect. Nor do I accept without reservation the totality of Mrs. Rowe's evidence. However it should not be assumed that Mrs. Rowe would have reached the same conclusions as those arrived at in relation to Kiln if she had been concerned with 418/417's own book plus the 11 run-off contracts.

Mr. Neil was called, as an expert witness on underwriting practice, by the plaintiffs.

In 1980 Mr. Neil was employed as active underwriter of Non-Marine syndicate 939 (Octavian). The business underwritten by Mr. Neil at syndicate 939 included North American casualty which was all written on a treaty excess of loss basis and included general liability amongst other categories of business. He was also a director of Octavian Underwriting Ltd, a joint members' and managing agency and Octavian Syndicate Management Ltd, an underwriting managing agency. Syndicate 939 in 1981 was relatively small, under £2m stamp capacity. In 1986 the capacity was approximately £13m and grew to £35m by 1991.

Mr. Neil said that the figures relating to asbestos and pollution "would have been no reason to keep the 1990 year of account open". Mr. Neil thought that paids as at 31.12.93 amounted to $300,000. As at 31.12.93 the total reserve for estimated future liabilities in respect of the 1990 year amounted to £39,468,055 of which the net outstanding claims in respect of asbestosis and pollution amounted to £691,746 and the IBNR amounted to £1,383,492.

For other points of distinction between 418/417 and 939 see the plaintiffs' closing submissions 21/22.

Mr. Rome was called as an expert witness on underwriting practice by Merretts.

Mr. Rome was the underwriter of syndicate 662 and a director of C.W. Rome (Underwriting Agency) Ltd, L.G. Cox & Co Ltd and Gammell Kershaw & Co Ltd. These companies are all managing agents of marine syndicates at Lloyd's. Mr. Rome joined Lloyd's on leaving school in 1955. He was appointed the active underwriter of syndicate 926 in 1972. In 1979 he founded C.W. Rome (Underwriting Agency) Ltd and syndicate 662 was formed. He continued as underwriter of both syndicates and they were merged in 1989 as 662. The syndicate ceased trading at the end of 1993. Mr. Rome was a director until 1988 of Bolton Ingham (Agency) Ltd which was a managing and members' agency acting for 2 marine and 1 non-marine syndicates. The non-marine syndicate 231 had written a long tail book of business and remained open for 2 or 3 years as a result of uncertainty on computer leasing. This syndicate had a significant number of asbestos claims. Mr. Rome has been actively involved in writing a wide range of business for over 30 years. He has been a leader, inter alia, of energy, hull, cargo, war and contingency business.

Mr. Rome has served on a number of Lloyd's and industry committees.

In 1988 Mr. Rome was asked by the then chairman of the Lloyd's Underwriting Agents' Association to join a working party under the leadership of Mr. Martin Hunter of Freshfields, who had been appointed to consider the underwriting by Mr. Outhwaite of a number of reinsurance contracts. Mr. Rome provided an expert report in the case of Stockwell v Outhwaite although he was not in the event called to give evidence as the case was settled out of court (see B.F. Caudle v Sharp [1994] CLC 216 at 223 - the report records that a sum of £116m was accepted by the names in full and final settlement of their claims against the agents).

Mr. Rome as underwriter of syndicate 662 was one of the underwriters on the errors and omissions line slips. A line on some of the layers of the lines slip would inevitably be exposed to successful claims in the Lloyd's litigation. As a name on syndicate 662 Mr. Rome is potentially at risk personally in relation to the result of this case. In subsequent years he wrote a substantial line on a stop loss contract which would be a substantial beneficiary if the plaintiffs in this action succeed. Further in the event of the litigation succeeding he would be able to make recoveries against the excess of loss programme. Thus he said he had a financial interest in the matter which he could not assess. In fairness to Mr. Rome he disclosed in paragraph 13 of his witness statement that he was one of the underwriters on the errors and omissions line slips. It is of course most unusual for an expert witness to have a financial interest in the result of the case. I do not suggest that this consciously affected Mr. Rome's evidence.

I have, however, a number of reservations about his evidence for other reasons. In my view Mr. Rome's evidence about the writing of the run-off contracts was unrealistic and unreasonably defensive. He said that if there were criticisms to be made of the writing of the run-off contracts they were not such as to lead him to believe that the writing of any of the run-off contracts was professionally incompetent. On the basis of such evidence as has survived he concluded that he could properly have written those contracts individually and in the aggregate. Paragraph 153 of his statement in relation to Sturge was materially inaccurate (see Day 34/91 et seq). The sentence in paragraph 138 of his statement "it is hard to see what other enquiries Mr. Merrett or Mr. Emney could have made to improve their knowledge of the risks under consideration" is not supportable.

Mr. Rome's statement did not contain any detailed critical analysis of the RITCs in years 1 to 6. Again I found his evidence at times in this connection unreasonably defensive. By way of example he said that if the underwriter and the auditors had known that the Ballantyne contract had deteriorated within 3 years of writing, to the extent that the incurred position had reached a deficit of $2.5m, he would not have expected them to be unduly concerned. I do not consider it was realistic to describe this contract as "one contract of many thousands of contracts, which form part of the accounts of that syndicate".

As to a comparison between the business of 418/417 and syndicate 662, Mr. Rome said that 418/417 was substantially larger than 662. 418/417 had written more business and had probably written larger lines. He added that it was impossible for the court to form more than a general impression of the relative sizes and exposures of these syndicates to each other.

Reports from Mr. B. Thomas Florence (on behalf of Merretts but also relied on by E&W) and Mr. John Ryan (on behalf of Merretts) were subject to Civil Evidence Act notices.

Mr. McNamara is a partner with the firm of Ernst & Young. In the period from 1980 to 1987 he was the Audit Partner responsible for the audit of Merretts' accounts and solvency reports, together with Mr. Nigel Holland.

Mr. McNamara qualified as a chartered accountant in 1973. In 1979 he was admitted as a partner in E&W. In September 1979 E&W merged with Baker Sutton & Co. and Mr. McNamara became involved with some of the insurance clients of the former Baker Sutton firm, and in particular the audit of the syndicates managed by Merretts. In addition he became involved with the audit of syndicates 401 (Cuthbert Heath), 317/661 (R.H.M. Outhwaite), 518 (Salter & Outhwaite) and 552 (Mander Thomas & Cooper). In 1983 Mr. McNamara led a team which made a successful proposal in a competitive tender for the audits of syndicates managed by Norman Frizzell Underwriting Ltd (Syndicates 979, 975 and 850). In 1983 Mr. McNamara became responsible for the audits of two further syndicates which had commenced underwriting in 1983 : 672 (I.C.A. Agnew Underwriting) and 321 (Outhwaite & Green). Mr. McNamara also became the audit partner for a syndicate formed by Mr. David Mann, formerly of Merretts, for the 1984 year of account.

In 1982 Mr. McNamara assisted with the Lloyd's enquiry into PCW and WMD Underwriting Agencies.

From 1987 until 1992 Mr. McNamara was the partner in charge of the UK Insurance Industry Group of E&W and subsequently Ernst & Young. Mr. McNamara has served on the Lloyd's Accounting and Auditing Standards Committee.

I was very impressed with the candid manner in which Mr. McNamara gave his evidence. He responded frankly to detailed questioning.

E&W were placed in a difficult position by the "shattering news" of early April 1985. They did however become aware that 417 was party to a portfolio of 6 run-off contracts in the course of the year 3 audit. The 6 run-off contracts were not given adequate attention by E&W in year 3. The breakdown in communication and organisation in the course of the year 3 audit was exacerbated by Merretts' failure to disclose the run-off contracts written by 418 and the Judd run-off contract.

It is never pleasant to have to make a finding of negligence against a professional man and it is with particular regret that I feel compelled to make a finding of negligence against E&W in years 4, 5 and 6 for the reasons set out below. I make the finding after appropriate allowance for all the difficulties that Mr. McNamara faced, particularly in year 4. I am bound to say that given the deadlines that apply to all Lloyd's syndicates and the particular problems that emerged in relation to 418/417 and Outhwaite 317/661, Mr. McNamara appears to me to have been subject to an unduly heavy burden of work, particularly in year 4.

Mr. Hill's statement was put in evidence on the basis identified at Day 43/61.

Mr. Holland is now retired. He qualified as a chartered accountant in 1951 and became a partner of Baker Sutton & Co. in 1960. When Baker Sutton & Co. merged with E&W in 1979 he became a partner in E&W. He retired in August 1988.

By the mid-1970s the major part of Mr. Holland's workload was insurance related. His curriculum vitae summarises his Lloyd's and insurance related experience.

Mr. Holland first became involved with the audit of the Merrett Syndicates in about 1957. As Mr. Holland was becoming increasingly involved with Lloyd's Committees and enquiries in the early 1980s, culminating in his appointment in January 1983 as one of two inspectors with respect to the Alexander Howden affair, Mr. McNamara took over principal responsibility for the audit of the Merrett Syndicates from the year end 31.12.82. From that year end onwards Mr. Holland's role was limited to that of "client partner". His involvement with the audit itself post-1981 was limited. He did not become involved with the detailed auditing, nor did he review the work that was conducted.

Mr. Attwood was called as an expert witness on behalf of the plaintiffs.

In 1974 Mr. Attwood became a partner in Robson Rhodes. Since 1989 he has been the Chief Executive Officer of R.S.M. International, the worldwide accounting group of which Robson Rhodes is the U.K. member. He is a representative of the I.C.A.E.W. on the Joint International Committee of Chartered Accounts. From about 1979 to 1983 he was his firm's representative on the International Professional Standards Committee, which was the committee responsible for setting standards for international auditing work throughout the world (being appointed Chairman during his later years of involvement). In 1976 he became the author of the fifteenth edition of the standard text "de Paula's Principles of Auditing" (Pitman) and has also been the author of the sixteenth and seventeenth editions. In 1978 he was asked by the I.C.A.E.W. to write an introductory text to the Discussion Drafts of the proposed Auditing Standards.

Mr. Attwood became a member of the Auditing Practice Committee in 1980. He was asked by the A.P.C. to become its representative on the C.C.A.B. Lloyd's Sub-Committee in 1982. At about that time Robson Rhodes was in the process of obtaining "recognition" by Lloyd's for the purposes of undertaking syndicate audits.

In 1984, Mr. Attwood became the Chairman of the newly formed A.P.C. Lloyd's Working Party, charged with the development of auditing guidance in relation to Lloyd's syndicates, following the recent Byelaw changes at Lloyd's and the publication by the A.P.C. in 1980 of the Auditing Standards and Guidelines. That role continued until the publication in 1992 of Practice Note No.2, "The Lloyd's Market", by the then Auditing Practices Board. Previously the Working Party had produced the Audit Brief "Lloyd's Syndicates" in 1986, and several additional Practice Notes providing guidance on specific topics, all of which then became combined in "The Lloyd's Market" publication.

In 1985 Mr. Attwood became a member of the I.C.A.E.W. Insurance Sub-Committee.

In 1982 Mr. Attwood was partner-in-charge of Robson Rhodes London office. Initially his role was as "second" or "support" partner to the audit partner responsible for work for the John Townsend group of companies, then comprising a Lloyd's broker, a members' agent, a managing agent and two marine syndicates with incidental non-marine syndicates (275/6 and 575/645). In about 1985 he took over lead responsibility for that client and remained involved with its syndicate audits for two years until the group's divestment of its managing agency activities.

Mr. Attwood was an extremely impressive witness. He has very considerable professional standing and knowledge. He was prepared to withdraw a criticism if it was not justified or supportable.

It is necessary in considering Mr. Attwood's evidence to bear in mind (a) that he had limited experience as a panel/recognised auditor (b) that his own standards in years 1 to 3 may to some extent be above the reasonable average (c) that at times his approach tended to be slightly over-purist/over-technical and (d) the approach adopted in relation to 275/6 as to which see below.

As to the appropriate materiality level or maximum level of tolerance of error in 418/417's RITC premium, whereas on the one hand I consider that the level adopted by Mr. Attwood was somewhat strict for a long tail syndicate, on the other hand I do not accept the very much higher percentages contended for by E&W and their experts.

While it is important to make appropriate allowance for the above I was left with the firm impression that Mr. Attwood's evidence was soundly based by reference to appropriate professional standards (by way of example only I refer to his evidence in relation to the need for audit evidence and the appropriate approach to management representations). I was particularly struck by an important point made by Mr. Attwood in the course of his evidence (Day 48/132/4):-

E&W rely on a number of points derived from an examination of the audit of syndicate 275/6. I have made appropriate allowance for these in my findings as set out below. It is however most important to remember that the 1981 year of account was left open as at 31.12.83 The 275/6 accounts at 31.12.83 stated:-

Mr. Whiter was called as an expert witness on behalf of E&W. His evidence was relied on by Merretts. Mr. Whiter's evidence addressed years 4 to 6.

Mr. Whiter has since February 1994 been the Finance Director of The Benfield Group Limited, a company whose principal subsidiaries consist of a Lloyd's broker, specialising in reinsurance, and a reinsurance company. For over 18 years until January 1994 Mr. Whiter was a partner in the accountancy firm Neville Russell.

In the latter part of 1982, Mr. Whiter led the team which investigated the "P.C.W. affair" on behalf of Minet Holdings PLC. Whilst a partner in the London office of Neville Russell, Mr. Whiter's clients included a number of Lloyd's syndicates, Lloyd's underwriting agencies and Lloyd's brokers. Among the Lloyd's syndicate clients for whom he was responsible as audit partner were twelve syndicates managed by R.W. Sturge & Co. (in respect of the audits as at 31.12.86 and subsequent years) and three syndicates (marine and non-marine) managed by Roberts & Hiscox Limited (in respect of the audits as at 31.12.83 and subsequent years) and, on a joint audit basis, three syndicates managed by F.L.P. Secretan & Co. (in respect of the audit as at 31.12.83 only). These audits included non-marine and incidental non-marine syndicates which had a material exposure to latent diseases and pollution. Certain of the Sturge and Hiscox syndicates had the benefit of run-off contracts. From about 1983 Mr. Whiter became responsible for the management of Neville Russell's Syndicate Book-Keeping Department. This department was responsible, on a sub-contract basis, for the book-keeping of a number of Lloyd's syndicates. At that time, the department dealt with approximately 80 syndicates including Outhwaite 317/661 and Secretan 367.

Mr. Whiter became Managing Partner of the London office in 1988 and Senior Partner of the London office in 1992, which role he retained until he left in January 1994.

Mr. Whiter is a defendant in the Secretan case which forms part of the Lloyd's Litigation (Long Tail category). It is of course most unusual to find that an expert witness has a direct financial interest in the result of another case in which similar issues arise, but I recognise that there are a limited number of auditors with the requisite experience to give expert evidence in the Lloyd's Litigation. I do not suggest that Mr. Whiter's interest in the Secretan case consciously affected his evidence.

I regret however that I have serious reservations about Mr. Whiter's evidence. It seemed to me that he was concerned to defend without reservation everything that E&W did in the years 4 to 6. I consider that at times Mr. Whiter's answers were evasive. Some of his evidence was unrealistic. By way of example I refer to Mr. Whiter's evidence (Day 49/page 169/line 2):-

By way of further example Mr. Whiter said in relation to the run-off contracts in year 4 that he would have been prepared to express an opinion provided he had the outstandings and the paids - he would not have needed anything else. It is to be noted that the reserves in respect of 10 of the run-off contracts in year 4 amounted to £55m. Mr. Whiter added that information as to the reinsurance cover available to the cedants would be helpful but not necessary.

I consider that at times Mr. Whiter's approach was not logical. I refer by way of example to paragraph 123 of his witness statement where he said:-

Mr. Sharp was called as an expert witness on behalf of E&W. His evidence was also relied on by Merretts. Mr. Sharp's evidence addressed years 1 to 3.

Mr. Sharp is the Managing Director of Archer Holdings Plc, a position he has held since August 1983. In 1976 he was admitted to partnership with Futcher Head & Gilberts a firm of chartered accountants who had the fourth or fifth largest market share of work done for Lloyd's syndicates for the late 1970's until he left in December 1983. After resigning from Futcher Head & Gilbert's in December 1983 Mr. Sharp was admitted to partnership in Spicer & Oppenheim London in January 1984. Spicer & Oppenheim were also Chartered Accountants and panel auditors. Mr. Sharp took a substantial part of the insurance practice of Futcher Head & Gilberts (including a number of their staff) with him to Spicer and Oppenheim. He was the head of the insurance group of Spicer & Oppenheim and Touche Ross & Company from approximately 1986 until he resigned from the merged partnership in December 1990. In his practice as an accountant Mr. Sharp was responsible for the audit of a number of syndicates with exposure to US casualty business including the Murray Lawrence syndicates, the Dolling-Baker syndicate 544 and the Frizzell syndicates. A number of the syndicates that Mr. Sharp audited which closed their years as at 31.12.82 and 31.12.83 had the benefit of run-off contracts.

On 1.1.91 Mr. Sharp became the Managing Director of Castle Underwriting Agents Limited who are Lloyd's managing agents, who were responsible for a number of non-marine syndicates. He held that position until he was appointed as Managing Director of Archer Holdings Plc in August 1993, which is one of the two publicly quoted Lloyd's underwriting agents.

Mr. Sharp was the Chairman of G.W.Run-Off Limited from its creation in October 1991 until April 1993. G.W.Run-Off Limited was a run-off company established to manage the run-off of the Gooda Walker syndicates.

Mr. Sharp was a member of the working party established by the A.P.C. of the C.C.A.B. in approximately 1984 which produced the Audit Brief entitled "Lloyd's Syndicates". Mr. Sharp became a member of the Institute of Chartered Accountants Insurance Industry Sub-Committee from 1991.

Mr. Sharp became a member of Lloyd's on 1.1.92.

In October 1993 Mr. Sharp was appointed as the Chairman of the Micro Reserving Group, which is part of the Lloyd's Equitas Project. On 1.1.95 the Micro Reserving Group and the Macro Reserving Group were merged and are now called the "Inwards Group". Mr. Sharp is Chairman of the combined group.

Of the syndicates under the management of Archer the Alec Sharp syndicate 839 leads a number of the higher layers on the members' agents E&O slip. Syndicate 741 (and possibly other syndicates) under the management of Archer has a line on an auditors' E&O line slip. I do not suggest that these matters influenced Mr. Sharp's evidence.

I do however have certain reservations about Mr. Sharp's evidence. By way of example I refer to paragraph 53 of his supplementary report where in dealing with the Ballantyne run-off contract he said:-

Further I consider, again by way of example, that some of Mr. Sharp's answers in respect of paragraph 3 of Mr. Murray Lawrence's letter were unsatisfactory.

Merretts did not call either Mr. Emney who scratched the 11 run-off contracts or Mr. Jackson who was the underwriter of 799. Both Mr. Emney and Mr. Jackson could have given me considerable assistance on important issues in this case for reasons explained elsewhere in this judgment.

I give one example as to Mr. Emney. In relation to the most significant of the 11 run-off contracts (Sturge/Fireman's Fund) written by 417 (37.5%) and Merrett syndicate 421 (12.5%) Mr. Emney said in the 421 Loss Review:-

This evidence to the 421 Loss Review was wholly inconsistent with Mr. Merrett's account in evidence before me. In reaching my conclusions as to the writing of run-off contracts I have disregarded Mr. Emney's evidence on all prior occasions (including the evidence referred to above), but I am left with a considerable sense of disquiet having only heard from Mr. Merrett.

Further I regret having to make findings against Mr. Emney without having heard from him.

17. THE REGULATORY REGIME FOR THE YEARS ENDED 31ST DECEMBER 1980-1986

The following Standards and Guidelines are relevant for the purposes of this case.

Auditing Standards and Guidelines - explanatory foreword (issued April 1980) provided:-

The Glossary of Terms in the Appendix stated:-

The Auditor's Operational Standard (issued April 1980) provided:-

The Auditing Standard: Qualifications in Audit Reports (issued 1980) provided:-

The Auditing Guideline: Planning, controlling and recording (issued April 1980) provided:-

The Auditing Guideline - Audit Evidence (issued April 1980) provided:-

The Auditing Guideline - Representations by Management (issued July 1983) provided:-

(See also in this connection I.C.A.E.W. Statements on Auditing No. 18 Audit problems of the smaller company (issued November 1972) paragraphs 5 and 6 and Auditing Guideline-Exposure Draft Management Representations (issued February 1982)).

As to the Audit Brief, published by the A.P.C. of the C.C.A.B. based on the Lloyd's Byelaws and the law as at 1.1.86, see below.

Auditing Standards: Explanatory foreword (issued April 1980 but revised January 1989) stated:-

(Practice Note No.2 - The Lloyd's Market was issued in July 1992).

In 1978 the Fisher Working Party, chaired by Sir Henry Fisher, was established to report on "Self-regulation at Lloyd's". The report was published in May 1980 and Chapter 23 dealt with the audit regime.

The regulatory regime for the solvency audit and the audit of the syndicate accounts was as follows:-

A. Section 73 Insurance Companies Act 1974

B. Rule 16 Assurance Companies Rules 1950 (1950 No.533)

D. Solvency Letter for 31.12.1980 Audit

Of these only the documents at A and E are relevant for succeeding years.

Ernst & Whinney contend that the document at E above was, as its name suggests, directed to Underwriting Agents, not to auditors, and was not binding on either Underwriting Agents or auditors. Nor, in that sense, did it constitute part of the regulatory regime for any audit.

The plaintiffs contend that the Manual constituted and/or reflected good practice within the market for both underwriting agents and auditors prior to the adoption of the true and fair view form of audit report. In that sense it formed part of the regulatory regime. The Plaintiffs further contend that Ernst & Whinney regarded it as setting out the proper practice within the market - see Mr Holland's evidence at Day 43/115-116 esp. /115/10-11: "The requirements for the first three years were the requirements indicated in the agents' manual". Mr Attwood also gave evidence that the Manual was one source of Ernst & Whinney's professional responsibility, being one of the documents they would have had regard to in accepting instructions to undertake audit work - Day 45/63.

The Members' Agents contend that auditors were aware that Lloyd's were telling agents that they should see that everything was done to enable their auditors to sign the audit certificate by the prescribed date and that this involved ensuring (inter alia) that the information required by auditors to enable them to satisfy themselves as to the proposed reinsurance to close an account was available by early April (para 1.4 J5/32). Panel auditors must have known that this reflected the expectation and understanding of the market, viz. that it was part of the auditors' job to satisfy themselves as to the proposed RITC.

The document at B above was revoked in 1982 by the Lloyd's (Audit Certificate) Regulations 1982 and the documents at C & D were revised annually.

The regulatory regime for the solvency audit and the audit of the syndicate accounts was as follows:-

A. Section 73 Insurance Companies Act 1974

B. The Lloyd's (Audit Certificate) Regulations 1982 (1982 No. 136)

D. Solvency Letter for 31.12.1981 Audit

E. Manual for Underwriting Agents

A. Section 73 of the Insurance Companies Act 1974 (which came into force on 31st August 1974) provided:-

The Auditor referred to in sub-section (4) is the Auditor

appointed by the Members' Agent and not the syndicate Auditor.

B. The Lloyd's (Audit Certificate) Regulations 1982 (which came into force on 8th March 1982) set out the required form of the certificate mentioned in section 73(4) ICA 1974 to be provided by the Auditor appointed by the Members' Agent in respect of each Name.

C/D. Document D was issued on a covering letter to Document C and the two should be read together.

C. The instructions for the Guidance of Lloyd's Auditors (The "Blues") provided, inter alia, as follows:-

The notes to Clause 6 included the following:-

D. The Solvency Letter for 31st December 1981 (the "Whites")

contained explanatory notes to document C above. In particular,

as regards Clause 3 of the Audit Instructions it provided, inter

alia, as follows:-

As to Matters to be Reported the Solvency Letter provided:-

E. Sections A.10 and Section F of the Manual for Underwriting

Agents provided inter alia as follows:-

Section F

(a) The Regulatory Regime

The regulatory regime for the solvency audit and the audit of the syndicate accounts was as follows:-

A. Sections 83-86 Insurance Companies Act 1982

B. Insurance (Lloyd's) Regulations 1983 (1983 No.224)

C. Instructions for Guidance of Lloyd's Auditors at 31.12.1982

D. Solvency Letter for 31.12.1982 Audit

E. Manual for Underwriting Agents

(b) Other Materials

Following the report of the Fisher Working Party, Lloyd's established Task Groups to consider the recommendations which had been made. In December 1982 Task Group 4 produced a consultative document on "The Annual Financial Report for Underwriting Members of Lloyd's" which included a Draft Lloyd's Accounting Manual. Neither document was binding on the Managing Agents or Auditors or, in that sense, constituted part of the regulatory regime as at 31.12.1982 Audit. The Plaintiffs contend that the Draft Lloyd's Accounting Manual represented or reflected the professional practice to be observed by Lloyd's panel auditors. The members of the Task Group included Mr. K.E. Randall and Mr. N.F. Holland.

A. Section 83 of the Insurance Companies Act 1982 (which came into force on 28.3.83) replaced section 73 ICA 1974, though the relevant provisions are in similar terms. In particular, sub-sections (4) and (5) provided that:-

Again, the reference to "auditor" in sub-section (4) is a reference to the Auditor appointed by the Members' Agent.

B. The Insurance (Lloyd's) Regulations 1983 (1983 No.224) (which came into force on 22.3.83) revoked the Lloyd's (Audit Certificate) Regulations 1982. Regulation 4/Schedule 2 of the 1983 Regulations set out the new required form of Audit Certificate to be provided by the Auditor appointed by the Members' Agent under Section 83 ICA 1982. The new certificate was identical to the previous certificate save that "underwriters" became "underwriting members" and "the Committee of Lloyd's" became "the Council of Lloyd's".

C and D. Document D was issued as a covering letter to Document C and the two should be read together.

C. The Instructions for Guidance of Lloyd's Auditors at 31.12.82 were broadly similar to those issued for the previous year save inter alia for the following alterations.

Clause 2 now provided as follows:-

Clause 6 now began:-

D. The Solvency Letter was broadly similar to that issued for

the previous year.

E. Manual for Underwriting Agents (see year 1 above).

(a) The Regulatory Regime

The regulatory regime for the solvency audit and the audit of the syndicate accounts was as follows:-

A. Sections 83-86 Insurance Companies Act 1982

B. Insurance (Lloyd's) Regulations 1983 (1983 No.224)

C. Instructions for Guidance of Lloyd's Auditors at 31.12.1983

D. Solvency Letter for 31.12.1983 Audit

E. Byelaw No 2 of 1984

F. Byelaw No 3 of 1984.

G. Manual for Underwriting Agents

(b) Other Materials

On 2.12.83 Lloyd's published a Provisional Lloyd's Accounting Manual. It was produced by the Accounting and Auditing Standards Committee of the Council of Lloyd's and relied heavily upon the Draft Accounting Manual produced by Task Group 4 a year earlier.

As with the Draft Accounting Manual, the Provisional Accounting Manual was not binding. But in a letter dated 1.2.84 the Chairman of Lloyd's invited Panel Auditors to encourage their clients to comply with its spirit in preparing the 1983 Reports and suggested a proposed form of report. The Plaintiffs contend that the Provisional Accounting Manual represented or reflected good practice to be observed by Lloyd's panel auditors.

E&W did this and their report this year tracked the proposed wording suggested by the Chairman in his letter.

A. Sections 83-86 ICA 1982 (see above).

B. Insurance (Lloyd's) Regulations 1983 (see above).

C. and D. Document D was issued as a covering letter to Document C and the two should be read together.

C The Instructions for Guidance of Lloyd's Auditors at 31.12.83 were broadly similar to those issued for the previous year save inter alia for the following alterations.

Clause 2 now provided:-

D. The Solvency Letter was broadly similar to that of the year before.

E. Byelaw No.2 of 1984. The 1983 Annual Reports of Syndicates Byelaw came into force on 13.2.84.

F. Byelaw No.3 of 1984. Disclosure of Interests came into force on 9.4.84.

The regulatory regime for the solvency audit and the audit of the syndicate accounts was as follows:-

A. Sections 83-86 Insurance Companies Act 1982

B. Insurance (Lloyd's) Regulations 1983 (1983 No.224)

C. Instructions for Guidance of Lloyd's Auditors at 31.12.1984

D. Solvency Letter for 31.12.1984 Audit

E. Byelaw No. 2 of 1984

F. Byelaw No. 3 of 1984

G. Byelaw No. 6 of 1984

H. Byelaw No. 7 of 1984 and explanatory notes dated 8.10.1984

I. Byelaw No. 10 of 1984 and explanatory notes dated 10.12.1984

J. Manual for Underwriting Agents.

A. Sections 83 - 86 ICA 1982 (see above)

B. Insurance (Lloyd's) Regulations 1983 (see above).

C. and D. Document D was issued as a covering letter to Document C and the two should be read together.

C. The Instructions for Guidance of Lloyd's Auditors at 31.12.84 were broadly similar to those issued for the previous year save inter alia for the following alterations.

Note (1) to Clause 6 contained the following additional provision:-

D. The Solvency Letter was broadly similar to that issued for

the previous year save inter alia for the following alteration:-

E. Byelaw No.2 of 1984 (see above).

F. Byelaw No.3 of 1984 (see above).

G. Byelaw No.6 of 1984 Syndicate Premium Income came into force

on 6.8.84.

H. Byelaw No.7 of 1984 and Explanatory Notes dated 8.10.84.

The Byelaw was published on 8.10.84 and came into force on 1.1.85

subject to the following transitional provision.

The Byelaw provided inter alia as follows:-

Schedule 1 Interpretation provided:-

Schedule 3 contained "Fundamental Principles and Statements

of Accounting Policies". In particular it provided that:-

The Explanatory Notes dated 8.10.84 stated inter alia:-

As to paragraph 11 of the Byelaw (Report of the Syndicate

Auditor) the Explanatory Notes stated:-

As to the provisions and requirements of paragraph 2 of and

Schedule 2 to the Byelaw the Explanatory Notes provided, inter

alia, that:-

As to Schedule 3 paragraph 4 - items to be determined on an

equitable basis where transactions affect members participating

in more than one year account - the Explanatory Notes provided:-

I. Byelaw No. 10 of 1984 Syndicate Audit Arrangements came into

force on 10.12.84

The regulatory regime for the solvency audit and the audit of the syndicate accounts was as follows:-

A. Sections 83-86 Insurance Companies Act 1982

B. Insurance (Lloyd's) Regulations 1983 (1983 No.224)

D. Solvency Letter for 31.12.1985 Audit

E. Byelaw No. 2 of 1984

F. Byelaw No. 3 of 1984

G. Byelaw No. 6 of 1984

H. Byelaw No. 7 of 1984

I. Further Explanatory Notes to Byelaw No. 7 of 1984

J. Byelaw No. 10 of 1984

K. Byelaw No. 6 of 1985

A. Sections 83-86 ICA 1982 (see above).

B. Insurance (Lloyd's) Regulations 1983 (see above).

C. and D. Document D was issued as a covering letter to Document C and the two should be read together.

C. Instructions for Guidance of Lloyd's Auditors at 31.12.85 were broadly similar to those issued for the previous year save inter alia for the following alteration. A new second sentence was added to Clause 6 so that Clause 6 read:-

D. The Solvency Letter was broadly similar to that issued for

the previous year save inter alia for the following alterations.

The Notes to Clause 6 were amended to read:-

E. Byelaw No.2 of 1984 (see above).

F. Byelaw No.3 of 1984 (see above).

G. Byelaw No.6 of 1984 (see above).

H. Byelaw No.7 of 1984 (see above).

I. Further Explanatory Notes to Byelaw No.7 of 1984 were

published on 9.12.85. The Notes were entitled "Explanatory

Notes - Reinsurance To Close". The introduction stated that the

Explanatory Notes were a guide only and did not override the

requirements of the Byelaw. The Explanatory Notes stated:-

J. Byelaw No.10 of 1984 (see above).

K. Byelaw No. 6 of 1985 The Reinsurance To Close Byelaw. This

byelaw commenced on 9.12.85.

(a) The Regulatory Regime

The regulatory regime for the solvency audit and the audit of the syndicate accounts was as follows:-

A. Sections 83-86 Insurance Companies Act 1982

B. Insurance (Lloyd's) Regulations 1983 (1983 No.224)

D. Byelaw No. 2 of 1984

E. Byelaw No. 3 of 1984

F. Byelaw No. 6 of 1984

G. Byelaw No. 7 of 1984

H. Byelaw No. 10 of 1984

I. Byelaw No. 6 of 1985.

A. Sections 83-86 ICA 1982 (see above).

B. Insurance (Lloyd's) Regulations 1983 (see above).

C. Instructions for the Annual Solvency Test of Underwriting Members of Lloyd's - 31.12.86. Whereas in previous years the Instructions and the Solvency Letter were separate documents, these were combined for the first time this year in a single document. The contents were reformulated but were broadly similar to those of the Instructions and the Solvency Letter.

D. Byelaw No.2 of 1984 (see above).

E. Byelaw No.3 of 1984 (see above).

F. Byelaw No.6 of 1984 (see above).

G. Byelaw No.7 of 1984 (see above).

H. Byelaw No.10 of 1984 (see above).

I. Byelaw No.6 of 1985 (see above).

(b) Other Material.

The Audit Brief was published by the Auditing Practices Committee ("APC") of the Consultative Committee of Accounting Bodies ("CCAB") in 1986 and was specifically addressed to the auditing of Lloyd's Syndicates. The status of this document was described in the revised Explanatory forward to the Auditing Standards and Auditing Guidelines issued in January 1989 in the following terms:

The Plaintiffs contend that the Audit Brief represented or reflected good practice for the conduct of the audits in years 3 to 6. Mr. McNamara accepted that the Audit Brief "broadly accorded with best practice that had emerged, certainly in my firm" (Day 43/42). See also E&W Insight No.32 June 1986.

The Audit Brief provided inter alia:-

TABLE 5

FLOWCHART

¯

Syndicate

Auditor

¯

Auditor appointed by

Members' Agent ("AMA")

¯

¯

Committee/Council of Lloyd's (¹)

¯

¯

Secretary of State

(¹) from 1982

18. THE NEVILLE RUSSELL LETTER AND THE RESPONSE

In response to the Neville Russell letter, Mr. Ken Randall, in his capacity as manager of the Underwriting Agents and Audit Department at Lloyd's, wrote a letter dated 18.3.82 inter alia to E & W as follows:-

The attached letter dated 18.3.82 from the Deputy Chairman Mr. Murray Lawrence stated:

19. RITC - SOME GENERAL PRINCIPLES

I turn to consider some general principles in relation to RITC and the role of the managing agents/underwriter and of the auditors.

"Reinsurance to Close" means an agreement under which underwriting members who are members of a syndicate for a year of account agree with underwriting members who comprise that or another syndicate for a later year of account that the reinsuring members will indemnify the reinsured members against all known and unknown liabilities of the reinsured members arising out of the insurance business underwritten through that syndicate and allocated to the closed year, in consideration of a premium and the assignment to the reinsuring members of all the rights of the reinsured members arising out of or in connection with that insurance business.

In computing a reinsurance to close the premium arrived at will take account of two elements: known outstanding claims and claims incurred but not reported (IBNR).

If a year is closed into a succeeding year the RITC is final. There is no mechanism for correcting past inaccuracies or inequities.

The following propositions are largely derived from the regulatory materials referred to in section 17 above.

1. The amount charged by way of premium in respect of reinsurance to close should, where the reinsuring members and the reinsured members were members of the same syndicate for different years of account, be equitable as between them, having regard to the nature and amount of the liabilities reinsured.

Compliance with "equity between Names" had to be demonstrated by the underwriter and managing agent in determining the reinsurance to close.

2. By year 4 it was strongly recommended that whilst the decision whether to close a year of account of a syndicate was the responsibility of the managing agent in consultation with the underwriter, no year of account should be closed before the managing agent determined whether the syndicate auditor intended to give a qualified audit opinion in respect of that year of account.

3. The determination of the IBNR element required the exercise by the underwriter of judgment as to the level of IBNR which was appropriate, having regard to all relevant materials and after appropriate enquiries. The Further Explanatory Notes to Byelaw No.7 of 1984 published on 9.12.85 set out in paragraphs 18 to 24 a number of matters which might fall to be considered in computing the IBNR. These include the nature of the business written by the syndicate as one of the main factors affecting the size and relative importance of the IBNR element of the reinsurance to close. Different classes of business gave rise to different considerations. The Further Explanatory Notes also stated that the reinsurance to close must be supported by records setting out the manner and bases upon which the final figure was determined in sufficient detail to "show and explain" the nature of the transaction. The Further Explanatory Notes also provided that it was important that the process of determining the IBNR, the more judgmental aspect of the reinsurance to close exercise, was documented to the same standard as was adopted in relation to outstanding claims. Documentation should include a record of the overall factors taken into account by the underwriter in arriving at his approach to the reinsurance to close. This should cover those factors which the underwriter considered had a significant impact on the year of account and might refer to those which did not and the reasons why such conclusions were drawn. Although the Further Explanatory Notes were published on 9.12.85, the matters referred to derived from the Notes probably reflected the approach that ought properly to have been followed in earlier years and in particular from year 4.

4. If the amount to be charged by way of premium in respect of the RITC could not be arrived at with a reasonable degree of accuracy having regard to the nature and amount of the liabilities reinsured, the account should be left open.

5. Where at its normal date of closure a year of account is left open an amount to meet known and unknown outstanding liabilities must nevertheless be included. The same considerations as apply to a reinsurance to close (with the exception of equity between names) will be relevant notwithstanding the fact that the objective is not to determine the final profit or loss for the year of account.

I wish to add one footnote which follows from the above propositions. If the amount to be charged by way of premium in respect of the RITC could not be arrived at with a reasonable degree of accuracy it would be fundamentally wrong, instead of leaving the account open, to close the account and seek to expand the syndicate in the hope that by doing so the (expanded) syndicate would be able to weather the difficulties.

The following propositions are derived from the regulatory materials referred to in section 17 above.

1. The auditors should obtain relevant and reliable audit evidence sufficient to enable them to draw reasonable conclusions therefrom (Operational Standard (issued April 1980)).

2. As to the nature of audit evidence, the sources and amount of evidence needed to achieve the required level of assurance were questions for the auditors to determine by exercising their judgment in the light of the opinion called for under the terms of their engagement. They would be influenced by the materiality of the matter being examined, the relevance and reliability of evidence available from each source and the cost and time involved in obtaining it (The Auditing Guideline - Audit Evidence (issued April 1980)).

3. As to representations by management, in certain cases, such as where knowledge of the facts was confined to management or where the matter was principally one of judgment and opinion, the auditors might not be able to obtain independent corroborative evidence and could not reasonably expect it to be available. In such cases, the auditors should ensure that there was no other evidence which conflicted with the representations by management and should obtain written confirmation of the representations. (The Auditing Guideline - Representations by Management (issued July 1983)).

4. For the purposes of the present case, from year 4 the report should state whether a true and fair view was given in the accounts.

5. As from year 4 the syndicate auditors should qualify their report if they were unable to obtain all the necessary information and explanations required. In the absence of a reference to these matters the syndicate auditors' confirmation thereof was implicit in an unqualified audit report.

(The following propositions are derived from the Audit Brief. Although the Brief is based on the Lloyd's Byelaws and the law as at 1.1.86 I find that it reflected the approach that ought properly to have been followed from year 4 (see in this connection Mr. Attwood's evidence, E&W Insight No.32 June 1986 and Mr. McNamara (Day 43/42/20 et seq)).

6. In selecting materiality levels, the auditor should have regard to the impact of syndicate transactions on the personal account of each syndicate member; he should look behind the syndicate to its constitution, as well as to the syndicate as a whole, in making judgments relating to materiality.

7. The auditor would need to be satisfied that the premium for the reinsurance to close a year of account was equitable as between the names on that account and those on the accepting year of account. The determination of the premium for the reinsurance to close involved the exercise of significant professional judgment and drew on the full experience of the underwriter.

8. The Auditor's Operational Standard stated that "the auditor should obtain relevant and reliable audit evidence sufficient to enable him to draw reasonable conclusions therefrom". Since the audit report on syndicate financial statements was expressed in true and fair terms, the auditor would need to ensure that he had gathered evidence of sufficient quality to support such an opinion.

9. The reinsurance to close a year of account was normally the area of greatest audit difficulty, because it was derived with the benefit of a substantial degree of underwriting judgment. In common with all accounting estimates, it was one of a range of possible outcomes and the audit approach should recognise that the objective was to ensure that the reinsurance to close was within a zone of reasonableness rather than an arithmetically accurate figure. (See also paragraph 5 of Mr. Randall's letter of 18.3.82).

10. The auditor would need to consider such matters as the nature of the syndicate's business, the overall size of the syndicate, the impact of the reinsurance protection programme, and the accuracy of previous estimates as a part of his assessment of the appropriate range within which he would expect the premium for the reinsurance to close to fall.

11. The results derived from statistical techniques should be treated with a degree of caution, since historically derived data might not be an accurate guide as to uncertain future events. The auditor should, therefore, ascertain from the underwriter the underlying basis for his estimate of claims incurred but not reported, so that appropriate additional evidence could be collected to support the computation.

12. Other matters the auditor might consider as a part of the audit of the reinsurance to close included the following. The syndicate might have reinsured the run-off of other syndicates or companies and the auditor must satisfy himself that due account had been taken of the liabilities which were likely to arise under such contracts. This evidence would usually take a similar form to that relating to the syndicate's own business.

Mr. Attwood's evidence provides material support for the above propositions, particularly insofar as they apply to auditors. Further support for the above propositions is found in Mr. Holland's lecture of 21.1.86 entitled "Setting the scene" as part of an E&W seminar for clients, "The RITC process" (D12/253 et seq):-

The materials referred to above, while distinguishing between the respective functions of the managing agents/underwriter and the auditors, show the interplay between those functions.

The defendants rely on certain passages in Mr. Neil's evidence eg. Day 29/137-8 as to whether or not objective justifiability is needed in setting an IBNR. I have already said that in my view Mr. Neil was at times confused by terminology in some of the answers that he gave. If and to the extent that any of his evidence was inconsistent with the above propositions I reject it. Although the determination of the IBNR element required the exercise by the underwriter of judgment that judgment plainly had to be exercised having regard to all relevant materials and after appropriate enquiries. I accept the plaintiffs' submission that the judgment must not be uninformed or exercised in an information vacuum or exercised without reference to the range of potential outcomes.

The Audit Brief referred to "a zone of reasonableness rather than an arithmetically accurate figure". Mr. Randall's letter of 18.3.82 stated "auditors will no doubt give special attention to the question of whether or not the Agent has decided to leave an account open in cases where the reserve for Asbestosis represents a material proportion of the total reserves of the syndicate or where there is a wide margin of error in the calculation". Considerable evidence was devoted to the appropriate materiality level or maximum level of tolerance of error in 418/417's RITC premium. Whereas on the one hand I consider that the level adopted by Mr. Attwood was somewhat strict for a long tail syndicate, on the other hand I do not accept the very much higher percentages contended for by E&W and their experts. I do not consider that it is necessary or appropriate to make a precise finding (in terms of a particular percentage) as to the appropriate materiality level in 418/417's RITC premium. It is plain than an assessment had to be made by the managing agents/underwriter and the auditors as to the width of the margin of error in the RITC calculations.

20. IDENTIFICATION OF 418/417's EXPOSURE IN RESPECT OF DEFENDANTS IN THE ASBESTOSIS LITIGATION.

Could Merretts discover at each year end from their own records or other sources whether in respect of any known/actual defendant in the asbestosis litigation they had insured that defendant direct or by facultative reinsurance, treaty reinsurance or retrocession?

As to the above question the plaintiffs' case was as follows.

It is not possible to say whether Merretts could have discovered at each year end from their own records whether or not they had any potential liability to a known/actual defendant to the asbestosis litigation. The E&W note in year 4 at D6/589 shows that they had some documents but not others. That is not to say that they ought not to have kept appropriate records, nor does it touch on the topic of whether they could have obtained such information from brokers or other sources. If they could have, they did not do so. If they could not have, because no such information was available anywhere and Merretts simply had to wait until an assured made a claim, then it follows that they knew that they would face liabilities which they were unable to identify until a claim was received.

As to the above question Merretts' case was as follows.

It would have been possible to identify nearly all policies to which 417 subscribed during the period 1953 to 1979 from the syndicate's underwriting records (shared with syndicate 799 for US casualty business). Two possible qualifications are (i) that the occasional record may have gone missing but this would be exceptional and (ii) that some binding authorities/line slips were written for which full declarations might not exist. This was not a particular problem in relation to the major asbestos defendants since, with the notable exception of US Gypsum, these defendants were not placed in the market through such facilities (and in any event major involvements were researched and notified to the market through Toplis & Harding).

Thus it would have been possible to identify from their own records (or from brokers if there was some difficulty) whether syndicate 417 had participated on a known defendants' programme of direct insurance. So far as the major defendants were concerned this was not necessary because these involvements were researched by the brokers and advised to the market at a very early stage. Other defendants' positions would be researched by the brokers as and when they advised involvement to the market.

On reinsurances Merretts could determine whether they had written a line on the reinsurance programme of an American domestic insurer or reinsurer, but that information did not tell them what exposures that insurer or reinsurer had to known defendants to the asbestos litigiation. The major domestic insurers all had some involvement. Again their involvements were reported upon to the market at a very early stage (that is not to say that the perception as to their ultimate losses was foreseen - it clearly was not). Mr. McNamara's schedule at year 2 lists many reinsurance policies (although many have a NIL reserve). Syndicate 417 had some retrocession policies for US reinsurers but otherwise retrocessions were not significant. Facultative reinsurance was not significant to syndicate 417 in asbestos-related claims.

As to Merretts' knowledge of the policy terms, in later years (from the late 1960s onwards) the majority of policy forms were standardised so that the market could identify relevant policy terms by knowing the form used. In earlier years this was less so. Identification of policy terms in the early years could not be done by Merretts, but had to be researched by the broker.

For the purposes of this judgment I am, save where otherwise stated, content to accept Merretts' case as set out above. There was a limit to the extent to which these matters were explored in evidence.

21. NOTIFICATION OF ASBESTOS-RELATED LOSSES

Merretts say the procedure was as follows.

At the very early stages of asbestos-related claims (i.e. in the mid to late 70s) an insured (who claimed to be covered by the London market) facing asbestos bodily injury claims by plaintiffs in the U.S. would first notify their U.S. broker of its exposure to these types of claims. The U.S. broker would then notify the London broker in writing of the exposure to such claims. Initially such notifications were extremely generalised. The response of the London broker would be to identify the Lead Underwriter (or one of the Lead Underwriters) providing coverage to the particular insured. The broker would then take the loss notification to the Lead Underwriter (or the Claims Manager of that syndicate) to obtain instructions. Almost without exception the first step would be for the Lead Underwriter to direct the claim be referred to a U.S. attorney to advise. The nominated attorney would then investigate the insured to establish the years of insurance coverage, the layers of such insurance protection, the extent of London market involvement, the number of claims made to date against the insured, the details of settlements and outstanding case reserves, the nature of the products giving rise to the losses and obtain general background information on the assured and its products. Having ascertained this information the attorney would make a first report to the market including giving advice on coverage issues and allocation of reserves (e.g. manifestation or exposure). That advice would list the years of coverage, the layers of coverage, how the claims reserve should be allocated between years and the number of claims paid and outstanding.

The report was received by the market via the broker. Upon receipt of the report the broker would identify from slips who were the participating syndicates on the years of coverage identified by the attorneys and disseminate the report and policy information to all involved syndicates. After the AWP had assumed responsibility for the handling of asbestos claims on behalf of the market, Toplis & Harding, were appointed to co-ordinate the distribution of the reports, so that it was Toplis & Harding who disseminated the information to all involved syndicates, having obtained the information on syndicate participation from the brokers.

As the system developed in the early 1980s identification of participants and dissemination of the information became more efficient. However, by 1980-81 certain major defendants had been identified. Nearly all of their direct coverage in London had been identified and the underwriters participting on layers exposed to claims had been notified of their participation. Attorneys' reports were available for all such defendants and reserve recommendations were circulated to the market at year end 1981 and at subsequent year ends.

Reinsurance claims were dealt with in a similar fashion. Once a reinsured notified its brokers of potential involvements with asbestos claims, that notification would be directed through the London broker to a Leading Underwriter on that reinsurance programme. Attorneys would then be instructed to report and advise. The attorneys' report would list years of cover, layers of reinsurance and principal involvements (e.g. Johns Manville, GAF etc). Such reports would advise on the likelihood of claims invading the reinsurance programme and, if appropriate, make reserve recommendations. The AWP did not immediately involve itself in reinsurance claims but by 1983 it had taken over responsibility for these as well. The Wellington Agreement and the ACF set up under it enabled a good data base of reinsureds' involvements to be established, and improved the ability of the market to set reserves on reinsurances.

In the early period 1980-81 LUNCO would advise the market of reinsurance claims on 1971 and post policies; pre-1971 policies would be advised through the broker and then by Toplis & Harding. In about 1982 LUNCO was requested by the AWP to stop advising reserves so that all asbestos-related claims, both direct and reinsurances, would be advised in the same way through Toplis & Harding. Thereafter LUNCO's only role was to send out cards on reinsurances covered by their system with no reserves advised but with instructions for the establishment of letters of credit where required under the terms of the reinsurances.

As with direct insurances, by year end 1981 certain major domestic insurers who had reinsurances placed in the London Market had been identified (Travelers, Home, CNA, Aetna and others), their reinsurers identified and notified, attorneys instructed and the reinsured's perceived exposure to underlying insureds reported upon with reserve recommendations if any. Underwriters in London were dependent upon the quality of the reinsured's information for reserving purposes and in particular to identify those underlying insureds which the reinsured expected to give rise to claims on the reinsurance.

There was essentially no difference between the way in which reinsurance and retrocession claims were dealt with. Retrocession claims were advised later than reinsurance claims.

According to Merretts the procedure was as follows. Every risk underwritten by Merretts which was the subject of an attorney's report giving reserve recommendations (even where the recommendation may have been nil) was notified to Merretts, initially by the brokers and subsequently by Toplis and Harding. No syndicate in Lloyd's would receive a copy of the attorney's report unless they had participated on the risk. With the attorney's report they would receive a schedule setting out each year that they had participated in the risk which was the subject of the attorney's report together with their percentage participation.

The system did not require Merretts to recognise that they had incurred any loss; that information would accompany the attorney's report. What Merretts had to do was to take the reserve recommended by the attorneys and apply the syndicate's share as set out in the accompanying schedule.

On the receipt of an attorney's report containing a reserve recommendation (including a nil recommendation) Merretts would write up a manual claims card recording that claim.

If the attorney's report showed a policy burning then Merretts would receive notification of that policy by receiving both the attorney's report and the schedule showing their participation on those policies which were burning. Secondly, it was not possible for intervening years in which Merretts participated to be missed since the schedule accompanying the attorney's report identified all years of coverage and all the syndicate's participation. If a policy could not be located by the broker but there was reason to believe one existed (e.g. years 1950-55 and 1957-1963 had been identified and traced but nothing for 1956) then Merretts could consult with underwriting records to locate it.

22. PERCEPTION AND THE MATERIALS AVAILABLE TO MERRETTS AND E&W

I turn to consider perception and the materials available to Merretts and E&W. It is vitally important to consider perception (separately) at the time of the writing of each of the 11 run-off contracts and at the time of each of the 6 RITCs and to distinguish between the perception of and the materials available to Merretts and the perception of and the materials available to E&W. Where materials are drawn on which would probably have been available only to Merretts or E&W this is indicated in brackets. Where witnesses gave evidence as to perception which was inconsistent with the contemporary documents, my findings as to perception are based on the contemporary documents. The contemporary documents are a far surer guide.

Mr. Merrett accepted that the best source of up-to-date information about the asbestosis problem was to be found in attorneys' reports (Day 16/98).

Further Mr. Jackson and Mr. Ayliffe were particularly well placed to receive information as to the development of asbestos and pollution claims. Mr. Jackson was a member of the market AWP from the outset and was Chairman from 1984. Mr. Ayliffe was a founder member of the AWP, subsequently a director of the ACF and the founder and initial Chairman of the Lloyd's Environmental Claims Group.

Mr. Merrett said that he was a regular reader of insurance periodicals such as Lloyd's List and Business Insurance, and of the Financial Times, the Economist and the Wall Street Journal. As such he was aware of those developments which were receiving press attention and evaluated the significance of what he read. As to attorneys' reports, there were numerous attorneys' reports in Merretts' possession. Many of these repeated comments made in previous reports. The chronology, Appendix 1 to this judgment, refers to examples of some attorneys' reports. The chronology is drawn from a document prepared by the plaintiffs which purported to identify "documents or information... actually in the possession of the respective defendant shown against the entry". I have made a number of revisions to the chronology in the light, inter alia, of a revised chronology provided on behalf of Merretts. If I have inadvertently referred to an attorney's report which was not in the possession of Merretts, the probability is that there were other reports in their possession to similar effect.

The availabity and system for circulation of attorneys' reports from time to time is reflected in the Chronology and in particular in the following entries:- the letter from the AWP dated 10.2. 81; the meeting of the AWP 10.8.81; the letter from the AWP dated 1.12.81; the letter from the AWP dated 16.2.82; Mr. Murray Lawrence's letter of 18.3.82 see above, paragraph 2; the attorney's report dated 20.1.83 and the letter from the AWP dated 27.4.83.

E&W accept that the knowledge which a reasonably competent syndicate auditor should have acquired includes knowledge from the following sources of information:

(iii)Any information given to the auditor by his client;

As to attorneys' reports, copies of attorneys' reports in Merretts' possession were generally available to E&W (see T13/125). (As to a particular point made by E&W with reference to J11/26/462, there appear to be very few examples of attorneys' reports marked "this report is not to be made available to brokers, reinsurers, auditors or any other parties.")

Mr. Attwood in his reports and evidence as to audit evidence and reliance on specialists and management representations said that, in his view, because of the uncertain nature of the asbestos liabilities and the materiality of amounts involved, the representations by Merretts as to the future development of these liabilities had to be corroborated by independent evidence before the representations could be accepted. Mr. Attwood singled out attorneys' reports as a source of such corroboration. The same point applies to pollution liabilities albeit from a later point in time. I refer in this connection to The Auditing Guidelines - Representations by Management (issued July 1983) supra.

E&W submit that it was not incumbent upon, nor would it have been a realistic exercise for, a reasonably competent auditor at any time to review the entirety of all attorneys' reports in Merretts' possession. E&W did refer to a sample of reports to see that the figures which Merretts were carrying for outstandings tallied with the figures recommended by the attorneys.

I accept that it was not incumbent upon E&W to review the entirety of all such reports in Merretts' possession, but the attorneys' reports provided important independent evidence as to the nature, extent and development of asbestos and pollution claims from time to time.

Having regard, inter alia, to the extent of the asbestos and (subsequently) pollution problems, the extent of the exposure of 418/417's own book (and subsequently the cedants') to these problems, the materiality of the reserves in connection with asbestos (and subsequently pollution), the critical importance of any assessment as to the future nature extent and development of these claims, and in the case of later years the inaccuracy of previous estimates, I accept Mr. Attwood's evidence that it was incumbent upon E&W to review a sample of the attorneys' reports to test the representations made by Merretts. I recognise that the attorneys' reports emphasized that they made no attempt to project an IBNR factor in respect of claims which had yet to be filed, but they contained extremely important independent information as illustrated below.

In my analysis of perception in relation to each of the six years I have distinguished between documents available to Merretts and documents available to E&W. In the case of the attorneys' reports I have referred to samples from the numerous reports in Merretts' possession. E&W were on my finding only obliged to review a sample and in doing so might well have reviewed reports other than those to which I have referred. However many of these reports repeated comments made in previous reports and, if E&W did not review the reports to which I refer below, the probability is that they would have read other reports in Merretts' possession to similar effect.

E&W were entitled to have regard to Mr. Ayliffe's and Mr. Jackson's knowledge and expertise in relation to asbestos and pollution problems, but the contemporary documents provide the best guide as to the limited extent to which these matters were in fact discussed with Mr. Ayliffe and Mr. Jackson in the context of 418/417. Further for the reasons set out above any such representations needed to be tested.

As to AWP minutes, reports and communications, at a panel auditors meeting on 15.1.82 panel auditors were informed that Lloyd's had set up a database in respect of asbestos claims and were told that the information was available to auditors with written authority from syndicate clients. (See also in this connection the letter from the AWP dated 16.2.82). However in the light of the evidence that AWP minutes, reports and communications were not shown to E&W I have disregarded these materials in examining E&W's knowledge in years 1 to 6. In addition I have taken a similar approach in respect of certain miscellaneous publications and reports.

23. THE WRITING OF THE RUN-OFF CONTRACTS

I set out below some general comments on the writing of the run- off contracts. The 11 individual contracts are considered in turn below.

1. The plaintiffs' pleaded case includes inter alia the following allegations.

(i) No limitations were placed either on the amount or on the duration of 418/417's liability to pay claims within the terms of the policies. If (which the plaintiffs deny) an ordinarily competent underwriter would ever have written such policies, he would have done so only if the placing or other information available at the time each risk was considered was such as to enable him reliably to assess with a reasonable degree of competence the reinsurer's ultimate net retained potential liability under each of the policies. Neither Mr. Merrett, nor Mr. Emney, nor anyone else at Merretts could or did have in relation to any of the run-off policies written, such information as would enable such a reliable assessment to be made.

(ii) Mr. Merrett, Mr. Emney and/or Merretts had no, or no adequate, system for detecting or monitoring the possible aggregation in 418/417 of particular risks included in the business ceded under the run-off policies. In failing to implement any such system, Merretts paid inadequate regard to the risk of potentially disastrous aggregation in 418/417.

(iii) By reason of the uncertainty over the volume, quantum and timing of asbestos-related claims, the potential for substantial further claims arising from other types of latent disease or complaints, and the yet further uncertainty generated by the spectre of pollution-related claims, Mr. Merrett, Mr. Emney and/or Merretts ought to have appreciated that there was no material on the basis of which a reliable or proper assessment of the ultimate outcome of accounts with a significant US casualty exposure could be made and that those cedants who were looking to obtain the benefit of run-off cover were doing so, in large measure, precisely because of the uncertainty and the consequent inability to make a reliable assessment of the ultimate outcome of their accounts. It was, in the circumstances, unsafe to reinsure the run-off liabilities of cedants.

(iv) Mr. Merrett, Mr. Emney and/or Merretts failed to obtain adequate reinsurance cover or other security against the liabilities assumed under the run-off policies.

(v) Before writing any of the run-off policies, Mr. Merrett and/or Mr. Emney failed to make any, or any adequate, enquiries or investigation as to the extent of the asbestosis problem for insurers and the implications thereof.

2. It is not in dispute that it was Mr. Emney's scratch which formally bound 418/417 on all 11 run-off contracts; nor is it in dispute that he played a substantial role in the decision to write the contracts. Despite this, Merretts did not call Mr. Emney to give evidence. The fact that Mr. Emney was not called by Merretts for tactical reasons has not made the task of doing justice between the parties any easier. Mr. Emney could have assisted the court on a number of issues including, by way of example only, the question of which materials constituted the placing information and the role of Mr. Merrett in the writing of the policies.

3. The plaintiffs contend that Mr. Merrett took part in the decision to write each run-off, or the run-offs as a whole, to the extent that he should be held personally liable for such conduct. The plaintiffs submit that there are three extraordinary aspects of this part of the case, which bear on this question:

(a) The writing of the run-offs by 418/417 was withheld from E&W (as to 6 until late in the audit of year 3 in 1984 and as to the remaining 5 until April 1985) and was not within the knowledge of the directors of MSL (apart from Mr. Emney and Mr. Merrett and possibly Mr. Smaje) until 1985. (I reject Mr. Merrett's evidence that the auditors had knowledge of the run-off contracts prior to the dates accepted by E&W).

(b) When the "shattering news" as to the deterioration on the run-off contracts broke in April 1985, no inquiry of any sort was instituted by the agency to determine who was responsible and how it had come about that the contracts had been written.

(c) After they were written the claims made under them were not handled by the Claims Manager, Mr. Ayliffe, or his department. Before the news broke in April 1985, they were apparently handled by Mr. Emney who thus added claims handling to his underwriting duties, both being in a field (US casualty business) which was not his primary area of expertise.

As regards the liability of Merretts (and the members' agents) the question of whether it was Mr. Emney alone or in conjunction with Mr. Merrett who wrote the run-off contracts is immaterial. The plaintiffs submit that in order to make good the claim against Mr. Merrett, it is not necessary to go so far as showing that Mr. Merrett scratched the slip, or even that he personally made the decision to write every policy. They accept that it is not possible to determine his precise involvement in the writing of each contract, but say that it is clear that he was aware that they were being written, that he had given the go-ahead in a general way, that he was certainly involved in the details of at least some individual contracts, that they could not have been written without his consent, and that he has been less than frank over the precise extent of his involvement. The plaintiffs accept that as the active underwriter on 418/417 Mr. Merrett was not required to assess every risk himself and make the decision to accept or not, but he was in overall control. They submit that it is quite unbelievable that a man of Mr. Merrett's personality and presence would have simply allowed Mr. Emney to enter this field and write this sort of business without keeping a close eye on what was going on.

4. Mr. Merrett said in his witness statement (paragraph 77):-

When giving evidence Mr. Merrett did not accept that the writing of the run-off contracts was a "colossal gamble" but referred to "an attempt, which in hindsight was severely misplaced, to provide a service to other syndicates on a basis that would be distinctly profitable to our Names." Mr. Randall said that in 1985 Mr. Merrett described the writing of the run-off contracts as "an underwriting blunder".

5. Mr. Merrett accepted that in order to write a run-off contract a view had to be taken as to the ultimate outcome of the cedant's account. He said that broadly speaking he assumed that such a view was formed by Mr. Emney simply because it would have been imprudent and inconsistent with due care and skill to have written the contracts without forming such a view. He added that with the exception of Verrall he was unable, save in the general terms referred to, to explain the methodology which was used in relation to the run-off contracts.

Mr. Merrett further accepted (as I find correctly) that it was of vital importance that either the cedant's IBNR should be known or the basis on which the IBNR was created should be known. Mr. Merrett explained that by this he meant that it was necessary to know the material on which the cedants had reached their IBNR, the individual constituent parts, how they addressed it, the information that they would have put into their calculcations (triangulations, statistical projections) and the basis on which outstandings were established. This information was necessary so that an assessment could be formed as to where the claims might end up. Without such adequate information to form a view as to where the account was likely to end up, or its equivalent in another form, a run-off contract would not be competently or prudently written. Mr. Merrett added that the underwriter should satisfy himself that the cover became purely notional at a level which was going to impact catastrophically on an individual name.

Mr. Rome accepted that the data and evidence which he had seen did not tell him what view Mr. Emney formed as to the outcome or ultimate outcome of the accounts being ceded.

6. The information which Mr. Neil considered was essential to assess the run-off contracts before writing them is set out in paragraph 187 of his report. The information included "IBNR loss reserves for both asbestos claims and non asbestos claims and the methodology behind the IBNR factors". (Mr. Neil's paragraph 187(g) should be read as referring only to direct business). He comments in paragraph 184 that :-

I prefer Mr. Neil's evidence in relation to the run-off contracts to that of Mr. Rome. In my view Mr. Rome's evidence about the writing of the run-off contracts was unrealistic and unreasonably defensive (see above).

7. When asked whether he considered it was consistent with skill, prudence and competence not to keep copies of the placing information in relation to the run-off contracts, Mr. Merrett accepted that prudence would have dictated a more extensive retention philosophy with reference to the contracts. Merretts' failure to keep full and careful records of the placing information in relation to the run-off contracts has caused difficulty not only in this litigation but in earlier litigation and arbitration. (See further in this connection the affidavit of Mr. Randall sworn in the Dolling-Baker litigation 1988 Folio 3514: C53/3 196).

8. The plaintiffs accept that there could have been few if any syndicates or persons whose knowledge of the asbestos problem, as it impinged on the London market, exceeded or even approached that of Mr. Ayliffe and Mr. Jackson. When asked whether Mr. Jackson would have written the 11 run-off contracts Mr. Merrett said "I do not think so, no. He may have written some of them, but he was not writing a London market reinsurance book at all..." When asked whether he thought Mr. Jackson would have taken on these risks had he been writing a London market reinsurance book Mr. Merrett added "there is no reason to suppose he would not have taken on Judd, for example. I would not want to go much further up the list". Mr. Merrett also said that the to the best of his knowledge Mr. Jackson was not consulted in respect of any of the 11 run-off contracts (and this is what the Names were told on 25.5.90 F6/337). Nor was Mr. Ayliffe consulted.

9. Six of the run-off contracts were written after Mr. Murray Lawrence's letter dated 18.3.82 quoted in section 18 supra (and see also clause 3(iii) of the Audit Instructions in year 1). Five of the run-off contracts were written within 3 months of the year 1 audit.

10. In an article in Lloyd's List dated 8.12.82 Mr. David Mann, a Director of MSL wrote:-

11. Mr. Chester at a meeting of the Audit Committee of Lloyd's on 2.3.82 (H1/471A) commented on the particular dangers of a concentration of exposure to asbestos-related claims in a small number of syndicates. Mr. Merrett was present at this meeting.

Further Mr. Chester at a panel auditors meeting on 9.3.82 (J7/92(3)) said that the writing of run-off contracts could lead to the funnelling of a large amount of liability into a small number of names and added that consideration was being given to asking the market to stop writing such reinsurances in the open years. Merretts were not represented on 9.3.82 but the point about funnelling should have been obvious to them.

12. The run-off contracts were not protected by adequate reinsurance. When asked whether he discussed with Mr. Emney what reinsurance would be necessary for the 11 run-off contracts Mr. Merrett said that "at that time it was agreed between us that it was not a matter of arbitraging, that we should either accept that the risks were risks that we could write and run or we should not write them; but after some time he discussed with me the advantages of taking out some reinsurance."

13. Mr. Merrett said that the view in 1985 was that Mr. Emney had not fulfilled his duties properly and that essentially was why, when he withdrew his resignation, he was dismissed. When asked in what respects Mr. Emney did not fulfill his duties properly Mr. Merrett said that "we had reservations at that stage, and substantial reservations as to the underwriting of the individual contracts, as to whether that had been done with the necessary care and attention and conservatism". Although Mr. Merrett referred to Mr. Emney drinking too much he said he was never aware of Mr. Emney doing any underwriting when he was the worse for drink.

14. According to Mr. Merrett if no run-off contracts had been written "it is a reasonable expectation that the syndicate would be trading and that there would be losses arising out of the 417 domestic account, but the subsequent position of the syndicate would have been very different".

24. THE WRITING OF THE PROVINCIAL RUN-OFF CONTRACT

The plaintiffs do not persist with their contention that the writing of the Provincial contract was per se negligent for the following reasons and on the following basis. The plaintiffs

accept that it is not possible to know with reasonable certainty what Merretts knew about the asbestos problem prior to the writing of the Provincial contract. They say there are indications that Merretts must have known of the looming problem and the uncertainties surrounding it. The plaintiffs also say that it is clear that by the time of the writing of the endorsements to this contract, much more was known, but no separate case of negligence was pleaded in this respect. The plaintiffs add that the abandonment of the allegations of negligence in relation to Provincial does not mean that, once written, it could be ignored as a factor when each of the later contracts came to be written because the nature of the asbestos problem in relation to the Provincial contract would have put Merretts on notice of the problem generally, because of the way the account progressed. Nor does the abandonment detract from the plaintiffs' submissions regarding the closing of the years.

25. THE WRITING OF THE UNIVERSAL RUN-OFF CONTRACT

When asked in cross-examination "Is it your position that no competent underwriter would have written the Universal contract or are you simply saying 'one can see where it went wrong, but I do not say it was incompetent by standards at the time'?", Mr. Neil replied "I am not sure it was incompetent by the standards of the time. I am saying that I believe further information should have been sought regarding potential asbestos exposures, and, had that information been sought, it may have made the underwriter think twice about writing it".

The writing of the Universal contract was an error of judgment, but given the date at which it was written and Mr. Neil's evidence, the error was not such as no reasonably well-informed and competent underwriter could have made.

26. THE WRITING OF THE BALLANTYNE RUN-OFF CONTRACT

As at 30.7.81 the future development and extent of asbestos-related claims were subject to considerable uncertainty.

I refer to the chronology, Appendix 1 to this judgment (which in the case of attorney's reports lists some examples of reports in Merretts' possession). As to the US cases at the above date see Appendix 2 to this judgment.

The nature and extent of the uncertainties as at 30.7.81 were known to Merretts. The broad nature and extent of the uncertainties as at 30.7.81 included the following.

(a) As to uncertainties disclosed by materials dated prior to 1.1.81 in Merretts' possession see the chronology. The AWP was established in 1980 - see the letter dated 5.8.80.

(b) As at 10.2.81 (Merretts only) a letter from the AWP to active underwriters stated that during the past year the number of cases in suit has increased from about 5,500 to in excess of 8,000 and at this stage it is not possible to project how many more claims will be filed.

(c) As at April 1981 an attorney's report referred to asbestos in public schools and added that this creates an additional potential plaintiff pool of many millions. Possibly more important are the potential property damage claims by school districts in order to make school buildings once again "safe". The same report stated that an Illinois jury has recently awarded $500,000, $375,000 of that punitive, to the spouse of an asbestos worker in a law suit based on loss of consortium. This appears to be the first award of punitive damages in an asbestos suit and, if indicative of a trend, greatly increases the potential liabilities of companies and their insurers.

(d) The Commercial Union position paper dated 12.5.81 and Dr. Selikoff's 1981 report (both Merretts only) are referred to in Mr. Ayliffe's witness statement (paragraph 59). According to Mr. Ayliffe these reports were viewed with scepticism (paragraph 60). But as the contemporary documents show there were (quite apart from the paper and the report) widely differing views.

The plaintiffs' case in respect of Ballantyne is set out in their closing submissions. Merretts accept that the writing of Ballantyne is open to criticism but they do not accept that it was negligently written for the reasons set out in their submissions.

1. I refer to the general comments on the writing of the run-off contracts set out above.

2. As to perception of asbestos-related claims at the date of this contract see above.

3. As to the US cases as at the date of this contract see Appendix 2 to this judgment.

4. As to the dispute as to the information provided at the date of placing, in the absence of evidence from Mr. Emney I am not satisfied on a balance of probabilities that any further information was provided beyond that agreed to have been provided. The true position is particularly difficult to assess in the absence of proper record keeping by Merretts and evidence from the person who scratched the risk.

5. I prefer the evidence of Mr. Neil to that of Mr. Rome in relation to this contract.

6. I find that in all the circumstances the writing of this contract was negligent. There was a failure to adhere to the standard of skill and care reasonably to be expected of Merretts at the time and with the knowledge that Merretts had or should have had. The central reason for the finding of negligence is that this contract exposed the plaintiffs to potentially huge liabilities, unlimited in time or amount, which were not capable of reasonable quantification on the material before Mr. Emney. There was insufficient placing or other information available at the time the risk was considered to enable a reliable assessment to be made with a reasonable degree of confidence of 417's ultimate net retained potential liability under the contract. Merretts failed to obtain all the information referred to in paragraph 187 of Mr. Neil's report including in particular IBNR loss reserves for both asbestos claims and non-asbestos claims and the methodology behind the IBNR factors.

I also refer to the detailed points made by Mr. Neil in relation to the material before Mr. Emney. The finding of negligence is made for the central reason set out above . In addition it is to be noted that there was no or no adequate system for detecting or monitoring the aggregation in 418/417 of particular risks included in the business ceded under the contract and there was inadequate reinsurance cover against the liabilities assumed.

27. THE WRITING OF THE VERRALL RUN-OFF CONTRACT

See above for perception as at 30.7.81.

The plaintiffs' case in respect of Verrall is set out in their closing submissions.

Merretts' submit that it is obvious from Mr. Emney's working paper that a view was taken as to the ultimate outturn of this contract.

It is to be noted that this contract was avoided for material non-disclosure.

1. I refer to the general comments on the writing of the run-off contracts set out above.

2. As to perception of asbestos-related claims at the date of this contract see above.

3. As to the US cases as at the date of this contract see Appendix 2 to this judgment.

4. As to the dispute as to the information provided at the date of placing, in the absence of evidence from Mr. Emney I am not satisfied on a balance of probabilities that any further information was provided beyond that agreed to have been provided. The true position is particularly difficult to assess in the absence of proper record keeping by Merretts and evidence from the person who scratched the risk.

5. I prefer the evidence of Mr. Neil to that of Mr. Rome in relation to this contract.

6. I find that in all the circumstances the writing of this contract was negligent. There was a failure to adhere to the standard of skill and care reasonably to be expected of Merretts at the time and with the knowledge that Merretts had or should have had. The central reason for the finding of negligence is that this contract exposed the plaintiffs to potentially huge liabilities, unlimited in time or amount, which were not capable of reasonable quantification on the material before Mr. Emney. There was insufficient placing or other information available at the time the risk was considered to enable a reliable assessment to be made with a reasonable degree of confidence of 418's ultimate net retained potential liability under the contract. Merretts failed to obtain all the information referred to in paragraph 187 of Mr. Neil's report including in particular IBNR loss reserves for both asbestos claims and non-asbestos claims and the methodology behind the IBNR factors.

I also refer to the detailed points made by Mr. Neil in relation to the material before Mr. Emney. The finding of negligence is made for the central reason set out above. In addition it is to be noted that there was no or no adequate system for detecting or monitoring the aggregation in 418/417 of particular risks included in the business ceded under the contract and there was inadequate reinsurance cover against the liabilities assumed.

For the avoidance of doubt I have arrived at the above finding without having any regard whatsoever to the conclusions of the arbitrators as to the writing of this contract.

28. THE WRITING OF THE FIREMAN'S FUND RUN-OFF CONTRACT

As at 13.11.81 the future development and extent of asbestos-related claims were subject to considerable uncertainty. I refer to the chronology, Appendix 1 to this judgment (which in the case of attorney's reports lists some examples of reports in Merretts' possession). As to the US cases at the above date see Appendix 2 to this judgment.

The nature and extent of the uncertainties as at 13.11.81 were known to Merretts.

The broad nature and extent of the uncertainties as at 13.11.81 included the following.

(a) As to perception at 30.7.81 see above.

(As to the Advisory Panel of Auditors meeting 10.11.81 (E&W only) see the chronology).

(b) As at November 1981 an attorney's report referred to a huge increase in the number of claims brought against one assured. As at 1.11.81, notices of a total of 4,656 claims against the assured in 28 American jurisdictions had been received. At 30.6.81 a total of 6,210 law suits involving 7,877 individual claimants had been filed against the assured. Since 30.6.81 the assured experienced an additional 300 new claims each month for a current total of approximately 9,000 claims. The report added that there are numerous well informed people who believe that the claims filed to date represent only the beginning of a potential flood of asbestos litigation.

The plaintiffs' case in respect of Fireman's Fund is set out in their closing submissions.

Merretts submit that Mr. Neil plainly thought that the Fireman's Fund broking memorandum (C9/25) was a reasonably comprehensive document. There were bound to have been discussions.

Merretts referred to the following passage in Mr. Neil's cross-examination (Day 33/43):-

Merretts accept that the writing of Fireman's Fund is open to criticism but they do not accept that it was negligently written.

Mr. Merrett accepted that the Fireman's Fund contract was the largest and most risky contract of the 11 run-off contracts (Day 18/27/16). It was suggested in cross-examination of Mr. Rome that the subsequent settlement cost the Names approximately $159m (Day 34/106/3).

Mr. Merrett said that in the 1950's and 1960's the non-marine market for casualty business was dominiated by two or three syndicates which included Sturge (Day 16/64/23).

In his witness statement Mr. Merrett said (paragraph 60 J1/1/38):-

This statement is to be contrasted with Mr. Merrett's evidence

when cross-examined (Day 16/9/10-14/11). At page 14/5 Mr.

Merrett said:-

When asked whether Mr. Rokeby-Johnson was wrong when he said in his letter dated 16.7.82 that "the content of a Lloyd's underwriter's book of business... makes it impossible to quantify the final outcome of these huge and complex claims with any degree of accuracy" Mr. Merrett said "I think, if one is addressing the Sturge syndicate uniquely, then it is a reasonable statement. I think it is an accurate statement with reference to Sturge."

It is to be noted that Mr. Mann the deputy underwriter on 799 in about September 1981 "declined to quote on the coverage (re: Sturge run-off account). He cited the asbestosis exposure and their already heavy involvement as the main reason. He pointed out that the known identified exposures to Sturge on asbestosis could easily run to excess of $40,000,000 (v. $10,000,000 currently reserved) and felt that Merretts' current exposure prevented him from exposing the syndicate to additional exposure from that source." (See the inter office memorandum dated 21.9.81 from Mr. Brown to Mr. Isom H1/367).

Thus 799 was not prepared to write this risk in about September 1981 but 417 wrote it in November 1981.

My conclusions are as follows:-

1. I refer to the general comments on the writing of the run-off contracts set out above.

2. As to perception of asbestos-related claims at the date of this contract see above.

3. As to the US cases as at the date of this contract see Appendix 2 to this judgment.

4. As to the dispute as to the information provided at the date of placing, in the absence of evidence from Mr. Emney I am not satisfied on a balance of probabilities as to the content of any further information provided beyond that agreed to have been provided. The true position is particularly difficult to assess in the absence of proper record keeping by Merretts and evidence from the person who scratched the risk.

5. I prefer the evidence of Mr. Neil to that of Mr. Rome in relation to this contract.

6. I find that in all the circumstances the writing of this contract was negligent. There was a failure to adhere to the standard of skill and care reasonably to be expected of Merretts at the time and with the knowledge that Merretts had or should have had. The central reason for the finding of negligence is that this contract exposed the plaintiffs to potentially huge liabilities, unlimited in time or amount, which were not capable of reasonable quantification on the material before Mr. Emney. There is insufficient placing or other information available at the time the risk was considered to enable a reliable assessment to be made with a reasonable degree of confidence of 417's ultimate net retained potential liability under the contract. Merretts failed to obtain all the information referred to in paragraph 187 of Mr. Neil's report including in particular IBNR loss reserves for both asbestos claims and non-asbestos claims and the methodology behind the IBNR factors.

I also refer to the detailed points made by Mr. Neil in relation to the material before Mr. Emney. The finding of negligence is made for the central reason set out above. In addition it is to be noted that there was no or no adequate system for detecting or monitoring the aggregation in 418/417 of particular risks included in the business ceded under the contract and

there was inadequate reinsurance cover against the liabilities assumed.

In May 1982, 418/417's 1979 year of account was closed by way of an RITC into the 1980 year of account; and it was reported on by Merretts on 4th May 1982.

In the 1981 Annual Report and Accounts for 418/417 was a Note by E&W to the Accounts to the effect that the reinsurance had been calculated by the underwriter and complied with the requirements of the Council of Lloyd's.

As to the regulatory regime for the year ended 31.12.81 see above.

As at 4.5.82 the future development and extent of asbestos related claims was subject to considerable uncertainty. I refer to the chronology, Appendix 1 to this judgment (which in the case of attorneys' reports lists some examples of reports in Merretts' possession). As to the US cases at the above date see Appendix 2 to this judgment.

The nature and extent of the uncertainties as at 4.5.82 were known to Merretts and E&W, alternatively in the case of E&W would have been known to E&W had necessary and appropriate audit tests and enquiries been carried out and conducted.

The broad nature and extent of the uncertainties as at 4.5.82 were reflected in the following materials.

Where materials are drawn on which would probably have been available only to Merretts or E&W this is indicated in brackets.

(a) As to perception/uncertainties as at 13.11.81 see above.

(b) As at November 1981 an attorney's report stated that an assured reported that it had 11,315 open cases and that new cases were being filed at the rate of approximately 100 per week. The report added that it is our observation that in cases where the plaintiffs is able to make out a prima facie cause of action, juries do find liability.

(c) As at November 1981 an attorney's report in respect of assureds stated that the asbestos cases manifestly represent grave potential exposure to the asbestos manufacturers and producers of the past 40 to 50 years. The situation must be viewed as one of certain liability. A major problem concerns the fact that it is impossible to predict with certainty the number of products liability claims that would be made against the assured. The number of potential claims would appear to be staggering.

(d) As at December 1981 (Merretts only) a letter from the AWP to all interested underwriters stated that Johns-Manville have exhausted their primary cover. Owens-Corning has recently been reported as having exhausted its primary domestic insurance with a result that claims will shortly be presented to interested underwriters in London. The database currently shows 14,526 individual claimants but on the basis of various projections which the working party is not in a position to verify, the total claimants will, in the end significantly exceed this number. During the period since the setting up of the working party there has been a substantial increase in the number of suits filed. New suits currently reported now average 300-400 per month which is indicative of the increasing severity of this problem to the asbestos industry and its insurers. It is not possible at this stage to perceive any clear indication of the likely development in the future.

(e) As at January 1982 (Merretts only) the notes of comments made at a meeting of the AWP recorded that no one knows what the real reserve situation is.

(f) As at January 1982 (E&W only) a note of a Panel Auditors Meeting recorded that policies giving rise to claims were issued between 1945 and 1975 with a certain number going back prior to 1945. The note also included the following information. There have been some 15,000 claims notified but they are increasing at the rate of 400 per month. It is difficult to guess what the final number of claims will amount to, but it was suggested that by the mid to end 1980's we should expect some 25,000 in total. (An aside by someone stated that the Prudential were guessing at a figure of 2 million claims. Mr. Nelson (a member of the AWP) said he considered this figure to be well wide of the mark). At the moment the loss reserves have been set up on a basis of an average cost per claim, based on the statistics available, of $125,000 plus expenses of $10,000 per claimant. Currently this means a total claim of $2,025,000,000. On an exposure basis 40% is with London companies and Lloyd's whereas on a manifestation basis it is 10%. As far as the IBNR factor is concerned, it is suggested that a view should be taken as to what can come forward within the next 5 to 6 years.

(g) As at February 1982 (Merretts only) a letter from the AWP to all interested underwriters stated that in view of the uncertainties of the future, it is difficult to provide any meaningful projection of the developments that are likely to take place over the coming years in regard to this problem and added that the number of claims is likely to escalate and future deterioration is inevitable.

(h) The Neville Russell letter (E&W only) dated 20.2.82 is quoted in full supra.

(i) As at March 1982 (E&W only) Mr. Nelson told a meeting of Panel Auditors that at present 400 new claims per month were being advised and that if this were projected over a 10 year basis would lead to approximately 50,000 claims. Mr. Nelson added that in his view a figure of 50,000 new claims over the next 10 years would seem to be realistic and that reports of up to 2 million new claims could well be an exaggeration. (see also Mr. Chester's remarks about run-off contracts - "funnelling of a large amount of liability into a small number of names" and "consideration was being given to asking the market to stop writing such reinsurances").

(j) As at March 1982 (E&W only) an internal letter from Mr. Bolger referred to the fact that in the White Letter accompanying this year's Lloyd's audit instructions the attention of auditors is drawn to risks which include liability for latent diseases and products liability when assessing the adequacy of reserves. Major losses under these categories have been known in the Lloyd's market for some time. The letter also stated the following. It is understood that there are 40 insureds of which 19 are direct in the London market. In respect of 15 of these, all the slips placed in the London market have been found. The total number of cases in litigation is in the region of 15,000 and this number is growing by approximately 400 per month. The product was readily available between 1945 and 1975. The pattern in Lloyd's is that up to 1962 syndicates have insured American carriers direct, and thereafter they have covered American companies by reinsurance in the London market. The size of the asbestosis problem became apparant some two years ago when it was agreed that normal assessments of settlements were not suitable. Estimates have been made on the basis of an average cost per claim together with an estimate of expenses. The average was said to be $125,000 plus $10,000 for expenses.

(k) The letter dated 18.3.82 from Mr. Randall of Lloyd's to E&W and the enclosure (a copy of Mr. Murray Lawrence's letter of 18.3.82 to all underwriting agents and active underwriters) are quoted in full in section 18 above.

The RITC for 1981 (prior to credit for the roll over policy) broke down as follows (rounded):-

The make-up of this figure is in J10/Schedule A and see Pie Chart 1.

Outstandings.

The Agency had prepared for it by Dataloyd a print out of outstanding claims (IO4). Reserves were based on recommendations from attorneys. 417 used a parallel recording system to that used by Syndicate 799. Of the reinsurance recoveries, some were automatically calculated by the computer because identification of the relevant reinsurance cover was included in the underwriting reference. Some were "manual specific" i.e. had to be based on a review by the Agency of relevant claims data and the result manually input. Recoveries in respect of aggregate losses were manually input.

From this material Mr. de Silva of Merretts prepared a summary of net outstandings by currency, classification of business (short or long tail) and year of account: D1, p.188-190. Mr. Wheatley of Merretts identified policies upon which claims or potential claims had been notified in respect of asbestosis risks, recording where applicable outstandings on a gross and net basis. Merretts also checked their records with the AWP computer records [D2/202]. Additional manual input was provided by the marine box staff in respect of those sections of the account written at the marine box. Mr. Wheatley took the syndicate's share of 100% of outstandings as reported by US attorneys (hence the reference at the RITC meeting to 417's share of the "market report figures"): p178(i). He made the necessary amendments to the IO4: page 229 and p148-174. This showed gross outstandings of $8.858m and net outstandings of $5.276m (derived from 162 policies and calculated on the higher of the exposure and manifestation bases). The details of the relevant policies are attached to the workings: D1, p.152-174. The policies were both direct policies and reinsurance policies.

For a comparison of 417 and 799's asbestosis outstandings gross and net see D1 p.178(1).

E&W reviewed outstandings: Schedule BA1(b) (J10/2) and Hill, para. 24 and p.203-4: see the Audit Programme for O.C.R. at p.203. In particular they reviewed and performed cross-checks on Mr. Wheatley's figures which produced $5.276m: see D1, p.204 and 229-233.

IBNR.

A loading of 50% was applied to total net outstandings in respect of all business as the loading for 417 as a whole: see the figures for "asbestos" and "others" under "loading" in Schedule A (J10/1): and Mr. Hulme's Schedule at D1, p.184. (The figure of £100,000 "additional" on Schedule A (J10/1) was added to cover a late discovered understatement of an outstanding on the 1973 account: D1, page 179(1)).

Pages 177-179 contain notes of the RITC meeting of 30.3.82 at which the 50% loading was agreed.

At 31.12.80 (the previous year end) the Agency had taken a 50% figure and had also added, by way of IBNR, a lump sum figure of £1m for asbestosis in respect of which there were then no outstandings, no claims in respect of asbestosis having been recorded at that date: p.177(1).

Mr. Wheatley's exercise had identified net outstandings in respect of asbestosis of $5.276m, which applying the 50% load to net outstandings, produced a load of $2,638,000 (£1.381m). What had previously been a loading unrelated to any specific asbestosis claim (none having been recorded) was now, therefore, directly related to such claims. 10 of the 12 assureds on Mr. Wheatley's list were on the list of 19 asbestos producers or manufacturers subsequently identified at D2/277 (insured either directly or by way of reinsurance of the main US carriers such as CNA, Home and Travelers). The list at D2/277 (Databank Reserves) in its heading refers to a meeting in a US attorneys' office on 8.9.92. Reference was made to "19 risks insured in the London market" at the Panel Auditors' Meeting on 15.1.82 (J7 p.87). The evidence does not establish whether the 19 risks referred to at this meeting were the same as the 19 assureds identified at D2/277.

The minutes of the RITC meeting record (D1/178(1)):

Mr. Hulme's schedule (D1, p. 184) shows that the result of using 50% as at 31.12.81. was that a deficiency of £1.97m arose on the back years. Although asbestosis reserves ($5.2 m + $2.6 m = $7.9m) were circa £4m, an increase of £3m on the previous year, the back year deficiency on reserves was only £1.97m. The AU38 showed a figure of £1.84m for the deficiency in the back year reserves.

The loadings adopted exceeded the Lloyd's percentage reserves: p.181-2.

The total reserves in respect of asbestos for 417 amounted to £4.14m of a total RITC for 418/417 of £46.93m: see J10/Schedule A. Thus asbestos reserves constituted approximately 9% of the total RITC.

The RITC is recorded in several places: e.g. p133 and 181-2. The AU 17 dated 23.4.82 signed by Merretts is at D1 p.118.

SYNDICATE 418

There is no equivalent of LUNCO in the Marine Market. Merretts kept manual records at the Box recording claims above a noting level. Information in these records was derived from (1) brokers' notifications, (2) market information, (3) settlements from LPSO and (4) reinsurance collection notes. At the end of the year the Box claims' staff prepared a summary of the claims (net of recoveries) based on these records. This summary was submitted to Mr. Merrett and the auditors. Mr. Merrett reviewed it and amended it if necessary. He had maintained over many years his own record ("the Red Book") which was multi-columned to show the development from year to year. The Red Book for 1981 is at D1, p.66-94 and a summary of it at D1, p.65. The steps taken by E&W to review outstandings are set out in Schedule BA2(b) (J10/2). The Hulme Schedule is at D1, p.29.

The Agency used the Lloyd's percentage reserves as an IBNR figure. (E&W did the relevant calculations for them). This was added to the sum of (i) outstanding claims (above a noting level) net of facultative and class X/L reinsurances (but no other); and (ii) 25% of specific reinsurance recoveries (a figure determined by the Agency which had been used in previous years) to allow for the potential irrecoverability of reinsurance. In other words they allowed for only 75% recovery under the reinsurances.

The precise make up of the RITC is shown at D1, p.28. D1, page 63 has a summary of the gross claims and the claims net of facultative reinsurance. D1, page 62 calculates the 25% add-back. In addition there was a specific loading for asbestos, which at the RITC meetings is referred to as $500,000, but was in the event $250,000: D1, p.57: item 3(a).

The Notes of the RITC Meeting are at D1, p.27.

Syndicate 418's 1979 account made an underwriting profit of £4.86m including a surplus from the years reinsured into that account (as appears from D1, p.29: see the figure of £3.5m under the first "Total").

The AU17 Certificate for 418 is at A(A)(1) Tab 28.

By 31.12.81 the following 4 run-off contracts had been written into the following years of account: 

Of these only Provincial fell to be considered as a constituent of the RITC as at 31.12.81. No claim on that appeared in the claims box summary or in the Red Book. The outstandings in relation to Provincial as at 31.12.81 were $802,852. The application of Lloyd's audit minima percentages applied to the Provincial premium produced a loading of $254,758 which was included in the overall IBNR for 418.

E&W requested Merretts to complete what was referred to as the Latent Disease Questionnaire in respect of both 417 and 418: D1, page 22 (- enclosure to E&W letter of 17.2.82 D1, page 20 which drew attention to clause 3(iii) of the Lloyd's white letter dated 1.2.83). Mr. Merrett's response for 417 stated inter alia, that:

Mr. Merrett's response for 418 stated:

E&W's stop loss reinsurance questionnaire (D1, p.252-3) asked whether Syndicate 418/417 (inter alia) had written whole account stop loss insurance in excess of 1% of the NPI of the Syndicate. Mr. Merrett's response was no - D1, p.145; and E&W reported accordingly with form AU.38: p135.

1. Merretts failed to comply with the guideline in paragraph 6 of Mr. Lawrence's letter -

Merretts failed to advise E&W of the Universal, Ballantyne and Verrall contracts (as to Provincial see below) and also failed to consider whether the open year reserves should be increased.

2. Merretts failed to comply in relation to the Provincial, Universal, Ballantyne and Verrall run-off contracts with clause 3 (iii) (c) and (d) of the Solvency/White Letter dated 1.2.82 (J5/55)-

3. Merretts' replies to the Latent Diseases Questionnaire were seriously misleading. In the case of 418 (D1/254) Merretts failed to inform E&W that a loss had been notified in the sum of $802,852 in respect of Provincial and failed to identify 418's exposure pursuant to the Universal and Verrall contracts. Merretts' answer in relation to 417 (D1/146) failed to identify 417's exposure pursuant to the Ballantyne contract.

(See also Merretts' answer on the Form Au17).

4. 418 subscribed to 50% of the Provincial contract. Its share of outstandings for the Provincial contract at 31.12.81 was $802,852. The contract was reserved at Lloyd's Audit minima - $254,758. There was no amount for Provincial included in the outstandings. Had the Provincial contract been reserved on the basis adopted for 417 (ie an uplift of 50%) this would have produced $1,204,278. The difference between the Lloyd's Audit minima reserve and the amount which would have been reserved on the basis adopted for 417 is $949,520.

5. It is unclear on the evidence as to the extent to which

Merretts complied with the guideline in paragraph 3 of Mr. Murray Lawrence's letter -

(a) Merretts

It is important to remember that the plaintiffs' case is that year 1 should have been left open (and no alternative case is advanced that if year 1 was to be closed it should only have been closed at a higher premium than that in fact adopted).

I do not consider that in all the circumstances Merretts' decision to close year 1 was a decision that no reasonably well-informed and competent underwriter/managing agent could have made. I so find inter alia for the following reasons and having regard to the following circumstances:-

1. Asbestos-related claims

The perception of asbestos personal injury and property damage claims is considered separately at each of years 1 to 6. These 6 sections of the judgment show the developing problem. The position as at year 1 should be contrasted with the position in subsequent years. As to perception as at 4.5.82 see above. The approximate number of personal injury claims/claimants as at 4.5.82 is there stated. Property damage claims were at a relatively early stage.

418/417's incurreds in respect of asbestos claims (main account) in year 1 were $5.276m.

2. Pollution claims

Merretts carried reserves in respect of Love Canal from 1979. As to the relevant legislation see the chronology, Appendix 1 to this judgment. CERCLA was passed in 1980. The Shell claim (see below) was first notified in October 1983. By year 4 pollution claims were recognised to be the next major problem for the market. The perception of pollution claims in year 4 is to be contrasted with perception in prior years. In year 1 the only substantive pollution claim in existence was Love Canal.

3. The Run-Off Contracts

In year 1 only the Provincial run-off contract fell to be considered as a constituent of the RITC as at 31.12.81. The figure of $1,204,278 (£630,512) see above, should be contrasted with the RITC premium in fact set for 418/417 of £47m.

4. The Plaintiffs' criticisms

As to the plaintiffs' criticisms of Merretts as at year 1, I have already held that some of these are well-founded (see above). The list of criticisms set out above does not purport to be exhaustive. However I do not consider that the criticisms that can be made of Merretts in year 1 lead to the conclusion that year 1 should have been left open.

The plaintiffs advance 7 principal criticisms of Merretts.

As to the first, I do not consider that no attempt whatsoever was made to calculate an IBNR loading to infinity for asbestosis claims. While there are criticisms which can be made of Merretts' approach and while I should not be taken to accept that the RITC as at year 1 received the attention that it should have received from Merretts, it does not follow that year 1 could not have been competently closed.

As to the second principal criticism (there was no justification for the use of the 50% loading in respect of asbestosis claims), Mr. Murray Lawrence's letter in referring to an "IBNR loading" and "the appropriate IBNR percentage" (paragraph 5) reflected the then practice of the market as to percentage loadings for IBNR. I should not be taken to accept that 50% was in all the circumstances the appropriate load for year 1 in respect of asbestosis claims, but the plaintiffs have tied their case to the question whether or not the year could properly have been closed, as opposed to the quantum of the load.

As to the third principal criticism (no consideration was given to leaving the 1979 account open) I consider that the decision to close the year involved implicit consideration of the alternative.

As to the fourth principal criticism (whole account stop loss) in view of the conflicting evidence as to the true meaning of this expression, I disregard this point.

As to the fifth principal criticism (see the response to the first and second principal criticisms above).

I have dealt with the sixth principal criticism above.

(b) E&W

As to E&W in year 1 it is important to remember that E&W were seriously misled by Merretts as to the run-off contracts (see criticisms 1-4 under the heading 'Some Criticisms of Merretts in Year 1' above). Further the case against E&W in year 1 must be judged in the light of their perception of asbestos-related claims as at 4.5.82 (see above).

It follows from my conclusions in relation to Merretts, that the plaintiffs' claim against E&W in respect of year 1 must also fail. It is accordingly unneccesary to consider the plaintiffs' detailed criticisms of E&W in year 1. Although I have noted that Mr. Attwood's standards in years 1 to 3 may to some extent be above the reasonable average, I accept Mr. Attwood's central contentions as to the need for appropriate audit evidence. I should not be taken to accept that E&W's audit approach and work in year 1 is not open to criticism. The plaintiffs have however tied their case to the question whether or not the year could properly have been closed, as opposed to the quantum of the premium. I do not consider that the plaintiffs have established that E&W should have disclaimed an opinion on the grounds of fundamental uncertainty in year 1.

30. THE WRITING OF THE DOLLING-BAKER, TOOMEY, GOODA AND HUMM RUN-OFF CONTRACTS

As at the above dates the future development and extent of asbestos-related claims were subject to considerable uncertainty. I refer to the chronology, Appendix 1 to this judgment (which in the case of attorneys' reports lists some examples of reports in Merretts' possession). As to the US cases at the above date see Appendix 2 to this judgment.

The nature and extent of the uncertainties as at the above dates were known to Merretts. As to perception as at 4.5.82 see above.

The plaintiffs' case in respect of Dolling-Baker is set out in their closing submissions.

Merretts' submit that it is obvious that there was significant non-disclosure in respect of the Dolling-Baker contract. When cross-examined Mr. Neil said (Day 33/50) that he would criticise the Dolling-Baker syndicate for the removal of paragraph 4 from C/13/50.

Further Merretts accept that the writing of Dolling-Baker is open to criticism but they do not accept that it was negligently written.

1. I refer to the general comments on the writing of the run-off contracts set out above.

2. As to perception of asbestos-related claims at the date of this contract see above.

3. As to the US cases as at the date of this contract see Appendix 2 to this judgment.

4. As to the dispute as to the information provided at the date of placing, in the absence of evidence from Mr. Emney I am not satisfied on a balance of probabilities that any further information was provided beyond that agreed to have been provided. The true position is particularly difficult to assess in the absence of proper record keeping by Merretts and evidence from the person who scratched the risk.

5. I prefer the evidence of Mr. Neil to that of Mr. Rome in relation to this contract.

6. I find that in all the circumstances the writing of this contract was negligent. There was a failure to adhere to the standard of skill and care reasonably to be expected of Merretts at the time and with the knowledge that Merretts had or should have had. The central reason for the finding of negligence is that this contract exposed the plaintiffs to potentially huge liabilities, unlimited in time or amount, which were not capable of reasonable quantification on the material before Mr. Emney. There was insufficient placing or other information available at the time the risk was considered to enable a reliable assessment to be made with a reasonable degree of confidence of 417's ultimate net retained potential liability under the contract. Merretts failed to obtain all the information referred to in paragraph 187 of Mr. Neil's report including in particular IBNR loss reserves for both asbestos claims and non-asbestos claims and the methodology behind the IBNR factors.

I also refer to the detailed points made by Mr. Neil in relation to the material before Mr. Emney. The finding of negligence is made for the central reason set out above. In addition it is to be noted that there was no or no adequate system for detecting or monitoring the aggregation in 418/417 of particular risks included in the business ceded under the contract and there was inadequate reinsurance cover against the liabilities assumed.

The plaintiffs' case in respect of Toomey is set out in their closing submissions.

Merretts point to Mr. Neil's answers in cross-examination (Day 33/56/66) but these are to be contrasted with his evidence in re-examination (Day 34/22). Merretts submit that Toomey was on the border (and should not be regarded as being negligent).

In a letter dated 31.1.89 (C15/241 at 243) Mr. Toomey wrote:-

My conclusions are as follows:-

1. I refer to the general comments on the writing of the run-off contracts set out above.

2. As to perception of asbestos-related claims at the date of this contract see above.

3. As to the US cases as at the date of this contract see Appendix 2 to this judgment.

4. As to the dispute as to the information provided at the date of placing, in the absence of evidence from Mr. Emney I am not satisfied on a balance of probabilities that any further information was provided beyond that agreed to have been provided. The true position is particularly difficult to assess in the absence of proper record keeping by Merretts and evidence from the person who scratched the risk.

5. I prefer the evidence of Mr. Neil to that of Mr. Rome in relation to this contract. I have paid careful regard to Mr. Neil's evidence in cross-examination and re-examination referred to above.

6. I find that in all the circumstances the writing of this contract was negligent. There was a failure to adhere to the standard of skill and care reasonably to be expected of Merretts at the time and with the knowledge that Merretts had or should have had. The central reason for the finding of negligence is that this contract exposed the plaintiffs to potentially huge liabilities, unlimited in time or amount, which were not capable of reasonable quantification on the material before Mr. Emney. There was a manuscript schedule C/15/4/43 giving "loadings for IBNR" on 1966-1970 accounts as at 31.12.77-80 inclusive but not as at 31.12.81 - see in this connection C15/241 at 243. There was insufficient placing or other information available at the time the risk was considered to enable a reliable assessment to be made with a reasonable degree of confidence of 417's ultimate net retained potential liability under the contract. Merretts failed to obtain all the information referred to in paragraph 187 of Mr. Neil's report including in particular up-to-date IBNR loss reserves for both asbestos claims and non-asbestos claims and the methodology behind the IBNR factors.

I also refer to the detailed points made by Mr. Neil in re-examination as to the material before Mr. Emney. The finding of negligence is made for the central reason set out above. In addition it is to be noted that there was no or no adequate system for detecting or monitoring the aggregation in 418/417 of particular risks included in the business ceded under the contract and there was inadequate reinsurance cover against the liabilities assumed.

The plaintiffs' case in respect of Gooda is set out in their closing submissions.

Merretts accept that the writing of Gooda is open to criticism but they do not accept that it was negligently written for the reasons set out in their submissions.

1. I refer to the general comments on the writing of the run-off contracts set out above.

2. As to perception of asbestos-related claims at the date of this contract see above.

3. As to the US cases as at the date of this contract see Appendix 2 to this judgment.

4. As to the dispute as to the information provided at the date of placing, in the absence of evidence from Mr. Emney I am not satisfied on a balance of probabilities that any further information was provided beyond that agreed to have been provided. The true position is particularly difficult to assess in the absence of proper record keeping by Merretts and evidence from the person who scratched the risk.

5. I prefer the evidence of Mr. Neil to that of Mr. Rome in relation to this contract.

6. I find that in all the circumstances the writing of this contract was negligent. There was a failure to adhere to the standard of skill and care reasonably to be expected of Merretts at the time and with the knowledge that Merretts had or should have had. The central reason for the finding of negligence is that this contract exposed the plaintiffs to potentially huge liabilities, unlimited in time or amount, which were not capable of reasonable quantification on the material before Mr. Emney. There was insufficient placing or other information available at the time the risk was considered to enable a reliable assessment to be made with a reasonable degree of confidence of 417's ultimate net retained potential liability under the contract. Merretts failed to obtain all the information referred to in paragraph 187 of Mr. Neil's report including in particular IBNR loss reserves for both asbestos claims and non-asbestos claims and the methodology behind the IBNR factors.

I also refer to the detailed points made by Mr. Neil in relation to the material before Mr. Emney. The finding of negligence is made for the central reason set out above. In addition it is to be noted that there was no or no adequate system for detecting or monitoring the aggregation in 418/417 of particular risks included in the business ceded under the contract and there was inadequate reinsurance cover against the liabilities assumed.

The plaintiffs' case in respect of Humm is set out in their closing submissions.

Merretts accept that the writing of Humm is open to criticism but they do not accept that it was negligently written for the reasons set out in their submissions.

1. I refer to the general comments on the writing of the run-off contracts set out above.

2. As to perception of asbestos-related claims at the date of this contract see above.

3. As to the US cases as at the date of this contract see Appendix 2 to this judgment.

4. As to the dispute as to the information provided at the date of placing, in the absence of evidence from Mr. Emney I am not satisfied on a balance of probabilities that any further information was provided beyond that agreed to have been provided. The true position is particularly difficult to assess in the absence of proper record keeping by Merretts and evidence from the person who scratched the risk.

5. I prefer the evidence of Mr.Neil to that of Mr. Rome in relation to this contract.

6. I find that in all the circumstances the writing of this contract was negligent. There was a failure to adhere to the standard of skill and care reasonably to be expected of Merretts at the time and with the knowledge that Merretts had or should have had. The central reason for the finding of negligence is that this contract exposed the plaintiffs to potentially huge liabilities, unlimited in time or amount, which were not capable of reasonable quantification on the material before Mr. Emney. There was insufficient placing or other information available at the time the risk was considered to enable a reliable assessment to be made with a reasonable degree of confidence of 418's ultimate net retained potential liability under the contract. Merretts failed to obtain all the information referred to in paragraph 187 of Mr. Neil's report including in particular IBNR loss reserves for both asbestos claims and non-asbestos claims and the methodology behind the IBNR factors.

I also refer to the detailed points made by Mr. Neil in relation to the material before Mr. Emney. The finding of negligence is made for the central reason set out above. In addition it is to be noted that there was no or no adequate system for detecting or monitoring the aggregation in 418/417 of particular risks included in the business ceded under the contract and there was inadequate reinsurance cover against the liabilities assumed.

31. THE WRITING OF THE BURDETT RUN-OFF CONTRACT

As at 28.7.82 the future development and extent of asbestos-related claims were subject to considerable uncertainty. I refer to the chonology, Appendix 1 to this judgment (which in the case of attorneys' reports lists some examples of reports in Merretts' possession). As to the US cases at the above date see Appendix 2 to this judgment.

The nature and extent of the uncertainties as at 28.7.82 were known to Merretts. As to perception at 29.6.82 see above. Further as at July 1982 a letter from Mr. Rokeby-Johnson of Sturge to Winchester Bowring (not seen by E&W until later see below) stated:-

The plaintiffs' case in respect of Burdett is set out in their closing submissions.

The plaintiffs' accept that in the case of Burdett Mr. Emney did have the cedant's/its auditors' assessment of the IBNR.

Merretts accept that the writing of Burdett is open to criticism but they do not accept that it was negligently written.

1. I refer to the general comments on the writing of the run-off contracts set out above.

2. As to perception of asbestos-related claims at the date of this contract see above.

3. As to the US cases as at the date of this contract see Appendix 2 to this judgment.

4. As to the dispute as to the information provided at the date of placing, in the absence of evidence from Mr. Emney I am not satisfied on a balance of probabilities that any further information was provided beyond that agreed to have been provided. The true position is particularly difficult to assess in the absence of proper record keeping by Merretts and evidence from the person who scratched the risk.

5. I prefer the evidence of Mr. Neil to that of Mr. Rome in relation to this contract.

6. I find that in all the circumstances the writing of this contract was negligent. There was a failure to adhere to the standard of skill and care reasonably to be expected of Merretts at the time and with the knowledge that Merretts had or should have had. The central reason for the finding of negligence is that this contract exposed the plaintiffs to potentially huge liabilities, unlimited in time or amount, which were not capable of reasonable quantification on the material before Mr. Emney. Despite the fact that Mr. Emney did have the cedant's/its auditor's assessment of the IBNR there was insufficient placing or other information available at the time the risk was considered to enable a reliable assessment to be made with a reasonable degree of confidence of 417's ultimate net retained potential liability under the contract. Mr. Emney failed to obtain all the information referred to in paragraph 187 of Mr. Neil's report including in particular the methodology behind the IBNR factors. I refer to the detailed points made by Mr. Neil in relation to the material before Mr. Emney (see J2 and J3 of his report). The finding of negligence is made for the central reason set out above. In addition it is to be noted that there was no or no adequate system for detecting or monitoring the aggregation in 418/417 of particular risks included in the business ceded under the contract and there was inadequate reinsurance cover against the liabilities assumed.

32. THE WRITING OF THE JUDD RUN-OFF CONTRACT

As at 29.12.82 the future development and extent of asbestos-related claims were subject to considerable uncertainty. I refer to the chronology, Appendix 1 to this judgment (which in the case of attorneys' reports lists some examples of reports in Merretts' possession). As to the US cases at the above date see Appendix 2 to this judgment.

The nature and extent of the uncertainties as at 29.12.82 were known to Merretts. As to perception at 28.7.82 see above. Further:-

(a) As at September 1982 a report by Conning & Co. (Merretts only) which is referred to in Mr. Ayliffe's statement stated:-

(b) As at December (Merretts only) 1982 an article by Mr. David

Mann Director MSL in Lloyd's List stated:-

(c) As at December 1982 an attorney's report stated the following in respect of two class action suits pending against GAF and numerous other defendants filed in Pennsylvania. The actions allege property damage caused by the presence of asbestos materials in schools and other public buildings. The class actions are in the very early preliminary stages and we are at this time unable to evaluate the overall merits of the actions, the potential damages, or the assured's possible exposure. The property damage claims cannot be reflected in the Claims Information System which is established for bodily injury claims, and separate reserve provisions for the property damage claims will be established.

The plaintiffs' case in respect of Judd is set out in their closing submissions.

The plaintiffs accept that in the case of Judd Mr. Emney did have the cedant's/its auditors' assessment of the IBNR.

Merretts submit that Mr. Neil's criticism of the Judd contract is particularly misplaced. Mr. Emney had the following protection:-

(a) The assessment of the cedant's RITC;

(b) A buffer of 50% excess the RITC;

(c) The time value of money from the time when the payment was made until the excess point was reached, if at all; and

(d) The benefit of an underlying run-off protection in respect of asbestos losses underwritten by Mr. Outhwaite for 33_%.

1. I refer to the general comments on the writing of the run-off contracts set out above.

2. As to asbestos-related claims at the date of this contract see above.

3. As to the US cases as at the date of this contract see Appendix 2 to this judgment.

4. As to the dispute as to the information provided at the date of placing, in the absence of evidence from Mr. Emney I am not satisfied on a balance of probabilities that any further information was provided beyond that agreed to have been provided. The true position is particularly difficult to assess in the absence of proper record keeping by Merretts and evidence from the person who scratched the risk.

5. I prefer the evidence of Mr. Neil to that of Mr. Rome in relation to this contract.

6. I find that in all the circumstances the writing of this contract was negligent. There was a failure to adhere to the standard of skill and care reasonably to be expected of Merretts at the time and with the knowledge that Merretts had or should have had. The central reason for the finding of negligence is that this contract exposed the plaintiffs to potentially huge liabilities, unlimited in time or amount, which were not capable of reasonable quantification on the material before Mr. Emney. Despite the fact that Mr. Emney did have the cedant's/its auditor's assessment of the IBNR there was insufficient placing or other information available at the time the risk was considered to enable a reliable assessment to be made with a reasonable degree of confidence of 417's ultimate net retained potential liability under the contract. Mr. Emney failed to obtain all the information referred to in paragraph 187 of Mr. Neil's report including in particular the methodology behind the IBNR factors. I refer to the detailed points made by Mr. Neil in relation to the material before Mr. Emney (see K4, K5 and K6 of his report). The finding of negligence is made for the central reason set out above. In addition it is to be noted that there was no or no adequate system for detecting or monitoring the aggregation in 418/417 of particular risks included in the business ceded under the contract and there was inadequate reinsurance cover against the liabilities assumed.

33. YEAR 2 : THE CLOSURE OF 1980 INTO 1981 AS AT 31.12.82 (MERRETTS' AND E&W'S REPORTS DATED 4.5.83).

In May 1983, 418/417's 1980 year of account was closed by way of an RITC into the 1981 year of account; and it was reported on by Merretts on 4th May 1983.

In the 1982 Annual Report and Accounts for 418/417 was a Note by E&W to the Accounts to the effect that the reinsurance had been calculated by the underwriter and complied with the requirements of the Council of Lloyd's.

As to the regulatory regime for the year ended 31.12.82 see above.

As to developments and changes in perception in previous years see above.

As at 4.5.83 the future development and extent of asbestos-related claims were subject to considerable uncertainty.

I refer to the chronology, Appendix 1 to this judgment (which in the case of attorneys' reports lists some examples of reports in Merretts' possession). As to the US cases at the above date see Appendix 2 to this judgment.

The nature and extent of the uncertainties as at 4.5.83 were known to Merretts and E&W, alternatively in the case of E&W would have been known to E&W had necessary and appropriate audit tests and enquiries been carried out and conducted.

The broad nature and extent of the uncertainties as at 4.5.83 were reflected in the following materials.

Where materials are drawn on which would probably have been available only to Merretts or E&W this is indicated in brackets.

(a) As at January 1983 (Merretts only) a press release agreed at a meeting of the Asbestos Claims Council referred to 20,000 claims pending and tens of thousands more expected over 30 years. The press release added that the ultimate cost in insurance payments will be in billions of dollars and, if past experience is repeated, half the insurance payments will be spent on legal fees and related defence costs.

(b) As at January 1983 (Merretts only) a letter from attorneys to the AWP referred to the continuing increase in suits arising from asbestos-related claims and added the following. While certain coverage issues have yet to be considered by the courts, some have reached a final determination which have most emphatically demonstrated the courts desire to maximise coverage. Suits continue to be reported at approximately 500 per month. Some indications exist to suggest that the severity of injury and/or disease suffered by plaintiffs is less serious than had formerly been the case, although it is much too early to draw any firm conclusions. It is likely that considerable activity will develop in regard to damage allegedly existing in buildings which incorporated asbestos.

(c) As at February 1983 (E&W only) minutes of a Panel Auditors Meeting recorded the following. In June 1982 the US Labour Department gave the following statistics: 21 million workers have been significantly exposed to asbestos in the last 40 years. 8,200-9,700 deaths from cancer attributed to asbestosis per annum for the next 20 years. 3,000 products in daily use contain asbestos. $38billion total claims for deaths expected. At present there are 25,000 plus claims on the data base for direct asbestosis claims. There are on file: 19 major companies assured, 39 lesser companies assured and 200 minor companies assured. Johns-Manville went into bankruptcy on 26.8.82 with 4,000 closed cases plus 17,000 cases outstanding. They are expected to get 52,000 cases by the end of the century. Other points made included the following. In US "double dip" can occur: a plaintiff can sue the employer as well as the holding company. "Downwind" claims are by those who have got asbestosis by wind borne dust. Friable asbestos has been used in buildings that must now be removed.

The RITC for 1982 (prior to credit for the roll over) broke down as follows:

417 418 417/418

Net Outstandings £20.2 £15.63 £35.8m

IBNR £12.3 £25.95 £38.2m

Total £32.5 £41.58 £74m

Net underwriting

result (£3.5) £5.0 (including

See J/10 Schedule A and see Pie Chart 2.

SYNDICATE 417

Merretts had the IO4 print out of outstanding claims, as before, and from this they prepared an initial outstanding claims summary: (D2, p.292-3) in currency and by year of account.

As before Merretts identified the net outstandings in respect of asbestosis risks. By this stage asbestosis claims details, i.e. details of assureds/reassureds who had made claims or given advices of claims (or, say Merretts, potential claims) and of the relevant policies were maintained on a separate computer system which was operated by the staff of 799. (Merretts assert that the database sought to identify every policy perceived to be at risk to asbestos claims and gave details of loss advices and policies where claims had not been made and attorneys had advised a nil reserve. According to E&W the database identified those policies in respect of which a claim had been received or a TBA notified and may have included policies where attorneys had advised a nil reserve). Merretts also compared their own records with the AWP records on asbestosis claims: see p.170.

There had been a substantial increase in asbestosis and (for the first time) DES claims arising from direct business during the year (see below). The minutes of the first RITC meeting on 10.3.83 record:

The substantial increase in outstanding US $ claims (from $18.6m to $30.05m) is shown at D2, p.240. Asbestosis outstandings had substantially increased from $5.276m to $13.754m, i.e. an increase of $8.478m (see Schedule A J10/1).

E&W took steps to review the outstandings: see Schedule BA3(b): (J10/2) and the Audit Programme (p.193) (J10/2), including (i) obtaining Merretts' lists of asbestosis outstandings which were checked to the supporting documents, (ii) ensuring that the listing reflected all the attorneys' reports received during 1982, and (iii) ensuring that the total outstandings for asbestosis and DES claims were included in the list: see Tests 11, 12 & 13 on D2, p.194. The resulting outstanding claims analysis is at D2, p.211. E&W's analysis of Asbestos outstandings is at p.242-243.

The Agency initially proposed a loading of 50% of net outstanding plus "Special loading" for asbestos: see Mr. Hulme's Schedule at D2, p.308-309, producing a total RITC of c £30.3m. At that amount the RITC would have shown a back year deterioration before roll over of £11.7m.

At the first RITC meeting on 10.3.83 Mr. Merrett confirmed that comparison had been made with the AWP records at LUNCO (as was also done the previous year). The notes continue

E&W agreed to examine the deterioration on asbestos by comparing the December 1981/December 1982 provision on a policy by policy basis within years of account of all policies thought to be exposed to asbestosis claims, with a view to seeing whether there was under or over reserving. This produced Mr. McNamara's Schedule relating to Syndicate 417's exposure to asbestos: D2, p.244-276. The purpose of this exercise - was described in Partners' Notes at D2, p,289-291.

Mr. McNamara's Schedules recorded the policies on which claims had been notified or on which attorneys advised that claims might arise. The Schedules set out :

(i) The policies;

(iii) The maximum exposure under the policy;

As to (iii) the plaintiffs say that this was theoretical only, because claims could exceed policy limits, because of the absence of aggregate limits, costs in addition to limits or reinstatements (reinsurances only). Merretts agree that this is correct but say that there was no detailed evidence as to the significance of this, which they dispute.

The plaintiffs say the number of lines/policies identified increased from 162 as at 31.12.81 to 334 as at 31.12.82. Merretts say the following. While it is possible to count the number of entries on Mr. Wheatley's Schedule at 31.12.81 and to count the number of entries on the first McNamara Schedule at 31.12.82, it is not possible to draw the conclusion that the number of policies "identified" by Merretts had changed as a result of that simple count. While it is likely that some new policies were identified during the calendar year 1982, there was a change of methodology between the Wheatley Schedule and the McNamara Schedule. The claims department at Merretts recorded all involvements in policies identified by attorneys and advised to the market through brokers and Toplis & Harding. Thus involvements in policies with nil reserve recommendations would have been recorded at 31.12.81 but Mr. Wheatley did not enter nil reserves on his schedule. The McNamara Schedule entered policies with nil reserves (although it is not now clear whether all policies with nil reserves were entered or only those which were perceived to be at risk)).

Mr. McNamara then considered the possible future deterioration taking into account the deterioration that had already occurred. He either marked the last column with a XX, meaning thereby that an IBNR for further deterioration was needed, or put down a figure.

The maximum further exposure excluding expenses on the policies identified in the McNamara Schedules was $40.6m. The loadings produced by this exercise are listed at D2, p.310(1). These loadings amounted to $9.8m which was approximately 25% of the $40.6m. The defendants say the loadings were based on a full provision for lines currently burning with an additional provision for (a) lines adjacent and (b) low level lines of other reinsureds. The plaintiffs say that the loadings were not made on a full provision basis, that only a selected number of policies were provided for and that there was no assurance that the lines/policies identified were complete. Merretts say there is no basis on which to question whether or not the lines/policies identified were complete. Merretts accept that it remains unclear whether or not the McNamara Schedule included all lines/policies recorded in Merretts files or whether those that were perceived not to be at risk of claims were omitted. E&W accept that they did not perform an audit test in order to verify the completeness of the policy list contained in the Schedule.

A figure of $16.2m (£10m) was reached by adding to the $9.8m $3m (30%) for expenses and $3.4m for new claims or further erosion of liability on existing notifications towards the maximum. D2 310(1) shows that "no account [was] taken of whole account protections under aggregate extension clauses" in respect of 1974 et seq - see further D2/205(1).

In the event the loading used was £12.3m arrived at as follows:

The total RITC (prior to the credit from the roll over) was £32.5m (£20.2m outstanding and £12.3m loading), an increase of £2.2m over the original proposal by Merretts of £30.3m.

The second RITC meeting was on 23.3.83. (D2, p.205) at which the RITC was agreed.

The additional loading of £1.18m arose because - D2, p.210 - various subsequently discovered overstatements of outstandings or understatements of recoveries were not adjusted for. This was left "as a buffer for possible deterioration on asbestosis etc" (D2/210).

The make up of the RITC is shown on Schedule A (J10/1) and at D2, pages 191-2. The total reserves in respect of asbestos for 417 amounted to £18.48m ($29.95m) being 25% of the total RITC for 418/417 (being £74m).

The Agency brought into account £8.2m ($13.284m) from a roll over facility as a credit against old year deteriorations. The cover note is at D2, p.295. This was reported in the Underwriter's report: E1, p.7(20) as follows :

The Agency calculated outstandings in the same way as before and the steps taken to review them by E&W were similar: Schedule BA4(a) and (b) (J10/2). The Red Book is at D2, p.106-126. The outstanding claims summary is at D2, p.96. A small proportion of claims - $250,000 + £20,000 were asbestosis related: D2, p.99, 100, 106 and 137. An additional £100,000 general reserve was added - semble in respect of the Royal, a US primary insurer.

D2/99 records "John Emney is reviewing maximum liability to asbestosis".

Merretts approach was the same as that adopted in the previous year. The Hulme Schedule is at D2, p.94.

The Notes of the RITC meeting of 17.3.83. are at D2, p.92(1)-(2).

By 31.12.82, the following 10 run-off contracts had been written into the following years of account:

1978 Provincial 418

Of these only the first two fell to be considered as a constituent part of the RITC of 1980 into 1981. No reference was made in the claims box schedule to outstanding losses on run-off contracts and no losses on the run-off contracts were apparent in the Red Book. The outstandings as at 31.10.82 in relation to Provincial and Universal were - $1,888,158 (see C26/293, initialled by Mr. Emney on 28.2.83, which shows exposures for Asbestosis, DES, Agent Orange and Love Canal totalling $52m - 50% = $26m). The application of the loadings used for 417's own book would according to the plaintiffs have produced a reserve of £2,289,738 and according to Merretts and E&W £2,734,436. The application of Lloyd's audit minima to the Provincial and Universal premium produced a loading of $486,801 which was included in the overall IBNR for 418.

E&W sent Merretts a Latent Disease Questionnaire in substantially the same form as that of the previous year. This year, however, the Questionnaire specifically requested evidence that syndicates had taken steps to identify and quantify known or potential liabilities in respect of inter alia run-off accounts containing latent disease liability: D2/63. In relation, inter alia, to that request the answer for 417 stated:

The answer for 418 to the Questionnaire stated:

The answer to the other matters questionnaire (D2, p.61 & 172) was negative. On this occasion the question was posed separately for each Syndicate and was :

The agency answered "yes" to the questionnaire on other matters in respect of this syndicate and gave details of nine contracts, including the six contracts which were written into 417 as well as 421 (D2 p.358). But the response to the 421 questionnaire did not indicate that 417 was also a party to those run-offs.

The percentage calculation for the purpose of the stop loss questionnaire is at D2/360. At 421's RITC meeting on 1.3.83 "it was agreed that E&W would set up a permanent file of risks written to monitor the run-offs" D2/201A. In fact no such file was set up.

YEAR 2 RITC - CONCLUSIONS

1. Merretts failed to comply with the guideline in paragraph 6 of Mr. Murray Lawrence's letter -

Merretts failed to advise E&W of the Ballantyne, Verrall, Fireman's Fund/Sturge, Dolling-Baker, Toomey, Gooda, Humm and Burdett run-off contracts (as to Provincial and Universal see below) and also failed to consider whether the open year reserves should be increased.

2. Merretts failed to comply in relation to the run-off contracts with clause 3 (iii) (a) and (b) of the Solvency/White Letter dated 1.2.83 (J5/221) -

3. Merretts' replies to the Latent Diseases Questionnaire were seriously misleading. In the case of 418 Merretts failed to inform E&W that a loss had been notified and initialled by Mr. Emney on 28.2.83 in the sum of $1,888,158 as at 31.10.82 in respect of Provincial/Universal (C26/293). Further the answers to the questionnaires D2/60 and 170 failed to inform E&W that 418/417 had written any of the run-off contracts. (See also Merretts' answer on the Form Au17).

4. The application of the loadings used for 417's own book to the Provincial and Universal contracts would according to the plaintiffs have produced a reserve of £2,289,738 and according to Merretts and E&W £2,734,436. The application of Lloyd's audit minima to the Provincial and Universal premium produced a loading of $486,801 which was included in the overall IBNR for 418.

5. It is unclear on the evidence as to the extent to which Merretts complied with the guideline in paragraph 3 of Mr. Murray Lawrence's letter -

(See also the new form of question as to Reinsurance Writings on the Latent Disease Questionnaire and the answer thereto).

6. Mr. McNamara's general IBNR of 10% (D2/310(1)) represented a judgment which should have been made by the underwriter and not the auditor.

(a) Merretts

It is again important to remember that the plaintiffs' case is that year 2 should have been left open (and no alternative case is advanced that if year 2 was to be closed, it should only have been closed at a higher premium than that in fact adopted).

I do not consider that in all the circumstances Merretts' decision to close year 2 was a decision that no reasonably well-informed and competent underwriter/managing agent could have made. I so find inter alia for the following reasons and having regard to the following circumstances:-

1. Asbestos-related claims

The perception of asbestos personal injury and property damage claims is considered separately at each of years 1 to 6. These 6 sections of the judgment show the developing problem. The position at year 2 should be contrasted with the position in subsequent years. As to perception at 4.5.83 see above. The approximate number of personal injury claims/claimants as at 4.5.83 is there stated. Property damage claims were still at a relatively early stage.

418/417's incurreds in respect of asbestos claims (main account) in year 2 were $14.511m as against $5.276m in year 1 (see "a staggering loss" above - D2/289-291).

2. Pollution claims

Merretts carried reserves in respect of Love Canal from 1979. As to the relevant legislation see the chronology, Appendix 1 to this judgment. CERCLA was passed in 1980. The Shell claim (see below) was first notified in October 1983. By year 4 pollution claims were recognised to be the next major problem for the market. The perception of pollution claims in year 4 is to be contrasted with the perception in prior years. In year 2 the Love Canal claim remained the only substantive pollution claim. The precautionary reserve recommendation of $100,000 at the 1981 year end remained in place.

3. The Run-off Contracts

In year 2 only the Provincial and Universal run-off contracts fell to be considered as a constituent of the RITC as at 31.12.82. The alternative figures of £2,289,738 (the plaintiffs) and £2,734,436 (Merretts and E&W) see above, should be contrasted with the RITC premium in fact set for 418/417 of £74m.

4. The Plaintiffs' criticisms

As to the plaintiffs' criticisms of Merretts as at year 2, I have already held that some of these are well-founded (see above). The list of criticisms set out above does not purport to be exhaustive. However I do not consider that the criticisms that can be made of Merretts in year 2 lead to the conclusion that year 2 should have been left open.

The plaintiffs advance 7 principal criticisms of Merretts.

As to the first, I do not accept that no attempt was made to calculate an IBNR loading for asbestos or other latent disease claims to infinity. While there are criticisms which can be made of Merretts' approach and while I should not be taken to accept that the RITC as at year 2 received the attention that it should have received from Merretts, it does not follow that year 2 could not have been competently closed.

As to the second principal criticism (Merretts encouraged E&W in the fallacy that it was possible to identify full exposures in respect of asbestosis, and set up loadings by reference to those exposures, when this could not be done) although there are criticisms which can be made of Mr. McNamara's Schedules, I do not consider that these lead to the conclusion that year 2 could not properly be closed.

The plaintiffs withdrew their third principal criticism.

As to the fourth principal criticism (no consideration was given to leaving the 1980 account open) the increase in incurreds from $5.276m to $14.511m was a matter of very considerable concern. I consider however that the decision to close the year involved implicit consideration of the alternative.

As to the fifth and seventh principal criticisms I have dealt with these above.

As to the sixth principal criticism (whole account stop loss business) I disregard this point for the reasons given under year 1 above.

(b) E&W

As to E&W in year 2 it is important to remember that E&W were seriously misled by Merretts as to the run-off contracts (see criticisms 1 to 4 under the heading 'Some Criticisms of Merretts in Year 2' above). I do not accept the plaintiffs' submission that E&W should have discovered the existence of the run-off contracts during their audit work in year 2. Further the case against E&W in year 2 must be judged in the light of their perception of asbestos-related claims as at 4.5.83.

It follows from my conclusions in relation to Merretts, that the plaintiffs' claim against E&W in respect of year 2 must also fail. It is accordingly unnecessary to consider the plaintiffs' detailed criticisms of E&W in year 2. Although I have noted that Mr. Attwood's standards in years 1 to 3 may to some extent be above the reasonable average, I accept Mr. Attwood's central contentions as to the need for appropriate audit evidence. I should not be taken to accept that E&W's audit approach and work in year 2 is not open to criticism. By way of example Mr. McNamarra's general IBNR of 10% (D2/310(1)) represented a judgment which should have been made by the underwriter and not the auditor. The plaintiffs have however tied their case to the question whether or not the year could properly have been closed, as opposed to the quantum of the RITC premium. I do not consider that the plaintiffs have established that E&W should have disclaimed an opinion on the grounds of fundamental uncertainty in year 2.

In May 1984, 418/417's 1981 year of account was closed by way of an RITC into the 1982 year of account; and it was reported on by Merretts on 15th May 1984.

In the 1983 Annual Report and Accounts for 418/417 were:

As to the regulatory regime for the year ended 31.12.83 see above.

As to developments and changes in perception in previous years see above.

As at 15.5.84 the future development and extent of asbestos-related claims were subject to considerable uncertainty. I refer to the chronology, Appendix 1 to this judgment (which in the case of attorneys' reports lists some examples of reports in Merretts' possession). As to the US cases at the above date see Appendix 2 to this judgment.

The nature and extent of the uncertainties as at 15.5.84 were known to Merretts and E&W, alternatively in the case of E&W would have been known to E&W had necessary and appropriate audit tests and enquiries been carried out and conducted.

The broad nature and extent of the uncertainties as at 15.5.84 were reflected in the following materials.

Where materials are drawn on which would probably have been available only to Merretts or E&W this is indicated in brackets. (a) As at June 1983 an attorney's report referred to a second school district class action filed in Pennsylvania naming a total of 50 defendants. The report added that the allegations in the national complaint, which state that approximately 110,000 public and private schools are involved, are similar to the allegations made in the Pennsylvania class action.

(b) As at June 1983 (Merretts only) a letter from attorneys to the AWP referred to the ACF and reported as follows. The benefits most certainly will be spelled out in significant economies attainable in both indemnity and defence as well as general claims handling. We are reminded almost daily by the press that upwards of 20,000 asbestos cases have been filed to date (the Lloyd's CIS indicates 27,548 as of 22.5.83). While overall numbers may differ depending whose predictions you read, unquestionably, with increasing surveillance an improvement in diagnostic techniques, we can reasonably anticipate that by the end of the day upwards of 50,000 will have been filed. With the average indemnity now exceeding $100,000 per case, at the current rate that will equate to a total loss of over $5billion. Defence expenditures at a 1 to 1 ratio (which is not the current experience) will equal that number. More realistically they will at least double, and more probably quadruple. It is, therefore, our view that the Facility, with certain modifications currently being addressed by Working Party members, is essential to the London market to assist the market to see the thousands of asbestos products liability claims to their final conclusion.

(c) As at November 1983 an attorney's report in respect of US Gypsum recommended in addition to bodily injury reserves a precautionary reserve for each policy period for potential property damage losses.

(d) As at December 1983 (E&W only) E&W Insight gave details as to the extent of asbestosis claims in the US and attendant litigation as follows. Approximately 24,000 claims have been filed in each of which an average of 20 defendant companies have been named. Some 12 insurers are involved in defending litigation while another 15 to 20 have made payments. Costs and compensation are expected to escalate over future years.

(e) As at January 1984 an attorney's report dealing with coverage issues stated that the producers of asbestos products unquestionably will contend that all of the potential triggers apply, perhaps even a continuing trigger from date of first sale to date of last possible connection to damage, `a la Keene.

(f) As at January 1984 an attorney's report stated that property damage was now evolving into a major issue.

(g) As at March 1984 (E&W only) notes of an E&W meeting recorded that the number of claims is difficult to determine but may be in the region of 25,000. New claims are still coming in at roughly 500 per month and the peak may not occur until 1990.

(h) As at March 1984 an attorney's report stated about $1billion in compensation and litigation expenses had been spent by the end of 1982 on more than 20,000 open and closed asbestos product liability claims. Many times that number of people have been exposed to asbestos, and the potential liability of the defendant firms runs into billions of dollars. Three major corporations have already filed chapter 11 bankruptcy petitions.

(i) As at April 1984 (not E&W, probably Merretts) a letter from Mr. Rokeby-Johnson of Sturge & Co. stated that asbestos is proving to be the most expensive claim in insurance history and perhaps will prove to be the tip of the iceberg. One hope is that the ACF will come into being and at least would drastically reduce legal costs and achieve realistic settlement levels. There are currently over 30,000 claims and they are still being filed at the rate of 500 per month with no sign of abating. The media are now seriously coming to grips with the School District cases which could alone cost $1.4billion without considering other industries which, without the same public sympathy, could still prove very expensive.

A DESCRIPTION OF THE YEAR 3 RITC

The RITC for 1983 (pre-roll over) breaks down as follows :

417 418 417-418

Net Outstandings £28.3 £14.83 £43.1m

Total £44.3 £46.35 £90.6m

Net underwriting result (£3.8) £3.6

See J10/Schedule A and Pie Chart 3.

The Agency's approach to outstandings was as before as was E&W's review: Schedule BA5(a) & (b) (J10/2). The Audit Programme is at D3, p.191, (and D4, p.250 is an index of E&W's work on outstanding claims). The major losses on the year were in respect of asbestosis, DES, and, for the first time, Agent Orange and DDT, and a detailed analysis of those claims was made. The preliminary list of total outstandings is at D4, p.555-6. The final E&W list of the I04 printout is at D4, p.270(1). The final figures which agree to the accounts are recorded at D4 p.271.

The asbestosis outstandings had increased from $13.76m to $15.9m (p.240), an increase of $2.14m (or 13% of the previous year's asbestosis IBNR of $16.2m), less than the $8.48m increase of the year before: see p.286-7 (analysed at p.288-296 including agreement to attorneys' reports). The Specific Risk Analysis (D3/182) recorded that:-

IBNR

The Agency again proposed a loading of 50% of net outstandings: see the Hulme Schedule at D4, p.565. This produced an RITC of £42.8m and showed a back year deterioration (before roll over) of £15.1m. Mr. McNamara's Schedules were updated in order, again, to test Merretts' proposals: see D4, p.297-330. The 1982 column (31.12.82) was amended to 1982/3, with the amended outstandings for 1983 shown under the 1982 figure. A feature of Mr. McNamara's Schedules was that there were almost no new assureds identified on them but adverse deterioration was arising from some assureds from additional years of liability. The plaintiffs say the number of lines/policies identified increased from 334 to 361. Merretts say the following. The question of counting the number of lines/policies on this Schedule is possible (although not straightforward): but that is not the same as the question whether or not Merretts had identified more lines/policies between the two year ends. The increase in the number of lines/policies between the two schedules may simply reflect a changed perception of those lines/policies at risk. The increase in the number of policies on the McNamara Schedule at 31.12.83 is small. It appears that 17 reinsurance policies were added to the list, 11 of which were reinsurances of the Travelers. These were higher layers of coverage provided to Travelers which obviously had previously been thought not to be exposed (notably since lower layers were recorded in the previous year with nil reserves). Travelers had previously advised its reinsurers that it did not expect its reinsurance recoveries to rise significantly.

The notes of the RITC meeting on 26.3.84 are at D4, p.258. At the meeting the RITC was agreed at £47m on the basis of previous discussions between Mr. Merrett and E&W and subject to completion of certain outstanding audit work.

In the event the loadings used, following a specific review by E&W of each of the major loss areas, were as follows :

See Schedule A (J10/1) and D4, p.240.

These outstandings and loadings totalled £47.0m, from which was deducted £2.7m in respect of Excess of loss reinsurance recoveries. That produced a net figure of £44.35m (an increase of £1.55m from the original Merretts' proposal). Recoveries of £11.4m were deducted under the roll over policy, producing a final figure of £32.93m. The total of £20m reserves for asbestosis was about 22% of the RITC for 418/417 of £90.6m (pre-roll over).

The loading for asbestosis set out in Mr. McNamara's Schedules - D4, p.297-330 - is summarised in the third column on D4, p.271. This produced a figure of $5.8m (£4m), to which expenses of £1m ($1.45m) were added. The expenses figure was less than before because expenses in excess of limits were included in the IO4 print-out of outstandings: p.331 and 243.

A further general loading of another £4m ($5.8m) - compare the previous year's $3.4m - was then added as a non-specific loading to deal with new claims, or policies not yet "burning or adjacent to the fire".

The DES outstanding claims at 31.12.82 were $3,469,000 and at 31.12.83 $3,092,000: a drop of about $377,000: see Schedule A (J10/1) for these two years. (The drop is not reflected in the net sterling decrease of only £8,435 - D4, p.342 - because of the deterioration in the £/$ ratio ($1.62/£ to $1.45/£)).

DDT was a new species of claim this year. The relevant claim was against Olin Corporation (a primary producer) arising from alleged leakage of DDT into a water supply. The loading was £200,000: D4, p.340.

The method of calculation of outstandings and 10% IBNR is set out at D4, p.266-269. At this stage negotiations to resolve claims were at an advanced stage and a major settlement was, in fact, concluded in May 1984.

The loading taken was 50% of outstandings.

Syndicate 417 again took to credit its roll over protection in the sum of £11.419m.

The Agency's approach to outstandings was as before. Mr. Merrett included in his Red Book - D3, p.93-116 - a reserve of $250,000 in respect of asbestosis related claims now recorded in the claims box summary identified in the previous year as claims arising out of 1951 and 1952. The outstanding claims are summarised at D3, page 88. E&W carried out a similar review to that carried out in previous years. See Schedules BA6(a) and (b) (J10/2).

The Agency's proposal - D3, p.127 - was again major net outstandings, net of facultative reinsurance, plus Lloyd's audit reserves plus 25% reinsurance disallowance. The RITC meeting is at D4, p.258(1).

By now all the run-off contracts had been written :

Of these only the first four were a constituent part of the RITC. The outstandings as at 31.12.83 on the 4 contracts were as follows:

Net O/S 418/417 Share

as at 31.12.83 Deductible of Liability

Provincial

and Universal $5,150,000 - $2,575,000 (50%)

Ballantyne $13,629,036* $11,100,000 $2,023,229 (80%)

Verrall $10,278,827* $12,000,000 -

Thus the 417 outstandings should have included $2,023,229 in respect of the Ballantyne run-off contract. Mr. McNamara accepted that on the balance of probabilities no outstandings were shown in respect of Ballantyne and thus there was no IBNR in respect of Ballantyne and I so find. I reject Merretts' contention that Ballantyne was reserved at $792,339 (B1/354) or any other figure. It is common ground that the application of Merretts' loadings in year 3 would have resulted in a reserve of $6,437,807. The 418 outstandings should have included $2.575m in respect of Provincial plus Universal. In fact there was no amount for Provincial or Universal included in the outstandings. It is common ground that the application of the loadings used for 417's own book in year 3 in the case of Provincial and Universal would have resulted in a reserve of $4,340,582 and in the case of Verrall a reserve of $3,156,616. Provincial and Universal and Verrall were reserved at Lloyd's minima amounting to $832,000. $6,437,807 + 4,340,582 + 3,156,616 - 832,000 converted to sterling (£1:$ 1.45) = £9,036,555.

E&W accept that they became aware that Syndicate 417 was party to a portfolio of six run-off policies written in 1981 and 1982: (see the policies highlighted above).

421's RITC meeting on 16.3.84 which refers to Ballantyne written into 417 and 421 is at D4/591. D4/569 (a 421 E&W document) records that copies of the placing slips of "all the (421) run-offs... now on 417 file". D4/568 dated 18.4.84 refers to the Fireman's Fund run-off - "Watch this policy for 1984 Audit" and also states "Merretts have taken out a specific R/I for their Run-off Portfolio (6 Policies of which [Fireman's Fund] represents circa 50% of the total PI of the Portfolio)". See also the reference at D4/567 to "John Emney keeps separate file on each special deal and receives quarterly returns from the broker giving details of claims paid and outstanding together with comments by the broker (as appropriate) - considered to be adequate monitoring".

E&W sent Merretts a Latent Diseases Questionnaire in substantially the same form as that of the previous year. In response to the specific request concerning inter alia run-off accounts the answer for 417 stated:

The answer for 418 to the Questionnaire stated:

Mr. Merrett's response - undated - to the whole account stop loss questionnaire for 417 (D3, p.221) and 418 (D3, p.80) was negative. The form of the question was different viz :

The AU17 for 418 is at D3, p.73 and for 417 at D3, p.218.

The AU38(a) form - 30.4.84 - section 6, at D3, p.53 records :

That answer is derived from the Agency's response to the questionnaire. E&W accept that the AU38(a) form was inaccurately filled in. (Merretts do not accept that the AU38(a) was inaccurate since it is their position that the reference to whole account stop loss was not understood by Mr. Merrett as a reference to run-off contracts. Further Merretts say the question was not directed at run-off contracts).

1. Merretts failed to comply with the guideline in paragraph 6 of Mr. Murray Lawrence's letter -

Merretts failed to advise E&W of the Humm and Judd run-off contracts (as to Provincial, Universal and Verrall see below) and also failed to increase the open year reserves in respect of any of the relevant run-off contracts as appropriate. In the last 6 months of 1983 incurreds on the Fireman's Fund contract increased by $12.7m from $47.7m to $60.4m - (D4/397) which produced an incurred to 417 (1982 open year) of $5.2m before specific run-off contract reinsurances. As to Fireman's Fund see further D3/174,D4/568 and D4/570.

2. In respect of the 4 run-off contracts written into 418 and Judd (417) Merretts failed to comply with clause 3 (iii) (a) and (b) of the White Letter dated 16.12.83 (J5/314) -

As to the remaining six run-off contracts (417) see below under E&W and compare Merretts' answers to the Latent Disease Questionnaires (below).

3. Merretts' answers to the Latent Disease Questionnaires (D3/79- 418, D3/219-417) failed to refer to the run-off contracts (c.f.421's responses to the same questionnaire D4/587 and the Other Matters Questionnaire D4/584-5). Mr. McNamara described the answers as "most unsatisfactory".

4. Of the 11 run-off contracts only Provincial, Universal, Ballantyne and Verrall were a constituent part of the RITC. The outstandings as at 31.12.83 on those contracts were as follows:

as at 31.12.83 Deductible of Liability

Provincial

and Universal $5,150,000 - $2,575,000 (50%)

Ballantyne $13,629,036* $11,100,000 $2,023,229 (80%)

Verrall $10,278,827* $12,000,000 -

Thus the 417 outstandings should have included $2,023,229 in respect of the Ballantyne run-off contract. C5/67 scratched by Mr. Emney on 9.4.84 (showing Ballantyne outstandings) should have been shown to E&W. Mr. Holland and Mr. McNamara agreed that the failure to do so was disgraceful/most unsatisfactory. Mr. McNamara accepted that on the balance of probabilities no outstandings were shown in respect of Ballantyne and thus there was no IBNR in respect of Ballantyne and I so find. I reject Merretts' contention that Ballantyne was reserved at $792,339 (B1/354) or any other figure. It is common ground that the application of Merretts' loadings in year 3 would have resulted in a reserve of $6,437,807.

The 418 outstandings should have included $2,575,000 in respect of Provincial and Universal. There was no amount for Provincial or Universal included in the outstandings. It is common ground that the application of the loadings used for 417's own book in year 3 would, in the case of Provincial and Universal, have resulted in a reserve of $4,340,582 and in the case of Verrall a reserve of $3,156,616. Provincial and Universal and Verrall were reserved at Lloyd's minima amounting to $832,000. $6,437,807 + 4,340,582 + 3,156,616 - 832,000 converted to sterling (£1:$1.45) = £9,036,555. The total reserve for the four contracts would have been £9,610,348.

The net underwriting result as in fact shown in the accounts was 417 (£3.8m); 418 £3.6m. The accounts showed a profit transferred to Names' personal accounts of £8.672m (before Names' personal expenses). E&W say that on the assumption (a) that the year 2 RITC had included a run-off reserve of £2.733m and (b) that the year 3 RITC had included a run-off reserve of £9.036m the profit after personal expenses would have been £32,000 (as opposed to £4.97m). The plaintiffs say (i) that on the assumption (a) that the year 2 RITC had included a run-off reserve of £2.289m and (b) that the year 3 RITC had included a run-off reserve of £9.036m the loss after personal expenses would have been £343,983 and (ii) that on assumption (b) only the loss after personal expenses would have been £2.5m - in each case as opposed to the £4.97m profit shown in the accounts. It follows that Merretts should have recognised that the year 3 accounts were seriously inaccurate. (See also Merretts' answers on the Form Au17 D3/73 and 218).

5. Paragraph 9 of Mr. Murray Lawrence's letter stated:-

The year 3 accounts did not mention the run-off contracts.

6. It is unclear on the evidence as to the extent to which Merretts complied with the guideline in paragraph 3 of the Murray Lawrence letter -

(See also the question as to Reinsurance Writings on the Latent

Disease Questionnaire (probably as for year 2) and the answer

thereto).

(a) Merretts

It is again important to remember that the plaintiffs' case is that year 3 should have been left open (and no alternative case is advanced that if year 3 was to be closed, it should only have been closed at a higher premium than that in fact adopted).

I am not persuaded on a balance of probabilities that in all the circumstances Merretts' decision to close year 3 was a decision that no reasonably well-informed and competent underwriter/managing agent could have made although the answer is less clear than in years 1 and 2.

I so find inter alia for the following reasons and having regard to the following circumstances:-

1. Asbestos-related claims

The perception of asbestos personal injury and property damage claims is considered separately at each of years 1 to 6. These 6 sections of the judgment show the developing problem. The position at year 3 should be contrasted with the position in subsequent years. As to perception at 15.5.84 see above. The approximate number of personal injury claims/claimants as at 15.5.84 is there stated. Property damage arising out of the use of asbestos was now developing into a major issue.

418/417's incurreds in respect of asbestos claims (main account) in year 3 were $16.88m as against $14.511m in year 2. Accordingly the increase in incurreds in year 3 was $2.369m as opposed to the corresponding increase of $9.235m in year 2. Merretts (and E&W) were entitled to take some comfort from the comparatively modest increase in year 3. (By contrast it will be noted that in year 4 incurred claims increased very substantially to $27.072m, as to which see below).

2. Pollution claims

Merretts carried reserves in respect of Love Canal from 1979. As to the relevant legislation see the chronology, Appendix 1 to this judgment. CERCLA was passed in 1980. The Shell claim was first notified in October 1983. By year 4 pollution claims were recognised to be the next major problem for the market. In year 3 clear warning signs were beginning to emerge.

3. The Run-Off Contracts

Of the eleven run-off contracts only Provincial, Universal, Ballantyne and Verrall fell to be considered a constituent part of the year 3 RITC. The figure of £9,610,348 (see above) should be contrasted with the RITC premium in fact set for 418/417 of £90.6m.

4. The Plaintiffs' criticisms

As to the plaintiffs' criticisms of Merretts as at year 3, I have already held that some of these are well-founded (see above). The failures in respect of the run-off contracts were extremely serious. I have given anxious consideration to this aspect of the case but on balance I do not consider that the criticisms that can be made of Merretts in year 3 necessarily lead to the conclusion that year 3 should have been left open.

The plaintiffs advance five principal criticisms of Merretts. As to the first I do not accept that no attempt was made to calculate an IBNR loading for asbestos or other latent claims (own book) to infinity. While there are criticisms which can be made of Merretts' approach and while I should not be taken to accept that the RITC as at year 3 received the attention that it should have received from Merretts, it does not follow that year 3 could not have been competently closed.

As to the second principal criticism, although there are criticisms which can be made of Mr. McNamara's Schedules I do not consider that these lead to the conclusion that year 3 could not properly be closed.

As to the third principal criticism (no consideration was given to leaving the 1983 account open) I consider that the decision to close the year involved implicit consideration of the alternative.

As to the fourth and fifth principal criticisms these are dealt with above.

(b) E&W

As to E&W, E&W accept that they became aware that 417 was party to a portfolio of six run-off contracts written in 1981 and 1982.

421's RITC meeting on 16.3.84 which refers to Ballantyne written into 417 and 421 is at D4/591. D4/569 (a 421 E&W document) records that copies of the placing slips of "all the (421) run-offs... now on 417 file". D4/568 dated 18.4.84 refers to the Fireman's Fund run-off - "Watch this policy for 1984 Audit" and also states "Merretts have taken out a specific R/I for their Run-off Portfolio (6 Policies of which [Fireman's Fund] represents circa 50% of the total PI of the Portfolio)". See also the reference at D4/567 to "John Emney keeps separate file on each special deal and receives quarterly returns from the broker giving details of claims paid and outstanding together with comments by the broker (as appropriate) - considered to be adequate monitoring".

Although only one of these (Ballantyne) was a constituent part of the RITC, the six run-off contracts were not given adequate attention by E&W in year 3. There was a breakdown in communication and organisation in the course of the audit as a result of which inter alia Mr. Jones' work on the run-off contracts (D4/568), the slips (D4/569), Mr. Rokeby-Johnson's letter (D4/409) and the $12.7m increase in the Sturge incurreds between 30.6.83 and 31.12.83 (D4/397) were not given appropriate attention by an E&W partner.

As to this year it is important to remember that E&W were in part seriously misled by Merretts as to the run-off contracts (see criticisms 1 to 4 under the heading 'Some Criticisms of Merretts in Year 3' above). Although there was a breakdown in communication and organisation in the course of the audit as set out above this was exacerbated by Merretts' failure to disclose the run-off contracts written by 418 and the Judd run-off contract.

It follows from my conclusions in relation to Merretts, that the plaintiffs' claim against E&W in respect of year 3 must also fail. It is accordingly unnecessary to consider further the plaintiffs' detailed criticisms of E&W in year 3. Although I have noted that Mr. Attwood's standards in years 1 to 3 may to some extent be above the reasonable average, I accept Mr. Attwood's central contentions as to the need for appropriate audit evidence. E&W's audit approach and work in year 3 is open to criticism inter alia for the reasons set out above. The plaintiffs have however tied their case to the question whether or not the year could properly have been closed, as opposed to the quantum of the RITC premium. I am not persuaded that E&W should have disclaimed an opinion on the grounds of fundamental uncertainty in year 3.

35. YEAR 4 : THE CLOSURE OF 1982 INTO 1983 AS AT 31.12.84 (MERRETTS' AND E&W'S REPORTS DATED 4.6.85)

In years 4,5 and 6 the plaintiffs make a number of principal criticisms of Merretts and E&W and further detailed submissions. Merretts' and E&W's responses are set out in their opening and closing submissions. I do not propose to summarise the extensive and detailed submissions of the parties (save where there is particular reason to do so). I have carefully considered all the submissions.

As to changes in stamp capacity, names etc. see Table 1 above.

In June 1985, 418/417's 1982 year of account was closed by way of an RITC into the 1983 year of account; and it was reported on by Merretts, on 4.6.85.

In the 1984 Annual Report and Accounts for 418/417, were:

and at E1/43:

As to the regulatory regime for the year ended 31.12.84 see section 17 above.

It was in this year that the "shattering news" of the losses under the run-off contracts broke in about early April 1995. (See Day 39/78 and Mr. Randall's memorandum to Mr. Merrett of 15.4.85 which referred to "the shattering news of the last 10 days").

There had been no mention of the shattering news at the RITC meeting on 28.3.85 (D5/251(1)).

As to developments and changes in perception in previous years see above. Perception in year 4 must be judged against this background.

As at 4.6.85 the future development and extent of (a) asbestos personal injury and (b) asbestos property damage and (c) pollution claims were in each case subject to very considerable uncertainty.

I refer to the chronology, Appendix 1 to this judgment (which in the case of attorneys' reports lists some examples of reports in Merretts' possession). As to the US cases at the above date see Appendix 2 to this judgment.

The nature and extent of the uncertainties as at 4.6.85 were known to Merretts and E&W, alternatively in the case of E&W would have been known to E&W had necessary and appropriate audit tests and inquiries been carried out and conducted.

The broad nature and extent of the uncertainties as at 4.6.85 were reflected in the following materials. Where materials are drawn on which would probably have been available only to Merretts or E&W this is indicated in brackets.

Asbestos-related claims constituted the most serious claims problem ever encountered by the insurance industry.

(a) As at May 1984 (Merretts only) Mr. Robin Jackson of Merretts described asbestos as the most serious claims problem ever encountered by the industry and added the following. The seriousness of it is not only the actual quantum of claims but more so in the policy interpretation. The basic rule is quite clear, it is to maximise coverage to the original insured.

(b) As at May 1984 (Merretts only) Mr. Jackson of Merretts, as Chairman of the AWP, in a letter to underwriters at interest referred to the steadily increasing volume of claims.

(c) As at August 1984 (Merretts only) Mr. Jackson in an article in Reinsurance referred to the avalanche of claims and to the fact that generally each original claimant sues seven or eight insureds - you may only have 30 to 40,000 claimants but you can multiply by 6 or 7 if you take each of them separately and have a separate defence each time.

(d) As at October 1984 (E&W only) E&W Insight stated that the latest estimate from Lloyd's is that asbestosis is likely to cost the market £1.5billion - this figure should be regarded as a minimum.

(e) As at October 1984 (Merretts only) an article in the Financial Times stated that absestosis and other asbestos-related injuries in the US have already turned out to be the largest natural disaster to hit world insurance and reinsurance markets. It is estimated that there are more than 30,000 individual claims at various stages of processing and about 500 claims are being made per month. The insurance industries are still not able to quantify the ultimate cost of asbestos-related claims - estimates range from £8bn to as much as £50bn.

(f) As at December 1984 Mr. Robin Jackson at a Meeting of Panel Auditors said that discussions had been taking place with the USA in order to introduce a facility with the original asbestos producers. New advices of losses were still being notified at the rate of approximately 6,000 per year. $50m had been paid out on claims in 1984. In the early stages direct losses were notified, then in 1983 reinsurance losses were quantified and 1984 was the year for retrocessional claims.

(g) As at January 1985 (Merretts only) Mr. Ayliffe of Merretts received a letter enclosing a recent article which stated that in the last three or four years, the number of claims filed by railroad workers alleging asbestos disease has far exceeded the total of such actions in the entire history of the American railroad industry.

(h) As at March 1985 an attorney's report referred to some 30,000 outstanding claims which, from past experience, will increase by some 5,000 new suits each year. During the last year the anticipated increase in reinsurance involvement has developed. It is reasonable to expect this trend to continue as the overall cost of the asbestos problem increases and more cedants' potential exposure exceeds retentions. In addition, it is inevitable that the market will develop a further up-surge in retrocessional involvements.

(i) Mr. Jackson's testimony - see below.

These claims were evolving into a major loss issue. They constituted a serious problem yet fully to develop and were subject to burgeoning litigation in the USA.

(a) As at October 1984 an attorney's report referred to a myriad of coverage issues and stated that all the factors referred to rendered the assessment of precise property damage reserves most difficult if not impossible at this time.

(b) As at November 1984 an attorney's report referred to a myriad of problems in assessing coverage and stated that it was difficult if not impossible to assess property damage reserves at this time.

(c) As at December 1984 an attorney's report stated that a myriad of other coverage issues exist in addition to the date of loss question, principal of which are the number of occurrences, whether there is consequential damage beyond damage to the product itself and, if so, the amount thereof. All of these factors render the assessment of precise property damage reserves most difficult if not impossible at this time.

(d) As at March 1985 an attorney's report stated that during the course of the past year there have developed new issues in regard to damage to property allegedly caused by asbestos containing materials, which create unique coverage issues which have yet to be addressed. In 1984 there was a continuing increase in the number of property damage actions filed against the producers of absestos products. As an illustration, in the Maryland action, brought on behalf of the Mayor and City Council of Baltimore, the plaintiffs seek damages of $225,000,000 and in addition seek an unspecified amount of punitive damages and costs.

(e) Mr. Jackson's testimony - see below.

As at March 1985 (Merretts only) Mr. Robin Jackson in testimony as Chairman of the AWP to the Senate Labour and Human Relations Committee's Sub-Committee on Labour stated that "the number of present and expected asbestos-related claims is enormous, and the problems they are creating for the producers and insurers are unprecedented, both in terms of the total dollars involved and of the human resources needed to handle these claims. ...Against this background of judicial uncertainty, already catastrophic losses, and the reality of massive property damage claims yet to come, the task of fixing meaningful reserves and managing cash-flow to pay claims will continue to demand virtual clairvoyance and a near reckless courage from the executives involved at primary level, as well from their re-insurer counterparts." (emphasis added). Mr. Jackson then added "You might well ask if we are getting it right. I will show you how we propose to do just that" and referred to the proposed Asbestos Claims Facility. While appropriate allowance must be made for the occasion on which these remarks were made their signficance is obvious.

Pollution claims were recognised to be the next major problem for the market.

(a) The EPA list as at August 1983 (Merretts only) obtained by Mr. Ayliffe identified 406 sites. Some of the site names on this list identified companies that were Merretts' assureds.

(b) As at March 1984 (Merretts only) a letter to Mr. Ayliffe referred to the New York Times report on toxic waste sites. The Office of Technology Assessment has found 10,000 sites that qualify for priority action, and it estimates that the cost of clean-up may reach $100billion. That office observes that the EPA has only 528 sites on its priority list and has given "remedial clean-up attention" to only 30% of them. The EPA disputes those figures, saying there are 800 sites on its current priority list with another 1,200 likely to be added. The general accounting office is preparing its own report on the toxic waste programme that will be issued shortly. One official in the office estimates that there are potentially some 378,000 sites, though most would not qualify for priority treatment.

(c) As at April 1984 (Merretts only) Lloyd's List reported that Lloyd's syndicates faced potential claims running into tens and perhaps hundreds of millions of dollars as a result of environmental pollution in the United States. The EPA is continuing to identify and investigate thousands of hazardous waste sites. Mr. Robin Jackson said the London market should be concerned about these developments because during the 1950's and 1960's it was much more involved in direct business from the US and at much lower limits than now.

(d) As at April 1984 (not E&W, probably Merretts) a letter from Mr. Rokeby-Johnson stated that the EPA is currently very active, under both political and public pressure to "clean-up America", listing various National Priority sites, and has been the instigator of the School District Cases. London is receiving preliminary advices of claims with great regularity, but it will be some time for proper evaluation to take place. One case that has received certain publicity is US Army v Shell but again evaluation of this problem will take time.

(e) As at December 1984 (Merretts only) a telex from Mr. Ayliffe to a US attorney recognised that EPA claims might arise from the insured being either an owner/operator of a waste site, or a transporter of toxic waste or a generator of toxic waste. A telex to the same attorney in the same month (Merretts only) stated that the list in the telex identifies the assureds which either have reported claims arising from hazardous waste disposal sites or, although not yet reporting claims, are listed by the EPA as potentially responsible parties in connection with the first 539 significant sites. The list also provides information concerning whether the assured is an owner/operator, transporter or generator and the name of the site, its location and a brief description. We are aware that other claims exist in connection with Olin, Monsanto and Uni Royal accounts.

(f) As at December 1984 a meeting of Panel auditors was told that the next major problem for the market will be pollution claims.

(g) As at February 1985 (Merretts only) a letter from Toplis and Harding signed inter alia by Mr. Ayliffe to insurers at interest stated:-

(h) Merretts' letter of 18.4.85 to the Direct Names stated "417 has been badly affected by the significant number of claims advices in respect of pollution and seepage and also asbestos-related items... there has been a particularly severe deterioration in the last quarter of 1984".

(i) Mr. Cassells' note dated 26.3.85 and Mr. McNamara's Notes on 417 RITC (E&W only) are quoted below.

A DESCRIPTION OF THE YEAR 4 RITC

The RITC for 1984 breaks down as follows:

£'000 £'000 £'000

Main Account

- Net outstandings 41,926 13,765 55,691

- IBNR 31,307 31,573 62,880

73,233 45,337 118,571

Run-Off Account

- Net outstandings 11,268 12,169 23,437

- IBNR 18,381 13,200 31,581

29,649 25,369 55,018

102,882 70,706 173,589

Roll-over/Asbestos

related Claims

Account (10,462) - (10,462)

Time & Distance

Credit (44,526) - (44,526)

47,894 70,706 118,600

Net underwriting

result per account (9,293) (11,813)

See J10/Schedule A and Pie Chart 4 (J10/1). This was the year in which Mr. Merrett wrote his letter of 18.4.85: I4D/103.

The 1982 Names paid £22.7m by way of premium for the T&D policy. If the T&D had not been purchased and assuming no discounting of reserves the 1982 Names would have paid the 1983 Names a further £67m i.e. a total of £163.127m. In fact the 1983 Names received £95.9m and the benefit of the T&D.

SYNDICATE 417

The work done by Merretts was similar to that of the previous year: Schedule B1(a) (J10/2). In addition Mr. Hart and Miss Ruby prepared a Schedule giving an explanation by year of the major movements on major outstanding asbestos-related claims and identifying potential for future deterioration: CB154, D6, p.359-362. Further (see below) Merretts obtained some limited outstanding claims information from cedants on the run-off contracts. E&W's review of Merretts' work was similar - Schedule B1(b) (J10/2). The Specific Risk Analysis Programme is at D5, p.137. The Audit Programme is at D5, p.139/137. Mr. Cassells' tests are at D6/587 et seq. At D6/589 (Test 2) Mr. Cassells recorded:-

(Merretts say Mr. Cassells' note was wrong in two respects. First there was independent information detailing Lloyd's policies exposed to DES and Agent Orange and other similar claims. Second, Toplis & Harding notified all syndicates of their involvement on all policies identified by the attorneys as covering the assured in question. On occasions when brokers were in difficulty tracing a particular slip then Merretts would research their underwriting records to provide that information.)

The RITC meeting of 28.3.85 is at D5/251-2. A feature of the account was a deterioration in asbestos claims and the emergence of pollution claims including the major claim "Shell Rocky Mountain". Shell Rocky Mountain was first advised in 1983. 1984 was the first year that there were separate reserves for pollution "clean-up" claims arising under CERCLA, primarily Shell Rocky Mountain. Outstandings were $5.073m.

The total for asbestos outstandings increased from $15.9 million (31.12.83) to $21.5 million (31.12.84) (D5 256) (per Mr. Merrett's statement page 100 $20.79 million), a deterioration of $5.6m (of which $1.5m was for the prospective Johns Manville settlement D5 p.252): D6, p.280. This was 193% of the deterioration in 1983 ($2.9m). See further Table 6 below taken from the E&W Schedule C(J10). An Analysis by D. Hart/K. Ruby of Deterioration in Asbestos Claims is at D6/359. Six of the producers identified on D6/362 accounted for $9.991m of deterioration in incurred position. $4m consisted of new advices which had been received on policies for which no provision had previously been made (D5, p.256). Some of that was asbestos property damage where according to E&W's notes "there is great uncertainty as to the liability of insurers": see page 256 (last para.) (See also references to PD in D6/359-362). (Merretts say that other views indicated that insurers believed they had substantial defences to property damage claims and rely on the evidence of inter alia Mr. Knowlton and Mr. Ayliffe).

The ACF was in prospect (the agreement was in fact signed in June of 1985) and it was believed that that agreement would dramatically reduce costs.

Merretts initially proposed a loading of 50% applied to total net outstandings in respect of all business excluding run-off/special contracts of £62.88m plus a special loading for run-offs of £35m: see Mr. Hulme's Schedule at D5, p.253. This produced an RITC of £97.88m and showed a back year deterioration (excluding the run-off contracts and before roll over and T&D credits) of £25.4m.

In a later Schedule - CB1/D, D5, p.212 - in addition to a loading of 50% applied to total net oustandings there was a further loading of $12 million in respect of Shell and Asbestos, (of which according to the defendants $7.5m was pollution and $4.5m asbestos: Mr. Merrett para 178), together with reserves in respect of the run-off contracts of £960,000 and $40 million (of which $6 million was a general run-off loading). This Schedule was prepared by Mr. Wallis of the Agency. It takes to credit the benefit of the roll over fund of £10.46 million. The total figure for RITC, after that credit, is £92.42 million. The same information appears on E&W's Schedule CB1/B, D5, p.210 (together with the deduction for the time and distance policy: see below). In the event Merretts proceeded with the £92.42 million figure as follows:-

£'000 US$'000 CD$'000 Equivalent

£'000

Others¹ 2,385 52,816 491 48,236

Special reserves 31 626 570

Run-off contracts 19,792 17,062

2,416 73,234 491 65,869

Recoveries

Run-off contracts (6,721) (5,794)

LMX (969) (6,753) (137) (6,881)

Asbestos & Shell 12,000 10,345

Others¹ (50% net o/s) 723 23,344 177 20,963

Run-off contracts 960 20,208 18,381

1,683 55,552 177 49,688

Recoveries Net loading 1,683 55,552 177 49,688

Total 3,129 115,312 530 102,882

Roll over balance (12,136) (10,462)

T&D premium 26,350 22,715

Time & distance (78,000) (67,241)

47,894

Footnote 1: includes asbestos and pollution.

£102,882 - 10,462 = £92,420

E&W prepared by comparison/review and after discussion with the Agency staff the Schedule at CB1/C, D5, p.211 ("E&W's Review Schedule"). This showed an alternative approach to loading for 417's own book by class of business, i.e. a more risk specific methodology. As to the run-off contracts D5/211 included the reserves in the Agency's £92.42m figure. E&W's Review Schedule finally produced (before crediting the T&D policy) an RITC of £93.445m i.e. approximately £1 million more. But it is clear that at an earlier stage E&W's calculations produced a figure of £90.599m: see D5, page 256. As stated above in the event neither of these figures was adopted and Merretts proceeded with the £92.4m figure supra (see D5/210).

The following paragraphs comment on the make up of the £93.445 million in E&W's Review Schedule: (see also Mr. McNamara's Note at D5, p.256-260, but with the caveat that that document is referring to a calculation which produced £90.599m).

The notes of the RITC meeting on 28.3.85 are at D5/251(1).

The figures appearing in E&W's Review Schedule (D5, p.211) for asbestos loading are US$14,770,000 and Can$300,000. Those figures were reached by the following process:

E&W established that the reserves carried forward in respect of Agent Orange from the previous year of $3.8m were more than adequate. They had been set up to cover US exposure on the basis of attorneys' reports which suggested that liability would fall on the manufacturers for the years in which Agent Orange had been manufactured for the US Army. In May 1984 a settlement of the class action took place. This involved payments by the manufacturers in the years in which Agent Orange was actually shipped to Vietnam. As a result there was a payment in the year of $1.459m; the previous reserves of $3.5m + 10% were too high; the claims outstanding constituted $61,948 being a small amount of US domestic liability and a number of claims by individuals opting out of the Vietnam class settlement: see D5, p.225. Hence E&W put a 10% figure: CB1/C-p.211: see D5, p.225-7.

The relevant documents are CB3/1-4: D5, p.228-231. These show a deterioration of the RITC brought forward of $1.6m (including a 25% load) or $571,465 without loading. An additional 25% loading was applied for the reasons expressed at CB3/4, D5, p.231: (a note of discussions with Miss Karen Ruby) namely that there was scope for deterioration of existing years because:

The only significant movement in the year was a new reserve of $218,926 in respect of 1955: D5, p.232-3. No claims were paid in the year. The result was a net deterioration of $198,915 or (with loading of circa 50%, $505,655). The load for the purposes of the E&W Review Schedule was increased from a provisional figure of $290,000 (according to Merretts the load used at the previous year end) (29.15% of O/S) - D5 p.232 - to $358,044 D5, p.211 - (30% of (higher) outstandings).

(See generally D6/257-9). Environmental Pollution emerged as a significant issue in the context of the RITC. An outstanding reserve of $5m had been fixed by Merretts for the Shell Rocky Mountain claim (for which only a precautionary advice had been received in 1983). The claim was in respect of contamination to a local water supply and other damage to the environment said to have been caused by toxic effluents which percolated from a 27 acre site part of which was leased by Shell from the US Army at Rocky Mountain Arsenal near Denver, Colorado. The US Army had used the site for development of chemical weapons. Shell had used it for chemical production. This reserve of $5m assumed a total cost of $250m to the market spread over a number of policy years of cover and then apportioned to the policies hit in each year. The attorney's report is at is at J11/25/437: see also D6. p.533.

The reserve was on what was described by Merretts/E&W as a "worst realistic" basis. That was the second worst possible scenario for Merretts. The first relevant question in determining reserves was whether for each year there was one occurrence or 10 occurrences (arising from the 10 separate locations at the site from which pollution had or might have arisen). If the latter the primary insurances would respond up to their limits in respect of each of the 10 sites each year before the London market responded as excess insurers. If the former, the London market would respond sooner. Merretts reserves assumed the former. The second question was whether to take the exposure as being from 1947 to 1983 or from 1952 to 1975 (1952 being the beginning of the period when Shell was the lessee and 1975 being the date of a cease and desist order after which non-disclosure defences arose: J11/26/496). Merretts took the latter. Hence the reserve was on "the worst realistic scenario" (p.234) and the "second worst possible scenario" (p.257). As to Merretts' tighter reinsurance programme from 1975 see D5/258.

As a result of discussion an additional reserve of $2.5m was added, equivalent to a total cost from the ground up of $413m - D5, p.235 (Attwood, I4d, ref: 109). 417's maximum exposure (which would assume a total cost of $558 million) would have called for an additional reserve of $3,483,675 (instead of the $2.5m). CB5/1, D5, p.235 and 237.

There was then added a further loading of $6,500,000 for "other EPA" covering the possibility of two further major losses of up to 50% of the size of Shell ($6.5m).

In fact todate nothing has been paid on the Shell claim (except

costs).

The plaintiffs say that the estimates of cost of clean-up vary widely (J11/25/435) and that the worst possible basis was not used, but only what was considered by Merretts/E&W to be the "worst realistic" basis, and that the insurers' defence costs were estimated (at $1.2m plus disbursements) and reserved for one year only. Further the plaintiffs say that 417 was not in a position to estimate its "ultimate exposure" to Shell because it had not yet identified all the policies, direct or indirect, on which it was exposed. Merretts say that 417 (and the other Merrett Syndicates exposed) knew all of the direct policies issued to Shell. Because of the nature of the account there was little reinsurance involvement for 417. See also D6/532. Merretts say that the "worst realistic" basis was in fact the worst case to the Merrett Syndicates.

All "other" business was loaded 50% on net outstanding figures with a specific provision of $2m which was the load for years of account 1977 to 1982.

The above paragraphs have commented on the make up of the £93.445m in E & W's Review Schedule.

Mr. Randall's memorandum to Mr. Merrett of 15.4.85 referred to "the shattering news of the last 10 days". All of the run-off contracts save Judd formed part of the RITC. The Agency (Mr. Randall and Mr. Hart) sought and obtained details from each of their cedants, either direct or through brokers and auditors of (i) outstandings at 31.12.84, and (ii) net settlements during 1984: see Mr. Hart, para. 17. To the product of that figure they applied a loading CB200-1, D6, p.373. The documents on E&W's files which reflect the Agency's exercise are found at D6/382 et seq.

The loading for each cedant was calculated by Mr. Hart on a "syndicate 799 basis". This involved using development factors from which to derive ultimate losses. These factors consisted of the loadings used for 799 in the underwriting years covered by the relevant run-off policies divided by the net outstandings, i.e. the percentage which the 799 loading represented of the 799 outstandings. The 799 loadings were determined by Mr. Jackson, who adjusted loadings which had been derived from the application of percentages (calculated subject as below from RAA development statistics) to incurreds, to take account of the characteristics of 799's book of business. As to 1964 and prior see Mr. McNamara Day 40 pages 4-6.

The aggregate of the outstandings for all the relevant 417 contracts save Burdett was $19,792,077 and of the loadings was $14,439,030: Schedule D (J10/4). For Burdett there were nil outstandings to the contract but Merretts adopted a loading of £946,626 (ibid). These figures of $19,792,077, $14,439,030 and £946,626 appear on the Schedule at D6, p.373. The total for 417 is $34,231,107 + £946,626. The figures also appear on D5, p.211 under "Specials" and on D5, p.210 & 212 (where $34,231,107 is rounded to $34m and £946,626 to £960,000).

The total Reserve for all the run-off contracts (on which 417/418 and 421 participated) produced by this exercise was $77,230,000 + £1,200,000: p.379.

of which 417's share was $2,610,577. See further page 440 for Mr. Cassells' conclusion.

The revised loadings produced increases in the figures for loading of £4.38m for 417 and £1m for 418: D6, p.379 and 380.

In the event, in the light of this work, an additional $10m was added as a block reserve: $6m to 417 and $4m to 418. (Approximately the ratio of the totals for 418 and 417 on D6, p.380). (see further D5/260).

The methodology involved is summarised at p.377-379. The result of the loading was to produce an IBNR loading which represented approximately 100% of known outstanding claims: see p.8 of Schedule A (J10/1).

E&W carried out certain tests in respect of the compilation of the Agency's run-off reserving schedules (CB202-212) at D6, p.382-443 and checked the 799 loadings which Mr. Hart had applied.

Schedule D (J10/4) shows, firstly, the compilation of the RITC in respect of the run-off contracts for 1984 and succeeding years. Thus, for 1984 it shows the outstandings and IBNR figures, (which are also at D6, p.373) and the special loadings of $6m on 417 and $4m on 418. The heading "Total per Merrett" contains the figures on D5, p.212.

The second half of Schedule D (beginning at p.1 of 13) shows, in respect of each run-off contract, for the years 1984-1986 the cumulative paid claims, the outstandings, the incurred to syndicate figures, the IBNR (all 100% figures) and the IBNR as a percentage of outstandings, the claims being broken down into constituent elements. For 1984 the IBNR percentage is Mr. Hart's original percentage (i.e. before the exercise referred to above).

$6,721,000 was credited in the RITC calculations in respect of recoveries under the reinsurance contracts protecting the run-offs. The contracts are at CB213-1 (D6, p.458) and CB214-1 (D6, p.462). The method of reaching the $6,721,000 is explained at CB215-1 (D6, p.468): the calculations are at D6, p.468-476.

Accordingly the RITC calculation in respect of the run-off contracts written by 417 can be summarised as follows:-

Outstandings 19,792 17,062

Less Reinsurance

recoveries (6,721) (5,794)

IBNR

- Specific load

(excl.Burdett) 14,208 12,248

- Burdett N/A 960

- General load 6,000 5,172

Total 29,648

In early 1984 the proceeds of the roll over policy were repatriated and held in an asbestosis-related claims suspense account and in this, and succeeding, years the asbestosis claims were paid from this account and the balance remaining off-set against the reinsurance to close premium. The revised balance on the account of £10.46 million was carried forward: the calculations were checked by E&W against the Agency's records: D5, p.200.

Merretts took out a Time and Distance Policy in respect of the 417 part of the 1982 account producing cover of $78 million for a premium of $26.4 million to cover losses settled after 1.1.85 in respect of the 1982 account. This produced a net benefit of $51.6m/£44.5m (£67.24m minus £22.71m). The Policy is at CB12-1 (D5, p.262ff). Claims were payable from 15.2.92 with aggregate limits per year.

E&W stipulated - see the Note at D5, p.254 - that the timing of recovery under any T&D policy should be such that "at no time were the funds carried forward left in the Syndicate in respect of the 1982 accounts and prior (be) inadequate to meet the claims as and when they fell due".

Merretts produced cash flow forecasts to demonstrate that the timing of recoveries would be sufficient to match the timing of payments of claims that were projected to be payable over the years ahead. These cashflow forecasts allowed for the acceleration of claims outflow because of the ACF. The criteria for allocating the payments are at D6, p.476. The actual cashflows are D9, p.973 and 974.

A note as to the operation of the time and distance policy (Note 6) appear in the accounts: Accounts E1, p.43. (The T&D was also referred to in the Underwriter's report E1 page 14).

SYNDICATE 418

The work done on outstandings was similar to that done in previous years: see Schedule B2 (a) and (b) (J10/2). The Audit Programme is at D5, p.28. Mr. Merrett's Red Book is at D5, p.53-81. (It included a reserve of $250,000 for asbestos). The outstanding claims summary is at D5, p.51. Of the total RITC for 418 of £70.7m, £25.4m was in respect of the run-offs (£14.4m outstanding, £13.2m loading, less £2.2m insurance recoveries). The effect of the reserves for the run-off contracts was to cause significant underwriting losses on 418.

Merretts proposed - see Mr. Hulme's Schedule D5, p.92/3 - an IBNR based, as before, on (1) Lloyd's minimum reserves, (2) major outstandings plus specific asbestos loading of $250,000 and (3) bad debt reserve (now of 10%) on reinsurance recoveries. The noting level was increased by Merretts from £20,000/$50,000 to £100,000/$100,000 for the 1980, 1981 and 1982 years of account: Mr. Merrett, para. 180. (The plaintiffs say additional IBNR was not calculated for unnoted, therefore unrecorded, claims resulting from this change in practice which led to a reduction of recorded outstanding claims. E&W accept that no additional IBNR was determined for unnoted claims resulting from the change in noting level at this year end. E&W say it was not necessary for the agency to do so because the existing methodology (outstandings + Lloyd's minimum percentages + bad debt reserves) provided adequate reserves). The bad debt reserve was reduced from 25% to 10%. An E & W document (D5 p47) dated May 1985 calculated that the effect of the two changes was to decrease noted outstandings by £6.2m.

The make up of the RITC is set out at CB1/2, D5, p.89 and tabulated at Schedule A p.8 (J10/1). (Note that the figure of $37,424,000 in the first line is $44,824,000 (line 1 on D5, p.89) minus $7,400,000 (line 4 on p.89); and the line "Recoveries" is an amalgam of the third and fifth lines on page 89. "Others" under the heading "Loading" means Lloyd's Audit Reserves).

The reserving methodology for the run-off contracts in respect of Syndicate 418 was the same as in respect of Syndicate 417 (see above) Schedule D1 (J10/4) shows the figures for outstandings of $16,712,000, IBNR of $11,311,000 and additional IBNR of $4 million.

The RITC calculations (D5/89-90) in respect of the run-off contracts written by 418 can be summarised as follows:-

Outstandings 16,712 14,407

Less reinsurance

recoveries (2,596) (2,238)

IBNR

- Specific load 11,311 9,752

- General load 4,000 3,448

Total 29,427 25,369

The AU17 form is at D5 p.37.

The draft AU38(a) forms are at D5 p.34,35 and 38. In the draft form an error occurred in the way in which credit was taken for the T&D. E&W credited the back years with 86% of the benefit of the T&D but did not debit those years with the corresponding proportion of the cost of the T&D. E&W accept that that was a mistake and therefore under-stated the deterioration in the back years by approximately £19.5m.

On the assumption that the asbestos outstandings increased to $21,514,709, the reserves in respect of Asbestos for 417 amounted to £31.70m ($36.772m) (Main Account) and the reserves in respect of Asbestos for 418 amounted to £215,517 ($250,000) (Main Account).

The reserves in respect of Pollution for 417 amounted to £12.994m ($15.073m) (Main Account). The reserves in respect of Pollution for 418 were nil (Main Account).

In relation to the run-off contracts, no precise breakdown of the reserves between asbestos and pollution for 418/417's share of the contracts at 31.12.84 or any subsequent year is available, as no apportionment of the contract deductible was made between the various types of claim. In addition, in 1984, no breakdown of the additional $10m load between asbestos, pollution or any other type of claim is available. The plaintiffs say that the reserves in respect of the run-off contracts (before reinsurance recoveries and the $10m additional load) amounted to £26.1m ($30.3m) asbestos and £9.9m ($11.5m) pollution. E&W say that the reserves in respect of the run-off contracts (before reinsurance recoveries and the $10m additional load) amounted to £21.73m ($25.20m) asbestos and £8.22m ($9.54m) pollution.

The reserves for asbestos 418/417 (Main Account) represented 18% of the RITC for 418/417 (before T&D and roll over); the reserves for pollution (418/417 Main Account) represented 7% of the RITC for 418/417 (before T&D and roll over); the total reserves for the run-off contracts (being £55.018m) represented 32 % of the RITC for 418/417 (before T&D and roll over).

418/417'S INTERNAL CONTROL PROCEDURES, SYSTEMS AND RESOURCES - YEAR 4

Before setting out my conclusions as to the Year 4 RITC it is convenient to consider by way of background 418/417's internal control procedures, systems and resources. The contemporary documents show that as at year 4 there were serious deficiencies and that these deficiencies were known to Merretts and to E&W.

1. At a meeting between Merretts and E&W on 29.6.84 (I4E/213 to discuss the audit as at 31.12.84.) it was agreed by Merretts that the current arrangement whereby E&W carried out an internal control procedure and even calculated the reinsurance to close figures for Merretts was totally unsatisfactory. There was as E&W noted a lack of understanding, and therefore commitment, within the agency as to the requirements of this work.

2. The Specific Risk Analysis dated November 1984 (D5/137) recorded that 417's system for the recording of claims was the same as that for 799, though with the major difference that the fortunes of 799 were closely followed and monitored by Mr. Jackson and Mr. Hart whereas there was no one taking such interest and responsibility in 417. This reflected a fundamental deficiency so far as 418/417 was concerned. Mr. Hart was given certain responsibilities in relation to 417's RITC and Mr. Randall, when he joined Merretts, was to take an overview. But subsequent documents reflect continuing deficiencies as below. Further neither Mr. Hart nor Mr. Randall was an underwriter and what was needed, but lacking, was detailed involvement by Mr. Merrett.

3. The notes of the RITC meeting on 28.3.85 record that it was again necessary for E&W to carry out a detailed review of asbestosis positions on years, layers and insureds as Merretts were unequipped to respond on this matter (D5/251(1)). A memorandum by Mr. Hill recorded that "a considerable amount of work has been done (by us!) to establish realistic data for known claims" (D6/278).

4. Mr. Randall's memorandum of 15.4.85 (G/56) which refers to the problems of the run-off contracts as "the shattering news of the last 10 days" states that there was an urgent need to formalise reporting arrangements within the group. The "shattering news" demonstrated that the systems operated by Merretts for the recording and control of claims were seriously inadequate. E&W should have made recommendations without delay to Merretts as to improvements to systems and controls. I find that a report summarising these recommendations (and approved by E&W) should have been sent to every members' agent having names participating on 418/417 no later than 15.5.85. (See Instructions for Guidance of Lloyd's Auditors at 31.12.84 (J6/491 clause 2A i) b)). Mr. McNamara accepted that there was a case for such a letter (Day 42/103).

5. E&W's management letter of 19.7.85 (G/70) which informed Merretts of certain matters which had come to E&W's attention during the course of the audit as at 31.12.84 recorded inter alia the following:-

It is extraordinary that this letter did not address in detail the problems that had emerged in relation to the run-off contracts.

6. The notes of a meeting between Mr. Hill of E&W and Mr. Randall and Mr. McCann of Merretts on 30.8.85 recorded (D7/290):-

7. It is clear from documents in subsequent years that Merretts' failed to address adequately the deficiencies referred to above. In their management letter dated 6.10.86 (G/191) E&W endorsed their previous recommendation that an appropriate person should be appointed to manage the affairs of 418/417. E&W noted that whilst there had been some improvement during the year, they did not consider that the resources committed were yet adequate to fulfil the important management reponsibility in respect of the reinsurance to close. In a memorandum to the Board of MUAM dated 22.10.86 (G/198) to which E&W's letter of 6.10.86 was attached, Mr. Randall wrote:-

On 23.6.87 (G/235) Mr. Randall in a memorandum to the Directors of Merrett Holdings Plc on the subject of Claims and Reinsurance Functions referred to the fact that at the last meeting of the Board he had outlined his concerns about the poor quality of the records and the weaknesses in internal organisation for dealing with outstanding claims and reinsurance recoveries. Mr. Randall had concluded that special attention was needed to deal with the present and continuing problems of 418/417 and that responsibility should rest fully with the underwriter for ensuring that all aspects of the claims and reinsurance functions were operating properly. Mr. Randall added:

Mr. Randall proposed the establishment of a new department, the "Claims and Reinsurance Administration Department" to assume responsibility for the maintenance of outstanding claims information and the collection of reinsurance recoveries.

As to Merretts' and E&W's knowledge of asbestos and pollution problems and uncertainties as at 4.6.85 see above.

In year 4, 418/417 was subject to fundamental uncertainties as to the future development of (i) asbestos bodily injury claims (ii) asbestos property damage claims and (iii) pollution claims, not only in respect of its own book going back to 1953 but also in respect of the books of the 10 cedants (whose years of account reinsured are set out at Table 2 above). Thus the uncertainties that had obtained in previous years had very substantially increased. The uncertainties were compounded by the fact that Merretts had inadequate information in relation to the 10 run-off contracts to justify the closure of year 4. Further E&W failed to require Merretts to obtain the necessary information.

In the estimation of the reinsurance to close regard should be had to the accuracy of previous estimates in considering whether it was possible to ensure that the reinsurance to close was within a zone of reasonableness. Further as Mr. Attwood pointed out asbestosis and environmental pollution were on a continuum where at one point in time one approach to reserving may have been appropriate but at a later point in time it was necessary to have regard to subsequent changes and adopt a different approach.

As to asbestos claims 418/417 main account, the incurred claims as at 31.12.83 amounted to $16.88m. The corresponding figure as at 31.12.84 was $27.072m (see Table 6). It is to be noted that within a year the incurred claims ($27.072m) were less than $3m below 418/417's estimate as at 31.12.83 of all claims to ultimate ($29.93m). It should have been apparent to both Merretts and E&W that the methodology adopted in year 3 for reserving for these claims was inaccurate to an unacceptable degree.

Given Merretts' knowledge of the fundamental uncertainties referred to above and of the additional uncertainties reflected in the detailed points as to Merretts set out below, I find that Merretts and in particular Mr. Merrett knew that a reinsurance to close figure could not be arrived at with a reasonable degree of accuracy/within a zone of reasonableness, and that Merretts should accordingly have left the year open. Having carefully considered all the evidence and formed an impression of the witnesses, I find that Merretts and in particular Mr. Merrett, while they knew that a reinsurance to close figure could not be arrived at with a reasonable degree of accuracy because of the extent of the uncertainties known to them, were nevertheless determined to close the year for commercial reasons. The commercial reasons included the commercial disadvantages of not closing and the perceived stigma attached to leaving the year open. The commercial considerations were seen to be more important than the principle of equity between names. Further had Merretts declined to leave the year open E&W should have disclaimed an opinion on the grounds of fundamental uncertainty. Had they done so I find that on a balance of probabilities Merretts would have had no alternative but to leave the year open.

Mr. Neil maintained that it was impossible to establish an IBNR within a reasonable degree of accuracy for those syndicates with substantial exposure to asbestos-related claims over a large number of years. This fundamental criticism applied particulary to 418/417 because it was one of the heaviest US casualty syndicates in Lloyds. In making this criticism Mr. Neil drew attention to the size and scale of 418/417's account, the number of years over which the business was written (1953 onwards), the type of business written, the number of claims, the source of those claims and the difficulty of identifying how many claimants there would be in the future, the number of years which would see claims in the future, and the amount that each claimant might recover. Mr. Neil made it clear that the strength of his criticism increased from year to year. By year 4 ten run-off contracts formed a constituent part of the RITC. I find that Mr. Neil's fundamental criticism was valid in year 4.

I was not referred to any document which explained to the Board how the RITC had been calculated in years 4, 5 or 6. The absence of such material is profoundly unsatisfactory given the responsibilities of the managing agents.

The documents do not suggest that Mr. Merrett himself spent any more than a very limited amount of time on the year 4 RITC.

As to E&W I accept the broad criticisms in relation to year 4 in Mr. Attwood's reports, as refined in his evidence. E&W should have realised that a reinsurance to close figure could not be arrived at within a zone of reasonableness. Given all the uncertainties referred to above and the detailed points set out below E&W should have disclaimed an opinion on the grounds of fundamental uncertainty.

It is extraordinary that there was apparently no further formal RITC meeting between Merretts and E&W after the meeting on 28.3.85 (which preceded "the shattering news" G/56). Mr. McNamara was involved with several other audits at the same time and had particular problems with Outhwaite 317/661.

The "shattering news" demonstrated that the systems operated by Merretts for the recording and control of claims were seriously inadequate. E&W should have made recommendations without delay to Merretts as to improvements to systems and controls. A report summarising these recommendations (and approved by E&W) should have been sent to every members' agent having names participating on 418/417 no later than 15.5.85. (See Instructions for Guidance of Lloyd's Auditors at 31.12.84 (J6/491 clause 2A i) b)).

I turn to consider some detailed points in relation to (A) Merretts and (B) E&W. Although it is necessary to refer at times to E&W in (A) and Merretts in (B) I have of course given separate consideration to their respective cases.

(A) Merretts

The marked deterioration in outstandings is referred to above. The scale of the deterioration demonstrated that the methodology employed in year 3 could not be relied upon to ensure a reinsurance to close within a zone of reasonableness.

The notes of the RITC meeting on 28.3.85 (D5/251(1)) recorded that the principal observation was a very marked deterioration in reinsurance brought forward much of which seemed to be a response to asbestosis and other latent diseases. Mr. Merrett is recorded as having "expressed surprise that the AWP was still finding so many new advices, with indications that there was more to come". The total for asbestosis outstandings was up from $16m at December 1983 to $22m at December 1984. Despite the inclusion in the IBNR at December 1983 of $6m for "fill-in" claims and $6m for new advices these now appeared inadequate.

Mr. Cassells' note of 3.5.85 (D6/286) stated that "future deterioration of reinsurances where exposure exists but no notification has been received is quite likely to be a significant area of deterioration in the near future (Karen Ruby suggests American domestic insurance companies especially). The large payments now being made to major producers will probably prompt a number of new notifications by reinsureds".

Mr. McNamara's Notes on 417 Reinsurance To Close (D5/256) recorded that it had been necessary to make a further provision for insurance policies for which no claim had been made or notified. This area presented some difficulty as in the last year there had been no less than $4m of new advices on policies for which there was no provision whatsoever in previous years. Mr. McNamara's notes recognised that the provisions made in respect of asbestos "may well prove to be inadequate" and recorded that "in 1984 there was a substantial increase in notified losses and not only that, the number of sufferers who are making claims has risen from 500 per month to 700 per month". The notes concluded:-

Mr. McNamara's Notes on 417 Reinsurance To Close (D5/256) referred to uncertainty over new advices relating not to bodily injury claims but to the potential for property damage claims, particularly claims against US Gypsum and National Gypsum. Mr. McNamara recorded that at this time there was great uncertainty as to the liability of insurers in respect of such claims.

Mr. Cassells' note dated 26.3.85 (D6/593) on EPA stated:-

The notes of the RITC meeting on 28.3.85 (D5/251(1)-(2)) recorded that provision had been set up for the first time in respect of Shell, Rocky Mountain. As with most syndicates, no previous reserve had been established specifically because of a lack of market information. Mr. Cassells (D5/235) recorded:-

Mr. McNamara's Notes on 417 Reinsurance To Close (D5/258) recorded:-

Mr. Ayliffe accepted in cross-examination that by at least the closure of the 1982 account as at 31.12.84 EPA was perceived as being potentially very serious indeed.

(a) The plaintiffs' case

The plaintiffs' case is that the reserves set for the run-off contracts and, in particular, the IBNR reserve for future claims on those contracts was arbitrary and without rational or justifiable basis. The plaintiffs submit that there was no justification for the use of the 799 loadings. Merretts adopted the 799 loadings for the run-off contracts in the absence of any other approach which they could adopt, not because it was an acceptable and justifiable way to proceed. E&W failed to seek or obtain the necessary audit evidence so as to be satisfied of the validity of Merretts' approach. In summary the plaintiffs' reasons for submitting that there was no justification for the use of 799 loadings are as follows:-

The plaintiffs submit that Merretts should have undertaken a detailed investigation so as to obtain full, complete and proper information from each of the run-off cedants falling within the categories of information set out in paragraph 7.4.2 of Mr. Attwood's report and that E&W should have sought audit evidence that Merretts had done this. The plaintiffs further submit that the terms on which the run-off contracts had been written (unlimited in amount and in temporal duration) coupled with the lack of significant outwards reinsurance protection necessitated the taking of such detailed and extensive enquiries before any reserve could properly be set. This is particularly the case in circumstances where the net outstandings plus IBNR in respect of the run-off account amounted to £55.018m.

(b) The defendants' case

Merretts reject the criticisms advanced by the plaintiffs and maintain that the approach they adopted was entirely appropriate, inter alia, for the following reasons.

Merretts accept that the use of the 799 factors was partly pragmatic. Syndicate 799 factors were immediately available. This was also a rational and reasonable decision. The first question was whether in principle one could use any other comparator to which the answer - in principle - must be that it was acceptable. Syndicate 799 had a heavily exposed US liability account which was severely impacted by asbestos and pollution claims. It was recognised as having a very strong reinsurance programme. Adjustments were made to allow for this. Reference was made to the differences between the various syndicate accounts and in particular to the so-called "golden years" of 799 but these were years that did not apply to the years used as comparators for the run-off contracts. The criticisms are disingenuous. Any syndicate with significant exposure to US liability business was going to be substantially afflicted with asbestos and pollution claims. Taking, as an analogue, a syndicate known to be one of the market leaders in such business with perhaps the best knowledge of the problem in the market was a rational approach. It was rational and sensible, in the same way as adopting market statistics published by the RAA or adopting and adapting Lloyd's audit minima derived from market sources. None of these is perfect but each is an acceptable method for estimating that which cannot be done with scientific precision.

E&W reject the criticisms advanced by the plaintiffs and maintain that the approach they adopted was appropriate, inter alia, for the following reasons.

E&W were faced with a stark question: namely whether or not Merretts' approach was one which they could regard as reasonable or whether, alternatively, they were bound to refuse to give an unqualified report. In E&W's submission they could, acting competently, think that this was a reasonable approach in admittedly difficult circumstances. The message which Merretts were giving to E&W was that 799 was an appropriate analogue and, indeed, erred on the side of caution since 799 was a long tail, non-marine syndicate (going back to the 1950s) which tended to write more heavily exposed classes of US casualty business than most others in the market and had done so for a long time and thus had an exposure to latent disease at least as high as that of the cedants (taken as a whole). Further, whether or not 799 was an appropriate analogue, was a question in relation to which E&W would necessarily have to be guided by Merretts. E&W could also properly take the view that 799 was itself properly reserved.

As to Mr. Attwood's contention as set out in para 7.4.2. of his report, this suggestion sets the high water mark of theorising over practicality. The universal practice of the market at the time was to assess an RITC covering reinsurance liabilities on the footing of figures for incurreds provided by cedants who owed their reinsurers a duty of the utmost good faith in reporting and had no reason to understate outstandings. There are many examples of writings in relation to which an RITC has to be, and habitually was, fixed on the basis of reported figures, e.g.

It was, by the standards at the time, perfectly competent for E&W not to refuse to give a true and fair opinion because full scale discovery and audit of cedants had not been carried out.

Even if there was a books and records clause (which there was not in the case of every contract) it would not have been feasible for such an audit to be carried out by the cedants' auditors and E&W at the same time.

Further there is no evidence that, even if E&W had carried out a full scale audit of the cedants, that would have affected the decision to close. The probability is the opposite as the events of the two following years show.

(c) Analysis and conclusions

(i) The Correct approach

It is elementary that the writing of 11 run-off contracts, exposed to US casualty risks and in particular to asbestos-related and pollution claims, (10 of which formed a constituent part of the 1982 account) served to increase very substantially, but to an extent which cannot be expressed mathematically, the uncertainties and difficulties attaching to any subsequent RITC of which the run-off contracts formed a considerable part -the more so as the run-off contracts were unlimited in time and amount and were not protected by adequate reinsurance.

I find that the correct approach to reserving for the run-off contracts was stated by Mrs. Rowe. I accept Mrs. Rowe's evidence (Day 27/201-202) that if she had been concerned with a syndicate which had written run-off contracts:- "(I) would have wanted to see the same materials for each run-off contract as I had for the syndicate itself... In other words for each run-off contract... if I were to have any comfort at all in closing a syndicate with a run-off contract in it, I would want to be able to do the same exercise for each run-off contract as I did for my own syndicate."

I prefer Mrs. Rowe's evidence as above to that of Mr. Rome (and to that of Mr. Neil to the extent that his evidence conflicts with the above).

Mr. Attwood's evidence as to auditors' duties was to similar effect. I accept Mr. Attwood's evidence (his report paragraph 7.4.2) that he would have expected an auditor to have required the managing agents to obtain the following information on each of the run-off contracts, for determining an RITC:-

(a) the particular circumstances of the reassured syndicates, categories of business written, type of policies written and identification of problem risks needing attention;

(b) an assessment of completeness of the syndicate records and ability to identify policies and exposures which were likely to be the subject of future claims;

(c) identification of direct and reinsurance policies affected by latent disease, pollution and other special situations, including exposure limits;

(d) identification of reinsurance cover available to the syndicates and assessment of recovery prospects;

(e) assurance that historical development patterns and data had been properly compiled and were reliable for use by Merretts;

(f) identification of maximum and likely losses on special claims;

(g) based on the above, a conclusion as to whether the information gathered was sufficiently complete to ascertain the underlying level of exposures as a base from which to estimate the IBNR; and

(h) determination of appropriate IBNR given specific circumstances of the syndicate's book of business.

As Mr. Attwood said if the above information could not be obtained, it is difficult to see how a proper evaluation of future liabilities could be made.

Mr. McNamara accepted that in year 4 the audit comprised the affairs not of one syndicate but of 11 syndicates. In a letter dated 18.12.90 Mr. McNamara listed the data that would have been required to support a reinsurance to close the 1985 underwriting account. He distinguished between two tiers of data (a) underlying information prepared in respect of the historical data of syndicate 418/417 and the cedant syndicates and (b) projections for each syndicate based on the underlying data. Significantly his letter drew no distinction between the information required in respect of the historical data of syndicate 418/417 and the cedant syndicates. As to (a) his letter stated:-

Although Mr. McNamara said in evidence that his letter was designed to "torpedo" any subsequent closure of the 1985 year, I consider that Mr. McNamara's letter provides material support for Mr. Attwood's evidence referred to above. In particular it draws no distinction between the information required in relation to 418/417's own book and the information required from the cedants. (For Mr. Hart's comments dated 25.1.93 on the letter dated 18.12.90 see I4G/296).

In subsequent years Merretts and E&W recognised the need for considerably more information than they had in year 4. In addition to Mr. McNamara's letter of 18.12.90 I refer to the following. As to the Questionnaire to cedants in year 5 see below. A document dated 7.9.87 (D11/790) from Merretts' files records that Merretts requested the cedants to report every 6 months on paid and outstanding claims, both gross and net of reinsurance recoveries, breaking the information down over years of account. It continues "a number of audits are being carried out at our instigation to test the accuracy of the information provided to us against the records of the reinsured company or syndicate. It is our intention that in due course, all contracts will be the subject of regular review of this type". See also G/215.

Further the Audit Brief provides support for Mr. Attwood's evidence. Paragraph 79 stated:-

Although the Audit Brief is based on the Lloyd's Byelaws and the law as at 1.1.86 I find that it reflected the approach that ought properly to have been followed as at year 4. (See in this connection Mr. Attwood's evidence, E&W Insight No.32 June 1986 and Mr. McNamara (Day 43/42/20 et seq)). As to Mr. Attwood's and Mr. Sharp's involvement with the preparation of the Audit Brief see above.

Although the evidence of Mr. Attwood and several of the materials referred to above are directed to the duties of auditors, they serve to confirm Mrs. Rowe's evidence as set out above.

I find that in all the circumstances a reasonably competent Lloyd's managing agent specializing in the writing of long tail risks would have recognised in year 4 that a reinsurance to close within a zone of reasonableness could not be ensured or even contemplated without evidence as to the run-off contracts similar in form to that relating to 418/417's own book of business. The relevant circumstances include inter alia the fact that by this time 10 run-off contracts formed a constituent part of the 1982 account, the extent of the exposures (including asbestos and pollution risks) and the amount of the net outstandings referable to the run-off account (£23.437m/$27.187m - Compare the outstandings in respect of the run-off contracts in

year 1 ($0.8m),

year 2 ($1.88m), and

year 3 ($4.6m).

The defendants say that it would have been difficult and/or impracticable to obtain this level of information but the need for this information was the result of the decision to write these particular run-off contracts. Whatever may have been the practice of the market in relation to reserving for other reinsurance liabilities, the nature and scale of these particular contracts required the approach referred to above.

It follows that Merretts had inadequate information in relation to the run-off contracts to justify the closure of year 4. It is not clear on the evidence that they could have obtained the necessary information but had they done so this would have served to underline the extent of the uncertainties referred to above and to confirm that it was not possible to arrive at a RITC within a zone of reasonableness.

(ii) The investigation undertaken by Merretts and the nature of the information obtained.

After "the shattering news" Mr. Randall and Mr. Hart carried out an investigation in considerable haste. Mr. Randall and Mr. Hart were not underwriters and I find that the investigation lacked sufficient input from an underwriter.

I refer to the documents resulting from the investigation carried out by Mr. Randall and Mr. Hart which show the limited extent of the information obtained. I should not be taken to accept that the investigation was as extensive as suggested by Mr. Randall and Mr. Hart in their witness statements. The materials obtained and the documents produced by them speak for themselves. (Mr. Randall said that he had not seen the placing files by March 1987). Mr. Randall and Mr. Hart did not produce a formal report for the Merretts Board following the investigation, despite the obvious significance of the matters under investigation.

Mr. Randall said that one of the most extraordinary features of the run-off contracts was the reluctance of the cedants to put themselves to trouble to supply Merretts with information right up to 1991. It proved impossible to establish a database in respect of the cedants on the same basis as for Merretts own book.

For examples of uncertainties in relation to the cedants as a result of lack of information see (iv) below.

(iii) Uncertainties evidenced by what the cedants were saying.

Concerns expressed by at least three of the cedants underlined the fundamental uncertainties.

1. Mr. Merrett accepted that the Fireman's Fund/Sturge contract was the largest and most risky contract of all. In a letter dated 16.7.82 (D6/444-E&W audit file for year 4) Mr. Rokeby-Johnson of R.W. Sturge & Co wrote:-

2. As to Dolling-Baker a Winchester Bowring memorandum dated 2nd April 1985 (C13/214) records:-

A memorandum dated 9.4.85 bearing Mr. Dolling-Baker's initials

(C13/227) states:-

In a letter from Mr. Dolling-Baker to Winchester Bowring dated 15.4.85 (C13/247) Mr. Dolling-Baker wrote:-

This letter was scratched by Merretts on 29.4.85.

In a letter from Mr. Dolling-Baker to Winchester Bowring dated 29.4.85 (C13/250) Mr. Dolling-Baker wrote:-

This letter was scratched by Mr. Emney on behalf of Merretts with the annotation "please advise amounts involved as soon as you (can)".

3. In a letter dated 31.1.89 (see I5/241) Mr. Toomey wrote to Mr. Randall as follows:-

It is to be noted that this letter was written in 1989. The probability is that the reference to Mr. Randall visiting the box in person was a reference to the investigation carried out in April 1985. Although this letter was written well after the closure of year 4 it must have been obvious to a reasonably competent Lloyd's managing agent (and to a reasonably competent Lloyd's panel/recognised auditor) in early 1985 that many if not all of the cedants had entered into the run-off contracts broadly for the reasons expressed by Mr. Toomey and in particular because they wished to put an end to the uncertainties involved in reserving accounts exposed to latent disease claims.

In paragraph 91 of his report Mr. Rome stated that the development of the run-off market 1979 to 1983 resulted from a number of factors including growing concerns in the market about long tail liability risks, particularly in respect of latent disease claims. (See also BF Caudle & Others v Sharp [1994] CLC 216 at 223, 10.18).

(iv) Some examples of uncertainties in relation to the cedants as a result of lack of information.

I refer to my findings set out above as to the nature and extent of information which should have been obtained from the cedants, particularly by reference to paragraph 7.4.2 of Mr. Attwood's report. I set out below some examples of uncertainties in relation to the cedants as a result of lack of information.

1. No information as to TBAs was obtained from the cedants (see for example Mr. Sharp's evidence as to the importance of TBA's (Day 51/95)).

2. In several cases the information obtained by Merretts did not identify whether the particular cedant was exposed to the Shell risk.

3. Merretts did not undertake any exercise to identify the extent to which the cedants were exposed to the principal defendants in the asbestos litigation. There was no information in relation to any of the cedants comparable to that contained in Mr. McNamara's Schedules.

4. When the example was put to Mr. Randall he accepted that Merretts in early 1985 did not go through the Dolling-Baker account to a level of detail that included lines, layers, insureds and reinsureds. Mr. McNamara accepted that E&W did not have any audit evidence as to (a) the split of business written by the cedant syndicates by currency (b) the split of business written by the cedant syndicates as between direct business, reinsurance business and retrocession business and (c) the lines written by the cedant syndicates, showing whether they were exposed on primary layers, or on high excess of loss layers.

5. There was at best limited information as to the quality of the systems and controls operated by the cedants. (418/417 was seen as a flagship syndicate and yet see above as to its own serious failures in years 1,2 and 3 in relation to the run-off contracts.)

6. Some of the cedants' figures for paids and outstandings were unaudited.

7. There was no information as to whether any of the cedants had written policies with a continuing obligation to pay costs in excess of indemnity limits (Cf D6/286;D6/364;D6/367). There was no information as to whether any of the cedants had written policies which lacked aggregate limits (Cf D5/257 and D6/371). There was no evidence as to whether any of the cedants had employed attorneys to investigate the books of original insurers reinsured by the cedant (Cf D6/595).

8. When the example was put to Mr. Hart he could not point to any document in relation to Provincial and Universal which showed their reserving practice.

9. Mr. Hart accepted that the placing information in almost all cases was not on the file.

(v) The use of 799 as an analogue was inappropriate

The use of 799 as an analogue (even allowing for the additional $10m block reserve) was inappropriate (as was subsequently recognised see below) and was no substitute for the approach referred to in paragraph 7.4.2 of Mr. Attwood's report. Without prejudice to this conclusion some of the difficulties and uncertainties inherent in the use of 799 as an analogue are referred to in 1 to 8 below.

1. Mr. Ayliffe (Day 13/72/23 et seq) accepted that attempts to compare one syndicate with another in terms of the impact of asbestos etc. on their books are liable to be "a trap for the unwary" because no syndicate is the same as another. Every one is different. Its historical background is different. See also Mr. Hart (Day 14/112), Mr. McNamara (Day 39/109) and Mr. Whiter (Day 50/55/4 et seq).

2. Mr. Merrett accepted that the use of 799 as an analogue was

a "rough and ready exercise" (although he maintained that 799 was a reasonable point of comparison for the run-off contracts taken as a whole). Mr. Hart referred to a "broadbrush

comparison". In his Notes on Syndicate 417 - Reinsurance to Close (D5/259) Mr. McNamara recorded:-

3. In his note headed Matters for Partner Attention dated 23.4.86 (D8/512) Mr. Potkins of E&W, working on the year 5 audit, wrote:-

4. In a note dated 28.4.85 (D6/377) Mr. Cassells described the

loadings as "necessarily subjective and based on more restricted information than would be the case with the syndicate's own business". In a note dated 29.4.85 (D6/440) Mr. Cassells concluded:-

Without further work and information E&W did not know the extent to which the loadings for the other run-off contracts were "equally inadequate". In a note dated 6.5.85 (D6/374) Mr. Cassells described the loadings as "clearly light".

5. By way of example, as to the inadequacy of the loading in respect of Ballantyne see Day 14/114-115. Mr. Hart's attempt to justify the loading given to Ballantyne was by reference to a perception ("the asbestos problem was largely behind us") which does not accord with the contemporary documents (see above). See further below as to E&W's graphs.

6. The plaintiffs submit that no evidence exists in support of the assumption that the 799 portfolio mix of business (let alone the cedants' portfolio mix) was basically similar to that for the RAA factors (see G/247a at 247e). The plaintiffs further submit that it was impossible to assess loadings based on the RAA factors in respect of 799's years of account prior to 1965 because the data necessary was not available (see G/247e).

The document as to RAA factors obtained by Mr. Cassells D6/577 states at page 579:-

7. Mr. Cassells' notes on the 799 audit dated 19.5.85 (D6/576) record:-

8. Mr. McNamara accepted that 799 had a number of characteristics peculiar to it - Day 39/110 et seq (a large proportion of indirect business; 1969 and prior were particularly bad years for asbestos, DES and Agent Orange; different protection levels for differing years; prior to 1961 the syndicate wrote large lines with no reinsurance protection; thereafter 799's outward reinsurance programme was of enormous significance).

According to Mr. Cassells' note dated... D6/560

(see further D6/593 as to "the new pre-75 Stop Loss" which did not apply to asbestosis). Thus 799 had far greater reinsurance protection than 418/417 although 799's protection was not evenly spread between the years. (For Mr. McNamara's description of 799's "unlimited sideways reinsurance cover down to a very low level" see Day 36/129/3). Mr. McNamara was unable to say whether any of the cedants would have had outward reinsurance protection on the scale of 799.

Mr. Hart prepared revised loadings in an attempt to take account of the differences between 799 and the cedants but this was no substitute for the approach which should have been adopted.

9. The notes of the 799 RITC meeting on 29.3.85 (D6/567-9) record that £3m of 799's reserves in respect of the "golden years" (1977-1980) were reallocated to 1965 and prior. The notes also record:-

I have disregarded this point for the following reason. Merretts say only four of the run-off contracts (Dolling-Baker, Gooda, Judd and Burdett) had any exposure to the golden years and that the process by which the run-off contracts were reserved would not have included any of the effects of the golden years save to the limited extent that these 4 contracts had some exposure to one or more of the golden years.

Finally the plaintiffs point out that Merretts did not call Mr. Jackson, the key person (see D6/559) who could give evidence as to how the 799 factors were arrived at (and their applicability or otherwise to the cedants).

Merretts carried out no or no adequate margin of error calculations in relation to the reserves in respect of 418/417's own book and the books of each of the 10 cedants (where the information was in any event inadequate) to reflect the fundamental uncertainties as to the future development of (i) asbestos bodily injury claims (ii) asbestos property damage claims and (iii) pollution claims. Had Merretts carried out adequate margin of error calculations these would have served to confirm that it was not possible to arrive at a RITC figure with a reasonable degree of accuracy.

(B) E&W

In year 4 E&W knew or should have realized, inter alia, the following six matters.

1. Merretts had failed to comply with the White Letter in years 1, 2 and 3 in relation to the run-off contracts.

2. Merretts' replies to the Latent Disease Questionnaires in years 1, 2 and 3 were inaccurate and seriously misleading.

3. Merretts did not tell E&W about the writing of the run-off contracts until year 3 (when reference was made to only 6 out of 11).

4. On Merretts' methodology there had been an under-reserving in year 1 of about $.949m, in year 2 of about $3.2/3.9m and in year 3 of about $13.103m (= £9.036m).

5. As to 418/417 asbestos claims main account, the incurred claims as at 31.12.83 amounted to $16.88m. Within a year the incurred claims were less than $3m below 418/417's estimate as at 31.12.83 of all claims to ultimate (see above).

6. There was a breakdown in communication and organisation in the course of the year 3 audit as a result of which, inter alia, Mr. Jones' work on the run-off contracts, the slips, Mr. Rokeby-Johnson's letter and the $12.7m increase in the Sturge incurreds between 30.6.83 and 31.12.83 were not given appropriate attention by an E&W partner.

As to E&W's knowledge of asbestos and pollution problems and uncertainties as at 4.6.85 see above. E&W's knowledge was far less extensive than Merretts'. Mr. Attwood in his reports and evidence said that, in his view, because of the uncertain nature of the asbestos liabilities and the materiality of the amounts involved, representations made by Merretts as to the future development of these liabilities had to be corroborated by independent evidence before the representations could be accepted. Mr. Attwood singled out attorneys' reports as a source of such corroboration. The same point applies to pollution liabilities. Having regard to the extent of the asbestos and pollution problems, the extent of the exposure of 418/417's own book and the books of the 10 cedants to these problems, the materiality of the reserves in connection with asbestos and pollution, the critical importance of any assessment as to the future nature extent and development of these claims, the inaccuracy of previous estimates and points 1 to 5 above, I accept Mr. Attwood's evidence that it was incumbent upon E&W to review a sample of the attorneys' reports to test the representations made by Merretts. Had E&W reviewed a sample of attorneys' reports for this purpose this would have served to confirm the extent of the fundamental uncertainties as to the future development of asbestos bodily injury claims, asbestos property damage claims and pollution claims.

The section under the heading (A) Merretts is repeated insofar as it applies to E&W.

As to the plaintiffs' and E&W's cases see above. As to the correct approach see above (under the heading (A) Merretts, The Run-Off Contracts, (c) Analysis and conclusions (i) The correct approach). E&W failed to require Merretts to obtain the necessary information as to each of the 10 run-off contracts, being evidence similar in form to that relating to 418/417's own book. It follows that E&W had inadequate audit evidence in relation to the run-off contracts to justify the opinion given. Mr. McNamara accepted that in year 4 there were practical difficulties in doing the exercise in the period of time available. It is not clear on the evidence that E&W could have obtained the necessary audit evidence in accordance with Mr. Attwood's paragraph 7.4.2, but had they done so this would have served to underline the extent of the uncertainties referred to above and to confirm that E&W should have disclaimed an opinion on the grounds of fundamental uncertainty.

E&W were aware of the investigation undertaken by Merretts and the nature of the information obtained (see (c)(ii) above).

As to uncertainties evidenced by what the cedants were saying the letter dated 16.7.82 written by Mr. Rokeby-Johnson of R.W. Sturge & Co. was on E&W's audit file for year 4 (D6/444). This letter referred to the most significant of the run-off contracts. As to the examples of uncertainties in relation to the cedants as a result of lack of information ((c)(iv) above), E&W were or should have been aware of these. For the very limited materials on E&W's files relating to the accounts of the cedants see D6/372-457. As to the use of 799 as an analogue (see c(v) above) E&W should have appreciated that this was inappropriate and no substitute for the approach referred to in paragraph 7.4.2 of Mr. Attwood's report. E&W were aware of the difficulties and uncertainties inherent in the use of 799 as an analogue to the extent to which the points in (c)(v) above refer to E&W.

I add the following further points which relate to E&W.

1. D5/211-E&W's Review Schedule did not involve any separate review of the run-off contracts but simply included the figure Merretts had put forward.

2. E&W's true and fair opinion in so far as it related to the Run-off Account (Net outstandings £23.437m plus IBNR £31.581m = £55.018m) was by reference to the very limited and inadequate materials at D6/372-457. The limited and inadequate materials relating to 10 cedants should be compared with the extensive materials relating to 418/417's own book reviewed by E&W - see D5 and 6.

Mr. Attwood said (Day 47/43-44)

3. The plaintiffs rely upon the graph exercise which Mr. McNamara undertook in relation to the run off contracts - see the graphs at D6/400 Burdett; D6/409 Dolling-Baker; D6/417 Verrall; D6/423 Ballantyne; D6/438 and 439 Sturge. In his supplementary witness statement at paragraphs 106(g) and (h) (page 47) Mr. McNamara sought to minimise the significance of the graphs as a "crude exercise" which "did not lead me to any specific conclusions". The plaintiffs submit that in fact the graphs, crude though they may have been, ought to have led Mr. McNamara to the alarming realisation that the 799 loadings produced reserves which were manifestly inadequate if the rate of progression of claims on certain of the contracts (especially Dolling-Baker, Verrall and Fireman's Fund 1966 and prior) continued in the future as it had done to date - Day 40/21/21-/22/22:

When asked what relationship reserves of this order might bear

to the issue of equitable treatment, Mr. McNamara's

evidence was as follows - Day 40/22/23-/23/4:

In my view there is considerable force in the plaintiffs' submissions. The graphs served to demonstrate that the use of 799 as an analogue was inappropriate.

4. When asked what consideration did E&W give in years 4,5 and 6 "to the absence of the very audit evidence in the case of the cedants which they deemed essential in the case of 417's own book" Mr. McNamara frankly said "not a consequential amount" although he maintained that what was done on 417 "was not regarded as essential across the piece" (Day 37/32/1).

5. The calculation of the reinsurance to close in respect of the run-off contracts written into 421 followed the same approach as that adopted for 417. In his Notes on Reinsurance to Close: Syndicate 421 dated 15.5.85 (D6/516(1)) Mr. McNamara referred to "the considerable uncertainty surrounding the estimates made".

In his Notes on Reinsurance to Close: Syndicate 418 of the same date (D6/516(2)) Mr. McNamara wrote:-

(See also the Notes on 417 D5/259-60 including the passage quoted above and the reference to the further provision of $6 million -"it is not easy to form any basis on which to make this assumption".)

E&W carried out no or no adequate margin of error tests in relation to the reserves in respect of 418/417's own book and the books of each of the 10 cedants (where the information was in any event inadequate) to reflect the fundamental uncertainties as to the future development of (i) asbestos bodily injury claims (ii) asbestos property damage claims and (iii) pollution claims. Had E&W carried out adequate margin of error calculations these would have served to confirm that E&W should have disclaimed an opinion on the grounds of fundamental uncertainty. (See in this connection the graph exercise referred to above which should have been seen as a red flag).

For the reasons set out above I have with regret come to the conclusion that a reasonably competent Lloyd's panel/recognised auditor in year 4 would have disclaimed an opinion on the grounds of fundamental uncertainty. Without prejudice to all the points made in the detailed analysis above I refer in particular to:-

(1) the fundamental uncertainties as to the future development of (i) asbestos bodily injury claims (ii) asbestos property damage claims and (iii) pollution claims as reflected in the materials available to E&W.

(2) the numerous references to uncertainties in the contemporary documents relating to the audit quoted/referred to above.

(3) the significance of the additional uncertainties in relation to pollution claims which became apparent in year 4.

(4) the fact that all the fundamental uncertainties had to be considered not only in respect of 418/417's own book going back to 1953 but also in respect of the books of the 10 cedants. There had been a funnelling of these claims with their attendant uncertainties into 418/417.

(5) the inaccuracies of previous estimates in years 1, 2 and 3.

(6) E&W's failure to test or test adequately the representations made by Merretts as to the future development of asbestos personal injury, asbestos property damage and pollution claims.

(7) the fact that the incurred asbestos claims (418/417 main account) at 31.12.84 ($27.072m) were less than $3m below 418/417's estimate as at 31.12.83 of all claims to ultimate.

(8) E&W's failure to require Merretts to obtain the necessary information as to each of the 10 run-off contracts with the result that E&W had inadequate audit evidence in relation to these contracts.

(9) the uncertainties as evidenced by what Mr. Rokeby-Johnson of Sturge was saying in relation to the most significant run-off contract (D6/444).

(10) the uncertainties in relation to the cedants as a result of lack of information.

(11) the inappropriate use of 799 as an analogue.

(12) the fact that E&W's opinion in so far as it related to the run-off account (Net outstandings + IBNR = £55.018m) was by reference to very limited and inadequate materials.

(13) the graph exercise which served to demonstrate that the use of 799 as an analogue was inappropriate and which should have been seen as a red flag.

(14) the fact that had adequate margin of error calculations been carried out these would have served to confirm that it was not possible to arrive at a RITC within a zone of reasonableness.

(15) the fact that the reserve for asbestos-related and pollution claims represented a material proportion of the total reserves of the syndicate (see paragraph 8 of Mr. Murray Lawrence's letter of 18.3.82).

(16) the background of Merretts' failures in years 1,2 and 3 with the result (a) that on Merretts' methodology (which was itself open to question) there had been under-reserving in year 3 of about $13.103/£9.036m and (b) that the year 3 accounts were seriously inaccurate.

For completeness I should mention the Form Au 38(a), the T&D policy and 317/661. These matters have not played any part in my conclusions as to year 4.

Form AU38(a) required the auditors to provide Lloyd's with an answer as to the following question: The reserves created for the 1981 and prior Accounts as at 31st December 1983 do/do not appear to have been adequate.

The reserves created for 1981 and prior as at 31st December 1983 had been £96,023,486. According to the answer apparently given by E&W in the Form AU38(a) one year later (ie. 31.12.84), the reserves which had been created for 1981 the previous year had been inadequate, but only by £652,566. The Form Au 38(a) actually filed with Lloyd's has not been found.

E&W accept that this answer was misleading because an error occurred in the way in which credit was taken for the T&D. E&W credited the back years with 86% of the benefit of the T&D but did not debit those years with the corresponding proportion of the cost of the T&D. As a result the deterioration in the back years was according to E&W understated by approximately £19.5m.

The plaintiffs contend that the true deterioration was far greater but accept that they are unable, on the evidence before the Court, to suggest that giving Lloyd's the figure for which they contend (£58,411,186) would have produced any particular reaction on Lloyd's part.

In view of the plaintiffs' concession the most that can be said is that E&W's admitted error indicates a lack of care on their part.

The use and accounting treatment of the T&D policy.

A considerable amount of evidence was directed to this subject.

As against Merretts the plaintiffs say that the true extent of the deterioration in year 4 was masked by the use of the T&D policy. However the plaintiffs accept that an informed reader of the accounts might have understood the effect of the T&D.

As against E&W the plaintiffs submit that E&W had inadequate audit evidence to satisfy themselves as to the timing and pattern of claims and as to the amount of future liability. The plaintiffs further submit that in circumstances where E&W had nothing more than necessarily highly subjective payment patterns, E&W ought not to have signed off on accounts in which full credit was taken for the anticipated future recoveries under the T&D policy.

E&W submit that the significance of this issue is extremely limited because the plaintiffs' case is that no fair RITC premium could be set whether or not a T&D policy was taken out. It is not their case that the taking out of the T&D policy made some crucial difference. E&W further submit that no case is, nor could sensibly be made, that if there had been no T&D, or if the T&D policy had been reported differently, the year would not have closed.

I have disregarded the use and accounting treatment of the T&D policy in reaching my conclusions in relation to year 4.

I have not had any regard to any comparison between 418/417 and Outhwaite syndicate 317/661 in reaching my conclusions in relation to year 4. 317/661 wrote many more run-off contracts. When it was suggested to Mr. McNamara in cross-examination that this syndicate had hardly any liability to asbestos and other latent claims in its own book, Mr. McNamara answered that 317/661's liability was predominantly in respect of run-off contracts. I refer again to Mr. Ayliffe's evidence about comparison betwen syndicates (see above).

36. YEAR 5 : THE CLOSURE OF 1983 INTO 1984 AS AT 31.12.85 (MERRETTS' AND E&W'S REPORTS DATED 2.6.86)

As to changes in stamp capacity, names etc. see Table 1 above.

In June 1986, 418/417's 1983 year of account was closed by way of an RITC into the 1984 year of account; and it was reported on by Merretts on 2.6.86.

In the 1985 Annual Report and Accounts for 418/417, were inter alia:

As to the regulatory regime for the year ended 31.12.85 see section 17 above.

As to developments and changes in perception in previous years see above. Perception in year 5 must be judged against this background.

As at 2.6.86 the future development and extent of (a) asbestos personal injury and (b) asbestos property damage and (c) pollution claims were in each case subject to very considerable uncertainty.

I refer to the chronology, Appendix 1 to this judgment (which in the case of attorneys' reports lists some examples of reports in Merretts' possession). As to the US cases at the above date see Appendix 2 to this judgment.

The nature and extent of the uncertainties as at 2.6.86 were known to Merretts and E&W, alternatively in the case of E&W would have been known to E&W had necessary and appropriate audit tests and enquiries been carried out and conducted.

The broad nature and extent of the uncertainties as at 2.6.86 were reflected in the following materials.

Where materials are drawn on which would probably have been available only to Merretts or E&W this is indicated in brackets.

On 19.6.85 the Asbestos Claims Facility (the Wellington Agreement) had been signed by 34 asbestos producers and 16 of their insurers. The gist of the facility was as follows :

Asbestos was seen as giving rise to the US's and the world's greatest occupational disease compensation problem.

As at July, August and October 1985 (Merretts only) Mr. Ayliffe said in the course of seminars held in Europe (addressed by Mr. Ayliffe and Mr. Rayment of Sturge):-

In my judgment the passage quoted above from the seminars addressed by Mr. Ayliffe and Mr. Rayment reflects the fundamental uncertainties in year 5 (and serves to confirm my conclusions in relation to year 4 as to the very considerable uncertainty as to the future development and extent of asbestos personal injury claims).

In addition:-

(a) As at August 1985 (Merretts only) a draft AWP report stated the following. There has been a noticeable increase in the rate at which new suits are being filed which raises the annual rate to 8,500 new cases per year. There are likely to be noticeable variations between different producer insureds. The recommendations do not make any allowance for IBNR and the market should not lose sight of the fact that new filings are being reported at a rate of 700 per month.

(b) As at August 1985 an attorney's report stated the following. Many factors complicate the setting of year end reserves at this time. In addition to the imponderables which have arisen, it has yet to be demonstrated that the necessary co-operation will be afforded by the plaintiff Bar to enable the ACF to achieve its objective of providing a viable cost-effective alternative to the tort system. Due to these uncertainties it is your counsel's recommendation that the market maintains a conservative approach in establishing reserves for the coming closing. There has been a noticeable increase in the rate at which new suits are being filed which raises the annual rate to 8,500 new cases per year. Our recommendations do not make any allowance for IBNR. New filings are being reported at a rate of 700 cases per month.

(c) As at September 1985 (Merretts only) a letter from the AWP to insurers at interest stated that it was too soon to measure the impact of the ACF; there has been acceleration of new claims filed currently running at 8,500 per year.

(d) As at September 1985 (Merretts only) the minutes of a meeting of the directors of MSL recorded the following. New claims were arising at the rate of approximately 700 cases per month. After the exhaustion of insurance protection in any year, the tendency of the US courts to move claims to immediately preceding years where protection had not been exhausted, created potential hazards in reserving. While recent claims are of a 'less serious' nature and the claims Facility is now available, much of these advantages could be eroded by inflation. It was extremely dangerous to make positive statements at the Names' meeting.

(e) As at October 1985 (E&W only) the Audit Planning memorandum for the year ended 31.12.85 recorded that it is rapidly becoming apparent that the potential claims arising from asbestosis will dwarf any claim in the history of the Non-Marine market.

(f) As at October 1985 (Merretts only) a memorandum from Mr. Randall stated that the trends indicated by the early reports (approximately 20% to date) look encouraging but there is potential for further deterioration on the large numbers of reports not yet seen and the impact could vary quite significantly from syndicate to syndicate.

(g) As at December 1985 (E&W only) a report to the assignment partner recorded the following. Last year saw a marked deterioration in the number of asbestos claims; the number of sufferers making claims having risen from 500 to 700 per month. This year the number of claims per month has risen to 1000 per month. It is hoped that the claims Facility will eventually result in a reduction in costs per claim, although these effects will not be seen for the first year.

(h) As at February 1986 (E&W only) a meeting between Lloyd's and recognised auditors was informed of the following. In the non-marine market, the ACF which was signed in June 1985 by 34 producers will lead to a revision in reserves at 31.12.85. There are at present about 46,000 claims in the market. Claims are being notified at the rate of about 1,000 per month but now appear to be "cheaper". On expense costs, as a result of the ACF, defence costs have fallen to about 20-25% but the Facility is making a charge of about 10% which is to be borne in the direct market only. The Johns Manville money invested in New York includes a London Market share of about $110m. This money is soon to be dispersed and this will represent a large cash outflow in 1986 on both direct claims and retrocessions.

(i) As at April 1986 (Merretts only) Mr. Jackson in an Address in Berlin stated that the reinsurance industry is facing the greatest crisis in its history.

(j) As at May 1986 (Merretts only) a letter from Mr. Jackson, Chairman of the AWP to insurers at interest stated the following. It is too early at this stage to project the reserve movement the London market is likely to see at the coming year-end, however there are now in excess of 40,000 claims outstanding, and new suits filed over the past year have reached a level of 1,000 filings per month. There has in addition been an increase in the average per case settlement level achieved by the ACF, which is in part affected by the recent resolution of a major class action in Texas. If no relief develops in these trends, it is likely that reserves will see a further deterioration.

(k) As at June 1986 (E&W only) E&W Insight stated that it is understood that by about the end of March 1986 some 8,000 claims had been cleared from an initial notification to the Facility of about 52,000 claims.

As to asbestos property damage claims as at July, August and October 1985 (Merretts only) Mr. Rayment, at the seminars referred to above, stated:-

In addition:-

(a) As at August 1985 an attorney's report stated that the market is aware that the ACF does not address property damage. The property damage issue of loss attachment date continues to be difficult because there are no appellate court coverage decisions which can be looked to for guidance.

(b) As at October 1985 an attorney's report stated that the property damage issues are no closer to a solution now than they were at year end 1984. Further, property damage is not yet addressed by the Facility Agreement. Producers are arguing for a Keene type of spread going from first installation through discovery, whereas insurers are maintaining that the date of occurrence should be tied into discovery. Since there is still uncertainty with respect to the property damage issues, the assessment of reserves continues to be most difficult.

(c) As at February 1986 (E&W only) the recognised auditors' meeting was told that asbestosis will also extend into property damage claims.

(d) As at May 1986 (Merretts only) a letter from Mr. Jackson to insurers at interest referred to the growing asbestos property damage problem.

(a) As at September 1985 (Merretts only) a letter to Mr. Jackson from US attorneys enclosed an updated booklet (165 pages) containing a list of companies that had been identified by the EPA as being potentially responsible parties at hazardous waste disposal sites in the US. An earlier booklet had been sent to Mr. Jackson the previous year. The letter stated:-

(b) As at September 1985 (Merretts only) the minutes of a meeting of the directors of MSL recorded that the pollution and seepage claims problem was potentially serious but much would depend on the attitude and interpretation of the US Courts to cases put before them.

(c) As at October 1985 (E&W only) the Audit Planning memorandum referred to above recorded that new laws regarding liability following pollution and other forms of environmental impairment could also produce problems for underwriters as these new laws appear to apply retroactively. Such subjects require constant reappraisal of the reserves set up in the past to deal with future claims.

(d) As at December 1985 (E&W only) a report to the assignment partner stated that environmental protection claims are causing some concern at the present time in view of the large number and settlement amounts.

(e) As at February 1986 (E&W only) the recognised auditors' meeting was told the following. Environmental Pollution claims will see an uplift of about 5% for legal costs. 1985 is not expected to see much movement on the Shell Rocky Mountain claim but the years 1986-1988 should see a greater movement.

(f) As at February 1986 (Merretts only) a letter from the Environmental Claims Group ("ECG") stated the following. In our last letter dated 19 November 1985 the ECG said that there were more than 15 declaratory judgment actions involving London underwriters already proceeding in various US courts. There are now more than 20 such actions. One of the differences between pollution and other matters currently facing underwriters is the great diversity of the problem. Where in asbestos we are concerned with the bodily injury and property damage claims brought in respect of the products of some 20 major assureds, pollution involves potentially hundreds or thousands of different assureds being sued by many different parties in respect of different types of injuries and damage. Underwriters have already been asked to give discovery of documents in the Shell Rocky Mountain litigation, Diamond Shamrock Dioxin litigation and a number of others. (Mr. Ayliffe was a member of the ECG).

(g) Mr. McNamara's Notes on Review of Run-off Contracts (D9/896) (E&W only) referred to "the list of noted toxic waste sites".

A notional reserving exercise was carried out at the half year by way of trial run for the exercise at the year end.

A summary of the reserving methodology was provided for the Revenue. In the case of Syndicate 417 it is at D9, p.814-825; in the case of Syndicate 418 it is at D9, p.827-836.

The RITC for 418/417 breaks down as follows :

417 418 Total

Main Account

- Net outstandings 35,040 16,653 51,693

- IBNR 23,206 23,762 46,968

58,246 40,415 98,661

Run-off Account

- Net outstandings 16,623 10,356 26,979

- IBNR 15,363 9,052 24,415

31,986 19,408 51,394

90,232 59,823 150,055

Roll-over/Asbestos

related claims Account (7,665) - (7,665)

Time & Distance Credit (53,793) - (53,793)

28,774 59,823 88,597

Net Underwriting

Result per Account (3,138) 17,287

SYNDICATE 417

The work carried out was similar to the work carried out before: Schedule B3(a) (J10/2) has the details. So also was the E&W work on outstandings: Schedule B3(b). The Audit Programme on the RITC is at p.408. The 417 print-out of outstanding claims proved to be inaccurate in several respects and amendments had to be made.

There had been an increase in the level of outstandings for asbestosis in the year from $21.51m (as to Merretts figure see Year 4 above) to $23.265m, an increase of $1.7m, considerably less than the previous year's increase of $5.6m (D6, p.280). The total new notings for asbestosis were $4.8m : D8, p.614. Of these $1.2m were outstandings in respect of Fibreboard, in respect of which Fireman's Fund had been reserving on a manifestation basis but were held liable on an exposure basis. Further - see Schedule C (J10/3) and Table 6 below - the rate of increase in incurred claims was as follows. From 1981-1982 (418/417 combined) the increase in incurred claims was $9.3m; from 1982-3 it was $2.4m; from 1983-4 it was $10.19m; from 1984-5 it was $6.6m; (from 1985-6 it was $5.3m).

The make-up of the RITC is set out at p.11 of Schedule A (J10/1) which is principally derived from the document headed "Merretts final version" at D8, page 581. That is Merretts' tabulation of the RITC showing a net premium of £28,773,550, the figure that went into the accounts. E&W's schedule at D8, p.580 CB/O produced a net premium of £28,885,944, a difference of £112,394 (the difference analysed at D8, p.583, was principally due to Merretts rounding certain US $ figures and is immaterial). The loadings used in relation to the specific categories appear at D8, page 586.

For the first time Merretts decided to apply different loadings to specific classes of business, viz:

(Different figures are found at D9 p.816 and D8 p.586. The plaintiffs accept that the differences are not material. Merretts say that in aggregate the outstandings are within $5,000 but the split is different).

E&W's review of Merretts' IBNR followed a similar pattern: Schedule B3(d) (J10/2). The Audit Programme is at D8, p.408. The RITC Meetings on 1.5.86 and 6.5.86 are at D8, p.274-280.

E&W's working papers in relation to asbestos loading have not survived. Mr. Hart's rationale - witness statement paras. 42 and 49, was as follows. The increase in gross outstandings in 1985 for Syndicates 799 and 417 combined represented 15% of the total outstandings at 31.12.85. According to Mr. Hart's witness statement (paragraph 49), Merretts took the view that there was "the equivalent of a further four more years development of claims at the same rate" as occurred during 1985. That would be a maximum of 60% of outstandings. In relation to the years 1966-68 the lower 50% figure was chosen because the reinsurance protection was stronger.

Mr. McNamara reviewed the proposed loading. He recognised that they constituted Merretts' "considered judgment of what is required but are generally highly arbitrary" - See Summary Review Memorandum page 6.

He compared - D8, p.611 - figures which he had estimated for further deterioration on individual policies, where there had been notifications of claims, with the figures reached by applying a 60% factor for IBNR. His figures totalled $6.6m. (Mr. McNamara's Schedules for the year do not survive). The reserve set up by the Agency by using 60% (mainly) was $13.5m. In effect, therefore, $6.9m ($13.5m - $6.6m) was provided for new or increased advices. In 1985 there had been $4.8m of new or increased advices in respect of the years 1953 to 1979: D8, p.614.

In the case of DES there had been an increase in notifications (matching the coming of age of the offspring of takers of the drug, which, itself, had been removed from the market in the 60's). The Agency expected a settlement to occur shortly. Neither DDT nor Agent Orange were significant in the context of the RITC. In respect of the Agent Orange claim there had been the class settlement in 1984 and the reserve of 25% related primarily to costs in relation to on going appeals.

Merrett's took the view (see the Minutes of the Marine Box Management Meeting of 9.9.85 - D7, p.27), that the 417 reserves created for Shell/EPA as at 31.12.84. would prove to be over-pessimistic. The loading reached after discussions between Mr. Randall, Mr. Jackson and Karen Ruby, was reduced to 75% of outstandings ($5.119m, almost exclusively Shell) which was according to the defendants equivalent to nine years further similar deterioration at the same rate as had occurred in 1985 (Mr. Hart, paragraph 53). The defendants say little movement had taken place in the market in the way of claims and there had been no new advice of any significance nor any claims paid. The plaintiffs say the following. As soon as Superfund was set up, the liability to clean up existed, with the possibility of claims being made against insurers. However by 1985, there had not yet been sufficiently co-ordinated action to identify and evaluate the quantum of claims. Advices had been received from insureds regarding potential problems (see Toplis & Harding 18.2.85: H2/134-8) but no effort was made to identify policies covering sites or assureds. Merretts acknowledged that they had received TBA claims, but did not identify burning and adjacent exposures (even to the limited extent of Mr. McNamara's asbestos exercise). The number of noted or TBA EPA claims (e.g. Love Canal, Lockheed etc. D6: 592, and Stringfellow, Times Beach, Shell Netherlands etc. D5:258) cannot now be established (see D9:896 "there is significant uncertainty regarding the trend in pollution claims and a substantial loading having regard to the list of toxic waste sites is necessary").

The Agency applied loadings based on RAA factors on a sliding scale. But the IBNR on the pre-1975 years of account was equivalent to 20% of outstandings. This loading was intended to take account of the possibility that some of the latent disease and environmental claims within the outstandings for those years might not have been specifically identified. For the years 1975 to 1983 the Agency applied individual loading factors to each year arrived at after consultation with Mr.Hart.

In respect of the run-off contracts there had been an increase in incurred losses in respect of DES and asbestosis (see J/10 Schedule D page 13). By now Merretts had developed their own computer system (per the plaintiffs a spreadsheet which recorded data received) for monitoring data from cedants from whom they had obtained information, following a questionnaire (substantially drafted by Mr. McNamara) sent round by Mr. Randall the previous autumn. Print-outs containing the information on an incurred basis are at p.622F. They give a break down of paid and outstanding claims. The figures are broken down as between Asbestosis, Shell, DES, DDT, Agent Orange, Pollution, Dalkon Shield and Other. See also J10/Schedule D which breaks the figures down into paid/outstanding/IBNR (a loading on outstandings).

Merretts considered three possible loadings on outstandings in respect of the run-off contracts and adopted the following (D8, p.620):

These are essentially the same loadings as applied to the Syndicate's own business, save that the asbestosis loading was 60% throughout.

A summary of the figures for outstandings and IBNR in relation to the run-off contracts is in Schedule D (J10/4). The underlying documents are CB 200/0 at D8, p.617/618 (summary of reserves and apportionment) and the CB 201 series at D8, p.622ff.

Mr. McNamara reviewed the proposed loadings on the run-offs. His notes on review of run-off contracts (D9 page 896 para.3) state:-

(The plaintiffs say there are no audit working papers or exercises evidencing the correlation. E&W say Mr. McNamara was the audit partner in respect of the audit of syndicate 975, and had therefore reviewed the approach being adopted by syndicate 975).

Syndicate 975 (Frizzell) was a non-marine syndicate which had underwritten liability business for several years prior to 1970. In essence Frizzell had looked at the potential for worsening of known claims and claims with nil reserves, the trend of new advices and multiplied the number of new advices anticipated by the average cost to their Syndicate per new advice. This produced a figure for IBNR which represented 58% of outstandings. J8 contains the exercise: pages 33-37.

Syndicate 975's 1983 year was in fact left open. Syndicate 975 had ceased to trade in 1985 and had reduced in size in 1984.

Mr. McNamara also reviewed the data in relation to the run-off contracts individually to consider how they might develop: see D9, p.896-7: para. 6ff. In particular he compared the loading with the level of deterioration in incurred losses during 1985. The run-off contracts were specifically considered, initially at the meeting on 1.5.86. -D7, p.274 at 277 - and then at the meeting on 6.5.86.: p.278.

The balance of the Roll over Fund (after using part to pay asbestos claims) was carried forward in the sum of $11.115m (£7.7m). The relevant workings are at D8, p.601.

The time and distance recovery of $78m (£53.8m) was again taken to credit (the premium accrued as at 31.12.84 having been paid during the year): D8, p.581. The Time and Distance Policy was referred to in the Accounts: E1, p.106..

The AU38(a) form for 418/417 is at D7, p.162. The AU17 form is at D7 p.171.

SYNDICATE 418

The work carried out by the Agency in relation to outstandings was similar to that carried out in previous years: Schedule B4(A) (J10/2). By now the marine claims outstanding summary was computerised: see D7, p.227 (manual) and D7, p.197 (computer). E&W's steps in reviewing the outstandings were similar: Schedule B4(b) (J10/2). The bad debt provision was dealt with on an item by item basis: D7, p.194.

This year the managing agents determined the RITC (apart from the run-offs) by calculations which initially assumed that, in respect of the several audit categories of marine business (Time, Voyage, Liability etc.) the size of the account was broadly similar from year to year and the pattern of settlement likely to be similar also. Thus, for the purpose of fixing a reserve for the 1983 year of account Time section, the initial assumption was that it would settle next year, i.e. 1986 (its fourth year) in much the same way as the 1982 year of account had settled in 1985 (its fourth year) and that in 1987 (its fifth year) it would settle in much the same way as the 1981 year of account had settled in 1985 (its fifth year). Similarly it was assumed that the 1982 year of account (already closed into 1983, now closing into 1984) would settle next year, i.e. 1986, its fifth year, in much the same way as the 1981 account had settled in 1985, its fifth year and that in 1987, its sixth year, it would settle in much the same way as the 1980 account had settled in 1985, its sixth year, etc.

The initial proposal of the Agency is at D7, p.265-270 from which it can be seen that - e.g. for the Time Account 1983 - the total outstandings, (i.e. the ultimate loss) is taken to be the amount settled in 1985 relating to 1982 and prior years ($2.67m) and a loading is derived by deducting from these figures, (slightly increased to £3m) noted outstandings.

The methodology, as finally adopted, is explained in the Summary of Reserves made for the Inland Revenue at D9, p.830 from which it can be seen that the £2.67m was considered inadequate and a final reserve of £4.106m was fixed for the 1982 Time Account: see D9, p.852 where O/S of £372,414 plus IBNR of £3,734,000 makes £4,106,144. In short, starting from a basic assumption, Merrett made changes reflecting circumstances applicable to individual years, so as to deduce an ultimate loss from which, by deduction of noted outstandings, an IBNR could be fixed. E&W extensively reviewed the workings of the ultimate loss ratio.

The RITC is set out in Schedule A (J10/1) and at D7, p.261. The RITC Meeting is at D7, p.274-280. The AU38(a) form is at D7, p.162; the AU17 form is at D7, p.171.

The reserves in respect of Asbestos for 417 amounted to £25.36m ($36.77m) (Main Account). The outstandings in respect of Asbestos for 418 amounted to £1.08m ($1.57m) (Main Account). There was no specific IBNR reserve in respect of absestos for 418 (Main Account).

The reserves in respect of Pollution for 417 amounted to £6.18m ($8.96m) (Main Account). The reserves in respect of Pollution for 418 were nil (Main Account).

The plaintiffs say that the reserves in respect of the run-off contracts (before reinsurance recoveries) amounted to £33.9m ($49.2m) asbestos and £7.5m ($10.8m) pollution. Merretts say that the reserves in respect of the run-off contracts (before reinsurance recoveries) amounted to £27.84m ($40.37m) asbestos and £6.25m ($9.06m) pollution. E&W say that the reserves in respect of the run-off contracts (before reinsurance recoveries) amounted to £27.41m ($39.74m) asbestos and £5.98m ($8.67m) pollution.

The reserves for asbestos (418/417 Main Account) represented 18% of the RITC for 418/417 (before T&D and rollover); the reserves for pollution 418/417 Main Account) represented 4% of the RITC for 418/417 (before T&D and rollover); the total reserves for the run-off contracts (being £51.39m) represented 34% of the RITC for 418/417 (before T&D and rollover).

418/417'S INTERNAL CONTROL PROCEDURES, SYSTEMS AND RESOURCES - YEAR 5

The contemporary documents show that as at year 5 there were serious deficiencies in 418/417's internal control procedures, systems and resources and that these deficiencies were known to Merretts and E&W. I refer to the section on this subject in year 4 above. What was needed, but lacking, was detailed involvement by Mr. Merrett in the RITC process.

As to Merretts' and E&W's knowledge of asbestos and pollution problems and uncertainties as at 2.6.86 see above.

418/417 in year 5 was subject to fundamental uncertainties as to the future development of (i) asbestos bodily injury claims (ii) asbestos property damage claims and (iii) pollution claims, not only in respect of its own book going back to 1953 but also in respect of the books of the 11 cedants (whose years of account reinsured are set out at Table 2 above). Looked at overall the uncertainties in year 5 were no less than those that obtained in year 4.

The uncertainties were compounded by the fact that there was inadequate information in relation to the run-off contracts to justify the closure of year 5 (albeit that there was considerably more information than in year 4).

As to asbestos claims 418/417 main account, the incurred claims as at 31.12.84 amounted to $27.072m. The corresponding figure as at 31.12.85 was $33.745m (see Table 6).

Given Merretts' knowledge of the fundamental uncertainties referred to above and of the additional uncertainties reflected in the detailed points as to Merretts set out below, I find that Merretts and in particular Mr. Merrett knew that a reinsurance to close figure could not be arrived at with a reasonable degree of accuracy/within a zone of reasonableness, and that Merretts should accordingly have left the year open. Having carefully considered all the evidence and formed an impression of the witnesses, I find that Merretts and in particular Mr. Merrett, while they knew that a reinsurance to close figure could not be arrived at with a reasonable degree of accuracy because of the extent of the uncertainties known to them, were nevertheless determined to close the year for commercial reasons. The commercial reasons were seen to be more important than the principle of equity between names. Further had Merretts declined to leave the year open E&W should have disclaimed an opinion on the grounds of fundamental uncertainty. Had they done so I find that on a balance of probabilities Merretts would have had no alternative but to leave the year open. I find that Mr. Neil's fundamental criticism (see above under year 4) was valid in year 5.

The documents do not suggest that Mr. Merrett himself spent any more than a very limited amount of time on the year 5 RITC.

As to E&W I accept the broad criticisms in relation to year 5 in Mr. Attwood's reports, as refined in his evidence. E&W should have realised that a reinsurance to close figure could not be arrived at within a zone of reasonableness. Given all the uncertainties referred to above and the detailed points set out below E&W should have disclaimed an opinion on the grounds of fundamental uncertainty.

I turn to consider some detailed points in relation to (A) Merretts and (B) E&W. Although it is necessary to refer at times to E&W in (A) and Merretts in (B) I have of course given separate consideration to their respective cases.

In reaching the conclusion that as at 2.6.86 the future development and extent of asbestos-related claims were subject to very considerable uncertainty I have placed primary reliance on the contemporary documents.

Mr. Hart at paragraph 49 of his witness statement said:-

Of those persons whose advice was said by Mr. Hart to have led to this loading being adopted, the only one to give evidence was Mr. Ayliffe. His evidence, when asked about the above passage in Mr. Hart's witness statement was as follows (Day 13/122/22 et seq):-

When Mr. Ayliffe's evidence as above was put to Mr. Hart, he agreed with it (Day 14/133-134). When Mr. Ayliffe's evidence was put to Mr. Randall he said "I believe that is the impression that I got at the time" (Day 24/49).

It is to be remembered that Mr. Ayliffe said in the course of the seminars held in Europe in July, August and October 1985:-

It is of course possible to point to conflicting indicators. The defendants point for example to the reduced rate of increase in incurreds (see Table 6 below) and the perceived advantages of the ACF, but when all relevant considerations are balanced fundamental uncertainties remained as reflected in Mr. Ayliffe's statement in Europe. There is an important difference between hope and the degree of certainty required to ensure a reasonable degree of accuracy for the purposes of a RITC.

In the Environmental Considerations Document of December 1985 (D8/402) E&W recorded:-

As to further matters relevant to asbestos see under the heading Run-off Contracts below.

Mr. Rayment, who accompanied Mr. Ayliffe to the seminars referred to above, described asbestos property damage claims as "perhaps a greater liability, certainly more difficult to evaluate at this stage... Reports say that it could be much larger than the bodily injury claims that we are seeing to date..."

The uncertainties in relation to pollution in year 5 were greater than in year 4. The state of the US authorities is set out in Appendix 2 to this judgment. Mr. Ayliffe referred in Europe to the experience of insurers before the US courts in the context of the asbestos problem. The attitude of the US courts to the proposed defences to pollution claims was at best uncertain.

As to the correct approach see year 4 above.

In a document entitled Matters for Partner Attention Mr. Potkins of E&W wrote:-

Mr. McNamara commented in respect of 2 "see my notes regarding comparability with 417 and 975" and in respect of 4 "as a general premise basis quite appropriate; although there remains substantial judgment".

D8/620 sets out three versions of the loadings. Mr. Potkins' note states that various versions of the loadings were considered with version 3 being the current 'final' set.

The notes of the RITC meeting on 1.5.86 (D7/274) record:-

In the course of this meeting Mr. Randall offered his initial comments on the run-off contracts. Despite the round-robin letter to the cedants (see for example the letter dated 11.9.85 to Burdett J/203) the notes of this meeting and further documents indicate that the information from cedants was unsatisfactory in year 5 (albeit that considerably more information was obtained than in year 4).

Further uncertainties in relation to the run-off accounts were referred to in the notes of the meeting held on 6.5.86 (D7/278).

In his Notes on Review of Run-off Contracts (D9/896) Mr. McNamara recorded:-

Mr. McNamara referred to a substantial increase in incurred losses during the year for Ballantyne.

As to the quality of information provided by the cedants Mr. McNamara recorded that for Sturge the quality of information provided was not wholly satisfactory as the analysis of the outstanding claims was incomplete. As to Toomey, Gooda and Dolling-Baker Mr. McNamara recorded that the quality of information provided on paid claims was inadequate particularly as they relate to 'other'. There was also some deficiency in information in relation to Judd.

The Summary Review Memorandum dated 31.5.86 contained similar general comments on the subject of the run-off contracts.

Mr. Randall said that Merretts had some difficulty getting analysis of the actual paid losses by category and had been unable to construct a database by policy of the asbestos exposures of the run-off contracts. He added that in other respects he thought Merretts were satisfied they had a sufficient amount of information and referred to "cartons full of information".

A number of other documents showed the unsatisfactory nature of information from the cedants. As to Dolling-Baker a document dated 19.4.86 (D9/768) stated:-

As to Gooda, a cedant which was considered to have good records, Mr. Randall accepted that there were difficulties in obtaining the necessary information and deficiencies in the information provided - see C17/401 - the letter dated 9.1.86 points 2, 3 and 4.

In the letter dated 19.2.86 in respect of Judd (D8/680) it was said that the syndicate maintained comprehensive records of major latent disease involvements which could be scrutinized by Merretts at any time. There is no evidence that Merretts took advantage of this offer in year 5.

There was very marked deterioration in the dollar provisions in respect of the run-off contracts between years 4 and 5 (after allowance for the addition of Judd in year 5) - see for example D10/404 (where 421 is also shown). D10/404 also identifies the different rates of deterioration as between the particular cedants. A comparison of the different rates of deterioration as between each of the 11 cedants and 418/417's own book at year 5 shows that an approach to loading which was undifferentiated as between each of the cedants and 418/417 could not safely be adopted.

For the reasons set out under year 4 above, in all the circumstances, a reasonably competent Lloyd's managing agent specializing in the writing of long tail risks would have recognised in year 5 that a reinsurance to close within a zone of reasonableness could not be ensured or even contemplated without evidence as to the run-off contracts similar in form to that relating to 418/417's own book of business. The relevant circumstances include inter alia the fact that 11 run-off contracts formed a constituent part of the 1983 account, the extent of the exposures (including asbestos and pollution risks) and the amount of the net outstandings referable to the run-off account (£26.979m/$39.1m).

The defendants say that it would have been difficult and/or impracticable to obtain this level of information but the need for this information was the result of the decision to write these particular run-off contracts. Whatever may have been the practice of the market in relation to reserving for other reinsurance liabilities, the nature and scale of these particular contracts required the approach referred to above.

It follows that Merretts had inadequate information in relation to the run-off contracts to justify the closure of year 5 (albeit that they had considerably more information than in year 4). Had they obtained the necessary further information this would have served to underline the extent of the uncertainties referred to above and to confirm that it was not possible to arrive at a RITC within a zone of reasonableness.

Merretts carried out no or no adequate margin of error calculations in relation to the reserves in respect of 418/417's own book and the books of each of the 11 cedants (where the information was in any event inadequate) to reflect the fundamental uncertainties as to the future development of (i) asbestos bodily injury claims (ii) asbestos property damage claims and (iii) pollution claims. Had Merretts carried out adequate margin of error calculations these would have served to confirm that it was not possible to arrive at a RITC figure with a reasonable degree of accuracy.

As to E&W's knowledge of asbestos and pollution problems and uncertainties as at 2.6.86 see above. E&W's knowledge was far less extensive than Merretts'. Mr. Attwood in his reports and evidence said that, in his view, because of the uncertain nature of asbestos liabilities and the materiality of the amounts involved, the representations made by Merretts as to the future development of these liabilities had to be corroborated by independent evidence before the representations could be accepted. Mr. Attwood singled out attorneys' reports as a source of such corroboration. The same point applies to pollution liabilities. Having regard to the extent of the asbestos and pollution problems, the extent of the exposure of 418/417's own book and the books of the 11 cedants to these problems, the materiality of the reserves in connection with asbestos and pollution, the critical importance of any assessment as to the future nature extent and development of these claims and the inaccuracy of previous estimates, I accept Mr. Attwood's evidence that it was incumbent upon E&W to review a sample of the attorneys' reports to test the representations made by Merretts. Had E&W reviewed a sample of attorneys' reports for this purpose in year 5, this would have served to confirm the extent of the fundamental uncertainties as to the future development of asbestos bodily injury claims, asbestos property damage claims and pollution claims.

The section under the heading (A) Merretts is repeated insofar as it applies to E&W. I add the following points.

E&W should have reviewed a sample of attorneys' reports to test the representations made by Merretts.

The Environmental Considerations Document of December 1985 recorded that there were known uncertainties with regard to potential new advices for property damage claims.

E&W knew of the list of noted toxic waste sites and that there was significant uncertainty regarding the trend in pollution claims (see D9/896 quoted above).

The section under the heading Merretts is repeated insofar as it applies to E&W.

As to the correct approach see year 4 above.

There was very marked deterioration in the dollar provisions in respect of the run-off contracts between years 4 and 5 (after allowance for the addition of Judd in year 5) - see for example D10/404 (where 421 is also shown). D10/404 also identifies the different rates of deterioration as between the particular cedants. A comparison of the different rates of deterioration as between each of the 11 cedants and 418/417's own book at year 5 shows that an approach to loading which was undifferentiated as between each of the cedants and 418/417 could not safely be adopted.

Although there was considerably more information available this year than in year 4, E&W failed to require Merretts to obtain all the necessary information as to each of the 11 run-off contracts, being evidence similar in form to that relating to 418/417's own book. It follows that E&W had inadequate audit evidence in relation to the run-off contracts to justify the opinion given. Had E&W obtained all the necessary audit evidence (see Mr. Attwood's paragraph 7.4.2) this would have served to underline the extent of the uncertainties referred to above and to confirm that E&W should have disclaimed an opinion on the grounds of fundamental uncertainty.

In the Notes on Review of Run-off Contracts quoted above, Mr. McNamara referred to syndicate 975 (Frizzell) where the managing agent was said to have done a very extensive exercise and applied a load of 65%. But Frizzell left their 1983 year open. I have already referred to the dangers of comparing any two syndicates. Further it is to be noted that Frizzell said:-

E&W carried out no or no adequate margin of error tests in relation to the reserves in respect of 418/417's own book and the books of each of the 11 cedants (where the information was in any event inadequate) to reflect the fundamental uncertainties as to the future development of (i) asbestos bodily injury claims (ii) asbestos property damage claims and (iii) pollution claims. Had E&W carried out adequate margin of error calculations these would have served to confirm that E&W should have disclaimed an opinion on the grounds of fundamental uncertainty.

For the reasons set out above I have with regret come to the conclusion that a reasonably competent Lloyd's panel/recognised auditor in year 5 would have disclaimed an opinion on the grounds of fundamental uncertainty. Without prejudice to all the points made in the detailed analysis above I refer in particular to:-

(1) the fundamental uncertainties as to the future development of (i) asbestos bodily injury claims (ii) asbestos property damage claims and (iii) pollution claims as reflected in the materials available to E&W.

(2) the references to uncertainties in the contemporary documents relating to the audit quoted/referred to above.

(3) the particular significance of the additional uncertainties in relation to pollution claims which became apparent in year 5.

(4) the fact that all the fundamental uncertainties had to be considered not only in respect of 418/417's own book going back to 1953 but also in respect of the books of the 11 cedants. There had been a funnelling of these claims with their attendant uncertainties into 418/417.

(5) the inaccuracies of previous estimates.

(6) E&W's failure to test or test adequately the representations made by Merretts as to the future development of asbestos personal injury, asbestos property damage and pollution claims.

(7) E&W's failure to require Merretts to obtain all the necessary information as to each of the 11 run-off contracts with the result that E&W had inadequate audit evidence in relation to these contracts (albeit that there was considerably more information than in year 4).

(8) the fact that had adequate margin of error calculations been carried out these would have served to confirm that it was not possible to arrive at a RITC within a zone of reasonableness.

(9) the fact that the reserve for asbestos-related and pollution claims represented a material proportion of the total reserves of the syndicate (see paragraph 8 of Mr. Murray Lawrence's letter of 18.3.82).

Further but without prejudice to all my findings set out above in relation to year 5, if year 4 had been left open (as I have

held it should have been), I find that the overwhelming probability is that the 1982 account would not have been closed as at 31.12.85. Had year 4 been left open this would have revealed to the names the nature and extent of the fundamental uncertainties to which 418/417 was subject. Quite apart from other considerations Merretts would have faced enormous pressure from members' agents representing names on subsequent years not to close the 1982 year. The probability is that Merretts would have been compelled to accede to such pressure.

(See in this connection the E&W meeting in respect of Outhwaite 317 on 9.5.85 (I4G/302) where Mr. McNamara said "... in view of the uncertainties ... it would be inevitable that we would have to give a form of opinion that was tantamount to a disclaimer and that as a consequence, the account would be likely to be left open probably for many years to come.")

Syndicate 421 left its 1983 account open for the following reasons:-

I add the above reference to 421 for completeness but for the avoidance of doubt I record that I have not paid any regard to 421 in reaching my conclusions set out above in relation to 418/417.

37. YEAR 6 : THE CLOSURE OF 1984 INTO 1985 AS AT 31.12.86 (MERRETTS' AND E&W'S REPORTS DATED 21.5.87)

As to changes in stamp capacity, names etc. see Table 1 above.

In May 1987, 418/417's 1984 year of account was closed by way of an RITC into the 1985 year of account; and it was reported on by Merretts, on 21.5.87.

In the 1986 Annual Report and Accounts for 418/417 were inter alia:

As to the regulatory regime for the year ended 31.12.86 see

above.

As to developments and changes in perception in previous years see above. Perception in year 6 must be judged against this background.

As at 21.5.87 the future development and extent of (a) asbestos bodily injury and (b) asbestos property damage and (c) pollution claims were in each case subject to very considerable uncertainty.

I refer to the chronology, Appendix 1 to this judgment (which in the case of attorneys' reports lists some examples of reports in Merretts' possession). As to the US cases at the above date see Appendix 2 to this judgment.

The nature and extent of the uncertainties as at 21.5.87 were known to Merretts and E&W, alternatively in the case of E&W would have been known to E&W had necessary and appropriate audit tests and enquiries been carried out and conducted.

The broad nature and extent of the uncertainties as at 21.5.87 were reflected in the following materials.

Where materials are drawn on which would probably have been available only to Merretts or E&W this is indicated in brackets.

(a) As at July 1986 (Merretts only) at a meeting of the AWP Mr. Ayliffe reported on the recent annual meeting of the ACF. At present there were 40,700 outstanding cases. 4,050 new cases had been notified to the Facility during the months of January to April. This was continuing the 1,000 new cases a month rate which had been experienced at the commencement of ACF operations. This was unexpected. It had been felt that notifications of new cases would fall off once the Facility was established.

(b) As at August 1986 (Merretts only) a letter from Toplis & Harding to members of the AWP enclosed a draft report proposed to be submitted by attorneys. The draft report stated that the rate of new law suits filed showed a steady increase to an average filing rate of 900 new cases per month during the course of the current year. 40,000 outstanding claims were yet to be addressed, and although there is evidence to indicate that more current filings relate to cases of less serious disability, the continuing up-surge of claims continues to be of concern. This difficulty is further heightened by the recent amendment to the New York Statute of Limitations in respect of certain hazardous products including disability arising out of the use of asbestos. The amendment allows claimants who were formerly time barred a 12 month period in which to file an action. Whilst it is difficult to foresee how much activity may now develop out of New York State, some observers have reported that up to 5,000 new filings can be expected, mainly arising from the Brooklyn Shipyards.

(c) As at August 1986 an attorney's report stated that from a recent analysis conducted by the Facility, the rate at which new law suits were filed has steadily increased from about 500 per month, which had been the consistent level over 1984/5, to an average filing of 900 cases per month during the course of the current year. Although there is evidence to indicate that more current filings relate to cases of less serious disability, the continuing up-surge of claims continues to be of concern.

(d) As at September 1986 (Merretts only) a letter from Mr. Jackson, as Chairman of the AWP, to the Guardian Royal Exchange stated that, as in the past, many imponderables continue to exist in projecting reserves for asbestos claims, the most significant being whether there is now developing a change in the severity levels in more recent filings. The letter also referred to the substantial volume of new filings.

(e) As at September 1986 (Merretts only) the minutes of a MUAM Board meeting recorded that the number of new losses being reported to the ACF is approximately 100% higher than anticipated but the potential deterioration is ameliorated by the following factors. The new claims tend to be for less serious physical injury; many assureds have now exhausted their insurance protection; it is anticipated that actual costs of settlement will fall particularly in view of the dramatic drop in defence costs from US$80m to 70m. However, the scope for deterioration on retrocessions is still difficult to assess.

(f) As at February 1987 Mr. Jackson addressed a recognised auditors meeting as to the continuing concern with asbestos. New cases are being advised at 1500 per month, which is higher than previously. The ACF means that expenses are down. It had been hoped that there would be a drop in claims in 1986 but this has not been evident. 900 new cases per month were reported in 1985, while 1500 new cases were reported in November and December 1986. The Facility settled claims at a higher rate than was expected. During the course of 1986 the London market expended approximately $70m in Facility billings and to some extent this figure was affected by accelerated cash-flow. Known claims will account for 25-30% increases in asbestos reserves at year end (31.12.86). Much of this increase will come from reinsurance and retrocessional contracts.

(g) As at February 1987 (Merretts only) a letter from Mr. Jackson, Chairman of the AWP to the insurers at interest dated 27.2.87 stated the following. There had been a substantial increase in the number of new law suits which arise from asbestos related causes. During the course of the first half of 1986 new cases were arising at the rate of approximately 900 new cases per month but as the end of the year approached a significant increase in new filings became apparent reaching a level of approximately 1,500 new cases for both November and December. The average cost of settlement per claim being achieved by the ACF has yet to reduce to the level which was the basis of the claimant reserve used in the calculations for year end reserves. There are a number of reasons why indemnity levels have not been capable of being reduced, the most significant being the aggressive attitude adopted by the Courts in the Texas class action and the material effect this has had upon the overall average settlement costs. Once again it has not to date proved possible to reduce the substantial outlay in regard to costs which are being incurred through the liaison counsel acting on behalf of the ACF. There are a number of reasons that bear upon this issue, the most significant of which is the pressure being exerted by various courts to speed up the number of cases which are addressed during the coming months. With this increased activity it appears unlikely that we shall see any meaningful reduction of legal costs during the present year. The main area of concern is the substantial increase that has developed in new filings which are clearly arising as a result of an all out effort by the plaintiff Bar in conjunction with the unions to canvas claimants from industries with only a remote asbestos involvement. Mass screening is developing in the tyre industry where pulmonary problems are said to exist due to an exposure to talc which may contain minimal quantities of asbestos and which is used in the moulding process. Similar screening activities are now being reported from the steel industry. The letter quoted an extract from a recent Wall Street Journal article which summed up this new form of ambulance chasing. It is significant that claims that are generated in this fashion arise from individuals who have little or no disability and even assuming that liability was to fall upon asbestos producers - which is questionable - the measure of damages should be minimal. For some time it has been the perception of the Facility that the quality of more recent filings was less serious than formerly. The average indemnity levels which we are experiencing in the Facility reflect the severity of claims arising some 5 years ago and it would be reasonable to anticipate some reduction to develop as we start to address more recent cases. I emphasized this point at a recent meeting of Panel Auditors as a consideration that needs to be kept in mind in endeavouring to address future loss development. The problems arising out of asbestos related claims continue to become more serious with the passage of time. Indeed many producers are now being forced to recognise the present trends are such that they must now contemplate that there will be a future point in time at which they exhaust all insurance coverage. The majority of claims arise from asbestos exposure in an occupational environment and for employees in certain occupations such as shipyards and railroads they already have protection afforded for occupation disease under existing Federal legislation. In the event that a Bill were to be passed by the House supporting this objective it would greatly ease the burdens being imposed upon asbestos producers under the strict product liability theories.

The Asbestos Hazard Emergency Response Act was passed in 1986.

(a) As at August 1986 (Merretts only) the draft report enclosed with the letter from Toplis & Harding referred to above stated that although there has been a steady increase in the number of property damage suits filed during the past year, there still exist many imponderables from a reserve stand-point.

(b) As at September 1986 an attorney's report referred to the general overall increase in property damage litigation and the fact that certain of the target defendants had been found liable for substantial damages.

On 17.11.86 the Superfund Amendments and Reauthorization Act was signed.

The Environmental Claims Reinsurance Group (ECRG) held its first meeting on 26.2.87. Mr. Ayliffe was a member.

(a) As at August 1986 (Merretts only) a letter from Toplis & Harding to members of the AWP stated that the Senate House Conference is now moving towards completion. It has agreed to impose a strict timetable upon EPA. The EPA must complete preliminary assessment of 23,000 potential sites by 1.1.88. These must be followed by site inspections at all sites by 1.1.89. Following this the EPA must increase the number of priority sites to 1,600. EPA does not even consider there to be an issue as to whether costs of remedial work are covered by liability insurance policies. Their view is that there is no question that such coverage exists under past liability policies.

(b) As at November 1986 (Merretts only) a letter from US attorneys to Merretts re Superfund Amendments and Reauthorization Act of 1986 stated the following. The Act's effect will clearly be to increase the pace and level of clean-up activity against persons and companies with environmental exposure. The Act will significantly increase potential liability exposure of the insurance and reinsurance communities. The potential aggregate exposure is difficult to quantify at present. It is likely to depend on judicial interpretations. Congressional sources indicate that the ultimate cost of the various clean-up programmes will be between $20 billion and $100 billion. Further recoveries of a substantial portion may be sought from insurers. Assuming, for the purposes of discussion that 75% is recovered, the loss by industry might range from $15 billion to $75 billion. In time, further recoveries of a substantial portion of that sum may be sought from insurers, and, even if discounted by a factor of 50%, the net potential aggregate exposure of the insurance and reinsurance industry may range from $7.5 billion to $37.5 billion. While these figures cannot be predicted with accuracy at this time, it is clear that, given the potential exposure, vigorous cost containment activities and close monitoring of clean-up site expenses will be significant in reducing the aggregate exposure. Equally important will be protection of contract rights and defences.

(c) As at January 1987 (Merretts only) a letter from attorneys to the ECRG enclosed an updated Priority List, identifying some 90 assureds.

(d) As at February 1987 at the meeting of recognised auditors referred to above it was stated that environmental pollution will account for increases in some reserves. The market will end up paying a lot on pollution but policy wordings may give us better defences than on asbestos. It appears inevitable that we are likely to see a continued growth in the involvement of the London market as new losses are reported. There appears to be a trend developing in the court findings arising out of various EPA coverage litigation which demonstrates more respect for the intent of insurers - namely that the seepage and pollution exclusion means what it says and that the date of damage cannot reasonably pre-date the time of discovery.

(e) As at April 1987 (Merretts only) a letter from attorneys to the ECRG stated the following. We have proposed, and the ECG has approved, the creation of a Priority List of assureds with pollution claims. The Priority List will include assureds whose pollution claims pose an imminent potential exposure to underwriters, involve a declaratory judgment action against underwriters, or require an indemnity or expense reserve. Because of the significant potential exposure of the pollution claims included on the Priority List, it is imperative that the Market be kept fully informed. The London market faces an enormous problem with the presentation of pollution claims. There are already many more assureds concerned with pollution than were concerned with asbestos. The number of pollution coverage lawsuits involving underwriters already exceeds the number brought during the whole of the asbestos problem.

By now Merretts were preparing much of the supporting documentation for the RITC e.g. the documents at D11, p.554 and the McNamara Schedules at D10, 317-341. This was the year in which MUAM became the Managing Agent.

The RITC breaks down as follows:-

- Net outstandings 37,018 18,843 55,861

- IBNR 22,623 18,004 40,627

59,641 36,847 96,488

Run-off Account

- Net outstandings 22,246 12,197¹ 34,443

- IBNR 20,257 5,692¹ 25,949

42,503 17,889 60,392

102,144 54,736 156,880

Roll-over/Asbestos

related claims Account (3,030) - (3,030)

Time & Distance Credit (62,989) (62,989)

36,125 54,736 90,861

Net underwriting result

per Account (6,119) 12,157

Footnote 1 cf D11 page 795.

The basis of the reserving is explained in the summary for the Inland Revenue which, in the case of 417 is D11, p.782 and in the case of 418 D11, p.795.

SYNDICATE 417

The work carried out was similar to that which had been carried out previously: Schedule B5(a) (J10/2). So also was E&W's work on outstandings: Schedule B5(b) (J10/2). The Audit Programme is at D10, p.304. An Audit Rationale is at CA1/A, D11, p.527-530.

E&W produced for this year spread sheets analysing improvements and deteriorations by class of business per year of account: see D11, p.533-542 (sterling) and p.543-548 (dollars). The spread sheets for Canadian dollars and combined currency do not survive. Merretts and E&W say the allocation of the settlement figures produced by Merretts per year were not reliable for that purpose and so the spread sheets were only used for comparing 1985 and 1986 outstandings: p.531. The plaintiffs have further criticisms of these spreadsheets.

The RITC for 1984 is set out in a number of documents. D11, page 597 - CB1/A - has the RITC in summary form. D11, pages 598 and 599 - CB1/B & C - have the same information in detailed form. Schedule A (J10/1) page 16 expresses in readable tabular form the contents of pages 598 and 599. This reconciles to page 13 of Schedule A which tabulates (in effect) page 597. The RITC Meeting is at D10 p.176.

The loadings on net outstandings (both for 417's own business and run-off contracts) were as follows (p.572):

The working papers - CA9 - in relation to the change of loading (see p.528) cannot be found. But it is clear from CA5/5-8 D11, p.558-561 that E&W considered the change and their observations are there set out.

The outstanding claims had reduced from $23,265,000 to $21,538,000 (less recoveries of $5,435,000). The rate of increase of incurred claims was reduced. For 1985 the incurred claims (for 417/418) were $33.7m. For 1986 they were $39.0m - an increase of $5.3m compared with an increase of $6.6m the year before: see J10, Schedule C.

The minutes of the RITC meeting on 16.4.87 record under the heading Asbestos:-

This approach was originally adopted by Mr. Hart in his paper at D11, p.574. The mathematics for the loading on net outstandings was as follows:

*Asbestos recovery: p.598.

(Merretts say the bulk of the new entries relate to reinsurance and retrocessional policies; it has not been possible to research these entries fully, but it is apparent that many of these are not new policies but further specific reserves being notified).

See also D11/561.

The outstanding figure for the Shell Rocky Mountain Claim was $3,150,000 (D11, p.598) which was the Syndicate's share on a worst case basis as outlined in attorneys' reports. Accordingly there was no separate IBNR. This was based on a total quantum of $300m (compared with $250m in the previous year). This was at a time when there was increasing doubt about the validity of the Shell claim. According to E&W's notes of the RITC meeting Mr. Merrett said that "in 1987 there was to be a case in London for Shell to demonstrate that it did have a claim; any subsequent case was likely to run for many years": D11, p.570. (Merretts say that it is extremely unlikely that Mr. Merrett said this. The Shell litigation was in the USA and Mr. Merrett would have known this as he had deposed as a witness in the case. E&W accept that the passage quoted may have been a mistaken reference to the coverage action in San Francisco).

Mr. Hart adopted a similar approach to "other" EPA as he did to asbestos: D11, p. 576. He looked at the increase in incurred claims in 1986 (of $3m gross), took the view it might last for another five years, making $15m in all which would produce a 200% loading on outstandings ie. twice the $7m which is the aggregate of the total at D11, p.580.

In his memorandum Mr. Hart said "It is, I believe, anyone's guess for how long such a level of activity will continue but I believe we would be very optimistic to assume anything less than 5 years".

The Minutes of the RITC meeting on 16.4.87 record the following under the heading EPA:

When applied to final net outstandings of $1,976,000 ($3,750,000 - $1,774,000 - D11, p.598) the resulting loading was $3,952,000. (The plaintiffs repeat their criticisms referred to in year 5 supra).

The same approach was adopted as with EPA so that the loading was $1,864,000 i.e. 200% of ($1,005,000 - $73,000): D11, p.598.

A loading of 20% overall was considered adequate. Merretts believed that they were fully reserved in respect of DES, for which there were gross outstandings of $5,174,000 - D11, p.598 (or D11, 555) - and in respect of which a settlement with Eli Lilly was in progress (and was reached in 1986). The IBNR loading was 10% on all save Eli Lilly, 25% for Eli Lilly, say 20% overall: see D11, p.575 of Mr. Hart's notes and the RITC meeting at D10, p.176. In the event no significant deterioration took place from then onwards.

This had ceased to be an issue. A large number of claims had been settled. There were outstandings of $56,000 (D11, p.599) set off by reinsurance recoveries of $97,000, producing a net balance in favour of the Syndicate. Merretts added 10% for fees and odds and ends.

Merretts applied (broadly) the same loadings to run-off contracts as they did in respect of the Syndicate's main account. (D11/790).

Schedule D (J10/4) shows the amount of the loadings for the run-off contracts for 1986 and, in respect of individual cedants the percentage for different categories of business. The base information from cedants was now produced six monthly and Merretts were testing the accuracy of the information provided against cedants' records. Where detailed information had not been provided by cedants, incurreds were determined by Merretts from the information available supplemented by Merretts' own knowledge.

The Audit file containing E&W's review of the run-off contracts cannot be found. E&W verified the loss information compiled by the Agency back to the submissions of the cedants D11/765-780: and the information derived from the cedants is tabulated at D11, p.806-817.

At the RITC meeting (typed Notes D11, p.569, MSS notes at D11, p.590) Mr. McNamara raised the question whether 418/417 ought to be left open given levels of uncertainty.

The minutes of the RITC meeting on 16.4.87 record:-

The Agency increased the time and distance policy cover by $40m to $118m for an additional premium of $24.8m. Mr. Hart produced a schedule setting out projected cash flows for the various types of business - D11, p.712 - in order to show that the timing of the recoveries under the T&D policy would match the payment of claims in the future. J14/tab.17 of the attachments to Hart's statement contains details of the method of calculating the time of payment of losses.

The Schedule was checked by E&W. The net effect of the additional protection less the additional premium was to reduce the losses for 1984 by £10.2m.

The T&D Policy was referred to in the Accounts: E2, page 255, note 6. This note expressly referred to the net benefit of the policy since (unlike in 1984) the additional benefit might not otherwise have been apparent. The T&D policy was also referred to in the Managing Agent's report: E2, p.211.

The balance of the Asbestos Suspense Account was taken into account namely £3m: D11, p.682.

SYNDICATE 418

The Agency's approach to determining outstandings was similar to the previous year: Schedule B6(a) (J10/2). The outstandings summary (on computer) is at D10, p.75-112. It includes reserves of $1,673,000 for asbestosis related claims viz :

There was also $200,000 for Environmental Pollution: D10, p.98 and $435,000 for toxic substances: D10, p.96. Merretts made a specific bad debt provision reached by an item by item review: D10, p.140.

The RITC is set out in tabular form at Schedule A, p.13 (J10/1) and in manuscript at D10, p.140 (which reconciles to the outstandings summary at D10, p.75).

E&W's review of outstandings was similar to the previous year: Schedule B6(b). The Audit Programme is at D10, p.68.

To determine the IBNR on the general account the Agency adopted, on the recommendation of Mr. Randall, a different approach, called the "chain ladder" approach. It is summarised in the explanation to the Inland Revenue at D11, p.799.

In essence they took the data available for the years of Account 1975-1984 on outstanding claims as at the third to twelfth years. From this - see D11, p.799 - they were able to calculate the ratio between incurred claims at the end of one year and those incurred at the end of the previous year. Thus for the 1975 year of account outstanding claims at 11 years were - see D11, p.801 - £17,674,000 which was 101.41% of £17,601,000 outstanding for the previous year. From this they deduced the average relationship (expressed as a percentage) of incurred claims at the end of any year, n, to the incurred claims at the end of the previous year (n-1): see line (a). They then calculated the relationship between the incurred claims in any one year and the claims incurred by the twelfth year (assumed to be final): line (b). Thus, on average, year 12 claims would be 99.35% of year 11 claims. Year 10 claims would be 100.13% of year 12 claims being, 100.79% of 99.35. This is because on average claims at year 11 are 100.79% of year 10 and claims at year 12 are 99.35% of year 11. Likewise outstanding claims at year 9 would be 98.97% of the year 12 figure, being 98.84% of 100.13 (i.e. the ratio of year 10 to year 9 multiplied by the ratio of the year 10 to year 12). From this an ultimate loss was projected by multiplying the outstanding claims at any given year by the percentage necessary to project the claims to year 12. This produced a reserve of £14,825,000. The Agency took the view that the use of ratios which supposed a decrease in incurreds in a later year would produce an unacceptable distortion in the prediction. So a second calculation was done - D11, p.802 whereby 100% was substituted in line (a) on those occasions where a lower figure had previously appeared. This produced a loading of £18,005,000.

In respect of the run-off contract the reserving method was the same as for Syndicate 417.

The Minutes of the Meeting are at D10, p.171 or 173. At the meeting Mr. McNamara raised a concern that no reserve had been included for 1974 and prior and that claims, such as pollution, arising out of policies written in old years might be notified. Mr. Merrett said that the Agency had considered the impact of pollution and that the impact of notification on such years had been fairly light, and that the reinsurance programme was in good shape so that single loss damage (into which category pollution fell) was still covered. Following discussion E&W accepted the Agency's determination of 418 RITC to be reasonable.

The AU38(a) for the combined Syndicates is at D10, p.252. The Solvency Report for 418 is at D10, p.262. The Solvency Report for 417 is at D10, p.448.

The reserves in respect of Asbestos for 417 amounted to (plaintiffs) £22.17m/(defendants) 18.49m ($32.81m/27.38m) (Main Account). The outstandings in respect of Asbestos for 418 amounted to £1.13m ($1.67m) (Main Account). There was no specific IBNR reserve in respect of asbestos for 418 (Main Account).

The reserves in respect of Pollution for 417 amounted to (plaintiffs) £7.33m/(defendants) 6.13m ($10.85m/9.08m) (Main Account). The reserves in respect of Pollution for 418 amounted to £.135m ($.2m) (Main account).

The plaintiffs say that the reserves in respect of the run-off contracts (before reinsurance recoveries) amounted to £36.36m ($53.85m) asbestos and £12.48m ($18.47m) pollution. Merretts say that the reserves in respect of the run-off contracts (before reinsurance recoveries) amounted to £30.9m ($45.75m) asbestos and £8.93m ($13.21m) pollution. E&W say that the reserves in respect of the run-off contracts (before reinsurance recoveries) amounted to £27.9m ($41.29m) asbestos and £8.98m ($13.28m) pollution.

The reserves for asbestos (418/417 Main Account) represented 15/13% of the RITC for 418/417 (before T&D and rollover); the reserves for pollution (418/417 Main Account) represented 5/4% of the RITC for 418/417 (before T&D and rollover). The total reserves for the run-off contracts (being £60.39m) represented 39% of the RITC for 418/417 (before T&D and rollover).

418/417'S INTERNAL CONTROL PROCEDURES, SYSTEMS AND RESOURCES - YEAR 6

The contemporary documents show that as at year 6 there were serious deficiencies in 418/417's internal control procedures, systems and resources and that these deficiencies were known to Merretts and E&W.

I refer to the section on this subject in year 4 above.

What was needed, but lacking, was detailed involvement by Mr. Merrett in the RITC process.

As to Merretts' and E&W's knowledge of asbestos and pollution problems and uncertainties as at 21.5.87 see above.

418/417 in year 6 was subject to fundamental uncertainties as to the future development of (i) asbestos bodily injury claims (ii) asbestos property damage claims and (iii) pollution claims, not only in respect of its own book going back to 1953 but also in respect of the books of the 11 cedants (whose years of account reinsured are set out at Table 2 above). Looked at overall the uncertainties in year 6 were certainly no less than those that obtained in years 4 and 5.

The uncertainties were compounded by the fact that there was inadequate information in relation to the run-off contracts to justify the closure of year 6 (albeit that there was considerably more information than in year 4).

As to asbestos claims 418/417 main account, the incurred claims as at 31.12.85 amounted to $33.745m. The corresponding figure as at 31.12.86 was $39.043m (see Table 6).

Given Merretts' knowledge of the fundamental uncertainties referred to above and of the additional uncertainties reflected in the detailed points as to Merretts set out below, I find that Merretts and in particular Mr. Merrett knew that a reinsurance to close figure could not be arrived at with a reasonable degree of accuracy/within a zone of reasonableness, and that Merretts should accordingly have left the year open. Having carefully considered all the evidence and formed an impression of the witnesses, I find that Merretts and in particular Mr. Merrett, while they knew that a reinsurance to close figure could not be arrived at with a reasonable degree of accuracy because of the extent of the uncertainties known to them, were nevertheless determined to close the year for commercial reasons. The commercial reasons were seen to be more important than the principle of equity between names. Further had Merretts declined to leave the year open E&W should have disclaimed an opinion on the grounds of fundamental uncertainty. Had they done so I find that on a balance of probabilities Merretts would have had no alternative but to leave the year open. I find that Mr. Neil's fundamental criticism was valid in year 6 (see above under year 4).

The documents do not suggest that Mr. Merrett himself spent any more than a very limited amount of time on the year 6 RITC. Mr. Hill's manuscript notes taken at the RITC meeting on 16.4.87 (D11/591) indicate that Mr. Merrett left the meeting (which started at 8.35 a.m. and finished at 10.31 a.m.) at 9.33 a.m. before the critical discussion as to whether or not the year should be left open took place.

As to E&W I accept the broad criticisms in relation to year 6 in Mr. Attwood's reports, as refined in his evidence. E&W should have realised that a reinsurance to close figure could not be arrived at within a zone of reasonableness. Given all the uncertainties referred to above and the detailed points set out below E&W should have disclaimed an opinion on the grounds of fundamental uncertainty.

I turn to consider some detailed points in relation to (A) Merretts and (B) E&W. Although it is necessary to refer at times to E&W in (A) and Merretts in (B) I have of course given separate consideration to their respective cases.

Mr.Hart's undated memorandum (D11/574) recorded:-

On about 7.3.87 Mr. Hart had seen the memorandum from Mr. Jackson to the market dated 27.2.87 (see above). When he was cross-examined about his undated memorandum he said:-

In the course of his evidence Mr. Ayliffe referred to the substantial increase in the rate of new filings subsequent to the ACF. He said:-

Mr. Randall was also asked about deterioration:-

Mr. Hart accepted that no exercise was performed by Merretts in an attempt to quantify the consequences of, on the one hand, the decrease in the seriousness of asbestos claims that were being made against, and on the other hand, the increase in the number of such claims.

The notes of the RITC meeting on 16.4.87 record:-

When asked about "the view that asbestos claims were starting to tail off because the use of the product had stopped a long time ago and there had been a concerted effort to discover claimants" Mr. Hart accepted that "there seems to be a discrepancy there".

Although Mr. Jackson's letter as Chairman of the AWP to insurers at interest dated 10.6.87 (G/230) came after the closure of year 6 on 21.5.87 the probability is that certain of the views as to asbestos property damage claims in that letter were held by Mr. Jackson as at 21.5.87 including for example the growing concern at the steadily increasing number of claims and the following sentence:-

In his undated memorandum (D11/574) Mr. Hart recorded:-

When he was asked about this passage Mr. Hart said:-

The notes of the RITC meeting on 16.4.87 record:-

As to the correct approach see year 4 above.

Merretts applied (broadly) the same loadings to the run-off contracts as they did in respect of the syndicate's main account (D11/790).

As to the difficulties of obtaining information from the cedants in year 6 see D11/770 Dolling-Baker, 774 Toomey and 778 Fireman's Fund/Sturge and Day 41/52 et seq.

There was very marked deterioration in the dollar provisions in respect of the run-off contracts between years 4, 5 and 6 (after allowance for the addition of Judd in year 5) - see for example D10/404 (where 421 is also shown). D10/404 also identifies the different rates of deterioration as between the particular cedants. A comparison of the different rates of deterioration as between each of the 11 cedants and 418/417's own book at year 6 shows that an approach to loading which was undifferentiated as between each of the cedants and 418/417 could not safely be adopted.

For the reasons set out under year 4 above, in all the circumstances, a reasonably competent Lloyd's managing agent specializing in the writing of long tail risks would have recognised in year 6 that a reinsurance to close within a zone of reasonableness could not be ensured or even contemplated without evidence as to the run-off contracts similar in form to that relating to 418/417's own book of business. The relevant circumstances include, inter alia, the fact that 11 run-off contracts formed a constituent part of the 1984 account, the extent of the exposures (including asbestos and pollution risks) and the amount of the net outstandings referable to the run-off account (£34.443m/$50.975m).

The defendants say that it would have been difficult and/or impracticable to obtain this level of information but the need for this information was the result of the decision to write these particular run-off contracts. Whatever may have been the practice of the market in relation to reserving for other reinsurance liabilities, the nature and scale of these particular contracts required the approach referred to above.

It follows that Merretts had inadequate information in relation to the run-off contracts to justify the closure of year 6 (albeit that they had considerably more information than in year 4). Had they obtained the necessary further information this would have served to underline the extent of the uncertainties referred to above and to confirm that it was not possible to arrive at a RITC within a zone of reasonableness.

It is to be noted that in this year Merretts began to appreciate the need for more evidence from the cedants. In the minutes of the MUAM Board Meeting on 17.2.87 (G/200) Mr. Randall noted that:-

In the minutes of a meeting of the directors of Merrett Holdings PLC on 30.4.87 (G/208) the following is recorded under the heading Run-Off Contracts:-

Further a document entitled Syndicate 417 Reinsurance To Close The 1984 Account dated 7.9.87 (D11/790) prepared by Merretts recorded that:-

The notes of the RITC meeting on 16.4.87 recorded:-

In his witness statement Mr. Merrett said "we reviewed what we perceived to be the greatest predictable adverse movement from our estimate: we reviewed that figure, $20m, against the combined stamp of syndicate 418/417 and determined that the variation of 10%, even if it transpired, was tolerable. We therefore decided that although the range of final outcomes appeared larger than before, it in no way prevented the proper closing of the year." It is to be remembered that according to Mr. Hill's note Mr. Merrett was not present at this point in the discussion. When giving evidence about the same passage in the minutes Mr. Randall's evidence was as follows:-

Merretts carried out no or no adequate margin of error calculations in relation to the reserves in respect of 418/417's own book and the books of each of the 11 cedants (where the information was in any event inadequate) to reflect the fundamental uncertainties as to the future development of (i) asbestos bodily injury claims (ii) asbestos property damage claims and (iii) pollution claims. Had Merretts carried out adequate margin of error calculations these would have served to confirm that it was not possible to arrive at a RITC figure with a reasonable degree of accuracy. I refer to the references above to "anyone's guess", "guesstimates" and "indications".

(B) E&W

As to E&W's knowledge of asbestos and pollution problems and uncertainties as at 21.5.87 see above. E&W's knowledge was far less extensive than Merretts'. Mr. Attwood in his reports and evidence said that, in his view, because of the uncertain nature of asbestos liabilities and the materiality of the amounts involved, the representations made by Merretts as to the future development of these liabilities had to be corroborated by independent evidence before the representations could be accepted. Mr. Attwood singled out attorneys' reports as a source of such corroboration. The same point applies to pollution liabilities. Having regard to the extent of the asbestos and pollution problems, the extent of the exposure of 418/417's own book and the books of the 11 cedants to these problems, the materiality of the reserves in connection with asbestos and pollution, the critical importance of any assessment as to the future nature extent and development of these claims and the inaccuracy of previous estimates, I accept Mr. Attwood's evidence that it was incumbent upon E&W to review a sample of the attorneys' reports to test the representations made by Merretts. Had E&W reviewed a sample of attorneys' reports for this purpose in year 6, this would have served to confirm the extent of the fundamental uncertainties as to the future development of asbestos bodily injury claims, asbestos property damage claims and pollution claims.

The section under the heading (A) Merretts is repeated insofar as it applies to E&W. Mr. Hart's undated memorandum (D11/574) was seen by E&W.

There is an audit working paper at D11/561 where the following was noted:-

The 417 Summary Review Memorandum (D10/271(1)) recorded:-

E&W should have reviewed a sample of attorneys' reports to test

the representations made by Merretts.

In an undated note on EPA (D10/315) Mr. Hill of E&W noted:-

E&W appreciated that the US courts might not give effect to the exclusion clauses. An undated note (D11/560) recorded:-

The section under the heading Merretts is repeated insofar as it applies to E&W.

As to the correct approach see year 4 above.

There was very marked deterioration in the dollar provisions in respect of the run-off contracts between years 4, 5 and 6 (after allowance for the addition of Judd in year 5) - see for example D10/404 (where 421 is also shown). D10/404 also identifies the different rates of deterioration as between the particular cedants. A comparison of the different rates of deterioration as between each of the 11 cedants and 418/417's own book at year 6 shows that an approach to loading which was undifferentiated as between each of the cedants and 418/417 could not safely be adopted.

Although there was considerably more information available this year than in year 4, E&W failed to require Merretts to obtain all the necessary information as to each of the 11 run-off contracts, being evidence similar in form to that relating to 418/417's own book. It follows that E&W had inadequate audit evidence in relation to the run-off contracts to justify the opinion given. Had E&W obtained all the necessary audit evidence (see Mr. Attwood's paragraph 7.4.2) this would have served to underline the extent of the uncertainties referred to above and to confirm that E&W should have disclaimed an opinion on the grounds of fundamental uncertainty.

The Summary Review Memorandum for 418 (D10/10(1)) recorded:-

E&W carried out no or no adequate margin of error tests in relation to the reserves in respect of 418/417's own book and the books of each of the 11 cedants (where the information was in any event inadequate) to reflect the fundamental uncertainties as to the future development of (i) asbestos bodily injury claims (ii) asbestos property damage claims and (iii) pollution claims. Had E&W carried out adequate margin of error calculations these would have served to confirm that E&W should have disclaimed an opinion on the grounds of fundamental uncertainty.

For the reasons set out above I have with regret come to the conclusion that a reasonably competent Lloyd's panel/recognised auditor in year 6 would have disclaimed an opinion on the grounds of fundamental uncertainty. Without prejudice to all the points made in the detailed analysis above I refer in particular to:-

(1) the fundamental uncertainties as to the future development of (i) asbestos bodily injury claims (ii) asbestos property damage claims and (iii) pollution claims as reflected in the materials available to E&W.

(2) the references to uncertainties in the contemporary documents relating to the audit quoted/referred to above.

(3) the particular significance of the additional uncertainties in relation to pollution claims which became apparent in year 6.

(4) the fact that all the fundamental uncertainties had to be considered not only in respect of 418/417's own book going back to 1953 but also in respect of the books of the 11 cedants. There had been a funnelling of these claims with their attendant uncertainties into 418/417.

(5) the inaccuracies of previous estimates.

(6) E&W's failure to test or test adequately the representations made by Merretts as to the future development of asbestos personal injury, asbestos property damage and pollution claims.

(7) E&W's failure to require Merretts to obtain all the necessary information as to each of the 11 run-off contracts with the result that E&W had inadequate audit evidence in relation to these contracts (albeit that there was considerably more information than in year 4).

(8) the fact that had adequate margin of error calculations been carried out these would have served to confirm that it was not possible to arrive at a RITC within a zone of reasonableness.

(9) the fact that the reserve for asbestos-related and pollution claims represented a material proportion of the total reserves of the syndicate (see paragraph 8 of Mr. Murray Lawrence's letter of 18.3.82).

Further but without prejudice to all my findings set out above in relation to year 6, if year 4 had been left open (as I have held it should have been), I find that the overwhelming probability is that the 1982 account would not have been closed at 31.12.86. Had year 4 been left open this would have revealed to the names the nature and extent of the fundamental uncertainties to which 418/417 was subject. Quite apart from other considerations Merretts would have faced enormous pressure from members' agents representing names on subsequent years not to close the 1982 year. The probability is that Merretts would have been compelled to accede to such pressure. (See in this connection I4G/302).

TABLE 6

MERRETT 418/7 ASBESTOS CLAIMS (MAIN ACCOUNT) IN US$'000

In year Cumulative Outstanding Incurred IBNR Ultimate Deterioration as

Year paid claims paid claims claims claims claims % of prior year

1981 5,276 5,276 2,888 8,164

1982 313 313 14,198 14,511 16,200 30,711 276

1983 389 702 16,178 16,880 13,050 29,930 -3

1984 4,606 5,308 21,764 27,072 15,257 42,329 41

1985 3,602 8,910 24,835 33,745 13,502 47,247 12

1986 6,922 15,832 23,211 39,043 11,272 50,315 6

Note

The asbestos claims in Syndicate 418 were not separately identified for all years

Where information is available it has been included.

combined per Other items

RITC noted on

summary Syndicate 418 Total

1981

Outstanding claims 5,276 5,276

IBNR 2,888 2,888

1982

Outstanding claims 13,754 444 14,198

IBNR 16,200 16,200

1983

Outstanding claims 15,928 250 16,178

IBNR 13,050 13,050

1984

Outstanding claims 21,514 250 21,764

IBNR 15,257 15,257

1985

Outstanding claims 23,265 1,570 24,835

IBNR 13,502 13,502

1986

Outstanding claims 21,538 1,673 23,211

IBNR 11,272 11,272

38. CONTRIBUTORY NEGLIGENCE

The Law Reform (Contributory Negligence) Act 1945 provides:-

If, as I have found, the plaintiffs succeed in their allegation that E&W were negligent in years 4, 5 and 6 and thereby caused the plaintiffs damage, E&W rely on section 1(1) of the 1945 Act.

E&W do not seek to prove that some or all of the individual names had actual personal knowledge of the alleged deficiencies in the RITCs and were, as a result of a failure to look after their own interests in the light of such actual knowledge, personally at fault. E&W do, however, contend that they are entitled to claim that the damages suffered by the plaintiffs were "as the result partly of (their) own fault" for three reasons:

(1) Names (direct and indirect) had delegated the entire conduct of their business as a name on 418/417 to Merretts who wrote the RITC on their account. For the purposes of determining whether the plaintiffs were at fault, they cannot properly disassociate themselves from Merretts.

(2) Indirect names had delegated the entire conduct of their underwriting business to their members' agents in the first place. They, therefore, also cannot disassociate themselves from their particular member's agent. The damages were caused as a result of the fault of the members' agents because (a) they are contractually responsible for the acts of Merretts to whom they sub-delegated their responsibilities; (b) Merretts' knowledge falls to be imputed to them. Armed with that imputed knowledge, they were in a position to and should have stopped each of the RITCs.

(3). The knowledge of Merretts is to be treated as the knowledge of the names, whether they are direct or indirect Names. As a matter of law the names are to be treated as if they knew all the facts relating to the RITCs. Accordingly, they were personally at fault in that armed with their imputed knowledge they did nothing to stop any of the RITCs.

As to the fault of Merretts, E&W submit that while the acts of a servant or agent for which a principal is vicariously liable to a third party would be a basis for reducing the principal's damage pursuant to the Act, it does not follow, as the plaintiffs contend, that such a circumstance is the only case where a principal is liable. Ultimately, it is submitted that issue is largely one of common sense, as evidenced by the Superhulls Cover case [1990] 2 Lloyd's Rep 431. E&W further submit the following. The fact that the plaintiffs delegated the entire conduct of their business without any right to interfere is a reason for associating the plaintiffs with the acts of their agents. The only relevant question is whether when Merretts were at fault, their fault is to be treated as the fault of the plaintiffs in the context of their relationship with and claim against E&W.

As to the fault of the members' agents and of the plaintiffs themselves, E&W refer to Article 102 in Bowstead and submit that it follows that the knowledge of Merretts regarding the status of the RITCs and the allegedly uncertain nature of the assessment of the reserves for asbestos and pollution liabilities falls to be treated as the knowledge of the plaintiffs, whether they are direct or indirect names, and of the members' agents. Armed with such knowledge the plaintiffs and the members' agents were at fault in failing to do anything to prevent the RITCs.

The plaintiffs submit that section 1 of the 1945 Act has no application inter alia for the following reasons.

1. The question which arises is whether a principal who is the plaintiff can have his damages reduced because of the contributory negligence of his agent. On first principles, if the agent is his servant the answer must be in the affirmative. This is because the actions of his servant are in law his actions. In the case of a director, the case is even stronger because the actions of the director are the actions of the company, as the company cannot act other than through its directors. Thus the contributory negligence of the director is the contributory negligence of the company and questions of agency do not arise. This is subject to a rider as follows - even where on general principles the contributory negligence of an agent can be ascribed to a principal, i.e. in the master/ servant context, the courts are reluctant to apply the general rule in circumstances where the defendant's breach of duty concerns the very relationship of the master to his servant. This arises in the case of negligence by auditors. If the auditor's employment covers the detection of defaults by the plaintiff's servants or directors, it is anomalous that the plaintiff master/company can be held guilty of contributory negligence where that negligence might have been avoided if the auditor/defendant had not been in breach of his obligations.

If, however, the agent is an independent contractor, on the same first principles, the plaintiff is not responsible for the contributory negligence of his agent. The managing agents and the members' agents are independent contractors of the plaintiffs, and there can be no question of any "ascribing" of their contributory negligence to the plaintiffs.

2. The doctrine of identification has no application where there would be no vicarious liability for the negligence of the agent. Further the plaintiffs would not be vicariously liable for the negligence of the managing agents because inter alia the contractual relationship between the plaintiffs and the managing agents through the chain of agency and sub-agency agreements specifically precludes any involvement or interference by the name with the agents' conduct of the underwriting of insurance business. Further the managing agent was obliged to have regard to the interests of two distinct sets of names in ensuring that any RITC premium set for closure of the year was likely to ensure equitable treatment between them. This is not consistent with the managing agent acting on behalf of the potential reinsuring names in the same sense as when conducting the day to day business of 418/417's year of account.

3. Even if (contrary to the plaintiffs' primary case) this is a case in which it is possible as a matter of principle for the plaintiffs recovery to be reduced having regard to the negligence of the managing agents, the court has a discretion to decide by what amount if any it would be just and equitable to reduce the plaintiffs' damages. This is a case in which it would be wholly unjust and inequitable to reduce the amount of the plaintiffs' recovery against the auditors. The whole rationale of the plaintiffs employing independent auditors to report to them on the state of the syndicate's financial position was that there should be an independent evaluation of the managing agents' statements as to the financial consequences of their actions on behalf of the plaintiffs. It makes a nonsense of the purpose for which the auditors were employed if the names' claim against the auditors is defeated by reason of the very negligence to which the auditors were supposed to be alerting the names. The proper mechanism by which E&W can ensure that the fault of the managing/members' agents is reflected in the amount E&W have to pay to the plaintiffs, is by seeking contribution pursuant to section 1 of the Civil Liability (Contribution) Act 1978.

In De Meza v Apple [1974] 1 Lloyd's Rep 508 Brabin J. held in a case where an auditor was employed by solicitors to complete consequential loss insurance certificates that the plaintiffs had been contributorily negligent in failing to take action in respect of a particular certificate. The solicitors were partly to blame for not noticing the mistake in the figures.

In the Superhulls Cover case supra, issues arose as to whether brokers were in breach of duty for failing to inform insurers that certain reinsurance was subject to a 48 months clause and whether the insurers themselves were contributorily negligent. Phillips J. held the following. The duties broken by the broker did not lie exclusively in contract; there were concurrent remedies in contract and in tort. A broker who sought to persuade an insurer to write a line of original insurance by informing him that specific reinsurance cover was available, was in a relationship with the insurer which gave rise to a duty of care in tort. Although the insurers owed no duty to the brokers to read the insurance wording with reasonable skill and care and to draw attention to any inadequacies in the cover, an insurer who was exercising reasonable skill and care in relation to the business he was conducting would have noticed the 48 month clause and would have queried its presence and effect with the brokers. The insurers were contributory negligent in that they failed to exercise reasonable care in carrying out what they accepted were customary checks on the manner in which the brokers had performed their duty, and the insurers' damages were accordingly reduced by 20%. (c.f. The Moonacre [1992] 2 Lloyd's Rep 501).

The New Zealand Contributory Negligence Act 1947 is modelled on the 1945 Act as are the statutes adopted by the jurisdictions within Australia. The Canadian legislation is similar in that it applies where there has been "fault" or "negligence" on the part of the defendant. I refer to a number Australian, Canadian and New Zealand Authorities.

Nelson Guarantee v Hodgson [1958] N.Z.L.R. 609 McCarthy J.

Pacific Acceptance Corp v Forsythe (1970) 92WN (NSW) 29, Moffit J.

West Coast Finance Ltd. v. Gunderson, Stokes, Walton & Co. 44 DLR (3d) 232, MacDonald J. and on appeal at (1975) 56 DLR 461.

In Simonius Vischer & Co. v Holt & Thompson [1979] 2 NSW LR 322 (New South Wales Court of Appeal) Moffitt P. said:-

Samuels J.A. said that the submission that a defence of contributory negligence was open to the defendants raised questions of considerable interest and complexity which were not necessary to resolve for reasons which he gave.

H.E. Kane Agencies Ltd. v Coopers & Lybrand (1983) 23 CCLT 233, Hoyt J.

In Revelstoke Credit Union v Miller (1984) 28 CCLT 17, McEachern CJSC said at page 52:-

I have found that the plaintiff's loss after early March, 1979 was caused by the concurrently operating negligence of both the auditors and Mr. Rafuse. The negligence of the latter is properly attributed to the plaintiff so each party should make good the loss in proportion to the degree in which each was at fault."

Walker v Hungerfords (1987) 44 SASR 532.

Fletcher v National Mutual Life Nominees Ltd [1990] 1 NZLR 97, Henry J.

Extensive consideration of the defence of contributory negligence in the context of inadequate internal controls is found in the judgment of Rogers CJ in AWA Ltd. v Daniels trading as Deloitte Haskins & Sells and Others (1992) 7 ACSR 579 and (1992) 10 ACLC 1643. Rogers CJ held inter alia that AWA was guilty of contributory negligence, viz, the failure to meet the standard of care to which it was required to conform for its own protection and which was a legally contributing cause, together with the auditors' default, in bringing about the loss. In such a case, damages were required to be reduced to such an extent as the court thinks just and equitable.

At page 833 he said:-

The present case is concerned with the unusual and complex commercial structure of Lloyd's and in particular the duties of the managing agent, the underwriter and the syndicate auditors in relation to a RITC, having regard not only to the relevant agency/sub-agency agreements and the audit engagement but also to the regulatory regime described in section 17 above. The Superhulls Cover case was concerned with a very different situation (insurers were held to have been contributorily negligent in failing to exercise reasonable care in carrying out customary checks on the manner in which brokers had performed their duty) and is distinguishable. Equally many of the Australian, Canadian and New Zealand Authorities are concerned with the question whether there was contributory negligence in very different, but more common, commercial contexts e.g. claims against auditors for failure to detect fraud by an employee where there were inadequate internal controls.

I refer to the section 19 entitled 'RITC - Some General Principles above' and in particular to the role of the managing agents/underwriter and the role of the auditors. Having regard to the relevant agency/sub-agency agreements, the audit engagement, the regulatory regime described above and in particular to the role of the managing agents/underwriter on the one hand and the role of the auditors on the other hand in relation to a RITC, I do not consider that the plaintiffs on a true construction of section 1 of the 1945 Act suffered "damage as a result partly of (their) own fault". I refer in particular to the following matters:-

1. Whilst the decision whether to close the year of account of the syndicate was the reponsibility of the managing agent in consultation with the underwriter, no year of account should be closed before the managing agent determined whether the syndicate auditor intended to give a qualified audit opinion in respect of that year of account.

2. As to the role of the auditors in relation to a RITC see section 19 above.

3. The regulatory regime (section 17 above) contained detailed provisions as to the respective accounting and other functions of members' agents, managing agents and syndicate auditors. As to the distinct functions of members' agents and managing agents see section 3 above.

4. For a flow chart as to the role of members' agents, managing agents and syndicate auditors as to syndicate accounts, the syndicate solvency report and the audit certificate see Table 5 above.

Having regard to the unusual and complex structure of Lloyd's and in particular to the four matters set out above I reject E&W's submissions. In the relevant context the negligence of Merretts' in relation to the 3 RITCs is not properly attributable to the plaintiffs. If contrary to the foregoing I am wrong in the above conclusion I would in the alternative hold that in all the circumstances it is not just or inequitable that the damages should be reduced having regard to the plaintiffs' share in the responsibility for the damage.

In reaching this conclusion I have given separate consideration to each of years 4, 5 and 6.

39. LIMITATION

The limitation issues are summarized in section 15 above and are set out in Table 4 above.

I turn to consider section 32 of the Limitation Act 1980 in the context of claims by the pre-1984 joiners and the 1984 joiners in the Hallam-Eames actions against Merretts and the members' agents. Section 32 is not relied on against E&W.

By agreement between and at the request of the parties, consideration of section 14A of the 1980 Act is to be left to a further hearing after delivery of this judgment. The alternative plea in misrepresentation/failure to report or disclose (see section 6) calls for further evidence beyond that adduced to date and will if necessary be subject to further directions, again after delivery of this judgment.

As to section 32 of the 1980 Act it is important to distinguish between the plaintiffs' case as to deliberate concealment against the managing agents on the one hand and the members' agents on the other hand. Further in considering the plaintiffs' case as to section 32, it is necessary to distinguish between the case as to the writing of the run-off contracts and the RITCs.

Section 32 of the Limitation Act 1980 provides:-

The plaintiffs allege deliberate concealment.

In Sheldon v Outhwaite [1995] 2 WLR 570 the question at issue was whether or not the plaintiffs could rely, for the purposes of section 32 of the Limitation Act 1980, upon deliberate concealment by the defendants of matters relevant to the plaintiffs' cause of action which occurred after the accrual of the cause of action. The majority of the House of Lords answered this question in the affirmative.

Lord Keith said at page 574H:-

Lord Browne-Wilkinson said at page 578B:-

Lord Nicholls said at page 585F:-

"Any fact relevant to the plaintiff's right of action"

In Hallam-Eames v Merrett Syndicates Limited Hoffmann LJ (as he then was) gave the judgment of the court in an appeal from an order of Gatehouse J. which declared, pursuant to RSC Ord. 14A, that certain claims in tort by the plaintiffs arising out of their losses as members of 418/417 were statute-barred. The appeal was concerned only with section 14A of the Limitation Act 1980. In that context Hoffmann LJ said:-

The passage quoted above, although written in the context of section 14A of the 1980 Act, provides valuable guidance as to what constitutes a fact relevant to the plaintiffs' right of action in the context of section 32. Before considering the writing of the run-off contracts and the RITCs it is necessary to set out certain background matters.

1. In a letter dated 18.4.85 to all the direct Names of MSL who participated on managed syndicates during 1982 and subsequent years of account Merretts set out a summary of the 1982 Account estimated results. Under the heading 'Summary of 1982 Account estimated results' the letter stated "We anticipate that syndicate 418/422/417 (capacity in 1982 £80.78m) will produce an overall loss in the range £12m to £17m giving rise to a loss of between £7,500 and £10,000 before personal expenses for an example share of £50,000". The year 4 accounts dated 4.6.85 show (after T&D) a closed year of account loss of approximately £11m. The year 4 accounts also show a net underwriting loss after T&D credit of £21.1m and to the informed reader a loss before T&D credit of approximately £65m.

2. The letter of 18.4.85 also stated under the heading 'The Run-Off Contracts':-

The statement that there were two main reasons for the late notification of the size of the losses failed to set out the true position having regard inter alia to the following:-

Accordingly, to say as at 18.4.85 that the late notification of the size of the losses resulting from the run-off contracts was due to the two main reasons stated, was to conceal from the plaintiffs Merretts' many serious failures in years 1,2 and 3 and the fact that the year 3 accounts were materially inaccurate.

In the course of a series of meetings of syndicate members in October and November 1985 Merretts did state:-

This limited statement did not disclose the true position in years 1, 2 and 3 as set out above.

As to the writing of the run-off contracts, the plaintiffs' case is that Merretts deliberately concealed from the plaintiffs, inter alia, the fact that the run-off contracts exposed the plaintiffs to potentially huge liabilities which were not capable of reasonable quantification on the material before Mr. Emney.

The minutes of the meeting of the Audit Committee held on 2.3.82 (H1/471A) attended by Mr. Merrett recorded:-

I do not accept Mr. Merrett's explanation of this passage in the minutes (Day 15/141-144). It is in my view plain that the reference to "telling its own Names" is in the context of a syndicate which had written run-off contracts. The point of concern was that such liabilities could fall on comparatively few syndicates. In fact Merretts did not tell E&W about the writing of the run-off contracts until year 3 (when reference was made to only 6 out of 11). The first the plaintiffs heard about the writing of the run-off contracts was on 18.4.85 - see the letter dated 18.4.85 and the meeting on the same day.

There was deliberate concealment of the position in relation to the run-off contracts by Mr. Emney of Merretts up to about early April 1985. The significance of the deteriorating position could not have escaped him. Although regrettably I have not heard from Mr. Emney I am driven to the conclusion that the concealment was deliberate. I am extremely troubled by Mr. Merrett's part. I have referred to the series of failures on the part of Merretts in years 1,2 and 3 above. Mr. Merrett was the active underwriter of 418/417. The consideration of the RITC was the most important function he performed for the syndicate each year. He knew about the writing of the run-off contracts and the developing problem with asbestos-related claims. He maintained that E&W knew about the run-off contracts prior to year 3 when they did not. How could he have failed to check the position as to the run-off contract in years 1, 2 and 3?

The letter dated 18.4.85 stated under the heading 'The Run-Off Contracts':-