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Can an insurer recover before the policyholder is paid?

Byline: Matthew D. Stockwell

Upon indemnifying a policyholder for a loss, an insurer generally has the right to recoup its loss by pursuing recovery from other entities or individuals who may be responsible for the policyholder's damages in the first place.

Subrogation rights vary across jurisdictions and can have serious consequences both for the policyholder and the insurer. Disputes often arise, such as the circumstances under which the insurer may subrogate and for how much, particularly where the policyholder has not been fully compensated for its losses.

Generally, an insurer's subrogation rights are limited to recovering no more than what it paid to its policyholder. However, there is a disagreement among jurisdictions as to whether the insurer can recover in subrogation before the policyholder is "made whole."

For example, if the insurer disputes part of the insured's claim and only partially compensates the policyholder, some jurisdictions subordinate the insurer's subrogation rights and require that the policyholder be made whole before the insurer can recover. This issue can become complicated depending on the circumstances, such as whether the applicable policy covers all or part of a claim, and in situations where the policyholder purchased inadequate limits to cover the loss or claim.

A majority of courts have agreed that an insurer may not recover in subrogation unless the policyholder is fully compensated for its losses. The courts reason that the insurer should bear the risk of loss, because the policyholder paid the insurer to assume that risk.

Conversely, a minority of jurisdictions adhere to the "insurer-whole" rule, whereby the insurer is made whole first out of a recovery from a responsible third-party up to the amount paid by the insurer to the policyholder. These courts reason that the policyholder chose the policy limits, and if the insurer compensates the policyholder in accordance with its obligations under the policy, the insurer should be permitted to subrogate for that amount. This situation is sometimes referred to as "partial subrogation," which occurs when both the insurer and the policyholder possess an interest in the subrogation claim. [See Winkelmann v. Excelsior Ins. Co., 650 N.E.2d 841, 844 (N.Y. 1995).]

Some courts have devised variations of these methods, such as a pro rata allocation in accordance with the percentage of the original loss paid to the policyholder. [See Culver v. Insurance Co. of North America, 559 A.2d 400, 404 (N.J. 1989).] Therefore, it is critical to understand which state's "made whole" laws will apply to a particular loss.

Related: 5 subrogation recovery tips

It's possible to avoid subrogation by clear terms dictated in an insurance contract. (Photo: iStock)

Made-whole doctrine may be modified by contract

Notwithstanding the laws of a particular jurisdiction, subrogation rights can be modified by contract. The majority of jurisdictions that have addressed this issue enforce express exclusions of the made-whole doctrine, and have determined that an insurance policy can grant subrogation rights to an insurer, even where the policyholder has not been completely indemnified.

Thus, the parties can circumvent subrogation by the clear and unambiguous terms of a contract. In most circumstances the parties are free to negotiate the terms of the policy; therefore, a majority of courts will generally enforce a policy's subrogation clause. [See Fortis Benefits v. Cantu, 234 S.W.3d 642, 649 (Tex. 2007).]

Policyholders and insurers alike should be aware of the applicable policy language. In order to repudiate the presumption that a policyholder is to be made whole before an insurer's subrogation rights arise, parties must use clear, specific language in the insurance policy.

Courts have reached opposite conclusions as to whether boilerplate language allowing an insurer to subrogate "in the event of any payment" under the policy is sufficient to override application of the made whole doctrine. [See Fireman's Fund Ins. Co. v. TD Banknorth Ins. Agency, 644 F.3d 166, 170-71 (2d Cir. 2011).]

Has the policyholder was made whole?

A critical issue that must be resolved is whether the policyholder has, in fact, been made whole.

When a case is resolved by settlement, there are likely to be questions as to whether the insured has been fully compensated. For example, the issue of whether a policyholder can assert that it has not been made whole until it has been compensated for its attorney's fees is often disputed. Most jurisdictions follow the "common fund doctrine" -- an equitable principle which states that "[t]o allow the others to obtain full benefit from the plaintiff's efforts without contributing equally to the litigation expenses would be to enrich the others unjustly at the plaintiff's expense." [Mills v. Electric Auto-Lite Co., 396 U.S. 375, 392 (1970).]

The reasoning behind this principle is that where an insurer that did not participate in the policyholder's litigation against a responsible tortfeasor but benefitted from the results of that litigation, the insurer should share in the costs of the litigation. Most courts require the insurer to pay a reasonable share of fees and costs, often a percentage based on the amounts recovered by the insured and insurer respectively, or a percentage of the amount recovered by the insurer, similar to a contingency fee.

A minority of jurisdictions do not follow the common fund doctrine, and permit the insurer to recover without compensating the policyholder for its attorney's fees. However, as with most equitable principles, the parties can nullify the common fund doctrine in writing.

Related: Are you getting the most out of subrogation?

Some courts require policyholders to be made whole for all damages, not just those covered by an insurer. (Photo: iStock)

How to address deductibles

A policyholder's deductible presents another barrier in determining whether the insured has been made whole. Some jurisdictions deem a policyholder's deductible to be an exception to the made whole doctrine, and permit the insurer to subrogate before the policyholder recovers its deductible. [See Fireman's Fund Ins. Co. v. TD Banknorth Ins. Agency Inc., 309 Conn. 449, 468 (Conn. 2013).]

These courts reason that the insurer and the policyholder entered into a contractual relationship whereby the policyholder agreed to a lower premium payment in exchange for a deductible. Thus, requiring the policyholder to be made whole before subrogation would create a windfall for the policyholder for a loss that the policyholder did not insure against when it agreed to the deductible.

Other states use different methods to allocate the cost of the deductible. For example, Pennsylvania has enacted regulations requiring the policyholder and insurer to share the cost of the deductible proportionally in a subrogation action. [31 Pa. Code [sec] 146.8(c).]

Settlement agreements

If the policyholder reaches a settlement with a responsible third-party without obtaining the insurer's consent, an issue may arise as to whether the settlement presumes that that policyholder has been made whole. This is especially pressing in the situation where the insurer's subrogation rights are eliminated by the policyholder's release of the third-party. Generally, however, a settlement alone does not carry with it a presumption that the policyholder has been made whole, nor does it operate to prevent the policyholder from proving that it still has uncompensated losses.

Some courts require the policyholder to be made whole for all elements of damages, and not just those damages paid by the insurer. The "double recovery" rule allows the insurer to be reimbursed only from that portion of a recovery which represents a double recovery for the policyholder. However, in 2013, in an Employee Retirement Income Security Act case, the Supreme Court found that, as with the made whole doctrine, the parties may abrogate the "double recovery" rule by contract. [US Airways, Inc. v. McCutchen, 133 S. Ct. 1537, 1541 (2013).]

Other jurisdictions have determined that recovery from a third party is divisible, and where the policyholder has been fully compensated for its losses that are covered by the policy, the principles behind the made whole rule have been satisfied. These jurisdictions reason that to hold otherwise would authorize the policyholder to be unjustly enriched by requiring the insurer to insure against losses which it had not agreed to.

As a result, where the policyholder successfully recovers from a responsible third-party, it is the policyholder's responsibility to allocate the recovery between compensation for damages that are covered by the policy and damages that are not covered.

The majority view is that a policyholder is entitled to be "made whole" before an insurer may recover from third-parties in subrogation. However, some jurisdictions that have adopted the majority view may resolve related issues differently. Policyholders and insurers alike must be aware of the applicable policy language and the laws in the applicable jurisdiction, not only when paying on a claim and contemplating subrogation, but also when pursuing subrogation and agreeing to settle third-party claims.

Matthew D. Stockwell is counsel with Pillsbury Winthrop Shaw Pittman LLP in New York. Email him at
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Publication:Property and Casualty 360
Date:Oct 12, 2016
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