Protecting Your Right to be Made Whole from a Subrogation Recovery

It seems simple. The insurance company has stepped up and settled that nettlesome liability claim you faced.

Your product, a furnace replacement part, was off spec and ruined an expensive furnace into which it was installed. It was made with zinc instead of the nickel that was necessary for proper operation. The settlement was $500,000. You contributed your SIR (or deductible) of $250,000 and your carrier paid the rest. It’s pretty clear that a third party was really to blame for the loss—a supplier that mistakenly sent you the zinc instead of the requested nickel in the first place. Your insurer chooses to exercise its subrogation rights and pursue the supplier for as much as possible. You sign a “subrogation receipt” or “assignment” entitling the carrier to make the claim in your name.

Neither the insurance policy nor the subrogation assignment is specific about how the proceeds of a subrogation recovery will be divided between you and the insurer. And nothing is said about the insurer’s legal fees to be incurred.

Six months later your carrier comes back to you. Good news. The supplier and its insurer want to avoid a suit and have offered to settle the subrogated claim for $400,000. Your carrier’s legal fees incurred in pursuing the subrogated claim have been $50,000. So your carrier proposes that those legal expenses be paid off the top of the settlement funds, leaving $350,000 in remaining proceeds ($400K-$50K). Since your insurer paid $250,000 to fund the underlying case, the carrier suggests that it receive $250K and you receive the remaining $100K. After all, the policy and subrogation receipt or assignment, while not addressing allocation of recovery proceeds per se, do say the insurer will be subrogated to the extent it paid the loss. (There is certainly nothing unethical about an insurer making a proposal on a point left open in the policy or assignment. When terms are silent, an issue becomes a point of negotiation.)

In our experience, many policyholders accept the offered settlement distribution without much, or any, question. But in most states, and under most liability insurance policies, they are shortchanging themselves when they do. A large majority of states are clear on the point—either by statute or judicial precedent—that in any subrogation recovery under general liability policies the policyholder is entitled to be made whole on its financial loss before any proceeds go to the insurer. And that the legal expenses of the insurer in pursuing subrogation are its own burden, and do not reduce the amount available to make the policyholder whole. (There are exceptions when Medicaid, Medicare, or consumer auto liability subrogation is involved.)

In the example above, the policyholder in most places would be entitled to all of its deductible/SIR back from the $400K subrogation recovery. In other words, it should receive $250,000, and not the $100,000 proposed. The carrier should receive the balance of $150K, and should pay its subrogation legal fees from that.

All of the above can be—and in good practice should be—spelled out in a simple subrogation proceeds agreement, or in the policy itself by endorsement. By simply stating that “[t]he Policyholder will be made whole for its entire loss from the proceeds of any judgment or settlement, including for the full amount of any SIR or deductible that it paid in connection with the claim that is subrogated, before the Insurer is paid from the proceeds of any judgment or settlement, or reimbursed for its legal expenses incurred”, you can avoid any arguments and get the proceeds you are entitled to.

Far too often, subrogation terms—both in the policy and after loss in a subro receipt or assignment—are treated as insignificant boilerplate. Treat them with the care they warrant and you will receive more for the insurance you have purchased.

Joe Bauer is the Principal of Bauer Advising LLC. Bauer Advising is an independent advisor and receives no commissions from any insurance company or broker, but assists policyholders, carriers, and brokers as settlement facilitators of disputed commercial insurance claims and related issues. Read more about Bauer Advising’s approach.