Subrogation refers to one person stepping into another person’s shoes. In the context of insurance, it’s when an insurer tries to recoup the expenses it paid out for a claim when a third party was responsible for causing at least some of the damage.
There is often considerable confusion as to whether subrogation arises from equity or contract law. An insurance policy can modify implied contractual rights and the rights that arise under equity through the express terms of the contract.
Subrogation only applies if the insured has been fully compensated under the policy. But even where an ‘average’ or ‘rateable’ clause reduces the payment, this can still constitute full indemnification under the policy, and subrogation will apply.
Starting an action
When exercising subrogation rights, the insurer has to sue in the name of the insured. In turn, the insured’s recovery is limited to what action the insured could have taken against the third party culpable for the loss. If the insurer can establish the claim has been paid in good faith, the company can pursue an action in subrogation.
However, if the policyholder prejudices the insured’s rights to subrogation the compensation payable can be reduced. Most policies prevent subrogation against co-insured parties.
Obligations for both parties
When either the insurer or the insured commences proceedings in a recovery action that involves subrogation, they are obligated to protect the rights of the other party. That means the insured cannot in its litigation prejudice the rights of the insurer by only pursuing damages over and above the amount that has already been compensated under the policy.
So while the insured can settle with a negligent third party for only its uninsured losses, it cannot prejudice the right of the insurer to proceed to recover its indemnified loss under the policy. Similar obligations apply to the insurer.
And if the insured’s loss is greater than the compensation provided under the policy, they have priority over the insurer to recover their uninsured loss in any action. In such instances, both the insurer and the policyholder have an interest in the outcome of the proceedings.
Recoveries are an important part of profit for an insurer. Where the insured’s loss exceeds the amount of cover, and the policy is unhelpful in setting out each party’s rights in the event of subrogation, careful negotiations are needed to set out the rights of both parties and prevent further litigation from eroding a successful recovery.