By Marianne Bonner. Business Insurance Expert
Marianne Bonner is a freelance writer and insurance consultant for the insurance industry. She is an industry veteran, having worked in the insurance business for three decades. You can reach her via email at firstname.lastname@example.org.
Subrogation is a legal term that is widely used in the insurance industry. Perhaps you have encountered this word in an insurance policy and wondered what it meant. This article will explain the meaning of this term and its significance to policyholders.
Subrogation derives from laws of equity (fairness). It is based on the idea that if Party A accidentally injures Party B. and Party C compensates Party B for his injuries, C has the right to sue A to recover the amount C paid to B .
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The right of subrogation may also arise as a result of a contractual agreement. Many insurance contracts contain a subrogation clause that gives the insurer the right to recover loss payments from the party responsible for the loss. However, subrogation laws already exist in most states, so insurers would likely have these rights even if policies did not contain that clause.
Typical Subrogation Clauses
Most commercial auto, liability, property and workers compensation policies contain a clause that addresses subrogation.
In the ISO policies, this clause is often entitled "Transfer of Rights of Recovery Against Others to Us." The clause found in one type of policy may vary somewhat from that found in another. Yet, they all have the same general intent.
A property insurer pays claims directly to the insured. This is reflected in the policy's subrogation clause. In the standard ISO property policy this clause states that if the insurer makes a payment to someone (typically you, the insured) that has a right to recover damages from someone else, those rights are transferred to the insurer.
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The following example demonstrates how this clause applies.
Jennifer owns a small commercial building that she uses to operate a pet grooming business. Jennifer has insured the building under a commercial property policy. One day, Jennifer is busy with a furry customer when she hears a loud boom. A moment later, one wall of her building bursts into flames. Jennifer calls 911 and the fire department arrives to extinguish the fire.
Jennifer's building has sustained significant damage. The fire was started accidentally by Bill, the owner of the building next door. Bill was using a welding torch to repair a pipe when he accidentally ignited a can of gasoline. Jennifer files a property claim that is paid by her insurer. The insurer then subrogates against Bill. That is, it files a suit against Bill seeking recovery for the amount it paid to Jennifer. Because the insurer has indemnified (reimbursed) Jennifer for the loss, it assumes her right to sue Bill, who caused the fire damage. The insurer has the right to pursue Bill only for the amount it paid to Jennifer.
The subrogation clause in the standard ISO general liability policy is straightforward. It states that If the insured has rights to recover all or part of any payment the insurer has made under the policy, those rights are transferred to the insurer.
For example, Sallie owns a retail clothing store called Rags to Riches. One day a store customer trips over a loose floor tile and falls, breaking her leg. The customer sues Rags to Riches, and Sallie's liability insurer pays the claim. The insurer subsequently discovers that floor was improperly installed as tiles are popping up throughout the store. The insurer sues the contractor that installed the floor for the amount it paid the injured customer. Because the insurer
has paid the claim against Sallie's business, it assumes her rights to sue the contractor that was ultimately responsible for the customer's injury.
Like the standard property and liability policies, the ISO commercial auto policy contains a "transfer of rights" clause. It states that if any person or organization to, or for whom, the insurer makes payment under the policy has rights to recover damages from another, those rights are transferred to the insurer. In other words, if the insurer pays an auto liability or physical damage claim, and someone other than the insured is liable for the injury or damage, the insurer may sue that party to recover the amount it paid.
Part One, Workers Compensation Coverage, of the standard NCCI workers compensation policy contains a clause entitled Recovery From Others. This clause gives the insurer your rights, as well as the rights of your injured employees, to recover its payments from anyone liable for the worker's injury. (A separate subrogation clause appears in Part Two of the NCCI policy, Employers Liability coverage.)
For example, suppose that your firm has purchased a workers compensation policy. One of your employees is injured in an auto accident and the insurer pays the employee the amount of benefits prescribed by state law. If someone other than the employee caused the accident, the insurer may sue that party to recover the amount of benefits it paid to your employee. Alternatively, the worker may sue the negligent party and collect an award.
Most states prohibit workers from "double dipping" (receiving duplicate recovery). Thus, the worker is usually required to reimburse the insurer for the amount of benefits he or she received from the insurer. Once the employee has reimbursed the insurer, he or she can usually retain any remaining damages.
Your Obligation to Preserve the Insurer's Rights
An insurer that has paid a claim is entitled to whatever rights you have against the negligent party that caused the injury or damage. If you have relinquished your rights, then you have none to transfer to the insurer. Virtually all subrogation clauses include language requiring you to protect the insurer's right to sue the negligent party. Most clauses prohibit you from waiving (giving up) your right to sue the responsible party after a loss has occurred .
For example, suppose that you are driving a vehicle covered by your business auto policy when you are rear-ended by another driver. You will violate the subrogation clause if you promise the other driver that you won't pursue a claim against him or her for the damage he or she caused.
Most subrogation clauses permit you to waive your subrogation rights against another party before a loss has occurred. This means that you can sign a contract in which you promise not to sue someone, event if he or she is responsible for a loss. Waivers of subrogation agreements are common in the construction industry. These will be addressed in a separate article.
Note that while many commercial insurance policies permit you to waive your subrogation rights before a loss occurs, the permission to do so may not be obvious. Many liability policies prohibit post-loss waivers but are silent on waivers made before a loss. The general consensus is that pre-loss waivers are permitted if they are not prohibited.
Exception to Post-Loss Waiver Rule
There is one exception to the post-loss waiver rule. The standard commercial property policy permits you to waive your rights after a loss if the waiver is made in favor of:
- another insured under the policy;
- a tenant of yours;
- a company that owns or controls your company; or
- a company that you own or control