October 3, 2013
Insurers that pay for their policyholders’ losses may recover from persons responsible under the theory of equitable subrogation. Issues arise about the allocation of the subrogation recovery when the insurer’s payment does not fully compensate the insured for the loss.
Many courts apply an equitable doctrine known as the “make whole” rule under which the insurer is not entitled to share in subrogation recoveries until the insured has recovered the amount of the loss in excess of the insurer’s payments. Until recently, the relatively low deductibles in most personal lines policies rendered the applicability of the make whole doctrine to the amount of the loss within the insured’s deductible an afterthought. Few cases considered whether policyholders also are entitled to recover their deductibles before sharing subrogation recoveries with their insurers. However, the increasing prevalence of large deductibles and self-insured retentions, particularly in commercial insurance policies, has shifted the focus to the portion of the loss within the insured’s deductible.
Does the “Make Whole” Rule Apply to Deductibles?
The Connecticut Supreme Court recently responded to a certified question from the Second Circuit about the applicability of the make whole rule to deductibles in Fireman’s Fund Ins. Co. v. TD Banknorth Ins. Agency, Inc., 309 Conn 449, __ A.3d __, 2013 WL 3818112 (Conn. 2013). There, Fireman’s Fund Insurance Company covered an insurance agency under an errors and omissions policy with a $150,000 deductible. Fireman’s Fund and the insurance agency settled a liability claim against the insurance agency for $354,000, with the insurance agency contributing its full $150,000 deductible and Fireman’s Fund paying the remaining $204,000.
The insurance agency and Fireman’s Fund, as the insurance agency’s subrogee, then brought a subrogation action to recover the full $354,000. The parties settled the subrogation action for $208,000, which was paid into an escrow account while the insurance agency and Fireman’s Fund litigated their dispute over allocation of the funds. The entire dispute was over whether the insurance agency’s $150,000 deductible should be reimbursed first, leaving Fireman’s Fund with $58,000, or whether Fireman’s Fund should have priority, leaving the insurance agency with only $4,000.
The Connecticut Supreme Court joined a small but uniform body of case law holding that equity does not justify applying the make whole doctrine to deductibles. The court explained that the insurance bargain between the insurance agency and Fireman’s Fund required Fireman’s Fund to assume only the risk of loss in excess of the deductible, and the premium was calculated based on the insurance agency assuming $150,000 in first dollar liability. Allowing the insurance agency to recover its $150,000 deductible before Fireman’s is reimbursed would, in the court’s view, unjustly enrich the insurance agency by giving it “an unbargained for, unpaid for, windfall.” (Quoting A. Windt, Insurance Claims and Disputes: Representation of Insurance Companies and Insureds (Thomson Reuters, 6th Ed. 2013).
Others have questioned the view that an insured’s agreement to be out-of-pocket for a deductible before the risk of loss passes to the insurer also constitutes an agreement to be last-in-line for distribution of any subrogation recovery. They take issue with the TD Banknorth Insurance Agency court’s assumption, unsupported by evidence, that policyholders bargain away their right to be made whole from third-party recoveries when they agree to retain part of the risk in the form of a deducible in exchange for a lower premium. If the essence of subrogation is achieving equity and the purpose of insurance is to make insured’s whole, they argue, courts should at least require insurers to show that subrogation recoveries were a factor in calculating the premium. They point to a variety of other actuarial reasons for the inverse relationship between the size of the insured’s deductible and the premium charged, including relieving the insurer of the obligation to deal with small claims and the reduced moral hazard inherent in leaving some risk with the policyholder. Thus, they see no reason to assume that the lower premium reflects the insurer’s priority over the insured with respect to uncertain, difficult to predict subrogation recoveries.