Subrogation – The circumstances and remedies for an insurer’s compromised rights

An indemnity policy constitutes a contractual agreement in terms of which the insurer indemnifies the insured in the event of a loss. The policy is neither intended to unjustifiably enrich nor undercompensate the insured. Its primary purpose is to restore the insured to their prior financial position subject to indemnity limits and avoid double indemnity.

Ordinarily, insurance policies include a condition which provides that on the occurrence of an event that is covered under the policy, the insurer is authorised to step into the shoes of the insured, in return for indemnification of the insured. The insurer is conferred with the right to pursue, in the name of the insured or in its own name, proceedings against or settlement negotiations with a third party who is liable for the loss suffered by the insured if the following requirements have been met –

• a valid insurance contract;
• the insurer must have performed fully or undertook to perform fully under the insurance contract;
• the insured’s loss must have been fully compensated to the extent insured;
• the insured’s right must be susceptible to subrogation; and
• subrogation must not be excluded by agreement between the insured and the wrongdoer.

An insurer’s exercise of its right of subrogation is usually clear and simple. However, it can be easily blurred where an insurer has indemnified an insured and the insured simultaneously receives payment from a third party in full compensation of the loss or in partial settlement of the excess loss that the insured has not been able recover from its insurer. There are instances where insureds also conclude a release and waiver agreement with the third party, either before or after being indemnified by the insurer, and release the third party from any liability arising out of the loss that they have caused.

An insured must act in good faith upon their receipt of a benefit from a third party, and settle with the insurer that amount which the insurer would have recovered from the third party by using its subrogation right less the amount of the loss borne by the insured e.g., as an excess or deductible.

In the absence of a policy provision, where the insured has prejudiced the insurer’s right of subrogation by receipt of additional compensation from the wrongdoer, the insurer acquires a common law right of recourse against the insured. This enables the insurer to recover the amount by which the insured, having received payment from the insurer under the policy as well as compensation from the third party, has been over-compensated.

Where a policy is silent on the sanction for breach of a subrogation right, which is usually the case, the insurer can rely on a general breach of condition term. This typically gives the insurer the power to render voidable the section only in respect of the risk to which the breach applies. This wording, which is an unfortunate remnant of the Multimark III policy wording, may create uncertainty in considering the insured’s claim.  The insurer does not have the remedy of avoidance available to it for a breach of a policy condition, it can only recover damages or reject an unpaid claim.

It is advisable that insurers reiterate their subrogation rights to the insured during the claims stage. Underwriters must consider revising the terms and conditions relating to subrogation rights in their policies.  Policies should include specific consequences for the insured should they prejudice the insurer’s rights such as their right to recover such funds directly from the insured. Ultimately, policies must be clear that any settlement of an insured’s claim against a third party must consider and protect the insurer’s interests.

First published by: Financial Institutions Legal Snapshot