Subrogation is a legal right afforded to insurance companies. It allows an insurer to recover the amount it has paid for a loss by suing the party that caused the loss.
Insurer Steps Into Insured’s Shoes
Here’s an example of how subrogation works. Suppose that Bill’s commercial building burns down. Bill’s property insurer pays him $2 million, the cost to replace the building. The insurer discovers that the fire was caused by the negligent use of a blow torch by Bill’s neighbor, Steve.
The insurer sues Steve to recover the $2 million it paid to Bill for the fire damage.
If Bill did not have property insurance, he would have the right to sue Steve for the cost to replace his building. Because Bill’s insurer compensated him for the loss, Bill’s right to sue Steve is transferred to the insurer. The insurer “steps into Bill’s shoes,” meaning it obtains whatever rights Bill has to sue Steve.
Insurers may obtain their right of subrogation from a law or a contract. Many insurance policies contain a subrogation clause that applies when the insurer has paid a loss to (or on behalf of) an insured. The clause gives the insurer the right to recover the amount of its loss payment from the party that caused the loss. An insurer might have this right even if it was not stated in the policy. Many states have enacted subrogation laws that permit insurers to pursue recovery once they have fully compensated their insured for a loss.
Typical Subrogation Clauses
Most business insurance policies contain a clause that explains the insurer’s subrogation rights. It usually appears in the policy conditions. In ISO policies, the subrogation clause is usually located under the heading Transfer of Rights of Recovery Against Others to Us. Subrogation clauses may vary from one policy to another but they all have the same general purpose.
They allow the insurer to recover a loss payment from the party that caused the loss.
1. Commercial Property Policies
Many commercial property policies contain a subrogation clause like the one found in the standard ISO policy. A portion of this clause appears below:
If any person or organization to or for whom we make payment under this coverage part has rights to recover damages from another, those rights are transferred to us to the extent of our payment.
To see how this clause applies, consider the following example:
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 collapses and then bursts into flames. The fire department soon arrives to extinguish the fire.
Jennifer’s building has sustained significant damage. The fire was the result of a boiler explosion in the building next door. The boiler exploded because Bill, the building owner, failed to maintain it properly. Jennifer’s property insurer pays for the fire damage to her building and 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. The insurer has the right to pursue Bill only for the amount it paid to Jennifer.
2. Commercial Liability Policies
Most business liability policies contain the same subrogation clause that appears the standard ISO general liability policy. The clause 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. The following example demonstrates how this clause applies.
Sallie owns a retail clothing store called Rags to Riches. One day, a store customer trips and falls on an uneven floor tile, breaking her leg.
The customer sues Rags to Riches for bodily injury. Sallie’s liability insurer pays the claim. It then sues the contractor that installed Sallie’s floor for the amount it paid to the injured customer. The insurer contends that the contractor installed the floor improperly and that its negligence caused the customer’s injury. Because the insurer has reimbursed Sallie for the cost of the claim, it assumes her rights to sue the negligent contractor.
3. Commercial Auto Policies
The standard business auto policy contains a subrogation clause similar to the one found in the ISO property policy. The clause essentially states 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 of its claim payment.
4. Workers Compensation Policies
The standard NCCI workers compensation policy contains two subrogation clauses: one under Part One, Workers Compensation, and another under Part Two, Employers Liability. Both are entitled Recovery From Others
The subrogation clause that appears in Part One gives the insurer your rights, as well as the rights of your injured employee, to recover payments it has made from anyone liable for a worker’s injury. For example, suppose that your firm has purchased a workers compensation policy. One of your employees is injured in an auto accident caused by the negligence of another driver. Your insurer provides workers compensation benefits to the worker. It then sues the negligent driver for the cost of the benefits it paid to your employee.
In some states, the injured worker could sue the negligent driver and collect an award. However, most states prohibit workers from “double dipping” (receiving duplicate recovery for the same injury). This means that a worker who collects damages from the negligent party must reimburse the insurer for the cost of the benefits he or she received. Once the insurer has been reimbursed, the worker may be permitted to retain any remaining damages.
The subrogation clause that appears in the Employers Liability section gives the insurer the right to seek recovery from anyone liable for an injury for which the insurer has paid damages under the policy. That is, if the insurer has paid damages as a result of an injury to an employee, it may sue the party that caused the injury to recover its payment.
You Must Preserve the Insurer’s Rights
Once an insurer has paid a claim, it is entitled to whatever rights you have against the negligent party. If you have relinquished your rights, you have none to transfer to the insurer. For this reason, 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 promise the other driver that you won’t sue him for the damage he caused to your vehicle. You have violated the subrogation clause.
Pre-Loss Waivers Permitted
Many commercial property policies specifically allow you to waive your subrogation rights before a loss has occurred. Liability policies are typically silent regarding pre-loss waivers, but the general consensus is that such waivers are permitted if they are not specifically prohibited. This means that you can sign a contract in which you promise not to sue someone for a loss if no loss has yet occurred. Waivers of subrogation are found in many types of business contracts.
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 one of the following:
- Another insured under the policy
- A tenant of yours
- A company that owns or controls your company
- A company that you own or control