Insurance policies, being legal contracts, rely heavily upon its parties adhering to them. Even as they are designed to address obligations and responsibilities, many gaps and assumptions are unavoidable. One assumption that may be thought of as safe is that both parties are looking after each other’s best interests. However well it is each party’s intention to do so, they have different viewpoints and goals. The policyholder is running a business or service that happens to be insured. The carrier’s business IS to provide insurance at a cost that contemplates their exposure as framed by its insuring agreement. The two parties are focused differently. They view their responsibilities via their own filters, so alignment is affected.

Let’s take a look at this case. It involved a grocery that, due to a fire, had to have its roof replaced. It was a loss that was eligible for coverage and was paid under a commercial property policy. Everything is shiny up to this point, but then it’s as if the insurance tripped, fell face forward and smacked its face on a gravel driveway.

The insurer stepped into the shoes of the grocer and subrogated against the roofing contractor. It considered the contractor negligent, responsible for starting the fire as it broke a gas supply line to an HVAC unit while installing it upon the roof. If you have the chance, click below for more details on what short-circuited the insurer’s attempt to recoup its payment for damages.

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In this loss, the insurer fulfilled its obligation, paying the grocery store for a fire loss. It then took another step, asserting its insured’s right to subrogate. Subrogation is a common insurance policy condition. It allows the insurer to act as the policyholder and seek re-payment from a party that can be held legally responsible for the loss. In this case, the insurer argued that the contractor performed negligently, creating the damages.

Subrogation is an important source of revenue for an insurer, right behind premiums and investment income. The condition typically includes language to protect this right.

Click here to see a discussion of various aspects of this policy condition. It is from the Insurance Services Offices Commercial Property section of PF&M found in Advantage Plus.

Is an insurer’s right of subrogation important? Yes! Is the insurer’s right to subrogate absolute? No, not even close! Even a cursory reading of the subrogation provision shows that it can be denied an insurer quite easily. It’s a matter of timing on the policyholder’s part.

If a loss occurs and the policyholder acts in a way that threatens an insurer’s ability to seek repayment from another party, the consequences can be quite serious. The insurer may take underwriting action and refuse to renew coverage. If the policyholder’s action was considered particularly harmful (prejudicial) the insurer may call for part or all of the funds for the loss be repaid, they may even sue their own policyholder to reclaim their payment. Due to these risks, a policyholder must be careful of any actions after a loss occurs.

If, before a loss occurs, the policyholder acts in a way that affects an insurer’s ability to seek repayment from another party, it may be consequence-free, especially if it is done in writing. There was a written agreement between the two businesses featured in this month’s case. The grocery store and the contractor agreed that the former would maintain full insurance on the property during the roof installation and both parties agreed to hold each other harmless for certain losses involving insurable perils. Typical subrogation provisions do not apply to pre-loss agreements nor is the policyholder required to get written permission before doing so.

Click here to see a discussion of various rationale for insurers to pursue its right of recovery (subrogation). It is from E-marketing for Agents found in Advantage Plus.

The insurer did not agree with the arrangement between the businesses and it tried to claim back its right to recovery via litigation and, ultimately, two courts believed that the agreement to hold the contractor harmless was valid and applied to the loss.

A policyholder that does agree to waive subrogation rights may appear to be acting in a way that is adversarial to an insurer. Yes, in this case, the insurer lost a chance to reclaim what it paid for a significant loss. However, in the larger picture, what was lost? Or, more accurately, was the insurer harmed? In essence, the insurer was in the same position as it was when it agreed to issue a commercial property to the grocery store. The loss that occurred was due to a peril that was eligible for coverage. The insurer paid out on the claim. So, in the end, the policyholder, via paying premiums, was able to rebuild after the insurer responded to the loss. The insurance contract between the parties was fulfilled. The insurer faced the exact risk it anticipated when agreeing to extend a policy to the grocery store.

On one hand, an insurer should definitely be concerned over a policyholder that routinely waives a right to recovery. On the other, there can be perfectly valid reasons for agreeing to waivers, particularly when contracts are mutually beneficial. The insurer in this case would unlikely have a problem if it were on the other end of the situation, where its insured caused a loss but it wasn’t subject to subrogation due to a pre-loss waiver.

Click here to see an excerpt of a relevant article on some aspects of subrogation as a revenue source. It originally appeared in the September 2009 issue of Rough Notes Magazine. It is from the magazine’s archives found in Advantage Plus.