Surrogacy refers to a person putting himself in the place of another person. In the context of insurance, it is when an insurer tries to recover the expenses it paid for a claim when a third party was responsible for causing at least part of the damage.

There is often considerable confusion as to whether surrogacy arises from equity or contract law. An insurance policy can modify implicit contractual rights and rights arising in equity through express terms of the contract.

Subrogation only applies if the insured has been fully indemnified under the policy. But even where an ‘average’ or ‘assessable’ clause reduces the payment, this may still constitute a full award under the policy, and subrogation will apply.

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When exercising subrogation rights, the insurer must sue on behalf of the insured. In turn, the recovery of the insured is limited to the action that the insured could have exercised against the third party guilty of the loss. If the insurer can demonstrate that the loss has been paid in good faith, the company can exercise the subrogation action.

However, if the policyholder harms the subrogation rights of the insured, the compensation to be paid may be reduced. Most policies prevent subrogation against co-insured parties.

Obligations of both parties

When the insurer or the insured initiates proceedings in a recovery action involving subrogation, they are obligated to protect the rights of the other party. This means that the insured cannot in his litigation prejudice the rights of the insurer by only pursuing damages above the amount that has already been indemnified under the policy.

So while the insured may settle with a negligent third party only for his uninsured losses, he may not prejudice the insurer’s right to proceed to recover his indemnified loss under the policy. Similar obligations apply to the insurer.

And if the insured’s loss is greater than the compensation provided in the policy, he has priority over the insurer to recover his uninsured loss in any action. In such cases, both the insurer and the policyholder have an interest in the outcome of the proceeding.

In summary

Recoveries are an important part of an insurer’s earnings. When the insured’s loss exceeds the amount of coverage, and the policy does not help establish the rights of each party in the event of subrogation, careful negotiations are needed to establish the rights of both parties and prevent further litigation from eroding a successful recovery.