Subrogation is a specialized area of the insurance industry that can be a powerful tool to manage risk. Insurance companies are oftentimes on the receiving (serving as a defendant) side of litigation, but there are situations where an insurer can pursue an alleged wrongdoer to recoup claim payments made to their insureds. After payment of a claim and the identification of a potential third-party wrongdoer, an insurance company can pursue a claim of subrogation.
Insurance companies take on risk, plain and simple. In the event an insured suffers a loss, and there is no other exclusion or condition that applies, the insurer is then there to make the insured, or third-party in the event of the insured's liability, whole. In turn, often there's a third-party bad/negligent actor who may be the cause of loss or harm. In those situations, after the insurer has paid its claim and incurred that financial loss, they have the ability under the insurance contract (between the insurer and insured) to step into the insured's place and sue a third party to recover.
The IRMI Glossary of Insurance and Risk Management Terms defines subrogation as follows: "The assignment to an insurer by terms of the policy or by law, after payment of a loss, of the rights of the insured to recover the amount of the loss from one legally liable for it."
How Insurers Step into the Insured's Shoes to Sue a Third Party
Subrogation rights are created, typically, under the terms of the insurance contract between the insurer and the insured. As a condition for coverage, the insurer wants to create a contractual provision/condition with the insured that they can assume the insured's rights to sue a third party. It's part of loss control and claim management.
Here's a sample subrogation clause from an insurance contract:
Subrogation. In the event of payment under this Agreement, the Company shall be subrogated to the extent of such payment to all of the rights of recovery of Indemnitee, who shall execute all documents required and shall do all acts that may be necessary to secure such rights and to enable the Company effectively to bring suit to enforce such rights. ("Subrogation Sample Clauses," Law Insider, accessed November 21, 2018.)
Note that not only does the insurer have the right to assume the insured's rights, the insured is also contractually obligated to support the insurer's efforts and, arguably, not do anything to impair the same.
Why Is Subrogation Necessary?
There are probably many reasons, but I'll propose the following three main reasons.
- Public policy—The United States is built on the notion that everyone, including corporations and businesses, is responsible for injuries or losses to others. For example, if I throw a baseball at somebody's window, I should be responsible for my actions. If the home owner's insurer pays to fix the window, it, in turn, should have the ability to pursue reimbursement from me, the responsible party.
- Litigation timeline—If an individual had to sue another individual for reimbursement of a loss, this could take a long time, and the aggrieved individual would have to shoulder that financial burden until recovery is secured if a recovery is attained at all. To illustrate, taking my baseball example above, if the home owner had to pay to have the window fixed and then pursue a claim against me, the baseball thrower, this could take time to recover depending on my financial situation, willingness to pay, and whether liability is disputed. Until resolved, the home owner would have to bear that financial burden (replacing the window) until reimbursement is obtained, if at all.
- Lowers insurance premiums—Focusing on the wrongdoer to ultimately pay for losses supports keeping insurance premiums lower. If the insurer had to truly absorb every financial loss, without the ability to pursue repayment from the wrongdoer, the costs of insurance would rise.
Other Subrogation Examples
There are many fact patterns that would illustrate the mechanics and value of subrogation, but the following are a few simple scenarios that are designed to illustrate the concept.
- Example 1—A corporate entity secures a builders risk policy and plans to build a new manufacturing plant. It hires a general contractor who works with a myriad of subcontractors to perform the work, which would include, for example, a metal fabricating company to weld structural brackets. Halfway through construction, a welder left his or her tool plugged in overnight, causing a massive fire that resulted in substantial damage. The corporate entity's insurer would arguably pay the claim to make the corporate entity whole but could pursue subrogation against the metal fabricating company for negligent behavior.
- Example 2—A customer slips on a fast-food establishment floor, breaking her arm and incurring various medical expenses. The restaurant has a premises liability insurance policy that reimburses the patron for her medical costs after a claim is made and lawsuit filed. Let's assume that, after an investigation, it is discovered that another person in the restaurant (a disgruntled former employee) intentionally poured water on the floor just before the customer slipped. The insurer who reimbursed the injured patron on behalf of the fast-food company might have a subrogation claim against the disgruntled former employee.
- Example 3—A retailer sells a bicycle to a family, and a child is injured while riding it because there is a sharp screw loose on the bike. The child incurred medical expenses and extra damages. The retailer's insurer pays the claim, assuming the family brings a successful claim against the retailer, but through investigation, discovers there was a manufacturing defect in the bicycle. In turn, the insurer could potentially pursue a subrogation claim against the manufacturer for reimbursement.
Final Thoughts
Subrogation is a valuable tool for insurance companies that serves many purposes. Subrogation, at its core, is when a person/entity (e.g., insurer) can step into the shoes of someone else (the insured) and pursue a claim against a third party. This is a well-established process, and many insurance companies have an entire department dedicated to subrogation/loss recovery. Without subrogation, bad/negligent wrongdoers may not be responsible for the injuries/losses they create, aggrieved insureds may have to shoulder financial losses for a longer period, and insurance premiums could rise.
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