Timothy P. Law and Esther Y. Kim | Reed Smith
The made-whole doctrine (also known as the make-whole doctrine or the full compensation rule) is an equitable principle requiring a policyholder to be made whole for its loss before an insurance company can exercise its subrogation rights against a third party. It is essentially a priority-of-payment rule that arises by operation of law, or more accurately, by operation of equity.
Adopted in various formulations, some states allow clear insurance policy or statutory wording to overcome the doctrine, but the starting point as a matter of equitable principle is that a policyholder is entitled to be made whole for its loss before an insurance company begins to recoup any portion of payments it made under an insurance policy. This includes amounts in excess of the insurance policy limits, amounts within any deductibles or retentions, and amounts not covered by the scope of the insurance policy.
This is, of course, completely right and just, but some courts (such as the Connecticut Supreme Court),[1] while adopting the doctrine, have struggled with its application as it relates to deductibles or retentions. Traditionally, there has been no exception to the made-whole doctrine for amounts falling within a deductible.
Often, when a policyholder suffers a loss, that loss is both covered by insurance and has been caused by a negligent third party who may be liable to the policyholder under the law for the loss, perhaps in tort or perhaps in contract. When the insurance company pays that loss, it becomes subrogated to the policyholder’s rights against that third party, but those rights are subordinated to the rights of the policyholder until the policyholder is made whole.
The Connecticut Supreme Court used an example from a House of Lords case, which is as good an example as any, with amounts shifted to dollars: the policyholder suffered a loss of $160,000, and had a $100,000 policy, which became applicable above a $25,000 deductible, so the policyholder was responsible (in relation to the $160,000 loss) for the first $25,000; the insurance company was responsible for the next $100,000, and the insured was responsible for the final $35,000 above those limits. The insured recovered $130,000 from the negligent third party.
The answer under the made-whole doctrine should have been simple. The policyholder has a contractual right to $100,000 from the insurance company. The policyholder has a right in tort (as indicted by the recovery) of $130,000 from the negligent third party. That $230,000 is in excess of the $160,000 loss, so the insurance company has a right of subrogation in the amount of $70,000. It avoids double recovery by the policyholder and subordinates the insurance company’s rights against the third party to the policyholder’s rights against the third party.
A policyholder pays premium for the protection granted by an insurance policy. Perhaps a policyholder pays less money for a policy with a deductible or retention than one without. Likewise, a policyholder likely pays less premium for a policy with a $100,000 limit than one with a $1,000,000 limit. Similarly, a policyholder may pay less premium for a policy with a more abbreviated scope of coverage. Of course, the insurance company’s contractual obligation to pay is limited by retentions, deductibles, coverages, and limits, but the insurance company received premium to pay loss within the parameters of coverage regardless of whether a policyholder has a valid claim against a third party.
Likewise, a policyholder has a right to recover from the third party in tort or otherwise regardless of whether the loss is insured or falls within the parameters of coverage. The policyholder’s insurance policy rights (typically considered contractual) are independent of the right to recover from the third party (typically in tort but perhaps in contract). One does not limit the other. Rather, the insurance company has a right to recover in subrogation against the third party to the extent of its payment under the policy, but that right of subrogation is wholly derivative of the policyholder’s own legal rights and is equitably subordinate to the policyholder’s right to be made whole first and completely.
A policyholder has every right to retain a non-duplicative recovery it obtained from a tortfeasor, including any amounts within a deductible or retention, above the policy limits, or outside the scope of coverage. The made whole doctrine is a straightforward rule of equity that prevents an insurance company from making its own interests predominant and avoids allowing a tortfeasor to escape full responsibility.
[1] Fireman’s Fund Ins. Co. v TD Banknorth Ins. Agency, Inc., 72 A.3d 36 (Conn. 2013).
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