Understanding Insurance – The Principles of Subrogation and Contribution

25-Apr-2020 1037

Jeff, these principles only apply in the case of indemnity, yet I’ve never heard of subrogation and I’m not sure how contribution is applied to insurance. 

Subrogation is a legal term that I think should be included in the wording of policies more often. It’s the right of one person (the insurer in this instance) to take over the rights of the other (the insured).

Here’s an example. In Kenya during the early 80s, we had a building, ten stories high. On one of the floors, a company moved out and another company moved in. Before they moved in, they hired a carpet contractor to fit carpet tiles but while they were laying the carpet, a cigarette burnt through a tile and reached the glue. The entire floor was burnt, the smoke damaged the upper floors, and the water used by the fire brigade damaged the lower floors. It was an incredible amount of damage.

Let’s assume the building was insured for $10 million. The actual cost of repairs came to about $3 million, so we paid it.

Just like that? 

We paid it using the principle of subrogation because the carpet contractors were to blame. We asked the insured to claim against the carpet contractors, they agreed, and we took the carpet contractors to court. From their insurers, we recovered $1 million indemnity (the amount they were insured for). Because it wasn’t enough, we took the carpet contractor’s assets and were able to recover an additional half a million.

The client is not entitled to that. We’ve already paid their $3 million. We have the right to recover and seek salvage. If your house burns down and we indemnify you, we may get some salvage. On the principle of subrogation, that’s our right. We take over your rights.

The client still gets what they want, right?

They’re indemnified. Anything else is ours. It’s important to remember that in the example above, if we couldn’t recover $1.5 million, we still would have repaid our client the $3 million. But this can disappoint and confuse clients who often say, ‘that’s my amount’. We explain to them what the word subrogation means and how it applies to their policy.

Is it a hard and fast rule?

Sometimes we can modify it. Take the oil fields in Indonesia as an example, where a major oil company may be working as a sharing contractor. They may bring in another contractor, sharing the same site. They’re all working together, and they’re in the same position. So, in those cases they’ll ask us to wave subrogation because it’s too complex. In that case, if we pay a claim, we have no chance of recovery.

Does that change the premium?

Oh yes, we’ll charge more for it. But the point is that we can change the policy. The other exception to subrogation is a ‘knock for knock’ agreement. In most countries, if one driver has a motor insurance policy with an insurer and has an accident with a driver who has a policy with a different company, one insurer will say to the other: I’ll pay for the damage to my client, and you pay for the damage to yours. We don’t want to go to court, we don’t want to recover losses…it’s too difficult.

In Cambodia we don’t have this agreement because not everybody is insured. There’s no compulsory insurance except for commercial vehicles. It might end up being a ‘knock for nothing’!

What about the principle of contribution?

Contribution is the right of an insurer to recover an equitable proportion of a paid claim on behalf of another insurer who is also liable for the claim. This happens when you’re double insured. It may happen accidentally.

You may insure a car, and your son who drives it also insures it with a different company, accidentally. You may claim twice but you don’t get 100% from both companies. You’ll only get 50% from each because of the principle of indemnity.

Another example is a factory with a Construction or All-risk policy and a Marine Cargo policy. If your two policies are with different insurers, I say to the client, please make sure your Marine Cargo policy has a 50/50 clause on it.

Here’s why. Say the cargo is air conditioning units stored on site for some time. When you open them, you realise they’ve been damaged somehow, somewhere. Who knows where? To make things simpler, we just say 50/50, and the insurers share the loss. That way, we prevent any fighting, and we don’t have to go to court.

These two principles – subrogation and contribution – seem to be designed to make sure the insurers are covered. 

It’s usually in our favour, but we have the right to wave them anyway. If we think it’s unreasonable, we can do that. This is why I won’t accept criticism of most insurers. I’ll amend these principles if I don’t think they’re fair to clients.

Read the complete Principles of Insurance series:

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