Recovering from Subrogation
Article, The Subrogator – February 2008
Insurance / Disputes
In order to ensure a successful recovery, it is essential for the subrogation potential to be identified soon after a loss occurs. Tony Levitt looks at the issues which should be taken into account when settling the original insurance claim.
Fires, explosions and mechanical breakdowns can all give rise to insurance claims, many of which are caused by a third party. In order to ensure a successful recovery, it is essential for the subrogation potential to be identified soon after the loss occurs. This does not always happen in practice as loss adjusters and others involved in the claim process are often preoccupied with the immediate measures, which need to be taken to minimise the loss and to ensure that the business is able to reinstate its operations as quickly as possible.
The claim will usually be indemnified by insurers to restore the company to the same financial position it would have been in, but for the damage. However, subrogation should be considered at the outset to maximise the potential for any recovery by the insurance company. This would involve the immediate and through investigation of the cause of loss and the preservation of all relevant evidence.
This article considers financial damages that may be sustained. In particular, it looks at the issues that should be taken into account when settling the original insurance claim to increase the prospect of a recovery in a subsequent subrogation action against a third party who caused the damage.
Quantifying the claim
The physical damage issues are usually considered in some detail, although with out much attention to quantum until some time after the date of the loss. The prospects for a successful subrogation action will be improved if quantum is addressed early on. Instead of only focusing on the amount of the loss for the purposes of the initial insurance claim, loss adjusters and forensic accountants should anticipate what will be required for the subrogation to take this into account. It is often too late to address the quantification of the claim for subrogation after the original loss has been adjusted and settled.
The effect of not anticipating subrogation at an early stage in the claims process is that it may not be possible to prove the amount of loss. Also, the ultimate recovery may be less than the damage is worth, or less than was actually paid by the insurance company.
It is often assumed that the amount claimed in the subrogation action will match the insurance settlement, but this is incorrect. The entire basis of each calculation may be different. The settlement is based on the insurance policy, whereas the claim in a subrogation action is likely to be for economic loss. For example, there might be losses not paid in the settlement of the original claim, which may be claimed in the subrogation. These could include deductibles, underinsurance, policy exclusions, or policy limits.
Documenting the claim
It may seem obvious that if there is potential for subrogation, then all relevant documentation should be retained. This does not always happen and the manner in which the adjustment and quantification of the loss is approached may need to take this into account. In checking the material damage, for example, it may be the loss adjuster’s standard procedure to check only a sample of invoices submitted in support of the cost of repair or rebuilding. In anticipation of subrogation, all documents should be retained and not just a sample. It is incorrect to assume that what was adequate as documentary support for the insurance claim will also be acceptable by the defendant in subrogation.
At the time the loss is being investigated and adjusted, all the documents will be available for review and should be retained and organised in anticipation of future disclosure. Moreover, the accounting system should be ‘frozen’ at the date of the loss, to ensure that all current data survives and that nothing is overwritten or deleted by subsequent entries. This is particularly important for real-time order entry systems, or data showing the backlog of orders at a point in time.
Retention of accounting documents is simple to achieve at the time, but much more difficult and costly if undertaken years later. Not only is there a likelihood that documents will have disappeared, but the people who created or were responsible for them may have left, or the company itself could have been taken over or moved to another location. Even if people have not left the company, there is often a lack of interest by the insured in subrogation claim, particularly if there is little for it to gain from the action. In this situation, the insured may be unwilling to devote resources to the pursuit of the claim.
These difficulties can be minimised by ensuring that all documents are retained at the time of the original loss adjustment. It is less time-consuming and far more cost-effective to do this, instead of incurring significant costs at the time of disclosure years later.
The calculation of the business interruption loss is often the most complex and controversial aspect of an insurance claim. There are a number of quantum issues to be considered in a subrogation action. For example, the period of interruption during which the company is financially impacted may not coincide with the policy’s indemnity period. If the policy restricts the indemnity period but the losses continued beyond that date, then there may be uninsured losses to be quantified for subrogations as they would not have been included in the original settlement.
There is enormous variety and choice in how companies insure their risks. The policy may be written for an individual company or for a group of companies, or there may be a local policy in the country in which the damage was suffered, with a global policy to cover the group as a whole. The nature of insurance cover can often give rise to differences between the insurance claim settlement and the calculation of economic loss in a subrogation action.
Some types of business interruption policy may give rise to a difference between the settlement amount and the claim in the subrogation action. The most obvious example of this is if a policy indemnifies the insured for Gross Earnings, whereas the subrogation claim may be based on Gross Profits, to establish economic loss. The Gross Earnings calculation will typically indemnify the sales value of the lost production during which the business is unable to produce at pre-loss levels of production. So, once the business has recovered it productive capacity, the indemnity period ceases. However, the insured may have lost a key customer or market share, which may take longer to recover. This will not form part of the insurance claim in this example, but may be included in the subrogation claim.
Business interruption calculations often include forecasts or projections on what would have happened but for the insured event. These are based on certain assumptions to establish the anticipated levels of sales had the loss not occurred. These assumptions and forecasts need to be investigated and tested during the adjustment process to ensure that they can be justified in the action against the third party. The loss settlement needs to be based on valid assumptions, properly documented, and not just a negotiated amount in order to settle the claim. It will be difficult to prove to a third party any settlement which cannot be substantiated, particularly if this is based on ’commercial considerations.’ It is likely that the defendant will reject this as a basis for the business interruption claim. Insurers and their advisors should always be mindful that a negotiated settlement of the insurance claim often limits the potential for a full recovery in the subrogation action.
The business interruption insurance claim may be reduced to account for the deductible. This could be in the form of a waiting period where, for example, the first 30 days of loss is not insured. Any loss sustained in the deductible period will be included in any subrogation claim. Similarly, if the sum insured is inadequate resulting in underinsurance or if there are specific policy exclusions which limit the insurance payment, these are likely to be taken into account in quantifying the business interruption for the subrogation action.
If there is the potential for a subrogation action, it is essential for forensic accountants to be involved in the claim as early as possible, preferably soon after the loss has occurred. This will enabled them to work with the loss adjuster in collating and preserving all the documentation. The calculations, particularly for business interruption, should be based on well-reasoned arguments leading to a settlement that can be justified in the subsequent subrogation action.
The early appointment of forensic accountants and other relevant experts is likely to be cost-effective as their involvement at the outset should avoid a costly investigation of the claim a second time, often years after the event. The experts will then be in a position to prepare calculations and reports earlier in proceedings, which could facilitate dialog with defendants and lead to a quicker resolution of the case. The objective of recovering from subrogation will then have been achieved.
The Subrogator is the quarterly publication of the US National Association of Subrogation Professionals.
As appeared in The Subrogator, February 2008.