Retention Leads to Recovery
Article, The Review: Worldwide Reinsurance – June 2007
Insurance / Disputes
Effective handling of the initial loss is the key to enhancing the prospect of subrogation success, says Tony Levitt.
When a company suffers damage it will make a claim on its insurers. If the damage was caused by another person or company, then insurers may seek to recover the amount paid. They will then subrogate on behalf of their insured against the party which caused the loss.
Where there is a prospect of subrogation, the cause of loss needs to be determined with sufficient certainty that the insured will be able to demonstrate to a court how the loss occurred and who was responsible for the damage. All documentary and other physical evidence needs to be preserved at the outset, for use in the subsequent recovery action.
The manner in which the adjustment and quantification of the loss is approached might also need to be adapted to account for the potential subrogation action. For example, in checking the material damage the adjuster may typically 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 documentary support for the insurance claim will also be accepted by the defendant in subrogation.
Lack of interest
At the time the loss is being investigated, all the documents will be available for review and should be retained and organised in anticipation of future disclosure. 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. There is often also a lack of interest by the insured in the subrogation claim, particularly if there is little 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.
Quantifying the claim
The calculation of the business interruption loss often gives rise to various considerations 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 to, say, 12 months, but the losses continue beyond that date, then there may be uninsured losses to be quantified for subrogation, as they would not have been included in the original settlement.
Some business interruption policies may give rise to a difference between the settlement amount and the claim in a subrogation action. The most obvious example of this is if a policy indemnifies the insured for gross earnings, whereas the subrogation claim is likely to be economic loss. The gross earnings calculation will typically quantify the sales value of lost production in the period the business is unable to produce at pre-loss levels. So, once the business has recovered its 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 are often based on forecasts or projections of what would have happened but for the insured event. These calculations use assumptions, which 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 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’. Insurers and their advisors should always be mindful that a negotiated settlement of the insurance claim can limit the potential for a full recovery in a subrogation action.
If there is the potential for subrogation, then some early actions can be taken to enhance the prospects of success. The way the initial loss is handled and the planning and involvement of the relevant experts at an early stage can play a vital role in working towards a quick resolution of the case in the most cost-effective manner.
- Retain all documentation in anticipation of future disclosure
- A negotiated settlement of the insurance claim can limit the potential for a full recovery in a subrogation action
- Do not assume what was adequate documentary support for the insurance claim will also be accepted by the defendant in subrogation
As appeared in The Review: Worldwide Reinsurance, June 2007.