Pursuant to the equitable made whole doctrine, where there are limited funds available, an insurer cannot pursue subrogation until the insured has been made whole – i.e., fully compensated – for its injuries. In City of Asbury Park v. Star Ins. Co., No. A-20, 083371, 2020 N.J. LEXIS 746, the Supreme Court of New Jersey (Supreme Court) addressed the question of whether the equitable made whole doctrine applies to first-dollar risk an insured takes on, such as a deductible or self-insured retention (SIR). More specifically, the Supreme Court considered whether the insured, here the City of Asbury Park, was entitled to recover all its $400,000 SIR before the insurer, Star Insurance Company (Insurer) could assert its subrogation rights. The court held that the made whole doctrine does not apply to first-dollar risk allocated to the insured.
As discussed in City of Asbury Park, Insurer was the workers’ compensation carrier for the City of Asbury Park (the City). The City had a $400,000 SIR, making it responsible for the first $400,000 of any workers’ compensation claim, with Insurer bearing responsibility for sums exceeding that amount. The insurance policy (the Policy) the City had with Insurer contained a subrogation provision that stated:
In the event of any payment under this insurance contract, the insurer shall be subrogated to all of the insured’s rights of recovery therefore against any person or organization, and the insured and the service company shall execute and deliver instruments and papers and do whatever else is necessary to secure such rights. No person or organization shall do anything to prejudice such a right.
John Fazio (Fazio), an employee of the Asbury Park Fire Department, was injured and filed a worker’s compensation claim against the City. The City paid Fazio its $400,000 SIR and Insurer paid $2,607,227.50, the amount in excess the SIR. The combined payments created a workers’ compensation lien against any recovery by Fazio against a third party in the amount of $3,007,227.50.
Fazio filed suit against a third party for his injuries, which settled for $2,700,000. Subsequently, Fazio, the City and Insurer agreed that $935,968.25 of the settlement would be set aside in partial satisfaction of all liens held by the City and Insurer. Based on the subrogation clause in the Policy, Insurer issued a demand to recover the entire $935,968.25. In response, the City argued that, pursuant to the made whole doctrine, it should be reimbursed in full before Insurer could assert its subrogation rights.
To resolve the matter, the City filed a declaratory judgment action and both parties moved for summary judgment. The United States District Court for the District of New Jersey (District Court) found that the City had no insurance coverage for the first $400,000 of the loss and that, under the subrogation provision, Insurer was subrogated to all of the City’s rights of recovery. In addition, the District Court held that the made whole doctrine does not apply to first-dollar coverage such as deductibles and SIRs. The City appealed the District Court’s decision to the United States Court of Appeals for the Third Circuit, who certified the question of whether the made whole doctrine applies to deductibles and SIRs to the Supreme Court.
Although the Supreme Court recognized that the made whole doctrine generally applies in New Jersey, it acknowledged that New Jersey courts have never addressed the question of whether the doctrine applies to first-dollar risk. Considering the equitable principles that guide the doctrine of subrogation alongside insurance policies that allocate first-dollar risk to the insured, the court found that the made whole doctrine does not apply to first-dollar risk allocated to the insured.
As noted by the Supreme Court, an SIR or a deductible represents the amount of risk the insured has agreed to assume in exchange for a lower premium cost for the insurance policy. In situations where the award from a subrogation action against a third party is insufficient to reimburse both the insured’s SIR and the insurer’s loss in excess of that amount, “to place priority of recovery with the insured would, in effect, convert the policy into one without a self-insured retention,” effectively writing a better policy for the insured than it purchased. Thus, the court held that if, read together, an insurance policy – including its provisions relating to SIRs, deductibles and subrogation rights – unambiguously provides the insurer with all of the insured’s rights of recovery against third-party tortfeasors, the made whole doctrine does not apply. In these circumstances, the made whole doctrine will not override the parties’ agreement.
In light of the court’s decision, a subrogation practitioner should carefully analyze the type of loss the insured is attempting to recover. If an insured is attempting to recover uninsured losses – such as those in excess of the policy limits – the made whole doctrine will apply. In contrast, if the policy allocates the first-dollar risk – such as a deductible or an SIR – to the insured and the insured is attempting to recover its first-dollar risk, the made whole doctrine will not apply. Subrogation practitioners should keep this distinction in mind when considering whether to pursue subrogation and/or to enter into a joint prosecution agreement with the insured in New Jersey.