Insurance subrogation is an important legal mechanism which enables insurers to reduce their losses after insurance indemnities are paid. However, opinions differ as to the application of reinsurers' right of subrogation. For example, the following questions often arise:
- Can reinsurers directly exercise subrogation against a liable third party?
- Should reinsurance indemnities be deducted from the amount claimed by a direct insurer when it exercises subrogation against a third party?
- Can a third party refuse to indemnify a direct insurer if the direct insurer has been partially or fully covered by reinsurance indemnities?
This article answers these questions from an international perspective.
Countries which use a civil law system generally have insurance legislation with corresponding provisions regulating insurance subrogation and reinsurance. However, there are seldom clear provisions on whether insurance subrogation is applicable with regard to reinsurance. The courts in civil law countries have been trying to use the method of legal hermeneutics to interpret the laws and legislative intent. For example, under Japanese commercial law reinsurers can subrogate the rights of a direct insurer against a third party. In a case delivered in 1938, a Japanese court held that the commercial law provisions on subrogation were arbitrary and could be excluded by special agreement. In another case delivered in 1940, a Japanese court held that although insurance subrogation is applicable with regard to reinsurance, by way of exercise, due to the trust relationship between the reinsurer and the direct insurer, the direct insurer had to subrogate on behalf of the reinsurer and then pay proportionally to the reinsurer what it had obtained from the third party. Thus, on the basis of recognising the reinsurers' right of subrogation, the court justified the rationality of an alternative method for reinsurers to exercise subrogation.
In common law countries, several cases support the application of subrogation in reinsurance. In Assicruzioni Generali de Trieste v Empress Assurance Co Ltd in 1907, a British court held that the reinsurer had the right to claim against the direct insurer for the reinsurance indemnities that it had paid. In Universal Ins Co v Old Time Molasses Co, a US court supported the reinsurer's claim after it paid half of the loss of the goods and tried to intervene in the lawsuit initiated by the insured against the liable third party. In Glacier General Assurance Co v G Gordon Symons Co Ltd, a US court held that the reinsurer did have the right of subrogation, but that the direct insurer should actually subrogate all of the losses and then the corresponding amount of the recovery income will be paid to the reinsurer.
From the above court rulings, it appears that reinsurers' right of subrogation is well recognised by both civil and common law jurisdictions. When determining the way of subrogation, the courts adopted the approach that:
- the reinsurers' right of subrogation will be exercised by the direct insurer;
- the direct insurer is responsible for subrogating against the third party for all of the insurance indemnities paid; and
- the direct insurer will amortise the recovery income (if any) back to each reinsurer according to the corresponding proportion.
Most courts in the United Kingdom, the United States, Germany, France and Japan adopt the above approach, mainly based on the following reasons and considerations.
Direct insurer exercises subrogation on reinsurer's behalf First, a direct insurer exercising subrogation on behalf of a reinsurer conforms with the functional position of insurance and reinsurance.
Direct insurers and reinsurers engage in the insurance and reinsurance business to make a profit. Direct insurers charge reinsurers a reinsurance commission in return for the insurance business that the insurer cedes to the reinsurer. This reinsurance commission is mainly used to cover the direct insurer's operating expenses, such as:
- establishing branches or retaining agencies to solicit business;
- hiring and training full-time claims settlement personnel; and
- carrying out subrogation after indemnities are paid.
After a reinsurer assumes insurance risks, it is not necessary for it to carry out the relevant external marketing, operation and training for the above purposes.
Based on the principles of following a settlement and utmost good faith, direct insurers must also fulfil their duty of care and deal with all of the related work from underwriting to claim settlement. Thus, the handling of subrogation should also be part of an insurer's duty. Therefore, a direct insurer exercising a reinsurer's right of subrogation occurs not only because the direct insurer has collected the reinsurance commission from the reinsurer, but also because it is conducive for the reinsurer to focus on the realisation of the core functions of reinsurance, such as risk retransfer and diversification.
Principle of economic efficiency Second, a direct insurer exercising subrogation on behalf of a reinsurer conforms with the principle of economic efficiency.
In practice, all of the direct materials and documents concerning underwriting and claim settlements are retained by direct insurers, while reinsurers do not have access to a complete record of the underwriting and settlements information unless specifically required. Therefore, the direct insurer has a better understanding of a third party liable for an insurance accident and the related circumstances. In order to simplify the procedures, in practice, direct insurers can deal with the matter of subrogation, which is more convenient for both the direct insurer and the reinsurer.
Generally speaking, although the liability of a reinsurer and direct insurer arises simultaneously, the interval between the direct insurer and the reinsurer fulfilling their obligation of indemnity is quite long. Normally, a direct insurer pays an insured in advance and asks the reinsurer to pay its portion of the indemnities. In certain types of reinsurance business, it can take a long time for the reinsurer to pay its portion, especially in long-tail business. In the above circumstances, if the reinsurer must wait until the corresponding reinsurance liability is determined, they will face a series of risks such as the expiration of the statute of limitation, which is not conducive for the protection of their rights.
Globalisation is also a characteristic of reinsurance. Reinsurers are often foreign insurers and it is inconvenient and inefficient for reinsurers to exercise subrogation worldwide. In addition, multiple reinsurers usually participate in the same insurance project. If different reinsurers exercise subrogation against a third party at different times or in different jurisdictions, it will increase the third party's burden to prepare the defence against the subrogation from various reinsurers.
Principle of relativity of contractual relationship Third, direct insurers exercising subrogation on behalf of a reinsurer conforms with the principle of relativity of a contractual relationship.
Although there is a connection between direct insurance and reinsurance, the contractual relationship between the insured and the direct insurer is distinct from that between the direct insurer and reinsurer. This doctrine is well recognised by some jurisdictions worldwide. For example, according to Article 29 of the Chinese Insurance Law, direct insurers cannot refuse or delay to fulfil their indemnity obligations towards an insured on the ground that the reinsurer failed to fulfil its obligations under the reinsurance contact. Similarly, a third party cannot claim to deduct the amount of subrogation on the ground that the direct insurer has coverage from reinsurance. If the liability of the third party will be different depending on whether the insurer has reinsurance, it is not only difficult to determine the amount of compensation, but also goes against the relativity of the contractual relationship between the insured and the third party.
Therefore, an insurer's claims for subrogation should be judged between the insurer and the insured. As for whether the insurer has additional coverage from reinsurance, this is not within the scope of consideration in subrogation claims.
This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.