Subrogating For More Than Your Insured’s Property Damage
Property insurers along all lines could simplify their business practices and lower their overhead considerably by simply paying any and all property damages, claims, expenses and consequential damages alleged to have been incurred by and in the amounts claimed by their insureds. Obviously, such a practice would be a shortcut to insolvency and would lead to a proliferation of claims fraud and loss exaggeration. The industry has a claims adjusting process for a good reason – it is important to competently determine coverage, assess legal liability, settle a claim fairly, and investigate third-party subrogation potential. Insurance benefits society and our economy not only as a financial mechanism to provide indemnity on covered losses, but also to ensure peace of mind and swift closure after a loss has occurred.
Insurers, focused on profitability and the bottom line, are aggressively pursuing subrogation of property losses whenever possible, recouping both their claim payments and their insureds’ deductibles. But what is only now coming into focus is an effort by our industry to subrogate not only for its claim payments, but also any and all Allocated Loss Adjustment Expenses (ALAE) incurred in and necessitated by the claims handling process. The law in this area has been slow to develop, but progressive carriers are more and more insisting on recovery of their claims expenses from responsible third-party tortfeasors.
Allocated Loss Adjustment Expenses
ALAE assignable or allocated to a specific claim are non-claim expenses incurred in the adjustment of insurance claims and borne by the insurer at the time of adjusting and settling a claim. They often require a reserve calculation for both pending and “incurred but not reported” (IBNR) claims. Examples of ALAE include attorney’s fees, bill reviews, investigator and surveillance charges, experts’ fees, and the like.
Such expenses are necessary in order to responsibly fulfill the time-honored goals of the claims process: (1) comply with the contractual promises and obligations contained in the policy, (2) support the insurer’s goal of making a profit, and (3) avoid paying fraudulent and exaggerated claims the cost of which are borne by honest policyholders. In claims where subrogation potential exists, these expenses were necessitated by the negligence of the third-party tortfeasor and should be borne not by the innocent property insurer, but by the negligent wrongdoer.
In the often turbulent intersection between the courts and the claims process, however, the recovery of ALAE in subrogation cases has been slow to evolve, but law is slowly coming into focus, which is shifting the burden for such expenses by allowing its recovery in subrogation. Efforts should be made in our industry to be sure we are rendering unto the tortfeasor that which should be paid by the tortfeasor.
There are actually two types of loss adjustment expenses – allocated and unallocated. The former represents the expenses incurred for a specific claim settlement. For instance, in the event of an engineer assessing the extent of hail of a metal roof, the costs incurred for appointment of the engineer and his report become part of the ALAE. The latter are expenses incurred by the insurer for routine operations of the claims department like salaries, maintenance, etc. These costs are not incurred for a specific claim but are incurred for the overall operations of the department. The tortfeasor didn’t cause the insurer to incur the latter, but is responsible for the former.
It only makes sense that the tortfeasor and/or its liability carrier should be responsible for reimbursing such ALAE in addition to any property damages caused as a result of the tortfeasor’s negligence. Some courts agree and some don’t. Some haven’t even looked at the issue, and that is where the aggressive pursuit of subrogated property claims can best serve the industry and helps pave the way for increased profitability. You never know what you can get unless you ask.
Subrogating For ALAE
The concept of ALAE as recoverable damages in property subrogation is, sadly, a subject of only relatively recent discussion and recognition in American courts. In 2013, a New Jersey district court provided some insight in Travelers Prop. Cas. Co. of Am. v. Hallam Eng’g & Const. Corp., 2013 WL 30174 (D.N.J. 2013). In its opinion, the court denied the defendant’s motion to strike damages paid to Travelers for their business loss, engineering, and fire damage experts.
The court used reasoning from two prior cases that said a party is entitled to recover expenses incurred to mitigate losses that were proximately caused by a defendant’s negligence. Oritani Sav. & Loan Ass’n v. Fidelity & Deposit Co. of Maryland, 744 F. Supp. 1311 (D. N.J. 1990); S.J. Groves & Sons Co. v. Warner Co., 576 F.2d 524 (3rd Cir. 1978). In Travelers, the experts were hired to confirm the loss suffered, determine what could be salvaged, and estimate the cost to repair the building.
The court determined most of the ALAE were incurred for the purpose of mitigating losses and, therefore, flowed directly from the defendant’s negligence such that they were recoverable as damages. On the other hand, the court did strike the damages for the amount paid to the Public Adjustment Bureau, as they were hired to adjust the plaintiff’s claim with his own insurer. This cost was not recoverable as the adjuster was “acting in [his] normal function as agent for Plaintiff.” Business Computer Resources v. Great Wall of Tinton Rd., Inc., 2009 WL 2426344 (N.J. Super. A.D. 2009).
In Oritani, the court distinguished between special and general damages. Special damages are not expected to occur regularly to other plaintiffs in similar circumstances. Although they are not as common, limitations on special damages do not apply where expenses in question were reasonably incurred in an attempt to minimize losses. On the other hand, general damages commonly flow from the kind of wrong that was done. Since plaintiffs are expected or, have a duty, to mitigate damages, costs incurred to do so occur regularly and, thus, are general damages. The court further distinguished between consequential damages and damages flowing directly from the wrong that was done. Consequential damages are not recoverable in insurance contract disputes; however, the court determined the losses flowing from this breach of contract were general damages, as Fidelity would have incurred the fees had they performed as promised in the contract. The court explained that had recovery efforts been directed towards minimizing consequential damages instead of its losses under the contract, then recovery may have been barred. Since the collection efforts were undertaken to recover losses for which coverage was sought, the court approved recovery for those expenses as damages.
The 3rd Circuit Court of Appeals also ruled on this type of damages in S.J. Groves & Sons, Co. v. Warner Co., 576 F.2d 524, 530 (3rd Cir. 1978), in which it held that a party is entitled to recover expenses incurred in mitigation of damages. The Court went on to explain a limitation regarding mitigation of damages. They held that mitigation of damages is not to be invoked by someone who breaches a contract as a basis for hypercritical examination of the conduct of the injured party. The defaulter cannot make an argument against the injured party that there were other options that may have been wiser or more advantageous to the adverse party.
State courts have also joined the discussion by explaining how the “American Rule” – each party is responsible for paying its own attorney’s fees – is used to determine appropriate damages. Generally, it is believed that the judicial system is best served if parties are responsible for their own counsel fees and other litigation expenses.
However, like most other rules, there are exceptions. If a party is compelled to act in protection of their interests because of the wrongful act of another, that third party is entitled to reasonable compensation for time lost, attorneys’ fees, and other expenses.
This exception is based on the idea that fees incurred in an action against a third party are damages flowing from the tort. In Travelers Prop. Cas. Co. of Am. v. Hallam Eng’g & Const. Corp., the exception did not apply to the public adjuster’s fees because it was not the third party’s expense but, rather, was necessitated by the plaintiff’s claim against the third-party insurer.
Courts in other states have also determined appropriate damages by distinguishing investigative costs from litigation costs. Stearman v. Centex Homes, 92 Cal.Rptr.2d 761, 769 (Cal. App. 2000). Investigative costs, fees paid to experts hired to determine appropriate repair methods to correct a defect, can be recovered as either costs or damages. California has said that, in order to be compensated for expert fees as costs, the expert must be ordered to testify by the court. Alternatively, the court may order the defendant to pay “a reasonable sum to cover [experts’] costs” if the defendant rejects a settlement offer and fails to obtain a more favorable judgment at trial. Expert fees can be recovered as damages where the wrongful act is a breach of an obligation not arising from contract. These tort damages are intended to make the plaintiff whole and include the cost of remedying the defect and the value of lost use or time lost. This method of recovery would not be applicable to any insurance matter arising from the contract formed between the insurer and the insured.
Some states have been slow to move toward allowing the subrogation of ALAE, but have shown tendencies in that direction. For example, in Washington, an insurer is allowed to deduct from its reimbursement of an insured’s deductible reimbursement amount after successful subrogation, a pro rata share of the allocated loss adjustment expense. Averill v. Farmers Ins. Co. of Washington, 229 P.3d 830, 835 (Wash. App. 2010). The same is true in California. Pac. Gas & Elec. Co. v. Superior Court, 50 Cal. Rptr.3d 199, 207 (Cal. App. 2006).
Parallels can also be drawn to workers’ compensation subrogation decisions in a few cases which allow a subrogated carrier to recover not only the medical and indemnity benefit payments it has made, but also nurse case management fees, claims handling expenses, etc.
Excess Insurers And Reinsurers
Subrogation of ALAE should be on the radar of both primary and excess insurers as well as reinsurers. Facultative casualty reinsurance certificates and working layer casualty excess of loss reinsurance treaties often require that the primary insurer and its reinsurer are both responsible for ALAE in proportion to their respective loss payments. This works well in most cases and both to evaluate the benefit of the bargain as they consider signing a reinsurance contract.
Subrogation complicates this relationship, however, as respecting ALAE. The apportionment of ALAE is based on the indemnity loss payments as determined after any subrogation recoveries or credits. But, if the amount of the primary carrier’s loss payment combined with its ALAE after subrogation is less than before subrogation, there is no financial incentive to pursue subrogation – a responsibility which usually falls to the primary carrier.
On the other hand, the reinsurer is often chomping at the bit to pursue subrogation. Subrogation of ALAE goes a long way toward aligning the interests of the two, which lends itself to more subrogation potential being aggressively pursued.
Unfortunately, while the recoverability of ALAE in subrogation cases makes sense, it has not been widely addressed or discussed in American jurisprudence. One major reason for this is simply that insurers have not asserted their subrogation claims to include such costs, which should rightly be borne by the tortfeasor responsible for their necessity. The New Jersey case of Travelers Prop. Cas. Co. of Am. v. Hallam Eng’g & Const. Corp. has not yet been cited in other decisions, and a majority of the cases it draws its reasoning from have only been cited in the 2013 case for their reasoning on damages. Nonetheless, a strong argument can be made that legitimate ALAE can and should be included in recoverable damages sought in subrogation actions, depending on what those ALAE represent and why they are incurred. The cost of utilizing experts should be recoverable. It appears that the use of an outside adjusting company for the “typical” loss may even be recoverable, contrary to Business Computer Resources, because it is a fee incurred by the third party, not the primary plaintiff.
One thing is certain. If we, as an industry, don’t stand up for and strive to expand our rights of subrogation, they will continue to contract and be the easy target for trial lawyers. Subrogation should not divorce itself from innovation. As Henry Ford once said, “If I’d have asked my customers what they wanted, they would have told me ‘A faster horse’.”
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