What Is Subrogation in Insurance?

Here's a typical scenario: A worker gets injured on a sales call at a third party's property, and the company's insurance pays out a workers' compensation claim. Here's where things stop being typical: After the compensation payout, the insurance company follows up by representing the injured worker in court to recover the money it paid on the workers' compensation claim from the third party. This process is called subrogation.

Through subrogation, an insurance company can recover money it paid out for insurance claims from the party that caused the injury or damage. Here's a look at how subrogation clauses work in insurance and what a business owner should know.

Editor's note: Looking for the right liability insurance for your business? Fill out the below questionnaire to have our vendor partners contact you about your needs.

What is a subrogation clause?

Some business insurance policies – primarily policies that cover property, workers' compensation, commercial auto and inland marine – can contain a subrogation clause. This clause allows insurance companies to pay their insured's losses while still seeking payment or reimbursement from the third party that caused the incident. 

The insurance company can recover money from the at-fault party or the at-fault party's insurance company using a debt collections process or the court system. Subrogation clauses can be found directly in the policyholder's insurance contract or added to existing contracts. 

Aside from slip-and-fall claims from employees on property owned by a third party, insurers can subrogate claims from accidents that involve machinery or equipment owned by a third party. Because businesses often rent equipment in their day-to-day operations, this aspect is essential for you to understand. 

Tip: If your business needs a credible insurance carrier, read our reviews of the best business insurance providers to gauge the type of coverage and costs available.

How does subrogation work?

In most cases, subrogation clauses in insurance contracts primarily benefit the insurer because it can recover money it paid out for a claim. But subrogation can also benefit the policyholder because having a subrogation clause often reduces the premium price. 

Rights and waivers of subrogation in insurance

If your business grants your insurance company the right to subrogate, you may pay a lower premium. But if you waive the right to subrogate, your premiums may go up because the insurance company faces increased exposure. 

For example, according to Hiscox, a small business insurance provider based in Atlanta, a waiver of subrogation can typically be used on its policies. "However, it increases our exposure, since you are giving up your right to recover any losses from your client(s)," Hiscox states on its website. "Therefore, your premium may increase with a waiver of subrogation." The company advises that you factor in premium increases when quoting prices for clients.  

In the case of an accident at your client's site, with a subrogation clause, your business would have the right to recover the portion of the loss that was your client's fault. But your clients may prefer that your business waive the right of subrogation so they won't be held liable for damages if they're partially responsible for a loss. If you don't waive the right of subrogation, your relationship with your client may suffer.

"When you waive your right of subrogation, your business (and your insurance company) are prevented from seeking a share of any damages paid," Hiscox states. "This waiver of subrogation eliminates potential conflicts between you and your client."

Did you know? Some business insurance costs are tax deductible, including insurance premiums in the tax year in which they apply.

When to include a subrogation clause

Not every policy or insurer asks for a subrogation clause. Insurance company The Hartford, in an example from one of its commercial auto insurance policies, states it will "help cover the loss and pay the insured within the terms of the endorsement" if a third party causes an accident and the insured waives its right to subrogate – meaning it waives its right to pursue a claim against the third party that caused the accident. 

If you are considering whether or not to include a subrogation policy, you'll need to weigh the benefits of a reduced premium against potential harm to the relationship with your client if the insurance company ends up going after that client for damages. 

It's also important to consider your company's inherent risk level and your industry's risk exposure, and whether or not your company's current risk management plan requires a waiver.

Tip: Read our in-depth review of The Hartford to learn more about this insurer.

Subrogation doesn't occur for every claim

Industry experts point out that subrogation doesn't occur for every claim that's paid out. In more than one-third of potential subrogation cases, either the case is closed or the insurance company doesn't pursue subrogation.

Global professional services firm Genpact states on its website that potential subrogation files are often closed for one of five reasons:

• There isn't proper documentation to show the defendant's liability.
• There's no collection strategy in place on the part of the insurance carrier.
• The carrier doesn't have collections experience. 
• There's no collections system in place to pursue the claim. 
• The insurance carrier doesn't handle files properly, so there's very low probability for a win. 

Statistically speaking, as it pertains to private industry before the coronavirus pandemic, the U.S. Bureau of Labor Statistics showed nonfatal workplace injuries and illnesses in 2019 remained unchanged from the previous year's essentially unchanged trend.

Bottom line: You must exercise due diligence when deciding to waive or include a subrogation clause on your company's insurance policy. Consider your insurance claims history and the severity of the claims.

Subrogation and surety

A surety is a legally enforceable three-party written agreement where a neutral third party (surety), acting as the issuer of the bond, guarantees one party (principal) will perform the terms of the contract for the other party (obligee).

There are numerous types of surety bonds, although most applicable to your small business are performance or contract bonds sold by insurance companies and banks, which protect you from financial loss if a contractor fails to perform. 

Subrogation occurs when the surety takes the place of the principal, and assumes its claims and legal rights. According to the court decision in Jones v. Nationwide, subrogation is an "equitable doctrine intended to place the ultimate burden of a debt upon the party primarily responsible for the loss."

Subrogation waivers in construction 

Waiver of subrogation clauses are standard in the construction industry, including the waiver of consequential damages, which appears standard in most construction contracts. This industry-standard waiver is included to prevent delays in construction because of disputes and litigation resulting from damages covered in the business owners insurance policy, which would impact the project. 

Under this clause, the owner waives rights to sue third parties in the project, such as contractors and subcontractors, to help avoid the costs and time lost from litigation and negotiation.

Subrogation waivers in automobile policies

An automobile accident is another example of when waivers of subrogation can be used. In some cases, settling a minor automobile accident with a third party is quicker than processing an insurance claim through the at-fault party's insurer. 

Some parties choose to use a waiver of subrogation in auto accidents because the incident could both hurt the at-fault party's insurance record and impact insurance premiums. As a result, the third party at fault settles the issue without filing a claim with the at-fault party's insurer by issuing a waiver of subrogation to the party who experienced the loss. 

Bottom line: Under an auto accident subrogation waiver, the parties agree to waive their right to pursue any damages – including future claims and litigation – beyond the settlement agreement from the at-fault party or their insurer.

Can you negotiate a subrogation claim?

For some, settling is quicker than processing a claim. Accidents can adversely affect premiums or terminate coverage for at-fault parties; therefore, settling could prevent negative activity from being recorded on your insurance profile. However, this type of agreement shouldn't be executed without consulting with either your insurance company or an attorney. 

Based on reviews of insurance companies, waivers of subrogation may or may not be permitted as per the insurance contract; this varies according to the type of insurance policy you have, along with any endorsements, changes or additions to the standard policy.

As discussed earlier, a waiver of subrogation means your insurance company won't pursue the at-fault party. For instance, in the case of an auto accident, you may choose to sign a waiver if the driver who's at fault prefers to settle. However, The Hartford specifically warns that you should consult with your insurer before signing any waivers. "Not every auto insurance company allows its drivers to sign waivers of subrogation or do anything that can affect its efforts to recover money," the insurer advises on its website. 

Some insurers prohibit their insureds from signing waivers of subrogation because waivers of subrogation add to the insurance company's risk. To that end, understanding your business's legal risk will help you make an informed decision when deciding whether waivers of subrogation will be to your advantage or disadvantage. Because of the complexities and legal implications of subrogation, consult your insurer or attorney.