Who gets what? Splitting the proceeds of recovery between insured & uninsured losses

Subrogated recovery actions provide an opportunity for insurers and their insureds to claim for losses incurred in respect of an incident. Therefore, enquiries must be made into any uninsured losses that the insured would like to claim to ensure that the insured doesn’t lose the right to claim at a future date. A subrogated claim should therefore always include both the insurer’s outlay and the insured’s uninsured losses. Agreement should be reached prior to pursuing both insured and uninsured losses in respect of the distribution of proceeds in the event of a successful recovery, and also in respect of payment of legal costs in the event that insurers are unwilling to fund the costs of pursuing the uninsured losses on behalf of the insured. Here we consider how to handle a claim which includes insurer’s and insured’s outlay in terms of the legal principle of ‘pay up, recover down’, agreeing how to distribute the proceeds of any recovery and how best to manage the insured’s expectations.

Napier: pay up, recovery down

The general principle of how to deal with the distribution of recovery proceeds between an insurer and its insured are set down in the case of Lord Napier v and Ettrick v RF Kershaw (No 1) [1993] A.C. 713 (HL). This explored the division of recovered funds between insured and uninsured losses.

The facts

Approximately 246 members of a Lloyds syndicate had suffered losses as result of the negligent underwriting of their risks by their managing agent. The insurer of these individuals paid for these losses under their insurance policies and brought a subrogated recovery action against the defendant. A recovery was made in respect of the losses incurred by the insurers and their insureds and the monies were held by their legal representative. The House of Lords (HoL) was asked to consider apportionment of the recovery between uninsured and insured losses.

The decision

It was held that the insured must receive a full indemnity for his loss before the insurer has any rights over any recovery proceeds. Lord Templeman, giving the leading judgment explained his reasoning using a hypothetical situation where losses in the sum of £160,000 were suffered. This was broken down into:

• £100,000 insured losses
• £25,000 policy excess
• £35,000 uninsured losses

Lord Templeman contemplated the distribution of proceeds on the basis that settlement had been agreed in the sum of £130,000. The principle of ‘pay up, recover down’ was applied in this case. That is, the loss is paid up by the layers, so the first payment towards a claim is the policy excess by the insured. Thereafter, insurers pay out the limit of their indemnity / amount of the loss in their opinion; and finally any additional costs are borne by the insured and claimed as an uninsured loss. Recovery proceeds are applied the other way round, i.e. from any settlement proceeds the total uninsured losses (excluding the policy excess) are deducted, then the insurer’s outlay and then any sums in respect of the policy excess. So, in the hypothetical scenario above, the distribution of £130,000 recovery would be:

• £35,000 uninsured losses
• £95,000 insured losses
• £nil policy excess

If the recovery had been over £135,000, for example, £136,000 then the distribution would be:

• £35,000 uninsured losses
• £100,000 insured losses
• £1,000 policy excess

Significance

The ‘pay up recovery down’ is the starting point for the allocation of monies recovered in subrogated claims. On the basis of the above principle, the insured may find themselves in the unfortunate position that they will not be able to secure a recovery of their policy excess or they may only secure a partial recovery. It is therefore important to make this clear to an insured at the outset, although often insurers are happy for their insured’s policy excess to be deducted from any recovery proceeds prior to them receiving their share. Insurers and their legal advisors should determine how they wish any proceeds to be distributed at an early stage to ensure that the insured is aware of how any proceeds would be split.

Managing the insured’s expectations

Insurers often are happy for their insured to recover their excess in full as it keeps them active in the claim and willing to provide solicitors with potentially vital information and/or documents regarding the incident which may help assist liability against the third party. Even though insureds are obliged to assist with claims under their insurance policy, there is little financial incentive to undertake a proactive approach to the recovery claim. The same position applies to parties who are no longer insured with the insurer exercising the rights of subrogation.

• A realistic stance has to be provided to the insured in relation to the prospects of success of the recovery action has to be provided from the outset of the claim.
• The insured should be advised to keep a record of all losses and supporting documentation, including uninsured losses.
• Insurers and solicitors should agree at the outset whether the policy excess should be repaid in full and ahead of insurer’s losses in the event of a successful recovery. This decision should be communicated to the insured as early as possible.
• In the event that the insured wishes to recover uninsured losses over and above the policy excess again, insurers and solicitors need to determine; (a) whether insurers are willing to fund the legal costs of pursuing those uninsured losses (assuming no LEI cover exists); and (b) if not, the solicitors needs to enter into a Claims Conduct Agreement with the insured in respect of payment of their fees and apportionment of their losses. The contents of this agreement should also be agreed by insurers.