The United States Court of Appeals for the Ninth Circuit recently explained the limited applicability of California’s “made-whole” rule which may preclude an insurer from recovering any third party funds unless and until the insured has been made whole for the loss. 

In Chandler v. State Farm Mutual, the court opined that “an insurer is permitted to recoup a payout from a third-party tortfeasor’s insurance company before the insured has sued the third-party tortfeasor, and without first making the insured whole.” A two-party automobile accident provided the factual background for the court’s decision. The subrogating carrier’s insured’s car sustained damages after another driver rear-ended the vehicle. As a result of the accident, the insured incurred $317.45 in rental car expenses while his car underwent repairs. The subrogating carrier paid 80% of these rental car expenses as required by the insurance policy, leaving its insured with $63.49 in out-of-pocket expenses.

After its payment, the carrier exercised its subrogation rights and settled with the third-party tortfeasor’s insurer. Subsequently, the insured requested reimbursement from the tortfeasor’s insurer for his $63.49 in out-of-pocket expenses, which that insurer rejected. Then, the insured sought to recover his out-of-pocket expenses from his own insurance (subrogating) carrier, which was also denied because the carrier had paid the full amount due under the policy.  After additional benefits were denied, the insured initiated an action against his insurance carrier claiming violations of California’s Unfair Competition Law, conversion, unjust enrichment, and declaratory relief. As the court noted, all of the claims essentially hinged on the applicability of the "made-whole" rule.

The court rejected each of the insured’s arguments and dismissed all claims against the insurance carrier because the "made-whole" rule did not apply. The court’s reasoning supported the policy considerations for both subrogation and the made-whole rule. First, where the insured has not yet sought to recover from the third-party tortfeasor, nothing indicates that the insured will not be made whole if he decides to initiate a suit. Moreover, allowing the insurer to subrogate furthers the fundamental purpose of subrogation: to hold third-party tortfeasors accountable for the injuries they inflict. If a carrier could not immediately subrogate, as the court explained, this purpose would be frustrated and the risk of loss would be placed on the insurer whenever the insured does not attempt to recover from the third-party tortfeasor. Finally, if an insurer was required to make its insured whole before subrogating against potentially responsible third-parties, it would remove the insured’s incentive to pursue its claims and would obligate the insurer to pay for more than the express terms of the insurance policy require.

Based on the court’s conclusion and reasoning, an insured’s failure to bring its own action does not prevent the insurer from subrogating to the insured’s claim before the insured has been made whole. The court’s holding bolsters a subrogating carrier’s argument that subrogation rights may be exercised immediately upon payment and cannot be prejudiced by an insured’s inaction.

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