In Fireman’s Fund Ins., Co. v. TD Banknorth Insurance Agency, Inc., SC 18796 (Conn. 07/30/2013), the Connecticut Supreme Court answered two certified questions of first impression under Connecticut insurance law:
Is the so-called “make whole” doctrine the default rule in Connecticut?
If so, does it apply to insurance policy deductibles?
A construction company retained an insurance agent to secure coverage for work on a housing development. The agent obtained builders’ risk coverage and inland marine coverage from separate insurers. The builders’ risk insurer denied coverage on a house in the development destroyed by fire because it was built on a lot that was not listed in its builders’ risk policy. The omission evidently resulted from an error committed by the agent, who thereafter reported the incident under its E&O policy.
The agent’s E&O policy in question was subject to a deductible obligation. The agent and its E&O insurer subsequently settled the loss, with the agent paying its deductible obligation and the insurer contributing the balance. Under the settlement, the construction company assigned the agent and the agent’s E&O insurer its rights against the insurers that issued the builders’ risk and inland marine coverage. A subsequent subrogation action yielded a recovery from both property insurers. Thereafter, a suit ensued in Connecticut federal court between the agent and its E&O insurer over their respective rights to the subrogation recovery.
The E&O insurer argued that it was entitled to the full recovery, while the agent maintained that it was entitled to recoup its deductible from the recovered funds. The trial court sided with the agent’s E&O insurer. Thereafter, the agent appealed to the Second Circuit, which certified the issue to the Connecticut Supreme Court for resolution.
At the outset of its opinion, the Connecticut Supreme Court explained that the so-called “make whole” doctrine is designed to deal with a scenario where an amount recovered from a third party “is insufficient to satisfy” – that is, “make whole” – the insured and the insurer for their respective payments in resolving a claim. As a general rule, the court noted that the make whole doctrine “restrict[s] the enforcement of an insurer’s subrogation rights until after ‘the insured has been fully compensated for her injuries, that is … made whole.’ In re DeLucia, 261 B.R. 561, 567 (Bankr. D. Conn. 2001), quoting Barnes v. Independent Automobile Dealers Assn. of California Health & Welfare Benefit Plan, 64F.3d 1389, 1394 (9th Cir. 1995).”
Indeed, in answering the certified question, the Connecticut Supreme Court expressly recognized the make whole doctrine as being the “default rule in Connecticut insurance contracts.” Nevertheless, on the issue of whether “an insured should be considered fully compensated for her loss under the make whole doctrine if she recovers all but the amount of her deductible,” the court found the doctrine inapplicable (emphasis supplied). Relying on equitable considerations, the court held that to rule otherwise would create a windfall for the insured by allowing it to recover for a loss that it did insure when it contracted for lower premium payments in exchange for a deductible.
This Fireman’s Fund decision places Connecticut in the mainstream of jurisdictions holding the make whole rule inapplicable to deductibles or self-insured retentions. Moreover, with more insurers insisting their policyholders assume deductibles or self-insured retentions to ensure they have proverbial “skin in the game,” it is likely that this issue will recur with increasing frequency. As a practical matter, as the Fireman’s Fund court noted, this means that “the deductible” will become “in effect akin to a ‘primary layer of self-insurance underlying the [liability insurance] policy, which policy is … the [functional] equivalent of an excess policy … [W]hen there is a recovery the “excess” level of insurance is entitled to recover before a lower level of insurance/deductible can recover.… (Citation omitted.)’” (emphasis supplied).
Of course, these rules only apply in the absence of controlling policy provisions. If a policy contains a provision spelling out how any subrogation recovery obtained from a third party will be shared between itself and its policyholder, the terms of the insurance contract should trump the vagaries of case law.