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Supreme Court Rules That Made-Whole Doctrine Does Not Apply To A Self-Insured Retention

By on July 24, 2020 in Claims with 0 Comments

In the lawsuit of City of Asbury Park v. Star Insurance Co., 2020 N.J. LEXIS 746 (June 29, 2020), the Supreme Court addressed a question of New Jersey law at the request of the United States Court of Appeals for the Third Circuit.  The question that was asked was “whether, under equitable principles of New Jersey law, the made-whole doctrine applies to first-dollar risk that is allocated to an insured under an insurance policy, i.e., a self-insured retention or deductible.”  This question arose from a dispute between a workers’ compensation carrier and its insured who is a public employer.

The City of Asbury Park (“the City”) had an insurance policy with Star Insurance Company (“Star”) that provided workers’ compensation coverage for claims against the City.  The policy included a self-insured retention of $400,000 per occurrence.  Star agreed to indemnify the City for its workers’ compensation claims that exceeded the self-insured retention.

In January 2011, John Fazio (“Fazio”), an employee of the Asbury Park Fire Department, was injured while fighting a fire.  He filed a workers’ compensation claim against the City, which paid him $400,000, the full amount of its self-insured retention limit.  Star paid him $2,607,227.50, which was the amount exceeding the self-insured retention limit. 

Subsequently, Fazio filed a third-party action for the injuries he suffered in the fire.  He and the third-party settled for $2,700,000.  Subsequently, Fazio, the City and Star agreed that $935,968.25 of the settlement proceeds would be set aside to partially reimburse the City and Star for its workers compensation lien.

Star demanded that it be paid the entire amount of $935,968.25, claiming that it was entitled to be reimbursed in full before the City could recover amounts paid on its self-insured retention.  The City claimed that under the made-whole doctrine, it was entitled to be reimbursed in full before Star could assert its subrogation right.  Star claimed that the made-whole doctrine does not apply to self-insured retentions and that an application of that doctrine would unjustly enrich the City. It argued that the application of this doctrine would essentially convert the policy into first-dollar coverage, which is not what the City paid for in premiums.

The City filed a declaratory judgment action against Star in the District Court of New Jersey.  That Court granted summary judgment in favor of Star, finding that “the City has no insurance coverage for the first $400,000” and that the parties expressly agreed that under the subrogation provision in the policy that Star had the right to substitute itself for the City and is subrogated to all the City’s rights of recovery and that the made-whole doctrine does not apply to the case.

The City appealed and the Third-Circuit certified its question to the Supreme Court as an important and unresolved matter of New Jersey law. 

The New Jersey Supreme Court noted that the funds that would be available for reimbursement would not cover the full amount paid collectively by the City and Star.  The question that was posed to the Supreme Court would be whether the City had priority to recover what it paid before Star may recover any of its losses. The Supreme Court accepted the question as posed and answered the certified question in the negative.

The question turned on the interplay between the made-whole doctrine and the provision in the contract between Star and the City under which the City agreed to retain a self-insured retention, a per occurrence deductible for workers’ compensation claims.  Based upon that self-insured retention, the City bears what is known as the “first dollar risk,” making it responsible for the first $400,000 of a workers’ compensation claim with Star being responsible for sums exceeding that amount.  The policy also contained a subrogation provision which stated that “the insurer shall be subrogated to all of the insured’s rights of recovery…” 

The Supreme Court noted that under the made-whole doctrine “an insurer cannot assert a subrogation right until the insured has been fully compensated for his or her injuries.”  This doctrine applies when the insured’s parties damages exceed the amount of funds from which a recovery may be had or, in other words, when the amount recoverable from the responsible third-party is insufficient to satisfy both the total loss sustained by the insured and the amount the insurer pays on the claim.  Under these circumstances, the made-whole doctrine would hold that “the injured party should be the first to tap into the limited pool of funds and recover on any loss and when someone cannot be fully paid, the loss should be borne by the subrogee, the insurer.” 

The Supreme Court noted that the New Jersey courts have long recognized and utilized the made-whole doctrine.  However, it also noted that the New Jersey courts have never addressed the question of whether the doctrine applies to first dollar risk, such as deductibles and self-insured retentions borne by insureds. 

The Court considered the equitable principles that guide the doctrine of subrogation alongside insurance policies that allocate first dollar risk to the insured and found “that the made-whole doctrine does not apply to first dollar risk allocated to the insured.”  It found that “a self-insured retention or deductible is an amount of risk that the insured has agreed to assume in exchange for a lower premium cost for the insurance policy.”  Further, it held that where there is an award from a subrogation action against a third-party and it is insufficient to reimburse both the insured’s self-insured retention and the carrier’s loss in excess of that retention, “to place priority of recovery with the insured would, in effect, convert the policy into one without a self-insured retention.”

The Court’s view of the made-whole doctrine requires a close examination of the insurance contract’s provisions to determine whether the doctrine would apply. The provisions relating to self-insured retentions or deductible and subrogation rights would need to be read together. 

Here, the policy unambiguously provides Star with all of the City’s rights to recover against third-party tortfeasors in the event that Star makes a payment under the policy.  Accordingly, the Supreme Court found that the made-whole doctrine would not apply in these circumstances.  This doctrine would not override the party’s agreement. 

Thus, the New Jersey Supreme Court reached the conclusion that under equitable principles of New Jersey law, “the made-whole doctrine does not apply to first dollar risk, such as a self-insured retention or deductible that is allocated to an insured under an insurance policy.”

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Betsy G. Ramos

About the Author

About the Author:

Ms. Ramos is an Executive Committee Member and Co-Chair of the Litigation Department at Capehart Scatchard, P.A. located in Mount Laurel, New Jersey. She is an experienced litigator with over 25 years experience handling diverse matters. Practice areas include tort defense, business litigation, estate litigation, tort claims and civil rights defense, construction litigation, insurance coverage, employment litigation, shareholder disputes, and general litigation.

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