Question

A drunk driver ran a red light and smashed into Josie’s car. The cost to repair the car is $8,000. She is unable to collect from the drunk driver. She has collision insurance on her car with a $500 deductible.

a. Explain how the principle of subrogation would be relevant in this case.

b. Explain how subrogation supports the principle of indemnity

Answer 1

1. Let's explore key terms in this reference:

• Insurer refers to Insurance Company ( who will pay compensation or claim to the person who suffered the loss covered under insurance)
• Insured refers to person or entity covered by insurance- also known as policyholder (who will receive the compensation as against the loss suffered from the Insurance company)
• Insurance: An arrangement where one party (Insurer) agrees to provide protection against any loss suffered by another party (Insured). In return of protection provided, Insurer gets premium amount at regular intervals (monthly/ quarterly/ semi-annually/ annually).
• Principle of Subrogation: It's one of the 7 basic principles of Insurance. Here, Insurer makes good the loss suffered by the insured and pays the claim amount to insured as negotiated under the insurance policy. After making good the loss, insurer now becomes the owner of that particular asset which was earlier under the ownership of insured and for which the insured has received the compensation. So now the ownership as well as the possession of that asset rests with Insurer who has full right to recover from third party involved, if any or sell it in open market or via auction and receive some amount as residual. (with respect to cars & machinery -this residual amount is termed as Salvage value)
• Principle of Indemnity: It's also one of the 7 basic principles of Insurance. Indemnity refers to paying an amount as compensation as against loss.(Compensation can be in the shape of repair, replacement & payment). The view of this principle is to indemnify the insured and restore him the financial status he had before the loss happened. It is worth noting here, Compensation amount would be lower of two- (a) Amount insured under insurance policy. or (b) Amount of loss suffered. Say, if insured amount is > amount of loss then- the compensation to insured will be restricted to amount of loss (lower of two). The purpose of this principle is simple- Insured should not make money/ profit from all this situation.  

2. In current situation where Josie's car gets damaged by drunken driver ( third party) causing the repair work costing $8000 to be done. Josie has an option to recover the loss amount from third party(drunk driver- because loss is caused by third party) or from insurance company (since Josie has collision insurance for her car). Unable to recover from driver, Josie can claim a compensation from the Insurance company to the tune of $7500 (after meeting expenses of $500- may be in the form of premium paid).

• Principle of Subrogation is relevant in this case- After paying Josie an amount of $7500- Insurance company gets all the rights over her car and now the ownership & possession of car gets transferred to Insurance company. Insurance company can do whatever it deems fit with the car since now it has become the owner of car. Insurance company can either sell this car and receive an amount or can demand from driver to the tune of damage done by him.
• Principle of Subrogation supports Principle of Indemnity- After payment of claim by Insurance company, all the risk & rewards (rights) of policyholder gets transferred to the Insurance Company- who can now recover the loss from the third party in play (drunken driver). In simple words, Insurance company can enjoy the rights of policyholder only after insurance company has paid/ compensated/ indemnified the policyholder (Josie) with the amount of loss. Please note-Policyholder can recover the loss from either driver or insurance company but not from both- Principle of Indemnity restricts policyholder from making profit in the occurence of events.