Published January 12, 2023 • 5 minute read
However, businesses that sign off on a waiver of subrogation run the risk of more costly premiums or the potential for breaching contracts with waiver-prohibiting language.
Before you approve a contract with a waiver of subrogation clause, it’s important to review how your business might be implicated by the decision.
To help you make an informed choice, this guide explains everything you need to know about subrogation, waivers of subrogation, potential pros and cons, examples, and how it relates to workers' compensation.
What Is Subrogation?
To understand what a waiver of subrogation is and its primary function, let’s first review subrogation.
When your insurance company covers a claim, they have a legal right to pursue the responsible third party to recoup their losses—a right known as subrogation.
In doing so, the insurer reimburses payments made toward the costs of a claim.
Virginia-based law firm Hirschler defines subrogation in the following way:
The principle under which an insurer that has paid a loss under an insurance policy is entitled to all the rights and remedies belonging to the insured against a third party with respect to any loss covered by the policy. (Lee R. Rugg, Couch On Insurance § 222.2, at 222-14 (3d ed.2000))
Through subrogation, the insurer may step into the position of the insured after a claim has been made to recoup the cost of damages from the party responsible.
What Is a Waiver of Subrogation?
A waiver of subrogation nullifies the insurance carrier’s legal right to seek compensation from a negligent third party to recoup costs from a claim.
Its main purpose is to contain a financial loss to a specific party’s insurance policy, as this helps companies control insurance costs and manage risk.
Waivers of subrogation are often included in construction-related contracts to protect third-party subcontractors from liability—revoking an insurer's right to recover losses from a claim in which the third party was at fault for damages.
Many subcontractors—especially in construction contracts—will include this legal endorsement without malicious intent, simply to protect their own liability. It is not the responsibility of the subcontractor to inform the insurance company of the waiver.
A Waiver of Subrogation Example
For instance, let’s say Cristoff the Contractor purchases a commercial liability insurance policy from Fairweather Insurance Company. He then outsources a portion of a construction project to a third-party subcontractor, aptly called Clumsy Crew.
Before beginning work, Clumsy Crew presents Cristoff with a service contract, which includes a waiver of subrogation provision. Cristoff never informs Fairweather Insurance Company of this clause, and Fairweather never reviews the details of the third-party’s contract adequately enough to notice this in the policy.
During construction, Clumsy Crew causes $1 million in damages, and by law, Fairweather Insurance Company is liable to pay for it. When the company moves to sue Clumsy Crew, they are blocked by a waiver of subrogation, which revokes any rights Fairweather Insurance Company has to the claim. A court of law would likely rule in favor of Clumsy Crew because, in theory, Fairweather was in the most favorable position to protect itself from paying for damages.
In an alternate—and more thorough—universe, Fairweather Insurance Company would performs due diligence before beginning Cristoff the Contractor's construction project. Fairweather notices there's a waiver of subrogation involved and responds by raising Cristoff the Contractor's insurance premium—shrinking the amount of risk for their own bottom line in the event of damages incurred by Clumsy Crew.
In most cases, there will be language in commercial or general liability policies prohibiting the insured from signing contracts that revoke or alter the insurer's rights to subrogation.
If the waiver-prohibiting language is present in Cristoff's policy, but he still goes ahead and signs the contract with Clumsy Crew that includes a waiver of subrogation, he is now in breach of contract. In the event of damages incurred, he may be dropped from coverage by Fairweather and also become liable for losses.
How Does a Waiver of Subrogation Relate to Workers’ Compensation?
It is also possible for companies to add a workers’ compensation waiver of subrogation that would protect the business in the event of an employee accident.
While this might seem like a no-brainer, there are several factors to consider with such a decision.
Perhaps the most glaring is that since the claim payment would come from a third party instead of your insurer, this would reduce your experience modifier (e-mod)—a multiplier used by carriers to calculate your workers’ compensation premium.
As a result, this score will likely increase your workers’ compensation costs for the next few years the e-mod takes into account the claim, explains an analysis from Wisconsin-based insurance agency McClone.
Pros & Cons of Waivers of Subrogation
As is evident by the examples we’ve highlighted, waived subrogations come with several caveats—some of which are favorable to vendors and others, not so much.
- Protects Third Parties Financially: Waivers of subrogation prevent third parties from hefty payments or other costs of assuming responsibility for a claim.
- Avoid Lawsuits: By preventing lawsuits, businesses and tenants can avoid fees and interrupted productivity that may have been compromised by legal action.
- Preserves Business Relationships: While it’s important to hold parties responsible, avoiding the courtroom also helps ensure organizations maintain good working relationships with clients.
- Potential Breach of Contract: If organizations do not read contract terms thoroughly, as in the example above, they could potentially be in breach of contract if they neglect any present waiver-prohibiting language.
- More Expensive Premiums: Insurers have to somehow compensate for not being able to legally pursue responsible third parties, and that usually comes in the form of hiking up your insurance premiums.
How BCS Helps
Instead of playing roulette with contract and policy provisions, maintain total transparency regarding contract language and hire professionals to track, review, and improve your insurance documents in real time.
BCS full-service tracking solutions automatically highlight compliance discrepancies as they occur, and instantly flag them for an easy return to compliance.
By maintaining this high-level transparency over all your processes, you can proactively stave off risks, protect vendor compliance, and maintain healthier business connections.
BCS offers certificate of insurance tracking solutions that make it easier to review contract language, maintain current documentation, and find qualified contractors in your area. Contact us today or watch a demo to learn more about how BCS can help protect your exposures.