New Jersey Supreme Court Instructs That Made-Whole Doctrine Does Not Override Policyholder’s Assumption of Risk

The New Jersey Supreme Court recently answered a question of law certified to it by the Third Circuit Court of Appeals, and held that 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.” See City of Asbury Park v. Star Ins. Co., __ A.3d __, 2020 WL 3493526 (N.J. Jun 29, 2020). In other words, when the amount recovered in a subrogation action is insufficient to reimburse both the insurer’s loss and the insured’s self-insured retention or deductible, the insurer has priority to the proceeds.

Case Background

In the underlying dispute, a city firefighter had filed a claim against the city for worker’s compensation related to injuries he suffered in the line of duty. The city’s insurance policy contained a $400,000 self-insured retention endorsement, and the city therefore paid $400,000 to the firefighter and Star paid the remainder of his claim, about $2.6 million.

The firefighter also brought suit against a third-party for the same injuries and obtained a $2.7 million settlement. The insurer and the city asserted liens against that settlement to recover the amounts they had paid for the firefighter’s claim. Ultimately, the parties agreed that the firefighter would set aside almost $1 million from his settlement to partially compensate the insurer and the city. The city sought to recover the $400,000 self-insured retention payment before the insurer was permitted to recover anything from the amount set aside. The city asserted that the made-whole doctrine applied to this dispute, which requires that an insured be fully compensated for all of its loss before the insurer may enforce its subrogation rights.

District Court Decision and Appeal

The federal District Court held that the made-whole doctrine is a gap filler that only applies where the policy is ambiguous about the priority of recovery, and that a self-insured retention indicates that the parties have already indicated the order of recovery. The city appealed to the Third Circuit Court of Appeals, and in the absence of clearly dispositive authority in New Jersey law, the Third Circuit requested that the New Jersey Supreme Court resolve the question of whether the made-whole doctrine applies to first-dollar risk that is allocated to an insured under an insurance policy.

The city advocated to the Court that, absent express terms granting the insurer priority of recovery over the insured, the made-whole principle applies and the insured must be made whole before the insurer may recover its losses. The insurer, by contrast, argued that to permit the insured to recover the self-insured retention before the insurer recovered its full payment would effectively write a first-dollar risk policy for the insured where the insured had not paid for a policy that covered first-dollar risk.

New Jersey Supreme Court Decision

Justice Fernandez-Vina, writing for the Court, answered the Third Circuit’s certified question in a June 29 opinion reasoning that applying the made-whole doctrine to a self-insured retention provision would improperly override the parties’ contractual agreement. Because a self-insured retention or deductible is the amount of risk that the insured has agreed to assume in exchange for a lower premium cost, allowing the insured to recover the self-insured retention amount would effectively negate the parties’ agreed allocation of risk. The Court cautioned, however, that a determination of the proper priority will depend on the language of the insurance contract at issue. Even though not every situation will produce the same results, now that the Supreme Court has provided guidance on this issue, insurers in the Garden State may be more aggressive in asserting their recovery rights when insureds recover from third parties following payment by the insurer in connection with the same injuries.