Why all or nothing? A middle ground to subrogation law will protect South Dakota's insureds.

• Author: Trefz, Marilyn F.

1. INTRODUCTION

   Historically, subrogation was established as an equitable principle allowing an insurer who has indemnified an insured "to stand in the shoes of the insured's claim" for damages against a tortfeasor. (1) Today, subrogation often centers on a conventional approach, flowing from a contract (2) or is statutorily driven, governed by the terms of a statute. (3) Black's Law dictionary defines a "subrogation clause" in insurance as "[a] provision in a property or liability insurance policy whereby the insurer acquires certain rights upon paying a claim for a loss under the policy." (4) These rights include receiving a full or proportionate amount of the benefits paid to the insured. (5)

   The concept of subrogation in property insurance was widely applied; however, the concept in the context of personal injury claims remained intensely prohibited at common law. (6) This tenor changed dramatically during the 1960's and 1970's when insurance companies, through aggressive collection efforts and litigation, quickly promoted the expansion of subrogation for medical bills paid by automobile insurers, (7) leaving only a minority of states resisting this movement. (8) Additionally, health insurers began adding subrogation clauses in an attempt to get a share of the damages paid to victims by tortfeasors after the first reported judicial decision addressed the propriety of health insurance subrogation in 1982. (9) Yet, "[m]ore and more jurisdictions have come to recognize the harsh results placed upon the insured through the doctrine of subrogation." (10)

   In fact, after an insurer has paid out benefits, but when an insured is not fully reimbursed for all of its losses, a split of authority exists as to who has a superior interest in the third-party recovery. (11) In Basic Text on Insurance Law, Robert E. Keeton describes five standard rules that courts and legislatures often consider. (12) The first and second rules favor the insurer:

   First Rule: The insurer is the sole beneficial owner of the claim against the third party and is entitled to the full amount recovered, whether or not it exceeds the amount paid by the insurer to the insured.

   Second Rule: The insurer is to be reimbursed first out of the recovery from the third party, and the insured is entitled to any remaining balance. (13)

   The third rule provides a middle ground approach between favoring the insurer and the insured. (14)

   Third Rule: The recovery from the third person is to be prorated between the insurer and the insured in accordance with the percentage of the original loss for which the insurer paid the insured under the policy. (15)

   The fourth and fifth rules favor the insured:

   Fourth Rule: Out of the recovery from the third party the insured is to be reimbursed first, for the loss not covered by the insurance, and the insurer is entitled to any remaining balance, up to a sum sufficient to reimburse the insurer fully, the insured being entitled to anything beyond that. Thus, if there is any windfall, it goes to the insured.

   Fifth Rule: The insured is the sole owner of the claim against the third party and is entitled to the full amount recovered, whether or not the total thus received from the third party and the insurer exceeds his loss. (16)

   In keeping with Keeton's Fifth Rule, (17) some states now have laws prohibiting subrogation, through either statute or common law. (18) While the majority of states allow subrogation, many of these same states, through judicial decisions and legislation, have pronounced the made-whole doctrine in order to minimize its detrimental effects of insurance subrogation on the insured. (19) Additionally, some federal courts have adopted the made-whole doctrine as the default rule. (20)

   Insureds anticipate a shift in the risk of loss to the insurer in return for their premium payment. (21) When a loss occurs, there is a certain expectation by insureds that they will be made whole because of this purchased protection. (22) The made-whole doctrine is an equitable limitation of the subrogation rights of an insurer (23) requiring that before the insurer can recover from the insured, the insured must be totally reimbursed for all losses, (24) as explained in Keeton's Fourth Rule. (25) The made-whole doctrine limits the right of subrogation even if an insurance policy provides to the contrary. (26)

   In 2011, for a second straight year, South Dakota, whose current subrogation laws favor the insurer, attempted to join the majority of other states that have adopted a made-whole approach to subrogation. (27) Yet, despite proponents' valiant efforts in 2011 and near victory in 2010, the South Dakota anti-subrogation bills lie defeated. (28) Unfortunately, compromise played little part in either legislative debate. (29) Middle ground proposals--sharing or prorating the recovery between insurer and insured as noted in Keeton's Third Rule (30)--were not considered as alternative possibilities to protect South Dakota citizens.

2. LEGISLATIVE HISTORY

   1. SOUTH DAKOTA SENATE BILL 169

      During the 85th South Dakota Legislative Session, Senator Nancy Turbak Berry (D-Watertown) and thirty-three co-sponsors introduced Senate Bill ("S.B.") 169, which sought to prohibit an insurer from participating in any recovery of money until the insured is fully compensated for bodily injury, death, or property damage. (31) Following an emotionally charged discussion from both sides, with insurance company lobbyists as leading opponents, the Senate's decision turned on the tie-breaking vote cast by then-Lieutenant Governor Dennis Daugaard in favor of the bill. (32) The House followed by passing S.B. 169 with 39 Yeas and 28 Nays. (33)

      Still, the hard fought battle ended with a veto from Governor Michael Rounds, who indicated in a letter addressed to members of the Senate that the State Bar should propose a compromise for the upcoming legislative session, stating:

      I believe, a change in this area is appropriate, but must contain more compromise than SB 169 does. I would support an effort by the State Bar to work on a proposal over the interim to present next Session.... Injured parties should not remain strictly at the back of the line, but I do not think the order of the line should simply be reversed. (34) Again, another battle was fought to rebound, but the Senate could not rally the needed votes to overcome Governor Rounds' veto decision. (35)

   2. SOUTH DAKOTA HOUSE BILL 1184

      No official formal recommendation came from the State Bar in the intervening year. However, knowing some of the key issues that surfaced in the 2010 veto, (36) proponents (37) modified the bill's language in 2011 to define made-whole further, measuring damages according to S.D.C.L. section 21-3-1. (38) The reference to S.D.C.L. 21-3-1 implicitly linked specific South Dakota pattern jury instructions and accompanying case law into the bill, illustrating the types of compensation to be considered in making an insured whole. (39)

      On January 27, 2011, with the new language in place, Representative Brian Gosch, (R-Rapid City) introduced House Bill ("H.B.") 1184 and reminded senators that he did not have "a dog in this fight," but saw it as a "David versus Goliath" type scenario with struggling injured parties on one side and many insurance companies on the other. (40) Again, a heated debate ensued between legislators concerned about catastrophically injured South Dakota citizens and the numerous insurance lobbyists. (41)

      One proponent, Steven Rounds, appearing on his own behalf, shared details of a tragic head-on collision that not only took the lives of his mother-in-law and unborn son, but also injured his wife, son, and daughter. (42) He explained the turmoil, time, and energy involved in pursuing a lawsuit against the state. (43) Further, he expressed that while the insurance companies showed no initial interest in being involved in the lawsuit, they were first in line and "had their hands open" to receive a subrogation recovery once it looked like there would be a settlement. (44) Such practice was discussed by the South Dakota Supreme Court in Bowen v. American Family Insurance, (45) when it affirmed the trial court's decision ordering American Family Insurance to pay its proportionate share of attorney fees when it sought to recover the $2,000 it paid for medical expenses from the insured's $16,500 settlement. (46)

      In opposition to H.B. 1184, Representative Mark Willadsen, (R-Sioux Falls) expressed his views as an insurance agent, arguing, that as tragic as these stories may be, "the legislation isn't in his clients' best interest: 'Make no mistake about it. This bill will increase auto insurance premiums....'" (47) Conversely, Representative Susan Wismer (D-Britton) "said the reason people buy insurance is so they are financially protected." (48) She combated Willadsen's claim, noting, "South Dakota is one of the 10 lowest states for auto premiums," with seven other states in the group having implemented the made-whole doctrine already. (49) She ended her remarks with sentiments that seemed to echo the majority of the House stating, "I really think it's the right thing to do...." (50) This time the House vote concluded with forty Yeas favoring and twenty-six Nays opposing the bill. (51) Proponents were hopeful because current Governor Daugaard had cast the tie-breaking vote in their favor the year prior. (52)

      However, even with the modification defining "made-whole," the solid victory in the House, and the impassioned speeches made by Senator Joni Cutler (R-Sioux Falls) imploring the senators not to let the insurance companies cut to the front of the line in front of the insureds and to take the opportunity to do something good for the people of South Dakota, the bill failed to receive a recommendation from the Senate Judiciary Committee. (53) Those in opposition concluded that this measure would increase insurance costs for both policyholders and insurers. (54)...