Author: Zhan Hao、Wan Jia

Insurance subrogation is an important legal mechanism for the insurers to reduce their losses after the insurance indemnities are paid. However, there are different opinions about the application of reinsurers’ right of subrogation. Whether the subrogation can be directly exercised by the reinsurers against the liable third party? Should the reinsurance indemnities be deducted from the amount claimed by the direct insurer when it exercises subrogation against the third party? Can the third party refuse to indemnify the direct insurer if the direct insurer has been partially for fully covered by the reinsurance indemnities? The answers for those questions will be discussed in this article under the framework of PRC law.

I. A Landscape of the Views in Foreign Jurisdictions

Under the insurance legislation in the countries of civil law system (China also is one of them), there are generally corresponding provisions regulating insurance subrogation and reinsurance, but there are no clear provisions on whether insurance subrogation is applicable to reinsurance. The courts in the countries of civil law system have been trying to use the method of legal hermeneutics to interpret the laws and legislative intent. For example, according to the general view in Japan, the reinsurer can subrogate the rights of the direct insurer against the third party according to Japan Commercial Law. In the case delivered in 1938, the Japanese court held that the provisions of subrogation under Commercial Law were “arbitrary laws” and could be excluded by special agreement. In another case delivered in 1940, the Japanese court held that insurance subrogation is applicable in reinsurance, but by way of exercise, due to the “trust relationship” between the reinsurer and the direct insurer, the direct insurer had to subrogate on behalf of the reinsurer and then pay proportionally to the reinsurer what it obtained from the third party. That is to say, on the basis of recognizing the reinsurers’ right of subrogation, the court justifies the rationality of alternative method for the reinsurers to exercise subrogation.

In common law countries, there are a number of cases support the application of subrogation in reinsurance. In Assicruzioni Generali de Trieste v. Empress Assurance Co. Ltd in 1907, the British court held that the reinsurer has the right to claim against the direct insurer for the reinsurance indemnities it paid. In Universal Ins. Co. v. Old Time Molasses Co., the reinsurer paid half of the loss of the goods and tried to intervene in the lawsuit initiated by the insured against the liable third party, the U.S. court supported the reinsurer’s assertion. In Glacier General Assurance Co. v. G. Gordon Symons Co. Ltd, the U.S. court held that the reinsurer did have the right of subrogation, but the direct insurer should actually subrogate all the losses, and then the corresponding amount of the recovery income shall be paid to the reinsurer.

II. Reasons and Rationales Behind the Rulings of Courts

From the above court rulings both in civil law countries and common law countries, it can be found that reinsurers’ right of subrogation is well recognized by some jurisdictions, but when determining the way of subrogation, the courts adopted the approach that the reinsurers’ right of subrogation shall be exercised by the direct insurer, the direct insurer is responsible for subrogating against the third party for all the insurance indemnities paid, and then the direct insurer shall amortize the recovery income (if any) back to each reinsurer according to the corresponding proportion. Most courts in Britain, the United States, Germany, France, Japan adopt the above approach, mainly based on the following reasons and considerations:

First, the direct insurer exercising the subrogation on behalf of the reinsurer confirms with the functional position of insurance and reinsurance.

As a rational economic man, the purpose of thedirect insurer and reinsurer engaging in the insurance and reinsurance business is to make profits. The direct insurer will charge the reinsurer the reinsurance commission in consideration for the insurance business that the insurer cedes to the reinsurer. This reinsurance commission fee is mainly used to cover the direct insurance operating expenses of the direct insurer, such as setting up branches or retaining agencies to solicit business, setting up and training full-time claims settlement personnel, and also for carrying out subrogation after indemnities are paid. After the reinsurer assumes the insurance risks, it is not necessary for the reinsurer to carry out the relevant external marketing, operation and training for the above purposes.

Based on the principle of following the settlements and the principle of utmost good faith, the direct insurer must also fulfill its duty of care and deal with all the related work from underwriting to settlement of claims, and handling of subrogation should also be part of insurer’s duty. Therefore, reinsurer’s right of subrogation exercised by the direct insurer is not only because the direct insurer has collected the reinsurance commission from the reinsurer, but also because it is conducive for the reinsurer to focus on the realization of the core functions of reinsurance, such as risk re-transfer and risk diversification.

Second, the direct insurer exercising the subrogation on behalf of the reinsurer confirms with the principle of economic efficiency.

In practice, all of the direct materials and documents concerning underwriting and claim settlements are retained by the direct insurer, while the reinsurer does not have access to a complete record of the underwriting and settlements information without specific requirement. Therefore, the direct insurer has a better understanding of the third party liable to the insurance accident and the related circumstances. In order to simplify the procedures, in practice, the direct insurer has the full power to deal with the matter of subrogation, which is more convenient for both the direct insurer and the reinsurer.

Generally speaking, although the liability of the reinsurer and the direct insurer arises at the same time, the interval between the direct insurer and the reinsurer fulling their obligation of indemnity is quite long. Normally, the direct insurer pays the insured/beneficiary in advance, and then the direct insurer asks the reinsurer to share its portion of the indemnities. In certain types of reinsurance business, the time for the reinsurer to share its portion will be very long, especially for long tail business. In the above circumstances, if the reinsurer has to wait until the corresponding reinsurance liability is determined, then the reinsurer will face a series of risks such as the expiration of the statute of limitation, which is not conducive for the protection of the reinsurer’s rights.

Internationalization is also one of the characteristics of reinsurance. The reinsurer is often a foreign insurance company, and it is inconvenient and inefficient for the reinsurer to exercise subrogation worldwide. In addition, usually there are multiple reinsurers participate in the same insurance project. If different reinsurers exercise subrogation against the third party at different times or even at different jurisdictions, it will increase the burden on part of the third party to prepare the defense against the subrogation from various reinsurers.

Third, the direct insurer exercising the subrogation on behalf of the reinsurer confirms with the principle of relativity of contractual relationship.

Although there is a connection between the direct insurance and reinsurance, but contractual relation between insured and the direct insurer is distinct from the one between the direct insurer and reinsurer. This doctrine is well recognized by some jurisdictions worldwide. For example, according to Article 29 of the PRC insurance law, the direct insurer shall not refuse or delay to perform its obligation of indemnity to the insured on the ground that the reinsurer fails to perform the obligation under reinsurance contact. Similarly, a third party may not claim to deduct the amount of subrogation on the ground that the direct insurer has coverage from reinsurance. If the liability of the third party will be different depending on whether the insurer has reinsurance or not, it is not only difficult to determine the amount of compensation, but also goes against the relativity of the contractual relationship between the insured and the third party.

Therefore, the insurer’s claims for subrogation should be judged between the insurer and the insured. As for whether the insurer has additional coverage from reinsurance, it is not within the scope of consideration in the subrogation claims.

III. The Majority View in Chinas Legal Practice

In the legal practice in China, the courts at different level also hold the same or similar view as above. For example, in the Understanding and Application of The Supreme People’s Court’s Judicial Interpretation (4) of Insurance Law, the Supreme People’s Court holds that in the dispute of insurance subrogation, the reinsurer shall not directly exercise the subrogation right against the third party, but shall be recovered after the direct insurer exercises the subrogation against the third party, which also conforms with the common practice of international insurance practice.

Shanghai High People’s Court and Zhejiang High People’s Court also hold the similar view as the Supreme People’s Court that according to the principle of contract relativity, the insurer may exercise the right of subrogation against the third party in respect of the total amount, and the compensation from the third party shall be apportioned to the reinsurer according to the reinsurance contract. In the dispute of insurance subrogation, because the reinsurer has no right to exercise subrogation against the third party, the court does not need to review the execution and performance of the reinsurance contract.

In sum, even though the legislation on the applicability of subrogation by reinsurers is not clear so far, the views hold by the courts provide sufficient guidance to the future cases. It is nonetheless recommended that the parties set forth in details regarding the right of subrogation by the reinsurer in the reinsurance agreement so as to avoid ambiguities and uncertainties.