Coinsurance, Deductible, and a Signed Release
A homeowner policy on a house with a $400,000 replacement cost has a $300,000 dwelling limit, an 80% coinsurance clause, a $1,000 deductible, and replacement cost loss settlement. A kitchen fire causes $80,000 in replacement cost damage; the actual cash value of the damaged property is $65,000. The insured has the repairs made. Before the insurer pays the claim, the insured signs a release with the negligent contractor who caused the fire. The release recovers $5,000 for the insured and discharges the contractor from all further liability for the fire. The insurer did not consent to the release and learned of it only when preparing its subrogation demand after paying the claim. The policy requires the insured to protect the insurer's subrogation rights and to do nothing after a loss to impair them. There is no other insurance. The insured asks the insurer to pay the full $80,000, less the deductible.
1. Calculate the insurer's payment if the insured has the repairs made. Show the coinsurance formula and explain any alternative if the insured had not repaired.
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The coinsurance requirement is 80% x $400,000 = $320,000. The insured carried $300,000, so the ratio is $300,000 / $320,000 = 0.9375. On a replacement cost basis with repairs completed, the loss payment is $80,000 x 0.9375 = $75,000, less the $1,000 deductible = $74,000. The policy limit is not exceeded. If the insured had not repaired, the insurer could pay actual cash value: $65,000 x 0.9375 = $60,937.50, less $1,000 = $59,937.50. The insured's demand for $79,000 ($80,000 less deductible) ignores the coinsurance penalty. The insured is 93.75% insured to the requirement and bears the rest.
2. What is the effect of the insured's $5,000 release with the contractor on the insurer's subrogation rights and on the claim payment?
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Subrogation gives the insurer the insured's rights against the negligent contractor to the extent the insurer pays. The policy also makes the insured's duty not to impair those rights a condition. By signing a release before the insurer paid, the insured destroyed the insurer's ability to pursue the contractor. The insurer can respond by denying or reducing the claim to the extent of the prejudice, or by seeking reimbursement of the $5,000. Because the release covers all further liability, the insurer may argue the entire subrogation right is lost; at minimum, it can offset the $5,000 settlement. If the insurer pays $74,000, it cannot also recover the same loss from the contractor. The insured's $5,000 is not a windfall if it represents the deductible or uncompensated loss.
3. If the insurer pays the claim and later sues the contractor, what limits its recovery, and who has priority?
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If the insurer pays and then sues the contractor, its recovery is limited to the amount it paid, here $74,000, and cannot exceed the insured's total damages. The insured would normally retain priority for the deductible and any uncompensated loss. But because the insured already released the contractor for $5,000, the insurer may have no claim to pursue; the release bars it. The insurer could sue the insured for impairing subrogation or offset the $5,000 against the claim. If the release were set aside or the contractor's liability exceeds the settlement, the insurer's recovery would still be capped at its payment. The insured cannot recover twice.