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Policyholders Must Be “Made Whole” Before Insurers Recover Payments From Third Parties



The Washington Supreme Court recently issued a decision strongly reiterating the “made whole” doctrine under Washington law, which provides that an insurer cannot exercise its right of reimbursement from a third party who injured its insured, until the insured itself has been made whole by recovery of damages or losses it has incurred. In Daniels v. State Farm Mut. Auto Ins. Co., State Farm paid for damage to its insured’s vehicle in full, less a $500 deductible. State Farm then recovered 70% of the damage from GEICO, which had insured one of the parties whose negligence had caused the loss. (Another party was determined to be 30% at fault; all parties stipulated that Daniels—State Farm’s insured—had no fault). State Farm then reimbursed its insured 70% of the $500 deductible.

State Farm’s insured objected, claiming that it should be reimbursed its entire deductible because it bore no fault for the underlying loss. The Supreme Court agreed, holding that “[w]hether in the context of a reimbursement requests, offset, or direct subrogation action, a fault-free insured must be made whole for their entire loss before an insurer may offset or recover its own payments.”

The Court also held that State Farm could not rely on policy language to get around the “made whole” rule. The Court held that, although policy language may provide that a payment for loss to the insured triggers an insurer’s right to pursue third party recovery, contract terms relating to allocation of payments recovered must be interpreted in a way that aligns with the common law. Thus, the Court said, there could be no reasonable interpretation of State Farm’s policy language regarding subrogation that resulted in its insured not being made whole before State Farm allocated any third party recovery to itself.

Daniels overturned Averill v. Farmers Insurance Co. of Washington, where the Court of Appeals had held that the “made whole” doctrine did not extend to this type of subrogation action, reasoning that deductibles are contracted-for risk on the insured’s part. Instead, the Daniels court adopted the view that the purpose of a deductible is to eliminate insurance coverage for small claims that are better covered by the insured due to the high administrative costs to insurers relative to small claims. For example, a lower deductible carriers a higher premium to cover the increased administrative costs of smaller claims. Further, deductibles are only reimbursed when the insured’s sustained loss exceeds their deductible amount.

Takeaway 1: The message from the Daniels decision is this: “made whole” means “made whole.” The Court rejected State Farm’s efforts to work around the doctrine by distinguishing between different forms of third party recovery, or taking advantage of ambiguous policy language. This decision strongly reaffirms what has long been the law in Washington: that an insurer’s right of third party recovery derives from and is conditioned upon its insured first being fully compensated for its loss. Although Daniels arose out of an automobile claim, the principles underlying the decision would apply in the case of any liability insurance policy, including commercial liability.

Takeaway 2: Insurance policies in Washington must be interpreted in accord with the common law. The policy at issue included language allowing for subrogation, in addition to the statement that “[State Farm’s] right to recover [State Farm’s] payment applies only after the insured has been fully compensated for the bodily injury, property damage or loss.” The Court found that this language—when read in accordance with this common law doctrine—required the insurer to pay proceeds of any subrogation action to the plaintiff first, until they were made whole. This repayment included a full reimbursement of the insured’s deductible, which State Farm failed to do.

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