Journal of Legal Studies
When tort judgments exceed the assets of tortfeasors and the tort victim has first-party insurance for a portion of the loss suffered, the question arises as to how the recovery from the tortfeasor should be divided between' the tort victim on the one hand and the insurer via its rights of subrogation on the other. A common view among the courts and legal commentators is that the insured should be made whole before the insurer recovers subrogation. This paper employs simple models of optimal insurance contracts to show that the opposite rule will often be optimal. Accordingly, there is little basis for judicial interference with freedom of contract when the insurance agreement provides that the insurer must be made whole before the insured receives any portion of the recovery. The analysis also provides some support for allowing the insurer to take first as a default rule at common law.
Alan O. Sykes, "Subrogation and Insolvency," 30 Journal of Legal Studies 383 (2001).