Background: The Concept of Subrogation
To understand the Mahler reduction, it is important to have a basic understanding of the legal concept of subrogation. Subrogation refers to when an injured party, after receiving a monetary settlement for damages from an at-fault party, must repay some of this settlement money to a third party, often an insurance company, who has paid for expenses on the injured party’s behalf.
A common example of subrogation can be found in the context of automobile accidents, where an injured party has been injured due to the negligence of another driver. In this circumstance, the injured party’s own insurance company is often the one that initially covers the injured party’s medical bills, if the injured party has Personal Injury Protection (PIP) coverage. In this common situation, the injured party’s insurer is essentially making upfront payments on behalf of the negligent party, so as to provide the injured party the ability to receive immediate medical care. It is not until much later in the process, after the claim against the negligent driver is settled either via settlement negotiation or in court, that the injured party receives monetary compensation for his/her medical costs from the negligent party’s insurance company.
In order to prevent ‘double compensation’ when the injured party receives settlement money for expenses that were paid by his own insurance company, the law often requires that the injured party pay back his insurance company from the settlement funds. This repayment duty is known as subrogation.
The Mahler Reduction
The Washington Supreme Court, in the seminal case of Mahler v. Szucs, held that, although an injured party has the duty to repay his insurer from settlement funds, the insurer must pay a “proportionate share of fees and expenses” incurred by the injured party to obtain such funds. The Mahler court felt that it would be “grossly inequitable” for the insurer to receive the entire subrogation payment when the injured party, not the insurer, has incurred the legal expense of recovering a financial settlement.
Thus, the ‘Mahler reduction’ was borne, which, when applicable, reduces the amount that the insurance company receives as a subrogation payment.
The effect of the Mahler reduction is that it allows an injured party to retain more money in a settlement and it forces the insurance company to pay for a pro rata share of the costs incurred by the injured party to recover a financial settlement. In practice, this Mahler reduction is calculated and withheld by the injured party or his attorney when the insurance company is paid the subrogated amount.
The Proper Way to Calculate the Mahler Reduction: Pro Rata Share Rather than Percentage
Personal injury attorneys often set their contingency fee at a percentage of the total amount recovered for the injured party. Many attorneys use 33% as a common contingency fee percentage, meaning that the attorney’s fee will be one-third of whatever amount is recovered on behalf of the injured party. If no settlement amount is recovered, there will be no attorney’s fees.
Although the injured party’s attorney’s fee is often calculated by a percentage, it is a fairly widespread myth that, to calculate the Mahler reduction, one simply multiplies the subrogated amount owed to the insurance company by the attorney’s contingency fee percentage. This incorrect belief is represented by the following equation:
INCORRECT Calculation of the Mahler Reduction = (PIP Amount) x (Contingency Fee Percentage)
Instead of using the contingency fee percentage in the formula, the correct Mahler calculation recognizes the pro rata share that the insurer must pay. The Mahler reduction is calculated by a formula that multiplies the total attorney’s fees not by the contingency amount but, rather, by the ratio of the amount the insurer paid (PIP amount) over the total settlement amount.
CORRECT Calculation of the Mahler Reduction = (Attorney’s Fees + Costs) x (PIP Amount / Total Settlement)
Although the correct and incorrect formulas sometimes produce the same result, the application of the correct Mahler formula has the potential to alter the end calculation. Take the example of Caleb, an injured party who receives a $15,000 settlement subject to $5,000 in attorney’s fees (33% of the settlement amount) plus $1,000 in costs. We will assume that Caleb received $8,000 in PIP payments from his insurance company. Under the basic rule of subrogation, we know that Caleb must repay some or all of the $8,000 to his insurance company. If the Mahler reduction is applicable, we know that injured party is able to reduce the $8,000 base repayment amount by the insurer’s pro rata share of attorney’s fees.
INCORRECT Calculation: ($8,000) x (33%) = $2,666
Applying the incorrect formula to Caleb’s situation produces a Mahler reduction of $2,666 (33% of the $8,000 subrogation amount).
CORRECT Calculation: ($5,000 + $1,000) x ($8,000 / $15,000) = $3,200
If, however, the correct formula is used and the correct fraction of 8/15 (PIP amount/total settlement) is applied to the $6,000 in attorney’s fees + costs, then $3,200 will be withheld from the payment to the insurer.
In this example, we see that the incorrect formula results in a payment to the insurance company of $5,334, while the correct formula produces a total repayment of only $4,800 — thereby producing a more favorable result to the injured party.
As Caleb’s situation indicates, the correct and incorrect formula will produce different results when additional costs are added to a contingency fee arrangement. If the attorney charges a contingency fee percentage, and there are no additional costs incurred, then the two formulas will produce the same result.
Caleb’s situation demonstrates that applying the wrong formula to calculate the Mahler reduction can produce potentially detrimental results to the client in cases where there are costs in addition to the attorney’s contingency fee. Applying the correct formula to the withheld amount is therefore important to ensure that the injured party receives the appropriate recovery amount, and to avoid objections from the insurance company receiving the repayment.
 “It is grossly inequitable to expect an insured, or other claimant, in the process of protecting his own interest, to protect those of the [insurer] as well and still pay counsel for his labors out of his own pocket, or out of the proceeds of the remaining funds… a proportionate share of fees and expenses must be paid by the insurer or may be withheld from its share.” Mahler v. Szucs, 135 Wn.2d 398 at 425 (1998).
 The formula for calculating a PIP carrier’s pro rata share of the insured’s legal expenses is “legal expenses multiplied by the ratio obtained by dividing the PIP reimbursement by total damages.” Safeco Ins. Co. v. Woodley, 150 Wn. 2d 765, 772-73, 82 P.3d 660 (2004).
Have questions regarding your rights in an accident? Contact one of our Kirkland personal injury attorneys.