Rethinking Arbitration

Insurers and reinsurers who believe that the current system of reinsurance arbitration represents a more efficient way of resolving reinsurance claims find themselves at a disadvantage because of inequities and ambiguities in the U.S. system. As a result, many questions are arising about the current practices in arbitration when instead there should be a greater emphasis on neutral, impartial arbitrators and more meaningful documentation of opinions.

Many insurance and reinsurance companies currently are strained under a large increase of reinsurance arbitration cases. A half century ago, an insurer and reinsurer rarely headed to arbitration because a we-can-work-it-out attitude prevailed. If one of the parties was concerned about an issue, a trip to the backroom or someone's office often resolved the problem. That all changed when claim levels rose. Given the sizeable claims and litigious nature of many business transactions, there's no sign of declining opportunities for reinsurance arbitration.

Since the reinsurance arbitration system in the U.S. differs greatly from the systems used in the UK and Bermuda, insurers and reinsurers should be aware of the relative fairness of those systems. The UK and Bermuda arbitration systems differ from the system in the U.S. primarily in the way party-appointed arbitrators are treated as neutral, impartial, and independent arbitrators. The tripartite (three-member) reinsurance arbitration system is governed by a contract that allows each party to appoint an arbitrator, with a third arbitrator — referred to as the neutral or referee — appointed by the first two party-appointed arbitrators.

Under the UK and Bermuda systems, private communication between the parties and a potential arbitrator should be limited to determining that there are no conflicts of interest and to confirm a potential arbitrator's qualifications and availability. Parties are prohibited from asking prospective arbitrators if they are pre-disposed to rule in their favor. Conversely, in the U.S., ex parte communications allow for the screening of party-appointed arbitrators by their respective parties before appointing them, following a similar process used in litigation to screen experts for trial. Typically, ex parte communications are discontinued after a specific point in time, by agreement of the parties.

The debate over the benefits of a party arbitrator system is far from over. Since the written agreement between insurers and reinsurers determines the method of arbitration, a change to the current arbitration system would only require minor revisions to these agreements. However, it would have a major impact on the way arbitrations are conducted in the U.S.

Lack of Consistency, Neutrality

It's difficult for some insurers to assess the disposition of arbitrators when transcripts and written decisions are not available. Similar disputes continually come up in arbitration with different rulings because of the lack of precedent and meaningful records. Companies have to come to terms with this system's shortcomings and try to shore up persistent squabbles. Ironically, it is typically the position of the arbitrators that they do not want to have their written opinions held against them in the future. Most arbitrators in the reinsurance arbitration system are not attorneys and there is a concern that their decisions will be subject to questioning if they do not draft their decisions correctly. These concerns have very little foundation since the U.S. courts hardly ever reverse an arbitration decision unless there is an absolutely clear violation of the law.

Arbitration decisions can be difficult to predict, given that only one out of three arbitrators on the tripartite panel is truly neutral under the U.S. system. The system has not developed into a neutral playing field. The two party-appointed arbitrators have the effect of adding a second layer of advocacy in the system. And if one party doesn't like the way a potential party arbitrator is leaning, they can seek someone else.

Although party-appointed arbitrators are advocates, they can appear as phantoms during the arbitration process. There is typically no explanation of an arbitration decision and the party-appointed arbitrators are limited in what information they can disclose to their party because of the nature of ex parte communications. One solution for companies to consider is to state a more neutral method for choosing arbitrators and a requirement for written opinions in the agreement of an arbitration clause.

Best Interests of Insurers and Reinsurers

The insurance industry sometimes looks longingly at the arbitration systems in Bermuda and the UK as prospective models for reforming the U.S. system. These systems all have their genesis in the same arbitration clauses; the difference lies primarily with the UK and Bermuda requirement that the party-appointed arbitrator be neutral, impartial, and independent. It all comes to down to whether or not insurance and reinsurance companies want reform because no other party or court is going to force change. While change to a more neutral system can be quite uncomfortable for the people who are at ease with the current system, an alteration in the arbitration system will benefit insurers and reinsurers in the long run by doing wonders for fairness and expenses.

The benefits gained through the U.S. party-appointed system are illusorily. While we can look to the Bahamas and the UK's neutral systems, many argue that it would be difficult to guarantee the benefits of a neutral system. Here's why:

Party-appointed arbitrators are foremost experts, not attorneys. The party-appointed arbitrator is desirable because companies can pick an expert that creates an additional layer of advocacy. The arbitrators are well qualified to present arguments since most of them are current and former insurance and reinsurance executives. This extra advocate makes sure during arbitration that the referee or neutral arbitrator is hearing the argument of the party-appointed arbitrator. The fallacy is that if there is a neutral panel, the members are experts in their fields. They know about insurance and reinsurance. Each party is trying to stack the deck, with both sides being heard by only one neutral arbitrator. All this does is to make the neutral arbitrator a swing vote.

Ex parte communications cut both ways. The American Arbitrators Association has a canon of ethics, which was last revised in 2004. The point in favor of ex parte communication is to guide arbitrators to focus on issues they feel are most important. It gives the insurer and reinsurer more control in the proceedings. That is a valid view, but the flip side is that these arbitrators are not neutral, the insurer and reinsurer pay them and the ex parte communications are analogous to communicating with their own attorneys on strategy.

The loss of neutrality is profound. The reason for convening three arbitrators in the first place is to even the odds of a given outcome. If only one arbitrator is neutral, companies run the risk of picking a person that could go either way. Insurers and reinsurers are limiting themselves and their outcomes.

Michael Katz and James Young are attorneys with Willman & Arnold in Pittsburgh, Penn. They can be reached at www.willmanlaw.com.