Alternative dispute resolution offers insurers and policyholders a quick, cost-effective alternative to litigation. Both mediation and arbitration are private and set no precedents. Yet despite these advantages, it's not necessarily the norm.
Although most insurers as well as policyholders recognize the benefits of ADR and prefer it over litigation, many standard-form U.S. commercial policies do not contain ADR provisions.
After a claim dispute arises, the relationship between policyholders and insurers often deteriorates rapidly, which makes the agreed upon use of options such as mediation and arbitration unlikely. Instead, the dispute ends up in court.
Given that commercial insurance disputes often lead to protracted, expensive and unpredictable litigation, it seems that underwriters and corporate risk managers should reexamine their commercial policies and consider adding ADR clauses wherever they are absent.
ADR methods such as arbitration are a "creature of contract," which means that parties have the opportunity to design their dispute resolution process as part of their contractual relationship.
In the context of standard commercial policies, items such as arbitrator selection, number of arbitrators, locale, governing law, discovery, remedies, etc., can be addressed in the ADR clause itself.
In addition, the clause will determine if "all disputes" under the policy are subject to the provision, or limit ADR to only certain types of disputes (such as damages when coverage is not in dispute).
In developing language for a standard-form commercial policy, underwriters would typically work with in-house counsel in determining appropriate language.
Often, insurers and policyholders are able to negotiate to a point regarding damages but are unable to close the gap. For this type of situation, the parties might agree to arbitration "within monetary limits." Under this protocol, the arbitration award must be somewhere between the insurer's highest offer and the policyholder's lowest demand. This eliminates extreme risk and preserves the benefits of prior negotiations.
In cases where the arbitration clause is limited to determining damages, a clause can provide for "baseball" arbitration, where the arbitrator must pick one of the numbers submitted by the parties. This protocol encourages both sides to submit a reasonable number. Of course, none of the above options are available in court.
Given the advantages and flexibility of arbitration, the question remains as to why arbitration clauses are not contained in commercial policies with greater frequency.
The answer may relate to the fact that the near universal embrace of arbitration agreements as valid and enforceable may not, in all cases, apply to contracts of insurance. Although there is no prohibition against arbitration of insurance disputes under the Federal Arbitration Act, certain states have enacted statutes that purport to restrict or limit the use of arbitration clauses in insurance policies.
Whether or not such statutes or regulations have been upheld by various courts is beyond the scope of this discussion. Suffice it to say courts that have addressed the issue typically consider the complex interplay between the statutes, the FAA and the McCarran-Ferguson Act, which reserves the regulation of insurance to the states.
The above considerations may, in some cases, discourage insurers from including arbitration provisions in their standard-form policies because of uncertainty and/or need to sort through a number of state-specific laws. Nevertheless, there's no need to throw the baby out with the bath water.
For example, insurers can address the issue by including arbitration clauses in policies and issuing "amendatory endorsements" in connection with those states that have statutes restricting the use of such clauses.
Such amendatory endorsements might delete the provision in specific states, or perhaps substitute language making binding arbitration an option that could be voluntarily elected by the insured after a dispute arises.
As an alternative, insurers can choose to adopt the "voluntary election" approach across the board. Inasmuch as any such election by the insured would be "post-dispute," such language likely would not run afoul of any state statutes or regulations restricting predispute arbitration clauses.
From a business standpoint, it would seem such clauses would also be extremely attractive to commercial policyholders, who tend to view ADR very favorably and regularly include ADR provisions in their non-insurance agreements.
In addition to the above, insurers should consider including mediation provisions, which would also fall outside the scope of any statutes restricting the use of predispute arbitration clauses. Mediation, which is nonbinding and has a high rate of success, is particularly well suited for complex insurance disputes.
For example, in coverage disputes, it's not uncommon for direct negotiations between insurers and policyholders to become strained and/or break down. Among other things, a mediator can act as a buffer as well as facilitate discussions, which can lead to a settlement without establishing legal precedent.
By including a mediation step in a policy's ADR provision, mediations can occur sooner rather than later, which will result in significant time and cost savings if the mediation is successful.
Various nonpolicy "insurance-type" agreements would also not be affected by statutory concerns.
In recent years, commercial insurance transactions have become increasingly complex, involving a variety of risk-financing and risk-transfer mechanisms. These types of risk management alternatives often involve significant premiums and resemble financial transactions more than traditional insurance arrangements. Large self-insured retentions with claim service agreements are not uncommon.
Although the above are "insurance-type" agreements, it is likely that most would fall outside the scope of statutes that restrict the use of arbitration clauses in insurance policies. Perhaps for this reason, many insurers routinely include arbitration clauses in these types of contracts. Companies that enter into these types of transactions should consider including such provisions if they are not already in their agreements.
As indicated above, there's no reason to take an all-or-nothing approach when it comes to incorporating ADR provisions into commercial insurance agreements. In the event of a dispute, such provisions offer insurers and policyholders the opportunity to resolve them in a manner that's quicker, less costly and more private than litigation.
Such provisions also allow parties to select their decision-maker(s), as opposed to being assigned to a judge or jury.
Today, insurance executives recognize that "underwriting discipline" goes far beyond risk analysis, and understand the impact attorney fees and the vagaries of the jury system can have on the bottom line.
Increased use of ADR through inclusion of arbitration (and/or mediation) provisions is one way to address such concerns. In short, ADR is too powerful a tool to ignore in the context of commercial insurance disputes and deserves a second look.
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