Billingham ReSolutions, Incorporated
Katherine L. Billingham, J.D., C.P.C.U
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Katherine L. Billingham, J.D., C.P.C.U
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WILL REINSURANCE ARBITRATIONS BECOME A LEGAL DINOSAUR?Katherine L. BillinghamSeptember 30, 2003 -- The reinsurance arbitration process has grown well beyond its ancestral proportions. This form of dispute resolution is groaning under the weight of increased time and expense as it evolves from its original purpose. Since arbitrations are generally private affairs, there is little in the way of available statistics but those operating within the system are expressing concerns. The run-off sector of the insurance and reinsurance industry is growing at an unprecedented rate. Chiltington estimates reflect that the liabilities associated with currently discontinued business in the United States total approximately $300 billion, and the projected growth for the run-off industry is exceeding that of the industry as a whole. Because of the long tail of liabilities for many of the companies in run-off, and the administrative costs required to sustain the process, many if not most, of these companies ultimately wind up – literally - in insolvency. This phenomenon has its genesis in a multitude of factors, not the least of which is market underpricing, reduced returns on investments, mergers and acquisitions, catastrophic losses and a sharp increase in environmental, including asbestos, claims. Run-off tends to breed more disputes between the reinsured and its reinsurer. When the reinsurer is in run-off, management strategy can include the slowing of the payment stream to cedants in order to generate more income on assets. Also, a run-off reinsurer will often increase its auditing of the cedant to facilitate, and even justify, the delay in the payment of claims. Conversely, when a cedant is in run-off and takes this approach with its own reinsureds, those same reinsureds are often reinsuring the cedant on some other program(s), and the reinsurer will exercise its legal or equitable rights of offset, with the net effect being that neither pays the other. Ultimately, one party becomes dissatisfied and seeks resolution. The flood of pollution and asbestos claims into the market in the last several years has also contributed to the number of reinsurance disputes. When faced with the prospect of otherwise litigating various coverage issues in the context of an actual or threatened insured bankruptcy, cedants often compromise such claims on proof arguably insufficient, and in some cases the claims are settled en masse or even with a policy buy-back. These claims have caused a wave of case law in regards to issues of trigger and allocation that varies from state to state. Reinsurers have questioned the allocation of such claims and at times have challenged the cession. As a result, the concept of “follow the fortunes” is now the subject of intense scrutiny. Consequently, in the past decade the number of reinsurance arbitrations has increased dramatically, as has the amount of money at stake. These developments have had the effect of steering the process into a new era, one more resembling litigation than arbitration. This evolution is generating some doubts as to the value of the time-honored process and would seem to be eroding the long-standing fundamental precept of “utmost good faith.” Most treaty reinsurance agreements contain an arbitration clause. Arbitration clauses arose under the English 1891 Stamp Act and the Marine Insurance Act of 1906 when treaties were underwritten prior to the inception of the contract itself and therefore, were considered to be legally unenforceable in the courts. (For this reason, and other practicalities, facultative agreements often do not contain an arbitration clause.) Since reinsurance treaties have continued to be processed in this manner, that is to say they are frequently signed after the coverage period has begun, and in some cases after the period has expired, it is impractical to negotiate and draft a lengthy and complex agreement, including an arbitration clause. Arbitration clauses have been referred to as the “Cinderella” clause because they receive little attention from underwriters who are more focused on the extent and price of the cover. This market reality is what founded the concept of good faith and fair dealing in the industry. In the case of the arbitration clauses, the parties expect that in the event of a dispute, experts in the industry will fill in the blanks by following “custom and practice.” Most arbitration clauses state that disputes will be resolved by a panel of three arbitrators, often requiring that those arbitrators be active or retired executive officers of an insurance or reinsurance company. The trade has historically preferred to have reinsurance disputes resolved privately by industry executives, not because these professionals necessarily possess honed dispute resolution skills but because they have practical business experience and can further the notion that following the customs and practices in the industry should be the guiding principle. Arbitration clauses also often state that the arbitrators are not bound by strict rules of law that would apply in court and that the reinsurance agreement is to be deemed an “honorable engagement.” Experienced veterans in the industry are capable of understanding and favoring the intent of the parties rather than the language of the contract itself. In a typical arbitration clause of a reinsurance agreement, each party will select an arbitrator and the two arbitrators together will choose an umpire. If they cannot agree on an umpire then each party will suggest three names to its arbitrator. Each arbitrator will then strike two names from the other arbitrator’s list and lot drawing from the two remaining candidates chooses the umpire. In the past, arbitrators and umpires were chosen swiftly and often by consensus. Now the process is often fraught with delay, posturing and controversy. In some cases, parties have filed suit at this stage over disputes about such things as the qualifications or alleged bias of a potential umpire on a party’s list. What once took only a matter of weeks can now take months, long before the real dispute is the focus of the parties’ resources. To add to the problem, increasingly the question arises as to whether a party-appointed arbitrator is to act as a partisan advocate, or is to simply be predisposed to the position of the party appointing him or her, or is to maintain complete neutrality. Some assume that because the party appointing that arbitrator pays the arbitrator’s fees, that arbitrator’s vote is, or should be, a foregone conclusion, a concept that can breed tension throughout the arbitration process. Most arbitrators take the position that they are to facilitate, not advocate, that they are to assist the umpire in understanding the position of the party appointing that arbitrator, and that they can ensure that the party will have an unfettered opportunity to take reasonable discovery and present its case in a fair manner. A party-appointed arbitrator will generally subscribe to the position of the party appointing him or her at the outset but will do so with the understanding that he or she will maintain an open mind with regard to making a final decision after considering all the facts at the arbitration hearing. In fact, if a poll were to be taken it would likely reveal that, more often than not, reinsurance arbitration panels render unanimous decisions. The customary practice of open communication between the party and its appointed arbitrator until the final hearing has also been the subject of criticism over the years as the process has moved towards more rigorous formalities. However, the value of this approach should not be underestimated. The free flow of information can allow the arbitrator to be pivotal in transferring helpful observations in both directions. An experienced arbitrator can assist the party in gaining a better appreciation for the flaws in its position and can help to move the parties toward more common ground and even a settlement. As the arbitration process becomes more litigious, parties are questioning whether they might be better off to simply forego the whole affair and take their matters through the court system. There is a prevailing theory that arbitrators tend to favor compromise decisions over aligned positions. If that were the case, with the time and expense of arbitrations being what they are, it is easy to understand why some might question the value of following the arbitration track. In truth, however, most arbitration panels avoid “splitting the baby.” The American Arbitration Association has performed a study which shows that only 11% of the panel decisions represent awards in the 40-60% range of the demand, as illustrated below.
Years ago, arbitration proceedings were completed in a matter of weeks or months. Now they can last for a couple of years or more, and the cost associated with them has grown proportionately if not exponentially. Where once the process was streamlined by comparison to litigation, now parties engage in pre-hearing disputes surrounding such issues as discovery and security. Often, these disputes are accompanied by several rounds of briefing. Arbitration panels are reticent to limit the parties in these quests because arbitrations are binding and there is little opportunity for appeal. Additionally, unlike overloaded court dockets, arbitrators can devote more time to these matters so they tend to give the parties wider latitude. Some of the long-valued advantages of arbitrations still prevail. Parties almost always agree at the outset of the matter that the arbitration will be confidential, thereby avoiding a precedent that could prove unfavorable for one or both of them in future disputes. They can also avoid the public exposure of an embarrassing example of market practice. Further, because the arbitration clause sets few mandates about how the matter should proceed, the parties are able to fashion a system that meets their specific needs. In response to the growing number of arbitrations, ARIAS (AIDA Reinsurance & Insurance Arbitration Society) was formed in the early 1990’s to provide arbitrator training and to set standards for the arbitration process. The AAA, the RAA (Reinsurance Association of America) and ARIAS maintain lists of reinsurance arbitrators. ARIAS is also exploring mediation as a means of reinsurance dispute resolution, and while it may be slow to acceptance, mediation may revive some of the original concepts underpinning the arbitration clause. Mediation has many benefits. A typical mediation will last one day, thereby cutting costs significantly. Each side has an opportunity to view its case from the vantage point of a neutral and skilled mediator, and each has an opportunity to advise the opponent directly about its viewpoint and can learn about any surprises the other side holds. A party can reevaluate its position with the freedom to walk away. Mediation can often achieve results that appeared to be incapable of attainment. Mediation is gaining much favor in England. Ten years ago the Center for Effective Dispute Resolution (CEDR) was founded and now mediates hundreds of disputes each year, including reinsurance matters. Last year the Claims Mediation Centre opened an office in Lloyd’s and expects that it can reduce the approximately $1.16 billion in annual legal costs by as much as one-third. In June of this year the International Underwriting Association and Lloyd’s retained Intermediation, a commercial mediation service, to provide a series of clinics for Lloyd’s. This fall, in Chicago, Mealey’s hosted a dispute resolution conference that included a reinsurance mediation, a series of workshops and roundtable discussions that was well attended and received. In the end, arbitration is still less expensive and faster to finality than litigation as a means of resolving reinsurance disputes but if current trends continue, it could be a distinction without a difference. Mediation may provide a viable alternative for those who are willing to consider a compromise solution, even if the compromise only involves avoiding further legal costs, commonly known as “nuisance value.” In any event, unless the dinosaur is reigned in, arbitration clauses may become a thing of the past, the “Ice Age” past. Katherine L. Billingham, J.D., CPCU is the former Vice President and General Counsel of Universal Reinsurance Corporation. In 1989 she founded her own firm and is a reinsurance consultant and arbitrator.
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