Arbitration of Insurance Coverage Disputes: A Policyholder's Definitive Survival Guide

Originally published in The John Liner Review, Fall 2010

Introduction

Arbitration provisions are becoming increasingly common in insurance policies, particularly where specialty coverage is concerned. Many legal practitioners favor arbitration over litigation, depending on the nature of the case. Unfortunately, when it comes to insurance disputes, arbitration can be disadvantageous for policyholders. Too often, the process is skewed in favor of the insurance company. Increasingly, insurance policy arbitration provisions contain language not only limiting a policyholder's rights, but also eviscerating established legal protections, both statutory and under common law. Most policyholders have no choice when it comes to the inclusion of such provisions, which often consist of standard form language. This has led several states to ban arbitration of coverage disputes. As of July 2010, the following states had anti-arbitration provisions: Arkansas, Georgia, Kansas, Kentucky, Louisiana, Missouri, Montana, Nebraska, Oklahoma, South Dakota, and Vermont.1 Rhode Island has a statute that allows for arbitration only at the option of the policyholder.2

When policyholders feel strongly that an insurance company is employing improper claim-handling tactics, or simply fighting a valid claim, there are sometimes ways that they can avoid arbitration and have the day in court they deserve. Too many policyholders, however, get stuck dealing with unanticipated claim disputes that must be resolved confidentially under arbitration provisions they may never have read or may not even have realized were included in the policy language. However, when they cannot be avoided, arbitration proceedings can be managed effectively to make the playing field less slanted.

Arbitrators have little incentive to side with policyholders whom they are unlikely to encounter again in the future.

Whether negotiating to avoid having arbitration provisions inserted into your coverage, fighting to avoid an unfair arbitration process, or facing an unavoidable arbitration, policyholders need experienced coverage counsel. At each stage, sophisticated policyholders and risk managers can avoid common mistakes. The idea is to make the negotiation or arbitration process work as well as possible by understanding in advance the ways in which the deck is stacked against the policyholder.

State courts and legislatures understand that coverage disputes do not involve an even playing field. Consequently, case law has developed and statutes have been enacted that contain significant protections for insurance consumers, including presumptions in favor of coverage or against the drafter of unclear policy language, as well as so-called fee-switching laws. Some standard-form arbitration provisions do away with these protections.

The operative arbitration requirement may not even be in the insurance policy itself, but rather included in a side agreement for collateralizing premiums or as "deductible security."3 Where a policyholder never agreed to arbitrate, but received side agreements containing arbitration provisions or final policy language after other essential coverage elements were bound, policyholders should not have to arbitrate.4

Here are ten specific ways arbitration can work against policyholders:

1. Forced Compromise: Arbitration by its nature is generally more focused on compromise than litigation, wherein a party's rights may be vindicated fully. Insurance companies routinely take advantage of this to avoid paying a claim in full. This is unfair because insurance disputes are different from typical commercial disputes. Policyholder consumers do not purchase insurance to have their loss split down the middle so they receive 50 cents on the dollar. When a policyholder suffers an accidental loss, he or she is not at fault in any way. Even where a policyholder may arguably have been negligent, leading to an accident, the argument can be made that the insurance company accepted that risk, took it into account when underwriting, and calculated and accepted premiums based on full payment. Moreover, most insurance companies evaluate risks — especially risks arising from negligence — before selling insurance and even tout their experience and expertise in doing so as part of what they sell. Accordingly, policyholders may reasonably expect to be made whole for a covered loss and to not be shunted into a confidential process specifically designed to promote compromise.

2. Loss of Legal Protections: Arbitrators seeking to find a compromise may ignore or only partially apply routine statutory or common-law protections of policyholder's interests. Certain protections, such as fee shifting, may be less available in arbitration because the arbitrator considers them to have a punitive element at odds with the spirit of compromise. Moreover, as mentioned above, many arbitration provisions expressly take these protections away by, for example, expressly disallowing the collection of fees by the policyholder.

3. Arbitrator Bias: Arbitration is a commercial enterprise. Arbitrators have little incentive to side with policyholders whom they are unlikely to encounter again in the future. Individual policyholders are unlikely to be a continuing source of revenue. This is not true of insurance companies that are in a position to offer repeat business. Judges are appointed or elected, but arbitrators generally are chosen by the parties. Arbitrators that are prepared to issue awards or decisions perceived as punitive toward insurance companies are less likely to be selected more than once by insurance companies, and so they may forfeit a substantial source of repeat business.

4. Streamlined Justice: In the more casual atmosphere of an arbitration, arbitrators may feel less compelled than sitting judges to follow the letter of the law. This is a particular problem when it comes to allegations of bad faith or other policyholder protections that an arbitrator may see as tangential and not within the scope of the streamlined arbitration proceedings, which are designed to foster speedy resolution through compromise. For example, even the most well-meaning arbitrator may be less inclined to apply the "any possibility of coverage standard" or construe policy language against the insurance company because the result would yield a complete victory for the policyholder, as opposed to a compromise resolution. Moreover, arbitrators have tremendous latitude with minimal public (and often no judicial) scrutiny.

5. Erosion of Rights: Arbitration provisions increasingly contain anti-policyholder consumer provisions, such as purported bars on the collection of "fees" or revisions to the standard rules of construction regarding ambiguity and drafting (contra proferentum). The following is a standard form arbitration provision:

   Any dispute, controversy or "claim" arising out of or relating to this policy shall be finally and fully resolved through arbitration in accordance with the commercial arbitration rules of the American Arbitration Association. The arbitrator(s) and the number of arbitrators shall be chosen in the manner and within the time frames provided by such rules.

   The arbitration proceeding shall take place in the "named insured's" state of domicile or in the domicile of the "insured," person or entity seeking relief from us or from whom we are seeking relief. The arbitrator(s) shall give due consideration to the general principles of the law of the insured's state of domicile in the construction and interpretation of the provisions of the policy; provided, however, that the terms, conditions, provisions and exclusions of this policy are to be construed in an evenhanded fashion as between the parties. Where the language of this policy is alleged to be ambiguous or otherwise unclear, the issue shall be resolved in the manner most consistent with the relevant terms, conditions, provisions or exclusions of the policy (without regard to the authorship of the language, the doctrine in favor of either party or parties, and in accordance with the intent of the parties).

   The written decision of the arbitrator(s) shall set forth its reasoning, and it shall be provided simultaneously to both parties and shall be binding on them. The arbitrators' award shall not include attorney fees or other costs. Judgment on the award may be entered in any court of competent jurisdiction. Each party shall bear equally the expenses of arbitration.

   Many states allow prevailing policyholders to recover their fees as both a counter to the insurance company's enhanced bargaining power (in general, very little policy language actually is negotiated) and to provide economic incentives to force a claim compromise by denying or delaying the provision of coverage.

6. Denial of Discovery: In arbitration, policyholders are often denied basic discovery under the guise of economy and efficiency. Basic information on how the claim was analyzed and handled may demonstrate that coverage could exist but was denied improperly. Whether this is true or not, the insurance company can force the policyholder to cooperate and turn over all sorts of loss information under the guise of the need to establish and document the claim. Insurance companies, on the other hand, have been known to hide the ball by requiring a policyholder to make specific requests even when the information is readily available to the insurance company. This defeats the whole purpose of discovery, but arbitrators are often reluctant (and have less authority) to order certain types of documents produced. Arbitrators are often reluctant to compel insurance companies to turn over guidelines or other internal insurance company training documents, reserve or reinsurance information, or information regarding how similarly situated policyholders or claims have been dealt with in the past or in alternative jurisdictions (insurance companies routinely take different...