Reinsurance Arbitration—A Primer

June 2006

As shocking as it may sound, disputes occasionally happen between insurance companies and their reinsurers. When these disputes arise, they are most typically resolved by arbitration. Why? Because most reinsurance contracts contain an arbitration clause that requires all disputes to be resolved by a panel of industry arbitrators. This commentary will discuss the basics of reinsurance arbitration.

by Larry P. Schiffer
LeBoeuf, Lamb, Greene & MacRae LLP

Many people ask, what is the difference between litigation and arbitration today anyway? Commercial arbitration, especially reinsurance arbitration, has become complex, costly, and time consuming. Fundamentally, there is no difference between litigation and arbitration because in each proceeding, a neutral third party decides the dispute between the parties and issues a binding decision. Procedurally, however, there are dramatic differences.

Arbitration is a consensual dispute resolution mechanism generally founded on a contract provision that requires all disputes be resolved by arbitration instead of litigation. Because it is generally a contract right, courts enforce arbitration clauses. A federal policy in favor of arbitration developed many years ago and was made part of the law by Congress when the Federal Arbitration Act was enacted. Most states also favor arbitration and have similar laws and court decisions enforcing arbitration clauses.

The biggest difference between litigation and arbitration is the decider of the dispute. In court, of course, it is a judge, either elected or appointed, but who is an employee of the government (or a judge and a jury if you really want to have fun with a reinsurance dispute). In arbitration, the decider is an arbitrator or a panel of arbitrators, who are private citizens being paid by the parties to resolve the dispute. In reinsurance, the practice has been to have a panel of three arbitrators chosen from either active or former executive officers of insurance or reinsurance companies. In other words, industry "experts" act as the arbitrators in reinsurance disputes.

Another big difference is the rules. In court, litigation is governed by either state or federal procedural rules. These rules cover all aspects of the litigation, from commencement through appeals. In commercial arbitration there may or may not be rules. The rules in commercial arbitration may come from arbitral bodies like the American Arbitration Association, or the International Chamber of Commerce, or in international arbitration the UNCITRAL Arbitration Rules. In reinsurance disputes, the parties may agree to use the Procedures for the Resolution of U.S. Insurance and Reinsurance Disputes, which were promulgated by a task force of insurance and reinsurance industry professionals, or may agree to procedures before the arbitration panel that suit both the parties and the arbitrators. Unlike other forms of commercial arbitration, it is rare that a reinsurance arbitration will take place under the auspices of an arbitral organization or tribunal with rules and procedures that must be followed.

Flexibility of the process is another significant difference between litigation and arbitration. In court, there is very little flexibility. The case will be tried in the courthouse, and the rules make clear how the process will unfold. In arbitration, the parties and the arbitrator may find that the arbitration hearing should be held in more than one location or that only briefs and oral argument are necessary to decide the case. Because commercial arbitration is a private, confidential, and consensual procedure, the parties and the arbitrator may adopt unique methods for resolving the dispute.

Of course, a huge difference between litigation and arbitration is confidentiality. In court, your dispute is on public display and anyone can sit and watch the trial. In arbitration, the process is private and confidential. While the industry rumor mill may leak some information, the fact is that in most commercial arbitration disputes, only the parties and the arbitrator see the evidence and hear the testimony.

Finally, another major difference is the ability to appeal. In court, the right of appeal exists by statute. In commercial arbitration, generally there is no right of appeal. While there are some ways to challenge an arbitration award, courts construe these grounds narrowly, and it is rare to see an arbitration award vacated.

Why Do Reinsurance Contracts Have Arbitration Clauses?

In general, most reinsurance contracts, especially reinsurance treaties, contain an arbitration clause. Arbitration clauses in reinsurance contracts tend to be very broad. This means that virtually any dispute or disagreement concerning the interpretation or application of any part of the reinsurance contract, including its formation, must be decided by arbitration.

But why arbitration? Arbitration has been the traditional method of dispute resolution for reinsurance disputes for many decades. Insurance and reinsurance companies would rather have their disputes resolved by a panel of industry experts who will decide disputes based on industry custom and practice. Traditional reinsurance arbitration clauses relieve the arbitrators from following the strict rules of law and specifically require the arbitrators to consider the reinsurance contract as an honorable engagement rather than a strict legal obligation. This way, instead of a judge that knows nothing about the industry and who will construe the reinsurance agreement like any commercial contract, reinsurance disputes are determined based on industry business practices by industry experts.

Reinsurance arbitrations are also private, confidential proceedings that are not open to public or competitor scrutiny. This is another reason why many insurers and reinsurers would rather arbitrate than litigate. While information about arbitrations often does find its way into the industry press, especially if a party goes to court to seek to confirm or vacate an arbitration award, for the most part, the details of the award and the dispute are kept confidential.

Ad Hoc Reinsurance Arbitration

Reinsurance arbitration differs markedly from commercial arbitration in other industries. As discussed above, a typical reinsurance arbitration is organized, administered, and controlled by the parties and the arbitrators, not by an arbitral body. In other words, no third-party organization administers the arbitration. The parties do it themselves.

Most reinsurance arbitrations traditionally do not require adherence to any particular set of rules. Unlike contracts that require arbitration before a specific arbitral organization under that organization's rules (e.g., the American Arbitration Association and its Commercial Arbitration Rules), reinsurance arbitration traditionally has no set of rules to follow. The parties and the arbitrators set their own rules for the arbitration.

As reinsurance arbitrations became more prevalent during the past decade, insurance and reinsurance professionals came together in a task force to put into writing the traditional ad hoc reinsurance arbitration procedures that most parties followed. Those rules, called the Procedures for the Resolution of U.S. Insurance and Reinsurance Disputes, are slowly being incorporated into reinsurance contracts by some companies, but widespread usage is not yet commonplace.

Commencing the Arbitration

Commencing a reinsurance arbitration is simple. Follow the requirements set forth in the arbitration clause of the reinsurance contract. If there is nothing said about commencing the arbitration, the party seeking arbitration (the petitioner or claimant) merely needs to send a demand for arbitration to the opposing party (the respondent) by any reasonable means of delivery where proof of delivery is available. In other words, a letter sent by overnight delivery demanding arbitration should do the trick. Because reinsurance arbitrations are rarely before an arbitral forum, there is no filing of the arbitration demand necessary, only delivery on the opposing party.

The Arbitration Process

The typical reinsurance arbitration process goes something like this. The claimant sends the respondent a demand for arbitration. The demand specifies the reinsurance contract and gives some indication about the dispute. The demand may name the claimant's arbitrator or, more typically, will demand that the respondent name its arbitrator within a set amount of time (generally set forth in the arbitration clause). If the respondent fails to name its arbitrator, the claimant may have a contract right to name the second arbitrator on the respondent's default. When the two party-appointed arbitrators are chosen, the two of them, with input from each side, will select a third arbitrator, who is often called the umpire.

Once appointed, the umpire will schedule a meeting between the arbitration panel and the parties. This meeting, called the organizational meeting, allows the parties to meet the arbitration panel, develop the arbitration schedule, resolve any interim or preliminary issues (which could include the place for the arbitration, whether the parties will be able to have private communications with their party-appointed arbitrator, whether any of the arbitrators have any conflicts with the parties or their counsel that requires the arbitrator to step down, pre-award security if one of the parties is a nonadmitted company or has financial problems, the scope of document and deposition discovery, and how the arbitration hearing will be conducted). At the conclusion of the organizational meeting, the parties usually have a schedule and are able to begin the arbitration process.

Reinsurance arbitrations today may include significant document discovery, discovery against third parties—like reinsurance intermediaries, managing agents, or third-party administrators—and depositions. Experts and expert discovery also may occur in appropriate cases. At the conclusion of discovery, the parties will typically disclose potential hearing witnesses and will then follow a briefing schedule for initial and reply arbitration briefs. The arbitration briefs generally are accompanied by a binder of exhibits each side believes the arbitration panel will need to decide the dispute.

The Arbitration Hearing

After the arbitration briefs and reply briefs have been provided to the arbitration panel, a hearing is held. The arbitration hearing typically includes opening and closing statements by each party and direct and cross-examination of witnesses. The arbitrators often ask questions of each witness after the direct and cross-examinations to make sure that they understand all the facts and circumstances. Post-hearing briefs are less common today, with the arbitrators relying on the parties' closing arguments and having available to them the transcript of the hearing testimony.

After the hearing, the arbitration panel will deliberate. Deliberations may take place immediately after the hearing, or may take place over the phone or in a series of conferences between the arbitrators over a few weeks.

The Arbitration Award

Once the arbitrators reach their decision, a written arbitration award is issued by the panel. Unless required by the reinsurance contract or the parties, the typical reinsurance arbitration award does not set forth the details or reasons for the panel's decision. The award typically states in a few sentences which party won what issues and how much one party has to pay the other party (generally, reinsurance disputes are all about who should pay what for certain claims). More complicated reinsurance arbitrations may require a second hearing to establish damages, with the first hearing used to establish liability.

An arbitration award may be brought to court to be entered as a judgment and enforced if the losing party refuses to comply. If the losing party is not a U.S. company, the award may be enforced through the relevant U.N. Conventions on the enforcement of arbitrations if the losing party is located in a signatory country.

As discussed above, unless provided for in the arbitration clause—which is virtually unheard of in reinsurance contracts—there is no appeal from an arbitration award. Under the Federal Arbitration Act, there are a few grounds to seek to vacate an arbitration award, but those grounds are construed very narrowly and it is rare to see an arbitration award vacated by a court.

Conclusion

Set forth above is merely a broad-strokes outline of the mysterious world of reinsurance arbitration. The reinsurance arbitration process has been under scrutiny by insurance and reinsurance companies because it has become much more litigation-like, and the supposed cost savings from speedy arbitrations has not come to fruition in many cases. Organizations like ARIAS•U.S., which was created to certify reinsurance arbitrators and improve the arbitration process through training, are leading the way in modernizing the reinsurance arbitration process.

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