Understanding Insurance Policy Arbitration Provisions

By Christopher H. Yetka | May 09, 2008
Arbitration provisions are common in first-party property insurance policies. Appraisal clauses are invoked when an insurer and policyholder cannot come to agreement on the value of property damage. Pursuant to the provision, each party selects an impartial appraiser, who in turn selects an "umpire." A decision by any two is binding. Parties typically bear the costs of their own appraiser and half the cost of the umpire.

Similar language has begun to creep into third-party liability policies, including directors' and officers' policies, and since 1985, by endorsement to commercial general liability policies. Rather than simply requiring parties to arbitrate the amount of coverage, the new provisions require the parties to arbitrate the existence of coverage.

For many companies, arbitration provisions are initially attractive because they are thought to reduce the expense of litigation. However, the opposite may be true. For example:

1. In litigation, most courts require some form of alternative-dispute-resolution procedure before trial. The parties can select arbitration, or some other form of alternative-dispute-resolution, such as mediation or mini-trial.

2. A binding arbitration provision may take away the right of appeal. Arbitrators may be more inclined to "split the baby" when not subject to review. When the very existence of coverage is at stake, an unfavorable and inequitable outcome in arbitration can eliminate coverage.

3. Arbitration, particularly before the American Arbitration Association, is often as expensive as full-fledged litigation, and includes discovery and motion practice.

4. It can be difficult to get a strong advocate as an arbitrator. While arbitrators are supposed to be neutral, insurance companies use the same arbitrators time and again, and they are almost universally strong advocates for the insurers' positions. Policyholders must make sure that their arbitrators are equally strong, or run the risk of losing control of the process. This is particularly important since the two arbitrators are typically picking a third, "neutral" umpire. Because insurers will come before umpires time and again, it is important to make sure that the umpire is not biased in any way. An umpire can unconsciously be swayed by the prospect of future work.

5. Policyholders should not be forced to travel to participate in mandatory arbitrations if they could have instituted a lawsuit in their home jurisdictions.

6. The arbitration provision can threaten legal presumptions in the interpretation of insurance contracts. Most courts treat insurance contracts as contracts of adhesion, and all ambiguities and uncertainties must be interpreted in the policyholder's favor. There is a risk that those same presumptions will not be applied by arbitrators, especially if the arbitrators are not lawyers or familiar with insurance law.

7. If more than one policy is triggered, an arbitration provision may double the litigation costs. For example, if an action against a company and its directors implicates both employment practices liability and directors' and officers' coverage, and only one policy contains an arbitration provision, a policyholder may be forced to invoke arbitration to obtain coverage under one policy and litigation for the other.

For the reasons listed above, when an arbitration provision shows up in a liability policy, policyholders are well advised to seek the advice of counsel and their broker to determine if the provision threatens to reduce the very coverage they are seeking.

Christopher H. Yetka is a trial attorney with Lindquist & Vennum PLLP whose practice is devoted to commercial litigation, particularly insurance recovery disputes. Reach Yetka at cyetka@lindquist.com or (612) 371-2416.