Protecting Policyholders from Arbitration Bias

Private arbitrations have become a major commercial enterprise in part because they appear to present a desirable alternative to traditional litigation. Commentators often claim that arbitration is less formal, less expensive and less time-consuming than traditional litigation. Some lawyers question whether these benefits are actually realized in insurance disputes. Experience demonstrates that pursuing resolution of insurance disputes through private arbitration can be frustrating, expensive and inherently unfair.

The inequity stems from the fact that one of the parties in a private insurance arbitration (the insurance company) routinely retains arbitrators and provides them with a steady flow of business, while the other party (the policyholder) does not. As Richard Rueben noted in California Lawyer magazine, private arbitrations “generate inherent conflicts of interest, including the provider’s pursuit of repeat business from high-volume customers.” As a result, policyholders should be reticent to sign an insurance program agreement that mandates binding private arbitration with industry-specific requirements for the neutral party.

Potential Conflict of Interest

In an article posted on the website of insurance think-tank ARIAS U.S., one private arbitrator warned his colleagues that they should “not become tempted to curry favor with an attorney or party to build a career.” This admonition against favoritism demonstrates that private insurance arbitrators are well-aware of the appearance of bias in situations involving steady insurance company customers.

When a private arbitrator has significant ties to the insurance industry, he or she may derive substantial income through their activities as an arbitrator, umpire, consultant or attorney retained by insurance company customers. In those situations, a reasonable person could justifiably question the arbitrator’s ability to be impartial or independent in a case pitting an insurance company against a policyholder. In the California Lawyer article, one Los Angeles entertainment lawyer went so far as to suggest that “anytime you are paying someone by the hour to decide the rights and liabilities of the litigants, and that person is dependent for future business on maintaining good will with those who will bring him business, you’ve got a system that is corrupt at its core.” The appearance of this potential bias should constitute a sufficient basis upon which to successfully challenge the impartiality of a proposed neutral arbitrator.

Private Arbitrations in the Insurance Setting

While it is uncommon for an insurance policy to require coverage disputes to be submitted to binding arbitration, it is not uncommon for such a requirement to be included in peripheral insurance program agreements. Many institutional policyholders enter into “loss sensitive” insurance programs as a risk financing mechanism. These programs involve the issuance of side agreements to the actual policies, such as deductible agreements, retrospective rating agreements or retrospective premium agreements. These peripheral agreements often include onerous binding private arbitration provisions. Such provisions can be drafted in such a way as to be slanted heavily in favor of the insurance carrier by requiring that the neutral arbitrator possess an insurance background or experience working for an insurance company.

Regardless of how these provisions are worded, they are inherently flawed because they can result in the selection of private arbitrators who have significant ties to the insurance industry. Such ties create the appearance of bias in favor of ruling on the side of the arbitrator’s steady customers which, in turn, threatens to diminish the public’s trust in the judicial system as a whole, and particularly in private arbitrations.

It was precisely this type of inherent conflict and potential bias that led the court in Benjamin, Weill & Mazer v. Kors, to vacate an arbitration award in favor of a large law firm in an attorney fee dispute case because the chief arbitrator derived a large part of his income from representing law firms and lawyers engaged in fee disputes with former clients. The court acknowledged the “danger that the arbitrator’s impartiality might be compromised by economic considerations.” The Kors court ultimately concluded that, based upon the chief arbitrator’s business connections, a reasonable person could “entertain reasonable doubt whether [the chief arbitrator’s] dependence on business from lawyers and law firms sued by former clients would prevent him from taking the side of a client in a fee dispute with a former law firm, because doing so might ‘put at risk’ his ability to secure business from the lawyers and law firms whose business he solicits.”

Private arbitrators wield “‘such mighty and largely unchecked power’ that the [California] legislature undertook ‘an increasingly more active role in protecting the fairness of the process.” For the arbitrators who serve as neutrals, private arbitration is a substantial professional and economic endeavor, occupying much of their time. It is, therefore, understandable that private arbitrators might be sensitive, even if subconsciously, to satisfy their steady customers. In such situations, policyholders should consider challenging the appointment of any “neutral” who has substantial insurance industry connection.

With respect to future agreements, policyholders should be reticent to sign an insurance program agreement that mandates binding private arbitration with industry-specific requirements for the neutral party. Insurance program provisions that require the neutral to have an insurance background, or a prescribed number of years of experience in the insurance industry, or be an active or retired insurance claims representative or underwriter are inherently unfair and slanted in favor of steady or repeat insurance company customers. If an insurance company is adamant that disputes arising under peripheral program agreements be submitted to binding arbitration, policyholders should only agree to such a procedure if the single arbitrator or the neutral arbitrator be a former jurist with no ties to any insurance company or insurance industry group.