Coming of age: arbitration--the reinsurance industry's method of settling contract dispute--is no longer effective and needs an update.

The arbitration system, the predominant method of dispute resolution in the treaty reinsurance business, is broken. This system was conceived in a different era to resolve business disputes between partners in long-term (and usually profitable) contracts to ensure fast, fair and cost-effective resolution by knowledgeable decision-makers. It has deteriorated into a process in which few of the originally intended benefits are realized.

Given the hundreds of millions-indeed billions--of reinsurance dollars currently in dispute before arbitration panels, it is imperative that the industry address the problem underlying today's arbitration system.

Defining the Problem

The system of reinsurance arbitration is in widespread use today purely and simply because it was deemed appropriate in a bygone era. Some professional reinsurers are beginning to offer treaties without arbitration clauses of with new modified language. But, in most cases, brokers continue to circulate standard treaty wordings with arbitration provisions because it is easier than explaining to the market why a change is necessary of advisable. Once an arbitration clause is included in a treaty and a dispute arises, absent an agreement by both sides, it is virtually impossible to escape arbitration.

Most reinsurance treaties in effect today contain an express provision requiring that disputes between the parties be resolved by a panel of three arbitrators with substantial industry experience. These arbitration clauses usually provide that the arbitrators are not bound by the "strict rules of the law" but, instead, are to view the cedent-reinsurer relationship as an "honorable engagement" and are to resolve disputes in accordance with "industry custom and practice." The premise underlying these arbitration provisions was that judges would be unable to comprehend the vagaries of the reinsurance business. Thus, one of the intended benefits of the reinsurance arbitration system was that the decision-makers presiding over disputes would "understand the business" in all of its arcane detail. This premise has not always been borne out in fact. Some noteworthy decisions in the courts may have missed the mark on reinsurance "custom and practice," although others have been remarkably thoughtful and well-reasoned.

In the 1980s and 1990s, the reinsurance market was inundated with unanticipated pollution, asbestos and other toxic tort claims that led to arbitration proceedings. In the late 1990s, the Unicover debacle sparked a spate of well-publicized disputes on issues such as fraud and the abuse of authority. Not surprisingly, the field of reinsurance dispute resolution has been flooded with lawyers and would-be arbitrators/consultants eager to "assist the industry" in resolving these complicated disputes on an hourly basis.

Many of these practitioners are quite knowledgeable about the reinsurance industry and skilled at dispute resolution. Others are not. In court proceedings, judges are constricted by the need to keep matters moving off the court's calendar. As a result, judges are highly motivated and often quite skilled at convincing the parties either to settle or start trial. Arbitrators and lawyers who are compensated by the hour--while quite well intentioned--often are not so motivated.

The influx of lawyers and arbitrators into the reinsurance arbitration field, combined with the staggering dollar amounts at issue and the demise of long-term cedent-reinsurer relationships, has resulted in arbitration disputes that resemble trench warfare, more than a civilized method to obtain a "fast, fair, and cost-effective resolution by knowledgeable decision-makers." Reinsurance disputes in arbitration today routinely take years to come to hearing, and the hearings themselves go on for weeks and months, something no judge would--or could afford to--allow.

Also, reinsurance arbitrators, even those with vast industry knowledge, are not necessarily equipped to handle this new era of disputes. The most experienced reinsurance arbitrators report that they have participated in "one hundred or more cases" over the course of 10 or 15 years. A typical judge, on the other hand, quite often has a hundred or more disputes on his or her docket at any given time. Judges hear hundreds (if not thousands) of motions concerning discovery issues, complicated privilege questions and procedural matters each year and, based on this extensive experience, usually resolve such disputes fairly easily. The typical reinsurance arbitrator just does not have the experience to say, for example, "I've seen that same privilege issue a hundred times before." Nor is the typical reinsurance arbitrator necessarily even trained in legal matters.

The typical arbitration provision in a reinsurance treaty provides little in terms of how the arbitration itself should proceed, beyond a method for selection of the arbitrators. Issues (such as the circumstances under which discovery is allowed, whether a hearing should be held, and if so, how it should be conducted)--which in court are addressed by written procedural rules--are typically left for the parties and the arbitrators to decide on a case-by-case basis.

While the uninitiated might assume that the cost of a reinsurance arbitration is less than a court resolution, that sadly is often not the case. In arbitration, the parties have the privilege of paying not only their lawyers by the hour, but also the three arbitrators and hired experts. At one time, it was rare for an arbitration panel to hear experts, because the arbitrators, who qualified to be panelists by virtue of their industry experience, were felt to be expert enough. Those days are gone. In one recent arbitration, over one party's objection, a highly experienced panel listened to expert testimony for 22 days on issues such as "underwriting."

Nor is there any uniformity to billing and accounting practices among arbitrators. Some arbitrators have taken to sending bills for tens of thousands of dollars in advance, for scheduled weeks of hearing time. Others become highly offended at the proposition of answering questions about their use of time. It is not at all uncommon for arbitrators to express preferences about which first class hotels they prefer, and catering choices for hearings. In these circumstances, it is the confident party, indeed, who questions an arbitrator about his or her bill or requirements.

Finally, because treaty wordings generally do not specify how the arbitration panel is to communicate its decision to the parties (or, indeed, the industry), the typical panel today refuses to render a decision explaining its reasoning (a "reasoned decision") unless both sides ask for one. One well-known arbitrator recently explained this reluctance as stemming from his concern that if he put his reasoning in writing, the losing side would be more likely to challenge him with an appeal.

Others have speculated that panels are reluctant to provide reasoned decisions because that would shed light on the "horse-trading" or "baby-splitting" process that is common behind the closed doors of the three-member, party-appointed panel. In any event, the absence of reasoned decisions leaves the parties (and the industry) in the position of having paid a small fortune for a decision that is devoid of any reasoning that could be used as a guide to avoid future disputes.

Not surprisingly, the reinsurance arbitration process, as it is practiced today, is satisfying no one--except arguably those charging by the hour. What, if anything, can be done?

A Solution

Once an actual dispute arises between parties to a particular reinsurance treaty, they are unlikely to trust each other enough to modify the arbitration clause applicable to them. So, it is vital to any meaningful change to the system that cedents and reinsurers examine their treaties wholly apart from and in advance of any particular dispute, and devise improvements that would apply if and when a dispute arises.

In this regard, we believe that the industry must work toward the creation of a "Convention on Reinsurance Arbitration," to be included in new treaties and appended to existing treaties by endorsement. The details and language of this convention should be the subject of meaningful discussion within the industry. We believe an expansion/refinement of the Procedures for the Resolution of U.S. Insurance and Reinsurance Disputes, (the "procedures") as promulgated by the Reinsurance Dispute Resolution Task Force, may be the most efficient means for achieving a good convention.

At a minimum, the convention should address, in addition to the "procedures" mentioned above, the following issues:

Arbitrator Qualification/Certification--Rather than making it compulsory that arbitrators must be retired or serving executives of an insurance or reinsurance company, the convention should require that only arbitrators who have obtained arbitrator certification as specified in the convention are eligible to resolve disputes. As with other professional certifications, the convention should specify required training that should include testing of the arbitrator's practical dispute resolution abilities, and should be at the level of dispute resolution training offered by universities and law schools around the country. The convention's training requirements should not be satisfied by attendance at a few weekend of even week-long seminars. This training should include a foundation in the rules of evidence. Although arbitrators retain latitude in applying evidentiary rules, a baseline understanding of the rules and the policy reasons underlying them will lead to a more orderly process.

Enforceable Ethical Standards--The convention should provide that only arbitrators who have completed formal training in arbitration ethics, and have agreed to be accountable to a certification entity in this regard, are qualified to serve as arbitrators under treaties to which the convention applies. At present, there is no body (such as the state bar associations for lawyers) to which misconduct can be addressed and rectified.

Neutral Arbitrators--In the absence of language prohibiting such conduct, it is customary in reinsurance arbitrations in the United States (but not in Europe of Canada) for each party arbitrator to have lengthy one-sided communication with the party that appointed him or her, right up to the close of discovery of the beginning of the hearing. This communication arguably tends to make the party-appointed arbitrators more partisan than they otherwise might be, and may lead to baby splitting and horse trading once the panelists get together to decide the case. The convention should provide a mechanism for the appointment of three neutral arbitrators, none of whom should perceive him of herself to be aligned with one side of the other in any respect. Ex parte contact should be strictly prohibited.

Discovery--Recent trends have been for counsel to use exhaustive discovery, which at times appears to be driven by improper motives. The convention should clearly define discoverable issues and require that arbitrators appointed under the convention limit discovery to those issues.

Calendar/Timetable--The convention should limit the maximum period of time for final resolution, and require that arbitrators accepting an appointment under a treaty to which the convention is endorsed agree to that timetable as a condition precedent to taking on a case.

Written Reasoned Decisions--The convention should state that written reasoned decisions are required and that any arbitrator may author a written dissenting opinion.

Abandon the Assumption of Confidentiality--The convention should state that confidentiality of the proceedings, while permissible if both parties agree, is not mandated and will not be enforced by the arbitrators over the objection of one of the parties. This will ensure that confidentiality is implemented only when both parties wish it, and is not used as a means to hide a poorly reasoned decision of a party's bad and recurring behavior from future panels.

Costs--The convention should empower and encourage a convention-qualified arbitration panel to award costs, arbitrators' fees, and/or attorneys' fees to the prevailing party (in a discovery dispute of in the entire action) as a means of cutting down abuses of the process and to foster settlement efforts.

While achieving a universally acceptable convention may seem a daunting task, the return on the investment of time, thought and energy will be significant for the industry in terms of long-term cost savings, accuracy and reasonableness of outcomes.

Linda Dakin-Grimm is a partner in the Los Angeles office of Milbank, Tweed, Hadley & McCloy LLP, and Mark B. Cloutier is president and chief executive officer of Overseas Partners Re Ltd., Hamilton, Bermuda.