Wisdom teeth: insurers look for ways to keep the bite in binding arbitration.

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HIGH PROFILE: Attorney William M. Shernoff recently landed one of the insurance arena's biggest arbitration awards. Yet, if such large awards become an industry trend he said it could cause insurers to revert from arbitration back to litigation.

* The Situation: Arbitration is the insurance industry's preferred way to settle claims disputes.

* The News: Arbitration caseloads are at an all-time high even though digital processing has expedited settlements.

* The Next Step: Recent big-time arbitration awards and Congressional scrutiny may cause insurers to retool their arbitration processes.

Arbitration has long been a staple of the insurance industry for settling claims disputes. But, due to a recent mega-arbitration award and pending federal legislation that would chip away at the Federal Arbitration Act, a lot could change.

"There's always been a trend by the insurance industry for arbitration because they consider that to be a more favorable format for them," said William M. Shernoff, senior and managing partner at the law firm of Shernoff Bidart Darras in Claremont, Calif. "The awards by arbitration seem to be a lot less, as far as dollar damages would go, than a trial by jury would give. That's why they put these arbitration clauses in their contracts."

Yet Shernoff recently represented a California breast cancer patient, Patsy Bates, in a binding, arbitrated health insurance case over the rescission of her individual health insurance policy. The case netted Bates "a very large punitive award," so there may be some second thoughts throughout the insurance industry about arbitration, he said. He declined to discuss the case in detail.

According to court records, the case, Bates v. Health Net Life Insurance Co., was settled for more than $9.3 million: $8.43 million in punitive damages; $936,811 in special damages; $750,000 for emotional distress; $129,809 for unpaid medical expenses; and $57,002 in interest.

Bates is perhaps the highest insurance arbitration award so far, Shernoff said. Such large awards are usually more common in litigation than in arbitration. On the other hand, court decisions can always be appealed, but arbitration normally can't be, he added.

That's a big "positive" for arbitration from the plaintiff's point of view, Shernoff said. "So if you get a decent award from an arbitration, it's much more likely to stick than a jury award, which many times gets reduced by the appellate courts," he said.

Bates could even start an arbitration trend among trial lawyers, he said.

"As far as I know, it's the First-ever arbitration award that included a substantial punitive damage award in a health insurance case," Shernoff said. And if several other large insurance arbitration awards came down, the arbitration trend in the industry could slow down or even stop, he said.

In February, shortly after the decision, the defendant's parent company, Health Net Inc., issued a statement saying it would take action on "some serious concerns" that the arbitrator had raised.

The insurer vowed to not rescind future policies without a binding, external, third-party review process; ensure its application and underwriting processes are clear, understandable and thorough; and comprehensively review all parts of the policy-issuing process, including enhanced broker review, training and education.

According to Shernoff, "[Insurers] have always considered arbitration a safe harbor, and that's why they put those clauses in there, and that's why they try to enforce those clauses as much as they can."

Historically, arbitration gives more favorable awards to the industry, he said. But if several other large insurance arbitration awards occur, the trend toward arbitration could slow down or stop, because the insurance industry wants to go where it will pay the least amount of money, he said.

"And so far, they think arbitration is the place to be," Shernoff said. "But that could change. You never know."

A Growing Option

"There are three major factors affecting the arbitration process today," said Cary Schneider, executive vice president at the Insurance Information Institute. "A focus on controlling the expense dollar; a greater recognition of the savings arbitration offers over litigation; and the ability to conduct arbitration electronically."

In the past several years, arbitration has moved from a "very paper-intensive process" to a "more high-tech, electronically focused way of getting things done," Schneider said.

He was speaking in particular of Arbitration Forums Inc., a leading, Tampa, Fla.-based arbitration firm for the property/casualty insurance industry.

"I think they have met with great success in seeing the number of arbitration filings grow as they have increased the ability of fliers to have the arbitration process electronically," Schneider said.

AFI handled a huge caseload last year--some 477,000 arbitration cases, almost double that of 1996--representing more than $2.2 billion in claims. Geoff Engert, AFI's director, said the caseload hike is due in part to the firm's move to electronic filings.

AFI is moving toward a totally paperless office environment with the help of new E-Subro Hub technology, a Web-based application, and is encouraging its members and clients to do the same. E-Subro Hub eliminates many manual tasks, freeing subrogation claims staff to focus on more valuable activities, Engert said.

"Most of the cases that AFI handles involve auto collisions, so we're talking about a highly competitive part of the property/casualty industry, one where holding down expenses is a critical factor in their success," Schneider said. "So I think that has a lot to do with looking for ways to save on costs such as litigation, and arbitration becomes an increasingly attractive alternative."

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E-Subro Hub is a "major leap" for handling arbitration cases, Schneider said. "It's kind of a give-and-take, the way subrogation works. You issue an offer, and another person responds. If they can do that back and forth electronically, that speeds the process dramatically."

The American Arbitration Association has seen growth in arbitration cases in the business-to-business and international business areas, said Senior Vice President Richard Naimark.

"Business-to-business arbitration is generally more cost effective than litigation. It generally has got finality to it," Naimark said. "Quite commonly the arbitrators are people who have some knowledge and expertise of the field, the subject matter of the dispute."

Globalization has contributed to the rise in international business arbitration cases, he said. The erosion of trade barriers and Americans' desire to avoid the courts of other countries have moved "everybody around the world toward arbitration," he said. "And they're scared of our courts, too."

Another trend winding its way through American business is mandatory arbitration, which is used quite often in insurance contracts, especially health care policies.

Yet mandatory arbitration clauses can be deceiving, Shernoff said. Once a contract containing an arbitration clause is signed, it's mandatory. But many contracts that contain such clauses do so in fine print, which can throw consumers off, he said.

"Unless you can somehow get out of it by saying that the fine print didn't comply with state regulations or something like that," he said.

His firm has been able to overturn arbitration clauses in California because of the state's tight requirements. The clause has to be prominently displayed above the signature line, and has to be in a predetermined type of bold print "so an average person would realize what they're signing," Shernoff said.

"But even then, most consumers don't realize they're waiving their fight to a jury trial," he said.

"Most consumers, when they sign these arbitration clauses, they're just a part of the contract," he said. "If you want the doctor appointment or whatever the case may be, you have to sign it. Otherwise you don't get the medical treatment or the health insurance or whatever it is you're bargaining for. So there is an element of duress there."

To counter that possibility, Sen. Russell Feingold, D., Wis., introduced the Arbitration Fairness Act of 2007. The bill would prohibit mandatory arbitration clauses in consumer transactions involving employment, consumer, franchise and civil rights disputes. A similar bill was introduced in the House of Representatives.

Committee hearings were held on both bills last fall, but no further action has been taken. Not surprisingly, insurance industry groups have come out against the proposals.

"We oppose both the House and Senate bills," said Melissa Sheik, vice president of federal affairs for the American Insurance Association. Either version "would abolish the use of pre-dispute arbitration agreements and consumer franchise and employment contracts," she said.

"We think doing that denies a meaningful resource for consumers who have relatively small claims," Sheik said. "If they don't go to arbitration, they'll probably end up with nothing."

AIA represents some 350 property/ casualty insurance companies that together write more than $123 billion annually in premiums.

The goal of the Arbitration Fairness Act of 2007 appears to be consumer protection, Naimark said. Yet, "in reality, litigation for most consumer and employee matters is not viable. It's hard to get a legal representative for relatively small claims. It's hard to navigate your way through the process," he said. "Properly done, arbitration is more accessible."

Rocking the Boat

Both Naimark and Sheik agreed that the proposed legislation would erode the 83-year-old Federal Arbitration Act. Naimark called it the "foundation of virtually all arbitration in the country."

"We think that's a mistake," Nainlark said. "If they're going to take legislative action, they should not touch it. They should pass some other legislation."

Naimark also said, "We've got 82 years of scrutiny, wisdom and guidance in the arbitration arena. It would be a non-intended collateral effect that could be very damaging. There's a huge amount of arbitration that goes on in this country. You really don't want to be affecting those."

Shelk agreed. "These arbitration agreements are a benefit to both sides. They avoid lawsuits and a lot of litigation costs," she said.

Proponents of the Arbitration Fairness Act of 2007 say it will help create equal economic power among the parties involved, Sheik said. She's not buying it.

"Even in commercial lawsuits there's unequal economic power," she said. "Nobody is exactly the same. There are a lot of industries that do use a lot of arbitration clauses. Securities uses it a lot. A lot of franchise contracts use arbitration in this, and I don't see anybody in the franchise industry jumping up and down, saying 'we have to abolish these'."

Besides, the courts can step in if they believe a pre-dispute arbitration clause is unfair--and in fact, they have in some cases, Sheik said. "It's not like there isn't any oversight of these clauses."

Naimark said that due process and rules of fair play for consumer and employment arbitrations already protect consumers and employees.

"All they really have to do is codify the due process protocol," he said, "so all the consumer arbitrations follow those rules of fair play, and they can accomplish the same goals without doing damage to other areas."

The existing system also provides that the location of the hearing and any fees to the individual are reasonable, Naimark said.

"All the remedies that might be achievable in court are available in arbitration."

When All Else Fails ...

There are two basic types of arbitration involving insurance: intercompany arbitration and arbitration for injury claims, said Dennis Bans, president of Premier Arbitration of Cumming, Ga. His firm gets involved in intercompany arbitrations for insurance companies that may be backlogged with cases, or are short of people due to storm duty or some other unforeseen causes.

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"When insurance companies can't agree on settling a case between themselves, then they go to intercompany arbitration," Baus said. Although there are several forums for intercompany arbitration, it is most commonly used for settling auto, property damage, liability and policy disputes or when an insurance company owes another insurer over a claims dispute, he said. Premier adjusters will take the place of attorneys to review cases, prepare and submit contentions through intercompany arbitration and try to win an award for the client.

Arbitration for injury claims helps speed up the settlement process, while cutting down on court costs and attorneys' fees, Baus said. "You don't have to go through a long trial--you can do it in a day or two. It can be binding or non-binding, depending on what the parties agree to," he said.

Sometimes arbitration for injury claims is used to "kind of establish parameters for what both sides feel a claim should be worth," Baus said. "Arbitrators will interject what their opinions of the case are to both sides."