Mediation and arbitration in insurance disputes

Mediation is a negotiation run by a neutral who cannot impose a result; it settles most disputes that reach it and costs far less than a lawsuit. Arbitration is a private trial: an arbitrator or panel hears the case and issues a decision that is usually final, with very limited review by a court. Appraisal, which many property policies contain, is a narrow cousin of arbitration that decides only the amount of a loss. Which of these applies depends first on what your policy says, and many commercial policies say nothing about arbitration at all.

This guide explains each process, where you are most likely to meet it in a commercial coverage dispute, and how to keep your rights alive while you use it. It assumes a dispute with your own insurer or between co-insurers; the regulator's complaint process is separate and is covered in how to complain to your state insurance department.

The menu of options

Mediation and arbitration can also be required by a contract that is not your policy, such as a construction contract, a loan agreement or a vendor agreement that names insurance disputes. Read each document for a dispute clause before you assume a court is the next step.

Mediation: how it works and how to use it

A mediator, often a retired judge or an attorney with insurance experience, meets with both sides, sometimes in the same room and often in separate rooms, and carries offers back and forth. The mediator has no power to decide. A mediation costs the mediator's fee, usually split between the parties, plus your preparation time.

Mediation fits several situations:

• Coverage disputes where the insurer has denied the claim or issued a reservation of rights letter and a business wants to avoid years of litigation.
• Amount disputes that appraisal cannot reach, such as scope, causation or the business income period.
• Liability settlements, where a mediation is the usual place for a plaintiff, the insured and one or more insurers to negotiate. Insurers' representatives attend with settlement authority. If a settlement could exceed the primary limit, the excess insurer should attend. See the hammer clause: what happens if you refuse a settlement for what happens when you disagree with your insurer's recommendation.
• Disputes between insurers over who pays defense costs, or how to share a loss.

Preparation matters more than the mediator. Send a short written position with the policy, the denial letter, your expert reports and a damage summary, in a form the insurer's decision-maker will read. Ask who will attend for the insurer and whether that person has authority to settle your full claim. If you are a policyholder, bring your own coverage counsel, and your broker if the broker knows the claim history.

Four mechanics protect you:

1. Check what the policy requires. A few management liability and specialty forms make mediation a step before suit. If yours does, do it first.
2. Protect the clock. A mediation does not stop the suit-limitation period unless the parties agree. If the policy allows only two years from the date of loss to sue (as the ISO commercial property conditions do), get a written tolling agreement before you mediate, or file suit and stay it. See what to do when your business insurance claim is denied.
3. Read the confidentiality terms. Most states protect mediation communications by statute or court rule, but the protection varies. Agree in writing at the start that statements are confidential and cannot be used later.
4. Get the deal in writing before you leave. A signed term sheet that states the payment, the timing, the release and who is released is usually enforceable. A handshake is not.

State-run claim mediation programs rarely help a commercial policyholder. Florida's Department of Financial Services program, for example, is created by section 627.7015 and by its terms does not apply to commercial coverages other than commercial residential. Private mediation is the usual route.

Arbitration: where it comes from and what it does

Arbitration exists only by agreement. In insurance disputes, that agreement comes from the policy or from an endorsement. You are most likely to see it in:

• Surplus lines and other non-admitted insurers, including London market policies with an arbitration or service-of-suit clause. See excess and surplus lines insurance explained and How Lloyd's of London works: syndicates, brokers and what it means for you.
• Manuscript policies for larger accounts, where the buyer's lawyer and the insurer negotiate the dispute clause.
• Reinsurance and inter-company agreements, which do not involve the policyholder directly.
• Some D&O, professional and excess policies, as a final step after mediation.

Admitted-market standard forms such as the ISO commercial general liability and property forms do not contain an arbitration clause for coverage disputes. The ISO property form's appraisal condition is different and is limited to the amount of loss.

Why state law matters

The Federal Arbitration Act favors enforcing arbitration clauses, but the McCarran-Ferguson Act says no Act of Congress shall be construed to invalidate, impair or supersede a state law enacted to regulate the business of insurance unless the federal act specifically relates to insurance (15 U.S.C. section 1012(b)). Some states restrict or bar mandatory arbitration in insurance policies, and courts have used McCarran-Ferguson to uphold those laws against the FAA. International agreements add a wrinkle: in Safety National Casualty Corp. v. Certain Underwriters at Lloyd's (5th Cir. 2009, en banc), the Fifth Circuit held that the New York Convention overrides Louisiana's state law against arbitration clauses, and the Supreme Court declined to review. Other circuits have reasoned differently. Whether a clause is enforceable against you therefore depends on the state, the type of insurer and the court. A coverage lawyer should answer that before you agree to a forum or refuse one.

Reading a clause line by line

The American Arbitration Association publishes a standard clause in its Commercial Arbitration Rules. Insurance policies vary it, but its parts show what to look for:

"Any controversy or claim arising out of or relating to this contract, or the breach thereof, shall be settled by arbitration administered by the American Arbitration Association under its Commercial Arbitration Rules, and judgment on the award rendered by the arbitrator(s) may be entered in any court having jurisdiction thereof."

• "Arising out of or relating to" is broad. It reaches coverage, claims handling and often tort claims linked to the contract. A narrower "arising under" can leave bad faith in court.
• "Administered by the American Arbitration Association under its Commercial Arbitration Rules" picks the institution and the rulebook. Under the rules amended September 1, 2022, expedited procedures apply by default to cases where no disclosed claim exceeds $100,000, and large, complex procedures apply when a claim is at least $1,000,000. Cases over $100,000 are directed to mediation, subject to opt-out, according to the AAA's rules.
• "Arbitrator(s)" leaves the number open. Policies often specify one or three arbitrators, and sometimes require insurance experience.
• "Judgment on the award... may be entered in any court" means the decision is enforced like a court judgment.

The clause does not say where the hearing will be, which state's law applies, who pays the fees or what discovery is allowed. Policy versions usually add those terms, and they can decide the outcome. A hearing seat far from your business raises your costs.

Limited review

Court review of an award is narrow. The FAA's grounds for vacating an award, which cover corruption, fraud, evident partiality, misconduct and arbitrators exceeding their powers, are exclusive, and the Supreme Court held in Hall Street Associates v. Mattel (2008) that parties cannot expand them by contract. A wrong reading of the policy is generally not a ground for reversal. Treat an arbitration as a one-shot decision.

Choosing a path

1. Name the dispute. Is it amount (appraisal or mediation), coverage (mediation, arbitration or court) or claims handling (regulator, mediation or court)?
2. Read every dispute clause in the policy, endorsements and related contracts, and ask your broker for the complete policy.
3. Calendar the suit-limitation date and any notice requirement for demanding appraisal or arbitration.
4. Decide how much you need a court. Bad faith claims, punitive damages and a published precedent usually require litigation; see insurer bad faith: what it is and the remedies.
5. Propose mediation early, after your documentation is complete and before either side has spent heavily.

A hypothetical example

Say a manufacturer's warehouse floods and its surplus lines property carrier agrees there is a covered loss but disputes the cause of $1.4 million of the damage. The policy has an arbitration clause with a New York seat and three arbitrators. The manufacturer's lawyer proposes mediation first, signs a tolling agreement and exchanges expert reports. At the mediation, held by video, the insurer's representative has authority up to $900,000. They settle at $1.05 million, with a signed term sheet. Had they not settled, the arbitration would have followed, with a limited right of appeal and a hearing seat in a distant city. The facts are invented.

When none of this applies

Many commercial policies have no ADR clause. Then the options are negotiation, appraisal if the property form has it, a complaint to the department of insurance and, ultimately, a lawsuit. Pick your forum with a lawyer's help if the amount at stake justifies it.

Key takeaways

• Mediation is non-binding and cheap; arbitration is usually binding and hard to appeal; appraisal decides only the amount of a property loss.
• Standard admitted-market forms (ISO CGL and property) do not require arbitration of coverage disputes, but surplus lines, London market and manuscript policies often do.
• State law, McCarran-Ferguson and the New York Convention can change whether an arbitration clause is enforceable against a policyholder, so get legal advice before agreeing to a forum.
• Protect deadlines with a written tolling agreement before you mediate, and settle only on a signed document.
• Read the entire clause: scope, rules, number of arbitrators, seat, governing law and fees can matter more than the choice of process.