What the future holds for reinsurance arbitration clauses

Is the use of arbitration to settle disputes fading in the international reinsurance market? While confidentiality issues make it difficult to pin down trends, it appears that the high cost and slow progress of arbitrations are increasingly of concern.

The most recent rule changes implemented by (re)insurance arbitration society Arias UK, to introduce shorter and less costly arbitrations, have been designed to deal with those criticisms. But despite this, are reinsurers generally shifting to courts as their preferred forum for dispute resolution?

Certainly in the case of reinsurance, classes and business that renew routinely on the basis of standard form contracts – catastrophe, property and so on – there are few signs that the market approach to the use of arbitration in reinsurance is changing.

Most practitioners are reluctant to deviate from what are usually treated as market-standard wordings, including in relation to arbitration clauses. That approach to consistency is what makes the market efficient in terms of the contracting process, as well as in the event of claims – the key time when disputes arise.

The down side is that when disputes arise in relation to those standard wordings, the parties must submit to arbitrations, with the result that there is a lack of binding precedent in relation to the way those standard provisions operate. 

Arbitral confidentiality means there is an inefficient lack of understanding as to how standard contractual terms are interpreted, so disputes about the same point will have to be arbitrated over and over again. That necessarily increases cost and is not commercially efficient.

With court-based litigation, on the other hand, once the court’s judgment has been obtained, it will bind disputes covering the same basic issues in future.

While it is clear that not every dispute is the same, the point is that at least with the public nature and precedential value of case law, a degree of predictability regarding the use of equivalent contractual provisions will be obtained.

Bespoke market

But, sitting alongside the placement of the more standard-form reinsurance business lies a reinsurance market of bespoke contracts, heavily negotiated terms and extensively documented transactions.

This is the market of loss portfolio transfer reinsurance, value-in-force reinsurance, longevity and mortality reinsurance and indemnity-based industry loss warranty reinsurance, to name a few. 

These arrangements are typically high-value transactions and typically one-off arrangements, and they are not normally renewed. What is increasingly evident in these types of reinsurance arrangements is a move away from arbitration.

It is difficult to understand the precise rationale for this shift. It may be that, given the increased expectation that terms will be negotiated and the lack of (incentive to agree) a market-standard approach, there is more of a willingness to reject arbitration due to the deficiencies identified above.

It may also derive from an inability by the parties at the outset of the arrangement to identify the class/type of arbitrators required for any future dispute. There is not really an experienced body of market practitioners for these types of bespoke reinsurance arrangements.

Arguably, a more explicable driver for the shift away from arbitration may derive from the types of parties that are typically commercially and legally interested in the documentation. 

Finance calls the shots

Many of these types of reinsurance transactions require extensive involvement of financiers to support the provision of funds, security, collateral and possibly other capital to reinsurers to support the transaction. Those financiers may be banks, hedge funds or other investment organisations.

While the documentation is in principle being negotiated directly with cedants by reinsurers, the financiers certainly are interested in the legal effect of the reinsurance documentation. After all, the effect of the reinsurance documentation will have a material impact on how the financing aspects of any such transaction work.

And those that are responsible for providing funding can be fairly persuasive in terms of getting their way with contractual provisions of concern to them. Put simply, if a bank or hedge fund is going to provide financing to reinsurers to enter into these transactions, those banks or hedge funds are going to go over the reinsurance documentation carefully to ensure that the reinsurance documentation will behave as expected.

Those financiers are looking to maximise certainty of outcome. Not only will those financiers be less disposed to arbitration panels, which can sometimes be under the influence of reinsurance market practitioners and carry the deficiencies expressed above, but they are part of a market and culture that has not traditionally referred material financing disputes to arbitration. They have tended to prefer court-based litigation.

Given the financiers’ preference, it is to be expected that that would extend to all the documentation connected to the transaction. There would be some risk if the dispute resolution mechanism differed as between the various documents comprising the overall transaction.

There is certainly a move away from arbitration clauses in at least part of the reinsurance market.  Time will tell whether that shifting attitude will broaden into other areas of the sector.

Victor Fornasier, partner, international insurance, Hogan Lovells