However, arbitration also has its disadvantages. The informality of the process may allow the arbitrator to ignore the traditional rules of evidence and other legal constraints that often favor an insured's reasonable expectations of coverage. Also, arbitration decisions generally cannot be appealed. Thus, the insured may be required to accept an incorrect or possibly unjust decision by the arbitrator.

The ISO CGL and Umbrella forms include arbitration within the definition of a "suit", as well as alternative dispute resolution methods, such as mediation, subject to consensual agreement between the insurer and the insured.  If not present in a policy condition, arbitration provisions may be added to a policy by endorsement.

When umbrella arbitration provisions state that such proceedings are both mandatory and binding, the results of arbitration are final. A few umbrella forms omit the "mandatory" provision, or allow for arbitration at the option of the insured. Some policies state that arbitration proceedings are to be conducted under the rules and procedures of the American Arbitration Association. Other insurers may require the proceedings be conducted under different guidelines, or omit any reference to rules of conduct.

There are three basic elements of arbitration provisions that, when present, affect conduct of the arbitration process. These elements are:

1. "Situs" requirements—The arbitration must take place in a specific locale, such as a specified city or the insurer's state of incorporation. Foreign insurers may specify locales such as London, England or the Bahamas . A situs requirement can be particularly onerous when the arbitration must be conducted in a state or country other than that in which the insured's operations are located. For example, an insured based in Los Angeles may not have the time or resources to attend an arbitration hearing in London .
2. "Choice of Law"—Policy coverage will be interpreted based upon applicable law of the specified jurisdiction, such as the State of New York or foreign jurisdictions. Such provisions may not always favor the insured, especially if the courts tend to interpret coverage more restrictively in the specified jurisdiction than in the jurisdiction where the loss occurred. Some umbrellas, however, state that coverage will be determined based on the law applicable where the insured's operations are conducted.
3. "Arbitration Selection Process"—The policy specifies how many and how arbitrators are to be selected. The selection process can be complicated and time-consuming, especially when a panel of several arbitrators is required. Fortunately for insureds, only a few umbrella policies contain such a provision. In most arbitration conditions, the policy is silent as to the arbitrator-selection process.

Arbitration conditions can lead to adjusting difficulties or disputes over payment of claims when they conflict between underlying and umbrella policies. A conflict most often occurs when policies issued by different insurers are purchased. As an example, a nonstandard underlying general liability policy may require arbitration to be conducted in New York, while the umbrella may require arbitration to take place in London . Attending proceedings in both locations simultaneously would obviously be difficult, as well as costly, for the insured.

Conflicts in arbitration provisions can be avoided by deleting the arbitration condition from the umbrella policy, or by amending the wording of the provision to conform with any arbitration provisions in underlying policies. Even if the insurer is unwilling to remove or amend the arbitration wording, it may be willing to make the provision conditional upon the exhaustion of underlying coverage limits.

Assignment (Transfer of Rights and Duties)

Policy assignment conditions preserve the right of the insurer to select and limit the entities and individuals they insure. An assignment condition prevents the transferring of the insured's rights under the policy to another party without the insurer's consent. Most umbrella policies contain an Assignment or Transfer of Your Rights and Duties Under This Policy condition. 

Many umbrella policies contain assignment condition wording similar to that found in the 1986 ISO CGL common policy conditions form under the caption Transfer of Your Rights and Duties Under This Policy. Under that wording, the insured's rights and duties under the policy cannot be transferred without the insurer's written consent, except in the case of death of an individual named insured. In case of death, the insured's rights and duties will be transferred to his legal representative. If such representative has not been appointed, the insured's rights and duties with respect to his/her property will be assigned to anyone having temporary custody of that property until the representative is appointed.

Although assignment clauses specifically refer to the assignment of rights and duties to a representative in the event of the insured's death or insolvency, policy benefits may be assignable to other persons or in other situations. Acceptable reasons for assignment and the conditions that must exist for an assignment to be valid may be determined by state law, by public policy or by the facts in a particular case.

Two requirements must usually be satisfied in order for the courts to recognize an insured's assignment of its rights under a policy to another entity. These requirements are: (1) the insurer must agree to the assignment and (2) the insured must have a valid cause of action against the insurer. If the insured has a valid cause of action, the insured's rights may then be assignable to a third party, who then acquires the interest of the assignor (insured) and, as a result, "stands in the shoes" of the insured. Even if there is a valid cause of action, however, a third party may not be able to bring an action under a duty owed to the insured by the insurer in the absence of an assignment of the insured's rights (see Xebec Development Partners, Ltd. V. National Union Fire Insurance Company, 12 Cal. App. 4th 501, 526 (1993) and Clemmer v. Hartford Insurance Company, 22 Cal. 3d 865, 889 (1978)). Thus, the most important question is not whether the insured is permitted to assign its rights, but whether a particular cause of action is assignable.

In some instances, consent of the insurer is not required for an assignment to be upheld by the courts.

For example, in California , an insured can assign a cause of action for breach of duty to settle without its carrier's consent even if the policy states that such consent of the insurer is required. The insured's rights of subrogation, breach of contract, contribution, and fraud also have been determined by the courts to be assignable causes of action. In addition, the courts have held that an insured's stipulated judgment for negligent misrepresentation and breach of fiduciary duty was sufficient to allow an insured to assign its rights against its insurer to underlying claimants with respect to a claim for damages that resulted from wrongful cancellation of a policy (see McLaughlin v. National Union Fire Insurance Company, 23 Cal. App. 4th 1132 (1994)).

In California , claims that are generally not assignable are those that involve some element of injury that is personal to the insured (i.e., personal injury committed by the insured and which injures the person, reputation or feelings of a third party.) Thus, while an insured may assign a cause of action against its insurer for breach of duty to settle a claim, that part of the claim which arises from the personal tort aspects of the bad faith cause of action is not assignable under California law. Accordingly, a California Supreme Court ruled that damages consisting of emotional distress and claims for punitive damages cannot be assigned. In Murphy v. Allstate Insurance Company, 17 Cal. 3d 937, 942 (1976), the court relied on a case in which an insured assigned his cause of action for breach of the duty to settle to the claimant, then subsequently sued the insurer for mental distress. The second action was held to violate an existing rule against splitting a cause of action. The insured is not permitted to assign part of his claim, but must either pursue the entire claim himself (the contract and bad-faith claim), or assign the assignable claims (all but the personal claims such as emotional distress) and give those unassignable claims up. As a result, the appellate court ruled the insured should have brought a single action (in his own name) for all damages and agreed to pay part of the recovery to the assignee.

Insurers may include an assignment provision in their policy forms to prevent the assumption of a risk that was not present or anticipated when the policy was written. For example, a change of ownership of an insured company could result in a material change in the nature of the risk. The courts have generally held that any loss that arises out of the operations originally insured is still covered, notwithstanding any policy assignment. The same rationale applies to coverage for any loss that occurs prior to the change of ownership.

In Texas , the courts have ruled that a prohibition against assignment of an interest under the policy does not apply to the assignment of causes of action that have arisen after a loss has occurred. Similarly, under California law, a no assignment clause was not honored when a loss occurred subsequent to a corporate transfer. In California , a purchaser of substantially all assets of a firm assumes, with some limitations, the obligation for product liability claims arising from the seller's pre-sale activities. This liability is transferred to the buyer regardless of any clauses to the contrary in the purchase agreement. As a result, the seller's right to a defense for claims arising out of pre-sale activities is transferred (assigned) to the buyer, who then becomes entitled to a defense under the seller's liability policy.

The rationale behind this concept is that the seller's insurer still covers only the risk it assumed when it wrote the policy. The seller's insurer would not be liable for losses resulting from post-sale activities, such as products manufactured and sold after the corporate sale, but only for claims arising from products manufactured before the sale. In addition, transferring policy benefits differs from transferring the policy itself and can be done even if the policy requires consent for assignments (see Northern Insurance Company of New York v. Allied Mutual Insurance Company, 955 F.2d 1353 (9th Cir. 1992)).

Another example where the courts have deemed a policy's non-assignment provision unenforceable is the case of McLaren v. Imperial Casualty & Indemnity Company, 767 F. Supp. 1364 (N.D.Tex. 1991).

Following a loss caused by a hotel fire, the insured assigned its rights in the policy to the claimant, who then brought an action against the insurer to recover policy benefits. The court gave little consideration to the insurer's argument that its non-assignment clause prohibited the assignment. It noted that even though there were no reported decisions, "the court has no doubt that a Texas court would hold that the policy prohibition against assignment of an interest under a policy is inapplicable to the assignment of causes of action that have come into existence after the losses occurred." This is a reiteration of the general rule, also adopted in California , that once a loss has occurred, the prohibition against assignment will not be enforced by the McLaren court. The court did not enforce the non-assignment clause. The non-assignment clause was for the benefit and protection of the insurer by providing a means for the insurer to avoid an increased risk that could result from a change of ownership that could occur without the knowledge of the insurer. In the McLaren case, however, the loss had already occurred. There was no increased risk of assuming a hazard that the insurer had not already agreed to assume. Therefore, an assignment that takes place after the loss occurs will not be invalidated pursuant to the non-assignment clause.

Some courts have found that a provision which allows an insurer to avoid a potential increase in the risk does not apply where the insured assigns the right of action on the policy after a loss has occurred, or assigns a claim to the proceeds once the policy has lapsed. These courts have reasoned that such an assignment does not increase the risk and/or hazard of loss under the policy. Also, restrictive provisions in insurance policies that prohibit assignment after a loss are often found to be contrary to public policy and, as such, are unenforceable.

Transfer of a liability policy from the seller to the buyer of a property does not increase policy limits or reinstate reduced aggregate limits. In the case of Golden Eagle Insurance Company v. Foremost Insurance Company, 20 Cal. App. 4th 1372 (1993), a California court reasoned that substituting the buyer for the seller as a named insured under the policy did not make two policies out of one. Since the buyer did not pay additional premium, it would be absurd to expect that every time the identity of the named insured changes, the insurer's liability increases by an amount equal to the face value of the policy.

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Bankruptcy

If either the insured or an underlying insurer becomes bankrupt or insolvent, the insurer's coverage obligations are usually stated in umbrella policy forms. Provisions regarding these obligations are typically contained in the policy's "Bankruptcy," "Maintenance of Underlying Insurance" or "Other Insurance" condition. In some umbrella forms, the provisions are contained in a separate "Bankruptcy or Insolvency of an Underlying Insurer" section of the policy.

Nearly all states have laws that require the insurer's obligations under a contract of insurance to continue in the event the insured becomes bankrupt or insolvent. Most umbrella policies, therefore, contain bankruptcy condition wording that states the insurer's intent to comply with that obligation. The following example from a Cincinnati Insurance policy is representative of bankruptcy condition wording used in many umbrella policies:

Bankruptcy or insolvency of the insured or the insured's estate shall not relieve us of any obligations under this policy.

The above wording states the policy will continue to provide coverage even in the event of the insured's bankruptcy. The wording, however, makes no reference to the insured's liability under a self-insured retention. It is therefore not clear if the umbrella would drop down and assume the insured's obligation, or if it will only continue to provide coverage for claims in excess of the self-insured retention as intended when the policy was written for the insured.

In response to the 1986 and subsequent ISO CGL policy form revisions, some umbrella insurers began adding wording to their policies that states that the insurer has no intention of assuming the coverage obligation of an insolvent underlying insured. An example of this revised wording from an Allstate Insurance Company form is as follows:

This insurance shall not replace any underlying insurance, when such insurance is not available due to bankruptcy or insolvency of an underlying insurer or Insured. [emphasis added]

Following numerous insurer insolvencies during the 1980s, a number of courts ruled that umbrella and excess insurers were required to drop down and assume the coverage obligations of an insolvent underlying insurer. Frequently, these rulings resulted from ambiguous wording of the umbrella policy that did not clearly state that coverage was provided in excess of underlying coverage limits, whether those limits were collectible or not.

Most umbrella policies issued after 1986 contain wording that clarifies the insurer's intended coverage obligation when an underlying insurer is bankrupt or insolvent. In some policies, this bankruptcy condition wording appears as follows in a Crum & Forster Insurance Company policy: